Iceland's 'tenacity' lifts economy out of crisis

Whisper it - Iceland's economy is on its way back. The frozen island on the edge of the Arctic, which had 10 straight quarters of shrinking GDP, is suddenly on a steady run of seven quarters of growth averaging at 2.5% per annum - something that few European countries can boast.

Unemployment has fallen to just below 5% and confidence is returning.

This nascent recovery from economic crisis is testament to the Icelandic character. The people here have for centuries clung to existence on a frozen remote island which is 70% tundra, and where in winter dawn breaks close to noon and dusk happens in the mid afternoon.

President Grimsson says the hardy nature of the Icelandic people has been key to the recovery

These natural challenges have made the people here tough, tenacious, diligent and very hard working.

"Essentially we're still a nation of farmers and fishermen," says Iceland's President Olafur Grimsson, who has been in office since 1996 and who has twice refused to sign legislation which would have repaid Britain the £2.3bn owed when Iceland's banking system collapsed in 2008, forcing the UK government to reimburse British savers who had Icesave accounts.

"The economy is just not an echo of banks. It's a community of people. If they don't feel strong, it doesn't matter whatever tax measure you adopt," Mr Grimsson says.

"This was shown via the referendum on the Icesave issue. Every Icelander was given a vote and got a new sense of self-worth; it made society stronger, this democratic thing helped give people empowerment."

Soaring repayments

But it has not all been without pain - quite the contrary. The macroeconomic statistics hide the reality of life for ordinary Icelanders. Higher taxes, spending cuts and a wave of repossessions have left many distraught.

The Magnusson's have been left with a mortgage far larger than their original home loan

Thousands who had taken out mortgages in foreign currencies when the Icelandic Krona was strong suddenly found that their properties were worth a lot less, but that the repayments had soared.

Worse was to come for others who had taken out index-linked mortgages. After the crash, incomes and house prices fell while inflation spiked upwards. Homeowners found themselves in negative equity, but with the outstanding amount even larger than the original home loan.

"I've been paying every month for 150 months and I owe much more than I borrowed," says IT specialist and reindeer hunter Theodor Magnusson. "I borrowed 6m Krona (£28,850) and I now owe 9.7m Krona (£46,642). And I've already paid around 5m Krona (£24,000) in these twelve-and-a-half years."

"It really makes me feel angry and sad because, you know, the country is made of people, the nation is made of people, and societies are made by people, for people. But now it seems like banks are running societies and that is horribly wrong."

In many ways Iceland is a victim of its own success. Its standards of living are still very high and in order to maintain them in a post-economic crisis world, many here have two or three jobs. Working a 60-70 hour week is not unusual.

Tax rises

Neil McMahon has been in Iceland for 38 years. He is a teacher, tour guide and translator. Even with 35 years of teaching experience, he only earns £24,000 per annum. That is not enough to afford a comfortable life in Reykjavik.

"I think for an outsider maybe just reading articles in the newspapers or watching brief coverage of Iceland on the TV, they might be fooled in thinking Icelanders have managed to extricate themselves very effectively from this crisis," Mr McMahon says.

Teacher Neil McMahon says that behind the headlines many are struggling to make ends meet

"However, there are still a lot of problems, and particularly with the younger generation; people who had huge mortgages and are now trying to deal with this situation."

Polls suggest that many here are disappointed with the current coalition government which took power at the height of the crisis. And as is often the case in politics, the party which inherits the mess does not always get much credit for cleaning it up.

"We faced this large gap in the public finances, so we had to increase taxes," Iceland's Finance Minister Katrin Juliusdottir says. "We have made difficult decisions, some were good, some were not that good, but overall I think we are well on the way to becoming a very strong economy again."

The collapse of Iceland's major banks in 2008 dragged the public finances down and caused the worst economic rupture seen in Europe since WWII. The Krona fell 50% against all major currencies, unemployment, hitherto unheard of, soared to 10% and money flew out of the country at an alarming rate.

But Iceland decided to deal with the crisis in its own, unique and somewhat irregular way.

Brain drain reversed

It imposed capital controls - banned in the European Union Single Market - to stop the haemorrhaging of cash. It introduced almost 100 new taxes and slashed spending. It also borrowed money from its Scandinavian neighbours and the International Monetary Fund.

Iceland has seen seven consecutive quarters of economic growth

But crucially, it let its privately owned banks, which had caused the crisis, die. Investors lost everything which meant taxpayers were not burdened with their banking debt as well.

Also and most controversially here, British and Dutch savers in Icelandic banks lost all their money (collectively worth €4bn) and had to be repaid in full by London and The Hague respectively.

The medicine was tough and the response immediate. Growth collapsed, thousands emigrated and Iceland became an outcast in the international financial community having been downgraded to "junk" status.

But then in the middle of the dark and cold winter of 2010 something happened. Iceland's exporters, which had struggled to recruit skilled graduates because they were being poached by bonus-paying banks for a decade, got the engineers, scientists, IT graduates and brainpower that they needed.

Ossur, which manufactures the prosthetic running blades that athlete Oscar Pistorius has made famous, is one company which has benefitted from the crisis, now finding it easier to recruit skilled staff than during the reign of the banks.

Its CEO Jan Siggursson has a message for Britain with its still dominant banking sector: "Don't depend on a phoney economy. It was not real and we understand that now. This was complete bubble. The financial business is necessary, don't get me wrong, but it is a very dangerous business because it sucks the best and it's not real. And the longevity of the financial business is not there. It's very easy to copy and it is not long term."

Thermal power

Iceland's president, Mr Grimsson, also says Britain could learn from the Icelandic experience by cutting its dependence on banking and finance, which draws talent away from more productive parts of the economy.

Energy intensive aluminium smelting is now a vital part of the Icelandic economy

But Iceland is not just blessed with an abundance of human talent; it also has a ready supply of cheap clean energy. Ninety-nine percent of the country's energy needs are supplied from hydroelectric sources or hot thermal springs. There are even plans to export this renewable power via enormous cables under the sea to Denmark or even Britain.

That cheap energy has attracted financially important industries such as aluminium smelting, which requires vast amounts of electricity to turn bauxite imported from Australia into aluminium products in Reykjavik. It is now the second most important component in the Icelandic economy with UK-listed Rio Tinto one of the largest smelters.

This cheap thermal energy also warms hundreds of outdoor pools across the land and most Icelanders start or finish their working day in one of them - irrespective of how cold it is outside.

They have mastered the challenge of surviving on a frozen and volcanic island, now they appear to be weathering their biggest man-made calamity. Though many are paying a large financial price for that.

Watch Joe Lynam's full report on Iceland's remarkable return to growth on BBC Newsnight on Monday 7 January 2013 at 10.30pm on BBC Two, then afterwards on the BBC iPlayer or Newsnight website.