In-Work Benefits and the Nordic Model

Topics: Unemployment, Employment, Higher education Pages: 41 (10311 words) Published: August 25, 2013
In-Work Bene…ts and the Nordic Model
Ann-So…e Kolmyand Mirco Toninz December 14, 2012

Abstract Welfare bene…ts in the Nordic countries are often tied to employment. We argue that this is one of the factors behind the success of the Nordic model, where a comprehensive welfare state is associated with high employment. In a general equilibrium setting, the underlining mechanism works through wage moderation and job creation. The bene…ts make it more important to hold a job, thus lower wages will be accepted, and more jobs created. Moreover, we show that the incentive to acquire higher education improves, further boosting employment in the long run. These positive e¤ects help counteracting the negative impact of taxation. JEL codes: H24, J21, J24 Keywords: Nordic model, in-work bene…ts, wage adjustment, unemployment, education, skill formation, earnings



A prominent feature of the so-called Nordic model is a comprehensive welfare state …nanced by taxes on labor. In fact, the public sector in many We want to thank Torben Andersen, Martin Flodén, Richard Freeman, Mathias Herzing, Eddie Lazear, Ethienne Lehman, Bruno van Linden, and participants at the Conference on the Economics of the Nordic Model. y Department of Economics, Stockholm University, S-106 91 Stockholm, Ph. +46 8 163547. Fax +46 8 161425, E-mail address: ann-so… z Economics Division, University of Southampton, UK; Economics Department, UniCredit & Universities Fellow, Central European University, Budapest; and IZA, Bonn. Email address:


of the Nordic countries is responsible for the distribution and allocation of resources amounting to more than half of their country’ GDP (Eurostat, s 2012). With an emphasis on redistributional transfers and service provision …nanced by taxes on labor, a concern with the model is, of course, that it induces weak incentives to work. In a more long term perspective, such a system may also reduce incentives to acquire skills, with a negative impact on future productivity and labor market outcomes. However, external observers are often surprised that the Nordic countries manage to combine low unemployment and high labor force participation with high taxes and generous welfare arrangements. So, how is this possible? One answer to this question is that many of the welfare arrangements in the Nordic countries are closely tied to market work. The generosity of the bene…ts are, in general, related to earnings. In addition, eligibility to a number of bene…ts and social services is conditional on employment. Subsidized childcare, for example, is, in principle, only available to employed workers. Also, some generous elements of the paid parental leave schemes are only accessible to employed workers. In addition, the more recently introduced earned income tax credit is by de…nition exclusively targeted to employed workers. The idea is that these bene…ts, by increasing the returns from working, increase the supply of labor. The observation that the Nordic countries have sustained high economic activity because bene…ts are closely tied to market work is not new. In fact this was noted as a contributing factor to the high participation rate observed in Sweden when a group of NBER economists studied the Swedish welfare state in the mid 1990s (see Freeman et al., 1997). This was also an important message in the discussion on the prospects and challenges of the Scandinavian model in Andersen (2008). The starting point for this paper is that entitlement to many of the bene…ts available in the Nordic countries is conditional on employment. As discussed above, this tends to increase the gains from working, which encourages labor supply. However, we argue that this is not the end of the story. To investigate the full impact of welfare state arrangements of this type, one needs to account for the general equilibrium e¤ects. This is particularly relevant because many bene…ts have been...
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