Bad news for social democrats – the Swedish model doesn’t work

Classical liberals can point to numerous examples of robust economic growth coinciding with low taxes and light-touch regulation: Britain in the 18th and 19th centuries; the US before the 1930s; and more recently Hong Kong since the 1960s. Of course, it must be conceeded that these examples were far from night-watchman states and the role of government remained significant in certain areas. But the general hypothesis that economic liberalisation aids the production of wealth receives further empirical support from the large number of countries that have experienced rapid growth after adopting free-market oriented reforms – from China in the late 1970s to some of the ex-communist nations of central and eastern Europe in the 1990s.

The history and geography of wealth creation is far more problematic for supporters of big government. Yet they often claim empirical support from the economic success of Scandinavia and Sweden in particular. The latter is said to combine a very large state with high levels of prosperity. But unfortunately for social democrats, the economic history of Sweden appears to be far more consistent with the classical liberal analysis than their interpretation.

Sweden enjoyed significant relative economic success in the first half of the 20th century. In this period, Sweden had a very small state by modern standards. In 1937, for example, state spending in Sweden constituted just 16.5% of GDP (see Crafts, 2002), lower than China today, while in the UK it was far higher at 30%. Even in 1960 – just after Sweden had overtaken the UK in GDP per head – state spending in Sweden was still only 31% of GDP – lower than in Britain. 

In relative terms, economic growth has been sluggish in Sweden since the early 1970s, since the size of government there had become really huge. For example, per capita GDP in Sweden was 16% higher than the UK in 1980 (and public spending accounted for a mammoth 60% of GDP), but only 3% higher in 2008. Indeed, Sweden suffered a severe fiscal crisis in the early 1990s, so high was the level of state spending, and radical reforms had to be introduced in an attempt to curb the growth of government.

While one should be cautious about drawing too many conclusions from growth statistics, Sweden’s economic record certainly fails to falsify classical liberal theories on the relationship between government intervention and economic prosperity.

13 January 2011, IEA Blog

North to pay heavy price for dependence on public spending

Public spending dominates the economy of the North of England. In the North-East region, for example, it accounts for close to 70% of GDP.

Many northern cities seemed to prosper in recent years. The luxury apartments and office blocks that sprang up in Newcastle, Liverpool, Manchester and Leeds were one visible sign. But it was largely a bogus boom based on Gordon Brown’s public-sector spending spree, which included substantial regeneration subsidies.

Times have changed and very severe reductions in government expenditure are now necessary. This suggests that those areas that are heavily dependent on public spending face a particularly painful adjustment process. These regions include not only the North of England, but also Scotland, Wales and Northern Ireland.

In the long-term, however, the cuts should bring benefits. Undoubtedly the bloated public sector has crowded out private sector activity in these areas, partly because it has artificially inflated wages.

Yet it may be over-optimistic to expect the private sector to become the economic dynamo it was during the 18th and 19th centuries and pull the North out of stagnation. Businesses now face barriers that would have been unknown to the great entrepreneurs of that era. Environmental legislation will make life very difficult for manufacturers, while the welfare state has blighted much of the North with endemic worklessness and poor skill levels.

Britain’s stagnating regions are therefore likely to be a major problem for the next government. But it should resist the temptation to repeat the mistakes of the past. Public subsidies to failing areas undermine the adjustment process needed for their economies to recover. Policymakers should instead focus on removing the barriers to entrepreneurship and self-help. This means deregulation to help businesses and improve labour mobility, and welfare reform to end the curse of long-term worklessness.

16 November 2009, IEA Blog

The dark side of climate change policy

The government recently announced a series of measures designed to make Britain a low-carbon economy, including a large expansion of renewable energy (primarily wind), grants for better home insulation and a so-called green transport strategy. Under the Climate Change Act, the UK is “legally bound” to reduce CO2 emissions by at least 26% by 2020 and 80% by 2050 (relative to 1990 levels).

Meeting such ambitious targets will require substantial investment and while ministers have emphasised alleged advantages, such as the creation of 400,000 “green jobs”, there has been little acknowledgement of the wider economic impact.

Higher energy bills and transport costs are likely to be devastating for many businesses. Some enterprises will be forced to close. Others will relocate to locations where energy and transport are cheaper and environmental regulations less burdensome. In some instances, potential entrepreneurs won’t even bother starting new ventures in the UK. Overall, jobs are likely to be lost rather than created.

Then there is the impact on the less well off. People on benefits, for example £64 per week Jobseeker’s Allowance, may already be using around one third of their (non-housing) incomes to pay utility bills inflated by existing environmental policies.

If this share increases further, there will be strong pressure to raise welfare benefits and winter fuel payments to compensate. Taxes will have to rise accordingly and the already weak incentives to enter low-paid work will be further undermined.

However, the most devastating impact of climate change policy is likely to be on the developing world. While some middle income countries may benefit initially from the flight of businesses from rich nations, it is unrealistic to think that a large upward shift in the level of political control and central planning can take place in the West without negatively affecting the Third World.

The resulting misallocation of resources will hamper entrepreneurship and innovation leading to reduced wealth creation. And restricted and constrained markets will inevitably limit the opportunities for trade, thereby hindering economic development.

The impact of climate change policy therefore goes far beyond landscapes ruined by wind turbines and higher electricity bills. Big cuts in CO2 emissions are likely to prolong the misery of hundreds of millions of the world’s poorest.

29 July 2009, IEA Blog

Cameron should focus on free trade rather than foreign aid

The development economist Peter Bauer famously observed that “Aid is the process by which poor people in rich countries subsidise rich people in poor countries.” Indeed there is a wealth of evidence, both theoretical and empirical, that foreign aid is largely counterproductive.

In particular, aid may help to sustain kleptocratic elites that feed off such infusions. Indeed, income is frequently diverted to buy weapons to suppress internal dissent, typically through the oppression of minority ethnic groups.
Foreign aid also tends to distort markets by creating unfair competition and crowding out local suppliers. Currencies may also be artificially inflated, harming exports. And let’s not forget the negative economic effect of extra taxation on donor countries, which in turn harms their poorer trading partners.

Politically, dependence on foreign aid may breed a bureaucratic, centrally planned, top-down approach to economic development issues, when what is really needed is a framework of basic institutions (such as private property) within which entrepreneurship can thrive. Accordingly, it is very difficult to find an example of a country that has achieved long-term economic development through foreign aid.

Yet despite the overwhelming evidence, and notwithstanding the UK’s worst-ever peacetime fiscal crisis, the Conservative Party has announced that if elected it will ring-fence Britain’s overseas aid budget and meet the UN target of spending 0.7% of GDP on aid by 2013.

David Cameron also wants to change the way aid is delivered to make it more effective. But it is surely naïve to think that, despite repeated attempts to solve this problem, aid can somehow be better targeted so that it doesn’t fall into the hands of corrupt elites. Third World politicians and bureaucrats will simply find different ways of siphoning off money.

If the Conservatives really want to help developing countries they should focus on removing trade barriers, particularly those imposed by the European Union, rather than adopting the failed policies of international socialism.

15 July 2009, IEA Blog