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The Icelandic Economic Miracle

The Icelandic Economic Miracle. Hannes H Gissurarson Professor of Politics University of Iceland. 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. Historical Highlights.

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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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