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Iceland Small Fish in a Global Pond Case Solution

Solution Id Length Case Author Case Publisher
2658 1519 Words (7 Pages) Michael E. Porter, Christian H.M. Ketels Harvard Business School : 708472
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Iceland, the second largest island in the Atlantic Ocean, is home to 308,000 people. It officially became fully independent in 1944. Iceland also had an important source of geothermal energy, a large hydroelectric power capacity, and the richest fishing grounds in the North Atlantic. Electricity, water and telecommunications services were initially provided only by state-owned enterprises and then privatized. Its unemployment rate stood at about 1.3%, and in 2006, it was ranked second on Human Development Index. Development in Iceland slowed down significantly in the early 1980s. Iceland joined the European Economic Area (EA) in 1994, a free trade zone primarily made up of her EFTA member states and the European Union. In the late 1990s, the Icelandic economy was heating up again with rapid development. Iceland was ranked 13th in the Global Competitiveness Report 2006 (GCR) Business Competitiveness Index. All industries were expanding rapidly in Iceland. However, household debt increased, from 80% of disposable income in 1990 to 192% in 2004.

Following questions are answered in this case study solution

  1. What was the Global Economic Problem that Iceland was facing?

  2. What caused the problem?

  3. What possible solutions are there for Iceland?

  4. If you are the economic and business advisor to the Government of Iceland what suggestion will you give to solve the economic problems?

Case Analysis for Iceland Small Fish in a Global Pond Case Solution

1. What was the Global Economic Problem that Iceland was facing?

In the early 1980s, Iceland's development significantly slowed down. Due to the recession and high-interest rates in other countries, the Government boosted interest rates to stabilize the currency rate. As a result of intense wage talks between business and labour union groupings and the Government, inflation increased to double digits. In Iceland's highly regulated financial markets, negative real interest rates destroyed savings and enticed otherwise unprofitable projects, leading to a significant misallocation of capital.

Economic activity had been artificially stimulated by transitory tax benefits following a change in the tax code in 1987, but this activity swiftly subsided. The Government drastically reduced the total permissible take to help the declining fishing populations around Iceland recover. To control the high inflation rate, monetary policy was tightened. Budget deficits lingered between 3% and 4.5% of GDP until the mid-1990s as the economy entered a recession and the state of the Government's finances worsened.

Trade unions and corporate groups reached a nationwide agreement in 1990 to moderate pay increases, which began to ease inflationary pressure. The workforce's degree of unionization declined during the next ten years, while decentralized pay discussions increased in frequency.

The Icelandic currency experienced heavy speculative pressure at the start of 2006. International investors made so-called "carryover trades," where they borrowed money in currencies with low-interest rates, such as the Japanese yen, and invested it in Iceland and other nations with higher interest rates but lower perceived devaluation risk. Iceland's enormous foreign debt, equal to around 120% of GDP, and current account deficit have raised questions about its capacity to sustain its economy. Later, the Investors cut back on their exposure to Iceland, which caused a dramatic decline in the currency's value.  

Despite the volatility of the financial markets, several studies commissioned by the central bank and other organizations concluded that there was little likelihood of a financial catastrophe. However, there were other justifications for joining the Eurozone to lower exchange rate volatility. 

2. What caused the problem?

The Icelandic parliament took control of its foreign affairs on April 9, 1940. After a month, British troops took control of the island, and throughout the rest of World War II, Iceland served as an important allied military outpost. The base came under American hands in 1941. Trade restrictions were eased, and the currency fell in 1960 to encourage exports. There were still stringent regulations on the financial and other domestic markets, and the government-controlled a sizeable share of the Icelandic economy. 

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