Iceland's Experiment With Neoliberalism

Paul Krugman recently wrote a NY Times Op Ed piece (here) as a follow up to his earlier "Icelandic Post-crisis Miracle" Op Ed (here). He thinks that Iceland is yet another example of an economy that "produced a decent standard of living for its people" but "was in effect hijacked by a combination of free-market ideology and crony capitalism." Of course, his analysis has been disputed (here and here).

Krugman compared Iceland's percentage changes in GDP since the start of the financial crisis (2007Q4) to Estonia, Ireland and Latvia. He argued that Iceland's approach (let the banks fail and continue deficit spending) allowed it to better weather the crisis than other countries. The critics argue that he was cherry picking starting points for comparisons and if you look back to 2000Q1 or even 2007Q3, Iceland's performance doesn't really look that good.

In some future post I'll look at Estonia, Ireland and Latvia, but for now I would argue that all such comparisons are questionable. Without having an attractor value for GDP growth in each country, it's not really possible to distinguish "bubble" growth from "normal" growth. The graph at the start of this post displays a simple business-as-usual (BAU) attractor path and 98% bootstrap confidence intervals for Iceland's GDP (in real $2000 USD). That graphic tells a better story about Iceland's late 20th century economic history than do the comparisons to other bubble economies provided by the Council on Foreign Relations.

For much of the mid-20th century, the Icelandic economy was underperforming. However, from the late 1980's until the mid-1990's, the economy went through a period of almost stagnant GDP growth. In response, Iceland undertook extensive neoliberal reforms (here). And, in the late 1990's the economy certainly seemed to take off into sustained growth.

Around 2001, however, the economy had reached is BAU attractor and, indeed, there was a period of slow growth. My guess is that growth in the 2% range around the attractor was simply not acceptable and Iceland's answer was financialization which seemed to be producing high growth rates for the foreseeable future (dark red arrow in the graphic) until the Icelandic financial crisis of 2008-2011 brought the economy back to the BAU attractor in 2010.

Compare Iceland to Germany (here). What Iceland has going for itself right now is that (1) it didn't overshoot its BAU attractor by that much (by 2020 the economy will be back to peak bubble GDP values) and (2) it is currently at or near its BAU attractor value (unlike Germany on both counts). The question for Iceland is whether modest growth rates stabilizing around 1% will be acceptable to right-wing, neoliberal policy makers.