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The Swedish Model: Free Markets and Economic Liberty?

During the 1970s and 1980s, Sweden was lauded for its exemplary standard of living. Synonymous with high taxes, low unemployment, and an iconic welfare system, the “Swedish model” became something some other countries envied.

Ulf Sjostedt | Photographer's Choice RF | Getty Images

Even today, well-renowned economist Paul Krugman regularly cites Sweden as an example of a solid working economy that has “sailed through” the recent economic crisis with government spending that is close to 50 percent of its growth domestic product (learn more).

But a new publication released by the Institute of Economic Affairs, a U.K. think tank, challenges that way of thinking. It argues that many of these values were in place before the Social Democrats, who governed for nearly 70 years, came into power. (Read the full report here.)

“Sweden did not become wealthy through social democracy, big government, and a large welfare state,” Nima Sanandaji, who authored the report said, arguing that high equality and favorable social outcomes were in existence before this time.

“[Sweden] developed economically by adopting free-market policies in the late 19th century and early 20th century. It also benefited from positive cultural norms, including a strong work ethic and high levels of trust,” he said.

His research then describes Sweden’s decline in relative economic performance since the late 1960s as the state grew rapidly. He says in terms of GDP per capita, the country slipped from fourth in the world in 1975 to 14th in 1993.

According to him, entrepreneurship floundered during this period and certain demographic groups developed a high level of dependency on welfare.

Sanandaji also looks at present-day Sweden and the reforms put in place since the country’s economic crisis in the early 1990s, when a housing bubble burst and created a credit crunch.

“Economic freedom has increased in Sweden while it has declined in the U.K. and U.S. Sweden’s relative economic performance has improved accordingly,” he said. “Since these reforms, and the reduction in taxes from the very-high levels of the 1970s to mid-1980s, Swedish relative economic performance has improved.”

Andreas Bergh, an economics professor at Sweden’s Lund University agrees with the report on the whole and doesn’t find it surprising that Sanandaji reached these conclusions.

However, Bergh told CNBC that he disagreed that the growth of the state in the 1970s coincided with a large decline in Sweden’s relative economic performance.

“This is actually hard to know for sure,” he said, adding that some would blame the failed macroeconomic policies of this period instead. “Sweden did so many things wrong in the 1970s, which means it is hard to say exactly what were the causes of economic decline.”

Bergh also is not convinced that Sweden’s growth from the mid-1990s is down to a reduction in tax levels.

“Taxes in Sweden are lower than they used to be, but they are still second highest in the world (after Denmark),” he told CNBC, adding that Sweden has experienced high growth despite having taxes between 45 and 50 percent of GDP.

Bergh added: “More important than the level is probably the fact that taxes are now much less progressive than they used to be,” indicating that the difference in tax rates for the wealthy and the not-so-wealthy isn’t that high, as opposed to a progressive system where the rich pay a larger slice.

Sweden’s marginal top tax rate of 56.6 percent kicks in at $81,000. In the U.S., on the other hand, the highest marginal tax rate of 35 percent kicks in at $388,000.

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