Denmark is located in Northern Europe between the North Sea and the Baltic.

Today
Denmark consists of the Jutland Peninsula bordering Germany and the Danish Isles and
covers 43,069 square kilometers (16,629 square miles).  1 The present nation is the result of
several cessions of territory throughout history. The last of the former Danish territories in
southern Sweden were lost to Sweden in 1658, following one of the numerous wars
between the two nations, which especially marred the sixteenth and seventeenth centuries.
Following defeat in the Napoleonic Wars, Norway was separated from Denmark in 1814.
After the last major war, the Second Schleswig War in 1864, Danish territory was further
reduced by a third when Schleswig and Holstein were ceded to Germany. After a regional
referendum in 1920 only North-Schleswig returned to Denmark. Finally, Iceland, withdrew
from the union with Denmark in 1944. The following will deal with the geographical unit of
today’s Denmark.
Prerequisites of Growth
Throughout history a number of advantageous factors have shaped the Danish economy.
From this perspective it may not be surprising to find today’s Denmark among the richest
societies in the world. According to the OECD, it ranked seventh in 2004, with income of
$29.231 per capita (PPP). Although we can identify a number of turning points and breaks,
for the time period over which we have quantitative evidence this long-run position has
changed little. Thus Maddison (2001) in his estimate of GDP per capita around 1600 places
Denmark as number six. One interpretation could be that favorable circumstances, rather
than ingenious institutions or policies, have determined Danish economic development.
Nevertheless, this article also deals with time periods in which the Danish economy was
either diverging from or converging towards the leading economies.
Table 1:
Average Annual GDP Growth (at factor costs)
  Total Per capita
1870-1880 1.9% 0.9%
1880-1890 2.5% 1.5%
1890-1900 2.9% 1.8%
1900-1913 3.2% 2.0%
1913-1929 3.0% 1.6%
1929-1938 2.2% 1.4%
1938-1950 2.4% 1.4%
1950-1960 3.4% 2.6%
1960-1973 4.6% 3.8%
1973-1982 1.5% 1.3%
1982-1993 1.6% 1.5%
1993-2004 2.2% 2.0%
Sources: Johansen (1985) and Statistics Denmark ‘Statistikbanken' online.
Denmark’s geographical location in close proximity of the most dynamic nations of
sixteenth-century Europe, the Netherlands and the United Kingdom, no doubt exerted a
positive influence on the Danish economy and Danish institutions. The North German area
influenced Denmark both through long-term economic links and through the Lutheran
Protestant Reformation which the Danes embraced in 1536.
The Danish economy traditionally specialized in agriculture like most other small and
medium-sized European countries. It is, however, rather unique to find a rich European
country in the late-nineteenth and mid-twentieth century which retained such a strong
agrarian bias. Only in the late 1950s did the workforce of manufacturing industry overtake
that of agriculture. Thus an economic history of Denmark must take its point of departure in
agricultural development for quite a long stretch of time.
Looking at resource endowments, Denmark enjoyed a relatively high agricultural land-to-
labor ratio compared to other European countries, with the exception of the UK. This was
significant for several reasons since it, in this case, was accompanied by a comparatively
wealthy peasantry.
Denmark had no mineral resources to speak of until the exploitation of oil and gas in the
North Sea began in 1972 and 1984, respectively. From 1991 on Denmark has been a net
exporter of energy although on a very modest scale compared to neighboring Norway and
Britain. The small deposits are currently projected to be depleted by the end of the second
decade of the twenty-first century.

Source: Johansen (1985) and Statistics Denmark ’Nationalregnskaber’

Good logistic can be regarded as a resource in pre-industrial economies. The Danish coast
line of 7,314 km and the fact that no point is more than 50 km from the sea were
advantages in an age in which transport by sea was more economical than land transport.
Decline and Transformation, 1500-1750
The year of the Lutheran Reformation (1536) conventionally marks the end of the Middle
Ages in Danish historiography. Only around 1500 did population growth begin to pick up
after the devastating effect of the Black Death. Growth thereafter was modest and at times
probably stagnant with large fluctuations in mortality following major wars, particularly
during the seventeenth century, and years of bad harvests. About 80-85 percent of the
population lived from subsistence agriculture in small rural communities and this did not
change. Exports are estimated to have been about 5 percent of GDP between 1550 and
1650. The main export products were oxen and grain. The period after 1650 was
characterized by a long lasting slump with a marked decline in exports to the neighboring
countries, the Netherlands in particular.
The institutional development after the Black Death showed a return to more archaic forms.
Unlike other parts of northwestern Europe, the peasantry on the Danish Isles afterwards
became a victim of a process of re-feudalization during the last decades of the fifteenth
century. A likely explanation is the low population density that encouraged large
landowners to hold on to their labor by all means. Freehold tenure among peasants
effectively disappeared during the seventeenth century. Institutions like bonded labor that
forced peasants to stay on the estate where they were born, and labor services on the
demesne as part of the land rent bring to mind similar arrangements in Europe east of the
Elbe River. One exception to the East European model was crucial, however. The demesne
land, that is the land worked directly under the estate, never made up more than nine
percent of total land by the mid eighteenth century. Although some estate owners saw an
interest in encroaching on peasant land, the state protected the latter as production units
and, more importantly, as a tax base. Bonded labor was codified in the all-encompassing
Danish Law of Christian V in 1683. It was further intensified by being extended, though
under another label, to all Denmark during 1733-88, as a means for the state to tide the
large landlords over an agrarian crisis. One explanation for the long life of such an
authoritarian institution could be that the tenants were relatively well off, with 25-50 acres
of land on average. Another reason could be that reality differed from the formal rigor of
the institutions.
Following the Protestant Reformation in 1536, the Crown took over all church land, thereby
making it the owner of 50 percent of all land. The costs of warfare during most of the
sixteenth century could still be covered by the revenue of these substantial possessions.
Around 1600 the income from taxation and customs, mostly Sound Toll collected from ships
that passed the narrow strait between Denmark and today’s Sweden, on the one hand and
Crown land revenues on the other were equally large. About 50 years later, after a major
fiscal crisis had led to the sale of about half of all Crown lands, the revenue from royal
demesnes declined relatively to about one third, and after 1660 the full transition from
domain state to tax state was completed.
The bulk of the former Crown land had been sold to nobles and a few common owners of
estates. Consequently, although the Danish constitution of 1665 was the most stringent
version of absolutism found anywhere in Europe at the time, the Crown depended heavily
on estate owners to perform a number of important local tasks. Thus, conscription of troops
for warfare, collection of land taxes and maintenance of law and order enhanced the
landlords’ power over their tenants.
Reform and International Market Integration, 1750-1870
The driving force of Danish economic growth, which took off during the late eighteenth
century was population growth at home and abroad – which triggered technological and
institutional innovation. Whereas the Danish population during the previous hundred years
grew by about 0.4 percent per annum, growth climbed to about 0.6 percent, accelerating
after 1775 and especially from the second decade of the nineteenth century (Johansen
2002). Like elsewhere in Northern Europe, accelerating growth can be ascribed to a decline
in mortality, mainly child mortality. Probably this development was initiated by fewer spells
of epidemic diseases due to fewer wars and to greater inherited immunity against
contagious diseases. Vaccination against smallpox and formal education of midwives from
the early nineteenth century might have played a role (Banggård 2004). Land reforms that
entailed some scattering of the farm population may also have had a positive influence.
Prices rose from the late eighteenth century in response to the increase in populations in
Northern Europe, but also following a number of international conflicts. This again caused a
boom in Danish transit shipping and in grain exports.
Population growth rendered the old institutional set up obsolete. Landlords no longer
needed to bind labor to their estate, as a new class of landless laborers or cottagers with
little land emerged. The work of these day-laborers was to replace the labor services of
tenant farmers on the demesnes. The old system of labor services obviously presented an
incentive problem all the more since it was often carried by the live-in servants of the tenant
farmers. Thus, the labor days on the demesnes represented a loss to both landlords and
tenants (Henriksen 2003). Part of the land rent was originally paid in grain. Some of it had
been converted to money which meant that real rents declined during the inflation. The
solution to these problems was massive land sales both from the remaining crown lands and
from private landlords to their tenants. As a result two-thirds of all Danish farmers became
owner-occupiers compared to only ten percent in the mid-eighteenth century. This
development was halted during the next two and a half decades but resumed as the
business cycle picked up during the 1840s and 1850s. It was to become of vital importance
to the modernization of Danish agriculture towards the end of the nineteenth century that
75 percent of all agricultural land was farmed by owners of middle-sized farms of about 50
acres. Population growth may also have put a pressure on common lands in the villages. At
any rate enclosure begun in the 1760s, accelerated in the 1790s supported by legislation
and was almost complete in the third decade of the nineteenth century.
The initiative for the sweeping land reforms from the 1780s is thought to have come from
below – that is from the landlords and in some instances also from the peasantry. The
absolute monarch and his counselors were, however, strongly supportive of these
measures. The desire for peasant land as a tax base weighed heavily and the reforms were
believed to enhance the efficiency of peasant farming. Besides, the central government was
by now more powerful than in the preceding centuries and less dependent on landlords for
local administrative tasks.
Production per capita rose modestly before the 1830s and more pronouncedly thereafter
when a better allocation of labor and land followed the reforms and when some new crops
like clover and potatoes were introduced at a larger scale. Most importantly, the Danes no
longer lived at the margin of hunger. No longer do we find a correlation between
demographic variables, deaths and births, and bad harvest years (Johansen 2002).
 
A liberalization of import tariffs in 1797 marked the end of a short spell of late mercantilism.
Further liberalizations during the nineteenth and the beginning of the twentieth century
established the Danish liberal tradition in international trade that was only to be broken by
the protectionism of the 1930s.
 
Following the loss of the secured Norwegian market for grain in 1814, Danish exports began
to target the British market. The great rush forward came as the British Corn Law was
repealed in 1846. The export share of the production value in agriculture rose from roughly
10 to around 30 percent between 1800 and 1870.
In 1849 absolute monarchy was peacefully replaced by a free constitution. The long-term
benefits of fundamental principles such as the inviolability of private property rights, the
freedom of contracting and the freedom of association were probably essential to future
growth though hard to quantify.
Modernization and Convergence, 1870-1914
During this period Danish economic growth outperformed that of most other European
countries. A convergence in real wages towards the richest countries, Britain and the U.S.,
as shown by O’Rourke and Williamsson (1999), can only in part be explained by open
economy forces. Denmark became a net importer of foreign capital from the 1890s and
foreign debt was well above 40 percent of GDP on the eve of WWI. Overseas emigration
reduced the potential workforce but as mortality declined population growth stayed around
one percent per annum. The increase in foreign trade was substantial, as in many other
economies during the heyday of the gold standard. Thus the export share of Danish
agriculture surged to a 60 percent.
The background for the latter development has featured prominently in many international
comparative analyses. Part of the explanation for the success, as in other Protestant parts of
Northern Europe, was a high rate of literacy that allowed a fast spread of new ideas and
new technology.
The driving force of growth was that of a small open economy, which responded effectively
to a change in international product prices, in this instance caused by the invasion of cheap
grain to Western Europe from North America and Eastern Europe. Like Britain, the
Netherlands and Belgium, Denmark did not impose a tariff on grain, in spite of the strong
agrarian dominance in society and politics.
Proposals to impose tariffs on grain, and later on cattle and butter, were turned down by
Danish farmers. The majority seems to have realized the advantages accruing from the free
imports of cheap animal feed during the ongoing process of transition from vegetable to
animal production, at a time when the prices of animal products did not decline as much as
grain prices. The dominant middle-sized farm was inefficient for wheat but had its
comparative advantage in intensive animal farming with the given technology. O’Rourke
(1997) found that the grain invasion only lowered Danish rents by 4-5 percent, while real
wages rose (according to expectation) but more than in any other agrarian economy and
more than in industrialized Britain.
The move from grain exports to exports of animal products, mainly butter and bacon, was to
a great extent facilitated by the spread of agricultural cooperatives. This organization
allowed the middle-sized and small farms that dominated Danish agriculture to benefit from
the economy of scale in processing and marketing. The newly invented steam-driven
continuous cream separator skimmed more cream from a kilo of milk than conventional
methods and had the further advantage of allowing transported milk brought together from
a number of suppliers to be skimmed. From the 1880s the majority of these creameries in
Denmark were established as cooperatives and about 20 years later, in 1903, the owners of
81 percent of all milk cows supplied to a cooperative (Henriksen 1999). The Danish dairy
industry captured over a third of the rapidly expanding British butter-import market,
establishing a reputation for consistent quality that was reflected in high prices.
Furthermore, the cooperatives played an active role in persuading the dairy farmers to
expand production from summer to year-round dairying. The costs of intensive feeding
during the wintertime were more than made up for by a winter price premium (Henriksen
and O’Rourke 2005). Year-round dairying resulted in a higher rate of utilization of agrarian
capital – that is of farm animals and of the modern cooperative creameries. Not least did
this intensive production mean a higher utilization of hitherto underemployed labor. From
the late 1890’s, in particular, labor productivity in agriculture rose at an unanticipated speed
at par with productivity increase in the urban trades.
Industrialization in Denmark took its modest beginning in the 1870s with a temporary
acceleration in the late 1890s. It may be a prime example of an industrialization process
governed by domestic demand for industrial goods. Industry’s export never exceeded 10
percent of value added before 1914, compared to agriculture’s export share of 60 percent.
The export drive of agriculture towards the end of the nineteenth century was a major force
in developing other sectors of the economy not least transport, trade and finance.
Weathering War and Depression, 1914-1950
Denmark, as a neutral nation, escaped the devastating effects of World War I and was even
allowed to carry on exports to both sides in the conflict. The ensuing trade surplus resulted
in a trebling of the money supply. As the monetary authorities failed to contain the
inflationary effects of this development, the value of the Danish currency slumped to about
60 percent of its pre-war value in 1920. The effects of monetary policy failure were
aggravated by a decision to return to the gold standard at the 1913 level. When monetary
policy was finally tightened in 1924, it resulted in fierce speculation in an appreciation of
the Krone. During 1925-26 the currency returned quickly to its pre-war parity. As this was
not counterbalanced by an equal decline in prices, the result was a sharp real appreciation
and a subsequent deterioration in Denmark’s competitive position (Klovland 1997).
When, in September 1931, Britain decided to leave the gold standard again, Denmark,
together with Sweden and Norway, followed only a week later. This move was beneficial as
the large real depreciation lead to a long-lasting improvement in Denmark’s
competitiveness in the 1930s. It was, no doubt, the single most important policy decision
during the depression years. Keynesian demand management, even if it had been fully
understood, was barred by a small public sector, only about 13 percent of GDP. As it was,
fiscal orthodoxy ruled and policy was slightly procyclical as taxes were raised to cover the
deficit created by crisis and unemployment (Topp 1995).
Structural development during the 1920s, surprisingly for a rich nation at this stage, was in
favor of agriculture. The total labor force in Danish agriculture grew by 5 percent from 1920
to 1930. The number of employees in agriculture was stagnating whereas the number of
self-employed farmers increased by a larger number. The development in relative incomes
cannot account for this trend but part of the explanation must be found in a flawed Danish
land policy, which actively supported a further parceling out of land into small holdings and
restricted the consolidation into larger more viable farms. It took until the early 1960s
before this policy began to be unwound.
 
When the world depression hit Denmark with a minor time lag, agriculture still employed
one-third of the total workforce while its contribution to total GDP was a bit less than one-
fifth. Perhaps more importantly, agricultural goods still made up 80 percent of total exports.
Denmark’s terms of trade, as a consequence, declined by 24 percent from 1930 to 1932. In
1933 and 1934 bilateral trade agreements were forced upon Denmark by Britain and
Germany. In 1932 Denmark had adopted exchange control, a harsh measure even for its
time, to stem the net flow of foreign exchange out of the country. By rationing imports
exchange control also offered some protection of domestic industry. At the end of the
decade manufacture’s GDP had surpassed that of agriculture. In spite of the protectionist
policy, unemployment soared to 13-15 percent of the workforce.
The policy mistakes during World War I and its immediate aftermath served as a lesson for
policymakers during World War II. The German occupation force (April 9, 1940 until May 5,
1945) drew the funds for its sustenance and for exports to Germany on the Danish central
bank whereby the money supply more than doubled. In response the Danish authorities in
1943 launched a policy of absorbing money through open market operations and, for the
first time in history, through a surplus on the state budget.
Economic reconstruction after World War II was swift, as again Denmark had been spared
the worst consequences of a major war. In 1946 GDP recovered its highest pre-war level. In
spite of this, Denmark received relatively generous support through the Marshall Plan of
1948-52, when measured in dollars per capita.
From Riches to Crisis, 1950-1973: Liberalizations and International Integration Once Again
The growth performance during 1950-1957 was markedly lower than the Western European
average. The main reason was the high share of agricultural goods in Danish exports, 63
percent in 1950. International trade in agricultural products to a large extent remained
regulated. Large deteriorations in the terms of trade caused by the British devaluation 1949,
when Denmark followed suit, the outbreak of the Korean War in 1950, and the Suez-crisis of
1956 made matters worse. The ensuing deficits on the balance of payment led the
government to contractionary policy measures which restrained growth.
 
The liberalization of the flow of goods and capital in Western Europe within the framework
of the OEEC (the Organization for European Economic Cooperation) during the 1950s
probably dealt a blow to some of the Danish manufacturing firms, especially in the textile
industry, that had been sheltered through exchange control and wartime. Nevertheless, the
export share of industrial production doubled from 10 percent to 20 percent before 1957, at
the same time as employment in industry surpassed agricultural employment.
 
On the question of European economic integration Denmark linked up with its largest
trading partner, Britain. After the establishment of the European Common Market in 1958
and when the attempts to create a large European free trade area failed, Denmark entered
the European Free Trade Association (EFTA) created under British leadership in 1960. When
Britain was finally able to join the European Economic Community (EEC) in 1973, Denmark
followed, after a referendum on the issue. Long before admission to the EEC, the
advantages to Danish agriculture from the Common Agricultural Policy (CAP) had been
emphasized. The higher prices within the EEC were capitalized into higher land prices at the
same time that investments were increased based on the expected gains from membership.
As a result the most indebted farmers who had borrowed at fixed interests rates were hit
hard by two developments from the early 1980s. The EEC started to reduce the producers’
benefits of the CAP because of overproduction and, after 1982, the Danish economy
adjusted to a lower level of inflation, and therefore, nominal interest rates. According to
Andersen (2001) Danish farmers were left with the highest interest burden of all European
Union (EU) farmers in the 1990’s.
Denmark’s relations with the EU, while enthusiastic at the beginning, have since been
characterized by a certain amount of reserve. A national referendum in 1992 turned down
the treaty on the European Union, the Maastricht Treaty. The Danes, then, opted out of four
areas, common citizenship, a common currency, common foreign and defense politics and a
common policy on police and legal matters. Once more, in 2000, adoption of the common
currency, the Euro, was turned down by the Danish electorate. In the debate leading up to
the referendum the possible economic advantages of the Euro in the form of lower
transaction costs were considered to be modest, compared to the existent regime of fixed
exchange rates vis-à-vis the Euro. All the major political parties, nevertheless, are pro-
European, with only the extreme Right and the extreme Left being against. It seems that
there is a discrepancy between the general public and the politicians on this particular issue.
As far as domestic economic policy is concerned, the heritage from the 1940s was a new
commitment to high employment modified by a balance of payment constraint. The Danish
policy differed from that of some other parts of Europe in that the remains of the planned
economy from the war and reconstruction period in the form of rationing and price control
were dismantled around 1950 and that no nationalizations took place.
Instead of direct regulation, economic policy relied on demand management with fiscal
policy as its main instrument. Monetary policy remained a bone of contention between
politicians and economists. Coordination of policies was the buzzword but within that
framework monetary policy was allotted a passive role. The major political parties for a long
time were wary of letting the market rate of interest clear the loan market. Instead, some
quantitative measures were carried out with the purpose of dampening the demand for
loans.
From Agricultural Society to Service Society: The Growth of the Welfare State
Structural problems in foreign trade extended into the high growth period of 1958-73, as
Danish agricultural exports were met with constraints both from the then EEC-member
countries and most EFTA countries, as well. During the same decade, the 1960s, as the
importance of agriculture was declining the share of employment in the public sector grew
rapidly until 1983. Building and construction also took a growing share of the workforce
until 1970. These developments left manufacturing industry with a secondary position.
Consequently, as pointed out by Pedersen (1995) the sheltered sectors in the economy
crowded out the sectors that were exposed to international competition, that is mostly
industry and agriculture, by putting a pressure on labor and other costs during the years of
strong expansion.
Perhaps the most conspicuous feature of the Danish economy during the Golden Age was
the steep increase in welfare-related costs from the mid 1960s and not least the
corresponding increases in the number of public employees. Although the seeds of the
modern Scandinavian welfare state were sown at a much earlier date, the 1960s was the
time when public expenditure as a share of GDP exceeded that of most other countries.
As in other modern welfare states, important elements in the growth of the public sector
during the 1960s were the expansion in public health care and education, both free for all
citizens. The background for much of the increase in the number of public employees from
the late 1960s was the rise in labor participation by married women from the late 1960s
until about 1990, partly at least as a consequence. In response, the public day care facilities
for young children and old people were expanded. Whereas in 1965 7 percent of 0-6 year
olds were in a day nursery or kindergarten, this share rose to 77 per cent in 2000. This again
spawned more employment opportunities for women in the public sector. Today the labor
participation for women, around 75 percent of 16-66 year olds, is among the highest in the
world.
Originally social welfare programs targeted low income earners who were encouraged to
take out insurance against sickness (1892), unemployment (1907) and disability (1922). The
public subsidized these schemes and initiated a program for the poor among old people
(1891). The high unemployment period in the 1930s inspired some temporary relief and
some administrative reform, but little fundamental change.
Welfare policy in the first four decades following World War II is commonly believed to have
been strongly influenced by the Social Democrat party which held around 30 percent of the
votes in general elections and was the party in power for long periods of time. One of the
distinctive features of the Danish welfare state has been its focus on the needs of
the individual person rather than on the family context. Another important characteristic is
the universal nature of a number of benefits starting with a basic old age pension for all in
1956. The compensation rates in a number of schedules are high in international
comparison, particularly for low income earners. Public transfers gained a larger share in
total public outlays both because standards were raised – that is benefits became higher –
and because the number of recipients increased dramatically following the high
unemployment regime from the mid 1970s to the mid 1990s. To pay for the high transfers
and the large public sector – around 30 percent of the work force – the tax load is also high
in international perspective. The share public sector and social expenditure has risen to
above 50 percent of GDP, only second to the share in Sweden.
Source: Statistics Denmark ‘50 års-oversigten’ and ADAM’s databank
The Danish labor market model has recently attracted favorable international attention
(OECD 2005). It has been declared successful in fighting unemployment – especially
compared to the policies of countries like Germany and France. The so-called Flexicurity
model rests on three pillars. The first is low employment protection, the second is relatively
high compensation rates for the unemployed and the third is the requirement for active
participation by the unemployed. Low employment protection has a long tradition in
Denmark and there is no change in this factor when comparing the twenty years of high
unemployment – 8-12 per cent of the labor force – from the mid 1970s to the mid 1990s, to
the past ten years when unemployment has declined to a mere 4.5 percent in 2006. The
rules governing compensation to the unemployed were tightened from 1994, limiting the
number of years the unemployed could receive benefits from 7 to 4. Most noticeably labor
market policy in 1994 turned from ‘passive’ measures – besides unemployment benefits, an
early retirement scheme and a temporary paid leave scheme – toward ‘active’ measures
that were devoted to getting people back to work by providing training and jobs. It is
commonly supposed that the strengthening of economic incentives helped to lower
unemployment. However, as Andersen and Svarer (2006) point out, while unemployment
has declined substantially a large and growing share of Danes of employable age receives
transfers other than unemployment benefit – that is benefits related to sickness or social
problems of various kinds, early retirement benefits, etc. This makes it hazardous to
compare the Danish labor market model with that of many other countries.
 
Exchange Rates and Macroeconomic Policy
Denmark has traditionally adhered to a fixed exchange rate regime. The belief is that for a
small and open economy, a floating exchange rate could lead to very volatile exchange rates
which would harm foreign trade. After having abandoned the gold standard in 1931, the
Danish currency (the Krone) was, for a while, pegged to the British pound, only to join the
IMF system of fixed but adjustable exchange rates, the so-called Bretton Woods system
after World War II. The close link with the British economy still manifested itself when the
Danish currency was devaluated along with the pound in 1949 and, half way, in 1967. The
devaluation also reflected that after 1960, Denmark’s international competitiveness had
gradually been eroded by rising real wages, corresponding to a 30 percent real appreciation
of the currency (Pedersen 1996).
When the Bretton Woods system broke down in the early 1970s, Denmark joined the
European exchange rate cooperation, the “Snake” arrangement, set up in 1972, an
arrangement that was to be continued in the form of the Exchange Rate Mechanism within
the European Monetary System from 1979. The Deutschmark was effectively the nominal
anchor in European currency cooperation until the launch of the Euro in 1999, a fact that
put Danish competitiveness under severe pressure because of markedly higher inflation in
Denmark compared to Germany. In the end the Danish government gave way before the
pressure and undertook four discrete devaluations from 1979 to 1982. Since compensatory
increases in wages were held back, the balance of trade improved perceptibly.
This improvement could, however, not make up for the soaring costs of old loans at a time
when the international real rates of interests were high. The Danish devaluation strategy
exacerbated this problem. The anticipation of further devaluations was mirrored in a steep
increase in the long-term rate of interest. It peaked at 22 percent in nominal terms in 1982,
with an interest spread to Germany of 10 percent. Combined with the effects of the second
oil crisis on the Danish terms of trade, unemployment rose to 10 percent of the labor force.
Given the relatively high compensation ratios for the unemployed, the public deficit
increased rapidly and public debt grew to about 70 percent of GDP.

Source: Statistics Denmark Statistical Yearbooks and ADAM’s Databank

In September 1982 the Social Democrat minority government resigned without a general
election and was relieved by a Conservative-Liberal minority government. The new
government launched a program to improve the competitiveness of the private sector and
to rebalance public finances. An important element was a disinflationary economic policy
based on fixed exchange rates pegging the Krone to the participants of the EMS and, from
1999, to the Euro. Furthermore, automatic wage indexation that had occurred, with short
interruptions since 1920 (with a short lag and high coverage), was abolished. Fiscal policy
was tightened, thus bringing an end to the real increases in public expenditure that had
lasted since the 1960’s.
The stabilization policy was successful in bringing down inflation and long interest rates.
Pedersen (1995) finds that this process, nevertheless, was slower than might have been
expected. In view of former Danish exchange rate policy it took some time for the market to
believe in the credible commitment to fixed exchange rates. From the late 1990s the
interest spread to Germany/ Euroland has been negligible, however.
The initial success of the stabilization policy brought a boom to the Danish economy that,
once again, caused overheating in the form of high wage increases (in 1987) and a
deterioration of the current account. The solution to this was a number of reforms in 1986-
87 aiming at encouraging private savings that had by then fallen to an historical low. Most
notable was the reform that reduced tax deductibility of private interest on debts. These
measures resulted in a hard landing to the economy caused by the collapse of the housing
market.
The period of low growth was further prolonged by the international recession in 1992. In
1993 yet another shift of regime occurred in Danish economic policy. A new Social Democrat
government decided to ‘kick start’ the economy by means of a moderate fiscal expansion
whereas, in 1994, the same government tightened labor market policies substantially, as we
have seen. Mainly as a consequence of these measures the Danish economy from 1994
entered a period of moderate growth with unemployment steadily falling to the level of the
1970s. A new feature that still puzzles Danish economists is that the decline in
unemployment over these years has not yet resulted in any increase in wage inflation.
Denmark at the beginning of the twenty-first century in many ways fits the description of a
Small Successful European Economy according to Mokyr (2006). Unlike in most of the other
small economies, however, Danish exports are broad based and have no “niche” in the
world market. Like some other small European countries, Ireland, Finland and Sweden,
the short term economic fluctuations as described above have not followed the European
business cycle very closely for the past thirty years (Andersen 2001). Domestic demand and
domestic economic policy has, after all, played a crucial role even in a very small and very
open economy