The Sweden Myth
by Stefan Karlsson
Recently, the so-called Swedish model — that is, the Swedish economic system
with high taxes and a big welfare state — has been celebrated again in the press.
The alleged recent success of the Swedish economy has allowed welfare statists
both inside and outside of Sweden to argue that high taxes and an extensive
welfare state are good for the economy. To fully understand this fallacy, we
should review Sweden's economic history.
Until the second half of the 19th century,
Sweden was fairly poor. But far-reaching
free market reforms in the 1860s allowed
Sweden to benefit from the spreading
Industrial Revolution.
And so, during the late 19th and early
20th centuries, Sweden saw its economy
rapidly industrializing, driven by the many
Swedish inventors and entrepreneurs.
During that time, Sweden produced
extraordinarily many inventions, given its small population, including: dynamite,
invented by Alfred Nobel (who established the Nobel Prize); the self-aligning ball
bearing, invented by Sven Wingquist (who used this to create the SKF company);
the sun-valve, invented by Gustav Dahlén (who used it to found industrial gas
company AGA); the gas absorption refrigerator, invented by Baltzar von Platen
(which was later used by Electrolux).
In addition, there were countless non-inventing entrepreneurs during that period:
car manufacturers Volvo and Saab, and telecommunications company Ericsson.
Indeed, with just a few exceptions, nearly all large Swedish companies were
started during the late 19th and early 20th centuries, which was not only a period
of strong growth, but also the time when the foundation for later economic
growth was laid.
Another factor which continued Swedish prosperity was the fact that Sweden was
able to stay out of both World Wars, and indeed all other wars as well. Sweden is
in fact the country with the longest consecutive period of peace, having fought no
war since 1809, when Sweden was invaded by Russia, losing Finland to the
invader.
Sweden has thus enjoyed 5 more years of peace than Switzerland, which
participated in the Napoleonic wars in 1814. As a result of its free market policies,
the resourcefulness of its people, and its successful avoidance of war, Sweden
had the highest per-capita income growth in the world between 1870 and 1950,
by which time Sweden had become one of the world's richest countries, behind
only the United States and Switzerland, and Denmark (who have since also fallen
behind because of high taxes).
But the foundation for future trouble had already been created. In 1932, the
Social Democrats rose to power in the face of the Great Depression. And like FDR
in America and Adolf Hitler in Germany, they started to expand government
power over the economy. Until 1932, government spending had been kept below
10% of GDP in Sweden, but the Social Democrats, under their leader Per Albin
Hansson, wanted to change this and remake Sweden into a "folkhem" ("people's
home"), a term Swedish Social Democrats adopted from the Fascists in Italy.
1
Even in the early 1950s, Sweden was still one of the freest economies in the
world, and government spending relative to GDP was in fact below the American
level.
But between 1950 and 1976, Sweden experienced an expansion in government
spending unprecedented during a period of peace, with government spending to
GDP rising from about 20% in 1950 to more than 50% in 1975. Virtually every
year, taxes were increased while the welfare state expanded relentlessly, both in
the form of a sharp increase in the number of government employees and ever
more transfer payment benefits.
During the first 20 years, this relentless government expansion took place
seemingly without ill effect, as Sweden benefited from rapid global growth —
although Sweden's growth had already started to slip in relative terms, from well
above average to just average. This changed in the 1970s after Olof Palme, from
the left wing of the Social Democratic party became Prime Minister. Palme
stepped up the socialist transformation in Sweden, rapidly increasing antibusiness regulations and sharply increased payroll taxes.
The payroll-tax increases, along with increasing wage demands from unions,
made Swedish businesses highly uncompetitive on the global markets, something
which Palme decided to solve by devaluing the Swedish krona. As a result, price
inflation rose sharply, leading to repeated devaluations. Popular discontent from
the economic woes created by the global economic downturn, the massive tax
increases, the increased regulations, and the increasing inflation enabled the
center right to come into power in 1976, breaking 44 years of uninterrupted
Social Democratic rule.
But because the center-right parties were unwilling to push for more radical freemarket reforms, the economic woes, including the inflation-devaluation cycle,
continued. For this reason, and because the three coalition parties — the
conservative Moderate Party, the Liberal Party, and the Center Party — were
unable to get along, the Social Democrats returned to power in 1982.
They immediately implemented one "big bang" devaluation of 16%, which they
claimed would be the last. They had claimed the same thing before all the
previous devaluations, including the 10% devaluation that the center-right
government had decided upon the year before. This time it appears that they
actually meant it, but as with The Boy Who Cried Wolf, no one believed them.
Inflationary expectations and thus union wage demands remained very high. And
in 1985, the government decided to deregulate bank lending. While this reform
was necessary in order to improve capital allocation, it had disastrous side effects
given the fact that at the time, real interest rates were way below zero after tax
and inflation. This caused a massive credit expansion, which in turn helped
further aggravate consumer price inflation while also creating a massive stockand real estate bubble. As the exchange rate remained fixed, Swedish
competitiveness was quickly undermined.
After Palme was killed by an unknown assassin in February 1986, pragmatist
Ingvar Carlsson became prime minister. Worried that Swedish growth had trailed
most other countries, Carlsson's government implemented a number of freemarket reforms. Among these were the lifting of all currency controls in 1989 and
a tax reform that dramatically reduced marginal tax rates (although they also
reduced a number of deductions, including deductions for interest payments).
Although these reforms have arguably contributed to improving the long-term
economic performance of Sweden, they would contribute to precipitating the deep
economic downturn in the early 1990s.
Meanwhile, as the economy started slowing significantly in 1990 after a series of
tightening measures, consumer price inflation slowed. With the combination of
2
continued high nominal interest rates, reduced capital gains taxation (and with
that, reduced deductions for interest payments) and falling price inflation, real
interest rates started rising significantly, helping to end the asset price bubbles.
On top of all of this came the oil price shock following Saddam Hussein's invasion
of Kuwait and an economic downturn in key trading partners such as the United
States, the United Kingdom, and Finland. The end result was that Sweden slipped
into a recession in late 1990.
As Sweden fell into a recession and its highly cyclical government budget balance
started to deteriorate rapidly, investor confidence in the Swedish fixed-exchangerate scheme started to deteriorate rapidly.
And with currency controls abolished a few years ago, the krona was fair game
for currency speculators. Unlike in the past, the government was determined not
to devalue, and they deemed a return to strict currency controls as unthinkable,
so they had no choice but to defend the currency by raising interest rates. But as
the currency speculators knew that these interest rate levels could not be
sustained, they renewed their attacks, knowing that their gain from a collapsed
currency regime would be far greater than the interest rate levels the Riksbank
could offer. The end result was that real after-tax interest rates were pushed up
into double digit levels — after having been negative just a few years earlier. That
in turn deepened the recession further.
In the end, though, the fixed-exchange-rate scheme collapsed in November 1992.
The dramatic increase in interest rates and the deep recession had at the same
time created a large amount of bad loans, making almost all major banks in effect
bankrupt. (The exception was Handelsbanken, known for its more cautious
lending practices.) Only after the Swedish government pledged they would bail
out the banks with whatever money they needed was a widespread banking
collapse averted.
All told, the recession became Sweden's deepest by far since the Great
Depression, with GDP in 1993 being 5% lower than in 1990, with employment
falling more than 10%, and the budget deficit rising to more than 10% of GDP.
By then Sweden had fallen to between 15th and 20th place in international
income
comparisons,
a
decline
from
which
it
has
never
since recovered.
After this deep downturn, Sweden has performed much better for a number of
reasons. The 20% decline in the value of the krona in late 1992 gave a strong
boost to exports and together with the dramatic lowering of interest rates, this
helped kick-start a cyclical recovery in late 1993. Moreover, a number of free
market reforms implemented during Ingvar Carlsson and conservative Carl Bildt
(who was Prime Minister between 1991 and 1994) had helped raise the structural
growth potential of the Swedish economy.
Apart from the already mentioned reforms of reduced marginal tax rates and
abolished currency controls, deregulated bank lending and significantly lower
inflation, this included privatizations of several state-owned companies and
deregulation of several key sectors, including the retail sector, the
telecommunications sector and the airline industry. Also, when the massive
budget deficit was eliminated, even the Social Democrats realized the need for
deep spending cuts, which together with the typical cyclical decline in the burden
of spending during booms helped reduce the extremely bloated burden of
government spending somewhat.
All of this has helped Sweden recover in relative terms from the stagnation of the
1970s and 1980s and the deep economic downturn in the early 1990s. It is this
relative recovery that is now seized upon by the Social Democrats and their
3
sympathizers inside and outside of Sweden when they claim that the Swedish
model of high taxes and a big welfare state is successful.
Yet as should be clear, the relative improvement of performance is due not to
high taxes (lower now than previously), but to free-market reforms.
The reason Sweden no longer trails the rest of Europe is that these reforms,
which have not been implemented in most continental European countires, have
made the Swedish economy relatively freer.
And even with these reforms, Sweden has not, in fact, performed better than the
rest of Europe. While headline GDP growth has been slightly higher, this
advantage disappears when taking into account that Sweden's terms of trade
have deteriorated significantly.
And if we exclude heavy-weight laggards Germany and Italy, Sweden has in fact
continued to fall behind the Continent, event with Europe's dismal performance
compared to most other parts of the world.
If we look beneath the aggregate production figures, we can see deep structural
problems. The number of people employed is now 6% lower than in 1990, a
weaker development than in any other western economy. By contrast, even with
the weak job growth in recent years (by American standards), employment in the
United States is 20% higher than in 1990.
And the number of people employed in Sweden is actually lower than in 1980,
too. You have to go back to the mid-1970s to find employment numbers lower
than the current ones. While total employment has been roughly unchanged since
1975, it masks a significant decline in male employment. And if you look only at
the private sector, employment is now at a level lower than in 1950.
Social Democrats still often claim that Sweden has a comparatively high
employment rate, but this claim is based on deceptive employment statistics that
count as employed many who have been on long-term sick leave or in some other
way on the receiving end of transfer payment programs, even though they don't
actually work.
Moreover, the "stay at home mom" is very rare in Sweden. Because of the
incentives created by the feminist construction of the Swedish welfare system,
mothers mostly leave their children at government day care centers. Even if you
believe that mothers who stay home to take care of their children are the victims
of patriarchical oppression, you cannot deny the childcare takes a lot of work, but
only those who take care of other people's children count as employed. By
shifting childcare from the home to the public sector, the government further
exaggerates Swedish employment figures.
The headline unemployment rate in Sweden is only 5–5.5%, but this number is
extremely misleading as it only includes a small number of the people who the
government pays not to work. Many unemployed are sent to so-called "labor
market political activities" — activities whose only purpose is to reduce the official
unemployment rate.
If we ignore this ruse, unemployment is 8%. And if you also include the
enormous number of early retirees and people who live off sickness benefits, the
real unemployment rate is more like 25%. The number of early retirees is
540,000, more than double the number of officially unemployed. Among nonWestern immigrants, the real unemployment rate is higher than 50%.
All of this is exactly what we should expect from transfer payment benefits to
people who don't work, from massive payroll taxes, income taxes, and valueadded taxes. This has greatly inhibited the growth of a labor-intensive private-
4
service sector that could have provided jobs for many of the unemployed
immigrants.
During the most recent year, however, growth has picked up significantly in
Sweden. To some extent, this reflects the global cyclical upswing, but there is
also a domestic Swedish factor at work here, which has helped push Swedish
growth higher than in most European countries. After the painful fiasco of the
fixed-exchange-rate regime in 1992, Sweden instead adopted inflation targeting.
This monetary policy regime seems so far to have been significantly more
successful, but the policy is creating new problems. Because of deregulation and
increased competition in a number of sectors in recent years, consumer price
inflation has been fairly low, indeed below the 2% target most of the time. Food
prices, for example, have been falling as fierce competition from low-price chains
like Lidl, Netto, and Willys, have forced the major supermarket chains to cut
prices in order to keep their customers.
Low prices are good for consumers, of course, but according to the inflationtargeting dogma, too low a rate of price inflation is itself a problem — a problem
that must be counteracted with increased monetary inflation. Thus the Riksbank
has been forced to push down interest rates dramatically in order to boost money
supply enough to help achieve a 2% consumer price inflation rate.
As consumer price inflation is now starting to creep back up toward 2%, it
appears that they will be successful, but this will have come at the cost of
unleashing an asset price bubble and household debt levels similar to the levels
experienced in the late 1980s.
Money supply rose 11.5% in Sweden in the year to May, even higher than the
8.9% seen in the Euro-zone. It is the dramatic acceleration of monetary inflation
in 2005 which has temporarily boosted Swedish growth. The timing of this boom
is, it should be noted, very convenient for the ruling Social Democrats and their
parliamentary allies, the Green Party and the communist Left Party, given the fact
that they face an election this year in September.
Ultimately, this artificial boom will have to come to an end, and although the
ensuing crisis will likely not be as deep as in the early 1990s, the seemingly
impressive Swedish boom will certainly be revealed as a fraud — just as the
whole story of the success of the Swedish economic model is a fraud.
5