Competitiveness and sustainable growth: Reforming the Finnish economy
Minister of Economic Affairs Olli Rehn, Bruegel Annual Meetings 2016
Ladies and Gentlemen,
The Bruegel Annual Meetings has become an institution that gathers together policy-makers and experts from various fields of European policies. For me, this event provides an excellent opportunity to listen to your views and have a productive debate in a genuine European spirit.
Thus, it is a great honor for me to be here today and provide you with an overview on our policy actions to reform the Finnish economy.
But before diving into the deep waters of the Finnish economy, let us have a look on the wider European economy, which of course sets the scene and framework also for Finnish economic policy.
The European economy returned to the path of recovery in 2013 after the debt crisis was initially tamed. The recovery has been continuous but fragile. Circumstances have not been optimal due to uncertainties caused by the world economy, and more recently, by the Brexit vote.
Therefore it is noteworthy that the Eurozone economy seems to be more resilient than what was probably expected. As we know, the Commission published its first post-Brexit Economic Outlook in July. The growth forecasts for 2016 and 2017 have been revised slightly but not dramatically downwards. It seems that the economic ramifications of Brexit, while already affecting investment, will rather materialize after the UK’s future relationship with the EU becomes fully known.
Over the summer there has been a lot of reflection on what would the future EU-UK relationship be like. It goes without saying that Britain will be a close partner for the EU also in the future, and the trade policy framework should likewise be made mutually beneficial. The question of Britain’s access to the Single Market will no doubt be at the core of the negotiations. In this regard it is of utmost importance not to water down the four freedoms. This was also clearly stated by the heads of 27 Governments after the European Council in June.
The Eurozone went through several reforms of economic governance in 2010-12 to correct the casting defects – or systemic shortcomings – of the Economic and Monetary Union (EMU), and to restore confidence into the euro. The reform process goes on with major projects like the Banking Union or the Capital Markets Union. And certainly, the discussion on the further reconstruction of the EMU will need to continue to make the Eurozone sturdier and capable of sustained, strong growth.
It is not reasonable, though, to concentrate only on institutional changes as there is only limited appetite for them now. We should rather focus on the real economy to reinforce the still fragile recovery, and thus the EU’s legitimacy. Economic reforms in Member States are critical in this regard. The experiences of Spain, Ireland and Latvia provide empirical evidence as to how to pursue difficult economic reforms quite successfully.
Let me next focus on my home country, Finland, which was in a stagnating recession and slow-motion economic decline for too many years. Our goal now is to turn the economy around on the path of sustainable growth and job creation. Last year’s growth was positive and this year’s forecast is positive as well, with +1.1 % growth.
But we have still much to do to solidify and strengthen the recovery. GDP of Finland in 2018 is still estimated to remain slightly below the level of the pre-crisis peak at the end 2007.
What was the root cause why the Finnish economy suffered badly after the financial crisis? It was the result of a combination of structural shocks rather than only a cyclical downturn. In other words, the low growth trajectory in 2011-15 was caused by several simultaneous structural factors: structural changes in our key industries (ICT and forestry), economic difficulties in our key export destinations, and a rapidly ageing workforce. At the same time, our export industries suffered from a very serious loss of cost competitiveness in terms of unit labor costs.
After a recession that lasted four consecutive years since 2011, the economy turned into a modest growth last year 2015. The job market has also reacted to this development, and employment turned upwards and finally, in June this year, the number of unemployed jobseekers went down – for the first time after 50 months of continuous increase in unemployment. For now, these are slight but positive signs that the Finnish economy will turn back into the path of growth, innovation, productivity, entrepreneurship, new jobs and increased value creation.
When the current Government started 15 months ago in June 2015, it was clear that our main task was to bring Finland back to the path of recovery and sustainable growth, and thus significantly raise the employment rate. Hence economic reforms and restoring sustainability of public finances are in the core of our four-year term.
As a matter of fact, one could describe "Case Finland" as a case in point of a northern Eurozone country that is going through an internal devaluation in the era of a common currency – and pursuing economic reforms in the spirit of Commission’s recommendations from the years 2010-2014. Thus, you may note that I do now practice what I preached in my Commission duty, and I am very motivated in this task!
To turn the economy on the path of sustained growth again, the Government focuses on three key objectives: first, restoring our cost competitiveness and pursuing structural reforms; second, ensuring the sustainability of public finances; and third, investing in growth sectors and improving the business environment. I will now focus on restoring cost competitiveness and pursuing growth and structural reforms.
The first necessary task of the Government was to restore our cost competitiveness. Following five rounds of negotiations with trade unions and employers, we concluded a Competitiveness Pact in May. Mandated by Prime Minister Sipilä, with two of my colleagues we invested all our time and energy over six months in Rounds 4 and 5 in the talks with the trade unions and employers. As the last signatures were sealed only yesterday, you may forgive me feeling a certain sense of relief today.
The agreement will reduce the unit labor costs by 4 percent with a rapid but permanent effect by increasing the effective working time by 3 days or 24 hours per year, and by shifting part of the unemployment and social security costs from the employers to employees. These measures will help the price competitiveness of Finnish companies, especially export industries, and they are comparable to effects of internal devaluation. The coverage of the Pact is now as high as 91 per cent. As part of the Pact, in return the Government will boost domestic demand by reducing income taxes by 515 million euros, which is ca. 0.25% of GDP.
The Finnish economists agree – which by the way is rather rare for any economists, knowing the old story of five economists and six positions – that the Competitiveness Pact will help creating 35 000-45 000 new jobs. The overall aim of the Government term is to create 110 000 new jobs during the parliamentary term and raise the employment rate to 72 %. Today, with the employment rate of 68.5%, we are badly trailing behind Sweden with 76% and Denmark with 75% employment rate.
The wage-setting system will also be reformed by specifying a so-called Finnish Model, which will be based on the benchmark of internationally exposed export sectors when setting the wages in other sectors.
All in all, the Pact will lead us to catch up in cost competitiveness with Sweden by 2018 and Germany by 2020.
Moreover, the Competitiveness Pact included significant elements towards firm-level local agreement on working conditions, such as on the working time. Local or firm-level negotiations are thus moving forward, not as a big bang revolution, but rather through a process of evolution.
Now, let me make a footnote concerning policy choices within the monetary union, even if that would be self-evident to those present here. That is, as a member of the currency union, Finland by definition has no option of currency devaluation, or external devaluation. No denying that is hard for a country that did get accustomed to devaluations as a major policy tool, since the history of economic policy of Finland is essentially a history of major devaluations in between 1921-92! Though it was not a pure paradise to restore growth in the 1990s’ world of free capital movements, after two devaluations of 30 % and with interest rates close to 20 %. Ordinary citizens carried a heavy debt burden, many SMEs went bust, and unemployment first soared to almost 20 percent.
In any case, the basic fact of living in a currency union leaves internal devaluation as the only relevant option to correct the profound loss of cost competitiveness, after Finland turned to a semi-permanent deficit country in 2011. It equals to a regime change in the country’s economic policy model, and calls for appropriate tools of economic adjustment.
It would be an illusion to believe that the surplus countries were to reflate the Eurozone out of the slow-growth trajectory, and as a nation we cannot count on that – neither could Greece or other program countries, as the Varoufakis experiment shows. John Maynard Keynes made quite a realistic observation at the time of preparing the Bretton Woods conference: “For a creditor country, adjustment is voluntary; but for a debtor country, it is obligatory”. I say this knowing well that the Eurozone would be better off by overcoming Keynes’ pessimistic but realistic maxim with cooperative solutions and a genuinely first-best policy mix.
However, the measures alone that I described are not sufficient, and we have to tackle our structural weaknesses with a bold reform agenda. Sustainable change for better economic performance, i.e. higher employment rates, improved fiscal balance and an upward trend in investment, requires a supportive business environment for enterprises that tend to invest, grow and employ when conditions are favorable.
One key policy program of the Government is the “Entrepreneurship Package”. We aim to remove barriers to entrepreneurship and improve the overall business environment for SMEs and other businesses aiming both at the domestic market and global markets.
Concrete actions include enhancing our state-funded internationalization services, strengthening and developing the various tools of corporate finance, opening the market to competition (for instance by liberalization of shopping hours) and cutting red tape. These are just to name a few. Only last week in the Government budget session, it was decided to reform the taxation of entrepreneurship by introducing “an entrepreneur deduction” as a tax cut for the smallest i.e. other than limited companies.
As a small nation with limited amount of natural resources, we must base our success on highly skilled workforce and world-class innovations. Finland has for long been among the top nations in investing in research, development and innovation per capita. However we should do better in turning innovations into commercial and especially export products and services. We have asked the OECD to conduct an analysis what could be done better in this regard, and will review policies by the Government’s mid-term review which will take place next March.
The Government is also investing to support the development in sectors where we see most potential for growth. I call them BCHD². That is B for the bioeconomy, C for cleantech, H for healthcare and health-related technologies, and D for digitalization as an underpinning driver of growth. For instance, we have a new investment aid programme for renewable energies and new energy technology. There are more than 40 investment applications mostly for bioenergy power plants in the program, and their total value exceeds 3 billion Euros.
Of course in a market economy it is not up to the Government to pick up the winners. But we can give an extra boost for the sectors where the potential for growth and jobs is greatest. The European Fund for Strategic Investments is an important funding instrument in this regard.
Moreover, we will complete these efforts by an Employment package and by a pilot study on basic income. The aim is to reduce the yax wedge and remove the incentive traps of work, and to reform social security benefits in a way that encourages taking up a job. Based on the evaluation of the pilot study in 2017-18, the Government will decide on potential future measures in advancing the basic income-type solutions.
Let me make one final note on the preconditions of stronger and sustainable growth, which applies equally to Europe in general and to Finland in particular. As the example of Japan’s Abenomics has proven, there is no silver bullet – or single arrow – to bring higher growth.
Instead, we must make all relevant arrows fly, which in Europe means boosting investment and reforms, consistently balancing public finances and executing an expansionary monetary policy. That’s the recipe for a stronger real economy – for sustainable growth and job creation.
Now I am looking forward to hearing your views. Thank you!