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Nordic Model

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Economics

Imagine you had to run your own country. You get to make all the laws and regulations. What would the economic system look like? Would it be a free-market economy, a command economy, or a mix of both? In this explanation, we will look at the Nordic model which is a real-life example of a mixed market economy.

Overview of the Nordic Model

Before we answer the questions above, let’s first define the Nordic model.

The Nordic model is a government model that combines both capitalism and socialism in the social welfare and economic systems.

Nordic Model Countries

The Nordic model has been adopted by all the Nordic countries: Sweden, Norway, Finland, Denmark, and Iceland. These countries have a combination of high incomes, high standards of living, and low inequality levels.

Much of this model is based on the similar culture between these five countries that have a shared history.

History of the Model

All Nordic countries have a shared history of family-driven agriculture. As most citizens were farmers of some sort, they were likely to face the same challenges. So whatever solution a government introduced would likely benefit all of the countries.

A key feature of the beginning of the Nordic model was the introduction of the ‘Grand Compromise’. This essentially was a compromise between workers and employers. It centralised the coordination of wage negotiations and workers' rights.

Additionally, unlike many other western countries, many of the citizens in these Nordic countries trust their government and the government also trusts that their population will do what is right.

This shared history is what makes the Nordic model work.

Characteristics of the Nordic Model

The Nordic model has a few key characteristics:

  • No minimum wage. Unions ensure that wages remain high. High-income levels allow consumers to enjoy a high standard of living.
  • Low levels of corruption. There has been a long history of transparency in Nordic society which ranks these five countries as the least corrupt in the world.
  • Strong property rights. Strong property rights give consumers an incentive to work and invest, promoting higher economic growth and development in these countries.
  • High tax burden. To finance the free availability of public goods, the governments rely heavily on tax revenue. Thus, there is a high tax burden on workers.
  • Public pension system and a generous welfare state. The pensions system is a system that guarantees all pensioners a minimum standard of living, regardless of previous earnings or how much one has contributed. The welfare state provides free services for all citizens such as child benefits, parental leave, and health services. This is a well-known characteristic of the Nordic model that is highly praised.
  • High levels of equality. The government encourages creative destruction which allows them to redistribute tax, wealth, and income to bridge the gap between the rich and poor.

Creative destruction refers to the constant change of the economy that ‘destroys’ inefficient processes to ‘create’ or make way for improved and efficient processes.

The term creative destruction was coined by Austrian economist Joseph Schumpeter in 1942. He described creative destruction as

the process of industrial mutation that incessantly revolutionises the economic structure from within, incessantly destroying the old one, incessantly creating a new one.

The Nordic model allows for citizens of these five countries to benefit from social gains such as free education, healthcare, and pension payments whilst simultaneously benefiting from the gains of a free market economy. This is illustrated in the figure below.

Nordic Model overview StudySmarterDiagram of how the Nordic economic model works, StudySmarter Originals.

The Nordic Model and other Economic Systems

The Nordic model is often the pinnacle of good governance and economics and is viewed as a model worthy of imitation. To understand the model and how it's different from other countries’ economic systems, we will compare it to a different model: the US system.

The Nordic Model vs the US System

The Nordic model often looks like a complete contrast to the US system, but there are actually some similarities.

One of their similarities is the level of economic growth. Despite the difference in approach to governance, the economy and the pressure of the 2020 Covid-19 pandemic, both the Nordic countries and the US have managed to have positive growth in their economies:

DenmarkSwedenNorwayIcelandFinlandUS
Actual growth for 20213.8%4.3%4.2%6.0%3.5%5.6%
Predicted growth for 20223.1%3.4%3.7%5.2%2.9%4%

Table 1. Nordic countries and the US predicted growth - StudySmarter.

As you can see in the table above, all six countries have had relatively similar economic growth despite the difference in the approach of governance and population size. For all countries, the growth figures for 2022 are much lower than the figures for 2021. This could be due to economists being uncertain about the long terms impacts of the pandemic.

However, there are many differences between the Nordic countries and the US economic system. Let’s review two of the main differences: taxation and the welfare system.

Taxation

The Nordic countries have one of the highest tax rates in the world. Sweden’s top personal tax rate was 57.3% in 2018. Whilst in America, the top personal tax rate was 37% for those who earn $500,000 or more.1

Tax rates in these Nordic countries are high for all income earners, not just the wealthy. But these tax rates are progressive in nature.

To learn more about the different types of taxes, check out our Taxation explanation.

When a country has progressive taxes it means that a greater proportion of tax is paid by those with higher incomes.

With these high tax rates comes high tax revenue that the government can use to provide quality social welfare services. Despite these high tax bands, these countries have similar rates of growth to the US and the UK.

High taxation levels in the Nordic countries

Taxes in these five countries are high. Their taxes can be split into four subcategories which are seen in the table below. The table shows taxation in the Nordic Countries as a percentage of GDP.

DenmarkFinlandIcelandNorwaySweden
Income tax29.015.217.214.715.9
Property tax1.91.42.01.31.1
Consumption tax14.814.411.912.112.4
Social security tax0.412.83.910.614.6
Total taxes45.944.036.738.744.0

Table 2. Taxes and their percentage of GDP in Nordic countries - StudySmarter.2

Taxes make up a considerable percentage of each country's GDP, compared to other Western countries, like the US and the UK where taxes as a percentage of GDP are around 24% and 34% respectively.

The high levels of tax revenue generated by the government allow them to spend generously on healthcare, education, social security, and other public services.

Additionally, citizens in these Nordic countries don’t evade taxes. This suggests that the tax level, although considerably high, is set at an efficient point.

The Laffer curve in the figure below helps us see how increasing taxes increases tax revenue, but only up to a certain point. After that point, tax revenue falls because consumers look for ways to not pay taxes or avoid them.

Nordic Model The Laffer curve StudySmarterFigure 2. The Laffer Curve - StudySmarter.

The tax rate in these Scandinavian countries must indicate that they are at the revenue maximising point, as they make considerable money from taxes and still have low levels of tax evasion among the population.

Welfare system

The emphasis of the welfare state in the Nordic countries is to maximise labour force participation whilst reducing poverty, promoting equality, giving extensive benefits, and redistributing income wealth and taxes effectively.

However, while in the US the aim to produce an effective welfare state is similar, it is executed differently. The US spends about 17% of its GDP on social welfare programmes like Medicaid, Supplemental Security Income (SSI), and Child’s Health Insurance Program (CHIP). The Nordic countries spend more than ¼ of their GDP to fund public social support.3

The immense funding to support the welfare systems in these Nordic countries has reduced poverty significantly and allowed for a more equal and fair society.

Is the Nordic model possible for other countries like the UK?

As most other developed economies also imitate the US system to a degree, we may wonder if the Nordic model could be introduced in other countries.

The Nordic model can be implemented by other countries to a degree as it provides a template that incorporates capitalism and socialism. Citizens get the benefits of high incomes, high quality of life, and low levels of inequality whilst gaining free public goods provided by the government.

However, there are some key differences between Nordic countries and many other countries:

  • Population size. The population of the Nordic countries together is 27.5 million people. In comparison to Germany (83.2 million), the UK (67.1 million), the US (332.5 million), and France (67.39 million), their population is significantly smaller.
  • History. Much of the Nordic model’s success is attributed to the countries’ similar histories.
  • Homogenous opinions and experience. This is another factor that many countries also lack in comparison to the Nordic countries. Differing opinions and experiences would be the main reason as to why introducing this model in other countries would fail or wouldn’t be as successful.

Advantages of the Nordic Model

Let’s look at some of the social advantages of the Nordic model.

  • Ensures free and good quality education. This allows for a more skilled workforce. The economy will be more productive, which will increase economic growth. As the citizens are skilled and talented, they will earn a higher income which will allow them to have a higher standard of living.
  • Ensures free and good quality healthcare for its citizens. As everyone has access to good quality healthcare, fewer people will take sick leave. This increases productivity in the economy.
  • Political stability. As citizens have trust in their government and vice versa, these countries experience political stability which allows them to experience many economic gains such as high levels of investment.
  • Equality. All five countries have low levels of income and wealth inequality. All citizens enjoy a good standard of living because of how well wealth and income are distributed.

Criticism of the Nordic Model

However great this model is, it has some limitations:

  • Sustainability. The sustainability of this model has come under question, largely due to two reasons: the ageing population and the influx of immigration. With an ageing population, the younger taxpayers have a high tax burden to support the older ones with free services like healthcare, which would be used more by the older citizens. Regarding immigration, immigrants are three times less likely to get a job. With higher rates of unemployment among immigrants, there is even more pressure on the tax-paying in society to provide for them too.
  • Immigration. With the influx of migrants also comes a difference in cultures. With the difference in cultures, there could be a reluctance among citizens to contribute to the greater good of all. If that occurs, the model falls apart.
  • High taxes and high governance to a degree. Many criticise the model because of high taxes and high levels of government intervention, which is different to the free market economy these critics prefer.

The Nordic model is a good case study to remember for your exams. It can be linked to a number of microeconomic and macroeconomic topics such as public goods, taxation, and government intervention just to name a few.

Nordic Model - Key Takeaways

  • The Nordic model is a model that combines both capitalism and socialism in the social welfare and economic systems.
  • It is adopted by the Nordic countries: Sweden, Iceland, Norway, Denmark, and Finland.
  • The shared history of family-driven agriculture is what makes the Nordic model work.
  • The introduction of the ‘Grand Compromise’ was the start of the Nordic model.
  • Some characteristics of the Nordic model are a high tax burden, low levels of inequality, strong property rights, a public pension system, and a generous welfare system.
  • Compared to the US system, both systems allow for similar levels of economic growth, however, they differ in the level of taxation and the state of the welfare systems.
  • Some criticise the model as being unsustainable because of the high levels of taxation and government intervention.

Sources

1. Trading Economics, 2021.

2. ‘Overview of taxation in the Nordics’, nordics.info, Aarhus University, 2019.

3. OECD, 2020.

Nordic Model

The Nordic model is an economic model that combines both capitalism and socialism.

The Nordic model is not socialist. It is a combination of capitalist features, such as a free-market economy, but with social benefits, such as a state pension.

The main characteristics of the Nordic model are no minimum wage, low levels of corruption, high tax burden, strong property rights, low levels of inequality, free education and healthcare, and a public pension system.

The concept of the Nordic model is to allow its citizens to benefit from social gains such as free education, healthcare, and pension payments whilst simultaneously benefiting from the gains of a free-market economy.

It has been adopted by all the Nordic countries: Sweden, Norway, Finland, Denmark, and Iceland.

Final Nordic Model Quiz

Question

What is the Nordic model?

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Answer

The Nordic model is an economic model that combines both capitalism and socialism.

Show question

Question

What countries have adopted the Nordic model?

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Answer

Sweden, Norway, Iceland, Finland and Denmark

Show question

Question

What was the 'Grand Compromise'?

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Answer

It was a compromise between workers and employers. It centralised the coordination of wage negotiations and workers rights.


Show question

Question

What are some characteristics of the Nordic model?

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Answer

Low levels of corruption

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Question

Define creative destruction.

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Answer

Creative destruction refers to the constant change of the economy that ‘destroys’ inefficient processes to ‘create’ or make way for improved and efficient processes.


Show question

Question

What is one similarity between the Nordic model and the US system?

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Answer

Both systems have similar economic growth rates.

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Question

What is the Laffer curve?

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Answer

The Laffer curve shows the relationship between tax rates and tax revenue.

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Question

What does the revenue max point on the Laffer curve show?

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Answer

It shows the most efficient point to set the tax rate.

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Question

Explain what happens after the revenue max point on the Laffer curve.

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Answer

After this point, any increase in the tax rate will reduce tax revenue as individuals will look for ways to avoid paying taxes.

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Question

What percentage of the US GDP is spent on welfare programmes?

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Answer

18%

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Question

What percentage of the Nordic countries’ GDP is spent on welfare programmes?

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Answer

25%

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Question

What are some factors that can prevent countries from introducing the Nordic model?

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Answer

Population size

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Question

What are some advantages of the Nordic model?

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Answer

Free and good quality education


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Question

What are some criticisms of the Nordic model?

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Answer

It is not sustainable

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Question

Who coined the term creative destruction?

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Answer

Joseph Schumpeter

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