The Strange Death of Liberal Iceland

Hannes H Gissurarson

Mont Pelerin Society

New York, 7 March 2009

Historical Highlights Settled 874-930 Commonwealth 930-1262 Under the Norwegian, later Danish, king Home rule 1904 Sovereignty, in a personal union with

Denmark, 1918 Republic, 1944

Main Facts Population 319,368 (1/1/ 2009) 103,000 sq. km (same as East

Germany) GDP per capita (PPP) 1992: $21,278 GDP per capita (PPP) 2004: $33,372 GDP per capita (PPP) 2007: $38,396 Main exports: fish, aluminium

874-1874, One of the Poorest Could only sustain 50,000 people 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

1874-1940, Less than Denmark

0

1.000

2.000

3.000

4.000

5.000

6.000

7.000

1870 1878 1886 1894 1902 1910 1918 1926 1934 1942

GDP per capita in 1990 US$

Iceland Denmark

Source: Hagskinna (Gudmundur Jonsson)

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 Some natural economic growth Signs of economic decline in late 1980s Turning point in 1991

Liberal Iceland 1991-2004 Cutting subsidies Stabilising economy Liberalising markets Privatising Cutting taxes Developing property rights to natural

resources Strengthening pension funds

Monetary Stability

0

10

20

30

40

50

60

70

80

90

1980 1983 1986 1989 1992 1995 1998 2001 2004

Inflation in %

Source: Icelandic Bureau of Statistics

From Deficits to Surpluses

-6

-5

-4

-3

-2

-1

0

1

2

3

1988 1990 1992 1994 1996 1998 2000 2002 2004

Deficit/surplus % of GDP

Source: Icelandic Ministry of Finance

Fiscal Responsibility

0

5

10

15

20

25

30

35

40

45

50

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

% of GDP

Iceland Net Public Debt OECD Net Average Public Debt

Source: Icelandic Ministry of Finance

Negligible Unemployment

0

1

2

3

4

5

6

7

8

1998 2000 2002 2004 2006 2008 2010

Unemployment in %

Iceland OECD

Source: Icelandic Ministry of Finance

Pension Fund Reforms Tax-financed public pension fund since 1930s Compulsory occupational pension funds since

1960s Pay-as-you-go funds replaced by

accumulation funds Voluntary private pension schemes

(supplementary) Pension reforms in 1998

Pension Fund Assets10 Largest Pension Fund Assets OECD 2005

0 50 100

Netherlands

Iceland

Switzerland

United States

United Kingdom

Finland

Australia

Ireland

Canada

Denmark

% of GDP

Source: OECD (Pension Markets in Focus, 2006)

Privatisation Travel bureau, printing house, publishing

house, fish processing plant, etc. 1992-2005 Government investment funds 1999, later

merged with others to form Glitnir Bank Landsbanki 2002 Bunadarbanki 2002, later merged with others

to form Kaupthing Bank Icelandic Telephone 2005 Total revenue from privatisation $2 billions

Tax Cuts Corporate incomes tax from 45% to

18% (15% since 2007) Individual incomes tax from 30.41% to

22.75% Turnover tax abolished High-incomes surcharge abolished Net wealth tax abolished Death duties (estates tax) reduced

Invisible Tax Cuts Reducing inflation = Cutting the inflation

tax Strengthening pension funds = Cutting

tax on future wealth creators (reducing taxpayers’ liabilities

Reducing public debt = Cutting tax on future generations

Corporate Incomes Tax Cut

0

5

10

15

20

25

30

35

1991 1993 1995 1997 1999 2001 2003 2005 2007

Tax Revenue, Billions ISK

0

5

10

15

20

25

30

35

40

45

50

Tax Rate in %

Tax Revenue, Billions ISK Tax Rate %

Source: Icelandic Ministry of Finance

Example of Laffer Curve?

0

20

40

60

80

100

120

Tax Rate in %

Tax Revenue in $

Development of ITQ System Open access to fishing grounds led to

overfishing 1975, individual quotas (% of total

allowable catch) in herring fishery 1984, individual quotas in cod and other

demersal fisheries Gradually, quotas became transferable 1990, ITQ system made universal

Efficient Fisheries Initial allocation on basis of catch history:

owners of fishing capital bought out, not driven out

Much resentment; compromise in 2002: nominal resource use fee

Total value of quotas about 350 billions ISK (appr. $5 billions)

Reduction of fishing effort; stronger and fewer fishing firms

Fishing Firms Profitable

-15

-10

-5

0

5

10

15

20

1981 1984 1987 1990 1993 1996 1999 2002

Inflation-adjusted Profit/Loss

Source: Icelandic Association of Fishing Vessel Owners

All Groups Benefited Average annual increase in purchasing

power after tax 1995-2004 4.8% Annual increase of lowest 10% group

2.7% OECD average of lowest 10% group

1.8% (1996-2000)

Risk of Poverty 2nd Lowest

0 2 4 6 8 10 12 14

Sweden

Iceland

Slovenia

Czech Republic

Norway

Netherlands

Finland

Austria

Denmark

Slovakia

% at risk of poverty

Source: Eurostat and Icelandic Bureau of Statistics

Income Distribution

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

Sweden Denmark Finland Norway Ireland UnitedKingdom

Iceland

Gini Coefficients in 2004

Source: Eurostat and Icelandic Bureau of Statistics

Liberal Iceland in 2004 One of 5 richest countries in the world One of 10 freest countries in the world Relatively even distribution of income Almost no poverty Negligible unemployment Almost no crime What went wrong?

Bank Expansion Banks privatised 1999-2002 Since 2002, total turnover of banks

almost 10-folded Total foreign assets 10-fold GDP Oversized in terms of Iceland, but not of

the EEA

Expansion Partly Sustainable Hernando de Soto: From dead to living

capital ITQ system: New capital Capital gains from privatisation Stronger pension funds Icelandic banks with no worse assets

than other European banks

Abuse of Power? European banks did not like Icelandic

competitors 2007-8, central banks, including the

Fed, refused to help the Icelandic Central Bank

October 2008: Gordon Brown used anti-terrorist laws against Icelandic banks

Who are the Terrorists? Icelandic Ministry of Finance, Central

Bank and Landsbanki put on official list of terrorist organisations, with Al-Qaeda and the Talibans!

Payments through London stopped Disastrous for an open economy like

Iceland Bank sector collapsed

Small is Dangerous Gordon Brown: Icelandic authorities

would not honour their legal obligations No evidence for that British authorities: Last-minute transfers

from London to Iceland Remains to be seen, but denied by

Icelandic banks

A Tale of Two Countries Lehman Brothers: Last minute transfers

of 4.4 billion GBP from London to US US Treasury, or the Fed, not put on list

of terrorist organisations! Swift: “Laws are like cobwebs, which

may catch small flies, but let wasps and hornets break through“

Structural Flaw in EEA Gordon Brown forced Iceland to go

beyond its legal obligations 100% of GDP, while German

reparations payments after 1st WW: 85% of GDP

EEA: One economic area, without one system of lender-of-last-resort

Hope Against Hope Infrastructure intact, unlike after war Natural resources, fish stocks,

waterfalls and hot springs Human capital Danger: Wrong lessons learned Free market discredited Only hope: Mises’ and Hayek’s

longevity!