finland in trouble. whom to blame? · – banking crisis – structural crisis – boom-bust...

Finland in Trouble. Whom to blame?

Adviser to the Board/Bank of Finland

Antti Suvanto

12.12.2014 1

11.12.2014 Antti Suvanto 2

Economic chill set to make Finland the sick man of Europe

Tony Barber Dec 02 07:16 Financial Times

Which of the eurozone’s 18 member states will be the weakest performing economy in 2015?

Italy, which has recorded no economic growth since 1999? Cyprus, which is still reeling from its financial sector collapse in 2012-13? Or some other hard-pressed southern European nation? No. In all probability, the sick man of the eurozone will be Finland.

Outline

• Finland in trouble. Some stylized facts

• Tale of two recessions

• Tale of two countries

• Short-term outlook

– Russian dimension

• Longer-term concerns

• Way forward?



Finland in trouble. Some facts

Some facts

• Output decline in 2009 the biggest annual drop since 1918

• Recovery started in 2010 halted in less than a year

• 2015 likely to show further negative growth

• Finland is a loser in Europe

• Exports worse than in Greece

• Industrial output low and stagnated, while public services continue

to grow

• Longer-term comparison is more favourable


Finland – a loser in Europe


GDP volume, 2008Q1=100

Export performance - the worst in the euro area


DE

ES

PT

IT

EL

FI

Value added by sector (current prices)


Change, % p.a. 2000–2007 2008–2013

Public services 5,5 % 3,9 %

Private services 5,2 % 2,7 %

Construction 7,0 % 0,2 %

Manufacturing 3,9 % -6,2 %

Longer-term comparison is more favourable



Tale of two recessions

Output growth


Source: Gulan, Haavio and Kilponen (2014)

Multiple crises in early 1990s

• Multitude of crises

– currency crisis

– banking crisis

– structural crisis

– boom-bust housing cycle

• Proximate causes

– bad policies

– bad banking

– bad luck

• Recovery

– good policies

– good management

– good luck


Too much complacency in late 1980s

- Finland – Japan of the North

- This time is different

Double recession post-2008

• Global financial crisis

– no domestic banking problems or financial distress

– strong government finances to begin with

– export structure made the country vulnerable to the global financial

crisis • specialisation to investment goods

• Domestic structural crisis

– loss of comparative advantage in ICT and paper industry

• On top of that:

– weak Europe

– Russia/Ukraine

– political uncertainty

– demography


Too much complacency in early 2000s

- Finland – the most competitive country

in the world

- Most modern and innovative and

innovative in Europe

Two recessions


Unemployment rate


Bust in the housing market


Decomposition of output growth


Source: Gulan, Haavio and Kilponen (2014)

A recent study

Adam Gulan, Markus Haavio and Juha Kilponen, ”Kiss me deadly: From Finnish great

depression to great recession”, Bank of Finland Discussion Paper 24/2014.

• We investigate the causes of the Finnish Great Depression in 1990-1993. We find

that the collapse of the overheated financial and banking sectors starting in 1989 was

the trigger of the economic crisis. Foreign shocks, which include the collapse of trade

with USSR in 1991, can account for at most about half of the slump, and these

shocks occurred only when the economy was already in free fall. Also, the

deleveraging and restructuring process of the financial system substantially

prolonged the subsequent recovery.

• Our methodology involves estimating a structural VAR model with sign and

exogeneity restrictions. Importantly, we are able to distinguish between financial

shocks affecting the demand for intermediated loans and those shifting the loan

supply curve. Hence we also contribute to the discussion on which financial shocks

actually matter.


http://www.suomenpankki.fi/fi/julkaisut/tutkimukset/keskustelualoitteet/Pages/dp2014_24.aspx




Decomposition of the latest downturn


2011:1 2011:3 2012:1 2012:3 2013:1 2013:3 2014:1-6

-5

-4

-3

-2

-1

0

1

2

3

4BKT:n vuosikasvun sokkihajotelma

Ulkoiset tekijät

Kotimaiset kysyntä ja tarjontatekijät

Kotimaiset rahoitusmarkkinatekijät

Muut

BKT:n vuosimuutos

External shocks

Domestic financial shocks

Domestic demand

and supply shocks Other shocks

Source: The Bank of Finland Bulletin 4/2014 (forthcoming)


Tale of two countries

Finland and Sweden in a cross-country comparison

• Until the Great Recession economic development almost identical in

the two countries

– both outperformed the euro area countries on average

• Economic policies have been very similar

– Riksbank has followed the ECB (similar inflation targets)

• Both countries undertook structural reforms (lesson from the crisis of

the 1990s)

– Sweden did more, while in Finland the drive for reforms halted

• Being in or out of EMU does not seem matter much; policy and

institutions matter much more

• As regards the future, the jury is still out …


GDP volume, 1998=100



GDP components

Private consumption Fixed capital formation

Exports Imports

SE

SE

SE

SE

FI

FI FI

FI EA

EA

EA

EA

Unemployment, current account and public finances


Unemployment, % Current account, %/GDP

General government surplus, %/GDP General government debt, %/GDP

Monetary policy interest rates


ECB Riksbank

SEK exchange rates


Exports, current prices


Labour market


GDP Labour force

Employment Unemployment, %

SE

SE

SE

SE

FI FI

FI

FI

Structural indicators


Source: Korkman and Suvanto (2014)

A recent study Korkman, S. and A. Suvanto (2014), “Finland and Sweden in Cross-Country Comparison:

What are the Lessons?”, in Andersen, T., Bergman, M. ja Hougaard Jensen, S. (eds.),

Reform Capacity and Macroeconomic Performance in the Nordic Countries, Oxford

University Press (forthcoming).

• It is tempting to see a causal link from crisis to reform illustrated by the developments

and economic policies in Finland and Sweden following the crisis in the early 1990s.

That crisis may be seen as somewhat of a blessing in disguise. It created a political

situation that allowed significant structural reforms to be undertaken, and economic

policies have since the crisis been more successful and “responsible” than in earlier

periods. Policies have been geared towards fostering structural change and

maintaining sound public finances.

• The (current version of the) “Nordic model” is relatively successful in combining equity

and efficiency.

• The monetary regime may matter less for economic performance than often argued

in the heated debate on the pros and cons of a single currency. While not constituting

a laboratory experiment, a comparison of the performance of Finland and Sweden

supports this contention. Admittedly, the jury is still out in the sense that Finland is

now facing a structural weakness of its export base, and it remains to be seen

whether domestic wage adjustment will allow this difficulty to be overcome within a

reasonable time span.



Short-term outlook

Headwinds ahead

• European weakness

• Slowdown in Russia and weakening of rouble

• Stagnant household real disposable income

• Cost competitiveness lost in 2007-2009 not returned

• Room of manoeuvre for fiscal policy is limited

– Finland had the most expansive fiscal policy in 2009 in Europe

• On the positive side:

– low interest rates

– sound banking system


Bank of Finland Forecast December 2014

2013 2014 2015 2106

GDP, % p.a. -1,2 -0,2 -0,1 1.0

Private consumption, % p.a. -0,7 -0,4 -0,1 0,6

Private investment, % p.a. -6,8 -4,0 1,2 3,2

Exports, % p.a. -1,7 -0,1 1,4 3,1

Imports, % p.a. -2,5 -0,4 1,9 3,1


Bank of Finland Forecast December 2014

2013 2014 2015 2106

GDP, % p.a. -1,2 -0,2 -0,1 1.0

Private consumption, % p.a. -0,7 -0,4 -0,1 0,6

Private investment, % p.a. -6,8 -4,0 1,2 3,2

Exports, % p.a. -1,7 -0,1 1,4 3,1

Imports, % p.a. -2,5 -0,4 1,9 3,1

Inflation (HICP), % p.a. 2,2 1,3 1,0 1,4

Current account, % of GDP -1,4 -1,5 -1,7 -1,7

General government surplus, % of GDP -2,4 -2,6 -2,2 -2,2

General government debt (EDP), % of GDP 56,0 59,3 61,7 63,8



Russian dimension

Finland’s trade in goods with Russia


0

2

4

6

8

10

12

14

2006 2008 2010 2012 2014

Exports Imports

EUR billion (12month moving sum)

Source: National Board of Customs

Trade values Trade shares

Finland’s energy dependency on Russia (2013)


Finland’s imports from

Russia by product group

Russia’s share of Finland’s

energy consumption

Impact of the Russian factor

• Sectors most affected

– food industry (sanctions)

– tourism (weaker rouble)

• Risk scenario in the Bank of Finland June 2014 forecast

– imports in Russia down by 20 %

– 25 % weakening of the rouble

– => GDP growth in Finland 0,9 percentage points lower in 2015

• In December two-thirds of the risk scenario assumptions have been

materialized


Exports to Russia 2014/Jan-Aug, % change, y/y


LT

LV EE PL FI SL SK CZ DE AT HU

RO

IT BG SE

GDP level in Russia


model exercise (BOFIT)*

* Rautava, J., “Oil Prices, Excess Uncertainty and Trend Growth. A Forecasting Model for Russia’s economy”, Focus

on European Integration Q3/13, pp. 77-87

1998Q1=100

2008Q1=100

2014Q1=100 model exercise (BOFIT)*

Assumptions: Oil price 85 $/bl + exchange rate

uncertainty similar to 1998-99 and 2008-09


Longer-term challenges

Structural challenges

• Comparative advantage lost in ICT and paper industry

– industrial jobs are diminishing

• Sustained recession adds to long-term unemployment reducing the

participation rate of youths

• Low demand and heightened uncertainty reduce investment

incentives, incl. R&D

• Ageing of the population

– working age population has started to diminish


Secular stagnation?

• Diminishing capital stock -> slower productivity growth -> lower

potential output growth

• Lower spending on R&D -> slower total factor productivity growth ->

lower potential output growth

• Declining participation rates -> lower labour supply -> lower potential

output growth


Cumulative effect of industry decline on GDP from

2007 to 2013


Declining net capital stock


Electrical engineering and electronics industry

Forest industry

Other manufacturing

Million euro (2010 prices)

Total factor productivity and R&D investment


Declining participation rate of younger workers

(difference from average)


Components of GDP growth



Way forward

Structural reforms

• Neither improved international business cycle nor domestic stimulus

cannot solve the structural problems

– corrective actions need to be structural

• Strengthen cost competitiveness

– little room for wage increases

– local agreements might help

• Strengthen productivity in the provision of public services

– health care reform

– municipality reform

• Implement the pension reform (already approved)

• Increase competition in retail trade and services

• Boost supply of housing by changing zoning practices and reducing

regulation


Do not forget these

• Educational achievement

• Infrastructure

• Good governance – low corruption

• Trust in institutions

• Good innovation system


Whom to blame?

• Bad policy (as always)

– some structural measures (health care reform, pension reform)

delayed unnecessarily long; no lack of knowledge

– deliberately overoptimistic expectations in 2011 when the new

Government took office

• Bad luck (as always)

– iPhone (Nokia) and iPad (paper)

– sovereign debt crisis in Europe

– Ukraine/Russia



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finland in trouble. whom to blame? · – banking crisis – structural crisis – boom-bust...

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