Economy & Business

The Swedish Lesson: Welfare States Create Moral Hazard

Sweden’s Prime Minister Stefan Lofven reads the statement of government in the parliamentary chamber in Stockholm, January 21, 2019. (TT News Agency/Jessica Gow via Reuters)
Having watched people game the welfare state, Nordic countries have scaled it back in favor of free markets.

At a time when the American Left wants to introduce Swedish-style socialism into the U.S., we should remember that generous welfare states pose a moral hazard. Their well-intentioned policies undermine individual responsibility and create a welfare-dependency trap. This is confirmed by history as well as by current developments in Sweden, where cheaters are targeting the country’s welfare system.

Even Franklin D. Roosevelt, the architect of the U.S. welfare state, understood that generous welfare could undermine social virtues. “The lessons of history, confirmed by the evidence immediately before me, show conclusively that continued dependence upon relief induces a spiritual and moral disintegration fundamentally destructive to the national fiber,” FDR explained in 1935. “To dole out relief in this way is to administer a narcotic, a subtle destroyer of the human spirit. It is inimical to the dictates of sound policy. It is in violation of the traditions of America.”

Roosevelt’s views were anything but uncommon. At the beginning of the 20th century, even the proponents of the welfare state were greatly worried that the buildup of welfare programs would endanger the social fabric. To understand why, bear in mind that, for the welfare state to function properly, it is not enough that most individuals pay their taxes. Neither does it suffice for most individuals to follow the norm of using welfare services only responsibly — that is, of not claiming more than they need or are entitled to. For the welfare state to be viable in the long term, the vast majority of individuals must abide by the social contract.

A small-government system relies on its citizens to follow a basic social contract: Do not harm others or their property, and abide by the laws. A government system with generous welfare and transfer programs also relies on its citizens to do that and more: to refrain from overusing benefits.

From the individual perspective, as transfer schemes become more generous and taxes are raised, it becomes increasingly lucrative to sideline the social contract, and so incentives in the form of monetary transfers can, and often do, undermine the motivation to depend on the fruit of one’s own labor.

If all individuals follow the norms of working, paying taxes, and using welfare programs only when in need, the system will function properly, even when the welfare system is large. If some begin to abandon society’s prevailing norms, however, imitators might follow suit. When those people gaming the system have reached a critical mass, they are liable to change social norms in that regard, leading to an erosion of welfare-related norms and to the collapse of the social contract.

Small-government systems create incentives for people to work hard and take responsibility for their lives. As the level of economic distribution through taxes and transfers grows, the system lessons the incentives for work and responsibility, increasing the incentives to gaming the system. Large-government systems foster dependency by gradually breaking down the norms that allow society to thrive. This, at least, is what we should expect in theory.

But in the early 20th century, the proponents of welfare policies argued that the erosion of social norms because of welfare was not a given. People could so appreciate the welfare state that they self-regulated their behavior. Perhaps generous welfare made everybody work harder and take more responsibility?

The proponents of the welfare state grew bolder, and then they continued to do so with time. They believed that the moral-hazard risk of welfare states could be avoided, at least in the social-democratic utopias that Scandinavian countries in general and Sweden in particular were often imagined to be.

Many proponents of the welfare state regard Sweden as a model whose policies others should emulate. The country is perceived as having implemented a large-scale welfare state, with generous and broad-ranging public programs, while avoiding the moral hazards associated with welfare policy. The reality is that Sweden’s generous welfare system has been undermined by large-scale cheating that has led to a reduction in welfare-state generosity. If even Protestant Sweden, where the work ethic was once so strong, could not withstand the moral hazard associated with generous welfare, what society can?

The World Value Survey gives strong support for the claim that norms in the Nordic countries have eroded. In the 1981–84 survey, for example, 82 percent of Swedes agreed with the statement “Claiming government benefits to which you are not entitled is never justifiable.” In the 2010–14 wave, merely 55 percent held the same view. The pattern is found in the other Nordic nations as well. This fall in responsibility seems to be stabilizing lately, following tax cuts and significant reductions in welfare-state generosity.

A number of attitude studies in Sweden conclude that a significant portion of the population has come to consider it acceptable to live on sickness benefits even if you aren’t sick. A survey from 2002, for example, showed that 60 percent of Swedes believed that it was acceptable to claim sick leave when you were not sick. Four years later, a center-right government was elected on the promise to cut the welfare benefits and taxes significantly. In fact, Swedish governments on both the right and the left have reduced the generosity of the welfare system. Additionally, gatekeeping functions have been introduced, mainly for sick-leave claims, to limit over-utilization and outright cheating.

Economist Martin Ljunge suggests that the reforms may need to be quite far-reaching to reverse the long-term effect that the welfare state has had. Politicians should consider that such policies can have lasting effects, in the form of eroded morale. Once other circumstances have been adjusted for, Ljunge finds, younger generations are much more likely to use welfare benefits such as sick leave. “The higher demand for sick-leave pay among the younger generations can be seen as a measure of how rapidly the welfare state affects attitudes toward the use of public benefits,” he explains (my translation from Swedish). The moral: Be careful when introducing generous welfare.

The Nordic states have reversed course in economic policies, cutting taxes and welfare benefits, but the moral-hazard problem of the welfare state remains. For example, the Swedish tax authority reports that during 2018 almost a thousand alarms were sent to the Swedish Social Insurance Agency about erroneous transactions, in some cases stemming from false identities being used to claim benefits.

Tobias Wijk, an expert at the tax authority, explains that one form of cheating is to bring poor immigrants from other European Union members to Sweden. The person is registered in Sweden with papers for a false job and then enrolled in the welfare system. Various government authorities have been tasked by the Swedish government to tackle benefit-cheating, but, Wijk says, the tax authority expects the problem to continue to rise this year compared with last year.

The market for personal assistants for the handicapped has become a prosperous market for organized crime. The Swedish government estimates that 3 to 6 percent of the funds it distributes for such services go to cheaters. In 2005, the government launched an investigation into wrongful payments by the Swedish welfare system and found that fully 4 percent were illegitimate because of a combination of error and cheating. It is worth noting that the government survey did not distinguish in detail between error and cheating.

A follow-up investigation found that in 2010 between 0.9 and 5.8 percent of welfare benefits paid out by the Swedish government were illegitimate. The estimate is quite imprecise and, again, fails to distinguish between error and cheating. The welfare system and its over-utilization have evolved to a point where planners and researchers cannot even measure the degree of mismanagement and of cheating precisely.

Even as Sweden has reduced welfare benefits, cheating appears to have increased, as criminal actors have homed in on the welfare system. This is one of many reasons why the Swedish welfare system has severe problems with long-term sustainability, as my colleague Gabriel Heller Sahlgren and I show in a study for the Swedish think tank Timbro.

Over-utilization also explains why Sweden and other Nordic countries are gradually shifting from social democracy to free-market reforms and slimmed-down government. In the 2018 election in Sweden, the Social Democrats gained 28.3 percent of the votes, the lowest level since a proportional election system was introduced in Sweden in 1911. The socialist Left Party gained an additional 8.0 percent of the votes. Both parties have shifted their policies significantly away from socialism. The Social Democrats have gone so far as to push through a partial privatization of the pensions system, accepting broad tax cuts for the middle class, and agreeing to let private, for-profit firms compete to provide publicly funded services such as education, health care, and elder care.

The Social Democratic government of Stefan Löfven continues to remain in power, but only after promising to introduce wide-ranging tax cuts and market liberalizations. Promising more and more government programs used to be a winning proposition in Swedish elections. Today that approach doesn’t work, as over-utilization of public programs has created skepticism.

American liberals have for decades pointed to Sweden and the other Nordic countries as the Shangri-La of social democracy. Yet the social-democratic model has failed because of the moral-hazard problem that FDR himself worried about. History has shown that the proponents of limited government, such as Ronald Reagan, were right all along.

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