The Strange Death of Liberal Iceland

1
The Strange Death of Liberal Iceland

• Hannes H Gissurarson
• Workshop on Economic Freedom
• Rio de Janeiro, 14/11/2008

2
Adam Smiths Insights

• Wealth of Nations Division of labour and free
  trade
• Limited government
• Ones profit not anothers loss
• Coordination without commands

3
Index of Economic Freedom

• Striking confirmation of Smiths theory
• Living standards highest in freest countries
• Economic growth fastest
• Quality of life best

4
Rawls Criterion

• Which system would we choose, not knowing our own
  position in it?
• Where worst-off best off (maximin rule)
• Index of EF Poorest best-off in freest countries

5
Share of Poorest 10
6
Income of Poorest 10
7
Rawls and Index of EF

• Worst-off defined as 10 poorest
• Best-off in freest countries
• Whether Rawls right or wrong, economic freedom
  powerful enough to meet his criterion
• Present state of affairs not only important, but
  also future opportunities

8
Economic Freedom in Iceland
Source Fraser Institute
9
Iceland No. 12
10
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

11
Main Facts

• Population 313,376 (1/1/ 2008)
• 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

12
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

13
1874-1940, Less than Denmark
Source Hagskinna (Gudmundur Jonsson)
14
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

15
Liberal Iceland 1991-2004

• Cutting subsidies
• Stabilising economy
• Liberalising markets
• Privatising
• Cutting taxes
• Developing property rights to natural resources
• Strengthening pension funds

16
Monetary Stability
Source Icelandic Bureau of Statistics
17
From Deficits to Surpluses
Source Icelandic Ministry of Finance
18
Fiscal Responsibility
Source Icelandic Ministry of Finance
19
Negligible Unemployment
Source Icelandic Ministry of Finance
20
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

21
Pension Fund Assets
Source OECD (Pension Markets in Focus, 2006)
22
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

23
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

24
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

25
Corporate Incomes Tax Cut
Source Icelandic Ministry of Finance
26
Example of Laffer Curve?
27
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

28
Overfishing with Open Access
Source H. S. Gordon, Journal of Political
Economy, 1954
29
Icelandic Debate on Fisheries

• How to reduce boats from 16 to 8?
• (a) Pigovian economists government auction of
  ITQs
• (b) Property rights theorists ITQs permanent,
  universal and freely transferable, initial
  allocation on basis on catch history
• (b) Pareto-optimal change No-one worse off

30
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

31
Fishing Firms Profitable
Source Icelandic Association of Fishing Vessel
Owners
32
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)

33
Risk of Poverty 2nd Lowest
Source Eurostat and Icelandic Bureau of
Statistics
34
Income Distribution
Source Eurostat and Icelandic Bureau of
Statistics
35
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?

36
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

37
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

38
Abuses 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

39
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!
• Landsbanki still on list
• Payments through London stopped
• Disastrous for an open economy like Iceland

40
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

41
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

42
From Versailles to Munich

• Gordon Brown trying to force Iceland to go beyond
  its legal obligations
• 100 of GDP
• German reparations payments after 1st WW 85 of
  GDP
• Iceland abandoned by the West, like
  Czechoslovakia in 1938

43
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 Hayeks longevity!