Annual hours worked per working age American, German and French, 1950–2013
12 May 2015 Leave a comment
in applied price theory, economic growth, economic history, great depression, labour economics, labour supply, macroeconomics, politics - USA, Public Choice, public economics, taxation Tags: Edward Prescott, Euroclerosis, France, Germany, labour supply, Robert Lucas, taxation and labour supply
Figure 1 shows that Americans work the same hours per year pretty much the entire post-war period. By contrast, there is been a long decline in hours worked in Germany and France. The large drop in 1992 was German unification.
Figure 1: annual hours worked per working age American, German and French, 1950 – 2013
Source: OECD StatExtract and The Conference Board Total Economy Database™,January 2014, http://www.conference-board.org/data/economydatabase/
The long decline seemed to tally with the disproportionately sharp rise in the average tax rate on labour income, including social security contributions in France and Germany. When tax rates on labour income, including social security contributions stabilised in about 1980, hours worked stabilised in all countries.
Figure 2: average tax rate on labour income,USA, Germany and France, 1950 – 2013
Source: Source: Cara McDaniel.
Some pander to the great vacation theory of European labour supply. This is the hypothesis of a large increase in the preference for leisure in the European Union member states. That is, mass voluntary unemployment and mass voluntary reductions and labour supply by choice by Europeans. They just decided to work less.
This is not the first outing for the great vacation theory of labour supply. In the late 1970s, Modigliani dismissed the new classical explanation of Lucas and Rapping (1969) of the U.S. great depression in which the 1930s unemployment was voluntary unemployment – the great depression was just a great vacation – with the following remarks:
Sargent (1976) has attempted to remedy this fatal flaw by hypothesizing that the persistent and large fluctuations in unemployment reflect merely corresponding swings in the natural rate itself.
In other words, what happened to the U.S. in the 1930’s was a severe attack of contagious laziness!
I can only say that, despite Sargent’s ingenuity, neither I nor, I expect most others at least of the non-Monetarist persuasion, are quite ready yet. to turn over the field of economic fluctuations to the social psychologist!
As Prescott has pointed out, the USA in the Great Depression and France since the 1970s both had 30% drops in hours worked per adult. That is why Prescott refers to France’s economy as depressed. The reason for the depressed state of the French (and German) economies is taxes, according to Prescott:
Virtually all of the large differences between U.S. labour supply and those of Germany and France are due to differences in tax systems.
Europeans face higher tax rates than Americans, and European tax rates have risen significantly over the past several decades.
Countries with high tax rates devote less time to market work, but more time to home activities, such as cooking and cleaning. The European services sector is much smaller than in the USA.
Time use studies find that lower hours of market work in Europe is entirely offset by higher hours of home production, implying that Europeans do not enjoy more leisure than Americans despite the widespread impression that they do. Europeans did not work less. They worked more on activities that were not taxed.
Is welfare dependence optimal for whom – part 7: the role of tagging in welfare benefits system
16 Dec 2014 Leave a comment
in economics of love and marriage, labour economics, labour supply, welfare reform Tags: child poverty, labour supply, poverty and inequality, welfare reform
The unambiguously favourable labour supply effects of work requirements are often contrasted with the ambiguous results of changes in benefit abatement regimes.
The twist is work requirements need to be accompanied by a categorisation of the welfare population into those who can work and those who cannot work. The latter do need welfare support because they are unable to earn a wage in the labour market or have carer responsibilities such as for pre-schoolers.
There is already a large population on other welfare benefits with short and long-term barriers to work because of sickness or invalidity classifications.
The favourable labour supply effects of work requirements depend on an ability to adequately categorise the welfare population into different groups. The large differences between otherwise comparable countries in the number on sickness and disability benefits suggest that this classification and sorting process is knowledge intensive and error prone.
The original support for negative income taxes from Friedman (1962) and Stigler (1946) was born of the notion that welfare bureaucracies are unable to adequately screen, categorise and tag welfare claimants by their capacity to work and diligent job search in a dynamic world with dispersed knowledge and moral hazard.
Negative income taxes were proposed as an administratively simple welfare reform to give adequate income support to the low paid, out of work and unable to work, while still providing reasonable work incentives for the low paid. The negative income tax was originally intended to replace existing welfare benefits for families at least.
The modern incarnations of negative income taxes manifest as in-work tax credits that supplement welfare benefits and reduce poverty among the working poor.
The ambiguous effect of negative income taxes on the net labour supply among the low-paid was acknowledged at the outset, and was borne out in experimental trials and experience with in-work tax credits.
The existing system of domestic purpose, unemployment, sickness and invalid benefits are all examples of screening, categorising and tagging of welfare claimants with varying degrees of success.
The tagging is based on relatively coarse screening devices such as job loss, sole parenthood and medical grounds.
Akerlof (1978) noted that the truly needy—those with low job skills who have extreme difficulty in becoming employed—can be partly identified by some measurable, observable characteristic, which he called tagging the poor. Some combination of indications of poor health, low levels of education and spotty employment histories might be indicators of low job skills.
If the government moves from a negative income tax, in which all those with income are paid benefits regardless of their characteristics, to a tagged system in which only the subset who have the particular set of characteristics indicating that they are needy are paid benefits, then higher benefits could be paid to the tagged individuals without changing total expenditure.
Depending on whether the welfare tag is job loss, sole parenthood, sickness or invalidity, different abatement regimes, benefit levels and work tests apply. ACC is another example of tagging with the screening based on accidental injury.
Most welfare systems tag Akerlof partly with family structure in mind as a characteristic, with benefits heavily concentrated on families with a single parent.
Family tax credits are based on tagging through the number of hours worked and the number of children that are dependent upon the wage earner.
Nichols and Zeckhauser (1982) argued that the imposition of “ordeals” on welfare recipients, of which work requirements were one example, but onerous application procedures and participation requirements are others, could serve to deter entry of the able-bodied.
The experience with tagging to date suggest that it’s not particularly accurate. social insurance systems for injury and illness have significant issues with moral hazard.
For example, before 15 July 1980, an employee injured in a workplace accident in Kentucky received compensations proportional to his or her wage with an upper limit of $131 per week.
On 15 July 1980, this limit was raised to $217 per week. The better paid wage-earners were substantially better compensated for accidents that occurred after that date.
The periods of convalescence of these better-paid workers grew 20 per cent longer. For accidents that occurred before 15 July, these employees had been off work for an average of 4.3 weeks; for accidents after 15 July caused the same employees to stay home for an average of 5.2 weeks.
The average convalescence period for injured workers who were less well paid was unaffected by the rise in the upper limit stayed the same before and after 15 July. It is absurd to suggest that workplace accidents had suddenly become more serious for these better-paid workers and only for them after 15 July 1980.
In the past three decades, the number of people who are on disability benefit has skyrocketed but incidence of disabling health conditions among the working age population is not rising. Autor (2006) found that disability rolls in the USA expanded because:
- congressional reforms to disability screening in 1984 that enabled workers with low mortality disorders such as back pain, arthritis and mental illness to more readily qualify for benefits;
- a rise in the after-tax income replacement rate, which strengthened the incentives for lower-skilled workers to seek benefits; and
- a rapid increase in female labour force participation that expanded the pool of insured workers.
Autor found that the aging of the baby boom generation has contributed little to the growth of disability benefit numbers to date.
David Autor and Mark Duggan (2003) found that low-skills and a poor education is predictor of disability: in the USA in 2004, nearly one in five male high school dropouts between ages 55 and 64 were in the disability program; that was more than double that of high school graduates of the same age and more than five times higher than the 3.7 % of college graduates of that age who collect disability. Unemployment is another driver of disability.
The only major success in reducing beneficiary numbers anywhere has been time limits in the USA in 1996. Time limits on welfare for single parents reduced caseloads by two thirds, 90% in some states.
The subsequent declines in welfare participation rates and gains in employment were largest among the single mothers previously thought to be most disadvantaged: young (ages 18-29), mothers with children aged under seven, high school drop-outs, and black and Hispanic mothers. These low-skilled single mothers were thought to face the greatest barriers to employment. Blank (2002) found that
nobody of any political persuasion predicted or would have believed possible the magnitude of change that occurred in the behaviour of low-income single-parent families.
Rebecca Blank is the field leader on the economics of welfare reform and got as high as Acting Secretary of the Department of Commerce for Obama.
Employment are never married mothers increased by 50% after the US reforms: employment a single mothers with less than a high school education increased by two thirds: employment of single mothers aged of 18 in 24 approximately doubled.
With the enactment of welfare reform in 1996, black child poverty fell by more than a quarter to 30% in 2001. Over a six-year period after welfare reform, 1.2 million black children were lifted out of poverty. In 2001, despite a recession, the poverty rate for black children was at the lowest point in national history.
This great success of US welfare reforms was that after decades of no progress, poverty among single mothers and among black children declined dramatically.
The best solution to poverty is to move people into a job. Simon Chapple is also quite clear in his mid-year book with Jonathan Boston that a sole parent in full-time work, and a two parent family with one earner with one full-time and one part-time worker, even at low wages, will earn enough to lift their children above most poverty thresholds. Welfare benefits trap children in poverty.
The best available analysis, the most credible analysis, the most independent analysis in New Zealand or anywhere else in the world that having a job and marrying the father of your child is the secret to the leaving poverty is recently by the Living Wage movement in New Zealand.
According to the calculations of the Living Wage movement, earning only $18.80 per hour with a second earner working only 20 hours affords their two children, including a teenager, Sky TV, pets, international travel, video games and 10 hours childcare.
This analysis of the Living Wage movement shows that finishing school so your job pays something reasonable and marrying the father of your child affords a comfortable family life.
Blogs so far:
part-one-the-labour-leisure-trade-off-and-the-rewards-for-working
part-two-the-labour-supply-effects-of-welfare-benefit-abatement-rate-changes
part-3-abatement-free-income-thresholds-and-labour-supply
part-4-in-work-tax-credits-and-labour-supply
part-5-higher-abatement-rates-and-labour-supply
Is welfare dependence optimal for whom – part 6: mandatory work requirements and labour supply
14 Dec 2014 Leave a comment
in labour economics, labour supply, occupational choice, welfare reform Tags: 1996 federal welfare reforms, Labour leisure trade-off, labour supply, mandatory work requirements, welfare reform
A mechanism for reducing welfare programme entries while increasing welfare exits is work requirements. These minimum hours can be spent working part time, in study and training, work preparation and job search assistance or volunteering.
A work requirement is a screening device removes any advantage of moving on to welfare in terms of more leisure time. U.S. welfare reform side-stepped the problem of programme entry with lifetime time limits on eligibility and work requirements making entry unrewarding. A lifetime time limit on eligibility also reduces inflow in to welfare receipt because workers have an incentive to bank their eligibility to hard time arise. Different work tests and abatement regimes that vary with circumstances on length of time on the benefit also increase exits without increasing entry.
Most work requirement schemes have waivers for those unable to work. Work requirements make welfare receipt less attractive and more hassle while not making welfare receipt any more or any less financially rewarding to those in work.
The gap between working and welfare receipt is larger because of the work requirements make the benefit less pleasant but no additional cash payments are made to encourage welfare programme entry.
Most welfare systems experiment with policy options to separate those who can work from the truly needy. Changes in financial incentives arising from abatement regimes, benefit levels and benefit durations are welfare reform workhorses. The clear-cut labour supply effects of work requirements are a useful contrast to the ambiguity of labour supply changes when benefit levels and abatement regimes change.
Figure 1 illustrates work requirements by introducing a minimum working hours requirement, which eliminates part of the budget constraint before the minimum hours. Work requirements combine a negative tied transfer – an obligation to work – with cash to induce those with a higher ability to work to self-select and opt out of the welfare system entirely.
Figure 1: The labour supply effects of mandatory work requirements as a condition of welfare benefit receipt
Arrows 1, 2 and 3 in Figure 1 represent possible labour supply responses to work requirements which lead to an increase in the hours worked by different types of workers, some moving to working part-time and others not working at all.
Arrow 1 shows some beneficiaries who are marginal workers increasing their hours from zero to the minimum. Other marginal workers will work more but no longer work enough hours to qualify for a benefit as shown by arrow 2.
This increase in labour supply, as shown by arrows 1 and 2 in Figure 1, is to be expected because a work requirement eliminates welfare benefits altogether over a certain range.
Welfare payments reduce the supply of labour unambiguously so reducing the generosity of welfare reduces the disincentives to supply labour.
A work requirement also reduces entry into and increases exit from the welfare system by more persistent workers as shown by arrow 3 in Figure 1.
This welfare exit effect and entry deterrence arises from the relative non-financial rewards of working and not working have changed in favour of staying in full-time and semi-work for persistent workers temporarily on a welfare benefit.
Persistent workers gain from anticipating the onerous nature of work requirements and searching more intensively for jobs which are more stable and enduring.
These job seekers may reduce their asking wage to win a lower paid but steadier job. Seasonal and temporary jobs will be less attractive if there are work requirements.
The incentive to cycle between the benefit and part-time and full-time work including seasonal and temporary jobs are reduce because work requirements make welfare receipt more onerous.
Those job seekers with fewer outside of the workforce obligations such as young children are the most likely to move to (stable) full-time work because of work requirements.
Those with more extensive outside commitments such as pre-schoolers work the minimum hours or make other arrangements because they now fail to qualify for welfare.
A work requirement unambiguously increases net labour supply and reduces the number of people relying on the welfare system now and into the future.
In contrast to abatement regime reforms, no one enters the welfare system as a new benefit claimant as the result of introducing work requirements.
The number of people working increase and some leave welfare rather than comply with the work programmes. Work requirements make welfare receipt unambiguously less attractive and will close the gap between earning full-time wages and the net rewards of not working or part-time work and partial benefit receipt.
The subsequent declines in welfare participation rates and gains in employment were largest among the single mothers previously thought to be most disadvantaged: young (ages 18-29), mothers with children aged under seven, high school drop-outs, and black and Hispanic mothers. These low-skilled single mothers who were thought to face the greatest barriers to employment. Blank (2002) found that:
At the same time as major changes in program structure occurred during the 1990s, there were also stunning changes in behaviour. Strong adjectives are appropriate to describe these behavioural changes.
Nobody of any political persuasion-predicted or would have believed possible the magnitude of change that occurred in the behaviour of low-income single-parent families over this decade.
The blogs so far
part-one-the-labour-leisure-trade-off-and-the-rewards-for-working
part-two-the-labour-supply-effects-of-welfare-benefit-abatement-rate-changes
part-3-abatement-free-income-thresholds-and-labour-supply
part-4-in-work-tax-credits-and-labour-supply
part-5-higher-abatement-rates-and-labour-supply
Lessons from field trials with work mandates
30 Jul 2014 2 Comments
in human capital, labour economics, labour supply, welfare reform Tags: 1996 US welfare reforms, labour supply, mandatory work requirements, policy trade-offs, welfare reforms, work for the dole
One of the most controversial aspect of the U.S. program changes are the negative incentives – time limits, sanctions, and diversion – that are built into their structure.
All of these policies limit the entitlement to cash public assistance, by either enforcing behavioural requirements (such as work search) or limiting the availability of assistance.
As Besley and Coate (1992) pointed out, linking such requirements with public assistance payments can help deter welfare participation among those who could find a job on their own.
The majority of evaluations of mandatory welfare-to-work programs show significant increases in labour supply and reduced welfare dependency. The drawback is the increase in wage income is greatly offset by the decline in benefit income. In–work tax credits played a major role in making work pay in 1996 U.S. welfare reform
The Minnesota Family Investment Program (MFIP) was implemented in 1994 and provided a strong earnings threshold, allowing women to receive some cash assistance until their earnings reached about 140 per cent of the U.S. poverty line. It also required participation in mandatory job search programs.
A randomly assigned control group remained in AFDC without work requirements or substantial earnings thresholds. MFIP involved both strong negative and positive work incentives. A subset of the treatment group (also randomly assigned) was provided with the earnings thresholds but not the mandatory work requirements.
The MFIP results allow the separate and joint effects of mandatory job search and earnings thresholds to be explored. When only positive work incentives are provided through an expanded earnings threshold, this has little effect on labour supply, consistent with earlier results. The additional income provided by these higher thresholds had strong income-increasing and poverty-reducing effects. Once mandatory work requirements are added to MFIP, then labour supply increases as well, but there is little further effect on income or poverty.
The evaluations of MFIP suggest that the stick of work requirements increases labour supply, but has little effect on overall income as increases in earnings are offset by reduced benefits.
The carrot of greater earnings thresholds provides an income enhancing effect. When used together, there is increased work and higher earnings, along with reduced poverty.
The relatively strong measures to mandate work participation can be effective. Work mandates with sanctions are more effective at inducing work than are more financial incentives. Strict work requirements by themselves may have little income-enhancing effects if they are not combined with some form of wage support for the low-skilled.
Education and training programs do not seem any more effective in promoting labour force attachment and increased earnings than work experience programs. In various welfare reform experiments in the U.S. during the 1990s, states tested training programs – human capital development programs — against work first programs – labour force attachment programs.
The work-first programs increased earnings and decreased welfare usage faster, while human capital development programs cost more, particularly in the first year when women were training rather than working.
But even three years out, after women from human capital development programs had been in the labour market two years, human capital development participants still did not outperform labour force attachment participants.
This may suggest that the gains to experience among women who have been out of the labour market may be larger than the gains to formal education and training. Employment outcomes did not seem significantly worse among less skilled participants or participants with identifiable barriers to work, such as child care or health problems. Learning by doing and job match and job search capital are major sources of hard-to-measure post-school human capital and wages growth even for less skilled workers. Work-first programmes suggest that the reward from working which is human capital as well as wages are greater than an investment in time away from working to train.
The dual emphasis in the U.S. welfare reforms on positive work incentives and more punitive work mandates seems to have been important.
Work mandates (mandatory welfare-to-work programs, backed by sanctions and time limits) forced more people into work faster than would have naturally left welfare even strong economic environments. With low wages and (often) part-time hours, many welfare leavers would have gained little in income without subsidies to low-wage work. Reduced earnings thresholds, the expanded EITC, and subsidies to assist with child care or other work related expenses, all helped make work pay.
Diagrams HT: rand.org Conflicting Benefits Trade-Offs in Welfare Reform by Jeffrey Grogger, Lynn A. Karoly, and Jacob Alex Klerman (2002).
Taxes and the labour supply in Europe
20 Jun 2014 Leave a comment
in applied price theory, labour economics, labour supply, macroeconomics Tags: labour supply, taxes
Richard Rogerson, 2008. "Structural Transformation and the Deterioration of European Labor Market Outcomes", Journal of Political Economy found that:
1. Hours worked per adult in France, Germany, Italy Europe decline by almost 45% compared to the US since 1956
2. The decline occurs at a steady pace from 1956 until the mid 1990s, in contrast to the fact that the relative increase in unemployment occurs in the mid 1970s.
3. The decline in hours worked in Europe is almost entirely accounted for by the fact that Europe develops a much smaller service sector than the US.
4. Relative increases in taxes and technological catch-up can account for most of the differences between the European and American time allocations to the market and outside over this per.
Ohanian, Rao and Rogerson 2008 in "Work and taxes: allocation of time in OECD countries" found
1. A steep decline in average hours worked per adult and large variations across OECD member countries in the magnitude of this decline.
2. Changes in labour taxes accounted for a large share of the trend differences.
3. Countries with high tax rates devote less time to market work, but more time to home activities, such as cooking and cleaning.
4. This reallocation of time from market work to home work is much stronger for females than for males.
The higher elasticities of labour supply of women, and married women and mothers are beyond dispute. Modern empirical labour economics as led by Mincer was built around explaining female and joint labour supply.
Richard Rogerson, 2007 in "Taxation and market work: is Scandinavia an outlier?" Economic Theory, found that how the government spends tax revenues when assessing the effects of tax rates on aggregate hours of market work.
1. Different forms of government spending imply different elasticities of hours of work with regard to tax rates.
2. While tax rates are highest in Scandinavia, hours worked in Scandinavia are significantly higher than they are in Continental Europe with differences in the form of government spending can potentially account for this pattern.
3. There is a much higher rate of government employment and greater expenditures on child and elderly care in Scandinavia.
Examining how tax revenue is spent is central to understanding labour supply effects:
1. If higher taxes fund disability payments which may only be received when not in work, the effect on hours worked is greater relative to a lump-sum transfer.
2. If higher taxes subsidise day care for individuals who work, then the effect on hours of work will be less than under the lump-sum transfer case.
The empirical foundations of supply-side economics – Michael Keane – YouTube
19 May 2014 Leave a comment
in labour economics, taxation Tags: labour supply, taxes
Most economists believe male labour supply elasticities are small, but a sizable minority of studies have large values. There is no clear consensus on this point.
The key factor driving these tensions is the failure of most studies to account for human capital returns to work experience.
In a model that includes human capital, even modest elasticities—as conventionally measured—can be consistent with large efficiency costs of taxation.
Conventional estimates of male labour supply elasticities have a severe downward bias because of their failure to include human capital accumulation. The opportunity cost of time includes their after tax wage and present value of increased earnings in all future years.
The return to work experience is high so working more has large long-term payoffs for younger male workers. Wages start low for young grow and then peak in 40s. When adjusted for the return for work experience, a large part of compensation when younger is human capital, and this peters away by the 40s.
Estimates where wages grow with work experience, with the accumulation of human capital, yield large male labour supply elasticities, as high as 3.8 rather than close to zero (Keane 2010, 2011). That is a profound difference.
Women have high labour supply elasticities, especially on the labour force participation margin, as most agree.
Estimates of long-run female labour supply elasticities—estimates that allow for dynamic effects of wages on fertility, marriage, education and work experience—are generally quite high.
Marginal tax rates and labour supply
17 May 2014 Leave a comment
in applied welfare economics, Edward Prescott, labour economics Tags: labour supply, taxes
Americans now work 50 per cent more than do the Germans, French, and Italians. This was not the case in the early 1970s, when the Western Europeans worked more than Americans.
Edward Prescott found that taxes accounted for these differences in labour supply across time and across countries; in particular, the effective marginal tax rate on labour income. The population of countries considered is the G-7 countries, which are major advanced industrial countries. Prescott concluded that
virtually all of the large differences between U.S. labour supply and those of Germany and France are due to differences in tax systems.
Prescott and many that followed him were truly puzzled by the lack of a role for employment mandates, employment protections and product market regulation in Europe’s poor economic performance
Richard Rogerson is a very sharp fellow who built on Prescott’s work. Most anything Rogerson writes is worth a look.
A non-technical note by Rogerson made these key points:
- Europe’s taxes punish working outside the home, so Europeans don’t work as much as they would otherwise;
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Dramatic differences in the overall change in hours worked per person aged 16 to 64 across countries between 1960 and 2000;
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at one extreme the U.S., with an increase of 10 per cent between these two dates;
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At the other extreme are Germany and France, with declines of more than 30 per cent;
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For the U.S. and France, the difference is staggering—more than 45 per cent;
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Richard Freeman and Ronald Schettkat (2001) studied time allocation by married couples in Germany and the United States.
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Their striking finding is about total time devoted to work (i.e., market work plus home production) turns out in the two countries is virtually the same.
In The Impact of Labor Taxes on Labor Supply: An International Perspective (AEI Press, 2010) Rogerson finds that:
• a 10 percentage point increase in the tax rate on labour leads to a 10 to 15 per cent decrease in hours of work.
• Even a 5 per cent decrease in hours worked would mean a decline in labour output equating to a serious recession.
• While recessions are temporary, permanent changes in government spending patterns have long-lasting repercussions.
• Although government spending provides citizens with important benefits, such benefits must be weighed against the disincentive effects of increased labour taxes.
• Policymakers who fail to account for the decrease in labour output risk expanding government programs beyond their optimal scale.
The rise of the Swedish welfare state, Swedosclerosis and Director’s Law
08 Apr 2014 3 Comments
in applied welfare economics, economic growth, macroeconomics, Public Choice Tags: labour supply, Sweden, taxes, welfare state
Sweden is a common example of a generous welfare state that is compatible with a prosperous society. One interpretation of the UN Development Index is you improve your national ranking by becoming more like Sweden.
Assar Lindbeck has shown time and again in the Journal of Economic Literature and elsewhere that Sweden became a rich country before its highly generous welfare-state arrangements were created
Sweden moved toward a welfare state in the 1960s, when government spending was about equal to that in the United States – less that 30% of GDP.
Sweden could afford this at the end of the era that Lindbeck labelled ‘the period of decentralization and small government’. Sweden was one of the fastest growing countries in the world between 1870 and 1960.
Swedes had the third-highest OECD per capita income, almost equal to the USA in the late 1960s, but higher levels of income inequality than the USA.
By the late 1980s, Swedish government spending had grown from 30% of gross domestic product to more than 60% of GDP. Swedish marginal income tax rates hit 65-75% for most full-time employees as compared to about 40% in 1960.
Swedish economists named the subsequent economic stagnation Swedosclerosis:
- Economic growth slowed to a crawl in the 1970s and 1980s.
- Sweden dropped from near the top spot in the OECD rankings to 18th by 1998 – a drop from 120% to 90% of the OECD average inside three decades.
- 65% of the electorate receive (nearly) all their income from the public sector—either as employees of government agencies (excluding government corporations and public utilities) or by living off transfer payments.
- No net private sector job creation since the 1950s, by some estimates!
In 1997, Lindbeck suggested that the Swedish Experiment was unravelling.
Sweden is a classic example of Director’s Law of Public Expenditure. Once a country becomes rich because of capitalism, politicians look for ways to redistribute more of this new found wealth.
Studies starting from Sam Peltzman (1980) showed that government grew in line with the growth in the size and homogeneity of the middle class that became organised and politically articulate enough to implement a version of Director’s law. Director’s law augmented by Gary Becker’s 1983 model of competition among pressure groups for political influence explain much of modern public policy.
Government spending grew in many countries in the mid-20th century because of demographic shifts, more efficient taxes, more efficient spending, shifts in the political power from those taxed to those subsidised, shifts in political power among taxed groups, and shifts in political power among subsidised groups.
The Swedish economic reforms from after 1990 economic crisis and depression are an example of a political system converging onto more efficient modes of income redistribution as the deadweight losses of taxes on working and investing and subsidies for not working both grew. Improvements in the efficiency of taxes or spending reduce political pressure to suppress the growth of the welfare state and thus increase or prevent cuts to both total tax revenue and spending.
After the rise of Swedosclerosis, the taxed, regulated and subsidised groups had an increased incentive to converge on new lower cost modes of redistribution. More efficient taxes, more efficient spending, more efficient regulation and a more efficient state sector reduced the burden of taxes on the taxed groups. Most subsidised groups benefited as well because their needs were met in ways that provoked less political opposition.
Reforms ensued led by parties on the Left and Right, with some members of existing political groupings benefiting from joining new political coalitions.
The Nordic median voter was alive to the power of incentives and to not killing the goose that laid the golden egg. The deadweight losses of taxes, transfers and regulation limit inefficient policies and the sustainability of redistribution.
For example, while tax rates are high in Sweden and the rest of Scandinavia, hours worked in Scandinavia are significantly higher than in Continental Europe.
Richard Rogerson found in Taxation and market work: is Scandinavia an outlier? that how the government spends tax revenues imply different rates of labour supply with regard to tax rate increases.
Rogerson considered that differences in the composition of government spending can potentially account for the high rate of labour supply in Sweden and elsewhere in Scandinavia. Specifically, examining the conditions on which how tax revenue is returned to Swedes as income transfers or other conditional payments is central to understanding the labour supply effects of taxes:
- If higher taxes fund disability payments which may only be received when not in work, the effect on hours worked is greater relative to a lump-sum transfer with no conditions; and
- If higher taxes subsidise day care for individuals who work, then the effect on hours of work will be less than under the lump-sum transfer with no conditions.
A much higher rate of government employment and greater expenditures on child and elderly care explain the high rates of Swedish labour supply.
Swedes are taxed heavily, but key parts of this tax revenue are then given back to them conditionally if they keep working. Policies that significantly cut the total wealth available for redistribution by Swedish governments were avoided relative to the germane counter-factual, which are other even costlier modes of income redistribution.
Utopia, you are standing in it! 
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