Two have developed in response to fighting banking crises. There’s the bank-sponsored model, which revolves around preserving the interests of banks and not allowing debt defaults under any circumstances. The other model is a citizen-oriented approach. This model was used in Iceland and focuses around restructuring and eliminating excess debt in the system and, crucially, not allowing citizens to pay for the poor investment decisions of bank management.
The article above from Reuters focuses on “successful” crisis fighting efforts in Ireland, yet completely ignores the even better results attained by Iceland. There are two differences between the countries. Ireland chose to use taxpayer money to bail out investors in Irish bank debt, mostly German and assorted Eurozone country banks while Iceland allowed its banks to fail. Additionally, Iceland has its own flexible currency, but Ireland shares a currency with 16 other countries.
Let’s compare the recent economic performance of Ireland and Iceland and ascertain which model is working better.
Iceland wins this battle. It’s growth has been higher on average since 2010, and the steep upwardly sloping trend confirms the good news. Iceland is growing faster because it purged debt from its financial system by allowing banks to fail and through a devaluation of the krona. Ireland spent taxpayer money supporting its banks, an indirect bailout of Eurozone institutions that made bad investment decision. A devaluation of the currency would have reduced the value of debt in Ireland, but this avenue of reform was blocked by its euro membership. The euro giveth, and the euro taketh away.
These numbers are just a little bit stale. Ireland added another 14% or so to its total for an Italian-like 120% ratio. Iceland only added 2.3% to move to a 101% ratio. If there are any Irish readers out there who have faith in their government, just look at how much money you are borrowing to support the banks and how much you could save by allowing them to fail:
The Irish budget deficit for 2012 was six times larger than Iceland’s, and the trend is not so hot either. That’s a lot of Guinness or smoked herring depending on your perspective.
By allowing banks to fail, Iceland avoided a much larger increase in its debt to GDP ratio. The massive debt pile in Ireland will sap growth for years. Iceland will do just fine.
The Reuters article quotes an economist giving the best case scenario for Ireland and the rest of the periphery:
In all of these countries, it’s going to take the rest of the decade to bring debt down to more comfortable levels…
The assumption underlying that statement is that Irish (and PIIGS) growth will return to more robust levels and reduce the debt to GDP ratio. However, high levels of debt reduce economic growth rates, so economic growth will remain low for the foreseeable future. By the end of the decade, the debt situation will at best be stagnant, though it will probably worsen as there will surely be a recession between now and 2020.
The much ballyhooed Irish export boom is a canard. Note the trend line for the last two years:
It’s basically flat. Iceland is actually the beneficiary of a notable increase in exports with a nice, rising trend:
The difference? Iceland was able to devalue its currency, but Ireland cannot devalue
Germany’s its own currency, because it belongs to Eurozone.
This is perhaps the most important comparison. A society with high unemployment is one that is prone to all sorts of ills. Quality of life declines with rates of depression, suicide, domestic violence and other maladies all increasing. See Greece for an example of what high, persistent unemployment can do to the social fabric. Ireland’s is currently 14.6%, while Iceland’s is only 5.7%. Hey, Ireland, at least the banks got their money.
A comparison of basic economic statistics shows that the Icelandic Model is clearly superior. Ireland is in a similarly situation position. Both countries are small island nations that are victims of banking crises. The debt Ireland took on to bailout its banks can be defaulted upon, and a return to the punt may still be accomplished. The only thing holding Ireland back is a government in the pocket of the banksters.