Economic sovereignty of monetary independent countries in the
European Union:
The economic policies of Denmark and Sweden
MA Thesis in European Studies Graduate School for Humanities Universiteit van Amsterdam Author: Frank Tijsterman Student number: 10175121
Main Supervisor: dhr. dr. Peter Rodenburg Second Supervisor: dhr. dr. P.W. Zuidhof June, 2017
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Table of Contents
1 Introduction ... 3
2 Economic sovereignty ... 5
2.1 The concept of economic sovereignty ... 5
2.2 The impossible trinity ... 8
2.3 Assessing economic sovereignty ... 10
2.4 Conclusion... 12
3 Economies of Denmark and Sweden ... 14
3.1 Economy of Denmark ... 14
3.2 Economy of Sweden ... 20
4 Key economic policy areas ... 27
4.1 Fiscal policy ... 27
4.2 Monetary policy ... 33
4.3 Trady policy ... 37
4.4 Competition and environmental policy ... 41
5 Discussion and conclusion ... 44
5.1 Discussion ... 44
5.2 Conclusion... 46
5.3 Avenues for further research and limitations ... 47
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1 Introduction
The European Union (EU) is a contested topic in many, if not all, of its member states, and even those outside it. How the European Union is viewed has changed often since its inception, but it is clear that in the last decade its image declined (European Commission (EC), 2015). Many arguments have been brought to the table to explain this, and recent examples include the migration problems that trouble Europe in which the EU does not seem to be handling effectively. Another example is the global economic crisis, or an accumulation of crises, that started in 2006 in the United States (Lane, 2012) and had enormous effects on the European economy and, as such, on the people living there. This also has to do with the European currency, the euro. While it should show the strength and unity of the eurozone, it has caused divisions between different regions as, for example, can be seen in the calling of the Mediterranean countries PI(I)GS1 (Kazemi and Sohrabji, 2012). Moreover,
nine members of the European Union have not been willing to adopt the euro, such as the United Kingdom, Denmark and Sweden.
Joining the euro has been a source of many debates, some of whom are still continuing, as can be seen in the recent debate between Thierry Baudet from the Dutch Party Forum voor Democratie (FvD) and the European Central Bank (ECB) director Mario Draghi at the tenth of May 2017 (FvD, 2017). For those countries that chose not to adopt the euro, three main themes can be found. First, in some countries the government did not think it was a good idea, was in the case of the UK, while, second, others held a referendum and the no-vote won, for example in Denmark and Sweden. Finally, some states joined the European Union in a later stage after the euro was already introduced and they needed time to converge (Downs, 2001). However, a common theme amongst all of them is, that the public opinion of joining the euro decreased after the economic crisis, specifically after the eurozone’s debt crisis (EC, 2015). In the United Kingdom and Poland plans to enter the euro were postponed, while in Denmark and Sweden referenda were likewise put off.
This increasingly negative view on the euro due to economic reasons is interesting, as one of the main arguments for introducing the euro was that it would bring economic growth even though it would limit control by the state and national bank on the economy (McCann, 2002). Though this economic argument was brought up often in the debates leading up to the creation of the euro, they might not be telling the whole story. André Szász, one of the directors of the Dutch Central Bank between 1973 and 1994 and closely involved in the creation of the European Monetary Union
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(EMU), argued in his 2001 book that the euro was a French wish and a German concession. As West-Germany wanted to unite with East-Germany, the French were afraid a united Germany would become too strong a state in the European Economic Community and that a common currency could counteract this (Szász, 1999). This suggests that political reasons might have been just as, if not more, important than economic reasons for the creation of the euro.
However, this thesis wants to look not at the economic and political reasons of whether to join the euro, but at the impact countries experienced when the euro was not joined. An often used argument against joining the euro has been the avoidance of surrendering additional sovereignty to the European Union. Because this topic is, in principle, economic, this thesis will focus on the phenomenon of economic sovereignty, although it is understood that the impact of the euro as a currency also impacts, among others, social, cultural and political areas. To research economic sovereignty in EU countries that do not have the euro as currency, two specific countries have been chosen: Denmark and Sweden. They both have a long history with the European Union, ranging from the Single Market to times of fixed exchange rates to many other treaties. Therefore, the research question of this thesis is:
How has the decision to keep the Danish Krone and Swedish Krona impacted Danish and Swedish economic sovereignty?
In an answering this research question, this thesis will contribute to the existing public debate in multiple EU countries on sovereignty and the euro. Moreover, it will extend the limited academic literature on economic sovereignty by providing a more specific definition on how to measure economic sovereignty. Finally, this specific definition of economic sovereignty will be used on two case studies, providing insight into how countries’ economic sovereignty is impacted.
To investigate this topic, the thesis will start in chapter two with a literature overview on the concept of economic sovereignty and will provide a specific definition that can be used to measure economic sovereignty. The next chapter will show the economies and economic policies of Denmark and Sweden to provide a broad context in which the concept of economic sovereignty can be used. The fourth chapter will review the economic sovereignty of Denmark and Sweden directly by looking at three key economic policy areas and what actors influence these policies, while the final chapter will conclude the research by discussing the findings, answering the research question, showing the research limitations and suggesting possible avenues for further research.
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2 Economic sovereignty
As mentioned, this thesis will focus on the effect of Denmark and Sweden being outside the euro for their economic sovereignty. In order to examine this it is therefore important to first discuss what economic sovereignty is and, moreover, how it can be assessed. This chapter focuses on these questions and will first provide an overview of the debate on sovereignty in general and economic sovereignty in particular. Next the impossible trinity, an economic concept, will be discussed in order to show that complete economic sovereignty does not exist. Finally this chapter will turn to measuring economic sovereignty and how this will be attempted in this thesis.
2.1 The concept of economic sovereignty
Having sovereignty is having supreme or ultimate power or authority, according to the Oxford dictionary. It is often used together with a state to indicate that the governing power of the land has the supreme authority to make decisions. Before nation states were created in Europe the concept of sovereignty was not really one that was discussed: the authority was with the ruling king or, in some cases, the church. Even with the nation states being formed the authority did not change: the sovereignty of the state remained embodied in the king. However, increasingly focus of these sovereigns was also on conferring individual liberties on private citizens (Habermas, 1998).This changed when calls for a more democratic society came up, arguing to limit the power of the King, as can clearly be seen looking at Thomas Hobbes, the writer of Leviathan (1651). His work contains one of the earliest ideas of social contract theory, which states that individuals surrender some of their freedoms to the authority in exchange for protection of their rights. For Hobbes (1651), this authority was an absolute sovereign, the king of England, and was inspired by the English Civil War that took place between 1642 and 1651 between Parliamentarians and Royalists. He argued that such a kind of war could only be avoided by having a strong, undivided government. Hobbes’ idea of an absolute sovereign did not come true in England, or most of Europe, and an increasing amount of countries switched from a monarchical system to a parliamentary system for government, so did the concept of sovereignty change from royal to popular sovereignty. In doing so, the authority of the state is based on the people, who are the source of political power, and no longer an absolute sovereign. This change however could only come to pass with the corresponding creation of the modern idea of a nation. This idea was necessary because it created a community for the citizens, a
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sense of belonging to the same group and as such it was the cultural basis for the constitutional state (Habermas, 1998).
Up until this point the discussion has focused on the internal sovereignty of the state, which concerns a country’s ability to maintain law and order (Habermas, 1998). But while the process of transforming the internal sovereignty from royal to popular sovereignty took place, the idea of external sovereignty asserted itself. As external sovereignty is the ability to maintain oneself in the competition for power among states and as such defends its territory (Habermas, 1998), it can clearly be seen in the Peace of Westphalia of 1648. In it the Holy Roman Empire, France, Sweden, Spain and the Dutch Republic not only signed peace for, respectively, the Thirty and Eighty Years’ War but also for the first time mentions respecting territorial integrity. Through the signing of the peace, the concept of Westphalian sovereignty arose, stating that every nation state has sovereignty, so the supreme or ultimate power or authority, over its own territory and domestic affairs. As such, no external powers can claim any sovereignty over these territories nor interfere in the domestic affairs of the country. Finally, every country is equal in international law, no matter how large or small it is.
As European states started to spread all around the globe, so did these principles of the Westphalian Peace, becoming part of international law. As Habermas mentions (1998), a state is now only seen as sovereign if it can both internally maintain law and order and externally protect its own borders. For over three hundred years this type of political sovereignty has been the primary form of sovereignty when it is being discussed, being important both for internal conflicts, e.g. human rights, and external conflicts between states. However, with globalisation countries became increasingly connected, especially also economically. Lowe (1985) argues that this resulted in problems of ‘extraterritorial jurisdiction’, the application of national law applied to foreign businesses outside the nation. Simon and Waller (1986) show that due to these problems international arbitrations, by the International Court of Justice, started not only to include the traditional sovereignty notion of territorial integrity, but also include economic concerns. For example, the United States passed a law in 1964 that embargoed the enrichment of foreign uranium ore in the US. As this hurt non-American producers, those companies got together to form a cartel, thereby increasing uranium prices over eight hundred percent. As this in turn impacted the US companies negatively, they tried to sue those non-US companies. However, the problem with this litigation was that no precedent in international law was previously set. Therefore, in the 1980s
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research lawyers started to think about the concept of economic sovereignty in order to solve these problems of ‘extraterritorial jurisdiction’.
Even though both Lowe (1985) and Simon and Waller (1986) spend most of their time discussing how economic sovereignty can help in legal cases and the conditions to use it, they do spend a little time in discussing what it entails. Lowe (1985: 744) states that “at the heart of the concept of economic sovereignty is the right of a State to regulate the structure of its own economy” whereas Simon and Waller (1986: 348) view economic sovereignty as “encompass(ing) the right to continue and preserve economic activities closely linked to the existence of the state”. For Lowe (1985) economic sovereignty is thus a continuation of political sovereignty, both internal and external. It is linked to internal sovereignty because he argues that the State has a right to regulate its own economy, thereby maintaining law and order. For example, in difficult times a government can nationalise companies it deems necessary for the good of the country. By having this power to regulate, this definition of economic sovereignty is also linked to external sovereignty because, even though no territorial borders are touched, the State now has the power to compete with other states (Habermas, 1986). The same holds true for Simon and Waller (1986) as they specifically make the connection to “activities closely linked to the existence of the state”, indicating that for economic sovereignty to come into effect in legal cases it needs to be about the impact on the state and its right to those economic activities. As Lowe (1985) and Simon and Waller (1986) after defining economic sovereignty use it for legal cases, they did not further define the components of economic sovereignty. Due to this, some ambiguity still remained concerning the concept. Savanovic (2014) argues this has led to four different meanings of economic sovereignty in the decades following Lowe and Simon and Waller. The first meaning of economic sovereignty was State ownership, a concept Savanovic dismisses as it is too limited to use. The second meaning is self-sufficiency: a state is only economically sovereign if it can, on its own, have the resources for its people. As only North-Korea tries, and fails, to do this, this meaning can also not be used to define economic sovereignty. The same holds true for the third meaning: lack of budget deficit and indebtedness to foreign creditors. Finally, the fourth meaning, what Savanovic (2014: 1039) subscribes to, is the “(a)bility of the “state” to independently decide on the use of its own resources (policies).” This meaning is closely related to those of Lowe (1985) and Simon and Waller (1986), showing that the main concept of economic sovereignty has not changed in the decades following them. However, the concept of economic sovereignty has been discussed more in depth, but in order to better
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understand this change it is important to first take a look at the connection between economic and political sovereignty.
Savanovic (2014) argues that in the twentieth century the sovereignty of states has been reduced, pointing to three reasons for this. Firstly, he sees supranational formations, such as the European Union, taking, or being given, legislative powers, for example concerning economic and political policies. Secondly, some external institutions like the International Monetary Fund (IMF) have become so powerful that they can force states to make certain decisions, for example forcing Greece to take austerity measures in order to gain loans. Finally, large transnational corporations (TNC) can influence political and economic decisions of states because of their economic power and impact. Legally, Savanovic (2014) states, these changes did do nothing to reduce the sovereign power of states as they remain the dominant source of legitimate power, but in practice this power is constantly attacked. A prime example can be found in Italy, where its prime minister was forced to abdicate by economic institutions (Martin, 2011). For Savanovic (2014) this shows that the sovereignty of states is not merely reduced, but suppressed by something that took its place: economic sovereignty has become the dominant aspect of sovereignty. This can be seen, he argues, in that states continue to have the legal authority, but that their power, what results they can bring about, is limited. The most important part here is power. Wallerstein (1999: 23) argues that “power is not a theoretically (that is, legally) unlimited authority. Power is measured by results.” These results show the distinction between political and economic sovereignty, because while governments still have legal political sovereignty, the results show that their influence has been reduced. To be, de facto, sovereign is now to have and be able to wield power, to get results. Therefore, it is to be able to manage ones resources, or to “impose the rules of appropriation, exchange and use of resources” (Savanovic, 2014: 1038). This, then, is economic sovereignty as previously defined: the ability of the state to independently decide on the use of its own resources (policies).
While a working definition of economic sovereignty is now found, explaining what it specifically entails still remains open for question. In order to further examine economic sovereignty, the next paragraph will turn to the economic concept of the impossible trinity in order to show that some limitations on economic sovereignty will always exist.
2.2 The impossible trinity
The impossible trinity consists of, as the name suggests, three parts: free capital movement, autonomous monetary policy and fixed foreign exchange rate (Baldwin and Wyplosz, 2009). First,
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capital movement, or capital mobility, concerns the freedom with which (financial) capital can move in and out of a country. In a free-market economy this is important as free capital movement allows capital to flow to the place with the highest returns, thereby increasing economic gains for all nations involved (Baldwin and Wyplosz, 2009). This is the reason that the European Union, and its predecessor, have over the last couple of decades pushed towards free capital mobility, making it mandatory if a country is to join the European single market, even including it in the 1990 Single European Act. Even though full capital mobility can never be achieved, some transaction costs will always exist, free capital movement is primarily defined as an absence of capital controls. These controls consists of measures such as transaction taxes, tariffs and legislation, but also volume restrictions and even a maximum of cash withdrawal in domestic banks.
The second aspect relates to monetary policy, which is the process by which the central bank, or another monetary authority, controls the supply of money, the total amount of money available. This is often done by buying or selling financial instruments such as foreign currency or treasury bills, thereby influencing the interest rate. Another example is that the central bank can increase or decrease the interest rate they use on loans to commercial banks, increasing or decreasing the money in circulation. Implementing monetary policies is done for multiple reasons. In Europe the main reason is to ensure price stability and trust, but economic growth, decreasing unemployment and influencing the exchange rate can also be targeted by these policies (Bădescu, 2015).
The final aspect of the impossible trinity is (fixed) foreign exchange rates. The exchange rate is the rate at which one currency can be traded for another currency and consists of two primary types: a fixed exchange rate and a floating exchange rate. In the fixed exchange rate the currency is tied to another currency, mostly the US dollar and the euro, but historically also to gold. The advantage is that by having a fixed exchange rate there are no more currency fluctuations, providing predictability for trade firms as well as encouraging investment and keeping inflation low. However, it also provides less flexibility to respond to economic shocks, such as oil price increases, current account imbalances will not be automatically solved through currency fluctuations and it forces a country to keep the currency fixed by for example increasing the interest rate, thereby decreasing autonomous decision making. That is where the second type, a floating exchange rate, comes in as under this type the currency exchange rate is determined by supply and demand, providing more flexibility and decreasing current account imbalances. Between these two extremes there are many types in between, such as a floating regime between boundaries and managed floating. Which course
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of action is the best is still being debated, with for example the eurozone and Sweden having free floating exchange rates and Denmark and Bulgaria having a fixed exchange rate.
As the name suggests, the three parts of the impossible trinity cannot al be in place at the same time, only two of three can exist alongside each other (Baldwin and Wyplosz, 2009). It has been tried to combine all three policies, but this has only caused financial crises, such as the 1997 Asian financial crisis and the 2002 Argentinean financial collapse. For every country there are only three options, with the first being full capital mobility and autonomous monetary policy. In this case the country has the advantages of free capital movement and can influence the economy via monetary policies, but the exchange rate cannot be touched by the state anymore. Most major economies follow this policy currently, such as US, the eurozone, Japan, the UK and Sweden. The second option is full capital mobility and a fixed exchange rate, thereby losing monetary policy. This means that countries can no longer directly influence their economy, trusting on the free market to be positive for them. This strategy is used by current members of the European Exchange Rate Mechanism II, such as Denmark and Bulgaria. However, this is also partly the case if a country is to join a monetary union, as one then transfers monetary policy decisions to the supranational central bank such as the European Central Bank (ECB). The final option of the impossible trinity is having a fixed exchange rate and autonomous monetary policy, thereby forgoing free capital movement. This strategy is mostly chosen by developing countries in order to improve their economy.
If the concept of the impossible trinity is linked to economic sovereignty, the ability of the state to independently decide on the use of its own resources or policies, an apparent flaw in the definition becomes clear: it is never fully possible to independently decide on its own resources or policies. Due to how the market economy works there will always be limitations on what a state can do, which has only increased with the globalisation of the economy (Bădescu, 2015). Moreover, the concept of the impossible trinity will be used in chapter four to examine the monetary policy of Denmark and Sweden.
2.3 Assessing economic sovereignty
Having provided an overview on the debate surrounding economic sovereignty and a working definition of it, and having shown the concept of the impossible trinity and how it impacts economic sovereignty, this chapter will now delve deeper into what economic sovereignty exactly is. This will be done by first expanding on the working definition previously provided, followed by specific examples of how this works in practice.
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Economic sovereignty was previously defined as subscribes to, is the “(a)bility of the “state” to independently decide on the use of its own resources (policies)” (Savanovic, 2014: 1039). The first part of this statement seems relatively straightforward: the state, i.e. government, must be able to make decisions free from outside forces. Only what “independently” entails specifically may be up to debate, but we will return to that later on. First we will focus on the second part of the definition, specifically what the meaning of “own resources (policies)” is. While Savanovic does not further clarify which type of resource he means, the assumption is made that is describing economic resources as it best fits into the topic of economic sovereignty. Thus, the, economic, resources are services or other assets that are used to create goods and services, often categorised in three or four factors of production: land, labour, capital and, sometimes, entrepreneurship (McConall et al., 2009). However, Savanovic also mentions policies and, again, no further clarification is provided. In order, then, to understand how policies are related to economic sovereignty we must first, once again, make the assumption that policies are understood as economic policies. Economic policy, according to the Oxford Dictionary of Economics, is “[t]he set of controls used by the government to regulate economic activity”, where economic activity is understood as the actions that involve production, distribution, and consumption of commodities, i.e. goods and services.2 Economic policy, then, is
how government manages or “impose[s] the rules of appropriation, exchange and use of resources” (Savanovic, 2014: 1038). So economic policy is how the state manages its (economic) resources. Therefore, looking at what actors decide on the actions involving goods and resources, or in other words what actors determines economic policy, allows us to examine the extent of economic sovereignty the government has. Thus, we will first turn back to what “independently” entails in order to see what bodies can influence economic policy before concluding this chapter with a deeper examination of the types of economic policy.
As mentioned above, being able to make independent decisions is imperative for economic sovereignty, the government must be free from outside control. Savanovic (2014) distinguishes three powers seeking to reduce limit this independence: supranational political formations, e.g. EU, international financial and economic institutions, e.g. WTO, IMF and the World Bank, and huge international corporations, or TNC’s. Other scholars, such as van Apeldoorn (2002) have made similar assessments, though often in the context of neoliberalism. In all three cases, power shifts from the nation states towards a different entity, as economic decisions are being made elsewhere.
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As per ruling of the US Supreme Court in the Gonzales v Raich case. While this definition has been criticised, it is also widely used nowadays.
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For example, members of the Eurozone must uphold the Stability and Growth Pact, limiting their fiscal policy options. Should a country need funding in order to continue working they can ask the IMF for funds, but the IMF will accompany these loans with additional demands, once again limiting economic decision making for governments. The final example is less direct, as TNC’s mostly, but not always, create indirect pressure on governments by, for example, threatening to leave the country if the tax structure is not to their liking. National governments often have no option but to give into the demands made by these three powers, but how this specifically impacts Denmark and Sweden will be discussed in the following chapters.
Economic sovereignty has multiple aspects: being able to independently make decisions, what economic resources and economic policies are and how economic activity is connected in this. As mentioned, economic policy is the means by which government can control the use of its resources and therefore deserves some additional examination to understand not only what it achieves, but in what ways. A good place to start is to look at why government uses economic policy, and although no universal economic goal(s) exist, it often intents to achieve aims such as economic growth, price stability and full employment. Defining the areas of economic policy is usually done in one of two ways. The first group of authors define it into three broad areas: fiscal, monetary and trade policy (Black et al., 2017). The second way to describe economic policy is by differentiating between macro-economic policy and micro-economic policy (Rodrik, 1996). Sometimes authors change one of these two views slightly, for example to include supply-side or antitrust policy, but then they often still use one of these two categorisations. For the subject of economic sovereignty it is best to follow Black et al. (2017), since it best provides specific examples of who has impacted decision-making concerning resources. Black et al. (2017) focus most of their attention to fiscal, monetary and trade policy and while these are certainly some of the largest areas for economic policy, some additional areas include redistribution, regulatory, anti-trust, industrial and supply-side policies, as well as decisions concerning the impossible trinity. Therefore, this broader definition of economic policy will be used to examine the economic sovereignty of Denmark and Sweden.
2.4 Conclusion
In conclusion, economic sovereignty is a concept that first originated from lawyers in the 1980s as a continuation of the traditional concept of political sovereignty. However, in the subsequent decades this changed as economic sovereignty started to suppress political sovereignty.
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And although the concept was at first broadly defined, and as such receiving different meanings, the core remained: the ability of the state to independently decide on the use of its own resources via economic policies. Important here is that economic sovereignty concerns de facto sovereignty: has the state the power and ability to decide on the use of its own resources or policies, not legal sovereignty as is the case for political sovereignty. Using the impossible trinity, it was shown that complete economic sovereignty does not exist, as a country has to settle on two aspects of the triangle: free capital movement, autonomous monetary policies or a fixed exchange rate. Finally, an overview on assessing economic sovereignty was provided by further expanding on the definition of economic sovereignty, showing that in order to define whether a country is economically sovereign one must focus on who decides on economic policy. Is it the government itself, or one of the three outside powers? In order to better understand how this has impacted Denmark and Sweden, the next chapter will profile the economies of both Denmark and Sweden.
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3 Economies of Denmark and Sweden
Having provided an overview on what economic sovereignty and its different characteristics are, we now turn to the economies and economic policies of Denmark and Sweden. For in order to understand to what extent Denmark and Sweden are still economically sovereign, it must be clear what it is they are, or are not, sovereign over. Therefore, economy is used here to indicate the national economy and will focus on the characteristics of the respective economies, such as GDP, (un)employment and the exchange rate. Economic policy, on the other hand, has already been discussed before and will be shown throughout this chapter in its sub-policies, such as fiscal and monetary policy. Where the next chapter will go in-depth and focus on a few key economic policy areas in order to identify what actors determined these specific policies, this chapter will show the developments of Denmark and Sweden over the last century to serve as a broader context in which these key economic policies were established. Therefore, first Denmark and its economy and policies will be discussed in three general time periods, followed by Sweden in four time periods. 3.1 Economy of Denmark
To better provide an overview of the economy and economic policy of Denmark since 1945, three time periods will be discerned: from 1945 to 1990, from 1990 to 2005 and from 2005 to the present. Starting at the end of the Second World War, Denmark’s economy was still mostly agrarian (Pedersen, 1995). Although the shift towards industrialisation was slowly started in the decades before the War, it was the economic crisis of the 1930s combined with the War that led to a more rapid shift from agriculture after 1945. According to Pedersen (1995), the reasons for this were twofold: prices for raw materials, including agriculture, plummeted during the economic crisis, as well as Denmark losing one of its main trading partners, the United Kingdom (UK), during the War. After 1945 the first five years were, in contrast to other European countries, not that great. While there was an increase in employment and GDP growth, it came slowly while at the same time foreign trade was rife with problems (Pedersen, 1995). On the supply side, the two main markets for Danish goods, Germany and the UK, were having economic problems, and on the demand side there was a lack of foreign currency and trading partners, leading to a deficiency of raw materials and energy. It was not until 1950 that Denmark restructured its trade more towards the USA, Scandinavia and the rest of the world. In terms of economic policy this lead to new commitment to high employment combined with a restriction of the balance of payment (Pedersen, 1995).
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Moreover, regulation of the domestic economy and foreign trade that had sprung up in the 1930s was loosened, instead turning to demand management via expansionary fiscal policy. The deregulation, combined with an increase in investments and a rapidly expanding public sector, contributed to the high growth of over four percent GNP growth during the late 1950s to the early 1970s, leading to low unemployment and inflation, as well as macroeconomic and public budget balance (De Long and Summers, 1991). This was achieved even though by joining the European Free Trade Association in 1960 Denmark’s agricultural export was limited, and although Denmark subsequently joined the European Economic Community in 1973, the sectoral shift from agriculture to industry was irreversible (Pedersen, 1995). Another contributing factor mentioned by Pedersen (1995) to growth was the combination of monetary and tax policy, as the real rate of interest net of taxes was minus three percent, leading to both a public and private sector expansion. However, due to higher inflation and current account deficits, Danish international competitiveness declined and macroeconomic imbalances increased, causing the end of the high growth years. Even the newly introduced incomes policy of the 1960s did not help to reduce this decline (Pedersen, 1995). Although economic growth was already coming to a halt in the early 1970s, the oil crisis of 1973 had great effect on the Danish economy. Part of this was the international recession, but also the imbalances created in the 1960s led to an inability to use policies to combat the recession. Moreover, the price increases automatically led to higher wages, increasing over forty percent during 1973 and 1975 which, combined with the eight percent currency appreciation, led to a significant decrease in competitiveness and, in turn, employment and economic growth. To avoid a repeat of this situation, the Danish government subsequently abolished wage indexing and started to devaluate the Danish Krone, though the slow institutional changes and conflicting economic policies still created an inability to decrease unemployment and increase growth in the 1970s (Pedersen, 1995). The 1980s started better, with a change to the fixed exchange rate and a focus on the private sector. However, the economic improvement was short-lived as the current account deficit caught up with Denmark, requiring tighter fiscal policy and a reformed tax system, while only the export industry was growing. Going into the 1990s Denmark, in contrast to other OECD countries, had a high unemployment rate of over eight percent, low economic growth and a current account deficit.
While the conservative-liberal governments of the 1980s did not create many institutional changes, in 1989 they did initiate a ‘paradigmatic shift’ on economic ideas (Andersen, 2011). Where the focus had previously been on creating a current account surplus and little attention was paid to fine-tuning economic policy, attention now shifted towards the supply side of the economy.
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Moreover, the government introduced the concept of ‘structural problems’, which was generally seen as regulation that hinders market flexibility (Andersen, 2011). The two focus areas were (un)employment and taxation, although the conservative-liberals did not have enough power to implement new policies. In 1993 this changed when a new centre-left government came into power. And while many of the problems categorised by the conservative-liberals continued to survive, the solutions for those problems were different. The main breaking point with earlier economic policy was that the new government followed a more expansionary policy to stimulate consumption (Andersen, 2011). This was done in four areas: increasing public expenditure, changing labour market policy, positively reforming taxation and liberalising credit opportunities for home owners. The first area, public expenditure, was allowed to grow over two percent in real terms in the 1990s, in contrast to the hesitation Danish government had in the 1980s. This active role of government can also be found in the labour market policy, where the previous ideas of ‘labour shedding’, in which early retirement is used to reduce unemployment, were abandoned and new emphasis was put on stimulating labour supply (Andersen, 2011). This idea is best seen in the idea of an ‘inclusive labour market’, announced in 1998 by the centre-left government to include marginalised groups as to maximise labour supply. The third reform area was taxation, with lower marginal taxes combined with fewer tax deductions, making the reform mostly revenue neutral (Andersen, 2011). The final important area was the liberalisation of credit opportunities for home owners, making it enticing for home owners to take additional loans or restructure their current ones. While this did stimulate public consumption and was an economic success in the short-term, it did create problems when the economic crisis hit in 2008. Overall, the ‘kick-start’ to the economy seemed very successful, with an almost three percent average GDP growth until 2011 and drastic declines in unemployment. But, although the centre-left government claimed credit for the economic success, it is by no means certain that the new economic policies were the cause of the economic upturn, or at least not to the full extent. While the ‘kick-start’ might have been the trigger, other economic factors that impacted the economy positively were the traditional macroeconomic policies, including increased savings and the solution to the balance of payment problems in the 1980s (Linderoth et al., 2010). Moreover, exports increased due to better performing economies of trading partners, especially in Germany after the unification. As can be seen in table 3.1 below, exports increased by over 600 percent leading to a 41 billion Danish Krones surplus in 1994. Also, in the late 1990s Denmark became the only EU member who had a net export of oil. Both these external factors and the economic policy did not change much after the 2001 elections in which the liberal-conservatives took over
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government again after eight years. The only significant change was in tax reform, as the new government specifically implemented a tax policy for a ‘tax stop’: tax could not be increased, only shifted or decreased. In both 2003 and 2007 tax cuts were implemented to achieve full employment, but this was never accomplished when the economic crisis hit Denmark in 2008.
The economic crisis first began in the United States in 2007 with the collapse of the subprime mortgage bubble, which led to a banking crisis shortly after (O’Hara, 2009). This in turn caused a global recession that hit Denmark in the third quarter of 2008, creating year long recession in Denmark (OECD, 2017b). Moreover, the subsequent European debt crisis caused even more economic problems (Lane, 2012). Generally, an economic crisis of this proportion is seen as an exogenous shock, an outside force that leaves a country such as Denmark in a situation with little room to manoeuvre (Lane, 2012). However, a strong national component also existed in Denmark, producing an economic downturn greater than in most other countries (Bernstein 2010; Sørensen, 2010). Multiple contributing factors can be seen, among others the liberalisation of credit policy, pro-cyclical credit and fiscal policy, the housing bubble and a decline in competitiveness. Although Denmark was doing well economically, and maybe because of it, government liberated credit policies, causing Danish banks to increase their credit expansion dramatically, building a deposit deficit of around forty percent of GDP. Moreover, the economic upswing in combination with credit liberalisation for home owners caused rising housing prices as well as an increase in private
Table 3.1. Structure of Danish foreign trade 1973-2009
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consumption due to the additional credit. In combination with an expansionary fiscal policy and relatively excessive wage increases, the decline in competitiveness combined with the economic crisis had a severe impact on the Danish economy (Andersen, 2011). GDP declined with over five percent in 2009, the greatest economic decline for almost two hundred years (Worldbank, 2017). Some crisis policies were implemented from 2008 onwards, but they had little effect. The already expansionary fiscal policy and automatic stabilisers such as unemployment benefits could do little to combat the crisis (Andersen, 2011). There was also institutional change regarding labour policy, as the idea of flexicurity slowly eroded by a multitude of changes during the crisis. Unemployment benefit terms became shorter and less liberal while government was looking for ways to contain the costs, which was necessary even though Denmark had a public expenditure surplus in the years before the crisis (Andersen, 2011). With the declining housing prices due to the economic crisis, as well as the high unemployment the Danish government had to focus on export-driven growth at the start of the 2010 decade and with increasing productivity there are some hopeful elements for the Danish economy. However, economists in 2011 saw short-term prospects as not being great due to a damaged competitiveness, low domestic consumption, lingering housing market problems and little to no profit from the economic upswing of trading partners such as Germany and Sweden. Five years later, these fears have shown to be reasonably correct (OECD, 2016a). It was not until 2014 that GDP started to increase again, one percent a year, and unemployment to drop, from seven to 6.5 percent. This was achieved mainly be an increase in exports in 2014, though the subsequent slowdown in Asia and Europe caused a decline in exports and 2015 and 2016 (OECD, 2016a). The reason export was the main driver of growth was because productivity growth is lagging. While Denmark has high living standards, productivity growth is almost seven percent lower than better performing countries such as Germany and Sweden, being one of the main reasons for low GDP growth in the last few years (OECD, 2016a). Another risk still existing in Denmark is the housing market, as there is high household debt of 127 percent of GDP, one of the highest in the OECD. This debt coupled with the very accommodative monetary policy could lead to a new housing bubble. This accommodative monetary policy, however, is something Denmark has a difficult time influencing as most of policy comes from the ECB and, with Denmark’s fixed exchange rate with the euro and free capital movement, impacts the Danish economy. Nevertheless, on other fronts the Danish economy is doing quite well, with inflation being below one percent and the current account surplus being between seven and eight percent of GDP. Moreover, government debt is just around forty percent, the public budget should be in balance within a few years and Denmark has the lowest
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Gini coefficient among OECD countries, although inequality is slowly rising since the crisis. Overall, while the crisis has hit Denmark hard and there are still some lingering risks, the Danish economy is quite robust and with the expected rise in exports in 2017 combined with recent policies to improve productivity growth, GDP is set to increase by almost two percent.
So during the first seventy year Denmark’s economy started doing well almost a decade after other European countries, finally leading to almost twenty years of high growth. But as can be seen in figure 3.1, economic growth has not remained consistent: up until the 1960s economic growth has been great, but this was already declining in the late 1960s and even decreased in the 1970s, especially due to the two oil crises. Even with a short upswing in the early 1980s, a few years later an almost decade long decline was initiated. The large swings in economic growth remained, with a positive 1990s leading into largest economic declines after the economic crisis in 2007. And although the economic crises definitely impacted the Danish economies, a strong national component remained as the correlation between Danish and EU business cycles was only 0.7, see
Figure 3.1. Danish GDP growth since 1960.
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figure 3.3 below. (Un)employment trends have had similar characteristics to economic growth, with unemployment decreasing in economic upswings and increasing when the economy started to falter. Another economic indicator with similar characteristics to economic growth has been competitiveness. Often due to increased inflation and wages, declines in Danish international competitiveness often preceded economic downturns. This was exacerbated by current account deficits until the early 1990s, although from the late 1990s onwards this has remained a surplus, helped by a rapid increase in exports since the 1970s. As for economic policies, the Danish government has throughout the years continued to focus on high employment policies, for example by the implementation of flexicurity in the 1990s and reductions in taxes in the 2000s. Moreover, economic regulation was systematically loosened during this seventy years period, e.g. credit liberalisation, and focus shifted from creating a current account surplus as it was achieved in the 1990s. In terms of monetary policy, it started off very accommodative in the 1960s and 1970s, although due to the start of fixed exchange rate in the 1980s the policy objective shifted to two percent inflation and further Danish impact here is limited. Finally, fiscal policy was expansionary in the 1950s to get the economy going, although the current accounts deficit led to these policies contracting. However, when this was deficit was solved in the early 1990s, Danish fiscal policy remained expansionary in the following decades with increased public spending and decreased taxes. 3.2 Economy of Sweden
The major shift in the Swedish economy started already in the mid-19th century. In the fifty year
period between 1840 and 1890 Sweden used its natural resources such as wood and iron to quickly industrialise and become an export-oriented country with good opportunities for entrepreneurs (Sjögren, 2008). This increased focus on foreign trade and globalisation was accompanied by liberal reforms and government investment in infrastructure such as railways. During this first wave of globalisation the shift from an agrarian society towards an industrialised country was started. Moreover, due to these developments Sweden had the highest growth rate of all industrialised countries at the end of the 19th century, which it would go on for a hundred years until 1970
(Henrekson et al., 1996). The high economic and productivity growth also led to large increases in real wages. Even in the economic crisis of the 1930s the Swedish economy performed relatively well, although unemployment was high. To combat unemployment the Swedish government initiated economic policies not unlike Keynes proposed a few years later, and it was the start of the full employment strategy the Swedish government followed until 1990 (Henrekson et al, 1996). During
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the Second World War, although Sweden was neutral, foreign trade declined leading to a response of the government to have stronger control in the setting of wages, prices and rents. However, the neutrality during the war did allow Sweden to quickly recover as there was little damage done to its infrastructure and, combined with the export opportunities due to the rebuilding of other European countries, this led to high economic growth. This was especially visible in the 1950s and 1960s where the Swedish economy was in the ‘Golden Age’, with growth rates going from almost three percent in the 1950s to over four percent in the 1960s (Henrekson et al., 1996). Also, inflation was kept relatively low, between two and four percent, unemployment dropped to 1.5% and exports increased by four hundred percent between 1945 and 1980. Part of this uncommon stability was the entrance to Bretton Woods in 1951, and subsequently the GATT and EFTA, combined with stabilising policies, but economists also point towards the Swedish model as having impacted the economy (Sjögren, 2008). What the Swedish model specifically entails is subject to much debate, but three broad areas can commonly be found (Henrekson et al., 1996). The first area is the existence of a strong labour movement represented by the Social Democratic Party and the LO, the blue-collar trade union. Secondly, the government invested in an ambitious package of economic policies for full employment, such as stabilisation, growth and welfare policies. Finally, the Swedish model is known for its large public sector, although this increase did not occur until the 1970s (Sjögren, 2008). The low unemployment and high wages combined with solidarity for low income employees made Sweden the model of welfare capitalism to follow in the 1960s.
This changed in the second half of the 1970s when OPEC I and OPEC II hit (Sjögren, 2008). Due to expansionary fiscal policy the Swedish government caused, instead of other much needed adjustments, higher prices and wages, leading to a loss in competitiveness and exports. Moreover, this caused large budget and balance of payments deficits, with the budget deficit increasing by almost forty percent of GDP in just ten years (Henrekson et al., 1996). One of the main causes for the large impact of the crisis were the underlying structural problems in the Swedish economy. The economy consisted of three sectors: the competitive sector, mostly the export and import companies, the sheltered private sector and the public sheltered sector. In the 1950s and 1960s productivity growth was twice as large in the competitive sector compared to the other two sectors. This lack of competition was, looking back, especially significant in the late 1960s when wages in the public sector increased to unsustainable levels. These high wages combined with a massive shift from private to public employment, public expenditure rose from 31 percent of GDP in 1960 to 62 percent of GDP in 1980, caused the loss in competitiveness and hindered economic
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growth (Henrekson et al., 1996). While economic and productivity growth fell, though still remained positive, unemployment remained low during the late 1970s and 1980s, even though inflation was rising. Low unemployment was one of the few successes for the Swedish government, as total industrial production fell by over ten percent between 1976 and 1978 and its interventions to save whole industries had little to no effect (Sjögren, 2008). Moreover, the necessary devaluations of the Krona were not accompanied by subsequent contractionary fiscal policies causing government debt to continue increasing. The return of the Social Democrats to power in 1982, after being side-lined for six years, saw a break with this policy. A sixteen percent devaluation was initiated in 1982 in order to kick-start the economy, but the plan was to accompany it with tight monetary and fiscal policy and an expenditure switch from the sheltered to the competitive sector due to deregulation (Henrikson et al., 2008). Although this seemed to work for three years, from 1985 onwards it was clear the plan failed. The budget deficit, although declining for a few years, started to increase again, just as price and wage inflation. Moreover, the deregulation and, unintended, expansionary policies led to an overheating of the Swedish economy in the second half of the 1980s. This was made worse by new economic policies of deregulation in the financial sector, ultimately causing speculation and insolvency by credit institutions, including banks, although the Central Bank (Riksbank) did achieve independence during this period. The subsequent financial crisis hit Sweden hard in the early 1990s, with three years of negative GDP growth. The deep recession finally led to high unemployment, moving from just two percent to over eight percent in a few years, causing the Swedish government to abandon the full employment strategy in favour of low inflation and supply side measures. Following the European currency crisis the Swedish Central Bank was also forced to switch to a floating Krona, leading Sweden into a new economic policy regime (Erixon, 2011).
The new economic policy regime in the 1990s did continue the deregulation started in the 1980s but, in contrast, focused on tight fiscal policy and restrictive monetary policy (Erixon, 2011). Tight fiscal policy was Sweden’s answer to the early 1990s crisis and was thought to be able to help combat the crisis by promoting private investments (Erixon, 2015). This was accompanied by new, stricter fiscal rules, including the obligation to achieve a one percent GDP public budget surplus over the complete business cycle. New monetary policy was also followed by the Riksbank due to the new focus to keep inflation around two percent and was necessarily restrictive due to the devaluations of the Krona. In 1998 this new economic regime was fully implemented and it seemed to be working well: Sweden climbed quickly out of the economic crisis of the early 1990s and achieved high productivity and economic growth during the 1998-2007 period, 2.6 percent and 3.4
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percent of GDP respectively (Erixon, 2011). This was attained even with the 2001 bursting of the dotcom bubble. Inflation was kept low and a public budget surplus was obtained for most years, although unemployment was still relatively high. However, the positive results may have skewed public perception on the success of the new economic policy regime as outside factors played an important role (Erixon, 2015). High GDP growth was achieved because of low to negative GDP growth in the early 1990s and, most importantly, favourable export opportunities, especially the emerging Asia market. Moreover, the productivity growth has mainly been achieved due to the tele-product sector, either directly or, via spill-overs, indirectly. Restrictive monetary policy and anti-inflationary policy did succeed in keeping inflation low, but also in an inability to reduce unemployment. Erixon (2015) even argues that while the fiscal austerity in the 1990s did lead to a fast public budget balance, it was not the main reason for the reduction in the debt reduction. In his view, the economic upswing between 1998 and 2007 was despite the fiscal arrangements, not because of them. An argument for his statement can already be found in 1993 when export growth led to economic improvement, despite tight fiscal and monetary policy which delayed the recovery, although the depreciation definitely did help. Moreover, Swedish monetary policy had what is called ‘divine coincidence’: no conflict between the inflation target and stabilising the real economy. Due to mixed business cycles in the European countries there was an absence of strong symmetric shocks. This however changed when the global financial crisis hit in 2008.
With Sweden’s high GDP growth, the current account and public budget in surplus and strong production, prospects for Swedish economic performance were strong. But the crisis in 2008 brought an end to ‘divine coincidence’, resulting in a simultaneous supply shock and financial crisis for Sweden. Still, the US mortgage crisis had no direct negative effect as Swedish banks barely had invested in the bad assets and, due to independent monetary policy, no housing bubble existed. Although the Swedish government had buffers to invest in the economy, fiscal policy remained restrictive in 2008 and 2009, a decision that did not work out well as the economy declined in 2008 and 2009 by numbers higher than the crisis in the late 1970s or early 1990s (Lane, 2012). The strong built-in stabilisers of a large public sector and the social insurance system could not prevent this decline. Unemployment did not rise by much, but productivity growth decreased and exports declined due to this loss in competitiveness and the abysmal situation of the world economy. 2010 and 2011 did show a rejuvenation of the economy with high GDP growth, though in 2011 the size of the economy was still not at pre-crisis levels. The growth was due to more expansionary fiscal policy and, as always for Sweden, export-led growth (Erixon, 2015). Export growth was achieved
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both via the composition of the economy, low and medium-tech raw materials that were in demand due to the strengthening of the world economy, and a strong rise in trade with Asia, specifically China. Economic results during this period were mixed, with an almost six year long public deficit from 2009 to 2014, though it never rose above two percent GDP, unemployment remaining between seven and ten percent and relatively high GDP growth. As was the case in the 1990s and early 2000s, fiscal policy was not the main cause for the relatively good economic performance. It was a combination of good independent monetary policy to prevent a housing bubble, an avoidance of a banking crisis due to the economic recovery of the Baltic states and flexible exchange rates to counteract the decline in exports in 2008 and 2009, leading to a renewed export growth in the following years (Erixon, 2015). After 2014 economic prospects continued to rise with 4.1 and 3.4 percent GDP growth in 2015 and 2016 respectively, and 2017 GDP growth predicted to be 2.4 percent (IMF, 2016). Due to expansionary monetary policy, including a negative .5 percent Repo rate, inflation has risen from a half percent in 2013 and 2014 to 1.2 percent in 2016 and unemployment dropped from eight to seven percent. Public budget deficit is small and declining, although the public deficit to GDP ratio has risen over seven percent compared to pre-crisis levels. Moreover, two main risks continue to exist for the Swedish economy (OECD, 2017b). Firstly, housing prices have been increasing rapidly, with over a forty percent rise in 2014, accompanied by heightened household debt, risking a housing bubble that was avoided in the 2008 financial crisis. Secondly, due to the openness of the Swedish economy, global economic developments continue to pose a risk, such as the distinct possibility of the Brexit. Overall though, while unemployment continues to be relatively high and some risks continue to exist, the Swedish economy is performing well and is set to continue expanding in the coming years.
Since the 19th century Sweden has had an export-oriented economy. Because of this Sweden
has had large export growth during this period, save a few times, such as the Second World War, the 1970s and the late 2000s, where due to a decline in competitiveness export decreased for a few years. One of the effects of this switch to export since the 19th century has been the great economic
growth until the 1960s. However, as can be seen in figure 3.2 the since the 1970s GDP has been a lot less consistent, although unlike Denmark these periods of negative GDP growth are all consistent with the economic crises that Sweden has experienced.
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Even the period of ‘divine coincidence’ in the late 1990s and early 2000s was not enough for Sweden to escape the economic crisis that started in 2007. Figure 3.3 shows that the Swedish business cycle only correlates to the EU business cycle for 0.6, indicating that just as with Denmark national components do still play an important role in the Swedish economy. After the 1930s, unemployment remained low until the 1990s and then jumped to around eight percent in the following decades, with a minimum of five percent even in the best years. Contrary to Denmark, save the 1970s Sweden did not have many problems with the current account, and in the last twenty years large surpluses have arisen on the balance of payment, especially due to an improved competitiveness since then. This was helped by the switch to a floating currency in 1977 allowing Sweden to devaluate the Krona and even though it joined the EU in 1995 it was allowed to keep its own currency. As for public budget, during the 1970s deficit increased rapidly and it was not until the late 1990s that the budget deficit of over 75 percent of GDP decreased to around forty percent in the late 2000s and early 2010s. Economic policy in Sweden focused on full employment for a long time, well in to the 1980s. Due to the recession in the 1990s this was let go and monetary policy with the objective of low inflation officially became the main target, although the Swedish government often tried to improve economic growth via currency devaluations. Another economic policy area
Figure 3.2. Swedish GDP growth since 1960.
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that was used to try to increase economic growth was deregulation, for example in the housing and financial sector and with the liberalising of credit opportunities. Finally, in broad lines fiscal policy has changed three times during the last one hundred years. It started off expansionary until the 1970s, but then turned constrictive as a response to both the economic crises and increasing public debt. Even though this has hindered economic recovery, it was not until 2010 that the Swedish government used expansionary fiscal policy to increase economic growth.
Figure 3.3. Correlation in business cycles with Euro area business cycles
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4 Key Economic policy areas
In chapter two it was shown that in order to define whether a country is economically sovereign one must understand to what extent different actors influence economic policy. Economic policy was the means by which government can control the use of its resources and then, defining it further, separated into broad policy areas. This thesis calls some of the most important policy sectors key economic policy areas. The previous chapter provided an overview on the economies of Denmark and Sweden over the last century. In doing so, it provided a broader context so that this chapter can focus on key economic policy areas in order to ascertain who influenced their final form. Examining in-depth three policy areas and understanding what actors influenced the decisions helps us to determine the extent of economic sovereignty Denmark and Sweden have. Therefore, each paragraph first provides an overview on what the specific policy area is and will then examine it in-depth in first Denmark and then Sweden. Following Black et al. (2017), this chapter will first discuss fiscal policy, followed by, second, monetary policy and, third, trade policy. Finally, a short overview on a few two smaller policy areas will be provided, competition and environmental policy.
4.1 Fiscal policy
Fiscal policy is the use of government revenue and expenditure to influence the economy. It is one of the two main macroeconomic stabilisation instruments, together with monetary policy (Baldwin and Wyplosz, 2009). This is the macroeconomic aspect of fiscal policy, as a countercyclical instrument, whereas the microeconomic aspect is about the structural characteristics, such as size of the budget, taxes and government spending. Looking at fiscal policy, three stances can be differentiated: neutral, expansionary and contractionary. In these government either spends as much as it receives, neutral, or spends more, expansionary, or less, contractionary. Expansionary policy is often used to help the economy improve when growth is low, while contractionary policy is used to decrease the overheating of the economy. Another important facet of fiscal policy is the difference between automatic stabilisers and discretionary fiscal policy (Baldwin and Wyplosz, 2009). Automatic stabilisers are those effects of fiscal policy that happen without government intervention. For example, when the economic is in a downturn government spending increases as unemployment benefits rise, automatically helping to stabilise the economy. Discretionary policy, on the other hand, is when the government decides to intervene, for example when government decides to lower specific taxes or invests in infrastructure. In order to gain an overview of the fiscal policies of
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Denmark and Sweden, this paragraph will first focus on the revenue side, taxes, before looking at government spending and finally at the public budget in the respective countries.
4.1.1 Fiscal policy in Denmark
Denmark is often categorised as one of the countries in the so called ‘Nordic model’ (Bentzen et al., 2017). This is one of the three different types of welfare states, in which society tries to correct the outcomes of an unregulated market economy, especially undesirable outcomes. The other two types are the liberal model, in which government plays a small role and only provides the minimum, and the corporatist model, which focuses more on hierarchy and corporate groups of economic sectors (Esping-Andersen, 1990). The Nordic, or universal, model however has a more designated role for the government as a central provider of social services. This explains the relatively large size of the Danish government, which in 2015 accounted for 55 percent of GDP (Bentzen et al., 2017).
Looking at the tax structure of Denmark as shown in figure 4.1, it is clear that the largest share of taxes comes from income taxation, with 44 percent income taxes and an additional ten percent labour market contribution. For personal income two tax brackets apply: the bottom and the top bracket tax, being 49.6 and 56.4 percent respectively, although a middle bracket used to exist.
Figure 4.1. Tax structure, Denmark 2015.
Source: World Bank, 2017
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Denmark has a high marginal tax rate of almost seventy percent and also tries to provide incentives for individuals to work (Bentzen et al., 2017). The other important tax for the government is the consumption tax, VAT, which has a flat tax rate of 25 percent, one of the highest in Europe. Some exceptions do exist, such as taxes on alcohol and vehicles, but these are relatively minor. Further, corporate taxes are 22 percent, while property is taxed for one percent until a fixed price, then jumping to three percent. Tax reforms have been undertaken quite frequently in the last thirty years: in 1987, 1994, 1999, 2004, 2009 and 2012 (Bentzen et al., 2017). In these reforms many changes have been made, although due to a tax freeze implemented in 2002 the last three reforms have only been tax reductions. First, for income taxes marginal tax rates have been lowered in the then existing three brackets, although the middle and top brackets got the larger breaks. Second, corporate taxation used to be relatively high with a rate of over fifty percent in the 1990s (OECD, 2011). This was slowly reduced until 28 percent in 2005 and finally 22 percent as it is currently. Third, indirect taxes have also historically been relatively high, but due to EU tax harmonisation rules slowly lowered since (OECD, 2011). This caused Denmark to implement special traveller rules to reduce over-the-border shopping. Finally, new environmental taxes have been introduced. Overall, the marginal income tax rates for both individuals and corporations have been reduced to strengthen work incentives (Linderoth et al, 2011).
As mentioned above, government spending in Denmark accounted for 55 percent of GDP. As discussed in the previous chapter, this was due to a rapidly expanding public sector in the 1950s and 1960s, levelling out in the 1970s (Bentzen et al., 2017). Of the public expenses in 2015, 53 percent is from public consumption and 37 of transfers. Some of this consumption goes to welfare services such as education, while the rest goes to classical public sector activities such as the police and judicial system. The public consumption consists for almost seventy percent of wage payments, indicating the large role the government has for employment. As for the function of the government spending, figure 4.2 shows that 43% goes to social protection. These transfers now amount to almost 24 percent of GDP. They have changed though over the years, as various labour market reforms have been implemented since the 1970s. First, adverse effects were tried to be weakened, focusing on income maintenance. However, this changed in the 1990s when labour market policy started to tighten, for example via reduction of unemployment benefits years, increased participation quota and making it more difficult to be eligible for unemployment benefits (Linderoth et al., 2011). Famous has become the term ‘flexicurity’, in which it is hiring and firing is relatively simple,
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‘flexible’, and workers have their incomes secured via transfers, ‘security’, which found its origin in Denmark.
Finally, the overall public budget in Denmark has switched between periods of budget surpluses, until the 1970s and from the late 1990s onwards, and deficits, in the period in between and during the economic crisis in the late 2000s. Since 1999 Denmark must, according to the Stability and Growth Pact, limit the government deficit to a maximum of three percent of GDP and public debt to a maximum of sixty percent of GDP. But although Denmark has to apply with these rules, and even stricter ones implemented in 2011 called the ‘six-pack’, it passed in 2012 the so-called ‘budget law’. This budget law is even stricter in order to gain fiscal sustainability, stating that the structural total budget balance cannot exceed a 0.5% deficit and public expenditures are managed according to four-year ceilings (Bentzen et al., 2017).
Figure 4.2. Functional distribution of Danish public expenses in 2015
Source: World Bank, 2017
