How Government Cutbacks Ended Sweden’s Great Depression
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How Government Cutbacks Ended Sweden’s Great Depression

How Government Cutbacks Ended Sweden’s Great Depression

Published on Wednesday, 25 December 2013 11:47

Written by C Per L. Bylund, PhD

During the recent financial crisis, Sweden has emerged as one of very few financially sound economies. The country’s strong position, setting it apart from most Western nations, makes it an interesting example of what could — or should — have been done. Indeed, Paul Krugman, the former economist and Nobel Prize laureate, has repeatedly pointed approvingly at how the Swedes handled their depression in the early 1990s as the reason for their recent success.sweden

Specifically, he notes the nationalization of some banks at the time of the crisis. While he misses the point by focusing exclusively on a narrow selection of short-term measures rather than longer-term changes, as is the hallmark of a Keynesian, Krugman is right that Sweden has done some things right.

In September of 1992 the Riksbank, Sweden’s central bank, raised the interest rate to 500 percent in a vain attempt to save the fixed exchange rate of the Swedish krona (Sweden’s currency). This drastic measure was taken in conjunction with large spending cuts and tax increases to address the free-fall of the nation’s economy. The economic meltdown was the culmination of two full decades of decline, and it fundamentally changed the political situation in Sweden.

Since 1992, Sweden has, across the board, seen consistent government cutbacks while increasing restrictions on welfare policies, deregulating markets, and privatizing former government monopolies. The country has instituted an overall new incentive structure in society making it more favorable to work. The national debt tumbled from almost 80 percent of GDP in 1995 to only 35 percent in 2010.

In other words, Sweden successfully rolled back its unsustainable but world-renowned welfare state. Despite Krugman’s wishful thinking, this is the real reason for Sweden’s success in riding out the present financial crisis.

The Rise and Fall of the Welfare State

Sweden experienced a century of high economic growth from approximately 1870 to 1970, which literally made one of Europe’s poorest countries into the world’s fourth-richest. The first half of this period of growth was marked by extensive free-market reform, and the latter half is notable for Sweden’s staying out of both world wars and thus benefiting from intact industrial infrastructure when the rest of Europe lay in ruins. While a welfare state was established and expanded during the post-war period, it was generally built around capitalist institutions and therefore had limited impact on economic growth.

But the political situation changed. The 1970s and 1980s saw a welfare state run amok with a greatly expanded scope with new government benefits, the introduction of very rigid labor market regulations, active propping up of stagnating sectors of the economy, and drastic increases in tax rates with some marginal rates in excess of 100 percent. In an attempt to fully nationalize the economy, löntagarfonder (“employees’ funds”) were instituted in 1983 to “reinvest” private companies’ profits in stock ownership and to be administered by the national labor unions.

During this period government deficits abounded and the national debt increased almost ten-fold from 1975 to 1985. Sweden also saw high price inflation, a situation aggravated by repeated devaluations of the currency’s exchange rate to boost exports: in 1976 by 3 percent; in 1977 by 6 percent at first, and then an additional 10 percent; in 1981 by 10 percent, and in 1982 by 16 percent.

Overall, the rapid expansion of the welfare state can be illustrated by the ratio between tax-financed and private-sector employment, which rose from 0.386 in 1970 to 1.51 in 1990. Sweden was heading for disaster.

via How Government Cutbacks Ended Sweden’s Great Depression | Economics | US – Right Side News.

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