Freeman

ARTICLE

The Rise and Decline of a Welfare State

NOVEMBER 01, 1978 by SVEN RYDENFELT

Dr. Rydenfelt is Professor of Economics at The University of Lund, Sweden.

The economic trials of recent years, according to a growing number of competent commentators, have nothing to do either with business cycles or structural long range changes. The sickness of the seventies is much more severe and goes to the roots of our industrial civilization—the market economy. In many western countries markets presently are in ruin.

All of us apprehend that the unprecedented wealth and living standard we enjoy is a product of the industrial system. But not so many are aware that the prime mover of this system in the western world has been the market economy in an air of freedom—a system now threatened by suffocation for lack of freedom.

As a matter of fact, we are living on fortunes inherited from the past, consuming a heritage created and built by free enterprise and free entrepreneurs. Unless we fundamentally change the economic policies that have brought us into the present situation, we cannot hope for relief.

The Road to the Welfare State

Since the 1930s—see the famous book Sweden the Middle Way by Marquis Childs in 1936—Sweden has been the leading country on the road to the welfare state. It is a road sloping downhill, and once the wagon had started, you could not prevent it from rolling on faster and faster. In Sweden, government successively has taken over more and more of the responsibilities for the citizens’ life and welfare from the cradle to the grave. And welfare is like a drug—greater and greater doses are needed. The pressure for greater doses has been so strong that no government so far has been able to resist.

But welfare is expensive and has to be paid for. So taxes had to be raised all the time. In 1960 taxes in Sweden took 30 percent of GNP, a share that in 1977 had increased to 53 percent.

Generous minimum standards of living, guaranteed to the citizens by the State, mean that a great many Swedes in the lower income brackets enjoy the same standard whether they earn a living or not. As a matter of fact, most Swedes are getting social allowances of different kinds, tested according to needs. Such allowances combined with the highest tax rates of the world mean that, after an income rise, you will be hit not only by extremely high marginal tax rates but by losses of social benefits, too. Most Swedes are virtually allowed to dispose of no more than 5 to 10 percent of an income rise, which means that incentives for working overtime or working hard to get promoted are very weak.

Sweden, as a matter of fact, is halfway socialized. But as all political parties have backed the "nationalizations," they never use the word "socialize." Very important sectors such as education and medical care are nearly totally socialized, as is the postal service, telegraph, railway and air communications and public utilities in local communities. The Swedish State Church means that a major part of religious service is socialized with the staff wholly integrated into the ordinary bureaucracy. The buildings are imposing but attendance extremely low.

Sweden Hard Hit

A few years ago only 5 percent of manufacturing industry was "nationalized," but because of the crisis and threatening bankruptcies a lot of big enterprises—shipyards, steel mills and textile factories—have been socialized in late years. The present share may be about 10 percent.

But this low figure is highly deceptive. Actually, there is no free enterprise in Sweden at present. And as for private enterprise, its freedom area is so restricted by governmental regulations that in practice it is half socialized. Liberties and incentives for private entrepreneurs are in short supply.

Sweden by wide margin holds the position as the number one welfare state of the world. And among all developed industrial countries it was most severely struck by the present economic crisis. This is not mere coincidence, as we shall see.

Since 1974 production in manufacturing industry has been declining. Housing construction since 1970 has been halved, while cement consumption in the same period shrank 40 percent. The 550 biggest Swedish companies reported average profits declining from 8 percent in 1974, 5 percent in 1975, 2 percent in 1976 to 0 in 1977. And in a country with 30 percent of the labor force in public sectors (where GNP is calculated from expenditures, not from revenues) GNP in 1977 fell 2.5 percent. And while 7 percent of the merchant marines of the world in 1977 were idle, the Swedish figure was 27 percent idle. If Swedish production figures since 1974 have been extremely low, inflation figures, on the contrary, have been extremely high (1977 = 14%).

If Sweden was most severely struck by the economic crisis, other countries did not escape their fate, either. Many people were puzzled by the simultaneous emergence of troubles in different countries, but this widespread occurrence is of central significance for the analysis.

According to most competent judges the trials of the seventies are effects primary and secondary—from governmental policies. And as similar and simultaneous causes will produce similar and simultaneous effects, the simultaneous emergence of troubles in different countries may, most easily, be explained as effects of similar governmental policies. As a matter of fact, the same thing was true in the depression years of the 1930s. And there certainly are conspicuous similarities in economic policies of different countries in the same periods, rather independent of the political color of the governments. Imitation and fashion behavior are to be found not only in garments but in policies, too.

Free enterprise is a system strong enough to endure certain amounts of bad treatment—State restrictions and regulations. But there are boundaries you cannot cross without severe consequences. In the 1970s many industrial countries have, obviously, passed beyond these limits, with adverse repercussions. And Sweden as the most advanced explorer of welfare territories, also suffered the worst repercussions.

Creative Powers of Entrepreneurs

In the economic world everything is started and kept going by individuals. And as machines are kept going by fuels, human beings are kept going by incentives. The strength of the incentives decides the performance.

In all business the entrepreneurs are key persons. Their skills and talents determine the success or the failure of the enterprise. And high qualities as leaders of production and personnel do not suffice. More important are ideas and imagination, capabilities of developing new and better products and methods. Above all, an entrepreneur must be creative.

No outstanding creative work can be done without freedom. Therefore, all restrictions, all commandments and guidances, all fetters and chains, check and impede creations.

In all countries under political dictatorship the freedom of the creators is strictly limited, and not only in arts and literature. For that reason, extremely few real innovations have been born in the Soviet Union since 1917. Almost everything in science and technology has been imported and copied from the West.

Like all creators, entrepreneurs need freedom. If they are given freedom—in societies with law, order, and infrastructures—they will start and develop enterprises with miraculous growth potentials. Under such conditions of economic freedom in the era of the industrial revolution, a fantastic development started in England in the 18th century. There were the miracle periods of West Germany and Japan after World War II, and the two "golden" decades (19501970) in other western industrial countries after the postwar "disarmament" of central regulations. Also notable in recent decades are such enclaves of economic freedom (not always political!) as South Korea, Taiwan, Hong Kong and Singapore.

Periods of economic freedom—economic miracle periods—always were lucid intervals in history, periods of relatively short duration. Sooner or later a system of State regulations was built that checked and impeded development.

In the 1970s began a new era of uninhibited governmental intervention, restricting entrepreneurial freedom. And those in power could exploit all the potentials of Big Government armed with modern communications, electronics, and computers.

According to a Swedish study (by Professor Kurt Samuelsson in 1975) the number of new laws regulating industry and working life was greater during the 5 years from 1970 to 1975 than during the 85 years preceding 1970.

In 1973 Sweden got 80 new laws threatening entrepreneurs with jail or fines. In 1974 the number was 127 and in 1975 no less than 180. An interesting coincidence was observed in this context—as the production of new laws accelerated, production of commodities and employment decelerated proportionally.

This flood of economic regulations meant that the freedom of entrepreneurs was restricted more drastically than it had been since pre-industrial times. The entrepreneurs are treated by their new political masters not like free men, but more like slaves. Thus are more and more entrepreneurs so disheartened and discouraged that they lose fighting spirit, capitulate, and leave their positions prematurely.

Wage Earners and Consumers in Power

Kings and emperors in power are seldom willing to accept the results of free markets. When universal suffrage transmits political power to the great majorities of wage earners and consumers, they also reject the market.

All citizens are consumers and hate price rises on food, housing, and the like. One cannot reasonably expect them to abstain from using the powerful State regulation apparatus at their disposal. The result is governmental price regulations—price controls, rent controls, currency controls, and so on.

Adult citizens are voters, too, most of them forming strong pressure groups, demanding social benefits and—in times of crises—extensive relief actions from government. And as few governments are able to resist such demands, State budgets are bound to be deficit budgets. The Swedish deficit in 1977 was no less than 20 percent of budget (almost 10 percent of GNP).

Big deficits mean big inflation, and the result in Sweden in 1977 was a price increase of 14 percent.

Most adult citizens want jobs. A job means not only income but social respectability, too. Especially in slowdown periods with few job opportunities, the bankruptcy of a firm often means severe hardships for the employees. In that case, employees of the firm (including representatives of their unions and their local governments) will form very strong pressure groups, desperately demanding relief actions. Very few governments are able to resist such demands for State subsidies. Often very large amounts are required.

In all market transactions two parties, seller and buyer, are involved. In free markets there is a power balance between the parties. Neither party is able to force upon the other conditions he is not willing to accept voluntarily. All transactions occur as the result of free bargaining. The central quality of a free market is the absence of coercion—nonviolence.

But as soon as one of the parties in a market is able to use the powerful State apparatus (with laws, courts, prisons, policemen, soldiers, executioners) the balance of power is distorted. The party disposing of the apparatus is always able to force upon the other party conditions the latter would not accept voluntarily. So it is that wage earners and consumers, by means of price controls, rent controls, currency controls, extensive state subsidies and high taxes, are busy undermining the foundations of free markets. The prime movers of free markets, the entrepreneurs have been neutralized in strait jackets, woven from hundreds of governmental regulations.

The Penalties for Oppression Must Be Paid

Those in power have fulfilled this "murder of the market" with good conscience, firmly convinced of the soundness and righteousness of their policy, as has always been the case of those in power.

But oppression and exploitation hurt not only the oppressed and exploited but the oppressors and exploiters as well. So one of the most fundamental ethical laws of history may be formulated: The penalties for such crimes have to be paid.

There was a time in history when entrepreneurs and "capitalists" used the State apparatus to oppress and exploit wage earners and consumers. Adam Smith and Karl Marx, among others, rightly criticized this exploitation. Now the power pendulum has swung from the one extreme to the other. But no matter who is the exploiter or the exploited, exploitation always works like a poison on the productive powers of a society.

In Sweden production has been falling since 1974. In spite of enormous borrowing from abroad (50 billion Swedish crowns 19751977) the living standard could not be prevented from falling in 1977, and it must continue to fall as long as this paralyzing policy is continued.

What about job security and the power of the wage earners, these "rights" extorted from entrepreneurs and guaranteed by State laws? The answer must be: These securities and powers are built on illusions. The more of these laws we have, the worse for the wage earners, because such exploitation of the entrepreneurs checks and impedes production. The result is a society with much unemployment and job opportunities in short supply. In such a society no government can guarantee living standards, real wages or employment.

The truth is that securities and powers of wage earners nowhere are greater than in a free market with high-speed production, full employment and labor in short supply. In the highly competitive labor market—the sellers’ market—there are lots of chances and choices for the job seekers. In such a market the wage earners have the trumps. In such a market only the more efficient and generous employers can get the manpower they need. Other employers soon have no personnel—and no enterprises.

Secondary Effects of State Subsidies

In slowdown periods with job opportunities in short supply, the bankruptcy of a firm most often means severe hardships for the employees. Because of the economic crisis, the Swedish Government in 1977 was pressed to pay more than 30 billion Swedish crowns to a number of threatened big companies, including 14 billion to the shipbuilding industry. At the same time the government acted to nationalize major parts of the shipbuilding and the steel industries and a minor part of the textile industry, on grounds that the relief sums were so enormous they could not reasonably be given to private concerns.

The shipyards were among the first plants severely hit by the crisis. Many of these plants obviously were superfluous and had to be closed. But which plants?

In a free enterprise system the market would have passed sentence. The high cost plants would have been doomed, and so the survival of the fittest would have been guaranteed.

But the pressure from employees and communities was so desperate that governmental resources were mobilized, subsidies paid and the threatened plants saved. Soon all orders had been filled; yet production went on. Ships that nobody wanted or needed were built, ships to be stockpiled at anchor in sheltered bays and fiords. Still, the competition for new orders grew more and more desperate. As Government paid the losses, prices far below costs were accepted.

The biggest Swedish shipyard, the Kockums in Malmö, from the beginning had a much stronger position than the big yards in Gothenburg—a result of good management—and therefore proudly refused the subsidies. But eventually they too were obliged to accept prices below costs to obtain new orders.

But no private enterprise can exist for more than short intervals under such circumstances; sooner or later it must capitulate. And so, in the last months of 1977, even the Kockums had to surrender and accept governmental relief.

Governmental subsidies start chain reactions, distorting the competitive balance and undermining even well managed and sound enterprises. Subsidies, like drugs, remove pains for the moment but with severe secondary effects upon the body. In recent years, for instance, the Swedish Government has paid 30 percent of the prices of new ships built in Sweden. The Norwegian Government, however, refused to grant import licenses for those ships, as such subsidizing according to OECD rules meant dumping. Shipping companies buying new ships at prices far below costs—and far below earlier price levels—of course were able to underbid companies that had bought their fleet in earlier periods. Because of such underbidding, freight rates in 1978 often cover no more than one third of total costs in old established companies. In Sweden the biggest shipping companies—the Broströms and the Salëns—as a consequence went bankrupt and had to be saved by Government.

As a matter of fact, lots of enterprises in Sweden—and in other countries, too—are kept going by means of State subsidies. And thanks to the subsidies they can sell and do sell below production costs, which means dumping. And while dumping transactions formerly were exceptions, they have become more and more the rule.

Governments cannot ignore this development. If they don’t protect domestic enterprises against such unfair practices, numerous efficient and sound firms will be ruined and have to close. One may deplore this development, this "new mercantilism," but should recognize that dumping—and protectionism—is nothing but the last link of a chain, the inevitable secondary effect of extensive State subsidies.

It is important to distinguish between firms that are able to compete with low prices because of State subsidies (dumping) and firms that are able to compete with low prices because of efficiency and low costs. In recent years countries like South Korea, Taiwan, Hong Kong and Singapore have often—because of their competitive powers—been charged with dumping. But such charges were mostly unjustified. Their competitive prices were, more probably, the natural outcome of a highly efficient free enterprise production system.

The Tide is Turning as Freedom Wanes

In the last decades of the 18th century when economic freedom released powers that started the industrial revolution, the tide was turning. Since then in the western world we have been living in a market economy, capable of producing higher and higher living standards. And we have been so integrated into this system that we take it for granted and look upon it as natural and normal.

But from a historical perspective all such happy periods are lucid intervals of limited duration. To all appearances we are now in the last stage of such an interval. Once more the tide is turning—the market economy threatened by suffocation for the lack of freedom. 

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November 1978

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