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Lessons from Financial Liberalisation in Scandinavia

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Abstract

The causes and consequences of the financial crises in the Nordic countries in the early 1990s are examined and lessons from this episode are extracted. The focus is on the boom–bust episode in Finland, Norway and Sweden as these three economies went into a deep recession. The lessons from the Scandinavian experience are organised under three headings: (i) how to liberalise without causing a boom–bust cycle, (ii) how to deal with a financial crisis, and (iii) the long-run effects of financial integration on stabilisation policies, growth and the distribution of income and wealth.

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Notes

  1. The term Scandinavia is used here as a synonym for the four Nordic countries Denmark, Finland, Norway and Sweden, although Scandinavia proper encompasses only Denmark, Norway and Sweden.

  2. This is a main message of Jonung et al. (2007).

  3. The Nordic experience of crisis has been covered in a number of studies. For earlier studies on the Finnish crisis, see among others Bordes et al. (1993), Honkapohja and Koskela (1999), Kiander and Vartia (1996a, 1996b), Kiander and Vartia (1998) and Åkerholm (1995). For studies on the Swedish crisis, see Englund (1999) and Jonung and Stymne (1997). Jonung et al. (1996) cover both the Finnish and Swedish record of boom and bust. The Norwegian record is well covered in the contributions in Moe et al. (2004). See also Steigum (2007).

  4. By now, the literature on financial crises in the 1990s is immense. For surveys, see, for example, Bordo et al. (2001), Bordo and Jeanne (2002), Caprio et al. (2001), Eichengreen (2002, 2003). A summary of the theoretical developments inspired by recent crises is found in Allen and Gale (2007).

  5. This project, involving collaborators from the four Nordic countries, will be reported in a forthcoming volume published by Edward Elgar with contributions by Vastrup (2006) on Denmark, by Steigum (2007) on Norway, by Englund and Vihriälä (2007), Fregert and Pehkonon (2007), Jonung and Hagberg (2005), and Jonung et al. (2007) on Finland and Sweden.

  6. For a summary of the balance-sheet approach to financial crisis, see Allen et al. (2002). Jonung et al. (2007) adopt this approach in their analysis of the record of Finland and Sweden in the early 1990s.

  7. For example, financial liberalisation deeply impacted corporate governance in Finland and Sweden. See Ylä-Antilla et al. (2005) on the Finnish case and Henrekson and Jakobsson (2005) on the Swedish case.

  8. The Scandinavian or Nordic model is recently evaluated in Andersen et al. (2007) and Calmfors (2007).

  9. This section is based on Vastrup (2006). See also Berg (1998), Callesen et al. (2008), Drees and Pazarbasioglu (1998), Mayes et al. (2001, Chapter 2) and Schaumann (1993).

  10. See also the banking crisis database compiled by Caprio et al. (2005), covering banking crises since the late 1970s. Here, the banking crises of Finland, Norway and Sweden are ranked as systemic crises, while the Danish banking record is not classified as a systemic crisis.

  11. For lesson-learning from the crises of the 1990s, see, for example, Caprio et al. (2001), Eichengreen (1999, 2002, 2003) and Isard (2005, Chapters 4–5). The IMF and the World Bank have produced a set of studies drawing lessons from the crises of the 1990s. The list can be made much longer.

  12. There are studies concerning the lessons from individual Nordic countries and from particular aspects of the financial crisis of the 1990s, but no study concerning the general lessons from all the Nordic countries.

  13. To the best of my knowledge, no thorough study projecting the macroeconomic consequences of financial deregulation was published in any of the Nordic countries prior to the financial crisis in the 1990s.

  14. As argued in lesson 11, international organisations should also be financially literate.

  15. Economists with a political economy background often argue that politicians are inclined to adopt short-term expansionary policies that turn out to be inflationary in the long run. However, in Finland and Sweden, the opposite pattern held in the early 1990s. Policy-makers were determined to carry out a contractionary policy in the short run in order to avoid inflation in the long run – while bringing about a deep crisis. The long-run result turned out to be successful in the sense that Finland and Sweden so far have managed to keep a low rate of inflation following the financial crisis of the 1990s.

  16. See Jonung (2000) for an analysis of the learning process of policy-makers and economists in Sweden during the 1970s, 1980s and 1990s.

  17. The role of the real rate in driving the boom–bust cycle is given more emphasis here than in the standard literature on financial crisis.

  18. This is an illustration of the Walters critique. See Walters (1994).

  19. See, for example, Wyplosz (2001, p. 157), summarising the post-war European experience of financial repression and liberalisation: ‘The lifting of capital controls requires the end of any fixed exchange-rate regime that might have been in place’.

  20. Henriksson (2007) describes the Swedish budgetary consolidation programme 1995–1997 by the Social Democratic government that came into power in the fall of 1994 – well into the recovery after the peak of the crisis in 1992–1993.

  21. The role of fiscal policy during the Nordic crises is a promising subject for further research as consensus is lacking.

  22. The same lesson holds for deposit insurance. Finland and Norway had such a system before the crisis. Sweden got one as a result of the crisis but the crisis proved that it was insufficient. Instead, the government served as the explicit guarantor of the stability of the banking system by directly supporting it in a number of ways.

  23. Denmark is not the only country in Europe that designed its financial liberalisation without creating a financial crisis. Austria and the Netherlands can be taken as other examples.

  24. The Swedish approach to resolution is covered in several studies, see, for example, Andersson and Viotti (1999), Bäckström (1997), Ergungor (2008) and Ingves and Lind (1996).

  25. The policy advice of the IMF during the East Asian crisis and the Latin American crises has been the subject of harsh criticism, see Eichengreen (1999, Chapter 7) and in particular Stiglitz (2002). See also various publications by the Office of Independent Analysis associated with the IMF. This office was set up as a response to the criticism of the recommendations by the IMF during the 1990s.

  26. The type of recommendations given by the IMF are revealed in the memoirs of Bengt Dennis, Governor of the Swedish Riksbank 1982–1994. In September 1992, in the midst of the financial turmoil in Europe, a delegation from the IMF examined the state of the Swedish economy. According to Dennis (1998, p. 64), its policy analysis could be summarised in three words: ‘consolidate the budget’. The IMF delegation viewed the rising budget deficit as the main cause for alarm and thus recommended a tight fiscal policy. The Riksbank held the same view. For this reason, it used the IMF report to successfully press the government and the opposition to tighten fiscal policy in a joint fiscal and monetary austerity programme in September. The programme succeeded in postponing the floating of the krona until November the same year.

  27. This is also my interpretation from meetings with IMF representatives while serving as chief economic advisor to Sweden's prime minister 1992–94.

  28. Eichengreen (1999, p. 110) summarises the criticism of the IMF in the following way: ‘The problem was that the Fund failed to adjust for the cycle. It failed to anticipate the severity of the Asian downturn or see that restrictive fiscal policies it recommended would themselves make that downturn worse. Once this realisation dawned, it modified its advice’.

  29. They deserve an in-depth analysis as financial integration has changed the foundations for the Nordic model in fundamental ways.

  30. See the evaluation by Boije and Fischer (2007) of the new fiscal framework in Sweden.

  31. See Henry (2007) and Tornell and Westermann (2005) for recent surveys of the issues involved. Their work focuses on the record of middle-income and emerging-market economies.

  32. To my knowledge, there has been no attempt to estimate and compare the short-run welfare costs and the long-run welfare benefits of financial liberalisation in any of the Nordic countries.

  33. Of course, the lesson is not that financial crises should be created in order to reap long-run growth benefits, but rather that the short-run costs of crises should be weighed against any long-run benefits from improved growth and efficiency. See also Demirgüc-Kunt and Detragiache (2001) and Tornell and Westermann (2005) among others on the long-run growth effects of financial crises.

  34. See, for example, Allen (2001), Eichengreen (1999, 2002, 2003) and Kokko and Suzuki (2006).

  35. Kokko and Suzuki (2006) stress the advantage of strong political institutions in Finland and Sweden compared to the situation in countries in Asia hit by financial crisis.

  36. A World Bank Report (2001, p. 152) – in a box entitled ‘The Swedish experience: a Saab in every garage?’ – argues that the lessons from the Swedish financial crisis may be difficult to export to developing countries due to country-specific features. In particular, institutions and the legal framework in Sweden were well developed to manage the bankruptcy procedures. Emerging countries may aim to acquire these characteristics but it would be like aspiring ‘to having a Saab in every garage’.

  37. Financial crises in emerging-market economies have been taken as an argument for reforms of the international financial architecture, in particular of the policies of the IMF. As the Scandinavian countries did not receive any financial assistance from the IMF, global financial arrangements did not surface as an issue in the Scandinavian debate. This is in itself a difference between the Nordics and most other crisis-hit countries in Asia and Latin America.

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Acknowledgements

I have received valuable comments and support from, among others, Magnus Astberg, Sigbjörn Berg, Michael Bordo, Yves Bouquiaux, Gerard Caprio, Hongyi Chen, Kenneth Chow, Philippe Derveaux, Emil Ems, Andrew Filardo, Thomas Hagberg, Russel Kincaid, Jarmo Kontulainen, Philip Lane, Göran Lind, David Mayes, Susan Schandler, István Székely, Olaf Unteroberdoerster, Claus Vastrup, Daniel Waldenström, Clara Zverina, seminar participants at the 13th Dubrovnik Economic Conference and at the Riksbank. An anonymous referee has made significant suggestions for improvement. I owe a special debt to Clara Zverina for assembling background data. Sophie Bland has given linguistic guidance. The views and opinions expressed here are those of the author, not those of DG ECFIN.

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Jonung, L. Lessons from Financial Liberalisation in Scandinavia. Comp Econ Stud 50, 564–598 (2008). https://doi.org/10.1057/ces.2008.34

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