Besides those countries that have built their economic systems in hundreds of years, there are countries with no background, whose importance on the international scene rose almost imperceptibly in the last decade.  It is often said that the real strength of the nations should not  be indicated only by their economic growth and political notoriety, but mostly by the way they respond to international disturbances, such as wars, gas shortages and economic crisis. An impossible situation often puts you face to face with the reality, just like a financial crisis puts countries face to face with the sustainability of their systems.

Iceland is probably the European country with the most unpredictable evolution . In the last  40 years, its entire economic system rose and fell to earth. In the 70’s, it was one of the poorest countries in the world, considering its GDP value and its almost non-existent economy. The outlines of Iceland’s success were created slowly and they could be explained by the governmental investments in tourism, ferrous metallurgy, energetic industry  and in a good long-term plan based on the use of natural resources. However, the major step to economic growth  came lately, in the 90’s, as a result of the international environment- economic boom- and the development of a strong banking sector.

Despite a complex system that seemed to be faultless the way to collapse was even shorter than anyone could have ever imagined: in only one week (October 2008), the three major banks of Iceland had become insolvent and then they were nationalized one by one. This failure represents, by far, the effect of  some unsustainable economic policies that Iceland adopted in the last few years.

First of all, the target rate of inflation that the National Bank used to announce was bellow its real value; this strategy was adopted in order to keep interest rates high (above 15%) and encouraged population  to take credits. The reason behind this strategy was a simple one- spending means consumption and increasing consumption leads to economic growth. Maybe that is why this strategy seemed to be so sustainable. But the reality looked different: the source of money that population took on tick was the outside world. Iceland used to borrow money, in large volumes, from countries where interest rates were almost 0%, which determined the appreciation of the national currency and the illusion of wealth. Later, interest rates increase, misallocation of resources and currency appreciation created a credit bubble, with a strong impact on investors who overestimated the value of their money. In 2007, according to “The Economist”, kona was the most overvalued currency in the world.

Secondly, Icelandic banks assumed great risks when they decided to lend colossal sums of money to countries from Northern Europe. The subprime crisis in US affected all European countries and it became harder and harder for Iceland to get back its lended money. Furthermore, Iceland invested about £3 billion in Great Britain in risky projects. The prospective profits of these projects were huge and encouraged Iceland to continue until 2008, when their external debts exceeded enormously the GDP.This moment coincided with the extension of financial crisis in Europe and the impossibility of companies to pay their debts which was reflected on the  bankruptcy of the Icelandic banking system.

Although Iceland was deeply affected by the global financial crisis and asked the IMF for help, it still fulfils the necessary conditions to start the accession negotiations with EU. But we shall see how Iceland will take advantage of this opportunity and whether its UE integration will be a necessary and sufficient measure in the process of building a stronger and more stable economy.

Alexandra Sarpe