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GIE ASSIGNMENT

Nordic Model: The Challenge of

Globalization

Report Submitted to:

Prof. Sangeeta Kamdar

As on 17th

March 2010

Submitted by Team 3SHILPA JHAMB 316

ANKUSH SHAIK 337

ANKIT JAIN 353

MADHU KUMAR M 358

AMIT NAGESHRI 359

HARSH KOTHARI 364

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Table of Contents

About the NORDICS ................................ ................................ ................................ ........................... 3

The Nordic Model ................................ ................................ ................................ .............................. 4

Impact of Globalization of Nordics ................................ ................................ ................................ ..... 5

Why ROW likes Globalization of Nordics? ................................ ................................ .......................... 8

Analysis of Globalization Impact on NORWAY ................................ ................................ .................... 9

Nordics vs. United States - Decent vs. indecent wages ................................ ................................ ..... 10

Recent Performance of Nordics after Globalization ................................ ................................ .......... 11

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About the NORDICS

The

c c

es

c

e

ve c

es

y Den k (Cons onal monarchy with a Parliamentary system -- an autonomousconstituent country within the Danish Realm),

y Finl nd (Semi- residential re ublic, inde endent since1917),y Sweden (Constitutional monarchy with a Parliamentary system, de facto inde endent

kingdom since1523),

y Icel nd (Parliamentary re ublic, inde endent since 1918, although in a union with and ade endency of Denmark until 1944),

y No ! way (Constitutional monarchy with a Parliamentarysystem, inde " endent since1905).Two of them: Iceland & No ! way are members of theNA

#

O1

but not of the EU

Three of them: Den $ ark, Finland & Sweden are members of theEU, but two of those Finland &

Sweden are not members of the NATO

Denmark does belong to NATO but not to the Western European Union whichseeks to co-ordinate

defence policies and procurement for European countries within NATO.

One of the three EU members, Finland is also a member of theE % U2 and so has the Euro as its

currency. Denmark and Sweden arestill using their own kroner.

Three of the Nordiccountries are monarchies and two, Iceland & Finland are republics

The Norwegians & Icelanders feel prosperous and comfortable outside the EU:

y Partly because of their huge oil revenues (they do not want to come under any restrictionsby joining the EU).

y Also theyhave a national interest that theysharestrongly with Iceland: fish. Neither countrywants to have its seas and fish stocks included in the Common Fisheries Policy. Iceland

remains a member ofEFTA3 together withSwitzerland and Liechtenstein.

TheNordic Passport Union allows citizens of these countries to travel & reside in other Nordic

countries without a passport or a residence permit.

1North AtlanticTreatyOrganization

2Economic & Monetary Union

3European FreeTrade Association

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Th rdic M d l

It is distinguished from other welfare states with similar goals by its emphasis on

y Maximizing labour force participationy Promoting gender equalityy Egalitarian and extensive benefit

levels

y Large magnitude of redistributiony Liberal use of expansionary fiscal

policy

There is actually no single model that among the five Nordic countries, they however share somecommon characteristics:

y Labour mar& et institutions and policies that provide relatively low employment protection,high unemployment protection, coupled with high income-support benefits, strict activation

policies and a high degree of centralized wage coordination;

y Comprehensive social benefits and publicly provided social services, as well as largeinvestment in education and research and development financed by taxes; and

y Openness to trade and Competitive product markets.y High taxes

There are three major pillars of the modern Nordic welfare state: social security' health care and

free education. These features together offer a collective mechanism for ris ( sharing and play a key

role securing the political acceptability of structural reforms.

The Nordic economies have performed well in recent years in the euro area. Inflation has generally

remained low over the last 3 years; although as elsewhere, recent increases in food and energy

prices are exerting upward pressures. And labour markets are characterized by high participation

rates' generally low unemployment, a small incidence of long-term unemployment and high job

mobility. For example, in the Nordic countries, older workers employment rate in 2006 was well

above the OECD4

average of 53%, reaching nearly 85% in Iceland.

At the same time as the Nordic countries have expanded the size of the economic pie, the

distribution of this pie has been widely shared. This in part reflects these countries tax and

welfare systems, which have generally ensured that the winners from structural transformation have

shared their gains with the losers. Income equality and poverty rates were lower in Denmark and

Sweden than in any other OECD country, and they were below the OECD average in Finland and

Norway.

An additional well-known feature of the Nordic model is the high tax burden. Taxation revenue to

GDP last year was close to 50 per cent in Denmark and Sweden and over 40 per cent in Finland and

Norway. This of course is needed to finance the comprehensive and generous social expenditures

and spending on education. But equally important is that in the Nordic countries, tax revenue is put

to efficient use.

Less well known internationally is the traditional commitment to free trade. Barriers to trade apart

from agricultural products and investments are low, and measures of Nordic country participation

in the international trading system are high. Similarly, Nordic countries score well in terms of

competition-friendly regulation in markets for goods and services.

4Organization for Economic Co-operation & Development

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Impact f Gl alizati n f rdics

Globalization is a long-standing phenomenon, and in a sense, the Nordic model is itself a response to

the challenge of globalization. But the pace of globalization has accelerated, with the emergence of

new players in the international trading system, bringing additional wor) ers 1 billion over the last

decade and new relationships such as cross-border out-sourcing and in-sourcing. In addition, the

globalization of innovation means that many OECD-based businesses are setting up R&D operations

in China and India, attracted by their abundant supply ofhighly s ) illed scientists and engineers.

These developments could pose challenges for the Nordic model, and will need to be addressed to

maintain Nordic competitiveness.

The costs of funding the Nordic model are

likely to rise faster than nominal GDP. This is

due to expected demographic changes,

leading to a higher proportion of retirees

relative to the number of workers, as the

baby boom5

generation retires, and life

expectancy continues to lengthen.

At the same time, governments room for

manoeuvre has become more limited, with

taxation levels already high, and tax bases6

becoming more mobile (especially on capital

and labour income). Both forces exert

tensions on the long-run sustainability of the

Nordic model.

Coping with globalization is about coping with change, and success in implementing policy reform

requires winning broad support for change. But as you are well aware, that is not an easy task. There

are winners and losers across countries and within each country. Even if a country benefits overall,

the adjustment costs cannot be ignored. Moreover, since globalization nowadays is increasingly

based on changing patterns of specialization coming fromdifferences in factor endowments, rather

than the intra-industry trade deepening, the adjustment costs are greater and more narrowly

concentrated.

The following other points show deeper impacts:

1. It limited their capacity to raise tax rates or to maintain high tax rates, given competitive pressures,particularly on the taxation of mobile factors of productionviz., capital.

2. It provides pressure for a restructuring of tax policies away from taxes on factors (particularlypayroll taxes) and toward general sales taxes as a means of limiting the impact on employment; in

this regard, it thus also creates pressures for changing the financing basis of welfare benefits away

from those that are employment-linked. In a similar vein, it creates incentives for a restructuring of

welfare policies to those which are of a personal account naturee.g., defined contribution pensionschemes, personal medical accounts. In the above context, and as noted above, one cannot ignore

that these fiscal effects of globalization on the Nordics are occurring at the same time as the forces

of demographic change will be independently pressuring the costs of the welfare state in industrial

countries. Limits on the capacity to raise taxes at a time of growing social insurance burdens

particularly those faced by PAYGO systemswill force reforms that both contain benefit growth and

put pressure to ensure an adequate safety net for the poorest of the elderly population.

5

A baby boom is any period marked by a greatly increased birth rate6

The sum of taxable activities, collective value of real estate, and assets subject to tax within a community.

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3. Globalization, combined with rapid technological change, accentuates the competitive pressuresfaced by domestic producers, with several important effectsrestraining the capacity of labour to

realize wage gains, maintaining pressure on producers for a lean labour force, and increasing the

ris0 of unemployment. If anything, this accentuates the importance of social safety net policies

welfare and unemployment benefitsas well as policies to facilitate the more effective functioning

of labour markets.

4. Another facet of globalization, which will only continue to be reinforced in the future, will bepressures for migration arising from the largely predetermined growth in the global labour force in

coming years (despite the drop in fertility rates globally and the obvious aging of industrial country

populations). Given the large disparity in incomes between aging industrial countries and less

developed countries, and the labour force needs of industrial countries, pressures for migration will

continue to be an important policy challenge in industrial countries. Such immigration pressures

have been felt as a double edged sword by the Nordics, providing some additional financial support

for financially weak welfare systems but also raising questions as to the eligibility for benefits of

these migrant groups.

5.

Globalization has also enhanced the uncertainty and ris1

faced by domestic producers to globalmarket changes. The last year has illustrated powerfully the way in which critical global commodity

prices can be affected by supply and demand shocks as well as by speculative forces in the capital

market. The ripple effects of such shoc 1 s can be transmitted quickly to local production markets,

whether in low income or advanced economies. Witness the impact of high oil prices on the

competitiveness of a whole range of industries in the United States, creating pressures on both

established social insurance programs (unemployment benefits) and for relief outlays outside the

formal welfare structure. (As an aside, out formal definition of the welfare state does not normally

include the provision of financing to shore up financial institutions or strengthen deposit protection

schemes, etc.). Also note the uncertainty created for producers who have created global supply

chains as the cost of transport has risen sharply, rendering business models involving decentralized

production processes less efficient. Such pressures could lead to greater competitiveness of

domestic producers, either in advanced countries or neighbouring countries whose labour costs may

now be more competitive. The important point is that uncertainty may be heightened, increasing

the returns to being able to flexibly respond.

6. One facet of globalization that has proved relatively efficient in the last decade has been the abilityof capital markets to recycle capital from current account surplus to current account deficit

countries. The recent pressures on commodity prices may have tilted current account surpluses to

high savings rate countries, thus dampening global demand pressures and weakening growth

prospects in many industrial countries. Higher rates of unemployment inevitably put pressure on

the Nordic countries that critically depend on maintaining relatively high employment rates.

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Globalization is in general beneficial to economic growth as it provides an opportunity to increase

the returns to factors of production via international exchange of goods and services and/or via

international factor mobility.

Nevertheless, increasing international mobility of labour also poses, if it continues unabated for

long, a threat to the Nordic model. The entitlements to education and retirement as well as to care

or benefits in the case of sickness, disability and unemployment belong to all citizens as individuals

in this model, while the cost of these entitlements are born collectively and shared by all via the taxsystem. With higher mobility of labour it becomes increasingly possible to benefit from the

entitlements without sharing the cost (paying the taxes). There are many examples:

Graduates from domestic tax financed universities increasingly make their careers (and pay their

taxes) abroad. Citizens who have spent most of their working lives (and paid their taxes) abroad,

return to their home country after retirement to collect the benefits of free (or cheap) hospital care

and care for the elderly.

Unemployment rates and the frequency of disability pensions tend to be higher for certain

immigrant groups than for domestic citizens.

With increasing claims on entitlements due to social tourism and eroding tax bases due to factor

mobility and tax competition between nations, the long-run sustainability of the Nordic model could

be in seriousjeopardy.

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Why R W7 lik s Gl alizati n f rdics?

y Strong property rights, contract enforcement, and overall ease of doing business.y Low barriers to free trade.y Little product market regulation. Nordic countries rank very high in product mar2 et freedom

according to OECD rankings.

y Little financial mar 3 et regulation. Denmark and Finland have the lowest regulation burden in EU-15according to OECD rankings.

y All Nordics have been pioneers in privatization alongside competitive public services. For instance,Sweden privatized education with education vouchers in 1992.

y Pension systems are privatized. Systems have higher pension funding rates than in most Europeancountries. They still have deficits4 however.

y Sweden has decentralized wage coordination, while Finland is ranked the least flexible. As in otherEuropean countries, the powerful labour unions tend to block attempts at reform. Reforms and

favourable economic development seem to have reduced unemployment, whichhas traditionally

been higher.

y Denmark's Social Democrats managed to push through reforms in 1994 and 1996. Denmark'sflexible mar5 et differs radically from other Nordics (Flexicurity

8). According to World Bank data,

Denmark has almost no labour mar5 et regulation, and ranks first in Europe in labour freedom.

y Sweden at 56.6% of GDP, Denmark at 51.7%, and Finland at 48.6% reflects very high publicspending, compared to 46.9% in Germany, 39.3% in Canada, and 33.5% in Ireland.

y A key reason for public spending is the very large number of public employees. They often havejobs-for-life and make up around a third of the workforce (more than 38% in Denmark). The public

sector's low productivity growth has been compensated by 6 urope's pioneering privatization and

outsourcing programs. Public spending in social transfers such as unemployment benefits and

early-retired programs is high. In 2001, the wage-based unemployment benefits were around 90% of

wage in Denmark and 80% in Sweden, compared to 75% in Holland and 60% in Germany.

Unemployed were also able to receive benefits several years before reductions, compared to quick

benefit reduction in other countries. Public spending in areas such as education or health is not farfrom the OECD median.

y Overall tax burden are among the world's highest; 51.1% of GDP in Sweden, and 43.3% in Finland,compared to 34.7% in Germany, 33.5% in Canada, and 30.5% in Ireland. Median employee's tax

wedge9 is between 57%-65%. Value-added tax rates are over 20% and corporate tax rates around

the OECD median at around 26%. Property taxes are low or non-existent. The tax burden is

particularly heavy on service sectors. The percentage of the buyers income entering the service

vendors wallet (inverted tax wedge) is around 15% in Nordic countries, compared to 10% in

Belgium, 15% in Germany, 25% in France, 30% in Ireland and 50% in the United States. Some

taxation is avoided by self-service and in the black market.

7Rest Of the World

8Flexicurity (a portmanteau of flexibility and security) is a welfare state model with a pro -active labour market

policy9

The tax wedge is the deviation from equilibrium price/quantity as a result of a taxation, which results in

consumers paying more, and suppliers receiving less

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Analysis f Gl alizati n Impact n RWAY

Norway is highly dependent on international trade, and has evolved into a very open economy with

some notable exceptions. Measured as a share of GDP, gross trade flows are higher than in most

other countries. Exports of goods and services accounted for 46 per cent of GDP in 2001, while

imports accounted for around 30 per cent. The importance of shipping, which represents Norways

second largest source of export revenue, has also contributed to support for a liberal trade regime.

As 90 per cent of the Norwegian fleet is engaged in cross trades, the Norwegian shipping industry

depends on open market solutions and a well functioning multilateral trading system.

The overriding objective of Norwegian trade policy is to provide for an open7 liberal and predictable

trading environment that also contributes to sustainable development. These policy objectives are

pursued along two tracks: a closer European integration and through multilateral liberalization.

Norway has a liberal trade and investment regime, with the agricultural sector being a prominent

exception. Agricultural tariffs are among the highest in the OECD and unpredictable temporary

tariff reductions which tend to favour nearby suppliers are used. Budgetary support to the sector

also remains high, amounting to around 70 per cent of all budgetary support in 2001, despite having

been reduced by around 25 per cent in real terms the past ten years. Some restrictions on foreign

investments remain in the fisheries sector, which is also extensively regulated.

For almost all industrial goods (which includes fish and fish products), however, tariffs are zero7 and

non-tariff import restrictions are minor. Norway has consistently built down barriers to trade

through participation in successive trade rounds in the GATT, and has a long-standing practice of

providing market openings for the developing countries. It is the Governments expressed goal to

remove all tariffs on industrial goods, in order to reduce costs for business and to save resources in

customs treatment.

Norway runs a wide ranging GSP10

-scheme granting almost all industrial imports from the developing

countries duty free entry. Most agricultural products enter either duty-free or with reduced tariffs

under the scheme. With effect from July 1 2002, all products from the least developed countries canenter free of duty and without quantitative restrictions. Norway has also dismantled all quantitative

restrictions on textiles and clothing and has duty-free treatment of textiles.

Norways WTO GATS schedule grants unlimited mar 8 et access and national treatment in a large

number of services. Norway has not taken recourse to anti-dumping or countervailing-duties, or

safeguard measures, since the mid 1980s. Norway has not participated as a defendant in a dispute

since the inception of the WTO, and has only participated as a plaintiff on one occasion.

Norway has used the substantial revenue generated by the offshore oil and gas sector to build up a

GPF11 for long-term investment in financial assets overseas. While income from the offshore sector

has benefited the Norwegian economy and made it possible for Norway to maintain and strengthenan extensive welfare system, it has also masked the need for structural reforms and has made their

implementation more difficult. The traditional manufacturing industries are in decline, and rapid

wage gains have caused a sharp deterioration in competitiveness since the mid-1990s. The country

is currently witnessing lower investments in the mainland business sector, and a weaker

development in the exports of traditional goods, while consumption growth has been buoyant

10

Generalized System of Preferences11

Government Petroleum Fund

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Nordics vs. Unit d tat s - Decent vs. indecent wages

What makes a country rich is not whether it has oil or something like that. It is productivity-- how

much it produces per hour. The latest OECD figures, from 2008, indicate that the level of

productivity is roughly the same in both the U.S. and Norway.

As a result, the level of hourly wages is also more or less the same, given that real wages are closely

tied to productivity. In Norway, the real wage in 2008 was about 130 krones (NOK 12) per hour, after

adjustment for differences in purchasing power.

The big difference between the Nordic

countries and the U.S. is the wage spread. The

main reason is that the lowest-paid workers in

the U.S. have very low incomes, indeed. The

minimum wage there is equivalent to NOK 45

per hour, and that is the actual wage for many

millions of workers. The minimum wage in

Norway is twice as much, NOK 90 per hour, and

even that level is regarded as too low.

But there is quite a difference between earning

less than NOK 100,000 per year and almostNOK 200,000 per year. It means that, in the

Nordic countries, workers earning the minimum wage can have a decent standard of living. But their

counterparts in the U.S. normally cannot; they need to have two or threejobs, social assistance, or

some other kind of support.

The most dramatic difference between the two models has to do with the highest income levels.

These figures refer to the average incomes of corporate management, in comparison with the

average income of workers. In Norway, the incomes of corporate leaders are, on average, about ten

times those of workers, i.e. 1000 vs. 100 per hour. The corresponding level in the U.S. is 200 times

the average wage (These figures are from 2007; the differential may be even greater now).

Of course, these are the extremes of the income scale, but they say a lot about wage structure in

general. This is very important for the distribution of wealth in society, since wages account for

nearly eighty percent of all income. For the individual, wages provide the basis of pensions,

insurance coverage, credit rating and other components of the living standard.

The amount of time spent at wor 9 is also an important factor in determining income. It is correct to

say that the U.S. is the richest country in the world, but that is very much due to the long working

hours - on average, about 25 percent longer than in Norway. It is this factor which explains the

difference in per capita income. Note that this does not have anything to do with productivity levels

which, as noted previously, are roughly the same in the U.S. and the Nordic countries. Nor does it

affect the poverty rate, which is about four times higher in the U.S. In the case of children, thedifference is even greater.

The final figure in this brief summary of socio-economic conditions refers to the proportion of the

population in prison, which is about fifteen times greater in the U.S. This has an obvious effect on

unemployment rates: While 1.5 per cent of the U.S. population has been statistically removed from

the labour force and placed in prison, the same proportion of the Norwegian population is involved

in retraining programmes and other measures connected with the labour market.

12

Norwegian Krone, 1 Norwegian krone = 0.170681 U.S. dollars

Comparison:American

Model

Nordic

Model

Productivity 100 100

Average hourlywage

100 100

Top hourly wage 20,000 1,000

Minimum wage 30 60

Working hours 125 100

Per capita income 125 100

Poverty 20% 5%

Prison population 1.5% 0.5%

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R c nt P rf ormanc ofNordics aft r Globalization

y Between 1984 and 2002, Sweden's GDP growth was 36% compared to 111% in Ireland.y High growth in the last years, (10,05 percent for the EU to 15 on 2000-2004, 15% for Finland 12.3%

for Sweden, 4.4% for Sweden and 5.5% for Finland in 2006.

y Low unemployment, the lowest of the European union for Denmark (3.4% in March 2007) afterhaving known high levels 10 years ago (9,1% in Sweden, 9.6% to Denmark and 16.3% in Finland for

1993

y Official poverty ris @ rate13 are 9% in Sweden, 10% in Denmark, 11% in Finland, 13% in France and19% in United Kingdom.

y According to libertarian think tank Timbro, when measured by wealth, the poor have less wealththan in the United States. For instance, they live in smaller apartments, have lower home ownership,

and have less household equipment. These findings are however contradicted by a peer-reviewed

study in the American Economic Review by American economist Lane Kenworthy who found that the

percentage of household living on less than 40% of U.S. median household income (adjusted for

household size) was lowest in the Nordic countries, and much lower than in the U.S.

y Governments have committed to fiscal responsibility. In 2004, Sweden, Finland and Denmarkpresented an excess of the public accounts (respectively of 1.2%, 1.9% and 2.6% of the GDP),

whereas France presented a deficit of 3.7% and United Kingdom a deficit of 3.1%.

y Flight of capital, as is often seen in any country where taxes are significantly higher than theirneighbours, incentive to move ones financial dealings outside of the country to avoid taxation can

become a problem. As a result, some Danes and Swedes have emigrated or based their financial

affairs outside of their home countries. Examples of this include Ingvar Kamprad, the Swede who

founded furniture retail chain IKEA, who has lived in Switzerland for the past 30 years, while the IKEA

business operates through a Netherlands-based holding company. Janus Friis, the co-founder of

Skype, is now based in the UK and another very recent Danish example is the boxer Mikkel Kessler,

who rebased to Monaco in 2007. Stephen Kinnock, son of former UK LabourParty leader Neil

Kinnock, and the husband of party leader Helle Thorning Schmidt of the Social Democrats, also

doesn't base himself in Denmark. This latter case is perhaps unsurprising as he is not Danish has

always worked for British or international organizations based outside of Denmark even though his

wife and children live in Denmark.

y The extensive social services networ A can potentially lead to situations where a statisticallysignificant amount of people live exclusively on unemployment benefits, without seeking

employment. The magnitude of this problem is not certain, but it is worth noting that the countries

following the Nordic model have very low unemployment.

y As globalisation becomes a more accepted part of business and personal life, many companies arebecoming more aware of international opportunities to cut costs, as with the high taxes and high

cost of living, they are finding they can recruit employees cheaper abroad. Thus outsourcing and off

shoring are becoming very common, especially in sectors such as IT and manufacturing, and many

building construction companies are importing labour from the new Eastern European members of

the European Union, rather than recruit internally and pay Nordic salary levels.

13The at-risk-of-poverty rate is a share of persons with income below the at-risk-of-poverty threshold.