Economic growth will moderate as capacity constraints tighten. Growth will slow, as the economy now operates around full capacity and labour shortages appear in many sectors (Table A). Shrinking residential investment following housing price falls is a further drag on the economy. Exports are expected to remain solid as long as the global economy keeps expanding.

Global uncertainties weigh on the outlook. The global economic environment is laden with uncertainties. As a small open economy highly dependent on exports, Sweden is vulnerable to potential global shocks, such as further intensification in global trade tensions, a disorderly Brexit, stress in European sovereign bond markets, as well as domestic events such as a severe drop of the housing market.

Rising employment has contributed to enhancing well-being and reducing poverty. However, robust capital income growth has pushed up inequality over the past few years. Nevertheless, inequality remains low, albeit higher than in the other Nordic countries (Figure B). Amending tax rules for unlisted companies and property, without increasing the overall tax burden, could help hold back inequality.

Sweden is a frontrunner in the fight against climate change and in greening the economy. CO₂ emissions per unit of GDP are well below the OECD average and falling. Air quality is good and environment-related patenting strong. The government has stepped up efforts, increasing investments in environmental protection and nature conservation. It has set clear objectives and policies to reduce carbon emissions and put in place an independent climate council to monitor progress. In addition to the carbon tax, the EU Emissions Trading Scheme and blending obligation for biofuels, there are measures such as subsidising solar cells, electric vehicles and charging points and supporting company and municipal investments reducing climate impact.

Fiscal policy has supported the recovery. Two decades of prudent policy had created the fiscal space for Sweden to use fiscal expansion to dampen recessions. In recent years, additional resources have been channelled to key areas such as education, immigrant integration, health, defence and environment protection, providing some stimulus despite high capacity utilisation. The 2019 budget is slightly expansionary, which is appropriate, especially as reduced margins for monetary policy will require fiscal policy to play a greater stabilising role in the next downturn.

Monetary policy has started to tighten, but remains supportive. With inflation close to the 2% target, albeit with some help from rising energy prices, the time has come to begin withdrawing stimulus (Figure C). Inflation expectations are close to the target. The Riksbank has started withdrawing monetary support, with a 25 basis points repo rate hike to -0.25% in December 2018. The gradual normalisation of policy rates should continue, to balance the risks of inflation undershooting against those of excess inflation and debt.

Housing prices have fallen slightly. Housing prices have fallen since mid-2017, largely as a result of increased supply of tenant-owned apartments in big cities (Figure D), but seem to be stabilising. Macroprudential measures, notably the introduction of a mortgage amortisation requirement, have also contributed to contain household indebtedness and housing price increases. Nevertheless, the housing price-to-income ratio remains about 30% above its long-term average and household debt continues to rise. Structural reforms are needed for the housing market to become more responsive to people’s needs.

The housing market suffers from excessive regulation that hinders the supply of new homes. The government is implementing a 22-point plan including measures to release more land for development, accelerate planning processes and subsidise the construction of affordable housing. While this is going in the right direction, broader reforms will be needed to achieve a well-functioning housing system, in particular moving towards more tenure-neutral taxation, further streamlining land-use planning procedures and easing rental regulations. Greater competition could help lower construction costs.

There is room for further progress on regulations and administrative procedures. Sweden is among the most business-friendly countries in the OECD. Nevertheless, some regulations and administrative procedures could be streamlined, taking advantage of the new opportunities offered by digitalisation.

Automation increases re-skilling needs. Digitalisation offers great opportunities to raise productivity, but puts nearly a third of jobs at risk of automation or significant change. Hence investment in re-skilling and up-skilling will be crucial to inclusive growth. This requires strengthening the foundation skills of the workforce and developing adult education, in cooperation with the social partners.

Labour legislation should adapt to evolving work patterns. As unconventional forms of work gain ground, labour legislation will need to evolve to ensure the right balance between flexibility and protection for all workers. New rules should be designed in close cooperation with the social partners.

Swedish school results have declined for two decades. Issues with design and implementation of a series of reforms in the early 1990s, coinciding with a deep economic crisis, likely contributed (Figure E). School inequalities, driven by residential segregation and school choice, likely reduce equality of opportunity. A reform programme for primary and lower secondary schools should coordinate funding better and strengthen governance, combine school choice and competition with greater attention to socio-economic diversity, and increase the attractiveness of teaching.

The institutional set-up of the school system needs strengthening. School funding has to better target needs related to pupils’ different socio-economic backgrounds. Developing a regional arm of the central government governance structure would enhance local cooperation, improve skills development, promote continuous quality improvements, and instil accountability at every level of the school system.

Competition and school choice must be steered to deliver for the public good. Municipalities need to take the socio-economic mix of pupils into account in municipal school entry and when investing in new schools. A liberal regime for the establishment and expansion of private schools needs to internalise a broader set of criteria, notably to counteract segregation. Municipalities should have a stronger say in such decisions. Pupils should be assigned to over-subscribed private compulsory schools by lottery, possibly with quotas reserved for pupils with unfavourable socio-economic backgrounds.

Teaching needs to become more attractive to address current teacher shortages, which are most acute in remote locations and set to intensify as the number of school-age children increases. Improving teacher education with a stronger research base, more instruction time and teaching practice, strengthened continuous learning and development, as well as feedback and support mechanisms to foster more cooperation between colleagues, would help. Furthermore, principals and education personnel should be shielded from unnecessary administrative procedures.