Sweden and the IMF

artwork from the cover of this publication   Sweden's Welfare State
Can the Bumblebee Keep Flying?

Subhash Thakur, Michael Keen, Balázs Horváth, Valerie Cerra

©2003 International Monetary Fund
May 1, 2003

Ordering Information


1 Introduction and Overview
2 Main Elements of the Swedish Welfare State
Structure of Government, Social Welfare, and Taxation
Past Developments in Fiscal Aspects of the Swedish Model
3 The Swedish Growth Experience
Has Swedish Growth Lagged Behind?
Emergence of the High-Technology Sector
Quality of Growth
4 Growth, Government, and the Welfare State
Growth and the Basic Functions of Government
Growth and the Welfare State
5 Labor Market Interventions
Background: A Brief History of Labor Market Outcomes
Assessing the Impact of Government
Collective Bargaining and the Effects of the Tax Transfer System
Wage Compression
Active Labor Market Programs
Temporary and Part-Time Employment
6 Investment and Savings
7 Redistribution
Inequality and Poverty
Impact of Policy on Inequality and Poverty
8 Pressures on the Welfare State
Increased International Mobility of Tax Bases
Spending Pressures
Political Economy
Changing Labor Market Institutions
9 Achievements, Lessons, and the Way Ahead
The Quality of Life in Sweden
Lessons for Others
Sweden: The Way Ahead
Appendix A Primer on Marginal and Average Effective Rates of
   Capital Income Taxation


Introduction and Overview

Sweden has long been regarded as epitomizing the modern welfare state. In fact, the "welfare states" of different countries differ in quite fundamental ways.1 That in Sweden—naturally if somewhat imprecisely referred to as the "Swedish model"—is marked by the use of big, centralized institutions and large-scale transfers, commonly provided on a universal basis (rather than being income related) with a view to reducing inequality, alleviating poverty, and insuring against social risks. The key features of this policy regime, which employs both fiscal and nonfiscal measures, include:2

  • An active and large state with a broad political mandate to intervene in the market process to secure equality of income and wealth distribution at a socially desired level;

  • Highly ambitious social insurance arrangements covering an unusually wide array of risks and providing generous income replacement when they materialize;

  • Relatively little use of means-tested benefits;

  • High levels of taxation and social security contributions, needed to sustain large-scale income transfers and sizable public consumption;

  • Elaborate centralized institutions and structures aimed at facilitating effective cooperation between the private sector and a large, service-oriented public sector, with the latter responsible not only for the financing but also for the provision of most social services;

  • Extensive regulatory and supervisory intervention (especially, but not only, in the labor market);

  • Wages and working conditions set in a framework of centralized bargaining (involving employers and well-organized trade unions, but not directly the government, which participates only in its capacity as employer), aiming for full employment, stable labor income, and peaceful conflict resolution;

  • Extensive public employment, concentrated in health care and education; and

  • A relatively large share of publicly owned enterprises.

The Swedish model has consistently enjoyed solid support from all sections of Swedish society. This support seems to stem both from altruism and self-interest. The former seems evident, for example, in the relative generosity of Sweden's foreign aid program, while the latter is suggested by the pattern of survey responses. There are quite large differences in attitudes, for example, between private and public sector employees, with high-level public employees in Sweden showing more support for the welfare state than do high-level private sector employees. More generally—and not surprisingly—groups with a stronger market position, whether along a gender or class dimension, show weaker support for state intervention. At the other end, the unemployed—the group with the weakest market position—display the strongest support for state intervention. Indeed, similar patterns are repeated throughout the advanced economies, regardless of the nature and extent of welfare provisions.3

The welfare state in Sweden has many impressive achievements. Sweden's quality of life, public health, and educational attainment indicators are among the best in the world.4 The country is politically stable, with high employment and participation rates and remarkably low levels of labor conflict. A high level of economic and gender equality, as well as substantial public support for the creation and preservation of human capital—both key features of the Swedish model—give rise to dynamic advantages that can offset any static efficiency losses arising from the higher public intervention in market processes. These dynamic advantages arise from, among other things: coverage against a wide array of risks not insurable in private markets (not least the risk of being born to poor or less-educated parents); greater use of talent resulting from higher female participation rates and the effective incorporation of minorities and immigrants into the labor market; greater ability to take risks owing to the presence of a strong social safety net; and enhanced intergenerational mobility. A greater degree of public intervention also has the potential to correct additional market failures arising from imperfect competition, asymmetric information, and various externalities. Not least, the pursuit of equality domestically is matched by relatively generous support for developing countries, and a high degree of sensitivity to environmental issues.

But maintaining a very large welfare state may involve substantial economic costs. The tax burden needed to sustain the welfare state in Sweden is among the highest in the world. Owing to the international mobility of capital, the effective burden of this is likely to be heavily concentrated on labor income. As shown in Figure 1, the high levels of direct taxation and social security contributions make the tax wedge on labor almost the highest in the OECD countries. This, together with generous welfare provisions, creates strong disincentive effects on effective labor supply and a sizable black economy, variously estimated at between 5 and 19 percent of GDP.5 The centralized institutions associated with the Swedish model lack flexibility, hampering efficient and timely adjustment to rapidly changing economic conditions. The compressed wage scale—a direct consequence of the centralized wage bargaining regime—may adversely affect work incentives at the high end of the skill distribution and is likely to discourage investment in human capital. Last, but not least, Lindbeck (1997) and several other participants in the academic debate on the Swedish model have argued that its excessive size was causally related to Sweden's relatively weak growth performance since the 1970s, reflected in a marked decline in its ranking by per capita GDP within the OECD.

While it is impossible to pin down the "optimal" size of the welfare state precisely—views on this will reasonably differ both in factual assessments of its effects and in judging its ethical merit—government was generally agreed to have become too big by the late 1980s. The "overshooting" in the size of government of this period—a theme in Lindbeck (1997)—was amplified by demographic developments—Sweden's population was the oldest in the world during the 1980s—and was viewed as an underlying reason for the crisis in the early 1990s, whose proximate cause lay in external shocks and macroeconomic policy mistakes. Despite tax revenues exceeding 60 percent of GDP on the back of a strong cyclical upswing (Figure 2), high and volatile public consumption and transfers (Figure 3) led to large general government deficits (Figure 4) from 1991, and, with the onset of a crisis, to rapidly rising public debt, reaching three-quarters of GDP in the middle of the decade. The resulting surge in budgetary interest payments was coupled with a widespread loss of confidence in fiscal sustainability, precipitating the crisis of the early 1990s. The steady streamlining of government following the crisis was thus seen not just as a short-term correction of avoidable macroeconomic policy mistakes, but as a structural necessity. The large role played by government was also believed to hamper the flexibility of the economy to rebound from shocks. The subsequent less than complete recovery of lost output since the crisis period of the early 1990s, despite relatively rapid growth in the past few years, underscores the need for a renewed streamlining of the welfare state to maintain sustainable high growth.

Whatever its past achievements and difficulties, the future seems certain to hold new challenges for the Swedish way of government. Globalization is changing the context in which the Swedish model operates by limiting its tax-based financing. In the past it was possible to maintain a drastically higher level of taxation to sustain a wide and all-encompassing social safety net and a pervasive role for the public sector in the economy, irrespective of what other countries did. But the fiscal basis for this strategy is being increasingly undermined. The scale and sensitivity of international capital flows make the base for taxing capital increasingly mobile. Rapid technological change, heightened regulatory and tax competition, and the increasing mobility of both commodities and labor pose further threats to budgetary revenues. Pressure can also be expected on the other side of the government's accounts, as the continued aging of the population increases spending needs. The government's ability to promote social objectives through regulatory measures is likely to be similarly constrained by greater private sector competition induced by globalization and deepening European integration.

The purpose of this short book is to review the prospects for the Swedish welfare state in the light of its past accomplishments. This is an important topic not only for the Swedes themselves but also for others who look to Sweden for lessons of what government can, and cannot, do to foster social equality and growth. The Swedish economy has indeed been widely studied, and the welfare state more generally remains a subject of intense debate among both economists and the wider public.6 This book draws on this extensive body of research to provide a relatively brief and accessible overview, and to assess the way ahead for Sweden.

The thrust of our argument is that it is both necessary and possible to streamline the Swedish model while preserving its key elements. Such a modified welfare state can underpin Sweden's competitiveness by building on the economy's existing strengths: effective governance in the public sector; wide-ranging public support for human capital creation, including through broad and efficient provision of education and health care; maintenance of high employment; and solidaristic assistance for the less fortunate at home and abroad to preserve social peace. Sweden's advanced position in the high-technology sector may also provide scope for enhancing public sector efficiency. Significant further strides in deregulation and privatization of state-owned enterprises in competitive markets would boost this process, and could help support the continuation of key elements of the welfare state. Finally, streamlining the Swedish model would involve a welcome reduction in the tax burden and in public spending, which should strengthen the fiscal position in the long run by raising employment, thus contributing to a broader tax base and reducing the need for budgetary transfers.

The book is structured as follows. Chapter 2 surveys the main elements of the Swedish welfare state. Chapters 3 and 4 explore the Swedish growth experience over recent decades and the extent to which it can be related, for better or worse, to the activities of government. Chapter 5 reviews labor market aspects, while the topic of Chapter 6 is investment and savings. Chapter 7 discusses redistribution, a central element of the Swedish model. Chapter 8 surveys various pressures on the welfare state, and Chapter 9 concludes with a short discussion on the future of the Swedish model and on lessons from the Swedish experience for other countries.

Figure 1: Tax Wedge

Figure 2: General Government Revenues

Figure 3: General Government Expenditures

Figure 4: General Government Balance

1Esping-Andersen (1990), for instance, identifies three types of welfare state: the "liberal," characterized by modest and largely means-tested benefits and strong stratification between welfare recipients and others (as in the United States); the "corporatist," concerned largely with preserving status rights and so providing, for example, benefits only loosely related to contributions (as in Germany); and the "social democratic," of which Sweden is the archetype, characterized by a considerable degree of universalism in benefits—provided at a level attractive even to the middle class—and committed to high employment levels both as a right and as a means to finance high benefits.
2Comprehensive accounts of the structure and history of the Swedish welfare state, from a variety of perspectives, can be found in Freeman and others (1997), Lachman and others (1995), Lindbeck (1997) and Lindbeck and others (1994), and OECD (2000).
3See, for instance, Svallfors (2002) and Boeri, Börsch-Supan, and Tabellini (2001).
4These aspects are critical in assessing economic performance. Nordhaus (2002) estimates, for instance, that improvement in health indicators over the past century may have raised welfare by an amount approximately equal to the increase in measured real consumption.
5National Tax Board (2000) and the European Commission (2001) estimate the share of the black economy in Sweden at up to and equal to 7 percent, respectively; the higher estimate is by Schneider and Enste (2000).
6See, for example, Atkinson (1995, 1999).