From the March/April edition of Foreign Affairs (subscription required):

ADAM SMITH observed in 1776 that economies work best when governments keep their clumsy thumbs off the free market’s "invisible hand." Two generations later, in 1817, the British economist David Ricardo extended Smiths insights to global trade. Just as market forces lead to the right price and quantity of products domestically, Ricardo argued, free foreign trade optimizes economic outcomes internationally.

Reading Adam Smith in Copenhagen–the center of the small, open, and highly successful Danish economy–is a kind of out-of-body experience. On the one hand, the Danes are passionate free traders. They score well in the ratings constructed by pro-market organizations. The World Economic Forum’s Global Competitiveness Index ranks Denmark third, just behind the United States and Switzerland. Denmark’s financial markets are clean and transparent, its barriers to imports minimal, its labor markets the most flexible in Europe, its multinational corporations dynamic and largely unmolested by industrial policies, and its unemployment rate of 2.8 percent the second lowest in the OECD (the Organization for Economic Cooperation and Development).

On the other hand, Denmark spends about 50 percent of its GDP on public outlays and has the world’s second-highest tax rate, after Sweden; strong trade unions; and one of the world’s most equal income distributions. For the half of GDP that they pay in taxes, the Danes get not just universal health insurance but also generous child-care and family-leave arrangements, unemployment compensation that typically covers around 95 percent of lost wages, free higher education, secure pensions in old age, and the world’s most creative system of worker retraining.

Does Denmark have some secret formula that combines the best of Adam Smith with the best of the welfare state? Is there something culturally unique about the open-minded Danes? Can a model like the Danish one survive as a social democratic island in a turbulent sea of globalization, where unregulated markets tend to swamp mixed economic systems? What does Denmark have to teach the rest of the industrial world?

These questions brought me to Copenhagen for a series of interviews in 2007 for a book I am writing on globalization and the welfare state. The answers are complex and often counterintuitive. With appropriate caveats, Danish ideas can indeed be instructive for other nations grappling with the enduring dilemma of how to reconcile market dynamism with social and personal security. Yet Denmark’s social compact is the result of a century of political conflict and accommodation that produced a consensual style of problem solving that is uniquely Danish. It cannot be understood merely as a technical policy fix to be swallowed whole in a different cultural or political context. Those who would learn from Denmark must first appreciate that social models have to grow in their own political soil.

COMPASSIONATE CAPITALISM 

AT THE CENTER of the current Danish model is a labor-market strategy known as flexicurity. The idea is to reconcile job flexibility with employment security. The welfare state is often associated with rigid job protections: laws and union contracts making it illegal or prohibitively expensive to lay off workers. In much of the rest of Europe, labor-market rigidities have been blamed for high unemployment rates and for a welfare state of "insiders and outsiders," in which the well employed fiercely protect their jobs at the expense of those with little or nothing. It is here that Denmark offers its most ingenious blend of free markets and social democracy: despite heavy unionization, there are no regulations against laying off workers other than the requirement of advance notice.

In fact, Denmark has Europe’s highest rate of labor turnover. What is more, much of it is voluntary. A 2005 Eurobarometer poll found that over 70 percent of Danes think it is a good thing to change jobs frequently, compared with less than 30 percent in neighboring Germany. Danish respondents reported that they had changed employers an average of six times, the highest figure in the European Union (EU). One in three Danes changes jobs every year. And with employers free to deploy workers as they wish and all Danes eligible for generous social benefits, there is no inferior "temp" industry, because there is no need for one. As precarious short-term contract employment has grown in most other countries, the number of Danes in temporary contracts has decreased since the mid-1980s. Where most other OECD nations have a knot of middle-aged people stuck in long-term unemployment, in Denmark, the vast majority of the unemployed return to work within six months, and the number of long-term unemployed is vanishingly small.

What makes the flexicurity model both attractive to workers and dynamic for society are five key features: full employment; strong unions recognized as social partners; fairly equal wages among different sectors, so that a shift from manufacturing to service-sector work does not typically entail a pay cut; a comprehensive income floor; and a set of labor-market programs that spend an astonishing 4.5 percent of Danish GDP on initiatives such as transitional unemployment assistance, wage subsidies, and highly customized retraining.

In return for such spending, the unions actively support both employer flexibility and a set of tough rules to weed out welfare chiselers; workers are understood to have duties as well as rights. Professor Per Kongshøj Madsen, director of the Center for Labor Market Research at Aalborg University, observes that the income security guaranteed by the Danish state, as well as the good prospects for reemployment, enables Danes to comfortably take risks with new jobs.

For the United States, 4.5 percent of GDP would be about $600 billion a year. Current U.S. spending on all forms of government labor-market subsidies–of which meager and strictly time-limited unemployment compensation makes up the most part–is about 0.3 percent of GDP, less than $50 billion. The dynamic U.S. economy, in other words, has plenty of flexibility but little security. Denmark suggests that a different path is possible.

The Danish model squares another circle by reconciling free trade with economic security. This is not an easy feat. In a global system, corporations can move around in search of low taxes, cheap labor, and scant social regulation. Yet in Denmark, even trade unionists are passionate free traders. One of my more startling interviews was with Marina Hoffmann, chief economist of the Danish Metalworkers Union and former senior economic adviser to the most recent Social Democratic prime minister, Poul Nyrup Rasmussen. "We need to convince Danish industry to do more outsourcing," this trade union leader improbably told me. "We are a small country and we survive by exporting … If a Danish multinational manufacturing corporation can be more competitive by outsourcing components, we will be more competitive as a nation." In other words, hiving off routine production jobs and moving them to China and eastern Europe can help keep higher-end, knowledge-based design and engineering jobs in Denmark. And as manufacturing becomes more automated, a national policy of professionalizing service-sector jobs takes up much of the slack. A nursing-home worker in Denmark, for example, gets far more training, status, and pay than one in the United States.

I encountered an equally surprising set of enthusiasms when I interviewed the director of the Confederation of Danish Employers, Henrik Bach Mortensen, whose support for union-management partnerships would be most unwelcome at, say, the U.S. Chamber of Commerce. Employers value the system, said Mortensen, both for its absence of industrial conflict and for its supply of good workers. The collaborative vocational training system, he noted, is essential for Danish competitiveness. This view was confirmed in an extensive survey of Danish employers conducted by Professor Cathie Jo Martin, of Boston University. Companies, she found, support the model because it brings them tangible benefits in the form of skilled and adaptive employees.

The productive work force helps both large and specialized Danish export industries thrive. Denmark is a global leader in such niche exports as hearing-aid production (through world-class companies such as Oticon), consumer electronics (Bang & Olufsen), insulin (Novo Nordisk), environmental technology, and finely engineered plumbing fixtures. As a seafaring nation, Denmark has global shipping giants such as Maersk, which ranks 138 on the Fortune Global 500 list. And in the service sector, Danish multinationals, such as the ISS Group, with 220,000 employees worldwide, are among the largest contractors for janitorial and security-guard services for office buildings, airports, and hospitals.

Wages in Denmark are about 70 percent above the OECD average, but the high productivity of the Danish work force justifies them. And because the Danish welfare state is financed primarily by income taxes and not payroll charges, overall labor costs to employers are moderated. But more than anything else, as Jørgen Søndergaard, director general of the Danish National Institute of Social Research, pointed out to me, it is Denmark’s culture of collaboration that allows win-win outcomes for corporations and their employees alike.

In another typically Danish bit of ingenuity, a good deal of consumer choice is deliberately built into the social-welfare model, since Denmark is highly libertarian as well as partly socialist. Choices are offered to accommodate individual preferences, so that the model enhances liberty rather than imposing one-size-fits-all regimentation. Consumer choice also allows the discipline of competition to keep social providers on their toes and to retain the support of more affluent Danes for the model. Thus, there is good socialized medical care, but the basic package is complemented by private insurance, now used by about seven percent of the population, and Danes have a broad choice of doctors and hospitals. There is excellent free public education all the way through university and graduate school, but private and religious schools can get 85 percent government financing. In the United States, school vouchers are promoted by the right as a way of undermining the public-school system; in Denmark, state-financed private schools are accepted by the left as a safety valve.