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In the early 1970s, Sweden enjoyed one of the highest standards of living in Europe. Since then, however, its economic performance has undergone a relative decline. By 1990, Sweden had been overtaken by Germany, France, and Japan in GDP per capita; three years later, it had also fallen behind Italy and the United Kingdom (Exhibit 1).
To examine the causes of this decline, the McKinsey Global Institute studied productivity and employment in several key sectors between 1980 and 1992, comparing Sweden’s performance with that of Germany, Japan, and the United States.1 In order to determine which features of capital, product, and labor markets influence differences in performance, it focused on eight industries: retail; banking; construction; film, TV, and video; processed food; cars; trucks and buses; and computers. (See pp. 137-144.)
Its principal findings were:
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In productivity and job creation, Sweden trails both global best practice and best European performance in all the industries studied except trucks and buses and computer software, where it is world class.
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Sweden’s performance is strongly affected by the unusually low level of competitive intensity in the large part of the economy that is sheltered from foreign competition. This protection robs corporations of incentives to adopt best practice and continuous innovation, which in turn limits growth in output, productivity, and employment.
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The sectors that are successful—trucks, software, and the recently deregulated banking industry—illustrate the benefits of competition.
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Although important in some industries, and for small businesses, labor market factors have not been the main brake on productivity and employment performance.
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The factors limiting growth in Sweden are mostly under the control of policy makers. The government could help improve the nation’s economic performance by stimulating domestic and international competition, removing remaining product market barriers, and reforming labor market regulation.
Sheltered from competition
Three-quarters of the Swedish economy is sheltered from foreign competition. It is in these sheltered areas—which fall mainly in the service sector—that the widest performance gaps are to be found, especially in food processing and construction (Exhibit 2). Conversely, globally exposed manufacturing industries such as metals have best-practice productivity (Exhibit 3). This suggests that solving the country’s employment and productivity problems will require shifting the emphasis from exports and manufacturing to domestic industries and services sheltered from foreign competition.
Low competitive intensity
All the sheltered industries studied were characterized by a small number of participants that created barriers to entry for new players and restricted competition among existing firms. This structure was frequently reinforced by rigid horizontal integration and the presence of dominant or sole providers of key inputs. Accordingly, competitive intensity was low. The construction and food processing industries illustrate this central problem in the Swedish economy.
Remediable shortfall
However, the good news is that the key causes of Sweden’s lower productivity can be tackled, as they are not structural (that is, embedded in lack of scale, of capital, or of labor skills). The gap between Sweden’s performance and that of benchmark countries is neither inevitable nor accidental. Rather, it is the outcome of management decisions that shape production processes.
Sweden’s banks, for instance, have efficient electronic systems, yet they still handle many transactions through the branch networks. The food processing industry’s capital investments and average plant scale are on a par with those of Denmark or the United States, but its productivity is low because of inefficient organization, outdated processes, short production runs, and excessive product proliferation. In construction, labor is highly skilled and modern equipment is used by the large companies, but productivity is again low owing to the lack of profit-maximizing general contractors.
Product market factors
The key determinant of low competitive intensity and productivity in sheltered sectors was product market barriers, mainly in the form of output restrictions and a lack of measures to promote competition. During the period studied, Sweden’s competition law was more lax than that of the European Union, and far more so than that of the United States. Price arrangements, direct communication among competitors, powerful industry organizations, and companies with dominant market shares were prevalent in construction, banking, and parts of retail.
Labor market factors
Overall, labor market factors were less important than product market factors in the industries studied, though they did help account for performance differences in low-wage, low-skill service industries. High labor costs have inhibited advances in retail employment and productivity, retarding the development of innovative, service-intensive formats. In construction and cars, productivity was held back by work rules: when employees are confined to a very limited set of tasks, it is hard to implement effective, time-based production.
Labor market factors are significant barriers for small and medium-sized businesses. Though laying off workers in the case of a business turndown is not difficult (and fairly common), the cost of dismissing employees for any other reason creates disincentives to hire. A firm may have to pay up to two years’ salary in legal costs and wages during the legal process—a huge liability for smaller companies.
The relative importance of product, labor, and capital market factors in explaining the shortfall between Sweden’s performance and global best practice is summarized in Exhibit 4 (productivity) and Exhibit 5 (employment). Apart from computers and trucks and buses, where Sweden is the world leader, the benchmark country is the United States, except in cars, where it is Japan.
Scale irrelevant
Some have argued that Sweden’s small domestic market prevents corporations from attaining sufficient scale in their operations, particularly if they are not allowed to have a dominant market share. In the industries studied, however, production scale and market size had little effect on performance. The only exception was retailing, where building enough outlets to run an advanced format efficiently can be difficult in a small country, and where the extra costs of gaining scale by operating across borders are significant. Mergers, on the other hand, had suppressed healthy competition in some industries.
The benefits of competition
Some Swedish sectors illustrate how industries with intense competition and few regulatory barriers can develop to world-class levels. In heavy trucks, Scania and Volvo were global productivity leaders by a wide margin. The intense domestic rivalry between them seems to have generated a virtuous competitive cycle. The needs of the Swedish forest industry encouraged the development of high-quality heavy trucks, but the small domestic market quickly made producers dependent on exports for the bulk of their sales. Both companies had to fight hard to maintain volume.
The innovations of modular design and flexible production allowed the two companies to overcome any disadvantages resulting from their relatively small size. The implication for policy is that even in a small country, competition can be a more powerful lever than scale economies in raising productivity.
The Swedish computer sector demonstrates how well an industry can do if it is allowed to operate in a market free from significant regulation. Sweden created more jobs in computer software and services than any of the other countries studied. It also lost more jobs in hardware, but its total net job creation was considerable. The success of this sector can partly be ascribed to its high competitive intensity and few product market interventions.
In banking, deregulation in the late 1980s created a dynamic industry and one of the most open markets in the world. In order to promote competition, the government granted new bank licenses to insurance companies, retailers, and brokers. As competition picked up, customer value increased, and the pace of rationalization quickened. New technologies such as telephone banking helped demolish some of the previous barriers to entry, such as access to branch networks. The government has played an important role in fostering a new spirit of competition by deregulating product markets and encouraging new entrants.
Policies for growth
During the 1990s, Sweden has deregulated its economy to a greater extent than most other OECD countries, relaxing zoning laws, simplifying construction codes, and transforming banking. It also adopted a new and much stricter competition law in 1993. Even these steps, however, are not enough to kick-start growth in the economy. Several key elements are still missing.
Our research findings suggest that any growth program needs to incorporate the following steps:
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Stimulating domestic competition and facilitating new business development. This would involve strictly enforcing the 1993 competition law so as to give new entrants a fair chance. This law may need strengthening through the introduction of stiffer penalties or an extension of the areas it covers.
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Promoting international competition—an important complement to domestic competition. Exposure to foreign competition through trade or direct investment may be a faster means than policy changes to increase competitive intensity in sheltered industries.
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Removing remaining barriers to entry and innovation. Though much has been done to eliminate product market restrictions, there is still a way to go. Some measures may conflict with noneconomic social goals, in which case, tradeoffs will have to be discussed explicitly.
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Dismantling labor market barriers. Here, the essentials are the ability to create low-wage jobs in low-skill industries and labor flexibility—the lack of which seems to deter smaller firms from hiring and expanding under current conditions. If there is a desire on the part of society for a more equal distribution of disposable income, using taxes and transfers would be preferable to blocking low-wage jobs.
The challenges for corporations
Five of the eight industries studied displayed significant productivity gaps between Swedish firms and global best practice. Such gaps will inevitably attract attention from world-class competitors. In the long run, the only way companies can protect themselves from attack is to raise their productivity to benchmark levels. The gaps represent a great opportunity for the Swedish companies that are the first to implement best practice and close them. Attractive returns are waiting to be won. 
About the Authors
Bill Lewis is Director of the McKinsey Global Institute, Washington, DC; Christer Gardell is a principal and Håkan Ekström is a consultant in McKinsey’s Stockholm office.
The authors would like to acknowledge the contributions of Karl Bengtsson, Kai Henriksen, Kathryn Huang, Svein Harald Øygard, and Eric Zitzewitz to the research underlying this article.
Notes