21/2/2012: Who has had the better crisis: Ireland or Iceland? Many would say Iceland, which Friday won a Fitch upgrade that restored it fully to investment-grade status; that puts it a step ahead of Ireland, which still has a "junk" rating from Moody's. Short-term, this verdict is probably right. But longer-term, Ireland's euro membership may bring benefits.
Both countries were brought down by reckless risk taking from outsize banking systems. But Iceland's banks were so large, at about 10 times gross domestic product, that the country had no choice but to allow them to fail and see their creditors take the hit rather than the government. Ireland's misfortune was that its banking system was only about four times GDP, just about small enough to be saved, while the European Central Bank's fear of contagion closed off the option of burning bondholders.
The costs of dealing with banking failure have been similar. Bank recapitalization cost about 45% of GDP in Iceland and 40% in Ireland. Both saw deep economic declines of 12%-13% of GDP. And both ended up with budget deficits in the double digits, as a percentage of annual GDP, which have required stiff fiscal tightening. Government debt is lower in Iceland, but not by much, reaching 100% of GDP in 2011. The difference is that Iceland grew 3% in 2011, Fitch estimates, versus 1% for Ireland.
But Iceland still faces tests. Capital controls, put in place during the crisis, are a barrier to investment, but removing them could lead to capital flight. The unresolved dispute over Internet bank Icesave could add to the debt burden. Longer-term, doubts lurk about Iceland's growth potential, with much debate over how to exploit its natural resources.
Ireland's policy choices have been constrained by the euro. But its recovery has been damaged by the euro zone's poor crisis management, which has dragged down the whole currency bloc's economy. Longer-term, euro membership should help Ireland lure investment and boost exports: Even in 2011, there was a 30% increase in companies investing in Ireland for the first time. Over time, that may prove the deciding factor. Read more. (Subscription required.)
