8 September 2016

Capping profits only benefits crony capitalists


Since the 1990s, Sweden has had a thriving welfare sector in which private firms, through vouchers or public contracts, carry out the provision of many welfare services. This has worked out well overall, as the for-profit schools, care for the elderly and health services are popular with the general public. Additionally, the public sector can mitigate the issue of loss-making public providers (public schools, for example, receive the same vouchers as private schools per pupil, but the former are often run with a deficit that taxpayers have to cover).

Recently however, there has been a shifting attitude towards for-profit welfare, amongst the general public and the parties on the left. The Social Democrat government has put forth a suggestion to regulate “excess-profits” in the sector. As it turns out, the suggestion is more about scoring populist points than actually promoting a better welfare market.

There is reason to be critical of how welfare services are carried out by some for-profit providers in Sweden. Particularly in the asylum-sector, where private providers have mushroomed as high numbers of refugees have been drawn to Sweden, there are examples of crony-capitalists who make big fortunes by providing poor care for refugees and sending expensive invoices to the public sector. The obvious reason is that the public sector lost control of the asylum process, desperately signing any available contract, and that a proper system for controlling quality does not exists.

The Social Democrat government is not, however, focusing on introducing quality control or a better system of procedure of contracts with the private sector. Instead the goal is to regulate excess-profits in the welfare system. It is easy to see why the government chose this path. The Social Democrats risk losing the support of many voters to the Socialist (former communist) party, which relies on exaggerated rhetoric about the evils of for-profit welfare and portrays the Social Democrats as being in bed with the capitalists. By suggesting anti-profit regulations, the Social Democrats can attract back some of these voters.

The beauty of it is that this legislation is sure to be blocked by the four center-right parties and the anti-immigration Swedish Democrat party. Together, these five parties have the big majority of voter support in Sweden. The Social Democrat’s legislation, which they themselves likely know is harmful, will not actually be introduced. But it can be used to attract left voters, while at the same time paint the picture of the Sweden Democrats as another party supporting the evil capitalists (the Social Democrats have lost many working class voters to the Sweden Democrats, and need this rhetoric to win them back).

It is worth keeping in mind that Swedish Social Democrats, like their sister parties in the other Nordic nations, have a long history of taking a pragmatic stance towards politics. Important policy suggestions are examined in depth by experts before being suggested in the public debate.

On the face of it, the same responsible approach is being taken with the welfare profit-regulation legislation. The government has given leading Social Democrat Ilmar Reepalu the mission of examining the question in-depth. A few days ago, the suggestion for profit regulation leaked out. It turned out that the pragmatic approach was all smoke and mirrors. There is little support of excess-profits and the government’s own expert – who has done the calculations – explains that he was instructed not to do a proper analysis.

The government has been gaining quite a lot of media attention with their attack on the welfare sector. Ilmar Reepalu has, for example, claimed that the profit levels of the welfare companies that have been examined are “between 40 and 50 per cent”. It sure sounds like crony-capitalism and excess-profits going on. But what does the actual government study show? There we can see that the true average level of surplus is 10 per cent, and this is not only profits, but rather: cost of capital + profits + corporate taxes equals 10 per cent, that is to say, quite normal levels rather than the government figures which are literally plucked from thin air.

Another common figure is given by Minister for Public Administration Ardalan Shekarabi, who claims that the excess-profits are 15 billion Swedish Kronors (1.5 billion Euros). The government report actually shows a level of 1.7 billion Kronos (0.17 billion Euros) a year; the trick is to multiply with nine years but not tell this to media. Even more concerning is that the expert doing the calculations of excess-profits has been given direct instructions not to calculate in the correct way. The sum of 1.7 billion Kronors – relatively low given that the public sector in Sweden has a budget of some 2,000 billion Kronors annually – is likely very exaggerated.

Joackim Landström at Uppsala University is the expert behind the governments calculations. He has explained that the suggestion, which is based on his report, could have “grave consequences”, amongst others leading to the liquidation of many companies. How would a regulation which is aimed at removing excess-profits lead to the liquidation of serious businesses? The answer is that the regulation is not about excess-profits, but reasonable levels of surplus which the government wants to prohibit.

Landström has been given the task of calculating what level of profit is reasonable, and where the government profit-ceiling should be set. He has chosen 8 per cent surplus to cover the cost of capital, taxes and profits. However, Landström himself says that the level “really needs to be higher”, so that it has space for value-creating investments in firms. He wanted to include this in his calculations, but was given strict instructions by the government not to do so. Thus the calculations are based on a market where firms that have efficient production and introduce innovations are not to be rewarded for this.

Why was this instruction given? It seems that the government didn’t want the already low level of 1.7 billion Kronors in excess-profits to become even lower, or even disappear, by having a correct analysis on what the market surplus should be. Would there even have been any excess-profits left with a reasonable analysis? If so, they would have been very low. It is also worth keeping in mind that the calculations of reasonable profit levels are based on large public companies, but the government is also applying them to small firms with 1-4 employees. This is weird, since profits in small companies largely are the reward of the work of the business owner. The reason is again obvious: half the excess profits are found in the very small firms, for which the methodology doesn’t make sense.

The really interesting part is that the Swedish government is uninterested to listen to the greates authority in the world on this issue. Two years ago French professor in economics, Jean Tirole, visited Stockholm. He was receiving the Nobel prize in economics, precisely for his work on how complex markets such as welfare should be regulated. Tirole felt obliged to give the government, which was already then toying with the populist idea of profit-regulations, some advice. The world-renowned economist warned against the entire idea of profit-regulation:

“You have to let companies make a profit if they reduce their costs or outperform quality expectations.

“It is important to encourage and spur them to work efficiently. With limited profit opportunity one only attracts the least efficient, ‘worst’ companies”.

Of course legislators can have demands on welfare markets, through regulations or public contracting. After all, this is not a pure market but a quasi-market with tax-funding. However, profit-regulation is simply not the answer. As the recent Swedish experience shows, to make the case for excess-profits the government has had to play around with the numbers and instruct calculations to be performed in an unreasonable way. And what would the benefits of the regulation be? While serious firms, who are delivering quality welfare services, risk liquidation since they are not being given the ability to cover reasonable costs of capital, taxes and profits through a limit on surplus, crony-capitalists would be unharmed. The reason is that the latter could easily shift profits to wages or to money billed to other companies that they own (to give one example: a welfare firm could set up an independent firm owning the property, for example, and raise the rent so that profits are transferred to the property firm from the welfare firm).

Government profit-regulation is simply a bad idea. The Swedish government is most likely well aware of this, but desperately looking for a way to mount a populist attack on welfare crony-capitalists. Thus, exaggerated rhetoric, false facts and intentionally skewed calculations take the place of serious policy suggestions. Hopefully this will be a warning example to other welfare states, not something other governments copy in order to paint themselves out as crusaders against welfare profiteers.

Dr. Sanandaji’s latest book, ‘Debunking Utopia – Exposing they myth of Nordic socialism’, wass published on the 16th August by WND books, RRP £12.97.

Dr. Nima Sanandaji is an author and researcher of Kurdish-Iranian origin who migrated to Sweden as a child, and grew up with welfare support. He has previously written twenty books, a number of which have had considerable international attention. Nima is president of the European Centre for Policy Reform and Entrepreneurship.