Transcript The Finnish Economy

The Finnish Economy
An introduction
Vaasa University, October 2008
1
The Finnish economy post-WWII

Liberalisation & deregulation
– foreign trade
– financial markets
– utilities

Closer integration with Western Europe
Vaasa University, October 2008
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A few important milestones

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The Helsinki Club 1957.
The FINEFTA agreement 1961.
The EEC agreement 1974.
EU membership 1995.
EMU membership (among the original
11) 1999.
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The first two decades

In the 1920’s and 1930’s, economic
policy strongly focused on agriculture &
the countryside, ”laissez faire” for the
rest of the economy (except exchange
rate policy).

Nevertheless, rapid growth &
development of manufacturing.
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A good start

In the 1920’s and 1930’s, Finland was
still very much an agricultural economy
exporting goods with low value-added.

In 1938, Finland was nevertheless
Europe’s 8th richest country as
measured by GDP per capita!
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The Finnish economy after WWII

At the end of WW II, Finland still
predominantly an agricultural society.
– around 1/3 of labour force employed in
agriculture

The forest industry by far the most
important industry.
– export share over 90% at its highest
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The war damages…

War damages to the USSR USD 300
million at 1938 prices, to be paid within
6 yrs (extended to 8 yrs in 1945).

Per capita war damages of German
allies:
– Finland USD 80
– Hungary USD 30
– Romania USD 15
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… and how they were paid

The war damages were paid in the form
of various industrial goods, of which
– machinery & equipment 33.6 %
– newly built ships 20.1 %
– paper industry products 19.7 %
– wood industry products 13.7 %
– cables & related products 8.3 %
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Consequences of the war damages

On the one hand, considerable
additional burden on the economy.

On the other hand, the war damages
gave a boost to industrialization and laid
the foundation for future trade between
Finland and the USSR.
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The bilateral trade with the USSR

Due to foreign currency shortage in the
USSR, trade with Finland took the form
of clearing trade.

Finland exported mainly machinery &
equipment and consumer goods,
imported mainly oil and other raw
materials.
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Trade with the USSR: some figures
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Finland’s trade with the USSR peaked
in 1983, with 27% of total imports and
25% of total exports.

In 1989, the USSR was still Finland’s
biggest trading partner in terms of
exports (14.5%) and third biggest in
terms of imports (11.5%)!
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The macroeconomic role of trade
with the USSR
+
+
-
Stabilisation of output and employment
Cheap Soviet oil ‘buffer’ against oil price
shocks in the 1970’s
Inefficiencies in some industries
(notably clothing & shoes)
Suboptimal resource allocation
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Between East and West

On the one hand, participating in the
trade liberalisation process in Western
Europe (EEC and EFTA) became
increasingly important to Finland.

On the other hand, the USSR highly
suspicious of Finland’s W-European
involvement.
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The first steps towards freer trade

In 1950, Finland signed the GATT
treaty.

In 1957, the ‘Helsinki Club’ agreement
granted Finnish exports the same
treatment as exports between OEEC
countries.
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Organisation for European
Economic Co-operation
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Emerged in 1948 from the Marshal Plan
(= U.S. economic aid package for
Europe).

This being the case, the OEEC thus had
a political dimension = problematic for
Finland.
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Nordic or European?

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The Nordic Council 1954 ➨ revival of
plans for a Nordic customs union.
However, with the creation of the EEC,
interest in the Nordic customs union
faded ➨ plans abandoned for good in
1959.
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The FINEFTA agreement 1961
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EEC membership impossible for
political reasons ➨ EFTA (the European
Free Trade Association) an attractive
(but not unproblematic) alternative.
Through the FINEFTA agreement in
1961, Finland became an associated
member of the EFTA.
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Nordic cooperation revisited

In the latter half of the 1960’s, revival of plans
for deeper economic integration between
Nordic countries ➨ common Nordic market
NORDEK.

Negotiations 1968-69, but the resulting draft
agreement did not satisfy Finland and
Sweden ➨ NORDEK finally buried with
Danish & Norwegian EEC application.
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The EEC agreement 1974

With the EC enlargement (Denmark,
Ireland and the UK) in 1973, securing
Finland’s position in the W-European
markets increasingly important.

Full EC / EEC membership still
politically impossible ➨ free trade
agreement in 1974.
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Moving closer to the EC…
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In 1986, Finland (finally!) became a full
member of the EFTA.

In 1989, talks about closer cooperation
between the EC and the EFTA ➨
European Economic Area (EEA).
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… and finally towards full
membership
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With the fall of the Soviet Union, the last
obstacles to full Finnish EC membership
were removed.

After Sweden had filed its membership
application in 1991, Finland followed in
1992 ➨ membership in 1995.
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EU membership and foreign trade
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The EU accounts for 56% of Finnish
imports and 54% of Finnish exports.

For the euro area, the corresponding
figures are 33% for imports as well as
exports.
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Other economic aspects of EU
membership
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Taxation
– Increasing pressure towards tax
harmonisation within the EU (e.g. sales tax
on alcohol).

Competition in the single market
– what advantages and disadvantages do
Finnish companies have in an increasingly
competitive EU market?
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General government tax and non-tax
receipts (% of GDP) 2005
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Finland
Euro area
Sweden
Slovak Republic
U.S.
Japan
53.2
45.3
59.1
34.7
32.8
31.7
Source: OECD
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Tax harmonisation in the EU
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So far, strongest pressure for
harmonisation of capital income taxes +
partial harmonisation of VAT and other
indirect taxes.

By contrast, no immediate pressure for
harmonisation of income taxes.
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Competition in the Single Market
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In the ‘old’ EU (12 members), Finnish
labour costs close to the EU average.
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However, with the 2004 (and 2007)
enlargements, competitive pressure on
labour costs has increased – though
wages are rapidly catching up in some
new Member States.
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Advantage Finland...

Strong position in high-tech – for now.
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Relatively low taxation of corporate
profits.
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Relatively flexible labour market (by ‘old
EU’ standards).
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... and disadvantage Finland
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Relatively high level of prices and costs.
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High income taxes (for middle and high
incomes).
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Below-average labour productivity
(although big differences between
sectors + ‘public sector bias’)
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Labour productivity per hour of
work 2005
Sweden
Finland
Euro 12
EU 15
90
92
94
96
98
100
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102
104
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Finland and the EMU
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On January 1, 1999, Finland joined the
EMU together with 10 other EU Member
States.
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From a historical perspective, EMU
membership is a major economic policy
regime shift for Finland.
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Exchange rate policy: an overview
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1945-82: Active exchange rate policy
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1983-91: The ‘strong’markka
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1992-95: The floating markka
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1996-98: ERM participation
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From defensive to aggressive
devaluations
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The three devaluations in 1945 (75, 40
and 12 % respectively) defensive
measure against post-war inflation.
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The 1957 devaluation (39 %) already
partly ‘aggressive’, and the 1967
devaluation (31 %) openly so.
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Exchange rate policy and the forest
industry
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‘The Finnish markka is devalued
whenever the interests of the forest
industry require it’.
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Net benefits of devaluations to the
forest industry significant because of
low ratio of imported inputs to exports.
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The ‘strong markka’ regime
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Already in the latter half of the 1970’s,
problems of the ‘devaluation cycle’
became evident.
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Following the European trend towards
exchange rate stabilisation (the EMS
1979), Finland adopted a fixed
exchange rate regime in 1983.
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The end of the strong markka period
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By the beginning of the 1990’s, the
markka already significantly overvalued,
start of the ‘countdown’:
– ECU peg in June 1991
– Devaluation (14%) in November 1991
– On September 7, 1992, the markka was
floated and subsequently depreciated by
around 30%
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The floating markka 1992-95
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After the September 7 floating, the
markka depreciated strongly until Q2 /
1993.
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From mid-1993 onwards the markka
started to recover ➨ fixed again within
the ERM in 1996.
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Meeting the convergence criteria
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Fiscal discipline imposed by the 199193 crisis + favourable economic
conditions in the latter half of the 1990’s
made it relatively easy to meet
convergence criteria.
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In 1997, only Finland and Luxemburg
fulfilled all the convergence criteria!
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The EMU experience so far
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Given Finland’s long track record of
active exchange rate policy, adjustment
to the EMU has been surprisingly
painless.
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Adjustment facilitated by the increasing
internationalisation of the Finnish
industry ➨ production across currency
areas.
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The EMU and public finances
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At present, public finances are healthy
(budget in surplus, public debt well
below Maastricht limit).

But downward pressures on taxes and
upward pressures on public expenditure
will become a challenge in the near
future.
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The EMU and the labour market
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Until recently, centralised bargaining
delivered relatively modest wage
increases.
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The current round of industry-level
negotiations, by contrast, has so far
produced significantly higher increases.
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Advantages of the EMU

Low and stable interest rates (at least
compared to a fixed markka regime).
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Reduced foreign exchange risks (on
trade with other EMU members).
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Access to an EMU-wide financial
market.
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(Potential) disadvantages
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Risk of asymmetric shocks
– structure of production & exports
– FX exposure of foreign trade
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Unsustainable development of wages
and costs
– will history repeat itself?
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The 1991-93 crisis
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After a period of exceptionally strong
economic growth in the latter half of the
80’s, Finland was hit by a severe crisis
in 1991.
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In 1991-93, GDP fell by 14% in volume
terms!!!
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What caused the 1991-93 crisis?
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Policy mistakes
– uncontrolled financial deregulation
– failure to curtail inflation in late 80’s
– defence of an overvalued markka
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External shocks
– collapse of the Soviet Union
– recession in Western Europe
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Financial deregulation in the 80’s
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Following the general international
trend, Finland started to deregulate
financial markets in the 1980’s.
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Problem: fixed exchange rates + free
international capital mobility = monetary
policy ineffective.
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The credit boom and the asset price
bubble
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Financial market deregulation caused
rapid credit expansion:
– from 1985 to 1989, total lending doubled
– foreign currency credits tripled
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Credit expansion fuelled growth of
domestic demand ➨ overheating, asset
price ‘bubble’.
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‘It hurts when bubbles burst’
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Higher interest rates + decline in
economic growth burst the asset price
bubble in the early 90’s.
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Floating of the markka inflated the
(markka) value of foreign currency debt.
– cost of banking crisis around EUR 6.5 bn!
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Economic policy during the crisis
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In 1991-92, fiscal policy still
accomodating.
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In 1993, shift towards a contractive
stance.
– restraints of the ‘double deficit’
– threat of liquidity crisis
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Recovery from the 1991-93 crisis
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Thanks to the depreciation of the
markka, exports started to recover
already in 1993.

Real GDP reached its pre-crisis level in
1996.
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The crisis in hindsight
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Should the markka have been devalued
or floated earlier?
– decline in GDP less severe with earlier
devaluation (9% compared to 14%)

Should fiscal policy have been more
accomodating?
– with the benefit of hindsight yes, but…
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Finland and the other Nordic
countries
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Finland and Sweden: forest &
engineering (including electronics).
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Norway: oil & gas.
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Denmark: agrifood.
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Finnish-Swedish cooperation
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In recent years, several big crossborder mergers between Finnish and
Swedish companies:
– Stora-Enso (forest industry)
– Nordea (banking)
– Telia-Sonera (telecommunications)
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The Nordic welfare society
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The Nordic welfare society is based on
‘the Swedish model’.
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The general principle is that the benefits
of the welfare society should be
available to everyone (and not, for
example, work-related).
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The future of the welfare society
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So far, the ’Nordic Model’ has been
quite successful in combining equality
and economic efficiency...

...but faces challenges from
international tax competition and an
aging population.
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The Nordic countries and the EU
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Finland: EU + EMU
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Sweden and Denmark: EU but not EMU

Norway: EEA only
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Different choices, different
objectives
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Norway: strength of the ‘oil economy’
makes advantages of EU membership
less obvious than for other Nordics.
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Denmark: strong & stable currency = no
obvious need for EMU participation.
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Different choices, different
objectives

Sweden: domestic economic policy
objectives come first ➨ ‘wait and see’
attitude towards EMU.

Finland: in addition to economic
aspects, EU membership also has a
strong political dimension.
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The future of the Finnish economy
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Demographic changes: with a rapidly
aging population, the labour force will
start to decline in the near future.

De-industrialisation: manufacturing is to
an increasing extent being relocated to
countries with lower labour costs and /or
rapidly growing markets.
Vaasa University, October 2008
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Where have all the young Finns
gone..?
Working-age population (15-64 yrs)
3600
3500
1000 pers.
3400
3300
3200
3100
3000
2900
2010
2020
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2030
59
The vital role of productivity

Long-term economic growth determined
by growth of the labour supply and
growth in labour productivity.

As the labour force starts to decline,
growth will depend entirely on the
growth in labour productivity!
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