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The Icelandic Economic Miracle

Explore the historical highlights and main facts of Iceland's economic transformation, from poverty to prosperity, through reforms like privatization and tax cuts. Learn how the country overcame challenges to achieve monetary stability and sustainable growth.

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The Icelandic Economic Miracle

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  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 • One’s profit not another’s 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 • Bakkavor’s acquisition of Katsouris Fresh Food in United Kingdom • Kaupthing’s 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

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