RWER issue 56: Wade and Sigurgeirsdottir
Iceland’s meltdown:The rise and fall of international banking in the North Atlantic
Robert H. Wade and Silla Sigurgeirsdottir  [London School of Economics and University of Iceland]“
Iceland should be a model to the world” (Arthur Laffer, November 2007)
“They [the Icelandic banks] shouldn’t be worried about the fundamental soundness of their business model. I think it is very sound and very good”. (Richard Portes, May 2008)
In 2007 average income in Iceland was almost $70,000, about the fifth highest in the world and 1.6 times that of the United States. Reykjavik’s shops brimmed with luxury goods, its restaurants made London look cheap, and sports utility vehicles (SUVs) choked its narrow streets. Icelanders were the happiest people in the world according to an international study in 2006, just ahead of Australians. They also enjoyed the least corrupt public administration in the world, according to Transparency International’s Corruption Perceptions index, an honour shared with New Zealand and Finland in 2007. They had a life expectancy at birth of 80.8 years by 2008, putting them 11th in the world (well above the US at 78.2 years and the UK at 79.9 though well below Japan at 82.2 years). The prison population per 100,000 was 60, lowest in the world (equal with Japan and Finland).
What was there not to like about this model? Iceland’s boom began in 2001 after the US Federal Reserve began cutting interest rates and pumping cheap money into the global economy. At about this time the Icelandic government privatized what had been small “utility”-oriented banks and set them free, much as the US government liberalized the Savings and Loans banks in the 1980s. The new banks discovered the alchemy of borrowing cheaply abroad, buying assets abroad, and then transforming the revenue streams into dramatically higher profits, wages, tax revenues and political support at home. Within only six years or so three Icelandic banks, with no prior experience of international banking, shot into the league of the world’s 300 biggest banks. Looking only at the results and overlooking how they were being achieved, just about everyone applauded while the borrowing lasted. Clever people streamed into finance, too few served the state. The politicians, regulators and most economists thought that all they had to do was keep out of the way while the financiers performed their magic. Of course, much the same happened in the US, Britain, and Ireland. But Iceland stands out from the other cases as a more transparent illustration of how “masters of the universe” confidence, sophistic ideology, mercenary gain, mendacity and sheer ignorance combined to drive the boom and bust.
From rags to riches, and the emergence of international banking
Iceland’s prosperity developed from an economy which was about the poorest in western Europe at the end of the Second World War, and which for most of the post-war period was more regulated, politicized and inward looking than its European neighbours. Its fast economic growth – especially between 1960 and 1980 — was driven by a combination of Marshall Plan aid; an abundant export commodity with the unusual property of a high income elasticity of demand — cold-water fish; a foreign-exchange earning US/NATO military base which was large relative to the rest of the economy; and a small population (about 300,000 as of the mid 2000s), with a high average level of education, a Lutheran work ethic, and a strong sense of national identity rooted in the Icelandic language and literature.
Through the second half of the twentieth century a bloc of some 14 families (popularly known as the “Octopus”) constituted the economic and political establishment, based in fishing, transport, oil importing and distributing, provisioning the NATO base, and domestic banking and insurance. This establishment provided the leaders of the two political parties which formed most of the coalition governments since the 1930s, and which divided up the spoils of office between core supporters. The dominant party was always the Independence (conservative) party, allied most of the time with the much smaller Progressive (agrarian) party. Occasionally social democrats and communists got a look in. Oligopoly and monopoly characterised the economy until the 1990s.
In the 1970s a dozen or so men studying law or business administration at the University of Iceland formed a group to promote neoliberal ideas, and took over the editorship of a journal called “The Locomotive”. As they moved into positions of influence and power they remained a network of mutually-promoting friends, more loyal to each other than to the organizations for which they worked. Known as the Locomotive group, they constituted a segment of Iceland’s “shadow elite”, using their influence in the Independence party and other organizations to win opportunities for themselves and refashion the society as a neoliberal model (far from the norms of Nordic social democracy, which they disparaged). Several of them stepped out of the shadows into the limelight, taking the top political and juridical positions.
 Robert Wade is professor of political economy at the London School of Economics. Silla (Sigurbjorg) Sigurgeirsdottir is lecturer in public policy analysis at the University of Iceland.
 Örnólfur Árnason, (1991). Á slóð Kolkrabbans; Hverjir eiga Ísland? Bókaútgáfan Skjaldborg. Reykjavík 1991..
 Wedel, J. R. (2009). Shadow Elite: How the world’s new power brokers undermine democracy, government, and the free market. Basic Books 2009, NY.
You may download the whole paper at: http://www.paecon.net/PAEReview/issue56/WadeSigurgeirsdottir56.pdf