ICELANDIC CAPITAL ACCUMULATION & THE 2008 CRISIS

AN ANALYSIS OF ICELAND'S ECONOMIC HISTORY, THE 2008 CRISIS & A NEW EMERGING
SOCIAL STRUCTURE OF ACCUMULATION

BY: JORDAN HANNA 7667607

ECON 2550 POLITICAL ECONOMY II PROF. F. BARAGAR UNIVERSITY OF MANITOBA APRIL 5TH, 2013

As a small, isolated island in the North Atlantic, Iceland as a capitalist economy has experienced a fairly rapid rate of growth and development in such a short time. By adopting popular neoliberal ideologies in the market, the small nation began to expand into foreign markets, establish a robust financial sector and establish both monetary and fiscal policies, which provide a solid foundation for quality of life for the population, a social structure for accumulation and opportunity for substantial foreign investment. This paper will look at the twenty-five year economic development of Iceland, how it contributed to capital accumulation and if that perhaps contributed to vulnerabilities during the 2008 economic crisis. With those in mind we can also analyze Iceland post-crisis if a new social structure of accumulation did in fact emerge, and if any lessons were to be learnt from the economic disparities.

I CELAND S ECONOMIC DEVELOPMENTS SINCE 1990

1990-2000
The economic developments in Iceland really began to shift greatly in the early 1990s. Iceland had adopted neoliberal market characteristics; particularly privatization of financial institutions, market deregulation and full integration into the global economy.1 These initial components of an emerging social structure of accumulation (SSA) provide a first step monetizing and incorporating Iceland into the global economy. Full market liberalization did not occur until full privatization of state-owned banks in 2003, but much earlier than that there was immense pressure from the European Union (EU) upon Iceland to conform to their economic framework and become a part of the EU. Incorporation into a new global arena meant a need for a financial market, and exchange rate policies for the Icelandic currency, the Krona. However, this created an issue with exchange rates, fiscal and monetary policies. But Iceland has had a strong and practical use of previous monetary and exchange rate policy manipulation to overcome such challenges, particularly in the 1980s when the 12-month rate actually

exceeded 100%.2 Tighter monetary restrictions and limits on exchange rate flexibility provided proper disinflation results that allowed Iceland to continue economic growth. With the global economy recovering from recession and a major shift to neoliberalism, the Eurozone began to pick up in economic development and investment. In the 1990s Iceland's economy was heavily based upon fish exports; to give that some breadth, the Icelandic fishing economy overtook the UKs marine economy by the middle of the decade. Fishing and their ancillary commodities constituted a 78% GDP share between 1990-1994.3 This meant at the time for accumulation that Iceland had a) a comparative advantage on fish market in the Northeast Atlantic and b) a disadvantage in not diversifying the economy into other sectors; if a drop in fish stocks were to occur, Icelandic output would be hit very hard. One thing contradictory in Icelandic policy is to host liberalization of markets and finances, but have much more stringent environmental, egalitarian and conservative measures. For example, the late 1990s
Were characterized by a slow improvement in the social welfare system in conjunction with more favourable economic development, high economic growth rates, a reduction in unemployment and budget surpluses leading to a more lenient fiscal policy. Social benefits became less earnings-related and benefits were increased in real terms, although not as much as wage-earners incomes.4

Although Iceland had a powerful marine economy, their conservation policy placed a limit on catches, or quotas upon how much can be harvested.5 When stocks replenished and when Iceland moved heavier into aluminum extraction, the economy began to expand. Expansion thus provoked further liberalization, particularly the credit market to allow for capital mobility and liquidity and incentivize loaning and investment. The only limit in the newly liberalized market, however, was nonresidential investment into fisheries and fish processing and the energy sector which was boasting growing amounts of untapped potential for hydro and geothermal energies.

2000-2008
The twenty first century showed a new, advanced and robust capitalist Iceland, which became much stronger economically in the last decade. The depreciation of the Krona in 2000 led to a rise in inflation rates, peaking at roughly 12% inflation in early 2001, prompting a new monetary framework to be established. The main objective of the Central Bank was to focus on price stability. To combat the price instability, interest rates rose from 6.9% in 2001 to over 12% by 2007; the government had abolished the old exchange rate target and established a new inflation target.6 The Central Bank, which had made extensive loans in wholesale markets such as the JPY, EUR and CHF, were functioning to expand domestic savings availability.7 Because of high interest rates compared to the rest of the Eurozone, foreign investors held onto their deposits, which did lead to an inflation of the Krona. Although profitable for those foreign investors, it creates an economic bubble for Iceland, meaning long-term that the value of the Krona had been greatly overestimated to its true value. Fiscal policy in Iceland had an impact on profitability and expansion of the economy, following neoliberal ideologies. First are the tax rates on corporations and labour. Tax rates on corporations were reduced after a fourteen-year period at 50% to only 18% in 2003.8 This improves the profit rate of firms, encouraging further reinvestment into the Icelandic market and to expand further. For labour, personal income taxes were reduced from 25.75% in 2004 to 22.75% in 2007; this was also accompanied by the abolishment of high-income surcharges in 2006.9 Tax reduction for labour and subsequently households promotes confidence to borrow from banks, to spend disposable income and to remain confident in the market, particularly house values. Second in fiscal policy is the promotion of the welfare state. A full pension fund was established as well as a properly trained and fully employed workforce. With low unemployment and an aging population with a larger disposable income, the treasury was able to see returns in terms of taxes collected from goods and services, translating to a 4% increase in economic growth in real terms since 1990.10 Icelandic fiscal policy up until the 2008

economic crisis, therefore, greatly promoted favorability for capital accumulation, which contributed greatly to corporate incomes, reduction in household burden of debt and to incentivize lending. Three main banks - Glitnir, Kaupthing, and Landsbanki, dominated the Icelandic financial system. As growing parts of a newly affluent and productive Iceland in the twenty first century, the three banks began great expansion and consolidation of assets. Financial consolidated assets of the banks expand[ed] from 100% of Icelandic GDP in 2004 to almost 900% at end-2007. By end-2007, over 50% of the banks assets were held abroad in branches and subsidiaries, principally in the Nordic countries and the U.K.11 This meant that banks could overcome domestic constraints in terms of capital assets, but would also double the foreign debt already incurred over the last twenty years. The banks handled large amounts of assets from wholesale markets, but because of such dependence on having all their eggs in one basket created a source for concern, particularly during global economic turmoil began to surface in mid-late 2007. In terms of the rate of profitability and ability to accumulate capital, the three financial institutions were making large amounts of profits, coupled with large returns on equity. This is evident by the 900% asset-to-GDP ratio of the banks assets; it reflects a large foreign expansion of credit and wholesale involvement on the behalf of Icelandic banks.12 Recall that approximately 50% of the financial institutions assets are overseas, and primarily those assets are used to refinance debt, or are repossessed by central banks of the state. With all eggs in one basket, if the external market degrades further, as it does moving into 2007 and on, Iceland will face serious debt obligations.13

V ULNERABILITIES TO THE 2008 CRISIS

The SSA that had been in place since the 1990s had began to erode away at itself in Iceland. The primary causes are the deregulation and privatization of the three main banks, and the ensuing monetary policy and governmental action. Banks became deregulated in 2001 and subsequent financial

privatization in 2003, allowing the profit motive to take on the course of Icelandic finance. In The Global Minotaur, author Varoufakis lays out several basic explanations for why the crisis in the US was prompted, and these are just as easily applied to Iceland. Most important to be covered is the irrepressible greed of the financial sector. Privatization means simply that the firm is privately owned, to motive is to make as much off of interest, transactions and payments as possible and provide a favorable return for shareholders. The financial sector received such low tax cuts 50% down to roughly 18% over a few years and full deregulation, that the pursuit of profitability caused instabilities in the social structure of accumulation. The explanation is predicated upon if activities in the market lead to excesses or mistakes, the role of state is to be ready & able to intervene to repair and make corrections, which means that for banks theres no incentive not to go after optimal amounts of profitability; they think they are too big to fail and that the government has a duty to intervene in such circumstances.14 This compounded by the fact the housing bubble in the US was about to burst, the profit motive put Iceland in a very vulnerable position in terms of credit market losses. 200015 9.5% $8.7 Billion 95% 4.5% 2008 18% $20.4 Billion 103% 18% Change + 8.5% + 234% + 8% + 13.5%

Interest rates GDP Household debt (of GDP) Inflation rate

As the table above shows, changes were made to affect these indicators. Specifically, foreign debts by way of the banking sector contributed greatly to these numbers. With so much domestic assets being swapped to foreign wholesale markets, it a) greatly overestimated the Krona, and b) caused inflation to increase because of the overestimation in currency value. Because of lower interest rates until its rise by 2005, the incentive to make loans for households increased. This allowed for increased

consumption, but also an increase in household debt against GDP. Again inflation did not rise until about 2006, but once it did increase the cost of living also increases; this means each dollar of household debt places a greater burden of debt upon them. The SSA that spanned from 1990 to 2008 produced a few results. First, it obviously greatly improved economic diversification, strength and growth. Second, the SSA promoted neoliberal ideology that did in fact make Iceland vulnerable to a US-led economic crisis, as evident by the change in household debts, inflation rates and the increase in unemployment from 2% to 9.5%.16 Iceland saw great benefits but also a great cost conforming to these policies. Subsequently, Iceland has made great changes, and a change in the social structure process of capital accumulation.

T HE E MERGENCE OF A N EW SSA IN I CELAND

After the rapid rise and precipitous fall of the Icelandic economy, the question remains has the small Nordic country put in place new systems to promote accumulation that are different than the neoliberal ideologies adopted two decades prior? In short, yes, there has been a new social structure of accumulation, most of which oppose the neoliberal approach. Regulation of finance, nationalization of banks and being more stringent on monetary policy are among the restructured policies following the crash. After the fall of the three largest Icelandic banks, an intense investigation emerged pertaining to what caused the banks to default. In addition to previously discussed large amounts of foreign assets (50% of assets), employees and executives who would take out loans from their banks to reinvest into stocks of the very same banks.17 These banks were quickly nationalized by October 2008, being absorbed by a financial supervisory authority based in Iceland. Heavy regulation has been put in place to ensure this corrupt and self-interested behaviour is eliminated; the malpractice of banks that coincided with the economic crisis led to an economic collapse that was comparatively the worst in modern history.

Fiscal policy was put into place following a $10 Billion IMF stimulus package to help promote a reestablishment of Icelandic finance and to fund welfare programs such as to help unemployment and kick start lending again.18 Unemployment rose to 9.3%, an all time high, but with the IMF loans allowed unemployment to decrease to below 7.8%.19 Monetary policy changed to reduce inflation from the 18% peak down to roughly 3% within a small two-year span, which trended very closely to interest rates going from 18% down to 4% in the same period.20 The cumulative effects of banking nationalization, monetary and fiscal policy and finally financial investigation and regulation that allowed a new social structure of accumulation to emerge after such a severe economic crisis.

C ONCLUSION
Within a thirty year span Iceland experienced large economic prosperity followed by the comparatively largest economic crash in history. Neoliberal economic ideology fueled great initial accumulation of capital, but neglected important indicators of an impending economic crisis, including modest economic growth, low inflation rates, greater profitability, growing household debts and most of profits being allocated to the banking and financial sectors.21 It is the unregulated and privatized nature of the banking industry that pulled Iceland into an economic downturn, and in turn had to be nationalized subsequently. Iceland has improved somewhat, currently at approximately 80% of its precrisis peak in terms of GDP. The newly regulated and government overseen finance sector is still a profitable for investors and the population and apart of a manageable economy, but the strings have been tied and the check stops will only become more legitimized with time.

The Central Bank of Iceland, The Economy Of Iceland, November 2005, published by The Central Bank of Iceland, http://www.cb.is/library/Skr%C3%A1arsafn/Economy-of-Iceland/November%202005.pdf, 16. 2 Ibid. 3 John Pike, Iceland Economy, Global Security, 2011, http://www.glo balsecurity.org/military/world/europe/iseconomy.htm. 4 Gudmundur Jonsson, The Icelandic Welfare State in the Twentieth Century, 2001, Accessed On April 1 st 2013, http://uni.hi.is/gudmjons/files/2010/05/2001-Icelandic-welfare-state-in-the-20th-century.pdf, 264. 5 The Economy Of Iceland, 22. 6 Central Bank of Iceland, Central Bank Interest Rates, Excel Document, Accessed on April 2 nd 2013, http://www.cb.is/statistics/interest-rates/. 7 Todd Fawley, Yan Phoa, The Icelandic Economy: Icebergs Ahoy!, 2009, 3. 8 Thorsteinn Glaerur, Fiscal Policy in Iceland and the Challenges of Globalization, IMF Conference in Reykjavik, PowerPoint Presentation, 2007, slide 5. 9 Ibid. 10 Ibid, slide 12. 11 International Monetary Fund (IMF), Iceland: Financial System St ability Assessment Update, Washington, D.C., Dec 2008, 5. 12 Ibid, 11. 13 Ibid, 12. 14 Yanis Varoufakis, The Global Minotaur, New York: Zed Books, 2011, 10. 15 Trading Economics, Iceland National Statistics, Accessed on April 3 rd 2013, Various Indicators, http://www.tradingeconomics.com/iceland/indicators. 16 Ibid. 17 Rowena Mason, Iceland Banking Inquiry Finds Murky Geysers Runs Deep, The Telegraph, April 13th 2009, http://www.telegraph.co.uk/finance/financialcrisis/5145969/Iceland-banking-inquiry-finds-murky-geysers-runs-deep.html. 18 CIA, Iceland World Fact Book, Central Intelligence Agency, 2013, https://www.cia.gov/library/publications/the world-factbook/geos/ic.html 19 Trading Economics, Statistics. 20 Ibid. 21 Prof F. Baragar, Summary of Economic Indicators, lecture, march 4 th 2013.
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