The Icelandic Economic Miracle

1
The Icelandic Economic Miracle

• Hannes H Gissurarson
• Professor of Politics
• University of Iceland

2
Adam Smith No Miracles

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

3
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

4
Main Facts

• Population 307,672 (1/12/ 2006)
• 103,000 sq. km (same as East Germany)
• GDP per capita (PPP) 2004 33,641
• GDP per capita (PPP) 2005 36,363
• Main exports fish, aluminium, financial services

5
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

6
1874-1940, Less than Denmark
Source Hagskinna (Gudmundur Jonsson)
7
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

8
The Icelandic Model 1991-

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

9
Monetary Stability
Source Icelandic Bureau of Statistics
10
From Deficits to Surpluses
Source Icelandic Ministry of Finance
11
Fiscal Responsibility
Source Icelandic Ministry of Finance
12
No Unemployment
Source Icelandic Ministry of Finance
13
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

14
Pension Funds Large Assets

• 2005, total assets of occupational pension funds
  1,200 billions ISK, 120 of GDP
• 2004, private pension schemes savings 13 billions
  ISK
• 2004, public pension fund paid out 19.3 billions
  ISK occupational pension funds 20.4 billions (to
  90 of pensioneers)
• 2004, average individual pension about 2,000 per
  month (154,000 ISK)

15
Pension Fund Assets
Source OECD (Pension Markets in Focus, 2006)
16
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

17
Tax Cuts

• Corporate incomes tax from 45 to 18
• Individual incomes tax from 30.41 to 22.75
• Turnover tax abolished
• High-incomes incomes tax abolished
• Net wealth tax abolished
• Death duties (estates tax) reduced

18
Corporate Incomes Tax Cut
Source Icelandic Ministry of Finance
19
Example of Laffer Curve?
20
1992-2008 Share of GDP 32
Source Icelandic Ministry of Finance
21
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

22
Overfishing with Open Access
Source H. S. Gordon, Journal of Political
Economy, 1954
23
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

24
Efficient Fisheries

• Initial allocation on basis of catch history
  meant 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

25
Fishing Firms Profitable
Source Icelandic Association of Fishing Vessel
Owners
26
Strong Financial Sector

• Since 2002, total turnover of banks increased
  more than 7-fold
• 2005, total assets of banks 7,700 billions ISK,
  7-fold GDP
• 2005, net worth of banks 530 billions ISK, about
  50 of GDP in 2000, net worth 7 of GDP
• More than 50 of total income from abroad

27
Change of Icelandic Economy
Source Icelandic Bureau of Statistics
28
Whence Came the Money?

• First ITQ system
• Second Capital gains from privatisation
• Hernando de Soto Previously dead capital
  became registered, transferable, and usable as
  collateral
• Third Pension funds

29
The New Vikings Ventures

• Brewery in Russia, sold to Heineken
• Arcadia, sold to investors
• Actavis investments in Bulgaria and Malta
• Bakkavors acquisition of Katsouris Fresh Food in
  United Kingdom
• Kaupthings acquisition of Danish and Dutch banks
• Novator investments in Eastern Europe

30
Economic Growth in Iceland
Source Icelandic Bureau of Statistics
31
10 Richest Countries, 2006
Source World Fact Book
32
All Incomes Groups Benefit

• 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
1996-2000 Lowest 10 Income
Source Icelandic Bureau of Statistics (Stefan
Olafsson) OECD (Michael Förster)
34
Risk of Poverty 2nd Lowest
Source Eurostat and Icelandic Bureau of
Statistics
35
Income Distribution in Europe
Source Eurostat and Icelandic Bureau of
Statistics
36
Rawls Worst-Off Best-Off

• Which system would we choose, if we did not know
  our own position in it?
• Where worst-off best off (maximin rule)
• Chosen neither the Nordic nor the Anglo-Saxon
  model, but the Icelandic?

37
The Way Ahead

• Cutting corporate incomes tax to 10
• Cutting personal incomes tax
• Cutting VAT
• Cutting import charges
• Continuing privatising
• In place of enforced equality, creating
  opportunities