Finland confronts the ‘dilemmas of success,’ weighs policy coordination options
| Author | Max Watson; Christina Daseking; Craig Beaumont |
| Position | IMF, European I Department |
| Pages | 61-64 |
Page 61
Finland’s economy has rebounded impressively from a deep crisis in the early 1990s, and its public finances have been rebuilt. On this sound foundation, the authorities face new challenges in the coming decade, including the impact of a rapidly aging population, risks of over-heating in the real economy and asset markets, and high structural unemployment.
Finland’s recovery from the recession of the early 1990s is one of Europe’s success stories. Its recent economic growth has been well above the European Union (EU) average, and unemployment has fallen from over 16 percent to below 10 percent. Finland’s story of crisis and recovery has elements in common with a number of other strong performers.
• An external shock—the impact of collapsing trade with the former Soviet Union—triggered the crisis, but deep-rooted problems, such as an overvaluation of the markka, a terms of trade deterioration, and the bursting of an asset price bubble, sharply deepened the severity of the crisis.
• A comprehensive policy package fostered a recovery of confidence. The authorities devalued the currency and exercised firm restraint over public spending. In fact, public spending fell by some 10 percentage points of GDP in six years—one of the strongest performances in the European Union. The public finances shifted from a deficit of 7 percent of GDP in 1993 to a small surplus in 1998. Together with a firm monetary policy, this cleared the way for Finland to become, in 1999, a founding member of European Economic and Monetary Union (EMU).
• Exports of goods and services drove the economic upswing. Exports rose from less than 25 percent of GDP at the start of the 1990s to some 40 percent of GDP in 1997. The current account shifted from a deficit of over 5 percent of GDP to a surplus of the same size—by far the largest adjustment among advanced economies. Telecommunications, with Nokia the flagship, expanded particularly strongly. As recovery spread to other sectors, growth accelerated to an average of almost 5 percent over the past three years.
• The labor unions responded to the crisis and its aftermath with a policy of wage moderation, achieved through a centralized bargaining system. This helped foster the steep fall in unemployment and was consistent with a decline of inflation to very low levels.
As Finland gains experience in managing its policies under monetary union, the authorities have cautioned that success must not breed complacency. Three challenges dominate the horizon. First, population aging over the coming decade and a half threatens to jeopardize the longer-run soundness of the public finances or trigger a further increase in Finland’s already high tax burden. Second, while fiscal policy has been adapted to allow a fuller operation of stabilizers, the risk of overheating remains. Finland’s economy con-Page 62tinues to grow rapidly, while euro-area monetary conditions are tuned to the less cyclically advanced core economies. Third, the labor market is not functioning efficiently. It continues to be characterized by high structural unemployment on average and large disparities between regions. The IMF’s most recent Article IV consultation with Finland and the subsequent IMF Executive Board discussion of the staff report focused on these issues.
The IMF consultation underscored that the issues confronting Finland are closely linked, and the approach to population aging will be of central importance. Finland can use various policy instruments to deal with the fiscal impact of this demographic shock. It can tighten the medium-term stance of fiscal policy (to reduce debt levels and interest costs), and it can strengthen a range of structural policies...
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