As of this week, more than 27,000 Icelanders have signed a petition urging outgoing four-term President Ólafur Grímsson (who famously stood in the way of the U.K. and Netherlands collecting billions owed by one of Iceland’s failed banks) to seek an unusual fifth term in office—not an insignificant number in a country of just 320,000. And why not? Just over three years after Iceland’s economy imploded, the country is already showing early signs of recovery while the U.S. economy stagnates and countries in the EU grapple with painful austerity measures and a mounting debt crisis that threatens to rip the eurozone apart.
The remarkable turn of events in Iceland has, not surprisingly, caused some to wonder whether the country’s unorthodox handling of the 2008 financial crisis—refusing to bail out the banks and jealously guarding and even expanding social programs—represents a model for other countries faced with a similar calamity in the future. The International Monetary Fund, which lent Iceland US$2.1 billion, even co-hosted a conference with the government on the subject in Reykjavik last fall. “The suffering that so many of our citizens are facing is unnecessary,” wrote Nobel prize-winning economist Paul Krugman, who was one of the conference’s invited guests. “If this is a time of incredible pain and a much harsher society, that was a choice. It didn’t and doesn’t have to be this way.” Or does it?
There’s no question that Iceland has come a long way in a very short period of time. GDP is up three per cent, unemployment is below seven per cent (though still high by Iceland’s standards) and, last year, the government returned to the international financial markets with a US$1-billion sale of sovereign bonds. It’s a far cry from just over three years ago when normally peaceful Icelanders were rioting in the streets—the end result of efforts to remake the island’s economy into one that was built on financial wizardry instead of fisheries. Privatized in 2000, Iceland’s banks relied on their somewhat unknown, though not necessarily bad, reputation and high interest rates to sell foreign bonds, and were then tapped for loans by ambitious local businessmen who bought huge stakes in overseas assets. As the industry took off, Icelanders flocked to work in Reykjavik’s outsized financial district and drove Land Rovers through the streets. Several banks also began offering savings accounts to foreign depositors, a move that would later come back to haunt the tiny country. By the time the credit crunch hit, Iceland’s three largest banks held debts worth a staggering 10 times the GDP. The fallout wasn’t pretty.
Yet, while the U.S. and the rest of Europe were busy with the unpopular business of propping up failed banks with taxpayer dollars, Iceland headed in the opposite direction. It guaranteed the deposits of citizens, but refused to pay off many foreign investors. And even when the government tried to pass a bill that would pave the way for the repayment of some US$8 billion worth of deposits that angry U.K. and Dutch governments had covered for their citizens, Grímsson stepped in—not once, but twice—so that the deal could be put to a referendum. He later said the decision was an effort to reaffirm the importance of democracy and civil society in Iceland. “There were a lot of people who predicted it would be the downfall of Iceland, that we would be isolated in the world and become the Cuba of the North,” he told CBC Radio in a recent interview. “But the fact of the matter is, the people of Iceland twice were able to exercise their democratic will, and now Iceland is coming out of this crisis and establishing recovery earlier and more effectively than other European countries.”
But some question whether the response to Iceland’s collapse would work elsewhere, or whether anyone would actually want to try. Take, for example, the decision not to bail out the banks. Most agree Iceland simply didn’t have any choice. The sector’s debts, mostly in foreign currencies, were so great compared to the tiny country’s economy that guaranteeing them would have only made things worse. Iceland also benefited by not being part of the eurozone (though it now wants to join). The krona dropped like an anchor and gave export and tourism industries a boost, helping to offset some of the decimation of the financial sector. However, that came as small consolation to Icelanders who saw the cost of everyday items (most goods in Iceland are imported) skyrocket. “The current upswing is basically in spite of the government policies and almost entirely due to a substantial increase in the export value of fish products,” says Ragnar Arnason, an economics professor at the University of Iceland, who adds that the government has a vested interest in trumping up Iceland’s recovery in order to soothe the fears of foreign investors.
Though Arnason agrees with the government’s general response to the crisis, he argues that many foreign observers have conveniently ignored key details when they marvel at Iceland’s “recovery.” In particular, he says a decision to prolong strict capital controls, used to stabilize the country’s plummeting currency by preventing money from leaving the country (Icelanders who move away need permission to take their financial assets with them), now threatens the country’s key industries—the same ones that are supposed to lead Iceland back to economic health. “Basically, the currency controls distort economic prices and prevent Iceland’s budding export industries from developing,” he says.
Iceland may have transformed itself into a high-stakes global banking centre in just a few years, but unwinding the damage that wrought promises to take much longer.