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Macroeconomic developments, prospects and policy challenges.

Since the end of 2000, activity has turned around sharply and the economy was technically in recession in the first two quarters of 2001. (1) After seven years of strong growth that culminated in a rise of gross domestic product (GDP) of 5.7 per cent in 2000, year-on-year expansion is estimated to have come down to a meagre 1/2 per cent in 2001, with the monthly figures showing output lower than a year earlier since June 2001 (Figure 1). In the manufacturing sector, the rupture was extremely steep. In the final quarter of 2000, manufacturing production peaked at a level 14 per cent higher than a year earlier, but in the third quarter of 2001 production had fallen back by 6 per cent from that peak. The factors behind this sharp turnaround are largely external. The economic slowdown in the United States and Europe led to a sharp contraction in exports of the paper industry. It weighed heavily too on exports of the electronic equipment industry, which also suffered from demand saturation and disappointing purch ases of new products. Feedthrough effects of falling exports on private consumption were small, however, as the initial impact on employment was limited and plummeting industrial output mainly showed up in lower productivity. Hence, despite the output collapse, unemployment edged down at the same moderate pace in the first half of 2001 as in the previous year. However, it remained high in an international and historical perspective (Figure 2) and the deterioration in economic conditions led to a rise in unemployment and a fall in vacancies in the third quarter. As a consequence, labour shortages are no longer a bottleneck for production.

The sustained sound management of fiscal and monetary policy, in combination with moderate wage agreements had underpinned the sharp recovery from 1994 to 2000. The central government budget swung from a deficit of 11 per cent of GDP in 1994 at the trough of the recession to a surplus estimated by the Ministry of Finance at 1.9 per cent of GDP in 2001. Recently, fiscal policy has become more focused on long-term issues, with the government setting a medium-term target for the central government budget surplus. The target is defined as a surplus of "at least 11/2 to 2 per cent of GDP on average over the next decade" (Ministry of Finance, 2001). This is appropriate given the expected fiscal pressures due to ageing, the need to reduce the tax burden further and the limited impact of fiscal policy on the cycle in a small open economy like Finland. However, it also implies challenges for setting budgetary policy in the years ahead. Structural reforms, especially of the labour market (see Chapter II), would help t o achieve the long-term budgetary objectives by improving economic performance.

Against this background, the following sections provide an overview of recent macroeconomic developments and discuss the macroeconomic policy stance. The chapter concludes with the prospects for 2002 and 2003, together with an assessment of both the risks surrounding these projections and the main macroeconomic policy challenges in the years ahead.

Recent economic developments

Exports and imports fell in 2001 after a surge in 2000

Slowing world demand has had a dramatic effect on Finnish exports since the last quarter of 2000. Before that, exports experienced a breathtaking upturn, surging by 18 per cent in 2000, the highest rate in decades (Table 1). (2) This record pace was mainly due to the phenomenal 50 per cent increase in exports of the electronic equipment industry, essentially Nokia (Box 1 and Figure 3), but exports of traditional products also fared well. In 2001, however, exports of goods and services dropped by an estimated 3.7 per cent despite a sizeable positive carry-over effect. As a result of lower foreign demand, forest-based exports declined substantially. More importantly, the Finnish electronic equipment industry fell victim to the global economic cycle, while at the same time it was affected by a lull in its product cycle. (3) These exports were also affected by reduced replacement demand for mobile handsets and saturation in some markets, (4) while exports of telecommunication network equipment slowed because the shipment of second-generation systems was wearing off. (5) Nevertheless, the Finnish electronic equipment industry weathered the heavy sectoral storm somewhat better than its competitors and probably gained market share, both for handsets and equipment. (6) Imports of goods and services also fluctuated sharply, largely reflecting the demand swings of the electronic equipment industry for intermediate goods. They shrank by an estimated 2.2 per cent in 2001 after increasing by 15.7 per cent in 2000 (Table 1).

Exports were supported by strong cost competitiveness (Figure 4). Based on unit labour costs in the manufacturing sector, it even improved further in 2000 because of the effective depreciation of the euro and the sharp rise in productivity, but this was broadly reversed in 2001 due to the distinct fall in productivity. This shows that the indicator is heavily influenced by the electronic equipment sector and may paint a too rosy picture for other parts of the manufacturing sector, although for them price competitiveness is currently also not a problem.

The global economic cycle also strongly influenced Finnish export prices, which fell by an estimated 2 1/2 per cent in 2001 after rising by 4 1/2 per cent in the previous year. Pulp and paper prices were the most volatile, dropping somewhat in 2001 after rising 12 per cent in the previous year. The euro exchange rate did not have much influence on export prices in 2001, in contrast to the preceding year when its depreciation vis-a-vis the US dollar pushed prices up in euros. In both years, merchandise export and import prices were negatively influenced by the trend decline in the price of ICT (Information and communication technology) products. World oil prices induced lower import prices in 2001 contrary to the previous year.

In 2000, the very favourable export development led to a record surplus of the current account of 7.3 per cent of GDP, despite the surge in oil prices. It was the second largest in the euro area after Luxembourg. The surplus is estimated to have diminished slightly in 2001 as the impact of the drop in exports was partly offset by the combined effect of weak imports and the improvement in the terms of trade. As a consequence of the huge surpluses in recent years, foreign debt excluding equities has fallen substantially, to an estimated 10 per cent of GDP in September 2001 from 35 per cent at the end of 1995. Including equities, however, foreign liabilities developed quite differently as they were dominated by stock market gyrations. Substantial foreign ownership of Finnish shares and the wild fluctuations of the ICT-dominated stock market led to a vigorous rise in foreign liabilities from 40 per cent of GDP in 1995 to 180 per cent of GDP at the end of 1999, but they plummeted thereafter to 45 per cent of GDP i n September 2001.

Private consumption underpins activity

In 2001, continuing, though more moderate, private consumption growth is likely to have prevented GDP from falling year-on-year (Tables 1 and 2). Supported by substantial rises in real after-tax wages and a continuing increase in employment, private consumption is estimated to have risen by 2 per cent. This rise occurred despite weaker consumer confidence following news of the less buoyant economic situation and despite the drop in car sales caused by high petrol prices and the expected cut in car taxes. The sharp reduction in the saving ratio in 2000 and the estimated partial bounce-back in 2001 (Figure 5) are mainly statistical artefacts as steep revenue increases due to stock options and capital gains in 2000 are not included in the national accounts measure of income, while taxes paid on these revenues are. (7) Real disposable income, rising by only 1/3 per cent in 2000, was distorted for the same reason.

There has been a relatively small impact on consumption coming from wealth effects despite large asset price changes. At the end of November 2001, the Helsinki stock exchange index was 55 per cent below its May 2000 peak, the steepest drop in the OECD area. Due to the limited domestic ownership of shares, the negative impact of this meltdown on households' financial assets was, however, restricted to a drop of 8 1/2 per cent between the end of 1999 and June 2001 (Figure 6). Up to 2000, households' indebtedness edged up as mortgage borrowing increased to finance house purchases but the financial position of households has remained solid with debt service expenses only a small proportion of income.

Residential investment is weak

Residential investment was subdued in 2000-01 as lending rates on new housing loans rose by 2 percentage points from mid-1999 to the end of 2000 -- only partly offset by the drop of 1.1 percentage point in the first nine months of 2001 -- and house price increases tapered off (Table 1). In the Helsinki area and in other fast-growing regions, construction remained hampered by a shortage of housing lots due to land-use planning bottlenecks. Moreover, in 2001, construction of more expensive dwellings may have been negatively influenced by the actual and foreseen decrease in stock option revenues.

Already in the first half of 2000, there was some correction of the long-running rise in house prices in reaction to higher lending rates (Figure 6). Later in the year, reduced optimism about future economic developments reinforced this correction. In the third quarter of 2001, average house prices were 3 per cent below the peak in the previous year, a minor correction given the rise of 60 per cent since the end of 1995. (8) Prices of existing houses are now probably close to the construction costs of new houses in most locations.

Business investment has turned around

Huge production gains, high capacity utilisation rates and impressive profitability (9) led to a significant pick-up in business investment in 2000 followed by a sharp turnaround due to weakening business sentiment. Investment is likely to have shrunk since the second quarter of 2001, but because of a strong carryover and vigorous growth in the first quarter, business investment is estimated to have risen year-on-year (Table 1 and Figure 7). (10) Although profitability and output growth have been high in international comparison in recent years, business investment growth was only marginally stronger than in the euro area. As a percentage of business output, it was even below the euro area average, partly due to the low capital intensity of the electronic equipment industry, and clearly lower than before the recession of the early 1990s when production was still dominated by the capital-intensive paper and basic metal industries.

Labour market tensions have disappeared

Despite the sharp turnaround in activity, employment continued to rise in 2001 as the slowdown initially caused mainly a fall in productivity. Labour hoarding in reaction to the slowdown may have been relatively strong as there has until recently been difficulties in finding suitable personnel. As in the previous year, however, employment growth was moderate and far below the record rise of 1999 (Table 3). The employment rate is estimated to have reached 68 per cent in 2001, which is still below the government's target of "close to 70 per cent" by 2003. Around a quarter of all jobs are now atypical (part-time, fixed-term or temporary jobs). The announced job cuts in the ICT sector are sizeable for the sector but relatively small in relation to total employment.

A considerable share of the increase in jobs -- in 2000 more than half -- was filled by persons previously outside the labour force. As a consequence, the labour force participation rate continued to rise, although it is still below its level of the end of the 1980s, while the drop in unemployment was relatively modest and unemployment has remained above the euro area average (Table 3 and Figure 8). The current rate -- 9.2 per cent in October 2001 -- is somewhat above the recently revised OECD estimate of the NAIRU, the non-accelerating inflation rate of unemployment (OECD, 2000 and Richardson et al., 2000), but such estimates are surrounded by great uncertainty. In the first half of 2001, unemployment continued to fall gently and vacancies were higher than a year earlier but labour market tensions have eased markedly thereafter. After falling from 9.3 per cent in December 2000 to 9 per cent in June 2001 the unemployment rate has risen to 9.2 per cent in October. Since August 2001, new vacancies declined (jo b advertisements already started to fall strongly in 2001).

Inflation recedes gradually

Oil prices have come down so that inflation -- measured by the harmonised index of consumer prices (HICP) -- has eased in 2001 after doubling to 3 per cent in the previous year (Table 4 and Figure 9). (11) The surge in oil prices in 2000, which was exacerbated by the depreciation of the euro, increased inflation by around 3/4 percentage point. (12) As elsewhere in the euro area, the decline of inflation in 2001 was limited by higher food prices prompted by poor weather conditions and the BSE (Bovine Spongiform Encephalopathy) and foot-and-mouth crises elsewhere in Europe, while the introduction of cash euros at the start of 2002 may have influenced price setting prior to this event (Ministry of Finance, 200 lb). Core inflation -- measured by the HICP excluding energy and food -- crept up during 2000 and 2001 due to higher unit labour costs in the service sector and to indirect and lagged effects of the oil price rise, both probably facilitated by an easy cost pass-through due to insufficient competition. In March 2001, price inflation fell below the euro area average for the first time since early 1999 and it stayed close to the average thereafter (Box 2). Core inflation, however, was somewhat above the euro area average throughout 2001.

Wage moderation continues

Wage gains accelerated in 2000-01 but were moderate in the light of the rising labour market tensions and did not undermine Finnish cost competitiveness. The form of negotiation -- in 2000 at the branch level (but with national co-ordination) and in 2001 at the national level -- does not seem to have influenced the result significantly. In 2000, contract wages were raised by 3.1 per cent (on a contract-year basis) for around 90 per cent of the employees and between 3.8 and 4.9 per cent for the other employees. On a year-on-year basis, contract wages increased by 2.8 per cent on average in 2000. The risk that the sectoral differences would lead to catch-up effects in 2001 did not materialise and, helped by sizeable tax cuts, the social partners reached a central wage agreement with moderate rises in contract wages of 3.1 and 2.3 per cent in 2001 and 2002, respectively. (13) After a lengthy partial strike, doctors in the public health sector were the only group of employees with a substantially sharper wage ris e, of 10.5 per cent over the two-year period.

The 2001-02 central wage agreement did not increase incentives for firms to employ lower-skilled workers. On the contrary, the additional wage increase for low-paid workers and the general nominal minimum gain has led to an above average contract wage rise for this category, although the difference in actual wage gains will probably be smaller as wage drift mainly affects high-skilled workers.

The monetary easing is welcome

In 2000, monetary conditions remained fairly relaxed with respect to the economic situation in Finland despite the hike in the European Central Bank's (ECB) policy rates of 225 basis points between November 1999 and October 2000 (Figure 11). The sharp production slowdown thereafter, which caused the immediate risk of overheating to evaporate, means that the current monetary conditions are largely appropriate for Finland at the current juncture. The ECB's interest rate cuts since May 2001, which will affect activity with some lag, and the further easing projected by the OECD are welcome as they will support a cyclical recovery also in Finland.

Fiscal policy: new challenges ahead

Fiscal policy has been very successful in correcting the serious budgetary imbalances caused by the deep recession of the early 1990s. However, with the government surplus projected to be below target in 2002, the need to reduce the tax burden further (see Chapter III) and the impact of ageing in the long term (Box 3), fiscal policy will face serious trade-offs in the years ahead, if spending is not pruned considerably. The central government balance has moved from a deficit of 11 per cent of GDP in 1994 to a surplus of 3.5 per cent of GDP in 2000, followed by a smaller estimated surplus of 1.9 per cent of GDP in 2001 (Ministry of Finance estimate). Thus, the target set in the 1999 Government Programme of a structural central government surplus -- recently specified as a surplus of 1 1/2 to 2 per cent of GDP on the basis of long-term scenarios -- was clearly exceeded in 2000 (Table 5). Moreover, Finland is fulfilling by a wide margin the requirement of the Stability and Growth Pact of a general government bu dget "close to balance or in surplus". However, the slowdown implies that the actual central government surplus is likely to drop significantly below the medium-term target in 2002, even though on a cyclically-adjusted basis it would still almost be met. The fiscal performance will not match the target agreed in the 2000 national Stability Programme (Ministry of Finance, 2000). A cyclical recovery may be insufficient to return to the target level soon and additional measures may be necessary. Also the recent budgetary slippage is worrying. Up to 2001, the budgetary target of constant central government spending in volume terms was broadly met, but approval of the draft 2002 budget will lead to a clear rise in the volume outlays. (14)

The 2000 budget outcome: a very high surplus was mainly due to one-off factors

In 2000, the rise in general government tax revenues on income and wealth was exceptionally strong (23 per cent) as substantial one-off revenues came on top of a sharp increase due to very rapid growth. (15) The rise was only somewhat mitigated by income tax cuts of EUR 1 billion (3/4 per cent of GDP) and somewhat reduced social security contributions. As a result, tax revenues rose by 0.7 percentage point to 46.6 per cent of GDP, the highest rate since 1994 (Table 5). This was accompanied by a sharp and mostly temporary rise in property income of 1.1 per cent of GDP. (16) Government consumption increased by 4.5 per cent in nominal terms but interest payments and investment fell somewhat, while social transfers were almost flat reflecting strong employment growth. As a result, total government outlays increased only moderately in nominal terms (2 per cent) and dropped substantially as a per cent of GDP (by 3.2 percentage points to 43.9 per cent). This sharp fall in the outlay ratio, together with the rise in the tax burden and in property income, led to a huge rise in the general government surplus, of 5 percentage points to 6.9 per cent of GDP, the largest surplus in the euro area. This marked improvement was not helped by the sale of third generation mobile telephone licenses as they were provided without charge, contrary to practice in many other countries. With economic growth stronger than projected and most one-off revenues not expected, the surplus was much higher than foreseen (Table 7). Furthermore, the debt target of the 1999 Government Programme for the period 2000-03 was already reached in 2000 as the central government debt fell below 50 per cent of GDP. (17)

The central government budget improved most -- it was in surplus for the first time since 1990 -- but there was also a better performance by the local government sector and the pension schemes (Table 7). The local government sector moved from a minor deficit to a marginal surplus mainly owing to booming tax revenues, only partly offset by the lowering of the local government share in corporate tax revenues. Although the local government sector as a whole was in surplus, the number of municipalities in deficit increased strongly. As a consequence, discretionary central government transfers to local authorities in financial difficulties doubled to EUR 0.1 billion.

The estimated 2001 budget outcome: a sharp drop in the surplus

In 2001, several of the factors favourable to the budget have reversed and the effective tax yield is estimated to have fallen by 1.9 percentage points to 44.7 per cent of GDP, the lowest ratio since the end of the 1980s. This was caused by sharply lower capital gains and stock options revenues, a sharp drop in profitability, further cuts in social security contribution rates and a substantial income tax cut of EUR 1 billion (3/4 per cent of GDP). Due to a special dividend paid by the partly state-owned financial conglomerate Sampo and a profit transfer by the Bank of Finland for the first time in many years, property income remained strong although it dropped from the previous year. The fall in total revenues of 2.5 percentage points and the rise in the expenditure to GDP ratio are estimated by the Ministry of Finance to have led to a drop of the general government surplus from 6.9 per cent of GDP in 2000 to 4.7 per cent in 2001, which is still higher than the surpluses in 1998 and 1999.

While the local government budget deteriorated from a small surplus to a small deficit, the central government budget surplus is estimated to have shrunk from 3.5 per cent of GDP in 2000 to 1.9 per cent of GDP in 2001 (1 1/4 per cent according to the OECD estimate). Despite mounting pressures to increase expenditure, central government spending was broadly in line with the target of unchanged spending in volume terms. Sticking to the target was facilitated by the room provided by a stronger than expected drop in interest payments. (18)

The 2002 budget: the surplus is projected to fall far below target

In the revised forecasts of November 2001 (Ministry of Finance, 2001d) underlying the draft 2002 budget (the first one denominated in euros), the authorities project a further drop in the effective tax yield of 0.9 percentage point of GDP reflecting a continuing drop in tax revenues on capital gains and stock options, the impact of the economic slowdown -- especially on corporate tax revenues -- coupled with further cuts in the income tax and social security contributions (Box 4). In line with the two-year wage agreement, income taxes will be cut by EUR 0.7 billion (1/2 per cent GDP), bringing the total income tax cut to EUR 2.1 billion in 2000-02, more than the EUR 1.7-1.9 billion announced in the 1999 Government Programme. Moreover, property income is projected to return to a more normal level. As a consequence, the fiscal stance will ease further. (19) The general government surplus is projected to decline to 2.6 per cent of GDP by the Ministry of Finance (to 1.9 per cent of GDP in the OECD's projection) while, in their November projections, the central government surplus is forecast to drop to 0.3 per cent of GDP, clearly below the medium-term target of 11/2 to 2 per cent of GDP. The OECD even projects a deficit of 1/4 per cent of GDP, reflecting lower activity than currently projected by the authorities.

Central government spending in the draft 2002 budget is higher than the target of holding expenditure constant in volume terms during the government period and higher than the updated spending limits of March 2001. Spending is expected to rise by 2 per cent in volume terms in 2002 and to be 2 3/4 per cent higher than in 1999. Although part of the rise is due to changes in accounting, the 2002 draft budget implies a slippage on the government expenditure target. Around half of the rise reflects the increase in transfers to municipalities fully offset by the lowering of the share in corporate tax revenues. In nominal terms, spending could surge by even considerably more as there is no automatic mechanism to offset higher than expected cost increases, such as the strong wage rise of doctors in the public health sector and its possible spillover effects.

The short-term outlook and risks

The projections

Against the background of a very weak global economic picture, Finnish growth is also projected to remain lacklustre in 2002 (Table 8). (20) Exports are projected to bounce back only towards the end of the year, as paper and other traditional exports benefit from stronger world demand. The recovery in Finnish paper exports is likely to be damped by the improved position of its Swedish competitors due to the recent strong depreciation of the Swedish krona. Exports of electronic equipment products are likely to increase again but will remain relatively weak in the short term as product innovations will be insufficient to increase replacement sales of mobile handsets markedly and sales of third-generation network systems still have to gather steam. The sector will only marginally contribute to GDP growth in 2002, but could gain considerable momentum again thereafter.

Supported by a solid financial position, a substantial income tax cut, robust wage and transfer increases, private consumption should support growth in 2002, despite some damping effect from the deceleration in employment growth and the presumed adverse confidence effects from the September attacks. Given the downturn in the previous year and the heightened uncertainties, business investment is projected to fall although the financial position of the business sector will remain sound. Slow growth will have a noticeable effect on the labour market, and unemployment is projected to rise during 2002. While there was excess demand in 2000, low growth in 2001 and 2002 will lead to a sizeable negative output gap. This negative output gap, in combination with the projected drop in oil prices in 2002 and the moderate strengthening of the euro relative to 2001, (21) should push inflation below 2 per cent -- restoring price stability as defined by the ECB for the euro area. The current account surplus is projected to drop somewhat further in 2002 -- but to remain large -- as subdued imports and an improvement in the terms of trade only partly offset low export growth.

In 2003, when the international recovery will gain momentum, growth is projected to recover also in Finland. The export-led recovery is, however, likely to be shallow and GDP growth projected at 3 1/2 per cent will remain low compared with the average pace of 5 per cent between 1995 and 2000, albeit stronger than in the euro area for the first time since 2000. The electronic equipment industry may start to benefit from the international roll-out of 3G (third generation) mobile telephony. Only in the second half of 2003 will stronger activity be reflected in a better employment performance and a renewed fall in unemployment, but this will be insufficient to cause a year-on-year fall in unemployment. The drop in interest rates since mid-2001 and improving employment prospects will lead to a recovery in residential investment and to a more rapid private consumption growth. Business investment should also recover owing to stronger demand and low interest rates. With unemployment rising at the time of the wage ne gotiations and the output gap clearly negative, wage rises should be moderate in 2003 and price inflation low. The current account surplus is projected to be sizeable and the net foreign interest-bearing asset position could switch from a deficit into a surplus.

Substantial uncertainties surround the projections

Finnish leading indicators point to a continuing weak economic development in the near term (Figure 12). Order books are thin and business sector sentiment is gloomy, while consumer confidence is relatively low. The 11 September attacks in the United States have markedly raised the already high uncertainty about international economic developments in the near term. An international recovery may take more time to materialise than is imbedded in the central scenario. Simulations with the OECD Interlink model indicate that no recovery in the rest of the OECD would reduce growth in Finland to 3/4 and 1 1/4 per cent in 2002 and 2003, respectively. It would lead to a rise in the unemployment rate to above 10 per cent in 2003 and a deterioration of the general government balance to a surplus of 1/2 per cent of GDP. In this context, the restoration of strong economic fundamentals since the mid-1990s -- a strong financial position of households and firms, a healthy banking sector, a central government budget in or clo se to balance -- is important as it should make it somewhat easier to weather the harsh international economic climate.

Another major uncertainty concerns the electronic equipment industry, where downside risks prevail in the short term but upward risks exist in the medium to long term. A successful international introduction of GPRS (General packet radio services) handsets and even more so of 3G mobile telephony could boost output of the Finnish electronic equipment industry considerably and push up productivity growth, but the uncertainty on international demand for electronic equipment is currently very high. In the somewhat longer term, output growth of the sector could be hampered by lack of skilled labour or Finland could lose it place as a centre of excellence.

Main policy challenges

In the Finnish situation there is currently room for letting the automatic stabilisers work in full and there is no reason for postponing the income tax cuts envisaged for 2002. In any case, as the cuts are part of the two-year central wage agreement, it would be virtually impossible to postpone them. Discretionary measures to bring about a recovery more rapidly may be tempting but would not be very effective given the high import leakage. Moreover, it would be difficult to get the timing and size of an additional fiscal easing right and it would move the government further away from respecting its fiscal targets. Decisions to increase spending may be irreversible and lead to a ratcheting up of public spending. The projected recovery may not bring the central government budget in line with the medium-term target of a surplus of 1 1/2 to 2 per cent of GDP. (22) Should this turn out to be the case, some additional consolidation measures would be needed and, as the tax burden is already too high, these measures should be taken on the expenditure side. At the minimum, the spending limits agreed in March 2001, but not adhered to in 2002, should be respected in 2003-05, when a recovery should be firmly underway. The government's aim to achieve a structural surplus in central government finances in 2003 in the negotiations on the spending limits of early 2002 is therefore welcome.

The recovery from the current slowdown could be later and shallower than projected but will certainly happen. However, as illustrated by the recent medium-term scenarios of the Ministry of Finance (Table 9), a combination of a somewhat weaker international development in the medium term, higher government outlays and stronger domestic cost rises could lead to the reappearance of a central government deficit and to a substantial rise in unemployment. The policy challenges for the rest of this and for the coming government period may thus be substantial. As outlined in the next chapters, structural reform measures, especially concerning the labour market and including employment-friendly changes in tax and benefit systems, should be undertaken to prevent the costs of ageing from undermining the welfare state. A change in incomes policy could also be helpful. The aim should be to make the system more flexible while preserving the overall wage moderation that served the Finnish economy well in the past.


(1.) In the second quarter, real GDP dropped 1.7 per cent from the previous quarter, the sharpest contraction in the OECD area after Turkey. GDP fell by 0.1 per cent in the first quarter. Based on monthly output statistics, GDP was unchanged in the third quarter.

(2.) For 2000, there is a major difference in exports of goods on a national accounts basis (a volume growth of 20.6 per cent) and on a customs basis (6.6 per cent). The main reason is the treatment of quality improvements in mobile handsets. In the national accounts, prices are adjusted for quality improvements, leading to a much bigger volume rise.

(3.) Product cycles are short and innovation is rapid in mobile telephony. In 2001, GPRS (General packet radio service) telephones were introduced, an upgrade of WAP (Wireless application protocol) telephones launched a year earlier. The impact of WAP telephones on sales has been disappointing and GPRS telephones are likely to be only used by a narrow group of business customers in the short term. These innovations are, however, minor compared to the coming leap forward from 2G (second generation) to 3G (third generation) mobile telephony. 3G networks will be much faster, allowing Internet, video and other services to be accessed by mobile telephones. GPRS telephones allow access to a limited extent to the Internet and are therefore often referred to as 2.5G telephones. In October 2001, Japan became the first country to roll-out a 3G system but at a limited scale and without some major services available. The start of the roll-out in European countries is scheduled for the end of 2002 but usage is not likely to reach great scale before 2004. The system to be used in Europe is more complex than the Japanese one as the handset will be able to fall back on the slower second-generation network when the telephone moves out of 3G coverage areas, which will be limited to large cities in the short run.

(4.) Output of the electronic equipment industry, which is almost completely exported, dropped by 5 and 16 per cent in the first and second quarter of 2001 from the previous quarter, respectively, after increasing by 10 per cent on average in the four preceding quarters. However, production in the third quarter rose 15 per cent from the second quarter.

(5.) Worldwide sales of mobile handsets are estimated to have dropped by around 5 per cent in 2001, after increasing by almost 50 per cent to 410 million in the previous year. As the retail sector substantially cut its inventory, production dropped even sharper than sales in 2001.

(6.) However, total exports of goods and services lost market share due to the overexposure to ICT and paper products.

(7.) With capital gains and income received from stock options included in disposable income, the saving ratio is less volatile, declining from 9.7 per cent of households' disposable income in 1999 to 8.7 per cent in 2000 and to an estimated 8.5 per cent in 2001.

(8.) The 60 per cent rise is partly a correction to the fall of 40 per cent between 1989 and 1995.

(9.) In 1999, measured by the rate of return, Finnish profitability, was the highest in the OECD (National Statistics of the United Kingdom, 2000). In its report, the statistical agency stressed problems of international comparability.

(10.) Government investment already dropped in 2000 as a major infrastructure project was finalised.

(11.) On a twelve month basis, inflation peaked at 3.4 per cent in October 2000 and came down to 2.4 per cent in October 2001. Measured by the national consumer price index, which unlike the HICP includes the capital costs of owner-occupied housing and is therefore influenced by changes in mortgage rates, inflation was 3.4 per cent in 2000, 0.4 percentage point higher than measured by the HICP. In October 2001, however, inflation based on the national index was 0.5 percentage point lower than measured by the HICP and at 1.9 per cent at the lowest pace in two years.

(12.) In both years, the oil price hike was partly offset by electricity prices. In 2000, high reservoir levels in Sweden and Norway due to wet weather led to cheap hydro-electricity imports. In 2001, low precipitation led to a steep rise in electricity prices in the Nordic countries.

(13.) This number refers to wage rises excluding carry-over effects. As it failed to get an additional wage increase for highly-skilled but low-paid public sector employees, the Confederation of Unions for Academic Professionals (AKAVA) did not sign the central wage agreement but many of its unions signed collective agreements in line with the agreement. As a consequence, the de facto coverage of the central wage agreement was 95 per cent. For 2001, the general wage rise was 2.1 per cent with a minimum of EUR 0.2 per hour (Social partners, 2000). Moreover, the social partners agreed to an 0.5 per cent rise to be decided at the sectoral level and an overall wage rise of 0.4 per cent to improve the position of women and lower-paid workers. For 2002, a general wage rise of 1.9 per cent was agreed, with a minimum of EUR 0.18 per hour. On top of this, there will be an overall wage rise of 0.3 per cent for sector-level distribution. The settlement contains an indexation clause: consumer price inflation exceeding 3 per cent over the period January-December 2001 will be fully compensated in 2002 unless contract partners decide otherwise. Based on the estimated inflation in 2001, this indexation clause will not be triggered. To facilitate agreement on a central wage settlement, the government decided to cut income taxes by EUR 1 billion and EUR 0.7 billion in 2001 and 2002, respectively. Moreover, it agreed to raise the earnings-related part of unemployment benefits by 3 percentage points in March 2002 and to prolong the job rotation" sabbatical leave scheme for two years.

(14.) Volume is calculated by deflating the various outlay items by their individual deflator.

(15.) Taxes and proceeds from stock options and capital gains paid by households (accrual basis) have risen from EUR 0.6 billion in 1998 to EUR 1.7 billion in 2000 (9 per cent of the total direct taxes paid by households). Taxes on capital gains (EUR 1.1 billion) were more important than on stock options (EUR 0.6 billion). In September 2001, the Ministry of Finance projected a drop to EUR 1.2 billion in 2001 and EUR 1.0 billion in 2002.

(16.) Property income received by general government increased by EUR 1.7 billion to EUR 4.9 billion. This was partly due to the EUR 0.4 billion extraordinary dividend of the fully state-owned bank Leonia on the eve of its merger with the private insurance company Sampo.

(17.) The debt target was later strengthened by correcting for privatisation proceeds. Corrected for these revenues, the central government debt fell below 50 per cent of GDP only one year later. Uncorrected, the central government debt is estimated at 44 per cent of GDP in 2001 compared to 57 per cent in 1998 and a peak of 68 per cent in 1996.

(18.) Central government interest expenditure is estimated to have come down by 12 per cent between 1999 and 2001. As a consequence, total expenditure rose only by 3/4 per cent despite the increase in non-interest expenditure of 2.8 per cent. Moreover, the government amended the spending target of the Government Programme somewhat in its decision of May 2000 on the use of privatisation proceeds. It increased spending by around EUR 0.2 billion over 2000-03, mostly by increased spending on universities.

(19.) The OECD's cyclically-adjusted budget balance is falling substantially in 2001 and 2002. Part of this fall is however due to less one-off revenues, and fiscal easing is therefore less than indicated by the OECD's indicator.

(20.) This projection is the same as the OECD Economic Outlook No. 70 projection (December 2001). The cut-off date for information used in the projection was 8 November 2001.

(21.) The projections are based on the technical assumption of currencies remaining at their level of 2 November, implying an exchange rate of USD 0.90 per euro. For Finland, this means a year-on-year effective nominal appreciation of 0.8 per cent in 2002, following an appreciation of 2.1 percent in 2001.

(22.) The OECD's estimates of the size of automatic stabilisers (Van den Noord, 2000) can be used to derive a rule-of-thumb. It is estimated that the government balance improves by 0.6 per cent of GDP for a 1 per cent acceleration in GDP growth. An acceleration of GDP growth from the projected 1 1/4 per cent in 2002 to the OECD's estimate of potential output growth of 3 1/4 per cent is therefore estimated to improve the central government balance from a deficit of 1/4 per cent of GDP in 2002 to around 1 per cent of GDP when growth is back at potential (assuming that the improvement in the general government balance shows up completely in the central government budget).

Glossary of acronyms and terms

3G Third generation

ALMP Active labour market programme

APW Average production worker

ATM Automatic teller machine

CAP Common agricultural policy

[CO.sub.2] Carbon dioxide

DIT Dual income tax

e-commerce Electronic commerce

EC European Commission

ECB European Central Bank

EITA Earned-income tax allowance

EMU Economic and Monetary Union

EU European Union

EUR Euro

FCA Finnish Competition Authority

FSA Financial Supervision Authority

G7 Major seven countries (Canada, France, Germany, Italy, Japan, United Kingdom and United States)

GDP Gross domestic product

GPRS General packet radio services

HEX Helsinki stock exchange

HICP Harmonised index of consumer prices

ICT Information and communication technology

ISA Insurance Supervision Authority

ISP Internet service provider

kg Kilogram

LFA Least favoured area

M&A Merger and acquisition

METR Marginal effective tax rates

MoU Memoranda of understanding

NAIRU Non-accelerating inflation rate of unemployment

[NO.sub.x] Nitrogen oxide

PES Public Employment Service

PPP Purchasing power parity

R&D Research and development

SA Seasonally adjusted

TEKES Technology development centres of the Ministry of Trade and Industry

VAT Value added tax

USD United States dollar

WAP Wireless application protocol


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[Figure 1 omitted]

[Figure 2 omitted]

[Figure 3 omitted]

[Figure 4 omitted]

[Figure 5 omitted]

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[Figure 7 omitted]

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[Figure 9 omitted]

[Figure 10 omitted]

[Figure 11 omitted]

[Figure 12 omitted]
Table 1

Demand and output

Percentage change, volume (1)

                               1998      1999      2000      2001 (2)

Private consumption             5.1       4.0       3.0           2.0
of which: Durable goods        17.5       7.9       4.2            ..
Government consumption          1.7       1.9       0.7           1.6

Gross fixed capital formation   9.3       3.0       5.5           1.3
  Public sector                -1.4      -2.2      -5.4          -3.1
  Private sector               11.6       3.9       7.4           1.9
    Residential                 7.8      12.7       3.4          -7.5
    Non-residential            13.0       1.0       9.0           5.3

Final domestic demand           5.1       3.3       3.0           1.8
Stockbuilding (3,4)             0.7      -1.2       0.9          -0.1

Exports of goods and services   8.9       6.8      18.1          -3.7
Imports of goods and services   8.5       4.0      15.7          -2.2
Foreign balance (3)             1.0       1.6       2.7          -1.0

Statistical discrepancy (3)    -0.9       0.7      -0.6            ..

GDP                             5.3       4.0       5.7           0.4
of which: Manufacturing         9.5       7.1      12.5            ..

                                       2000          2001
                               1st half  2nd half  1st half

Private consumption               3.8      -0.2       3.2
of which: Durable goods           6.8      -9.2      -9.9
Government consumption           -1.7       2.8       1.8

Gross fixed capital formation     5.8       4.6       3.2
  Public sector                  -7.4     -12.8      -0.5
  Private sector                  8.3       7.6       3.7
    Residential                   4.8      -7.5      -7.5
    Non-residential               9.7      13.7       7.7

Final domestic demand             3.0       1.5       2.9
Stockbuilding (3,4)               1.3       1.6      -1.6

Exports of goods and services    20.5      13.9      -9.3
Imports of goods and services    19.5      12.2      -6.5
Foreign balance (3)               2.5       2.3      -2.3

Statistical discrepancy (3)        ..        ..        ..

GDP                               6.6       5.3      -1.5
of which: Manufacturing          14.7      14.1      -8.6

(1)Semi-annual data is seasonally adjusted; annualised growth over
previous period.

(2)OECD estimate.

(3)Contribution to GDP growth.

(4)The semi-annual data include the statistical discrepancy.

Source: Statistics Finland and OECD.
Table 2

Household appropriation account

                                 prices,    1996  1997  1998  1999
                               billion EUR


Real disposable income            49.9      -0.3   5.9   3.5   4.7
Real consumption expenditure      49.1       4.2   3.5   5.1   4.0

Saving ratio (%) (3)               6.0       2.0   4.4   3.1   4.0

Disposable income                 49.9       1.1   7.4   5.3   5.8


Contribution to disposable
 Compensation of employees        47.3       4.1   5.2   7.2   4.9
 Enterpreneurial and property     13.6      -0.6   2.4   1.2   1.8
 Transfers received               21.9       0.1   0.1   0.4   1.0
  Transfers paid                  16.0       0.4   0.8   1.9   1.4
  Direct taxes                    14.0       3.3   0.1   1.6   0.6
  Interest on consumer debt        2.9      -1.1  -0.5   0.0  -0.2

                               2000 (1)  2001 (2)

Real disposable income           0.3        4.1
Real consumption expenditure     3.0        2.0

Saving ratio (%) (3)             1.7        3.5

Disposable income                3.8        6.8

Contribution to disposable
 Compensation of employees       5.9        5.6
 Enterpreneurial and property    4.1        0.8
 Transfers received              0.0        1.5
  Transfers paid                 0.9        1.5
  Direct taxes                   4.5       -0.6
  Interest on consumer debt      0.8        0.2

(1)Heavily influenced by steep revenue increases due to stock options
and capital gains which are not included in the national accounts
measure of income, while taxes paid on these revenues are.

(2)OECD estimates.

(3)Ratio of household saving to disposable income.

Source: Statistics Finland and OECD.
Table 3

Labour market developments

                                  average (1)   1995  1996  1997  1998


Employment rate (%) (3)               65.9      61.1  61.9  62.9  64.1

Real GDP per worker                    4.5       2.6   3.0   3.4   3.2

Employment                            -4.8       2.2   1.4   2.0   2.4
Labour force                          -1.2       0.8   0.3  -0.2   0.9

                                  Per cent of
                                  labour force

Unemployment rate                     10.9      15.4  14.6  12.7  11.4

Persons unemployed for more than
 12 months (% of total) (4)           11.7      30.1  30.1  30.5  30.2

Active labour market programmes
of which:
 Job creation                          2.0       2.6   2.6   2.5   2.3
 Labour market training                1.0       1.6   2.1   2.3   2.1

                                  1999  2000  2001 (2)

Employment rate (%) (3)           66.0  66.9    67.5

Real GDP per worker                1.1   4.3    -1.1

Employment                         3.3   1.7     1.3
Labour force                       2.0   1.2     0.7

Unemployment rate                 10.2   9.8     9.3

Persons unemployed for more than
 12 months (% of total) (4)       28.1  27.7    27.4

Active labour market programmes
of which:
 Job creation                      2.0   1.7     1.5
 Labour market training            1.9   1.6     1.4

(1)Annual rate for percentage change series.

(2)Average of monthly data available for series in per cent of labour
force. OECD estimates for percentage change data.

(3)Total employment as a per cent of working-age population (both age

(4)Registered unemployed.

Source: Ministry of Labour, Statistics Finland, Ministry of Finance and
Table 4

Prices and wages

Percentage changes

                                         1995  1996  1997  1998  1999

Consumer price Index                      1.0   0.6   1.2   1.4   1.2
At year end (2)                           0.3   1.0   1.9   0.8   2.0
Harmonised indexofconsumerprices (HICP)    ..   1.1   1.2   1.4   1.3
Core HICP                                  ..   0.5   0.9   1.6   1.4

Negotiated wages (3)                      3.6   3.1   1.3   2.7   1.8
Wage drift (3)                            1.0   0.8   1.1   0.8   1.0
Wage rate (4)                             4.7   4.2   2.4   3.5   2.8

Wage rate (5)                             5.0   3.3   4.1   4.9   2.6
Compensation rate (5)                     4.1   2.1   2.8   4.4   2.2

Unit labour costs                         2.6  -0.1  -1.0   1.7   0.6

                                         2000  2001 (1)

Consumer price Index                      3.4     2.8
At year end (2)                           3.5
Harmonised indexofconsumerprices (HICP)   3.0     2.5
Core HICP                                 2.1     2.2

Negotiated wages (3)                      2.8   3 1/2
Wage drift (3)                            1.3       1
Wage rate (4)                             4.1   4 1/2

Wage rate (5)                             5.9   4 1/2
Compensation rate (5)                     4.3   4 1/2

Unit labour costs                        -0.2       3


(2)Rates of change from December to December.

(3)Annual average of quarterly data.

(4)Total wage and salary earnings index, break in series in 1995.

(5)Private sector, national accounts data.

Source: Statistics Finland, Ministry of Finance and OECD.
Table 5

Public finances

Per cent of GDP

                                1994  1995  1996  1997  1998  1999  2000

Expenditure                     57.5  54.3  54.0  51.3  48.1  47.1  43.9

Revenue                         51.8  50.6  50.9  49.8  49.4  49.0  50.8
Tax (2)                         47.6  45.9  46.6  46.0  45.8  45.9  46.6
Other revenue (3)                4.1   4.7   4.2   3.9   3.5   3.1   4.2

Net lending                     -5.7  -3.7  -3.2  -1.5   1.3   1.9   6.9
Central government             -10.8  -8.7  -7.2  -3.7  -1.5  -0.7   3.5
Local government                 1.3   1.2   0.8  -0.7  -0.3  -0.3   0.1
Social security funds            3.8   3.8   3.3   2.8   3.1   2.9   3.3

Gross debt (4)                  58.0  57.2  57.1  54.1  48.8  47.3  44.0
of which: Central government    58.9  63.6  67.5  65.3  60.2  56.5  48.2

Government bond yield (%) (5)    9.0   8.8   7.1   6.0   4.8   4.7   5.5

                               2001 (1)

Expenditure                      44.6

Revenue                          48.3
Tax (2)                          44.7
Other revenue (3)                 3.6

Net lending                       3.7
Central government              1 1/4
Local government                  --
Social security funds             --

Gross debt (4)                   42.1
of which: Central government      --

Government bond yield (%) (5)     5.0

(1)OECD estimates.

(2)Including social security contributions.

(3)Property income and transfers received other than social security

(4)EMU definition.

(5)Ten-year government bond rate.

Source: Statistics Finland and OECD.
Table 6

Long-term budget scenario

As a per cent of GDP

                                            2000  2010  2020  2030  2040

Expenditure                                 46.7  42.5  45.1  48.0  49.4
Employment pensions (1)                      6.7   8.6  10.7  11.9  12.4
Health care                                  4.2   3.9   4.6   5.5   5.9
Social services                              3.9   3.6   4.2   4.9   5.4
Other expenditure                           29.1  25.0  25.0  25.0  25.0
Interest payments                            2.8   1.4   0.6   0.6   0.6

Revenues                                    53.6  46.9  46.6  49.4  50.4
of which: Employment pension contributions   7.2   8.0   9.1  10.1  10.4

Financial balance                            6.9   4.4   1.5   1.4   1.0

Gross debt                                  44.0  18.9   9.8   9.6   9.7

Memorandum items
Real GDP (%change)                           5.7   2.3   1.1   1.3   1.4
Unemployment rate (%)                        9.8   7.0   7.0   7.0   7.0


Expenditure                                 50.1
Employment pensions (1)                     12.5
Health care                                  6.2
Social services                              5.7
Other expenditure                           25.0
Interest payments                            0.6

Revenues                                    51.4
of which: Employment pension contributions  10.8

Financial balance                            1.3

Gross debt                                   9.6

Memorandum items
Real GDP (%change)                           1.3
Unemployment rate (%)                        7.0

(1)The employment pensions do not include central government pensions,
which amounted to 1.8 per cent of GDP in 2000.

Source: Ministry of Finance (2001). Stability Programme for Finland,
November 2001 update.
Table 7

Budgetary plans and outcomes

Billion EUR, national accounts basis


                                   1998       1999      2000

Central government
Revenue                            29.6       30.2      35.8
Expenditure (3)                    30.8       30.8      31.2
Balance                            -1.7       -0.9       4.6
 % of GDP                          -1.5       -0.7       3.5

Net financing requirement (-) (4)  -0.1        3.2       4.5

Local government
Revenue                            17.6       18.0      19.5
Expenditure (3)                    17.9       18.3      19.3
Balance                            -0.4       -0.3       0.2
 % of GDP                          -0.3       -0.3       0.1

Social security
Revenue                            23.9       24.1      25.0
Expenditure (3)                    20.3       20.5      20.8
Balance                             3.6        3.5       4.3
 % of GDP                           3.1        2.9       3.3

General government balance          1.5        2.3       9.0
 % of GDP                           1.3        1.9       6.9

-Underlying projections, %:
  Real GDP growth                   5.0        4.2       5.7
  Unemployment rate                11.4       10.2       9.8


                                               Preliminary     2002
                                   Budget (1)  results (2)  Budget (2)

Central government
Revenue                               34.1        34.8         34.6
Expenditure (3)                       32.1        32.1         34.1
Balance                                1.9         2.6          0.5
 % of GDP                              1.5         1.9          0.3

Net financing requirement (-) (4)      2.2         1.1          0.5

Local government
Revenue                               20.0        20.1         20.7
Expenditure (3)                       19.8        20.3         21.0
Balance                                0.2        -0.2         -0.4
 % of GDP                              0.2        -0.2         -0.3

Social security
Revenue                               25.7        25.4         25.8
Expenditure (3)                       21.3        21.5         22.3
Balance                                4.4         3.9          3.5
 % of GDP                              3.4         2.9          2.5

General government balance             6.5         6.4          3.6
 % of GDP                              5.0         4.7          2.6

-Underlying projections, %:
  Real GDP growth                      4.2         0.6          1.6
  Unemployment rate                    8.9         9.2          9.4

(1)September of preceding year.

(2)Updated forecast in November 2001.

(3)Including consumption of fixed capital, capital formation and net
capital transfers.

On a cash basis.

Source: Ministry of Finance.
Table 8

Short-term projections

Percentage change, volume

                               Currentprices,  1999  2000  2001  2002
                                billion EUR

Private consumption                 58.2        4.0   3.0   2.0   2.1
Govemment consumption               25.1        1.9   0.7   1.6   1.3

Gross fixed capital formation       21.7        3.0   5.5   1.3  -1.3
  Public sector                      3.4       -2.2  -5.4  -3.1   2.5
  Private sector                    18.3        3.9   7.4   1.9  -1.8
    Residential                      4.8       12.7   3.4  -7.5  -2.3
    Non-residential                 13.5        1.0   9.0   5.3  -1.7

Final domestic demand              105.0        3.3   3.0   1.8   1.2
Stockbuilding (1)                    1.1       -1.2   0.9  -0.1   0.1
Total domestic demand              106.2        2.0   4.0   1.7   1.3

Exports of goods and services       45.0        6.8  18.1  -3.7   1.0
Imports of goods and services       34.8        4.0  15.7  -2.2   1.3
Foreign balance (1)                 10.2        1.6   2.7  -1.0   0.0

Statistical discrepancy'            -0.4        0.7  -0.6   0.0   0.0

GDP                                116.0        4.0   5.7   0.4   1.2
GDP of the euro area                 --         2.7   3.5   1.6   1.4

Employment                        2213.0 (2)    3.3   1.7   1.3   0.5
Unemployment rate (%)               11.4       10.2   9.8   9.2   9.6

Output gap (%) (3)                  -0.7       -0.3   2.2  -0.5  -2.5

Private consumption deflator         --         1.1   3.5   2.6   1.7
GDP deflator                         --        -0.1   3.4   2.1   1.6
Private sector wage rate             --         2.6   5.9   4.5   4.2

Net lending (% of GDP)               --         1.9   6.9   3.7   1.9
Household saving ratio4              --         4.0   1.7   3.5   4.3
Current account (% of GDP)           --         6.0   7.4   6.6   5.9

Interest rates (%)
  Short-term                         --         3.0   4.4   4.2   3.0
  Long-term                          --         4.7   5.5   5.0   4.8


Private consumption             2.5
Govemment consumption           1.3

Gross fixed capital formation   2.6
  Public sector                 1.3
  Private sector                2.8
    Residential                 2.1
    Non-residential             3.0

Final domestic demand           2.2
Stockbuilding (1)               0.0
Total domestic demand           2.2

Exports of goods and services   6.4
Imports of goods and services   4.2
Foreign balance (1)             1.5

Statistical discrepancy'        0.0

GDP                             3.4
GDP of the euro area            3.0

Employment                      1.2
Unemployment rate (%)           9.6

Output gap (%) (3)             -2.3

Private consumption deflator    1.9
GDP deflator                    2.0
Private sector wage rate        4.2

Net lending (% of GDP)          2.1
Household saving ratio4         4.0
Current account (% of GDP)      6.5

Interest rates (%)
  Short-term                    3.8
  Long-term                     5.2

(1)Contribution to GDP growth.

(2)Thousand persons.

(3)Deviations of actual GDP from potential GDP as a percentage of
potential GDP.

(4)Per cent of disposable income.

Source: Statistics Finland and OECD (2001), Economic Outlook, No. 70.
Table 9

The Finnish economy in the medium term


                              Baseline scenario  Slow growth scenario

                              % change, annual
                                rate 2001-07

Private consumption                  2.7                 1.6
Public consumption                   1.0                 1.1
Exports                              5.2                 2.1
Imports                              5.2                 2.0
GDP                                  2.7                 1.5
Private consumption deflator         2.0                 2.2
Employment                           0.5                -0.7
Labour productivity                  2.1                 2.1

                                  Per cent,

Unemployment rate                    7.5                14.0
Employment rate (age 15-64)         68.3                62.6

                                 Per cent of
                                  GDP, 2007

Govemment financial balance          4.2                 0.3
of which: Central government         1.5                -1.5

Source: Ministry of Finance.

Box 1.

Nokia fact sheet

In 2000, Nokia's exports amounted to EUR 13 billion, 24 per cent of total Finnish exports of goods and services and around 80 per cent of the exports of telecommunications equipment. Less than half (46 per cent) of its turnover was realised in Finland. The European Union was its main market (36 per cent of its turnover), followed by the United States (18 per cent) and China (10 per cent), while the Finnish market accounted for less than 2 per cent of its turnover. Its value added was 4 per cent of GDP, which is relatively small due to its extensive production network (the share of the total electronic equipment industry was 8 1/2 per cent). In 2000, the number of employees in Finland rose marginally to 24 500, around 2 per cent of total employees in the business sector, but the share of Finnish personnel declined to 42 per cent from 51 per cent in 1998. The staff level in Finland and abroad has dropped only slightly during 2001. Almost 60 per cent of its Finnish staff (and a third of its total staff) work in research and development (R&D). Nokia paid approximately EUR 1 billion taxes in Finland (1 1/2 percent of total taxes received by the general government). Dividend paid amounted to EUR 1.3 billion, 22 per cent of its profits before tax and 4 per cent of its turnover. The company has a very strong balance sheet, with a ratio of interest bearing debt to equity of 9 per cent at the end of the third quarter of 2001. As a result of substantial outstanding loans, partly vendor financing of telecommunications operators, the net debt-to-equity ratio was even negative (28 per cent). At the end of 2000, Nokia shares were 70 per cent of the market value of the Helsinki stock exchange and foreigners held 90 percent. At the end of November 2001, its share price was EUR 26.1, some 60 per cent below its peak of May 2000, but 14 times the share price at the beginning of 1996. This recent slump in its share price was nevertheless smaller than that of its main competitors.

Box 2.

Finland was the best inflation performer among the "peripheral" euro area countries

In discussions about economic performance and the effect of the euro area-wide monetary policy stance, a distinction is often made between "peripheral" countries of the euro area (Finland, Greece, Ireland, Netherlands, Portugal and Spain) and core" countries like France, Germany and Italy. Related to this is the policy debate on how the authorities in small euro area countries should react to overheating or over-cooling risks, as the overall monetary policy stance is unlikely to be ever well tuned to their domestic needs. With the current economic slowdown in the euro area, which is especially strong in Ireland and Finland due to their high exposure to the ICT sector, the earlier debate about overheating risks has vanished. If the present slump were to be protracted, over-cooling could become the major risk. In the case of a V-shaped recovery -- a low probability scenario- overheating risks could, however, soon resurface. The rapid change in economic fortunes shows vividly how difficult it might be to get the timing of a more pro-active fiscal policy right but also suggests that countries especially subject to such cyclical volatility need to encourage flexible adjustment mechanisms in both labour and product markets.

Above average economic growth was a common feature of the peripheral countries in the period 1996-2001, being accompanied by a sharp decline in unemployment, strong rises in house prices and, with the exception of Finland, above average price inflation (Figure 10). However, there are also substantial differences within the "peripheral" group: Spain (*) and Finland still have high unemployment while the others are close to full employment; productivity gains were mediocre in Spain while they were excellent in Ireland and Finland; Finland and the Netherlands have hefty current account surpluses while Spain and especially Portugal and Greece have sizeable deficits; Finland and Ireland have substantial budget surpluses while Portugal still has a deficit. More fundamentally, Portugal, Spain and Ireland are "catching-up" to average income and productivity levels, while Finland and the Netherlands recovered from under-performing temporarily after converging in previous decades.

Finland has most in common with Ireland as the strong economic performance is to a great extent due to the ICT sector - mainly foreign-based enterprises in Ireland and domestic ones in Finland -- with its, until recently, exploding production and productivity. There are also substantial macroeconomic differences between the two countries, however, the difference in inflation performance being among the most important ones. In Ireland, the strong economic growth has led to substantial domestic cost pressures, but also catch-up (Balassa-Samuelson) effects played a role (OECD, 2001; McGowan, 2000). In Finland, on the other hand, inflation only marginally and temporarily exceeded the euro area average. However, without the current slowdown, it is also likely that wage and price inflation would have accelerated strongly in Finland.

(*.) Statistical harmonisation, to be implemented in 2002, will, however, markedly reduce the measured rate of Spanish unemployment (OECD, 2001 b).

Box 3.

The impact of ageing on the budget will be substantial in the long term

As highlighted in the previous Survey, the Finnish population will age rapidly and earlier than in many other OECD countries. The number of people aged over 65 is projected to increase already by over 50 per cent up to 2020, while the working age population (20 to 64 year-olds) is expected to drop by around 3 per cent and the labour force could start to decline already within a decade. As a consequence, the old-age dependency ratio (those over 65 years as a percentage of the working age population) will rise from the current 25 per cent to 39 per cent by 2020, the fastest rise in the OECD area. Ageing will continue thereafter, with the dependency ratio reaching 50 per cent at around 2030.

Ageing will strongly affect public finances. In the baseline scenario recently presented by the Finnish authorities (Ministry of Finance, 200 l), (*) public pension outlays (flat-rate national pensions and earnings-related employment pensions) are expected to rise by about 6 percentage points of GDP, somewhat stronger than on average in the OECD, to 13 per cent of GDP in 2050 (Table 6). At the same time, more health and care services for the elderly are needed, which will lead to an increase in health and social security expenditure by 4 percentage points. The rise in total old-age-related spending is projected to be the fourth steepest amongst the OECD countries. With expenditure on education falling, total public spending is projected to rise by 3 percentage points, requiring a gradual rise in the tax burden after 2020 and a gradual drop in the general government surplus. In this baseline scenario, central and local government debt is gradually heading lower from the current 44 per cent of GDP to 10 per ce nt in 2015, and stabilises thereafter.

Weaker trend growth would make the ageing consequences more problematic as is illustrated by the slow growth scenario of the Ministry. Lower annual productivity and output growth would lead to substantially higher government spending (56 per cent of GDP in 2050 instead of 50 per cent). At the same time the tax burden would be higher (50 per cent of GDP instead of 46 per cent), the surplus smaller and government debt higher (35 per cent of GDP instead of 10 per cent).

Based on the long-term scenarios, a central government surplus target of at least 11/2 to 2 per cent of GDP on average during the current decade has been set. This target reflects the assessment of future economic developments by the Ministry of Finance (Ministry of Finance, 2001). Although the new target is reflected in the 2002 budget proposals and in the 2001 update of the Stability Programme (Ministry of Finance, 2001c), it does not form part of the Government Programme -- which set as target an unspecified structural surplus -- and hence there is less political commitment to this new target.

(*)The scenario is close to the recent scenario of the OECD IOECD, 2001 c; Dang et al., 2001).

Box 4.

Summary of measures in the 2002 budget proposals

In its draft 2002 budget, the government proposed the following key measures to Parliament:

- A cut of one percentage point in all central government income tax scales, a substantial rise (4.5 per cent) in the lowest tax bracket, and a further increase in the earned-income tax allowance in the municipal income tax. The total income tax cut is estimated at EUR 0.7 billion.

- A cut in the pension contribution rate paid by employers and in the sickness insurance contribution rate paid by pensioners.

- The lowering of the corporate tax revenue share of municipalities from 36.39 to 23.33 per cent. Based on 2002 projections, this is financially neutral as it is accompanied by an increase in the transfer from the state to municipalities.

- Four infrastructure projects (three railway projects and one motorway project) will be started.
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Publication:OECD Economic Surveys - Finland
Article Type:Statistical Data Included
Geographic Code:4EUFI
Date:Jul 1, 2002
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