Iceland: from ruin to role model?
Three years ago Iceland led the way into an economic abyss. Now, by raising taxes, letting the banks go bust and protecting the public sector, it is showing a way out. Could Ireland do the same, asks PAUL CULLEN
NOTHING BETTER symbolises the rebirth of Iceland after its devastating economic crash of three years ago than the newly opened Harpa concert hall, on Reykjavik’s waterfront. After the crash this was a tattered shell, its half-built superstructure an insistent reminder of the country’s fall from grace. A project initiated by one of the banks that caused the crisis, and abandoned almost as soon as the bank went under, the Harpa seemed destined to remain for years an eyesore on the skyline of the capital.
That this didn’t happen is testament to the remarkable turnaround in this tiny nation. Just a few years after Iceland led the world into the financial abyss, its government has been able to finance the completion of a €110 million venue. No expense was spared in creating an architectural tour de force, its facade composed of 10,000 windows in 1,000 shapes, to house the national symphony orchestra. There are four auditoriums on the site, the largest of which has 1,800 seats – and this is in a country of only 300,000 people.
Just as Harpa has risen from the ruins of a crisis, so also is the country recovering from its economic pounding. The economy is growing again, unemployment is under control and the banking problem is almost overcome. Inflation has fallen below 5 per cent and the country’s economic deal with the International Monetary Fund (IMF) ended in August.
Iceland’s experience, as many have pointed out, raises important questions for Ireland, not least whether we can emulate its success in overcoming adversity or are doomed for failing to follow its example. Most interest has centred on whether Ireland should have followed Iceland’s example by hanging the banks out to dry rather than spending billions on rescuing them. This horse bolted some years ago, but what strikes the visitor to Iceland now is the difference in atmosphere compared with the ferment in other bailout nations.
As Ireland prepares for yet another tightening of the rack in December’s budget, and Greece teeters into crisis, it seems that Iceland is already bidding farewell to its hair shirt. Reykjavik’s highways thrum with expensive 4x4s and the tourism sector is expecting a record year. The country’s social-welfare system has come through the crisis largely unscathed and public-sector numbers are undiminished, with wages increased under a new collective agreement. Education and health services have been protected, and plans are advanced to build Reykjavik’s new hospital as a public-private partnership.
It’s as though the financial crisis is over. “We’re finished with austerity,” says a senior political source, predicting only “minor cuts” in next month’s budget.
The IMF’s representative in Iceland, Franek Rozwadowski, admits it’s “probably true” that Iceland has got off lightly compared with Ireland in the austerity measures it has had to implement. In 2009, he says, Iceland was heading into a huge recession caused by the collapsing economy and mounting debt. “The natural thing to do in such circumstances is to cut spending and raise taxes, but how can you do this when the country is heading into recession?” So instead of demanding immediate adjustments, as in Ireland, the IMF allowed Iceland a one-year delay on cutbacks, the theory being that the contraction in the economy would have a similar effect anyway.
Rozwadowski says the IMF programme committed the country to “tough” cuts in the following four years but that Iceland was allowed to choose what measures to implement in order to achieve targets. The left-wing government’s insistence on preserving the country’s social-welfare system was not a problem for the IMF. Far from cavilling at this demand, Rozwadowski insists it was important that Iceland’s generous welfare state was preserved.
The Icelandic government opted to make half the required adjustments by raising taxes and half by cutting spending, in contrast to our own Government’s preference for spending cuts over tax increases.
While there is much in common in the recent history of the countries, two factors make Iceland’s experience different from that of Ireland. First, Iceland isn’t in the euro zone, so it is able to adjust its exchange rate. The decision to devalue the krona was devastating for ordinary Icelanders as it reduced the purchasing power of their money, but it helped get the situation under control rapidly.
The other difference is that Iceland supposedly burned the bondholders. Except that it didn’t, as Rozwadowski points out.
“The Icelandic government did not default on its obligations to anyone,” he says. “The difference lies in how private-sector debts were handled.”
Whereas Ireland propped up its banking system, Iceland allowed the banks to collapse. The three bloated entities whose speculation caused the problem were put into administration, and much smaller domestic banks were carved out of their carcasses. The remainder, the “bad banks”, were handled according to standard bankruptcy procedures. In the case of two of them, the bondholders who had invested in the banks ended up as owners. (Meanwhile, this month, the former prime minister, Geir Haarde, has been in front of a special court, facing charges of “failures of ministerial responsibility” in relation to his handling of the 2008 financial crisis.)
“In Iceland there wasn’t any option but to do things this way,” Rozwadowski says. The banks were worth 10 times Iceland’s gross domestic product, so the country couldn’t have saved them even if it had wanted to. In Ireland, where the banks were valued at about five to six times GDP, the Government clearly felt able to attempt saving them.
A similar point is made by Iceland’s minister for finance, Steingrímur Sigfússon. “We didn’t do what we did out of choice,” he says. “It was impossible for us to preserve the banks as they were.”
Sigfússon is reluctant to make comparisons, but he says that Ireland is now paying the price for decisions it took when introducing the bank guarantee in 2008. “Those who try to revive an oversized banking sector are going to pay an enormous price for it,” he warns.
Far from alienating the financial system through its policy on the banks, Iceland appears to have won respect for its uncompromising attitude.
“More and more economists are saying that this model – letting the banks go bust – is the best, especially for small countries,” says Timo Summa, the EU’s representative in Iceland. “The foreign bondholders lost a lot, but that came after years of huge profits.”
In any case, the bondholders seem to hold no grudges. The Icelandic government’s return to international debt markets last June saw its bond offering subscribed twice over.
Sigfússon points out that before it pulled the plug on the banks, his government brought in laws making bank depositors priority creditors. This effectively secured the savings of Icelanders, but at a fraction of the cost of Ireland’s bank guarantee.
He doesn’t accept that the IMF has been softer on Iceland than on Ireland, and suggests a different reason why we are enduring greater austerity. “I’m sure Ireland is free to choose between tax and spending measures, but there doesn’t seem to be much support in your country for increasing taxes. However, cutting spending has social consequences.”
Iceland has increased income tax and VAT, has pushed up corporation tax from 12 per cent to 20 per cent and has introduced a wealth tax. Capital projects, such as upgrading the road network, have been put on hold. The old reliables – drink, tobacco and petrol – have been hit hard.
Sigfússon stresses that Iceland has still paid a heavy price for its self-generated banking woes. The crisis has cost the country a sum equivalent to about 20 per cent of its GDP. (In Ireland, the cost is about 50 per cent of GDP.)
Driving a hard bargain has served Iceland well. The IMF says the stabilising of Iceland’s economy has been a tremendous success.
Sigfússon says Iceland isn’t out of the woods yet, but he exudes quiet satisfaction. “There was a time when Irish politicians made a point of saying: ‘We’re not Iceland.’ Well, they’re not saying that any more.”
Home free? Iceland's debt-forgiveness scheme
Hard-pressed homeowners in Ireland might look with envy at the measures introduced in Iceland to ease the burden of indebtedness among mortgage-holders.
The mortgage crisis in Iceland was much worse than anything that has so far happened in Ireland. An estimated 20,000 households were in difficulty after the banking crash, or about one household in five.
Many of these homeowners had mortgages that were linked to the consumer price index, and found themselves unable to meet their payments when inflation spiked in the immediate aftermath of the crisis. Others had mortgaged their properties with loans secured in strong foreign currencies, such as the Swiss franc, and were hit badly when the Icelandic krona was devalued.
Much of this borrowing was foolish, and some was speculative, but the government was still moved to introduce measures to alleviate the hardship of homeowners. The alternative, it was felt, was that loans would go unpaid as Icelanders emigrated.
Homeowners were given the option of restructuring loans, as happens in Ireland, but the Icelandic government went much further. A debt-forgiveness scheme was introduced: loans were written off where they exceeded 110 per cent of a house’s value. So a person who borrowed the equivalent of €500,000 to buy a house that then halved in value could potentially have €225,000 of the mortgage written off.
In addition, the government is spending the equivalent of €100 million on interest-rate subsidies for indebted households, which will receive two payments a year to ease their burden. Banks and pension schemes have been told to contribute another €40 million to this scheme, which will run for two years.
For those still in difficulty, court procedures have been revamped and simplified. Householders can avail of the advice of a debt ombudsman, who can accompany them to negotiations with banks. Files prepared by the ombudsman can be used in court should these talks break down.
As in Ireland, the level of house repossessions remains very low.