Why do Scandinavians Work?

I guess I'd better go hunt for a paycheck

If there is anything on this planet that resembles the mythical elves, it would be the Scandinavians. They live nearly forever, lead the world in the portion of their income that they donate to help poor countries, are hard-working, practically incorruptible, pathologically honest, supremely healthy, environmentally conscious, literate and multilingual, masters of gender equality. And good-looking to boot.

Now there appears to be another thing that sets them apart. Usually, incentives lead people to do things, disincentives to stop doing something. Raise labour taxes, and people will work less. Put in place a more generous social safety net, and people will be tempted to enjoy its benefits and shun work. Not in Scandinavia. There, high taxes and generous welfare do not seem to pull people away from employment: labour market participation is remarkably high. Just how do they do it?

CESifo researcher Torben Andersen, of Aarhus University in Denmark, explains why in his latest CESifo Working Paper, “Why Do Scandinavians Work?”.

Nobel laureate Edward Prescott argued recently that the difference in tax rates between the US and some larger European countries can account for their difference in labour supply (in total hours relative to population size), implying that if these European countries were to reduce taxes to US levels, the labour input would be about the same on a per capita basis. Other authors echo these claims.

But it is not as simple as that. A closer look at the cross-country evidence reveals not only a more complicated picture, but one that makes the Scandinavian performance look like a paradox in this respect.

The usual line of reasoning is that the unemployment benefit programmes of many countries implicitly provide a marginal subsidy to leisure, since they stipulate that benefits are conditional on not working, or that the benefit is to be reduced in response to any labour income. On top of that, the generosity of the social safety net makes the selling of labour unnecessary to maintain a decent standard of living. 

But according to Mr Andersen these models do not depict the Scandinavian reality accurately. The conventional metric to measure the extent to which work incentives are distorted by taxes and the social safety net is the so-called marginal effective tax rate (METR). The METR includes both the taxation of income earned when working and the loss of transfer when shifting from non-work to work. This double effect implies that the METR can be fairly high, both in general in countries with a generous tax-financed social safety net, and for specific groups, where it can even exceed 100%. The METR is 90-85% in Denmark and Sweden respectively, suggesting very weak work incentives in the two countries.

And yet, Scandinavia’s labour force participation and employment rates are close to the US level, the high level applying equally to men and women, and to groups with low education.

But assessing work incentives solely from the METR is too simple, and presumes that the option of living on transfers is available without any constraints or conditions. This easily leads to the above conclusions of "subsidizing leisure" or "paying people not to work".

Labour market and social policies in the Scandinavian countries have a long tradition for building on a so-called "work-line" based on the idea that individuals enjoy social rights but also have duties to perform. On the policy arena, this has translated into a generous social safety net and a compressed wage structure on the one hand, and active labour market policies on the other, helping Scandinavia top the list for both transfer generosity and spending on active labour market policies. These policies include various requirements attached to eligibility for benefits, going from active job search to participation in education programmes, or job training. While these policies are not specific to the Scandinavian countries, the way they have been clustered in a policy package makes all the difference.

A striking fact that shows the effect of this is that some persons are in employment even though they get a very low or even negative economic return from working.

Mr Andersen takes the Danish scheme as an example. Particularly generous by international standards in terms of benefit levels and duration for unemployment benefits, this scheme gives low-income groups a replacement rate of 90%, and about 65% for the average production worker. Unemployment benefits are granted for up to four years, after which the unemployed transit into the social assistance system offering a lower (means-tested) benefit.

But the other side of the coin are the various requirements attached to claiming of transfers. During a benefit spell, the requirements are stepped up from an initial requirement of active job search to full-time activation. Similar requirements apply upon transition to social assistance for people assessed as capable of working. These requirements make sure that receiving transfers does not constitute a carefree alternative to work.

The entire idea behind these policy packages is to change the efficiency-equity trade-off in the direction of making it possible to pursue ambitious distributional goals without unduly jeopardizing the incentive structure.

An empirical analysis conducted by Mr Andersen corroborates this, showing that incentives are affected negatively by the METR but positively by the employment conditionalities.

So, there was no Scandinavian puzzle, after all. Just another bit of elfish wisdom.

Torben Andersen: Why Do Scandinavians Work?, CESifo Working Paper No. 3068

• Other CESifo Working Papers by Torben Andersen
• Other CESifo Working Papers dealing with labour supply
• CESifo Working Papers published in the past three months