In 2008, when the banking systems collapsed throughout Ireland and Iceland governmental distress, unemployment, budget deficits, and bankruptcy were among some of the most damaging events that occurred in both countries for many years to follow. Eventually, being named the Global Financial Crisis (GFC). To provide a better understanding of how extreme this financial crisis was, we first must analyze the years leading up to it. Just one year before the GFC, both Iceland and Ireland were in surplus. Ireland was running a primary surplus for many years leading up to the crisis, and Iceland running an even larger one, at nearly 5% of its GDP in years 2005, 2006 and 2007 (Geithner, T. & Metrick, A.). From the late 1990’s up until 2008, both Iceland and Ireland were widely perceived as states that had managed to use globalization to their advantage. Both had high and sustained growth rates, living standards among the highest in the world, and governments in power whose policies stimulated free market activity (Thorhallsson, B., Peadar, K.). So, where did things go wrong? The following research will provide an overview of both countries using a compare and contrast method.
The Irish financial crisis was brought on by interdependence on foreign markets and a dependence on a housing market, which was prone to bubbling (Boullet 1). When the Irish economy modernized, it saw returns that were unprecedented. Its housing market was fueled by tax breaks and state subsidies, which created an artificial demand. Also contributing to the market’s artificial growth, were the interest extremely low interest rates set by the European Union during a period that the economy was booming for Ireland (Thorhallsson, B., Peadar, K.). At the time, the larger economies of the Union were suffering from “Eurosclerosis” and were not growing at desired rates. Eurosclerosis, a term coined by Herbert Giersch, described the pattern of economic stagnation in Europe beginning in as early as 1973. From 1981-1985, the average annual growth rate of GDP in parts of the EU were 1.1 per cent, only half the rate which the U.S. economy achieved and only a quarter of the figure for Japan (Giersch, H.).
To stimulate growth in those markets, the EU set low interest rates which made borrowing money for investments cheap. However, Ireland was not struggling at the time. Easy access to liquidity contributed to the housing boom and added fuel to the fire. With the structure and size of the Irish economy changing so rapidly, the risk involved rose considerably. In the meantime, however, Ireland was celebrating its successes. The long boom, which was active for about 14 years from 1993-2007, was a unusually pleasing experience for Ireland in terms of its length and high growth rates, averaging 7.3 per cent per annum over the period and surpassing 10 per cent in 1996. Additionally, unemployment fell from 15.6% to 4.4% during this period of time due to the high demand for jobs in the real estate and construction business (Thorhallsson, B., Peadar, K.).
As an unintentional result of this, the economy would eventually become overleveraged on imbalances. The market demand was tenuous, and the size of the market would tie the direction of the market directly to the Irish economy. When the housing market began a contraction, the house of cards the rest of the economy was built on began to crumble. The housing market directly affected the banks, which was a new and booming market in the Irish economy. Irish banking systems which had lent €200 billion largely to property developers (Boullet, V.). When the banks were unable to recoup from their loans, they were unable to pay off the money they had borrowed from elsewhere.
Iceland was a country that had been slow to adopt economic trade policies and when they finally did, they saw dramatic effects that altered the economic landscape of the country. In the 1990s the country made a deliberate attempt to deregulate markets and pursue “rapid economic growth” and privatized formerly public markets. This growth came at the expense of stability, as additionally the emergence of the new banking industry overtook the traditional fishing industry in GDP by the year 2007 (Thorhallsson, B., Peadar, K.). The banking industry in Ireland had assets valued at more than ten times the total of Iceland’s GDP and were borrowing six times the amount of Ireland’s GDP. This was high-stakes poker. When things were good, the banks realized impressive gains, but if fortunes were to change, there would be drastic consequences. In 2007 when foreign markets started collapsing the investments that Iceland’s banks were betting on, such as mortgage backed securities in the United States, began to fail, and their entire economic structure began to crumble (Tan, G.).
One thing both of the two countries shared in common was overleveraging by the banking industry. In both countries the banks borrowed very large sums of money to engage in speculative trading. However, the successes of these investments were born largely out of artificial markets, when those markets hit their limits and began to contract, the banks were so out of position to survive having become overly reliant on the successes of those markets (Boullet, V.).
Having joined the European Union, the Irish economy would inherently be tied to the risks of foreign markets. However Iceland was not fully insulated to those risks due to the international nature of international banking in the 21st century. However, despite more risk involved in getting drawn into a foreign recession, Ireland also had the benefits on leaning on larger or more stable economies in times of trouble as well (Thorhallsson, B., Peadar, K.). This was one advantage that Iceland did not have. In a way, this case study is about two countries on opposite ends of a largely unavoidable problem.
Worldwide, too many players had recklessly borrowed money which provided a false-illusion of growth. Both Ireland and Iceland’s economies were historically poor and began to modernize and saw immediate benefits. Being excited by the growth caused the governments and banks to loosen regulations on the banks which borrowed money to invest in other markets. Here is where differences began to emerge. Ireland’s involvement in the EU meant that some policies enacted for the benefit of the union were not tailored to the particular circumstance of Ireland, and led to excess risk in provided cheap liquidity in a booming economy (Tan, G.). In Iceland, even though there were high rates on domestic loans, foreign cash was still available pretty cheaply, which tied their economy to that of other economies. When the international markets began to crash, Ireland had the backing of its EU partners to shoulder some of their burden while Iceland had neither the assets nor the expertise of the older, more developed, European markets. “If membership of the Euro increased vulnerabilities for Ireland, Regling and Watson argue that being a member of a large monetary union “helped Ireland to survive better the global financial crisis” since without it funding problems for the banking sector would have become bigger, firms and households would have borrowed more in foreign currency and so would have been exposed to greater risks (as happened in Iceland), and coordination problems for national central banks would have been significant (Thorhallsson, B., Peadar, K.).”
To help stop the bleeding of the economy, the Irish were in a position where they had to accept a bailout package from the European Union, the European Central Bank, and the International Monetary Fund (Tan, G.). Iceland was forced to look elsewhere for countries to help, having no preexisting agreement with other countries to help in a situation like this. Iceland was able to find lenders in Poland, the other four Nordic states, and a self-governing island group (Thorhallsson, B., Peadar, K.). Without these loans, Iceland would have been unable to stabilize its exchange rate or guarantee sustainability past the day-to-day (Thorhallsson, B., Peadar, K.).