Some additional reasons why Iceland has done well

I agree with much of Paul Krugman’s recent posts on Iceland, here and here.  But there are neglected factors behind the Icelandic recovery, namely real shocks.

Note that Iceland is a small, open economy and fish accounts for 40 percent of Icelandic exports.  It does not hurt that Norwegian cod prices have risen 20 percent over the last year; I cannot find a separate figure for Icelandic cod prices but that is a likely major factor behind the Icelandic resurgence.  Here is a separate, brief report on the boom in the Icelandic fishing sector.  Especially when it concerns small countries, always look first for the real shocks.

As an aside, there seems to be a system of fairly flexible wages for the major export:

The lay system of remuneration is used extensively in fisheries. Under this system, fishermen are paid a share of the catch value, perhaps after subtracting some costs, rather than a fixed wage. There may, however, also be a fixed wage element, so that fishermen get a share of the catch value in addition to the fixed wage, or a fixed wage as a minimum in case the fishing trip turns out to be unrewarding.

That is a Norwegian source about fisheries worldwide and not Iceland-specific, and here is another general source on compensation for fishermen with a similar message; can anyone speak to Iceland in particular?

Krugman writes: “And nominal wages are downwardly rigid. That’s simply a fact, true always and everywhere.”  But that is an overstatement, especially when an output-linked and value-linked bonus system is in effect.

Iceland has had both currency flexibility and, it seems, a higher than average degree of wage flexibility in the major export sector, automatically built in at that.  (If further and more targeted sources contradict this portrait I will gladly report the update.) That real wage flexibility may or may not be a major factor in the Icelandic comeback (only 4,000 fishermen in the whole sector, and the fisheries already do their accounts in euros), but it does show the standard theory of optimum currency areas should not be applied here without considerable caution.

Finally, note that a flexible exchange rate does not bring all of the wage-reducing benefits of yesteryear.  Workers are employed increasingly in domestic services (health care, education) and many export sectors are less labor-intensive than before, at least in the West.  With the progress of mechanization and globalization, the ability to cut your real wages rapidly for your exports is arguably diminishing in value.  The relevant rigidities are becoming increasingly domestic, it would seem.


I predicted that Iceland would do better at the same time that so many were saying it would do worse since it wasn't bailing out its banks.
I also predicted that countries that did a lot of bailouts would do worse... lets see what happens when this is all over.

I have a hard time looking at any island with a population around that of Corpus Christi, TX as a 'country'

Yes, I know it is one but I fail to see how we can learn any lessons of note for countries like Germany, the US, China, Japan, etc from it.

On the flexible wages point, "fishermen are paid a share of the catch value, perhaps after subtracting some costs, rather than a fixed wage", describes arrangements in Persian Gulf pearl diving until the market waned due to the development of cultured pearls c. 1900. The diet on board was poor -- expenses counted against your share. And the oysters were opened with everyone present. Pearl diving could only take place in the summer months due when the water at depth warmed sufficiently. It remains fascinating to me that in the span of less than 100 years the descendants of the diving crews from the GCC are living a life of luxury.

"Finally, note that a flexible exchange rate does not bring all of the wage-reducing benefits of yesteryear."

That may or may not be true. Even if wages are a smaller fraction of the total cost of export production, the value of flexible exchange rates does not decline that much.

Why? Because currency devaluation is (likely) to reduce the cost of many of the other factors of production as well. This is not to say that the nominal local currency price of the other factors will decline. The local currency price may actually rise. However, the rise in the local currency price will be more than offset by the decline in the exchange rate making the other production factors cheaper in Euros, Dollars, etc.

What other factors of production? Rents, taxes, services, locally produced spare parts, etc. The only production factors that won't decline in real terms are those that must be imported (notably oil in the case of Iceland).

Consider a hypothetical modern factory. Given a high level of automation, factory floor wages may be only a small part of the finished product prices. However, the great preponderance of the other costs (design, management, marketing, parts, local raw materials, etc.) will fall in real terms in the aftermath of devaluation.

This is an old thesis. See "The Case for Flexible Exchange Rates" by Milton Friedman,

"If internal prices were as flexible as exchange rates, it would make little economic difference whether adjustments were brought about by changes in exchange rates or equivalent changes in internal prices. But this condition is clearly not fulfilled. The exchange rate is potentially flexible in the absence of administrative action to freeze it. At least in the modern world, internal prices are highly inflexible. They are more flexible upward that downward, but even on the upswing all prices are not equally flexible. The inflexibility of prices, or different degrees of flexibility, means a distortion of adjustments in response to changes in external conditions. The adjustment takes the form primarily of price changes in some sectors, primarily of output changes in others.

Wage rates tend to be among the less flexible prices. In consequence, an incipient deficit that is countered by a policy of permitting or forcing prices to decline is likely to produce unemployment rather than, or in addition to, wage decreases. The consequent decline in real income reduces domestic demand for foreign goods and thus demand for foreign currency with which to purchase these goods. In this way it offsets the incipient deficit. But this is clearly a highly efficient method of adjusting to external changes. If the external changes are deep-seated and persistent, the unemployment produces steady downward pressure on prices and wages, and the adjustment will not have been completed until the deflation has run its sorry course."

Icelandic exports of fresh fish are up 5.1% for August over last August.

The value in August was about 2 billion ISK, or $18 million. If we assume Iceland has been averaging that much for the past year, we get $221 million, and if that is a 5% increase, we get an annual boost of about $10 million dollars.

So the "cod effect" is about 0.08% of Iceland's GDP. It "does not hurt" because it is probably not felt at all.

Iceland is also an island and imports a lot from Germany which is experiencing inflation, so you'd have to include that (much larger) shock as well.

The average monthly balance of trade since August 2008 is about +$74 million, or about 7% of GDP.

The biggest increase has been in the export of non-ferrous metals (mostly aluminium) at 3.8% relative to GDP increase from 2009 to 2010. Fish is much smaller. Because of their incredibly cheap geo thermal power, Iceland can smelt aluminium at fractions of the costs of other countries.

That sounds more convincing than the cod to labor ratio.

By the way, if you want to read about how the banks cause the Icelandic implosion, and how the "regulatory" system was captured by the banks under a "no regulation" and totally free market regime, read Michael Lewis's "Boomerang". Pity the Icelanders but I wouldn't take up a collection for them. After the crisis, they elected a lesbian president to clean house.

Your math is wrong on the fish.

2.14 billion / 116.1 = 18 432 385.9 (dollars, 116 = isk/$, total fresh fish exports for August 2011)

(18.4 * 12) - ((18.4 * 12) / 1.05) = 10.5 (million $, per year, estimated from August data)

There was some rounding in the post. However, there was an error in that the fish only included fresh fish (and not processed, dried, etc). Overall, the fish represented a ~1% of GDP increase in exports 2009 to 2010 which is still dwarfed by the four-times-as-big aluminium boost.

"The lay system of remuneration is used extensively in fisheries. Under this system, fishermen are paid a share of the catch value, perhaps after subtracting some costs, rather than a fixed wage. There may, however, also be a fixed wage element, so that fishermen get a share of the catch value in addition to the fixed wage, or a fixed wage as a minimum in case the fishing trip turns out to be unrewarding."

My word, so this idea of paying bankers a basic wage plus a bonus has some value then? High enough wages to attract people willing to take the risks of upturns and downturns?

Anyone told Occupywherever yet?

"describes arrangements in Persian Gulf pearl diving"

Similarly Australian although there was a definite racial angle there as well.

Are you suggesting there's enough similarity between catching fish and gaming finance markets that they should have similar payment schemes?

But if fish prices and the value of the catch are up strongly doesn't this mean that the fisherman's wages were flexible upward in this case-- just the opposite of what your theory implies should be responsible for their success.

i cant help to quote this:

"it's about the money lebowski."

ie the currency devaluation

When I went out on a trawler as a lad, the system was one share for each crewman (bar the lad), two for the skipper and one "for the boat". At least, so my not-terribly-good memory reports.

In a quota system you might also have one "for the sea".


Your statement that there are "Only about 4,000 fishermen in the entire sector" is a bit misleading as to the magnitude. Iceland has a population of ~320k, so this workforce amounts to about 1.25% of the country, and 40% of the exports. In that light, it seems much more substantial.

I tried to use the BLS site to compare with the US, but the best I could find was a table stating that there are about 700 fishermen in the US. I admit to weak knowledge of fishermen, but this seems absurdly low to me. Maybe I'm reading the table wrong, or they literally mean only the person who extracts the fish from the water (occupation code 45-3011).

PS: I considered that it might be (thousands), but then other numbers become absurd - there may be too many of them, but there aren't 922 million attorneys in the US.

Kind of off-topic but I just can't help it. Krugman wrote this one explaining why his posts are written in an 'informal style':

Oh thank you master Krugman for your benevolence! He lowers his incredible mind to the level of the common man so we can all benefit from it!
The guy has a planet-size ego that can't take criticism in any shape or form! That is one insecure dude...

Care to re-read his post with less judgement and more understanding? Being a well respected economist isn't the only reason he writes for the NYT.

Of course not. He is a party activist. But (oh look, I am starting a phrase with but! I am bringing it to the hood!) he should at least be honest about that instead of trying to make the point that if he really wanted to he could write his posts in rhetorical Econobable and no one would understand him!

Seriously… Do you think anyone else (like Tyler for example) would ever write such a pompous and conceited post like that one? Krugman is arrogant beyond belief.

Wow. This is serious Krugman Derangement Syndrome.

Krugman says he writes somewhat informally so as to be clear and readable, and to avoid boring his readers, and you find a reason to be offended.

Fish prices, especially cold water cod are up. I can't. Imagine diesel is down for them. Trawlers love to eat diesel. Further the steel and every pump,part, line,rope and net is imported. And the break,rip and get lost, a lot. 20% up might well be eaten up by post crash price increases from burned suppliers, etc.

Iceland is tiny. It's somewhat silly to extrapolate anythere there to even smallish countries.

Exactly. I'd wager most folks there know or know of almost every other person in the 'nation'.

To me this was the most interesting commentary from Krugman here:

I remember the debates about the desirability of the euro; whenever skeptics tried to point this out, euro advocates replied either with assertions that labor market reform would provide the needed flexibility or that the euro area would not face large asymmetric shocks.

It's not happening fast enough, if at all. We have non-integrated labor markets sharing a currency and we're getting about what you'd expect to happen in the face of fiscal irresponsiblity. The 60% Greek haircut looks to be just the begninning.

I agree that real shocks are very important in small countires, and that the fish boom may play an important role in Iceland's
recovery. But keep in mind that the government/education/health care argument cuts both ways. Yes, currency depreciation
helps those sectors less than manufacturing. But it also means that NGDP boosts help the economy even more, as most of the
gain will go to the less stable sectors of the economy. Alternatively, if those sectors receive a stable amount of revenue, then
a 10% fall in NGDP relative to trend may cut expenditure in the less stable sectors by 20%.

Cod prices are up because the EU cut the quotas, not because there is a boom in cod. The prices will be the same as the Norwegian prices because they sell into the same markets.

The "Norwegian source about fisheries" is in fact originally Icelandic.
More reliable sources on these matters are probably not available.

Yet to be resolved is the matter of how Iceland will satisfy claims against it in European Free Trade Association Court.

Iceland has free trade and other privileges as long as it conforms to most EU laws, and it has failed to do so in the case of Icesave when it treated Icelandic citizen accounts preferentially.

If we were to apply the current Iceland policy in Greece, Italy, Spain, those nations would pay 100% on accounts and debt of Greeks, Italians, and Spaniards respectively, while defaulting on all those of non-citizens. Such a policy wouldn't solve Greece's problems, but it probably would solve those of Italy and Spain.

Basically, Iceland is recovering better because the Icelanders voted to default on Iceland's international debt obligations.

If Iceland is expelled from the EU free trade zone, will Iceland recovery unaffected, or should Iceland pay what it owes?

1. Iceland doesn't have a flexible exchange rate. There are massive restrictions in place that prevent the currency from depreciating further.

2. The labor market isn't flexible either. Unions play a big role and recently negotiated a large general wage increase that is, of course, showing up in inflation numbers.

This goes back to my suggestion that the success is due to them not bailing out their banks. :-) Thanks.

I definitely agree. I have some papers on the topic I'd be happy to share or post. Email me at if interested.

So we see Icelandic wages vs. the euro.

Does anyone know how Icelandic wages look vs. the dollar?

Really, I think the story goes something like this:
Icelandic banks: "We're bankrupt! We've lost everything!"
Other countries: "That's terrible! Iceland, pay us back!"
Iceland gov't: "Nope, sorry, no can do."
Other countries: "Oh, poop."

How long ago would the last phrase have been instead, "This means war!" and Iceland would become a colony of somewhere else?

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