Sweden – from Macroeconomic Failure to Macroeconomic Success

A nice paper by Lars Calmfors of Stockholm University.

Just 20 years back Sweden was going through a major crisis. And now it is much better off.

Sweden has recently come to be seen as an example of macroeconomic success. This largely reflects the strong public finances which place Sweden in a very different situation than most other EU countries. But there was also only a limited deterioration in labour market conditions in 2009-2010 and output as well as employment picked up more quickly than in most other European countries after the downturn. Taking a more long-term outlook, output has grown faster in Sweden than in the euro area over the last fifteen years.

The recent macroeconomic success of Sweden stands in stark contrast to the situation in the early 1990’s. Sweden then suffered a deep economic crisis, with large falls in output and employment and soaring government deficits, much like the current situation in, for example, Ireland and Spain. This crisis came on top of a long period of stagnating growth in the 1970’s and 1980’s. Hence, in the mid-1990’s, Sweden was considered to be a macroeconomic failure.

The paper shows the journey from failure to success:

Major economic reforms have been carried through in Sweden during the last two decades. Most of the reforms have been made in response to long-standing rather than to acute problems. There has usually been a strong perception among economists, policy makers and the general public of the problems that the reforms have sought to address. Reforms in other countries have sometimes provided inspiration. Most of the reforms were based on a broad political consensus. A heavy input from economic research has often been used as a basis for change.

The paper points to the importance of devaluation of currency post crisis:

Naturally, the higher growth immediately after the recession in 1991-1993 mainly represents a normal recovery phase. However, a crucial factor for the swift recovery was the large real exchange rate depreciation that took place (see Figure 6). Between 1991 and 1993, relative unit labour costs decreased by 20 per cent. The main explanation was a nominal exchange rate depreciation of around 17 per cent. This reversed the real exchange rate appreciation that occurred in the 1980’s.

….Thus, Sweden provides a vivid illustration of the importance of swift real exchange rate depreciations for economies caught up in a situation with large fiscal deficits, low output growth and an appreciated real exchange rate. Without a real exchange rate depreciation, tax rises and government expenditure cuts are bound to reduce aggregate demand and output. Hence, tax revenues will fall and the fiscal consolidation will be very slow. This is the current predicament of the most crisis-ridden euro countries. They are not able, as was Sweden in the 1990’s, to achieve export-led growth in the short run, since a large real exchange rate depreciation within the eurozone requires a fall in nominal labour costs, which can only be achieved after a lengthy period of high unemployment

The author talks about following reforms:

  • Tax reform
  • Deregulations of product and service markets
  • Reforms of wage bargaining
  • A new fiscal framework
  • A new monetary-policy framework
  • General labour market reforms

Apart from discussing the various reforms, he looks at the approach from various angles:

1. To what extent have the reforms been responses to long-standing problems and to what extent to acute crises?
2. How have the problems motivating the reforms been perceived by public opinion, by policy makers and by economic experts?
3. How important have international influences been and to what extent have reforms represented new thinking and to what extent a return to earlier principles?
4. Have the reforms been based on a political consensus or have they been carried through by the political majority against the will of the opposition?
5. How has the resistance from various vested interests been overcome?
6. Have the reforms had the character of shock therapy or have they been introduced gradually?

Answers to these questions:

  • There is only limited support for the hypothesis that fundamental reforms require a deep economic crisis. Instead, most of the reforms in Sweden have been responses to long-standing problems rather than to acute crises.
  • In most cases, there has been a strong perception among economists, policy makers and the general public of the problems that the reforms have sought to address.
  • International developments have been important inspirations for many of the reforms. This holds true above all for the product and service market deregulations.
  • Most of the reforms have been based on a broad political consensus. This is true for the tax reform, product and service market deregulations, the pension reform, the central bank reform and the establishment of a stricter fiscal framework.
  • The Swedish experiences illustrate a number of ways of overcoming resistance to reforms from vested interests. The Swedish experiences illustrate a number of ways of overcoming resistance to reforms from vested interest. They include compensating transfers to potential losers (in the case of tax reform), strong ex-ante commitment (sometimes with the help of cross-party agreements or EU rules as discussed above, sometimes − as with the general labour market reforms − with the help of widely publicised pre-election promises), and complexity of the reforms making it difficult for the general public to see through them (as was probably the case with the pension reform). 

The vested interest bit is interesting from Indian perspective..However, the context etc is very different..

Nice overview..

What is interesting to note is how both India and Sweden had a crisis almost at the same time…We continue to have similar problems faced back in 1990s whereas Sweden has overcome them. Yes, I am fully aware that they are not comparable and it is a case of apples and oranges..

However, the point is Sweden did graduate from being a rotting apple to a shining one…We remain  an orange which has great juicy potential but remains a low juicy variety…

 

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