Sweden – Donald Marron

After 20 Years, Sweden’s Labor Market Still Hasn’t Recovered

By many accounts, Sweden did a great job managing its financial and fiscal crises in the early 1990s. But more than 20 years onward, its unemployment rate is still higher than before the crisis, as noted in a recent commentary by the Cleveland Fed’s O. Emre Ergungor (ht: Torsten Slok):

And its labor force participation rate is still lower:

Does Sweden’s experience portend similar problems for the United States? Ergungor thinks not. Instead, he attributes this shift to a structural change in Swedish policy that has no direct analog in the United States:

One study of public sector employment policies published in 2008 by Hans-Ulrich Derlien and Guy Peters indicates that for many years, the labor market had been kept artificially tight by government policies that replaced disappearing jobs in failing industries with jobs in the government. The financial crisis was the breaking point of an economic system that had grown increasingly more unstable over a long period of time. It was a watershed event that marked the end of an unsustainable structure and the beginning of a new one. Public sector employment declined from 423,000 in 1985 to 240,000 in 1996 mainly through the privatization of large employers—like the Swedish postal service, the Swedish Telecommunications Administration, and Vattenfall, the electricity enterprise—and it has remained almost flat since then.

With such a large structural change, what came before the crisis may no longer be a reference point for what will come after. Having corrected the root of the problem, the Swedish labor market is now operating at a new equilibrium.

That doesn’t mean smooth sailing for the United States, as he discusses. But it does leave hope that perhaps we do better than Sweden in creating jobs in the wake of a financial crisis.

Swedish Lessons for EU Bank Owners

Sweden is rightly admired for the way it handled its banking crisis in the early 1990s (and its ensuing fiscal challenges).

In yesterday’s Financial Times, Dag Detter looks back for some lessons for Europe as it struggles to resolve its current banking crisis:

When the Swedish banking system crashed in 1992, the government faced an identical problem. Yet in the end, Sweden’s taxpayers came very well out of their experience of bank ownership. How was this achieved, and what lessons can be learnt for Madrid and the EU’s new bank resolution policy?

First, move fast. Spain and bankers have been in denial about the scale of bad lending for too long. The Rajoy government rightly came to office this year on a promise to force banks to write down bad loans. The situation has predictably turned out to be much worse than assumed, but their policy is the right one. Painful as it is, transparency on the scale of bad debt is vital for the market to be confident that it understands risk and uncertainty in Spain and can therefore price it properly.

Catharsis can come only with a purge of bad assets. Banks should present plans to handle problem assets, strengthen controls and improve efficiency. This might require government or even supranational assistance in the orderly closure of moribund institutions. In addition, “bad” bank parts must be demerged from the “healthy” to facilitate recapitalisation. The state should never be left holding the junk while the healthy part of a bank wriggles free.

Second, maintain commercial principles. In Sweden, each state bank investment was made on what would have been commercial terms in a normal market, always with the aim of maintaining competitive neutrality. The terms of the investment must be structured in a way that gives the bank and its owners no grounds to request more state funding than is necessary, combined with the incentives to facilitate a swift exit. Yet it must be sufficient to ensure that the bank can return to profitability without additional government assistance.

The whole piece is worth a read.

Unemployment, Small Business, Quantitative Easing, and More

The Fed’s quantitative easing programs did indeed lower interest rates, but more so for Treasuries and mortgage-backed securities than for other kinds of debt. Small businesses are overrated as job creators. Extended unemployment insurance does increase unemployment rates, but not that much.

Those are just a few of the findings from papers presented today at the Brookings Institution’s twice-yearly conference, Brookings Papers on Economic Activity.

Courtesy of a Brookings release, here are brief summaries of five papers discussed today:

In Recession and the Costs of Lost Jobs, authors Steve Davis of the University of Chicago and Til von Wachter of Columbia University find that when mass-layoffs occur in good economic times, men with 3 or more years of job tenure suffer a $65,000 loss in the lifetime value of their earnings (a fall of about 10%), relative to otherwise similar workers who retain their jobs. But in a recession, a similar shock causes workers to lose $112,000 in the lifetime value of their future earnings (or about 19%). The authors also track worker perceptions about layoff risks, job-finding prospects, and the likelihood of wage cuts, finding a tremendous increase in worker anxieties about their labor market prospects after the financial crisis of 2008. This heightened anxiety continues today, they find. Davis and von Wachter also show that prior economic employment models have been unable to address the facts about the earnings losses associated with job loss, yet those earnings impacts appear to be one of the main reasons that individuals and policymakers are so concerned with recessions and unemployment. Finally, they note that pro-growth policies may be the most efficient and cost-effective means available to policymakers to alleviate the hardships experienced by displaced workers.

In What Do Small Businesses Do authors Erik Hurst and Benjamin Wild Pugsley of the University of Chicago overturn the conventional wisdom about the role of small business, finding that they aren’t the job engine most believe them to be. Most small business owners neither expect nor desire to grow or innovate, but rather intend to provide an existing service to an existing customer base. Analyzing new survey data, the authors find that, instead, it is non-financial reasons — such as work flexibility and the desire to be one’s own boss – that are the most common reason that entrepreneurs start their own business. Hurst and Pugsley note this behavior is consistent with the industry characteristics of the majority of small businesses, which are concentrated among skilled craftsmen, lawyers, real estate agents, doctors, small shopkeepers, and restaurateurs. They conclude that standard theories of entrepreneurship may be misguided and result in sub-optimal public policy, suggesting that subsidies for small businesses may be better spent if they are targeted to businesses that expect to grow and innovate, rather than small businesses in general. They laud the partnership between the US Small Business Administration and venture capital firms as an example of strong targeted public policy.

In Unemployment Insurance and Job Search in the Great Recession, Jesse Rothstein of the University of California, Berkeley finds that recent extensions to the period in which the unemployed can draw unemployment benefits had a significant but small negative effect on the probability that eligible unemployed would exit unemployment, and that the effect is mainly concentrated among the long-term unemployed. Rothstein calculates that without those extensions, the unemployment rate would have been about 0.2-0.6 percentage points lower—a much smaller impact than implied by previous analyses, and that the long-term unemployment rate would have been even lower. He finds that half or more of these impacts are due to the unemployed remaining in the labor force rather than reductions in the chances of finding employment. As a result, Rothstein suggests that a generous extension of UI benefit in deep recessions should last until the labor market is strong again, thus giving displaced workers a realistic chance of finding new employment before their benefits expire.

In The Effects of Quantitative Easing on Interest Rates, Arvind Krishnamurthy and Annette Vissing-Jorgensen of Northwestern University show that the Federal Reserve’s recent quantitative easing (QE) programs (“QE1” and “QE2”) did in fact significantly lower interest rates on Treasury securities, as well as GSE bonds and highly rated corporate bonds. They also find that such programs affect interest rates differently depending on which assets are purchased: QE1, which involved the purchase of mortgage-backed securities (MBS) in addition to Treasury securities, significantly lowered MBS rates, whereas QE2, which focused exclusively on Treasury securities, had little effect on MBS rates. The authors identify several channels through which QE affects interest rates: first, QE increases the premium paid for assets with low-default risk (and thus lowers rates on these assets), by reducing the supply of such assets available to investors; second, QE drives down interest rates broadly by signaling a commitment by the Federal Reserve to keep interest rates low for a long period; and third, when QE involves purchases of mortgage-related assets, it lowers rates on such assets by affecting the price of mortgage-specific risk. Because QE does not affect all long-term interest rates equally, examining the impact of a QE policy that focuses on purchases of Treasury securities on long-term Treasury rates is likely to overstate the program’s impact on the long-term corporate and mortgage interest rates that all relevant to investment and housing demand. Interestingly, the results about having the Fed use its communication channel alone – that is, signaling its intentions – might be having a significant impact on rates without having the Fed actually take on the risks associated with increasing its balance sheet. The authors also conclude that expected inflation increased substantially due to QE1 and modestly due to QE2, implying that reductions in real rates were larger than reductions in nominal rates.

In Practical Monetary Policy: Examples from Sweden and the United States, Lars E.O. Svensson, the Deputy Governor of the Swedish Central Bank (Sveriges Riksbank) analyzes the actions of the U.S. Federal Reserve and the Swedish Riksbank during and after the summer of 2010, looking for evidence that perhaps central banks make mistakes. In that time period, both the Fed and Riksbank forecasts for inflation were below their target and their forecasts for unemployment were above the sustainable unemployment rate, suggesting that more expansionary policy was warranted. However, the Riksbank tightened policy while the Federal Reserve held rates steady. Although the Swedish economy developed better than expected, and the U.S. economy developed worse than anticipated, Svensson argues that these developments were the result of external factors — not, in fact, the nations’ respective monetary policies. The Riksbank benefited from higher-than-anticipated domestic and export demand, upward revisions of GDP data, and a lack of structural problems. On the other hand, the Fed had to contend with fiscal policy problems, a slower housing market recovery, and substantial downward revisions of GDP data. The author concludes that the Riksbank’s decision to tighten policy is difficult to justify, while the Federal Reserve’s decision not to tighten was appropriate, although there is also a case to be made that they should have eased more.

Use Sweden’s Playbook

During the financial crisis, the best single piece of advice I received was: “Use Sweden’s playbook.” Sweden faced a severe financial crisis in the early 1990s and had managed it–through a combination of guarantees, capital injections, and good bank / bad bank separations–about as well as one could hope.

As our attention turns from the financial crisis to our looming fiscal crisis, that advice continues to be useful. When its financial crisis ended, Sweden found itself on an unsustainable fiscal trajectory, yet found a way to pull itself out. As Jens Henriksson wrote in a fascinating paper (“Ten Lessons about Budget Consolidation“) in 2007:

In its Economic Outlook of December 1994 the OECD projected that the Swedish public debt would explode. By the year 2000 the public debt was expected to hit a record 128 percent of GDP. Today we know that the gross debt for 2000 turned out to be less than half that figure at 53 percent. And within a few years the budget deficit, from a high of over 11 percent of GDP, turned into a large surplus.

How did Sweden do it? You should read Henriksson’s paper for all ten lessons, but two particularly important ones are:

Set clear, easily communicated budget goals (e.g., specific deficit targets that get the government debt under control).

Combine deficit-reducing measures into a single package so that it’s perceived as shared sacrifice, not as targeting specific interests.

These lessons are useful both for domestic politics and for world capital markets. Clear goals with shared sacrifice can, in the hands of strong political leaders, establish a commitment to budget consolidation, easing the path to success at home:

As a politician you can never explain why you need to cut pensions alone. But if, at the same time, you cut child benefits and unemployment insurance and raise income tax for the richest, you are on safe ground. The idea is to not single out the losers.

At the same time, clear, credible commitments will be rewarded by world capital markets through lower interest rates, which can help offset some of the contractionary effects of tightening the budget. (Henriksson’s description of Swedish politics at the time occasionally sounds like parts of the Clinton years, when the opinions of the bond market loomed large).