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An interview with Thorvaldur Gylfason

Thorvaldur Gylfason is one of Iceland’s most respected economists. He holds a PhD in economics from Princeton University and is currently Professor of Economics at the University of Iceland. He was an economist with the International Monetary Fund in Washington D.C. from 1976-1981 and is one of the editors of the European Economic Review. Since Iceland’s economic collapse he has been one of the most lucid and outspoken contributors to the debate on how to reconstruct Icelandic society. His is the name most frequently mentioned as the man people would like to see take over as director of the Central Bank of Iceland, or as Minister of Finance.

You have made no secret of your opinion that the current cabinet should resign. What sort of government do you see as an alternative, particularly at this time, and is it wise to hold elections in the midst of the current crisis?

As I see it, there are three main ways forward. One would be for the cabinet to resign and the Prime Minister to call new parliamentary elections in which case the President of Iceland would ask the current cabinet to continue in a care-taker capacity until a new government can be formed after the elections. This has occurred several times in the past. In this case the elections would have to be held as soon as possible, within weeks, almost surely an unattractive prospect at least in the eyes of the Independence Party that leads the present coalition government and that, because it is widely considered to hold prime political responsibility for the crisis, is expected to suffer a massive loss of support at the polls if elections are held any time soon. The Independence Party has been the largest political party in Iceland throughout the history of the republic and now faces the prospect of landing in third place.

Another possibility would be for the cabinet to resign and for the leaders of all five parties represented in Parliament to form a national government. It is unlikely, however, that all parties would agree to this strategy. This has never been done.

A third option is that the cabinet resign and the leaders of the two coalition parties agree not to try to form a new government with majority support in the Parliament but rather advise the President to form an extraparliamentary government comprising individuals who do not sit in Parliament and may or may not be affiliated with any of the political parties. This has been done once before, in 1942-44.

There are three main arguments for the third method in the current situation. First, an extraparliamentary government is more likely to inspire confidence among the public and perhaps also abroad, given the deep distrust that many Icelanders feel for the political class, government and opposition alike, in view of its co-responsibility for the crisis with the banks and with big business. In second place, an extraparliamentary government would not have to call new elections as soon as possible but could, with the consent of Parliament, continue to serve the rest of the term if necessary, that is, until the spring of 2011, an argument that should appeal to those who fear political turmoil, or loss of support, if new elections were called in today’s charged and possibly volatile atmosphere. Third, an extraparliamentary government, if left in peace by the Parliament, could accomplish quite a lot even without new legislation because many of the things that now need to be done can be done without new laws – such as, for example, (a) replacing the leadership of public institutions such as the Central Bank and the Financial Supervisory Authority; (b) making certain that the IMF program in place is properly implemented and supported by growth-friendly reforms and signals, including an application for EU and EMU membership; (c) reorganizing the three banks that failed and putting them on a firm footing; and (d) appointing an international commission of inquiry to investigate the origins and the aftermath of the banking crisis. Iceland has a strong executive branch that would give an extraparliamentary government adequate elbow room for reform unless the Parliament chose to sabotage the reforms.

You are one of the advocates of Iceland joining the European Union. Do you see that as the solution to Iceland’s current predicament?

No, EU accession is no panacea, and never was. Iceland’s entry into the EU and EMU has, however, in my view, become inevitable now in order to restore confidence in the Icelandic economy at home and abroad.

The arguments for joining the EU and the EMU are political as well as economic. The economic rationale has to do with the benefits of increased efficiency for living standards stemming from closer integration with the rest of Europe – through lower food prices, lower interest rates, keener competition, a stable currency, among other things. A weakened economy, even only temporarily, has a greater need than a strong economy for the economic boost to be expected from EU membership.

The political rationale for EU membership is a different matter. One of the main purposes of the EU is to be a forum of shared sovereignty to reduce risks. The sharing of sovereignty is unacceptable to many Icelanders, especially those who have exercised their unfettered sovereignty to drive Iceland’s economy into the ground. Had Iceland become a member of the EU at the same time as Austria, Finland, and Sweden in 1995, as it should have from my point of view, the current crash would have been significantly less likely to occur. By announcing its intention to apply for EU and EMU membership without further delay, the government would signal to the world financial community that it intends to get back on its feet as quickly and effectively as possible and that it wants to reclaim its status as an equal and trusted member of the international community.

What would you say to those who point out that Iceland will lose control over its resources, such as its fishing grounds and fresh water reserves, if it joins the EU?

Icelandic opponents of EU membership have stressed that the EU’s Common Fisheries Policy and the sharing of fish with foreigners that it might entail is unacceptable to Iceland. But there is a simple solution, as I described in print almost twenty years ago: sell the fishing rights on a level playing field. That way, Iceland would gain if foreign fishing firms were willing to pay a higher price than Icelandic firms for Icelandic fishing permits. And that way, foreigners would not have to be granted free access to Icelandic waters which, of course, would be out of the question in any case. Equal access to the Icelandic market for fishing permits would preclude discrimination by nationality, thereby making it unnecessary to contemplate other ways in which foreign vessels might be granted access to Icelandic waters and fish resources.

Icelandic fishing firms oppose this market-friendly solution because thus far they have been granted free access to Icelandic waters, even if they are defined by law as a common property resource. The boat owners do not welcome the prospect of having to pay for the quotas. They will have to lay down their opposition to fishing fees that were actually written into Icelandic law in 2002, but remain quite modest. The fishing industry is smaller than many realize: in 2007, it accounted for 7 percent of Iceland’s GDP.

There was considerable controversy around Iceland taking a loan from the International Monetary Fund. You were in favour of the loan … what would you say to those who claim that countries are often worse off after accepting the terms of the IMF?

They are mistaken. On the whole, as I see it, the IMF has done a lot of good around the world over the past sixty years or so. The Fund has helped member countries not primarily by dispensing short-term loans to stabilize currencies and ease balance-of-payments difficulties, but perhaps even more importantly by giving sound economic advice and thus strengthening the hand of local reformers who often, without expert help from abroad, would be unable to convince the political authorities of what needs to be done.

The IMF employs good and well-educated economists with lots of practical economic policy experience from around the world, and they share the views of local experts on a wide range of policy issues. Economists actually agree among themselves more often and about more issues than they are sometimes given credit for. The Iceland program now in place is a good example. Almost all Icelandic economists who have commented on the program in public debate have declared themselves in agreement with the major ingredients of the program, given that the government was unwilling to announce an immediate application for EU membership. Such an announcement would have made it possible to consider the possibility of fixing the exchange to avert the danger of a further temporary decline of the króna, but this option was not on the table, so the program had to be organized around a flexible exchange rate.

The fiscal policy aspects of the program as well as the acceptance of temporary capital controls demonstrate the Fund’s flexibility and its ability to learn from the criticism that it received in the past. My impression is that the IMF program enjoys wide public support in Iceland, partly because the deeply unpopular government is perceived as dragging its feet. Individual ministers even speculate in public, thoughtlessly, one would hope, about the possibility of introducing policy measures such as multiple currency practices that directly contradict the program. But the so-called IMF program is, in fact, the Icelandic government’s program, duly signed by the Finance Minister and the Governor of the Central Bank on behalf of the government. It is their program, and it is, therefore, their responsibility to ensure that the program is implemented as intended in accordance with the agreement between the government and the IMF.

You have said that both the Central Bank of Iceland and the Financial Supervisory Authority made grave mistakes in the lead-up to the economic collapse. Briefly, what were those mistakes and, in your view, how should those institutions shoulder responsibility?

The Central Bank made a series of blunders, as could be expected from a central bank governed by a self-appointed former Prime Minister without economic expertise (imagine George W. Bush whisking Ben Bernanke aside and appointing himself in his place without any criticism, not even from political opponents).

Among the most serious mistakes were the following:

1. The Central Bank reduced reserve requirements and then stopped using them to accommodate the wishes of the commercial banks when it should instead have increased reserve requirements to restrain the rapid expansion of domestic credit from the banking system.

2. During the long upswing in economic activity the Central Bank neglected to increase its foreign exchange reserves in tandem with the rapid increase of short-term foreign indebtedness of the commercial banks.

3. The Central Bank failed to reach both of its chief objectives stipulated by law: most of the time it failed to keep inflation on, or even close to, the officially announced inflation target of two and a half percent per year, and it likewise failed to ensure stability of the financial system.

4. The Central Bank did little to ease the liquidity crisis until, at a late stage, it negotiated swap agreements with other Nordic central banks.

5. Apparently not realizing the gravity of the situation despite repeated warnings, the Central Bank showed no signs of seeking technical assistance from other Nordic central banks that have built up world-class expertise in handling troubled banks and banking crises.

6. The Central Bank was not given access to a currency swap agreement in mid-2008 among the Federal Reserve Board in Washington, D.C., and the central banks of Denmark, Finland, Norway, and Sweden, apparently – this has not yet been officially acknowledged – because they all advised Iceland to seek assistance from the IMF and Iceland refused.

7. The Central Bank was too hasty, and worse, may have acted out of political spite when it took over Glitnir and set in motion the events that led to the collapse of the other two banks, Landsbanki and Kaupthing, within a week.

8. The Central Bank ought to have impressed on the government in early 2008 the need for assistance from the IMF rather than oppose such a request.

The Central Bank even made a desperate, almost comical attempt to secure emergency assistance from the Russian government apparently in an attempt to avoid having to turn to the IMF; perhaps the Russians also told the Icelandic authorities that they needed help from the Fund. Also, it has been reported in the British press that the UK Prime Minister, Gordon Brown, advised his Icelandic counterpart as early as April 2008 to seek IMF assistance.

In view of these events, it is astonishing that the Icelandic Prime Minister continues to praise the performance of the Central Bank and declare full confidence in the bank. Many wonder why. The governor is increasingly referred to, even in government circles where more and more officials are beginning to “sing,” as Iceland’s J. Edgar Hoover.

[NB apologies to anyone who had trouble viewing this article earlier. It worked fine in Firefox and Safari, but IE had a problem. It had to do with pasting from Word and is fixed now.]



Comments on this entry are closed.

  • Sólveig January 14, 2009, 12:35 pm

    This is an excellent interview with some very good points. An superb addition to the IWR!

    The IMF certainly has done a lot of good in the world, but there have also been mistakes, mostly where the IMF wasn’t fully aware of the local situation and conditions, IMO. However, Iceland is a fully developed country with all its infrastructure in place, so it shouldn’t be too hard for the IMF to develop policies to get us back on track… one would think.

    It’s amazing to see politicians drag their feet so much and only see what they want to see. Although that can go for the nation at large, to some extent… although not so much anymore.

  • tj January 14, 2009, 2:14 pm

    I must say this is very impressive to see a high quality interview about this subject. Here in the USA where I live there is much useless chatter instead of clear discussion of what caused the economic problems for us and for others.

    The International Monetary Fund worked out badly in some undeveloped nations. Iceland does match up better to the IMF than most third world nations, as Sólveig an earlier commentator mentioned.

    I would caution though that Europe in general and Scandinavian Europe in particular did not escape the current economic crisis. Some beneficiaries of the IMF also did not escape. What will happen next is not clear I think to anyone.

    Professor Gylfason is refreshing to hear from as he is not spouting partisan party rhetorical nonsense as we have so much of here in the States.

  • Stan January 14, 2009, 2:25 pm

    What a wonderful first interview. Way to go!

    One point, among many, that really got my attention was the fact: “The fishing industry is smaller than many realize: in 2007, it accounted for 7 percent of Iceland’s GDP.”

    I keep hearing how Iceland will get bailed out (bad pun) by its fish. Yet the quotas have been squandered and I understand that many have actually been taken as collateral by foreign banks.

    Interviews such as this help to reassure foreigners, particularly stakeholders, that there is a reservoir of competency in the country. You are doing a great service.

  • Andrew January 14, 2009, 2:50 pm

    Sounds like he would make an excellent head of the Central Bank. You have a scoop here – IWR is rapidly becoming the main source of unbiased news from Iceland!

  • Not Quite January 14, 2009, 5:15 pm

    “IWR is rapidly becoming the main source of unbiased news from Iceland”

    Is this your determination? If not what is your source?

    Excellent interview BTW.

  • Muriel Volestrangler January 14, 2009, 6:58 pm

    Thanks for the excellent interview with the learned professor.
    Thorvaldur is very careful with his words. I suspect that behind his formal logical argument for joining the EU he has other, unspoken reasons, namely, that the present situation is hopeless and the present government can and will do nothing to solve the problem. Thorvaldur probably knows some things that he is not telling us, such as the possibility that the foreign creditors (mainly the Germans and English) will forgive Iceland of its huge debts once Iceland joins the EU. Or if Iceland votes for the EU immediately, then the EU will offer short-term aid right now (and perhaps even allow use of the Euro), until it formally joins the EU, since eventually the EU will assume responsibility for propping up the country .
    I have a few doubts about his “market-friendly” plan to sell Icelandic fishing grounds rights (i.e. keeping the 200 mile limit but selling the quotas). First, you can’t sell something that you don’t own. And second, as the Norwegian lecturers in Iceland said a few days ago, the EU has made no exceptions — none — to the common fishing policy — that means free access to all.

  • Ljósmynd DE January 14, 2009, 10:02 pm

    Good Job! One might agree or disagree on certain points but any way those prudent words based on profound background knowledge constitute a powerful statement.

    I’ve just read that it’s now 100 days since this emergency law was installed – without anybody accepting responsibility and stepping down. I wonder how long it needs to keep on counting.

    Somehow OT, belonging to your last post: One of the most striking slogans of the days before the collapse of the Berlin Wall was “Wir sind das Volk”, roughly translated to “WE are the nation”, which might be set against this infamous and unworldly “you are not the nation”-statement by your FM. Just as a suggestion for an extended selection of printed T-shirts – this slogan proved very powerful in the end. 🙂

  • alda January 14, 2009, 10:13 pm

    Thanks, everyone.

    LDE – we’re getting similar slogans here, too. The people behind the demonstrations on Saturdays call themselves The Voices of the People.

  • Jessica January 14, 2009, 11:43 pm

    I’m so relieved to see that a respected economist with a PhD pointed out what all us common folks were thinking about Oddson running the Central Bank. Um, shouldn’t the person in charge of a nation’s money have some economics background? Hello? Critical job requirement? And I absolutely cringe at the thought of George Bush handling money….spooky! But great analogy!

  • NWO January 15, 2009, 3:05 am

    Great job! Fascinating interview.

  • Finnguy January 15, 2009, 4:49 pm

    Excellent interview.

    Have you Icelanders been considering shadow parliament yet? It seems obvious that considerable pressure is to be exercised to achieve new elections, which you truly deserve.

  • Elín January 15, 2009, 7:39 pm

    Excellent interview – clear and concise. It gives one hope to read this.

  • James January 15, 2009, 7:41 pm

    An excellent high-quality interview – and also succinct considering the complexity of the subject matter.

    However, stating that “the fishing industry is smaller than many realize: in 2007, it accounted for 7 percent of Iceland’s GDP” may be misleading. Didn’t banking account for an unusually large part (I read over 80% somewhere) of Iceland’s GDP in 2007? A more relevant statistic would therefore be the estimated percentage for the fishing industry in future, for example in 2009 or 2010.

  • Ljósmynd DE January 15, 2009, 10:29 pm

    I would expect that the percentage of the GDP which the fishing industry accounts for will be considerably larger in the next years than in 2007 as the part of the financial sector, the construction industry and the output of the aluminium smelters has dropped. The issues around the fishing industry are certainly some of the most sensitives.

    Thorvaldur skipped the question about the feared loss of control over the fresh water ressources when joining the EU. Is this question aimed at the exploitation of hydro power or loss of fishing permits to foreigners or what are the concerns? I would have been interested in his answer.

    I fear that whenever it might be viable and profitable to exploit more of Iceland’s hydro and geothermal power reserves in the future, it will be easy for foreign investors to push their interests through against all environmental concerns – as weak as Iceland’s position is. But this might happen with or without Iceland beeing in the EU.

  • alda January 15, 2009, 10:40 pm

    LDE – the fresh water question is precisely that – Iceland currently has ample supplies of fresh drinking water which in the future will become increasingly scarce. Exports are just beginning here and are going very well. People fear loss of this resource if and when we join the EU.

  • Sigga January 16, 2009, 12:11 am

    Finally got to see it… great interview and really is reflective of what I believe is the truth to the current situation. What does it take to get Geir and David out of their cushy little chairs? They are not alone though, a clean sweep needs to be made of all the embætismen that they put in place. I had dealings with one ministry and could not understand the incompetence of the guy that I was dealing with – questioned how he got his job and was informed he was David´s brother in law… urgghhh… so so so anoying

  • alda January 16, 2009, 10:22 am

    Sigga – Annoying? Infuriating!! That sort of thing has GOT to stop. I want a New Iceland with no more of that kind of nepotism and corruption.

  • JoeInVegas January 16, 2009, 9:20 pm

    Very intelligent individual, sorry that he has no power to make any of it happen. Or do you all, unless the government lets it.

  • R.Jacob January 19, 2009, 7:26 pm

    Iceland has a very educated population and can come out of the present crisis faster than many others. It has to put its act together and regain the confidence of international investors. One way of doing this is to begin paying or declare when the interest will be paid to holders of fixed income securities and perpetuals in the nationalised banks. Investors can certainly appreciate that the principal repayment will have to wait till the situation gets better. The Icelandic authorities can also publicly declare that Iceland will honour all its international debts and commitments and request the support of investors during this difficult period.

    Thorvaldur’s comments indeed is proof that Iceland is rich with right thinking people , new ideas and creative solutions.

    Best wishes to the people of Iceland.

  • portkins January 29, 2009, 2:13 am

    What about getting on a gold standard.
    Then you will have an honest currency

  • Oliver May 7, 2009, 9:04 pm

    EU & IMF = Bad.