Speech on Iceland crisis - by Steingrímur Sigfússon
Mr SIGFÚSSON (Minister of Economic Affairs of Iceland) – First, thank you for the invitation; it is good to be back. I really enjoyed my work here in the Parliamentary Assembly, not least chairing the Committee on Equal Opportunities for Women and Men, but I was called back to other duties when the financial crisis hit Iceland hard in autumn 2008. I became Minister of Finance on 1 February 2009 in the midst of the crisis and the social and political turmoil that followed it.
I have built on my experience from that time, dealing with the sovereign debt crisis and the overall economic crisis. I tried to draw some lessons from that with relevance to the topic that is being discussed here today.
What happened in Iceland? Well, we had the traditional overheated economy, which had been growing rapidly for a number of years. The newly privatised banks took advantage of the free regulation to invest and expand their balance sheets all over Europe. They grew to an amazing number – 10 times the size of the Icelandic economy in a matter of a few years. Then they collapsed in the first week of October, following the fall of Lehman Brothers. No doubt they would have had some problems regardless.
What happened? We lost 85% of our financial sector in a matter of a few days. An emergency law was put in place allowing the authorities to move all deposits and assets from the failed banks over to new ones. Capital controls were introduced and, by mid-2009, 93% of the financial sector was gone. Our crisis was at least threefold. We had a banking and financial crisis, we had a currency crisis as the krona devalued by about 50%, and we had a major crisis in the building and contracting business, which had expanded during the bubble and which then came down very hard. Unemployment rose from practically nothing – from 1.5% to more than 9%. The sovereign debt accumulated from about 30% to 80% in one and a half years, and the net debt went from zero to more than 40%. The revenue fall was dramatic as expenditure rose through increased unemployment and higher interest payments on the accumulated debt. The interest payments rose from between 2% and 3% of the budget to 15% in two years. So all of a sudden, we had to take away 15% of the budget to pay the interest. The number of non-performing loans rose from the usual 1% to 2% in the banking sector to around 50%, so about half of all debt was not being repaid in the usual way.
In short, we fell victim to the extreme neoliberal exercise that was carried out in Iceland in the years before the crisis, and which came to a sudden, costly and painful end for the Icelandic population in October 2008. We entered into an International Monetary Fund programme. The economy contracted 6.8% in 2009 and an additional 4% in 2010, making a contraction of around 11% altogether. The deficit rose to about 14% in 2008 and about 10% in 2009. We were therefore dealing with a two-digit figure for sovereign debt.
So, what did we do? What actions did we take? In the middle of 2009, immediately after the elections, we took the first measures, both on the revenue and the expenditure sides. We did not wait, as had been intended. Many thought that we should allow the automatic stabilisers to work and wait for a while until things calmed down, but we did not do so. We immediately went in and took the first measures. That was followed by very tough budgets in 2010, 2011 and 2012. At the same time, the government made a firm commitment to preserve Iceland’s Nordic-style welfare system, and I believe that we have done so. I can honestly say that we have done all in our power to try to take society through this as softly as possible.
On the revenue side, we took extensive measures involving tax increases. We introduced a three-bracket private income tax, which put the burden on medium and high-income groups. We raised capital gains tax and corporate taxes. We introduced a CO2 tax and raised the taxes on alcohol and tobacco. In fact, there were very few things left that we did not raise a tax on in that way. We even introduced a wealth tax on the richest families.
We also took extensive measures on the expenditure side, but we designed them in such a way as to cut two to three times more in general expenditure and investments than in welfare expenditure. I believe that that was the socially right thing to do, and in Iceland’s case at least, it also turned out to be the economically wise thing to do. The fact that we were able to preserve the purchasing power of the lower income groups has definitely helped to carry the economy through.
We chose what we called a mixed approach, in which we acted on the revenue side and the expenditure side, as well as taking quite a lot of side measures to compensate those who were most affected. That was extremely important. To deal with unemployment, we introduced several programmes, not least those that made it feasible for young people to go to school and educate themselves instead of being unemployed. We transferred a lot of money from unemployment benefit to the education system, so instead of paying out unemployment benefits, especially to young people, they took that money with them into the education system. We have succeeded in bringing several thousand people out of unemployment and into school.
Iceland’s co-operation with the IMF was interesting. Iceland was running a rather unorthodox programme. In the light of what I have already said, how did the IMF react to that? We are often asked that question. The fact is that trust was built up as the IMF saw that we were serious about tackling the problems, and it became more at ease with the situation. It decided that it was up to us to design and adapt the programme to suit our needs. We said that we were going to preserve the Nordic welfare system, but that we would take measures to deliver the necessary economic results. The IMF said, “Okay, that’s up to you as long as you deliver.” And we have done so. In the light of the IMF’s past history, it has to be said that it showed a good degree of flexibility as things moved on.
How has it all worked out? We have brought the deficit down from that horrible two-digit figure to about 1.52% this year. We have a slight primary surplus on the budget this year, and we are aiming for a fully balanced budget in 2014. Unemployment has been reduced from around 9% to 6%. The latest figure, for May this year, is 5.6%. Growth is back; the economy grew 3.1% last year and we estimate economic growth of between 2.6% and 3% this year. We completed the IMF programme successfully at the end of August last year. We have already repaid more than 50% of the loans from the IMF, the Nordic countries, Poland and the Faroe Islands much earlier than expected. Iceland is back on the international capital markets. We issued US $1 billion in June 2011 at decent terms, and we repeated that this spring, with and additional US$1 billion with 10 years’ maturity in June this year.
We are not out of the woods yet, however. The debt burden still weighs heavily on households and certain businesses. Unemployment is of course too high by our standards, even though our figures would not amaze some European countries, and a lot of work remains to be done in many areas. The outlook is steadily improving however. What are the main lessons? First, do not wait. Act on the problems right away, otherwise they will just get worse. You only have a certain amount of time and support for doing the most difficult things, and if you do not do them early on, it becomes more and more difficult to carry them through. People get impatient and they want to see results. They are entitled to see the light at the end of the tunnel, and we must keep their hope and spirits up.
Secondly, if you have to apply for assistance and to work with international institutions, be it the IMF, the World Bank or the European Union, try to take as much ownership of the programme as possible. It is the key to success to be involved on your own terms. It is all very well to draw up a programme at a desk in Washington or Brussels, but the hard part is to execute it. That can be done only by the authorities at home.
Thirdly, try to preserve the welfare structures and to shelter the low-income groups and the weakest in society. Fourthly, choose the right mixture. In Iceland’s case, it was impossible to solve the problems through austerity alone or by raising taxes alone; we had to do both. It was a delicate matter to choose the right mixture and to include certain activating programmes to support growth and create jobs at the same time.
Fifthly, you must try to explain to the population what you are doing and why you have to do it. Try to get people to understand that what is being done is necessary. If you do not do it now, someone else will have to do it later. There is also a question of responsibility. Do we as a generation shoulder the burden of these events, or do we defer the bill to the future and expect our children to pay it?
Sixthly, a lot has to be done in the financial system. We cannot have a system that constantly privatises the gains and socialises the losses. That is an awful system. Why on earth should we – ordinary people, the taxpayers – pay when financial institutions get into trouble? They see it as perfectly normal to take the gains themselves, paying outrageous bonuses and salaries in the good times, so-called. Many of these practices, such as the short-sighted gains-based bonuses, turned out to be extremely harmful, and in my mind they should be abolished or banned. There is therefore still a lot to do if we do not want a repeat of what has happened in 10, 20, 30 or 50 years.
Anyway, the main lesson of all this is: do not give up. These problems can be tackled. They can be solved, and they must be. There is hope and light at the end of the tunnel.
- Text auf Deutsch: Es geht auch anders: Islands Umgang mit der Finanz- und Wirtschaftskrise