The people of Iceland have now twice voted not to repay international debts incurred by banks, and bankers, for which the whole island is being held responsible. With the present turmoil in European capitals, could this be the way forward for other economies?

The small island of Iceland has lessons for the world. It held a referendum in April to decide, more or less, whether ordinary people should pay for the folly of the bankers (and by extension, could governments control the corporate sector if they depended on it for finance). Sixty per cent of the population rejected an agreement negotiated between Iceland, the Netherlands and the UK to pay back the British and Dutch governments for the money they spent to recompense savers with the failed bank Icesave. That was less resistance than the first referendum last spring, when 93% voted no.

The referendum was significant since European governments, pressured by speculators, the IMF and the European Commission, are imposing austerity policies on which their citizens have not voted. Even devotees of deregulation are worried by the degree of the western world’s servitude to unconstrained financial institutions. After the Icelandic referendum, even the liberal Financial Times noted with approval on 13 April that it had been possible to “put citizens before banks”, an idea which does not resonate among European political leaders.

Iceland is an unusually pure example of the dynamics that blocked regulation and caused financial fragility across the developed world for 20 years. In 2007, just before the financial crisis, Iceland’s average income was the fifth highest in the world, 60% above US levels; Reykjavik’s shops were stuffed with luxury goods, its restaurants made London seem cheap, and SUVs choked the narrow streets. Icelanders were the happiest people in the world according to an international study in 2006. Much of this rested on the super-fast growth of three Icelandic banks that rose from small utility institutions in 1998 to being among world’s top 300 banks eight years later, increasing their assets from 100% of GDP in 2000 to almost 800% by 2007, a ratio second only to Switzerland.

The crisis came in September 2008 when money markets seized up after the (...)