Iceland: How Could This Happen?

Iceland: How Could This Happen?

Thorvaldur Gylfason

Conference on Reform Capacity and Macroeconomic Performance in the Nordic Countries,

Copenhagen Business School, Copenhagen, 20-21 September 2013

The Chamber of Commerce recommends that Iceland

stop comparing itself with other Nordic countries

because we are superior to them in most respects.

Iceland Chamber of Commerce, February 2008.

Overview

• Historical background• Relevant comparisons– Denmark, Finland, Norway, and Sweden– Ireland, Portugal, and Greece– Faroe Islands

• Gathering clouds, once more–Weakened institutions, failed banks, broken

trust: Deep trouble– Uncertain prospects for reform and restoration

History and volatilityGDP per capita 1870-2012

(1990 international Geary-Khamis $) GDP per capita 1901-2012

(change in % per year)

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

Denmark Finland Norway Sweden Ireland Greece Portugal

19011908

19151922

19291936

19431950

19571964

19711978

19851992

19992006

-20

-15

-10

-5

0

5

10

15

20

Denmark

Iceland

Ireland caught up after 1980

1901-2012 1945-2012 1960-20120123456 Denmark

Iceland

Standard deviation

Source: Maddison Project. Source: Maddison Project and Statistics Iceland.

http://www.ggdc.net/maddison/




1900 1904

1908 1912

1916 1920

1924 1928

1932 1936

1940 1944

1948 1952

1956 1960

1964 1968

1972 1976

1980 1984

1988 1992

1996 2000

2004 2008

2012 0

500

1000

1500

2000

2500

FramleiðslaFramleiðslugeta

Iceland: GDP per capita (1900-2012, constant prices)

1900: GDP per person was similar to that in Ghana today at ppp

Ghana

1900 = 100Actual output

Potential output

China

India

Botswana

Greece

Korea

Iceland’s per capita GDP

was equal to ca. half that

of Denmark in 1900, and

had caught up by 1960

Source: Statistics Iceland, World Bank World Development Indicators, and author’s computations.

GNI per capita(1980-2012, current international $, ppp)

Nordics Periphery

0

10000

20000

30000

40000

50000

60000

70000

Denmark

Finland

Iceland

Norway

Sweden

0

5000

10000

15000

20000

25000

30000

35000

40000

45000

Greece

Iceland

Ireland

Portugal

Source: World Bank World Development Indicators.

Norway has left others behind

Iceland parted company in 2008

Where to look?InvestmentExportsEducationInstitutions

Hours of work per employee 1950-2012

Nordics Periphery

19501954

19581962

19661970

19741978

19821986

19901994

19982002

20062010

0

500

1000

1500

2000

2500

3000

DenmarkFinlandIcelandNorwaySweden

19501954

19581962

19661970

19741978

19821986

19901994

19982002

20062010

0

500

1000

1500

2000

2500

3000

GreeceIcelandIrelandPortugal

Source: The Conference Board Total Economy Database™, January 2013, http://www.conference-board.org/data/economydatabase/

Hours of work per capita 1950-2012

Nordics Periphery

19901992

19941996

19982000

20022004

20062008

20102012

0

300

600

900

1200

1500

1800


19901992

19941996

19982000

20022004

20062008

20102012

0

300

600

900

1200

1500

1800

GreeceIcelandIrelandPortugal

Source: Author’s computations based on preceding charts.

GNI per hour worked 1990-2012 (Current international $, ppp)

Nordics Periphery

19901992

19941996

19982000

20022004

20062008

20102012

0

10

20

30

40

50

60

70

80

Denmark

Finland

Iceland

Norway

Sweden

19901992

19941996

19982000

20022004

20062008

20102012

0

10

20

30

40

50

60

70

80

Greece

Iceland

Ireland

Portugal

Source: Author’s computations based on preceding charts.

Unemployment(1980-2011, % of labor force)

Nordics Periphery

19801982

19841986

19881990

19921994

19961998

20002002

20042006

20082010

0

2

4

6

8

10

12

14

16

18


19801982

19841986

19881990

19921994

19961998

20002002

20042006

20082010

0

2

4

6

8

10

12

14

16

18

20Greece

Iceland

Ireland

Portugal


Iceland joined

Nordic mainstream

Inflation(1961-2012, consumer prices, % per year)

Nordics Periphery

19611965

19691973

19771981

19851989

19931997

20012005

2009-10

0

10

20

30

40

50

60

70

80

90

Denmark

Finland

Iceland

Norway

Sweden

19611965

19691973

19771981

19851989

19931997

20012005

2009-10

0

10

20

30

40

50

60

70

80

90Greece

Iceland

Ireland

Portugal


2003-01

2003-09

2004-05

2005-01

2005-09

2006-05

2007-01

2007-09

2008-05

2009-01

2009-09

2010-05

2011-01

2011-09

2012-05

2013-0102468

101214161820

CPI

CBI Inflation target

Iceland: Missed inflation target% per year

99.95%

Banking

• Three main banks and Central Bank collapsed– Recapitalization of three commercial banks cost 18% of

GDP– Recapitalization of Central Bank cost 18% of GDP

• Damage incurred equaled seven times GDP– Foreign creditors, shareholders, and depositors lost five

times GDP– Local residents lost two times GDP (stock market was

wiped out, pension funds took a big hit) – Public debt rose from 29% to 93% of GDP, or by 64% of

GDP – close to world record

Banking

• Banks broke the law (SIC report 2010)– Insider trading– Market manipulation– False reporting– Breach of trust– Foreign-currency indexed loans– Local-currency indexed loans?

• Special prosecutor’s office set up in 2009– Staff expanded from 3 to 100, with foreign help– 80 cases involving nearly 200 individuals

Black, Ferguson, Galbraith, Stiglitz and others make similar claims for the US, with Akerlof and Blinder not far behind

Banking

• No banking strategy in place as yet– Rumors of Russian money laundering before crash– No foreign competition in sight yet– Government has a big stake in Landsbanki, smaller

stakes in other two banks– Rumors of selling stakes to, yes, Chinese banks– New government immediately closed down EU

accession talks, cozying up instead to China and Russia as well as to Greenland and the Faroe Islands

– Strict capital controls: No end in sight

Ten largest corporate bankruptcies of all time (USD billion)

Source: Financial Supervisory Authority of Iceland.

Bank assets(1990-2011, % of GDP)

Nordics 1990-2011 Periphery 1995-2011

19951997

19992001

20032005

20072009

20110

100

200

300

400

500

600

700

800

900

1000Greece

Iceland

Ireland

Portugal

19901992

19941996

19982000

20022004

20062008

20100

100

200

300

400

500

600

700

800

900

1000Denmark

Finland

Iceland

Norway

Sweden

Irish government, unlike the Icelandic one,

decided to bail out the banks, at huge cost

Iceland did have a banking crisis

in 1989-1993; it was covered up


General government gross debt (2001-2012, % of GDP)

Nordics Periphery

20012002

20032004

20052006

20072008

20092010

20112012

0

20

40

60

80

100

120

Denmark

FinlandIceland

NorwaySweden

20012002

20032004

20052006

20072008

20092010

20112012

0

20

40

60

80

100

120

140

160

180

Greece

Iceland

Ireland

Portugal

Iceland: Sovereign default? Hardly.

Another rescue by IMF? Possibly. Source: Eurostat.

Interest rate spread(1961-2009, lending rate minus deposit rate, %)

Nordics 1970-2009 Periphery 1961-2005

19701973

19761979

19821985

19881991

19941997

20002003

20062009

-15

-10

-5

0

5

10

15



Without foreign competition,

Iceland’s bank privatization

failed to reduce spread

In Ireland, Portugal, and Greece,

local banks face foreign competition

19701973

19761979

19821985

19881991

19941997

20002003

-15

-10

-5

0

5

10

15

Greece Iceland

Ireland Portugal

Bank nonperforming loans(2000-2012, % of gross loans)

Nordics Periphery

20002001

20022003

20042005

20062007

20082009

20102011

20120

5

10

15

20

25

30

35

40

45

Denmark

Finland

Iceland

Norway

Sweden

20002001

20022003

20042005

20062007

20082009

20102011

20120

5

10

15

20

25

30

35

40

45Greece

Iceland

Ireland

Portugal


Iceland’s banks: Still in a

class by themselves

Trust in Icelandic institutions 2013 (% expressing a lot of trust in institutions)

MMR Capacent

Banking sy

stem

Parliament

FSA

Central B

ank

Judicial sy

stem

Specia

l Prosecu

tor

Universi

ty of Ic

elandPolic

e0

10

20

30

40

50

60

70

80

90

Banking sy

stem FSA

Media

Parliament

Central B

ank

Government

Universi

ty of Ic

elandPolic

e0

10

20

30

40

50

60

70

80

90

Corruption 2012 (Business corruption as measured by Transparency,

political corruption as measured by Gallup)Transparency Gallup

Denmark

Finland

Sweden

Norway

Iceland

Ireland

Portugal

Greece0

10

20

30

40

50

60

70

80

90

100

Sweden

Denmark

Norway

Finland

Ireland

Iceland

Portugal

Greece0

10

20

30

40

50

60

70

80

90

100

Exports of goods and services (1960-2012, % of GDP)

Nordics Periphery

19601964

19681972

19761980

19841988

19921996

20002004

20082012

0

10

20

30

40

50

60

70


19601964

19681972

19761980

19841988

19921996

20002004

20082012

0

20

40

60

80

100

120

Greece

Iceland

Ireland

Portugal


Iceland: Exports shot up

when the króna collapsed

Greece and also Portugal

remain remarkably closed

Import volume 2000-2011 (2000 = 100)

Nordics Periphery

20002001

20022003

20042005

20062007

20082009

20102011

0

20

40

60

80

100

120

140

160

180

200

Denmark

Finland

Iceland

Norway

Sweden

20002001

20022003

20042005

20062007

20082009

20102011

0

20

40

60

80

100

120

140

160

180

200

Greece

Iceland

Ireland

Portugal


Manufactures exports(1962-2012, % of total exports)

Nordics Periphery

19621966

19701974

19781982

19861990

19941998

20022006

20100

10

20

30

40

50

60

70

80

90

100Denmark Finland Iceland Norway

Sweden

19621966

19701974

19781982

19861990

19941998

20022006

20100

10

20

30

40

50

60

70

80

90

100Greece Iceland

Ireland Portugal


Norway pays for its oilIceland is decidedly low-tech

Herfindahl merchandise export diversification index 1995-2012

Sweden Denmark Portugal Finland Greece Norway Ireland Iceland0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1995

2012

Source: UNCTAD.

Gross capital formation(1965-2011, % of GDP)

Nordics Periphery

19651968

19711974

19771980

19831986

19891992

19951998

20012004

20072010

0

5

10

15

20

25

30

35

40

Denmark Finland

Iceland Norway

Sweden

19651968

19711974

19771980

19831986

19891992

19951998

20012004

20072010

0

10

20

30

40

50

60

Greece

Iceland

Ireland

Portugal

20002001

20022003

20042005

20062007

20082009

20102011

2012-10%

-5%0%5%

10%15%20%25%

Iceland: Collapse of net investment


% of GDP

Labor force with primary education(1992-2011, % of total)

Nordics Periphery

19921994

19961998

20002002

20042006

20082010

0

10

20

30

40

50

60

70

80

90

Greece Iceland

Ireland Portugal

19921994

19961998

20002002

20042006

20082010

0

10

20

30

40

50

60

Denmark Finland Iceland

Norway Sweden


Iceland: Why so much primary?

Labor force with secondary education(1992-2011, % of total)

Nordics Periphery

19921994

19961998

20002002

20042006

20082010

0

5

10

15

20

25

30

35

40

45

Greece Iceland

Ireland Portugal

19921994

19961998

20002002

20042006

20082010

0

10

20

30

40

50

60

70

Denmark

Finland

Iceland

Norway

Sweden


Because there is too little secondary …

Labor force with tertiary education(1992-2011, % of total)

Nordics Periphery

19921994

19961998

20002002

20042006

20082010

0

5

10

15

20

25

30

35

40

45Greece Iceland

Ireland Portugal

19921994

19961998

20002002

20042006

20082010

0

5

10

15

20

25

30

35

40

45

Denmark Finland

Iceland Norway

Sweden


… and too little tertiary education

Periphery: Banking crises vs. fiscal crises

Fiscal measures 2007 (% of GDP) Bank assets 2007 (% of GDP)

Greece Iceland Ireland Portugal0

20

40

60

80

100

120

140

Central government debt

General government expenditure

Greece Iceland Ireland Portugal0

100

200

300

400

500

600

700

800

900

1000

Greece and Portugal:

Crisis spread from budget to banks

Iceland and Ireland: Crisis spread from banks to budget

In 2012, ca. half of Irish households had negative equity in their houses compared with about a quarter of Icelandic households

Iceland 2008 vs. Faroe Islands 1989

Iceland• Root cause: Corruption, esp.

incestuous relations among banks, business, and politics

• 2009-2010: GDP fell 10%• No significant emigration yet,

this could change• Króna fell by 33% in real terms• Promised constitutional

reform, but did not deliver, ignored national referendum

• Limited trust: From cohesion to contempt

Faroe Islands• Root cause: Corruption, esp.


• 1989-1993: GDP fell 33%• 15% of population fled, a third

of which returned later• Fixed exchange rate, tied to

Danish krone one-to-one• Promised constitutional

reform, but did not deliver, did not hold national referendum

Essentially same story

Final comparison

Iceland 2008 vs. Faroe Islands 1989

Iceland• Root cause: Corruption, esp.


• 2009-2010: GDP fell 10%• No significant emigration yet,

this may change• Króna fell by 33% in real terms• Promised constitutional

reform, but did not deliver, ignored national referendum

• Limited trust: From cohesion to contempt

Iceland: Trust in parliament

20032004

20052006

20072008

20092010

20112012

20130

5

10

15

20

25

30

35

40

45

50

To heal, as every doctor knows,

wounds must first be cleaned

Final comparison

Iceland: How Could This Happen?

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