The love of lamb meat is not the only thing Greeks and Icelanders have in common. Greece and Iceland are among the first European countries to complete the International Monetary Fund’s bailout program. According to the IMF, Iceland graduated successfully but with some delays in 2011 and Greece with some successes and numerous failures in 2012.
Few Greeks and Icelanders share this view with the IMF as they have had to pay dearly for the deeds of their corrupt politicians and bankers. Iceland now enjoys the contested status of being a low-wage country with record high private debt level and capital controls in place to stop the currency from collapsing. The crisis in Greece is now the deepest in Europe in terms of contraction, unemployment and economic hardship.
In both Greece and Iceland, the IMF managed to achieve its goal of fiscal consolidation. Here the success story ends for Greece but Iceland managed to restore growth in 2011 and regain access to international financial markets. However, growth has been persistently lower in Iceland than projected by the IMF and the market access came at a very high cost.
The collapse of the banking sector in 2008 led to a 50% devaluation of the Icelandic krona, wiped out the wealth of many in Iceland and lowered wages, making the country’s exports more competitive in foreign markets. The devaluation aggravated the private debt problem as all consumer loans are indexed to the price level that rose with higher prices of imported goods. Instead of general write-downs of private debt to speed up recovery, the IMF supported indexation of loans and a lengthy case-by-case debt relief program for distressed households and businesses.
The slow debt restructuring and the high interest rates, to support capital controls, have suppressed investment and growth in Iceland. The capital controls were introduced by the IMF in 2008 to fence off carry trade money (40% of GDP). Their abolishment is impossible without either a devaluation disaster or major asset write-downs, as liquidated assets of the bankrupt banks owned by vulture funds are now also waiting to be exchanged into foreign currencies. Growth prospects are bleak for this year as business investment is expected to drop to negative numbers and demand in domestic and foreign markets is weaker.
The Greek government sought assistance from the Troika (EU, EBC and IMF) in 2010 after the country’s sovereign debt had been downgraded to junk status. At that time, Greece needed debt restructuring but the euro partners ruled it out to protect their banks. The IMF gave in to pressure from its major shareholders and relaxed its criteria on debt sustainability fully aware that unsustainable debt depresses investment and growth. The delay in debt write-downs created opportunity for private creditors to sell off their sovereign bonds into public hands making the sovereign debt even more unsustainable under the bailout program.
With a fixed exchange rate and unsustainable debt level, Greece had to enforce a massive internal devaluation or wage cuts to boost economic growth. Under the firm hand of the Troika, public sector wages and pensions were cut but little was done at first to lower private sector wages to enhance competitiveness. The economic contraction caused by fiscal cuts was, therefore, not offset by strong private sector growth as projected by the Troika. The Greek economy became trapped in a downward spiral of falling output, fast rising unemployment and eroding disposable income moving the country to the brink of social disaster.
The Troika’s harsh austerity measures have been met with massive protests in Greece and fiscal targets were adjusted in 2011. The IMF has admitted that an earlier adjustment of fiscal targets would have tempered contraction. The Troika also subjected Greece to ever more detailed fiscal conditionality that went against IMF´s principle of parsimony and created great uncertainty about each bailout payment (cf. psychological warfare). Fiscal targets were also relaxed in Iceland, as actual growth in 2010 deviated grossly from the fund’s growth projections.
Being outside of the EU, the Icelanders were more successful than the Greeks in resisting the substitution of private debt for public debt. The EU member countries had only the board of the IMF to pressure the Icelandic authorities to compensate UK and Dutch depositors lured by high interest rates of Icesave accounts in Landsbankinn. The Icelandic voters rejected two different repayment agreements as unacceptable, despite pressure from the IMF and delays in reviews of the bailout program. This year, the EFTA court ruled in Iceland’s favour but Icelanders are still haunted by the dispute. Under the IMF´s bailout program, a state guarantee was given to ensure Landsbankinn has pounds and euros to compensate British and Dutch depositors. This guarantee cannot be honoured as the economy does not generate sufficient foreign currency.
The bailout program enjoyed less public support in Greece than in Iceland as it did little to ensure burden sharing. High income groups in Greece continued to be able to avoid paying taxes while the tax system in Iceland was already effective in preventing tax evasion. Iceland was, thus, able to finance more generous social transfers to those hardest hit by the crisis. The devaluation of the krona cut wages across the board, not only in the public sector, as was the case in Greece. After the crisis, disposable income equality increased in Iceland and the number of people at risk of poverty fell. However, a tremendous wealth transfer was allowed to take place from those with indexed loans to capital owners. In Greece, increased inequality and poverty deepened divisions in an already polarized society.
The lessons we can draw from the bailout of Iceland and Greece is that the IMF´s overoptimistic growth projections are made to serve the interest of foreign creditors. The focus of the IMF’s bailout program must shift from backfiring austerity measures to general write-downs of excessive debt in order to ensure growth. Bailout programs safeguarding the interests of the rich and the IMF’s major shareholders undermine social cohesion and IMF’s credibility.