Recession and a ratings cut by S&P and one immediately thinks of Greece (or Ukraine, or…) but this has also happened much closer to home and in one of the economies that is often seen as a shining light of how things should be done, namely Finland.
Reasons for this, and in particular lessons for Latvia, if any, are what this article is about.
When discussing Greece (or other southern European countries) much of the trouble is structural – a hopelessly inefficient supply side – but this is not (or, according to data, certainly should not be) the case in Finland. In the World Economic Forum’s competitiveness ranking Finland is fourth (Latvia 42nd), in the World Bank’s Ease of Doing Business index Finland is 3rd (Latvia 23rd), in Transparency International’s Corruption Perceptions Index Finland is again 3rd (Latvia 43rd) and I guess many are familiar with Finland typically scoring best in Europe in the PISA (Programme for International Student Assessment) tests. In other words, a great country in which to do business; with well-educated people and good competitiveness.
So what is the problem?
First some statistics. Finland’s economy has indeed performed poorly, see Figure 1. Its economy entered recession territory back in early 2012 and has been flatlining for the past 1 ½ year.
Figure 1: Annual GDP growth, quarterly data, 2011 Q1 – 2014 Q4
Source: Eurostat
Lack of growth implies higher unemployment and less tax revenue which hurts the government budget – unless austerity is imposed (which the Finns are typically quite happy to demand from e.g. Greece) – and in Finland the budget has indeed deteriorated, see Figure 2.
Figure 2: Government budget balance, % of GDP, 2011 – 2014
Source: Eurostat
This, combined with declining GDP, has increased Finland’s debt burden quite a bit (see Figure 3) and enough to make Standard and Poor’s cut its rating from AAA to AA+. Some go further and even predict a Doomsday scenario, with Finland heading for the IMF within a few years but I wouldn’t subscribe to that.
Figure 3: Government gross debt, % of GDP, 2011 – 2014
Source: Eurostat
So, government inaction is to blame for the ratings cut but where does the growth malaise come from? Poor productivity growth and poor demographics (certainly also relevant in Latvia’s case), as argued in this fine article but I think one can go further. Before the current downturn Finland enjoyed a small boom, which led to the usual outcome with substantial wage increases – nice for people but bad for competitiveness. Add to that the demise of their once-giant Nokia and problems appear. Figure 4 shows the deterioration of Finnish external competitiveness – not much, perhaps, but still visible.
Figure 4: Real Effective Exchange Rate (REER), 2005 = 100, Eurozone 18 and Finland
Source: Eurostat
Then add to this policy indecision on what to do and investors, foreign and domestic, also stay away, further damaging the economy.
Lessons for Latvia? External competitiveness must be watched carefully, especially in a currency union; fiscal tightness is also demanded and again particularly in a currency union; clear policy goals stretching far into the future are important to provide certainty to investors and other market participants. And this on top of improving the structural indicators mentioned in the beginning of this piece.
And perhaps also that the economy should never be too reliant on one company or one industry, but in that respect Latvia seems well diversified for me, perhaps with some over-reliance on wood and some local over-reliance on a particular firm (“Liepājas metalurgs”, for instance).
Morten Hansen is Head of Economics Department at Stockholm School of Economics in Riga and member of the Fiscal Discipline Council of Latvia
Komentāri (33)