Iceland after the financial crisis

In the space of a few days last October Iceland’s whole banking system collapsed and was taken into public ownership, including the three banks which went from nowhere in 2002 to rank among the world’s 300 biggest by 2007. These three now make it into a less glorious league – Moody’s list of the 11 biggest financial bankruptcies in history. The country’s average income fell from 160 per cent of the US’s in 2007 to 80 per cent this year.

Yet, walking around Reykjavik and other cities this summer, one sees no signs of economic distress. The country looks amazingly prosperous. Traffic density has fallen a little, but only to 2005 levels. Unemployment has risen to 8 to 9 per cent, nearly twice the previous postwar record – but is still below that of several other high-income countries. Applications for free food from charities have increased, but numbers remain small. Four out of five households have been affected only at the margins.

Robert Wade, “Iceland shows the dangers ahead for us all”, Financial Times, 27 August 2009.

That is the good news. The bad news is “appearances are deceiving”. Professor Wade believes that crisis has not been averted, but only postponed: “When the government brought in the International Monetary Fund in late 2008 the IMF prescribed deferring the pain for a year. Now the pain is coming.”

But is such gloom and gloom justified? I have not followed Iceland closely, but my understanding is that its government did not bail-out the banks, although it did protect depositors – domestic depositors at least. With one exception, the government abstained from nationalising failed banks, taking them into receivership instead. This should translate into reduced costs for Iceland’s taxpayers, and most of those who stand to lose money – the creditors of failed banks – are foreigners. For this reason net public sector debt is projected to rise only modestly, to 40% of GDP next year, from approximately zero before the financial crisis.

Is Professor Wade’s forecast plausible? Time will tell. In the meantime, comments are open. Please enlighten me.

Political scientist Robert Wade is author of Governing the Market (1990, 2003). He is currently Professor of Political Economy and Development at the London School of Economics.

Update: Iceland’s parliament has agreed to pay more than 5 billion dollars to the governments  of the UK and the Netherlands to compensate about 400,000 depositors who lost money in the Icelandic online bank Icesave. Payments will begin in seven years, and will be limited each year to a maximum of 6% of Iceland’s GDP. The government expects this concession to help it to get additional financial aid from the UK and the Netherlands. The governments of the UK and the Netherlands still have to ratify the agreement, but there is nothing in these developments so far to support a forecast of gloom and doom. More information is available here and here.


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