Diagnosing Iceland’s Productivity Slowdown: Firm-Level Evidence

Iceland maintains one of the highest levels of GDP per capita among advanced economies despite a marked slowdown in productivity growth over the past decade. Using firm-level data from the IMF RES-ORBIS database, this paper investigates the sources of the productivity slowdown and finds that the problem is primarily allocative. While continuing firms continue to record productivity gains and laggard firms converge rapidly toward the domestic productivity frontier, these gains do not translate into stronger aggregate productivity growth. The analysis points to four interconnected factors: weak allocation of labor and capital toward the most productive firms, convergence toward a domestic frontier that remains below the European frontier, declining market selection with rising prevalence of low-productivity “zombie” firms, and a pervasive productivity penalty associated with firm expansion. The findings suggest that strengthening competition, improving business dynamism and resource reallocation, facilitating firm entry and exit, easing scaling constraints, and investing in innovation, skills, and infrastructure could help raise productivity growth and support stronger long-term economic performance in Iceland.