The Blame Iceland First Crowd
No one disputes that the economic troubles of Iceland are largely the country’s fault. But there may be more to the story, at least in the view of Icelandic government, its citizens and even some outsiders. As grave as their situation already was, they say, Britain — their old friend, NATO ally and trading partner — made it immeasurably worse.
I actually sort of would dispute that the economic troubles of Iceland are largely the country’s fault. Being small is hard. Think of a small city who’s largest employer is a factory that makes airplane parts. Most people in the city don’t work at the factory. You’ve got kids and retirees and stay-at-home spouses. You’ve got some teachers, cops, firemen, librarians, postal workers, and bureaucrats. You’ve got banks and shops and restaurants and guys in the building trades. But the largest employer is the factory. And if the airplane industry suffers a severe downturn and needs to lay off workers and cancel shifts and bonuses, then that’ll be substantially less revenue for the stores and restaurants. People will have less cash on hand to pay for home repairs, and more time to try and do it themselves. So the shops and restaurants start cutting back on employment and hours. So their employees need to scale back their spending. And tax revenues go down, meaning less money for the public employees. All of which means even less revenue for the town’s stores. And down and down things will go until orders go up at the factory. Did the town government make some serious policy error? Well, probably they could have done something better, but fundamentally it’s in the nature of small places to be buffeted by trends that are too big for the city to control.
And the residents of our city can fairly easily try to find work elsewhere in the region and just accept a longer commute. Or they might move away. Or other firms might see costs declining in the city and decide to locate there.
Iceland is a small city of about 300,000 and though the country is open to trade, the nature of things is that it’s much more closed off from the outside world than an American town is from the rest of the country. A country like that isnisn’t big enough to have a balanced economy. They’ve got a fish-exporting industry, and then economies of scale dictate that if they manage to get successful in some sector of the global economy, that sector will come to dominate the country’s economy. For Iceland, it wasn’t a factory making airplane parts — it was banks. Run into a global banking slowdown, and the country is screwed. But it’s not clear what they could have done to stop this. Iceland’s banks were very big relative to Iceland but Iceland was far too small to alter the course of the global financial system.
48 Responses to “The Blame Iceland First Crowd”
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November 2nd, 2008 at 2:40 pm
I for one am happy to see the Icelandic menace knocked off balance for a little while.
November 2nd, 2008 at 2:47 pm
I feel for Iceland, but they can pull out of it. I grew up in Bethlehem, PA. When I was growing up, the town had about 120,000 people and the steel mill employed 75,000 of them. That steel mill is no longer there, but the people are. If you have talented people, you will survive things like this. But that was the key to how Bethlehem survived and Flint didn’t. Bethlehem had the corporate headquarters of Bethlehem Steel. So it had the engineering and business talent it needed to survive. And those people were trapped in Bethlehem by dueling issues. They owed more on their house than it was worth, and their kids were going to pretty good schools. The talented people had no choice but to stay and build a better Bethlehem. And they did it. Iceland will too. They have the talent and no other alternative.
November 2nd, 2008 at 2:48 pm
Britain — their old friend, NATO ally and trading partner
That’s a mysterious claim–the actualy 20th century hisotry of the two countries was one of repeated conflict, sometimes armed
November 2nd, 2008 at 2:50 pm
but they still print issues of McSweeney’s…don’t they?
November 2nd, 2008 at 2:54 pm
We could have not privatized the banks ten years ago. We could also have regulated them in a way that would have prevented them from getting so big. But ideas like that were unpopular and seen as backward-looking at the time. Try being a politician who says: “I want to stop our most successful companies from growing!”
But that was a pretty good post, Matt.
November 2nd, 2008 at 3:01 pm
rea is right that the idea that Iceland and Britain are “old friends” is a bit conceited. rea mentions the Cod Wars but let’s also not forget that Britain invaded and occupied Iceland in WWII. That things turned out for the best there (no German counter-attack/bloodshed, the British won the war, the British were essentially the good guys) makes people forget that it was, you know, an unprovoked act of aggression.
November 2nd, 2008 at 3:12 pm
But, given a long enough time scale, the scenario of– 1) Iceland finds a niche in the global economy, and then 2) Iceland’s niche disappears– is always going to happen. Iceland is always going to have occaisional big problems, maybe every 20-30 years or so.
November 2nd, 2008 at 3:31 pm
Well, probably they could have done something better, but fundamentally it’s in the nature of small places to be buffeted by trends that are too big for the city to control.
If one doesn’t understand by the first decade of the 21st century to not have all your economic eggs in one basket – after three decades of repeated catastrophes at the scale of both cities and nation-states and everything in between – well, there ain’t much you can do to fight human nature.
November 2nd, 2008 at 3:35 pm
And the thing is, from reading this very site, Iceland was already diversifying. Heck, the bank thing was an attempt to not be so reliant on fishing to begin with. They had also been trying to leverage their abundant geothermal power to be a world class aluminum refiner (and other similar stuff that’s energy intensive)
November 2nd, 2008 at 3:39 pm
I think that the big problem was this:
http://www.nytimes.com/2008/11/02/world/europe/02iceland.html?scp=1&sq=iceland%20britain&st=cse
“The troubles between the countries began three weeks ago when Britain took the extraordinary step of using its 2001 antiterrorism laws to freeze the British assets of a failing Icelandic bank. That appeared to brand Iceland a terrorist state.
“I must admit that I was absolutely appalled,” the Icelandic foreign minister, Ingibjorg Solrun Gisladottir, said in an interview, describing her horror at opening the British treasury department’s home page at the time and finding Iceland on a list of terrorist entities with Al Qaeda, Sudan and North Korea, among others.
In a volatile economic climate, in which appearance matters almost as much as reality, being associated with terrorism is not a good thing.
“The immediate effect was to trigger an almost complete freeze on any banking transactions between Iceland and abroad,” said Jon Danielsson, an economist at the London School of Economics. “When you’re labeled a terrorist, nobody does business with you.”
The Icelandic prime minister, Geir H. Haarde, accused Britain of “bullying a small neighbor” and said the action was “very out of proportion.” In a recent speech in Beijing, Sir Howard Davies, a former deputy governor of the Bank of England and now the director of the London School of Economics, said that Britain had used a “beggar thy neighbor” approach to Iceland.
And an online petition signed so far by more than 20 percent of Iceland’s population said the British prime minister, Gordon Brown, had sacrificed Iceland “for his own short-term political gain,” thereby turning “a grave situation into a national disaster.”
In other words, Britain used extraordinary measures to halt the movement of funds that Iceland needed to avert the avalanche. By the way, Britain is doing a pretty good job of looking out for it’s own interests in this crisis. Brown has just been in the Gulf trying to direct money to Britain.
November 2nd, 2008 at 3:41 pm
Did the trouble really start with the freezing of assets? I would have thought the bank failures that preceded it were part of the problem. Whether or not the Icelandic government in fact refused to guarantee deposits, that was certainly the perception in Britain. British government actions were, I think, related to internal politics — a perception that they couldn’t let British depositors be screwed without being seen to take drastic action or the political fallout would be too dangerous. You see internal US politics cause collateral damage elsewhere all the time; it’s just a pity that Iceland gets caught playing beyond their league and real people get hurt.
Also using anti-terrorist statutes for unrelated ends is depressingly common these days and not restricted to the UK. Definitely a bad thing, but the lesson to learn about that is not about the evil Brits, but that powers once granted will get used for other purposes here as well.
November 2nd, 2008 at 4:12 pm
Iceland has made two big mistakes:
(1) they relied on an ever expanding global financial trading in dimensions far beyond Iceland’s GDP; this was extremely risky, and they should have known that;
(2) they did not enter the European Union.
Had they been part of the European Union, Europe would have bailed them out. A few billion Euros – lethal for tiny Iceland – are (almost) peanuts for Europe.
Why did Iceland not enter the EU in the last 20 years? -
Arrogance of the naive short-term genius … who thinks he is sooo good and can go it alone.
All this said, the British way to deal with Iceland was unnecessarily mean; and Iceland will come back – as a part of the European Union.
November 2nd, 2008 at 4:50 pm
The decision not to join the EU was a calculated one that was not born out of arrogance. It was a rational economic choice.
Iceland has long depended on fishing for its livelihood. Some years back the country made the very painful decision to strongly regulate Cod fishing so as to preserve the fishery from overfishing. This meant the decimation of small towns across the country as fewer and fewer fishermen were needed.
This caused large scale social disruption throughout the country (and led to the Cod Wars with England). But it largely worked, as the fishery is still in reasonably good shape. However, if Iceland joined the EU, they would have to give up self-regulation of their fishing industry, with certain exploitation of the fishing grounds by other EU members and decline of the fishery for all. To many in Iceland, not joining the EU was a rational act of self preservation.
As to the banking industry, Kohole is right. It was seen by many as a way out of Iceland’s historic dependence on fishing. Last year my friends in Iceland talked about their worries about the sudden growth of the banks as a thing that was too good to be true. Unfortunately, this year they were right.
November 2nd, 2008 at 5:31 pm
Look, Iceland got into banking, and, in order to lure in foreign deposits made some spectacularly stupid gambles that far exceeded its ability to cover, and they lost big time.
However, we should not leave them to the mercy of the EU or the wrath of the UK when we could just purchase Iceland for the value of its debts (plus a small premium), and welcome them in as the 51st. state. Their 2 senators, most likely Democrats, would come in very useful.
November 2nd, 2008 at 5:37 pm
I actually sort of would dispute that the economic troubles of Iceland are largely the country’s fault. Being small is hard.
Being small is hard in some ways and easy in others. So is being big. One of the advantages of being small is that it allows you to generate a high per capita GDP by occupying niche positions in the global economy.
Run into a global banking slowdown, and the country is screwed. But it’s not clear what they could have done to stop this.
They could have avoided allowing their three big banks to acquire assets more than ten times the size of their entire GDP. That was a disaster waiting to happen, and they have no one to blame but themselves. They could also have joined the EU.
November 2nd, 2008 at 6:22 pm
FWIW, Iceland is not a small city, as you said in your last paragraph, it is a country with approx. 300,000 inhabitants.
November 2nd, 2008 at 6:44 pm
As the 51st state I can promise you that both our senators would be Democrats and would continue to be for the forseeable future. I’d estimate that the republican vote here would not exceed 10 percent.
Our senators would however at best be useless and at worst be mendacious since our politicians are mostly somewhere there between.
November 2nd, 2008 at 6:47 pm
I accept “small city” as a mattpo.
Iceland’s economy was out of balance already well over a year ago. They were offering crazy interest rates and attracting a lot of temporary cash that way, but it’s basically the situation similar to a credit card borrower on the verge of default. The larger strategic issue is one thing, but definitely — and of course they weren’t alone here — they had too much risk on the table when the bubble burst. That seems like a tactical policy error of some kind.
November 2nd, 2008 at 7:16 pm
The lesson of this is that a country should never rely on banking and financial manipulation rather than the actual production of tangible goods. The Icelanders thought they were too ‘modern’ and fancy for the herding and fishing lifestyle that their ancestors had followed. They were wrong, and now they are learning a hard lesson. But they will come out of it OK, and will be a better society for it- more humble, more traditional, more respectful of hard physical labor, and less in the thrall of the financial manipulation that is the modern world’s equivalent of usury. I hope that other European countries will learn the same lesson and will return to their roots- Ireland most particularly. It is better to earn a meager living through hard labor than a comfortable living through financial manipulation.
November 2nd, 2008 at 7:49 pm
Those damn Icelanders have been asking for it for a long time.
I say it serves them right.
November 2nd, 2008 at 8:17 pm
Hector-
Most Icelanders are quite familiar with hard labor and hard times, are you? Periodic famines have dogged Icelanders on and off through the centuries. For example, in 1783 the volcano Laki erupted, killing 3/4 of all livestock. One in ten Icelanders died from starvation. In the 20th century, malnutrition was a major issue until after World War II.
Icelanders are acutely aware of how vulnerable they are and always have been. As to the current crisis, the majority of the population had nothing to do with the banks’ risky ventures. Yet now they all will suffer. Being knifed by Gordon Brown’s unnecessary use of England’s terrorism laws has made a disaster that much worse.
As to your wishes for Ireland, I suggest that you read a brief history of the potato famine, a time when tradition and hard labor didn’t stop more than a million people from dying.
November 2nd, 2008 at 8:39 pm
Platypus,
Er, yes, that’s my point. The nature of Iceland is a society characterized by hard labor and fishing. Icelanders should return to that identity that they had until a few years ago, and stop trying to be a banking society.
November 2nd, 2008 at 8:50 pm
Icelanders are acutely aware of how vulnerable they are and always have been. As to the current crisis, the majority of the population had nothing to do with the banks’ risky ventures.
Sorry, the people of Iceland voted for their government (successive governments, in fact) that enacted the policies that made their economy so vulnerable, in the hope of reaping big rewards. They took a big risk, and it worked for a while, but they ended up losing their shirt.
November 2nd, 2008 at 9:31 pm
Thanks
November 2nd, 2008 at 9:31 pm
Matt talks about being a small country as though that is some inevitable fact of nature. Being an island in the North Atlantic is a fact of nature; being a small country is a choice.
Iceland could choose to become part of a larger country. Right now, I suspect no-one’s much willing to take on their debts, but it was their choice (and for that matter Greenland’s) to leave Denmark. They have, for reasons I don’t understand, not chosen to join the EU, and while they have mumbled about adopting the Euro, they haven’t actually done anything about it. There are obviously some advantages to being independent — and there are many disadvantages. You don’t get to whine about how the world owes you a break when the disadvantages kick in; that was part of the deal all along. If you want to rant about how vitally important it is that you be able to teach your kids in Icelandic (or Welsh, or Scottish, or Basque), that you require not just some degree of autonomy but full-fledged independence, well, you take on the full burdens of independence as well at that point.
The world might be better off if we had rather more realists pointing out the disadvantages of independence and the advantages of limited autonomy, rather than the present media environment that assumes that every political disagreement on earth can be solved by splitting off the parties into separate countries.
November 2nd, 2008 at 10:13 pm
Maynard Handley,
Er, no. The world would be better off if most large countries broke up into a bunch of smaller countries. The illusory trade and financial advantages that might come with joining the EU are not worth the price of centralization and the loss of identity and rootedness.
November 3rd, 2008 at 12:39 am
Maynard – Talking to Damien Thorne and Nicolae Carpathian again, are we?
November 3rd, 2008 at 4:31 am
Our [Icelandic] senators would however at best be useless and at worst be mendacious since our politicians are mostly somewhere there between.
Splendid! They’ll fit right in!
November 3rd, 2008 at 5:46 am
Can any of you claiming that being in the EU would have “saved” Island actually explain the mechanism by which EU-membership would have prevented the country’s current crisis? Before you answer, the country is already part of the common market and a full participant in the Schengen Agreement (unlike the U.K. incidentally), which means they’ve got, more or less, all the benefits of free movement of people and goods. What is it exactly they are missing except for a Franco-Spanish veto on their fishing regulations?
November 3rd, 2008 at 5:47 am
Iceland was a testbed for the “free market” deregulation philosophy of Friedrich Von Hayek. Iceland was a Libertarian’s wet dream, and they were touting Iceland’s success until very recently. Now the chickens have come home to roost, and and the madness of supply side, trickle down, deregulatory economics is becoming clear.
November 3rd, 2008 at 11:07 am
We had a long discussion over this at Marginal Revolution.
Iceland now has capacity for 765k tonnes pa of aluminium, with low cost (and carbon free) electric power. The large current account deficit was partly the cost of Alcoa building one of the world’s most efficient smelters.
At $2000/tonne that is c. $1.53bn of aluminium exports pa or $5100 for every Icelander (about 13% of pre Crash GDP). Aluminium prices have ranged from $1000 lows to $3300 or so highs over the last 15 years.
Icelandic Central Bank forecast (in 2005) that aluminium would be 35% of Iceland’s exports when this capacity was fully installed.
It’s also a place where companies like Intel and Google will put their server farms (cheap carbon free power, and on the main transatlantic fibre links). And there is the potential of a power link to the British Isles (it’s doable, with a DC cable).
So Iceland is anything but only a fish-exporting nation. Their resistance to joining the EU was based on the (well-founded) fear that the EU systematically allows overexploitation of fish stocks (it does, taking 4X what its own scientists advise) whereas Iceland is a determined conserver of fish stocks because it knows its children unto the generations will live on them.
This is going to be painful. But Iceland is a country with a full welfare state and national medical service, where it is no stigma to be an illegitimate child (you take your father or mother’s name as in Sven-son, son of Sven, and he in turn might have been Ragnar-son, your grandfather was named Ragnar). In America, people die without healthcare, but not in Iceland.
This isn’t your usual 3rd World (or Second World) crash where people will starve. It will be tough, but Icelanders will survive.
Anyways Magnus Magnusson was amongst the most famous of British TV personalities (’Mastermind’). In a worst case, they can come and live here. When we are not fighting Cod Wars with them, they fit in easily.
November 3rd, 2008 at 11:10 am
ERM
If Iceland had been part of the Euro, then no currency crash. See Wolfgang Munchau in today’s FT.
However the property bubble might have been worse then (4.5% interest rates rather than 15%). However there would have been limited or no foreign currency borrowing.
November 3rd, 2008 at 12:20 pm
Iceland was a testbed for the “free market” deregulation philosophy of Friedrich Von Hayek. Iceland was a Libertarian’s wet dream
Ha ha ha ha! Good one. Let’s see: When Iceland was doing well, it was a Nordic social democracy and its success demonstrated the benefits of social democratic policies. Now that Iceland has collapsed, it turns out the nation was actually “a libertarian’s wet dream,” but nobody realized.
You people need to get your story straight.
November 3rd, 2008 at 6:49 pm
Valuethinker,
Amen to that.
November 4th, 2008 at 2:34 am
Valuethinker,
Well yes but the banks still would have gone tits up. Still point well taken, though EU =/ the euro.
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