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By John Fund From the March/April 2008 Issue

Filed under: World Watch, Economic Policy

A small country with a skilled workforce, booming exports, and enormous prosperity has become the envy of Europe.
For years, prosperous and peaceful Switzerland has been underappreciated. Being small and successful, frankly, is boring to many people. Consider the Cold War spy movie “The Third Man.”

In a famous scene, the shady character played by Orson Welles observes, “In Italy, for 30 years under the Borgias, they had warfare, terror, murder, bloodshed—they produced Michelangelo, Leonardo da Vinci, and the Renaissance. In Switzerland, they had brotherly love; they had 500 years of democracy and peace, and what did that produce?

The cuckoo clock.” To add insult to slur, the cuckoo clock is actually from Germany. In reality, the Swiss have produced a remarkable success story that goes far beyond the signature tourist products they are known for: chocolates, watches, and knives.

They have one of the world’s most stable economies, a skilled workforce, internationally recognized export companies, a sound currency, and renowned banking and financial services. All this is combined with remarkable social harmony, given that Switzerland has four national languages and great religious diversity. 

The nation also has a high degree of personal freedom, linked to a decentralized government in which voters are the ultimate sovereign through an elaborate system of direct democracy—citizens can both propose their own laws and challenge any action of the government.

As a matter of fact, Swiss citizens may advance new legislation or “initiatives,” which must be put to a nationwide vote if their proponents can round up 100,000 signatures in support of the legislation. By means of referendum, the Swiss can also challenge a piece of legislation already approved by the federal parliament.

If opponents of the new legislation amass 50,000 signatures in the first 100 days after the law is published, the electorate is allowed to make the decision. Singapore’s Lee Kuan Yew, the founding leader of another economic success story, has told associates he modeled his policies after those of Switzerland minus its reluctance to interfere in the daily lives of its citizens and the accountability of its direct democracy.

In 2005, The Economist Intelligence Unit ranked the “quality of life” in 111 countries and found Switzerland a stellar achiever in the nine factors of its index: material well-being, health, political stability, both family and community life, climate, job security, political freedom, and gender equality. Indeed, when ranking “human misery” among all countries, Switzerland ranked at the very bottom.

The Swiss have produced a remarkable success story that goes far beyond the signature tourist products they are known for: chocolates, watches, and knives.

When it comes to competitiveness—the set of policies and institutions that determine a country’s productivity—Switzerland ranks second among all countries according to the latest report of the World Economic Forum, funded by 1,000 of the world’s leading corporations.

It is bested only by the United States. Following behind it are Denmark, Sweden, Germany, Finland, and Singapore. “Switzerland’s top ranking reflects a combination of world-class capacity for innovation, and the presence of a highly sophisticated business culture,” the Forum concluded.

“Business activity in [Switzerland] benefits from a well-developed institutional framework, characterized by respect for the rule of law, an efficiently working judicial system, and high levels of transparency and accountability within public institutions. Flexible labor markets and excellent infrastructure facilities are two healthy features of the business environment.”

It wasn’t always so. For much of its history, Switzerland was a backward society of farmers and tradespeople. It had scant natural resources and was so poor that many of its young people emigrated to America in order to make a living (Albert Gallatin, Thomas Jefferson’s treasury secretary, and John Sutter, who set off California’s Gold Rush, were two notable examples). Just a century ago, Switzerland was much poorer than Argentina.

Today, Switzerland looms much larger in the world economy than its small size and  population of only 7.5 million people would lead one to guess. Its passion for quality has raised global standards worldwide in fields from pharmaceuticals to biotechnology to medical devices. It ranks among the top 20 global exporters. When only services are considered, Switzerland ranks among the top 12 exporters.

Trade, along with efficient industries (such as machinery and electronics), has been essential to Swiss economic well-being. Its lamentable agricultural protectionism aside (it pays each of its famous cows an annual subsidy of more than $1,500), Switzerland benefits from relatively open trade policies. And its bank law structure makes Switzerland a uniquely attractive destination for foreign investment.

As a direct investor in the United States, Switzerland’s share is greater than all of Latin America, Africa, and Asia (excluding Japan) combined.

Europe is by far the most important Swiss trading partner, with four-fifths of all imported goods and almost two-thirds of all exported goods being traded with the EU. But the ties between the United States and Switzerland, which share a similar federal democratic structure, are extensive.

The United States is the biggest foreign investor in Switzerland, and Switzerland represents the sixth-largest foreign investor in the United States. Indeed, America imports more Swiss goods than any other country except Germany. As a direct investor in the States, Switzerland’s share is greater than all of Latin America, Africa, and Asia (excluding Japan) combined.

In visiting Switzerland, I was struck by the almost complete absence of one topic in business conversations: labor strife. The Swiss economy has a skilled and cooperative workforce at the same time that a quarter of the country’s full-time workers are unionized. Ever since a landmark 1937 national agreement, in which both labor and management pledged to try to settle disputes without disrupting the economy, there has been a high degree of harmony.

Disputes are settled through 600 collective bargaining agreements. These negotiated agreements between employers or employer associations and trade unions refer to salaries, holidays, working time, and termination of working contracts. They exist in almost all fields of economic activity and are signed for a limited period of time in which labor peace has to be respected. As a consequence, strikes have been very rare ever since. The total number of days lost to labor action is among the very lowest of all industrialized nations.

“There is a respect for the individual at all levels of Swiss society,” says Micheline Calmy-Rey, president of Switzerland—a position that rotates every year among seven members of the multiparty Federal Council. “We are not a glamorous country,” she says, “but we put human beings at the center of our system.” “We never had the street rise up and view the social order as illegitimate,” says Stéphane Garelli of the University of Lausanne’s business school. “There has never been a revolution here. Wealth here is expected to be discrete, but it is respected and protected.” He notes that while 17 billionaires currently live in Switzerland, only five are Swiss.

Indeed, each canton (the equivalent of a U.S. state) is allowed to set its own tax policy, and many sign individual contracts with high-income foreigners specifying what their tax rate will be should they settle in the country. This brings the country both glamorous residents, such as British actor Roger Moore, along with controversial personalities, such as financier Marc Rich. An international commodities trader, he fled the United States in 1983 to live in Switzerland while being prosecuted on charges of tax evasion and making illicit oil deals with Iran during the hostage crisis. He received a pardon from President Bill Clinton in 2001.

Corporate taxes are levied at both the federal and cantonal level. The federal tax rate is the same throughout Switzerland, at 8.5 percent for corporate income, with cantons adding their own modest corporate tax rate on top of that. Cantonal income tax rates also vary.

This has resulted in a form of tax competition within the country. In 2004, the canton of Schaffhausen lowered taxes to induce high-income earners to move to it. Other cantons have followed. The latest is the canton of Obwalden, whose citizens voted nine to one last December to impose a 1.8 percent income tax rate. The first $8,700 of income will be exempt, in order to ensure a slight, progressive tilt to the system.

‘We never had the street rise up and view the social order as illegitimate,’ says Stéphane Garelli of the University of Lausanne. ‘There has never been a revolution here.’

The Swiss finance minister, Hans-Rudolf Merz, has publicly welcomed the flurry of tax competition. In a recent speech, he said that tax competition protects the citizen from the “excessive tax appetite” of governments and that it was one of the most important tools for budgetary discipline. Finally, he stressed that tax competition is a valuable “discovery procedure” leading to new and innovative taxation models. On a federal level, almost everything had been learned from watching the cantons experiment.

Christoph Blocher, Switzerland’s former justice minister and the president of the conservative Swiss People’s Party, is aware of the need to cultivate a business climate friendly to free enterprise. The owner of a major chemical company before entering politics, his keynote speech before the annual St. Gallen Business Conference in 2006 was a stirring defense of classical liberalism. “Anyone who still speaks in socialist rhetoric has slept through history,” he declared. “Economic liberalism has done more to fight poverty and create jobs than any other doctrine.”

Most Swiss do not speak in such ideological terms. “We tend not to make grand speeches; instead, we foster the stability that businesses crave and seek,” says F. X. Perroud, a senior adviser to Nestlé, the food conglomerate. A visit to company headquarters in Vevey, on the shores of Lake Geneva, is a revelation. Employees at Nestlé headquarters represent an astonishing 72 nationalities, and only half of the worldwide workforce is Swiss. Fully 94 percent of the company’s revenues are earned outside its native country.

‘We tend not to make grand speeches; instead, we foster the stability that businesses crave and seek,’ says an adviser to Nestlé, headquartered on the shores of Lake Geneva.

“The lessons that the Swiss have held close to their heart are simple,” says Perroud. “One, there is no such thing as a miracle or a free lunch—everything has to be earned, so there is a strong work ethic. Two, we put as much responsibility as possible where people are in control. In small towns, even teachers used to be elected until recently. Everything is highly transparent, so it is difficult for anyone to accumulate too much power.”

But what about the supposed dark side of Switzerland? There was a scandal over the application of the country’s bank-secrecy laws in the 1990s. Accusations swirled that bank accounts opened by Jews before and during World War II were handled improperly: Swiss bankers were charged with either failing to search aggressively enough for the account holders—survivors or heirs—or not giving those holders appropriate access to their accounts. The issue was a public relations fiasco for the country, and resulted in a settlement of nearly $1.3 billion in 1998.

But in 2001, after an exhaustive four-year investigation, the Claims Resolution Tribunal, which was charged with adjudicating claims on Swiss accounts dormant since the end of World War II, released its findings on a list of 5,570 foreign accounts. It found that most dormant Swiss bank accounts thought to have belonged to Holocaust survivors were established by non-Jewish clients who later neglected the accounts. Only about 200 accounts could be traced to Holocaust victims; claimants were awarded $11 million.

Overall, Swiss financial institutions have an enviable reputation. Zurich is an international center for bond trading; Geneva is both the world’s third-biggest oil-trading center after London and New York and also a renowned center for private banking. “The Swiss are famous for being discrete and service-oriented,” says Kevin Milne, the managing director of the International Capital Market Association Ltd. “Private banking has a long legacy in Switzerland. There is a compelling logic that if you are wealthy, want to minimize your tax, and not display your wealth, you choose Switzerland  for your banking.”

How long will Switzerland be able to keep trading with the EU through bilateral agreements while remaining a hole in the doughnut of a politically centralized Europe?

But there are warning signs that all is not serene in the Swiss economy. For one thing, immigration has become a hot-button political issue as asylum seekers and guest workers brought in for short-term job assignments increasingly find ways to stay.

Evidence of popular discontent can be found in the spectacular rise in support for the People’s Party. Led by Christoph Blocher, the party became the largest in the country during the last few years. It won 29 percent of the vote in the October 2007 parliamentary elections, running in part on a platform of tightening asylum laws and making it easier to deport criminal aliens and their children. Blocher’s electoral success so upset the status quo of Swiss politics that the other parties combined to engineer his departure from the seven-member executive council that runs the country.

In addition, Switzerland’s long-standing advantages in pharmaceutical research and development are vanishing. In 2002, Novartis moved the headquarters of its worldwide research arm from Basel to Cambridge, Massachusetts. Government price controls and restrictions on advertising bear much of the blame.

In 1990, the pharmaceutical industry spent 50 percent more on research in Europe than in the United States. In 2001 the situation was reversed, with 40 percent more spent in the United States. In 1992, six out of the ten top medicines in worldwide sales were European, while in 2002 only two of the top ten were Europe-based. Biotechnology is another Swiss-pioneered research area that is under increasing regulatory pressure.

In a 2005 referendum, for example, Swiss voters approved a five-year ban on the agricultural use of genetically modified organisms. Compared to the situation in the United States, biotechnology still has some way to go in Europe before becoming established as a mature and consolidated industry. Only 16 percent of European biotechnology companies have gone public, whereas in the United States public companies represent 77 percent of the total.

There are other challenges. Famous for its neutrality and standoffishness, Switzerland has prospered by not being part of the European Union. “Don’t put us into the political mess of the EU,” says Garelli of the Lausanne Business School. But Swiss officials are under increasing pressure to integrate with the rest of Europe.

And there is growing doubt that Switzerland will always be able to pull off the hat trick of trading with the European Union through bilateral agreements while remaining a hole in the doughnut of a politically centralized Europe.

Here’s hoping the doughnut hole is never completely filled. Despite Orson Welles’s famous line, Switzerland has shown how a once-poor country can get the basics of a successful economy nailed down “tight and right.”

The country’s economic management has produced low inflation, low long-term costs of capital, a good investment climate, and a high quality of life, along with sound and transparent public finances. Cutting-edge Swiss architects, visual artists, graphic designers, and Nobel Prize winners in science have made the country a leader in ideas-based industries that will drive its growth in the 21st century.

And for the vast majority of the world’s people who most want a prosperous life, Switzerland still represents what amounts to a bourgeois heaven. And there’s nothing at all unimpressive about that.

John Fund writes the weekly column “On The Trail” for