Iceland’s road to recovery

The conference in late October looked at how Iceland has worked its way back to recovery, which lessons have been learned and which have been the greatest challenges. Among the participants were award-winning economists, including Nobel laureate Paul Krugman, several IMF economists and Icelandic professors of economy. 

The conference opened with a video statement from Joseph Stiglitz, professor at Columbia University and recipient of the Nobel Prize in Economic Sciences (2001). Stiglitz spoke about the Icesave row between Iceland and the UK and the Netherlands. He praised the Icelanders for voting no when asked in a referendum to accept the Icesave agreement, because the agreement would oblige the Icelandic state to take on the money owed by the Icelandic online bank to savers in the UK and the Netherlands.

“What Iceland did was right. It would have been wrong to burden future generations with the mistakes of the financial system,” said Stiglitz.

Collective madness

Nobel laureate Paul Krugman observed that Iceland’s economic crisis did not turn out to be as dramatic as the world had feared. Unemployment didn’t rise as much as expected. Today it stands at 7.6 percent. The high interest rate is a problem for Iceland. But Krugman does not see any guarantees for lower rates should Iceland join the euro - on the contrary there’s a risk the Euro would bring unforeseen consequences. 

Iceland’s problem is that 30 percent of its BNP consists of foreign owned kronor. The worry is that as soon as the capital controls are lifted, foreign owners will ditch their kronor for foreign currencies. That could lead to economical problems for Iceland. But Krugman does not see any simple solutions to this problem.

Willem H. Buiter, chief economist at Citicorp, was outspoken in his address. He compared the situation in Iceland before the crash to collective madness. He also said the world should learn from Iceland’s experience and underlined that financial systems must not be allowed to outgrow any country. He also warned against foreign currency mortgages.

“Assume most people are greedy, shortsighted and not very well informed even if they’re very well educated. So protect households from themselves,” said Buiter.

All corruption is local, claimed Buiter. He went on to say corruption is a problem found in all countries and especially in smaller ones. He also said Iceland is too small to be able to staff all positions with domestic talent. The country must therefore cooperate with other countries and enter into unions.

“Join the EU! Join the euro”, said Buiter.

Buiter reckons Icelanders still owe far more than their properties are worth. It is estimated that properties are valued at 100 percent more than their actual worth. These are debts Iceland will have to get rid of, Buiter pointed out. 

The Icelandic banks have been thoroughly restructured. Two of Iceland’s three banks are owned by New York based hedge funds. Buiter said he was worried the banks could be paralysed by this fact. He encouraged Icelanders to immediately change course and to work along the presumption there are good and bad banks.

Financially isolated

The managing director at the Confederation of Icelandic Employers, Vilhjálmur Egilsson, felt IMF’s help was necessary for Iceland to manage the crisis, but he pointed out that Iceland is now financially isolated. He criticised the lack of a formal end date to the IMF deal, which instead was simply presumed to come to an end in the autumn of 2010. He asked who was responsible for this deception. Why should it now last until 2013, asked Egilsson.

“There was no exit strategy,” he criticised. Iceland’s Central Bank has always been much more concerned about enforcement of capital controls than by lifting them.

“If the goal is to preserve krona stability, the controls will last forever,” feared Egilsson.

He called for a growth strategy from the government. 

“Who should believe in the krona if our own government doesn’t believe in the krona,” asked Egilsson.

Már Guðmundsson, the governor of the Central Bank of Iceland, was more optimistic and said capital controls were a necessary measure. He promised capital controls would be lifted soon enough to stop them having a negative impact on the country’s financial stability. 

Mortgages and other loans in foreign currencies have resulted in major problems for Icelandic households. A devalued krona has resulted in price rises and a collapse in imports. Interests are still high. But the government has done what it can for households, according to professor of sociology at the University of Iceland, Stefán Ólafsson. He also admits the government could have done even more to support individuals through the financial crisis.

Returning back home

The state contribution to Iceland’s welfare system makes up a larger part of BNP today than before the crisis, according to Ólafsson. The welfare system has worked well to help dampen the effects of the crisis. People on low income have been receiving various benefits, and the government has also increased taxes for high earners. Mid and low income groups have been protected as much as possible.

But many Icelanders do not agree with Ólafsson. Some showed their discontent by demonstrating outside the conference hall. They feel the government has not done anything at all and that it needs to act. Ólafsson felt there was still scope for further tax increases for high earners. 

Many Icelanders have left the country to work abroad, especially in Norway. But Ólafsson thinks the threat of emigration is exaggerated. Even before the crisis a record number of Icelanders were working abroad. These have returned. Icelanders have always moved abroad in difficult economic times. But they have returned when the economy improves. Ólafsson believes this will happen this time too.

Sceptical to world banks

The Icelandic currency is a hot potato. Most of the speakers agreed Iceland was lucky to have the krona which meant devaluation was possible. But many also agreed that Iceland in the future must join the Euro. The managing director at the Confederation of Icelandic Employers, Vilhjálmur Egilsson, is for Iceland joining the Euro. He doubts the country will be able to keep the krona in the future. 

Egilsson got support from the president of the Icelandic Confederation of Labour,  Gylfi Arnbjörnsson. He is sceptical to the future of the krona.

But economics professor Krugman disagrees. He admits there are many benefits to joining the Euro but feels the arguments against weigh more. The former chief economist at the IMF, professor of economy Simon Johnson at the Massachusetts Institute of Technology, wondered whether the Eurozone was on the brink of a global crisis akin to that of the 1930s. He admitted his assessment was somewhat pessimistic, but said he was also sceptical to world banks which have grown so huge that they are forced to take large risks.

“There is no risk-free access to the financial system,” said Johnson.

“Nobody should look to the euro as a model right now,” he continued.

Successful cooperation

Many at the conference were very satisfied with the successful cooperation between the IMF’s group of experts and the Icelandic government. Minister of Finance Steingrímur J. Sigfússon cited the example of how the IMF had laid down a framework for economic recovery and later left it to the Icelandic government to implement. Iceland was allowed to do the work on Iceland’s terms. IMF’s economists were for instance initially sceptical to the capital controls but later acknowledged they had been the right choice to make.

Economist Julie Kozack was part of the IMF group which worked with the Icelandic government. She said today’s main challenge was to end capital controls, while continuing to work towards shrinking and restructuring debts and continue to oversee the financial sector. 

Iceland has not had unemployment since World War II, but during the past three years unemployment has become a problem - even if unemployment figures have been lower than for the rest of Europe. Economist Kozack says it should now be a priority for the government to reduce unemployment. But it also needs to oversee debt restructuring and to stimulate increased growth based on investments.