sou · H3B353en · 2015-06-04 00:00:00 — However, the US is large, has a hegemonic position among western countries and supplies the global reserve currency, among other things. It is thus questionable whether the US position is replicable by any other country, and in this way constitutes a usable benchmark, especially for small countries. Bilaga 4 till LU15 Figure 2.2 Per capita income relative to , 1970–2012 Note: Income measured as GDP per capita, current prices, current PPP. For there is a clear upward trend due to the petro-sector, and for this reason is not included in the figure. Data source: Based on data from . It is beyond the scope of this paper to provide a detailed discussion of the determinants of production and income levels. For the following discussion it is useful to note the importance of two factors in determining per capita income, namely hourly productivity and per capita labour input.7 Figure 2.3 displays combinations of productivity and labour input for countries. It also shows by the line the combinations of productivity and labour input yielding the same per capita income as in the US (so-called isoquants). The Nordic countries (except , due to the sector) fall short of the US both in terms of productivity and labour input. 7 Per capita income Y/P is equal to the product of hourly productivity Y/(HE) and per capita labour input in hours HE/P, where Y is income, P population size, H working hours, and E employment. Bilaga 4 till LU15 Economic performance Figure 2.3 Per capita income, productivity and labour input, Note: Hourly productivity measured as GDP at current prices and PPP relative to average hours actually worked, and work input is total hours worked (average hours actually worked times civilian employment) relative to total population. All variables are measured relative to US values, and the US-isoquant gives combinations of work input and productivity leading to the same per capita income as in the US. is in an outlier position since petro activities are included in GDP. Source: Computed based on data from . Total labour input can be split along the intensive (hours) and extensive (number of persons). In comparative perspective working hours are low, but labour force participation is high in the Nordic countries. Figure 2.4 illustrates the age dependent employment rates, and it is seen that they are among the highest within the , especially for the age group 30–60. One important reason for this is a high female labour force participation rate. It is thus an important point that the Nordic countries have been more successful in supporting labour along the extensive than along the intensive dimension, an issue discussed further below. Bilaga 4 till LU15 Figure 2.4 dependent employment rates, 2012 Note: Employment to population rate for both sexes. Minimum is the lowest employment rate for the given age group among countries, and Maximum is the highest employment rate for the given age group among countries. Data source: Based on data from . 3 Welfare state characteristics An extended welfare state as in and the other Nordic countries has been known under the name of the Scandinavian or Nordic welfare model. (1990) launched a widely used welfare state typology where the Nordic model is associated with social rights to all; that is, eligibility to welfare arrangements is individual and independent of contributions as well as social status.8 As a prelude, first a remark on terminology and measurements. In the public discourse the terms public sector, welfare state and welfare society are often used interchangeably. The term welfare state may be deceptive since it tends to associate all welfare arrangements with the public sector. This is misleading since in particular labour market institutions are also important (see e.g. and Moene (2013)). It is beyond the scope of this paper to discuss labour market institutions.9 With this caveat the terms welfare state and public sector are used interchangeably in the following. It should be noted that there are significant measurement issues pertaining to the public sector and in cross- 8This model differs from the liberal or residual model relying more on market solutions leaving the state in a more marginal role, and the role where entitlements are related to status and the family plays a larger role. The classification proposed by Esping- (1990) has been contested on various grounds, but it remains useful to identify some key properties. There is a large political science and sociological literature on welfare regimes in general and the Nordic model in particular, see also e.g. Korpi and (1998), (1995). 9This is associated with a compressed wage structure but also wage setting institutions with a clear focus on the importance of wage competitiveness for small and open economies. This is also related to what is sometimes dubbed a “consensus tradition” where solutions are sought with the social partners on important issues in relation to business and labour market conditions. Political discourse is thus less partisan than in many other countries, perhaps a reflection of the historic legacy of being small and open countries in fierce international competition. Welfare state characteristics Bilaga 4 till LU15 They are discussed in some detail in Appendix. The welfare arrangements rest on two pillars, namely the social safety net offering income support to people unable to support themselves and provision of basic welfare services like education, health and care. Important premises are that the social safety net should offer decent living standards to those incapable of supporting themselves, and that the welfare services provided should meet the reasonable requirements of most people. The publicly provided services are not a second-rate solution only used by those who cannot afford otherwise. They are to be used by all and to be of contemporaneous standards (see e.g. et al. (2014) for a further discussion). The welfare arrangements are financed via various forms of taxes. The Nordic welfare state can thus be characterized by individual entitlements and collective financing in the sense that entitlements are for all independently of financial contributions to the welfare state.10 The growth of the public sector is largely concentrated to the 1950s and 1970s. In the mid-1950s the tax burden in the Nordic countries was at about the same level as in the US, see Figure 3.1. Since the 1980s the size of the public sector measured by the expenditure share or tax burden relative to GDP has been more stable, cf. Figure 3.1, which may be interpreted as the welfare state has become mature.11 The expansion of the public sector can roughly be divided in two phases. First, public expenditures and thus provision of welfare services rose driven by improvements in education, health care etc., and second the social safety net was expanded and expenditures increased (also driven by the crisis in the 1970s). 10 This is the basic principle, but there are important exceptions. E.g. unemployment insurance which has membership fees, and pensions related to previous earnings. In addition there are requirements for public pensions. 11 Based on overall expenditure or revenue shares, the size or extent of the public sector has been steady for three to four decades. Views on retrenchment of the welfare state or expansion alongside globalization have not been vindicated. Bilaga 4 till LU15 Figure 3.1 Total tax revenue as a share of GDP, 1955–2012 Data source: 1955-65 Revenue Statistics 2007, 1965–2012 . Despite the concept of a Nordic model, a careful study of policies in the Nordic countries reveals some striking differences.12 First, there are no unique approaches or solutions adopted in the Nordic countries, the key policy instruments do not in any significant way differ from those applied in other countries. It is not the ingredients, but the packaging which makes a difference. Second, there are notable differences among the Nordic countries in the specific policy design of welfare policies and their financing.13 As an example, and have chosen very different paths in the design of pension systems.14 Unemployment insurance is voluntary in , and , but mandatory in . While tax burdens are high in the Nordic countries (except for ), the tax structure differs with having the larger share of tax revenue accruing from direct income taxes and value added tax, while e.g. raises much more tax 12In terms of welfare arrangements is usually considered a latecomer in the ”Nordic welfare model”, and has, at least before the financial crisis, explicitly stated that it is not opting for the Nordic model (see Gylfason (2015)). In recent years has become an outlier due to the large importance of oil revenues. 13In terms of monetary regimes the Nordic countries feature the whole span from floating exchange rates with inflation targeting (, and ), fixed exchange rates () and membership of and Monetary Union (). 14Sweden has adopted a so-called notional defined contribution scheme where benefit entitlements are proportional to contributions during working-life, while has a system combining tax financed pensions with defined contribution labour market pensions. Bilaga 4 till LU15 revenue from social contributions, cf. These differences in specific policy designs underline the point that the package matters more than the specific ingredients. It further implies that the naïve ”copy and paste” perspective often taken in comparative policy discussions focusing on a single or few policy instruments is misleading since it overlooks the complementarities between the different policy elements. The Nordic model should not be defined or assessed in terms of specific policy instruments, what matters is the overarching objectives. They have remained stable over time, but the specific policies/instruments to reach them differ across time and countries. Figure 3.2 Tax structure, countries, 2011 Note: Revenue from different revenue sources as a percent of total public tax revenue. Countries are ordered from highest to lowest gross tax burden. As noted the welfare state rests on two important pillars in the public sector, namely the social safety net and the provision of welfare services. Figure 3.2 shows the total public expenditures on these two pillars. Consider first the social safety net. There are several important points to be made. Social transfers in the Nordic countries are often portrayed as being very generous.15 This is a 15 The average replacement of various social transfers has declined in recent years in , see et al. (2014) and (2012). Bilaga 4 till LU15 statement which needs to be carefully qualified. Considering e.g. the average replacement rate for unemployment benefits for the average worker, it is not particularly high in the Nordic countries compared to the average (see e.g. and Svarer (2007)). However, for low income groups the replacement rate is high. This property over to the social safety net in general; that is, the compensation offered to groups with low income and/or marginal attachment to the labour market as well as lack of work capability is high in a comparative perspective, see e.g. (2004). While the system has some traits in the sense that eligibility is an individual right independent of contributions16 and status, it is important to point out that the social safety net in all the Nordic countries has means testing. It is not a passive system equivalent to a “demo-grant” system. It is also an explicit condition for entitlement that one is not able to support oneself. Importantly the social safety net also features a number of conditionalities as part of the eligibility criteria. These are known as the labour market policies and include requirements on job search, participation in educational programmes, job training etc. The labour market policy has the dual purpose of enhancing qualifications and employability as well as strengthening job search incentives, see Section 6.4. 16 As already noted there are exemptions to this in e.g. the unemployment insurance scheme. Bilaga 4 till LU15 Figure 3.3 The social safety net and public consumption Note: a) Include all forms of social transfers, care etc. For as a share of mainland GDP. b) Public consumption as a share of GDP split between individual and collective public expenditure. Data applies to 2011. For as a share of mainland GDP. Turning next to public consumption (see Figure 3.3 part b), there is an important distinction between collective and individualized expenditures. The former refers to classic public sector activities like administration, policy, legal system, military etc. The latter refers to solutions offered directly to individuals and which in principle could be offered by the market17, the family or the civil society (public provision of private goods). The main items are socalled welfare services like education, health, and child and old age care. What makes the Nordic countries stand out is the extensive provision of welfare services, cf. These expenditures constitute about 2/3 of total public consumption. Importantly, they are provided on a principle since they are available to all and financed collectively via taxes.18 Moreover, since access is based on universalism, service provision contributes to redistribution and equality beyond what is captured by standard income measures. The effect is significant as seen from Figure 3.4 showing both the standard coefficient defined over disposable income (also used in Figure 2.1 above) and the coefficient 17Market imperfections may be one reason why they are provided by the public sector, cf. 18There may be some user charges. This applies in particular to child-care. Bilaga 4 till LU15 when including the value of services received from the public sector (the logic being that this would be equivalent to an income transfer of the same amount).19 For all countries public provision of services contributes to a reduction in inequality; that is, there is a progressive element in welfare provision. The proportional reduction in inequality is larger in the Nordic countries than in other countries (reduction in the case of is 23 percent, while in the US it is 18 percent) showing that significant redistribution is taking place via public provision of services. Figure 3.4 Redistribution via services, 2007 Note: The Gini-disposable income is the coefficient measured over equivalent disposable income (standard measure), and the Gini-including series is the coefficient when adding the value of service use to disposable incomes. The dotted line is the 45-degree line. Source: (2011b). Public expenditures also differ across a different dimension in how they affect economic performance. At some simplification a distinction may be made between and passive expenditure, where the former has a direct impact on employment and income in opposition to the latter. An example of an expenditure may be education while a passive expenditure would be e.g. 19 For a detailed analysis for see et al. (2012), and for see Aaberge et al. (2010). Bilaga 4 till LU15 Clearly there may be good welfare reasons to have socalled passive expenditure, but in understanding how the size and composition of the public sector interact with economic performance the distinction is important (and is discussed further below). A stylized decomposition of public expenditures in and passive expenditures is made in Figure 3.5. The Nordic countries have a high spending level, but also a high level of spending. This strongly suggests that the composition of the public sector is as important as its composition in relation to economic performance. Figure 3.5 Total and public spending, countries 2011 Total public net‐spending, % GDP Note: expenditures include education, health expenditures for persons below the age of 60, child and old age care and labour market policies. Expenditures are made comparable by correcting for the tax treatment of social transfers, cf. Own calculations based on data from . The welfare state is often portrayed as a “from cradle to grave” model. This is captured in Figure 3.6 based on data for , and . The figure shows the average net-transfers from the welfare state to the individual at different ages. In net terms the welfare state is to the benefit of the young and the old, while the working-age population on average is the contributors ensuring the financial balance of the model. This pattern is also found for other countries, but clearly the amplitude increases with the extent of the welfare state, see and Bhattacharya Bilaga 4 till LU15 (2015). This property of the welfare state is important for economic performance and is discussed in more detail in Section 4.2. Figure 3.6 dependent net-transfers between the individual and the welfare state – , and , 2009 Note: The net transfer is defined as the difference between the value of various services and transfers received and tax payments for an average person at given ages. Non-individualized expenditures are distributed equally over all individuals. Data for and applies to 2009, and for . Swedish data is adjusted for wage increases in 2009, and data is presented in USD using adjusted exchange rates. Data source: (2012), Norwegian (2011), Swedish (2011) and . Figure 3.6 also brings out why the welfare model is an “employment model” and relies on a higher labour force participation of those in the work age group, cf. With an extended welfare state a decrease in employment has wide public financial implications due to the double budget effect released by larger expenditures on the social safety net and reduced tax revenue.20 Since the welfare state is extended, this effect is large. Unless the (private) employment rate is high, it will be difficult to 20 (2008) shows how public finances are affected by transitions between employment and various social transfers. Bilaga 4 till LU15 ensure the financial viability of the model. This is seen clearly from Figure 3.7 giving the sensitivity of the budget to a one percentage change in private employment. Figure 3.7 Budget sensitivity to variations in private employment % af BN P Note: The figure shows the one-year budget effect measured relative to GDP of a decrease in employment of one percent. Horizontal line gives the average. Source: (2011) Employment Outlook. Given the large public sector and the organized labour markets, it is often claimed that Nordic countries are semi-socialist countries adopting “policies against markets”. This is not an accurate description of the private sector and therefore of what in economics jargon may be termed product markets. Fairly liberal policies have been pursued, and state intervention in the form of state-owned companies and the like has not played a large role in comparative perspective. The Nordic countries are better characterized as following a social-liberal model with a liberal private sector and extensive social objectives catered for through labour market institutions and the public sector. Figure 3.8 shows an index of product market regulation and intervention for countries. For a large group of countries the differences in the index are small. and belongs to a group of countries with relatively low product market regulation, while and belong to a group of countries with a medium index value. The Nordic countries do not stand out as having a particular less liberal private sector than other countries. Bilaga 4 till LU15 This also holds historically, although the Nordic countries have followed the common trend towards deregulation of product markets. Figure 3.8 index for product market regulation, 2013 Not: Data for applies to 2008. Source: Market Regulation Index, 4Welfare state arrangements and economic performance A distinctive feature of the Swedish and thus Nordic model is the extent of service provision and the implied strong life-cycle pattern in net-contributions to the welfare state, cf. While it is difficult to imagine a welfare state where there is no such pattern, the amplitude and thus the extent of the shifting of resources and options across the life-cycle is much stronger in the Nordic countries than in other countries (see e.g. and Bhattacharya, 2015). This section considers the implication of tax financed service provision for economic performance at the macrolevel, that is, employment and income/growth. To set the scene, the section starts with a brief recapitulation of how the taxexpenditure nexus affects economic performance in standard models and then turns to some key reasons why this does not fully capture all effects. This section also includes empirical evidence on how both the size and composition of the public sector affect economic performance measured by economic growth. 4.1Preliminaries – Basic theory insights It is useful to start by a short overview of the implications of taxes for economic performance. When discussing taxation and distortions two issues are often confused, namely whether taxes lead to a distortion and the precise way in which tax rates affect labour supply and, hence, employment, wages etc. Tax financing has a common pool property inducing a wedge between private and social returns; that is, private after tax returns unambiguously fall short of the social before tax returns. In the context of labour supply this implies that the individually chosen level of labour Welfare state arrangements and economic performance Bilaga 4 till LU15 supply unambiguously falls short of the social optimal level. This captures the common pool problem that e.g. a labour supply changes release effects which the individual does not take into account in its decision. The individual looks at the after tax reward for work, while the implications for tax revenue are disregarded. The latter does not rely on irrationality, but on the fact that there is no relationship between the individual tax payment and entitlement to welfare services. From the society´s perspective these implications for tax revenue should also be taken into account, hence the individual underestimates the return to e.g. work. The next question is how individual labour supply responds to a change in e.g. the labour income tax rate. This is a much more complicated question, and often theory leaves an ambiguous answer. The standard approach to answering how labour supply responds to a tax change is based on the textbook model of individual labour supply where counteracting income and substitution effects are identified as crucial. A higher tax reduces the reward from work (the substitution effect) tending to lower labour supply, while the higher tax reduces disposable income inducing the individual to work more (the income effect). These two effects go in different directions, and hence there is an ambiguity in the answer to how a tax change affects labour supply. Empirical evidence does, however, find that the substitution effect tends to dominate.21 While this is an important basic insight, it is often overlooked that this setting assumes that the tax is financing something which does not have any behavioural consequences for the individual by affecting for instance marginal utilities of private consumption or work. But this may be misleading when taxes are financing welfare services like health or day care. In short the labour supply responses in equilibrium cannot be assessed independently of what the taxes are financing. This is illustrated in Figure 4.1 considering three different cases distinguished by whether the tax is financing i) a lump sum transfer 21 See e.g. Hausman (1985). For empirical evidence see e.g. et al. (2005) and Meghir and (2008). Bilaga 4 till LU15 Welfare state arrangements and economic performance