Iceland: Bailed No One, Stiffed Creditors and Recovering Nicely

Four years after the collapse of the global economy, there are some glimmers of hope emerging from the doom and Iceland is one such sparkler. This tiny island nation has gone from 10 straight quarters of declining gross domestic product (GDP) to multiple consecutive quarters of GDP growth.

Consequently, Iceland provides the most recent example of a government that took some dramatic, and ultimately successful, steps to drive its economy back into the growth lane. However, it can be argued that while some of these actions could be successfully duplicated in other nations, no one country is likely able to replicate all of them thereby leaving Iceland as an interesting and unique case-study.

Iceland’s economic collapse in 2008 preceded that of other European nations and its government took three major steps to counter the decline: it let its privately held banks fail, enforced capital controls and did not implement austerity measures – but did reduce government spending.

Of all these decisions, the one to let the private big banks fail was probably the most controversial. Iceland’s president recently stated that banks should be treated no differently from telecommunication or railway companies and the government certainly followed that mantra.

The immediate impact of this decision was quite dramatic. As local and overseas investors lost all their funds, capital flew out of the country and unemployment grew to 10 percent. Since some investors were citizens of the United Kingdom and Denmark, the Icelandic government’s action caused London and Copenhagen to first demand and then sue for their funds.

Iceland, who is not a member of the European Union (EU), adamantly refused, forcing the British and Dutch governments to make up for the losses, costing them approximately $5 billion. Both countries, by the way, lost their cases for reimbursement against Iceland in the European Free Trade Association Court as it ruled in Reykjavik’s favor on March 28, 2013.

Clearly, this is something that cannot be duplicated by other major nations. For example, if the United States were to follow Iceland’s lead, it would first be liable for the FDIC-limit funds resulting in significant costs. In addition, Washington would have to manage the significant impact these failures would have had on the confidence in the US banking system.

Iceland, however, was able to use the monetary savings from this decision to implement social spending measures which were infinitely more popular and necessary. In addition, since it doesn’t belong to the EU, Iceland could devalue its currency – by 50 percent – and implement capital controls. The former decision helped improve the value of its exports initiating the first embers of recovery. The layoffs also helped companies recruit skilled employees at low wages and the country’s abundant cheap energy helped reduce production costs.

The GDP growth, however, does not mean that life is all wine and roses for the country’s residents. Reykjavik’s decision to impose 100 new taxes, reduce expenditures and lower wages continue to bedevil the Icelanders. Many hold multiple jobs but on a positive note, at least they can find work.

Iceland’s economic growth is based on substantive industries and this can translate the current slow growth into a sustained uptick. This is especially important since production costs will rise, Iceland – if it joins the EU – will face more regulatory pressures and competition will increase. On the other hand, Reykjavik’s decision to let investors flail in the wind will leave a bad taste in their mouth for a long time and, unless Iceland can continue to grow using just its own resources, lead to fund raising problems in the future.