Economic history of Iceland

Agricultural modernization

Certain institutional arrangements in Iceland retarded the modernization of agriculture and the growth of non-agrarian sectors.^[4] One such institution was "the system of land tenures with its heavy obligations to landlords and insecure farm leases, which discouraged fixed capital investment on the farms. The other was a wide-ranging social legislation set up to regulate family formations and to maintain a balance between agriculture and the fishing sector in favour of the former. The most effective regulatory device was a stringent labour bondage which had few parallels in Europe."^[4]

Urbanization

According to University of Iceland economists Davíd F. Björnsson and Gylfi Zoega, "The policies of the colonial masters in Copenhagen delayed urbanisation. The Danish king maintained a monopoly in trade with Iceland from 1602 until 1855, which made the price of fish artificially low – the price of fish was higher in Britain – and artificially raised the price of agricultural products. Instead, Denmark bought the fish caught from Iceland at below world market prices. Although the trade monopoly ended in 1787, Icelanders could not trade freely with other countries until 1855. Following trade liberalisation, there was a substantial increase in fish exports to Britain, which led to an increase in the number of sailing ships, introduced for the first time in 1780. The growth of the fishing industry then created demand for capital, and in 1885 Parliament created the first state bank (Landsbanki). In 1905 came the first motorised fishing vessel, which marked an important step in the development of a specialised fishing industry in Iceland. Iceland exported fresh fish to Britain and salted cod to southern Europe, with Portugal an important export market. Fishing replaced agriculture as the country’s main industry. These developments set the stage for the urbanisation that was to follow in the twentieth century."^[5]

Food consumption

A 1998 study found that food consumption patterns differed from those in the rest of Europe: "The prominence of domestically produced dairy products, fish, meat and suet, and the insignificance of cereals until the nineteenth century, are among the most unusual features."^[6]

Growth of the fisheries sector

The fisheries sector in Iceland grew "with the expansion of Icelandic sailing smacks during the late nineteenth century which provided an intermediate stage between the traditional and modern technology. The mechanization of the fisheries got under way about 1905, although a few engines had been installed into small fishing boats before then."^[7]

Fisheries was an overwhelming share of the value of Iceland's exports in the early 20th century.^[8]

World War I

In the quarter of a century preceding the War, Iceland prospered. Iceland became more isolated during World War I and suffered a significant decline in living standards.^[9][10] The treasury became highly indebted, there was a shortage of food and fears over an imminent famine.^[9][10][11]

Iceland traded significantly with the United Kingdom during the War, as Iceland found itself within its sphere of influence.^[12][13][14] In their attempts to stop the Icelanders from trading with the Germans indirectly, the British imposed costly and time-consuming constraints on Icelandic exports going to the Nordic countries.^[13][15]

The War led to major government interference in the marketplace that would last until the post-World War II period.^[16]

The Great Depression

Icelandic post-World War I prosperity came to an end with the outbreak of the Great Depression, a severe worldwide economic depression. The Depression hit Iceland hard as the value of exports plummeted. The total value of Icelandic exports fell from 74 million kronur in 1929 to 48 million in 1932, and was not to rise again to the pre-1930 level until after 1939.^[17] Government interference in the economy increased: "Imports were regulated, trade with foreign currency was monopolized by state-owned banks, and loan capital was largely distributed by state-regulated funds".^[17] Due to the outbreak of the Spanish Civil War, which cut Iceland's exports of saltfish by half, the Depression lasted in Iceland until the outbreak of World War II when prices for fish exports soared.^[17]

World War II

The British and American occupations of Iceland caused an end to unemployment, and contributed to the end of the Great Depression in Iceland.

1945-1960

Iceland remained relatively protectionist during the period 1945-1960, despite its participation in the OEEC's Trade Liberalisation Program (TLP).^[18] Economic historian Guðmundur Jónsson attributes Icelandic protectionism in the post-WWI period to the "external shock caused by the war, creating an artificial economy internally and the overvaluation of the krona, made adjustment to peacetime circumstances extremely difficult. The task was made harder by a public policy prioritizing on growth and investment rather than balanced macroeconomic management. Last but not least, Iceland's commercial interests were not easily reconcilable with those of the other members of the OEEC because of her special pattern of trade."^[18]

1980s

The Icelandic economy was in an upswing in the mid-1980s.^[19] In 1987, the tax rates were temporarily reduced to zero.^[19][20]

1990s

In 1991, the Independence Party, led by Davíð Oddsson, formed a coalition government with the Social Democrats. This government set in motion market liberalisation policies, privatising a number of small and large companies. At the same time economic stability increased and previously chronic inflation was drastically reduced. In 1995, the Independence Party formed a coalition government with the Progressive Party. This government continued with the free-market policies, privatising two commercial banks and the state-owned telecom Síminn. Corporate incomes tax was reduced to 18% (from around 50% at the beginning of the decade), inheritance tax was greatly reduced and the net wealth tax abolished. "Nordic Tiger" was a term used to refer to the period of economic prosperity in Iceland that began in the post-Cold-War 1990s.^[21]

The welfare state

The social expenditure as a percentage of GDP in Iceland lagged considerably behind the social expenditures in the other Nordic states during the 20th century.^[22] There are two primary reasons in the academic literature for why Iceland lagged behind:

1. "The absence of a strong social democratic party" - Whereas labor unions were fairly strong in Iceland, votes on the left were split between several leftist parties, which meant that the leftist tendencies did not translate into political power.
2. "A stronger emphasis on individualism and self-help"^[22]

Icelandic financial crisis

The "Nordic Tiger" period ended in a national financial crisis in 2008, when the country's major banks failed and were taken over by the government. Iceland went from the fourth richest country in the world (GDP per capita) in 2007 to the 21st place in 2010.^[23] According to a 2011 study, Iceland privatized its banks in the early 2000s and the rapid expansion of the banking system, coupled with Iceland's small size, meant that the central bank was incapable of serving as the lender of last resort if a crisis were to occur.^[24] The banks made risky loans and manipulated markets.^[24] Iceland's regulators and public institutions were weak and understaffed, and were thus not properly regulating or supervising the banks.^[24] Political connections between senior bank managers, key shareholders and elite politicians meant that there was insufficient will to properly regulate the banks.^[24]

Following sharp inflation in the Icelandic króna during 2008, the three major banks in Iceland, Glitnir, Landsbanki and Kaupthing were placed under government control. A subsidiary of Landsbanki, Icesave, which operated in the UK and the Netherlands, was declared insolvent, putting the savings of thousands of UK and Dutch customers at risk.^[25] It also transpired that over 70 local authorities in the UK held more than £550 million of cash in Icelandic banks.^[26][27] In response to statements that the accounts of UK depositors would not be guaranteed, the British governments seized assets of the banks and of the Icelandic government.^[28] On 28 October 2008, Iceland's central bank raised its interest rate to 18 per cent to fight inflation.^[29]

Following negotiations with the IMF,^[30] a package of $4.6 billion was agreed on 19 November, with the IMF loaning $2.1 billion and another $2.3 billion in loans and currency swaps from Norway, Sweden, Finland and Denmark. In addition, Poland has offered to lend $200 million and the Faroe Islands have offered 300 million Danish kroner ($50 million, about 3 per cent of Faroese GDP).^[31] The next day, Germany, the Netherlands and the United Kingdom announced a joint loan of $6.3 billion (€5 billion), related to the deposit insurance dispute.^[32][33] The assistance bolstered the Central Bank of Iceland's foreign currency reserves, which was an important first step in the economic recovery.^[23] By the end of 2015, Iceland had repaid all the loans that it received in relation to the IMF program.^[34] The IMF did not impose the kind of strict conditions on the assistance as it had done in similar past situations in Asia and Latin America. According to economists Ásgeir Jónsson and Hersir Sigurjónsson, "Iceland was treated differently from developing countries and former IMF clients. There was no call for Iceland to adopt sharp austerity measures at the inception of the joint economic plan. Instead, the government would be allowed to maintain large public deficits in the first year – 2009 – allowing fiscal multipliers to counteract the output contraction that was underway. Iceland also was not asked to downsize its Scandinavian-type welfare system."^[35]

Iceland is the only country in the world to have a population under two million yet still have a floating exchange rate and an independent monetary policy.^[36]