16 Oct 2012

The surprising renaissance of the Nordic model

By Juhana Vartiainen, Director General, Government Institute of Economic Research, Helsinki, Finland

During the Cold War, the opposition between Communism and liberal democracy dominated Western politics. Liberal democracy eventually won the big contest of ideas, but there has been another Cold War winner, too: the Nordic welfare state. Nordic societies have been able to combine the best elements of market liberalism and European socialism to produce wealthy yet egalitarian societies. Time after time, the Nordic countries emerge on top of international rankings, both in quality of life as well as in overall material well-being.

This success has also become acknowledged in the international economic policy discussion. Under the Cold War, there was less room for nuances. Communists tended to see Nordic social democracy as class treason, whereas rightwing politicians were suspicious of the Nordic welfare state as a halfway station to communism.

From the 1990s onwards, a remarkable change of perspective has taken place. Nowadays, mainstream business papers such as the Financial Times heap praise on Nordic economic policies. Even the economics profession increasingly seems to like the Nordic states. And why not? Many studies indicate how market-friendly the Nordic societies are. As small and open economies, they have always been pro-trade and suspicious of protectionism. Yet, in European comparison, they also display less product market regulation and a greater appetite for privatisation than many other countries. True, they have regulated labour markets and strong unions, but even there the outcomes seem benign: encompassing collective agreements restrain local industrial conflicts and provide tools for effective labour market adjustment.

Furthermore, few economists fail to notice how most Nordic countries have been able to implement sustainable fiscal policies as well as credible monetary arrangements – precisely as economic textbooks would advocate.

Be open but share the fruits of openness

The modern view is that the Nordic welfare state works in tandem with the market economy, not against the market economy. In short, the Nordic countries have understood that international openness is the only guarantor of material well-being; but, in contrast to many other countries, they also have understood that the continued success of pro-market policies requires popular consent. This means that the fruits of openness must be shared between citizens. The Nordics want to use the global economy to become wealthy, but they also pool the risks and share the fruits of this inherently risky undertaking.

Learning from one’s mistakes

Another ingredient of success is policy experimentation. Many scholars have seen the Nordic economic model as a set of fixed institutions like high taxes, ambitious redistribution, strong unions and state-provided basic services. Yet Nordic history suggests that remarkable policy reorientations have taken place even as the general pursuit of material well-being and egalitarian objectives has remained unchanged.

For example, in the 1960s and 1970s, economic redistribution was sought by extremely solidaristic wage policies, in Sweden in particular. This means that low-wage groups did get systematically higher pay increases than high-wage professionals. This ambitious wage compression, however, was clearly at odds with the allocative function of the labour market. It led to a crisis and a breakdown of centralised pay bargaining. since then, Sweden has gradually implemented rather individualistic and decentralised pay bargaining, while redistribution is mostly taken care of by taxation and the provision of welfare services.

Another broad reorientation is the turn of labour market policies and social policies towards activation, i.e. fewer transfers and more emphasis on measures that push and even cajole individuals into employment. The Danish “flexicurity” policies, as well as Swedish labour supply measures during the 2000s, are prime examples of this approach. Even here, we see a rational response to an economic challenge: the Nordic countries get older, and the fiscal sustainability of the welfare state can only be ensured if employment and participation rates are high. The Nordic model provides a great package of services to its citizens, but it cannot let them get away with too many leisure years.

Challenges ahead

What about threats and challenges? Nordic success can breed complacency. Yet there are grounds for some optimism as to the continued success of the Nordic countries. With their low level of corruption, decent infrastructure, generally competent education systems and an acceptance of the market economy, they cannot but be winners in a global economy full of opportunities.

The Nordics are not all alike, however. Sweden and Norway display very solid economic fundamentals, with no sustainability problems, to speak of, in their public finances. Finland, however, has been less proactive in adjusting to the current demographic shock. Painful decisions on the retirement age remain to be taken, and the country generally lags behind the other Nordics in the employment rate of senior groups.

In my view, the main threats and challenges of the Nordics are internal and related to the political support of responsible policies. Firstly, as mentioned, a deterioration of the dependency ratio requires a stringent approach to labour market policy. Such activation policies contradict the values of many workers and trade union members who then may become attracted to populist anti-immigrant parties. Another factor that may undermine the political support of responsible policies is excessive executive pay. Lastly, the integration of young people as well as immigrants into the labour market is a continuous challenge. The Nordic countries need immigrants to keep their economies growing and their welfare states robust. In none of them, however, is the labour market integration of immigrant youth completely satisfactory. There is ample need for the Nordics’ ability for social innovation even in the future.

Juhana Vartiainen

Juhana Vartiainen

Director General, Government Institute of Economic Research, Helsinki, Finland

Photo: Arild Moen