Why Scandinavian social policies work

Scandinavia is a mystery: marginal tax rates on labor income are astronomical, yet labor force participation is high, even higher than in the United States where tax rates are much lower. In addition, they is an impressive social safety net, which should also depress the labor supply, yet it is high. No standard economic model would be able to predict anything close to this, and the question is thus what is so special about Scandinavia.

Torben Andersen (the one living in Denmark) has an answer. He claims that this has to do with how the social safety net is designed. First, it is build in a way to never exclude anyone, thus there is much less marginalization and fewer people who have abandoned the labor market. Second, the social safety net provides services in a large part only conditionally on participating in the labor force. But this is not like workfare in the United States. The level of support is much higher, and thus there is a stronger incentive to try to work. But high support acts like an implicitly high minimum wage, which has consequences for labor demand. To overcome this, a strong emphasis is put on education to keep the proportion of working poor small. Education is basically free and retraining for adults is also offered (and used).

All this points towards an implicit social contract where the state provides education and insurance, and in return is getting paid through taxes when income is available. Whether this works out better than a model where the state does not intervene and people have stronger incentives to improve their well-being, but not necessarily the ability, is ultimately an empirical question. And it is not clear their is a middle ground. Considering the corner-solutions (US and Scandinavia), it is not obvious one Pareto-dominates the other.

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