Johnny Munkhammer was Member of Parliament in Sweden and Author of The Guide to Reform (Timbro/Institute of Economic Affairs).
Every country should choose its own path, and it is up to each nation to decide which way they should go. But I believe that the economic history of the world sends a clear message about which economic models and policies create prosperity and which ones create stagnation, unemployment and social problems. My book The Guide to Reform contains many of these lessons. The Nordic countries, which I naturally know the best, are a very useful showcase, and here I will focus on them, with a specially detailed look at Sweden.
Let us compare Sweden about 150 years ago with Gambia in the early 2000s, regarding important welfare indicators. The GDP per capita was almost the same in Sweden 150 years ago as in today’s Gambia – which is a poor country. Life expectancy and infant mortality rates were even worse in Sweden than in today’s Gambia. Something happened that made Sweden change for the better.
Several changes in institutions and policies were launched in Sweden, starting in the 1850s, which would be essential for the coming century. Finance Minister Gripenstedt forcefully reformed the country, abolishing numerous regulations. Free enterprise as a principle replaced government regulation of all economic activity. Trade was substantially liberalized. Financial markets were also opened up: banking was freed, so capital was available for entrepreneurs and innovators. Universal education had been introduced in 1842, creating an inclusive society with opportunities for all. Taxes remained lower than the European average and lower than in the United States until the mid-1950s. And institutions worked efficiently. This is how Sweden went from poor to rich.
In fact, this is how every country has gone from poor to rich – because every country has been poor. The diagram below shows GDP per capita versus degree of economic freedom. The latter is measured annually by the Heritage Foundation in 184 countries, using a great number of indicators. The core concept of economic freedom is how easy it is to start a company, attract capital, change jobs, plan your finances, trade with consumers all over the world, etc. Every dot in the diagram represents a country. As you can see, the higher degree of economic freedom, the higher is their GDP per capita, just as Sweden once improved its economic freedom, and became prosperous.
As described further in my book, economic freedom continuously increased throughout the world during the past twenty-five years. All over the former Soviet Union and in South-East Asia, not least in China and India, as well as in most other countries, economic freedom increased. This led to the biggest increase in global GDP ever recorded. And it did not only benefit “the rich”: On the contrary, economic freedom has been positive for hundreds of millions of people who have left poverty behind for better living standards. Most European countries also increased economic freedom and positive social outcomes were clearly seen. It should also be noted that the countries in the OECD that reformed the most could see the governments responsible for those reforms being re-elected, sometimes several times. Reform has also been politically rewarding.
The global picture emerging from this quarter-century time period is very positive. GDP per capita per person has increased by some 50 per cent, despite the fact that the world population has grown substantially. And extreme poverty around the world was cut in half in about 20 years. Economic freedom has provided people with the means necessary to improve their lives.
Turning to Europe, the results from different policies in different countries can be evaluated. The Nordic countries do have some differences, but they perform very similarly in a number of important aspects. First, in the likelihood of escaping from poverty – social mobility – versus the employment rate, the Nordic countries perform well. The outcome is positive on both indicators, with high employment and a high likelihood to escape from poverty.
Secondly, we compare European countries regarding the likelihood of escaping poverty versus the so-called Gini Coeffcient, that is, income distribution. Again, in the Nordic countries, people who get into poverty will find it much easier to escape from it – and incomes are quite equally distributed. Income levels are more similar for people in the Nordic countries than in practically any other part of the world.
Third, we consider the Nordic performance in both employment and unemployment. Unemployment is quite low and employment is high. It can be relevant to show both indicators, since sometimes people are neither employed, nor looking for a job and registered as unemployed. They may be on sick leave or early retirement. The Nordic countries have had problems with people in such categories, but all in all, unemployment and employment levels look good.
The Nordic countries also have their public finances in order, with lower budget deficits than most European countries. This seems to be related to the structure of fiscal policy – regulations aimed at limiting budget deficits or public debt. With strict frameworks for sound public finances, public debt is lower. The Nordic countries have limited public debt. Sweden is the only European country that has had a public budget surplus in the last two years.
No country is the same as any other country. Policies cannot be copied directly, because conditions are different. Sometimes, this is related to things such as culture, tradition, or religion. To deepen insight into conditions in Northern Europe, the “values” map below might be useful. It shows the Nordic countries in the upper right corner. That is, countries that are very secular (non-religious) and where people emphasize self-expression rather than traditional values. The Nordic countries have a high degree of individuality.
Listing some special Nordic features, according to surveys and other studies, would show that personal freedom is very high in the Nordic countries. People choose their lives, families, religion, job, and so on, very freely. Modernity is another keyword – in this region, technology is adopted fast and change is usually embraced. Organizations and corporations are flat and flexible rather than hierarchical. Society is cohesive, with a high level of trust, almost no corruption, and there is a high participation rate for women in the labor market.
Moving beyond the more fundamental cultural and societal features to policy, one can study three well-known indices. In the Index of Economic Freedom, mentioned earlier, the Nordic countries are close to the top. They are among the freest countries in the world; steep taxes and high public expenditure are the main categories in which they do not score top grades. Second, in the Globalization Index, measuring degree of openness to the world (technological, economic, and social), the Nordic countries are among the most open. Third, in the World Economic Forum Competitiveness Index, they are at the very top. According to the WEF, the Nordic countries are highly competitive.
Some people believe that these countries are socialist, that Sweden is “socialism with a human face”, the bumblebee that flies? Well, as mentioned, Swedish growth took off in the second half of the 1800s, following liberalization. Taxes, government and regulations remained very limited until the 1960s. In fact, taxes remained lower than the European average and lower than in the United States until the 1960s. In the late 1960s and early 70s, taxes, government and regulations exploded. Sweden chose a socialist path. This created substantial problems. Sweden dropped from being the fourth wealthiest country in the world (OECD) to number 17 between 1970 and the early 1990s. Real wages did not increase at all during those 20 years. Stagflation was all over society. Unemployment and budget deficits increased. But from the late 1980s, there have been waves of reform away from these unfortunate 20 years of socialism. After this, Sweden again became a successful and prosperous country. Sweden is now back as number nine in the OECD list of GDP per capita.
The diagram below shows the Swedish tax levels from the year 1900 to now (total tax revenue as a share of GDP). As can be seen, taxes remained low for most of the growth period until the 1960s. Then, taxes increased substantially for about 25 years, which became the least profitable period in the Swedish economy for about 100 years. True, stagflation was not a single Swedish phenomenon; true, there was a oil crisis; true, government interference in the economy increased in many ways and not only through taxes – but Swedish development was worse than in most OECD countries, and that was not without cause. The rise in taxes came as part of a strong wave of socialist ideas in the late 1960s, a time when many were impressed by Soviet propaganda.
Sweden is now leaving big government behind. One can summarize the free-market reforms that Sweden has launched during the past 25 years. The Central Bank was made independent with the aim of low inflation (maximum 2 per cent), putting an end to inflation through several steps in the early and mid-1990s. Practically every product market was deregulated, earlier than in most similar countries, from transport, to mail, and energy. Telecommunications, for example, was deregulated, creating a highly innovative sector with successful companies such as Ericsson. State-owned companies have been sold to private owners and most government monopolies, such as pharmacies, health care or education, have been abolished and competition introduced. Taxes have been decreased (especially capital and corporate tax rates) and flattened out (income tax). Tax on earned income went from the highest in Europe to average levels: now, low income earners pay only 20 per cent income tax. In the last ten years, public expenditure has dropped by ten per cent: it has gone down from 55 to 45 per cent of GDP. Social insurance systems have been made stricter, with lower levels of reimbursement and limited periods, creating incentives to return to work. Education reforms have been launched, aimed at improving quality, and making universities more independent from government. The labor market has also become more flexible; one way has been to allow private staffing agencies, now a booming business sector.
With the financial crisis, many countries attempted to stimulate the economy according to Keynesian principles, allowing big public deficits and exploding public expenditure. A few countries also increased public spending before the financial crisis. Only three countries decreased it (Sweden, Slovakia and Bulgaria), and 24 increased theirs. The Nordic countries either decreased their public expenditure or held it close to the same as before. But countries that really increased public spending also increased their deficits. The result is the same when comparing the development of public expenditure with the development of public debt: more spending equals more debt. Stimulating the economy by increasing expenditure is meant to increase economic growth. But the countries that increased public spending achieved lower economic growth. Countries that stuck to lower expenditure and budget balance had better economic growth, such as the Nordic countries and Germany.
This is no coincidence. One of the most studied parts of economics is how public expenditure affects economic growth. Naturally, there is spending that is positive for growth, such as maintaining functioning institutions and investing in education. But the latest summary of this research shows that higher public expenditure, all else being equal, will lead to lower economic growth. If you increase public expenditure by ten per cent, annual growth will decrease by 0.5 per cent.
Every country can improve, and every country has a need to reform. The Nordic countries still need to make labor markets more flexible, decrease taxes and public expenditure, and open up opportunities for entrepreneurship – but they have done much. To summarize the reasons for their success, one could emphasize these reasons: economic freedom, sound public finances, lower taxes and public expenditure, inclusive and cohesive societies, well functioning institutions, and a high degree of openness to the rest of the world.