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Smallness: Problem or Opportunity?Reflections of an Icelander
Professor Hannes H. GissurarsonTorshavn 22 March 2014
Iceland: Historical Highlights
• Settled 874-930• Commonwealth 930-1262• Under Norwegian, later Danish, king• Home rule 1904• Sovereignty, personal union with Denmark,
1918• Occupied by UK 1940, US taking over 1941• Republic, 1944, member of NATO 1949
Iceland: Main Facts
• Population 325,671 (1 January 2014)• 103,000 sq. km (same as East Germany)• GDP per capita (PPP) 1990: $21,297• GDP per capita (PPP) 2004: $33,716• GDP per capita (PPP) 2008: $39,477• GDP per capita (PPP) 2013: $39,996• Main exports: fish, aluminium, tourism, and
(in past), financial services
A Poor Nation, 874–1874
• Could only sustain 50,000 people or less, Malthusian Trap
• 1709: possibly 38,000; 1787: 39,190• Famines until 19th century; then emigration to
America• Poverty unfairly blamed on Danish colonial
rule• Agriculture held down fisheries; ruling farmers
hindered development of resources
Population, 1703–2014
1703175317721791181018291848186718861905192419431962198120000
50000
100000
150000
200000
250000
300000
350000
Population of Iceland
Iceland and Denmark, 1874–1945
18701875
18801885
18901895
19001905
19101915
19201925
19301935
19401945
0
1,000
2,000
3,000
4,000
5,000
6,000
GDP per capita in 1990 US$
IcelandDenmark
1940–1991, False Prosperity
• Profits, both in hot and cold war• Wider resource base by four extensions of
EEZ, finally to 200 miles in 1975• Overfishing, first of herring, then of cod• However, also some spontaneous economic
growth• Signs of economic decline in late 1980s• Turning point in 1991: Oddsson’s government
First day: 30 April 1991
1991–2004, Liberal Reforms
• Cutting subsidies• Stabilising economy• Liberalising and opening markets (EEA)• Privatising• Cutting taxes• Developing property rights to natural
resources• Strengthening pension funds
Main Tax Cuts
• Corporate incomes tax from 45% to 18%• Individual incomes tax from 30.41% to 22.75%• Turnover tax abolished• Special surcharge on office and trade buildings
abolished• Special surcharge on high incomes abolished• Net wealth tax abolished• Death duties (estates tax) reduced
More Revenue with Lower Rate
1990 1995 2000 200315
20
25
30
35
40
45
50
55
0.7
0.8
0.9
1.0
1.1
1.2
1.3
Corporate Tax Rate Corporate Tax Revenue % of GDP
Corporate Tax Rate
Corporate Tax Revenue % of
GDP
Development of ITQ System
• Open access to fishing grounds = overfishing• Gradual discovery: Effort quotas not efficient• 1975, individual quotas (% of total allowable
catch) in herring fishery• 1984, individual quotas in cod and other
demersal fisheries• Gradually, catch quotas became transferable• 1990, ITQ system made comprehensive• Profitable fisheries: Reduction of cost
Last day: 15 September 2004
2004–2008: Crony Capitalism
• 1991–2004 market capitalism: competition, independent judiciary, free media, economic power separate from political power
• 2004 battle about media law, Oddsson loses, Jon Asgeir Johannesson and cronies win
• 2004–2008 crony capitalism: Johannesson owned media, supported by politicans (and supporting them), cooperative judiciary
What Happened in 2008?
• Icelandic bank collapse no worse a crisis than in many other European countries
• Icelandic banking sector big, but so were such sectors in Switzerland and the UK
• The Icelandic bankers reckless, but not more so than in other countries
• Worked under same regulatory framework as in other EEA countries
• Vulnerable situation, crucial decisions
Irony: High Ratings Led to Bubble
1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
A2A1
Aa3
AaaAa1
A1
Baa3
Baa1
External Debt: 2004 Crucial Year
1992 1996 2000 2004 20080
2000000
4000000
6000000
8000000
10000000
12000000
14000000
16000000
External debt in millions of kronur
Johannesson’s Bubble
1/1/05 1/1/06 1/1/07 1/1/080
1000
2000
3000
4000
5000
6000
Loans to Johannesson and croniesLoans to Exista and re-lated companiesLoans to Landsbanki main owners and related com-panies
Johannesson’s Manhattan Flat
101: Johannesson’s private jet
101: Johannesson’s private yacht
Systemic Risks in Iceland
• One specific risk to Iceland (SIC): too much cross-ownership, overvalued assets, Johannesson and his cronies
• Another specific risk to Iceland: field of operations all of EEA; field of institutional support Iceland alone
• General international risks: moral hazard; government mistakes; difficulty of pricing risk with new techniques
Three Crucial Decisions Abroad
• 24 September 2008, Fed refuses to make currency swap agreements with Iceland, makes them with Scandinavia at same time
• 7 October 2008, British Labour government closes the two Icelandic-owned banks in England, bails out all other banks at same time
• 8 October 2008, British Labour government uses anti-terrorism law against Icelandic companies, stopping all transfers to or from Iceland, making recovery impossible
Reconstruction or False Recovery?
• Key to reconstruction: sharp depreciation of currency enabling export industries to fuel recovery; and division of banks into “good” domestic banks and “bad” foreign banks
• However, petty, vengeful hard-left government came to power February 2009
• IMF became hand collector for British and Dutch governments in Icesave dispute
• Icesave deals twice voted down; finally, 2013 EFTA court decided on no obligation
Rough Waters Ahead
• Still much debt owed to foreign bank creditors• Hard-left government did not really cut
expenditure, only postponed investments• Hard-left government scared away investors and
tried to destroy the ITQ system, “suicidal” (WSJ)• Voted down in 2013, greatest debacle in Icelandic
political history, lost 27,7% of total vote• New centre-right government battle-scarred and
cautious
General Lesson: Less Uniformity
• Extensive regulation did not hinder crisis• Strict regulation of financial sector creates false
security• Harmonisation of financial companies creates
additional systemic risk• More correct pricing of risk, if competition and
diversity in markets, also smaller units• Only one realistic strategy: tax cuts and economic
growth
Athens: Much Bigger than Melos
Thucydides’ Classic Melian Dialogue
• 417 BC, Athenians demand that Melians surrender and pay tribute, or be destroyed
• Athenians: “You know as well as we do that right, as the world goes, is only in question between equals in power, while the strong do what they can and the weak suffer what they must”
• Melians refuse; and are destroyed• Irony of History: Later, Athens loses the war and
Melos is restored
Iceland’s Lesson: Needs Allies
• Left out in the cold, in 2008• Needs a shelter which is not a trap• EU more a trap than a shelter, witness Cyprus• Close cooperation with three Anglo-Saxon
neighbours a better shelter: US, UK, Canada• Necessary to reestablish ties with US• Maintain good ties with friendly neighbours
like Faroe Islands and Greenland
Final Reflections on Smallness
• We cannot help our smallness; our fate• Challenge, opportunity, not only problem• Low information costs, good cohesion without
coercion; open economy• Same challenge in Iceland and Faroe Islands:
Strong, vibrant economy creating jobs necessary; otherwise people leave
• Capitalism our only hope