Most countries in Western Europe have been experiencing serious economic problems for a number of years, even if the business cycle is good at the moment. Main problems include low economic growth, high unemployment and many people dependent on government. In such times, politicians have tried to look for inspiration from other countries to solve the problems. The radical market-oriented reforms in Eastern and Central Europe have undoubtedly produced great results, but since many don’t dare do such radical reform, they have instead looked to the Nordic countries for inspiration. That is very risky.
The problems in Western Europe are by no means a coincidence, bad luck or a consequence of globalisation. They are a direct result of that kind of economic and political model, where the core is a very big government; a state that is a very big part of society. High taxes not only limit the freedom for people, they also put a brake on growth by punishing all productive activities. And in paying most of the taxes to people who don’t work mean that non-working is rewarded by the state. Combined with heavy regulations in the labour market, few new jobs are created. Last but not least, public monopolies for school, health care and elderly care have problems because they are monopolies. The so-called social model is the problem, not the solution.
But the Nordic countries have a better reputation. They seem to be able to combine a high economic growth rate with a big welfare state, i e with high taxes and vast systems for welfare services and social security. A closer look at the facts shows that to be wrong on several accounts. First of all, there is no “Nordic Model”. There are great differences between the Nordic countries, placing them on opposite ends in Europe concerning many relevant fields, such as labour market, taxes and pensions. Second, the Nordic countries are successful in some ways, but in very different ways. Third, to the extent that they are successful, it is because of market-oriented reform away from the traditional welfare state and where problems remain, it is because of lack of reform. A look at the different Nordic countries reveal a lot.
Between 1890-1950, it had one of the highest growth rates in the world, with an average tax burden (taxes collected as a percentage of gross domestic product) of 10-20 per cent. This period explains much of today's wealth. Of Sweden's 50 largest companies, only one was started after 1970. That's no big surprise as by 1980, the average tax burden had reached 50 per cent (where it remains today) while the labor market became highly regulated and the size of the welfare state reached epic proportions.
Sweden would pay dearly for these follies. According to the OECD, the country's per capita GDP ranking slid from fourth place in 1970 to 13th place today. Officially, unemployment hovers around 7-8 per cent but once all those on sick-leave, early retirement or otherwise subsisting on state aid are included, the figure balloons to around 17 per cent. Between 1995-2003, 11 of the EU-15 countries saw greater employment growth than Sweden. Youth unemployment is about 23 per cent, fifth highest in the EU.
In the early 1990s, though, market reforms were enacted that improved Sweden's economic performance. The telecom market was deregulated, marginal tax rates were cut, companies were allowed to provide private health care coverage and the pension system was reformed. As a result, between 1995 and 2004, average GDP growth per capita was 2.6 per cent. This compares to only 0.8% between 1985 and 1994.
Here's a similar, though less extreme, case. In 1970, in terms of GDP per head, Denmark was the world's third richest country, surpassed only by the U.S. and Switzerland. In 2003 – after more than 30 years of expanding welfare state – Denmark dropped to seventh. Recent changes, such as easing firing rules, have ensured that this drop in prosperity was not more dramatic. For instance unemployment benefits are now limited to four years and the unemployed are forced to take training programs to qualify for support. Long-term unemployed, as well as young people, also risk losing benefits for refusing a job offer. Thus, Denmark is doing well in the labour market, with one of the lowest rates of youth unemployment in Europe – due to flexibility. Some claim that the mix of flexibility and security, “flexicurity”, is the success model, but the pattern is clear concerning which parts are the successful ones. Countries with only flexibility still succeed while countries with only security don’t.
The country suffered a severe economic depression in the beginning of the 1990s, resulting in the bankruptcy of countless inefficient companies. That's when the government started cutting costs, accelerated privatization and eliminated the double-taxation of dividends. As a result, private wealth, corporate profits and tax revenues skyrocketed. This, in turn, made it possible to lower the personal income tax rates by six percentage points in all income groups, on average to 35 per cent from 41 per cent. These dramatic changes galvanized the Finnish economy.
It's is a special case as its incredibly generous welfare state can only be financed by enormous oil and gas revenues. And yet, even there, market-oriented ideas enjoyed a certain renaissance when the hegemony of the Labor party was broken in 1981 and a coalition of nonsocialist parties liberalized the financial markets, abolished the state's broadcasting monopoly and introduced private hospitals. When a more "moderate" Labor party came back to power in the early 1990s it chose not to reverse these policies. The center-right coalition, returned to power in 2001, went further, introducing competition between private and public schools. As one out of three Norwegian workers works in the public sector and revenues from oil and gas will decrease over the years, the demands of an aging population can only be met with further reforms to strengthen the private sector. But that's in doubt. The current Socialist coalition won the 2005 election promising “less markets and more government”.
Today, this Arctic island is one of the wealthiest countries in the world. But until the late 1980s, Icelandic society was deeply socialistic with many state-owned enterprises, high taxes and excessive government interference in business. Starting in the early 1990s, Iceland has steadily liberalized. Corporate taxes were cut to 18 per cent from 45 per cent in 1991 and income taxes to 23.75 per cent from 32.8 per cent. During the same period, most state-owned companies were privatized and streamlined regulations. Iceland's GDP grew on average 4.3% annually between 1995-2005. The sole exception was 2002 when the economy contracted 1.3 per cent mainly due to a decrease in investments as a result of the Icelandic Central Bank's actions to curb inflation in that year. Purchasing power, though, has grown every year since 1995 and unemployment is 1.6 per cent.
Thus, the conclusion that can be drawn is that the Nordic countries built their first success when they were very market-oriented with low taxes and small government. And when they tried socialism, success faded and problems mounted. Now, they have made market-oriented reforms in completely different fields of society and created success: Finland in telecom, Denmark in the labour market, Iceland in banking, Sweden in private pensions, etc. This is an empirical study in the success of the market and reforms liberating free exchange. It confirms numerous scientific studies about how low taxes bring high economic growth and how a free labour market creates more jobs. Sure other countries can learn from this. Avoid the socialist big welfare state and continue to do market-oriented reforms.
Author serves as Program Director at Timbro, a Free-Market Institute in Sweden.
Article was published in Slovak language in Conservative Letters 09/2006, a newsletter of the Conservative Institute.