Small populations make it harder to do what Nordic countries do
Matt Bruenig
18220

Are Small Populations a Nordic Handicap or Nordic Help?

Matt Bruenig wrote a piece today arguing that, well, here’s his title:

The point of his post is summarized at the end. Namely:

In other words, his argument is that smallness makes it harder for the Nordics to maintain a robust welfare state, rather than easier.

The basic argument for this is agreed upon by not-very-analytically-minded-people on the left and right. It goes like this:

  1. Welfare states are expensive
  2. To pay for expensive things, you need money
  3. To get money, you have to have higher taxes
  4. Higher taxes are disliked by people paying them
  5. Workers, inventors, innovators, business owners, and investors will tend to shy away from high taxes
  6. Welfare states will therefore tend towards financial death-spirals without some outside force

This is believed for countries and, famously, for U.S. states: think about the California vs. Texas arguments.

It’s an idiotic and wrong-headed view. Let’s walk through it.

Are Welfare States Expensive?

Yes.

Here’s government revenues (all types) vs. GDP for developed countries:

Way out on the right are Nordics like Norway, Finland, and Denmark. So it does seem like a social-democratic government is expensive! It takes a lot of taxes to pay for stuff!

Do You Need Money to Pay For Things?

Yes.

This may seem obvious, but actually gets kinda nuanced: obviously you need money to pay for things… but you could always try and borrow money from the future. There’s great debate about the sustainability of various debt loads that I won’t wade into, but I’ll note that none of the Nordics has experienced meaningful sovereign debt default risk. The closest scare was Iceland during the recession, a case to which we will be returning for more details about the Nordic model later.

Finland is globally famous for its fastidiousness with debt: it’s the only country to have paid its WWII reparations in full. It was also the only Nordic country to have to pay reparations. Norway and Finland have among the most pristine sovereign debt histories on earth, and they’re not young countries. Denmark and Sweden have both had to restructure their debts — in 1813 and 1812, as a result of the Napoleonic Wars.

So, to be clear, you do need money to pay for things, but there’s no evidence that Nordic democracy is associated with risky public budgeting. Meanwhile, countries with much smaller revenues as a share of GDP like Mexico, Greece, Ukraine, and Russia have gone through sovereign debt restructuring in the last few decades. The United States has come much closer to massive-scale fiscal collapse than any of the Nordics except, again, perhaps Iceland.

Do You Need High Taxes to Raise Money?

Yes… and No.

The United States’ tax system is far more progressive than Sweden’s. This will be treated as heresy, but hear me out.

First of all, Sweden has a 6–25% consumption tax, Norway has 10–25%, Denmark has 25%, Finland has 10–24%, Iceland has 12–24%. In the U.S. general consumption taxes range from 0–12% depending on locality, 6% is typical. Consumption taxes tend to be regressive: poor people pay more of them.

So one way the Nordics raise money is by taxing poor people more.

They also have higher taxes on poor peoples’ incomes! Here’s my rough calculations of the total tax rate on a single, $30,000-earning person who claims only standard deductions, exemptions, or credit (so not EITC or anything fancy like that):

This is driven by the fact that, in many Nordics, local income taxes can be 20% or more. Employer-side taxes like the U.S. payroll and Medicare taxes are also vastly higher. Now, of course, these taxes pay for most healthcare costs (though not all; all 5 countries still have various amounts of private healthcare spending), so it’s not like that money is just lost.

But we need to be aware who is being taxed. These countries also have comparable or lower taxes on corporations and investment income. You can read the details on Nordic tax policy here.

The point of this is simple. Yes, you have to raise taxes to pay for welfare. And the Nordics do it by taxing poor and middle-income people more. Yes, they tax rich people more too, but not as much more.

So keep in mind that the “Nordic model” presupposes that we will have less progressivity in the tax code. Now, on the whole, the Nordics do far more to redistribute than the US! But they do it through spending, not through taxation. In terms of taxation, boy-howdy, they’re not very progressive at all.

Do Higher Taxes Reduce The Things They Tax?

Yes! But it varies how much.

The Nordic countries place higher taxes than the U.S. on things that have a hard time moving: poor peoples’ incomes, middle-class spending and consumption. They also levy more taxes directly tied to services like pensions and healthcare.

Meanwhile, the Nordics have about the same taxation of investment income, lower taxation of corporations, and only slightly higher taxation of rich people.

Here’s where it gets interesting. Poor people are asset-constrained, so don’t move in response to tax changes quite as much. Corporations choose locations primarily based on entity-level tax rates, not shareholder or worker tax rates (although those do matter to a lesser degree), and so are attracted by the very favorable investment climate. And while corporations may dislike paying taxes for employer healthcare, in the U.S. they pay shares of insurance costs, which may not be any cheaper, and may require extra overhead for them. Yes, I’m arguing here there are some economic benefits to public healthcare. As a conservative, I also think there are some very real costs. But, crucially, these costs don’t show up in the pro-con list for a major investment project.

Do Taxed People Leave the Nordics?

A Bit. But Other People Arrive.

By taxing poor people and consumption instead of investment, the Nordics manage to avoid capital flight and labor flight. The truth is, many rich people are location-constrained as well by highly specialized jobs, and so given that the Nordic tax rates are not that extreme compared to the things they pay for, many people choose to stay. Now, yes, many people do leave due to taxes, but it’s not a flood. It’s a trickle. I won’t bore you with the stats here but suffice to say there’s no shortage of academic research showing tax-motivated migration out of the Nordics, but it’s not demographically significant.

What is demographically significant is the fact that the Nordics have high GDP per capita and, since EU integration, fairly open immigration policy. This awesome website shows the history of Swedish migration. The story is similar for other Nordics: they often have positive net migration because they have vastly higher income than the former Eastern Bloc countries or the developing world. No amount of taxes will make Sweden worse than Mali or Finland poorer than Ukraine.

So yes, people leave the Nordics due to taxes. And people leave New York or California due to taxes. But gazillions more people move there from further away, drawn by huge asymmetries in earning potential and local productivity. As such, there’s no serious risk of high tax rates driving the labor pool to emigrate. Taxes could impact the labor force on the intensive margin, but their extensive effect will be swamped by vastly more powerful forces.

Do Welfare States Face Death Spirals?

Not necessarily.

Welfare states do not have to face death spirals if (1) they can motivate workforce participation, (2) they can replace lost tax-migrants, (3) they can maintain fiscally responsible politics. None of these are a given, but the Nordics have mostly accomplished them thus far.

Workforce participation can be reduced by generous benefits… but mostly by means-tested benefits. In fact, the high-but-flat Nordic tax system might discourage work less than the U.S. tax system. Meanwhile, some welfare benefits may increase workforce participation, like subsidized childcare. More broadly, a culture with an extremely strong work ethic supported by ethnic and philosophical-religious norms that value work make strong foundations for social democracy. Some countries have very robust welfare states and mass disemployment as a result. Others do not. Culture is one factor that drives this.

The ability to replace inevitable tax-migrant losses is also key. In a world of economic equality, Sweden would suffer more than it presently does from its high taxes. However, so long as massive global inequality persists and rich countries can gain workers from poor countries, the Nordics and other countries like them should be able to maintain substantial workforces. The only question here is whether the strong culture mentioned above can be maintained intact as the underlying population changes substantially. In some cases, the answer will be yes. In other cases, the answer will be no. It is not entirely clear what determines the “yes” vs the “no.” Certainly the Nordic countries are nobody’s gold standard for immigrant integration, and have not been immune to the radicalized far-right.

Finally, the question of maintaining good fiscal policies (meaning here “avoiding sovereign or currency risk”) really speaks to the biggest question. Most of what makes governments good has nothing to do with their actual policies, and everything to do with whether or not they arbitrarily murder dissidents, whether or not officials take bribes, the degree to which opposition parties can work together amid crises, the independence of key institutions, the reliability of the police force, etc. Countries with fairly libertarian policies or fairly social democratic policies can have very similar outcomes in terms of human flourishing if they share similar institutional quality. The Nordics have astonishingly strong institutional quality.

So Yes, Being Small Helps

There’s no reason, fundamentally, to think a small welfare state is less stable than a large welfare state because, as I’ve shown, none of the factors that make a welfare state possible have anything to do with the size of the state. At least, not in a direct economic sense. In a political sense, state size may matter, because it may relate to institutional quality.

There is debate about what causes very good Nordic institutional quality. Some suggest that labor mobilization caused strong institutions. If so, then the United States is SOL, because the age of mass labor mobilization has ended. Even if we tried really, really hard to boost unionization, it’s unlikely we could create a labor movement even a pale shadow of what it was in the early- and mid-20th century Nordic countries.

Others have suggested what we’re seeing is the inherited culture of Lutheranism, noting that Lutheran-dominated states in the U.S. like the Dakotas, Wisconsin, or Minnesota often have similarly robust institutions. If true, then the United States is once again SOL, because my people are few in number and getting fewer, and, more generally, American Christianity is a receding demographic and cultural force, not a rising one.

It’s also been not-facetiously suggested that climate may driven good institutions, with note being made that nearness to the equator seems to associate with institutional quality in both hemispheres, and that good institutional quality persists in Canada as well. Again, true or false, the U.S. is just SOL here, because we can’t change our geography. And if the climate force driving good institutions is cold weather or regular seasonality, then climate change could make our conditions even worse.

Another suggestion argues that good institutions arise from ethnic homogeneity; or at least ethnic solidarity. That is, if a given population views itself as having few meaningful divisions, it causes people to play nicer together in every walk of life. This lowers societal transaction costs, improving crisis response, easing employment transitions, and generally making all of life better. This argument is once again bad news bears for the United States because, whoops, we’re a deeply divided tribalistic society with virtually no common thread among us besides our passports.

Another suggestion relates to the Federal/geographic structure of countries. Here we have a problem with Matt Bruenig’s story. He said that the Nordics aren’t very concentrated around just a few cities. Except that’s actually one of the sometimes-cited reasons for their success: they’re more likely to be glorified city-states. Here’s the population share for selected countries residing in the largest metro area:

Sweden is the only Nordic country that isn’t pretty heavily dominated by one city. And lest you think I’ve cherry-picked by looking at just the biggest city, let me be clear: these truly are one-city-countries. Here’s a chart of the ratio of the population of the largest metro area in each country to the next five largest combined:

Whoops.

See, what’s going on here is each Nordic country has one big city that represents a large share of the population and which is able to command the resources of a whole nation. Unlike U.S. states where the large city is usually separate from the capital, in the Nordics, the large city is the capital, and the city often predates the nation. The result of this is what I would call the Minas-Tirithization of national politics: the politics of Stockholm are the politics of Sweden, to a great extent. This is not the case in the U.S., where New York’s politics are, while neat enough, ultimately fairly parochial. Indeed, the local politics of any metro area in the U.S. is a local matter, whereas metro-level politics in Helsinki are the national politics of Finland.

So Matt is wrong about the Nordics not having juked stats thanks to cities. But even aside from his error, note that, if this city-political uniformity and the prominence of individual cities is what drives Nordic institutional quality, then the U.S. is again just not gonna ever be Nordic, because we have a highly geographically diversified population.

What’s Your Point, Lyman?

I’m not just trying to be a jerk to Matt Bruenig, really. And he’s correct that there’s no self-evident case for small nations having more robust welfare states.

Small nations can be extremely disharmonious or at least non-homogenous. Rwanda, Eritrea, Haiti, Lebanon, Bosnia, I could go on with a list. Mere smallness, in size or population, does not create strong institutions.

However, it does seem reasonable that at least some part of Nordic success may relate to being relatively small countries, sheltered from immigration from generations at a time, with highly uniform religious and cultural millieus, directly connected to the large markets of Europe, with highly dominant urban capitals, and with long histories of state stability.

Being small doesn’t create homogeneity, but being large does make homogeneity harder. Being small doesn’t create urban-capital dominance, but being large does make it harder. Being small doesn’t create uniform philosophical or cultural inheritance, but being large does make it harder. Being small doesn’t always mean you can avoid being drawn into major wars, but it does make it a bit easier. Combine all these, and you have fertile soil for prosperity. And if you’re an oil exporter too (Denmark and Norway), or if the ground beneath your feet can be used as an industrial power plant (Iceland), or if you implement incredibly lax banking standards to attract investment (Iceland), or if you have a huge mining-and-timber industry (Sweden and Finland), or if you have 1,300 years of specialization in boat-construction thanks to your extensive coastline and islands (all the Nordics; a trait shared with Greece), then, yeah, things go well for you. Add in a climate free of tropical disease and you’re golden.

To the extent the Nordics prosper as a result of social democracy, we must ask “Whence cometh social democracy?” and there we will find homogeneity, urban dominance, shared cultural values, etc. The various explanations for strong Nordic institutions are all things the United States can’t easily duplicate. Meanwhile, plopping down policies that rest on a specific set of cultural norms in the United States just won’t work.

One Last Note

During the last age of migration, governments around the world were very small. We are engaged today in a global experiment of rising migration into the rich world alongside historically (talking in the hundreds-of-years arc of history here) very high levels of government involvement in the economy. We haven’t been here before. Anyone who tells you that we know that high rates of cultural transformation can be sustained alongside a very large state is speaking without reference to evidence. Indeed, my suspicion is that the only long-run durable positions are generous welfare with restricted immigration, or open immigration with quite restrictive welfare. We don’t know what the future holds. But in 2015, every Nordic country’s GDP per capita plummeted as a direct result of rising immigration and failure to create economic growth enough to maintain living standards. I don’t know of inequality statistics for 2015 yet, but my guess is it got worse.

As the Nordics receive more immigrants, I expect their vaunted social models are going to change. Their outcomes will start to look more like the United States, or perhaps worse. Their welfare programs will face increasing criticism and calls for reform (many have slowly been rolled back or reduced in generosity over the last 20 years). The reason for this is not that welfare states are unsustainable, but that immigration and generous welfare states are hard to maintain together. The only “easy” way (in terms of economic and policy mechanics) to maintain a generous welfare state is with tight immigration policies and a high birth rate, to compensate for the natural leakage due to tax preferences and adverse selection. However, Nordic birth rates are among the lowest in the world, with every Nordic country having below-replacement fertility.

In sum, the United States can’t mimic the Nordics because we have almost nothing in common with them. However, it’s possible that Minnesota or Wisconsin, or maybe Vermont, could mimic the Nordics. Huge amounts of “Nordic” government and taxation are carried out by regional and local governments. There’s no fundamental reason why the same can’t be true in the United States.

Check out my Podcast about the history of American migration.

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I’m a native of Wilmore, Kentucky, a graduate of Transylvania University, and also the George Washington University’s Elliott School. My real job is as an economist at USDA’s Foreign Agricultural Service, where I analyze and forecast cotton market conditions. I’m married to a kickass Kentucky woman named Ruth.

My posts are not endorsed by and do not in any way represent the opinions of the United States government or any branch, department, agency, or division of it. My writing represents exclusively my own opinions. I did not receive any financial support or remuneration from any party for this research.