This is the question that Nordic countries have faced and answered. The Economist has a really interesting 14-page feature called “The Northern Lights” on how Nordic countries—Sweden, Denmark, Norway, and Finland—have reformed their government, dramatically cut their debt-to-GDP ratios over the years, and yet protected a generous welfare state that favors individual choice (statist individualism, they call it.)
In the first of eight articles, you learn about the new Nordic model:
They continue to believe in combining open economies with public investment in human capital. But the new Nordic model begins with the individual rather than the state. It begins with fiscal responsibility rather than pump-priming: all four Nordic countries have AAA ratings and debt loads significantly below the euro-zone average. It begins with choice and competition rather than paternalism and planning.
Some of the policies and results in Sweden are impressive:
Sweden has reduced public spending as a proportion of GDP from 67% in 1993 to 49% today. It could soon have a smaller state than Britain. It has also cut the top marginal tax rate by 27 percentage points since 1983, to 57%, and scrapped a mare’s nest of taxes on property, gifts, wealth and inheritance. This year it is cutting the corporate-tax rate from 26.3% to 22%.
Sweden has also donned the golden straitjacket of fiscal orthodoxy with its pledge to produce a fiscal surplus over the economic cycle. Its public debt fell from 70% of GDP in 1993 to 37% in 2010, and its budget moved from an 11% deficit to a surplus of 0.3% over the same period. This allowed a country with a small, open economy to recover quickly from the financial storm of 2007-08. Sweden has also put its pension system on a sound foundation, replacing a defined-benefit system with a defined-contribution one and making automatic adjustments for longer life expectancy.
Most daringly, it has introduced a universal system of school vouchers and invited private schools to compete with public ones. Private companies also vie with each other to provide state-funded health services and care for the elderly. Anders Aslund, a Swedish economist who lives in America, hopes that Sweden is pioneering “a new conservative model”; Brian Palmer, an American anthropologist who lives in Sweden, worries that it is turning into “the United States of Swedeamerica”.
There can be no doubt that Sweden’s quiet revolution has brought about a dramatic change in its economic performance. The two decades from 1970 were a period of decline: the country was demoted from being the world’s fourth-richest in 1970 to 14th-richest in 1993, when the average Swede was poorer than the average Briton or Italian. The two decades from 1990 were a period of recovery: GDP growth between 1993 and 2010 averaged 2.7% a year and productivity 2.1% a year, compared with 1.9% and 1% respectively for the main 15 EU countries.
In another piece The Economist notes:
On public services the Nordics have been similarly pragmatic. So long as public services work, they do not mind who provides them. Denmark and Norway allow private firms to run public hospitals. Sweden has a universal system of school vouchers, with private for-profit schools competing with public schools. Denmark also has vouchers—but ones that you can top up. When it comes to choice, Milton Friedman would be more at home in Stockholm than in Washington, DC.
Note that everything isn’t perfect. These countries still have a lot more to do before their model is fully sustainable. Spending as a share of GDP remains high and so are taxes, which “still encourage entrepreneurs to move abroad: London is full of clever young Swedes.” The Economist also adds that “Too many people—especially immigrants—live off benefits.” But they demonstrate that reforms can be implemented and make a very serious difference in the short-term and on the way to longer-term fiscal health. Moreover, they have put in place some reforms that have led to a trust in government institutions that you don’t find in the United States or in the rest of Europe.
The whole feature is very much worth reading. It includes pieces on the Nordic welfare state, immigration, and cultural revolution among other topics.