Many economists are fond of saying that a country can have relatively high employment or relatively low inequality – but not both. The argument runs like this. Good employment outcomes can only be achieved through free, competitive markets, with low levels of social regulation, a high degree of wage flexibility, curbs on trade unions and tough welfare to work policies. Such policies are bound to widen earnings inequalities – but any attempt to counter this effect through tax/transfer redistribution measures would simply nullify the economic and employment benefits of the market liberalisation measures. Higher inequality is therefore a pre-condition for higher employment.

Economic theory alone cannot prove or disprove this kind of argument. Subject to the usual qualifications, economists start with a strong presumption in favour of free and competitive market economies – but once a high level of market freedom is attained, as is now the case in all Western societies, the profession is far from unanimous about the incremental effects of further market liberalisation on economic performance.

So we need to turn to the empirical literature for guidance. Many economists like to compare “Anglo” countries (the US, UK, NZ and Australia) with those in continental and southern European countries (which I will call “Continentals”). This comparison does lend support to the ‘trade-off' theory: Anglo countries have generally performed better on employment criteria than the Continentals but worse on income inequality.

The Nordic experience

However the trade-off hypothesis is undermined by the experience of the Scandinavians (Denmark, Norway, Sweden, Iceland and Finland) and countries like Ireland, Netherlands and Austria. These Northern Europeans, which I will call “Nordics' for short, have generally been able to deliver low levels of inequality as well as strong employment outcomes.

Some critics refuse to accept this assessment. In particular they challenge the employment statistics put out by Nordic countries. They argue, for example, that while the official Swedish unemployment rate is well under 5%, the “true” jobless rate is closer to 15% because official figures fail to include discouraged workers who have stopped looking for work, young mothers who choose not to work, people on sick leave or on training and employment schemes, and so on.

Economists have always known that official unemployment figures tend to under-state the degree of under-utilisation of the work force and that there is considerable ‘hidden unemployment'. But this is not something unique to the Nordics. Exactly the same can be said of other countries. For example, in the USA and Australia, if one adds on the number of discouraged and under-employed workers to the official rate, the true jobless rate is very much higher than the official rate. The estimates range from 10 to 20% depending on what you include.

The OECD has rightly chosen not to get into these messy complications. It publishes members' official unemployment figures on a comparable and widely accepted measurement basis. And it tries to give some indication of cross-country differences in the incidence of ‘hidden unemployment' by publishing figures on the ratio of employment to working age population and labour participation rates. On all these indicators, the Nordic employment performance is quite comparable to that of the Anglos.

So how do we explain the Nordic success? In a forthcoming paper I hope to examine the issues in detail. In this short opinion piece I will, at the risk of over-simplification and over-generalisation, sum up my tentative views on four specific questions.

Q. 1. Why are the Nordics able to deliver social outcomes that are at least as good as the Continentals' – yet out-perform them on employment?

I believe the answer lies with the methods of redistribution employed which differ from the Continentals in three respects. First, Nordic countries rely less on employment protection legislation. In particular, they allow more flexibility on hiring and firing.

Secondly, the Nordics provide generous benefits for the jobless but the benefits are more tightly linked to work. That is, they reward well those who enter education or training or are actively searching for work but reduce their benefits if they reject these options. Thirdly, the Nordics rely relatively heavily on “social investment” as an instrument of redistribution and, as argued below, this approach is employment-friendly.

Q.2. Why are the Nordics able to deliver lower social inequality than the Anglos — yet match them on employment?

Although Nordics allow more labour market flexibility than the Continentals, they have retained higher levels of employment protection, stronger legal safeguards for trade unions and generally higher minimum wages than the Anglos. This network of worker protection regulation, combined with more generous welfare benefits and more progressive taxes, helps explain why they have lower levels of inequality.

But doesn't economic theory suggest that higher social regulation damages employment performance? Why hasn't this happened in the Nordic countries? My explanation is twofold.

First, as many economists have long suspected, it appears that in moderation worker protection regulation is not too damaging for employment. Indeed an argument can be made that the deregulation process works best in the initial stages and then runs into diminishing returns and may even become counter-productive for productivity and employment if taken too far.

Secondly, and more importantly, the Nordics have used non-regulatory instruments of redistribution to promote employment. Three types of “social investment” seem to have contributed most to the Nordic success.

– specific targeting of early child and youth disadvantages;

– policies which explicitly seek to reduce socio-economic inequalities of access to health care, pre-schooling, public education, public housing and public transport; and

– “active labour market programs” targeted specifically at disadvantaged job seekers and people of working age (disabled persons and lone parents). These programs include diligent, well-funded job search and placement services; in-work bonuses; government training and job-readiness schemes; family-friendly policies such as paid parental leave and good quality and affordable child care assistance; remedial programs for youth who drop out from high school; financial incentives for employers to employ and train the long term low-skilled jobless; and subsidies to jobless persons who are capable of setting up and managing their own business.

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There are credible studies showing high national economic returns in the long term from many of these social investment programs. The returns come in the form of higher employment (participation) rates; a more productive workforce and citizenry; greater geographic and occupational mobility of labour; less waste of potentially successful entrepreneurs; diminished health costs; lower imprisonment rates; less spending on juvenile delinquency; and savings in commuting time. There are also ‘external' economic spin-offs from increased community trust and harmony and greater community acceptance of structural reform.

In short, a major reason why Nordics have been able to reconcile high employment with low inequality is that they have invested heavily in their people and this has tended, over time, to offset any negative employment, efficiency and disincentive effects from social regulation and relatively high taxation.

3. Is the Nordic achievement sustainable in the long term?

It is often argued that Nordic tax levels are unsustainable in the long term. This argument has two stands. One is that voters will eventually rebel. And to an extent they have — but not sufficiently to fundamentally alter their social model. The other argument is that, in an integrated, highly competitive world economy, governments will in time be forced to cut taxes in order to avoid a brain drain and compete with low tax countries. That argument too is questionable. While high taxes do have negative effects per se, it appears from the Nordic experience that the economic returns from social investment have over time tended to outweigh the tax efficiency costs and there is no reason why the economic balance sheet should change markedly in the future.

4. Is the Nordic model exportable to Australia?

Until quite recently, Australia could boast that it had achieved a reasonable balance between employment and equality. Sure, we substantially deregulated the labour market but we also invested heavily in human capital and maintained a strong social safety net. However the Howard Government's recent workplace and welfare measures have put us firmly in the American camp.

Does the Nordic social model offer Australians an alternative policy route to high employment? Many believe not. They argue that Nordic tax and redistribution policies cannot be exported to countries with a very different set of social values and priorities. There is more than a core of truth in that view. Nordic redistribution policies rest on three pillars: deep-rooted egalitarian values (which stand out clearly in all international surveys); an electoral system which ensures that these values are fully reflected in the Parliament; and a population which is ethnically homogeneous and geographically concentrated. These features are lacking in most other countries. For example, in the USA and Australia, the poor tend to be predominantly from minority groups and are often geographically and socially segregated from the better off people, producing a “them” and “us” mentality.

But Australians still have a strong and passionate belief in equality of opportunity – the notion that everyone should have an equal chance to achieve their full potential, irrespective of their social background. It is the essence of what we all mean by a “fair go”. Since the Nordic ‘social investment' model is all about equalising opportunities, parts of it should appeal to Australian values. Of course, we can never go a long way down the Nordic path. But the confident assertion of Howard Ministers that the only way to improve our employment performance is through measures which produce greater inequality is a half-truth masquerading as economic science.