An excessively rigid labour market is at the root of Sweden's high youth unemployment and helps explain the recent proliferation of young people in early retirement schemes, argues Nima Sanandaji, CEO of the Captus think tank.

There are those who believe that Sweden has a low level of unemployment. This is far from the truth. The combination of high taxes, generous government benefits and a regulated labour market has led many Swedes to rely on handouts rather than work. The system does succeed in one thing: hiding true unemployment figures.

A few years ago, Swedish economist Jan Edling noted that the number of people on sick leave and early retirement tended to correlate strongly with unemployment figures. The reason, Edling explained, was that many of the unemployed were hidden from the statistics through these measures.

Far from being a right-leaning economist, Edling at the time worked for LO – an influential labour union with strong official and unofficial ties to the then-ruling Social Democratic party. The claim that the Swedish welfare state hid actual unemployment through various measures was unpopular among Swedish socialists. So unpopular in fact that Edling's report was not published, causing him to resign after 18 years faithful service.

Four years ago a centre-right government was elected with the promise to reduce visible and hidden unemployment. The government has had some success in this, at last before the financial crisis hit and again raised unemployment. Tax cuts and reduced generosity of government benefits have promoted work over dependence. However, among one group reliance on government has not decreased: young people who rely on early retirement for their living.

The concept of relying on early retirement among the relatively youthful might sound a bit strange. Swedish politicians have even changed the term “early retirement” into “activity and sickness compensation” to make it sound more acceptable. And it has oddly enough become more or less an accepted fact that many young Swedes who cannot find a job instead rely on early retirement – often on a permanent basis.

Since 2004 close to 70,000 Swedes in the ages 20-39 have been supported by early retirement. This represents close to three percent of the total population among this age group living in the country. In the Stockholm region, where the labour market is strong, two percent of the young population is living on early retirement. In regions where jobs are scarcer, the figure is four percent. Even among the youngest group – those between 20-24 years – more than two percent of Sweden’s population is being supported by early retirement.

One reason for the popularity of early retirement stems the fact that is increasingly difficult for young Swedes to find employment. According to Statistics Sweden, unemployment among those between 15-24 years was fully 24 percent in the beginning of 2009. Although Sweden does not have minimum wages set by the government, the vast majority of employers have to follow labour union contracts and these contracts in turn include very high effective minimum wages.

Not only is the price of youth labour set too high for demand to meet supply, but employers find it too risky to hire inexperienced young people since rigid labour market regulation makes it difficult to fire those who do not perform well on their job.

High unemployment among young people is not only an economic, but also a social issue. Many young people feel depressed since they cannot find a meaningful purpose and cannot contribute to society. This feeling, strong among young people who are not even officially employed, but rather hidden from the statistics through early retirement, sick leave or other systems.

The OECD measures the percentage of those who are officially declared to be outside of the workforce but view themselves as being unemployed. This group is referred to as “discouraged workers”. In countries such as Denmark, Germany and the United Kingdom only 0.1 percent of the labour force of 15-24 year olds is composed of discouraged workers. In Sweden, the figure is almost a hundred times higher.

The Swedish welfare system is seen by many as a role model. When it comes to creating opportunities for the young however, Sweden could learn much from free-market systems. Or, for that matter, it could learn from neighbouring welfare state Denmark, which has combined welfare mechanisms with a dynamic labour market. The combination, coined by previous Social Democratic Prime Minister Poul Nyrup Rasmusson as “flexicurity”, is far superior to the system of high effective minimum wages and rigid labour regulations introduced by the Social Democrats and their labour union allies in Sweden.