STOCKHOLM—This is a high-tax, high-spend country, where employees receive generous social benefits and ample amounts of vacation time. Economic orthodoxy would suggest the dynamics of a welfare state like Sweden would be detrimental to entrepreneurship: Studies have found that the more a country’s government spends per capita, the smaller the number of start-ups it tends to have per worker—the idea being that high income taxes reduce entrepreneurs’ expected gains and thus their incentive to launch new companies.

And yet Sweden excels in promoting the formation of ambitious new businesses, on a level that’s unexpected for a country whose population of roughly 10 million puts it at 89th in the world in population size. Global companies like Spotify, the music-streaming service; Klarna, the online-payment firm; and King, the gaming company, were all founded here. Stockholm produces the second-highest number of billion-dollar tech companies per capita, after Silicon Valley, and in Sweden overall, there are 20 start-ups—here defined as companies of any size that have been around for at most three years—per 1,000 employees, compared to just five in the United States, according to data from the Organization for Economic Cooperation and Development (OECD). “What you see is that start-ups have a high survival rate in Sweden, and they have relatively fast growth,” Flavio Calvino, an OECD economist, told me. Sweden also ranks highest in the developed world when it comes to perceptions of opportunity: Around 65 percent of Swedes aged 18 to 64 think there are good opportunities to start a firm where they live, compared to just 47 percent of Americans in that age group.

Producing start-ups matters for any economy that strives for efficiency, job creation, and all-around dynamism, but it is especially relevant for countries, such as the U.S., where new-business creation has slowed. Despite the current cultural fascination with start-ups, only 8 percent of all firms in the U.S. meet that definition today, compared to 15 percent in 1978. In Sweden the trend is reversed: The pace of new-business creation has been accelerating since the 1990s. As the U.S.’s GDP growth remains sluggish, Sweden’s economy grew at a rate of 4 percent in 2015 and 3 percent in 2016—a big jump, even considering that its economy is a lot smaller than the U.S.’s to begin with. And Sweden’s GDP has also outperformed that of other major European countries since the mid-1990s. So, what has Sweden been doing right?

There are several dimensions to answering that question, many of which involve changes that took place in the past 30 years. Since 1990, Sweden has made it easier for upstarts to compete with big, established firms. The 20th-century economist Joseph Schumpeter theorized that economies thrive when “creative destruction” occurs, meaning new entrants are able to replace established companies. Sweden used to have a heavily regulated economy in which public monopolies dominated the market, which made it difficult for such replacements to occur, but regulations have since been eased. While Sweden was making it harder for monopolies to dominate the market, the U.S. was changing its regulatory landscape to favor big companies and established firms (largely through overturning anti-monopoly laws and permitting industry consolidation), argues Lars Persson, an economist at Sweden’s Research Institute of Industrial Economics who has studied new-business creation in Sweden.

Sweden’s reforms were a response to a financial crisis in the 1990s, when GDP growth sank, unemployment spiked, and the government, in an effort to avoid devaluation of its currency, raised interest rates to 500 percent. To jump-start economic growth, the government deregulated industries including taxis, electricity, telecommunications, railways, and domestic air travel to increase competition, according to Persson. Deregulation helped lower prices in industries such as telecommunications, which attracted more customers. Some public services such as elder care and primary education were outsourced to private firms. So-called “product market reforms” made it easier to license new companies, and helped force inefficient legacy firms out of the market, Persson said. A new Competition Act in 1993 sought to block big mergers and anti-competitive practices. “The general lesson is that if you make it more difficult for monopolies to dominate the market, then you will have new firms entering the market,” according to Pontus Braunerhjelm, a professor of economics at Sweden’s Royal Institute of Technology.

Sweden also gives some credence to the controversial idea that cutting corporate tax rates can help stimulate entrepreneurship. The reforms of 1991 lowered corporate income taxes from 52 percent to 30 percent. (Sweden’s corporate tax rate today, at 22 percent, is much lower than the U.S.’s 39 percent, though few companies actually pay a rate that high.) Before the reforms of the 1990s, Sweden favored established companies over individuals who wanted to start a business in a number of ways: Individuals in Sweden had to pay taxes on their firm’s income and their own income from the business, while established businesses had a number of ways to reduce this double taxation.

The reforms “considerably” leveled the playing field, Persson said. “Until 1991, the Swedish tax system disfavored new, small, and less capital-intensive firms while favoring large firms and institutional ownership,” Persson wrote in a paper last year. In the 2000s, Sweden also got rid of its inheritance tax and a tax on wealthy people, which further incentivized people to earn large sums of money and, often, invest it back into the economy. “There was more capital available, so angel investors started to appear,” Braunerhjelm said. Today, there are significant tax breaks for starting and owning a business; for example, entrepreneurs can now have a larger share of their income taxed as capital income, which has a lower tax rate.

This doesn’t necessarily mean that cutting corporate taxes is guaranteed to spark new-business creation, Tino Sanandaji, an economist at the Stockholm School of Economics, told me. On top of that, such cuts can also increase economic inequality. But Sweden’s case does suggest that targeted tax cuts can make an economy more dynamic. Sweden has a reputation for having high income taxes, but today, taxes are much lower than they used to be, and are lower for corporations than they are in other developed countries. The reforms beginning in 1991 lowered the top marginal income tax rate from 85 percent to 57 percent, and today, the tax system is relatively flat, meaning that most individuals, not just rich people, pay a relatively high tax rate. Though this means the middle class pay a lot in income taxes, many Swedes I interviewed said they didn’t mind the high taxes because they got things in return, like free education and health care, that they’d otherwise have to pay for.

Before the 1990s, there was also little foreign competition in Sweden. Protectionist legislation prohibited foreigners from taking substantial ownership in Swedish companies, and fewer than 5 percent of private-sector employees worked in foreign-owned companies in the 1980s. Then, Sweden opened its market to foreign competition in the 1990s, which helped in a few ways. Instantly, there were more companies that could acquire mature start-ups, which added to the incentives to start new businesses; Mojang, the gaming company, for instance, was acquired by Microsoft for $2.5 billion in 2014. And inefficient domestic firms that weren’t able to compete with foreign firms tended to go out of business, creating a vacuum in which new companies could arise. The share of foreign ownership of Swedish companies shot up from 7 percent in 1989 to 40 percent in 1999.

All this deregulation coincided with the rise of the internet, which meant that more people were creating businesses at the same time that they were experimenting with new technology. In the 1990s, the government gave a tax break to companies that gave their employees home computers, on the condition that these computers were available to everyone, whether they managed the company or cleaned the toilets. At the same time, the government invested early in fast internet service. Though Sweden’s computer adoption rate was similar to that of the U.S., it primed entrepreneurs to think digitally when the reforms of the 1990s opened the country to development. “Every inhabitant of Sweden under 40 basically grew up with a PC in their home,” PJ Pärson, a partner at Northzone, a London-based venture-capital firm, told me. “In the 1990s, pretty much everyone was online.” (Even today, Sweden has among the fastest internet speeds in the world, with an average speed of 22.5 megabits per second, compared to 18.7 megabits per second in the United States.)

This captures the experience of Birk Nilson, one of the co-founders of Tictail, a Swedish e-commerce company that has raised $32 million in funding. Having a computer as a kid motivated Nilson to begin coding at a young age, he told me, in Tictail’s Stockholm offices, where programmers are crammed into an open office space and where the foosball tables feature hockey players instead of soccer players. Nilson, who is now 33, learned to code at age 11. He began working in tech when he was in high school, creating a blog for a Swedish magazine when he was 16. By the time he was 19, he’d met his co-founders and began working on Tictail.

Like many Swedish start-ups, Tictail began as a global company, and Nilson and his cofounders always planned to sell internationally. Because Sweden’s size means there is a limited market for its companies’ products, those companies often plan to sell internationally from the outset, and so are subject to a great deal of international competition, which tends to make them nimbler. In the U.S., by contrast, firms can afford to focus almost exclusively on the large base of consumers in-country, without having to face foreign rivals and competitors. “We’re kind of raised to think about exporting,” Nilson told me. Tictail recently moved its headquarters to New York, and opened up a storefront on the Lower East Side. The U.S. is Tictail’s largest market at the moment.

All of these dynamics, added up, create a lot of businesses, which in turn employ a lot of people. Swedish companies that survive for at least three years create five new jobs for every existing 100 jobs in the economy, according to the OECD, while that number is only two in the U.S. “When you look at the total net job creation in Sweden relative to other countries, Sweden is one of the best performing countries,” Calvino, the OECD economist, said. Start-ups in Sweden also have among the highest survival rate after three years; 74 percent of all its start-ups make it past three years.

Sweden’s impressive start-up record can also be attributed to some broader aspects of how the country is set up. Its social safety net, for instance, helps entrepreneurs feel safe to take risks. In Sweden, university is free, and students can get loans for living expenses, which allows anyone to pursue higher education. Health care is free too, and childcare is heavily subsidized. None of these benefits are contingent on having a job, which means people know that they can take entrepreneurial risks and still know many of their necessities will be covered.

“I think if you want to be an innovative country, you have to give people security so they dare to take risks,” Mikael Damberg, Sweden’s minister for enterprise and innovation, told me. Birk Nilson, for instance, knew that if his company fell apart, he’d still have health coverage; he also didn’t have any student-loan debt to pay off. “Even if you fail, even if you file for bankruptcy, Sweden has a well-known and ambitious safety net,” he told me. “So I do think that taking on risk is not as daunting in Sweden as it is in the U.S.”

The country’s start-ups also appear to benefit from characteristics that are less about the economy and more about culture. For instance, because Sweden is relatively small, Nilson and his co-founders frequently worked with and sought advice from the founders of companies like Spotify and Klarna and other successful ventures. This sharing of knowledge between entrepreneurs can make them each more productive. It’s also been argued that Swedes share cultural traits that make them more likely to collaborate. Erik Stam, a professor at the Utrecht University School of Economics, says that Swedes have high levels of trust in one another relative to other countries, which means they’re less likely to require complicated contracts to work with one another and which makes collaboration easier. There’s also an argument to make that because of this trust, supervisors tend to allow employees flexibility in what they do at work, which can spark new ideas.

Relatedly, Sweden has a high degree of “intrapreneurship,” which refers to when coworkers collaborate on projects outside of their usual assignments. For example, the telecom firm Ericsson has a division called Ericsson Garage where employees can work on projects ranging from wearable technology to tools for caregivers who help elderly people. In Sweden, 28 percent of working adults were involved in an intrapreneurial activity in the last three years, compared to 11.7 percent of Americans, according to a recent study by Stam and Mikael Stenkula, of Stockholm’s Research Institute for Industrial Economics.

Of course, there are parts of Sweden’s system that can make it difficult to start and run a company. Recruiting talented employees from abroad is difficult because income taxes for the middle class are so high relative to those in other countries, said Rune Andersson, the founder and chairman of Mellby Gård, a Swedish industrial giant. And Sweden currently levies an income tax on stock options, a form of compensation that many start-ups offer to entice prospective hires. (The government is changing that policy early next year.)

But Sweden does prove that a dynamic economy can coexist with relatively high taxes and a robust safety net. And it also proves that economies can change over time, from places where new businesses are few and far between to places where they thrive. Andersson told me that in the 25 years since he started his own business, Sweden has gotten better and better for entrepreneurs. “We have become a bit of a start-up nation in Sweden, and that’s a new phenomenon,” Braunerhjelm said. It took a giant economic shock to bring the country to this point. One hopes other countries can do the same with less urgent prompting.