Swedish Economic Rule Book Faces Rewrite as Challenges Mount

The rule book that over the past 25 years helped transform Sweden from an economic basket case to a superstar needs a rewrite.

In an age of increased competition, fluid labor markets and record immigration, the framework that imposed fiscal discipline, kept inflation at bay and forced wage conformity is losing relevance, according to Sweden’s hottest companies and economists at its largest banks.

“The economic policy rule book that Sweden wrote in the 1990s has served us enormously well in the last 20 years but it now needs to be updated,” said Anna Breman, chief economist at Swedbank.

In a warning to the government, the founders of music streaming behemoth Spotify this month said that Sweden’s tightly regulated housing and labor markets may force it to move even more of its business abroad. The concerns are being voiced even as Sweden’s economy is booming -- growing at a pace of more than 4 percent -- amid unprecedented central bank stimulus and immigration.

The Social Democratic-led government has also realized it can’t work under the current surplus target constraints, which have helped halve public debt since 1995 to 34 percent of gross domestic product and cut inflation to 1.5 from 10.5 percent in 1990.

The government is pushing for a balanced budget approach, giving it more fiscal leeway in dealing with the refugee inflow and other programs to drive down unemployment.

Finance Minister Magdalena Andersson said in an interview on Tuesday that a balanced budget target could probably be introduced in 2018 at the earliest. The committee evaluating the regime could have reached their conclusion “in a few weeks,” she said.

One big challenge will be how to absorb the record inflow of immigrants in an economy that is based on high wages and job security.

Robert Bergqvist, chief economist at SEB, said Sweden must scrap the “foolhardy” straight-jacket forcing a 1 percent of GDP surplus over a business cycle so that it can spend more on education and cutting employment costs for companies that hire immigrants.

“If we don’t succeed with integration policies the likelihood will increase for social and perhaps political turmoil,” he said. “If we fail to get enough people to join the labor market, we will probably be forced to raise taxes to keep public finances in order.”

According to Bergqvist, politicians must also create financial incentives to address a big housing shortage so that people can move to where the jobs are.

Housing Shortage

The housing shortage has highlighted other flaws in Sweden’s rule book.

Concerns over a bubble has meant that the central bank for years kept interest rates up while failing to meet its inflation target, before making a complete turnaround and unrolling unprecedented stimulus to avoid deflation.

The bank has for the past five years consistently predicted, but never delivered, on its 2 percent inflation target. That’s hurt its credibility and prompted a heated debate about the framework and about how long the bank should be allowed to stray from its inflation target. Deputy Governor Cecilia Skingsley, who last week opposed a decision to expand unprecedented government bond purchases, yesterday invited to a conference in June to discuss “Rethinking the Central Bank’s Mandate.”

“The law needs to become much clearer on that the Riksbank can deviate from the inflation target to consider things like employment, economic growth and financial stability,” Breman said. “The Riksbank should be allowed to deviate if, for example, high productivity gains result in low inflation.”

And the final procedure that’s being questioned is how wages are set. In 1997, Sweden agreed on a system where wage increases by industrial exporters set the norm for gains in other sectors.

According to Jan Haeggstroem, chief economist at Svenska Handelsbanken, globalization means the system has become outdated.

“There are a lot of other sectors that also export things today, it’s not just industry,” he said. “In the services sector there are very qualified people who compete on an international labor market and if we don’t give them the salaries that they’re worth they will move somewhere else. It won’t help the Swedish economy if we lose good people.”

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