Is Iceland really doing so well?

I agree with Megan McArdle’s general point that the winners and losers from this financial crisis have not yet been sorted out.  Here is Jon Danielsson, with some negative notes on Iceland’s economic performance:

Based on the current state of the Icelandic economy, the Fund’s claim of success [for Iceland] does not stand up to scrutiny.

  • Public finances are not on a sustainable path,
  • Exchange rates are not fully stable even with capital controls,
  • Investment has collapsed, and
  • The financial sector is dysfunctional.

At the same time, the Fund forced Iceland to impose a high interest-rate policy at the time when every other developed economy was doing the opposite…

GDP has declined by about 11% since the crisis of October 2008, but modest and volatile growth has returned, sustained primarily by an increase in private consumption catching up after two years of austerity. Worryingly, export growth is low, even with a sharp fall in the exchange rate, while investment is at a record low.

Business investment rates in Iceland equalled the EU average from 1995 to 2008, according to Eurostat.

  • Over the past two years the investment rate in Iceland collapsed to 10% whilst the EU only suffered a small decline to 17%.

…Initially, the capital controls were touted as a temporary measure to prevent a sharp depreciation of the currency, but by now the domestic economy has adapted to their presence, and become increasingly inward looking. The signs point to the controls remaining.

…Unfortunately, the government has also been using the capital controls as means to implement industrial policy, politically selecting those allowed to use cheap offshore kronas to buy Icelandic assets. Such direct political selection of investors can only breed corruption, mistrust, and inefficiency.


Well, Professor Cowen, Iceland on a corruption cale of 1- 10 (1 being Tony Soprano and 10 being Mother Therese) Iceland is rated 8.5 on the corruption scale while your beloved Latvia, the country which pegs to the Euro and deflates its workers income with 25% unemployment is rated down at 4.0. Again, reality showing that pesky liberal bias.

You and Megan are really hoping Iceland (which is actually practicing classic IMF austerity with a devaluation of its currency) comes a cropper since if it gets out of this mess faster and in better shape than most it will serve as a poor moral example since it repudiated its private banks debts instead of making the population serfs to the banks for the next 50 years.

"Beloved Latvia"? You are at the wrong blog. I don't recall blogging Latvia, except for the good Russian food there.

Maybe not Latvia but you've been doing your share of Ireland boosterism. For all the talk about free markets it seems there's more then a few libertarians who don't like the idea that some countries didn't bail out their failed banks.

This is hilarious. Show me any recognized libertarian economists that supported the bailing out of banks. Any.

The left's glasses have a liberal bias?

I'm not hoping any such thing. I think it's quite possible that Iceland will turn out to have done the right thing for itself. Or more likely, some right, some wrong.

My point was merely that people tend to seize on whatever country happens to be doing well as some sort of example to us. It's foolish multiple ways:

1) Economies differ; what's right for a small, open economy in a currency union wouldn't necessarily have much significance for us.
2) It is far too early to tell what has "worked" and what has not; economies are volatile post crisis, and will be doing very well one quarter, then very badly another. These things take time to sort out.
3) Even with the time, there are confounding factors (The soy boom that has boosted Argentina's GDP; the fishing boom that is apparently boosting Iceland's.)

I thought it moronic that Ireland's experience somehow became a proxy (on either side) for the US stimulus discussion, for all those reasons. I still think it was. I also think that whether it will turn out to be most growth-enhancing to devalue, slap on capital controls, and let the banks go under is an empirical question that will not be affected by how fair or not fair you feel it to have been.

(In re the banks, I also don't see what choice Iceland had, so the question is moot for them. But it is not for, say, Germany)


The reason to avoid devaluing is your banks crash. Private debt holders default.

However if your banks are going to crash anyways, or already have, then that ceases to be a reason to devalue.

As for private default (of debts to foreigners) that transfers losses to foreign creditors. Logically they will impose a future risk premium eg on Euro or CHF lending to Hungarian homeowners (such foreign currency mortgages were common in the UK in the early 90s, after we exited the ERM in 1992 they have become much harder to obtain eg 40% minimum downpayments).

This all strikes me a bit like Britain up to Black Wednesday in 1992. It was deemed disastrous and impossible that we should exit ERM. We did, and it turned out to be the best medicine imaginable for the British economy. 20% devaluation, interest rates fell, economic growth was restored, eventually the housing market bottomed (2 years later). this despite tight fiscal policy (although less tight than the Coalition is attempting now).

What's clear is Greece cannot go on with austerity measures. the best that could be extracted is microeconomic reforms to pensions, labour markets, business licensing etc-- the sort of thing that Bossi is resisting in Italy. That's long run more important than fiscal deficits.

Now if lots of countries try this devaluation in theory we get competitive devaluation which is not nice.

*however* what that really means is looser monetary policy-- inflationary. If countries are already at the zero interest rate lower bound, the stimulus they get from a deflation can more than offset the loss of competitiveness/ exports by other countries. Because you are speeding the exit of the devaluing countries from the private sector debt/ deflation trap. It's not symmetric win-lose.

And the mix of debt default and inflation is precisely how you exit a private sector debt imbalance crisis. Private agents wish to lower their indebtedness, the economy cannot return to normal until they do so.

'ceases to be a reason NOT to devalue' -- sorry typo

Oddly enough, Tim Worstall & Bob Murphy seem to promote the Icelandic example of letting banks fail as exemplifying the proper behavior of governments by libertarian standards. And of course if Iceland isn't doing great now, it wouldn't be surprising to anybody who thought they were making the most of a bad situation.

Unfortunately, the government has also been using the capital controls as means to implement industrial policy, politically selecting those allowed to use cheap offshore kronas to buy Icelandic assets."

What assets are we talking about given the only assets I'm aware of are its fishing rights, its electric power generation capacity, and its people?

Should the republic serve the republic's public? Or should the republic serve foreign corporations seeking to make Iceland a colony?

If there are Icelandic industrial ambitions I'm afraid industrial policy is not the right or best way to go about it. Foreign investors can help guide the most competitive, realistic, and economical decision.

So it becomes the perfect place to locate server farms (over half the lifecycle cost of a server farm is power and power is cheap, and Iceland is cold). Hence Facebook's recent decision to locate to a small town in Sweden for its European servers.

Iceland is a significant tourism market. Unfortunately they are one of 3 countries (plus US Aleut Indians) who still hunt whales, despite the latter's contribution to their tourism industry.

It has a decent sized agricultural industry (sheep and byproducts mostly). There is a software sector: like all Scandi countries they were early to the mobile revolution.

They will prove to be an important logistics base for the coming resources boom in Greenland and offshore drilling. They could get quite rich supporting that activity: consider Aberdeen or Louisiana. The closest thing to 'civilization' that there will be to those mines and rigs.

The financial sector is dysfunctional.

So they're not that different then.

"Such direct political selection of investors can only breed corruption, mistrust, and inefficiency."

Aren't pundits supposed to be a little less brazen with their dogmatism after the financial crisis?

One needs to be really careful here.

A big chunk of Icelandic fixed capital formation was those Alcoa smelters.

If you recall interviews with the Minister of Finance during the Boom Years, he made precisely that point. That Iceland ran a huge current account deficit was always explained as being a product of the investment in those smelters.

When those smelters are finished, which I believe they are, investment goes off a cliff.

When you have a country with 300,000 people, quite a capital intensive economy, you are really making comparisons with the economy of Boise Idaho, say.

And so the economic numbers will be volatile, effected by large one offs like those smelters.

Looks like the problem was Alcoa wanted more electricity than the government was prepared to grant it.

So the first smelter finished in 2007 (346k tonnes pa, Alcoa's second largest) but the Bakki smelter will not go ahead. - Alcoa's first new primary smelter in 20 years.

At 346k tpa and $2500/ tonne, that would be $990m pa of exports from Iceland (assuming domestic consumption minimal). Or per capital around $3300 per capita of exports on a GDP per capita of c. $38k.

GDP stats for Iceland seem to show a smaller number, but there would be intermediate processing (so would find itself into other exports).

Aluminium and other electricity intensive industries appears to utilize about 60% Icelandic electric power consumption.

The country is basically an aluminium smelter with a picturesque fishing village attached. And some banks ;-).

"The country is basically an aluminium smelter with a picturesque fishing village attached. And some banks"

Reading the Danelson article he is somewhat contradictory:

- he does not like the bank bailout because it was not bad bank/ good bank

- the banks have been sold to foreigners -- that would be foreign investment then? Which he derides? (or is it just 'unknown vulture funds' that worries him? Ie there are good foreigners, and bad foreigners?)

- the country is as pre crisis adverse to foreign investment in the fisheries industry (remembering the Tragedy of the Commons, Iceland may have a point)

- the IMF programme has not succeeded because the country is not running a structural surplus

- the restrictions on currency exchange, which act to prevent carry traders exiting and Icelanders investing abroad, are bad. However Iceland was the last country to abolish such (1992) and it led to massive speculation and the crisis that we see now: basically Icelandic banks and entrepreneurs borrowed cheaply in Iceland and invested wildly eg acquiring very significant chunks of the UK retail industry. So maybe restrictions on Icelanders investing abroad have a point?

He might be making a valid point about poor export performance, anecdotally there seems to be a lot more tourism interest in Iceland. But again Icelandic exports are very sensitive to the aluminium price.

We all do remember Iceland's big brother Norway, right? The one that guarantees the Icelanders will not default on anything that Iceland and Norway agree is critical to not default on? Like imports of food or oil (well, actually, the Norwegians are just guaranteeing themselves, essentially - being a producer, they can just literally give it away).

Iceland is so non-applicable as a model for economies that don't share its many unique characteristics that sometime I wonder why anybody uses Iceland as anything but a stand alone exhibit of an isolated, 1000 year Scandinavian culture in the middle of a stormy ocean, sitting between fire and ice, with a total population essentially less than the growth in Fairfax's inhabitants over the last two decades. Not Northern Virginia's, not the DC metro region - just Fairfax. And yet, I've yet to read a single piece talking about Fairfax County as a bellwether for international economic studies.

And yet, I’ve yet to read a single piece talking about Fairfax County as a bellwether for international economic studies.

The real explanation for the citations is that economists want to justify a research grant that lets them have a holiday in an interesting place like Iceland.

Once sufficient numbers of economists have had their Icelandic holiday, expect to see Micronesia grow in importance as an economic case study.

prior approval

If we have learned anything in the last 50 years, it is that a producer cannot just 'give it away'. Because there is an opportunity cost to doing that. As one Canadian economics professor memorably wrote to the Prime Minister of Canada (about the 'made in Canada' oil price) 'can I have a made in Canada Mercedes price please?'

I'd like to know more about these guarantees. Iceland is a former Danish colony, I believe and whilst there was a 'Scandinavian bailout' were these arrangements pre-dating the Crash?

Economic stats don't break down nicely by US county-- imports and exports.

Your analogy would be fair if Fairfax County had its own banks, its own currency, its own sovereign government and nationality. And also if it was the size of New England with a key strategic location in world trade routes and with massive natural resources. NATO did not build an airbase in Fairfax County.

Nor did sovereign Fairfax County banks buy up c. 5-10% of the UK retail sector, and kick off the crash that brought down the world financial system.

Regional economic theorists would agree with you that we should pay more attention to regions and intra-regional comparisons. Bavaria to Milan or Ile De France or the UK Home Counties, for example, compared to Greenwich Connecticut or the DC area, perhaps. Sometimes these tell us more than national comparisons. An analysis of Italy that level pegs the Veneto and Naples (respectively almost the richest region in Europe, and one of the poorest) is not always helpful.

But zeroing down to suburban counties I doubt is terribly helpful. The examples I gave above have say 4-10 million people and the GDPs of significant countries.

But Iceland is still beautiful.

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