23 Things They Don't Tell You About Capitalism

For a while, the financial expansion seemed to work wonders for Iceland. Once a financial backwater with a reputation for excessive regulation (its stock market was only set up in 1985), the country was transformed into a vibrant new hub in the emerging global financial system. From the late 1990s, Iceland grew at an extraordinary rate and became the fifth richest country in the world by 2007 (after Norway, Luxemburg, Switzerland and Denmark). The sky seemed to be the limit.

Unfortunately, after the global financial crisis of 2008, the Icelandic economy went into meltdown. That summer, all three of its biggest banks went bankrupt and had to be taken over by the government. Things got so bad that, in October 2009, McDonald’s decided to withdraw from Iceland, relegating it to the borderland of globalization. At the time of writing (early 2010), the IMF estimate was that its economy shrank at the rate of 8.5 per cent in 2009, the fastest rate of contraction among the rich countries.

The risky nature of Iceland’s financial drive since the late 1990s is increasingly coming to light. Banking assets had reached the equivalent of 1,000 per cent of GDP in 2007, which was double that of the UK, a country with one of the most developed banking sectors in the world. Moreover, Iceland’s financial expansion had been fuelled by foreign borrowing. By 2007, net foreign debt (foreign debts minus foreign lending) reached nearly 250 per cent of GDP, up from 50 per cent of GDP in 1997. Countries have gone to pieces with far less exposure – foreign debts were equivalent to 25 per cent of GDP in Korea and 35 per cent of GDP in Indonesia on the eve of the Asian financial crisis in 1997. On top of that, the shady nature of the financial deals behind the Icelandic economic miracle was revealed – very often the main borrowers from the banks were key shareholders of those same banks.

New engine of growth?

Why am I spending so much time talking about a small island with just over 300,000 people that does not even have a train station or a McDonald’s, however dramatic its rise and fall may have been? It is because Iceland epitomizes what is wrong with the dominant view of finance today.

Extraordinary though Iceland’s story may sound, it was not alone in fuelling growth by privatizing, liberalizing and opening up the financial sector during the last three decades. Ireland tried to become another financial hub through the same strategy, with its financial assets reaching the equivalent of 900 per cent of GDP in 2007. Like Iceland, Ireland also had a bad fall in the 2008 global financial crisis. At the time of writing, the IMF estimate was that its economy contracted by 7.5 per cent in 2009. Latvia, another aspiring financial hub, has had it even worse. Following the collapse of its finance-driven boom, its economy was estimated by the IMF to have shrunk by 16 per cent in 2009. Dubai, the self-appointed financial hub of the Middle East, seemed to hold on a bit longer than its European rivals, but threw in the towel by declaring a debt moratorium for its main state-owned conglomerate in November 2009.

Before their recent falls from grace, these economies were touted as examples of a new finance-led business model for countries that want to get ahead in the era of globalization. As late as November 2007, when the storm clouds were rapidly gathering in the international financial markets, Richard Portes, a prominent British policy economist, and Fridrik Baldursson, an Icelandic professor, solemnly declared in a report for the Iceland Chamber of Commerce that ‘[o]verall, the internationalisation of the Icelandic financial sector is a remarkable success story that the markets should better acknowledge’.[1] For some, even the recent collapses of Iceland, Ireland and Latvia have not been enough reason to abandon a finance-led economic strategy. In September 2009, Turkey announced that it will implement a series of policies that will turn itself into (yet another) financial hub of the Middle East. Even the government of Korea, a traditional manufacturing powerhouse, is implementing policies aimed at turning itself into the financial hub of Northeast Asia, although its enthusiasm has been dented since the collapse of Ireland and Dubai, after which it was hoping to model the country.