SYMPOSIUM the icelandic economic collapse: how to overcome constraints associated with smallness? baldur thorhallsson Faculty of Political Science, School of Social Science, University of Iceland, 101 Reykjavı´k, Iceland. E-mails: [email protected]; www.uni.hi.is/baldurt/ doi:10.1057/eps.2012.37; published online 26 October 2012 Abstract The article identifies a number of fundamental flaws concerning the Icelandic government’s economic handling and administrative working practices, which contributed to the scale of the 2008 crash. At the same time, it argues that the authorities altogether failed to take account of the risk associated with the country’s small size during the Icelandic ‘out- vasion’. It claims that small-state studies need to move back to the basics and consider the original small-states literature, such as the small domestic market, the use of a small currency and the weaknesses associated with a small public administration, in order to fully understand the reasons for the Icelandic economic meltdown. A small state needs to acknowledge its limitations and take appropriate measures to compensate for them. Keywords small states; economy; public administration; Iceland; size; alliance INTRODUCTION EU and Euro frameworks was exposed to the international financial crisis and celand’s economic crash provides an whether this status limited or facilitated ideal test case on whether the size of its responses to the crisis. I the economy and public administra- Iceland is the only state that experi- tion is more relevant than factors asso- enced a collapse of almost its entire finan- ciated with economic management and cial sector in connection with the 2008 administrative competence for under- financial crisis (the three main banks, standing how states are affected by, which collapsed, accounted for about and respond to, global economic turmoil. 85 per cent of the sector) (OECD, 2009). Also, it provides an interesting insight into Moreover, Iceland was the only OECD how a globalised small state outside the country to experience a currency crisis. 320 european political science: 12 2013 (320–332) & 2013 European Consortium for Political Research. 1680-4333/13 www.palgrave-journals.com/eps/ In total, the Icelandic kro´na (ISK) depre- ‘One of the most ciated by around 48 per cent between y 2007 and 2009 (O´lafsson and Pe´tursson, important lessons 2010). In the autumn of 2008, the is the restricted Icelandic Central Bank only provided capacity of small foreign currency for the import of food, medicine and fuel (Central Bank of Ice- economies to engage land, 2008). Inflation rose from single in the international figures to 18 per cent and unemploy- global economy ment rose, from full employment, to 8 per cent. Household and corporate debt without a proper ally’ sky-rocketed; many homes and busi- nesses had borrowed in foreign currency Previously, most politicians had argued (IMF, 2009). Immediately, the Icelandic that full participation in the European government sought assistance from the project would impose severe constraints International Monetary Fund (IMF). In on Iceland’s economic and monetary 2009, GDP decreased by 6.8 per cent. policy, fisheries and agriculture. Member- This was the largest drop in GDP ever ship of the European Economic Area recorded since measurements began in (EEA) (1994) and the Schengen scheme 1945 (Statistics Iceland, 2010). (2001) was seen as serving Icelandic The economic crash soon created a interests adequately. The EU application political crisis, that is, violent protests on signalled a gradual geo-political transfor- the streets of Reykjavik, a collapse of mation. Iceland had slowly been directed the coalition government consisting of the towards its Eurasian Plate side after it conservative Independence Party and the had been sighted rather more on the North Social Democratic Alliance (SDA), a par- American Plate, politically speaking, dur- liamentary election and the subsequent ing the Cold War – under US protection. creation of the country’s first left of centre From the beginning, the focal points in government. The Conservatives were small-states literature have been the vari- thrown out of office after 18 years; for ables associated with states’ capabilities most of the time (1995–2007), they had (Neumann and Gsto¨hl, 2006) in terms of been in a coalition with the centrist numbers of inhabitants, the size of the agrarian Progressive Party. Immediately economy, military strength and territorial after gaining a parliamentary majority, size (Archer and Nugent, 2002). Further- the new government, consisting of the more, the influence of having a small Left Green Movement and the SDA, applied central bureaucracy and small diplomatic for membership of the European Union corps was mentioned early in the devel- (EU) in the summer of 2009. The Social opment of the literature (Va¨yrynen, 1971) Democrats insisted on a speedy accession although this was never properly dealt process and the adoption of the Euro. with or taken fully into account. Their electoral success, despite the fact Small states were said to be more eco- that they were partly blamed for the nomically vulnerable due to the size of crash, had been achieved through these their GDP, their small domestic markets, promises. reliance on external trade and exposure Iceland, an island on the European to international economic fluctuations periphery in the North Atlantic, straddling (Katzenstein, 1984, 1985). Small entities the mid-Atlantic Ridge, with about 315 were even regarded as not being eco- thousand inhabitants, became the small- nomically sustainable or viable (Com- est state to apply for EU membership. monwealth Consultative Group, 1985). baldur thorhallsson european political science: 12 2013 321 The small size of their administrations The economic success of small Western posed constraints on their international European states was found to be a behaviour, that is, they had less capacity result of their flexible democratic corpor- both to defend themselves diplomatically atism, based on the culture of consensus and to engage in international affairs (Katzenstein, 1984, 1985). The success (Handel, 1981). Importantly, doubt was of small states in regional and inter- even cast on small states’ ability to national organisations such as the UN govern themselves, that is, to run the and the EU has been seen as a result of necessary apparatus. It was argued that their administrative working practices in they had less capacity to manage their terms of prioritisation, informality, flex- exposure to risk due to the small size of ibility and the autonomy of their officials their bureaucracy (Reid, 1974) and less (Thorhallsson, 2000). Small states were margin for error, that is, they are more found to be notably influential in the multi- vulnerable to absolute loss of manpower, lateral arrangement of the international territory or economic infrastructure than system. most larger states (Barston, 1973). Accordingly, the small-states literature Small states were said to rely on larger gradually shifted its focus from the mere states for their internal and external vulnerability consequences of the size of policymaking. Moreover, they relied on the economy and the central bureaucracy their larger neighbours for basic survival to opportunities associated with small- and engagement with the outside world ness. However, the question that remains (Thorhallsson, 2006). Alliance formation unanswered is whether economic manage- was a must for their success (Keohane, ment and administrative competence are 1969). Their domestic affairs and foreign related to opportunities and constraints policy were under a strong influence from associated with smallness. The aim of this their protectors. Accordingly, the smallest article is to examine whether a small state European states – Liechtenstein, Andorra, like Iceland encounters, purely or partly, Monaco and San Marino – did not gain structural problems associated with its access to the League of Nations and its smallness, in the international system: successor the United Nations (UN) until Does Iceland’s small size in terms of the early 1990s. Their foreign policies its economy and bureaucracy provide were not seen as being independent from a better understanding of the economic those of their larger neighbouring states collapse and its responses to the crisis, (Duursma, 1996). than do factors regarding economic man- After many of these hypotheses had agement and administrative competence? been proven wrong (Katzenstein, 1984, Moreover, did the non-EU and Euro mem- 1985), small states began to be seen as bership matter in the lead-up to the crisis, economically and administratively smart, during the crisis itself, and in cleaning up salient, resilient and faster, and more fit after the event? Are small states more or to adjust to global competition and other less in need of an external shelter (an ally challenges (Briguglio et al, 2006). They or an alliance) in order to cope with the were no longer seen as being constrained new globalised economy? The article will by their small administrations and the address these concerns by examining a smallness of their economy. Instead, the number of independent analyses conducted informality and flexibility of their bureau- in order to understand the Icelandic eco- cracy and the small domestic market – nomic collapse. The aim is to apply the small community – were seen as provid- literature on small states, concerning ing them with opportunities, domestically