9 May 2018

The Nordic Tiger - Iceland's recovery

Rory writes:*

Iceland was one of the worst hit countries in the 2008 global financial crisis. In the years leading up to the crisis, banking had become one of the largest industries in the remote country. Why did this happen, how did it leave the Icelandic economy as exposed as its mid-Atlantic location, and how did Iceland recover so quickly (unlike Ireland and Greece) from the hit?

For centuries the Icelandic economy had been built upon its fisheries, however following deregulation around the millennium it allowed the Icelandic banking industry to crazy, offering far better interest rates to European countries than they could get at home. So this deregulation seems a bit of a double edged sword, whilst it allowed Icelanders the chance to make a decent living doing something other than metal smelting or fish farming, it also was the reason why in 2008 the Icelandic economy was somewhat put out to sea.

But the 2008 debacle is somewhat of a blip on Iceland’s story from salmon to success. One of the key factors in the recovery is that those in charge quickly realised that the recent success of the Icelandic financial industry had been nothing more than a bubble, they realised their models were unsustainable, so they let them fail, the Icelandic government let the big banks fall, and with them the entire economy as if they realised it would be better to build from a new. Learning what a lack of regulation could do, they quickly implemented strict financial regulation. But this would not have been possible without the ability to implement monetary policy, thanks to Iceland’s independent currency.

But I would be amis if I were to focus solely on the financial sector in talking about Icelandic economic growth and development. As I said thanks to a swift recovery the 2008 crisis was somewhat of a blip. That is because over the last couple of decades Iceland has achieved an amazing transformation, overcoming their comparative advantage in fishing and aluminium smelting to have their GDP dominated by tourism, renewable energy, and (naturally) the financial market. It seems they have done this by tapping into an undiscovered comparative advantage, in their environmental geography, allowing tourists incredible views and geothermally produced renewable energy, and in their political geography, a non-EU, non-Euro island with stable markets and investment opportunities.

Bottom Line: Iceland’s economic story is one of both under, and over regulation, however it has succeeded in unprecedented diversification and has learnt to sustainably exploit its drastic geography, a factor that had traditionally held it back.

* Please help my growth and development economics students by commenting on unclear analysis, other perspectives, data sources, etc. (Or you can just say something nice :)

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