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.

Is Another EU Recession Likely?

Concerns are developing (here) that the European sovereign debt crisis could trigger another recession that spreads from the EU area to the US. In an appearance before the US Congress yesterday, US Fed chair Ben Bernanke warned more government action would be needed to prevent a recession in the US. The transmission for this recession would be the banking systems of both the EU and the US which are heavily interconnected.

My business-as-usual (BAU) GDP forecast for the EU is presented above. Actual GDP is displayed as a solid line while the attractor value is the dashed red line with the 98% bootstrap confidence intervals displayed in green and blue dashed lines. After 2003, the EU bubble began developing and peaked in 2007 followed by a crash in 2009 to very low levels in 2010. The model suggests that forces will began pushing the economy back to its attractor value but that does not mean that that future shocks (such as a Greek default) could not push the EU to improbably low GDP levels.

The European Economic Commission's forecast for 2010-2012 (here) suggest that:

The European Commission's autumn forecast foresees a continuation of the economic recovery currently underway in the EU. GDP is projected to grow by around 1.75% in 2010-11 and by around 2% in 2012. A better than expected performance so far this year underpins the significant upward revision to annual growth in 2010 compared to the spring forecast. However, amid a softening global environment and the onset of fiscal consolidation, activity is expected to moderate towards the end of the year and in 2011, but to pick up again in 2012 on the back of strengthening private demand.

The graph above displays the EEC's confidence interval for GDP growth rates. The EEC forecast suggests a small probability of negative growth rates after 2011.
The annualized growth rate of the BAU attractor for GDP in the EU is displayed above. My forecast is for a continually decreasing growth rate approaching zero after 2060.

The definition of economic depression (here) is a little squishy (a drop of more than 10% in GDP lasting for three to four years). In terms of attractor models, the EU economy has been underperforming ever since 2009. The rate of return to the modest growth rates predicted by the BAU GDP attractor will depend on future financial and non-financial shocks to the EU economy.