The ethics of competitiveness and the spirit of federalism

The success of the Swiss model appears to lie in the competition between the 26 cantons in the areas of efficiency, income distribution and tax equalization

The economic conditions in Switzerland are enviable and the country regularly ranks high in international competitiveness rankings. This begs the question: How much of this success is due to the political system?

The economic performance of the Swiss Confederation is easily quantifiable, but for many observers at first glance difficult to explain. How is it possible that a country with such a small domestic market, where average incomes are among the highest in the world, can present such stable Gross Domestic Product figures, come close to full employment and – even more surprising – be among the most competitive nations in the world?

For the eighth consecutive year, Switzerland has been ranked first in the global economic competitiveness rankings compiled by the World Economic Forum, a well-known international organization based in Cologny, a pretty village in the Republic and Canton of Geneva.

The link between federalism and the economy has long been the subject of debate in academia and among practitioners: can a decentralized and multi-level political system – Confederation, cantons and communes – have a favourable impact on economic performance?

The answer at the university level, in all recent studies, is very simple: yes. If Switzerland can count on a competitive economy, it is mainly thanks to federalism.

But why, and above all how, does federalism actually promote economic competitiveness?

Efficiency, income distribution and equalisation

Efficiency is the first of three ways in which federalism facilitates economic activity. The fact that a local government can intervene “close to where the action is” makes the system more dynamic and accountable, and is what stimulates competitiveness. True federalism, like Switzerland’s, spurs accountability among public administrators.

Second, the federalist system helps improve income distribution and acts as an insurance mechanism. For example, labor market mobility allows for a flow of skills from underperforming regions of the country to more dynamic ones.

And then there is financial equalization, a system in which money is transferred from richer cantons to those with fewer resources. This mechanism, based on economic and political solidarity within the Swiss Confederation, means that any economic collapse in a region can be mitigated by national transfers and funds.

Approximately 20 percent of each “shock” affecting a region is absorbed by the Swiss federalist system as a whole. This allows the economy to take more risks and maintain a high level of industrial or production diversification: think of watchmaking in Neuchâtel, the pharmaceutical industry in Basel or finance in Zurich.

The 26 cantons as “laboratories of innovation

The most important success factor of federalism, however, is even more tangible. The Swiss cantons function as small “laboratories of innovation”, “transformers of intelligence”, often in competition with each other, developing their own solutions, which (when successful) are presented as models to be followed throughout the country.

Cantons can learn from each other. The education system is a case in point: although each of the 26 states is largely responsible for its own education policy, all are continually looking for what works best. Although it is difficult to quantify, this “laboratory effect” is crucial to Switzerland’s success.

The same is true in more traditional areas such as taxation and internal competition. Due to the rivalry between cantons over corporate income taxes or foreign direct investment, there is a constant reassessment of the relationship between tax rate and public services.

The RFFA as a mortgage on everyone’s future

In Switzerland, even before the Federal Law on Tax Reform and Financing of the Old Age and Survivors’ Insurance (RFFA) comes into force and will be fully effective in 2025, corporate taxation varies greatly from one canton to another: from 12.3% in Lucerne to 24.2% in Geneva, although in fact many large companies enter into special agreements with the authorities and everyone benefits greatly.

And, in the end, what happens is a healthy competition between territorial public authorities of various levels to administer services efficiently, to be able to lower the tax burden and to attract businesses and workers within their territories.

No one knows exactly what the right balance between taxes and public services is. But internal competition allows everyone to benefit and experiment. Constant “questioning” is an important factor in stimulating and growing the economy in a “win win” system.

Small municipalities want to merge and often do so, providing efficiency gains for municipal coffers and lower tax rates for their citizens.

A virtuous circle, which feeds on itself

It is not surprising, therefore, that even in these times of pandemic, Switzerland has managed to simultaneously maintain high standards of health service (despite some interested or superficial fake news from a neighboring country …) and good overall economic performance.

The GDP growth has been in fact about three times lower (read: 3!) than all neighboring countries and Swiss citizens have never been limited in their inviolable freedoms.

Federalism therefore seems to be the secret of economic competitiveness and the lintel on which Swiss liberal democracy is founded, an example for the whole world…