April 2, 2008
REYKJAVIK, Iceland
The global credit crisis has sparked fears that Iceland's economic miracle is about to unravel. Critics point to the large current account deficit and private-sector debt as evidence of impending doom. As a result, investors have pushed down the krona about 20% against the euro in the last month alone, forcing the central bank to lift rates by 125 basis points to 15%.
But fears of a meltdown in my subarctic homeland are vastly overblown. True, the current account deficit was 16% of GDP last year, but that's an improvement from more than 25% in 2006. And while net private-sector debt is about 120% of GDP, there is virtually no public debt in Iceland. This is largely the result of unparalleled political stability and continuity. The business-friendly Independence Party has led the government since 1991 and has turned persistent fiscal deficits into surpluses, cutting the public debt to a projected 3.8% of GDP this year from 32.7% in 1994.
The bulk of Iceland's private debt is the result of aggressive investing by banks and investment funds. But this brings us to the second reason why Iceland should not be regarded as a high-risk country. To correctly assess the health of the economy, it's not enough to look only at the future value of the investments financed by this debt but also at the new capital that has been created in Iceland over the last 16 years. This new capital, rather than reckless borrowing, is the main explanation why Icelandic investors have recently been able to play a far more important role in international finance markets than the small size of our economy might suggest.
Where did this new capital come from? In the early 1990s Icelanders, traditionally a nation of fishermen, developed an ingenious system of semiprivate property rights -- so-called individual transferable quotas, or ITQs -- for their rich fish stocks. Each fishing firm holds a transferable and divisible right to harvest a given proportion of the total allowable catch in each fish stock over each year. Before the reform, fishing was for free, which led to overfishing and overinvestment. Only with the introduction of the ITQs has the fishing stock in essence become registered, transferable capital, which could be used as a collateral. The total value of these fishing rights is about $5 billion.
The second source of new capital in Iceland came from the extensive privatization of public assets since 1991, including banks, and investment funds. Capital which had laid largely dormant in public companies became registered, transferable and could be used as collateral. The additional value of Iceland's privatized assets is about $6 billion.
Third, Iceland has (on a per capita basis) one of the strongest state pension systems in the world, according to the OECD. The total assets of the pension system, not counting various private pension plans, amounted to about $24 billion at the end of 2006, more than the total GDP of about $17 billion in that year.
What has happened in Iceland since 1991 can best be explained by Hernando de Soto's famous contrast between dead and liquid capital. Many poor countries are held back in their development because capital is unowned, unregistered, untransferable and cannot be used as collateral. The transformation of the Icelandic economy since 1991 was essentially one to liquid from dead capital.
So it is no mystery why in recent years Icelandic investors have been able to burst upon the international financial scene. What's more, Iceland's main export goods, seafood and aluminium, presently fetch record prices.
In the current financial crisis, there is less reason to be worried about Iceland than about many other places. Iceland is not melting down.
Mr. Gissurarson is a board member of the Central Bank of Iceland and a professor of political theory at the University of Iceland.
James Morton
Sent from my BlackBerry device on the Rogers Wireless Network
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