Those within the IMF were beginning to admit their errors. In a confidential report leaked to the New York Times, IMF staff members agreed that their lending conditions worsened the crisis. “Far from improving public confidence in the banking system,” the report stated, “[our reforms] have instead set off a renewed ‘flight to safety’,” referring to continued withdrawal of investment from the region that prompted banking closures. In other words, the IMF’s programs had worsened the sense of panic, not only because of its dire warnings which scared investors, but also because high interest rates and budget cuts slowed down the economy.36
The natural experiment in East Asia had striking results. When Malaysia refused to cut its public health budgets, immunization programs and food assistance projects were preserved, and the country did not experience a marked rise in malnutrition and HIV, unlike its neighboring countries that slashed health budgets. As one UNICEF report concluded, “In Malaysia, unlike in Indonesia, the Republic of Korea and Thailand, there is little doubt that the social impact of the crisis has been contained.” An independent analysis of the data by Australian public health experts summarized the situation: “These results strongly suggest that social protection programs, adapted to meet the needs of the most threatened population groups, are necessary and important tools to protect against the adverse effects of an economic crisis on health and health care.” Researchers at the Johns Hopkins School of Public Health agreed, concluding that “social protection programs play a critical role in protecting populations against the adverse effects of economic downturns on health and health care.”37
Ten years after the East Asian Financial Crisis, the worldwide Great Recession hit Indonesia. It brought the country an opportunity to learn from its mistakes; this time the Indonesian government increased some subsidies to poor people. Thus, the poor could still afford cooking oils amid rising food and fuel prices in 2008 and 2011 (which were due in part to the movement of investors out of mortgage-backed securities and into food commodities investments).38
It was only in this current Great Recession crisis that the IMF issued a formal mea culpa for its shortcomings during the East Asian Financial Crisis. In October 2012, the Fund admitted that the economic damage from its austerity and liberalization recommendations in East Asia may have been as much as three times as great as it had previously assumed. While the IMF had predicted its measures would grow Indonesia’s economy by 3 percent, the economy actually contracted by 13 percent. The director of the Fund issued a formal apology. Such apologies were of little use to the millions of lives destroyed by the IMF’s “help.” Many East Asian countries will not go back to the Fund if they can avoid it; these countries together have amassed $6 trillion in savings accounts filled with foreign exchange investments in case of another economic downturn. “People learn from what happened in the past,” said Indonesia’s Trade Minister Gita Wirjawan. “Certainly what we went through in 1998 was painful. I lived through that, and hopefully the difficulties we went through served as lessons.”39
The lessons of history—the New Deal, Shock Therapy in Russia, and the IMF programs in the Asian Financial Crisis—are clear. They present us all with a clear decision. Will we continue to balance budgets on the backs of the most vulnerable members of society? Will tens of millions of people like Olivia in California, Dimitris in Athens, the McArdles in Scotland, Vladimir in Russia, and Kanya in Thailand have to suffer for misbegotten austerity programs? Or will we finally recognize that economic health and human health go hand in hand?
PART II
THE GREAT RECESSION
4
GOD BLESS ICELAND
“Gud Blessi Is’land.”
The three words appeared in blocked white letters on television screens all over Iceland on October 6, 2008.
“Fellow Icelanders,” a voice began. “I have requested the opportunity to address you at this time when the Icelandic nation faces major difficulties.”1
Most people in this island nation of 317,000 refer to each other by their first names. This was Geir Hilmar Haarde, the prime minister, speaking. The block letters on the screen were replaced by his image: he stood behind a cluster of microphones, wearing his signature blue blazer, next to the country’s flag. His cheeks sagged with worry.
“There is a very real danger, fellow citizens, that the Icelandic economy, in the worst case, could be sucked with the banks into the whirl pool and the result could be national bankruptcy,” he said, adjusting his glasses nervously.2
The stress was palpable. In 2008, financial crisis had spread like a virus across the Atlantic, from the American mortgage crisis to the European stock market, and now to this tiny island nation. In December that year, The Economist reported that “Iceland’s banking collapse is the biggest, relative to the size of an economy, that any country has ever suffered.” The crisis came as a massive shock to the peaceful nation of Iceland, and many commentators predicted doom. All its biggest banks failed, the stock market crashed by 90 percent, and investments worth nine times the country’s annual economic production disappeared within one week in October 2008. The Icelandic Public Health Institute asked local journalists to write more positive stories in an effort to curb the risk of suicide. As Bloomberg financial news reported, “This was no post–Lehman Brothers recession: It was a depression.”3
As a result, Iceland’s people now faced their biggest health threat since World War II. With a large rise in debt, the universal healthcare system faced bankruptcy. The entire system was publicly funded and run; there were virtually no private hospitals, clinics, or insurance. So if government funding dried up for the health service, people’s access to healthcare would be directly impacted. Another threat was that if Iceland’s currency, the krona, depreciated, the cost of importing essential medicines would soar—making medicines unaffordable at a time when government budgets were already overstretched. Adding to the risks, the possibility of major job losses and home foreclosures threatened to provoke depression, suicides, and heart attacks, placing pressure on Iceland’s public health service.4
Geir continued his speech. “I am well aware that this situation is a great shock for many, which raises both fear and anxiety. If there was ever a time when the Icelandic nation needed to stand together and show fortitude in the face of adversity, then this is the time. I urge you all to guard that which is most important in the life of every one of us, protect those values which will survive the storm now beginning.”
Iceland stood apart from other nations battling the Great Recession. While most people were focusing on the US, UK, Greece, and Spain, Iceland served as a miniature laboratory to examine how the recession affected public health. First, by studying a sparsely populated island of people with similar culture and diets, it was possible to pinpoint the impacts of economic policies in a way that is much more difficult within larger nations or whole regions like the European Union. In Iceland, nearly every person had the same health insurance coverage, and it was possible to keep track of every person in terms of their visits to the doctor, their hospitalizations, and their death. By contrast, Europe had varied healthcare coverage and access, and people were often lost from the system (especially the most vulnerable groups, like the homeless), so pinpointing what factor caused certain people to be ill was difficult to investigate. Second, Iceland had developed a strong, Nordic-style system of social protection programs—programs including food support, housing assistance, and job re-entry programs. Its people had a high degree of trust in the government, at least until the crisis began, and a remarkably high degree of social inclusion—membership in organizations and clubs. For all of these reasons, the World Values Survey, run by a network of social scientists across the globe, consistently found that the island was “the happiest” country in the world (in contrast with the Russians, who were the most unhappy) since the late 1990s. Hence, Iceland was a good place to test our hypothesis that the country’s strengths—notably, its democratic participation, social suppo
rt, and inclusive social protection system—could make it more resilient to an economic meltdown, preventing a public health disaster despite experiencing a terrible financial crisis.5
To understand what happened in Iceland, and properly test our hypothesis, it was essential to understand why this island was affected by the US mortgage foreclosure crisis. That connection provides a critical lesson on how Iceland’s government faced a choice about whether or not to cut social protection programs during the crisis, and why it made the choices it ultimately did.
The story begins with the history of Iceland’s boom, bubble, and bust.
Sitting outside the Eurozone, Iceland is a proud and independent nation with its own currency, the krona. But it was not, historically, a wealthy nation. Discovered by Irish monks, rediscovered by Norwegian Vikings, and later colonized by the Danes (who ruled until the early twentieth century), Iceland had been one of the poorest Western European countries through the 1940s, when its main economic product was fish. Since World War II, the economy grew at a modest pace, partly by attracting tourists to its famous blue lagoons and steamy thermal baths.6
In the mid-1990s, the island’s government decided that the economy needed to expand beyond fish and tourism. Their strategy, like that of other micro-states such as the Caymans, was to become a private offshore banking center. Iceland reinvented itself as a tax haven for the world’s ultra-rich. In the early 2000s, commercial and investment banking merged together, paving the way for new methods of loaning money and investing it in high-yield commodities. In scenes reminiscent of the period leading up to the East Asian Financial Crisis, Iceland’s city planners boasted about exponential growth of grandiose buildings in the capital city: “If Dubai, why not Reykjavik?”7
One of the most popular of these new investment vehicles would also prove the riskiest. IceSave, an Internet-based banking program run by the private bank Landsbanki, offered 6 percent interest rates to attract foreign investors. The BBC branded it a “best buy.” IceSave was soon inundated with foreign investments. Over 300,000 Britons, for instance, put their retirement savings into the IceSave program, enticed by high interest and the promise of a stable economic environment. Even Cambridge University’s investment office and the UK Audit Commission—an independent financial watchdog—transferred large portions of their endowments to Iceland. Seeing Landsbanki’s success, other Icelandic banks also set up high-interest-rate investment schemes to woo depositors. As a result of these deposits, the country’s three largest banks (Landsbanki, Kaupthing, and Glitnir) moved up into the list of the world’s top 300 investment trusts.8
By the beginning of 2007, Iceland had become the fifth richest country in the world, with an annual per-capita income 60 percent higher than that of the United States. Masses of capital flowed into the country, as economists labeled Iceland’s situation a “capital inflow bonanza.” Stimulated by easy loans, business was booming. Unemployment fell to 2.3 percent, the lowest in Europe.9
Everyone was quick to praise Iceland’s meteoric rise. The Wall Street Journal trumpeted the “Miracle on Iceland” as “the greatest success story in the world.” The economist Arthur Laffer, once a member of President Ronald Reagan’s economic advisory board, agreed: “Iceland should be a model to the world.”10
Behind the scenes, however, Iceland’s economy balanced on a precipice. In order to maintain a high level of payouts to its bank investors, the country was running enormous deficits from high levels of imports and vast borrowing of foreign currency, a situation reminiscent of East Asia in the 1990s. Businesses and new building construction were relying on loans from Icelandic banks. These banks in turn were paying out the loans from dangerous investments overseas, mostly investments that promised a high return that had not yet materialized (for example, the mortgage-backed securities in the United States). Then came the first warnings of impending doom: in 2006, the Danske Bank of Copenhagen labeled Iceland a “geyser economy,” on the brink of exploding because of the heavy reliance on foreign financial flows. In August 2007, Robert Wade of the London School of Economics gave a public lecture warning Icelanders about their risky economic strategy, but business and government leaders dismissed him as “alarmist.” When Robert Aliber, an expert on financial systems, came to Iceland in 2007 and 2008 and also warned of the dangers, his statement that “You’ve got a year before the crisis hits” was ignored by the business community. As the prime minister reported in March 2008, five months before the crash, “Negative reports on the Icelandic economy, as published in several foreign newspapers recently, come as a surprise to us. All indicators and forecasts are consistent that the prospects are good, that the situation in the economy is by and large strong and the banks are sound.”11
Just a few months after the government denied that there was a problem, a shockwave from the United States hit Iceland’s economy. The country’s finance minister announced, “It all went down the drain.” Across the ocean in the United States, “mortgage default swaps”—bundled investments of mortgages sold by American banks, often under false premises—had whirled up a price bubble that burst. Iceland’s banks had invested much of their money in the mortgage investments and US stocks. In the midst of American home foreclosures and stock market crash, the Icelandic banks lost substantial parts of their investments, and were no longer in a position to pay back their own investors. Consumers started to withdraw their funds from IceSave, worried that the bank would not be able to pay back their money given the stock market crash in America.12
They were right. In October 2008, IceSave began to implode, as customers rapidly withdrew their investments and Iceland’s stock market fell by 90 percent. The country’s GDP fell by 13 percent, and unemployment rates rose from 3 percent to 7.6 percent between 2008 and 2010. Nearly 40,000 homeowners were unable to make their mortgage payments as a result of income losses; over a thousand homes were foreclosed. With a shrinking tax base due to higher unemployment, would Iceland be able to pay for public healthcare care, unemployment support, pensions, and other social protection programs?13
To help pay for the government’s mounting debt, the Central Bank of Iceland asked Europe for help. But the island had quickly become a pariah. No one wanted to give money to a country that had just lost all of its investments. After tens of thousands of Brits lost their life savings in IceSave, Icelanders became so unpopular that some living in Britain began pretending that they were from the Faroe Islands. “They treated us like terrorists,” said one Icelander to a BBC reporter, commenting on the public jeers being received by those who identified themselves as being from Iceland. A BBC headline read: “Iceland: Britain’s Unlikely New Enemy.”14
So it was clear that Iceland wasn’t going to receive much help from its neighbors. The politics of the crash were also creating internal rivalries within Iceland. A small group of bankers in Iceland—less than 1 percent of the population—had seen their wealth grow as the country’s currency strengthened during the banking boom. The Icelandic banking elite became like Russia’s oligarchs—using this new wealth to buy SUVs, expensive tuna from Japan, caviar, and private jets. They also found it relatively affordable to borrow from banks abroad with such a strong and rising currency, and total debt grew to 9.5 trillion Icelandic kronas—over 900 percent of the value of domestic industrial production, the second highest ratio in the world. But when the krona then dropped from 190-per-euro to 70-per-euro over just a few months, disaster hit home. More than a third of Icelanders lost a major house hold item, typically their home. Anger focused on the government as riots rocked this once-peaceful island nation. People were divided about whether they should pay back the debts from IceSave and other collapsed investment schemes. An immigrant community of Poles, who worked in fishing, became the target of hatred and blame. “Incompetent government” was another oft-heard phrase. In the midst of the chaos, a Swedish filmmaker, Helgi Felixson, sensed an opportunity to capture a nation falling apart, and started making a documentary about its recessio
n and social strife, entitled God Bless Iceland.15
Desperate to find a way to manage its debt, the government turned to the lender of last resort. In October 2008, Iceland called on the IMF to develop a rescue package for the country. It was the first time since 1976 that the Fund been asked to bail out a European country (in 1976, the United Kingdom had requested a bailout). As usual, the financial plan for Iceland came with recommendations for austerity. Iceland would get $2.1 billion in loans, but the government would have to slash public spending by 15 percent of GDP. It would have to implement strict austerity measures in order to quickly pay back IceSave’s private investors, even though the IceSave program was operated by a private bank rather than by the government. IceSave’s debt was several times the country’s entire economy, and the IMF was calling for 50 percent of Iceland’s gross income to be paid to private investors over a seven-year period, between 2016 and 2023: in other words, in very short order.16
Icelanders were now faced with a profound moral question. To what degree if any were they as a people and a country responsible for the malfeasance of their business class? Iceland’s public taxpayers were being asked to pay for a private bank’s bad investment decisions. This was serious news in a country where there was already a vast disparity between a rich few who had amassed great debt through a lavish lifestyle and the rest who were now being asked to pay. Of the country’s 182,000 families, some 100,000 had little or no debt, while 244 wealthy families had each accrued investment debts exceeding $1 million. Even though only a few Icelandic bankers had bet on high-risk investments, the entire Icelandic community would now have to shoulder their debt, and suffer the consequences.17
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