Scandinavia and the social state

The Scandinavian countries are considered to have strong economies despite of a large welfare state and high taxes.

Scandinavia, part of northern Europe, is generally held to consist of Norway, Sweden and Denmark, some also include Finland and Iceland.

Nordic model
The main characteristics of the "Scandinavian" or "Nordic model" include:
 * a comprehensive welfare state with an emphasis on transfers to households and publicly provided social services financed by taxes, which are high notably for wage income and consumption;
 * a lot of public and/or private spending on investment in human capital, including child care and education as well as research and development (R&D); and
 * a set of labour market institutions that include strong labour unions and employer associations, significant elements of wage coordination, relatively generous unemployment benefits and a prominent role for active labour market policies.

Free market versus the social state
Scandinavian countries are highly ranked in the Index of Economic Freedom. Although the United States ranks higher than these nations, they are more free in several decisive areas. Denmark has greater business freedom, investment freedom, financial freedom, property rights, and freedom from corruption, while having comparable monetary freedom, and trade freedom scores to the U.S. Sweden has greater business freedom, investment freedom, financial freedom, property rights, and freedom from corruption, while having comparable trade freedom, and monetary freedom, to the United States. Finland has greater business freedom, financial freedom, property right enforcement, and freedom from corruption than the United States, while having comparable monetary freedom, investment freedom, and trade freedom. Norway, the lowest ranked Scandinavian nation (but still rather high at no. 37), has greater freedom from corruption and property right enforcement than the United States while having comparable business freedom and trade freedom. Iceland has greater fiscal freedom, investment freedom property right enforcement, and freedom from corruption, while having comparable business freedom, and trade freedom.

A 2007 study from the Cato Institute concluded that Nordic nations are reasonably successful in spite of the welfare state. The United States enjoy a faster economic growth, per capita economic input, and a higher disposable income. Private consumption is also higher, even when it includes items paid for by the public sector. Nordic nations lag behind in economic output per capita GDP (with the notable exception of oil-rich Norway).

In respect to "income inequality", the poorest 10 percent of Americans have about the same level of income as the poorest 10 percent of Finns, Swedes, and Danes. Only in oil-rich Norway is there a noticeable gap. What differentiates America from the Nordic nations is the income of everyone else. The rich, the middle class, and the working class in the United States enjoy higher levels of income than their Nordic counterparts. The long-term development, however, may not be as positive. As one researcher explained, "Over the last decade, the incomes of the poorest 10% of the population have grown eight times faster in Ireland than in Sweden, and six times faster in Britain. As a result, so-called Anglo-Saxon economies like Ireland and the UK now for the first time have a smaller proportion of their population below the poverty line than does Sweden." This would suggest that strong economic growth is better than income redistribution if the goal is to help the least fortunate in society.

The unemployment numbers are comparable or in some respects better than in the United States; although with worse statistics for the long-term unemployed. A noteworthy feature is the role of government as a major employer. As noted by a German think tank, "On average, the share of state employment in total dependent employment across Scandinavia is 32.7%, compared to only 18.5% in the non-Scandinavian countries of the EU-15. " In the United States, government workers account for slightly more than 15 percent of the workforce (2007 numbers). Moreover, the same researchers say that some Nordic nations are prone to re-characterize welfare beneficiaries as government employees, a practice that artificially overstates economic output (since government salaries are added to GDP) and artificially understates unemployment.

Government spending as a percentage of GDP consumes a larger share in all Nordic nations than it does in the United States. Sweden has the biggest burden of government, followed by Denmark and Finland, with Iceland and Norway closer to the American level. The larger burden of government presumably does not bode well for Nordic competitiveness since this means politicians and bureaucrats have more power over how resources are allocated. And since policymakers are more likely to be influenced by political considerations rather than economic factors, that undermines economic performance. High levels of government spending, not surprisingly, are associated with higher levels of taxation. Denmark, Sweden, and Finland all impose much higher tax rates on personal income. Norway’s top tax rate is significantly higher if the payroll tax rate is included. Iceland, however, has a less punitive system for highly successful taxpayers, and Norway actually has a slight advantage over the United States if measuring only the personal income tax. In the Nordic nations the top tax rates penalize a much larger share of the population - the top tax rate is imposed on taxpayers with middle-class incomes.

On the other hand, every Nordic nation enjoys a lower corporate tax rate than the United States. Corporate income in the United States is taxed at 39.3 percent, while the tax rate in Nordic nations is no higher than 28 percent. The tax burden in Nordic nations and America was remarkably similar until 1960. Not coincidentally, it was during this pre-1960 era that Nordic nations grew rapidly and became rich. Beginning in the mid-1960s, and accelerating through the 1970s and into the 1980s, however, the Nordic nations created large welfare states.

Before the 1960s, Nordic nations had modest levels of taxation and spending. They also enjoyed—and still enjoy—laissez-faire policies and open markets in other areas. These are the policies that enabled Nordic nations to prosper for much of the 20th century. Once their countries became rich, politicians in Nordic nations focused on how to redistribute the wealth that was generated by private-sector activity. Nordic nations became rich, and then government expanded. This expansion of government has slowed growth, but slow growth for a rich nation is much less of a burden than slow growth in a poor nation.

Sweden
Until the second half of the 19th century, Sweden was fairly poor. But far-reaching free market reforms in the 1860s allowed Sweden to benefit from the spreading Industrial Revolution. And so, during the late 19th and early 20th centuries, Sweden saw its economy rapidly industrializing, driven by the many Swedish inventors and entrepreneurs.

Another factor which continued Swedish prosperity was the fact that Sweden was able to stay out of all wars, including both World Wars. Sweden is the country with the longest consecutive period of peace since 1809, when Sweden was invaded by Russia, losing Finland in the process. As a result of its free market policies, the resourcefulness of its people, and its successful avoidance of war, Sweden had the highest per-capita income growth in the world between 1870 and 1950, by which time Sweden had become one of the world's richest countries, behind only the United States and Switzerland, and Denmark (who have since also fallen behind because of high taxes).

In 1932, the Social Democrats rose to power in the face of the Great Depression. Until 1932, government spending had been kept below 10% of GDP in Sweden, but the Social Democrats, under their leader Per Albin Hansson, wanted to change this and remake Sweden into a "folkhem" ("people's home"), a term Swedish Social Democrats adopted from the Fascists in Italy.

Even in the early 1950s, Sweden was still one of the freest economies in the world, and government spending relative to GDP was in fact below the American level. But between 1950 and 1976, Sweden experienced an expansion in government spending unprecedented during a period of peace, with government spending to GDP rising from about 20% in 1950 to more than 50% in 1975. Virtually every year, taxes were increased while the welfare state expanded, both in the form of a sharp increase in the number of government employees and ever more transfer payment benefits.

During the first 20 years, this relentless government expansion took place seemingly without ill effect, as Sweden benefited from rapid global growth — although Sweden's growth had already started to slip in relative terms, from well above average to just average. This changed in the 1970s after Olof Palme, from the left wing of the Social Democratic party became Prime Minister. Palme stepped up the socialist transformation in Sweden, rapidly increasing anti-business regulations and sharply increased payroll taxes.

The payroll-tax increases, along with increasing wage demands from unions, made Swedish businesses highly uncompetitive on the global markets, something which was to be solved by devaluing the Swedish krona. As a result, price inflation rose sharply, leading to repeated devaluations.

After Palme was killed by an unknown assassin in February 1986, pragmatist Ingvar Carlsson became prime minister. Worried that Swedish growth had trailed most other countries, Carlsson's government implemented a number of free-market reforms. Among these were the lifting of all currency controls in 1989 and a tax reform that dramatically reduced marginal tax rates. Although these reforms have arguably contributed to improving the long-term economic performance of Sweden, they would contribute to precipitating the deep economic downturn in the early 1990s.

Meanwhile, as the economy started slowing significantly in 1990 after a series of tightening measures, consumer price inflation slowed. With the combination of continued high nominal interest rates, reduced capital gains taxation (and with that, reduced deductions for interest payments) and falling price inflation, real interest rates started rising significantly, helping to end the asset price bubbles. On top of all of this came the oil price shock following Saddam Hussein's invasion of Kuwait and an economic downturn in key trading partners such as the United States, the United Kingdom, and Finland. The end result was that Sweden slipped into a recession in late 1990.

In the collapse in November 1992, the dramatic increase in interest rates and the deep recession had at the same time created a large amount of bad loans, making almost all major banks in effect bankrupt. Only after the Swedish government pledged they would bail out the banks with whatever money they needed was a widespread banking collapse averted.

The recession became Sweden's deepest by far since the Great Depression, with GDP in 1993 being 5% lower than in 1990, with employment falling more than 10%, and the budget deficit rising to more than 10% of GDP. By then Sweden had fallen to between 15th and 20th place in international income comparisons, a decline from which it has never since recovered. After this deep downturn, a number of free market reforms and budget cuts were implemented and Sweden underwent a recovery.

The jobless rate was traditionally very low in Sweden, averaging about two percent. Over the past two decades, however, the official unemployment rate has more than tripled, and the official numbers almost certainly undercount the true rate of unemployment. The McKinsey Global Institute estimates that the real unemployment rate is 15 percent.

Estimates usually put total Swedish unemployment, including the so called hidden unemployment, at somewhere between 15 and 20 percent, about three times above the official unemployment figures. In 2005, Mr. Hans Karlsson, a member of the prime minister's cabinet as secretary of labor, was quoted in Dagens Industri, a major business daily, as saying that about 20 to 25 percent of the work force is unemployed and that most of them are "stashed away" in the statistics on long term sick leave, in labor market programs, or in early retirement and similar programs.

Reform movements
Sweden has reduced public spending as a proportion of GDP from 67% in 1993 to 49% in 2013. It could soon have a smaller state than Britain. It has also cut the top marginal tax rate by 27 percentage points since 1983, to 57%, and scrapped a mare’s nest of taxes on property, gifts, wealth and inheritance. This year it is cutting the corporate-tax rate from 26.3% to 22%.

Sweden has also donned the golden straitjacket of fiscal orthodoxy with its pledge to produce a fiscal surplus over the economic cycle. Its public debt fell from 70% of GDP in 1993 to 37% in 2010, and its budget moved from an 11% deficit to a surplus of 0.3% over the same period. This allowed a country with a small, open economy to recover quickly from the financial storm of 2007-08. Sweden has also put its pension system on a sound foundation, replacing a defined-benefit system with a defined-contribution one and making automatic adjustments for longer life expectancy.

Sweden has introduced a universal system of school vouchers and invited private schools to compete with public ones. Private companies also vie with each other to provide state-funded health services and care for the elderly.

There can be no doubt that Sweden’s quiet revolution has brought about a dramatic change in its economic performance. The two decades from 1970 were a period of decline: the country was demoted from being the world’s fourth-richest in 1970 to 14th-richest in 1993, when the average Swede was poorer than the average Briton or Italian. The two decades from 1990 were a period of recovery: GDP growth between 1993 and 2010 averaged 2.7% a year and productivity 2.1% a year, compared with 1.9% and 1% respectively for the main 15 EU countries.

The other Nordic countries have been moving in the same direction, if more slowly. Denmark has one of the most liberal labour markets in Europe. It also allows parents to send children to private schools at public expense and make up the difference in cost with their own money. Finland is harnessing the skills of venture capitalists and angel investors to promote innovation and entrepreneurship. Oil-rich Norway is a partial exception to this pattern, but even there the government is preparing for its post-oil future.

This is not to say that the Nordics are shredding their old model. They continue to pride themselves on the generosity of their welfare states. About 30% of their labour force works in the public sector, twice the average in the Organisation for Economic Development and Co-operation, a rich-country think-tank. They continue to believe in combining open economies with public investment in human capital. But the new Nordic model begins with the individual rather than the state. It begins with fiscal responsibility rather than pump-priming: all four Nordic countries have AAA ratings and debt loads significantly below the euro-zone average. It begins with choice and competition rather than paternalism and planning. The economic-freedom index of the Fraser Institute, a Canadian think-tank, shows Sweden and Finland catching up with the United States.

Why are the Nordic countries doing this? The obvious answer is that they have reached the limits of big government. "The welfare state we have is excellent in most ways," says Gunnar Viby Mogensen, a Danish historian. "We only have this little problem. We can’t afford it." The economic storms that shook all the Nordic countries in the early 1990s provided a foretaste of what would happen if they failed to get their affairs in order.

There are two less obvious reasons. The old Nordic model depended on the ability of a cadre of big companies to generate enough money to support the state, but these companies are being slimmed by global competition. The old model also depended on people’s willingness to accept direction from above, but Nordic populations are becoming more demanding.

Links

 * Nordic model on Wikipedia
 * "Should Scandinavia Be Our Model?", Cato Daily Podcast, April 2007
 * Should the United States Be More Like Scandinavia?, Cato Policy Forum (video), April 2007
 * Johnny Munkhammar and Tony Leon in defense of free market capitalism, Cato Weekly Video, May 2007
 * Scandinavian Irony: Socialism Meets Liberalization by Sara F. Cooper, September 2006
 * Are High Taxes the Basis of Freedom and Prosperity? by Sudha R. Shenoy, October 2007
 * World in the Grip of an Idea: 17. Sweden: Tightening the Screws by Clarence B. Carson, May 1978
 * The New Scandinavian Model by Anders Aslund, November 2010
 * Fiscal Turnarounds from the Committee For a Responsible Federal Budget, February 2010
 * Sweden's March Toward Capitalism: Economist Andreas Bergh on the "Capitalist Welfare State" (video), May 2010
 * How Laissez-Faire Made Sweden Rich by Johan Norberg, October 2013