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Denmark: The Danish economy needs reforms, dynamism and reality checks

By Hans Jørgen Whitta-Jacobsen, Michael Svarer, Jens Hauch  KRAKA

Support for business during the corona crisis has been historically high, but as it is - hopefully - a 
one-off expense  and interest rates are low, fiscal policy still looks sustainable. We can therefore 
afford to continue with the current rates in taxes and transfers.
If politicians stay focused, the green transition can also be made affordable. Kraka recommends 
uniform greenhouse gas charges as a supporting instrument. We have also shown that such taxes 
can be put together by 2030 so that the green transition does not burden the public budget.
Still, there are challenges:
Over time, the average Dane exchanges some of the rising wealth for more free time via shorter 
working hours. It reduces tax revenue. As this is not included in the calculation of fiscal 
sustainability, this is actually inferior to what is officially calculated

Moreover, there is only lingering political support for uniform greenhouse gas taxes. Selecting 
other instruments or exempting some sectors reduces economic efficiency. This will make 
Danes poorer and reduce tax revenues. If one chooses state funding, the public budget is charged 
directly. In addition, revenue neutrality can hardly be maintained after 2030, as lower greenhouse 
gas emissions will lead to lower tax revenues.
Finally, we have the Baumol problem, which is due to the fact that productivity growth in public 
service production must be expected to develop weaker than in private manufacturing. Over time, 
this will mean that public services will look poorer compared to private consumption, unless more 
resources are added to the public sector.
Denmark must embark on the right path of reform
In the early 00s, fiscal policy was unsustainable. One could have increased taxes, reduced public 
spending, or one could have made labor supply reforms. Labor supply reforms became the main 
instrument, and the Welfare Agreement of 2006 in combination with the Withdrawal Agreement 
of 2011, which ensures that the early retirement and retirement age follows the increasing life 
expectancy, were the key elements in the reform policy.

The 'light' labor supply reforms have now been implemented. Any forthcoming reforms will 
typically have less labor supply effects, less improvements in the public finances, be 
administratively heavier and less politically acceptable, and more of the recent policy proposals 
and agreements will unfortunately increase the problem.
For example, the government wants fewer English-language educations to avoid foreign students 
who otherwise make a positive contribution to the Danish economy. Instead, one should implement 
a SU reform that makes the SU on the master's part a loan, which is waived after a few years of 
employment in Denmark. It will encourage Danish students to get a job quickly, it will encourage 
foreign students to stay and work in Denmark after graduation, and it will reduce the cost of SU.
You can also let the universities' grants partially follow the graduates' subsequent income. It 
encourages universities to educate the most productive graduates.
However, a political majority wants to move education places out into the country and thus 
counteract the Danes' increasing search for the larger cities, where they get a higher salary and 
therefore pay more in taxes.

Education policy should ensure more educated and relevant high quality education. However, it is 
doubtful whether the standard of learning can be maintained in small educational institutions, and it 
is not likely that relocation will improve the overall level of education. The relocated educations are 
typically not research-based, and an otherwise useful research interaction with the private business 
sector is therefore not realized.
A higher rate of return on equities is considered political. Instead, one should make a tax reform, 
taxing the return on all types of capital - For example, housing, interest, stocks, etc. - at the same 
rate. With a progression step on the total return, it can be designed revenue- and distribution- 
neutral and at the same time improve the economic efficiency and thus the overall prosperity.
Embrace the dynamics
Many reform discussions are based on preserving the existing. "We must avoid depopulation of 
outlying areas", "no one must lose jobs due to the green transition". Reforms should instead focus 
on dynamism.
The labor market dynamics are strong and beneficial. In Denmark, the annual job turnover is 
approximately 800,000 people. So many typically go from one job to another over the course of a 
year. A basic element in the Danish flexicurity model is that it must be easy to fire, because then 
companies will not refrain from hiring. It provides good opportunities for the unemployed to 
quickly find new employment, and it provides higher incomes and tax revenues. 

Labor market dynamics also mean that people can easily switch to more efficient companies or 
industries in progress when inefficient companies and industries languish. Overall, it is good 
because it increases both wealth and tax revenue.
Although politicians often talk about wanting to create jobs, it is largely the supply of labor that 
determines employment in the long run. Think of the entry of women into the labor market - it did 
not make men unemployed. And technological development will not create unemployment either.
In that light, technology and globalization should not be slowed down, but accepted as changes that 
can improve our overall prosperity. The public sector should be involved in managing the 
adjustment costs, for example through good in-service training efforts.
Align expectations for the welfare state - and for future reforms
It is good in itself if we can get more immigrants and descendants into work and give more young 
people good education. Such 'second-generation reforms' can provide greater labor supply and thus 
help alleviate the Baumol problem. We should therefore give full support to sensible such reforms, 
and fortunately there will be proposals for this from the Reform Commission.
But also in this area, the Danes must face reality, because in the very long term there is no way 
around the dilemma of the Baumol problem:
Either we must have higher taxes - and that way there are natural limits to how far one can go - 
or we must accept that parts of the services that the public sector today makes available to citizens 
as transfers or services do not or will not fully keep pace with developments in private consumption, 
qualitatively or quantitatively.
But before we get there, we can postpone the dilemma by implementing a series of sensible but 
minor reforms that are based on dynamics rather than maintaining the existing ones.
The Danes are well educated and healthy, our society is well-functioning, and the economic 
starting point is good. Both the green transition and the future of the welfare state can be handled. 
But it requires smart labor supply reforms, political focus on wholeness rather than the next election, 
voters' views on public service must have a reality check and last but certainly not least, politicians 
should embrace flexibility and dynamism rather than fight them. 

Hans Jørgen has especially researched and taught macroeconomic theory with special emphasis on 
business cycles and labor market theory. Michael Svarer is a Senior Fellow and Jens Hauch is Chief 
Economist And Deputy Director, Ph.D  at KRAKA, Copenhagen.