Iceland proves that the debtor has rights too

Recent events in Iceland may have completed that country's transformation from free market, credit-fuelled billionaire playground to champion underdog. The Icelandic Parliament’s offer to the UK and Dutch governments earlier this week that it will pay back its debts but only at a level it can afford, could provide an invaluable model for how indebted nations can start putting the needs of their people ahead of the desires of the global financial markets.

Iceland has become synonymous with the financial crisis after nearly a decade of drinking neo-liberal kool aid. Around 2000 Iceland went on a deregulation and privatisation binge, totally reforming its financial sector, dropping bank reserve requirements, raising interest rates sharply, sucking in foreign capital and encouraging massive borrowing. It lived the dream being promoted by most European capitals at the time. So many millionaires flew into tiny Rejavik that a local politician demanded limitations on planes coming into the country.

Such a highly indebted financial system was, unsurprisingly, an early victim of the credit crunch, even though Iceland was not invested in sub-prime loans. Their situation was certainly not helped by Gordon Brown – proponent of the very policies Iceland had slavishly followed – who designated the country a terrorist state last October in order to seize Iceland’s banking assets in the UK. His attempt to derive popularity amongst investors at home neatly side-stepped the failure of UK authorities to adequately regulate UK investment.

The enormous anger that followed in Iceland toppled the government, and since then has radically reduced support in Iceland for the country’s membership of the EU. Most recently ordinary citizens have pushed members of the ruling coalition and opposition parties into opposing the enormous repayments being demanded by the British and Dutch governments.

That is the background to the decision earlier in the week of the Icelandic Parliament – the Althing –that it would repay its debts, but only at a rate it could afford. That is defined as spending no more than 4% growth in GDP to repay UK debts (and 2% for Dutch debts). If the economy doesn’t grow (because of inappropriate conditions forced on the country by creditors for example) Iceland pays nothing.

This decision, if implemented, is historical. Michael Hudson, Professor of Economics at the University of Missouri, has said that it is the first agreement “since the 1920s to subordinate foreign debt to the country’s ability to pay”. Hudson is referring to the 1920s debate that raged over capping Germany’s First World War reparations repayments. Keynes argued at the time that insisting on debt repayments beyond a level which also allowed the country to grow would inevitably mean forcing Germany to sell its assets or alternatively to borrow more money. He predicted the subsequent anger and discontent caused in Germany, which led straight into World War II.

But the situation which Iceland is trying to deal with is one which has faced scores of developing countries for decades – countries with less responsibility for the current mess than Iceland. Many countries still have to pay unreasonable levels of debt by selling off assets, skewing their economy towards unsustainable export trade and foregoing their right to development.

Iceland is correct to assert that states in debt have rights that trump the rights of creditors to bleed their economies dry. When companies and municipalities become insolvent, they are protected by work-out laws – but no such work-out mechanism exists when it comes to countries.

If limiting Iceland’s debt repayments is right, the same must apply, to an even greater extent, to poorer countries. Lebanon spends over 50% of government expenditure in servicing debts, Uruguay 32% and the Philippines 31%. These states top a much longer list of developing countries who understand from experience the injustice of indebtedness better than any European government.

Iceland has led the way in standing up for the rights of debtors. It may be followed by a range of indebted Eastern European countries who are also currently having their economic policies dictated to them by the International Monetary Fund.

This article was first published in the Morning Star.