Is Finland out of the woods?

by Juha Kilponen

Photos by Lauri Rotko

After rapid economic expansion both before and after joining the euro in 1999, the Finnish economy ran into a brick wall after the global financial crisis. During 1995–2008 the GDP per capita grew on average by 3.4 per cent and exports by 7.5 per cent per annum, driven mainly by the success of the Nokia-led ICT cluster and the paper and pulp industries. The relatively large financial surpluses (both private and public) and current account surplus became the norm: by 2008 the public debt-to-GDP ratio had fallen to 33 per cent of GDP while the unemployment rate had declined to 6.5 per cent.

During these years about half of the growth in the economy came from manufacturing, 60 per cent of which derived from the electronics industry and 20 per cent from the rest of the metal industry.

In the midst of the global financial crises, the tide turned: GDP per capita fell by a stunning 8.7 per cent in 2009 and exports collapsed, falling by 20.5 per cent in per capita terms. Finland had been hit extra-ordinarily hard by the global financial crises.

Short-lived recovery

However, the economy rebounded quickly during 2010–2011, reaching GDP growth rates of nearly 2.5 per cent. It looked like a typical V shaped recovery from a sharp downturn. Thanks to a relatively well capitalized banking sector, healthy balance sheets of non-financial corporations and households and a current account surplus, the financial sector did not restrain the recovery, unlike in many other euro area countries.

The recovery was short-lived and the Finnish economy fell into another slump starting in 2012. The GDP contracted for three, almost four, consecutive years. The manufacturing sector firms suffered from collapsing demand as world demand weakened, leading to a fall of their profits and productivity. Based on National Accounts data, the manufacturing sector profits had fallen almost 6 percentage points and capital productivity some 4 percentage points relative to 2008. With falling profits, the firms’ appetite for risky investments and hiring was long gone and private sector cut their R&D investments heavily, too. Productivity growth stalled. It looked as if Finland had lost its growth recipe for good.

By 2015 exports and GDP per capita had tumbled about 15 per cent and 8 per cent below their peaks in 2008, respectively, while private investments had fallen by a steep 20 per cent relative to 2008. Notably, at the same time, world GDP per capita had grown almost 7 per cent. Finland had lost track of the world economic trend.

At the same time, however, private consumption had increased 5 per cent and the public consumption was slightly above its volume in 2008. The flip side of relatively strong consumption but falling income was an increase in both private and public sector debt. In 2015 the private sector debt ratio (debt relative to disposable income) stood at 124.2 per cent and the public sector debt-to-GDP ratio had increased to 63.6 per cent.

Juha Kilponen

Juha Kilponen

Juha Kilponen is a macroeconomist and Head of Forecasting at the Bank of Finland. Prior to his current position, he has worked as Research Advisor and as an economist at the Bank of Finland, and also as Senior Economic Advisor at the European Financial Stability Facility (EFSF). He has also previously been employed by the Government Institute for Economic Research (VATT). He has taught macroeconomics for the Finnish Doctoral Programme in Economics. He has also held visiting positions in the Cass Business School in London and the European Central Bank.

Recovery strengthens - challenges ahead

A new recovery started during early 2016. An exceptionally accommodative monetary policy kept interest rates and interest rate expectations low, investments started to revive and positive sentiment spread in the economy. GDP growth reached 1.9 per cent.

The early phase of recovery was exceptional since it was spurred by domestic demand and not from exports as usually occurs. But this was the case in the majority of the other euro area countries, too. In Finland, exports started to recover more substantially during the early part of 2017. According to the latest Bank of Finland forecast published in December 2017, GDP will reach the 2008 level in 2018, fueled by strong exports and investments particularly.

But is Finland out of the woods? The answer is probably not. First of all, this is not a normal business cycle. Productivity, long-run income growth and real interest rates have been, and are expected to remain, abnormally low. Interest rates cannot be pushed much further down by the ECB and quantitative easing cannot provide much more relief from sluggish demand.

Demand can still expand through debt accumulation. But this is a dangerous road. The pension and health care liabilities that are coming due are growing fast as the baby boomers are shifting from working life to consuming their retirement and health care benefits. At the same time, the working age population is already shrinking. A combination of slow productivity and income growth, low investment return and shrinking working age population creates an income shortage. To put it simply, the Finnish economy is currently not producing enough to fulfill its future spending.