How a tiny country with high government spending bred a large number of vibrant young businesses

STOCKHOLM—This is a high-tax, high-spend country, where employees receive generous social benefits and ample amounts of vacation time. Economic orthodoxy would suggest the dynamics of a welfare state like Sweden would be detrimental to entrepreneurship: Studies have found that the more a country’s government spends per capita, the smaller the number of start-ups it tends to have per worker—the idea being that high income taxes reduce entrepreneurs’ expected gains and thus their incentive to launch new companies.

And yet Sweden excels in promoting the formation of ambitious new businesses, on a level that’s unexpected for a country whose population of roughly 10 million puts it at 89th in the world in population size. Global companies like Spotify, the music-streaming service; Klarna, the online-payment firm; and King, the gaming company, were all founded here. Stockholm produces the second-highest number of billion-dollar tech companies per capita, after Silicon Valley, and in Sweden overall, there are 20 start-ups—here defined as companies of any size that have been around for at most three years—per 1,000 employees, compared to just five in the United States, according to data from the Organization for Economic Cooperation and Development (OECD). “What you see is that start-ups have a high survival rate in Sweden, and they have relatively fast growth,” Flavio Calvino, an OECD economist, told me.

Sweden also ranks highest in theFor Canada’s tech to thrive, startups must grow up developed world when it comes to perceptions of opportunity: Around 65 percent of Swedes aged 18 to 64 think there are good opportunities to start a firm where they live, compared to just 47 percent of Americans in that age group.

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There are several dimensions to answering that question, many of which involve changes that took place in the past 30 years. Since 1990, Sweden has made it easier for upstarts to compete with big, established firms. The 20th-century economist Joseph Schumpeter theorized that economies thrive when “creative destruction” occurs, meaning new entrants are able to replace established companies. Sweden used to have a heavily regulated economy in which public monopolies dominated the market, which made it difficult for such replacements to occur, but regulations have since been eased. While Sweden was making it harder for monopolies to dominate the market, the U.S. was changing its regulatory landscape to favor big companies and established firms (largely through overturning anti-monopoly laws and permitting industry consolidation), argues Lars Persson, an economist at Sweden’s Research Institute of Industrial Economics who has studied new-business creation in Sweden.

Sweden also gives some credence to the controversial idea that cutting corporate tax rates can help stimulate entrepreneurship. The reforms of 1991 lowered corporate income taxes from 52 percent to 30 percent. (Sweden’s corporate tax rate today, at 22 percent, is much lower than the U.S.’s 39 percent, though few companies actually pay a rate that high.) Before the reforms of the 1990s, Sweden favored established companies over individuals who wanted to start a business in a number of ways: Individuals in Sweden had to pay taxes on their firm’s income and their own income from the business, while established businesses had a number of ways to reduce this double taxation.

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The reforms “considerably” leveled the playing field, Persson said. “Until 1991, the Swedish tax system disfavored new, small, and less capital-intensive firms while favoring large firms and institutional ownership,” Persson wrote in a paper last year. In the 2000s, Sweden also got rid of its inheritance tax and a tax on wealthy people, which further incentivized people to earn large sums of money and, often, invest it back into the economy. “There was more capital available, so angel investors started to appear,” Braunerhjelm said. Today, there are significant tax breaks for starting and owning a business; for example, entrepreneurs can now have a larger share of their income taxed as capital income, which has a lower tax rate.

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