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Lessons from Iceland

Capitalism, Crisis, and Resistance

Martin Hart-Landsberg teaches economics at Lewis and Clark College in Portland, Oregon. His latest book is Capitalist Globalization: Consequences, Resistance, and Alternatives (Monthly Review Press, 2013).

The author would like to thank Erin Haswell for her research assistance and insights into the Icelandic experience. This work is a part of the research organized by the Institute for Social Sciences at Gyeongsang National University, which is supported by a National Research Foundation of Korea Grant (NRF-2010-413-B00027).

If we are to build support for an alternative to capitalism we need clarity on the causes and consequences of the contemporary capitalist drive for greater liberalization and privatization, as well as the benefits from and limits to state direction of capitalist economic activity. Although a small country, Iceland’s recent experience has much to teach us about capitalist dynamics and strategies of transformation.

In 1991, the Icelandic government began an aggressive program of liberalization and privatization which gave rise to the hyper-expansion of three Icelandic banks. Their highly leveraged growth fueled massive stock market and housing bubbles, all of which combined to make Iceland’s per capita GDP one of the world’s highest by the mid–2000s. Iceland’s economy collapsed in October 2008 when the three banks were forced into bankruptcy; the country suffered one of the deepest downturns in the world.

In a response that remains unique in Europe, the Icelandic people forced the political leaders responsible for the neoliberal program to resign. They then elected a social democratic coalition government which aggressively intervened in financial, currency, and housing markets, and engaged in a targeted expansion of key social programs. As a result, Iceland has experienced one of Europe’s most rapid and broad-based economic recoveries. Unfortunately, the scope of these state actions was limited by still powerful capitalist-class relations. Working-class gains may well be reversed, particularly with the political reversal in April 2013, and the election of a conservative government representing the dominant interests.

Capitalist Class Dynamics and Neoliberalism

Iceland is certainly not unique either in the 1990s or more recently in electing a government promoting neoliberal policies. Moreover, the class dynamics producing such an outcome are not the same in each country. Still, a study of the Icelandic process does provide useful insights into the broader phenomenon. Among the most important is that neoliberalism is, above all, a capitalist-class project. As such, state decisions about liberalization and privatization are carefully made with the aim of expanding capitalist profit-making opportunities, an aim that often contradicts the libertarian claims used to give them legitimacy.

Iceland was one of the poorest countries in Western Europe at the end of the Second World War. It had been a colony of Denmark and only gained its full independence in 1944. As a consequence of its colonial history, “Icelandic capitalism was dominated from the start by a bloc of some fourteen families, popularly known as The Octopus, which constituted both the economic and the political ruling elite.”1

The Octopus was not a formal group. Rather the name reflected the fact that these families jointly dominated most key industries. The Octopus projected its power through its control over the country’s most powerful political party, the Independence Party; many of the party’s top leaders were members of the most influential Octopus families. A second, less powerful group of families was known as the Squid. They dominated the Progressive Party, which often served as the Independence Party’s junior coalition partner.

Iceland, like most of Europe in the immediate post-Second World War period, had a highly controlled economy. Beginning in the 1960s, Iceland, again following European trends, began a controlled liberalization of economic activity. However, because of its history, Iceland’s economy remained more regulated and shaped by clientelism than other Western European economies.

For example, the largest banks were state owned, “capital was rationed between different industries by the government, nominal interest rates were set by the Central Bank of Iceland (CBI), which was controlled by the government, and real interest rates were kept negative until the late 1980s.”2 At the same time, these banks were largely managed for the benefit of the major political parties and their respective backers. For example, Independence Party appointees ran the state-owned Landsbanki and directed its loans to Octopus-controlled businesses.

In broad brush, the Icelandic economy performed well in the post-Second World War period. Despite its poor starting point, “by the 1980s [Iceland] had attained both a level and a distribution of disposable income equal to the Nordic average.”3 Yet, developments were underway that would soon transform the country’s political economy.

The first and most important development was the rise of a “neoliberal/libertarian” political interest group in the early 1980s known as The Locomotives. The group was dominated by former Law and Business Administration students from the University of Iceland. They took their name from a similarly called journal which the students ran in the early 1970s and used to promote free-market ideas.

Members of the Locomotive group argued that Iceland needed to unleash market forces to break the state-corporate stranglehold on the Icelandic economy. Their message found an increasingly receptive audience as Icelandic growth slowed over the 1980s, labor-capital conflict intensified, and governments advocating neoliberal policies came to power in Europe and the United States.

David Oddsson, one of the Locomotive founders, became mayor of Reykjavik in 1982. His aggressive privatization policies won him support from other Independence Party members and he quickly rose through the ranks, eventually becoming party leader and prime minister of the country in 1991. He held power for fourteen years before resigning to become head of the CBI in 2004. Oddsson was a relative outsider in terms of Independence Party politics and his successful rise to become prime minister and architect of Iceland’s neoliberal transformation was predicated on his ability to “reassure the old, established wealthy families of Iceland that rapid, systematic privatization was not going to impoverish them or dilute their power.”4

Iceland’s ruling families were growing increasingly dissatisfied with their economic situation. The small size of the country as well as continuing state ownership of banking and other significant business sectors placed limits on their opportunities for profit. And, as economic problems and political tensions grew, Oddsson’s leadership of the Independence Party became ever more attractive to them.

Soon after becoming prime minister, Oddsson began lowering corporate tax rates and privatizing state-owned companies. Serious change came only after 1994, when Iceland joined the European Economic Area (EEA), the free-trade bloc of the European Union. Membership gave Iceland open access to European markets and the country’s political and business leaders were quick to grasp that a privatized, deregulated, and expanded finance sector was their best vehicle for overcoming the country’s profit-constraining market size.5

Bank privatization began in the late 1990s through a highly controlled and politicized process that was completed in 2003. The first privatization was of a small investment bank. A family associated with a relatively new business group known as the Orcas gained control of that bank, and through mergers and acquisitions created Glitnir, which became one of Iceland’s three major banks. The two large state banks—Landsbanki and Buradarbanki (later to become Kaupthing)—were the main prize, and the government ensured that the bidding process would deliver majority ownership of the former to supporters of the Independence Party, which meant Octopus families, and the latter to supporters of the Progressive Party, which meant Squid families. The new owners then established private holding companies which tapped their respective banks for funds to start new businesses, and in some cases took over existing businesses owned by other elites. The new owners also funneled money back to their respective parties and party leaders.6

The resulting transformation of the Icelandic economy did produce a change in the relationship between state and ruling elites, with the latter increasing its relative power. It also led to a restructuring of elite relations, in particular a weakening of ties among leading families and the rise of new power centers. However, despite the free-market/libertarian rhetoric that accompanied it, the transformation was never designed to, nor did it, destroy close state-business ties or end monopoly dominance over the economy.

Growth and Crisis

Iceland’s economy soared, especially over the years 2003 to 2007. The annual average growth in GDP was 5.5 percent and unemployment declined from an already low 3.4 percent to 1 percent.7 The IMF estimated that Iceland was the world’s third-richest nation in per capita terms in 2005.8 As we see next, these gains were fueled by the highly leveraged expansion of the country’s three leading banks, an expansion that contained the seeds of the country’s eventual 2008 economic collapse.

The rate of growth of Iceland’s banking system from 2003 to 2007 was unprecedented.9 Total end-of-the-year assets held by the three largest banks rose from less than twice the country’s GDP in 2003 to over eight times in 2007, and to almost ten times as of June 2008.10

The banks relied heavily on foreign money for their expansion. Early funding came largely from selling bonds in the European market. When foreign rating agency warnings about the health of Icelandic banks closed off the European market in 2006, the banks turned briefly to the U.S. bond market. The following year, Landsbanki and Kaupthing turned to yet another market, foreign retail deposits, especially in the United Kingdom and the Netherlands. All three banks also used their subsidiaries in Luxemburg to engage in indirect collaterized borrowing from the Eurosystem. By the end of 2004, Iceland was the world’s most heavily indebted country measured in terms of gross external debt to GDP.11

Underpinning and eventually destabilizing Iceland’s growth process was the complex relationship between and among the banks and their ownership groups. For example, this relationship was key in enabling Icelandic banks to tap foreign bond markets. Icelandic banks appeared especially creditworthy because of their high-capital-adequacy ratios. These high ratios were deceiving however, since they were largely the result of artificially inflated share prices. As Robert Wade and Silla Sigurgeirsdottir describe:

Iceland’s new banking elite rode the bubble, intent on expanding their ownership of the country’s economy, both competing and cooperating with each other. Using their shares as collateral, they proceeded to take out large loans from their own banks, some of which they spent on buying more shares in the same banks, inflating share prices. Their executives were instructed to follow suit. They performed the same task for other clients, including the other banks. Bank A lent to shareholders in Bank B, who bought more shares in B against the shares as collateral, raising B’s share price. Bank B returned the favor for shareholders in Bank A. The net result was that the share prices of both banks rose, without new money coming in.12

While the banking elite used their access to funds to purchase control of many Icelandic businesses, they also engaged in heavy investing outside of Iceland. Major targets were fashion outlets, toyshops, soccer teams in Britain, and supermarkets in the United States and throughout Scandinavia.13

This activity boosted Icelandic stock prices, creating a stock market bubble. Average share prices rose at an annual average rate of 43.7 percent between 2003 and 2007. Easy credit coupled with rising stock prices also generated a housing market bubble; housing prices rose an average of 16.6 percent a year over the same period. These developments produced a sharp rise in corporate and household wealth, borrowing, and spending, and thus economic growth. They also produced an enormous trade imbalance; the current account deficit grew from 5 percent of GDP in 2003 to 20 percent in 2006.14

This finance-driven growth process was further encouraged by CBI policy. Worried about rising prices, the CBI pushed up interest rates. However, as the interest rate differential between Iceland and other countries grew, financial traders—Icelandic and foreign—took advantage of the fact that they could make money borrowing outside of Iceland and lending in Iceland.

Icelandic banks intensified their domestic retail lending. “Brokers crisscrossed the country, persuading households to load up on more debt and to convert new or existing Icelandic krona debt into much lower-interest Swiss francs or Japanese yen.”15 Foreign banks bought Icelandic bonds, and then repackaged and sold them as “Glacier” bonds; they offered interest rates as much as five times higher than the rates in Europe.

The resulting inflow of money pushed the krona up relative to the euro and other European currencies, enriching Icelanders and encouraging them to go on an import binge. However, as Wade and Sigurgeirsdottir point out, “the carry trade is risky and unsustainable, and currency traders flee at the first sign of trouble. That’s what happened when the banks—heavily indebted, illiquid and unable to meet their obligations when credit dried up—finally collapsed.”16

As noted above, warnings were issued in 2006 about the stability of the Icelandic banking system. Among the top concerns: the quality of bank assets and the fact that government resources were inadequate to backstop the country’s banks if problems developed. The concerns were real. Without continuing inflows of money to cover a current account deficit that had grown to 20 percent of GDP, the krona would dramatically fall. That, in turn, would create a debt repayment problem for those who borrowed in foreign currency, threatening the solvency of the banking system. Prices of imports would also soar, undermining domestic spending and production. The combination could be expected to sink the Icelandic economy.

The currency did fall briefly in 2006, as did the stock market. However, the “mini-crisis” was quickly overcome. The Icelandic government and Chamber of Commerce launched a major public relations campaign to deny that the Icelandic banking system was unsound. Both the Columbia Business School economist Frederic Mishkin and the London Business School professor Richard Portes issued separate endorsements. More importantly, the banks doubled down on their debt strategy.

The banks were well aware of their vulnerabilities and need for new funds. Thus, Landsbanki and Kaupthing took advantage of Iceland’s membership in the EEA to establish retail operations in several European countries, which enabled them directly to access foreign deposits. Landsbanki launched an Internet-based banking service called Icesave in the United Kingdom in October 2006 and the Netherlands in May 2008. More than 300,000 people and many institutions—including Oxford and Cambridge Universities, the Metropolitan Police, and 116 local governments—deposited money in Icesave accounts. In the Netherlands, more than 125,000 people opened accounts.17 Kaupthing followed by establishing Kaupthing Edge in 2007 in Germany and several other European countries.

Although the strategy was the same, the two banks pursued it differently. Landsbanki operated though overseas branches while Kaupthing operated through subsidiaries. The difference mattered: branches fall under the supervision and insurance of the bank’s home country, while subsidiaries fall under the supervision and insurance of the bank’s host country. In 2008, European investors had approximately $10.5 billion in Icesave accounts.18 That amount was over half Iceland’s GDP; there was no way that Iceland’s monetary authority could cover a failure of Icesave’s operations.

The growing domination of finance was not limited to Iceland, nor was the contradictory nature of the process. In particular, the collapse of the U.S. bubble economy triggered a series of financial shocks with international ramifications. Lehman Brothers, the fourth-largest investment bank in the United States at the time of its demise, declared bankruptcy in September 2008. Its collapse led to a freezing of international credit markets and the unraveling of Iceland’s banks and economy.

Glitnir, the weakest of Iceland’s three major banks, felt the effects first and approached the CBI for help. Oddsson, who now headed the CBI, ordered the central bank to buy 75 percent of Glitnir’s shares. Regardless of intent, the action undermined international confidence in the country’s entire banking system. Credit lines were canceled and a run began on Icesave’s overseas branches.

Iceland’s three major banks failed within the first two weeks of October 2008 and were taken over by the Icelandic government. To put their bankruptcies in perspective, if taken together, their closure would “rank third in the U.S. history of bankruptcies, with Lehman ($691 billion) first and Washington Mutual ($328 billion) second. As separate entities, Kaupthing ($83 billion) would rank fifth, Landsbanki ($50 billion) ninth and Glitnir ($49 billion) tenth.”19

The default of the banks led to a rapid and interrelated series of crises: a currency crisis, a stock market crisis, a repayment crisis for Icelandic businesses and households, and a housing crisis. The krona fell by more than 80 percent against the euro in 2008 and the stock market lost 75 percent of its value.20 Real wages fell by 4.2 percent in 2008 and another 8 percent in 2009.21 The unemployment rate soared from 1 percent in 2007 to 8 percent in 2009 and those with jobs lost hours in addition to pay.22 Not surprisingly given the rapidity and shaky underpinnings of the country’s growth, Iceland suffered one of the developed world’s worst economic declines, with its GDP falling by a combined 9.3 percent from 2008 through 2010.23

Households were hit especially hard by currency and price movements. Household debt at the beginning of 2008 was equal to 100 percent of GDP and an even more staggering 225 percent of disposable income. Approximately 13 percent of the debt was foreign-currency-indexed loans which doubled in domestic-currency terms from 2008 to 2009.24 Approximately 80 percent of household debt was indexed to inflation, and prices rose by 27 percent over the same period. Many people, unable to pay their debts, lost their cars and homes. Non-financial businesses were also hammered. Their debt at the end of 2007 was over 300 percent of GDP; approximately 70 percent of all bank loans to these businesses were foreign-currency-indexed loans.25

With its banking system frozen and its currency in freefall, the Icelandic government turned to the International Monetary Fund (IMF) for help in October. However, the IMF made its assistance conditional on Iceland agreeing to reimburse the governments of the United Kingdom and Netherlands for the money they spent compensating their respective Icesave depositors. Since Icesave was a branch of Landsbanki, the Icelandic government was responsible, under the terms of its membership in the EEA, for providing a guaranteed minimum-deposit insurance of 20,887 euros for each account. But, the United Kingdom and Netherlands wanted more from Iceland. The two governments, without waiting for Iceland to act, had themselves reimbursed their own depositors the full amount they lost—and they now wanted Iceland to reimburse them, with interest.

While the United Kingdom and the Netherlands pressed Iceland to agree to their terms, the great majority of Icelanders strongly opposed any such agreement, well aware that it would require sizeable tax hikes and cuts in government spending, and all to cover a private bank’s failed overseas operation. Desperate for foreign exchange, the Icelandic government eventually “agreed to compensate at least some of the depositors at some time in the future.”26 This commitment satisfied the two governments and Iceland received a $2.1 billion loan from the IMF and an additional $3 billion loan from the Nordic countries and Russia.

Resistance, State Intervention, and Recovery

Protests against the Icelandic government began in late October almost immediately after the start of the crisis, anchored by ever-larger Saturday rallies at Reykjavik’s main square and Monday evening meetings in Reykjavik’s main theater. The most common demands were for the resignation of the prime minister and the election of a new government. In January 2009, two thousand demonstrators banging pots and pans outside the parliament building were attacked by riot police. This touched off what the Icelandic press labeled the “pots and pans revolution” as demonstrations grew in size and militancy.

Unable to pacify popular anger, the ruling Independence Party first announced new elections for April 2009. Then, when its coalition partner the Social Democratic Alliance withdrew its support, the prime minister and cabinet resigned. An interim government headed by the Social Democratic Alliance and the Left-Green Movement filled the vacuum and the same coalition emerged victorious in the April voting. “To date, Iceland’s remains the only government to have resigned as a result of the global financial crisis. It is also the only country to have shifted distinctly to the left in the aftermath of September 2008.”27

Iceland’s progressive government took a series of policy actions over the following years that were quite different from those of other European governments. Most importantly, rather than try to resuscitate existing structures and patterns of economic activity through austerity measures, it actively intervened in financial, currency, and housing markets, as well as strengthened targeted social programs that protected majority interests. The results, as the editors of Bloomberg View describe, have been impressive:

Few countries blew up more spectacularly than Iceland in the 2008 financial crisis. Since then, Iceland has turned in a pretty impressive performance. It has repaid International Monetary Fund rescue loans ahead of schedule. Growth this year [2012] will be about 2.5 percent, better than most developed economies. Unemployment has fallen by half. In February, Fitch Ratings restored the country’s investment-grade status, approvingly citing its “unorthodox crisis policy response.”28

Although far from radical, the Icelandic government’s response to the country’s crisis was indeed unconventional. It was also more successful in promoting economic recovery and protecting majority well-being than the more conventional responses of other European governments.

Financial Policy

One Icelandic analyst explained the core differences between the Icelandic government’s financial policy and those of other European countries as follows:

Unlike other badly “Kreppa”-hit countries like Ireland, Greece and now SpainIceland didn’t save its failed banks.29 The credo of the European Central Bank and the European Commission has been that no bank must fail in the Euro zone and no bondholders must suffer losses, so as not to undermine the faith in the euro. Another concerted action that set Iceland apart from other European countries in recession is the widespread and extensive write-down of loans, both for companies and individuals.30

Glitnir and Landsbanki were nationalized on October 7, 2008. Kaupthing was taken over the next day. Each of the three banks was divided into two, a new and old bank. The new state-owned banks were given all the mortgages, other bank loans, and deposits of the old banks, with only international obligations remaining at the old banks. To ensure the viability of the new banks, loans held by the old banks were often transferred to the new banks at a steep discount.

In response to an IMF directive, the government privatized two of the newly created banks; it is in the process of increasing the private ownership share of the third, the new Landsbanki. Creditors of the old banks eventually reinvested in the new banks. All three new banks were “recapitalised with strong capital ratios—in excess of 16 percent of all assets—and are 90 percent funded with deposits. Most smaller savings banks were also restructured. During the whole process, all deposits in Iceland (both of residents and non-residents) were guaranteed in full.”31

The government also took steps directly to reduce the debt burden on households and non-financial businesses. In June 2010, the Supreme Court ruled foreign-currency-linked motor-vehicle loans invalid. In December 2010, the Parliament made a similar ruling for mortgage loans. In June 2011, the Supreme Court included loans to corporations. All these loans “were converted into domestic currency loans, whereby the outstanding principles of the loans were reduced considerably, and the interest rates were also recalculated (retroactively as well) using the lowest non-indexed interest rate published by the Central Bank of Iceland.”32

These developments had nothing to do with Icesave and demands by the governments of the United Kingdom and the Netherland for repayment. Finally, in October 2009, under pressure from the European Community, the Icelandic government presented the Icelandic parliament with the terms of a negotiated agreement in which it committed to pay the two governments 5.5 billion euros (approximately 50 percent of Iceland’s GDP) over an eight year period, from 2016 to 2023. The parliament reluctantly approved the agreement in December, but the President of Iceland announced that he would not sign it without a national referendum. In March 2010, the voters rejected the agreement with 93 percent of the votes in opposition. A new agreement was negotiated, one that extended the payout period and lowered the interest rate. A new referendum was held in April 2011; this time 66 percent of the voters said no.

After this second vote, the European Free Trade Association Surveillance Authority sued Iceland in the European Free Trade Association’s court. The case was finally decided in January 2013. The court, surprising many, announced that Iceland was under no obligation to compensate the two governments since the regulations on cross-border deposit insurance did not apply in the face of “a systemic bank failure of the magnitude experienced in Iceland.” Regardless, Iceland has already repaid more than 90 percent of the minimum deposit guarantees required by EEA membership from money raised selling Landsbanki assets.33

Currency Policy

Iceland’s currency remained strong during the country’s pre-crisis expansionary period in spite of its enormous current-account deficit because of the large inflow of foreign funds. With the collapse of the banking system, that inflow stopped and the krona went into free fall. The decline intensified the country’s economic problems. Many households and businesses held foreign-currency indexed debts that exploded in domestic cost. As noted above, the government worked to minimize the economic harm from this development by forcing banks to restructure their loans in domestic currency.

At the same time, there was a positive side to the currency decline. In particular, it enabled the country quickly to regain its international competitiveness and economic traction. Iceland recorded a current account surplus in 2009, which was achieved in part thanks to a recovery of exports. “Among the thirty-four countries for which Eurostat publishes constant price data on exports of goods and services, Iceland was the only country where there was a growth in 2009 compared to 2008.”34 In addition, the higher import prices also stimulated a revival in the country’s import substitution industries.

Iceland’s crisis experience is often compared to those of Ireland and Latvia. All three countries relied heavily on foreign borrowing and debt bubbles to drive growth, and all three suffered major economic collapses for roughly the same reason. Ireland and Latvia suffered greater economic declines than did Iceland, and their recoveries have been far weaker and more punitive.35

One reason for this outcome is that neither Ireland nor Latvia changed their respective currency values; the former uses the euro for its currency and the latter remains committed to a fixed rate of exchange with the euro. As a result, both Ireland and Latvia were forced to pursue international stability through what is called an “internal devaluation.” Said differently, they relied on slashing domestic wages and prices to boost their respective economic competitiveness.

Iceland’s currency policy also includes the use of strict capital controls which make most transnational capital movements illegal.36 These controls have blocked an estimated $8 billion, roughly equal to 50 percent of Iceland’s GDP, from leaving the country. Had the government not taken action, the resulting outflow would no doubt have led to a complete currency meltdown. Thanks to the controls, the krona, although lightly traded, soon strengthened and then stabilized.

Housing Policy

The government took strong steps to minimize the threat to household finances caused by the collapse of the housing bubble and to restore stability to the housing market. As the IMF explains, the government quickly implemented a number of measures “to ensure that families did not lose their homes owing to temporary problems and to prevent a spike in foreclosures leading to a housing market meltdown.” Those measures included:

a moratorium on foreclosures, a temporary suspension of debt service for exchange-rate-and CPI-indexed loans, and rescheduling (payment smoothing) of these loans. About half the households with eligible loans took advantage of payment smoothing, which reduced current debt service payments by 15 to 20 percent and 30 to 40 percent for CPI-indexed and foreign-exchange-indexed loans, respectively.37

The government then introduced several new initiatives designed to provide more long term relief. These lowered household debt and mortgage interest payments as well as provided support for housing alternatives and renters. For example, the government first pursued a strategy of encouraging householders to directly negotiate write-downs with their lenders, often with the assistance of an ombudsman. Given the slow progress, the government introduced a debt-forgiveness plan that wrote down underwater mortgages to 110 percent of a household’s assets. To ensure that working people were the main beneficiaries of the plan, the amount of relief was tied to the value of a modest house and family size. More detailed financial examinations were available for households in especially serious financial trouble, with the possibility of greater write-downs.38

As noted above, the government ruled mortgage loans indexed to foreign currencies illegal, which meant that households no longer saw payments rise due to the depreciation of the currency. It also offered means-tested, mortgage-interest-rate tax rebates and special subsidies to help homeowners in difficult circumstances meet their interest obligations; these were financed through a special tax on financial institutions and pension funds.39

Finally, the government also worked “with financial institutions, local authorities and NGOs, to establish more varied options in family housing, including new renting options.” It also significantly increased rent rebates to low income families.40

Social Policy

The Icelandic government faced a serious fiscal challenge as a result of the crisis, with its budget deficit rising to 13.5 percent of GDP in 2009. Impressively, it reduced overall spending and the deficit to 2.3 percent of GDP in 2011 while simultaneously strengthening key social programs. For example, the government increased unemployment benefits over the years 2007 to 2010 and also lengthened the period during which workers could receive unemployment benefits from three to four years. In addition it significantly boosted the means-tested social assistance allowance and the minimum pension benefit.41

Over the same period, the government also increased subsidies for mortgage interest payments by 108.1 percent, far outstripping the 40.6 percent increase in mortgage costs. This increase raised the average household subsidy for interest costs from approximately 13 percent to 20 percent of the total interest cost. Moreover, the interest rebates were largely targeted at working-class households, which meant “that about a third of the interest cost of lower and average income households was paid by the government in 2010.”42

The government engaged as well in important labor market interventions. For example, it significantly increased the minimum wage by an amount that was almost twice the increase of the average wage level and almost matched the increase in prices.43 In sum, although the effects of the crisis remain, with most social indicators still below past highs, Icelandic government policy has been generally successful in protecting working-class interests.

Financial markets have also demonstrated their confidence in Iceland’s recovery. Many analysts had argued that Iceland would never be able to borrow in international markets as long as it maintained capital controls and refused to resolve Icesave debts. Yet, “the country already seems to have been forgiven by the markets. The Icelandic government issued $1 billion in sovereign debt in June [2011] at an interest rate of around 6 per cent. This was twice oversubscribed by investors.”44 As of 2012, it cost approximately “the same to insure against an Icelandic default as it does to guard against a credit event in Belgium.”45

Given this record, it should not be surprising that Iceland has become a model and inspiration for many opponents of neoliberalism. A number of progressive economists, including Joseph Stiglitz and Paul Krugman, have pointed to Iceland’s experience to argue the superiority of state activism, at least in periods of crisis, to reliance on market forces.46 Many activists, including Naomi Klein, have celebrated the Icelandic experience as proof “that it is possible to resist the Shock Doctrine.”47

The Limits of Reform

While the Icelandic experience demonstrates that state action in defense of popular interests can be effective, it also reveals the fragility of popular gains when state policy remains bounded by capitalist-class logic. Iceland was ruled by a coalition government led by the Social Democratic Alliance and the smaller Left-Green Movement from January 2009 to April 2013. And, as we have seen, that government had generally pursued policies responsive to the popular movement that put it in power. However, capitalist-class interests placed serious limits on the reform process, ones that appear likely to lead to the weakening of state capacities and the undoing of many of the gains achieved to this point.

Icelandic activists were well aware of these limits and their political and social consequences, even though many outside of Iceland were not. As Árni Daníel Júlíusson explains:

In December 2010 and January 2011, Attac Iceland started to receive a lot of questions about the quiet revolution in Iceland from members of Attac France and Attac Spain.48 Activists even started to visit Iceland to find out about the quiet revolution.

When Attac Iceland was slow to respond—and when it did it would not be ready to agree that there had been any sort of revolution in Iceland—it was pointed out by the international activists that the Icelandic banks had been nationalized, that the government had been forced from power, that the governors of the Central Bank of Iceland had been replaced, that Iceland had shown true grit by the rejection of the Icesave treaty. All of which was true, but Attac Iceland has not interpreted this as a revolution, even if it certainly can be viewed as a very powerful and successful protest movement, one of the most powerful popular responses to the collapse of the neoliberal order, and up until 2011 certainly the most powerful.

So, for the Icelandic activists and anti-neoliberalist, the situation is a bit awkward. When finally Iceland produces something worthy of admiration of the international activist community, the activist groups in Iceland have been reluctant to admit to it being what the foreigners perceive it to be. Why is this?49

One reason was the nature of the government’s bank restructuring process. As discussed above, the Icelandic government allowed the country’s three major private banks to collapse and then created three new state banks, each built on a transfer of loans and deposits from the old to the new. At the time of the process, many foreign creditors held bonds issued by the three private banks. With the collapse of the banks, most creditors, despairing of recovering any value, sold their bonds to “vulture” investors for pennies on the dollar. When the government, under IMF pressure, committed to privatizing two of the newly created state banks, these investors were well placed to take advantage of the situation. In short, they traded the government their bonds in exchange for controlling shares of the new banks.

Loans made by the old banks were heavily discounted when transferred to the new banks. While the government intended the new banks to share the discount with the borrowers, this was never made mandatory. As a result, “Household debts acquired at 30 to 50 percent of face value have been re-valued at up to 100 percent. So unpayably high debts are kept on the books, at transfer prices that afford a windfall to financial predators, dooming debtors to a decade or more of negative equity.”50

The government still has an 81.3 percent stake in the third newly created bank, Landsbankinn. However, it is committed to selling enough of its stock to bring its holdings down to a two-thirds share. It has also made clear its willingness to sell its remaining small shares of stock in the other two banks.51

Another reason for Icelandic activist concern was the government’s public commitment to unwind its system of capital controls. The government’s original target date was 2013, but it appears that this has been pushed back until 2015. Still, powerful export firms and financial interests pressed the government to move as fast as possible.

But a central contribution to the defeat of the Social Democratic Alliance in the April 2013 elections was its determination to pursue Icelandic membership in the euro area, which would have meant the country would not only have to abandon its capital controls but its currency as well.52 Iceland applied to join the European Union in July 2009. Formal negotiations began approximately one year later and continued to move ahead. According to the New York Times, “Iceland has now finished 10 of the 35 ‘chapters’ of EU laws that new members must work their way through—a pace that Enlargement Commissioner Stefan Fule said was the fastest for any country since new rules were adopted in 2006.”53 Up to a few moments before their defeat the Social Democratic Alliance led government continued to pursue membership in a euro area in crisis. The new government immediately dropped the bid to join the euro zone, to general relief.54

A revolutionary process would include, at a minimum, an increasingly popular supported state commitment to a publicly owned-and-controlled banking system and a system of capital controls, both key elements in any effort to establish a domestically rooted, full-employment growth process. In contrast, what we saw was quite the opposite. The Icelandic government not only gave up ownership of two of its three large banks to foreign vulture investors, it did so in a way that has allowed those investors to exploit its citizens.

Lessons from the Icelandic Experience

The popular movement in Iceland deserves recognition for its achievements and support as it struggles to learn from its electoral defeat in April 2013. More generally, I believe that the Icelandic experience offers useful lessons for all those working to build movements capable of initiating meaningful social transformations. The first lesson is that countries do not adopt neoliberal policies because of a policy mistake or the takeover of government by extremist elements. Rather it is an expression of a generally shared capitalist desire for bigger profits coupled with the realization that this requires greater market freedom, both regulatory and geographic. The fact that the adoption of these policies may cause a shake-up of capitalist-class relations does not change this conclusion.

The second is that expansion generated by neoliberalism contains the seeds of its own undoing. Capitalism is a contradictory and unstable system and the more unchecked are market forces, the faster the economic rise and the more dramatic the economic fall. The Icelandic experience, in particular, offers a frightening illustration of how easily our well-being can be threatened by the machinations of financial interests.

The third is that states can effectively intervene in multiple, interconnected markets and achieve impressive results. More to the point, comparing the experience of Iceland with that of other countries makes clear that active state intervention in restructuring and directing markets is the key to a socially desirable response to crisis.

The fourth is that crisis alone is not sufficient to deter capitalist interests from their support for liberalization and privatization. In most countries, the same capitalist interests that orchestrated the adoption of the neoliberal policies that generated the crisis remain adamant defenders of the same policies. Iceland was unique in that popular forces succeeded in forcing the responsible government out of office and replacing it with a more social-democratically oriented one.

However, the previous governing interests remained in powerful positions and never ceased to agitate for their return to power. For example, the media never ceased to be under Independence Party control; Oddsson, the former Prime Minister, is the editor-in-chief of the leading Icelandic daily newspaper. “Majority opinion in the Independence Party continues to believe that ‘alpha Iceland was hit by a perfect storm from abroad,’ meaning that ‘the crisis was not our fault’ Polls show that it has succeeded in convincing a majority of the population that the current [Social Democratic] government is somehow responsible for their troubles.”55 The Independence Party and the Progressive Party were the overwhelming winners of the April 2013 elections, receiving over 51 percent of the votes compared with 23 percent for the Social Democratic Alliance and Left Green Movement.

The fifth is that social democratic policies, regardless of how successful they may be in defending popular interests during a period of crisis, do not automatically generate support for an agenda of social transformation. One reason is that social democratic parties tend to present their interventions as temporary, made necessary by unusual circumstances. Once stability is regained, capitalist interests are well positioned to argue that such interventions need to be undone so as not to become fetters on expansion.

The final lesson is that to advance a meaningful revolutionary process, activists must not only build popular support for expanded public ownership and state capacities to direct economic activity, but they must do so as part of a movement that directly challenges the legitimacy of capitalist imperatives and encourages new visions of social ownership and patterns of production and distribution.


  1. Robert H. Wade and Silla Sigurgeirsdottir, “Lessons From Iceland,” New Left Review no. 65 (2010): 10.
  2. Sigridur Benediktsdottir, Jon Danielson, and Gylfi Zoega, “Lessons From a Collapse of a Financial System,” Economic Policy, April 2011, 187–88.
  3. Wade and Sigurgeirsdottir, “Lessons From Iceland,” 11.
  4. Roger Boyes, Meltdown Iceland: Lessons on the World Financial Crisis From a Small Bankrupt Island (New York: Bloomsbury, 2009), 33.
  5. Benediktsdottir, Danielson, and Zoega, “Lessons From a Collapse of a Financial System,” 215.
  6. Boyes, Meltdown Iceland, 44; Wade and Sigurgeirsdottir, “Lessons From Iceland,” 12.
  7. Benediktsdottir, Danielson, and Zoega, “Lessons From a Collapse of a Financial System,” 186, 202.
  8. Omar R. Vaklimarsson, “IMF Says Bailouts Iceland-Style Hold Lessons in Crisis Times,” Bloomberg Businessweek, August 13, 2012,
  9. Benediktsdottir, Danielson, and Zoega, “Lessons From a Collapse of a Financial System,” 185.
  10. Robert H. Wade and Silla Sigurgeirsdottir, “Iceland’s Rise, Fall, Stabilization and Beyond,” Cambridge Journal of Economics 36, no. 1 (January 2012): 134.
  11. Stefán Ólafsson, Iceland’s Financial Crisis and Level of Living Consequences, Working Paper no. 3:2011, Social Research Centre, University of Iceland, December 2011,, 4.
  12. Wade and Sigurgeirsdottir, “Lessons From Iceland,” 13–14.
  13. Boyes, Meltdown Iceland, 2.
  14. Benediktsdottir, Danielson, and Zoega, “Lessons From a Collapse of a Financial System,” 202.
  15. Wade and Sigurgeirsdottir, “Lessons From Iceland,” 14. The government’s 2004 decision to relax mortgage rules, allowing financing for up to 90% of a property’s value, helped to promote a surge in foreign currency tied housing loans by Icelandic banks.
  16. Ibid, 22.
  17. Boyes, Meltdown Iceland, 127.
  18. Ibid, 133.
  19. Benediktsdottir, Danielson, and Zoega, “Lessons From a Collapse of a Financial System,” 197.
  20. Ibid, 201.
  21. Ólafsson, Iceland’s Financial Crisis and Level of Living Consequences, 9.
  22. Benediktsdottir, Danielson, and Zoega, “Lessons From a Collapse of a Financial System,” 203.
  23. Ólafsson, Iceland’s Financial Crisis and Level of Living Consequences, 6.
  24. Foreign currency indexed loans are loans paid out and repaid in krona but indexed to foreign currencies.
  25. Benediktsdottir, Danielson, and Zoega, “Lessons From a Collapse of a Financial System,” 201; Ólafsson, Iceland’s Financial Crisis and Level of Living Consequences, 9, 11.
  26. Boyes, Meltdown Iceland, 178.
  27. Wade and Sigurgeirsdottir, “Lessons From Iceland,” 23.
  28. The Editors, “Fighting Recession the Icelandic Way,” Bloomberg View, September 26, 2012,
  29. Kreppa was commonly used to mean “in a pinch” or “to get into a scrape.” It now generally refers to the country’s financial crisis.
  30. Sigrún Davíðsdóttir, “Iceland: From a ‘Kreppa’ Basket Case to a Miracle Example,” Reykjavik Grapevine, February 10, 2012,
  31. Zsolt Darvas, “A Tale of Three Countries: Recovery After Banking Crises,” Bruegal Policy Contribution, Issue 2011/19, December 2011, 7.
  32. Ibid, 6.
  33. Robert Myles, “Iceland Triumphs Over UK and Netherlands in Icesave Court Battle,” Digital Journal, January 31, 2013,
  34. Darvas, “A Tale of Three Countries: Recovery After Banking Crises,” 10.
  35. Ibid, 9–14.
  36. Ministry of Economic Affairs, Government of Iceland, Act No. 127/2011 Amending the Foreign Exchange Act, the Customs Act and the Act on the Central Bank of Iceland, article 13b.
  37. International Monetary Fund, World Economic Outlook April 2012: Growth Resuming, Dangers Remain (Washington, DC: International Monetary Fund, 2012), 107,
  38. Ólafsson, Iceland’s Financial Crisis and Level of Living Consequences, 19.
  39. Ibid, 20.
  40. Ibid.
  41. Ibid, 13–14.
  42. Ibid, 14.
  43. Ibid.
  44. Ben Chu, “Iceland: The Broken Economy That Got Out of Jail,” Independent, September 6, 2011,
  45. Valdimarsson, “Icelandic Anger Brings Debt Forgiveness in Best Recovery Story.”
  46. Davíðsdóttir, “Iceland: From a ‘Kreppa’ Basket Case to A Miracle Example.”
  47. Anna Andersen, “A Deconstruction of ‘Iceland’s On-going Revolution,’Rekjavik Grapevine, August 24, 2011, After learning more about developments from local sources, Klein acknowledged that events in Iceland did not represent the social transformation she had originally thought.
  48. Attac is an abbreviation for the Association for the Taxation of Financial Transactions and for Citizens’ Action. The association has independent national branches in many countries. Although begun in the late 1990s as a single-issue movement in support of the Tobin tax on currency speculation, branches are now involved in a range of issues related to globalization and debt.
  49. Árni Daníel Júlíusson, “Inspired By Icelandno, really!,” Rekjavik Grapevine, July 10, 2011,
  50. Olafur Arnarson, Michael Hudson, and Gunnar Tomasson, “‘Vulture Capitalism’: Iceland’s New Bank Disaster, A Dress Rehearsal for Greece and Italy?,” Global Research, November 15, 2011,
  51. Balazs Koranyi, “Europe Should See Iceland as Recovery Role Model: PM,” Reuters, June 12, 2012,
  52. Independence Party leaders are pushing to replace the Icelandic krona with either the U.S. dollar or the Canadian dollar. They claim this change will make it possible for Iceland to immediately end capital controls without fear of capital flight.
  53. Paul Geitner, “Iceland Plans to Join European Bloc Despite Economic Turmoil,” New York Times, June 22, 2012,
  54. Omar R. Valdimarsson, “Laureate Phelps Warns Against EU as Iceland Drops Bid,”, May 23, 2013.
  55. Wade and Sigurgeirsdottir, “Iceland’s Rise, Fall, Stabilization and Beyond,” 141.
2013, Volume 65, Issue 05 (October)
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