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 Smith’s Insights • Wealth of Nations: Division of labour and free trade • Limited government • One’s profit not another’s loss • Coordination without commands

3. Index of Economic Freedom • Striking confirmation of Smith’s 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 Hayek’s longevity!