Swedish lessons for the Commission of Audit

Sweden shows it’s possible to maintain a welfare state and good public finances Shutterstock

As the Abbott government’s Commission of Audit busily scours the globe for answers to our fiscal woes, where in the world will it look?

My tip is that it will dwell with the usual suspects: the UK, the United States, good old New Zealand, and maybe Canada, at a stretch. Expect Europe to figure not as a solution to our ills but as an example of what not to do if we really are keen to get our financial house in order.

A country that is likely to be forgotten is slap bang in Europe, but farther north than we tend to see. Sweden, the bastion of social democracy genuinely ranks as a nation to follow rather than avoid.

There, the age of entitlement is firmly entrenched, courtesy of a giant welfare state delivering services for all, thanks to a tax base that is almost one third bigger than our own.

All that social expenditure has had a dramatic effect, for on most measures the Swedes have the most equal society in the west, thanks not just to generous social security payments, but also a welfare state that keeps employment of women at levels most other nations can only dream of.

But being a champion of equality is one thing, a paragon of fiscal virtue is quite another. Why might we expect a truly independent champion of sound finance to trumpet Sweden as a potential budget saviour?

How to support a welfare state

Back in the early 1990s, Sweden got hit by a massive financial crisis that caused the economy to shrink and government finances to go deeply into the red. That prompted a re-think about how to mind the till that has continued through to this day.

Sweden now has some of the tightest fiscal policy settings in the west, with a set of policy principles firmly enshrined, and now with broad support across the party spectrum.

The principles commit Sweden to running budget surpluses equivalent to 1% of GDP across the business cycle. This compares to our own current commitment of a balanced budget over the cycle.

To ensure this happens, the government has put in place two safeguards around expenditures that so far have worked rather well. The first involves committing to expenditure caps three years in advance. This means that expenditures are unlikely to balloon if revenues unexpectedly swell.

The second involves committing each year to an expenditure envelope across the public sector that is less than the formal cap. The gap between the envelope and the cap forms a safety margin to protect against the unexpected, thereby limiting risks to the budget balance, and enabling expenditures to be shifted across the public sector from areas of less to pressing need.

The new principles are flexible, and enable the budget’s “automatic stabilisers” to work effectively during a recession. When the economy and employment shrink, spending on unemployment rises and tax revenues fall causing the budget balance to worsen thereby giving the economy a lift. In other words, deficits are allowed, but only when they are needed to ensure public spending makes up for a contraction in private spending.

To cap it off, Sweden has also introduced a non-partisan and independent Fiscal Policy Council charged with the responsibility of monitoring what governments do. They publish annual reports about financial performance versus targets and the transparency and accuracy of what has been done. This oversight keeps the politicisation of public finances to a minimum, while exposing the government of the day to a degree of scrutiny not seen before.

In contrast to much of the rest of Europe, Sweden’s public accounts recovered quickly from the Global Financial Crisis, swinging quickly back into balance. Instead of growing, its gross public debt has been shrinking, and it remains one of the few countries in the OECD whose financial assets considerably exceed its liabilities to the tune of more than 20% of GDP.

Yet social expenditures remain high, and the Swedish welfare state remains strong.

It seems unlikely that Sweden’s success will get much of a hearing from the Commission of Audit. AAP

Competing where it matters

And all this has been possible because the economy continues to grow. McKinsey and Co have put this down to “continued productivity gains in the areas most exposed to international competition: manufacturing and business and financial services, which together account for only about one-third of the nation’s economy”.

After a missstep during the global financial crisis in 2008 and 2009, and an unexpected slowdown last year, Sweden’s economy has been growing at a healthy clip, and at a faster rate than the OECD as a whole (see below).

Swedish growth compared to OECD members. The World Bank

And unlike other western nations, Swedes’ trust in government (over 60%) is amongst the highest in the western world, roughly one third above the OECD average as a whole (40%).

Which is not surprising, given that Sweden has shown successfully how a culture of entitlement and relative equality can coexist alongside a balanced budget funded by high taxation in an economy doing pretty well for all.

Now that’s a model to aim for.

But one unlikely to get much of a hearing in a Commission of Audit that is likely to say much about financially troubled central and southern Europe and ignore the great things happening in a social democratic exemplar of sound finance farther north.

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