Finland's Economy - Last One Out Turn Off the Northern Lights?

Or still willing to shine?

By Aapo Markkanen: Tampere

If Joseph Schumpeter still lived, he would like Finland. Few other countries in the world have so thoroughly proved his point about creative destruction, which has it that the rise and fall of enterprises at the micro level, and national economies at the macro level is defined by how well and how soon they can adapt to change; by accepting that the operational environment is inherently evolutionary, and that the greatest art you can master is the art of letting go. It’s a lesson worth learning, and not least for the Finns themselves.

Finland, isolated by geography, started its industrial revolution rather late, at the end of the 19th century, and remained largely an agrarian society until halfway the 20th; when it became independent in 1917, 70% of the employed population was working in agriculture. Even if the step to manufacturing took its time, the next ones up the value ladder were less hesitant; yet brought about by the country’s own willingness to move on and to the evolutionary imperative - the dire circumstances of the early-1990s, that is.

Like other European market economies, Finland liberalised its financial sector at the beginning of the 1980s, which launched an intense credit boom, since borrowing wasn’t anymore a luxury reserved to the finest of society. In this case the policy was totally reactive, at best: out of fear of foreign capital, Finland had been Europe's laggard when it came to free its financial markets, and therefore couldn’t have the benefit of gradualism. As a result, the people went credit-mad and the banks, having been under inadequate scrutiny, lent them money for almost non-existent securities.

The boom and bust cycle came to an end around 1991, hence coinciding with the collapse of the Soviet Union - the destination for one fifth of Finnish exports - and doubling the trouble. For firms, bilateral bargaining with the mighty neighbour had been very favourable, so there had been no serious incentive to focus on the quality of products, or think "what's next". To make matters even worse, the Central Bank (previously a culprit of "playing Italian", i.e. granting a devaluation whenever the big exporters, namely the paper mills, and the affiliated trade unions, gestured for one), in search of credibility, had pushed for a stubbornly overvalued Finn Mark, and exports were not only of low quality but also far too expensive. When the recession was finally over in 1994, the country had lost about 14% of its 1991-level GDP and went from full-employment to a 20% unemployment rate.

Luckily, in the 1980s there had been some other issues that Finnish policy-makers had actually got right. As this paper (PDF) stresses, the policy of innovation underwent a healthy overhaul during that decade. The traditional public approach had been one of picking winners and investing money in them, whereas the Finnish government had understood - for reasons unknown, considering everything they did not understand - that innovation has more to do with micro than macro, and can merely be enabled, rather than directed. Following this vision, and along with the other Nordic nations, Finland was the first country in the world to open its telecoms market, thus allowing a company typically linked to the production of pulp, car tires and toilet paper to use it as an everyday laboratory. And as the mentioned conglomerate also took the risk of focusing on a product for which there were no mass market at the time, this all eventually paid off; Nokia was the first to move, and - once the recession had wiped off most of the low-value businesses - could as well find enough human capital to facilitate its expansion. Had politicians bailed out the old industries, this couldn't have been possible.

So if the water is already boiling, the frog (indeed, the Finnish parliamentary race isn't Europe’s only spring election) usually jumps out of the kettle. But that was fifteen years ago. How widely awake is Finland today?

First of all, it should be as awake as possible. Finland's median age is the world's fourth highest, exactly at 41 years. Total fertility is at Nordic levels, at 1.8 children, so the long-term situation is not as alarming as in most parts of Europe, yet the large number of baby-boomers will make it sure that roughly from 2010, and at least until the 2030s, Finns will have to live with the idea of constant austerity and growth levels on par with inflation, at best. If perceived in merely relative terms, the country's current public debt, presently 38% of GDP, may provide some relief - being rather modest by pan-European standards, and down from the 60% recession levels - but this, unfortunately, doesn't make its own straightjacket any looser. The debt level remains after all rather high, owing its shrinking largely to GDP growth rather than to actual debt settling. Hence spending the upcoming decades away won't be an option, and the next four years will be the last "normal years" for governing.

And if you use the mandate that is ending as a yardstick, the normal years have been good years. In 2006, the Finnish GDP grew by 5.5% (approx one per cent is a statistical mirage, due to a 2005 lockout in the paper industry) and is now $32.800, above Belgium and nearly even with Australia. Households saw their real income rise by 1.6%, which is partly thanks to some (arguably generous, considering the future) tax cuts introduced by the incumbent coalition. The overall taxation, in terms of GDP, is now at 43.5% and, if you listen to the OECD's advice, there's no fiscally sustainable way to push it lower; all decreases should be balanced by equal cuts in expenditure. As the safe margin has been exhausted, the OECD suggests instead that Finland should move from taxing incomes towards higher taxes on property (currently among Europe's lowest), yet such a maneuver wouldn't go down well among the electorate. It is a land where seven out of ten own their own homes - and, as you might guess, the remaining three that don't, have no political clout either.

The keenness of Finnish to own their homes, and the government's keenness to sponsor it, have also had their consequences for the labour market. The official, and somewhat fiddled, figures put the unemployment rate close to 7%, yet the regional disparities are dramatic. The prospering south and south-west regions, specifically the one surrounding Helsinki, are already suffering from a chronic labour shortage whereas declining areas in the east and north-east parts of the country sometimes have more than a fifth of their population jobless; and moving is, naturally, difficult if one has to sell property in a place where demand is low and then move to the booming capital.

Housing policy is definitely the only rigidity troubling the Finnish labour market. One myth about the so-called Nordic model is that of flexicurity, i.e. low job protection but high unemployment security. It may certainly be valid in Denmark, but Finland, or Sweden, are rather different cases, as you can see for example in this paper (PDF); in terms of hiring and firing Finland is more or less your average EU country - one that, moreover, has a long tradition of setting wages through collective agreements and universal pay raises. This has arguably contributed to containing inflation, and maintaining low income differences, but - by ignoring varying productivity levels - has also priced many low-skilled workers out of jobs altogether. Generally speaking, all these rigidities have not only led to a high-unemployment rate but also to an increasingly two-tier labour market, where a majority is enjoying well-protected permanent contracts and the worse-off minority has to combine one short-term or part-time post after another; as you can see from this PDF (and Chart 2.6), among OECD's EU members only Spain and Portugal have a bigger share of their workforce under temporary contracts.

Finland's total participation rate is nevertheless 70%, and has been on the rise since the government reformed the pension system in 2005. Prior to the changes, pensions were defined by the final salary of the retiree; in the new system it's the whole career that matters, and the working years from 63 to 68 have been made particularly lucrative. As concluded in this paper (PDF warning, again), for example, the reform can be considered a comparative success (namely in comparison to failed reforms e.g in France or Austria) but even then, it still left many problems unsolved - being "a new-entrant reform" and thus leaving the existing handouts untouched. (It is exactly cases such as this that made Peter Drucker to predict that intergenerational conflicts of interests will bring chaos to the increasingly obsolete political systems everywhere.) So the system has been tinkered with, but not fixed.

You can say the same about the education system, no matter how hard it has been benchmarked after the PISA results. To sum it up: the primary level does a good job with the young minds, the secondary level starts to waste their skills, and the tertiary level provides an equal distribution of mediocrity to everyone whose skills haven't been been wasted so far. You can read about the secondary level here, whereas the main problem of higher education is pretty simple: lack of money.

Universities were still adequately funded about ten years ago, but since then Finland has run into the same trouble as every other country that doesn't charge for tuition; if you don't allow the universities to collect their own money you must increase their public support by sums equal to inflation rates - and do it while the other services are also claiming for more money. It's nearly impossible. Also, if university revenues have no direct link to their own funding they will never get a true incentive to specialise or start competing with each other or, above all, their peers abroad. In other words, Finland has plenty of faculties that are "okay" or "good" but very little pockets of excellence. It can't make knowledge a business.

"Could be better, could be much worse" seems to describe best how Finland is like in the eve of demographic decline. Its macroeconomic prospects aren't as alarming as in most other developed countries (the point made by WEF's Competitiveness Reports year after year - it's the macroeconomy, stupid!) and it has indeed made an effort trying to make its welfare model sustainable. But is it enough? As it appears now, Finland is most likely to keep its head above the water but not much more. It will muddle through but it won't sparkle.

That is, unless it can learn some new tricks. The true lesson for Finland has been, after all, one of letting go. If Finns turn out to be as willing (or as forced) to change their ways as they have been before, they should do alright - assuming that their memory has not begun to fail them once they've grown older. If it indeed has, and Finns have grown complacent, then the future won't be too bright. The next four years will tell a lot.