Iceland’s Economy Shrinks In Third Quarter - Austerity delivers anaemic growth: No surprise there

Austerity delivers anaemic growth: No surprise there

After years of growing at a respectable rate, the Icelandic economy seems to have stalled. According to the most recent measurements of Statistics Iceland the Icelandic, published on December 5, the Icelandic economy barely registered any growth over the first nine months of the year, and actually shrunk in the third quarter.

These results stand in stark contrast to the extremely rosy projections of a couple of weeks ago, which promised a growth rate of 2.7% over the year. Analysts at the large banks were similarly projecting growth around 3% for the year. Now it seems more likely we will see an economy that is flatlining, rather than growing.

Although the Central bank still maintains there is a near-term outlook for strong growth, these news no doubt played a role in its decision to lower interest rates. At a press conference yesterday morning, it was announced that the bank had lowered its interest rate by 0.5 percentage points.

Dramatic turnaround

According to Statistics Iceland, the seasonally non-adjusted GDP during the first three quarters of 2014 increased by only 0.5%, compared to the same period in 2013. The year over year change in GDP in the third quarter was actually negative by 0.2%. To put that into perspective, the economy had grown by 5.2% year over year in the third quarter of 2013.

This marks a dramatic turnaround. After the infamous crash of 2008, the Icelandic economy shrunk in 2009 and 2010. However, since 2011, the economy has been growing at a respectable rate, by 2.1% in 2011, 1.1% in 2012 and 3.5% in 2013. While purchasing power has yet to reach its pre-crash peak, and many families are still acutely aware of the crash when trying to make ends meet, the economy had safely exited recession. Now it seems the recovery was more fragile than many had hoped.

A non-performing economy, political blunders and scandals

As if the conservative-progressive government needed more bad news? The government has stumbled from one blunder to the next, struggling with scandals small and large, and now it is saddled with a stalled economy. Which is made worse by the fact that these parties spent the previous four years denouncing the economic record of the left-wing government which inherited the crash, while promising they would get the “wheels of the economy turning” once back in office.

To that end, their first actions once they assumed power last spring were to implement large tax cuts for the wealthy and the most profitable industries, supposedly to spur investment. To pay for these tax cuts, classic austerity measures were implemented. Last year’s budget introduced new fees, for example on university students, and now this year’s budget promises even more dramatic budget cuts and greater fee hikes, as well as an increase in the value added tax on necessities, from 7% to 11%.

When we consider the track record of austerity budgets and tax cuts for the wealthy it should come as no surprise that the result has been neither prosperity nor growth.

What is the problem?

The main reason growth has not been in accordance with previous projections is that private consumption is growing far slower than previously estimated: Cutting budgets and raising fees on government services does not increase people’s purchasing power. Austerity does not produce growth, it’s that simple.

But the problem goes deeper. Icelandic wage earners faced a massive decrease in their purchasing power after the crash of 2008, and over the past years people have been willing to accept low wage increases, all in the name of economic stability. At the same time, CEOs have been receiving hefty raises, bonuses in the financial sector are back to pre-crash levels, and the shareholders of the largest fishing corporations are paying themselves huge dividends. The fruits of economic growth have not been flowing to the public.

People simply do not have the money to fuel growing consumption.

Moreover, the politics the government pursues seem tailor made to create economic instability. By raising fees and taxes on working families, while doling out billions to special interests, the government is stoking the fires of labour unrest. The great loan modification, which was supposed to spur consumption, has been a complete failure, creating confusion and disappointment rather than consumer optimism.

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Magnús Sveinn teaches economic history at the University of Bifröst.