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Overcoming the crisis and beyond.

Finland was among the most affected OECD countries during the crisis as demand for its mainly capital-goods intensive exports collapsed. The financial sector weathered the shock well, but credit contracted, reflecting both demand and supply factors. Employment has been aided by the scheme of subsidies for temporary layoffs, as well as labour hoarding. Despite supportive fiscal and monetary policies, recovery has been slow. This is likely to reflect a muted pick-up in world capital goods trade, structural rigidities in the labour market, potentially weakened competitiveness due to the strength of the euro and large wage increases prior to the downturn, and a slowdown in productivity growth. While the largely appropriate fiscal stimulus and active labour market policies are likely to have mitigated the impact of the crisis on demand, the post-crisis fiscal outlook has substantially worsened due to a largely permanent fiscal stimulus and lower potential output. Consolidation plans should be announced as soon as possible, to be implemented as the recovery takes hold. More attention to structural reforms to increase labour market flexibility and boost competitiveness and productivity would help to restore stronger growth and raise living standards over the longer term.

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In the period up to the crisis, Finland enjoyed an impressive economic expansion following a deep recession in the early 1990s, aided by booming world trade, a sharp initial currency depreciation and sound economic management. Macroeconomic stability was boosted by fiscal consolidation and pension reforms that led to structural fiscal surpluses and low public debt, stronger financial supervision that solidified the banking sector, and moderate centrally co-ordinated wage increases. Together with significant success in lowering product market regulation and loosening employment protection, structural reforms in secondary education and investment in research and development (R&D), this boosted productivity and accommodated structural change. The traditional industries, such as forestry and paper, gave way to dynamic new export industries, particularly in the information and communication technology (ICT) sector, which leveraged an increasingly educated and outward looking workforce and exploited rising opportunities in world markets. Unemployment declined steadily and Finland's income per capita converged towards its Nordic neighbours. Inflation remained low relative to other EU and Nordic countries. Finland also topped many international comparisons of education outcomes, competitiveness, quality of life, institutions and the environment.

Nevertheless, the global recession hit Finland harder than most OECD countries. Led by declining exports, output dropped by almost 9% over the year to the second quarter of 2009, the largest decline among OECD countries over this period. Unemployment is set to return to double digits. In contrast to some other developed economies, there were few signs of overheating prior to the recession and the financial sector was in good shape. However, high exposure to the international trade cycle, particularly the ICT and capital goods sectors, and to severely affected markets such as Russia, explains much of the contraction in activity. (1) The strengthening of the euro in the period leading up to the downturn was also an important factor, particularly given the large share of Finland's trade outside of the euro area.

The recession also revealed some underlying structural weaknesses that may prolong the downturn and mute the recovery. Progress in further reforming the still rigid labour and product markets and the generous social security systems had slowed, setting back productivity growth. Potential output may fall further if inflexibilities in the labour markets lower participation rates and tighter credit conditions weigh on investment. A slowdown in productivity growth and large wage increases just prior to the downturn may have adversely affected competitiveness. While there have been recent reforms in the tertiary education sector, a number of issues remain to be tackled which would further promote innovation and productivity. The strong pre-recession economy also hid fiscal slippages, as buoyant revenue growth masked the impact of rising expenditures in municipalities which are not constrained by the expenditure ceiling. Together with the burden of rapid ageing and the fiscal response to the crisis, this raises concerns about fiscal sustainability going forward.

Against this background, returning to sustainable growth puts Finland's policy framework to a new test. This Suruey deals with the related policy challenges. After reviewing recent macroeconomic developments, the rest of Chapter 1 analyses the authorities' response to the downturn and macroeconomic policy requirements for ensuring a sustainable recovery and providing a credible exit strategy. Chapter 2 looks at structural fiscal challenges highlighted by the crisis and the scale of fiscal consolidation which will be needed to achieve fiscal sustainability. Fiscal consolidation needs to address both revenues and expenditures, broaden tax bases, restrain expenditure growth in municipalities and pursue further pension reforms. Consolidation should be supported by reforms to the fiscal framework. Chapter 3 looks at policies to stem the outflow from the labour market into inactivity. Hindering premature exit from the labour market, maintaining work capacity, getting people back to work, and boosting competitiveness are needed to sustain activity. More proactive labour market policies, making work pay, further reforming the pension system and rationalising wage setting frameworks are of particular importance. Wide-ranging labour market reform can have significant impact on income distribution and labour market outcomes as well. As discussed in Chapter 4, this calls for a better grasp of growing inequalities to facilitate social harmony and acceptability of change. While tax and welfare policies are key to understanding changes in equality, regional disparities in labour market outcomes, demographic change and the viability of a large share of Finland's municipalities need also to be addressed.

A severe downturn led by trade

Finland was primarily hit through the trade channel during the recent world economic downturn. The 9% peak-to-trough fall in output and the close to 30% drop in trade volumes over the year to mid-2009 are among the largest in the OECD (Table 1.1; Figures 1.1 and 1.2). Apart from a high degree of openness, this reflects both the destination and structure of Finnish exports; about two-fifths of exports are from ICT industries with high income elasticities (Box 1.1) and one-tenth were destined to Russia, which has suffered disproportionately through this recession. In contrast, private consumption has held up well, buoyed by strong disposable income growth on the back of large negotiated wage increases and tax cuts, declining inflation, the lagged impact of the crisis on employment, and social transfers (see Annex 1.A1). While household debt-to-income ratios climbed considerably before the recession (Bank of Finland, 2009a), rapidly falling interest rates boosted purchasing power by lowering debt servicing costs. This has also enabled an increase in household savings from the negative ratios which prevailed prior to the recession. While holding up initially, the large decline in external demand and the consequent falls in industrial production led to a collapse in business investment. Inventory adjustments were another drag on growth, accounting for about a third of the decline in output over the year to the second quarter 2009. Conversely, public investment has continued to contribute positively to activity through the downturn, aided by government stimulus programmes.

Unemployment has increased less than expected

As in a number of other OECD countries, unemployment in Finland has increased, but by less than expected given the drop in output. Employment has been aided by subsidised temporary layoffs which by the end of 2009 equated to approximately 3% of the labour force (Figure 1.3) and this has helped to hold the unemployment rate below 9%. Firms are also likely to have hoarded labour given the high fixed costs of firing and hiring in Finland and concerns of future skill shortages as were seen in many industries prior to the downturn. The industrial composition of exports may also have contributed to the muted labour market response to date, as the less labour-intensive export sectors have driven the downturn. In addition, the participation rate began to decline considerably after the first few quarters of the recession (see Box 1.3).

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Box 1.1. The external sector and the downturn

The collapse of trade in most OECD countries over the past year led
to large declines in GDP (Figure 1.4). More open economies have
suffered the most, with especially large declines in countries with
large shares of volatile ICT exports. (1) The share of machinery
and transport equipment (which includes ICT goods) has increased
substantially in Finnish exports over the last 15 years (Table
1.2). Together with the high income elasticity of these exports,
this explains part of the large drop in trade (Table 1.2),
particularly in comparison with past episodes when the composition
of exports was considerably different. While a number of other
countries with a similar composition of exports have not suffered
quite such large export declines, many of them have been aided by
competitiveness-enhancing currency depreciations.

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At the same time, Finnish service exports seem to have held up
better. Service exports tripled in volume between 2003 and 2008 and
were around one fourth of all exports by 2008. Finland is second
after Ireland in the OECD in increasing its service exports since
2000. Computer and information services, other business services,
and other unclassified business services (2) account for the
majority of this growth. While the data on Finland's service
exports is sparse, it does appear that they have weathered the
downturn better than goods exports. A significant proportion of
this trade is intra-group business services, which is likely to
hold up comparatively well through a downturn. Also the destination
of Finnish services exports is considerably less concentrated than
goods exports.

(1.) ICT goods comprised around 20% of total Finnish goods exports
in 2006 (OECD, 2008a).

(2.) Other unclassified business services include unclassified
business services including commission trade, operational leasing
and services within an enterprise group not classified elsewhere.


Wages have driven inflation pressures

While inflation in Finland was among the lowest in the euro area for much of the past decade, since mid-2008 it has moved to be well above the euro area average (Figure 1.6, first panel). (2) As in most of these countries, inflation peaked towards end-2008 driven by higher world energy and food prices, and has started to moderate in recent quarters. However, inflation in Finland has not fallen to the same degree as most other euro area countries and is now among the highest in the euro area, despite a large output gap, as food and services prices have continued to increase (Figures 1.5 and 1.6). This is a stark change, as until 2008 Finland was among the best performers in the euro area (Figure 1.6, first panel). While import price developments have been broadly similar across the euro area (Figure 1.6, second panel), Finland stands out as having one of the most rapid rises in unit labour costs (fourth panel). In recent years non-tradable service prices have been driven up on the back of high wage increases in the more productive tradable sectors (the so-called Balassa-Samuelson effect) within the wage bargaining system. Unit labour costs in the service sector grew by 5.5% in 2008 in contrast to 3.1% in the euro area. The continued rise in food prices may also reflect low competition in the wholesale distribution sector, which is dominated by two large vertically-integrated firms.

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The wage setting process is likely to have contributed to the rise in labour costs. Wages in Finland are typically negotiated every three years on a tripartite basis involving the social partners and the government. To increase flexibility in the negotiations and help align wages more with economic conditions, the government adopted a hands-off approach during the 2007 round. However, the result has been a surge in wage growth across all sectors (Figure 1.6). Moreover, the round produced only marginally more flexible wage conditions in a few of the more dynamic sectors, and little progress was made in aligning wages with productivity at the firm level or with competitive pressures across professions. As discussed in the previous Survey (OECD, 2008b), the outcome of the previous wage negotiations was suboptimal, with all sectors being awarded high wage increases. Measures to improve wage formation are discussed in Chapter 3.

The wage share in GDP did fall after the early 1990s recession (OECD, 2008c; Arpaiaa et al., 2009), but remained fairly constant until 2007 at around its historical average of the past decade and above the euro area average (Figure 1.6, final panel). Thus, claims prior to the last wage round that a general upward adjustment in the wage share was called for seems unwarranted, even though labour outflows in certain sectors, such as the nursing profession, might have required an adjustment. The latest large wage increases have pushed the wage share well above its historical average and it is now among the highest in the OECD, suggesting that competitiveness may be a concern. In fact, the problem may be understated as the labour share may have become increasingly artificially depressed in recent years, as labour income may have been diverted to capital income due to changes in the tax system (see Chapter 4).

Competitiveness is a risk going forward, particularly in light of recent large wage increases

Finnish exporters are likely to face considerable competitive challenges in coming years which makes progress in productivity especially important. Indeed, while wage outcomes across the sectors of the economy have been more or less uniform over the past decade, unit labour costs have diverged substantially as a result of the widening gap in productivity performance. Only since the last wage negotiations in 2007/2008 have unit labour costs in the manufacturing sector begun to climb, as wage costs jumped and productivity in the sector slowed (Figure 1.7). As a result, unit labour costs have risen substantially more than in many of Finland's trade competitors, such as Germany, Japan and Korea since 2007 (Figure 1.7). While some of the recent slowdown in productivity growth is likely to be cyclical, Finland's substantial terms-of-trade decline since 2000, (3) as prices of consumer electronics and ICT-related capital goods have trended downwards, adds to competitiveness concerns. In addition, an appreciating exchange rate has contributed to weaker competitiveness. The impact of these developments on Finland's international competitiveness is borne out by the ECB's harmonised competitiveness indicator based on unit labour cost indices for the total economy. The deterioration of this indicator for Finland over the past two years is second only to Slovenia's and considerably larger than the euro area average. (4) Unless these trends are reversed they may slow the recovery from the recession.

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Despite spending 3.5% of GDP on research and development (R&D), on a par with Sweden and Korea, and having a high share of researchers per capita in the OECD context, outcomes seem to have been relatively poor lately with innovation at the firm level not matching the quantity of resources dedicated to R&D (Figure 1.8). This general lack of innovation at the firm level has contributed to low levels of post-entry growth in small Finnish firms. Bartelsman et al. (2009) show that even by European standards, employment growth in Finnish firms seven years after establishment is very low. The lack of dynamism at the firm level may be related to Finland's relatively poor ranking in barriers to entrepreneurship (European Commission, 2008), especially in terms of rigid bankruptcy and insolvency regulations. Attempts to boost entrepreneurship through changes to the taxation of capital income in 1993 and again in 2005 have had only a minimal impact. It is too early to assess the effects of recent changes to company formation, auditing, bankruptcy and restructuring laws aimed at promoting entrepreneurial risk taking. (5) In addition, a number of issues remain in the education sector which could also help in improving Finland's productivity performance (Box 1.2).

The recession is likely to lower potential output

The current downturn is expected to lower the level of potential output substantially. Financial crises tend to have significant permanent effects on the level of potential output, including in Finland in the past (European Commission, 2009). While the full long-term effects of the downturn cannot be estimated with certainty, the costs measured in terms of lost output and employment are likely to be large (see e.g. Furceri and Mourougane, 2009). The weakening labour market is expected to lead to a rise in structural unemployment, which contributes to an expected reduction in potential output in Finland that is larger than the average in the OECD (Figure 1.10). Recent estimates of the decline range from 3% by the Finnish Ministry of Finance (2009) and the Bank of Finland (2009a) to about 5% by the OECD (2009b). (6) These assume a significant fall in capital intensity as the cost of capital rises with permanently higher risk aversion, an increase in the NAIRU over time from rising long-term unemployment and hysteresis effects, lower participation and lower trend productivity. In Finland the participation effect is likely to be particularly strong given the high average age of the workforce and easy access to early retirement options (Chapter 3). A permanent loss in export market share after the recession may also bear on the level of potential output due to the sector's high productivity relative to the rest of the economy.

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Apart from a drop in credit growth, the financial sector impact has been small

The direct effects of the international financial crisis on Finland's banks have been relatively minor, although credit conditions did tighten. The memories of the 1990's banking crisis and strong supervision had encouraged prudence in risk taking, and Finnish banks weathered the crisis without recourse to the assistance offered by the government in late 2008. Nor did Finland experience a housing price bubble. Bank credit to non-financial firms continued to grow by 20% per annum until end-2008 (Figure 1.11, left panel), potentially aided by government guarantees to smaller firms. However, as economic conditions worsened through the first half of 2009, growth in loan volumes fell dramatically. This reflected both lower demand and tightening credit conditions as lending margins rose and demand weakened on the back of the deteriorating economic outlook. Some improvement has taken place since mid-2009 when banks started to have better access to funds, and large firms in the non-financial sector raised funds directly. Smaller companies continue to struggle to access credit.

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Box 1.2. Education reforms to promote productivity

Finland is justifiably renowned for the excellent performance of
its pre-tertiary education sector. As highlighted in the previous
Survey (OECD, 2008b), Finland topped the 2006 PISA rankings of the
performance of students at 15 years of age. However, the previous
Survey also pointed out that significant problems remain:

* Drop-out rates at the secondary level, particularly for males,
are relatively high, with around 18% of the cohort not ending up
with a diploma or qualification after basic education (Prime
Minister's Office, 2009).

* The process for students moving between the secondary and
tertiary levels of education remains inefficient and has resulted
in a large matriculation backlog whereby secondary school graduates
can be forced to wait a number of years before gaining entrance to
a university or a polytechnic. The previous Survey suggested that a
more standardised system of university entrance would be helpful
rather than the current system where entrance procedures and
requirements can vary across different institutions and courses of
study. A more widespread use of matriculation results as the basis
of entrance into tertiary education would be one way forward.

* Average tertiary study times in Finland tend to be very long
compared to most other OECD countries. Around 43% of all 20 to 29
year olds in Finland are students, well above the OECD average of
25% (Figure 1.9). Only 45% of university students complete their
studies within the targeted duration (Prime Minister's Office,
2009). Legislation introduced in 2005 limits the study period to
seven years, but it appears to be relatively easy to receive
permission to extend study times beyond this.

* The courses offered by universities tend to be unresponsive to
market signals with the widespread use of numerus clausus that
restrict the supply of positions in the popular courses and
adjustment to these quotas are made infrequently. This is in part
related to how universities are funded. Students themselves and the
choices they make are insulated from labour market signals by not
having to repay any of the cost of their tuition and by having
ready access to generous in-study benefits.

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The government has made a number of reforms focusing on increasing
the autonomy of the universities by mandating the composition of
their boards with 40% required to be external members. It is hoped
that this will give the universities more independence in
decision-making and a more outward focus, including being more
responsive to labour market signals. The reforms also took steps to
increase the financial independence of universities, including
broadening the range of funding sources. A program of university
mergers has also begun with the view to promoting interdisciplinary
innovation.

Currently, Finnish tertiary students do not directly repay any of
the cost of tuition while living expenses are covered primarily by
government scholarships and grants (55% of students), and
government subsidised loans taken with private banks (39% of
students) (OECD, 2009c). This contrasts with Sweden where around
83% of students graduate with repayable debt. The 2005 reform of
student financing in Finland sought to reduce study times by
increasing student dependence on loans and thereby internalising
some of the cost of excessive study times. Given the short period
of time since these reforms took place, it is difficult to gauge
their effectiveness, although preliminary research suggests modest
success in reducing study times (Asplund, 2008). There are a number
of factors that might explain the difference in take-up rates of
loans between Finland and Sweden. In Finland loans are repaid as
per a mortgage, while in Sweden repayment is income contingent, as
in Australia (see below). Moreover, in Finland interest payable is
fixed at I% during study, but upon graduation the interest rate
switches to a commercial rate. In contrast, in Sweden the interest
rate is fixed at 2.8% for the life of the loan. Once the full
effect of the 2005 reforms becomes clear, further changes might be
needed that encourage students to rely more on personally repayable
debt rather than grants to further sharpen incentives to graduate
as quickly as practicable. This is especially pertinent in Finland
where private returns to tertiary study are unusually high by OECD
standards (OECD, 2009c).

The Australian HELP/HECS Scheme

As recommended in the previous two Surveys (OECD, 2006; OECD,
2008b), the introduction of tuition fees would help to tackle
several of the problems identified at the tertiary level. Like in a
number of other OECD countries, tuition fees could be financed
during study by government loans, and thus repayment could commence
upon graduation and be income contingent, as in Australia.

Australia's Higher Education Contribution Scheme (HECS), introduced
in 1989, is an income-contingent government loan provided to
tertiary students to cover payment of part of the cost of tuition.
Currently the student contribution amounts to around one quarter of
the total cost of tuition. Repayments are made through the personal
income tax system on the basis of post-graduation taxable income
and begin only after income exceeds a threshold of around 70% of
the average wage. Repayment rates are progressive, starting at 4%
of assessed income, rising to a maximum of 8% of income at around
1.2 times the average wage. Interest is not paid on the debt but
outstanding debt is indexed to the consumer price index (CPI).
While upfront payment is an option which attracts a 25% discount,
over 80% of students use the income-contingent deferred payment
option. Repayments in addition to what is required through the tax
system also attract a 10% bonus.

The scheme is administered jointly by the Department of Employment,
Education and Workplace Relations, and the Australian Tax Office
(ATO) and is available to Australian citizens and in limited cases
to permanent residents. To cover living costs while studying,
students may be entitled to Youth Allowance or AUSSTUDY payments,
which are means and assets tested. Further assistance is also
available in the form of scholarships.

In 1996 a three-tier structure was adopted whereby debt was accrued
at a higher rate for those studying in courses deemed to have high
income earning potential, such as medicine and law. A national
priority band also exists which currently includes courses in
education, nursing, mathematics, statistics, and science, and which
attracts lower student contributions. In 2005, the Higher Education
Loan Programme (HELP) replaced HECS and included a number of
changes, most notably allowing individual universities to raise or
lower fees by up to 25% of the standard fee. Study times were
limited to 7 years for undergraduate study and a parallel FEE-HELP
scheme was put in place for post-graduate study which included
life-time limits on total borrowing with some variation across
fields of study.

Since the introduction of the three-tiered system, the average debt
accrued per student has varied according to course of study. A
liberal arts student who graduates on time accrues around AUD 11
000 of debt, while a medical student accrues around AUD 36 000. The
liberal arts student earning the average wage would take around 6
years to repay their debt (Long, 2002). Research suggests that the
transition from no tertiary fees prior to 1989 to the HECS system
of partial fees with income-contingent deferred payment has had no
substantive effect on the participation of lower socio-economic
groups and had only a marginal effect on the transition to
parenthood, with the average level of debt of less than AUD 20 000
thought to be insufficiently large to affect fertility decisions
(Marks, 2009; Chapman and Ryan, 2005).

Similar schemes have been introduced in a number of other
countries. From 1992, students in New Zealand had access to
government loans to cover both tuition and living expenses. From
2006 institutions in the United Kingdom could charge students
tuition fees of up to GBP 3 000 per annum, which are repaid once
income exceeds GBP 15 000.


Unlike banks in neighbouring countries, exposure to the Baltic countries poses little direct risk to Finnish banks. Some indirect risks do exist, however, as around two-thirds of resident bank balance sheets belong to foreign bank subsidiaries and branches (Bank of Finland, 2009a) with the parent banks holding significant Baltic exposures. These risks could materialise if the Scandinavian parent banks were forced to repatriate assets in the face of Baltic-related stresses. However, stress tests by the Finnish Financial Supervisory Authority (FIN-FSA) and the Bank of Finland in April/May 2009 indicate that Finnish banks are in a good position to weather these risks, or a further deterioration in economic conditions. This includes any escalation in mortgage defaults as labour market conditions worsen (Bank of Finland, 2009a). A further iteration of the stress tests should be undertaken and the results published, especially as many of the parameters are outdated, including the magnitude of the economic downturn.

The near term outlook remains muted

The economy is expected to stage a modest recovery in 2010-11 as growth in world demand gathers pace (Table 1.1). Exports are projected to pick up only gradually given Finland's specialisation in capital goods. In the current context with worldwide over-investment prior to the recession and lots of spare capacity, this lag may be even more pronounced. Consumption is projected to recover only moderately in light of a weakening labour market and expected modest wage increases. While the recent cuts to VAT on food and income tax will provide some support, these will be partly offset by a general VAT increase in mid-2010 and other fiscal consolidation measures expected in 2011 and beyond. Housing investment should start to recover through 2010 on the back of a turnaround in house prices, low interest rates and evidence of significant underlying demand, particularly in the Helsinki region. However, real estate transactions remain far below their historical average, which suggests that a complete recovery in housing construction is some way off. Business investment should stabilise in 2010 as the export outlook improves, but growth will remain muted for some time as prospects for Finnish exporters remain uncertain. Restocking is also expected to play a significant role in the recovery.

The unemployment rate is expected to reach close to 10% by the end of 2010, as some of the temporary layoffs flow through to permanent unemployment. The fall in employment will be offset to some extent by an expected large decline in the participation rate, reflecting the loose attachment to the labour force of many older workers who have easy access to early retirement and disability pensions (see Chapter 3). Inflation is projected to remain elevated through the forecast period and stay significantly above the euro area average in part due to previous wage outcomes and despite a one-off deflationary impulse from the VAT cut on food at the end of 2009. A spike in inflation is expected in the third quarter of 2010 coinciding with a VAT increase of 1% across the board, although the rate on restaurants and catering will decrease to harmonise with the recently reduced rate on foodstuffs.

On the whole, risks to the outlook are balanced. Exports may bounce back more quickly than projected as the international outlook and conditions in financial markets improve. On the other hand, the labour market may deteriorate more than projected given rigidities and distortions in the Finnish system and could result in weaker domestic demand than projected. This may also pose risks to Finnish banks, particularly given the weakened state of household balance sheets, which could deteriorate further once interest rates begin to normalise.

While the recovery from the current recession is projected to be muted, even in comparison to other OECD countries, the trough is not likely to be as low as the recession of the early 1990s, and the current recovery is likely to be more rapid (Box 1.3). This is partly due to the different nature of the shocks, as the current export collapse is likely to be more cyclical compared to the severe structural shock in the early 1990s from the long-term collapse of Russian trade. Also overheating and the role of the domestic banking crisis were a serious issue in the lead up to the early 1990s recession, but not today. Domestic demand and employment are expected to decline by less and recover faster in the current downturn, while for exports the shock is larger and recovery may be slower. This reflects the synchronised nature of the current global downturn and the composition of Finland's exports, while the 1990s shock was accompanied by a large depreciation. The recovery may also be slower if competitiveness worsens.
Box 1.3. Comparing this recession and the last

In comparison to the recession in the early 1990s, the decline in
GDP after five quarters into the most recent recession has been
larger (Figure 1.12). This is mostly due to a greater trade impact
in the current recession as export volumes fell just over 30%,
compared to 10% in the past. This is partly due to the rise in
openness since the early 1990s with exports as a share of GDP
almost doubling, but also due to the synchronised nature of the
current recession and high dependence on income-sensitive exports.
However, the overall downturn is expected to be less deep and
recovery faster, except on the exports side.

The initial labour market response has, however, been similar with
a moderate decrease in employment and muted increase in
unemployment, despite the more rapid fall in output during the
recent downturn. The labour market is expected to deteriorate less
and recover faster in this downturn due to a number of factors. In
the past, employment outcomes were worsened by abandoning the
government's employment guarantee as unaffordable, whereas the
current recession has witnessed the wide use of
government-subsidised temporary layoffs and reduced-hours schemes
(see Chapter 3). The sectoral composition of the two downturns also
affects labour market outcomes, as the current collapse of trade is
in more capital-intensive manufacturing (Table 1.3). Labour
hoarding by employers is also likely to play a role now, given the
relatively high costs of hiring and firing in Finland (IMF, 2009)
and past skill shortages.

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Policy response to the current crisis was adequate while returning to growth will be a challenge

The policy response to the crisis was broadly appropriate. Finnish authorities responded quickly to the economic and financial crisis with a number of policy measures. By the beginning of 2010 these included a significant fiscal stimulus package comprising both tax cuts and increased spending, and specific measures aimed at cushioning the impact of the crisis on the domestic financial sector and on Finnish businesses more generally (Box 1.4). Additionally, European monetary policy was eased significantly from the end of 2008. However, the crisis has revealed important weaknesses in the macroeconomic policy mix in Finland, which pose a threat to a sustainable recovery. Although macroeconomic policies have been broadly prudent over the past decade, the crisis-related weakening of the fiscal stance, structural weaknesses not tackled and the looming ageing problem, all create an extra burden on policy.
Box 1.4. Policy responses to the crisis

The government implemented a comprehensive array of policy measures
designed to combat the impact of the global financial crisis on
Finland:

Business sector measures focused on sustaining activity through the
downturn by maintaining access to working capital and export
financing:

* Allowing state-run pension funds to purchase commercial paper
directly from Finnish businesses.

* Increasing the funding of the export credit agencies (Finnvera
and Finnish Export Credit Ltd).

* Providing assistance to the housing construction sector,
including subsidies and credit guarantees for new rental property
construction and certain renovation projects.

* Phasing out employer's national pension contributions.

* Temporarily increasing depreciation rates.

* Allowing greater forbearance on overdue corporate tax payments.
The 2010 Budget proposal extends this through 2010.

Financial sector measures focused on helping banks to maintain
lending to households and businesses, as well as being ready to
assist banks that might become distressed:

* Guarantees against new debt issuance by solvent banks with
maturities between three months and five years with a maximum
duration of five years and compensation at commercial rates. The
scheme was provisionally open until end-2009 and capped at EUR 50
billion.

* Tier I level private equity capital injections with the option of
charging interest where banks were deemed able to pay in line with
similar measures in the 1990s crisis.

* The government announced that it stood ready to recapitalise
distressed banks, including government control and nationalisation,
and impose conditions related to remuneration schemes.

* Amendments allowing the government to oblige distressed banks to
apply for assistance and proscribe certain market activities
including short selling.

* Increasing deposit insurance from EUR 25 000 to EUR 50 000.

Fiscal policy measures focused on sustaining domestic demand while
at the same time seeking to minimise the longer term impact of the
downturn, particularly on the labour market:

* The 2009 budget included a fiscal expansion of around 1% of GDP
including both tax cuts (VAT and income) and increases in spending.

* An amended 2009 budget included support to exporters and
assistance in the housing sector.

* In January 2009 the government announced further fiscal measures
valued at around EUR 2 billion (1.7% of GDP) with a focus on job
training for unemployed youths, as well as transport and other
infrastructure spending, and temporary measures to boost housing
construction by means of grants and interest rate support for the
construction of rental housing. This package also included the
beginning of the phasing out of employers' national pension
insurance contributions which were then completely abolished in a
supplementary budget later in 2009.

* In the 2010 Budget proposal a I percentage point increase in the
VAT rate is planned for mid-2010, with the rate on catering and
restaurants being lowered to 13% to harmonise with the lower rate
on food. Income tax is to be cut for lower income earners by
lowering the limit on the local government income tax allowance.
The excise rate on tobacco is to be increased. The 2010 Budget
proposal also includes additional appropriations for labour market
spending, and increased transfers to municipalities that are
struggling to fund service commitments through the downturn.
Finally, the complete abolition of employers' national pension
contributions is to be funded in the 2010 Budget.


Substantial loosening by the ECB helped sustain demand

The ECB monetary stance meant a substantial loosening in monetary conditions in Finland despite the appreciating currency. However, measured by a simple Taylor rule (Figure 1.13), which does not account for quantitative easing, the ECB policy stance implied extremely tight monetary conditions for Finland given the substantial drop in activity and the consequent large output gap. In Finland, declines in ECB policy rates were rapidly translated into lower lending rates as most mortgages are linked to the Euribor. The impact

of the loosening on corporate lending has, however, been offset by a tightening in bank lending standards toward the end of 2008, reflecting banks' own funding difficulties and rising perceptions of risk. When conditions in the interbank market improved over the spring, large firms began to turn to the corporate bond market for financing. This was facilitated to some extent by allowing pension funds to enter the market. However, conditions for smaller corporations have been considerably more difficult as access to corporate loans dried up. The government measures (see Box 1.4) may have assisted funding in small businesses to some extent.

[FIGURE 1.13 OMITTED]

The fiscal position has deteriorated

Finland came into the recession with public finances in better shape than most OECD countries (Figure 1.14). The fiscal position was relatively strong with a run of surpluses dating back to the 1990s and low public debt, even though international comparisons of deficits and debt levels are somewhat misleading due to the inclusion of private pension funds in the government deficit in Finland (see Chapter 2). Strengthening of the fiscal framework with multi-year expenditure ceilings in 2003, ambitious surplus targets and a new pension system in 2005 all contributed to the strong initial position. However, while the expenditure ceiling on non-cyclical central government spending remained intact, overall government spending grew rapidly and momentum for tax cuts was accumulating although the government simultaneously did foresee future sustainability problems.

Public finances moved rapidly into deficit in 2009 and the fiscal situation is expected to deteriorate further (Figure 1.15; Table 1.4). Government net lending is projected by the OECD to shift from a surplus of 4.4% of GDP in 2008 to a deficit of more than 5% of GDP in 2011, which is the largest projected deterioration in public finances in the OECD between 2008 and 2011 (Table 1.4).

The exceptional worsening in the fiscal position is due to lower expected potential output, strong automatic stabilisers and the ambitious fiscal stimulus (Figure 1.15). Fiscal policy has been loosened successively during the recession. While some elements of the expansionary policy mix were in place before the recession, additional measures have been implemented in the budget proposals for 2009 and 2010 and the supplementary budget of 2009 (Box 1.4), amounting to 1.8% and 1.5% of GDP respectively. As the bulk of the measures are permanent, fiscal stimulus will add around 3% of GDP to the structural deficit between 2008 and 2011. The fiscal outlook is also worsened by an expected reduction in potential output as a consequence of the recession (OECD, 2009b). The contribution of weaker potential output to the structural deficit is estimated to 2.2% of GDR This estimate may be optimistic, as evidence from the 1990s recession suggests that hysteresis effects can be even more pronounced than what current estimates imply (Gronqvist and Kinnunen, 2009).

[FIGURE 1.14 OMITTED]

[FIGURE 1.15 OMITTED]

The stimulus package has broadly helped sustain activity. Although fiscal multipliers tend to be low in open economies, the increased transfers to municipalities and infrastructure investment probably have relatively large multipliers. At the same time, the impact of the measures on activity is likely to be dented by increases in municipal income taxes from 2010 and onward. The stimulus has also mostly been delivered in a timely fashion, although active labour market programmes have been slow to gain traction due to Finland's late activation during unemployment spells (Chapter 3). The permanent nature of the measures do however weigh significantly on fiscal sustainability and remedial action will have to be taken when recovery firms.

The dramatic worsening in the deficit, coupled with the costs of rapid ageing, requires an exit strategy in terms of a credible consolidation plan. While Finland's immediate fiscal challenges are smaller than in most OECD countries, fiscal sustainability is increasingly at risk. Although this issue was covered in some depth in the two previous Surveys, the sudden deterioration in public finances has made return to sustainability even more pressing. As shown in Chapter 2, the fiscal sustainability gap is expected to increase from an estimated 3% of GDP before the crisis to 8% of GDP by 2011. Given the scale of the required consolidation, a combination of expenditure cuts, tax increases and policies to increase labour supply should be pursued (see Chapter 2). The proposed VAT increase in 2010 combined with the rise in energy taxes starting in 2011 and additional increases in taxes on tobacco, etc., are only first steps that are estimated to bring only around 0.9% of GDP in additional revenue over a full year (Ministry of Finance, 2009). Even though Finland's net debt levels are low compared to many other European countries, a concerted fiscal consolidation effort needs to be set out, announced and get underway as soon as the recovery gets onto a steady footing. Further consolidation could be initiated from 2012 and onwards. Attempting to reach the government's relatively tight fiscal targets stipulated in the current fiscal framework (see Chapter 2, Box 2.4) would be unwise in the current economic situation. A revised fiscal framework and a fiscal council would support consolidation (Chapter 2).

Return to sustainable growth will also require increasing the flexibility and productivity of the economy with structural reforms. This is particularly important in the context of a fixed exchange rate. To support a strong recovery, more attention is needed on addressing labour market rigidities that tend to hold down participation rates and labour mobility (Chapters 3 and 4). These include inefficiencies in the higher education system, factors affecting regional mobility, and the generosity of certain social benefits. Finland is also facing a number of challenges to its competitiveness from the wage bargaining system, if it continues to result in overall real wage increases well above productivity. Rising inequality may become a problem for adjusting to rapid change. This is particularly important in the Nordic context, where egalitarian values rank high in the social welfare function. Inequality of incomes and regional inequalities have risen in recent years (Chapter 4). Finally, sustainable development policies will also have to deal with climate change challenges in general, and in particular to energy taxation and subsidies to peat and other energy-intensive sectors.
Box 1.5. Recommendations on macroeconomic policy and education

* While supporting the economy still remains a policy priority, the
government should now formulate and articulate an exit strategy
that includes a consolidation path which is contingent on a firm
recovery taking hold.

* Public confidence would be enhanced if further stress testing of
the banking system were undertaken and the results published. The
previous round of stress tests is outdated, as macroeconomic
outcomes have been significantly worse than envisaged at the time,
and risks to banks have now shifted from funding and capital
adequacy risks to default and external risks.

* Reforms in the education sector would help to boost productivity.
These should include addressing inefficiencies in the interface
between the secondary and tertiary levels (the "matriculation
backlog"), and by the introduction of tertiary tuition fees.
Tertiary fees could be facilitated by a scheme of government loans
to students for which repayment would be income contingent and
commence only upon graduation.


ANNEX 1.A1

Progress in structural reform

This annex reviews action taken to follow recommendations made in the 2008 OECD Economic Survey of Finland and earlier Surveys. Recommendations that are new in this Survey are shown in the boxes at the end of each relevant chapter.
Recommendations                   Action taken since the
                                  previous Survey (June 2008)

                           Pension reform

Increase the effective            The government and stakeholder
retirement age to 65 and fully    organisations agreed in Spring
close the unemployment            2009 on the gradual raising of
pipeline to retirement.           the retirement age by 3 years
                                  by 2025. Two committees have
                                  recently finalised the
                                  analysis of alternative means.
                                  Pipeline not fully closed but
                                  entry age raised by two years.

Make study periods ineligible     No action taken.
for pension credit
accumulation, and scrutinise
the effectiveness of the
higher accrual rates for older
workers.

                           Tax reform

Continue to lower the taxation    Average taxes on earnings have
of labour with priority given     been lowered across the income
to lowering the top marginal      classes. The Finnish Tax
tax rate on labour in order to    Committee has suggested a
keep and attract highly           moderate shift in the burden
skilled jobs and to reduce        of taxation from labour to
incentives for income             consumption.
reclassification.

Raise property tax revenues by    The new system of property tax
setting property assessment       base valuation is in progress.
values (for tax purposes)         Furthermore, it takes energy
equal to 100% of market           saving improvements into
valuations and by raising         consideration as well.
property tax rates.

Raise the minimum municipal tax   Both the minimum and the maximum
rates on all immovable            rates of municipal property
property types and remove the     tax were raised in 2010, but
maximum threshold. Extend         the maximum was not removed.
the property tax base to          No extension to agricultural
agricultural and forestry land.   and forestry land.

To improve incentives for         No action taken.
municipalities to raise more
revenue from property
taxation, apply a maximum tax
rate on labour income (instead
of to property as at present).
To ease the transition, a
relatively high maximum could
be levied to start with, and
then gradually reduced
overtime. Alternatively,
oblige municipalities to match
any increases in income tax
rates with proportional
increases in property tax
revenues.

Eliminate the share of            The share of the corporate
corporate income tax flowing      income tax revenues directed
to municipalities. Fill the       to the municipalities was
resulting funding gap by a        temporarily raised from 22% to
combination of higher property    32% due to the economic
taxes and higher state grants.    downturn.

Raise the revenue efficiency      The VAT on food was lowered in
of the VAT by eliminating         2009 from 22% to 12%. The food
reduced VAT rates. Use the        served in restaurants is taxed
additional revenue to lower       accordingly in 2010. All the
either the overall VAT rate or    VAT rates are raised by 1
labour taxes more generally.      percentage point each on 1
Tax cuffing potential in the      July 2010.
short term should not be used
to further lower reduced VAT
rates as currently planned.

Consider ways to further          The Finnish Tax Committee is
broaden the corporate tax base    considering reform to
and lower the rate.               corporate taxation.

                           Municipal reform

Open up the municipal             The new service bond
purchasing of non-core            legislation in social and
services to competitive           health care services can in
bidding by introducing more       the future open up the markets
mainstreaming of outsourcing      in municipal services. It
policy. All municipal             gives the residents the right
activities that could             to choose their service
potentially be supplied by the    producers.
private sector should be
judged to be economic
activities and the purchase of
their services should be open
to competitive bidding.

Promote the implementation of     The central government
municipal-level productivity      currently promotes municipal-
programmes, including an          level productivity programmes
explicit policy of replacing      in co-operation with the 20
only a certain percentage of      largest cities, which is
all retiring workers, as is       planned to be extended to all
the case at the central           municipalities. Each
government level.                 municipality sets its own
                                  targets for the amount and
                                  percentage of replacing
                                  retiring workers. The central
                                  government monitors how the
                                  municipalities meet their
                                  targets.

Develop more sophisticated        The Best Municipal Service
benchmarking exercises and put    Practices project has collated
in place other structures to      means of achieving
facilitate the sharing of best    efficiencies in municipal
practice municipal management.    services and surveyed examples
                                  of good service practices.

Continue to promote municipal     Municipal merger legislation
mergers and favour mergers        has been renewed. The new Act
over partnership areas.           (in force from January 2010)
                                  will support and promote the
                                  merger processes better.

Ensure that private sector        A committee has been set up to
companies face a level playing    define how competition
field with respect to             neutrality can be guaranteed
municipally-owned agencies by     when the public sector is
encouraging the incorporation     acting in the market.
of all municipally-owned
activities that constitute
economic activities.

Ensure that                       To be handled by above-mentioned
municipally-produced services     committee.
do not receive implicit
subsidies, by introducing
best-practice accounting
systems which ensure that
internal costs incurred by
municipally-owned activities
are correctly attributed. As
part of this, municipalities
should be required to pay tax
on their own property.

In the absence of reform to       No scope for improvement
European VAT legislation,         without changes in the EU VAT
consider modifying national       legislation.
legislation to broaden the
definition of activities that
are classified as taxable.

                           Labour market reform

Continue to negotiate wages at    No action taken.
the decentralised level with
some degree of government
co-ordination. Maintain the
objective that any changes to
the wage negotiation framework
encompass the objective of
moderate aggregate wage
outcomes with a view to
maintaining international
competitiveness.

Make opting out of collective     A minimum wage act has not
agreements easier and             been considered by the
re-considered the current         government.
practice of putting wage
negotiation outcomes into
legislation as it constitutes
a further impediment to wage
flexibility. Consider
replacing this with a minimum
wage.

Put more emphasis on              Labour market training for
subsidised training rather        young unemployed, temporary
than on subsidised employment,    laid-off workers and recently
especially for the older          dismissed workers in order to
unemployed, to direct them        prevent long-term unemployment
away from declining industry      is a priority in the ALMP
sectors towards more dynamic      during the economic crisis
ones.                             (Supplementary budgets for
                                  2009 and Budget proposal for
                                  2010).

Tighten legal requirements for    Sanctions or other legal
geographical (and                 requirements not tightened.
occupational) mobility of the
unemployed, and step up
sanctions and enforcement.

Audit the subsidies currently     No special auditing or
directed at assisting             independent evaluation.
inter-regional mobility.          Maintenance allowances, which
Supplement those that are         are paid during the active
found to be effective and         measures, will be increased on
abolish those (like the second    1 January 2010.
residence subsidy) that are
found to be less effective.

Taper unemployment benefits       No action taken.
over time as is currently done
in many other OECD countries.

Abolish the unemployment          Access restricted.
"pipeline".

Tighten access to sickness and    No action taken.
disability benefits by pairing
stricter activation
requirements with improved
retraining to match skills to
the new structure of the
economy.

Review options for part-time      The current part-time pension
work and their effectiveness.     is deemed by the government to
Make pension rules more           work poorly. There is access
accommodating of part-time        to part-time care for
work. Expand part-time work       children.
opportunities for disabled
workers. Address
inflexibilities in child care
arrangements so as to promote
greater part-time
participation of mothers.

Refine the interaction of the     No action taken.
tax and social security
systems with a view to
addressing the disincentives
to labour force participation
and skills training for those
workers who face extremely
high average and marginal
earning tax rates. For
instance, taper unemployment
benefits over time. Reassess
the Home Care Allowance with a
view to improving incentives
for the labour market
participation of women with
young children.

                           Education reform

Address the matriculation         Two working groups appointed
backlog by allocating             by the Ministry of Education:
additional starting places to     i) on the development of
areas of greatest student         student selection in Higher
demand and by providing more      Education Institutions (HEIs);
financial support to students     ii) on speeding up the
to do their degrees outside of    transition to the education
Finland as temporary measures.    and taking off the degree.
Provide more information for
students on employment
prospects and wages of recent
graduates.

Encourage tertiary                No action taken.
institutions to increasingly
assess applications using the
matriculation exam results
only, so that by the end of
the 3-5 year transition period
most students are able to
enter tertiary education in
the same year that they
matriculate. From that point
onward, separate university
entrance exams in most fields
should be abolished. At the
same time strengthen the role
of the Open University and
polytechnics as alternative
routes to university for those
with poor matriculation
results (this would include
clarifying the transfer of
credits between polytechnics
and universities).

Relax the centrally-planned       The New Universities Act 2009
system of starting places and     makes it possible to charge
introduce tuition fees            tuition fees on a trial basis
together with an                  (2010/14) to students from
income-contingent loan system     outside EU/EEA countries who
that covers tuition fees and      are taking part in separate
living expenses.                  master's programmes, provided
                                  that the arrangements include
                                  a scholarship scheme.

Speed up graduation times by      On 2 March 2009 the Ministry
tightening the annual minimum     of Education appointed a
requirement for progress in       committee to look into the
studies for the study support.    development of student
Transform the study support       financial aid and put forward
system into a system of           proposals for the structural
income-contingent loans.          reform of the student
Ensure that student benefits      financial aid scheme to give
(such as cheap housing and tax    more incentive for full-time
deductions on their loans) are    study. In the opinion of the
available only to students        committee:
meeting the minimum progress
requirements.                     1. The student financial aid
                                  should encourage students to
                                  pursue planned, full-time
                                  studies. The committee
                                  proposes that:

                                    * student financial aid be
                                    granted first for the
                                    completion of the first cycle
                                    degree in accordance with the
                                    two-cycle degree structure,
                                    and only then for second-cycle
                                    studies;

                                    * the withdrawal of only
                                    housing supplement would be
                                    taken into account in the
                                    calculation of the time during
                                    which the aid has been
                                    granted;

                                    * the monthly study attainment
                                    requirement used in the
                                    monitoring of study progress
                                    be raised to 5 study points
                                    and the system for monitoring
                                    progress in studies will be
                                    further reviewed during the
                                    spring of 2010 as part of the
                                    assignment;

                                    * the maximum aid for academic
                                    postgraduate studies be set at
                                    nine months; and

                                    * separate means-testing of
                                    salary received for trainee
                                    periods or a scholarship
                                    awarded by the higher
                                    education institution be
                                    discontinued.

                                  2. The student loan should be
                                  made more feasible as a form
                                  of financing studies. The
                                  committee proposes that:

                                    * the state guarantee for
                                    student loans be granted to
                                    everyone entitled to study
                                    grant;

                                    * the loan guarantee amount
                                    for studies abroad be raised
                                    up to EUR 600;

                                    * the income limits used in
                                    the granting of the interest
                                    subsidy be revised in
                                    accordance with the rise in
                                    the income level, and

                                    * the system of tax
                                    concessions relating to
                                    student loans to be reviewed.

                                  3. The student financial aid
                                  must be sufficient to enable
                                  students to concentrate on
                                  studying full-time. The
                                  committee proposes that:

                                    * the student financial aid be
                                    bound to an index,

                                    * the amount of meal subsidy
                                    for higher education students
                                    be raised, and

                                    * a supplement in the study
                                    grant be made in the case of
                                    students with dependent
                                    children.

                                  No decisions based on working
                                  groups' proposals have been
                                  made.

Change university admittance      The Higher Education
rules, so that students would     Evaluation Council will
be automatically enrolled in a    conduct an evaluation of the
Bachelor's instead of a           degree structure in 2010. The
Master's degree. Admission to     degree structure will be
a Master's degree should be       reassessed as a whole after
contingent on completion of a     this evaluation.
Bachelor's degree with a
sufficiently high standard but
should not include entrance
exams.

Amend university financing, so    The number of Bachelor's
that a larger weight is given     degrees has been added to the
to the number of Bachelor's       University budget formula for
Degrees.                          the period 2010-12. The focus
                                  on degree-based funding will
                                  switch from targets to
                                  outputs. The extent of
                                  education (40% of total state
                                  university budget) will be
                                  determined according to
                                  specific criteria (see Table
                                  1.A1.1).

Revise public sector hiring       No action taken.
requirements, so that a
Bachelor's degree (from either
a university or a polytechnic)
would be sufficient for
certain positions. Develop the
Master's degree as a
conversion programme away from
the subject of the first
degree or as a professional
development programme.

Consider giving credit to         No action taken.
students for work experience
or internships.

Increase the focus on the         The new budget formula for
quality of Doctoral degrees by    Universities puts more weight
introducing, for example, a       on the quality of research.
performance-based financing       The quality and effectiveness
system that would put emphasis    of the research and researcher
on the employment of Doctoral     education will be determined
graduates and the quality of      on the basis of specific
research.                         thematic entities and criteria
                                  (35% of total state university
                                  budget) (see Table 1.A1.2).

                               Labour migration policy

Streamline the work permit        The Government has proposed
system so that foreign workers    that the permit system for
with the right skills can be      labour immigration shall be
accessed efficiently. Consider    simplified in 2011. Every
adopting a green card scheme      residence permit issued to a
like that in Canada and           foreign national will include
Denmark and doing away with       the right to work. The system
the requirement for an            of determining the
"immigration work assessment".    availability of Finnish labour
                                  for a given position will be
                                  phased out but the employer
                                  must first advertise the post
                                  in Finland and the EU and EEA
                                  and Switzerland. A residence
                                  permit for ten months (instead
                                  of six) shall also be
                                  introduced for foreigners
                                  completing a degree or
                                  qualification in Finland to
                                  enable them to seek
                                  employment.

Identify the industry sectors     No action taken.
most in need of foreign labour
and direct assistance to firms
and potential immigrants in
these industries.

Provide greater assistance to     An Action Plan on Labour
Finnish firms competing to        Migration was adopted as a
attract workers in the            Government Resolution in
European labour market            November 2009 including
including more promotion of       description of current
Finland as an attractive          situation, strategic
destination and co-sponsoring     guidelines and proposed
employment fairs in source        measures. The Plan has been
countries.                        drafted for 2009-11. Examples
                                  of ongoing measures funded by
                                  the European Social Fund:
                                  initiative guidance system,
                                  attraction strategy and
                                  regional labour migration
                                  pilot projects.

Do more to promote Finland as     See above.
a destination for foreign
students and encourage these
students to stay after
completing their studies.
Extend the duration of the
post-study job-search permit.

Do more to help the existing      Labour market training in the
stock of immigrants better        State budget for 2010 includes
integrate into the labour         EUR 34 million for basic
market, including by providing    skills and language training
substantial resources for         for immigrants. This includes
basic skills and language         an increase of EUR 4 million
training.                         compared to 2009 budget. The
                                  pre-contract between State and
                                  local authorities of the
                                  metropolitan area has been
                                  signed on the 8th of December
                                  2009. The aim of the pre-
                                  contract is to promote the
                                  integration of the immigrants
                                  and fasten the process into
                                  the labour market by fostering
                                  the human resources of the
                                  employment and business
                                  offices. Custom-based
                                  processes between the local
                                  authorities will be clarified.
                                  The pre contract will be
                                  implemented and reported
                                  during the years 2010-12. New
                                  and innovative ways of
                                  employing immigrants and
                                  supporting their integration
                                  will be explored in the
                                  context of a pilot programme
                                  established by the Ministry of
                                  the Interior in 2009. The aims
                                  of the project include
                                  developing new and innovative
                                  ways of employing immigrants
                                  and supporting their
                                  integration, training
                                  municipalities to recognise
                                  and prevent problems in
                                  residential areas with a high
                                  number of immigrants.
                                  Additionally, municipal
                                  services will be developed to
                                  meet the needs of the
                                  immigrants.

Improve foreign qualification     No action taken.
recognition schemes so that
migrant workers are utilised
to their full capacities and
to avoid the over-
qualification phenomena seen
in many other OECD countries.

Table 1.A1.1. University budget criteria

                                                         Weighting
                                                             %

1. Computational number of students                         30

   a) Full-time equivalent degree students                  85

   b) The calculated number of full-year students in        15
      the Open University and the calculated number of
      full-year students with a separate right to study
      in total

2. Goals of the first-and second-cycle higher               35
education degrees

   a) Total number of first-cycle higher education          25
      degrees agreed upon in the agreement between the
      Ministry and the university

   b) Total number of second-cycle higher education         75
      degrees agreed upon in the agreement between the
      Ministry and the university (1)

3. Completed first- and second-cycle higher                 35
education degrees

   a) Number of completed first-cycle higher                25
      education degrees at the university

   b) Number of completed second-cycle degrees at the       75
      university (2)

(1.) In the calculation, the goal of those second-cycle higher
education degrees with no equivalent first-cycle degree is
multiplied by 1.3. This applies both to the goals and completed
degrees.

(2.) In the calculation, the degrees obtained by field of education
are taken into account up to a maximum of the goal for the agreement
period.

Table 1.A1.2. University research-funding criteria
                                                                 Weight
                                                                   %

1. Research funding competed for nationally                        60
   a) Academy of Finland funding used by the university            75
   b) Tekes funding used by the university                         25

2. Scientific publications                                         20
   a) Number of refereed international publications                70
   b) Number of other scientific publications                      30

3. Internationalisation of research                                20
   a) Amount of international research funding competed for (1)    60
   b) The overall amount of teacher and researcher mobility (2)    40

(1.) Funding does not include enterprise funding or EU Structural
Funds.

(2.) The overall amount of mobility to and from Finland
(minimum 2 weeks).


ANNEX 1.A2

The Nordic model, recessions and economic performance

Social model literature often classifies mature OECD economies into four groupings: Anglo-Saxons, Continentals, Mediterranean and Nordic according to the extent of redistributive policies, social and employment protection (equity), and product market competition (efficiency). (1) The Nordic system has often been touted as a role-model, as the Nordic countries have achieved high incomes with low unemployment and relatively equal income distributions. (Figures 1.A2.1 and 1.A2.2). The Nordic model is characterised as promoting equity with high tax rates (Figure 1.A2.3) and large social transfers, while at the same time fostering efficiency with high productivity growth supported by modest levels of employment protection and strong competition in product markets (Sapir, 2005; OECD, 2009).

[FIGURE 1.A2.1 OMITTED]

There are concerns that the Nordics (and also the Anglo-Saxons) may pay a price for higher long-run efficiency by experiencing more macroeconomic volatility (Figure 1.A2.4). Large differences in changes in unemployment among countries during the recent economic crisis have also raised questions of the impact of various social or economic models in smoothing recessions and sustaining growth and welfare (Reverchon, 2009; Rodier, 2009; Bini Smaghi, 2009). The Nordics, with the recent exception of Norway, and the Anglo-Saxons have been among the worst hit by recessions since the early 1980s. Declines in employment, investment and consumption have been larger, and longer lasting among the Nordics than in the Mediterranean or Continental groups (Figure 1.A2.4). While the results are partly influenced by country size, (2) the Nordics' greater flexibility also probably contributed. At the same time, the Nordic model of large social transfers and automatic stabilisers has performed best in protecting disposable incomes (Figure 1.A2.4) during downturns, and thereby mitigated social costs. Volatility and social protection have not been at the cost of growth, which has been robust over the period, sustained by strong total factor productivity gains (Figure 1.A2.5).

[FIGURE 1.A2.2 OMITTED]

[FIGURE 1.A2.3 OMITTED]

[FIGURE 1.A2.4 OMITTED]

[FIGURE 1.A2.5 OMITTED]

Bibliography

Andersen, T. et al. (2007), "The Nordic Model. Embracing Globalization and Sharing Risks", ETLA.

Bini Smaghi, L. (2009), "A Failure of Capitalism?", Lecture at Centro di Ricerca sul Cabiamento Politico, University of Siena, 16 October.

Claessens, S., M. Kose and M. Terrones (2008), "What Happens during Recessions, Cruches and Busts?", IMF Working Paper, WP/08/274, Washington.

Esping-Andersen, G. (1990), "The Three Models of Welfare Capitalism", Princeton University Press, New Jersey.

OECD (2009), Going for Growth, OECD, Paris.

Reverchon, A. (2009), "Quel modele social resistera le mieux a la tourmente?", Le Monde Economie, 13 October.

Rodier, A. (2009), "Eviter d'abord l'eloignement du marche du travail ", Le Monde Economie, 13 October.

Sapir, A. (2005), "Globalisation and the Reform of European Social Models", Bruegel Policy Briefs, 2005/01, November.

Notes

(1.) See, for example, Esping-Andersen (1990), Sapir (2005) and Andersen et al. (2007). Following Esping-Andersen (1990) large mature OECD countries are divided into four groups--Nordic: Finland, Denmark, Norway, Sweden; Anglo-Saxon: Australia, Canada, Ireland, the United Kingdom and the United States; Mediterranean: Greece, Italy, Portugal, Spain; Continental: Austria, France, Germany and the Netherlands.

(2.) Controlling for openness did not show any consistent pattern in terms of duration or depth of recessions.

Bibliography

Arnold, I. and B. Verhoef (2004), "External Causes of Euro Area Inflation Differentials", Intereconomics: Review of European Economic Policy, Springer, Vol. 39(5), pp. 254-263, September.

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Notes

(1.) Not only is Finland more exposed to the ICT cycle by virtue of the composition of its goods exports but also through royalty and other service income flows directly related to the ICT and capital goods industries. Over the five years to 2008, the value of Finland's service exports almost tripled, driven by a rapid growth in computer services, royalties and licence fees, and other business services (most particularly transactions within international group enterprises and the centralisation of group activities from abroad). (Source: Statistics Finland, International Trade in Services, 2008.)

(2.) Since euro adoption, inflation rates across the EMU countries and volatility within countries have declined substantially (Arnold and Verhoef, 2004). This was particularly notable for Finland which used to suffer from large swings in exchange rates and prices. However, despite this convergence there remains a considerable variance in inflation outcomes across the zone. This can be due to level convergence, changes in bilateral exchange rates (via the differential composition effects on import prices, or via external demand effects) and the output gap. For instance, Zdarek and Aldasoro (2009) show that most of the intra-euro area dispersion in inflation has originated in the non-traded sector, while Honohan and Lane (2003) argue that bilateral exchange rate movements against the euro affect different euro area countries differently and show that this has been an important factor explaining intra-euro area inflation differentials. Arnold and Verhoef (2004) find that the output gap has been an important determinant of inflation differentials in the euro area since the adoption of the euro, although with considerably lags.

(3.) Between 2000 and mid-2009, Finland's terms of trade declined by over 10% while, on average, the other euro area countries saw an increase in their terms of trade of around 3%, with only Ireland showing a significant decline but still only around half that of Finland.

(4.) The outlook has changed considerably since the IMF's 2008 Article IV assessment, finalised at the end of 2007, which concluded that Finland's external competitiveness was adequate. Indeed at the time, with moderate wage outcomes, a booming export sector and a healthy current account surplus, this seemed like a justified assessment to make.

(5.) The Limited Liability Companies Act was amended in 2006. Amendments to the Restructuring of Enterprises Act came into force in 2007. The Adjustments of Private Individual Debt Act was enacted in 2007.

(6.) Difference between potential output level estimates for 2012 between OECD Economic Outlook 84 (December 2008) and OECD Economic Outlook 86 (November 2009). Methodological differences may account for a small part of the change.
Table 1.1. Economic projections

                                   2006

                                  Current
                                prices EUR
                                  billion

Private consumption                 85.9
Government consumption              36.6
Gross fixed capital formation       32.3
Final domestic demand              154.8
  Stockbuilding (1,2)                4.2
Total domestic demand              159.0
Exports of goods and services       75.4
Imports of goods and services       67.2
  Net exports (1)                    8.3
GDP at market prices               167.2
Memorandum items                    ...
Output gap (3)                      ...
Harmonised index of consumer
  prices                            ...
Unemployment rate                   ...
General government financial        ...
  balance (4)
Cyclically-adjusted financial
  balance (3)                       ...
Current account balance (4)         ...

                                 2007    2008    2009    2010   2011

                                                     Projections

                                      Percentage changes, volume
                                              (2000 prices)

Private consumption               3.3     1.5    -2.8     0.2    1.9
Government consumption            0.6     1.7     1.3     0.2    0.7
Gross fixed capital formation     8.6     0.4   -11.8    -4.4    4.9
Final domestic demand             3.8     1.3    -3.8    -0.7    2.1
  Stockbuilding (1,2)             0.3    -0.6    -1.6     0.5    0.1
Total domestic demand             4.0     0.6    -5.5    -0.1    2.2
Exports of goods and services     8.1     7.5   -26.5     3.7    6.5
Imports of goods and services     6.5     6.9   -25.2     0.3    6.4
  Net exports (1)                 1.4     1.0    -3.4     1.5    0.7
GDP at market prices              4.1     0.8    -6.9     0.4    2.4
Memorandum items
Output gap (3)                    2.7     0.2    -8.8    -9.1   -7.6
Harmonised index of consumer      1.6     3.9     1.7     1.5    1.4
  prices
Unemployment rate                 6.9     6.4     8.3     9.7    9.7
General government financial      5.2     4.4    -2.3    -4.8   -5.2
  balance (4)
Cyclically-adjusted financial     4.2     4.1     1.2    -0.5   -1.5
  balance (3)
Current account balance (4)       3.7     2.8     0.8     0.9    0.9

(1.) Contributions to changes in real GDP (percentage of real GDP
in previous years), actual amount in the first column.

(2.) Including statistical discrepancy.

(3.) Per cent of potential GDP.

(4.) Per cent of GDP.

Source: OECD, OECD Economic Outlook 86 Database.

Table 1.2. Demand elasticities for Finland's goods exports with respect
to destination country GDP

Good type                     Income      p-value    % share of total
                             elasticity                goods exports
                             estimate

                               2008                    1995    2008

All goods                       1.7       0.05 **     100.0   100.0
Machinery, transport            2.1       0.07 *       28.9    43.8
  equipment
Basic manufactures              1.7       0.14         42.9    27.9
Chemicals and related           2.7       0.01 **       6.3     8.2
  products
Miscellaneous manufactured      2.6       0.04 **       6.9     5.1
  articles

* significant at the 10% level; ** significant at the 5 % level.

Note: The income elasticity is estimated for each of the different
categories of Finland's goods export values with respect to the
change in GDP through the recession in all OECD countries, OECD
accession countries and the BRICs (37 countries in total).

Source: OECD Economic Outlook Database, Customs Finland and OECD
calculations.

Table 1.3. Decline in value added and employment across industries
Year to second quarter 2009

                                    Change in
                                     valued     Change in
                                      added     employment
                                       (%)         (%)

Primary production                      0.6         0.7
Whole manufacturing                   -22.1        -0.9
Construction                          -13.3        -7.5
Trade, hotels and transport           -11.6        -4.3
Financial, real estate, renting,
  business activities                  -1.4        -3.8
Other service activities               -0.2         1.7

                                                     Contribution
                                    Contribution       to total
                                    to total value    employment
                                     added change       change
                                      (% points)      (% points)

Primary production                        0.1             0.0
Whole manufacturing                      -6.4            -1.3
Construction                             -0.7            -0.6
Trade, hotels and transport              -2.2            -1.0
Financial, real estate, renting,
  business activities                     0.3            -0.5
Other service activities                  0.3             0.6

Source: Statistics Finland and Eurostat.

Table 1.4. Recent fiscal outcomes and projections

                                  In per cent of GDP

                                  2006   2007   2008

Receipts                          52.5   52.6   53.4
  Annual growth in receipts (1)    5.7    7.4    4.4
Outlays                           48.6   47.4   49.0
  Annual growth in outlays (1)     3.6    4.0    6.3
Government net lending             3.9    5.2    4.4
Cyclically-adjusted net lending    3.2    4.2    4.1
Output gap                         2.1    2.7    0.2
Gross public debt (Maastricht)    39.2   35.2   34.1
Net financial assets              67.9   71.1   51.1

                                  2009   2010   2011

                                      Projections

Receipts                          53.9   53.9   52.9
  Annual growth in receipts (1)   -5.1    1.0    2.5
Outlays                           56.2   58.4   58.1
  Annual growth in outlays (1)     7.6    5.8    3.0
Government net lending            -2.3   -4.8   -5.2
Cyclically-adjusted net lending    1.2   -0.6   -1.5
Output gap                        -8.8   -9.1   -7.6
Gross public debt (Maastricht)    37.0   45.6   55.1
Net financial assets              52.1   46.4   39.5

(1.) Per cent per annum.

Source: OECD, OECD Economic Outlook 86 Database.
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Date:Apr 1, 2010
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