Friday, October 01, 2010

Swedish-Danish Labor Markets Again

I previously used the comparison between the labor market developments in Sweden and Denmark as evidence of the effect of incentives for reducing unemployment. I pointed out then that employment during the financial crisis fell a lot less in Sweden than in Denmark.

While leftist Matthew Yglesias tried to attribute this to the fact that the Swedish krona depreciated during the crisis while the Danish krone had (and still has) a fixed exchange rate to the euro, that was never very convincing as the main effect of this exchange rate policy, assuming foor the sake of the argument that the theory that a weak currency boosts growth is true, would have come in the form of higher growth (or less contraction), yet as I pointed out before, Sweden's loss in output was no smaller than Denmark's (and in fact revised numbers shows that the Swedish drop in out was in fact greater). The most striking difference between the countries was that the decline in output in Sweden was associated with a much smaller decline in employment.

While the weaker Swedish currency could have contributed to this to a very small extent as the higher inflation this caused helped reduce real wages, the main explanation is clearly the fact that the Swedish government has aggressively pursued a strategy of reducing marginal income tax rates for the poor and the middle class, while reducing unemployment- and sick leave benefits, while the Danish government has done almost nothing to improve incentives to go from unemployment to employment. (Unlike the Swedish government it has however reduced the top income tax rate. But while this can be expected to improve GDP growth it has little effect on employment growth).

Now things have changed in both the sense that the European business cycle have gone from bust to boom (at least for now) something which has boosted growth in both Denmark and Sweden more than average and also in the sense that the Swedish krona has appreciated more than 25% relative to the euro and therefore also the Danish krone since its March 2009 lows. But there is one thing that hasn't changed, namely that employment has been much stronger relative to output growth in Sweden compared to Denmark.

As stated, growth in both Sweden and Denmark has been higher than the European average, with Sweden's GDP growing by 4.6% and Denmark's by 3.7%.

Yet employment, in terms of hours worked has during this period increased by 2.1% in Sweden while declining by 1.3% in Denmark. And do please note that this much stronger Swedish performance happened after the Swedish krona appreciated by about 25% against the Danish krone, seriously undermining the relevance of Yglesias' currency weakness theory.