Finland in Trouble. Whom to blame? Adviser to the Board/Bank of Finland Antti Suvanto 12.12.2014 1
Finland in Trouble. Whom to blame?
Adviser to the Board/Bank of Finland
Antti Suvanto
12.12.2014 1
11.12.2014 Antti Suvanto 2
Economic chill set to make Finland the sick man of Europe
Tony Barber Dec 02 07:16 Financial Times
Which of the eurozone’s 18 member states will be the weakest performing economy in 2015?
Italy, which has recorded no economic growth since 1999? Cyprus, which is still reeling from its financial sector collapse in 2012-13? Or some other hard-pressed southern European nation? No. In all probability, the sick man of the eurozone will be Finland.
Outline
• Finland in trouble. Some stylized facts
• Tale of two recessions
• Tale of two countries
• Short-term outlook
– Russian dimension
• Longer-term concerns
• Way forward?
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Finland in trouble. Some facts
Some facts
• Output decline in 2009 the biggest annual drop since 1918
• Recovery started in 2010 halted in less than a year
• 2015 likely to show further negative growth
• Finland is a loser in Europe
• Exports worse than in Greece
• Industrial output low and stagnated, while public services continue
to grow
• Longer-term comparison is more favourable
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Finland – a loser in Europe
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GDP volume, 2008Q1=100
Finland – a loser in Europe
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GDP volume, 2008Q1=100
Finland – a loser in Europe
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GDP volume, 2008Q1=100
Export performance - the worst in the euro area
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DE
ES
PT
IT
EL
FI
Value added by sector (current prices)
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Change, % p.a. 2000–2007 2008–2013
Public services 5,5 % 3,9 %
Private services 5,2 % 2,7 %
Construction 7,0 % 0,2 %
Manufacturing 3,9 % -6,2 %
Longer-term comparison is more favourable
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Longer-term comparison is more favourable
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Tale of two recessions
Output growth
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Source: Gulan, Haavio and Kilponen (2014)
Multiple crises in early 1990s
• Multitude of crises
– currency crisis
– banking crisis
– structural crisis
– boom-bust housing cycle
• Proximate causes
– bad policies
– bad banking
– bad luck
• Recovery
– good policies
– good management
– good luck
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Too much complacency in late 1980s
- Finland – Japan of the North
- This time is different
Double recession post-2008
• Global financial crisis
– no domestic banking problems or financial distress
– strong government finances to begin with
– export structure made the country vulnerable to the global financial
crisis • specialisation to investment goods
• Domestic structural crisis
– loss of comparative advantage in ICT and paper industry
• On top of that:
– weak Europe
– Russia/Ukraine
– political uncertainty
– demography
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Too much complacency in early 2000s
- Finland – the most competitive country
in the world
- Most modern and innovative and
innovative in Europe
Two recessions
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Two recessions
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Unemployment rate
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Bust in the housing market
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Decomposition of output growth
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Source: Gulan, Haavio and Kilponen (2014)
A recent study
Adam Gulan, Markus Haavio and Juha Kilponen, ”Kiss me deadly: From Finnish great
depression to great recession”, Bank of Finland Discussion Paper 24/2014.
• We investigate the causes of the Finnish Great Depression in 1990-1993. We find
that the collapse of the overheated financial and banking sectors starting in 1989 was
the trigger of the economic crisis. Foreign shocks, which include the collapse of trade
with USSR in 1991, can account for at most about half of the slump, and these
shocks occurred only when the economy was already in free fall. Also, the
deleveraging and restructuring process of the financial system substantially
prolonged the subsequent recovery.
• Our methodology involves estimating a structural VAR model with sign and
exogeneity restrictions. Importantly, we are able to distinguish between financial
shocks affecting the demand for intermediated loans and those shifting the loan
supply curve. Hence we also contribute to the discussion on which financial shocks
actually matter.
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Decomposition of the latest downturn
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2011:1 2011:3 2012:1 2012:3 2013:1 2013:3 2014:1-6
-5
-4
-3
-2
-1
0
1
2
3
4BKT:n vuosikasvun sokkihajotelma
Ulkoiset tekijät
Kotimaiset kysyntä ja tarjontatekijät
Kotimaiset rahoitusmarkkinatekijät
Muut
BKT:n vuosimuutos
External shocks
Domestic financial shocks
Domestic demand
and supply shocks Other shocks
Source: The Bank of Finland Bulletin 4/2014 (forthcoming)
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Tale of two countries
Finland and Sweden in a cross-country comparison
• Until the Great Recession economic development almost identical in
the two countries
– both outperformed the euro area countries on average
• Economic policies have been very similar
– Riksbank has followed the ECB (similar inflation targets)
• Both countries undertook structural reforms (lesson from the crisis of
the 1990s)
– Sweden did more, while in Finland the drive for reforms halted
• Being in or out of EMU does not seem matter much; policy and
institutions matter much more
• As regards the future, the jury is still out …
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GDP volume, 1998=100
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GDP components
Private consumption Fixed capital formation
Exports Imports
SE
SE
SE
SE
FI
FI FI
FI EA
EA
EA
EA
Unemployment, current account and public finances
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Unemployment, % Current account, %/GDP
General government surplus, %/GDP General government debt, %/GDP
Monetary policy interest rates
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ECB Riksbank
SEK exchange rates
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Exports, current prices
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Exports, current prices
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Labour market
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GDP Labour force
Employment Unemployment, %
SE
SE
SE
SE
FI FI
FI
FI
Structural indicators
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Source: Korkman and Suvanto (2014)
A recent study Korkman, S. and A. Suvanto (2014), “Finland and Sweden in Cross-Country Comparison:
What are the Lessons?”, in Andersen, T., Bergman, M. ja Hougaard Jensen, S. (eds.),
Reform Capacity and Macroeconomic Performance in the Nordic Countries, Oxford
University Press (forthcoming).
• It is tempting to see a causal link from crisis to reform illustrated by the developments
and economic policies in Finland and Sweden following the crisis in the early 1990s.
That crisis may be seen as somewhat of a blessing in disguise. It created a political
situation that allowed significant structural reforms to be undertaken, and economic
policies have since the crisis been more successful and “responsible” than in earlier
periods. Policies have been geared towards fostering structural change and
maintaining sound public finances.
• The (current version of the) “Nordic model” is relatively successful in combining equity
and efficiency.
• The monetary regime may matter less for economic performance than often argued
in the heated debate on the pros and cons of a single currency. While not constituting
a laboratory experiment, a comparison of the performance of Finland and Sweden
supports this contention. Admittedly, the jury is still out in the sense that Finland is
now facing a structural weakness of its export base, and it remains to be seen
whether domestic wage adjustment will allow this difficulty to be overcome within a
reasonable time span.
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Short-term outlook
Headwinds ahead
• European weakness
• Slowdown in Russia and weakening of rouble
• Stagnant household real disposable income
• Cost competitiveness lost in 2007-2009 not returned
• Room of manoeuvre for fiscal policy is limited
– Finland had the most expansive fiscal policy in 2009 in Europe
• On the positive side:
– low interest rates
– sound banking system
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Bank of Finland Forecast December 2014
2013 2014 2015 2106
GDP, % p.a. -1,2 -0,2 -0,1 1.0
Private consumption, % p.a. -0,7 -0,4 -0,1 0,6
Private investment, % p.a. -6,8 -4,0 1,2 3,2
Exports, % p.a. -1,7 -0,1 1,4 3,1
Imports, % p.a. -2,5 -0,4 1,9 3,1
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Bank of Finland Forecast December 2014
2013 2014 2015 2106
GDP, % p.a. -1,2 -0,2 -0,1 1.0
Private consumption, % p.a. -0,7 -0,4 -0,1 0,6
Private investment, % p.a. -6,8 -4,0 1,2 3,2
Exports, % p.a. -1,7 -0,1 1,4 3,1
Imports, % p.a. -2,5 -0,4 1,9 3,1
Inflation (HICP), % p.a. 2,2 1,3 1,0 1,4
Current account, % of GDP -1,4 -1,5 -1,7 -1,7
General government surplus, % of GDP -2,4 -2,6 -2,2 -2,2
General government debt (EDP), % of GDP 56,0 59,3 61,7 63,8
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Russian dimension
Finland’s trade in goods with Russia
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0
2
4
6
8
10
12
14
2006 2008 2010 2012 2014
Exports Imports
EUR billion (12month moving sum)
Source: National Board of Customs
Trade values Trade shares
Finland’s energy dependency on Russia (2013)
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Finland’s imports from
Russia by product group
Russia’s share of Finland’s
energy consumption
Impact of the Russian factor
• Sectors most affected
– food industry (sanctions)
– tourism (weaker rouble)
• Risk scenario in the Bank of Finland June 2014 forecast
– imports in Russia down by 20 %
– 25 % weakening of the rouble
– => GDP growth in Finland 0,9 percentage points lower in 2015
• In December two-thirds of the risk scenario assumptions have been
materialized
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Exports to Russia 2014/Jan-Aug, % change, y/y
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LT
LV EE PL FI SL SK CZ DE AT HU
RO
IT BG SE
GDP level in Russia
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model exercise (BOFIT)*
* Rautava, J., “Oil Prices, Excess Uncertainty and Trend Growth. A Forecasting Model for Russia’s economy”, Focus
on European Integration Q3/13, pp. 77-87
1998Q1=100
2008Q1=100
2014Q1=100 model exercise (BOFIT)*
Assumptions: Oil price 85 $/bl + exchange rate
uncertainty similar to 1998-99 and 2008-09
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Longer-term challenges
Structural challenges
• Comparative advantage lost in ICT and paper industry
– industrial jobs are diminishing
• Sustained recession adds to long-term unemployment reducing the
participation rate of youths
• Low demand and heightened uncertainty reduce investment
incentives, incl. R&D
• Ageing of the population
– working age population has started to diminish
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Secular stagnation?
• Diminishing capital stock -> slower productivity growth -> lower
potential output growth
• Lower spending on R&D -> slower total factor productivity growth ->
lower potential output growth
• Declining participation rates -> lower labour supply -> lower potential
output growth
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Cumulative effect of industry decline on GDP from
2007 to 2013
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Declining net capital stock
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Electrical engineering and electronics industry
Forest industry
Other manufacturing
Million euro (2010 prices)
Total factor productivity and R&D investment
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Declining participation rate of younger workers
(difference from average)
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Components of GDP growth
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Way forward
Structural reforms
• Neither improved international business cycle nor domestic stimulus
cannot solve the structural problems
– corrective actions need to be structural
• Strengthen cost competitiveness
– little room for wage increases
– local agreements might help
• Strengthen productivity in the provision of public services
– health care reform
– municipality reform
• Implement the pension reform (already approved)
• Increase competition in retail trade and services
• Boost supply of housing by changing zoning practices and reducing
regulation
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Do not forget these
• Educational achievement
• Infrastructure
• Good governance – low corruption
• Trust in institutions
• Good innovation system
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Whom to blame?
• Bad policy (as always)
– some structural measures (health care reform, pension reform)
delayed unnecessarily long; no lack of knowledge
– deliberately overoptimistic expectations in 2011 when the new
Government took office
• Bad luck (as always)
– iPhone (Nokia) and iPad (paper)
– sovereign debt crisis in Europe
– Ukraine/Russia
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Q&A