Sweden's secret free market success

All of Europe is an economic disaster zone. All of Europe? Well, not quite.

In a small country, just outside the eurozone, a bunch of indomitable Swedes hold out against the forces of euro doom and gloom. They show that with a good combination of free markets, sound public finances and a strong work ethic you can still achieve positive economic and social results. Even in Europe.

At least that is the optimistic summary of a discussion paper just published by the London based Institute of Economic Affairs.

Written by Nima Sanandaji, a Swedish author with a Kurdish Iranian background, The surprising ingredients of Swedish success – free markets and social cohesion argues that Sweden is more successful than other European economies because it is, in many respects, more economically liberal than its neighbours.

Sanandaji's paper is surprising in more than one way. Sweden is often thought of as the very model of a social-democratic utopia, not as a bastion of free market thinking.

The soy decaf latte sipping, left-leaning intelligentsia around the world usually look towards Sweden for inspiration. But you wouldn't expect a paper praising Sweden coming out of the IEA, an institute whose historic claim to fame is as the intellectual driver behind Margaret Thatcher's economic reforms of the 1980s. And now the IEA is celebrating the Swedish folksheim society, the "People's Home” welfare state?

If you look at Sweden more closely, you will find that, international perceptions aside, it is not a semi-socialist paradise, and has more to offer to the world than IKEA, the Millennium trilogy and ABBA. Sweden has weathered the economic storms of the financial crisis remarkably well and holds useful lessons for less fortunate countries in Europe and around the world.

Perhaps the single biggest error about Sweden is to believe that it is, and has always been, a government dominated society. True, Sweden's socio-economic system had the state squarely at its centre for a large period of post-war history, roughly from the 1950s until the 1980s. Prior to this, Sweden was a rather liberal society, and recently it has undergone a profound economic reform process.

Sanandaji reminds his readers that Sweden first became rich well before the advent of the welfare state now synonymous with the country. Economic liberalisations of the late 19th century turned its agrarian, inward looking society into a dynamic market economy. Many of the country's best known companies and brands then developed over the following century in an environment characterised by business-friendly regulations and low taxes, among them IKEA, Volvo, Tetra Pak, and Ericsson.

In 1950, Swedish tax revenue was 21 per cent of GDP when it already stood above the 30 per cent mark in many other developed countries. Sweden was also prosperous by world standards. Until the mid-1970s, it was ranked as fourth richest among OECD economies.

However, during three decades of mainly Social Democratic rule, government spending increased steadily and taxes rose dramatically. Astrid Lindgren, author of Pippi Longstocking, triggered a broad discussion about the Swedish tax system in 1976 when she demonstrated how her own marginal tax rate had topped 102 per cent. No wonder that under such circumstances Sweden's ranking fell to 14th place in the OECD by the early 1990s.

What is less well known about Sweden than its past government tax and spending excesses is the way in which it has left them behind. For the past 20 years, Sweden has implemented far-reaching economic reforms. Though they have certainly not turned Sweden into a tax haven, they have liberalised many other areas of the economy.

Sweden's education system, for example, now operates on school vouchers that allow for more choice. Pensions have been part-privatised, giving Swedes greater control over their savings for retirement. The labour market has also seen big policy changes, allowing for easier dismissal of workers and curbing benefits available under the social insurance system.

As a result of all of these reforms, Sweden's performance in international rankings of economic freedom has improved steadily.

Both the Heritage Foundation's Economic Freedom Index and the Fraser Institute's Index of Economic Freedom record the same results. Until the mid-1990s Sweden was by a large margin the least liberal among the Scandinavian countries and miles behind the US and the UK. Today it is on par with its neighbours, not far behind the US and perhaps even slightly more liberal than Britain. This reflects both a deterioration in the fate of economic liberalism around the world and a strong reform drive in Sweden itself.

Sweden's more liberal policies are producing good economic results. The country recovered from the shock of the GFC with growth rates of 6.1 per cent in 2010 and 3.9 per cent in 2011. Government debt, which had peaked at 73.3 per cent of GDP in 1993, has fallen even through the GFC and now stands at 38.4 per cent. Sweden has also regained some of the previous drop in the OECD rankings.

Such positive results from Sweden's reform experience should certainly provide encouragement to other European countries which still have similar economic reforms ahead of them.

From an Australian perspective, a side aspect of Sanandaji's paper is worth considering. In concluding he remarks that "Swedish society is not necessarily moving away from the idea of a welfare state, but continual reforms are being implemented that increase economic liberty and incentives for work within the scope of the welfare system. Such trends are also visible in Finland and Denmark, with only oil-rich Norway being an exception.”

He is right that Norway's blessing with natural resources has decoupled it from the economic liberalisation trend of its Scandinavian neighbours – most likely because the Norwegians can still afford big government thanks to their resources boom. Not only do the Norwegians keep their welfare state untouched; they even stash away their oil and gas revenues into a sovereign wealth fund to keep the welfare state big when their resources run out.

Considering Sweden's remarkable economic performance throughout the GFC in the absence of minerals cash, there can be little doubt about which of these two Scandinavian countries pursues the better economic policies. Thinking about Australia on the other hand, it is also clear that it rather resembles big-government Norway than smart-government Sweden.

Dr Oliver Marc Hartwich is executive director of The New Zealand Initiative. Nima Sanandaji's 'The surprising ingredients of Swedish success – free markets and social cohesion' is available at www.iea.org.uk.