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The Finnish Economy

The Finnish Economy. An introduction. The Finnish economy post-WWII. Liberalisation & deregulation foreign trade financial markets utilities Closer integration with Western Europe. A few important milestones. The Helsinki Club 1957. The FINEFTA agreement 1961. The EEC agreement 1974.

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The Finnish Economy

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  1. The Finnish Economy An introduction Vaasa University, October 2008

  2. The Finnish economy post-WWII • Liberalisation & deregulation • foreign trade • financial markets • utilities • Closer integration with Western Europe Vaasa University, October 2008

  3. A few important milestones • The Helsinki Club 1957. • The FINEFTA agreement 1961. • The EEC agreement 1974. • EU membership 1995. • EMU membership (among the original 11) 1999. Vaasa University, October 2008

  4. The first two decades • In the 1920’s and 1930’s, economic policy strongly focused on agriculture & the countryside, ”laissez faire” for the rest of the economy (except exchange rate policy). • Nevertheless, rapid growth & development of manufacturing. Vaasa University, October 2008

  5. A good start • In the 1920’s and 1930’s, Finland was still very much an agricultural economy exporting goods with low value-added. • In 1938, Finland was nevertheless Europe’s 8th richest country as measured by GDP per capita! Vaasa University, October 2008

  6. The Finnish economy after WWII • At the end of WW II, Finland still predominantly an agricultural society. • around 1/3 of labour force employed in agriculture • The forest industry by far the most important industry. • export share over 90% at its highest Vaasa University, October 2008

  7. The war damages… • War damages to the USSR USD 300 million at 1938 prices, to be paid within 6 yrs (extended to 8 yrs in 1945). • Per capita war damages of German allies: • Finland USD 80 • Hungary USD 30 • Romania USD 15 Vaasa University, October 2008

  8. … and how they were paid • The war damages were paid in the form of various industrial goods, of which • machinery & equipment 33.6 % • newly built ships 20.1 % • paper industry products 19.7 % • wood industry products 13.7 % • cables & related products 8.3 % Vaasa University, October 2008

  9. Consequences of the war damages • On the one hand, considerable additional burden on the economy. • On the other hand, the war damages gave a boost to industrialization and laid the foundation for future trade between Finland and the USSR. Vaasa University, October 2008

  10. The bilateral trade with the USSR • Due to foreign currency shortage in the USSR, trade with Finland took the form of clearing trade. • Finland exported mainly machinery & equipment and consumer goods, imported mainly oil and other raw materials. Vaasa University, October 2008

  11. Trade with the USSR: some figures • Finland’s trade with the USSR peaked in 1983, with 27% of total imports and 25% of total exports. • In 1989, the USSR was still Finland’s biggest trading partner in terms of exports (14.5%) and third biggest in terms of imports (11.5%)! Vaasa University, October 2008

  12. The macroeconomic role of trade with the USSR • Stabilisation of output and employment • Cheap Soviet oil ‘buffer’ against oil price shocks in the 1970’s • Inefficiencies in some industries (notably clothing & shoes) • Suboptimal resource allocation Vaasa University, October 2008

  13. Between East and West • On the one hand, participating in the trade liberalisation process in Western Europe (EEC and EFTA) became increasingly important to Finland. • On the other hand, the USSR highly suspicious of Finland’s W-European involvement. Vaasa University, October 2008

  14. The first steps towards freer trade • In 1950, Finland signed the GATT treaty. • In 1957, the ‘Helsinki Club’ agreement granted Finnish exports the same treatment as exports between OEEC countries. Vaasa University, October 2008

  15. Organisation for European Economic Co-operation • Emerged in 1948 from the Marshal Plan (= U.S. economic aid package for Europe). • This being the case, the OEEC thus had a political dimension = problematic for Finland. Vaasa University, October 2008

  16. Nordic or European? • The Nordic Council 1954 ➨ revival of plans for a Nordic customs union. • However, with the creation of the EEC, interest in the Nordic customs union faded ➨ plans abandoned for good in 1959. Vaasa University, October 2008

  17. The FINEFTA agreement 1961 • EEC membership impossible for political reasons ➨ EFTA (the European Free Trade Association) an attractive (but not unproblematic) alternative. • Through the FINEFTA agreement in 1961, Finland became an associated member of the EFTA. Vaasa University, October 2008

  18. Nordic cooperation revisited • In the latter half of the 1960’s, revival of plans for deeper economic integration between Nordic countries ➨ common Nordic market NORDEK. • Negotiations 1968-69, but the resulting draft agreement did not satisfy Finland and Sweden ➨ NORDEK finally buried with Danish & Norwegian EEC application. Vaasa University, October 2008

  19. The EEC agreement 1974 • With the EC enlargement (Denmark, Ireland and the UK) in 1973, securing Finland’s position in the W-European markets increasingly important. • Full EC / EEC membership still politically impossible ➨ free trade agreement in 1974. Vaasa University, October 2008

  20. Moving closer to the EC… • In 1986, Finland (finally!) became a full member of the EFTA. • In 1989, talks about closer cooperation between the EC and the EFTA ➨ European Economic Area (EEA). Vaasa University, October 2008

  21. … and finally towards full membership • With the fall of the Soviet Union, the last obstacles to full Finnish EC membership were removed. • After Sweden had filed its membership application in 1991, Finland followed in 1992 ➨ membership in 1995. Vaasa University, October 2008

  22. EU membership and foreign trade • The EU accounts for 56% of Finnish imports and 54% of Finnish exports. • For the euro area, the corresponding figures are 33% for imports as well as exports. Vaasa University, October 2008

  23. Other economic aspects of EU membership • Taxation • Increasing pressure towards tax harmonisation within the EU (e.g. sales tax on alcohol). • Competition in the single market • what advantages and disadvantages do Finnish companies have in an increasingly competitive EU market? Vaasa University, October 2008

  24. General government tax and non-tax receipts (% of GDP) 2005 • Finland 53.2 • Euro area 45.3 • Sweden 59.1 • Slovak Republic 34.7 • U.S. 32.8 • Japan 31.7 Source: OECD Vaasa University, October 2008

  25. Tax harmonisation in the EU • So far, strongest pressure for harmonisation of capital income taxes + partial harmonisation of VAT and other indirect taxes. • By contrast, no immediate pressure for harmonisation of income taxes. Vaasa University, October 2008

  26. Competition in the Single Market • In the ‘old’ EU (12 members), Finnish labour costs close to the EU average. • However, with the 2004 (and 2007) enlargements, competitive pressure on labour costs has increased – though wages are rapidly catching up in some new Member States. Vaasa University, October 2008

  27. Advantage Finland... • Strong position in high-tech – for now. • Relatively low taxation of corporate profits. • Relatively flexible labour market (by ‘old EU’ standards). Vaasa University, October 2008

  28. ... and disadvantage Finland • Relatively high level of prices and costs. • High income taxes (for middle and high incomes). • Below-average labour productivity (although big differences between sectors + ‘public sector bias’) Vaasa University, October 2008

  29. Labour productivity per hour of work 2005 Vaasa University, October 2008

  30. Finland and the EMU • On January 1, 1999, Finland joined the EMU together with 10 other EU Member States. • From a historical perspective, EMU membership is a major economic policy regime shift for Finland. Vaasa University, October 2008

  31. Exchange rate policy: an overview • 1945-82: Active exchange rate policy • 1983-91: The ‘strong’markka • 1992-95: The floating markka • 1996-98: ERM participation Vaasa University, October 2008

  32. From defensive to aggressive devaluations • The three devaluations in 1945 (75, 40 and 12 % respectively) defensive measure against post-war inflation. • The 1957 devaluation (39 %) already partly ‘aggressive’, and the 1967 devaluation (31 %) openly so. Vaasa University, October 2008

  33. Exchange rate policy and the forest industry • ‘The Finnish markka is devalued whenever the interests of the forest industry require it’. • Net benefits of devaluations to the forest industry significant because of low ratio of imported inputs to exports. Vaasa University, October 2008

  34. The ‘strong markka’ regime • Already in the latter half of the 1970’s, problems of the ‘devaluation cycle’ became evident. • Following the European trend towards exchange rate stabilisation (the EMS 1979), Finland adopted a fixed exchange rate regime in 1983. Vaasa University, October 2008

  35. The end of the strong markka period • By the beginning of the 1990’s, the markka already significantly overvalued, start of the ‘countdown’: • ECU peg in June 1991 • Devaluation (14%) in November 1991 • On September 7, 1992, the markka was floated and subsequently depreciated by around 30% Vaasa University, October 2008

  36. The floating markka 1992-95 • After the September 7 floating, the markka depreciated strongly until Q2 / 1993. • From mid-1993 onwards the markka started to recover ➨ fixed again within the ERM in 1996. Vaasa University, October 2008

  37. Meeting the convergence criteria • Fiscal discipline imposed by the 1991-93 crisis + favourable economic conditions in the latter half of the 1990’s made it relatively easy to meet convergence criteria. • In 1997, only Finland and Luxemburg fulfilled all the convergence criteria! Vaasa University, October 2008

  38. The EMU experience so far • Given Finland’s long track record of active exchange rate policy, adjustment to the EMU has been surprisingly painless. • Adjustment facilitated by the increasing internationalisation of the Finnish industry ➨ production across currency areas. Vaasa University, October 2008

  39. The EMU and public finances • At present, public finances are healthy (budget in surplus, public debt well below Maastricht limit). • But downward pressures on taxes and upward pressures on public expenditure will become a challenge in the near future. Vaasa University, October 2008

  40. The EMU and the labour market • Until recently, centralised bargaining delivered relatively modest wage increases. • The current round of industry-level negotiations, by contrast, has so far produced significantly higher increases. Vaasa University, October 2008

  41. Advantages of the EMU • Low and stable interest rates (at least compared to a fixed markka regime). • Reduced foreign exchange risks (on trade with other EMU members). • Access to an EMU-wide financial market. Vaasa University, October 2008

  42. (Potential) disadvantages • Risk of asymmetric shocks • structure of production & exports • FX exposure of foreign trade • Unsustainable development of wages and costs • will history repeat itself? Vaasa University, October 2008

  43. The 1991-93 crisis • After a period of exceptionally strong economic growth in the latter half of the 80’s, Finland was hit by a severe crisis in 1991. • In 1991-93, GDP fell by 14% in volume terms!!! Vaasa University, October 2008

  44. What caused the 1991-93 crisis? • Policy mistakes • uncontrolled financial deregulation • failure to curtail inflation in late 80’s • defence of an overvalued markka • External shocks • collapse of the Soviet Union • recession in Western Europe Vaasa University, October 2008

  45. Financial deregulation in the 80’s • Following the general international trend, Finland started to deregulate financial markets in the 1980’s. • Problem: fixed exchange rates + free international capital mobility = monetary policy ineffective. Vaasa University, October 2008

  46. The credit boom and the asset price bubble • Financial market deregulation caused rapid credit expansion: • from 1985 to 1989, total lending doubled • foreign currency credits tripled • Credit expansion fuelled growth of domestic demand ➨ overheating, asset price ‘bubble’. Vaasa University, October 2008

  47. ‘It hurts when bubbles burst’ • Higher interest rates + decline in economic growth burst the asset price bubble in the early 90’s. • Floating of the markka inflated the (markka) value of foreign currency debt. • cost of banking crisis around EUR 6.5 bn! Vaasa University, October 2008

  48. Economic policy during the crisis • In 1991-92, fiscal policy still accomodating. • In 1993, shift towards a contractive stance. • restraints of the ‘double deficit’ • threat of liquidity crisis Vaasa University, October 2008

  49. Recovery from the 1991-93 crisis • Thanks to the depreciation of the markka, exports started to recover already in 1993. • Real GDP reached its pre-crisis level in 1996. Vaasa University, October 2008

  50. The crisis in hindsight • Should the markka have been devalued or floated earlier? • decline in GDP less severe with earlier devaluation (9% compared to 14%) • Should fiscal policy have been more accomodating? • with the benefit of hindsight yes, but… Vaasa University, October 2008

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