Transcript 12. finland: economic doctrines 1945 - 1990

12. FINLAND: ECONOMIC DOCTRINES 1945 - 1990
1. Preliminary considerations
2. The accumulation doctrine
3. The exchange rate as anchor of policy
1. Finland in 1945 – 1990: Preliminary considerations

the decades after WWII were the high period of keynesianism globally, not so in
Finland (illustrating a certain Finnish ’exceptionalism’)
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Finland after WWII was not a mature capitalis economy but an economy lagging
behind and hoping to catch up relative to Sweden and others
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The economic structure was charaterized by the large share of population in
agruculture
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There was shortage of capital to build up industry, needed to finance imports and
to pay war reparations to the Sovjet Union, to create infrastructure and to exploit
the natural resources in Northern Finland
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There was excess supply of labor due to high fertility and declining share of
population in agriculture, large-scale emigration
The trade balance (blue), the war reparations (green) and the current account
(the line), all in relation to GDP
Cont.
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Trade was gradually liberalized and the Finnih markka made convertible (in the late 1950s)
but capital imports remained tightly regulated
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Finland was and is a small open economy (competitiveness important)
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The external constraint (shortage of foreign exchange) was often binding, a source of
problem for macroeconomic developments and policies
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Regulation was widespread after the war, notably regulation of the financial system. More
generally, the state was a powerful actor which intervened extensively by regulation to affect
investment, saving, price developments …
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Corporatism was of great importance for policies
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Politics was characterized by splits within the labor movement; government coalitons were
often short-lived
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Overall economic developments were characterized by volatility or instability
2. The accumulation doctrine

Finland pursued supply side policies with emphasis on the accumulation of capital
(cf. Marx: ”Accumulate, accumulatte! That is Moses and the Prophets.”)
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The rationale was spelled out in 1952 by Urho Kekkonen in a small book ”Onko
maallamme malttia vaurastua?” (Does our country have the patience to become
wealthy?): he argued for forced saving in the form of government budget
surpluses to finance heavy investment, particularly in the North
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FISCAL POLICY. The government had no ambitions to stabilize the economy by
fiscal policy but emphasized budget balance (as did civil servants)

The balanced budget doctrine was associated with procyclical policies that were
destabilizing for the economy

This policy kept government debt at a low level (roughly 10 per cent of GDP)
Cont.

The government aimed at budget balance in cash terms, using tax financing not only for
government consumption and transfers but also for investment and for lending to the
private sector (to finance investment)

The external constraint contributed to destabilizing policies: an increase in exports
improving the trade balance allowed lax policies while a fall in exports, by weakeneing
the trade and current accounts, called for tighter fiscal and monetary policies

Financial constraints were key determinants of economic policy. The government was
mostly not allowed to borrow from the central bank (which was independent), foreign
capital was regulated or not available, there was no domestic bond market of any
significance and banks were unwilling to lend to the government!
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Mauno Koivisto, as prime minister, had more or less to beg the commercial banks to
lend money to the government in certain situations of cash shortage. Somewhat
remarkable that a financially solid government was squeezed in this way
Cont.
•
TAX POLICY was structured so as to given business strong incentives to invest: high
statutory tax rate (even 40 per cent), ample opportunities to reduce or avoid taxes
by investment and generous depreciation allowances
•
Dividends were taxable with the normal income tax rate but long-term capital
gains (more than 10 years) were not taxed at all
•
In practice the tax rate on capital income was very low – provided that the
company invested heavily and the owner took out the profit in the form of longterm capital gains
•
This policy gave strong incetives to invest but had also strong ’lock-in’ effects, such
that resources could not easily be reallocated and were often inefficiently
allocated
•
Also, tax deductibility of interest expenses favoured debt financing, with the
implication that the financial structure of firms was weak (high debt/equity ratio)
Central government debt in Finland, 1860-2011, % of GDP
80
70
60
50
40
30
20
10
0
1860
1880
1900
Valtion bruttovelka/BKT.
Lähde: Valtiokonttori/Mika Arola.
1920
1940
1960
1980
2000
Central government debt, per cent of GDP
General government saving and investment, % of GDP
General government financial saving (pillars) and central
government financial saving (light blue line), scale to left
Cont.
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MONETARY AND CREDIT POLICY. The discount rate, the interest rate paid by banks
when borrowing from the central bank, was for political reasons kept low and
stable (a ’Keynesian’ element of policy?)
•
There was noramlly excess demand for credit and therefore credit rationing, the
allocation of the (scarce) credits then depending on considerations by the banks
and (to some extent) recommendations of the Bank of Finland (which gave priority
to industrial investment while discouraging consumption loans )
•
Banks were normally indebted to the central bank (instead of having positive
reserves in the central bank). Each bank had a quota for CB-boroowing. Additional
borrowing (above the quota) raised the marginal cost of borrowing, and this
marginal cost was the main instrument of monetary policy
•
Interest rates on bank loans and deposits were often negative in real terms,
meaning that almost any investment would be profitable – if you could borrow
The base rate or discount rate of the Bank of Finland
Various marginal rates of interest for central bank financing of banks
(changing a lot and mostly being much higher than the discount rate)
The rate of consumer price inflation
Some key interest rates (deposits, loans, base rate) and inflation
Some key interest rates (deposits, loans, base rate) and inflation
Cont.
•
EXCHANGE RATE POLICY was in these times considered an instrument of policy
separate from interest rate policy (given foreign exchange regulation and the
pegged exchange rate)
•
Finland undertook rather large devaluations with roughly 10 year intervals (the
’devalution cycle’)
•
The devaluation cycle was not only a passive reaction to preceding inflation but
was rather an element of the accumulation policy by raising profits and by assuring
the export sector that profitability of investment would be ensured if need be by a
devaluation (thereby reducing the risks of investment)
•
INCOMES POLICY, occasionally in the form of lagre packages with heavy
government involvment, were often used with a view to wage moderation and the
preservation of competitiveness and profitability of business
The markka was devalued again and again
The accumulation policy: results, consequences
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1. The doctrine achieved what it set out to achieve: a very high rate of investment (the
highest among 22 countries, cf. Matti Pohjolas ”Tehoton pääoma”)
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2. Macroeconomic developments were unstable partly because of the structure of the
economy (narrow export base) but also because of the focus of policy on growth and
neglect of stabilization
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3. Economic growth was rapid but not impressivly so in light of the extremely high share
of investment and low consumption
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4. There was increasing evidence of distorted investment decisions (too low required
return on capital) and misallocation of resources in favor of excessive capital intensity,
which reduced efficiency and stability (encouraging tax-induced investments in boom
times etc.)
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5. The distortions were accentuated ncreased by high and increasing inflation, nottably
in the aftermath of the first oil crisis.
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In all, in the first decades after WW2 Finland was a highly regulated (and therefore
financially stable) country with all policies geared towards achieving and maintaining a
high rate of capital accumulation without regard to microeconomic efficiency