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Sweden shimmers in pre-euro glow

STOCKHOLM - How long will Europe's fringe continue to do better than its core? When the euro was conceived the main concern was that the core would become more prosperous at the expense of the periphery. But the reverse seems to have happened. A brief visit to Sweden confirms the view that the fringe could continue to do well for quite a while yet.

Stockholm, of course, is as orderly and as beautiful as ever, shimmering in the spring sun. But then it was orderly and beautiful in 1990, when the country was in an even deeper recession than we had in Britain and people were in a state of shock that their famed big-government Swedish economic model would have to be abandoned.

It hasn't been abandoned, though it was sharply trimmed back, but now the country is nudging itself towards two decisions: what to do about the euro and how much the economic model needs again to be changed.

As far as the euro is concerned, Sweden is the other big "out". After Britain it is the largest EU member that has decided to remain for the time being outside the euro bloc. As in Britain a referendum on membership is promised, and as in Britain, the government is broadly in favour of joining and the people are broadly against - currently only 40 per cent of the population favours membership and that proportion has been falling in recent months.

It is not hard to see why, because in many ways the Swedish economy has become rather a success story. There are micro-economic shadows, of which more in a moment, but the macro-picture is bright. After that particularly nasty recession at the end of the Eighties the economy has enjoyed solid, low-inflationary growth. It managed 3 per cent in 1998 and will achieve 2 to 2.5 per cent this year. Consumer price inflation was negative for much of last year and was zero in March. It will come up a bit now, but the effect of the disappearance of inflation has been to give real wages a sharp boost. Living standards have been rising by about 4 per cent a year for the past four years (see graphs).

Other measures of success? Well, there is a big current account surplus, so there is no pressure there. Employment has been rising since the beginning of last year, which is a relief because the Swedish economy has not been good at creating private-sector jobs. The budget deficit is comfortably under 3 per cent, and the economy still has room to grow in the sense that there is still an output gap of 1 to 2 per cent of GDP.

It all sounds almost too good to be true: good growth, no inflation, trade surplus, more jobs - and all this with high public spending on welfare, the highest public spending relative to GDP of any country in the world. You can see why there is little popular pressure to change anything, for example by joining the euro.

Unsurprisingly there is a flipside to the coin. If everything were so wonderful why did the finance minister resign in protest a few weeks ago? Why have a number of Swedish companies moved either their headquarters or important divisions outside Sweden? Why do ambitious young Swedish people strive to get a job abroad?

You pick up the answer from the Swedish business community. Yes, in macro- economic terms the economy has made considerable advances, but then it certainly should have done given the extent to which it was caned in the early Nineties. It has had a long slog digging itself out of recession and it ought to be able to achieve a few years of non-inflationary growth.

But that was only half the problem. In micro-economic terms the record of reform is much more mixed. A lot of the problem is tax. While top rates of income tax have come down, but are still close to the top of the European range, the total share of GDP spend by government has been held at just on 60 per cent, but that is still the highest in the world. Company taxation, by contrast, is quite low, but Swedish companies can still benefit from that while shifting workers overseas. Most worrying of all, the level of new business start-ups is low and the businesses that are starting seem in general to be remaining quite small. With the notable exception of Ikea, the famous company names of Sweden, like Volvo and Ericsson, were all founded nearly a century ago. Swedish business people ask: where are the giants of tomorrow, and ponder why their best employees all want to get jobs in London or New York.

This erosion of talent, coupled with the fact that it is virtually impossible to persuade foreign executives to move to Sweden, is the main reason why Swedish companies are being forced to locate more and more functions abroad. To run a multinational company you have to have access to the global pool of human capital.

This contrast between macro-economic success and micro-economic failure carries a powerful message to the rest of Europe. We often tend to think about economic policy in a sloppy way, bundling together macro- and micro- policies. But of course the two are quite separate. It is possible to have a micro-economic success and a macro-economic failure, as Britain did in the late-Eighties and Italy did for much of the post-war period. Similarly it is possible to have macro-economic success and micro-economic failure, as, arguably, France has done in the Eighties and Nineties.

Sweden is an interesting test case in the sense that if it manages to sustain decent growth, maybe the fact that it has been slow at making structural reforms won't matter too much. Maybe it can continue to grow its way out of trouble. I happen to think that it can't: that a further wave of reform is inevitable and that reform will include some downsizing of the state's role. But at the moment a few years of good growth have made structural reform appear less urgent.

So there will be two things to look for from Sweden in the medium-term. One is the simple issue of the euro. If Sweden stays out - and it looks as though the referendum will be towards the end of next year - then this will have some direct impact on the UK in a tight vote. If it goes in, then psychologically it will tend to nudge us towards entry too.

The other is the shape of the European welfare system. If Sweden can be reasonably successful in economic terms and still maintain the high- spending model then it will be beacon for other European governments inclined in that direction. If it is forced to reshape it in a radical way, then the "tax-and-spend" model for European welfare will have lost its most extreme example.