Download 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
2
A few important milestones





The Helsinki Club 1957.
The FINEFTA agreement 1961.
The EEC agreement 1974.
EU membership 1995.
EMU membership (among the original
11) 1999.
Vaasa University, October 2008
3
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
Vaasa University, October 2008
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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 %
Vaasa University, October 2008
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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.
Vaasa University, October 2008
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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

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%)!
Vaasa University, October 2008
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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
Vaasa University, October 2008
12
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

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.
Vaasa University, October 2008
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Nordic or European?


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.
Vaasa University, October 2008
16
The FINEFTA agreement 1961


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.
Vaasa University, October 2008
17
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.
Vaasa University, October 2008
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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.
Vaasa University, October 2008
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Moving closer to the EC…

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).
Vaasa University, October 2008
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… and finally towards full
membership

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.
Vaasa University, October 2008
21
EU membership and foreign trade

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.
Vaasa University, October 2008
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Other economic aspects of EU
membership

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?
Vaasa University, October 2008
23
General government tax and non-tax
receipts (% of GDP) 2005






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

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.
Vaasa University, October 2008
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Competition in the Single Market

In the ‘old’ EU (12 members), Finnish
labour costs close to the EU average.

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.

Relatively low taxation of corporate
profits.

Relatively flexible labour market (by ‘old
EU’ standards).
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... and disadvantage Finland

Relatively high level of prices and costs.

High income taxes (for middle and high
incomes).

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
Vaasa University, October 2008
102
104
29
Finland and the EMU

On January 1, 1999, Finland joined the
EMU together with 10 other EU Member
States.

From a historical perspective, EMU
membership is a major economic policy
regime shift for Finland.
Vaasa University, October 2008
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Exchange rate policy: an overview

1945-82: Active exchange rate policy

1983-91: The ‘strong’markka

1992-95: The floating markka

1996-98: ERM participation
Vaasa University, October 2008
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From defensive to aggressive
devaluations

The three devaluations in 1945 (75, 40
and 12 % respectively) defensive
measure against post-war inflation.

The 1957 devaluation (39 %) already
partly ‘aggressive’, and the 1967
devaluation (31 %) openly so.
Vaasa University, October 2008
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Exchange rate policy and the forest
industry

‘The Finnish markka is devalued
whenever the interests of the forest
industry require it’.

Net benefits of devaluations to the
forest industry significant because of
low ratio of imported inputs to exports.
Vaasa University, October 2008
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The ‘strong markka’ regime

Already in the latter half of the 1970’s,
problems of the ‘devaluation cycle’
became evident.

Following the European trend towards
exchange rate stabilisation (the EMS
1979), Finland adopted a fixed
exchange rate regime in 1983.
Vaasa University, October 2008
34
The end of the strong markka period

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%
Vaasa University, October 2008
35
The floating markka 1992-95

After the September 7 floating, the
markka depreciated strongly until Q2 /
1993.

From mid-1993 onwards the markka
started to recover ➨ fixed again within
the ERM in 1996.
Vaasa University, October 2008
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Meeting the convergence criteria

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.

In 1997, only Finland and Luxemburg
fulfilled all the convergence criteria!
Vaasa University, October 2008
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The EMU experience so far

Given Finland’s long track record of
active exchange rate policy, adjustment
to the EMU has been surprisingly
painless.

Adjustment facilitated by the increasing
internationalisation of the Finnish
industry ➨ production across currency
areas.
Vaasa University, October 2008
38
The EMU and public finances

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.
Vaasa University, October 2008
39
The EMU and the labour market

Until recently, centralised bargaining
delivered relatively modest wage
increases.

The current round of industry-level
negotiations, by contrast, has so far
produced significantly higher increases.
Vaasa University, October 2008
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Advantages of the EMU

Low and stable interest rates (at least
compared to a fixed markka regime).

Reduced foreign exchange risks (on
trade with other EMU members).

Access to an EMU-wide financial
market.
Vaasa University, October 2008
41
(Potential) disadvantages

Risk of asymmetric shocks
– structure of production & exports
– FX exposure of foreign trade

Unsustainable development of wages
and costs
– will history repeat itself?
Vaasa University, October 2008
42
The 1991-93 crisis

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.

In 1991-93, GDP fell by 14% in volume
terms!!!
Vaasa University, October 2008
43
What caused the 1991-93 crisis?

Policy mistakes
– uncontrolled financial deregulation
– failure to curtail inflation in late 80’s
– defence of an overvalued markka

External shocks
– collapse of the Soviet Union
– recession in Western Europe
Vaasa University, October 2008
44
Financial deregulation in the 80’s

Following the general international
trend, Finland started to deregulate
financial markets in the 1980’s.

Problem: fixed exchange rates + free
international capital mobility = monetary
policy ineffective.
Vaasa University, October 2008
45
The credit boom and the asset price
bubble

Financial market deregulation caused
rapid credit expansion:
– from 1985 to 1989, total lending doubled
– foreign currency credits tripled

Credit expansion fuelled growth of
domestic demand ➨ overheating, asset
price ‘bubble’.
Vaasa University, October 2008
46
‘It hurts when bubbles burst’

Higher interest rates + decline in
economic growth burst the asset price
bubble in the early 90’s.

Floating of the markka inflated the
(markka) value of foreign currency debt.
– cost of banking crisis around EUR 6.5 bn!
Vaasa University, October 2008
47
Economic policy during the crisis

In 1991-92, fiscal policy still
accomodating.

In 1993, shift towards a contractive
stance.
– restraints of the ‘double deficit’
– threat of liquidity crisis
Vaasa University, October 2008
48
Recovery from the 1991-93 crisis

Thanks to the depreciation of the
markka, exports started to recover
already in 1993.

Real GDP reached its pre-crisis level in
1996.
Vaasa University, October 2008
49
The crisis in hindsight

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…
Vaasa University, October 2008
50
Finland and the other Nordic
countries

Finland and Sweden: forest &
engineering (including electronics).

Norway: oil & gas.

Denmark: agrifood.
Vaasa University, October 2008
51
Finnish-Swedish cooperation

In recent years, several big crossborder mergers between Finnish and
Swedish companies:
– Stora-Enso (forest industry)
– Nordea (banking)
– Telia-Sonera (telecommunications)
Vaasa University, October 2008
52
The Nordic welfare society

The Nordic welfare society is based on
‘the Swedish model’.

The general principle is that the benefits
of the welfare society should be
available to everyone (and not, for
example, work-related).
Vaasa University, October 2008
53
The future of the welfare society

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.
Vaasa University, October 2008
54
The Nordic countries and the EU

Finland: EU + EMU

Sweden and Denmark: EU but not EMU

Norway: EEA only
Vaasa University, October 2008
55
Different choices, different
objectives

Norway: strength of the ‘oil economy’
makes advantages of EU membership
less obvious than for other Nordics.

Denmark: strong & stable currency = no
obvious need for EMU participation.
Vaasa University, October 2008
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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.
Vaasa University, October 2008
57
The future of the Finnish economy

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
58
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
Vaasa University, October 2008
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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