How this country went bust -- and came back strong

(Money Watch) COMMENTARY Millions of Spaniards took to the streetson Thursday to protest another round of government spending cuts. Yet while the IMF and other global lenders have for decades used such austerity measures in bailing out debt-laden nations, there is considerable evidence that the policies don't work. The most recent cases in point -- the contrasting fortunes of Greece and Iceland.

Only four year ago, Iceland was an economic basket case. After going on a borrowing binge banks between 2001 and 2008, the country's banks were $85 billion in debt, which equates to 700 percent of the nation's GDP. As Michael Lewis wrote in his book "Boomerang," Iceland represents a case in which "an entire nation without immediate experience or even distant memory of high finance had gazed upon the example of Wall Street and said, 'We can do that.' "

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After the financial crisis struck in 2008, Iceland was effectively shut out of the international capital markets, making it impossible to borrow money to cover the country's interest payments. By the start of 2009, the government had taken over its banks and became the first Western European nation since 1976 to take out a loan from the IMF. Then Iceland took the road less traveled -- it declined to cover its banks' debts. It forgave debt held by Icelandic citizens. It prosecuted bankers. It rejected austerity.

This came with a cost. The following year, Iceland's economy shrank nearly 7 percent. The nation's credit rating fell to junk status and unemployment shot up. Yet by 2010, only two years after the crash, its economy was recovering and is currently growing at an annual rate of 2.9 percent. That growth tops that of every country in the EU except Germany.

Compare Iceland's return from oblivion to what Greeks are facing. Greece did not default on its loans and did not prosecute the people responsible for destroying its economy. It has gone along -- grudgingly -- with international lenders' slash-and-burn approach to reducing the country's debt. And yet this has increased, not lowered, that debt.

Athens is now saddled with a "recovery plan" that, in many respects, has already failed. Thanks to austerity, Greece's economy has collapsed, with popular revolt a distinct possibility. Its unemployment rate is over 21 percent, the highest of any eurozone nation except Spain. One in 11 people in greater Athens are now using soup kitchens, and half of the most prescribed medicines in Greece are in short supply. The country is surviving on international handouts, with large chunks of each payment going to pay off the previous handout.

Which road would you follow?

  • Constantine von Hoffman On Twitter»

    Constantine von Hoffman is a freelance writer and writing coach. His work has appeared in outlets such as Harvard Business Review, NPR, Sierra magazine, Brandweek, CIO, The Boston Herald, TheStreet.com, CSO, and Boston Magazine.

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