Sunday, April 6, 2014

Myth: The Scandinavian countries are proof socialism works.

Myth: The Scandinavian countries are proof socialism works.

This is a myth that is quite pernicious because no one bothers to fact check it. However, to those who have done their research, the Scandinavian countries are definitely not an example of where socialism works, rather they are an example of market economies with large public sectors. Also, it appears as though their large public sectors have been detrimental to economic growth, not conducive to it.

The Scandinavian countries economies are based off of the Nordic Model. Features of the Nordic Model include:

Welfare state programs such as:
-Universal healthcare and "free" education
-High percentage of workers belonging to unions
-High government spending as a percentage of GDP/ high tax burden

They also have strong free market traits including:
-Strong property rights, contract enforcement, and overall ease of doing business.
-Low barriers to free trade
- Little product market regulation. Nordic countries rank very high in product market freedom according to OECD rankings
- In many aspects of economic freedom, such as business, monetary, and investment freedom, Scandinavian countries are actually more free than the United States.

Indeed, the Scandinavian countries on net are some of the most capitalist countries in the world. In fact, the Scandinavian countries score very highly on the Economic Freedom of the World report 2013 report (10 being the highest and 0 being the lowest scores):

Economic freedom ranking:

-Sweden: 7.58 
-Denmark: 7.78. 
-Finland: 7.98 (7th freest in the world)
-Iceland: 7.37

The research on economic freedom is generally supportive of the idea that more economic freedom leads to higher economic growth rates and the prosperity that comes with those growth rates. [2] From an economic perspective, the Scandinavian countries have excellent trade and monetary policies, but have sub-par labor freedom policies and their governments spend way too much. The economic policies of the Scandinavian countries can only be considered to be socialistic insofar as they have large public sectors. 

Government Spending as a % of GDP by country in 2012 [3]:

Scandinavian countries:
-Denmark: 56%
-Sweden: 51.2%
-Norway: 43.9%
-Finland: 55.1%
-Iceland: 47.3%

For comparison:
-United States: 41.6%
-Canada: 41.9%
-Switzerland: 33.8%
-Australia: 35.3%
-Hong Kong: 18.5%
-Singapore: 17.1%
-United Kingdom: 48.5%

Basic economic theory as well as research and empirical evidence has continuously suggested that high levels of taxation and government debt seriously retard economic growth [4]. More importantly, a survey of the empirical literature on government spending on economic growth has stated: “
The most recent studies find a significant negative correlation [between government size and economic growth]: An increase in government size by 10 percentage points is associated with a 0.5 to 1 percent lower annual growth rate.” [5] This suggests that the big governments the Scandinavian countries are famous for are most likely detrimental to their economic well-being and not the cause of it as socialists and progressives like to suggest.

Additionally, the same survey also found that countries with large governments can mitigate the negative effects of government spending on economic growth by implementing market friendly policies in other sectors of the economy (i.e trade and labor freedom) and by having high levels of social trust. Luckily, the Scandinavian countries do in fact have high levels of social trust and have instituted market friendly policies throughout their economies with the exception of labor freedom.  

As the charts below show, the evolution of prosperity in the Scandinavian countries has stagnated significantly in the last few decades, not coincidently with the development of their welfare states. For example, “according to OECD figures, Denmark was the 5th most prosperous economy in the world in 1970, immediately behind Switzerland and the United States. In 2004, Denmark was 10th.” [6]

Additionally, when we look to the graphs below we can note that job creation and worker productivity has also remained stagnant. This could be as a result of the high levels of unionization. Research that has been done in the United States tends to show that unionized industries hire less workers and actually shed jobs more than non-unionized industries [7]. This may be the case in the Scandinavian countries as well.

In contrast to the high taxes in Scandinavia, Ireland has had drastic reductions in tax rates with positive results. Additionally, between 1987 and 2005, Ireland’s government spending as a percentage of GDP decreased from over 50% in 1987 to just below 35% in 2005 [6]. It has risen since then unfortunately.  “In barely 18 years Ireland jumped from the 22nd to the 4th place in the OECD prosperity ranking. Ireland did not reduce its social welfare benefits. On the contrary. The unprecedented growth led to an increase of fiscal revenue and social expenditure. It was sufficient to improve the productivity of the government.” [6]

Despite all the praise of "Scandinavian socialism", the only Scandinavian country that makes it into the top ten richest countries (measured by GDP per capita, PPP) is Norway. In contrast, my favorite economies are those of Switzerland, Hong Kong, Singapore, Canada, Australia, and to a lesser extent the United States, which are all within the top ten richest countries. Why do I like them? Because all of these countries have high economic freedom rankings and maintain levels of government spending below 40% of GDP (except Canada and the US). However, even government spending of 40% of GDP is too much. Empirical research suggests that the optimal level of government spending is no greater than 25% of GDP for the average country [8].

Also, when we compare my favorite economies, which are have higher economic freedom scores and lower government spending than the Scandinavian nations, it appears as though the growth rates that the Scandinavian nations have achieved are nothing spectacular or even noteworthy.

Growth rates by country (Real GDP 5- year compound annual economic growth, PPP) [9]:

Scandinavian countries:

-Denmark: -0.9%
-Sweden: 1.0%
-Norway: 0.6%
-Finland: -0.6%
-Iceland: -1.1%

My top picks:
-Australia: 2.5%
-Canada: 1.2%
-United States: 0.6%
-Hong Kong: 2.5%
-Singapore: 4.3%
-Switzerland: 1.2%

The question becomes, why do the Scandinavian countries perform so badly when they have such high economic freedom rankings? I speculate that their large public sectors and lack of labor freedom are the cause. When I extended this hypothesis to James Gwartney, the author of the Economic Freedom Report, he said: "Your speculation makes sense, but I do not know if it is correct.". There could be other factors causing these low growths rates worth exploring. 

In conclusion, the data is clear, the Scandinavian countries are not economic miracles nor are they examples of socialism. Rather they are examples of market economies with large public sectors. Most likely as a result of recent decades of government expansion, the Scandinavian countries have been lagging behind many other countries they once outperformed. Also, they have slower growth rates than countries of similar wealth but have smaller governments. As Dan Mitchell of the Cato Institute has stated:

Conservative critics correctly condemn the large welfare states, but often overlook the positive results generated by laissez-faire policies in other areas. Liberals, meanwhile, exaggerate the economic performance of Nordic nations in an effort to justify welfare-state policies, while failing to acknowledge the role of free market policies in other areas.” [10]



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