SWEDEN: SUCCESS AND FAILURE

“We must understand that we are at the beginning of the creation of a new European economy in the context of a rapidly changing global economy. The stagnation in some of the central economies isn't the really interesting story at the moment -- the interesting story is the success of the radical reform policies initiated by Estonia a decade ago and recently reinvigorated by Slovakia. Over time, the success of these reforms, and the new growth opportunities they are creating, will influence all the other European economies. Few things have been as misdirected and counterproductive as all the talk about safeguarding some imaginary European social model. It has created the impression that change and
globalization is something that is threatening and dangerous, and that the
task of politics is to resist change. It has been truly damaging to Europe as a whole.”
--Carl Bildt

Swedish model is oftenly traced in mainstream media. It is also interpreted on a large basis especially in transitional developing countries. In the context of economic debate, critics, columnists, commentators and also professional experts point out that Sweden is the most successful society the world has ever known. In Slovenia, the economic debate about Swedish model of combining social welfare and sound economic performance has been reaching its peak as well. The question that comes to our mind is wheatear Swedish model, based on high income tax rates, extensive welfare and income redistribution, is really as efficient and productive as many academics and self-proclaimed experts say. In Slovenia, there is a hot debate when the country is on crossroad. Some claim that Swedish model is the most efficient and guaranteed option for Slovenia to be successful in the future while only a tiny minority (myself included) warns the public about potential dangers of copying the Nordic model. Misguided intellectuals are, indeed, very much in favor of copying Nordic problems instead of solutions. Proponents of exploding welfare state are forgetting that there is no such thing as a single Nordic model and that Nordic models frequently involve a good set of solutions. Is the Swedish model of high taxes, increased regulation and government intervention truly a wonder of the earth as
falsified unsophisticated and misguided experts say? They ignore the fact that due to Swedish model which they justify; Sweden has slammed into long-term economic recession after having achieved the highest economic growth rates during 1870 and 1950.

The story of Swedish success started back in 1860 when economic policymakers started to launch the implementation of liberal economic reforms based upon the principle of low rate of public expenditure. Accumulated set of solutions and industrial revolution stimulated Swedish economy at that time. Quick and immediate structural development outshined Sweden’s historically most reputed entrepreneurs and innovators like Alfred Nobel, Sven Wingquist, Gustav Dahle and Baltazar von Platten. In the period of rapid economic transformation toward free and unregulated market, entrepreneurial phenomena, such as Ericsson, SAAB and Volvo have been established and set on track. On the road to free economy, the birth of entrepreneurial generation of innovators had been the foremost basis of further economic and structural progress (Munkhammar, 2006). Another reason why Sweden safely enjoyed in period of prosperity, is that since Sweden has not been involved in any kind of war effort since 1809. The neutrality of Swedish foreign policy resulted in the avoidance of war conflicts and several disputes which plagued the world during the 20th century. The early
construction of the Swedish model had been based upon the expanding investment in human capital infrastructure (Norberg, 2006). Consequently, the Swedish GDP per capita between 1860 and 1950 had been the fourth highest in the world, right behind the United States, Switzerland and Denmark (Johnsson, 2003). After 1950, Sweden went socialist. The government started to run an expansionary policy of rapid growth of public consumption and welfare spending. It grew from 20 percent before 1950 to an enormous 50 percent of the GDP in 1976. Marginal tax rates on personal and corporate income were raised on a yearly basis. Socialistically streamlined economic policies of Olof Palme constantly included tight regulation of business sector and the process of collective bargaining through which trade unions enhanced its monopoly positions in the market. Peaking up at 83 percent, the rate of unionization had been the broadest in the world. Economic policies of several socialist governments pushed Swedish economy away from the advantages and benefits of global economic growth. Macroeconomic impacts of such policies have been disastrous. After trade unions collectively demanded wage increases, despite the fact that marginal productivity rates were negative, inflation expectations grew enormously after series of currency devaluations. In 1985, Swedish government was determined to deregulate the financial sector with a particular emphasis on banking reform. This was a necessary step forward. Terrible side effects of banking reform were on its way ahead. The interest rate was negative and thus consumer lending skyrocketed. Consequently, inflation accelerated much quicker than it was anticipated and assumed by the central bank as well as rapid growth
rate of consumer lending at negative interest rate, create stock and real estate bubbles. Exchange rate was fixed and the level of competitiveness of the Swedish economy had been at the lowest point ever recorded in modern history. Latter government of Mr. Ingvar Carlsson implemented a wide variety of moderately free-market economic and structural reforms. Currency control
was abolished and marginal tax rates on individual and corporate income were cut. At the
beginning of the 80s’ and 90s’ the economic growth rate was rachitic. Low levels of direct corporate taxation coupled with high nominal interest rates and unexpectedly decreasing level of prices caused high real interest rates what accurately stimulated the explosion of the real estate bubble on the market. Aftermath, the oil shock followed and Swedish export sector was stroke by a major hit. As a result, the volume of international trade between Sweden and its biggest trade partners at that time (U.K., U.S. and Finland), decreased significantly as those economy were severely hit by a global economic downturn. Consequently, Swedish economy faced a deeply rooted economic recession in the beginning of 90s’. After the abolishment of currency control, Swedish government pledged not to stimulate the devaluation of the Swedish crone. Swedish central bank, Riskbank, defended the currency by increasing the level of interest
rates. As currency speculators knew that surprisingly high level of interest rates will not be retained, they recharged the currency attack by knowing that devastated currency regime would not yield better conditions as those offered by the central bank, Riksbank. Consequently, real interest rates went double-digit and the recession prolonged. Fixed exchange rate regime collapsed in November 1992. After a dramatic increase in the real interest rates and a deep economic recession, the majority of banks, except for Handelsbank, consequently went
bankrupt due to generous lending practices. Macroeconomic profile of that time was terrible. In 1993, the gross domestic product was 5 percent lower than in 1990. Unemployment increased by 10 percent as well as the budget deficit increased by the same rate.

According to international economic surveys, Sweden fell on the 20th place in the world on the scale of income per capita. The economic turn is traced back in 1992 when the devaluation of Swedish currency boosted Swedish exports. The recovery of Sweden’s international competitiveness was begun by central bank’s dramatic decrease in interest rates and by a smooth cyclical recovery at the end of 1993. A wide variety of liberal economic reforms was introduced under the leadership of Mr. Ingvar Carlsson and Mr. Carl Bildt. Those structural reforms immediately ripped off currency control and deregulated the financial sector. The privatization was on its way as well. The liberalization of retail and telecommunication sector and of airplane industry, were effectively enforced. An efficient inflation-targeting policy framework in search of nominal anchor (Bernanke, Posen, Laubach, Mishkin, 1999)
contributed very much to the effectiveness of monetary policy in stabilizing the price level. One reason why Sweden fled into economic recession had been associated with highly progressive tax system. Today tax revenues present 50 percent of the GDP. Between 1950 and 1980, the aggregate tax burden increased by 150 percent respectively (Karlsson, 2005).

Today, the marginal tax rate on individual income equals 57 percent. In early and middle 70s, the rate of individual taxation peaked at 90 percent. After coherent structural measures were undertaken in the early 90s, the individual income tax rate was reduce despite still being triggered to 51 percent. Corporate tax rate of 28 percent is moderate compared to other high-tax jurisdictions. Before 1991, employers faced a 52 percent corporate tax rate. The rate dropped to 28 percent in the future period. Payroll tax extends to 40 percent of the total amount of collected revenue from income tax. 32,28 percent of the payroll tax is paid by employers. Expensive public welfare programs of early retirement, unemployment support
and social transfer payments have been financed through the revenue collected from the payroll
tax. The wealth is also taxed. Assets up to the value of SEK 1 500 000 is excluded from the wealth tax is currently rated at 1,5 percent. The overall picture of tax burden is awful. From 1950 to 2000, the aggregate tax burden moved from 21 percent to 53,9 percent of the total output. The sources of tax revenue are mostly individual and corporate income (37 percent), payroll (29 percent), goods and services (26 percent) and some other sources as well (8 percent).

Sweden is historically known after high tax rates on personal income. Reality highlights a marred damage of high taxation. The most successful and high-income taxpayers must pay are taxed at 60 percent on each further earned krona. High, burdensome and progressive taxation is making a heavily complicated and non-simultaneous tax system. Such tax system is marred by devices of tax fraud and avoidance. It hampers further investment, saving and dynamically innovative entrepreneurship. In several studies, OECD has warned Sweden about the need to cut marginal tax rates in the form of a comprehensive tax reform (OECD, Economic Outlook, 2004). All the way up from 1970, the rate of marginal taxation of individual income had never been dropped below 50 percent. A typical employee living in Sweden is forced to contribute a relative fraction of his income to state, regional and local levels of government. This means that an employee in the highest tax bracket receives less than 30 SEK on each 100 SEK earned (Karlsson, 2005).

An extremely high level of corporate and wealth taxation could have a devastating economic impact. Venture capital and fresh investment funds could leave highly constrained business environment and move to investment locations with significantly smaller tax burden such as in Slovakia, Estonia or Ireland where the labor costs (per unit) and aggregate tax burden are significantly lower. High rates of corporate taxation threat long-term performance of the economy through the hampering of economic growth. And since there is no betterment without economic growth, expansionary fiscal policy is a major threat to competitive economy with outperformed economic growth rates. Sunesson (2005) found out that total wealth asset in the worth of 9 billion SEK is avoiding to pay the wealth tax rate of 1,5 percent. Bager-Sjögren and Klevmarken (1996) demonstrated the wealth mobility in the Swedish economy after the area of periodic tax cuts and accelerated deregulation of real estate sector. Their main finding was that the mobility of wealth strongly increased after the wealth taxation burden was reduced.
The ability of entrepreneurial sector to sustain relatively high rates of market growth is
constrained by high compliance costs, high marginal tax rates, high social security contributions and payroll tax. The amount of high tax burden indirectly affects growth potentials of entrepreneurial sector in their mission to trigger high market growth rates and future
strategic market expansion. Standard 25 percent VAT volumes 1 025 pages. A large panel of goods and services is taxed at lower VAT rates of 12 percent and 6 percent. Swedish high-tax jurisdiction has not yet eliminated double taxation. Thus, a successful enterprise with
excellent annual business results is obligated to pay a unique tax of 30 percent on the payment of dividends. After all, wealth tax occupies the enterprise with a tax rate of 1,5 percent exposed on 80 percent of net market value of stocks and shares. In general, a gradual shift to high tax rates supported the preferences of part-time employment and thus did not encourage further education and human capital investment to grow (Engström, Holmlund, 2006).

One of the lingering worries of tax rates had been significantly decreased and hardly noticeable economic growth. High taxes inevitably decreased the amount of tax revenues as the tax base slightly stagnated. This is admirable evidence that shows how effectively the Laffer Curve Rule works in practice. Another, more oftenly exposed worry, that Sweden faces today is an incredible rate of unemployment which grew right after the labor market started to become inflexible and thus supervised by restrictive government regulation. Official statistical rate of unemployment is equal to 8 percent but this is very far from the actual rate of joblessness. Sweden has had a long tradition of government-funded labor participation programs which are very broadly attended by unemployed. The participants are not statistically examined as unemployed despite not having a job. A compound of labor program participants, unemployed youth and officially unemployed yields an astounding 15-20 percent rate of real unemployment (Sianesi, 2001; Ibison, 2006; Silberstein, 2005). Unflattering characteristics extend to a wide range of structural indicators. Gross capital formation is one of the foremost indicators of legal and economic friendliness to businesses. Since 1990, the rate of gross capital formation has always been below 20 percent of the GDP. In increasingly competitive business environments, in Ireland for instance, the rate of gross capital formation exceeded 25 percent of the GDP in 2005 already (Larson, 2005) and there are advantageous tendencies of the increase in the upcoming period of dynamic global investment growth. Socialistically designed economic policies yielded a dangerous stimulation formula for capital flight – high tax rates on corporate and individual income, tight regulation, rigid and inflexible labor markets, difficult hiring and firing procedures, restrictive government intervention and vastly expansive fiscal policy. Such features forced many Swedish companies to retreat from Sweden and fly to more liberal places for doing business. The entire pharmaceutical industry escaped abroad. Pharmacia was acquired by Michigan-based UpJohn. Astra, once the jewel of big Swedish companies, was acquired by Zeneca. Research facilities were moved abroad while a fraction of high-tech companies maintains its operations in Sweden. In the mid-90s, VolvoCars was excluded from Volvo Corporation after having been acquired by Ford. SAAB, which was taken over by General Motors, built its own production plants in Belgium and Netherlands. IKEA escaped to much less tax burdened Switzerland. Even TetraPak left Sweden and built technological facilities in England. As a result of highly encumbered business environment, capital flight was more than obvious. Between 1993 and 2000, the emigration of young graduates increased by 48 percent. A sampled panel analysis of statistical data shows that “brain-drain” emigration accelerated seven times faster than the birth rate. Due to strong absence of very much needed human capital, Swedish economic growth was rachitic. According to ECB, the inefficiency of public sector is a serious structural problem. Fraser Institute’s Economic Freedom in the World shows that Sweden has the biggest public sector in the world as well as the least efficient one in Northern and Western Europe. Recent reactions have shown that there is no willingness to accelerate the privatization of public sector services such as health-care and social security. A long tradition of public sector’s privileges and tax revenue’s protection at the expense of Sweden’s global competitiveness and economic growth rate, has resulted in a government’s restrictive attitude toward private sector. Not even a single job in the private sector has been created since 1950 (Norberg, 2006).

According to international charts of economic liberty and competitiveness, Sweden is falling off the cliff. In 2006, Sweden was ranked 19th on the rank of economic freedom. In 2007, Sweden dropped to 21st place, being 72,6 percent free economy. According to Fraser’s Economic Freedom in the World, Sweden is ranked 24th on the scale of economic liberty. Thanks to efficiently managed monetary policy of low inflation, solid protection of property rights, sound contract enforcement, strong protection of investors, moderate commercial regulation standards and to a low level of black market activity (WB Doing Business 2006), Sweden still maintains the status of mostly free economy though there is still a long road for Sweden to become a free economy. Recent trends in economic performance have been interesting. Recent, comparably high rate of economic growth, has not been surprising. Swedish central bank, Riksbank, has been forced to raise the interest rate above the level of 2 percent which helped to stimulate the economic growth mostly at the expense of estate bubbles and household debt. Relative deregulation of the economy released the economic potentials and, thus, fostered the economic growth close to 5 percent. Low-price retailers recently entered the Swedish market. Increased competition led to a huge price reduction so that established retailers could continually rely on their customer basis. Lower prices and increased supply side lifted the consumption and thus empowered the economic growth. Money supply increased by 11,5 percent respectively so that the acceleration of inflation for a little bit, brought a certain amount of optimism among companies and market stakeholders, after the inflation rate had been one of the lowest in the Europe for years.

The definition of the Swedish model as the most successful one the world has ever known could hardly be justified on the ground of fatal welfare experiments. Early periods of peace, stability and neutrality brought a bulk of opportunities to Sweden. Years of non-conflicts foster the implementation of free market reforms based upon one the world’s lowest public consumption rates. Free market reforms empowered Swedish bright economic performance between 1860 and 1950 when Sweden had the 4th highest income per capita in the world, after the United States, Switzerland and Denmark. After 1950, Sweden went socialist and its future path
towards the “paradise of social democracy” had been a shrink rather than success. The economic recession had been stopped by the implementation of very much needed reforms by Mr. Carl Bildt and Mr. Ingvar Carlsson. Their structural reforms included the privatization, deregulation, liberalization and tax cuts. It is almost hilarious to defend the Swedish model on the basis of
high welfare, big government and high taxes. Early Swedish economic boom was consequently led by liberal economic reforms and by substantial entrepreneurial development which was exercised through the miracle of free market. Government non-intervention approach to business and social life was combined with intense development of human capital
infrastructure, and early research and patent development. If Sweden were the U.S. state it would emerge as fifth the poorest state (Bergstörm, Gidehåg, 2004) beyond the income per capita levels of Alabama and Oklahoma. Early economic and structural reforms were the key to the invigoration sustainable long-term economic growth. A high degree of economic freedom pursued a dynamic entrepreneurial road onward. Future periods of exploding socialism based upon expansive welfare spending robbed Swedes. The entrepreneurial sector was turned into the source of revenue for continually prolonged welfare spending and for one of the world’s public consumption rate in the advanced economies of the 20th century. Labor market came under restrictive government regulation while giving the privileged position to monopoly trade unions hampered further productivity growth. Economic policies of socialism resulted in a huge economic crisis as deep economic recession was on its way to reach the top of the edge. Welfare state has always been an excuse for undermined economic performance. Citing Murray Rothbard, I finish this post by sending a message to many who still believe in the myth of the welfare state – Welfare state is a warfare state.

Literature, Sources and Further Reading:

Daniel J. Mitchell, GÖran Normann; Pension Reform in Sweden: Lessons for American Policymakers, Backgrounder, The Heritage Foundation, 2006
http://www.heritage.org/Research/Taxes/upload/wm_1219.pdf

Anders Björklund, Tor Eriksson, Markus Jäntti, Oddbjörn Raaum, Eva Österbacka; Brother Correlations in Earnings in Denmark, Finland, Norway and Sweden Compared to theUnited States, IZA Discussion Paper Series, Forsuchungsinstitut zur Zukunft der Arbeit, 2000
http://ideas.repec.org/a/spr/jopoec/v15y2002i4p757-772.html

James Gwartney, Robert Lawson, William Easterly; Economic Freedom of the World,
2006 Annual Report, Fraser Institute, 2006
http://www.freetheworld.com/2006/EFW2006complete.pdf

Mårten Palme, Ingemar Svensson: Financial Implications of Income Security Reforms in Sweden, National Bureau of Economic Research, 2005
http://www.nber.org/books/intlSS-p3/sweden6-29-05.pdf

Thomas Andrén, Björn Gustafsson; Income Effects from Labor Market Training Programs
in Sweden During the 80’s And 90’s, Institute for Labor Policy Innovations, 2002 http://ideas.repec.org/p/hhs/ifauwp/2002_015.html

Lars Bager-Sjögren, Nils Anders Klevmarken; Inequality and Mobility of Wealth in Sweden 1983/84 - 1992/93, Uppsala University Department of Economics Working Paper Series, 1995 http://ideas.repec.org/p/fth/uppaal/21.html

Richard C. B. Johnsson; Economic Freedom in Sweden 1950-2002, The Ratio Institutet, 2004
http://ideas.repec.org/p/hhs/ratioi/0055.html

André Sapir, Philippe Aghion, Giuseppe Bertola, Martin Hellwig, Jean Pisani-Ferry, Dariusz Rosati, José Viñals, Helen Wallace; An Agenda for a Growing Europe -
Making the EU Economic System Deliver,
Report of an Independent High-Level Study Group
established on the initiative of the President of the European Commission, European Commission, 2003
http://www.euractiv.com/ndbtext/innovation/sapirreport.pdf

Sven R. Larson; The Swedish Tax System - Key Features and Lessons for Policy makers, Prosperitas, Vol. VI, Issue 2, Center for Freedom and Prosperity, 2006
http://www.freedomandprosperity.org/Papers/sweden/sweden.shtml

Sweden's Economic Performance; Recent Development, Current Priorities,
McKinsey&Company Executive Summary, McKinsey Global Institute, 2006
http://www.mckinsey.com/mgi/publications/sweden/

Per T. Ohlsson; Sweden - Still the Middle Way, A Talk Presented
at Columbia University in New York City, September 28, 2006

Per EngstrÖm, Bertil Holmlund; Tax Evasion and Self-Employment in a High-Tax Country: Evidence from Sweden, CES-IFO Working Paper No.1736, 2006
http://ideas.repec.org/p/hhs/uunewp/2006_012.html

Daniel J. Mitchell; Fiscal Policy Lessons from Europe, Heritage Backgrounder, The Heritage Foundation, 2006
http://www.heritage.org/research/budget/upload/bg_1979.pdf

Johnny Munkhammar; Don't copy the Nordic Model, A Speech held at Stefanik Institute in Bratislava, Slovakia, 2006
http://www.heritage.org/research/budget/upload/bg_1979.pdf

Fredrik Bergström, Robert Gidehag; EU versus USA, Timbro Institute, 2004
http://www.timbro.com/euvsusa/pdf/EU_vs_USA_English.pdf

Johan Norberg; In Defence of Global Capitalism, CATO Institute, 2003
http://www.johannorberg.net/?page=indefense

Johan Norberg; Swedish Models, National Interest, 2006
http://www.nationalinterest.org/Article.aspx?id=11488

Barbara Sianesi; An evaluation of the active labour market programmes in Sweden,
Institute of Labor Market Policy Evaluation, 2001
http://ideas.repec.org/p/hhs/ifauwp/2001_005.html

Johnny Munkhammar; Hot Swedish Models, TCS Daily, March 1, 2006
http://www.tcsdaily.com/article.aspx?id=030106D

Polly Toynbee; The most successful society the world has ever known, The Guardian, 10/25/2005
http://www.guardian.co.uk/Columnists/Column/0,,1599939,00.html

Johnny Munkhammar; Beyond the European Social Model, Open Europe, 2006
http://www.openeurope.org.uk/media-centre/pressrelease.aspx?pressreleaseid=14

Johnny Munkhammar; The Urgent Need for Labor Freedom in Europe—and the World,
2007 Index of Economic Freedom, The Heritage Foundation

Stefan M. I. Karlsson; The Sweden Myth, Mises Blog, 8/7/2006
http://www.mises.org/story/2259

2007 Index of Economic Freedom, The Heritage Foundation
http://www.heritage.org/research/features/index