TO BE A Swede is once again to be admired. Sweden is "the most successful society the world has ever known", declares the left-wing British newspaper the Guardian; "Swedes lead Europe in reform", claims the free-market-oriented Financial Times; only the Nordic model "combines both equity and efficiency", explains a recent report initiated by the European Commission.

In a contentious European debate marked by hostility, riots and unrest, Sweden looks like a safe bet--neutral, uncontroversial and with no natural opponents. Sweden is a Rorschach test: The Left sees a generous welfare state, and the Right sees an open economy that pushes for deregulation in the European Union. The only thing British reformists and French protectionists could agree on at the EU summit in Brussels in March was that Europe should learn from the Scandinavian model's combination of generous social provisions and a high-growth economy. Sweden is seen as the proverbial "third way", combining the openness and wealth creation of capitalism with the redistribution and safety nets of socialism. It is the best of both worlds.

But things in Sweden are not as good as the advocates would like to believe. Long the paragon of social democracy, the Swedish model is rotting from within. Ironically, the unique social and economic foundation that first allowed Sweden to construct its political edifice--and which makes it such a difficult model for other countries to emulate--has been critically weakened by the system it helped create. Far from a being a solution for the new sick men of Europe, Sweden must face serious and fundamental challenges at the heart of its social model.

The Origins of the Welfare State

TO SAY that other countries should emulate the Swedish social model is about as helpful as telling an average-looking person to look like a Swedish supermodel. There are special circumstances and a certain background that limit the ability to imitate. In the case of the supermodel, it is about genetics. In the context of economical and political models, it is about the historical and cultural background.

Gunnar and Alva Myrdal were the intellectual parents of the Swedish welfare state. In the 1930s they came to believe that Sweden was the ideal candidate for a cradle-to-grave welfare state. First of all, the Swedish population was small and homogeneous, with high levels of trust in one another and the government. Because Sweden never had a feudal period and the government always allowed some sort of popular representation, the land-owning farmers got used to seeing authorities and the government more as part of their own people and society than as external enemies. Second, the civil service was efficient and free from corruption. Third, a Protestant work-ethic--and strong social pressures from family, friends and neighbors to conform to that ethic--meant that people would work hard, even as taxes rose and social assistance expanded. Finally, that work would be very productive, given Sweden's well-educated population and strong export sector. If the welfare state couldn't work in Sweden, the Myrdals concluded, it wouldn't work anywhere.

Sweden's economic success story began in the late 19th century, after a fundamental political shift towards free markets and free trade. Swedish traders could export iron, steel and timber, and entrepreneurs created innovative industrial companies that became world leaders. Between 1860 and 1910, real wages for factory workers rose by about 25 percent per decade, and public spending in Sweden didn't surpass 10 percent of GDP.

The Social Democratic Party came to power in 1932 and has governed Sweden for 65 of the last 74 years. They realized early on that a party of class struggle wouldn't be able to hold on to power in Sweden. Instead, they became a party of the middle class by creating social security systems that gave the most pension, unemployment, paternal-leave and sick-leave benefits to those with high wages. (Most benefits were proportional to the amount paid in, so the wealthy middle class would have an interest in supporting the system.) It was a policy of socialization from the consumption side: The government would not take control of the means of production, but would instead tax workers, in the form of sales and income taxes, to provide welfare. It was markets and competition for big business, a welfare state for the people. Still, as late as 1950 the total tax burden was no more than 21 percent of GDP, lower than in the United States and Western Europe.

This meant that the Social Democrats were eager to please industry and not allow the social agenda to interfere with the economy's progress. Free trade was always the rule. Regulations that were introduced were adapted to benefit the biggest industries--for example, wages were equalized, but for the purpose of keeping wages low for the big companies, while small and less productive companies were forced out of business. The trade unions, for their part, were relatively positive to the creative destruction of capitalism, so they allowed old sectors like farming, shipping and textiles to pass away, as long as new jobs were created.

These policies, and the fact that Sweden stayed out of two world wars, meant that the economy yielded amazing results. Sweden was rich: In 1970 it had the fourth-highest per-capita income in the world, according to OECD statistics. But at this stage the Social Democrats began to radicalize, with coffers filled by big business and heads filled with ideas from an international leftist trend. Social assistance was expanded and the labor market became heavily regulated. Public spending almost doubled between 1960 and 1980, rising from 31 percent to 60 percent of GDP.

This was also the time when the model began to run into problems. From 1975 to 2000, while per-capita income grew by 72 percent in the United States and 64 percent in Western Europe, Sweden's grew by no more than 43 percent. By 2000, Sweden had fallen to 14th in the OECD's ranking of per-capita income. If Sweden were a state in the United States, it would now be the fifth poorest. As the Social Democratic Finance Minister Bosse Ringholm explained in 2002, "If Sweden would have had the same growth rates as the OECD average since 1970, our common resources would have been so much bigger that it would be the equivalent of 20,000 SEK [$2,500] more per household per month."

Too Much of a Good Thing

THE SOURCE of the problem was the fatal irony of the Swedish system: The model eroded the fundamental principles that had made the model viable in the first place.

The civil service is a powerful example of this phenomenon. The efficiency of the civil service meant that the government could expand, but this expansion began to undermine its efficiency. According to a European Central Bank study of 23 developed countries, Sweden now gets the least service per dollar spent by the government. Sweden still reports impressive results on living standards (just as it did before the introduction of the welfare state in the years following World War II), but not at all what you would expect from a country with the world's highest tax rates, currently at about 50 percent of GDP. If the public sector were as efficient as Ireland's or Britain's, for example, the expenditure could be reduced by a third for the same service. The Swedish Association of Local Authorities and Regions reports that Swedish doctors see four patients a day on average, down from nine in 1975. It is less than in any other OECD country, and less than half of the average. One reason is that a Swedish doctor spends between 50 and 80 percent of his time on administration.

On the economic side, the old Swedish system of encouraging investments in big industry worked well, as long as there was little need for innovation. Once that occurred, however, the system ran into trouble. The competitiveness of industry had to be propped up several times by depreciating the currency. Globalization and the new knowledge and service economy made it more important than ever to invest in human capital and individual creativity. High marginal tax rates on personal income, however, reduced individuals' incentives to take risks and to boost earning potential by investing in their education and skills, and made it extremely difficult to attract skilled workers from abroad.

Furthermore, the Swedish model was dependent on having a small number of large industrial companies. As these diminished in importance, or moved abroad, Sweden needed something to take their place. But the policies that benefited the biggest firms created a deficit of small- and medium-sized businesses. Those that did exist didn't grow, partly because of the risks and costs of highly burdensome employment rules that prevented the firing of workers. Indeed, the most important Swedish companies today are those that were born during the laissez faire period before the First World War; just one of the fifty biggest Swedish companies was founded after 1970. Meanwhile, services that could become new private growth sectors, like education and health care, were monopolized and financed by the government. As they grew in importance and size, a steadily growing part of the Swedish economy thus became protected from international market forces and investments that could have turned them into successful and productive enterprises.

In the early 1990s a deep recession forced Sweden to abandon a lot of the excesses from the 1970s and 1980s. Marginal tax rates were cut, the central bank was made independent, public pensions were cut and partially privatized, school vouchers were introduced, and private providers were welcomed in health care. Several markets were deregulated, like energy, the post office, transportation, television and, most importantly, telecom, which opened the way for the success of companies like Ericsson.

But Sweden retained the world's highest taxes, generous social security systems and a heavily regulated labor market, which split the economy: Sweden is very good at producing goods, but not at producing jobs. According to a recent study of 35 developed countries, only two had jobless growth: Sweden and Finland. Economic growth in Sweden in the last 25 years has had no correlation at all with labor-market participation. (In contrast, 1 percent of growth increases the number of jobs by 0.25 percent in Denmark, 0.5 percent in the United States and 0.6 percent in Spain.) Amazingly, not a single net job has been created in the private sector in Sweden since 1950.

During the recession in the early 1990s, Sweden had an unemployment rate of about 12 percent. The official rate has been halved since, but the difference has been offset by a dramatic increase in other forms of absenteeism. For example, there are 244,000 openly unemployed workers in a total population of 9 million. But this does not include 126,000 working in labor-market projects (the largely unsuccessful programs geared towards helping people acquire the skills to find employment) or the 89,000 job-seekers who are receiving some form of education. And there are another 111,000 in "latent unemployment", people who are not defined as part of the work force, but who can and would like to work. If all of these workers are included in the calculation, Sweden's true unemployment rate is still 12 percent. (Although other countries' unemployment figures, including those for the United States, also fail to reflect the real rate joblessness, Sweden's array of government-funded projects for work and education particularly distort the data. In addition, Sweden does not include in its figures students that are seeking employment, breaking with international norms.)

Moreover, the unemployment rate says nothing about another hidden labor problem: rampant absenteeism. Swedes are healthier than almost any other people in the world, but they are also out sick more often than any other people, according to available data. In 2004, sickness benefits absorbed 16 percent of the government budget, while health absenteeism has doubled since 1998. With a sickness benefit of up to 80 percent of a recipient's income (depending on his or her wage level), it is not surprising that there is an epidemic of absenteeism. Moreover, about 10 percent of the working-age population has retired with disability benefits. A researcher at the main trade union, LO, recently left his job when he was not allowed to publish his estimate that close to 20 percent of Swedes are unemployed, either openly or hidden in labor-market projects, long-term sick-leave and early retirement.

Immigration and Politics

SWEDEN HAS no official minimum wage, but trade unions with political power set de facto minimum wages through collective bargaining. That de facto minimum wage for workers in Sweden is equal to about 66 percent of the median wage in the manufacturing sector, compared to 32 percent in the United States. In economic terms, this means that if you are less than 66 percent as productive as the median Swedish manufacturing worker--perhaps because you are unskilled, have no experience or live in a remote area--you will probably not find a job. Any company that would hire you would be forced to pay you more than what you are able to produce. And if you are never successful in gaining employment, you will not gain the skills and experience to raise your abilities and productivity.

Immigrants are the hardest hit. Since the early 1980s, Sweden has received a large number of refugees from the Balkans, the Middle East, Africa and Latin America, which has ended the country's homogeneity. Today, about one-seventh of the working-age population is foreign born, but no where near that proportion is actually employed. Sweden has one of the developed world's biggest differences between the labor-market participation of natives and immigrants. Many immigrant families are discouraged by the lack of job prospects and end up in welfare dependency.

Unemployment problems in turn result in de facto segregation. Despite little history of racial conflict, the labor market is more segregated than in America, Britain, Germany, France or Denmark--countries with far more troublesome racial histories than Sweden. A report from the free-market Liberal Party ahead of the election 2002 showed that more than 5 percent of all precincts in Sweden had employment levels lower than 60 percent, with much higher crime rates and inferior school results than in other places. Most of these precincts are suburban, so outsiders rarely see them. The number of segregated precincts has continued to grow. In some neighborhoods, children grow up without ever seeing someone who goes to work in the morning. Pockets of unemployment and social exclusion form, especially in areas with many non-European immigrants. When Swedes see that so many immigrants live off the government, their interest in contributing to the system fades.

Like in other parts of western Europe, the segregation of immigrant areas leads to insularity, crime and, in some cases, radicalism. Last year, Nalin Pekgul, the Kurdish chairman of the National Federation of Social Democratic Women, explained that she was forced to move out of a suburb of Stockholm because of crime and the rise of Islamic radicalism. The announcement sent shock waves through the entire political system. "A bomb waiting to explode" is one of the most common metaphors used when social exclusion in Sweden is discussed.

Those immigrants who do keep their entrepreneurial spirit intact often take it elsewhere. Hundreds of unemployed Somalis and Iranians leave Sweden every year and move to Britain, where they are often successful in finding work. The contrast in experience can be staggering. The Swedish economic historian Benny Carlson recently compared the experiences of Somali immigrants in Sweden with those of Somali immigrants in Minneapolis, Minnesota. Only 30 percent had a job in Sweden, about half as many as in Minneapolis. And there are about 800 businesses run by Somalis in Minneapolis, compared to only 38 in Sweden. Carlson quoted two immigrants who together summed up the disparity. "There are opportunities here", said Jamal Hashi, who runs an African restaurant in Minneapolis. His friend, who migrated to Sweden instead, told a different story: "You feel like a fly trapped under a glass. Your dreams are shattered."

A Model No More

SO IF THE Myrdals were right when they said that if the welfare state couldn't work in Sweden, it wouldn't work anywhere, what will it mean if Sweden's system fails? The answer seems obvious.

The Swedish model has survived for decades, but the truth is that its success was built on the legacy of an earlier model: the period of economic growth and development preceding the adoption of the socialist system. It is difficult to see how other countries--especially the troubled systems of Western Europe so keen to adopt the Swedish approach, but which lack the unique components for a welfare state first noted by Gunnar and Alva Myrdal--could cope with a similar welfare state. Bigger and more diverse countries with a weaker faith in government and more suspicion towards other groups would likely see an even stronger tendency to exploit the system, work less and abuse social assistance. The United States and much of Western Europe face immigration challenges at least as daunting as Sweden.

The economy has rebounded since the recession of the 1990s and the reforms that followed--in contrast to the stagnant continental economies--mostly because of a small number of successful global companies. But the problem is that a growing part of the population is left out and old attitudes about work and entrepreneurship are fading. Since 1995 the number of entrepreneurs in the European Union has increased by 9 percent; in Sweden it has declined by 9 percent. Almost a quarter of the population of working age does not have a job to go to in the morning, and polls show a dramatic lack of trust in the welfare system and its rules.

The system of high taxes and generous welfare benefits worked for so long because the tradition of self-reliance was so strong. But mentalities have a tendency of changing when incentives change. The growth of taxes and benefits punished hard work and encouraged absenteeism. Immigrants and younger generations of Swedes have faced distorted incentives and have not developed the work ethic that was nurtured before the effects of the welfare state began to erode them. When others cheat the system and get away with it, suddenly you are considered a fool if you get up early every morning and work late. According to polls, about half of all Swedes now think it is acceptable to call in sick for reasons other than sickness. Almost half think that they can do it when someone in the family is not feeling well, and almost as many think that they can do it if there is too much to do at work. Our ancestors worked even when they were sick. Today, we are "off sick" even when we feel fine.

The real worry is that Sweden and other welfare states have reached a point where it is impossible to convince majorities to change the system, despite the dismal results. Obviously, if you are dependent on the government, you are hesitant to reduce its size and cost. A middle class with small economic margins is dependent on social security. This was Bismarck's plan when he introduced a system that would make those dependent on it "far more content and far easier to handle."

Sooner or later, politicians begin to identify a new, influential bloc of voters--those who live at others' expense. A former Social Democratic minister of industry recently explained what his party meetings in northern Sweden looked like: "A quarter of the participants were on sick-leave, a quarter was on disability benefits, a quarter was unemployed."

This creates a damaging cycle. With high taxes, markets and voluntary communities are crowded out, which means that every new problem has to find a government solution. If change seems too far off, a large part of the electorate becomes more interested in defending good terms for unemployment and sick-leave than in creating opportunities for growth and jobs. And that goes even if you have a job. If regulations make it difficult to find a new job, you worry more about losing the one you have and will see suggestions of labor market deregulation as a threat. OECD interviews show that well-protected workers in Sweden, France and Germany are much more afraid of losing their jobs than workers in the less regulated United States, Canada and Denmark.

In that case, sclerosis creates a public demand for policies that create even more stagnation. This might help explain the lack of reform in Europe, despite all the political ambitions. The more problems there are, the more dangerous radical reforms seem to the electorate: If things are this bad now, the logic goes, think how bad they'll be without state protection. For example, it seems like the Swedish voters are now willing to oust the Social Democratic government in September. But that is only after the center-right opposition abandoned the more radical suggestions--such as labor-market reform and reduction in social security benefits--that it used to champion.

Radical reform seems far off. On the other hand, just like the step-by-step construction of the welfare state that slowly but steadily reduced the willingness to work and the sense self-reliance, incremental reforms to expand freedom of choice and reduce the incentives to live off fellow-citizens might rejuvenate these fundamental values and increase the appetite for reform.

Johan Norberg is a Swedish writer and a senior fellow at the Centre for the New Europe, a Brussels-based think-tank. He is the author of several books, including In Defense of Global Capitalism (2003).