Not so long ago, Sweden could claim world leadership in unmitigated Keynesian economics, with a 90 percent marginal tax rate and a welfare state second to none.

Now Swedes look at the conflict between the U.S. and German examples over whether more spending or more austerity is the key to financial salvation, and for them the choice is easy: Germany was right. Northern Europe harbors no sympathy for the spendthrifts of Southern Europe.

Americans still think of Sweden as a tightly regulated social-welfare state, but in the last two decades the country has been reformed. Public spending has fallen by no less than one-fifth of gross domestic product, taxes have dropped and markets have opened up.

The situation is similar in the other Scandinavian countries, the Baltic nations and Poland. But no turnabout has been as dramatic as Sweden’s.

From 1970 until 1989, taxes rose exorbitantly, killing private initiative, while entitlements became excessive. Laws were often altered and became unpredictable. As a consequence, Sweden endured two decades of low growth. In 1991-93, the country suffered a severe crash in real estate and banking that reduced GDP by 6 percent. Public spending had surged to 71.7 percent of GDP in 1993, and the budget deficit reached 11 percent of GDP.

Turning Point

The combination of the crisis and the non-socialist government under Carl Bildt from 1991 to 1994 broke the trend and turned the country around. In 1994, the Social Democrats returned to power and stayed until 2006. Instead of revoking the changes, they completed the fiscal tightening. In 2006, a non-socialist government returned, and Finance Minister Anders Borg, with his trademark ponytail and earring, has led further reforms. Sweden successfully weathered the global financial crisis that started in 2008, and the Financial Times named Borg Europe’s best finance minister last year.

Before 2009, Sweden had a budget surplus, and it has one again. For the past two years, economic growth has been 4 percent on average, and the current-account surplus was 6.7 percent in 2011. The only concerns are the depressed demand for exports caused by the current euro crisis and an unemployment rate that is about 7.5 percent.

Sweden’s traditional scourge is taxes, which used to be the highest in the world. The current government has cut them every year and abolished wealth taxes. Inheritance and gift taxes are also gone. Until 1990, the maximum marginal income tax rate was 90 percent. Today, it is 56.5 percent. That is still one of the world’s highest, after Belgium’s 59.4 and there is strong public support for a cut to 50 percent.

The 26 percent tax on corporate profits may seem reasonable from an American perspective, but Swedish business leaders want to reduce it to 20 percent. Tax competition is fierce in some parts of Europe. Most East European countries, for example, have slashed corporate taxes to 15-19 percent.

In the bad old days, the annual centralized-wage bargaining between the Trade Union Confederation and the Swedish Employers’ Confederation was a prized custom. But in the 1970s, this system led to both inflation and strikes. Today, it is long gone. Wage bargaining is still collective, but it is decentralized. Wage inflation is no longer a concern and strikes are extremely rare. The employers have won, but real wages are rising with productivity, so the workers are benefiting, as well. As everywhere, trade unions are losing members, money and power.

Debt Averse

Sweden has belonged to the European Union since 1995, but it isn’t a member of the euro area, and the exchange rate of its krona floats freely. Finance Minister Borg argues against a more expansionary policy in Sweden in case Europe faces a real meltdown. After the Keynesian financial and monetary stimulus in the 1970s and ’80s, which led to inflation, repeated devaluations and low growth, Swedes believe in fiscal discipline. They are scared of huge national debt and budget deficits -- especially at the levels they are in the U.S.

Where are the left-wing intellectuals to challenge this new order? They have disappeared. The old socialist research organizations have closed down. The Center for Labor Market Studies was a state institution that generated propaganda, not research, and the government closed it. The Trade Union Confederation had a sophisticated research institute, which it eliminated for not being sufficiently political.

The union economists, who dominated Swedish economic debate in the 1970s and ’80s, have been replaced by bank economists. The free-market right has influential research centers in Stockholm.

After many years of absence from the debate, I attended a conference on the Swedish economy in the southern city of Malmo last month. Swedbank, a large bank, was the organizer, and the 180 speakers represented the full range of Swedish views. I was amazed to hear how far the consensus had moved to the free-market right, even among Social Democrats and trade-union leaders. The values are competition, openness and efficiency, while social and environmental values remain -- a social-welfare society without the social-welfare state. The idea is to make it more efficient through competition among private providers.

The name of the conference said it all: “Growth Days.” Wanja Lundby-Wedin, the president of the Trade Union Confederation, declared without hesitation: “We want flexibility in the labor market.” She complained that the media no longer pay attention to the labor market. The reason is that it functions so well.

During the global financial crisis, the metalworkers’ union quietly agreed to major wage cuts to safeguard their real

Moving Right

The Social Democrats haven’t only joined the free-market consensus, but seem to attack the current government from the right, pushing for a better business environment. Gone are demands for the restoration of social benefits. Opinion polls have rewarded the Social Democrats for their right turn with sharply improved ratings.

Sweden is still offering good social welfare, but more efficiently and sensibly and increasingly through the private sector. This model of falling taxes and public spending is rapidly proliferating from the north of Europe toward the south, and the northern Europeans have little tolerance for the statist conservatism and fiscal negligence of Southern Europe. Nor do the Swedes understand the fiscal irresponsibility of the U.S., while they still admire American research and innovation.

(Anders Aslund is a senior fellow at the Peterson Institute for International Economics and was a professor at the Stockholm School of Economics from 1989 until 1994. The opinions expressed are his own.)

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Anders Aslund

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Katy Roberts at kroberts29@bloomberg.net