The Nordic Model - Embracing globalization and sharing risks

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Public finances are presently recorded as having a large surplus – yet public finances are under present policies unsustainable in the long term increase from just below 2 to over 6 per cent over the same time period. Figures are broadly similar (though somewhat less alarming) for Denmark and Sweden. Accordingly, dependency ratios will start increasing dramatically from around 2010. Obviously, the balance between those contributing to and those benefiting from the welfare state is shifting to such an extent that these demographic trends are putting the financial sustainability of the system in danger. In the absence of corrective measures Finland’s general government budget surplus will – according to calculations made in the Ministry of Finance – turn into a growing deficit (and public debt could amount to 120 per cent of GDP by 2050). The projection (which is no forecast) brings home the message that public finances are unsustainable in the long run when assessed in the light of current spending programmes and tax rates. Somewhat paradoxically, the general government finances are presently recorded as being in a large surplus, yet are deemed to be unsustainable in the long run unless significant action (corresponding to at least 1–2 per cent of GDP) is undertaken to improve the budget on a permanent basis. 1.5 MANY PROPOSED “SOLUTIONS” ARE UNWORKABLE More rapid growth will not solve the sustainability problem of public finances In public discussion there have been a number of suggestions as to how these challenges can be handled. Unfortunately, many of those suggestions turn out to be non-workable on closer inspection. We will deal here with some of these not-so-helpful reform proposals and explain why they do not work. Economic growth. One of the most common proposals for solving the fiscal sustainability problem of the Nordic model is to undertake measures to raise the overall rate of GDP growth. The suggestion appeals to common sense: by “baking a bigger pie” we could get enough tax revenues and other resources to handle the increasing demands on the welfare state. Yet a little reflection reveals that economic growth per se does not solve the problem, and might even aggravate it. It should be emphasized that we are Introduction and summary · 21
not contesting economic growth as the key to higher living standards in the future. But however desirable growth is, it is unlikely to resolve the financial dilemma of the welfare state that we see looming in coming decades. Growth of GDP is mainly achieved via increased productivity in the production of goods, while productivity change in the provision of many services is lagging behind. Nevertheless, higher private sector productivity will raise real wages not only in the private sector but in the whole economy, including in the public sector (as a consequence of market forces and/or wage coordination by unions). Though growth increases tax revenues, it also raises the public sector wage bill. In addition, political pressure will normally prevent public pensions and other transfer payments from falling permanently behind general income developments. Finally, higher incomes are likely to increase the demand for publicly provided welfare services. The overall result may, therefore, be that more growth leads to a deterioration rather than an improvement in public finances. It can help public finances only under the dubious or unrealistic assumption that public sector wages and/or transfers are allowed to fall permanently behind general income developments. Higher taxes. Technically, the fiscal sustainability problem can be solved by sufficient increases in tax rates, either now (for “tax smoothing” reasons) or later when deficits would otherwise start to materialize. However, tax increases can solve the fiscal problem only under the assumption that they do not negatively affect the size of tax bases – or at least that such effects are quite small. We do not believe that this assumption is realistic in economies which already have quite high tax rates and which operate in an increasingly globalized environment. Higher tax wedges would lead to further substitution away from taxed activities (like work in the regular sector) to untaxed activities (like leisure, household production and work in the “informal” sector). They can also have detrimental effects on entrepreneurship, saving and capital accumulation – and thereby on economic growth. In the longer run, internationally mobile tax bases, like highly skilled labour, will spend an increasing proportion of their activity in jurisdictions with a lower tax burden. Growth increases the tax base and tax revenues – but also the public sector wage bill and transfers as well as the demand for welfare services Higher overall tax rates are no longer a realistic option 22 · The Nordic Model
Page 1 and 2: The Nordic Model Embracing globaliz
Page 3 and 4: ETLA B232 ISBN 978-951-628-468-5 IS
Page 6 and 7: THE AUTHORS Torben M. Andersen is P
Page 8 and 9: CONTENTS PREFACE THE AUTHORS 1 INTR
Page 10: 8.5 The future of public services -
Page 13 and 14: Globalization is primarily an oppor
Page 15 and 16: ices financed by taxes, which are h
Page 17 and 18: 14, respectively, out of a total of
Page 19 and 20: are the effects of technical change
Page 21: - and, particularly, their effect o
Page 25 and 26: 1.6 AN EFFECTIVE WAGE BARGAINING PR
Page 27 and 28: etter be tried in individual cases
Page 29 and 30: The scheme of the social contract c
Page 31 and 32: is worthy and realistic. But the de
Page 33 and 34: supportive interaction of openness
Page 35 and 36: The financial deregulations in the
Page 37 and 38: horizontal axis). These indices are
Page 39 and 40: does can nowadays be seen, in a bro
Page 41 and 42: employment increases in the public
Page 43 and 44: are not at the top of the league, t
Page 45 and 46: ENDNOTES 1 Wikipedia refers to popu
Page 47 and 48: consider employment and productivit
Page 49 and 50: from the mid-1980s. Finland has gra
Page 51 and 52: % 7 6 5 4 3 2 1 0 IT expenditure, %
Page 53 and 54: As technological change is to a sig
Page 55 and 56: 3.3 SOCIAL EQUALITY Economic effici
Page 57 and 58: 0.9 0.8 0.7 Net Fin Den 0.9 Composi
Page 59 and 60: ANNEX: GROWTH ACCOUNTING The Nordic
Page 61 and 62: sources of GDP growth in the EU15,
Page 63 and 64: 11 These decompositions have been c
Page 65 and 66: 4.1 THE WELFARE STATE AS A SOCIAL C
Page 67 and 68: The extent, coverage and quality of
Page 69 and 70: % % 80 80 60 60 40 20 0 OECD max Fi
Page 71 and 72: % 80 Total Old age % 80 60 60 40 40
Page 73 and 74:
tem is seriously affected. Today, t
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Historically, however, the share of
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More children. Since the problem is
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Actually higher growth may make the
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dependency ratio driven by the baby
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82 · The Nordic Model
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to handle much bigger fields today,
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Table 5.1 Projections of public hea
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5.4 AN EASY FIX - BRING SERVICES BA
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Box 5.1 Growth and the welfare stat
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it implies that the long-run defici
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The level of taxation is already hi
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One may ask why this problem arises
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globalization may contribute to bot
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able to pay to seek private solutio
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102 · The Nordic Model
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ily policies that Nordic demographi
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absolute and relative terms than hi
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in the participation decision of th
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Table 6.2 The activity rate, aggreg
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Thus, responsible unions should res
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als take part in various unemployme
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Box 6.2 What is the Danish “flexi
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ENDNOTES 1 In his history of the ec
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particularly noteworthy in a euro a
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7.2 COORDINATION AND DECENTRALIZATI
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also depends on the business cycle.
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ut not in any dramatic way (cf. fig
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displays higher nominal rigidity th
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model stem from an age in which the
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mostly in the years 1980-2000. For
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Table 8.1 Government expenditure by
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ure. This selection bias alone will
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that everyone gets their worth as m
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8.3 THE CASE FOR GOVERNMENT PROVIDE
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maximizing firms tend to focus exce
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than zero based budgeting) are impe
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sectors, place at or above the medi
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The demands for objectivity limit w
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assessed case by case. The importan
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c. Vouchers Vouchers are issued by
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mechanically in the political debat
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ENDNOTES 1 The private sector inclu
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The biggest hurdle to overcome for
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ment has a higher return when spent
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REFERENCES Adema, W. and Ladaique,
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Jonung, L. and Hagberg, T. (2005):
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Is there a Nordic model? What are t
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