The Nordic nations, and Sweden in particular, are seen by many as the proof that it is possible to combine innovative and entrepreneurial economies with high tax rates. It is often argued that nations such as the US can gain the attractive social features of Denmark, Sweden, Norway and Finland — such as low crime rates, high life expectancy, and a high degree of social cohesion — simply by expanding the welfare state. An in depth analysis, however, shows that this line of reasoning is flawed.
To begin with, one should remember that free-markets have been at the core of the Nordic success stories. Sweden, for example, was an impoverished nation before the 1870s; one indication of that was massive emigration to the United States. As a capitalist system evolved out of the agrarian society, the country grew richer. Property rights, free markets, and the rule of law, in combination with large numbers of well-educated engineers and entrepreneurs, created an environment in which Sweden enjoyed an unprecedented period of sustained and rapid economic development. Globally famous companies such as IKEA, Volvo and Tetra Pak were founded during a period when Sweden was characterized by business-friendly economic reforms and relatively low taxes.
However, during the late 1960s, policies steered sharply to the left and the overall tax burden rose significantly. The Swedish economist Magnus Henrekson has shown that the effective marginal tax rate (marginal tax plus the effect of inflation) that was levied on Swedish businesses could be more than 100 percent of the profits. The sharp left turn in Swedish economic policy did indeed affect entrepreneurship. Sten Axelsson, another Swedish economist, has shown that the period between the end of the 19th century and the beginning of the First World War was a golden age for the founding of successful entrepreneurial firms in Sweden. After 1970, the establishment of new successful firms almost stopped. The experiment of following a middle way between socialism and capitalism was not only unsuccessful, but also short-lived. In the 1990s and onward, a range of market reforms were implemented, paving the way for new entrepreneurial firms.
Taxes still remain high in the Nordic nations, particularly in Denmark and Sweden. The high tax pressures create high costs for the societies. A report recently published by the European Central Bank finds that both Denmark and Sweden are on the tip of the Laffer curve when it comes to both taxes on income and on capital. This means that capital taxes are so damaging that reducing them by one Kronor would stimulate the economy to grow, so that more than one Kronor in additional taxation could be levied (at the lower tax level). Many entrepreneurs relocate their businesses to other countries in order to avoid Sweden's high taxes. Skype, for example, was founded by a Dane and a Swede, but they chose to startup in free-market oriented Estonia, and later move the ownership to another free-market oriented nation, Luxembourg.
So how come the Nordic nations are so prosperous? A key reason is that they, particularly since the 1980s, have compensated for high tax regimes by implementing a range of market reforms. These reforms range from Flexicurity — a combination of strategies to provide flexibility for employers and security for workers — in the Danish labor market, to partial abolition of rent-control in Finland, to school vouchers and partial privatization of the pension system in Sweden. Indeed, the Nordic nations have risen sharply in both the Heritage/WSJ and the Frasier Institute indexes of economic freedom over the years.
It is also important to realize exactly why the Nordic nations have been able to implement large welfare states, and what the benefits have been. The cultural and economic systems in the Protestant Nordic nations have historically given rise to very strong norms related to work and responsibility. Coupled with uniquely homogeneous societies, these norms made it possible to implement larger welfare states in the Nordic nations than those in other industrialized countries. Since the norms relating to work and responsibility were so firmly rooted, Nordic citizens were not as likely as other Europeans or Americans to try to avoid taxes or misuse generous public support systems. Also, the "one-solution-fits-all" systems of the welfare state are typically less disruptive in a strongly homogeneous social environment, since most of the population has similar norms, preferences, and income levels.
However, with time the norms have evolved. In the World Value Survey of 1981-84, almost 82 percent of Swedes responded that "claiming government benefits to which you are not entitled is never justifiable", but in the survey of 1999-2004, only 55 percent held the same belief. It is no coincidence that much of the public policy debate in Norway, Sweden, Denmark and Finland has focused on curbing overutilization of welfare systems.
Many of the favorable social outcomes in the Nordic nations relate to our unique culture, and the policies cannot simply be copied. In1950, long before the high-tax welfare state, Swedes lived 2.6 years longer than Americans. Today the difference is 2.7 years. The two researchers Jesper Roine and Daniel Waldenström have similarly shown in a new study that "most of the decrease [in economic inequality in Sweden] takes place before the expansion of the welfare state", occurring during the period when the nation was characterized by low taxes, a small state and a flexible labor market.
Clearly, the social success in the Nordic countries is not simply a result of welfare policies, but related to cultural and demographic factors. Therefore it would be difficult, if even possible, to achieve these results in nations such as the US simply by introducing a high tax regime. Why not instead be inspired by the fiscal conservatism and the free-market reforms that make the Nordic nations prosper today?
Flickr Photo by 'creating in the dark' (Helen Harrop): Gate to the Mazetti Chocolate Factory, Malmö, Sweden
Nima Sanandaji has published several books in Sweden relating to subjects such as entrepreneurship, integration and women's career opportunities. He is the author of the study, "The surprising ingredients of Swedish success – free markets and social cohesion", which has recently been published by the Institute of Economic Affairs.