Saturday, 30 June 2012

Sweden - a cherry on top

The final chapter of the cross-country coverage of successful (and not so successful) recoveries ends this month with Sweden, the star of the recovery. 

Sweden is often hailed by Keynesists and many alike as a "poster child" of a welfare state that succeeds in creating an equal society while maintaining macroeconomic stability. It is very often promoted as the model upon which the US and the UK should organize their economies.  

But Sweden today is far from it. It has moved from a focus on equality to a focus on dynamic growth. It is persistently ranked among the most free nations in the world (along with other Scandinavian countries). Particularly in the last 20 years, Sweden became the perfect example of a state with high levels of individual and economic freedom. It has an institutional system which clearly defines rules in a society but which doesn't discourage innovation or incentives to work and create value. 

Its history of strong unions, high taxes, high government spending and high inflation has put too much pressure on the country which culminated in its 1991 crisis, following a housing bubble burst and a credit crunch. The systemic instabilities accumulated over the years became obvious and reforms needed to be done. 

Andres Borg lecture

The best person to speak of this is the Swedish finance minister, Andres Borg, several years in a row voted as the best finance minister in Europe by the Financial Times. He did a lecture in April this year in Washington at the Peterson Institute (find the transcript here). I strongly encourage you to read the entire text or at least see his presentation

Figure 1: Sweden and the crisis. Source: Andres Borg, Lessons
from Sweden on the Global Financial Crisis
. April 24, 2012.   
He pointed out that Sweden “weathered the current crisis relatively well” compared to the rest of Europe. The reason for this were the lessons they learned in the 1990s and the structural reforms they made back then which made them much more resilient to future demand shocks. 

It is hardly a surprise that Germany and Sweden were the two economies that came strongest out of the crisis. The Swedish structural reform, as told by Mr. Borg was very similar to what Germany did in its Agenda 2010. The structural reforms which I will touch upon in the text are the reasons why both Germany and Sweden maintained the competitiveness of their labour force. 

Figure 2: Competitiveness crisis. Source: Andres Borg,
Lessons from Sweden on the Global Financial Crisis.
April 24, 2012
It wasn’t the euro’s fault that Germany benefited (after all Sweden doesn’t have the euro); it was the fault of the PIGS which failed to reform their labour markets. Their governments lacked the courage to fight the unions and other blocking interest groups and failed to reform their entitlements and transfer systems. Just look at the difference between unit labour costs between Sweden and Greece (or Italy, or Spain) in 2007. It amounts to almost 70 basis points. Borg also points out how Italy for example had a negative total factor productivity since 1995 (-0.5), meaning that nothing justified these rising labour costs, apart from union pressures. 

What Sweden did in the 90-ies 

The starting point was as hard as it is in peripheral Eurozone now. Lagging growth, low productivity, highly regulated markets, huge barriers to entry for entrepreneurs, high marginal tax rates, political battles between unions and businesses (Borg points to the proposals of unions to take over controlling stocks from companies and for themselves to become owners – does this ring a bell?), inflation-driven wages set by the public sector (which was a big deal with a 10% average inflation), entrepreneurs leaving the country, and finally large deficits and rising debt levels. This sounds like a description of a typical peripheral Eurozone country today. But Sweden was determined to reform: 
“Since then, there has been a period of two decades of consistent...and broad-based reforms. While keeping a very well-functioning welfare state, we have been able to transform the labor market, so it is much more flexible. We have increased production [and] productivity in the industry substantially...We have cut taxes. We have restored our public finances...Last year we repaid the last of our current account debt that we built up over the last two decades.” 
All this wouldn’t have been possible without a broad-based political support. They made a consolidation close to 15% of GDP, using both taxes and expenditures, and for that a social cohesion and a broad coalition are a necessity. 
“My experience from Sweden, from Latvia, from Ireland and from other countries that I’ve been involved in..., I would argue that the combination of broad-based [political support] and social cohesion is very, very important. Equally important and even more so in the current situation are the structural reforms to be pro-growth. To be able to grow out the crisis, you have to deal with the fiscal side but you must also deal with the structural side, if this is going to be long-term sustained, because....growth [means] creating the resources.” 
His point from this is that there is no quick fix with structural reforms, that a broad-based support in the electorate is needed to undergo through this, and most importantly that there is no one-size-fits-all solution: 
“Ours was balanced between revenues and expenditure cuts. You must remember that we are coming from a very, very high tax rate to begin with. So you cannot say that there is a one size fits all [approach]. One has to go through the details of the specific country and try to balance the reform program. But in general terms, a European situation where public expenditures are in the neighbourhood of 45-50% of GDP, it is quite clear that most of the consolidation should be taken on the expenditure side, and if you’re in a situation where the tax rates are substantially lower, the balance could be in a different manner. For example, it was more natural for Latvia to do tax increases than it was for Sweden, given that they had very low taxes to start with.”
The reforms
"We’ve done a major tax reform...We have cut back the taxes on income, particularly earned income...The overall tax level in Sweden is still very close to slightly below 50% and so we still have a very high tax level, but that is based primarily on the ATs and social fees, rather than income taxes. The role for income taxes have been quite dramatically changed in the composition of taxes...The actual tax for a blue-collar job working half time...would not be higher than 10-15%." 
"There was a very, very broad based deregulation. Today, if you go to the OECD “Going for growth” report, they are looking at 8 different sectors; 6 out of those we have a regulatory burden less than the US. So we have gone from being one of the heaviest regulated economies of Europe to one of the least regulated when it comes to product markets." 
"There were other structural reforms. The pension reform [increasing the retirement age, lowering the indexation for the pension system]...European Union membership has lowered the tariffs and opened our economy even further. We are today well above 50% in exports. We have changed the central bank system to independent central bank, the wage setting system has been reformed, and all of these reforms have strengthened each other. There is a new sense among the Swedish unions that we are now setting wages so that the competitive sector starts first. That becomes a norm for the rest of the wage negotiation."
The health reform was also a major success, where Sweden is spending half of what the US is spending and is offering equal or in some cases even better health care (based on diagnoses and the frequency of certain illnesses). They have imposed a balanced budget requirement in health care, changed incentives in patient care, changed the prescription system and introduced competition particularly in the primary care sector. 

A model to follow 

Finally, going through all these structural reforms, it’s time to say something about why Sweden was able to close the output gap in the 90s so fast. If anyone want’s proof that austerity works (real austerity that is, – one based on real reforms and adjustments, and on decreasing expenditures, while not increasing the overall tax burden), look no further than Sweden: 

Figure 3: Austerity worked?. Source: Andres Borg, Lessons
from Sweden on the Global Financial Crisis
. April 24, 2012
This is now about how big the optimal government should be (again, every country is different in that perspective), but it’s clear why Swedish consolidation worked. 

The biggest success in all of this is that Sweden has switched from an equal and non-dynamic society, to a society that is both equal and dynamic – in my opinion the best possible scenario. But it had the courage to reform no matter how painful it initially was. The United States, not only Europe, should learn from this. 

8 comments:

  1. Sweden is the best example UK can learn from: deregulate, cut taxes, broaden the tax base, reform pensions and most importantly reform the NHS by introducing more competition.

    I read Borg's lecture, it's really good, thanks for pointing it out!

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    1. Except that, to be like Sweden, UK would have to increase its taxes, and its pensions.

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    2. Not necessarily, all the UK needs to do is to improve it's government's inefficiencies.
      What I believe Charlie was referring to was the initial move that Sweden made and that the UK has failed to make since Thatcher times..

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  2. This article comes at a great time for me. I am currently writing a book and needed extensive footnotes about the Scandinavian nations and the way they have in recent years turned away from cradle to grave socialism, heavy taxes and market regulation.

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    1. In that case I would recommend you read this book (here is a pdf of the introductory chapter)
      It's a series of NBER articles on reforming the Swedish welfare state in the 90-ies.
      Borg's lecture at the Peterson Institute can come as a perfect follow up to this.

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  3. Sweden experienced a good outcome of restructuring in part because it had a more equal income distribution to start with. This made it much less a burden for the people, even if the effect was purely psychological. What also helped was that no one felt injustice of seeing the bankers who caused the crisis being bailed out, while everyone else had to withstand the consequences in accepting falling wages, job losses, lower pensions, lower health and social benefits and so on.
    My point is that their success starts with equality.

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    1. The relatively higher equality did help, but it certainly wasn't the key determinant of their success. We can talk about more favourable psychological effects or less public anger, but the Swedish government did experience strong resistance in their negotiations with the unions and in other sectors they were trying to reform.

      Reforms are always hard to do which is why governments need to apply them carefully and make them as painless as possible, even though very often this isn't the case. That's why things like currency depreciation or higher equality can help, but they can't be proclaimed the main reasons to why a country had succeeded.

      Your argument is basically that equality helped in making people easily accept the reforms, and I agree. But it was the reforms which changed the system and made it more resilient.

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  4. This article is full of excellent informative content. The points you make are interesting and original, and I agree on many of them. Thank you for writing on this topic.

    ibc

    ReplyDelete