The Welfare Model in Crisis (and what not to do about it)

January 27, 2017

Author Articles, Health, Politics Public Policy, Public and Social Policy, Public health, Public management

Mårten Blix examines the impact of technology and immigration on welfare systems.

Ostensibly, the Swedish Welfare State stands strong. While polarization is wreaking political havoc across both sides of the Atlantic with the election of Trump in the US and with Brexit in the UK, perhaps generous welfare systems with low inequality could provide a beacon of hope? Cannot the Welfare State uphold social cohesion and prevent populists from taking over?

Table. Comparing Sweden’s crisis in the 1990s with 2017.

Note: See my book for a full explanation of this table.

On the surface, it would appear that Sweden is doing well. This is especially the case for the macroeconomy, for which successful institutional reforms in the 1990s turned the country around from a near-abyss experience. Public debt was at the time spiraling out of control and Sweden faced a humiliating exit from the fixed exchange rate with Europe. The krona could not even be saved by the Riksbank’s extraordinary 500 percent interest rate hike in the autumn of 1992.

From the late 1990s, the economy turned around. Sweden’s prosperity showed a remarkable upswing. Growth returned and inflation was pushed back into the box (perhaps a little too strongly). From being one of the weakest fiscal systems in the OECD, it is now one of the strongest: Public debt is among the lowest in the OECD.

By contrast, inside the economy of the Welfare State, serious problems remain unaddressed, especially in the housing and in the labor markets. This matters greatly for the Welfare State. The country may already be in pre-eruption mode and social cohesion, stable for so long, is showing increasing strains. The riots in the Stockholm suburb of Husby in 2013 with looting and burning cars may well be a preamble to much worse strife down the road.

New challenges stem from the effects of digitalization and immigration. The combination will become a perfect storm for the Welfare State, as I discuss in my new book Digitalization, Immigration and the Welfare State.

Powerful forces are in play. Low inequality has long been the Welfare State’s signature policy but it is set to increase dramatically as immigrants will find it hard to get jobs in a country with the highest minimum wages in the world. The wage levels are governed by agreements in collective bargaining agreements between the unions and the employer organizations. With the blue collar union losing members, it has little incentive to agree to lower wages for immigrants, fearing that these could spill over to its members. In this the union might be right, but research is inconclusive. In my assessment, the overall result would crucially depend on the details of the reforms. Any change, however, remains unlikely.

What is not in doubt, however, is the political sensitivity of the issue.

As for the effects from digitalization: it implies that some work bypasses the collective wage bargaining agreements on which the entire labor market rests. Platform-based labor markets, such as Uber or Upwork, directly link the worker with the person paying for the task, thereby ignoring the established institutions. This together with the automation of work is upsetting the fragile status quo in the labor market. The influence of the unions and the employer organizations could continue to wane, leading to an erosion of the wage norm that has helped Sweden remain competitive.

Digitalization will also gradually prove challenging for public finances: costs are on the increase across several spending areas (care of the elderly, health care, infrastructure, defence, and immigration) while revenue sources from labor will be harder to uphold. Automation and gig work makes it possible to reduce regular labor and use machines in many more ways, resulting in even stronger job and wage polarization. While this is problematic for all countries, the Welfare State is especially vulnerable as it already has among the high taxes on labor income in the world.

In 1992, the Lindbeck Commission gave the country a blueprint for reform. Could a similar commission repeat that feat?

I argue that the situation in the present day is much more dire, with no easy quick-fix in sight. A modern day Lindbeck Commission would face an entirely different – or even hostile environment. For one, the left and the right political blocks lack basic agreement on what the challenge is – much less how to tackle it. Moreover, the policy-levers to improve the integration of immigrants are mostly in the hand of the employer and union organizations, not the government.

To make matters worse, basic security is slipping. There are already 53 no-go zones in Sweden identified by the police where gangs rule and the rule of law is absent. The police in Sweden are few in numbers compared to other countries of similar size as well as being poorly managed. In the city of Malmö, cars burn and murders are rampant. The citizens might be forgiven for asking what value for money the high tax rates bring when basic security is failing and the state is not fulfilling its basic night watchman duties.

Sweden’s strong performance on the macroeconomic front can no longer disguise cracks in the Welfare State. Timid tinkering within existing programs is unlikely to result in an immediate crisis for the Swedish Model. But postponing necessary changes cause much harder choices further ahead. The stakes are high and ultimately, the future of the Swedish Welfare State hangs in the balance.

Mårten Blix has a Ph.D. in Economics and is former secretary of the Commission on the Future of Sweden. He has worked in various management positions at the Riksbank, at the Ministries of Finance and Enterprise, and been expert at the European Central Bank.
www.martenblix.com or www.ifn.se/eng.