štvrtok, marca 01, 2007

On Swedish Model

Predominantly left-leaning newspapers such as British Guardian say that Sweden is the most successful society the world has ever known. This discussion has primarily already taken place back in the second half of the 20th century when policymakers, economic advisers and largely Keynesian experts embodied Sweden as a model for economic success which supposedly combined generous welfare safety mechanism with an unlimited free enterprise industrial and entrepreneurial sector. Political and economic debates about Sweden have confronted two specific points of view. The first point of view dominates that Keynesian economic policy and practice have successfully put up an “optimal” combination of wealth and income redistribution in addition to free entrepreneurial sector. The second point of view is quite the opposite from what the proponents of the so called Swedish model claim. Swedish success story is accorded to a long period of free-market and a very limited government. For years, the rate of public spending had not exceeded 10 percent of the annually adjusted GDP. In Slovenia, Swedish model is vastly popular among the politicians who see Sweden as an example how to admire the rest and simply forget the best. The aim of this article is to crystallize the Swedish model and unmask the most commonly confused myths about Sweden.

Swedish economic miracle was largely a result of long periods of peace and aided prosperity. The transformation of Swedish economy began in 1846 when a group of classically liberal reformers instituted a religious liberty, deregulation, structural liberalization and free trade. The institutions of free market benefited Swedish society as industrial revolution galvanized Swedish economy. Between 1860 and 1970, Sweden had, after Japan, the highest economic growth rate in the world. The second industrial revolution created a firm entrepreneurial foundation as many Swedish multinational engineering companies (DynoNobel, LM Ericsson, ASEA/ABB, SKF, Alfa Laval) built a bulk of inventions and innovations that streamed toward a high value-added of goods and services and thus further pushed Swedish economy toward a rapid growth rate. Sweden’s development included the participation of foreign investment in improving the infrastructure, mainly in railroads and technological improvement. As Sweden did not participate in neither of two World Wars, the export sector had been breaking records and meanwhile became, beside stable institutions, protected private property rights and flexible contract enforcement, the foremost component of the economic growth in Sweden. When the international trade was partly liberalized, the removal of trade barriers turned shortages into surplus and the prices went down rapidly. As firms had to cut their prices to keep on maintaining and increasing their market share, their income was cut and a number of firms went into liquidation. On the other side, unemployment and production fall increased dramatically. It took some years before the economy started to grow again.

When the Great Depression slightly struck the Swedish economy, the unemployment increased by 25 percent due to the belief that trade protectionism and currency regulation would be the surest protection against the global economic slump. Compared to other countries, Sweden survived the depression much better than its global counterparts. When in 1931, the Swedish krona devaluated against dollar, the export activity grew by 30 percent. Due to the rapid recovery since the crisis of the 1920s, the economic growth increased significantly. The first leap towards the interventionism was made in 1932 when the new government of social democrats wanted to take a greater role in the economy and society in terms of controlling and fighting unemployment which became the first priority. Keynesian economic policy under the government of social democrats aim to closely control the economy and take interventionist features to control the business cycle. The Second World War did not touch Sweden and thus, the production facilities remained undamaged. Export sector was growing meanwhile the war was on. After the war, Swedish economy had a much better starting position than its counterparts in Continental and Western Europe. Sweden took a major advantage of both World Wars as being aided with neutrality and peace and easier became one of the wealthiest countries in the world.

Swedish model is interpreted as a historical compromise between a social democratic government and widespread privately-owned industrial and entrepreneurial sector. The proponents of copying the Swedish model abroad do not understand that Swedish model did not include the nationalization of industries and means of production at that time as many policymakers in the rest of the Western Europe largely exercised. Private industrial ownership was largely smaller in France and the United Kingdom as in Sweden. The Swedish model emerged in 1932 when Gunnar and Alva Myrdal designed a generously expansionary welfare model saying that Sweden is an ideal country for such an experiment. They claimed that small and homogenous population and protestant working ethics would additionally support the creation of a generous welfare state and expansionary government spending and regulation. The compromise in the pool of the Swedish model has involved strong bargaining position of trade unions. Together with the government, the unions play an explosive role in labor market policies. The government devised numerous systems of taxation and wealth and income redistribution. The “middle way” between state socialism and market capitalism had been coined and thus became a surprisingly successful original Swedish trademark. Until the 1970s, the economy was booming as well as specific economic indicators and characteristics were seemed great. Swedish economy strongly exceeded the average world economic growth rate between 1950 and 1970. The reason why Swedish economy still grew despite the increase in government spending is that industrial business sector successful restructured to compete with global competitors on international markets. Gross value added output increased strongly between 1950 and 1970. Textile industries faced tough global competition as costs associated with welfare and employers’ contribution to health and social insurance reduced the return on each invested unit of capital. On the other side, engineering sector achieved the greatest gross value added output levels on an international scale. The supply of technical staff in the market was large enough to avoid structural unemployment. Its rate went extraordinarily low to 2 percent between 1950s and 1960s. But in 1960, Swedish labor market saw major changes. The employment in the service sector was growing while was a drop in the employment base for industrial and textile workers. The socialistic economic policy of Palme government leaned further toward orthodox Keynesianism and excessive spending. During the late 60s and early 70s, the number of people employed in the public sector grew rapidly. At the same time, the number of job leavers depended on social welfare and labor training programs considerably as well. The outcome of government’s disastrous welfare and spending policy had been the highest tax burden in the OECD group of countries. For example, the marginal tax rate on individual income was above 80 percent in the middle of the 80s.

Structural crisis went evenly deeper in the early 70s as international economic crisis negatively affected Swedish economy. As Sweden is largely export-oriented economy, the oil crisis of 1973-74 left negative effects on the economy more than in any other country. The stability of the export sector was shook when the decline in international business activity was completely unexpected and optimistically above the immediate expectations. The structural problems involved greater pressures from trade unions which led to dysfunctional wage formation and problems connected with higher inflation and rapid expansion of money supply at a rate far above the GDP growth rate. Macroeconomic stability of public finances was not flattering. Budget deficits and a growing size of public debt caused the macroeconomic financial risk as the economic policy was focused on the expenditure side of the budget. At that time, the business environment was very inhospitable as high taxes discouraged capital and job formation and supported capital flight. Tough international industrial competition in shipbuilding and steel industry was faced and employment level in those sectors went down dramatically. High taxes and substantial government intervention discouraged strategic restructuring and market reorientation and consequently the capital flight was made a bubble waiting to explode. In the absence of restructuring and in the presence of enormous contribution to social welfare programs, the entrepreneurs streamlined towards moving the production plants abroad. The government solution to the problem was, as Milton Friedman would say, even worst than the problem itself. The government relied on massive subsidies to those industries. This kept employment up only temporarily. The need for spending on granted subsidies turned into a growing size of budget deficit. The Central bank, Riksbank, broadened the monetary base which immediately resulted in a higher inflation rate. High cost increases and a decreasing level of international competitiveness of the Swedish economy fostered several devaluations of the krona. The devaluations supported the short-term competitiveness and export based industries but worsened the long-term problems associated with higher inflation so that Riksbank adopted the policy framework of inflation targeting in search of a nominal anchor.

The overall picture of Swedish economy was scrapped in the scratch, worse than anytime before, after the World War 2. In order to let the economy grow, Swedish policymakers initiated several deregulations; transportation sector, telecommunication market and financial market were among the most exposed. In the financial market, loan restrictions were liberalized and some barriers were dismissed. The reaction of the market was quite logical. The lending expanded rapidly quickly, focusing mostly on real estate market. Rigid, stoned and hard-hand regulations contributed the major share to the risk of credit expansion. Due to the devaluation, the export sector was given a monetary surplus and the liquidity problem had been solved by investing into real estate sector which contributed to a rapid growth of overall asset prices.

As the banking system overheated, credit risk led to the instability of the financial system due to credit losses and the loss of liquidity. The combination of structural crisis was coupled with government financial crisis and currency crisis. The latter led to the abandonment of fixed exchange rate regime which partly exported inflation risk and pressures to the major trading partners. The transformation to free-floating exchange rate regime depreciated Swedish krona. This made a positive effect on export activity but it was still not enough to cover the whole loss turbulently created in times of the near collapse of financial and service sector. The official unemployment jumped to 8,2 percent and the GDP between 1990 and 1992 fell by 5 percent. It is quite hard to predict the real jobless rate as numerous unemployed participate at the labor training programs and statistical office does not count them as unemployment though they are not seeking a job on the labor market or working.

The deepest economic crisis since 1930s was marred by a blurred picture of deteriorating public finance. In 1994, the budget deficit was above 15 percent. The public debt climbed at around 80 percent as central bank disciplined its policy to hit the inflation through inflation targeting and tightening the money supply. All in all, due to the combination of two decades of low growth and economic crisis, Sweden slid in the OECD’s Prosperity League from 4th place in 1970 in 16th place in 1998.

Several economic reforms and measured features were introduced in order to move the economy out of depression. Central bank gained independence in targeting inflation while the government had to cut the expenditure rate. Health-care sector was fundamentally changed. Private health-care insurance schemes were allowed. Reforming the pension system has been oriented toward individual retirement accounts as it has been partially privatized. Vouchers and competitive mechanisms were introduced in the education system. Budget outlays were reduced and the general budget policy turned into the policy of golden surplus, minimizing the pressure on public finance and short-term policy expectations.

Sweden is a country that went from rags to riches. Aided by peace and neutrality, it continually relied on a minimal GDP consumption. The foundations of early entrepreneurship and free trade introduced in early 1860s were also the ground for a rapid development through industrial revolution and high economic growth rates as well. This had largely been the result of running on the road to free economy which had been based on entrepreneurial innovations and numerous inventions that additionally helped create an enriched profile of gross value-added output and this is one of the several components that helped Swedish economy succeeded in international trade. In 1950s and early 1960s, the government intervention sparked and after 1970s, it became an explosive experiment of excessive welfare spending. In the case of Sweden, Keynesianism bankrupted again when Swedish economy slid into depression, facing a GDP fall, inflation pressures and high unemployment. The middle way embodied in the Swedish model is not appealing as left-leaning charlatans, socialists of all parties and economically illiterate self-proclaimed experts would wish.

In Slovenia, where “the gradualist way” of economic policy inhibited the transition to market economy, the worst features of the Swedish model streamlined the course of public policy. Thus, we still have the highest taxes in Central and Eastern Europe, not to mention substantial government ownership of banks and several corporations. Trade unions possess politically given monopolized position in the labor market which is one of the least free in Europe. In the beginning of transition to market economy, only the “rest” of the Swedish model was copied to Slovenian public policy, including excessive welfare spending and extremely rigid and inflexible labor markets. Copying Nordic problems immediately revenged when the economy and society have been fading on the scale of international competitiveness.

The relevant question to ask is how Nordic countries, say Sweden, became rich and how they progressed structurally, achieved high rates of economic growth and what kind of set of solutions was exercised when the economy was coming in the recovery. At last but not least, when talking about the Swedish model my advice is simple:

Admire the best and don’t think of the rest.

Rok SPRUK is a supply-side economist and a classical liberal. He lives in Slovenia where he studies economics and business. His fields of professional interest and research are economic growth, international economics, macroeconomics, tax reform, international competitiveness, free trade and globalization. In the field of business he is focused on strategic management, financial markets, business models, marketing and innovation. Rok works for economic freedom, individual liberty, free enterprise and a free society. His ideas, writings and observations are posted on his blog Capitalism & Freedom. You can contact Rok by sending an email to rok.spruk@gmail.com