China and the West May Soon Compete for Troubled Iceland

By Guillaume Xavier-Bender

BRUSSELS-In front of the dominating church of Hallgrímur, in Iceland's capital Reykjavik, stands the statue of Leif Ericson. He is described as the "son of Iceland, discoverer of Vinland," the Norse name for what would become North America. The inscription serves as a reminder of the island's physical and symbolic position in the middle of the Atlantic.

On April 27, Icelandic voters brought back to power the center-right conservatives they had ousted after the financial crisis of 2008 in favor of a pro-European socialist-green coalition. Beyond the political result, the elections exacerbated some of the pressing economic and strategic challenges that lie ahead for Iceland. Between accession to the European Union, the potential for a renewed relationship with the United States, and a strengthened partnership with China, Iceland faces numerous choices concerning its role in the transatlantic relationship.

Five years after a financial crisis made Iceland the center of international attention, a disconnect between the country's economic and social recovery is palpable. Emergency measures taken in the wake of the crisis with the blessing of the International Monetary Fund may have protected domestic depositors and assets, but they have led to higher taxes, currency devaluation, repossessions, and lower paying jobs. Despite steady 2.5 percent growth, unemployment projected to be below 5 percent by the end of the year, a positive current account balance, and government debt now below 100 percent of GDP, much of the population is still struggling. Growth may have returned sooner than expected, but it has been weaker. More pressing, household debts are still crippling; in 2012, 10 percent of homes were still in default with mortgages or rent.

Iceland's economy relies heavily - perhaps too heavily - on its geography and geology, which have enabled the development of successful fishing, geothermal energy, aluminum production, and tourism industries. With diversification now needed, Iceland must create the necessary conditions to attract foreign direct investment. This would require foreign creditors to suffer losses in an orderly way and the lifting of capital controls in a manner that avoids the further depreciation of the króna. The new Icelandic government will need to convince its people that it is capable of helping those still most affected by the crisis.

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But beyond economic recovery, it is Iceland's role in global affairs that may be at a critical juncture. Despite continuing skepticism over the country's accession to the European Union and the euro, reinforced by the overwhelming victory of the center-right parties opposed to EU membership, talks might still go ahead under the new coalition government. Many Icelanders have voiced their interest in seeing what a finalized accession package would look like, with particular attention focused on the thorny issue of fisheries.

Iceland is also proving a strategic gateway of another kind. In early April, it became the first European country to sign a free trade agreement with China. The large size of the Chinese embassy in Reykjavik is a fair representation of the ambitions that Beijing may have in the region, and why it has been seeking for support to become a permanent observer of the Arctic Council. By 2020, approximately 15 percent of Chinese trade may be transiting through the Northern Sea Route.

Iceland's proximity to the Northwest Passage and to the resources of the Arctic confer it a key position in the region, and the island could become a hub for maritime transport or an advanced base for rescue missions in the north. Iceland has already signaled its willingness to play a central role in the region by forming the Arctic Circle, a non-profit, non-partisan platform designed "to facilitate dialogue and build relationships to confront the Arctic's greatest challenges." One of these challenges might yet be for Iceland to find signs of renewed interest in Washington following the closing of the Keflavik air and naval base in 2006.

Reykjavik must convince Americans and Europeans of its strategic relevance, whether or not it opts to become a member of the European Union. While Iceland still remains under the military protection of the United States, history also helps to remember that it is in Reykjavik's Höfði that Ronald Reagan and Mikhail Gorbachev met in 1986 to discuss arms control and nuclear disarmament. And in 1991, it was Iceland that was the first country to recognize the independence of Estonia, Latvia, and Lithuania from the USSR - all three of which are now part of the EU.

Beyond asking to participate in discussions over a Transatlantic Trade and Investment Partnership, Reykjavik should continue to position itself as a natural strategic hub in the northern Atlantic. At the same time, both Washington and Brussels should more actively reach out and engage with Iceland, in order to avoid seeing the island drift too far away.

Guillaume Xavier-Bender is a program officer for economics in the Brussels office of the German Marshall Fund of the United States. Reprinted with permission.

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