The Danish Model – don’t try this at home

I write this blog in English since it might be of interest to an international audience. The reason I think it might appeal to a broader international audience is that I am increasingly, both in Denmark and abroad, being met by the claim that Denmark somehow is proof that a gentler socialism is preferable to free market capitalism, promising more happiness, greater wealth or both. Recently, the Democratic contenders to become the presidential candidate of their party, Bernie Sanders and Hillary Clinton, were declaring their love for the Denmark. I came across the rising attraction of the model myself at the Greek Emergency Summit i Athens, Greece, earlier this year, and I gave a talk on it at the Student for Liberty conference in Sofia last month. My advice was: Don’t try this at home; at least until you understand what the Danish Model is about.

The first thing to realize is that Denmark, as are the other Nordic countries, quite free markets, apart from their welfare state transfers and high government consumption. They tend to get rather high rankings on measures of the most free economies in the World. Denmark is thus number 22 on the Economic Freedom of the World (EFW), published by Fraser Institute et al, and number 11 on the one publish by the Heritage Foundation. It is number 3 at the World Bank “Doing Business”-list.

EFW

In the table you can see the Danish scores on the five sub-indices of the of the EFW index. The high tax revenue, marginal tax rates and government spending related to the welfare state earns Denmark a very low rank on the Index related to size of government, but on the other indices we are quite high, in some cases in the top ten. Protection of property rights and the integrity of the legal system are very high by international standards, as is the soundness of the monetary system (with the Krone being pegged to the Euro or Deutch Mark for more than 30 years). Being a small country very dependent on international division of labor and comparative advantages, Denmark has a long tradition for free trade with the outside World (nowadays the trade regime is to a high degree decided by the EU). Also when it comes to regulation, Denmark scores quite well. Credit markets are among the less regulated internationally. During the recent financial crisis, tax payers did not have to subsidize banks, and some banks were allowed to fail. The Danish labor market is very flexible: There is no legislated minimum wage, and there are few restrictions on hiring and firing. The overall labor market EFW score is, however, dragged down by the existence of conscription. Finally, Denmark is the most uncorrupt country in the World according to Transparency International.

The second thing to realize is that Denmark did not become a rich country recently. If you consult the figure, you will see that Danish per capita GDP relative to other countries reached a maximum 40-60 years ago (ignoring the ‘noise’ from the Great Depression and WW2). Denmark caught up to and overtook “old Europe” in the fifties, while it narrowed its gap to the US and other Western offsprings until the early 1970s, when the process of catching up came to a hold. The Danes are still not as rich as the Americans.

danish GDP

At the time Denmark became rich relative to the rest of the World, it was not a welfare state. In fact, Denmark has historically been a low tax country by international standards. Until the 1960s, the Danish tax revenue to GDP ratio was at the same level as the US, and lower than the British. The sharp divergence in the Danish tax level really occurred in the second half of the 1960s, when first a left wing coalition government and then a right wing one increased the tax to GDP ratio by some ten percentage points.

skattetryk

Interestingly, government spending was to a large extent driven by increases in tax revenue stemming from the introduction of VAT and withholding taxes on wage income.

The 1970s saw a strong tax revolt, as Mogens Glistrup’s newly formed Progress Party became the second largest in the 1973 “landslide” election. Nevertheless, spending kept growing as the welfare state attracted new clients and new programs were added, the economic crisis lead to increasing unemployment and attempts were made to combat the crisis by expansionary fiscal spending. By the early 1980s the economy was in very bad shape, with high unemployment, an inflationary deflation spiral, a huge and widening government deficit, and strong concerns over the wide external deficit. All governments since the right wing government, which came to power in 1982, have implemented structural reforms of the welfare state and tax system, reducing welfare state “generosity” and cutting marginal tax rates, as well as consolidating public finances.

So, Denmark first became rich, and then introduced the programs, which make up the welfare state. The huge increase in government spending has been accompanied by deep structural problems, which has made it necessary to reform the Danish economy and welfare state ever since. It can hardly be claimed that introducing the welfare state made Denmark rich; rather it was the other way around. Denmark first became rich, and then authorities began to redistribute some of the wealth.

deaton happy

But what about the apparent happiness in Denmark? Maybe material wealth doesn’t matter that much if you are satisfied with your life. If fact, life satisfaction and income are quite correlated both across country averages and across individuals within a country, as pointed out by the comprehensive study of the literature by Stevenson and Wolfers. (2015 Nobel laureate in economics, Angus Deaton, has made the same point, cf. the figure). They reject the so-called Easterlin’s Paradox, which saw only a between and not a within country correlation, and thus could be interpreted as a case for redistribution: If redistributing from the rich to the poor didn’t make the rich less happy, redistribution could increase ‘gross national happiness’. And in that case welfare state redistribution could be the reason for the Danish World record in self-reported happiness.

Alas, Denmark is no longer the happiest country in the World, having been overtaken by the low taxed Swiss in the latest survey. And more importantly, as pointed out, Easterlin’s Paradox is not supported by the literature. The most important reason for the Danish happiness level is probably the high income level. Futhermore, as pointed out by Christian Bjørnskov, a high level of trust also seems to increase life satisfaction, and, as Danes are quite trustful, that might play a role here too. Again, the high level of trust preceded the Welfare state in Denmark rather than being caused by it.

In many respects, Denmark could serve as a model for the World (just like most other countries). But if you fail to learn the right lessons, it could be dangerous to try to imitate our model. Especially the idea that you can become rich by redistributing wealth or that there is a gentler way to socialism than the one experienced by typical socialist countries in general could get you into trouble.

And it would certainly be ironic, if the Danish case were to become an excuse for politicians in e.g. Greece or the US to avoid economic reforms, and fiscal consolidation, since we have been reforming and consolidating for decades to handle the problems created by the introduction of the welfare state.

14 tanker om "The Danish Model – don’t try this at home"

  1. Lars

    You could have written almost exactly the same narrative about Norway – and Sweden. Excellent work!

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  2. Andrew Carey

    Marvellous writing. Denmark is a country of extremes – the most popular European country to cycle, the fewest adults in their 20s living with their parents, and the most expensive cake. Maybe these are connected to the happiness.
    But as always, describing a satisfactory destination is not the same as describing the journey. Thank you for some interesting economic history.

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  4. Walter Sobchak

    Thanks for the information. The chart historical tax burden understates the US tax burden because it does not include taxes impoosed by state and local governmnets. I think the total is more like 35%.

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  5. JWJ

    Two other keys point is the incredible level of homogeniety among the relatively small population of 5.6M. What is possible amount 6M might not work for 350M.

    The other is the small amount (at least relative to the US) Denmark (and pretty much all Western European countries) spends on national defense at about 1.3% of GDP vs the US level of around 3.5%.

    Svar
  6. kennycan

    The Krone was pegged to the DEM and now to the Euro. The Euro is now undertaking massive QE programs and ZIRP. Are you comfortable that your “sound” money ratings will remain as long as you keep your Euro peg? After all, Switzerland became concerned about their appreciating currency and pegged to the Euro, only to find that the interest rate cuts and SFR printing needed to maintain that peg were doing more harm than good. So they recently broke the peg after a few years experiment. Perhaps Denmark should peg to the SFR? 8>)

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  7. Gordon

    Thanks for writing this.

    One of the other things that has to be understood is that Denmark’s success takes place in a country smaller than several of the US states, with a very homogeneous population. That level of trust simply doesn’t exist in the US, with our wide range of ethnicities.

    When someone pointed out that Sweden has very little poverty to Milton Friedman, he replied that there was very little poverty among US Swedes, as well. The US state of Minnesota is a good example: settled by Germans, Norwegians and Swedes, with a few Finns, Minnesota had a strong work ethic and traditions of thrift and probity. Then, in the mid-1970s, generous welfare programs were created.

    This drew in the urban poor from Chicago, Detroit and Gary, Indiana. The legislature tried to make the welfare benefits conditional upon living in the state for a period of time, but the federal courts struck that down. Now Minnesota is a welfare magnet.

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  8. Snorri Godhi

    One of the reasons why i left Denmark is the poor communication skills of most of the people i worked with (and of the Danish language teachers). This certainly cannot be said of the author of this excellent post.
    A couple of relatively minor points. First, welfare benefits are taxed in Denmark, as is the norm in continental Europe but not in the US or UK. That means that welfare spending is not as large as it seems to be: much of the money goes straight back to the government. It’s an accounting trick, if you wish.
    Another point i am less sure about. I remember reading that the Danish government spends a few percent of GDP on the welfare police (much more than on national defense). That might explain why there are few people living in poverty in Denmark: the Danes make sure that the money goes to those who need it, while the UK and the US just throw the money out of the window.
    Corrections or confirmations of these points would be welcome.

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