New SSE Riga/BICEPS occasional paper by Hilmar Þór Hilmarsson (University of Akureyri).
Abstract. The global crisis hit hard in Iceland and Latvia. Economic development prior to the crisis, as well as response to the crisis, was different in these two countries, also yielding different results. Prior to the crisis both countries privatized their banking system. In Iceland the banks were sold to local investors. The Latvian banks were primarily owned by international investors. During the crisis Iceland nationalized its largest banks. In Latvia the foreign owned banking system survived. In Iceland a large currency depreciation took place that boosted exports and mitigated the GDP decline. In Latvia the national currency is linked to the Euro and did not depreciate and Latvia suffered a large GDP decline with high unemployment. Thus both the privatization of the banking system prior to the crisis was very different as well as the response to the crisis. The post crisis economic situation in Latvia and Iceland is also different. Latvia’s reform program has been characterized by austerity while the adjustment in Iceland seems much milder, e.g. with lower unemployment. Iceland seems to have been successful in protecting its social fabric while the human costs of adjustment seem high in Latvia. The fact that these two countries responded so differently to the crisis makes a comparative case study feasible. While this study focuses on Iceland and Latvia it can also yield interesting results for other cases. Important lessons can be learned about the effects of different policy responses during times of crisis. This comparative case study is based on a review of theoretical literature, interviews, secondary data and the author’s previous experience as a staff member of the World Bank in Latvia and as Special Advisor to the Foreign Minister of Iceland.
Keywords: Small states, Latvia and Iceland, global crisis, economic policy, privatization.
JEL codes: H12, E63, L33