The Strange Death of Liberal Iceland Hannes H Gissurarson Workshop on Economic Freedom Rio de Janeiro, 14/11/2008

Adam Smith’s Insights Wealth of Nations: Division of labour and free trade Limited government One’s profit not another’s loss Coordination without commands

Index of Economic Freedom Striking confirmation of Smith’s theory Living standards highest in freest countries Economic growth fastest Quality of life best

Rawls’ Criterion Which system would we choose, not knowing our own position in it? Where worst-off best off (maximin rule) Index of EF: Poorest best-off in freest countries

Share of Poorest 10%

Income of Poorest 10%

Rawls and Index of EF Worst-off defined as 10% poorest Best-off in freest countries Whether Rawls right or wrong, economic freedom powerful enough to meet his criterion Present state of affairs not only important, but also future opportunities

Economic Freedom in Iceland Source: Fraser Institute

Iceland No. 12

Historical Highlights Settled Commonwealth Under the Norwegian, later Danish, king Home rule 1904 Sovereignty, in a personal union with Denmark, 1918 Republic, 1944

Main Facts Population 313,376 (1/1/ 2008) 103,000 sq. km (same as East Germany) GDP per capita (PPP) 1992: $21,278 GDP per capita (PPP) 2004: $33,372 GDP per capita (PPP) 2007: $38,396 Main exports: fish, aluminium

, One of the Poorest Could only sustain 50,000 people Famines until 19th century; then emigration to America Poverty unfairly blamed on Danish colonial rule Agriculture held down fisheries; ruling farmers hindered development of resources

, Less than Denmark Source: Hagskinna (Gudmundur Jonsson)

, False Prosperity Profits, both in hot and cold war Wider resource base by four extensions of EEZ, finally to 200 miles in 1975 Overfishing, first of herring, then of cod Some natural economic growth Signs of economic decline in late 1980s Turning point in 1991

Liberal Iceland Cutting subsidies Stabilising economy Liberalising markets Privatising Cutting taxes Developing property rights to natural resources Strengthening pension funds

Monetary Stability Source: Icelandic Bureau of Statistics

From Deficits to Surpluses Source: Icelandic Ministry of Finance

Fiscal Responsibility Source: Icelandic Ministry of Finance

Negligible Unemployment Source: Icelandic Ministry of Finance

Pension Fund Reforms Tax-financed public pension fund since 1930s Compulsory occupational pension funds since 1960s Pay-as-you-go funds replaced by accumulation funds Voluntary private pension schemes (supplementary) Pension reforms in 1998

Pension Fund Assets Source: OECD (Pension Markets in Focus, 2006)

Privatisation Travel bureau, printing house, publishing house, fish processing plant, etc Government investment funds 1999, later merged with others to form Glitnir Bank Landsbanki 2002 Bunadarbanki 2002, later merged with others to form Kaupthing Bank Icelandic Telephone 2005 Total revenue from privatisation $2 billions

Tax Cuts Corporate incomes tax from 45% to 18% (15% since 2007) Individual incomes tax from 30.41% to 22.75% Turnover tax abolished High-incomes surcharge abolished Net wealth tax abolished Death duties (estates tax) reduced

Invisible Tax Cuts Reducing inflation = Cutting the inflation tax Strengthening pension funds = Cutting tax on future wealth creators (reducing taxpayers’ liabilities Reducing public debt = Cutting tax on future generations

Corporate Incomes Tax Cut Source: Icelandic Ministry of Finance

Example of Laffer Curve?

Development of ITQ System Open access to fishing grounds led to overfishing 1975, individual quotas (% of total allowable catch) in herring fishery 1984, individual quotas in cod and other demersal fisheries Gradually, quotas became transferable 1990, ITQ system made universal

Overfishing with Open Access Source: H. S. Gordon, Journal of Political Economy, 1954

Icelandic Debate on Fisheries How to reduce boats from 16 to 8? (a) Pigovian economists: government auction of ITQs (b) Property rights theorists: ITQs permanent, universal and freely transferable, initial allocation on basis on catch history (b) Pareto-optimal change: No-one worse off

Efficient Fisheries Initial allocation on basis of catch history: owners of fishing capital bought out, not driven out Much resentment; compromise in 2002: nominal resource use fee Total value of quotas about 350 billions ISK (appr. $5 billions) Reduction of fishing effort; stronger and fewer fishing firms

Fishing Firms Profitable Source: Icelandic Association of Fishing Vessel Owners

All Groups Benefited Average annual increase in purchasing power after tax % Annual increase of lowest 10% group 2.7% OECD average of lowest 10% group 1.8% ( )

Risk of Poverty 2nd Lowest Source: Eurostat and Icelandic Bureau of Statistics

Income Distribution Source: Eurostat and Icelandic Bureau of Statistics

Liberal Iceland in 2004 One of 5 richest countries in the world One of 10 freest countries in the world Relatively even distribution of income Almost no poverty Negligible unemployment Almost no crime What went wrong?

Bank Expansion Banks privatised Since 2002, total turnover of banks almost 10-folded Total foreign assets 10-fold GDP Oversized in terms of Iceland, but not of the EEA

Expansion Partly Sustainable Hernando de Soto: From dead to living capital ITQ system: New capital Capital gains from privatisation Stronger pension funds Icelandic banks with no worse assets than other European banks

Abuses of Power European banks did not like Icelandic competitors , central banks, including the Fed, refused to help the Icelandic Central Bank October 2008: Gordon Brown used anti- terrorist laws against Icelandic banks

Who are the Terrorists? Icelandic Ministry of Finance, Central Bank and Landsbanki put on official list of terrorist organisations, with Al-Qaeda and the Talibans! Landsbanki still on list Payments through London stopped Disastrous for an open economy like Iceland

Small is Dangerous Gordon Brown: Icelandic authorities would not honour their legal obligations No evidence for that British authorities: Last-minute transfers from London to Iceland Remains to be seen, but denied by Icelandic banks

A Tale of Two Countries Lehman Brothers: Last minute transfers of 4.4 billion GBP from London to US US Treasury, or the Fed, not put on list of terrorist organisations! Swift: “Laws are like cobwebs, which may catch small flies, but let wasps and hornets break through“

From Versailles to Munich Gordon Brown trying to force Iceland to go beyond its legal obligations 100% of GDP German reparations payments after 1st WW: 85% of GDP Iceland abandoned by the West, like Czechoslovakia in 1938

Hope Against Hope Infrastructure intact, unlike after war Natural resources, fish stocks, waterfalls and hot springs Human capital Danger: Wrong lessons learned Free market discredited Only hope: Mises’ and Hayek’s longevity!