Information about Europe Europa

I Overview

Desmond Lachman, Ramana Ramaswamy, J. Green, Robert Hagemann, and Adam Bennett
Published Date:
October 1995
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Desmond Lachman

Sweden’s macroeconomic performance in the early 1990s differed in a number of fundamental respects from its performance during most of the postwar period. Distinctive features of macroeconomic developments in the early 1990s included the deepest and longest economic recession since the 1930s; a rise in the overall unemployment rate to levels substantially above those previously experienced by the country; a ballooning in the public sector’s overall budget deficit to an extent rarely encountered in member countries of the Organization for Economic Cooperation and Development (OECD); and a decline in the value of the currency to levels even below those reached immediately after Sweden’s 1981-82 devaluations. As has increasingly been recognized in Sweden, these macro-economic developments raise questions about the country’s capacity to sustain the comprehensive welfare state that has evolved in the postwar period. The purpose of this study is to provide a detailed analysis of recent developments in Sweden in a longer-term context, and to assess their implications for future policy choices.

Between the first quarter of 1990 and the first quarter of 1993, real GDP in Sweden declined by a cumulative 7 ½ percentage points, before a significant export-led recovery got under way. Section II examines the proximate causes of the recession and analyzes the main reasons for its depth and its long duration. This section focuses particularly on the demand shocks to which the economy was subjected in early 1990 and reviews the main impact of the recession on the economy. A vector autoregression analysis is also presented, which allows a more rigorous examination of the possible causes of the recession. The main conclusion of the section is that the proximate cause of the recent recession is mainly attributable to demand shocks that affected in particular private consumption and construction investment. Furthermore, the marked tightening of monetary policy in the second half of 1992 contributed importantly to the length and depth of the recession.

A distinctive feature of Sweden’s labor market performance until 1990 was its enviably low unemployment rate over the preceding two decades. However, the recession that began in early 1990 fundamentally altered this favorable performance: overall unemployment rose to about 14 percent in the first half of 1994. Section III outlines some of the distinctive institutional features of the labor market, and reviews the main developments in the 1990s. It focuses particularly on the operation of Sweden’s labor market programs, which distinguish the Swedish labor market from its main European partners. The section also examines the impact of Sweden’s wage bargaining system and labor market regulations on competitiveness and on long-run productivity. In the context of Sweden’s present high level of unemployment, it underlines the need both for single-level wage bargaining that is more responsive to local labor market conditions and for labor market reform that would allow greater flexibility in the functioning of the labor market.

Sweden’s overall public finances deteriorated from a surplus in 1990 to an estimated deficit of 11 percent of GDP in 1994. Over the same period, the ratio of gross public debt to GDP almost doubled to over 90 percent. Section IV discusses the principal factors underlying this marked deterioration, and documents the series of measures by which the authorities intend to rebalance the public finances and stabilize the public debt-to-GDP ratio. The section also quantifies the high degree of sensitivity of the fiscal deficit and public debt to changes in interest rates and output growth.

Between 1970 and 1993, social security spending in Sweden more than doubled in relation to GDP. Thus, by 1993 public sector transfer payments accounted for 29 percent of GDP, which is substantially above the corresponding European average. Furthermore, as of that date, Sweden’s social security spending was greater than elsewhere in Europe in virtually all major social spending categories. Section V reviews Sweden’s highly complex and generous system of public transfers to households and considers the various options available for reducing outlays on sickness benefits and on programs related to family allowances. The section also reviews the main elements of the recently approved long-run reform of Sweden’s pension system. A basic purpose of this reform was to strengthen the link of future pensions to lifetime contributions and to base future pension adjustments on the overall performance of the economy.

Section VI on generational accounts analyzes the fiscal stance in Sweden, taking into account the impact of taxes and transfers on different age and sex groups in the population. It assesses the impact of recent and prospective fiscal policy measures on the net tax burden imposed on future generations. The results of this analysis highlight the fact that under the existing structure of taxes, transfers, and government consumption, today’s males under age 60 and females under age 55 face a positive net tax burden over the remainder of their lives. In contrast, today’s men and women over age 60 and 55, respectively, are the principal beneficiaries of current policies. Recent fiscal policy measures, together with the pension reform, would improve significantly the relative position of future generations, but, nevertheless, they would continue to face a substantial net tax burden.

The abandonment of the fixed exchange rate for the Swedish krona in November 1992 has resulted in a real effective devaluation of the currency of around 25 percent. Section VII first describes the impact of the devaluation on competitiveness and on export and import performance. Sweden’s trade performance since 1992 is contrasted with that following the 1981-82 devaluations, as well as with the recent trade experiences of Italy, Spain, and the United Kingdom. The section then investigates empirically Sweden’s trade performance and the pass-through of the devaluation on import and export prices in local currency. The main finding of this analysis is that although export volumes have risen sharply, as would have been expected following the floating of the currency in November 1992, import volumes have also risen in a manner that is difficult to explain by the more traditional trade equations. Moreover, while the determination of export and import prices seems to be generally explicable in terms of the standard variables, the slowness in the rate of pass-through of the devaluation to domestic prices to date is significantly more modest than earlier relationships would have indicated.

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