Aiming for Denmark, drifting to Greece?

The US primaries are in full swing and as part of the discussions surrounding Bernie Sanders and Hilary Clinton is the Democratic fascination with the region of the world I call home: Scandinavia. In particular, both Sanders and Clinton as well as the influential Huffington Post occasionally argue that the US ought to develop in the direction of the Scandinavian welfare states. As a socialist, Sanders apparently believes that the success of Denmark and Sweden provide evidence that democratic socialism can work, Many other Democrats also ascribe the particular Danish happiness to the welfare state.

The image of Scandinavian welfare states that is being propagated by the US media and Democratic candidates in particular is one of societies with high and strongly progressive taxes that funds free healthcare and education, public redistribution and substantial regulation of and government involvement in the economy. The main problem is that the story told of Denmark in the US presidential campaigns and in most US media is a myth. My co-blogger and fellow economist Otto Brøns-Petersen wrote about it sometime ago in a post that eventually became a Cato Institute Economic Development Bulletin. More recently, University of Chicago economist Luigi Zingales voiced similar concerns in Washington Post.

Part of the myth derives from the fact that Denmark and Sweden are schizophrenic societies in the sense that the public sectors are very large – the total Danish tax burden in 2015 was above 50 % of GDP and the parliament still didn’t manage to balance the budget – but large parts of the other half of the economy is extremely capitalist. According to both the Heritage Foundation and the Vancouver-based Fraser Institute, the Danish private sector is significantly less regulated than in the US. As Andreas Bergh of Lund University in Sweden emphasizes in his illuminating book about The Capitalist Welfare State, the relative success of his country rests on continual reforms of the welfare state in which both leftist and right-leaning Swedish governments have liberalized business regulations and the tax system and introduced private healthcare, a voucher system in the educational sector, and reduced the bureaucratic burden on the private sector.

Deregulation, liberalization and in general more capitalist policies and economic freedom than in the US have been preconditions for being able to maintain a large welfare state in Scandinavia: Having a welfare state of a Scandinavian size requires a very productive private sector in order to be able to fund it. Building and maintaining a large welfare state with a regulatory burden and the rule of law as in Italy or Spain – which is what Sanders’s proposals seem to imply – is the recipe for disaster. Plenty of research in recent years has documented how poor judicial and regulatory institutions and policies undermine productivity such that high taxes – in themselves a problem for a dynamic economy – are unlikely to be sufficient to fund welfare policies anywhere near as generous as in Scandinavia.

However, recent research also suggests that a particular culture is necessary in order to be able to maintain and fund a welfare state. In joint research with Andreas Bergh (Lund University) and Gert Tinggaard-Svendsen (Aarhus University), I show that the Nordic trust culture is a main factor in explaining the continued existence of the particularly expansive welfare state developed in that region. Without a high degree of trust in other people, a large welfare state is most probably heading for financial ruin.

The trust literature suggests two main reasons. First, in order to have a large welfare state that doles out unemployment benefits, educational support and dog support for the homeless, it needs a large bureaucracy. Similarly, having free health care with public hospitals and closely regulated prices requires a regulatory apparatus with a bureaucracy. The problem here is that if the public bureaucracy is not very efficient, free of corruption or not subject discretionary political interference, it is going to be extremely expensive. At a global level, one must therefore ask which countries have such Weberian bureaucracies that can handle the paperwork of a welfare state without absurd costs. A US version of this question is what might happen if organizations such as the IRS or the Department of Motor Vehicles suddenly expanded in size, scope and political attention.

The second reason is that ordinary citizens will need to be willing to pay for the welfare state. It is entirely possible that some politicians are able to convince voters that the welfare benefits are going to be paid by ‘the rich’ or that magic social effects will imply that the welfare state funds itself. But when the actual expenses are to be funded, the necessary tax increase has to be paid by a large share of society, which will include the middle class. To maintain a Scandinavian welfare state therefore also requires that the middle class is somehow willing to pay the full price for large, universal transfers and public goods to strangers. And they do not only have to be willing to impose a heavy tax burden on other people, but also be willing to pay themselves. In other words, there can be very little tax evasion in a Scandinavian-style welfare state.

From a literature on social trust that stretches almost 20 years back to Stephen Knack and Philip Keefer’s seminal 1997 study, it is known that the necessary requirements for a large, universal welfare state to hold, a high-trust culture is needed. Tax evasion, being willing to extend public services and help to strangers, limiting corruption and bureaucratic inefficiency, and maintaining a reasonably dynamic private sector are all associated with higher social trust. Try to implement a Danish welfare state in a society with low trust levels, and you get Greece or Southern Italy instead. In Bernie Sanders home state of Vermont, the attempt failed with the voters. Why does anyone expect that it will succeed in a country consisting of as many Mississippis and Louisianas as Vermonts and Minnesotas?

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