Download Smallness: Problem or Opportunity? Lessons from Iceland

Smallness: Problem or Opportunity?
Reflections of an Icelander
Professor Hannes H. Gissurarson
Torshavn 22 March 2014
Iceland: Historical Highlights
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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
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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: $39,996
Main exports: fish, aluminium, tourism, and
(in past), financial services
A Poor Nation, 874–1874
• Could only sustain 50,000 people or less,
Malthusian Trap
• 1709: possibly 38,000; 1787: 39,190
• Famines until 19th century; then emigration
to America
• Poverty unfairly blamed on Danish colonial
rule
• Agriculture held down fisheries; ruling farmers
hindered development of resources
Population, 1703–2014
Population of Iceland
350000
300000
250000
200000
150000
100000
50000
0
1703
1764
1794
1824
1854
1884
1914
1944
1974
2004
Iceland and Denmark, 1874–1945
GDP per capita in 1990 US$
6,000
5,000
4,000
Iceland
3,000
Denmark
2,000
1,000
0
1870
1880
1890
1900
1910
1920
1930
1940
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
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Cutting subsidies
Stabilising economy
Liberalising and opening markets (EEA)
Privatising
Cutting taxes
Developing property rights to natural
resources
• Strengthening pension funds
Main Tax Cuts
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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
55
1.3
50
1.2
45
1.1
40
Corporate Tax
35
Rate
30
1.0
0.9
Corporate Tax
Revenue % of
GDP
25
0.8
20
15
0.7
1990
Corporate Tax Rate
1995
2000
2003
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
Aaa
Aa1
Aa3
A1
A1
A2
Baa1
Baa3
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
External Debt: 2004 Crucial Year
16000000
14000000
12000000
10000000
8000000
External debt in millions
of kronur
6000000
4000000
2000000
0
1992
1996
2000
2004
2008
Johannesson’s Bubble
6000
5000
Loans to Johannesson
and cronies
4000
Loans to Exista and
related companies
3000
2000
Loans to Landsbanki main
owners and related
companies
1000
0
1/1/05
1/1/06
1/1/07
1/1/08
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
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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