The current global economic crisis has elicited a wide range of responses from peaceful protests in Ireland and Russia to violent riots in Greece and Spain. However, arguably the most extreme consequence of the current downturn is the collapse of governments.

Despite being an extreme scenario, governments such as Latvia, have nonetheless collapsed. But most notably, and shockingly, this has happened in Iceland.

Iceland

Iceland, prior to the government’s collapse, had a very high standard of living. For example, Iceland’s GDP per capita for 2008 was $42,600, just slightly below the United States’ $48,000.¹ 

However, it should be noted that the GDP per capita figure for Iceland is a better representation of the general public due to a more even distribution of income. The United States, on the other hand, has very wealthy people as well as very poor people. Thus the GDP per capita measure of the United States does not reveal much about the average standard of living. Rather, it is used here as a point of comparison.

Furthermore, Iceland benefits from abundant natural resources, including fish and geothermal vents which are used to create energy. The vents, together with hydropower, have provided Iceland with nearly complete energy independence for electricity and heating.² This provides Iceland with a great advantage because it has no oil reserves of its own to create energy.

But despite these natural advantages to economic growth, Iceland’s economy has suffered greatly during the later end of 2008 and beginning of 2009. This was largely due to the rapid expansion of Iceland’s financial sector which expanded into foreign markets and allowed borrowers to take out loans in foreign currencies.

When global markets collapsed, the expanding Icelandic financial sector came to a halt. With much of their assets linked to the collapsed markets, Iceland’s three largest banks failed. The failure of banks in Iceland caused foreigners to pull their money out of Iceland. This in turn caused the value of Iceland’s currency to quickly depreciate. With money that was now worth less, Iceland needed to exchange more of their currency for a foreign currency. Since their debts were in foreign currencies, the amount owed skyrocketed and Iceland was left with a debt that was 10 times their GDP.³ 

Solutions

Standards of living fell across the country as the unemployment rate rose from1.6 percent in 2008 to 9.4 percent in February 2009. Furthermore, the consumer price index, which measures an average price of goods purchased by households, rose by 18.6 percent between January 2008 and January 2009.⁴ To put this in perspective, a loaf of bread that cost $5 in 2008 would now costs nearly $6.

These large price increases and high unemployment rates prompted the government to borrow $10 billion from the International Monetary Fund. This money was used to stabilize Iceland’s currency and ensure bank deposits. However, this was too little too late and, despite the bail out, Iceland’s economy is still expected to contract by 10 percent in 2009.⁵ 

In response to the deteriorating economic conditions, people began to protest and place pressure on the government to do more. This caused the Prime Minister, Geir Haarde, to resign, and dissolved his cabinet. Elections were then pushed forward and the rival party, which was part of the coalition government before the collapse, took power. The new government leader, Ingibjorg Gisladottir, criticized the former prime minister for not taking swift enough action.

But in what is being called the “most severe economic crash of any country during peacetime,” Iceland can not rely on the typical tools used to fight recession.⁶ 

Thus, Iceland has had to turn to unique and previously dismissed ideas to jumpstart its economy. The most recent discussions have turned to the idea of joining the European Union. The former president had originally rejected this idea, arguing that joining the European Union would diminish the sovereignty of the country. However, since the collapse of the government, there has been an increase in support for joining the EU due to the stability associated with being a member.

But this assumption is itself being challenged, and joining the EU may not be the solution Iceland needs right now.

In addition to the fact that it takes a great deal of time to join the union, it is also experiencing its own economic difficulties. This has left some to question whether or not the European Union itself can even survive this economic downturn.

History of the European Union

The roots of the European Union can be traced all the way back to 1951. Following WWII, Europeans were searching for a way to ensure lasting peace. To do this, the countries needed to be linked both economically and politically. Thus, the European Coal and Steel Community was created to fulfill this purpose for the founding six members - Belgium, West Germany, Luxembourg, France, Italy and the Netherlands.⁷

These six countries continued to create treaties, lower trade barriers, and expand their membership to form today’s European Union. Currently, 27 countries are members, 16 of which share a common currency. This decreases the transaction costs that are created when countries need to exchange currencies in order to trade.   

Furthermore, the citizens of member countries are allowed to move freely between other member countries. This is one of the key differences that separate a trade union from a free trade area or agreement. For example, the United States is a member of the North American Free Trade Agreement, yet border security with Canada and Mexico, the other members of NAFTA, remains.

Current problems within the EU

Despite the advantages associated with the trade union, the European Union is nonetheless feeling the effects of the current economic downturn. Economists have predicted that the EU’s economy will shrink by 1.8 percent in 2009.

But the slowdown has not been evenly distributed across the member nations. Rather, the eastern European countries have been struggling relatively more than the western European countries, which were able to inject large amounts of capital back into their economies. This has led some to argue that a new iron curtain has fallen upon Europe separating the rich counties from the poor.

As the western European nations focused inward, the eastern countries pleaded for bail outs. One author makes the frustration of the eastern European countries clear, stating that “a Czech auto worker deserves the same treatment as a French one.”⁸ 

Hungary and Latvia eventually received funds from the European Union, but not without debate. Germany for example, had rejected the initial bailout plan for Eastern Europe, and others, such as the Austrian Finance Minister, have argued that the EU simply does not have enough money set aside for bailouts.⁹  This is all despite the EU’s promise to provide aid to countries as needed.¹⁰ 

But the east-west conflict is not the only one that has emerged. For example, the conflict between Germany and France is also creating difficulties within the Union. Germany has accused France of trade protectionism while France has accused Germany of trying to create a global economic council led by Germany.¹¹

Conclusion

Iceland needs to question if the decision to join the European Union is the right one. Although they may receive additional bailout funds from the union, it is questionable if there are even enough funds to bailout current members. Furthermore, with the already existing members having difficulty receiving money, it is questionable if newer members would be bailed out even if the money were available.

Finally, Iceland would be trading its current difficulties for the infighting, accusations, and perceived favoritisms that exist within the EU. Despite the Czech premier’s comment that any idea of a split was “rather more a media thing than reality,” the tensions between these countries are real and the future of the union remains unclear. Thus, Iceland needs to weigh these costs with the potential benefits before deciding to join the EU.

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