Does suffering Finland’s economy need more cuts?

Finland’s government is ready for more spending cuts. But with a high unemployment and almost non-existent economic growth is this a needed and sustainable strategy for the economy or maybe not so much, and why? Read few comments.

Vesa VihriäläManaging Director, Research Institute of the Finnish Economy

Yes, spending cuts are being debated currently in Finland, given that the government has presented its budget proposal and plan for public finances for the coming 4 years to the parliament.

There are people, both economists and opposition politicians, who oppose the cuts, on two grounds: (1) they hurt growth, (2) increase inequality.

I personally believe that the fiscal policy approach of the government is fundamentally sound and responsible, even if the cuts hamper growth in the short term. There are several reasons for this assessment:

– There is a long-term sustainability gap in the public finances, even if its magnitude is uncertain. Rapid ageing of the population is a key reason for this.
– without spending cuts or tax increases, the ratio of public debt to GDP is going to continue to increase throughout the current electoral period , and reach some 67 % in 2019. This means that it also violates the debt criterion of the EU treaty
– similarly, without consolidation measures, Finland would fail to meet its medium term objective (MTO) of -0,5 in terms of structural balance
– the overall tax and expenditure ratios (to GDP) are among the highest in the EU, so tax increases are not very attractive way to solve the deficit and debt problems.

Our growth problem stems originally from weak export performance, which in turn is explained by major “asymmetric shocks” such as the decline of Nokia, weak demand for print paper, weka global investment growth (Finland specialises in the production of investment goods) and most recently by the weakness of the Russian demand. But also our cost competitiveness has weakened due to high wage growth in 2009 and 2010, in particular.

Exports are still some 15 % below the pre-crisis peak and have not grown at all in the past four years. This problem cannot be helped by fiscal expansion unless the expansion takes the form of fiscal devaluation. Fiscal expansion through tax cuts or say higher infrastructure investment would most likely only slow down the necessary adjustment of labour costs to increase cost competitiveness.

While I agree on the government’s basic approach to fiscal policy, I disagree partly on the composition of the measures. In particular, the cuts focus too much on funding for research and education. While the level is good in Finland, we would need to improve further our efforts in boths areas.

Pekka Sutela, Professor of Practice, Lappeenranta University of Technology, Docent, Aalto University School of Business

First, even given the policy framework of the current government, the deficit of next year’s budget is expected to be the biggest ever.

Further, the problem is not so much the sustainability of the next couple of years, but the longer perspective. All Finnish forecasting institutes agree that Finnish growth potential until 2036 is about one per cent annually. At the same time we have the fastest aging population structure in the Union with obvious implications for pension and other social security expenditure, including health. The question is about our ability or not to maintain the kind of Nordic welfare state we have built since about 1970.

Estimates differ according to assumptions on retirement age, now between 63-57, exact economic growth and possibilities of higher productivity of welfare provision, but there is no disagreement on the existence of the sustainability gap as such.

So this is not a Keynesian issue, it is a structural issue. There are however obvious Keynesian implications. I guess everybody agrees that downward expenditure revisions should only be started when we have entered growth, but we do not know when that might be. Also, what credibility might the government in power since Spring have if they had announced that expenditure would be cut sometime in the future. I understand such are the reasons the government takes the Keynesian costs now. They have made unnecessary policy design mistakes as well.

The credibility of the opposition is damaged by the fact that they – Social Democrats, the Left Alliance and the Greens in particular – were in government just previously, knowing the same facts, and doing nothing. Also, the Social Democrats make themselves seen as hostages of a couple of powerful bluecollar trade unions. The Moderates and the Center, on the other hand, are widely seen as being too cosy with the employers.

Many would agree that something like previous labor market reforms in Germany and Sweden should be implemented, but the Social Democrats have a strong status quo slant due to their trade union connection.

So many experts – including traditional supporters of current opposition parties – would agree that the current government is taking the right path while having committed unnecessary mistakes in policy design.

There are primarily academic economists who argue in purely Keynesian terms and further claim that the export performance problem is not about cost competitiveness, but about collapse of Nokia and decline in forest industries. Naturally our export base is much narrower than that in Sweden and hugely more narrow than in Germany. On the other hand I understand that the Finnish export performance has actually not been worse, at least much so, than in Sweden if one excludes Russia from the calculations (which I have not seen published yet).

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One Response

  1. Thanks for this interesting post on Finland’s problems. As the problem is structural, it requires a reallocation of resources away from declining business sectors towards new sectors with a higher potential for growth, laying a foundation for a new period of growth. Since Finland is in the euro it cannot devalue against its European neighbours, which would help it to rebalance. Some form of industrial strategy will be necessary, which could take on a more or less interventionist form. It would help if the Eurozone economy were not performing so poorly. Germany in particular needs to increase it domestic demand and reduce national savings relative to investment, so that its current account surplus falls and it provides faster growing markets for its neighbours’ exports. With a stagnating Eurozone and the global economy slowing, it will be a difficult road for Finland.

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