Strong and relevant skills are vital for helping Iceland to adjust to rapidly changing technology and competition in the world economy and safeguard high prosperity and well-being. Many students lack solid core skills and competences, especially those with an immigration background, weakening the skills-base. Vocational and tertiary education do not always provide skills needed by the labour market. A comprehensive approach is required to strengthen skills, based on systematic assessment and forecasting exercises. This should include measures to improve teaching quality, including through stronger professional development, and ensure its equitable distribution, strengthen the work-based component of vocational training, and ensure that tertiary education provides the right skills. Beyond education, effective re-skilling and up-skilling programmes, including for immigrant workers, and strong work incentives are essential for further skill development and help make the best use of existing skills.

Iceland had to deeply reshape the public finances after the 2008 crisis, through both spending cuts and tax increases. The need to act swiftly and boldly left little room for appropriate design in the various spending areas. As a result, the quality of public spending – i.e. the contribution of spending to growth and less inequality - has declined. In particular, public investment remains weak, weighing on productivity, while the disability benefit system is generous, weighing on employment. Effectiveness of government spending is low, especially in education, with PISA results declining despite rising spending. This chapter identifies main challenges in spending for education, health, infrastructure, social security and other areas. Overall the authorities should strengthen the link between spending and objectives in the various policy areas, i.e. by broadening spending reviews. In particular, investment for transport, energy and digital infrastructure should be increased; in education, teacher salaries should be more differentiated and partially linked to performance; in health care, general care should be favoured against specialised care and co-payments for hospital care introduced; the disability system should more strongly aim at labour market integration of claimants; and high implicit tax rates in the tax-benefit system should be reduced, e.g. by abandoning means-testing of child benefits.