Sachs sings the praises of Scandinavia

If you listen to the Fraser Institute or like-minded think-tanks on the right, high taxes kill incentives to work and invest. They argue that Canada needs to lower its taxes in order to produce higher rates of economic growth. By their logic, the Scandinavian countries, all of whom have levels of taxes relative to GDP substantially higher than Canada’s, ought to be utter basket cases economically.

But this is not the case. In addition to providing top-notch public services, poverty rates are very low by Canadian standards, and these countries consistently appear at the top of the league tables when looking at economic competitiveness (as reviewed by organizations like the World Economic Forum’s Global Competitiveness Report).

In a recent column for Project Syndicate, Jeffrey Sachs weighs in on the oft-ignored Nordic countries:

Lessons From the North
Jeffrey D. Sachs

Fewer debates over economics would be needed if the world spent more time examining what actually works and what does not. Almost everywhere, debate has raged about how to combine market forces and social security. The left calls for an expansion of social protection; the right says that doing so would undermine economic growth and widen fiscal deficits.

But the debate can be moved forward by examining the successful economies of Denmark, Finland, Iceland, the Netherlands, Norway, and Sweden. While no regional experience is directly transferable, the Nordic countries have successfully combined social welfare with high income levels, solid economic growth, and macroeconomic stability. They have also achieved high standards of governance.

To be sure, there are also differences among the Nordic states, with social welfare spending the highest in Denmark, the Netherlands, Norway, and Sweden, and a bit lower in Finland and Iceland. Nevertheless, whereas the taxes at the national level in the United States are equal to around 20% of GNP, in the Nordic countries the ratio is more than 30%.

High taxation supports comprehensive national health care, education, pensions, and other social services, resulting in low levels of poverty and a relatively narrow income gap between the richest and poorest households. In the US, the poorest 20% of households receive just 5% of total income, putting their income at around one-fourth of the national average. In the Nordic countries, by contrast, the poorest 20% of households receive nearly 10% of total income, putting them at roughly one-half of the national average.

American conservatives argue that a large public sector is subject to inefficiency and mismanagement, corruption, and bureaucratic abuse, while the taxation needed to support it blunts economic efficiency. But each of these propositions is refuted by the Nordic experience.

Consider the claims of inefficiency and waste. As a result of government-funded national health insurance, the Nordic countries have a higher life expectancy and a lower infant mortality rate than the US. Life expectancy is close to 80 years in the Nordic countries, compared to 78 years in the US, where the government does not guarantee national health insurance and millions of families are too poor to pay for it on their own. Ironically, the heavy reliance on the private sector in the US system is so inefficient that Americans pay a larger share of GNP for health (14%) than do the Nordic countries (11%), but get less.

Similarly, although social welfare spending is lower in the US than in the Nordic countries, its budget deficit as a share of national income is much larger. The US spends less in the public sector, but it taxes even less than it spends.

Nor has high taxation in the Nordic countries impeded economic performance. Rather than relying mainly on income taxation, as in the US, the Nordic countries rely on value-added taxation, which provides a relatively high amount of revenue with relatively low rates of evasion and few distortions to the economy.

The Nordic experience also belies conservatives’ claim that a large social welfare state weakens incentives to work and save. National saving in the Nordic countries averages more than 20% of national income, compared to around 10% in the US.

Moreover, economic growth in the Nordic countries has been similar to that in the US in recent years. Income levels are higher on average in the US, but mainly because the Nordic countries work fewer hours per week. In any case, all of the Nordic countries have very high incomes, and Norway’s per capita income actually exceeds the US.

Several factors appear to explain the Nordic countries’ economic success. Taxation is broad-based and relatively non-distorting, while open international trade, market forces, and private ownership of industry are relied on to maintain incentives. The Nordic countries are not “socialist” economies, based on state ownership and planning, but “social welfare” economies, based on private ownership and markets, with public provision of social protection. Importantly, they invest heavily in higher education and in science and technology, so they remain at the cutting edge of high-technology industries.

Half a century ago, the free-market economist Friedrich von Hayek argued that a large public sector would threaten democracy itself, putting European countries on a “road to serfdom.” Yet the Nordic states have thrived, not suffered, from a large social welfare state, with much less public-sector corruption and far higher levels of voter participation than in the US. According to Transparency International, the Nordic countries have the world’s least corrupt political systems (with Iceland and Finland ranking as the least corrupt), while the US, with its big money politics, is fairly far down on the list.

But how replicable are the Nordic successes? These countries have small populations, easy access to international trade, natural resources, and peaceful neighbors. Most notably, they are ethnically homogeneous, so that social divisions are more amenable to compromise. However, this means that the challenge of maintaining a strong social welfare state in ethnically and racially diverse societies such as the US is not economic, but one of promoting respect and inclusiveness.

Jeffrey Sachs is Professor of Economics and Director of the Earth Institute at Columbia University.

Copyright: Project Syndicate, 2006.