Capitalism with Scandinavian characteristics

It is a truth universally acknowledged that arguing about the definitions of terms like "capitalism" and "socialism" is a waste of time. So I will simply assert that the world has many flavors of capitalism — U.S./British, Japanese, Scandinavian, German, French/Italian/Southern European and others.

I've known some genuine socialists who favor outright government ownership and control of the means of production, which necessarily means government making all the decisions about what is produced, where it is produced, how it is priced, who gets hired and how much workers get paid.

But most people who talk a socialist game, when asked for real-world examples, tend to sidestep the more extreme (and less attractive) possibilities and point to European countries — in particular, to Northern European countries like Sweden, Denmark, Norway and sometimes Finland.

The genuine socialists I know view these countries as sellouts to capitalism. The Scandinavians themselves are quick to deny that they are socialists, too. For example, the prime minister of Denmark gave a talk at Harvard in 2015 and said:

"I know that some people in the U.S. associate the Nordic model with some sort of socialism. Therefore, I would like to make one thing clear. Denmark is far from a socialist planned economy. Denmark is a market economy. … The Nordic model is an expanded welfare state which provides a high level of security for its citizens, but it is also a successful market economy with much freedom to pursue your dreams and live your life as you wish."

If we want to avoid quibbling over the s-word and instead just refer to a Scandinavian style of capitalism, what are some of its key elements?

The question is tricky, because the Scandinavian style of capitalism has gone through several stages in the last 50 years or so. In a 1997 article, the prominent Swedish economist Assar Lindbeck described how in the decades after World War II Sweden had a growing economy, generous public services, full employment and a fairly equal distribution of income. But this was followed by slower growth in the 1970s and a collapse of full employment and rise of inequality by the early 1990s.

In Lindbeck's words, the Swedish model looked "less idyllic" by the early 1990s. Problems include "disincentive effects, problems of moral hazard and cheating with taxes and benefits, deficiencies in competition … as well as inflexible relative wages … [and] the ever higher ambitions of politicians to expand various government programs, and the gradually rising ambitions of union officials to compress the distribution of wages as well as to expand the powers of unions."

In short, the Swedes themselves didn't think the Scandinavian model of capitalism was working all that well in the 1980s and early 1990s, and they carried out a hardheaded redesign.

For example, there was a broad recognition that as a small, market-oriented economy open to international trade, Sweden needed healthy companies and skilled workers, so top tax rates were rolled back. Many government benefit programs were redesigned and rolled back. A ceiling was put on public spending. Sweden's ratio of national debt to GDP fell from 80 percent in 1995 to 41 percent in 2017.

The U.S. system of capitalism relies on financial incentives to encourage work. In the Scandinavian model of capitalism, high taxes reduce the financial incentive to work but pay for social services that encourage work.

Henrik Jacobsen Kleven described this trade-off in a 2014 article. He calculated that "in the Scandinavian countries … an average worker entering employment will be able to increase consumption by only 20 percent of earned income due to the combined effect of higher taxes and lower transfers. By contrast, the average worker in the United States gets to keep 63 percent of earnings when accounting for the full effect of the tax and welfare system."

But Kleven also points out that the higher Scandinavian taxes finance government policies that make it easier for many people to work — in particular "provision of child care, preschool, and elderly care." He writes: "Even though these programs are typically universal (and therefore available to both working and nonworking families), they effectively subsidize labor supply by lowering the prices of goods that are complementary to working. … [T]he Scandinavian countries … spend more on such [labor] participation subsidies … than any other country. …"

The resulting higher tax burden is substantial. The total tax burden in the Scandinavian countries is almost half of GDP, while the combined spending of all U.S. levels of government is about 38 percent of GDP.

Some in the U.S. claim a Scandinavian level of social protection could be financed by taxing corporations and the rich. The Scandinavians recognized the unreality of that hope back in the 1990s. An October 2018 report from the Council of Economic Advisers (CEA) noted:

"The Nordic countries themselves recognized the economic harm of high tax rates in terms of creating and retaining businesses and motivating work effort, which is why their marginal tax rates on personal and corporate income have fallen 20 or 30 points, or more, from their peaks in the 1970s and 1980s."

In addition, the Scandinavian countries impose a value-added tax of 24 or 25 percent on purchases. (A VAT functions like a sales tax, although it is collected from producers rather than at the point of sale.) The CEA report notes that, as a result, taxation of households in the Scandinavian economies is overall less progressive than in the U.S.

The Scandinavian model of capitalism has more equal economic outcomes. But for advocates for a higher U.S. minimum wage, it's perhaps worth noting that the Scandinavian countries do not have minimum wage laws. However, rates of unionization are typically 70-90 percent of the workforce in Norway, Denmark and Sweden, as opposed to about 11 percent of the U.S. workforce. Negotiating pressure from these unions is a powerful reason for the greater equality of wages and benefits for labor.

Last fall, New York Times columnist Paul Krugman illustrated the greater economic equality in Scandinavian countries by citing estimates of income levels for people at different points in the income distribution. This comparison looks at income after taxes are paid and transfer payments are received.

Below about the 30th percentile of the income distribution, income levels are higher in Nordic countries. This shows both the greater equality of wages and greater government support for economic equality in those countries. (For perspective, the 30th percentile of the U.S. income distribution is roughly $32,000 per year.)

A low-income person at the 10-20th income percentile in Denmark or Finland has an income about 20 percent higher than an American's at that place in the U.S. income distribution. But among middle-income people in the 55th-60th percentile of the income distribution, incomes in Denmark and Finland are 20 percent below those of the similar person in the U.S. income distribution. Overall, average income levels are about 20 percent higher in the United States.

(Health care benefits provided through government programs are not included in the estimates cited by Krugman. The omission is interesting to consider. U.S. health care spending per person is much higher than in other countries. Thus, including it would make U.S. income levels look much higher — and would probably close much of the income gap at lower levels of income.)

In my experience, a number of the features of the Scandinavian system of capitalism come as a surprise to Americans. Here are some additional examples:

• In the early 1990s, Sweden set up its equivalent of the K-12 school system so that parents have vouchers that can be used at public, private and for-profit schools.

• College tuition in the Nordic countries is free to the student. However, college graduates in these countries don't earn substantially higher wages. As a result, Americans are more likely to attend college, even needing to pay for it.

• The Scandinavian countries have national programs of health insurance coverage, but with substantial co-payments. For example, data from the Organization for Economic Cooperation and Development (OECD) suggest that out-of-pocket health care spending is only a little lower in Norway than in the United States.

• Although the Scandinavian countries have greater government regulation of labor markets than the U.S., they tend to have lower levels of regulation for product markets and companies.

• Sweden's social security system is based on mandatory contributions to individual accounts, with people having a wide range of several hundred possible investment options for their accounts, or a default fund mostly invested in stocks.

Whether these various aspects of the Scandinavian model appeal, or not, it's worth remembering what works in one country may not transplant easily.

After all, the combined population of Sweden (10 million) Denmark (5.8 million) and Norway (5.3 million) is roughly comparable to that of the greater New York City metropolitan area, and rather less diverse. The Nordic countries have intimate economic and regulatory ties with the much larger European Union. However, Sweden, Norway and Denmark have kept their own currencies and don't use the euro.

It seems inaccurate to me to label the Scandinavian model of capitalism as "socialism," but arguing over definitions of imprecise and emotionally charged terms is a waste of breath. What does bother me is when the "socialist" label becomes a substitute for actually studying the details of how different varieties of capitalism have functioned and malfunctioned, with an eye to what concrete lessons can be learned.

Timothy Taylor is managing editor of the Journal of Economic Perspectives, based at Macalester College. He blogs at http://conversableeconomist.blogspot.com.