Globalization and the Crisis of the Swedish Welfare State

Storm is coming!
Globalization and the Crisis of the Swedish Welfare State - Martin Wikfalk


In the 1950s and 1960s Sweden was often referred to as a 'model' country capable of combining an egalitarian society with high economic prosperity and growth. People from all over the world envied the 'Swedish model' which was able to maintain its goal of redistribution, a relatively low inflation rate, high economic growth and full employment while also adjusting to international competition. The Swedish model is based on an active role of the state in allocating and distributing resources. Some important features are: a politically strong labor movement, represented by the Social Democratic Party and the trade union federation, LO; a large and increasing public sector; government intervention in the economy through various policy packages characterized by stabilization, growth, labor market, and far-reaching welfare policies.

However, beginning in the early 1970s this model has come under increasing strain. Between 1970 and 1992 the growth rate of Swedish GDP has only been around 60 percent of that of the OECD average. In 1970 Sweden's GDP per capita measured in purchasing-power parity was the third highest in the OECD. In 1990 it fell to fourteenth place and by 1993 it had fallen to seventeenth place, 13 percent below the OECD average. The low rate of unemployment (1-3 percent), which has characterized the Swedish model since 1950 rose to 8-13 percent in the early 1990s.1 This deterioration of Sweden's economic performance combined with high long-term interest rates, unemployment and large public debts has resulted in a reduction in public spending and social insurance entitlement-levels and services. "Domestic demand has been depressed, public expenditure cut and a process of welfare state dismantling has been proposed, accompanied by the spread of an anti-welfare, market-oriented ideology in previously consensual, corporatist polities."2

Accounts of the fall of the Swedish model have proliferated during the last years and although the explanations provided range widely, some of the most oft-repeated factors are: wage-cost explosion, the catching-up effect, insufficient saving and physical capital formation, the lack of competition, the effects of stabilization and labor market policies, public sector expansion, and allocative inefficiencies (sclerosis). While these factors have certainly been important to bring about this change, it is the argument of this paper that any explanation of the crisis of the Swedish welfare state is insufficient as long as it fails to include what has occurred in the international sphere. The reason might seem rather obvious; Sweden is a small country with a large export sector, making it strongly dependent on foreign trade. It is estimated that exports account for more than 30 percent of its GDP.3 Therefore, it seems that it is not a pure coincidence that the period of the decline of the Swedish welfare state has also witnessed an increase in the globalization of the world economy. Henrekson, et al, argue that when examining economic growth and the Swedish model one must consider that "in addition to domestic reasons ... crucial changes in the conditions regarding production and the international division of labour have occurred, and that these changes disfavoured the Swedish model."4

The purpose of this paper is to investigate whether there is indeed a link between the increasingly globalized international economy and the crisis of the Swedish welfare state.5 First, the concept of globalization will be unpacked and assigned analytical meaning. Second, the mechanisms by which globalization is assumed to undermine the welfare state are presented. It is argued that these processes will operate through the labor market. Two distinct but interlinked areas of globalization will be investigated, i.e., production and finance. Third, the Swedish Model and some of its most important features are presented following an analysis of how it functioned, first in a world-economy a la Bretton Woods and then in a more globalized economy. It is the argument of this essay that the demise of the Swedish welfare state is to a large extent caused by global factors. Three factors that are all closely linked to the globalization process seem especially important. First, the shift from a Fordist to a Post-Fordist mode of production which can be seen as a continuation of the globalization of production process. Second, the deregulation of capital markets and hence the increasing power of capital. This can be seen both as a cause and a result of the globalization of finance. Third, the shift of economic order from an expansionary Bretton Woods system to a world economic order with a deflationary bias.

Globalization, a Contested Concept

It is now widely held that we live in an era in which our lives are becoming increasingly determined by global processes. However, there is greater controversy over what such globalization entails and what its implications are. The fact that globalization in the 1990s has become a buzzword, often used without any analytical meaning has not made things any clearer. Therefore any attempt to define such a contested concept is a difficult endeavor. Nevertheless, the term globalization is often invoked to "describe the process of increasing interdependence and global enmeshment which occurs as money, people, images, values, and ideas flow ever more swiftly and smoothly across national borders."6 According to Anthony Giddens globalization should be understood in two discrete dimensions. One is a spatial dimension which considers the degree to which international interactions have been stretched across the globe, while the other examines how there has been a deepening or increased density of these interactions.7 Most writers argue that technology is the major driving force behind this globalization, which influences power, wealth and relations between societies, governments and states. Economic globalization, which will be the focus in this paper, designates a change in the operation of capitalism. In this paper the term will be used to denote the process of deepening internationalization of production, trade, investment, and finances. The advantage of using economic globalization is twofold. First, it makes it possible to grasp and understand these interrelated processes in one single analysis. Second, the concept facilitates an investigation on how global processes can have an impact on the internal structures of nation states. In order to demonstrate that globalization is indeed occurring there will be a brief presentation of some figures of the increasing internationalization of three different sectors (trade, foreign direct investment, and finances) and an account of a shift from the Bretton Woods system to a new economic order.

Trade is one economic process by which globalization can be illustrated. Since WWII, the increase in the volume of trade has . exceeded the increase in volume of production in almost every year. Between 1960 and 1989, exports of the OECD countries have grown almost twice as fast as GDP; 6.3 percent annually compared with 3.7 percent. However, it has to be noted that the ratio of trade relative to GNP did not reach its pre-WWI level of 11 percent until 1970. Sweden's exports as a share of GDP increased from a low of 5 percent at the end of WWII to above 30 percent in the 1980s.8

Foreign direct investment (FDI), another commonly used indicator, is growing even faster than trade. World outflows of FDI grew 3 times faster than output and 2.5 times faster than both exports and domestic investment between 1986 and 1990. Between 1980 and 1991 there was almost a fourfold increase in the world stock of FDI. Specifically, Swedish direct investment in the European Community rose almost sevenfold between 1985 and 1988.9

Notwithstanding, the sector in which globalization is argued to be most advanced is that of finances where, coupled with instant world communications, vast dealings can be executed around the clock. Their magnitude is manifested by the fact that in 1990 daily transactions in foreign exchange markets were almost 40 times the daily value of international trade. Moreover, it is estimated that 'five days' worth of foreign exchange transactions are equivalent to a full year's exports worldwide of goods and services, "while 24 days worth of those transactions are equivalent to a full year's output of world goods and services."10

Globalization can also be seen in terms of a change in the world economic order. The Bretton Woods system, sustained by the dollar-based fixed exchange rate regime, and public multinational norms governing capital controls and flows has been replaced by a market mediated, global credit system. The purpose of the Bretton Woods system was to enable individual states, in capitalist countries, to manage their internal economies so as to maintain a high level of employment and social services while sustaining international economic relations from which all could benefit. Funds were available to help avoid a conflict between national welfare and international cooperation by giving countries time to make necessary and internationally agreed adjustments in national economic policies. In sum, this so-called 'embedded liberalism' was an attempt to construct a stable international economic order that also harmoniously achieved the national goals of the managerial welfare state.

The break down of the Bretton Woods era in the mid 1970s caused a substantial shift in state-market relations so as to maximize the exposure of states to international capital markets.11 Two features in the post-Bretton Woods system are central to this. First, the importance of circulating forms of financial capital has increased at the expense of productive forms of capital. Second, since states compete for scarce investment resources, financial capital that is both highly mobile and transnational has gained unprecedented structural power. It is now 'business confidence' that determines "the direction of capital flows, the availability of finance, and future investments, upon which future production, employment, and tax revenue depends."12 To conclude this section, we have seen by looking at economic processes, trade, FDI and finances, and the shift in economic order that the trend towards globalization is clear. Now let us see how this relates to the erosion of the welfare state.

Globalization and The Welfare State

Having established that the world economy is becoming increasingly globalized our task is now to show in what ways this phenomenon is linked to the demise of the welfare state. In other words, what are the mechanisms through which these economic processes can have an impact on the internal institutional structures of nation states? Andrew Martin argues that globalization will work through the labor market, in the sense that it is making it more difficult for states to maintain full employment. This, in turn, will strain the resources of welfare states in two ways. First, its revenues will fall simply because less people work, in other words, the tax-base diminishes. Second, public expenditures will increase since claims for social assistance and/or unemployment benefits will increase. The result of these factors is a deterioration of public finances, thus increasing the likelihood of a fiscal crisis.13 This is a rather straightforward argument, in fact William Beveridge claimed already in the aftermath of WWII when he designed the British welfare state that full employment was an essential condition for the economic and, in turn, political viability of welfare states. The influence of his findings among policy makers in Sweden is evident. Full employment was clearly named as the number one target and this had been delivered until 1990 when the unemployment rate rose to between 8-13 percent. What remains to be explained, however, is how globalization makes full employment unattainable in the first place. The following analysis will try to demonstrate this by focusing on two dimensions of globalization: the globalization of production and the globalization of finance.

The Globalization of Production Argument

According to the globalization of production argument there has been a global shift in the production of manufactures using unskilled labor. In terms of world trade, the South exports raw materials to the North,14 and in turn the North exports manufactured goods to the South. Now there has been a shift in this structure leading to a situation in which both the South and the North are exporting manufactured goods. This can be seen in the dramatic change in the composition of the South's exports. In 1955 manufactures made up 5 percent of the South's total exports; by 1990 they made up more than half.15 This increase in production of manufactures is largely made up of goods produced with unskilled labor. In the North, on the other hand, exports have been concentrated in skill-intensive goods. One of the main reasons why production by unskilled labor in the South is able to be more competitive than production in the North is that workers there are paid much lower wages. As a result of this the demand for unskilled workers in the North has fallen while the demand for skilled workers has increased. Because of downward wage 'rigidity' in labor markets, this has led to increased unemployment of unskilled workers in the North. In addition, in a country like Sweden with a solidaristic wage policy,16 wage differentials have been resisted. Thus, wages of those unskilled workers that remain employed, the insiders, have increased almost as much as those of skilled workers. The effect of this is an acceleration of inflation since wages rise for both skilled and unskilled workers. Theresultingproblemisthatitisnowmoredifficulttoreconcilelowunemployment with low inflation. If the monetary goal is that of price stability "it must deflate the economy to eliminate the shortages of skilled labour."17 Such deflation will result in an increase in unemployment among unskilled workers. In one way, this reveals how globalization of production undermines Sweden's capacity to implement an employment and wage policy.

This argument seems plausible but it is weakened by the fact that trade with the South does not make up a large enough portion of the North's total trade to be such a decisive factor in raising the unemployment level. For example developing countries account for less than one tenth of Swedish trade. Furthermore, it is now asserted that the basis for global competition in manufacturing has shifted from a Fordist system based on mass production to a Post-Fordist stage in which the wage costs are becoming less important and flexible specialization, automation, innovation and geographical proximity of the production to final markets are becoming more important, thus disfavoring the South's competitive advantage in unskilled low-cost labor. This has increased the importance of production in countries that are close to the final markets. However, as we will discuss later, Post-Fordism has disfavored the Swedish model by shifting production to the continent.

The Globalization of Finance Argument

The globalization of finance argument maintains that full employment will become unattainable because the globalization of finance is rendering governments increasingly constrained and restricted in their macroeconomic policy choices. After the fall of the Bretton Woods system there has been an enormous increase in the size of the private international exchange markets.18 This has led to an increased discrepancy between the amount of hot money, that is, short-term capital that can be shifted almost instantaneously from one country to another depending only on where the rate of return is the highest, and the official reserves that central banks can deploy to defend their currency. A Business Week article claims that "in a market that trades $1 trillion worth of currency daily, the few billions that central bankers can buy and sell are peanuts."19 The core of the globalization of finance argument is that the world financial markets will respond negatively to expansionary policies adopted in order to keep unemployment down while they will respond positively to policies that aim to maintain or reduce the level of inflation. In other words, the globalization of finance has created a 'deflationary bias'20 in the world economy making it very difficult and costly for governments to keep full employment.

To see how this mechanism works imagine a country whose government pursues relatively more expansionary policies than other countries, for example, in order to increase social services or to create employment. In this case money will flow out from the country in the expectation of a higher relative rate of inflation unless offset by interest rate increases, which would defeat the purpose of the expansionary policies. The result of this outflow of money is depreciation, if the exchange rate is floating, or depletion of reserves if the currency is fixed or pegged. In the first case depreciation will put upward pressure on inflation thus speeding up the flight of capital which will lead to further depreciation and so on. In the case of fixed exchange rates the credibility of the government's commitment to keep the currency pegged will decline at the same rate that the currency reserve is being depleted. The closer it comes to the point where the government has to choose between abandoning the peg or reversing its expansionary policies, the more likely it is that this will be speeded up by a speculative run on the currency. In order to prevent a devaluation the state will have to adopt restrictive policies, increase interest rates as well as tightening fiscal policies, to dampen the demand and stem the outflow of money, which means that it will have to deliberately increase unemployment. It is in this way global finance is assumed to discipline governments to reduce their welfare policies.

The Swedish Model in the World Economy

Two distinct features of the Swedish economy have made it heavily dependent on changes in the international environment. First, Swedish mass production was relatively undiversified; it was composed of a few large firms with a narrow product composition, e.g. IKEA, Volvo, Asea, and Electrolux. Their viability rested not so much on domestic demand but export performance, which therefore made them dependent on demand in the world economy. Mass consumption, on the other hand, was diversified. Therefore it was dependent on imports, which were financed by foreign exchange earned from high value added commodities in the export sector.

Second, the institutional configuration for economic planning was formulated in the doctrine of the "Rehn-Meidner Model." It was based on solidaristic wage policy that forced Swedish industry to transform itself through technical innovation so it could afford to pay the centrally negotiated wages. A restrictive wage policy forced stagnant firms that could not pay the going rates out of business and hence productivity increase could proceed without high inflation. This system ensured that Sweden's export sect or remained competitive. However, technological innovation was not assured through an expansion of domestic aggregate demand. "Rather it was ensured through the 'transformation pressure' the Rehn-Meidner Model exerted on the Swedish economy ... and by the demand-pull of the international economy."21 Thus, both Sweden's economic structure and its economic policy paradigm made the Swedish economy heavily dependent on the international economy.

The Rehn-Meidner Model's emphasis on profit-squeeze and transformation structure meant expansion of external demand was a prerequisite for macroeconomic policy to be able to ensure full employment. This was provided firstly by the expanding international economy and the reconstruction of Europe through the Marshall Plan, and subsequently by expansion of trade and increasing liberalization. Furthermore, the Bretton Woods system made it possible for macroeconomic policy makers to fine-tune the economy which was needed in order to make full employment and the profit squeeze compatible.

...And in a Globalized Economy

This section will analyze the Swedish performance in the globalized economy from the 1970s onwards by focusing on the three elements mentioned in the introduction, that is, the shift from Fordism to Post-Fordism (globalization of production), the fall of the Bretton Woods System, and the deregulation of financial markets (globalization of finance).


Following the international recession after OPEC I in the 1970s, the Swedish government adopted a policy of bridging over, which entailed an expansionary policy in order to compensate for the fall in foreign demand. Magnus Ryner argues that while Sweden had benefited from the 1974/75 raw-materials boom it was badly hurt by a stagflation crisis in 1976. This crisis was enforced by the fact that "Sweden's 'narrow' export sector was disproportionally composed of firms producing in a late phase of the product cycle and in special steels, that became 'price takers' rather than 'price makers.'"22 In sum, there was a loss of competitiveness internationally, which meant that the Swedish crown had to be devalued twice, which was mainly due to Sweden's particular form of Fordism.

The incompatibility of the Swedish model and Post-Fordism can also be showed by the results of the Swedish government's shift in policy direction in the 1980s when they adopted 'the third way' (between Thatcherism and Keynesianism). The idea was to create an export-led recovery through a one off devaluation, combined with a tight domestic fiscal and monetary policy and an active labor market policy. This recovery was then believed to increase total tax revenues and stabilize the economy while ensuring full employment and the existing levels of social benefits and services. Helped along by the Reagan boom, this strategy of export-led recovery was remarkably successful in the beginning in meeting its aims of competitiveness, profitability, investments, macroeconomic stability and full employment. Sweden's balance of payments was showing surpluses, and the budget deficit was rapidly being eliminated.

However, the policy ultimately faltered because the long term GDP and productivity growth was not realized. Apart from the success of pharmaceuticals, there was little growth in new dynamic sectors and enterprises. Instead the strategy benefited existing firms, which enjoyed a golden decade despite the pale performance of Sweden's economy. These firms disproportionately located high value-added activities in continental Europe. Most importantly, this form of post-Fordist restructuring has resulted in a relative peripheralization of the Swedish production structure, as its multinationals reorganize themselves on a continental scale. Swedish companies pursued this strategy partly in order to be closer to final markets but also as a response to the relatively high wage cost in Sweden. It is estimated that the 25 biggest Swedish companies have 75 percent of their employment, production and sales abroad. Therefore, globalization of production in the form of a movement from Fordism to Post-Fordism, explains a great deal why unemployment has increased in Sweden and thus why the Swedish welfare system has been put under pressure.


The fall of the Bretton Woods system was significant since Sweden relied on the demand-pull of the world economy in order to generate sufficient aggregate demand. This demand-pull lessened as other western states abandoned their full employment commitment, and started focusing on fighting inflation instead. The end of fixed exchange rates made

the situation even worse. "Sweden initially joined the European monetary snake to retain a stable framework for economic policy, but withdrew in 1977 when the full employment commitment could not be rendered consistent with Bundesbank-led monetary policy."23 After that failure Sweden has tried to compensate for the comparatively high price increases, resulting from trying to keep unemployment lower than trade competitors through devaluing the Swedish currency at frequent intervals. This policy of national reflation has not been very successful, since it has led to wage and price increases and thus further inflation. "In other words, the Swedish Model required anchoring in an international expansionary regime qua Bretton Woods, but could not work in a restrictive one, qua EMS."24


The Swedish government deregulated capital and money markets at a period of a booming economy in 1985 (a formal deregulation of foreign exchange markets followed in 1989), which contributed to the 'overheating' of the Swedish economy at the end of the 1980s and consequently increased the rate of inflation sparking capital flight. In an attempt to 'cool' the market, previously inconceivable policies were adopted by the Social Democrats such as the decision to apply for EC membership and to abandon the full employment commitment in favor of keeping the rate of inflation down.25 The political support of the Social Democrats declined sharp I y and they suffered a humiliating electoral defeat in 1991. Furthermore, the recession of 1991-1994 was especially severe in Sweden, resulting in an increase in unemployment from 2 to 8 percent and thus a shortfall of tax revenues and an increase in public expenditure in the form of unemployment insurance, thus showing the adverse effect of globalization on the welfare state.

The public deficit did not improve after the Conservative government's decision to cut taxes. Speculations about overvaluation triggered off a run on the Swedish crown in the end of 1992. The interest rate rose dramatically in an attempt to defend the currency. The short-term marginal rate was forced up to 500 percent before the government had to give up and float the crown, which subsequently fell sharply in value. Of course both the increase in interest rate and the depreciation of the Swedish crown further exacerbated the fiscal crisis. The debt as a percentage of GDP increased from comparatively low 45 percent in 1989 to approaching 100 percent in 1994. This led the government to present a number of so-called 'crisis-packages,' which focused on cutting back on welfare universalism.

Therefore, one cannot fail to conclude that capital deregulation and the strategy to increase Sweden's interest sensitivity seriously backfired. When quantitative controls were abandoned internationally determined interest rates, enforcing a discipline through the balance of payments constraint, was seen by the Central Bank as the only effective means to control inflation.


This paper has linked the crisis of the Swedish welfare state with the process of economic globalization. By doing so it reveals implicitly how purely domestic explanations cannot fully explain this change. By taking the transnational approach, the main findings have been the following. First, the Swedish Model was geared towards an international economic system such as the Bretton Woods, which not only provided sufficient aggregate demand but also gave the macroeconomic managers enough leeway in adjusting the national economy. When the Bretton Woods system was replaced by a world economy with a deflationary bias, aggregate demand in Sweden fell short of full employment. Furthermore, the Swedish economy became less insulated from shocks in the world economy as a result of deregulation in capital and money markets and increased capital mobility. Second, the structure of the Swedish export sector has led it to relocate core economic activities on the European continent as a response to the crisis of Fordism. There is therefore no doubt that "the Swedish Model fundamentally presupposed the post World War II 'embedded liberal' world order and the process of neo-liberal globalization is central to its crisis."26

Let us now see what the policy options are for the future. It is possible to discern two main alternatives: Sweden can either choose to adopt a neo-liberal market oriented model with a higher level of unemployment, higher inequality and lower social security than before or it can try to rebuild the Swedish welfare model. There are problems with both alternatives. The problem with the neo-liberal model is that due to an increased polarization of the society it will intensify social conflict and might therefore be unstable over time. Furthermore, in the light of today's unemployment levels in Europe, the argument that by reducing social entitlements in the labor market, more employment will be created, is not particularly convincing. On the other hand, it is naive to think that there can be a return to a 'golden age' of the social democratic welfare state with full employment and continuous high growth. As shown in this paper the international circumstances are not the same as two or three decades ago. In particular, an attempt to unilaterally recreate such a model on a national level is not viable in an increasingly globalized world economy.

The best solution would be to 'disembed' the world economy by creating a new international monetary regime. In practice, capital markets do not work best when they are completely unregulated as the last months' events in South East Asia have demonstrated. The EU in general and the Economic and Monetary Union in particular can be seen as stepping-stones for such a project. In this light, it is unfortunate that Sweden has chosen to remain outside the EMU cooperation, at least from its inception. For a small country like Sweden, a multilateral strategy is the only viable solution and although a European welfare model will necessarily be less extensive than the Swedish model such an alternative is in contrast to the other two both stable and achievable.


Martin Wikfalk, from Helsingborg, Sweden, is concentrating in International Economics and Conflict Management at The Johns Hopkins University School of Advanced International Studies. He graduated from the London School of Economics and Political Science with a B.Sc. in International Relations.