Iceland May Soon See a 2% Unemployment Rate

For a frigid country that’s preoccupied with elves and whose economy relies on the export of fish fillets, frozen fish, fish flours, fish meal, preserved fish and crustaceans, Iceland has done pretty well for itself.

While it was hit hard by both 2008’s global recession and its very own banking crisis, the Nordic state now boasts an unemployment rate that’s under 5% and likely to continue falling. In fact, according to Iceland’s 38-year-old prime minister, Sigmundur Gunnlaugsson, who recently spoke to Bloomberg News, the country's unemployment rate is on track to dip below 2%. Gunnlaugsson acknowledges that the number, “may sound strange to most other Western countries” but explains that, “Icelanders aren’t accustomed to unemployment.”

How did Iceland attain this feat — one that’s been praised by the International Monetary Fund and economist Paul Krugman alike? By letting its banks fail and prosecuting banking executives who broke the law.

The bubble that burst: The outlook for Iceland hasn't always been so rosy.

In the 1990s, former Icelandic Prime Minister David Oddsson prioritized the liberalization and diversification of Iceland’s fish-focused economy, leading up to the deregulation and privatization of the country’s banks just after the turn of the century. A banking boom ensued from 2002 onward, as Iceland’s institutions began to open themselves to the global market, and issue bonds and offer savings accounts abroad. By 2007, the banks’ assets were valued at almost 750% of the country’s GDP and Icelandic unemployment was, indeed, below 2%.

And then, in fall 2008, the country’s three largest banks — Kaupthing, Glitnir and Landsbanki — went bust. Credit markets dried up as foreign institutions faced their own liquidity crises, and the Icelandic banks proved unable to cover their debts. Given the banks’ astronomical growth, Iceland’s government simply couldn’t afford a bailout — by then, the banks were in hock for about nine times as much as the country’s economy was worth. All three banks went into receivership and were restructured as far smaller, domestic-only outfits.

And then? As outspoken Icelandic President Olafur Ragnar Grimmson famously put it:

In short, in order to get back on its feet, Iceland took IMF loans, but did so without the deep and divisive austerity measures — such as slashing welfare programs and government wages — that were required in countries like Greece. It also banned foreign currency loans, implemented capital controls, and allowed the Krona to lose value.

More importantly, rather than bailing out banks, it reformed and placed restrictions on the banking sector, such as limiting bonuses, and began prosecuting over 100 financial crimes. The CEOs of Glitnir and Kaupthing were convicted of breach of trust and market manipulation, respectively. The former was handed a nine-month sentence, while the latter has just begun his five-and-a-half years in jail.

Source: PolicyMic
January 2014

Unemployment Rate Falls to 4% in Iceland

Iceland let its banks fail in 2008 because they proved too big to save.

Now, the island is finding crisis-management decisions made half a decade ago have put it on a trajectory that’s turned 2 percent unemployment into a realistic goal.

While the euro area grapples with record joblessness, led by more than 25 percent in Greece and Spain, only about 4 percent of Iceland’s labor force is without work. Prime Minister Sigmundur D. Gunnlaugsson says even that’s too high.

“Politicians always have something to worry about,” the 38-year-old said in an interview last week. “We’d like to see unemployment going from where it’s now -- around 4 percent -- to under 2 percent, which may sound strange to most other western countries, but Icelanders aren’t accustomed to unemployment.”

The island’s sudden economic meltdown in October 2008 made international headlines as a debt-fueled banking boom ended in a matter of weeks when funding markets froze. Policy makers overseeing the $14 billion economy refused to back the banks, which subsequently defaulted on $85 billion. The government’s decision to protect state finances left it with the means to continue social support programs that shielded Icelanders from penury during the worst financial crisis in six decades.

Debt Relief

Of creditor claims against the banks, Gunnlaugsson says “this is not public debt and never will be.” He says his main goal while in office is “to rebuild the Icelandic welfare state.”

Though bank creditors, many of them hedge funds, are still trying to recoup their money, Iceland’s approach has won praise from the International Monetary Fund and from numerous economists, including Nobel Laureate Paul Krugman.

Successive Icelandic governments have forced banks to write off mortgage debts to help households. In February 2010, 16 months after Kaupthing Bank hf, Glitnir Bank hf and Landsbanki Islands hf failed, unemployment peaked at 9.3 percent. The rate was 4.2 percent in December, according to Statistics Iceland. In the euro area, unemployment held at a record 12.1 percent in November, Eurostat estimates.

“Even though the situation is a lot better here than in many other countries, having over 4 percent unemployment is something we don’t want,” said Gunnlaugsson, whose government was elected in April.

Welfare Spending

The government’s 2014 budget sets aside about 43 percent of its spending for the Welfare Ministry, a level that is largely unchanged since before the crisis. According to Stefan Olafsson, a sociology professor at the University of Iceland, the nation’s focus on welfare has been key in restoring growth.

The economy will expand 2.7 percent this year, according to the Organization for Economic Cooperation and Development. That’s better than the average for the OECD-area as a whole, which will grow 2.3 percent, the Paris-based group estimates.

Still, Iceland’s efforts to resurrect its economy have been far from smooth, Olafsson said. Inflation, which peaked at 19 percent in January 2009, has hurt Iceland more than most other countries because most mortgages are linked to the consumer price index. Though the set-up protects investors, households see their debt burdens grow as prices rise. Inflation was 4.2 percent in December.

Inflation Pain

“Although we’re spending more on welfare matters today than before, we have to keep in mind that purchasing power has gone down since 2008,” Olafsson said in an interview. “On top of increasing spending in the health care and education systems, the government should place emphasis on increasing people’s purchasing power. That’s the biggest single task.”

Most of Iceland’s inflation has come via the exchange rate, which has been protected by capital controls since plunging 80 percent offshore against the euro at the end of 2008. Gunnlaugsson says any efforts to scale back existing currency restrictions will only take place at a pace that safeguards krona stability.

“It is a problem that can be solved, and can be solved quite fast,” Gunnlaugsson said.

The krona has appreciated around 10 percent against the euro over the past 12 months. Still, today’s rate of about 157 per euro compares with an average of 88 in 2007, a year before the island’s financial collapse. It slid 0.04 percent to 157.02 as of 12:50 p.m. in Reykjavik.

To support households, Gunnlaugsson in November unveiled a plan to provide as much as 7 percent of gross domestic product in mortgage debt relief. The government intends to finance the plan, which the OECD has criticized as being too blunt, partly by raising taxes on banks.

Source: Bloomberg
Iceland24, January 2014