The Danish economist Lars Christensen recently visited our beloved little nature island, to speak at the Open Day for the Icelandic Financial Services Association. Having observed and analyzed markets for decades — he famously warned about the overheating and imbalances in the economy before the 2008 meltdown — and returning to Iceland again and again, he had a few interesting things to say about this exceptional and exceedingly rich, yet dysfunctional economy.
Christensen made quite some noise in local media, too, but then spent a full hour on his Makropuls podcast (in Danish) discussing the groundhog-day phenomenon in Icelandic political-economy matters:
“Iceland isn’t primarily a Nordic economy”
– Lars Christensen
For all of us Nordic aficionados, we should realize that the Icelandic economy operates fundamentally differently from the more mature, developed (and diversified!) Nordic economies. We are not the same… and actually not in a good way.
While a little bit of a spicy take, it’s true in the very nature of what we produce here. This tiny island nation has several elements of all the Nordic countries, but none of the mature, balancing, and stabilizing economic safeguards that make those economies work reasonably well. Iceland is also the (annoyingly rich) little brother who hasn’t figured it out yet. “It’s a globally exposed economy” — tourism, fish, aluminum, data centers — all of which become a modern version of a raw-commodity exporting third-world nation: a complete price taker, walloped around by an ocean of capital inflows and outflows into hot sectors that might not be thriving next year: “It’s an economy where many factors can easily become destabilizing.”
As Lars explained both in the podcast and in a feature with Morgunblaðið, an Icelandic business news outlet, Iceland really shouldn’t have a money of its own: money wants to be one, so every existing fiat currency fights against monetary gravity for its existence. While all, or most, have some rationale for their arrangements and certainly play some national-identity function, the Icelandic króna has neither:
“Icelanders very much want currency stability and… I don’t think I’ve ever been to a country with so much love to for their country and so much hate for their own currency as in Iceland.”
Plus, given the primary extracting nature of the Icelandic economy and the dysfunctional economic institutions — centralized wage negotiations without internalized consequences; a weak, flaccid and always-accommodating central bank — to patch up the boom-and-bust swings that characterize commodity trades, Seðlabanka Íslands is forced to perform too much of the stabilizing, countervailing balancing act.
Translated from the Vísir interview,
“Christensen says Denmark has learned from inflation and economic difficulties in previous decades: government, business and unions must take joint responsibility. In Iceland, he sees more conflict between factions and the same disputes repeating themselves. He points out that Icelanders are good at standing together when the national teams compete in handball and football. He would like to see more of that solidarity in the fight against inflation and a greater willingness to understand the perspectives of others.”
In the podcast episode, Christensen outlined this political-economy conundrum further:
“What happens in Iceland all the time is the distributional troubles of finding 100 krónur on the street… somebody finds it, and now what? Who gets the gains? Who gets to keep the windfall?”
Basically: “One sector, be it fishery or aluminum smelters or data centers or tourism, takes off and someone makes a ton of money. The constant political conversation in Iceland becomes: who received something they shouldn’t have had, and how should those things be (re)distributed?”
“I’m not too worried about the Icelandic economy. It’s doing very well, apart from inflation.” (Vísir)
…which is sort of the point of his monologue.
“The Icelandic economy is too small for its own good,” and inflation becomes the central bank’s only way out in facing the aggressive, centralized labor agreements that push for high wage increases unsupported by economic fundamentals. And because there’s been great price inflation in past years, the next round of negotiations include even stronger demands for wages to compensate for the loss of purchasing power. The other Nordic countries fixed this runaway wage-price spiral in the 1970s and 1980s, usually through a combination of local wage determination, pegging the currency, or forcing the unions to internalize the unemployment externality of their too-aggressive actions. But Iceland has had none of that.
Compare Norway, another Nordic raw commodity exporter. What you do in Norway is take all the oil revenue, collect it in a pot — invested in the oil fund — and take only a small portion into the Norwegian government’s coffers. The extreme rise and fall of the global petroleum business becomes less of a concern in Norway’s economy proper, with the fund and its amassed savings offering a countercyclical buffer. “Norwegians,” explained Christensen, “are able to decouple their great natural resources revenue from what they call onshore Norway.”
Importantly, the Norwegians counteract the Dutch disease of an overvalued currency hampering their own productive capacities by having this gigantic fund constantly sell kroner to invest in assets denominated in foreign currencies. This, the Icelanders can’t do — or at least, have chosen not to do. It’s not the same singular raw commodity dominating exports year after year (varying between tourism, housing boom, data centers, aluminum, fishery), so levying an appropriate resource tax becomes trickier and less transparent. (Plus, the small-size, rent-seeking nature — some might say “corrupt” — of the political and economic elites, make that arrangement gameable and pretty impossible to achieve.)
Building up a similar sovereign wealth fund to counteract booms and stabilize or support the economy during busts could be a great way to alleviate Seðlabanka Íslands’ singular response function: inflation as the release valve.