What Can the U.S. Learn from Big Government in Sweden and Denmark?

What Can the U.S. Learn from Big Government in Sweden and Denmark?

photo: Artiom P

Leaders of the Democratic Party in the United States have moved to the left of the political spectrum (Wall Street Journal). Bernie Sanders, who describes himself as a democratic socialist, has mounted a successful campaign against Hillary Clinton. He has identified Denmark and Sweden as examples of countries with larger government sectors that he would like the United States to emulate (Krugman). Specifically he has proposed free tuition for college students, expanded social security benefits for retirees, and expanding the role of government in health care by making the government the single payer for health insurance. He has also been critical of Wall Street, and he has advocated breaking up big banks. In response, Clinton has also moved to the left, and she has tried to persuade voters that she is as progressive as Sanders.

Sweden and Denmark: Prosperity in Spite of Large Government Budgets

What can the United States learn from the experience of Denmark and Sweden? Those countries do have larger government sectors in terms of government expenditure and tax revenue relative to GDP than the United States. However, their larger government sectors have not forced them to suffer large losses in income. GDP per capita in 2014 was $55,860 in the U.S., $46,710 in Sweden, and $46,160 in Denmark. Their incomes are lower than US income, but they remain ranked fourth and fifth among the 28 countries in the EU and near the top 10% of all countries in the world. They are relatively prosperous economies with large government sectors. They are primarily market economies with minimal interference from governments in product and labor markets. They are not economic disasters, such as China under Chairman Mao, the former Soviet Union, or North Korea today.

Economic Freedom: Size Versus Intrusiveness of Government   

Could the United States benefit from a more socialistic economy, as the economies of Sweden and Denmark are often described (Krugman)? The description of the Swedish and Danish economies as socialist is seriously misleading about the way the governments relate to the private sector. They are more socialistic than the US in the sense of having larger government budgets and larger taxation relative to GDP. However, in their regulation of the private sector, the governments of Sweden and Denmark are less socialistic or intrusive than the US government. This distinction between a large government budget and a government that allows substantial economic freedom in the private economy can be seen in the well-known Index of Economic Freedom Index (Heritage). All three countries rank high in total Economic Freedom out of 178 countries. In the 2016 Index, the US ranked 11th, Denmark 12th, and Sweden ranked 26th. The Index decomposes Economic Freedom into four categories, and in the three categories that reflect government regulation, both Sweden and Denmark have greater freedom than the United States. This characteristic indicates that they are better described as market economies, rather than socialist economies (Andersen et al).

One component of the Index is Limited Government, and Sweden and Denmark rank low because of large government spending and taxation. A second component is Rule of Law, which includes the right to acquire private property secured by clear laws enforced by the state officials who are free from corruption. A third component is regulatory efficiency that includes the ability to start, operate, and close a business. The final component is Open Markets that includes the right to trade and invest freely with transparent and impartial regulations. Sweden and Denmark rank higher than the US on rule of law, regulatory efficiency, and open markets. They have demonstrated that they can have large government budgets without unduly interfering with private economic activity. Their regulatory behavior contrasts with the criticism of Wall Street by Senator Sanders and his advocacy of breaking up large banks.

A recent study of the Nordic economies by Danish economist, Torben Andersen and Danish colleagues, also emphasizes the mainly private market orientation of Sweden, Denmark, and other Nordic countries. They point out that describing the economies as “semi-socialist countries or pursuing politics against the market” is not an accurate description of their successful private sectors. They cite an OECD measure of product market regulation and intervention that agrees with the Index of Economic Freedom Index that Sweden and Denmark have less regulation than the OECD average.

Prosperity Preceded the Rise of the Welfare State

How have Sweden and Denmark accomplished high incomes and greater regulatory efficiency of the public sector in spite of a larger government budget? First, the high incomes of Sweden and Denmark were achieved prior to the expansion of the welfare state in the 1970s and 1980s (Munkhammar, Brons-Petersen). In the early nineteenth century, Sweden was a low income economy stifled by many restrictions on trade. Economic reform began around 1870, following the guidance of Johan August Gripenstedt, who led the Swedish transition to a capitalistic economy. Sweden then began its Hundred Years of Growth, 1870-1970, which transformed it from a backward economy into one of the most prosperous countries in Europe (Schon). Sweden’s prosperity emerged prior to the growth of the welfare state. During this period of rapid growth, taxes remained low, and by 1950, Sweden’s tax burden was below the European average, and it was also below the tax burden for the United States. By 1970 Sweden had the fourth highest GDP per capita in the world. The expansion of the government sector and the welfare state began in 1970, and by 1990 its GDP rank fell to 20th. Income growth slowed during the period 1970-1990, and real wages grew by only 1%. Economic growth recovered after the reforms that followed the crisis of 1992-93 (Jonung).

Size, Homogeneity and Trust

Sweden and Denmark are small, open economies with populations that are among the most homogeneous in Europe. The US population is more than 30 times the population of Sweden. The US has 320 million people, Sweden has 10 million, and Denmark has 6 million people today. The U.S. state of North Carolina is one of 10 states that is as large or larger than Sweden. Sweden and Denmark are both ethnically, racially, and religiously more homogeneous than the US. The Swedish economist, Lars Jonung, attributes the success of the welfare state to a “consensus society” that is easier to achieve in a homogeneous society. A high level of trust is important for economic transactions, and trust was achieved in these small countries before they became welfare states (Munkhammar). Trust has an important influence on economic development, and the level of trust is lower in ethnically diverse cities and neighborhoods. Also, Alesina and Giuliano have shown that ” people tend to trust members of their own nationality more than they trust foreigners”. It has been easier to develop trust in small and homogeneous Sweden and Denmark than in the much larger and heterogeneous United States.However,recent immigration has made Sweden less homogeneous, and immigrants have expressed frustration about how seniority features of labor laws make it difficult for newcomers to get good jobs (Norberg). Trust that comes from smallness and homogeneity has made it easier to provide good governance in Sweden and Denmark, in spite of their large government sectors.

Fiscal Reform in Sweden                

Small and homogeneous populations have made it easier to develop efficient government, but the 1970-1990 period of government expansion led to a banking crisis in 1992-93 that resulted in a 6% reduction in real GDP (Aslund). It resulted in a devaluation of the krone and a switch to a floating exchange rate with an inflation target for monetary policy. It also resulted in a major fiscal reform that required the national government to have a balanced budget over the business cycle, effective in 2000 (Jonung, Dolan). The government budget need not balance every year, but budget deficits in some years must be offset by budget surpluses in other years. As a result of this fiscal reform, Sweden’s debt has fallen from 70% of GDP to 42% in 2014 (Jonung). The average debt ratio for the European Union in 2014 was 90%. Sweden entered the Great Recession with a small debt, which allowed it to use automatic fiscal stabilizers to temporarily increase its debt without reaching dangerous levels.

Sweden’s fiscal reform was a response to the economic crisis and an acknowledgement that Sweden’s budgetary process was one of the weakest in the European Union, ranking between Greece and Italy (Jonung). In addition to the balanced budget (the current rule actually calls for a 1% budget surplus), Sweden instituted a non-partisan fiscal council to advise the government on fiscal policy. To be effective, the council must be viewed as non-partisan, which is easier to accomplish in Sweden, where there is a consensus on broad issues, rather than in the US, where there is political polarization (Jonung). Critics have questioned the independence of the Council, since it is organized as an agency under the Ministry of Finance, which determines its budget. In response to the current refugee crisis, Social Democratic Finance Minister Magdalena Andersson, has recommended a zero budget balance rather than a 1% surplus, but the current coalition government has not yet challenged the basic idea of a balanced budget over the business cycle (Washington Post). This fiscal reform implies that Sweden can have a large government budget, but it must finance the budget either by raising taxes or reducing other expenditures. “Swedish fiscal policy has moved from one extreme of fiscal laxness to the other of fiscal prudence in the past 40 years” (Jonung).

Other Reforms in Sweden

When the Swedish welfare state was at its peak, the government financed and provided basic services, such as healthcare, education, day care for children, and services for the aged. State agencies were monopolists in providing these services, and they tended to follow the rule of “one size fits all”. Since the crisis of 1992-93, Sweden has retreated from the state monopoly provision of many services. Education vouchers can be used at private schools, and patients can receive medical services from private suppliers (Economist). Daycare and services to the aged remain publicly financed, but recipients are free to choose private providers of these services. Reform of service provision adds to consumer choice and increases competition among suppliers. The government has reduced public pensions and introduced private retirement schemes to deal with looming demographic problems.(Munkhammar). Child allowances, unemployment benefits, and housing subsidies were also reduced (Samuelson). This retreat from an extreme and inflexible form of a welfare state, is representative of the willingness to learn and reform that is characteristic of the Swedish and Danish systems (Andersen et al, Jonung)

Reform in Denmark

Denmark has also reformed government programs by recognizing the adverse effects of economic incentives on certain programs. College tuition was free and students were eligible for 6 years to receive stipends that paid more than welfare recipients received. Recently officials acknowledged that the incentives were encouraging Danish students to take longer to complete college than in other EU countries. Recent reforms reduced the size of stipends and the number of years students are eligible for stipends (Daley, Gortz).

Denmark has a social safety net, but it also has a “strong emphasis on obligation to work” (Andersen et al). Access to the social safety net is means-tested, including “active requirements for job search, participation in educational programmes, job training, etc. “. (Andersen et al). Denmark has a free labor market with no legal minimum wage (Brons-Petersen). There are no restrictions on hiring and firing. In 2011 Denmark reduced the duration of unemployment benefits from 4 years to 2 years. They raised the retirement age to 67 effective in 2027 and indexed the retirement age to life expectancy thereafter. Recently Denmark was criticized by many foreigners for requiring refugees to surrender some of their assets when they arrived in Denmark. The response by Danish officials was that Danish citizens were also subject to a means test to qualify for social services.

Conclusion

What can Americans learn from the experience of Sweden and Denmark with “big government”? First, less intrusive government regulation and a lower level of corruption that Sweden and Denmark have achieved would be welcomed by many Americans. However, large differences in population size (320 million vs. 8-10 million) and the degree of homogeneity suggest that certain institutions and practices will not transfer well from one country to another (Andersen et al, Jonung). Smallness and homogeneity contribute to trust, transparency, and the rule of law, and those factors mitigate the level of corruption.

Recent reforms indicate that Sweden and Denmark have learned from earlier policy mistakes, and they have demonstrated “willingness and ability to constantly reform” (Andersen et al, Jonung). When it became apparent that subsidies to college students and workers influenced how long they remained in college and how long they remained unemployed, benefits were reduced. Allowing recipients of school and health subsidies to choose private as well as government suppliers increases competition, and it makes the subsidies more attractive to consumers. With respect to Bernie Sanders’ proposals to expand government influence in health care and increase subsidies to college students, Sweden and Denmark have recognized that earlier subsidies had adverse effects on economic incentives, and they have reduced the size of the subsidies.

Fiscal reform appears to have the greatest potential for transfer to the US. The current public debt of the US has reached unprecedented levels relative to GDP (Grennes and Strazds), and the implicit debt related to Social Security, Medicare, and Medicaid continues to be ignored by both political parties. Sweden’s adoption of a balanced budget over the business cycle (not annually) was a bold reform that has immediate relevance to US fiscal and debt problems. However, it is not the kind of reform that Bernie Sanders or most Americans associate with social democracy and the welfare states of Sweden and Denmark.

References

Andersen, Torben, U. Michael Bergman, and Svend E. Hougaard Jensen, eds. 2015. Macroeconomic Perspectives on the Nordic Economies. Oxford Scholarship Online.

Aslund, Anders. 2012. “Booming Sweden’s Free Market Solution”. Bloomberg View, June 6

Alesina, Alberto and Paola Giuliano. 2015. “Culture and Institutions”. Journal of Economic Literature. December.

Brons-Petersen, Otto. 2015.” The Danish Model: Don’t Try This at Home”. Cato Economic Development Bulletin no 24.

Daley, Suzanne2013. “Danes Rethink a Welfare State Ample to a Fault”. New York Times. April 20.

Dolan, Ed. 2011. “How Smart Fiscal Rules Keep Sweden’s Budget in Balance’. EconoMonitor, July 31.

Economist. 2014. ‘Education Reform: a Good Choice?” October 6.

Gortz, Mette. 2013. Reforms Are Tactical in Denmark. New York Times May 5.

Grennes, Thomas, and Andris Strazds. 2015. “United States Government Debt is in Uncharted Territory” EconoMonitor. September 25.

Heritage. 2016. Index of Economic Freedom, Heritage Website.

Jonung, Lars. 2015. “Reforming the Fiscal Framework: the Case of Sweden 1973-2013”. In Andersen et al. Macroeconomic Perspectives on the Nordic Economies.

Krugman, Paul. 2015. “Something Not Rotten in Denmark”. New York Times, October 19.

Munkhammar, Johnny. 2011.” The Swedish Model: It’s the Free Market Reforms Stupid” Wall Street Journal, January 26.

Norberg, Johan. 2013. “Why Sweden Riots”. Spectator, June 6.

Samuelson, Robert J. 2012. “The Swedish Model”. Washington Post, April 25.

Schon, Lennart. 2008. “Sweden: Economic Growth and Structural Change1800-2000”. EH.net Encyclopedia, February 10.

Wall Street Journal. 2015. “Socialism’s Lost Sting Aids Sanders”. February 8.

Washington Post. 2015. “Sweden Opens Doors to Unfinanced Budgets Amid Refugee Crisis”. November 13.