The Icelandic Way Out of the Crisis Welfarism, redistribution and austerity



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The Icelandic Way Out of the Crisis

Welfarism, redistribution and austerity

by

Stefán Ólafsson



Working Paper no. 1: 2012
Þjóðmálastofnun – Social Research Centre,

University of Iceland

Executive summary
Iceland worked out its own policy to deal with the crisis, in cooperation with the IMF. Iceland graduated from the IMF program earlier this year. Iceland already has started to pay back the crisis loans it received from IMF and the other Nordic nations, earlier than required by the loan agreements. Iceland seems now to be firmly on a dynamic resurrection course, with economic growth having been 3.1% in 2011 and prospects are of a 2-3% growth in 2012. Real wages have increased significantly and so has private consumption. Unemployment was generally well below the EU average through most of the crisis and is presently on a slow downward path. So the economic winds have already changed in Iceland, in fact earlier and more forcefully than in many of the other countries that were deeply hit by the financial crisis.

The main characteristics of Iceland’s approach are an emphasis on redistribution, through the tax system and the social protection system, along with debt relief measures that also were disproportionally aimed at the middle and lower income groups. Redistribution meant that need for expenditure cuts, classic austerity measures, were not as great as otherwise would have been. Various efforts to alleviate unemployment were also implemented. While the national currency (the Icelandic Krona) had a role in exaggerating the bubble economy effect prior to the crisis, its devaluation helped export industries maintaining their operation after the collapse. The cost of that devaluation however fell drastically on households, with a big cut in real earnings (through price inflation while incomes lagged behind). That cut in living standards fell however disproportionally on higher income households, due to the policy of redistribution. We see the redistribution policy as supporting a stimulus effect by keeping up consumer demand to some extent, helping to contain unemployment trends and faciliutating economic recovery from the depression (see also Krugman 2012). The policies have also succeeded in containing poverty problems and softening financial hardships amongst the most vulnerable.

When comparing Iceland and Ireland we see completely opposite policy effects in distributing the burdens of the crisis, with lower income groups getting much more cuts in real earnings in Ireland than in Iceland, while the higher income groups were more hit in Iceland. The top income group in Ireland actually increased its real earnings in the early stages of the crisis. The Irish pattern seems to be similar to the USA pattern and partly to the UK pattern. Due to the emphasis on redistribution in Iceland the income distributin became much more egalitarian by end of 2010 than it had been before the crisis (which actually was associated to great increases of income inequality up to 2007).

We cover debt relief measures significantly in this report, showing the effects of the measures taken. Debt levels have actually come significantly down by end of 2011, in fact close to the level prevailing in 2007, a year before the financial collapse. Debts have been written down for some 15-20% of households and debt relief has been greatly expanded through subsidies of interest costs of housing loans. The government now pays about 35% of the interest cost of housing loans in Iceland and up to 45% for the lowest income groups. That measure is also quite redistributive in its effect on income distribution.

The following is the IMF recent verdict on Iceland’s policies: „Targeted household debt restructuring policies can deliver significant benefits. Such policies can, at a relatively low fiscal cost, substantially mitigate the negative impact of household deleveraging on economic activity. In particular, bold household debt restructuring programs such as those implemented in the United States in the 1930s and in Iceland today can reduce the number of household defaults and foreclosures and alleviate debt repayment burdens. In so doing, these programs help prevent self-reinforcing cycles of declining house prices and lower aggregate demand“.

Recent policies in 2012 have primarily seen fine-tuning of policies already in place, but with a growing emphasis on job creation. The government recently announced a major investment plan to take effect in 2013, with foreseen great positive effects on job creation. Such policies would harness the already fairly good prospects.


Table of Contents

Executive summary

Part 1. Iceland’s Way Out of the Crisis

1. Mapping the progress:

1.1 How to cut and not cut welfare expenditures

1.2 Iceland’s and Ireland’s approaches compared

1.3 Growth and employment

1.4 Wages and private consumption


2. Debt relief in the context of austerity

2.1 Debts and debt burden up to 2011

2.2 Debt relief and redistribution

Part 2. The Policy Responses 2011-2012 in detail

3. Welfare monitoring activities

4. A major new investment plan for job creation
5. Poverty alleviation
5.1 Poverty alleviation – Towards the 2020 goals

5.2 Poverty reduction amongst the elderly



Appendix I: IMF’s 2012 verdict on Iceland’s debt relief program

Appendix II: Extra data
References
Part 1. The Icelandic Way Out of the Crisis

Now three and a half year after the spectacular collapse of the Icelandic financial system of October 2008, we are in a position to assess quite profoundly how Iceland tackled this excessive crisis. What we find is that Iceland’s approach appears to have been quite successful to date. We also find that Iceland has partly designed its own policy approach, in cooperation with the IMF, exemplifying its own special strategies. We explain the main characteristics of this Icelandic approach and how it has worked in practice.

The main characteristics of the approach are an emphasis on redistribution, through the tax system and the social protection system, along with debt relief measures that also were disproportionally aimed at the middle and lower income groups. Redistribution meant that need for expenditure cuts, classic austerity measures, were not as great as otherwise would have been. Various efforts to alleviate unemployment were also implemented. While the national currency (the Icelandic Krona) had a role in exaggerating the bubble economy effect prior to the crisis, its devaluation (which started at the beginning of 2008, well before the collapse of the banks) helped export industries maintaining their operation after the collapse. The cost of that devaluation however fell drastically on households, with a big cut in real earnings (through price inflation while incomes lagged behind). That cut in living standards fell however disproportionally on higher income households, partly due to the policy of redistribution.

We will start by profiling the progress through the crisis to date, mainly with statistical material. Then we survey policy measures and their results, with a special focus on debt relief, position of pensioners and poverty alleviation, also with a reference to the EU2020 goals as well as Iceland’s 2020 goals.



1. Mapping the progress

Iceland’s government that came to power in February 2009, a few months after the collapse, pledged itself to pursue egalitarian welfare policies as far as possible and to shelter lower and middle income huseholds against the vagaries of the crisis. The main tools of that approach were the tax and benefits policy, debt relief, employment policy and activation. Given that government finances were in ruins immediately after the collapse the task of being “a Nordic welfare government” in those circumstances was gigantic indeed. The government started its course of financial and economic resurrection of Iceland with a 14.5% deficit on the government budget, massively increased debts of government, firms and households and a seriously eroded level of trust amongst the public as well as amongst trading partners and governments of neighbouring countries. So the task was enormous by any standard. Iceland was however falling from great heights that also meant that there was some room for dealing with a serious setback. The society should have been able to take cuts in living standards.

The government embarked on a program of resurrection based on improving public finances by raising tax revenues on the whole as well as by cutting expenditures. Welfare expenditures were however sheltered, with a lower overall degree of cuts than in other sectors of public expenditures. Welfare expenditures were also rearranged, such that there were significant increases in some areas while cuts came in other areas. Welfare expenditures were on the whole more directed at lower income huseholds, both pensions and benefits, and while the overall taxation level was raised the actual tax burden on lower and just over middle-income level households were actually lowered while the tax burden on the top 40% were increased (Kristjánsson and Ólafsson 2011; Kristjánsson 2011)). There were however some increases in indirect taxes (VAT went from 24.5% to 25.5%) that are more regressive in nature.


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skrar -> Crisis Policies in 2012 and Challenges Moving Forward


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