The New Scandinavian Model

November 4, 2010 10:15 AM

In the 1970s, the Scandinavian or Swedish economic model was popular among leftwingers around the world. Today, in the aftermath of the global financial crisis, the Scandinavian model has achieved a new popularity but not with the left. Instead it is admired by the socially responsible, yet free-marketeering right.

The old social welfare state model was utterly statist, allowing social transfers to rise unimpeded as they were financed with ever higher taxes. The new Scandinavian model is a modern social welfare society. The role of the state is still large and welfare is pretty comprehensive, but public expenditure has shrunk impressively. Social transfers have been trimmed to reasonable proportions, and most publicly financed services are carried out by private, nonprofit, cooperative, and public contractors based on the free choice of Swedish citizens. For example, Sweden has a comprehensive school voucher system allowing parents to choose school for their children without private cost, if the kids only pass the entrance grades. This interesting evolution hopefully offers lessons to others.

The Scandinavian welfare state of the 1970s was utopian because it was impossible to finance. Its very populist idea was that the state should do ever more for the people without consideration of costs. But one of the outcomes was low growth from 1970 to 1993, accompanied by rising budget deficits. In the 1970s, Swedish social democratic economists harbored the naïve hope to "bridge" the business cycle, imagining that they had overcome the business cycle. The late social democratic Swedish Prime Minister Olof Palme symbolized such leftwing populism. In his world, everything that was economically rational was "politically impossible." Still, the Scandinavian economies were always free-trade oriented, dominated by efficient, competitive private companies that were forced to finance the social democratic excesses through exorbitant taxes.

Utopia ended with big financial crashes and government changes. Resource-poor Denmark was the pioneer. In 1982, conservative Prime Minister Poul Schluter pegged the exchange rate of the Danish kroner to the deutschmark and used this disciplining anchor to slim down public redistribution and liberalize the economy. This peg remains.

Norway, Sweden and Finland continued devaluing, but they were all hit by severe banking crises in the early 1990s, bringing most of the big banks in the region into bankruptcy. During three years of crisis the Swedish GDP plummeted by 6 percent and the Finnish by 14 percent. Ultimately, the crisis was caused by a refusal to face up to resource constraints, but also by a gradual and poorly sequenced financial deregulation. Both Sweden and Finland were forced to devalue once again, but then both moved to inflation targeting, and in 1999 Finland adopted the euro.

The crisis brought down the long-lasting social democratic governments and ushered in principled free marketers, with Swedish Prime Minister Carl Bildt (1991–94) as a leading ideologue. The combination of severe financial crisis and new free-market governments cleared the way for systemic change. Because of its abundance of oil, wealthy Norway could persist with the old statist model while Sweden and Finland caught up with the pioneer Denmark. These crises laid the groundwork for recent economic successes.

Although social democrats intermittently returned to government in Sweden and Finland, they had accepted the new market-oriented paradigm. During the next 15 years, Sweden went through an extraordinary financial cleansing, cutting public expenditures from 71 percent of GDP in 1993 to 52 percent in 2008—that is, by almost one-fifth of GDP. Public revenues fell also with lower taxes, but only from 60 percent of GDP to 54 percent of GDP. As a result, Sweden's budget deficit of 11 percent of GDP was transformed into a budget surplus of 2.5 percent of GDP. Meanwhile, its public debt declined from 78 percent of GDP to 47 percent of GDP. Finland's public finances went through a similar tightening.

Growth has not suffered but accelerated during this financial cure because of stimulation of supply rather than demand. The Scandinavian countries have abandoned the old social democratic dogmas—but they have not gone all the way to free-market ideology. The question today is empirical: What works best? And the conclusion is energetic: Let us do it! Admittedly, deregulation, competition, and privatization are the most common solutions, but the choice is more pragmatic than ideological. Finland's state-dominated school system is the best in the world, according to regular surveys by the Organization for Economic Cooperation and Development. The Swedish Teachers' Trade Union tries to catch up with the Finns by demanding higher qualification of teachers and more testing of pupils in schools. When you call to a state agency or ministry in Sweden, you can usually reach the official you seek, while multi-questioning automatic answering machines are banned. The Swedes believe that the state should be competent, transparent, humane, and efficient.

As the crisis hit the world in the fall of 2008, the Scandinavian countries had budget surpluses and public debts of around 45 percent of GDP. These very open economies were badly hit by the crisis, which was worst for Finland, which had a GDP fall of 8 percent in 2009 and is already experiencing a double dip. Thanks to their remaining social transfers, the Scandinavian countries cushioned unemployment and provided large instant stimulus through these automatic stabilizers. Unemployment is almost as high as in the rest of the European Union, and is a major concern, but no unemployed need sleep in the street. The nonsocialist governments were adamantly opposed to any socialization of failing enterprises. Hardly any discretionary subsidies to dubious companies in structural crises were admitted. Sweden let Ford sell Volvo to Chinese Geely and GM Saab to Dutch Spyker.

As a result, the Scandinavian countries stand out as having pursued a responsible financial policy before, during, and after the global financial crisis. Sweden maintains a budget deficit of only 2 percent of GDP this year, aiming for a nearly balanced budget next year, and 2 percent of GDP budget surplus during the coming business cycle. Their economies are bouncing back, as always led by the export industry. Sweden is expecting a growth of nearly 5 percent this year after a similar decline last year. After their experiences with "Keynesian" demand management in the 1970s and 1990s, Scandinavians no longer believe in it. Their lesson is that sound fiscal balances are preferable and safer, while growth is brought about through supply measures: deregulation, privatization, and investment in human capital. Proportionately, they have the largest investment in research and development in the world, but much remains to be done to improve higher education and research.

Arguably, the Scandinavian countries are better managed and wealthier than ever. So is the new Scandinavian model something to boast about? I asked Swedish Foreign Minister Carl Bildt. He responded emphatically: No! "Last time Sweden was perceived as a model led to a complacency we could not afford. We have to continue reforming our society in an ever more competitive world. If we accept it as a model, we shall only lean back, doing too little to improve it."

On September 19, the Swedish center-right government led by Fredrik Reinfeldt faced elections. It was reelected in spite of the financial crisis. This was all the greater a sensation since Sweden has been ruled by social democrats for 62 of the last 78 years. But this victory was well deserved. This government had cut taxes four times and abolished wealth taxes—the preceding social democratic government had actually eliminated inheritance and gift taxes, but even so achieving a budget surplus and reducing the public debt. Seldom has a government carried out so many small deregulatory reforms on a broad front.

With the social democrats obtaining only 30 percent of the vote even in their "homeland" Sweden, their statist model seems history. Populism is no longer popular in Scandinavia. Can the social democrats make a comeback with a more liberal face or do they belong to the dustbin of history? The competitive pressures from China and other emerging economies closer to Scandinavia are relentless.

Scandinavians still believe in the good state, but that state is much smaller and more exposed to competition than used to be the case.

Anders Åslund is author of the book The Last Shall Be the First: The East European Financial Crisis.

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Anders Åslund Former Research Staff

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