Iceland vs. Greece: could Iceland be the role model for Greece? with Eva Önnudóttir & Spyridoula Nez

Aug 16, 2017 by

by Patricia Polderman & Alex Lantos

The two countries were both heavily affected by the 2008 Financial Crisis that originated from the mass default of subprime mortgage loans in the United States. Both crises essentially began with a political announcement, be it Iceland’s former Prime Minister revealing the country’s failing financial system with the unprecedented closing phrase “God bless Iceland” or the newly elected Greek government’s disclosure of the previous government’s underreporting of the country’s public debt stock. Although the timing of the crises originated here, the issues revealed grew out of very different corners of the economy. In the years preceding the crisis, the interest rate on Greek government bonds had converged with that of more reliable economies such as Germany as a result of their entry into the European Union. As such, their costs of borrowing greatly declined, thereby allowing the nation to accumulate debt at a much faster rate. The problem was, however, that this borrowed money was not invested in productive parts of the economy but was channelled into the public sector where corruption was ripe. Upon the political announcement of the misreporting, investor confidence in the country’s ability to repay its debt faded, leading to the self-fulfilling crisis.

There are two core similarities in the way the crisis was dealt with. Importantly, both countries received rescue packages from the International Monetary Fund (IMF) with Iceland being the first Western country to receive such a package. The receipt of these packages was conditional on the implementation of austerity – raising tax rates and decreasing public spending – in order to approach fiscal consolidation. The economic effectiveness of the packages, however, differed greatly across the two nations: while Iceland recovered soon after, Greece required two additional packages in subsequent years. Two factors can explain the discrepancy in the effectiveness of these outcomes. Firstly, because Iceland was not part of the EU and had its own floating currency the krona, the capital outflows from the country caused a depreciation in its exchange rate, thereby boosting the country’s exports. Since Greece had the euro as an EU Member State, it had no such mechanism to soften the blow of the crisis. This is one of the limitations the critics of the EU often highlight. Since it is only a monetary union but not a fiscal union, no redistribution mechanism exists that could aid periphery countries, as there exists in the United States. Secondly, the funds channelled to Greece were directly transferred to core country banks and insurance companies to repay debts, whereas those going to Iceland were channelled into its economy. Naturally, these measures were highly unpopular amongst the citizens of the countries, causing a variety or revolts.

Importantly, however, differences remain. Iceland has developed a completely different and new perspective after the crisis of 2009. The country released a dominant position to the financial sector, informing financial creditors about their plan to focus on their own productive economy, such as tourism, instead of focusing on repaying their debts. This was partially made possible with the loans provided by some assisting Scandinavian countries, thereby reducing the severity of the country’s debts. The strategy used the realisation that citizens that are unworried by financial concerns are also able to contribute better to the economy. More than five years later, the Icelandic economy has not only recovered, but has surpassed the performance of various countries within the Eurozone.

Similarly, a solution also exists to remedy the Greek economy. The austerity measures that were imposed on Greece were relatively unprecedented, harming the economy further and pushing the country deeper into debt. Even during the 1950s, German War reparation payments were only collected once the nation achieved a certain income threshold, thereby allowing the economy to rebound before collecting the debts. A similar approach should be implemented in the case of Greece. This would allow investor and consumer confidence to also rebound, thereby boosting both consumption and investments within the country and allowing it to be restored to its former state.