Sweden’s Quiet Revolution

Without much fanfare, the Scandinavian country has been moving away from socialism.

Duncan Currie
Thursday, September 30, 2010

There is something about Sweden that provokes a mix of envy, horror, and bewilderment among American observers. Liberals have traditionally celebrated its cradle-to-grave safety net, while conservatives have disparaged its high taxes and centralized health-care regime. Yet both groups have generally agreed that Swedish-style socialism is a far cry from rough-and-tumble U.S. capitalism.

In fact, contemporary Sweden is much less socialist than many Americans realize. Since the early 1990s, when it suffered a painful financial crisis, the Scandinavian country has deregulated key industries (such as airlines, telecommunications, and electricity), lowered its overall tax burden, established universal school vouchers, partially privatized its pension system, abolished certain government monopolies, sold a number of state-owned enterprises (including the parent company of Absolut vodka), and trimmed public spending. Several years ago, it eliminated gift and inheritance taxes. The World Economic Forum now ranks Sweden as the second-most competitive economy on earth, behind only Switzerland. According to the 2010 Index of Economic Freedom (compiled by the Wall Street Journal and the Heritage Foundation), Sweden offers greater business freedom, trade freedom, monetary freedom, investment freedom, financial freedom, freedom from corruption, and property-rights protection than does the United States.

Since taking office in 2006, the center-right administration of Prime Minister Fredrik Reinfeldt has reduced income and corporate taxes, repealed a longstanding wealth tax, tightened unemployment and sick-leave benefits (which are still exceedingly generous), and privatized various state assets. On September 19, Reinfeldt became the first conservative premier in modern Swedish history to win reelection, though his government apparently fell just short of securing a parliamentary majority. The once-mighty Social Democratic party captured less than 31 percent of the vote, its worst performance in nearly a century. Meanwhile, the far-right Sweden Democrats (SD) — a populist-nationalist party critical of Muslim immigration — finally gained entrance into the Riksdag, picking up a remarkable 20 seats (out of 349) and virtually doubling its vote share from 2006.

Both the ruling coalition and the left-wing opposition have rejected an alliance with the SD, whose impressive electoral showing hit Sweden like an earthquake. The party has neo-Nazi roots, but it has worked hard to purge members with Nazi ties, rebrand itself, and achieve greater respectability. Its growing influence reflects widespread anxiety over the sluggish pace of Muslim assimilation — anxiety that the mainstream parties have failed to address. This failure has given the SD a boost, especially in southern Sweden around Malmö, the country’s most Muslim city.

The broader story of the 2010 election is the collapse of Sweden’s old political order, which was dominated by the Social Democrats (who held power for all but nine years and a few months between September 1932 and October 2006). “There is a general change in Swedish society,” Stockholm University political scientist Jenny Madestam told the New York Times prior to the vote. “Social-democratic ideas are losing their grip on Sweden, and we are getting more and more individualistic.” Indeed, the country is a far more market-friendly place today than it was 20 years ago, thanks in part to reforms implemented by the Social Democrats themselves. Over the past two decades, it has been one of Western Europe’s most energetic liberalizers — cutting taxes, loosening regulatory shackles, and increasing competition.

Bolstered by prudent economic stewardship and a relatively conservative financial sector, Sweden entered the global recession on a sound footing. While it endured a nasty spike in unemployment, its export-driven recovery has been so vigorous that the central bank is now concerned about inflation risks. In the second quarter of 2010, Sweden posted a 4.6 percent annual growth rate, prompting the Wall Street Journal to hail it as “the biggest success story in post-recession Europe.” It currently has the lowest deficit-to-GDP ratio in the entire European Union. Before the election, Swedish finance minister Anders Borg announced plans to privatize another $14 billion worth of state assets. “If we get a surplus in place,” Reinfeldt told a Reuters interviewer, “we will deliver on tax cuts for 6.1 million workers and pensioners.” (The total Swedish population is roughly 9.4 million.)

To be sure, Sweden won’t look like Hong Kong or Singapore anytime soon. It still has a lavish welfare state, and its aggregate tax burden is still quite heavy. The top marginal income-tax rate is 57 percent in Sweden, compared with 35 percent (for now) in America. On the other hand, a 2008 OECD study found that household taxes are substantially more progressive in the U.S. than they are in Sweden, even after we control for America’s higher level of income inequality. Sweden has a much lower average statutory corporate-tax rate than the U.S., and also a much lower effective corporate-tax rate on new capital investments (according to University of Calgary economists Duanjie Chen and Jack Mintz). Its tax structure is made even more regressive by a 25 percent value-added tax on consumption of most goods and services.

Which brings us to a common misconception about the Swedish system — that it takes from the rich and gives to the poor. Actually, says Lund University economist Andreas Bergh, “the majority of the taxes you pay are given back to you during your life cycle.” Thus, “if you pay more when you work, you will also get more when you retire.” Even upper-class Swedes enjoy bountiful government largesse.

Another popular myth would have us believe that Sweden’s wealth was somehow created or facilitated by social democracy. In reality, “Sweden’s prosperity is the result of well-functioning capitalist institutions,” says Bergh, author of the new Swedish-language book The Capitalist Welfare State. As Cato Institute scholar Johan Norberg explained in a 2006 National Interest essay, the relative “success” of the country’s social-democratic model “was built on the legacy of an earlier model: the period of economic growth and development preceding the adoption of the socialist system.”

During the first half of the 20th century, Sweden benefited enormously from its non-participation in the two world wars, which devastated Europe’s major industrial powers. Blessed with abundant natural resources, it was a staunch defender of property rights and a robust advocate of free trade. Cultural homogeneity, a strong legal framework, and a lack of corruption promoted famously high levels of trust and social cohesion. Sweden had a welfare state, but it also had an open, free-market economy. “As late as 1950,” Norberg observed, “the total tax burden was no more than 21 percent of GDP, lower than in the United States and Western Europe.”

In other words, Sweden became a fantastically rich country before it started greatly boosting taxes, spending, and regulation during the 1970s. Cleveland Fed economist Emre Ergungor has noted that “the marginal income tax rate on full-time workers earning the average hourly wage increased from 35 percent in the second half of the 1960s to 65 percent in 1976.” Soaring taxes funded a dramatic expansion of government: The public sector accounted for 20 percent of total Swedish employment in 1965 and 38 percent in 1985.

At the start of the 1980s, Sweden was grappling with persistently high inflation. Over the course of that decade, its financial markets experienced a rapid burst of liberalization that led to massive credit growth, which in turn spawned a real-estate bubble. Meanwhile, the country continued to maintain a fixed exchange rate. Crunch time arrived in the early 1990s, writes Ergungor, when the reunification of East and West Germany drove up German interest rates. This fueled a sharp rise in Swedish interest rates, as did Stockholm’s efforts to defend an overvalued krona (the national currency). The government eventually adopted a floating exchange rate, but not until November 1992.

By that point, Sweden’s asset bubble had imploded. The fallout was disastrous: Housing prices plunged, nonperforming loans accumulated, and the economy sank into a deep recession. This had a severe impact on the country’s relative wealth: According to a McKinsey & Co. analysis of per capita GDP and purchasing-power parity, Sweden went from being the fifth-richest OECD member in 1970 to being the 16th-richest in 1998. Since then, propelled by ambitious free-market reforms, it has regained much (though not all) of the ground it lost. Private-sector productivity growth has been vigorous, and Sweden now boasts “a near-perfect pension system,” says economist Anders Åslund of the Peterson Institute.

Yet certain aspects of the old Swedish model have proved stubbornly resistant to change. For example, the government-run health-care system remains plagued by long waiting times, and onerous labor regulations make it very difficult for companies to hire or fire workers. Labor-market rigidity has contributed to a yawning employment gap between natives and immigrants, which has retarded the process of integrating Swedish Muslims.

Decades ago, Stockholm chose to embrace liberal asylum policies, thereby inviting future waves of refugees from the Middle East, the Balkans, East Africa, and elsewhere. In a country once known for its homogeneity, the foreign-born population share is now approximately 14 percent. Unfortunately, Sweden has not made the labor-market adjustments necessary to accommodate mass immigration. The ghettoization of Muslim communities in poor, crime-ridden neighborhoods has inflamed cultural tensions and heightened fears over the sustainability of the welfare state. Sweden has “essentially imported an underclass,” says UCLA historian Peter Baldwin, a scholar of contemporary Europe. “It’s a huge social problem just waiting to explode.”

Solving that problem will require more than simply enhanced labor flexibility. It will also require government officials to move away from multiculturalism and rethink their basic approach to assimilation. After witnessing the recent electoral success of far-right populists, the Swedish establishment may finally be shocked into taking constructive action. That should be the hope, anyway, of liberal and conservative Swedes alike.