What Do We Mean by “Economic Reform?”

The term ‘economic reform’ implicitly meant more government between 1875 and 1975, and has implicitly meant less government since.  That’s how we can tell whether or not we are still in the neoliberal era.

When the recent financial crisis first hit I was worried that it would push us toward statism, just as in the 1930s.  And indeed that seems to have occurred in the US.  By the spring of 2009, however, I noticed that the rest of the world seemed to be moving in the opposite direction.  Parties of the left kept losing in places like India (the communists), Argentina, and Germany.  At the time many commenters said I had things wrong, that I was misinterpreting complex local conditions.

Now I think we now have enough information to know I was right.  The financial crisis has turned out to be a huge problem for parties on the left.  Here’s a recent headline on the election in Sweden:

(Reuters) – The crash of Sweden’s long-ruling Social Democrats to their worst defeat since 1914 highlights the decline of socialist parties in much of Europe, drained by social change, economic crisis and the rise of new issues.

Obviously Sweden will continue to be far more social democratic that the US.  But the effect of the crisis has been for countries like Sweden, Denmark and Holland to trim back government.

Look at how envious the British are of Sweden:

For decades, conservatives have played an important role in Swedish politics: they are there to be defeated. They advocate lower taxes, and are duly accused of planning savage cuts. So the voters traditionally stick with the Social Democrats who have held power for seven of the last eight decades. Every other decade Swedish conservatives come on for some light entertainment, before being booted out after a term. Never in modern Swedish history has a conservative prime minister been spared this fate. Until now.

This week Fredrik Reinfeldt, a bald and deeply dull 45-year-old who communicates with David Cameron by text message, is celebrating the first re-election in history of his party, the Moderaterna. He is also celebrating the success of an extraordinary experiment. His response to the recession was to cut taxes, a move his critics said the country could not afford. The European Commission warned him it would end in tears. But instead, the lower taxes were a spur to growth and Sweden now has the fastest-growing economy in the Western world.

When elected four years ago, leading a four-party coalition, Reinfeldt had a striking slogan. ‘We are the new workers’ party,’ he said, meaning he would cut taxes for those in employment, but not for those on benefits. When faced with protests about how the poorest would be paying a higher marginal tax rate, he appealed to voters’ innate sense of fairness – and resentment at the high level of welfare dependency. At every stage, his ministers would explain the basics of low-tax economics. Cut tax on wages, and you increase the incentive to work. ‘This will increase employment,’ Reinfeldt said. ‘Permanently.’

Not that he was believed – at first, anyway. The party fell 20 points behind in the polls, and braced itself for the ritualistic electoral ejection. It carried on regardless, with tax cuts for cleaners and baby-sitters (most home helpers were paid ‘black’, as the Swedes say, because the tax was so high). Tax on low-paid jobs fell sharpest. Nursing assistants, for example, saw their tax bill drop by a fifth. The aim was to make work compete more aggressively with Sweden’s famously generous welfare state.

Taxes for the rich also came down. Reinfeldt abolished the notorious wealth tax, which took 1.5 per cent a year from any Swede worth over about Skr1.5 million (£125,000). Anders Borg, the finance minister, faced predictable protests about a Bush-style tax cut for the rich. He replied: ‘The big winners are, in the long term, all Swedes, because we must create conditions for companies to match global competition.’ So while the Tories were endorsing Gordon Brown’s plan to increase the tax on the rich, the Swedes were cutting the tax rate – in order to collect more from the well-paid.

When the recession came, Sweden was badly hurt, as one would expect from an export-orientated economy trading with a stricken continent. But the damage was limited because Sweden had properly regulated financial institutions (having been stung by a serious financial crisis in the 1990s. Banks which had embarked on misadventures in the Baltic cleaned up their own mess. The government entered the recession with a surplus. A Gordon Brown figure would have been impossible in Sweden because its laws prohibit politicians running up the national debt in boom years.

Like most of Europe, Sweden launched a stimulus, but Reinfeldt set aside two thirds of his for a tax cut. Corporation tax fell from 28 per cent to 26.3 per cent [the US rate is over 40%], taxes on jobs were cut further still while income tax thresholds were raised. Determined not to let a crisis go to waste, he declared the tax cuts permanent. So while Brown was planning to increase National Insurance, the Swedes were doing the reverse and explaining why. ‘If you tax work higher, you will get fewer people in work,’ said the education minister, Jan Björklund. ‘But if you tax work less you will get more in work.’ This was a battle of ideas, and it was a battle that Reinfeldt and his coalition allies were winning.

In April last year, his party pulled ahead in the polls for the first time since his election. As election day approached, it became clear just how effective his tax cuts had been. Unemployment never hit the forecast 10 per cent – it was 8 per cent in July and 7.4 per cent in August. Two think tanks have confirmed Reinfeldt’s assessment that his tax cuts have created some 100,000 jobs. The deficit was tumbling as the economy recovered. Extraordinarily, Sweden has now overtaken the United States and reached second place in the World Economic Forum’s yearly competitiveness rankings.

Ask about the recession in Sweden now and you are met with a blank stare. Consumer confidence is at a ten-year high. Its recession was steep, but shorter than its downturn after 9/11. In fact, this had come to worry Reinfeldt. ‘Our medicine may have been just too effective,’ one of his state secretaries told me over the summer. ‘Voters don’t think about the economy now. The recession is becoming a distant memory.’

It helped that the deeply unpopular Mona Sahlin was leading the Social Democrats. It also helped that her party was intellectually exhausted. The left has had to embrace ‘free schools’ (the model adopted by Michael Gove) because they are now so popular among parents. The Social Democrats spent much of the campaign trying to persuade voters to forget they ever opposed them. ‘Pupils should choose schools,’ ran one of its posters, ’schools should not choose pupils.’

The Social Democrats’ main economic argument – that tax cuts mean vicious spending cuts – was exposed as false by the Reinfeldt recovery. Ms Sahlin did not dare to propose reversing what had been the sharpest tax cuts in Swedish history.

And finally, a little comic relief from The Economist:

But Maria Wetterstrand, the Greens’ co-leader, demurred, saying her party could not support a government that “kicks sick people off health insurance, does not have a climate policy and wants to build ten new nuclear power plants.”

PS:  Why did we go the other way from the rest of the world?  I’ve always thought our liberals were motivated by unfinished business.  We never really completed the welfare state, leaving millions without health insurance.  Matt Yglesias says that now that Obama has finished the job, the real need is efficient neoliberal reforms, not even bigger government than currently forecast.

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About Scott Sumner 492 Articles

Affiliation: Bentley University

Scott Sumner has taught economics at Bentley University for the past 27 years.

He earned a BA in economics at Wisconsin and a PhD at University of Chicago.

Professor Sumner's current research topics include monetary policy targets and the Great Depression. His areas of interest are macroeconomics, monetary theory and policy, and history of economic thought.

Professor Sumner has published articles in the Journal of Political Economy, the Journal of Money, Credit and Banking, and the Bulletin of Economic Research.

Visit: TheMoneyIllusion

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