Finland’s Economic Decline: What to Do Next?

Finland was one of the harshest critics of Greece for its lack of fiscal discipline which led to its current debt crisis. Paradoxically, Finland was the worst performing economy in the eurozone last year, left behind even by Greece: in the 3rd quarter, Finnish GDP contracted by 0.6%, 0.1% more than Greek GDP. How is it possible that a triple-A rated country has fallen down so much? In short, it is an outcome of 5 factors: (1) a decline of the forestry industry, (2) the end of the Nokia era, (3) cut trade ties with Russia, (4) a sharply ageing working-age population and – often emphasized by economists – (5) weak global competitiveness. As a result, Finland has fallen into a 4-year recession. This raises a natural question: “What to do next?”

Olli Rehn, Finland’s Minister of Economic Affairs, claims that, first of all, the Finnish government needs to eliminate the main cause of the economic decline in his opinion: weak global competitiveness. In the World Economic Forum’s (WEF) Global Competitiveness Index (GCI) 2015–2016, Finland ranks 8th out of 140 countries. For comparison: it ranked 4th out of 144 countries on the GCI 2014–2015. In the flexibility of wage determination category, now it ranks last, while between 2014 and 2015 it was second to last.

In Rehn’s opinion, in order to improve Finland’s global competitiveness, the government needs to undertake structural reforms, balance the public economy, examine ‘the employment and competitiveness regimes’ and attract more investment. He also mentions that it is important to create a more business-friendly environment. He proposes the following course of action: to introduce better legislation, diversify economic activities, support exports, strengthen ‘the financial position of growth-oriented enterprises’ as well as to increase funding for biotech and cleantech projects. He also points out that the effectiveness of innovation commercialization should be enhanced. “Part of the problem may be weaknesses in marketing and certain features in our leadership culture”, he points out some problematic areas.

Simon Nixon, Chief European Commentator of The Wall Street Journal, stresses that in addition to better global competitiveness, Finland’s economy needs more flexibility. This requires “deep structural reforms of its public sector, labor rules and welfare system”, he argues. At the moment, public spending equals 59% of Finnish GDP, while tax revenues account for 56% of GDP. In addition, Finland has one of the worst labour flexibility rates in the world: it was 103rd out of 144 countries ranked by the World Economic Forum (WEF) between 2015 and 2016. In Nixon’s opinion, this inflexibility has sharply increased unit labour costs. It is estimated that they are 20% higher than in Germany. Nixon also observes that Finland’s social welfare system discourages working-age residents from working. Its employment to population ratio is 5% lower than in Sweden, the World Bank’s (2011–2015) data show. All of these issues should be included in the government agenda.

Tim Worstall, Senior Fellow of the Adam Smith Institute (ASI), thinks that task No. 1 for the government is to cut labour costs. Internal devaluation will help restore Finland’s competitiveness. He warns that it will be a painful process: in contrast to currency devaluation an option taken away by the eurozone membership it will last for years, and will increase unemployment in the country.

Erkki Liikanen, Governor of the Bank of Finland, gives a 4-point recommendation to the Finnish government. First, it should consolidate the public finances. He observes that the gap between Finnish GDP and welfare spending has widened: “Our GDP is smaller but our welfare state has not shrunk so much.” Second, the government should reform the labour market to increase its competitiveness. Third, it should implement a pension reform. Finally, it should work on policies boosting innovation. In his opinion, local tech-startups will flourish even more if their needs are better addressed.

Pasi Sorjonen, Chief Analyst at Nordea Markets, also argues that the Finnish government needs to reduce public spending. “If at the same time they cut taxes they [will] help healthy businesses. Whereas they now harm the healthy businesses just to protect jobs in the public sector,” he explains.

References:  [1] Eurostat / [2] Richard Milne, Financial Times / [3] Olli Rehn, Finland’s Ministry of Employment and the Economy  / [4] Tim Worstall, Forbes / [5] Szu Ping Chan, The Telegraph