Transcript The Icelandic Economic Miracle - Hannes Hólmsteinn Gissurarson

The Strange Death
of Liberal Iceland
Hannes H Gissurarson
Workshop on Economic Freedom
Rio de Janeiro, 14/11/2008
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
Index of Economic Freedom




Striking confirmation
of Smith’s theory
Living standards
highest in freest
countries
Economic growth
fastest
Quality of life best
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
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
Least Free
Quartile
3rd Quartile 2nd Quartile
Most Free
Quartile
Income Share Held by Lowest 10%,
1990-2006
Share of Poorest 10%
$10,000
$9,000
$8,000
$7,000
$6,000
$5,000
$4,000
$3,000
$2,000
$1,000
$0
Least Free
Quartile
3rd Quartile 2nd Quartile
Most Free
Quartile
Income Level of the Poorest 10%,
1990-2006
Income of Poorest 10%
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
Economic Freedom in Iceland
Economic Freedom
Iceland
9
8
7
6
5
4
3
2
1
0
7.4
7.7
7.6
7.7
7.8
7.9
7.8
2000
2001
2002
2003
2004
2005
2006
6.6
6.3
1970
7.8
4.8
5.1
5.3
1975
1980
1985
Source: Fraser Institute
1990
1995
Iceland No. 12
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
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: $38,396
Main exports: fish, aluminium
874-1874, One of the Poorest




Could only sustain 50,000 people
Famines until 19th century; then
emigration to America
Poverty unfairly blamed on Danish
colonial rule
Agriculture held down fisheries; ruling
farmers hindered development of
resources
1874-1940, Less than Denmark
Iceland
Denmark
GDP per capita in 1990 US$
7.000
6.000
5.000
4.000
3.000
2.000
1.000
0
1870 1878 1886 1894 1902 1910 1918 1926 1934 1942
Source: Hagskinna (Gudmundur Jonsson)
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
Liberal Iceland 1991-2004







Cutting subsidies
Stabilising economy
Liberalising markets
Privatising
Cutting taxes
Developing property rights to natural
resources
Strengthening pension funds
Monetary Stability
Inflation in %
90
80
70
60
50
40
30
20
10
0
1980
1983
1986
Source: Icelandic Bureau of Statistics
1989
1992
1995
1998
2001
2004
From Deficits to Surpluses
8
Deficit/surplus % of GDP
6
4
2
0
-2
-4
-6
1988 1990
1992 1994 1996
Source: Icelandic Ministry of Finance
1998 2000
2002 2004
Fiscal Responsibility
Iceland Net Public Debt
OECD Net Average Public Debt
50
45
40
% of GDP
35
30
25
20
15
10
5
0
1998
1999
2000
2001
Source: Icelandic Ministry of Finance
2002
2003
2004
2005
2006
2007
Negligible Unemployment
Iceland
OECD
8
Unemployment in %
7
6
5
4
3
2
1
0
1998
2000
Source: Icelandic Ministry of Finance
2002
2004
2006
2008
2010
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
Pension Fund Assets
10 Largest Pension Fund Assets OECD 2005
Denmark
Canada
Ireland
Australia
Finland
United Kingdom
United States
Switzerland
Iceland
Netherlands
0
50
% of GDP
Source: OECD (Pension Markets in Focus, 2006)
100
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
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
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
Corporate Incomes Tax Cut
Tax Revenue, Billions ISK
Tax Rate %
35
50
40
25
35
30
20
25
15
20
15
10
10
5
5
0
0
1991
1993
1995
Source: Icelandic Ministry of Finance
1997
1999
2001
2003
2005
2007
Tax Rate in %
Tax Revenue, Billions ISK
45
30
Example of Laffer Curve?
Tax Revenue in $
120
100
80
60
40
20
0
Tax Rate in %
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
Overfishing with Open Access
Total Cost
Total Revenue
120
100
80
60
40
20
0
0
2
4
6
8
10 12 14 16 18 20
Fishing Effort (Number of Boats)
Source: H. S. Gordon, Journal of Political Economy, 1954
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
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
Fishing Firms Profitable
Inflation-adjusted Profit/Loss
20
15
10
5
0
-5
-10
-15
1981 1984 1987 1990 1993 1996 1999 2002
Source: Icelandic Association of Fishing Vessel Owners
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)
Risk of Poverty 2nd Lowest
Slovakia
Denmark
Austria
Finland
Netherlands
Norway
Czech Republic
Slovenia
Iceland
Sweden
0
2
4
6
8
10
% at risk of poverty
Source: Eurostat and Icelandic Bureau of Statistics
12
14
Income Distribution
0.4
0.35
0.3
0.25
0.2
0.15
0.1
0.05
0
Sweden Denmark
Finland
Norway
Ireland
Gini Coefficients in 2004
Source: Eurostat and Icelandic Bureau of Statistics
United
Kingdom
Iceland
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?
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
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
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 antiterrorist laws against Icelandic banks
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
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
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“
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
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!