Finland and New Zealand: A Cross-Country Comparison of Economic Performance

Frame, Dave Working Paper Finland and New Zealand: A Cross-Country Comparison of Economic Performance New Zealand Treasury Working Paper, No. 00/01 Provided in Cooperation with: The Treasury, New Zealand Government Suggested Citation: Frame, Dave (2000) : Finland and New Zealand: A Cross-Country Comparison of Economic Performance, New Zealand Treasury Working Paper, No. 00/01, New Zealand Government, The Treasury, Wellington This Version is available at: https://hdl.handle.net/10419/205416 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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The Treasury takes no responsibility for any errors or omissions in, or for the correctness of, the information contained in these working papers. Acknowledgements: I wish to thank many people whose discussions have contributed to this work, and especially Sarah Box, Andrew Coleman, Lesley Haines, Dean Hyslop, Benedikte Jensen, Kevin Cosgriff, Sian Robyns, and Andrew Sweet. In particular, I would like to thank Colin James for assistance in obtaining information on the Finnish economy and policies. TREASURY WORKING PAPER 00/1 Finland and New Zealand: A CrossCountry Comparison of Economic Performance Dave Frame ABSTRACT The working paper compares and contrasts the macroeconomic performance of the New Zealand and Finnish economies over the entire post-WW2 period. It notes that Finland has gradually overtaken NZ in terms of GDP per capita, productivity performance and export performance. Finland suffered a severe recession in the early 1990s (the deepest affecting any western industrialised economy in the Post WW2 period). Very high growth rates since 1994 in Finland may partly be ascribed to cyclical rebound from this recession, with much of the remainder driven by rapid growth in the telecommunications giant Nokia. Finland also faces some particular policy challenges: high structural unemployment, medium term fiscal pressures from an ageing population and impediments to the growth of small and medium sized enterprises. The paper shows that differences in economic performance between New Zealand and Finland cannot simply be ascribed to contrasting policy approaches. Cultural and geographical differences, and historical antecedents have also played a role. There may be lessons to learn from Finland’s approach to education and R&D policy. The Finnish approach of experimenting with different policy settings and carefully evaluating their effect is also instructive. In most other respects, Finland’s economic strategy bears a close resemblance to that of New Zealand. TABLE OF CONTENTS ABSTRACT........................................................................................................ 1 TABLE OF CONTENTS..................................................................................... 2 EXECUTIVE SUMMARY ...................................................................................4 Comparative Performance.......................................................................................................................4 Different Routes of Economic Diversification........................................................................................5 Nokia – an Important Element.................................................................................................................6 The Education System.............................................................................................................................6 R&D and Industry Policy........................................................................................................................7 Policy Evaluation.....................................................................................................................................8 Consensus Building and Social Capital...................................................................................................8 Liberalisaton and Integration...................................................................................................................8 Policy Challenges....................................................................................................................................9 Can Small Countries Aspire to High-technology Leadership?..............................................................10 Conclusion.............................................................................................................................................11 MOTIVATION AND OBJECTIVES .................................................................. 13 COMPARING FINLAND AND NEW ZEALAND.............................................. 15 FINLAND AND NEW ZEALAND SINCE WORLD WAR II ..............................18 Output....................................................................................................................................................18 GDP Growth..........................................................................................................................................19 Population..............................................................................................................................................24 Productivity ...........................................................................................................................................25 Recent History..........................................................................................................................................27 Causes of Recession..................................................................................................................................27 Domestic Considerations.......................................................................................................................27 Collapse of Eastern Trade......................................................................................................................28 Trade .........................................................................................................................................................29 Exports by Region.................................................................................................................................33 Composition of Export Industries..........................................................................................................36 Finland as a Gateway.............................................................................................................................38 Current Account ....................................................................................................................................38 Sectoral Breakdown.................................................................................................................................39 Output....................................................................................................................................................39 Industry..................................................................................................................................................42 Services..................................................................................................................................................47 Industrial Structure................................................................................................................................50 New, Technology-based Firms..............................................................................................................51 High-technology Firms in Small Countries...........................................................................................53 Social Capital in Finland .......................................................................................................................55 New Zealand starts on the diversification path later than Finland.........................................................56 3 GOVERNMENT POLICY................................................................................. 57 Monetary Policy........................................................................................................................................57 Interest Rates.........................................................................................................................................60 Consumer Prices....................................................................................................................................62 Fiscal Policy ..............................................................................................................................................63 Composition of Government Expenditure.............................................................................................65 Superannuation......................................................................................................................................65 Other Welfare Costs ..............................................................................................................................66 Health ....................................................................................................................................................66 Education...............................................................................................................................................68 Education and the Knowledge-based Economy ....................................................................................70 Labour Market.........................................................................................................................................72 Unemployment......................................................................................................................................72 Employment ..........................................................................................................................................72 Wage Setting .........................................................................................................................................74 Flexibility ..............................................................................................................................................74 Tax.........................................................................................................................................................74 Summary................................................................................................................................................76 Industry Policy..........................................................................................................................................77 1. Competition Policy..................................................................................................................79 2. State Aid..................................................................................................................................79 3. R&D Policy.............................................................................................................................80 4. Venture capital for Research and development.......................................................................81 5. State Ownership......................................................................................................................82 6. Financial Markets....................................................................................................................82 7. Energy Policy..........................................................................................................................82 8. Environmental Policy..............................................................................................................83 9. Regional Policy.......................................................................................................................83 10. Administration of Industrial Policy.........................................................................................84 11. Development of the Service Sector.........................................................................................84 12. Small and Medium-sized Enterprises......................................................................................84 13. Agriculture and Forestry .........................................................................................................85 DISCUSSION AND CONCLUSIONS............................................................... 86 Comparing Finland and New Zealand...................................................................................................86 Elements of Finnish Economic Strategy................................................................................................87 Industry policy.......................................................................................................................................88 Policy making and social capital ...........................................................................................................88 APPENDIX 1: FINNISH AND NEW ZEALAND GROWTH RATES................ 90 APPENDIX 2: FINNISH INHERITANCE AND GIFT TAXATION..................... 91 Tax on Inheritances ...............................................................................................................................91 Gift Tax .................................................................................................................................................91 Real Property Tax..................................................................................................................................92 REFERENCES................................................................................................. 93 4 EXECUTIVE SUMMARY New Zealand and Finland share some common characteristics – both countries are small, open economies, with similar populations, similar land masses and resources, and comparable average incomes. This makes Finland an interesting comparison country for New Zealand, particularly given the fact that, in the years since the Second World War, it has successfully transformed itself from a low-tech, resource-based economy into a high-tech, high value-added economy. Having started the post-war era well behind New Zealand in terms of average national income, Finland is now ahead. Given the different paths of the two countries and the Finns’ considerable success in developing high value-added industries, one of the main focuses of this working paper is to examine the role of government policy in the development of these industries. However, country comparisons are always difficult. There are significant differences between any two countries and it is difficult to judge which policies from Finland are worth replicating in New Zealand. For example, one significant difference between the two countries is geographic: Finland is well integrated into the wider European economy and, importantly, has European Union membership. The Finns have also proved adept at taking advantage of their proximity to Russia, especially during the Cold War years. New Zealand, on the other hand, is by far the world’s most isolated industrialised country. The comparison certainly provides compelling evidence that an appropriate mix of location, available resources, human capital and policy settings is crucially important – and that adopting Finnish policy without careful thought about the other pre-conditions of success is unlikely to achieve such impressive results. In fact, one of the most striking characteristics of Finnish public policy is the very careful thought given to how it can help different industries and sectors, such as in its agricultural policy (see page 82). Comparative Performance Finland started the post-war period considerably behind New Zealand in GDP per capita. However, during the 1950s, 1960s and 1970s its economic performance improved as resources were moved from agriculture into industry and services, unleashing higher productivity growth. Solid growth in Finland (and weaker than average growth in New Zealand) has seen the Finns enjoy higher average incomes than New Zealanders since about 1980. In the European context, Finland has been an average performer for most of the post-war period, with its GDP per capita matching the European average until 1979. During the 1980s Finland briefly enjoyed above-average European income levels, but economic difficulties and a major recession brought it back to the 5 pack with a bump in the early 1990s. This massive recession – the largest to hit any industrialised country since the Great Depression – has dominated Finland’s recent past, driven by a bursting asset price bubble and, to a lesser extent, a collapse in trade with the Soviet Union. Finland’s growth since 1994 has averaged around 5% per annum, but mostly because of a cyclical rebound. Growth is expected to soon slide back to a more sustainable level. In the post-war period before the 1990s’ recession, Finland enjoyed greater macroeconomic stability than New Zealand. Output growth was less volatile, which may have encouraged Finnish investment and contributed to rising income levels. (Note that although this working paper has not established the reasons for this less volatile growth, the macroeconomic environment is likely to have played a part. Future research could focus on comparing the relative importance of terms of trade effects and fiscal and monetary policy.) Different Routes of Economic Diversification After World War II Finland owed the Soviets substantial reparations, which it paid in metal and engineering products. As a result, it developed a strong manufacturing base in ship-building and engineering. During the same period, New Zealand was doing very well out of feeding a recovering Britain and was slower to diversify. It is likely that these different pressures caused the two countries to produce different sets of goods, seeding different sorts of industries. Both New Zealand and Finland have since diversified their exports, and New Zealand’s story may be the more dramatic. In Finland, the forestry industry and its related offshoots have remained strong, joined by metal and engineering products and an especially notable period of recent growth in the telecommunications sector. Considerable diversification has occurred in New Zealand since the dismantling of import controls and agricultural subsidies and the introduction of tariff reductions. In 1960 some 92% of New Zealand’s exports were of pastoral origin; in 1996 that figure was down to 36%. Although New Zealand has not achieved a growth in GDP per capita to match Finland’s, the theme of export diversification is possibly more important in New Zealand than in Finland because of the greater initial homogeneity. 6 Nokia – an Important Element The success of Finland’s telecommunications giant Nokia explains a substantial share of Finland’s overall growth in the 1990s. Nokia’s telecommunications business took off in 1992, had net sales of US$8 billion in 1998 and has enjoyed staggering growth of 25% per annum since 1994. The Finnish Institute of Economics (ETLA) estimates that the electronics equipment industry added 1.5% to annual real GDP growth during 1998 and Nokia alone accounted for 1% of real GDP growth1. Nokia’s development provides insights into factors that may be responsible for Finland’s overall performance. Nokia’s present success dates to its strategic decisions to invest in leadingedge research and development (R&D) in the 1960s and 1970s. The groundwork for telecommunications was laid in the 1960s when the company researched the field of radio transmission in its electronics department. In the late 1970s, mobile phones and telecommunications infrastructure products were developed for both domestic and international customers. Nokia invested in digital technology when it was in its infancy. These decisions, followed by a continuing strong commitment to R&D, allowed Nokia to develop and maintain its competitive edge. The policy environment was another factor driving the development of an internationally competitive Finnish telecommunications industry: • Deregulation (competition among telephone system operators and with foreign suppliers of telecommunications equipment to the Finnish market) put pressure on Nokia to continually develop its businesses and products. • Finnish policy insisted that technical standards meet internationally accepted norms. The upshot was that Finnish suppliers were ready to service a growing international market, at a time when potential competitors (eg Motorola) were cocooned within domestic regulatory environments and not producing systems compatible with worldwide requirements. The Education System The growth of high-technology firms such as Nokia and its affiliates has so far not been hampered by a shortage of the necessary engineering and other technical skills. The Finns do well in standard international literacy and quantitative competency comparisons. Their education system follows the traditional Northern European model of streaming students into either vocational training schools or upper1 OECD Economic Surveys: Finland, Organisation for Economic Cooperation and Development, Paris, 1999, p20. 7 secondary schools, which prepare them for university. There is fierce competition for the most popular university courses, allowing universities to maintain high entrance standards. This study has not assessed Finland’s education model in detail, but there may be something to learn from the way it funds and manages its compulsory education sector. However, it should be remembered that educational results are produced by the interaction of family mores, individual attributes and formal training. As in all inter-country comparisons, it is difficult to disentangle the effects of cultural differences (for example, do the Finns place more importance on education excellence than many New Zealand families?) from the performance of the education system. The Finns are concerned with shortages in graduates with commercial and entrepreneurial skills. They are also concerned that the system is not responsive enough to employer needs and that bottlenecks in the tertiary system are encouraging students to spend too long on courses that are not preparing them well for job opportunities. R&D and Industry Policy Nokia’s history shows that telecommunications liberalisation early in Finland’s history played a significant role in the growth of its high-technology sector. The Finns have also recently reformed other elements of their industry policy, but still believe there is a role for government in industry. That said, the Finnish Government has slashed state aid to business over the last decade and focused the remaining subsidies on intangible assets such as R&D. It believes that without some government support for these activities Finland will lose valuable spill-over effects. Much of Finnish industry assistance policy is based on risk-sharing between the Government and businesses. For example, businesses wanting to access government R&D grants must pay at least 50% of the costs. If the project meets appropriate criteria, the Government then contributes a share of the necessary funds. Public spending on R&D did not play a major role in Nokia’s development, although the company did forge strong links with university research institutions in the 1960s and 70s and thus indirectly benefited from government spending. The recent emphasis on risk sharing with private R&D ventures may help Finland to maintain its lead in high-technology developments. The Finnish Government certainly views this policy as an investment for the future. However, it is too early to categorically review its effect. 8 Policy Evaluation The Finns seem eager to stand back and evaluate policy so that they can minimise errors, with their approach to R&D an interesting example. A high premium is placed on evaluating the success or otherwise of their policies. Consensus Building and Social Capital Consensus building appears to be another feature of Finland’s policy – and especially political – landscape. The parties forming the Government regularly represent more than 70% of Finnish voters, which probably enables them to debate policy subtleties in a more sophisticated way than is possible in more adversarial systems. High social capital or trust is likely to be a significant feature. Social capital, with attributes such as the level of trust and co-operation between individuals and groups in society (including between businesses), is one suggested explanation for the high income levels in Nordic countries. Most measurements of social capital place these countries at the top of international comparisons. It may be that homogeneity, egalitarianism or some other cultural phenomenon drives this more in Scandinavia than in other small countries such as New Zealand. Higher levels of trust and co-operation may help in the transfer of knowledge between firms in an industry and thus explain the degree of innovation and rapid diffusion of know-how in Nordic countries. Liberalisaton and Integration Finland has pursued trade liberalisation since the 1950s and had low levels of protectionism for some time. Finland had a special trading relationship with the Soviet Union and did not gain European Union membership until 1995. However , Finland has always had strong trade relationships with the rest of Europe (through the Nordic Council since 1951, and the European Free Trade Association from 1961)2, and has been quick to enter newly emerging markets in the Americas and Asia. Finland joined with the other Nordic countries to harmonise domestic regulations in such areas as telecommunications. Finland’s long history of outward orientation and emphasis on harmonising domestic regulations with other countries appears to explain some of its recent export led economic success, especially telecommunications. 2 Padma Desai, Going Global: Transition from Plan to Market in the World Economy , 1997 Uni/Wider, p274. 15 COMPARING FINLAND AND NEW ZEALAND Finland has always been a buffer between the competing influences of Protestant Sweden and Orthodox Russia. Even though Finland gained its independence in 1917, its modern history has still been dominated by its Nordic and (until recently) Soviet neighbours. If New Zealand sometimes feels that isolation is its defining geographical characteristic, Finland’s has been the opposite – a surfeit of sometimes prying neighbours. These pressures have continued to affect Finland throughout the 20th century. The Finns are justly proud of their successful resistance against Soviet aggression during the Second World War, although by entering the war as a cobelligerent of the Nazis they found themselves in an awkward position in international affairs: not only did they owe the Soviet Union some US$226 million in war reparations, they came under threat of direct Soviet intervention in the form of military occupation, and indirect intervention in the form of Soviet political agitation. In 1948 the Finns signed the Treaty of Friendship, Co-operation and Mutual Assistance with the Soviet Union, which provided the basis for Finnish relations with its eastern neighbour throughout the Cold War. This approach gave the English language a new verb – to Finlandize, which the Shorter Oxford Dictionary defines as to “induce (a country) to adopt a policy of benevolent neutrality towards the Soviet Union”. This policy prevented Finland from joining the European Economic Community or the Council of Europe on the grounds that the Soviet administration considered these organisations antithetical to its interests. Foreign policy considerations like this have shaped most of Finland’s dealings with the rest of the world over the last 50 years. Although culturally and socially Finland has more in common with the Nordic countries to its west, geopolitical considerations have limited its political freedom. It is only since the collapse of the Soviet Union that Finland has been able to consider full membership of the European family. While Finland welcomed the foreign policy freedom associated with the demise of the communist bloc, the collapse of the Soviet Union occurred at a bad time and was one of the factors triggering Finland’s massive economic crisis in the early 1990s – when real GDP contracted by around 13% and unemployment reached 18%. Finland has recovered remarkably well from this recession – one of the worst in an industrialised country this century, including the Great Depression. Aside from the very different political histories of the two countries, New Zealand and Finland share a lot in common. This is why Finland is, like Ireland, a reasonable country with which to compare New Zealand (see Table 1). The countries have similar populations, geographical areas, resource bases and standards of living. In terms of average income the countries are similar, 16 although Finland is now slightly ahead. Both countries have export-oriented open economies, although the product mix is quite different. Given the similarities between the two countries it is worthwhile to examine the Finnish experience and compare it with our own. However, it is important to note one major difference between the two countries: location. Figures 1 and 2, centred on Helsinki and Wellington, demonstrate this. The radii of the circles are the same in each case. Within the circle centred on Helsinki there are 39 countries and approximately 300 million non-Finnish people. Within the circle centred on Wellington are Norfolk Island, and a little of New Caledonia. Figure 1 17 Figure 2 These graphs are obviously a little facetious – if we widen the radii enough, both will contain the same number of people – but they do illustrate the magnitude of our isolation. Finland New Zealand Area6338,145 269,057 1950 population74,009,000 1,914,000 1995 population85,117,000 3,681,500 Major urban areas9Helsinki 539,000 Espoo 200,834 Tampere 188,726 Vataa 171,297 Turku 168,772 Oulu 113,567 Auckland 1,057,100 Wellington 345,500 Christchurch 337,200 Hamilton 164,600 Napier-Hastings 115,700 Dunedin 112,800 Table 1 6 National Geographic Atlas. 7 Penn World Tables. 8 Statistics Finland, Statistics New Zealand. 9 Statistics Finland, Statistics New Zealand. 18 FINLAND AND NEW ZEALAND SINCE WORLD WAR II Output Gross Domestic Product At the end of the Second World War the economies of Finland and New Zealand headed on somewhat divergent paths. While New Zealand sought to feed an ailing post-war Britain (as well as itself), Finland set about repairing its infrastructure, which had been damaged by three separate conflicts throughout the war. In addition, Finland owed US$226 million in reparations to the Soviet Union10, most of which it paid in finished product exports from its metal and engineering industries. Although the foundations of these industries had been established before the war, the reparation process helped them develop and take their place alongside the traditionally powerful forestry industry. Total GDP US$ million ( 1985 ) 0 10000 20000 30000 40000 50000 60000 70000 80000 90000 1950 1953 1956 1959 1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 Time GDP US$ million (1985) Finland New Zealand Figure 3 Source: OECD, Penn World Tables The already strong forestry industry focused on Western Europe, while the nascent shipbuilding and engineering industries sold to the East via five-year bilateral trade agreements in which metal products, textiles and clothing were exchanged with the Soviet Union for oil. World market prices for oil affected the volume of Finnish exports, and declining oil prices in the 1980s were the first warning of the fragility of Finland's trade with its eastern neighbour. Although this system of trade ultimately collapsed at the beginning of the 1990s, there is evidence that it was a profitable 10 Finland is the only European country to have repaid its war reparations. 19 arrangement for Finland – that the prices it obtained for its goods were a little higher than it would have received had it sold them to the West. In addition, a guaranteed Soviet market meant that Finnish exporters could shift production to this market when other countries suffered recessions in the 1980s, and to some extent this helped smooth Finland’s economic trajectory. New Zealand, by contrast, experienced weaker, more volatile growth through the 1970s and 1980s, with a prolonged period of weak growth from 1987 into the early 1990s. Solid growth reappeared in the mid-1990s but declined towards the end of the decade because of the Asian crisis. GDP Growth Figure 4 and Table 2 show annual growth rates for Finland and New Zealand, which are then averaged over longer time periods. It can be seen that – generally – New Zealand’s growth has been more volatile than Finland’s, about a lower mean. Since 1961 New Zealand has grown at an average rate of 2.5%, while Finland has grown at around 3.4%. Most of New Zealand’s growth occurred between 1961 and 1974 (with an average of 4.2%); since 1975 it has averaged only 1.5%.11 GDP Growth -10 -5 0 5 10 15 1961 Year Percent GDP growth New Zealand Finland Figure 4 Source: OECD 5 Presenting the situation in this way may make things seem a little more extreme than they really were – 1974 was a high water mark for New Zealand, so choosing it as an end-point exaggerates the story a little. 20 Finland achieved moderate growth in the 1960s and strong growth in the early 1970s, before succumbing to the general malaise in the late 1970s. However, its experience in the late 1970s was not as bad as that of many countries – this is because the bilateral trade deals with the Soviet Union supplied Finland with oil that was not subject to many of the price fluctuations associated with oil from OPEC during this period. Finland posted a growth rate of 3.5% during the 1980s – accelerated towards the end of the decade by a credit-driven boom – before the combination of a credit crunch and the collapse of the Soviet Union plunged the economy into recession in the early 1990s. Subsequent growth has been strong, although much of it has been a bounce-back phenomenon. Figure 5 shows the annual growth rates for GDP per capita. This is slightly different from Figure 4 as population growth is incorporated in the economy’s annual performance. GDP per Capita Growth -15 -10 -5 0 5 10 15 1951 Years GDP per capita growth (%) Finland New Zealand Figure 5 Source OECD, Penn World Tables Annual growth rates for Finland and New Zealand are provided in Appendix 1, while Tables 2 and 3 below show average growth rates for the two countries for periods since 1960. Since 1975 the only period when New Zealand’s growth has been higher than Finland’s for any extended period was during the early 1990s. 21 Table 2: Average GDP Growth (%) Years New Zealand Finland 1961-69 3.4 4.5 1970-74 5.6 5.4 1975-80 -1.3 2.7 1981-89 2.6 3.5 1990-93 1.9 -1.5 1994-98 2.3 5.0 Considering the post-war period as a whole (Table 3), Finland has grown faster than New Zealand by a comfortable margin. Table 3: GDP Growth 1962-1998 Statistical properties New Zealand Finland Average 2.46 3.37 Variance 14.3 10.2 GDP per capita Figure 6 forms one of the prime focuses of this report. In 1950 New Zealand was clearly a long way above the OECD average12 in terms of national income, with Finland slightly below average. New Zealand continued to enjoy higher than average national income throughout the 1950s, 1960s and early 1970s, coming back to the pack with a bump in the mid-1970s. Since 1974, New Zealand’s performance has been considerably weaker than most – it was not until 1984 that New Zealand managed to beat its 1974 per capita income level in real terms. Since then, growth has continued to be weak – between 1972 and 1992 its per capita income hovered between US$10,00013 and US$11,500. Over the same period, the average OECD income improved from US$8,860 to US$12,190, an increase of around 38%. 12 This is not strictly an average over the entire OECD. Countries that have joined the OECD in the 1990s have been excluded from this comparison. 13 1985 US dollars. 22 Figure 6 Source: OECD, Penn World Tables Finland, although a little behind the average in terms of per capita income in the 1950s and 1960s, had by 1970 basically closed the gap. Although the Finns tended to oscillate around the OECD mean through the 1970s, their income accelerated in the 1980s and by 1989 had moved about as far above the OECD average as New Zealand’s was below it. However, Finland’s bubble burst in 1990 and its dramatic effects can be seen at the extreme right of Figure 6. The Finnish economy has since picked up and the Finns are now again above the OECD mean in national per capita income. In the European context, Finland has been an average performer for most of the post-war period and its GDP per capita matched the European average until 1979. Finland briefly enjoyed above-average European income levels during the 1980s before economic difficulties and the recession brought it back to the pack with a bump in the early 1990s. GDP per Capita 3000 5000 7000 9000 11000 13000 15000 17000 1950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 Time GDP per Capita ($US 1985) Finland New Zealand OECD Av. 23 Figure 7 Source: OECD, Penn World Tables However, if we restrict our attention to the three large Nordic countries (Sweden, Norway and Denmark) we see (Figure 8) that Finland has generally been poorer than its immediate neighbours. However, there has not been a great closing of this gap, so the catch-up story is not entirely convincing. GDP per Capita 0 2000 4000 6000 8000 10000 12000 14000 16000 1950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 Time (Year) GDP per Capita Finland Europe 24 Figure 8 Source: OECD, Penn World Tables Population New Zealand’s population has grown much faster than Finland’s since the war. New Zealand’s 1990 population was 1.92 times its 1950 population, while the corresponding ratio for Finland is 1.27. This has implications for the relative economic performances of the two countries. Since GDP per capita is a common measure of economic welfare, New Zealand’s comparatively rapid population growth means that the denominator of this variable has been growing faster than Finland’s denominator. This means that New Zealand has to achieve greater net growth rates than Finland if it is to maintain parity in terms of GDP per capita. Additionally, if this growth is the result of a higher birth rate (as opposed to higher levels of immigration) the age profile will differ between the two countries, with New Zealand’s being more heavily weighted towards younger people. This may give rise to systematic income differences between the two countries because younger people usually earn less than older people. This is consistent with the situation in New Zealand and Finland. Annual net migration to New Zealand has averaged around 5000 since the turn of the century, and for the post-war period accounts for only a small fraction of the 1.6% per annum growth in New Zealand’s population. Most of the population growth in New Zealand is owing to high birth rates, and this may mean that GDP per capita is a measure that will systematically favour a country with a GDP per Capita 0 2000 4000 6000 8000 10000 12000 14000 16000 18000 20000 1950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 Time (Year) GDP per Capita Nordic av. FInland 31 The actual volumes of imports for Finland and New Zealand are plotted in Figure 10, with exports in Figure 11. New Zealand’s performance since the Asian crisis shows up at the far right of these graphs, finishing on a weaker note than Finland. (Of course, if the series had ended in 1995, the outlook would have looked worse for Finland and better for New Zealand.) The difference in trade data is presented in another way in Figures 12 and 13, where natural logs of trade are presented for the same period (1961-98). In addition to a vertical separation, there is a difference in slope, which attests to the consistently faster growth rate of Finnish exports and imports. Natural Log of Imports -3 -2.5 -2 -1.5 -1 -0.5 0 0.5 1 1.5 1960 Years US$ billion New Zealand Finland Figure 12 Source: OECD This can be seen in a variety of ways. The lines can be seen as separated by a vertical step, corresponding to a time-invariant wedge in the coefficient of the exponential export (or import) function. Alternatively, the lines could correspond to an enduring temporal wedge, with New Zealand being on essentially the same track as Finland, with a 5-10 year delay. The second interpretation is encouraged to some extent by Brian Easton’s discussion in In Stormy Seas , in which he sees New Zealand as having transformed itself from a quasi-Argentine economy to a quasi-Finnish economy15, in that despite the differences in average annual change in exports and imports (the slope of the logarithmic series) New Zealand has diversified its exports dramatically over the last two decades. In 195816 pastoral products accounted for 93.3% of New Zealand’s exports. In 199617 the pastoral share of exports was down to 36%. In Finland, wood and paper accounted for around 15 In Stormy Seas, p9-10. 16 Source: New Zealand Yearbook 1960. 17 Source; Statistics New Zealand Monthly Merchandise Trade data. 32 69% of exports in 196018. Although this share has declined as other industries have grown, the higher initial homogeneity of exports in New Zealand is likely to mean that export diversification has played a greater role in New Zealand than in Finland. Clearly, it takes time to build expertise in new fields and this process of “getting up to speed” in new export industries may account for a part of New Zealand’s post-war economic story. New Zealand’s exports were about as “diversified” (in the sense of the share of commodities in total exports) in the late 1970s as Finnish exports in 1960. Although only an impressionistic statistic, this supports the view that New Zealand is following a quasi-Finnish path, with a time-lag of around 15 years. However, this view obscures several salient features of both countries’ post-war trade stories: • Finland’s liberalisation of trade arrangements in the 1960s and 1970s, and New Zealand’s slower moves towards doing this. • The shock to Finland’s trade at the end of the Soviet era and the shock to New Zealand’s trade by Britain’s accession to the European Community. Natural Log of Exports -3 -2.5 -2 -1.5 -1 -0.5 0 0.5 1 1.5 1960 Years US$ billion New Zealand Finland Figure 13 Source: OECD The wedge between Finland’s and New Zealand’s trade stories is widening in exports faster than in imports. In the aggregate series, the shock of the early 1990s appears greater in Finland’s import sector than it does in exports, with imports dropping from about US$2.5 billion in 1990 to about US$1.5 billion in 1993-94. The drop in export values was approximately half this magnitude, although the “bounce-back” has been in the order of US$1.5 billion. 18 Source: Finnish Foreign Trade Statistics. 33 Net Exports (Exports - Imports) -0.4 -0.2 0 0.2 0.4 0.6 0.8 1 1960 Years US$ billion New Zealand Finland Figure 14 Source: OECD This has led to an interesting shift in Finland’s net export position. Whereas New Zealand has remained near zero in net export terms, the early 1990s recession precipitated what appears to be an enduring change in Finland’s trading profile. This can be seen in the net exports figure, in which the Finnish track departs from “near zero” during the early 1990s, accelerates until around the end of 1993 and then stays approximately constant at around US$0.8 billion. Exports by Region Since the Second World War, the bulk of Finland’s trade has been with countries that now comprise the European Union. In fact, in spite of Finland’s placatory policies towards the Soviet Union and its allies, Finland’s share of trade with Western Europe has actually dropped since the end of the Cold War. This is largely the result of Finland’s expansion into other markets; Figure 15 shows that Finland’s exports to other industrialised countries have grown about three-fold since 1970. The former Soviet Union consumed a large proportion of Finland’s exports (21% in 1980), and Finland lost a lot of this market when the Union collapsed. Exports to Russia still comprise around 8% of all its exports, but this is significantly down on Cold War figures. However, exports to other former members of the Soviet Union have grown. In particular Finland has been developing an interesting and fertile relationship with Estonia, its nearest Baltic neighbour. 34 Figure 15 Source: Economic Survey, Ministry of Finance, Finland. 35 Figure 16 Source: Economic Survey, Ministry of Finance, Finland. Figure 16 shows a more resolved picture of the destination of Finnish exports, and plots the annual changes in the export shares of Finland’s top four export destinations for the last 10 years. The rapid collapse – and subsequent mild recovery – of eastern trade is the most dramatic feature, but also evident is the gradual diminution of trade with Britain, Germany and Sweden. This is the result of increased trade with North America and, especially, Asia through the period of very high growth in that region before 1997. Export prospects to this region have weakened and Finnish exports are not expected to increase at the same fast rate – 11% per annum19 – as since 1994. 19 Economic Survey 1998, Finnish Ministry of Finance. 36 Composition of Export Industries Finland’s exports by industry in the period since the Second World War tell an interesting story. Over this period the metals and engineering industry has increased its share of the export sector enormously – an approximately five-fold expansion in 37 years. Consequently, the shares of the other export industries have contracted in relative terms, with the exception of the chemical industry – another high-technology sector. Figure 17 Source: Economic Survey, Ministry of Finance, Finland. 37 The rapid rise of metals and engineering can be seen more clearly in Figure 18. The vast majority of the industry’s increase has occurred since 1991, but this growth is not expected to be sustainable – demand is expected to decline as markets mature, and output capacity within Finland is expected to reach its limits in the next couple of years, with further expansion likely to happen overseas. A large part of this growth is due to the Nokia Corporation (see page 44). Figure 18 Source: Economic Survey, Ministry of Finance, Finland Table 8 shows export data for Finland’s recent past (covering the recovery period). The metal and engineering sector – specifically the sector in which value is added to basic metals – now forms the majority share of Finnish exports, with the traditional mainstay, forestry, now second. This reflects Finland’s successful diversification away from resource-based exports into hightechnology, value-added exports. 38 Table 8 Source: Economic Survey, Ministry of Finance, Finland Finland as a Gateway Although Finland lost a large share of its trade with the Soviet Union in 1990, it has begun to rebuild trade with its eastern neighbours, particularly through productive links with Estonia. The Estonian and Finnish languages are members of the Uralic family and this has helped diminish communication barriers. Finland’s relationship with Estonia allows Finnish firms access to a reasonably skilled workforce with low labour costs. As a result, some firms have been locating production facilities in Estonia, which has a beneficial spill-over for Estonia in building skill capability and drawing Estonia into the international market economy. Another aspect of the gateway trade is re-exports. Finland now exports tropical fruit to Russia; a reflection of its experience in trading with other market economies, which means it has been able to adapt quickly to meet Russian demand for a variety of goods. Finnish firms hope to consolidate their gateway role as Russia develops over the next decades. Current Account Finland currently runs a current account surplus of around 5% per annum. The accrual of surpluses has been helped by falls in import prices and by the Finnish enthusiasm for investing overseas. Direct investment in foreign companies has risen dramatically since the recession and is currently around 22 billion Markka (NZ$6.7 billion). Foreign investment in Finnish firms has also risen in the last decade, and is now around 8 billion Markka (NZ$2.4 billion). 39 Figure 19 Source: Economic Survey, Ministry of Finance, Finland. Sectoral Breakdown Output Table 9 shows the decline in primary production in Finland since the war, a phenomenon which has occurred to greater or lesser extents throughout the industrialised world. A similarly ubiquitous phenomenon can be seen in the growth of service industries, which increased from 34% to 60% of economic output in Finland between 1950 and 1995. Industry and construction have remained reasonably constant throughout the post-war period after an immediate post-war expansion (owing to reparations and repairs to the Finnish infrastructure). Main Components of Total Output, Finland 1950 1960 1970 1980 1995 Primary production 26 18 12 10 4.6 Industr y and construction 40 38 40 39 35.6 Services 34 44 48 51 59.8 Total 100 100 100 100 100 40 Table 9 Source: National Accounts, Statistics Finland New Zealand’s experience has been different. In the years between the end of the Second World War and Britain’s entry into the European Community in 1973, New Zealand had a large, guaranteed market for its produce. This meant that New Zealand continued to rely heavily on its primary produce, as it had done for most of its history. Only since the 1970s has New Zealand faced pressures to diversify its produce and seek new markets. There is some suggestion that the economic policies pursued in the 1970s and early 1980s retarded the development of diverse, internationally competitive industries, and it has only been in the last 15 years that New Zealand has begun to really compete in non-agricultural global markets. Adjustment in the wake of Britain’s accession to the European Community is often given as a reason for New Zealand’s sluggish performance over the last 15 years – it takes time to learn the new skills and management techniques appropriate to international free trade. Main Components of Total Output, New Zealand 1952 1960 1970 1980 1995 Primary production 22.5 20.7 15.5 10.7 Industr y and construction 31.8 34.8 32.0 32.2 Services 45.7 44.5 52.5 57.1 Total 100 100 100 100 100 Table 10 Source: New Zealand Yearbooks To some extent the different experiences of Finland and New Zealand have meant they have embarked on different trajectories. While Finland was pushed into industry and manufacturing by its post-war situation, New Zealand was encouraged into further reliance on commodity production. These different forces have driven the economies in slightly different directions, although these differences are perhaps masked by the broad classification of economic “sectors”; much of Finland’s recent growth has been in the hightechnology service sector – particularly in telecommunications and electronics – while these sectors have not (yet) grown as vigorously in New Zealand. 47 In spite of modest recent growth in the chemical industry, the Finns seem optimistic that this has been due to turbulence in the oil industry and that the chemical industry should be able to flourish in the long run. Growth has been negative in most of the “other” categories, except food, which has been aided during the recovery by the “gateways” opening up to the East. In particular the clothing and textile sector has been hit hard over the last decade, especially since the collapse of trade with the Soviet Union (which was the destination for much Finnish clothing). Services The movement away from the primary sector into the service sector has been a common phenomenon throughout the industrial world since the end of the Second World War. Finland shares this trend with most countries, including New Zealand (see Tables 9 and 10). However, Finland’s recent past (Figure 22, Table 13) masks Finland’s success in services because the 1990s’ recession shows so strongly in that sector. Figure 22 shows all the plotted sectors sinking in terms of their output between 1990 and the mid-1990s. Some of these sectors have taken longer than others to recover – generally the high-tech, high value-added end of the service spectrum has bounced back more quickly than the low-technology sectors, and this is reflected in the column at the far right of Table 13, which shows that many service sectors had not recovered to their 1980s’ boom level even by 1997. However, as Finland shakes off the last of the effects of the recession, the service sector is expected to grow by around 10% in the next year or two. 48 Table 13 Source: Economic Survey, Ministry of Finance, Finland. Value added in private services increased by 20% between 1994 and 1998, although some areas – such as commerce and financial intermediation – continue to drag the chain. Much of the slowness in some sectors is due to the gradual recovery of domestic demand for these services in the post-recession years. Transport and communication services have grown faster than any other service sector, reflecting the blossoming of Finnish telecommunications. This trend is expected to continue into the future as telecommunications strengthens. Computer services, business services, construction technology, advertising and security services are also growing robustly towards the end of the decade. 49 Figure 22 Source: Economic Survey, Ministry of Finance, Finland. 50 Industrial Structure Finnish authorities express some concern that their history and culture have not supported entrepreneurship. This is because the large-scale industrialisation that has taken place over the past 50 years has often been associated with large, often government, firms. A culture of “going out on your own” does not seem to have developed to the level the Finns would have liked. Table 14 shows Finland’s industrial structure in firm size and employment. New Zealand has more firms at all sizes than Finland does. The fourth column presents the ratio (in percentage form) of the number of New Zealand firms at each size to the number of Finnish firms at each size. The final column then weights these ratios by the average ratio of New Zealand firms to Finnish firms to see – relatively – the differences in composition between the sizes of firms in each country. Firm size Finland New Zealand Ratio NZ/Fin Weighted ratio 0-10 190,931 224,720 117.7% 100.0% 10-49 10,128 15,955 157.5% 133.8% 50-99 1082 1429 132.1% 112.2% 100+ 1217 1276 104.8% 89.1% Totals 203,358 243,380 117.7% 100.0% Table 14 Sources: Statistics Finland, Statistics New Zealand. Compared with New Zealand, at least, the Finnish authorities do appear to have a point: New Zealand has more than half as many firms in the 10-49 employee range as Finland. Even when we consider that New Zealand simply has more firms than Finland, we can see there are proportionally a third more firms of this size within the New Zealand economy than there are in Finland. Only at the largest scales in terms of firm size do we see anything like aggregate parity, and this implies that there are proportionally fewer large New Zealand firms than large Finnish firms. And the largest of Finnish firms are quite large – Nokia employs 32,000 people (worldwide), while New Zealand’s largest private sector employer is Telecom, with about 9000 staff. Finland is particularly anxious about the number of small and medium-sized enterprises (SMEs) – that there are not enough of them and that costs are very high for small businesses (in compliance and in employers’ social security contributions20). This situation probably arose out of Finland’s post-war industrial structure, where large firms and a large public sector dominated employment, and unions – representing the interests of workers – sat across the table in negotiations. 20 Both unemployment and social security are partially funded by employers. 51 The result seems to have been that SMEs were for some time left out of the policy loop, and only in the recent past have Finnish authorities been seeking to make it easier for these firms to do business. Another part of the reason for renewed focus on SMEs is that this is where a good portion of Finland’s growth has been occurring, even during the recession. Encouraging entrepreneurship is one of the main planks of industrial policy, along with the development of Finland as an information society. The next section discusses growth owing to new, technology-based firms in Finland, with particular focus on growth among these firms before and during the recession, which is also before and up to the start of the Nokia boom. It is therefore likely that many of these high-tech firms were being started and beginning to prosper independent of Nokia. New, Technology-based Firms New, technology-based firms (NTBFs) have been a prime force behind Finland’s growth over the last dozen or so years. High-technology firms have had higher creation and destruction rates than others and this sector responded differently to the recession from other sectors by experiencing higher volatility (perhaps reflecting a different risk profile of high-tech enterprises).21 The high-tech industry also accounted for higher proportional job growth (relative to its share of the economy) than other sectors, while the low-technology sectors contributed proportionally more in job destruction. Several different explanations have been offered for the economic contributions from NTBFs: • Schumpeterian – NTBFs are the agents of “creative destruction” destroying old firms and replacing them with more efficient high-tech enterprises. • Flexible specialisation – NTBFs allow more flexible specialisation than would be available under other institutional arrangements. • Innovation system – NTBFs fulfil the role of innovation assets, possibly arising from the process of vertical disintegration of research and development enterprises. • Industrial organisation – NTBFs develop as the balance between internal and external co-ordination costs changes. During the recession of the early 1990s NTBFs continued to proliferate in Finland. This is consistent with several of the explanations of the effects of NTBFs – the presence of unemployment among innovative punters provides a somewhat desperate incentive to create their own entrepreneurial enterprises. 21 See, for example, Vainiomaki and Laaksonen (1999). 52 The rapid growth in high-technology sectors in Finland in 1986-93 “indicates a sharp increase in the relative importance of high-technology sectors during the economic recession”22. The number of firms in high-technology sectors increased by 42% between 1986 and 1993, despite the fact that the total number of industrial firms declined by 9% over the same period. Looking at the Finnish economy as a whole, NTBFs increased from 19% to 27% across all industries over the same period. Increases in the high-tech sectors were most common in very large firms (firms employing over 1000 people increased by 57%) and very small firms (firms employing four or fewer). This is consistent with explanations of the effects of NTBFs which emphasise the importance of networking. There was less growth over the period in medium-sized NTBFs. One explanation for this is that once firms reach around 10 employees the next phase of growth eats capital, partly because small firms often have difficulties accessing distribution channels. There was rapid growth among the smallest firms during the recession, and this is consistent with the recession-push explanation, as is the increasing rate of unemployment among university-trained engineers during this period. During the recession the highest growth occurred in high-technology services, among the smallest-sized firms. Strong growth was also recorded among small firms in some of the high-tech hardware sectors (instruments, fine-mechanical apparatus, etc) and much of this is believed to have resulted from the effects of clustering, particularly in the telecommunications industry where the success of the Nokia Corporation has helped small firms grow. The strong growth in high-technology sectors was (obviously) not sufficient to completely ameliorate the effects of recession in other parts of the economy. During the recession the share of people employed in high-technology sectors increased from 13% to 17% of the total workforce, but such relative changes must be viewed with some caution because of the large contraction in employment over this period. On another hand, other evidence supports the flexible specialisation explanation. Many of the more successful SMEs on the Helsinki Stock Exchange are subcontractors to the Nokia Corporation, and it seems their success is not entirely independent of that fact. 22 Erkkp Autio & Annaleena Parhankangas, Employment Generation Potential of New, Technology-Based Firms During a Recessionary Period: The Case of Finland, Small Business Economics , 11: 113-123, 1998. 53 High-technology Firms in Small Countries Michael Porter’s The Competitive Advantage of Nations emphasised the important role played by firms clustering with other relevant firms to produce positive externalities in the production process. On this view, competitiveness can be generated via the numerous interactions and networks that firms can share with other firms working in similar industries, or at least towards similar goals. According to Porter, national competitiveness is generated by the number and size of internationally competitive firms in a given country, and ultimately this is a function of the capacity of an industry to innovate and upgrade. If a country can create internationally competitive industries, it can potentially bring greater growth to the national economy. The agglomeration or clustering of similar or related industrial activities is an important part of most accounts of clustering. This co-location of firms can occur on a variety of scales: a few city blocks, a province or region, or even across an entire small country. Clustering does seem to be a common phenomenon, and there might be various reasons why this is the case. Marshall (1890) proposed the following reasons why clustering might be important in some industries’ success: • It provides a pooled market for workers with specialised skills. • It facilitates the development of specialised inputs and services. • It enables firms to benefit from spill-overs Because technological progress, technological spill-overs and human capital are important to this process, and because they are under-provided by the market23, there is potentially a place for government action in enhancing human capital and correcting for private sector under-investment. Finland does this by risk-sharing between government agencies such as the National Technology Development Centre (TEKES) and the Academy of Finland, and the Finns seem enthusiastic about the results. The idea that Finland can become an “information society” seems to have some real faith behind it. Finland also seeks to encourage people into certain areas of education – engineering and the natural sciences, and business and commercial skills. The growth of Nokia and the high-tech telecommunications sector has encouraged many people to believe that Finland should concentrate on hightech, high value-added products, consistent with Porter’s emphasis on technological progress and the ability to innovate. The increasing fraction of 23 This seems less controversial in Finland than in New Zealand. 54 GDP devoted to R&D in Finland provides some evidence that it is committed to the information society in a concrete way. It is important to note that this R&D is not necessarily in high-tech sectors – Finland is relatively specialised in the lowor medium-tech sectors, and this is where much research activity happens. For example, the Finnish forestry industry spends approximately 3% of value added on R&D, while the Swedish and Canadian forestry industries spend 2.5% and 1% respectively24. It has been suggested (by Maskell et al, for instance) that small countries lack competitive advantage in research-intensive activities, and will struggle to maintain high-tech industries in the long run. On this view: • high-technology is high risk. Old technological leaders tend to get new competitors under control by massive R&D investments, economies of scale and acquisitions • leading technology is expensive and normally exceeds the financial resources available to small companies and small countries • scarcity in the availability of capital and labour in small countries can seriously constrain development. Finland has been experiencing this recently with shortages of scientists and commercially trained people, although this may potentially be a smaller problem in countries that speak more widely-spoken languages • spill-overs are not always contained within the country investing in R&D. Technological spill-overs are likely to pour across borders as windfall gains for countries that have not made the initial investment • small domestic markets can fail to make intensive R&D investment worthwhile. • small countries lack the sorts of R&D facilities that large countries enjoy, which inevitably leads to specialisation. In Finland this has been in forestry and telecommunications; in New Zealand, grass products. Maskell et al offer quite a lot of evidence for their position, but there are enough counterexamples, both in the region25 and in other small countries, to think that this might be a general rule rather than an inviolable law. They discuss the paths by which Nokia and Ericsson came to their current positions of strength, and offer somewhat melancholy conclusions: that largecountry firms such as Motorola and AT&T might move into the small-country firms’ markets to the detriment of the Scandinavian firms. When considering their discussion of the idiosyncratic path of the Scandinavian cell-phone manufacturers, it is worthwhile remembering that similarly idiosyncratic stories of good fortune and path dependence can be told about any successful firm, regardless of the country of origin. However, there is 24 Hernesniemi et al, 1996. 25 Volvo, Husqvarna, Saab, Ericsson, Nokia, for instance, are all high-technology firms from Scandinavia. 55 probably good reason to suspect that the conclusions are reasonable enough – that small countries’ competitive advantage in innovation is in highly specialised, niche products where technological innovation is on the process rather than product side. The comparison certainly provides compelling evidence that an appropriate mix of location, available resources, human capital and policy settings is crucially important – and that adopting Finnish policy without careful thought about the other pre-conditions of success is unlikely to achieve such impressive results. In fact, one of the most striking characteristics of Finnish public policy is the very careful thought given to how it can help different industries and sectors, such as in its agricultural policy (see page 85). Social Capital in Finland The social capital explanation is another commonly advanced for the success of some high-tech firms (on which Maskell et al touch but which has been discussed further in Perry (1998), and even Scientific American ). According to this view, firms prosper when there is a high level of trust and information-sharing across firms within industries. Silicon Valley is the most commonly cited example – it is said there is a culture of idea-sharing that enables the firms to perform more highly than would otherwise be the case. Various arguments have been advanced for why small countries may be more likely to generate and sustain higher levels of social capital. These include: • co-ordination issues – co-ordination is considerably easier in smaller countries, and this may be a reason why centralised wage setting has lasted better in small countries • homogeneity – shared senses of identity contribute to trust, as does shared experience. If the members of a community are experiencing the same events as their neighbours, bonds are more likely to develop between them. Most measurements of social capital place the Nordic countries at the very top of international comparisons. It may be that homogeneity, egalitarianism or some other cultural phenomenon drives this in Scandinavia more than in other small countries like New Zealand. One thing Nordic governments seem particularly adept at is managing to bring the whole country with them when they change; generally the political process in Scandinavia is more consensus-based and less adversarial than it is in New Zealand. If trust is the goal, it seems reasonable that consensus-based policymaking has some advantage over the adversarial processes often employed in New Zealand. 56 In addition, the Nordic countries generally do very well on internationally standardised literacy and numeracy tests, and there is probably a link between a country’s social capital and its educational performance. Perhaps another salient feature in Finland’s cultural milieu is newspaper circulation. Finland has the third highest newspaper circulation per capita in the world26 behind Norway and Japan, two countries often cited as exemplars of social capital. If nothing else, this reflects the high level of Finnish literacy and suggests they take an interest in their community. These two features alone go some way to suggesting that the Finns enjoy a reasonably healthy democracy27. New Zealand starts on the diversification path later than Finland As pointed out by Brian Easton in In Stormy Seas , New Zealand started the post-war period with an economy similar to that of Argentina or Uruguay, but closes the century with an economy more like that of Finland, although nowhere near as technically oriented. Both New Zealand and Finland have diversified their exports since the war, and New Zealand’s story may be more dramatic in this regard. Easton’s point about New Zealand’s post-war similarity to Argentina has an ominous echo in Jane Jacobs’ comparison between Uruguay and New Zealand in Cities and the Wealth of Nations , where she discusses these countries in the context of “supply regions”. These are regions – “economic grotesques”, Jacobs calls them – that are removed from the cities they supply and that specialise in very few, usually primary sector, products. “Today Uruguay has what is called a Third World economy, but even when it was prospering, Uruguay had a Third World economy insofar as that term conveys backwardness, lack of development. Uruguay had merely been rich, and the difference between a rich backward economy and a poor backward economy is not all that great. Rich or poor, supply regions are inherently over-specialized and wildly unbalanced economies, hence unresilient and fragile, helpless when they lose their fragments of distant markets….”28 Although New Zealand’s performance over the last couple of decades has been less than stellar, it has not been as catastrophic as Jacobs suggests it might otherwise have been. New Zealand’s forays into import substitution were arrested before they could wreak the sort of damage they wrought in Uruguay. In many senses, if we are looking for “counterfactual” countries for New Zealand, we would be better to look at countries from which we have diverged 26 Economist Intelligence Unit Country Profile 1999-2000. 27 See, for example, the interesting discussion on necessary pre-conditions for democracy in Machiavelli’s Discourses. 28 Jane Jacobs, Cities and the Wealth of Nations: principles of economic life , 1984, Random House, p63 63 Fiscal Policy The public sector of Finland’s economy has – predictably – grown significantly in the last decade: in 1988 it was a mere29 40.5%. A decade later, following the recession, the tax burden had risen to 47% of GDP, while government expenditure was at 54% of GDP. The generous welfare entitlements which the Finns share in common with their Nordic neighbours have magnified the costs of the recession – when unemployment increased more than five-fold between 1989 and 1993, welfare costs increased considerably. Finland did not reduce transfers during the recession, nor did it raise tax rates to cover the full costs of welfare. It treated the welfare costs incurred as largely temporary and was prepared to fund them through borrowing (see Figure 27). Finnish debt increased from less than 20% of GDP in the late 1980s to nearly 70% by 1996. The central government financial balance has recently moved from deficit to a small surplus of ½% of GDP in 1998. The central government is using asset sales to retire debt. Central government debt as a fraction of GDP is projected to fall to around 60% by the end of 1999, a 13% reduction on the maximum debt of 68.9% in 1996. Finland has recently embarked on dealing with some of the less desirable incentives which (may) arise from a generous welfare state. In early 1997 the Government began to reform some welfare programmes, tightening the rules around benefit eligibility30 and reducing the generosity of some benefits. Since the crisis in the early 1990s (rises in transfers and decreases in output affect both the numerator and denominator in tax/GDP), fiscal consolidation has become an increasingly important priority. Austerity packages have been introduced during the last two administrations, and savings of about 6% and 4% (respectively) of GDP have been attained. These packages have targeted a variety of areas: • Reductions in central government transfers to municipalities. • Social transfers to households. • Central government consumption and subsidies. 29 By Nordic standards. 30 In the areas of unemployment, early retirement and various labour market programmes. They have also moved to ensure medical authenticity in the areas of sickness and invalid benefits. 64 Figure 27 Source: Economic Survey, Ministry of Finance, Finland. These austerity measures have mitigated the effects on expenditure, and the consensus seems to be that they have largely met their objectives – government expenditure peaked in 1993 at just over 60% of GDP and has since fallen to 54%. The initially low level of indebtedness probably helped Finland weather the crisis better than it would have otherwise – blowing out from 20% to 70% involves lower servicing costs than blowing out from 60% to 110%. Because the Finnish economy is currently in a phase when the brakes need to be applied, and because the Finns have effectively lost monetary policy as a tool for controlling their economy, the task of arresting the voracity of excess demand falls to further fiscal prudence. In order to do this, and to reduce government debt levels, the Government has introduced further spending cuts in the last year or so (although these only amount to around 0.5% of GDP). This has been accompanied by small tax cuts (to payroll tax). 65 Composition of Government Expenditure Table 15 shows Finnish and New Zealand government expenditure according to sector. The most immediately evident feature is the huge difference between the welfare components between the two countries. In Finland, as in New Zealand, superannuation accounts for much of this, but unemployment figures strongly in the Finnish picture – approximately 5% of GDP in 1996. This share has declined but the Finns still contribute considerably more of their national earnings towards transfers. Finland New Zealand Health 4.7 5.7 Education 5.9 5.4 Social security and welfare 22.6 13.0 Other 17.1 10.8 European Union and regional transfers 2.7 - Subsidies 2.9 - Total as percent of GDP 55.9 34.9 Table 15 Sources: Statistics Finland, New Zealand Treasury. New Zealand spends about 20% more on health than Finland, but about 9% less on education. However, given Finnish enthusiasm for science and engineering this should not be surprising as these endeavours are costly. Amongst the “Other” category are expenditures such as core government services, law and order, defence, transport and communication, financing costs (more severe for Finland than New Zealand) and the purchase of other goods and services by the Government. Superannuation Finland has recently revamped its superannuation system, largely because of concerns about the sustainability of the previous system in the face of population ageing. This problem has been exacerbated by the lowering of retirement age over time and the erosion of the tax base during the recent crisis. Reform has included introducing a means test for the flat rate pension. The Finnish superannuation system has two tiers: 1. National Flat Rate Pension Scheme – provides a basic income to all people aged over 65 (this accounts for around 4.5% of GDP). The rate is not flat, but falls with increasing income from the occupational scheme. 66 2. Occupational Scheme – all working Finns contribute a percentage of their income to “pay-as-you-go” pension plans, which are usually run by private pension institutions and normally provide more income than the national scheme. The expenditure on occupational pensions at 9.6% of GDP is more than twice the expenditure on the national scheme. While managed by private institutions, defined benefits are not fully financed. These contributions are essentially a tied tax, which is supplemented by general revenue sources to pay any deficit31. The two schemes between them account for 11.6% of GDP, substantially exceeding both New Zealand’s expenditure (around 6%) and the OECD average of around 7.5%. Only Sweden and Italy spend more on their older citizens. Finland’s population is ageing more rapidly than those in most other OECD countries and this places increasing pressure on public pension financing. The ratio of elderly people as a percent of the working age population will increase from 21.5% in the year 2000 to 24.3% in 2010, 34.7% in 2020 and 41.1% in 2030. The comparable ratios for New Zealand are 17.1%, 18.9%, 24.6% and 30.5%. Summary Finland already spends considerably more than the OECD average on its older citizens and has been looking to reform its own system. The ageing of its population means that the fiscal burden of pension financing will rise dramatically in the first few decades of the next century. Other Welfare Costs Despite the cost blow-outs of the early 1990s, Finland is continuing to pursue the Nordic system of welfare – universality, gender equality and a reasonable benefit level. However, as the fiscal costs of welfare have ballooned as unemployment has risen, tensions have increased between the employed and unemployed, with some claiming that there is a cultural change taking place (the beginnings of an “unemployment culture”). Health Public provision is the dominant form of financing both general and specialised health care in Finland, with the public sector fulfilling the role of both purchaser and provider. Budget reform in 1993 has meant that the system has basically been run at municipal level over recent years. Municipal authorities enjoy almost full discretion on the scope, content and organisation of health services. 31 David W Kalisch and Tetsuya Aman Retirement Income Systems: The Reform Process across OECD Countries , Social Policy Division, OECD, p12. 67 Central government transfers lump sum funding to municipal health authorities, which add it to their own funding. The health authorities then spend this as they see fit. Primary health care is provided by municipal health centres, which provide a wide array of services including general care, health counselling, maternity, infant and school health care, ambulance transport and dental care. In 1998 there were around 250 of these centres in Finland. Physicians in Finland are allowed to create their own private practices but generally these services are provided on a part-time basis by physicians who hold full-time posts at hospitals. A high proportion of visits to specialists are to private practices32. The fees for service paid to private physicians are only partly reimbursed by the national health service, so the services tend to accumulate in the wealthier urban areas. Many municipalities are too small to sustain their own hospital, so many Federations of Municipalities have been created to co-ordinate regional care. In 1998 there were 51 municipal hospitals, of which five are university hospitals, 16 are central hospitals and 30 local hospitals. Recently (1997) municipalities have been allowed to purchase hospital care from outside their own hospital district, and the less specialised hospital services offered by health centres also offer some degree of competition between health providers. The recession led to sharp reductions in central government funding. This resulted in reduced volume output, largely through efficiency gains with – according to the OECD – minimal loss in the scope and quality of care provision. Health care currently accounts for roughly 7.5% of GDP in Finland, of which about 4.5% is provided by central government and the rest is locally funded. The aggregate expenditure is consistent with the average for OECD countries. The Finnish health system is generally regarded as excellent, both in terms of facilities and health workers’ skill. As a result, the Finns enjoy good health with reasonable life spans in spite of questionable diets. At the other end of the life span, they have a tradition of broad-based child care and school care. They consequently enjoy some of the lowest rates of peri-natal and infant mortality in the OECD. Historically the Finns have not had the most nutritious diet, but programmes focusing on nutrition, exercise, smoking and reproductive health have made some positive in-roads over the last 15 years. However, in spite of these positive moves there are significant differences between the life expectancies of older and younger generations, with circulatory diseases being among the highest in Europe. 32 The majority of private practices in Finland are run by specialists. 68 Finland also has a large gap in potential lives lost between men and women, which has several causes including cardiovascular disease and injuries. However, the most important component of this gap is believed to be the high incidence of suicide among young and middle-aged men. Because municipalities control health far more than they did in the 1980s, there are substantial variations in health care costs per capita across the 21 hospital districts. This is not necessarily a result of to economies of scale – for example, in the Helsinki district the costs of health care are 20% higher than the national average. It is expected that further efficiency gains can be made. Education Finns spend a long time in the education system. Primary and secondary schooling is run by municipal authorities (which also run voluntary day care and pre-school centres). Comprehensive schooling lasts for nine years, from the age of seven to 16, and is compulsory for all Finns. After that, pupils can (and around 60% do) enter upper secondary schools that offer three years of broadbased education (again run by municipal authorities). If a pupil does not wish to continue into the upper secondary school system, they can move into vocational education. Most schools that provide this are small, with narrow focuses. However, the Government has recently moved to enjoin some of the vocational schools into polytechnics; in 1991 85 vocational schools were re-assembled to comprise 22 polytechnics. Studies in polytechnics take three or four years – approximately the same length of time as upper secondary school – at the end of which students leave with diplomas that are classified as being on the same level as university degrees. At the end of upper secondary school pupils sit matriculation examinations, which they are required to pass before they can enter one of the 20 state-run universities (which offer both undergraduate teaching and postgraduate research). The Finnish university system has expanded significantly in the last 30 years and has been subject to considerable reform in the last decade. Although Finnish education is of a very high standard, there are problems in the system, notably at transition points. There are concerns that many able students find it hard to get into university in their first-choice course – it takes on average two to three years after matriculation to find a place at university. Because of the shortage of places, students normally apply for several courses at once in the hope of gaining entry to a second-choice course in the likely event that their first choice is not available. They frequently change courses as soon as a place in their preferred course becomes available and as a result often have several unfinished courses to their credit. This lengthens the already long duration of study in Finland. 69 Another point of strain for the system is at the top end when students attempt to make the transition from study to work/ There are concerns that the system’s unresponsiveness to employer demand means that it churns out too many of some types of graduates (social sciences) and too few of others (business graduates). There is evidence that some students from the less employable areas extend studies even further in response to the relatively high levels of unemployment among their colleagues. The cost of the system is relatively high – historically very high – but the economic crisis has led to substantial fiscal consolidation in this sector. As of 1996 students did not pay tuition fees to attend university. Labour Market Training (LMT) is managed by the public employment service and aims to enhance the skills of the unemployed. During the crisis the number of people enrolled in LMT increased dramatically. The focus of LMT programmes has been shifted in recent years towards the high-tech sectors that are underlying much of Finland’s growth and increasing shares of its exports. Reforms In 1995 the Finnish authorities adopted a Development Plan for Education and University Research, the aims of which are three-fold: 1. Promoting vocational skills and entrepreneurship – training on small business management and entrepreneurial skills will be included in the vocational education sector. 2. Improving the transition from higher education to work – basically making universities more responsive to the demands of employers. Lecturers will be appointed on five-year contracts and “output-based” resource allocation will be implemented, whereby universities will be measured against various performance indicators. 3. Increasing training for the unemployed – in addition to increases in LMT, the vocational training establishments will seek to increase the number of (currently) unemployed using their services. There is a strong correlation between education and earnings in Finland. Male university graduates can expect to earn 1.9 times the amount earned by those who have only completed upper secondary school – however, there is evidence that this ratio may be somewhat inflated at the moment because increases in demand for the highly skilled have so far outstripped the ability of Finnish universities to produce sufficient numbers of graduates. It is expected that the returns to education will decline to more normal international levels as the supply of graduates increases. Finland, to a greater extent than most countries, exemplifies the current trend away from traditional industries towards knowledge-based, high-tech industries – the export share of high-tech products has quadrupled in the last two decades. Even within the more traditional sectors such as forestry and paper there is a shift towards product diversification and high value-added products. 70 “These developments have been driven by the wealth of engineering know-how in Finland.” (OECD Economic Survey, 1996). Science parks – intended to create clusters or networks of engineering expertise – have also played a part in revamping the Finnish economy. There is concern, however, that the development of marketing, economic and business skills has lagged behind engineering and the natural sciences. (The OECD regards the development of these skills as “essential”, since the demand for commercial workers is expected to grow significantly.) However, Finland is concerned that it is under-investing in business subjects rather than overinvesting in technical subjects, and as part of its attempt to “Make Finland an Information Society” has started a development programme to improve skill levels in mathematics and the natural sciences. Education and the Knowledge-based Economy The Finnish education system is currently being revamped to more seamlessly fit the enterprise and research systems. In particular, Finland is attempting to refocus the education system so that students are more likely to be aware of and respond to career opportunities once they leave the training system. Part of this refocusing has involved reducing the research resources of universities, although funding in technical areas has remained high and the resources of the Academy of Finland have been left virtually untouched. The university system is well integrated into the wider research environment, and it is through the universities that many of the state-funded projects are carried out. Both aspects of higher education – teaching and research – are being positioned to deal with the needs of employers. Polytechnics are specialising in educating people in advanced professional skills, while changes are proposed to the structures of some university courses so that students gain greater exposure to needed skills. Despite some adjustments in the funding of university research, the total share of R&D funding has increased in Finland to 2.9% of GDP. Of this amount the Government intends a 60/40 private/public split. The Finns are attempting to find a balance between basic and applied research, product development, technology development and training under what might broadly be called an innovation system. The main features they desire from this system are quality, relevance and efficiency. Stitching together research, education and industrial needs will obviously require strong and responsive communication networks, and the Finns apparently see the development of such networks and information sharing schemes as aspects of “clustering”. Finnish authorities are keen to embrace external players and forces in their innovation strategy, and to this end actively seek project partners from outside 71 Finland. In addition, the innovation system involves monitoring (and learning from) research being conducted outside Finland. European Union structural funds33 are also used to fund the innovation system through the establishment of science and technology parks and the development of systematic mechanisms for ensuring a high level of innovation. Summary The Finnish education system suffers bottlenecks and appears slow to respond to changes in demand from employers. However, the Finns do very well on standardised international comparisons, so maybe there are lessons for New Zealand in terms of the way they construct their comprehensive sector. In the university sector, the lack of discrimination on the basis of course cost probably helps Finland continue to produce such large numbers of technically trained graduates. If New Zealand is serious about improving capacity in these areas, harmonisation between education policy and industrial policy appears important. Recent Finnish education initiatives, designed to foster appreciation of mathematics and the natural sciences, are new and as yet untested. If successful, they may provide some insight as to how Government can increase interest in science. This may have relevance for New Zealand, where there have been concerns about current levels of scientific literacy. 33 Not as significant for Finland as they are for Ireland. 72 Labour Market Unemployment In the 1980s Finland enjoyed decreasing unemployment, to the point where it was under 3% before the bubble burst in 1989. However, the recession sent unemployment levels soaring more than six-fold to over 18% between 1990 and 1993 (see Figure 28). Unemployment has fallen steadily since 1993 to around 10% in 1998 in response to the export-led recovery and subsequent increase in domestic demand. New Zealand’s experience has been more moderate, with a steady rise in unemployment between the mid-1980s and 1990, peaking around 11% before an equally steady fall to a mid-1990s’ low of around 6% in 1994-95. Unemployment has risen slightly since then, partly in response to the Asian crisis, although the magnitude of this factor is open to dispute. Unemplo y ment Rates 0 2 4 6 8 10 12 14 16 18 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Years Seasonally adjusted unemployment New Zealand Finland Figure 28 Source: OECD. Employment As Figure 28 shows, employment in Finland has grown reasonably steadily over the last five years. Sectorally, services have seen constant rises in employment, especially in areas such as community and personal services, financing and real estate and transport, storage and communications. Continued growth in the service sector reflects a broader long-term trend in Finland and indeed most industrialised economies, as does the decline in jobs in agriculture and forestry. 79 1. Competition Policy Barriers to competition have been removed to enable the smooth functioning of competitive markets. Unfair competition has been attacked through legislation, and cartels and the abuse of dominant market positions have been prohibited. Finnish competition policy also incorporates various European Union regulations that have been designed to prevent the distortion of competition in the European market. Included in the European Union regulations are merger controls that apply to very large corporate takeovers, although Finland’s position on this seems (at the time of the white paper) equivocal. The adoption of the Euro heralds new competition in domestic finance, and this is expected to increase the Finnish market share of foreign banks. The Finns also apply regulations on competition to state-owned enterprises: state institutions that are transformed into limited liability companies are subject to all the normal regulations governing other enterprises, as well as policies aimed at maintaining neutrality in the marketplace. However, the regulations governing market operations of state-owned institutions are a little ambiguous – an institution is expected to follow business principles when operating, but at the same time the state is ultimately responsible for its borrowing. This is exacerbated by general service objectives that allow state institutions to operate in their (often sheltered) core business, while at the same time allowing them to operate outside their core areas, competing in the open sector. 2. State Aid Another aspect of competition policy that has been addressed in the 1990s is state aid. The Finns have been seeking to move away from direct aid towards the creation of favourable general business conditions. This requires substantial cuts to and refocusing of public subsidies. The Ministry of Trade and Industry is over-seeing this task, and one of its main objectives is “the harmonisation of corporate subsidies” by aiming at reducing overlap, distortions and complexity. The initial step was a “severe pruning” of corporate subsidies – between 1995 and 1999 FIM1.9 billion (NZ$0.58 billion) was cut, mainly in the areas of regional support (transport subsidies), energy subsidies, company internationalisation support and interest subsidies for exports. At the same time the amount directed towards technical R&D has remained fairly constant, and as a result the share of these schemes has increased from 28% to 43% of all Ministry of Trade and Industry subsidies. Finland has attempted to make all subsidies that are not aimed at product development – which seems to amount to regional aid – fund intangible 80 investments. The exception – development subsidies – is intended to aid internationalisation and support the development of SMEs on the basis that “there is every reason to support the development of Finland’s economic structure in a way that creates an abundance of new industrial and service enterprises capable of exceeding the export threshold”. The white paper acknowledges that “all corporate subsidies distort competition” and attempts to recast the objective of state aid in a way that focuses on market failures and encourages the development of projects that would otherwise not be developed. Although Finland accepts that there will be windfall gains where firms accept subsidies for projects they would have undertaken anyway, greater targeting through more precise eligibility criteria and fixed terms for support schemes is expected to alleviate the problem somewhat. The evaluation of the success or otherwise of projects is expected to play an important part in improving the process. One danger with corporate subsidies is that regional competition is generated as cities or provinces or countries compete for a firm’s investment. Having witnessed some of the excesses this “corporate welfare” has produced in the United States, the European Union has been quite active in attempting to ensure that member states refrain from such bidding wars with each other. The Finns are enthusiastic about European Union attempts to prevent the establishment of corporate welfare on the continent. The main problem the white paper identifies with the Finnish system of corporate subsidies is a perceived lack of coherence or “harmonisation” between different subsidy programmes, especially given the increasing number of European Union regulations that must be combined with Finnish policy. The Ministry of Trade and Industry seems to be giving more attention to harmonisation as part of the refocusing and simplifying of industry policy generally. 3. R&D Policy The Finns have moved from subsidising plants and equipment – as is often done in regional industrial policy – in favour of supporting intangible R&D. The Finnish authorities believe that this is where they can best assist, that without some government support for these activities they will lose valuable spill-over effects. • Finland pursues an active policy of assisting private sector R&D via grants aimed at subsidising intangible investments, rather than capital items. • The Finnish authorities essentially “chip in” to approved private sector projects to help encourage marginal investments. • They do not fully fund private sector research projects from the ground up. • Asset sales have been used to fund the increases in public sector R&D. 81 • The Finnish authorities aim for a 60/40 private/public split in R&D spending, and to this end have recently upped their contribution in response to increased private research investment. • The Finns attempt to target their subsidies fairly closely – imposing time limits on grants and introducing review processes in order to monitor the success or failure of particular programmes. • In addition, general research funding has been refocused in the 1990s to strengthen support for scientific and technical programmes, with other areas experiencing cuts. • Support is directed at viable competitive ventures, and this support is reconsidered if the venture appears to be too reliant on government support. • One primary concern is to fund projects that would not happen in the absence of government support. There are two sorts of possible errors here: 1. The Government can fund projects that would have happened anyway 2. The Government may not fund valuable projects that it should. The New Zealand stance suggests we are more worried about the first sort of error, while the Finnish position is clearly more concerned with avoiding the second. The Finnish Government’s white paper on Industrial Policy (1996) does address the first sort of error, but it believes that the incidence of these errors can be decreased by careful targeting and review processes. 4. Venture capital for Research and development Sitra, the Finnish National Fund for Research and Development, was established in 1967 but made independent of the Bank of Finland in 1991. It is an independent public fund responsible to the Finnish Parliament. Its operations are financed through income from endowment capital (FIM2.9 billion (ECU0.5 billion, NZ$0.88 billion)) and the return on the investment operations. The primary aim behind Sitra is to “facilitate Finland’s social and economic adaptation to international changes, chart and present new strategic alternatives to increase the competitiveness of the Finnish economy, as well as to identify, develop and test new instruments with an impact on the country’s competitiveness”. In order to achieve this, Sitra provides finances and implementation for nationally significant research, training and innovative projects. Sitra also invests in technology companies and funds both in Finland and abroad. Sitra finances economically promising, small-sized technology firms. This is aimed at promoting firms’ development and internationalisation. Sitra operates as a venture capital firm, and sees one of its roles as introducing new operative models to Finland, promoting competence and expertise in the field. Sitra also invests in international technology funds. They constitute a part of Sitra’s co-operation network and provide Finnish technology companies with an 82 opportunity to find international partners and financiers. The co-operation network has been created in geographical areas that are vital to Finnish technology firms, including not only the European Union and the US, but also Finland’s neighbouring areas. 5. State Ownership Several guidelines have been laid down for the operation of Finnish stateowned enterprises: • Enterprises should be profitable, once they are well established, and they should not maintain production which is not going to be profitable in the long term. • Enterprises should avoid becoming excessively leveraged. • Enterprises should pay a dividend corresponding to normal business practice. • Enterprises should work under the same conditions as relevantly similar enterprises and are not allowed to abuse their special position in competition. • If special conditions are placed on state-owned enterprises they must be compensated for the costs these conditions bring. • For the purposes of public subsidies, state-owned and privately owned enterprises are treated the same. In addition, Finland has in the 1990s embarked on a programme of asset sales, divesting the Government of mature businesses that can operate in an open, competitive economy and that are not correcting for market failures. Funds from the sale of state-owned enterprises are being used to finance a large and permanent increase in state-sponsored R&D. The composition of the governing authorities of many state-owned enterprises is being reviewed with the intention of ensuring that efficiency and expertise relevant to the operation of the enterprise are emphasised in its management. 6. Financial Markets The banking sector in Finland is expected to face considerable competition in the wake of European Monetary Union. The banking sector in Finland does not seem to have been as well developed or as efficient as the banking sector in other countries, and there seems to be widespread concern about the ability of Finnish banks to remain competitive in the wake of monetary union. 7. Energy Policy Finland’s industry has for a long time been energy intensive; the share of its energy-intensive sectors has remained high at around 30% of total industry. 83 The demand for energy is also growing at the moment, and there seem to be concerns about possible future shortfalls. This is being addressed by the introduction of active measures and financial incentives that reward energy conservation. In 1997 the Government altered energy taxation to encourage more frugal use of electricity and oil (remember that the bilateral trade agreements with the Soviet Union shielded the Finns from the pro-conservation effects of the oil shocks as well as the more hurtful price shocks). The energy markets are also being made more competitive by increasing competition and by addressing monopolistic practices where they occur. The Government is “committed to safeguarding an adequate supply of energy and to promote energy saving, primarily through market mechanisms”. In addition, the Government is promoting research into (price-competitive) alternative sources of energy. 8. Environmental Policy Finland’s environmental policy is being integrated into its industrial policy, and it is enthusiastic about moving from an industry-based society to a knowledgebased society. This is partly because it signifies a shift away from the unsustainable exploitation of natural resources and a shift towards more environmentally-friendly forms of work. The Finnish authorities support the harmonisation of environmental taxes (including energy taxes) within the European Union, and believe that these taxes should assist the development of new sectors rather than prevent them. However, Finland is in a somewhat different position from New Zealand as far as the environment is concerned; biodiversity is more of an issue for New Zealand, where many of our indigenous flora and fauna reside nowhere else in the world. 9. Regional Policy The northern and eastern parts of Finland have proved slower to develop than other regions, and Finnish authorities are keen to ensure these areas are not left behind. In addition to the use of European Union structural funds (Finland was eligible for around 2 billion Markka (NZ$0.6 billion) in 1997), the Finnish Government has established a national rural programme designed to safeguard balanced rural development and revitalise rural areas “by increasing the income of their inhabitants, by improving the functioning of services and rural communities and particularly by strengthening the competitiveness and attractiveness of these areas as places to live and carry out business activities”. 84 10. Administration of Industrial Policy Finland has an active and comprehensive approach to industrial policy, but also needs to be mindful of limitations and incentives placed on its policy by European Union membership. Because of this it is currently seeking to harmonise its policies as much as possible to improve its international competitiveness and identify and destroy toxic incentives, double-ups and other undesirable policy implications. This is an ongoing task. 11. Development of the Service Sector The high-tech service sector has basically been responsible for much of Finland’s growth over the last 20 years. Its employment share (as well as the output share) is also very high – every second Finn works in the sector. The Finnish authorities are anxious to integrate the continuing growth of the service sector with the important manufacturing sector. Because many of Finland’s exports and services make use of high-technology processes, the Finnish Government is attempting to encourage synergies between the two sectors. About 15% of Finnish R&D funding is channelled into “knowledge-based services” that comprise engineering, information technology, “well-being services” and tourism. Approximately 25% of the TEKES budget goes into information technology, and this is seen as an area offering higher than usual returns on investment. 12. Small and Medium-sized Enterprises Finland sees the development of SMEs as a central part of its industry policy. They have become increasingly important in the Finnish economy over the last decade; those with fewer than 250 employees account for about 42% of GDP and about 60% of the private sector labour force (40% of all jobs). One – probably very significant – advantage Finnish SMEs enjoy over their New Zealand counterparts is their proximity and access to large, integrated markets. Although most Finnish SMEs have a domestic focus, the European Union market provides an opportunity for small firms to go international without the regulatory, tariff, geographic or cultural barriers New Zealand firms may have to overcome when they attempt to become export firms. In spite of the fact that SMEs are often innovative, they often have difficulty carrying out research and development owing to their lack of resources. Additionally, financiers often see small firms as risky and this can make it hard to attract low cost finance. However, the Finns see SMEs as fundamental to the country’s economic performance and the Ministry for Trade and Industry and the Council for SMEs have been working to help these businesses in start-up, growth and operation by reducing compliance and labour costs, reviewing the implications of the tax code for SMEs and improving financing arrangements for small businesses. 85 13. Agriculture and Forestry The white paper on Industrial Policy acknowledges that agriculture in Finland suffers from permanent disadvantages: “Due to Finland’s northern location, transportation costs are greater, harvests are poorer and construction costs are higher than in most other European Union countries. This results in a permanent competitive handicap for agriculture…” which the Finns attempt to ameliorate by direct income subsidies and by diversifying the production and service base of rural areas and farms. The forestry sector is one of Finland’s traditional strengths and has contributed strongly to the recovery over recent years. The industry employs around 100,000 people, with around 140,000 indirectly employed in associated occupations. Forestry has proved important in regional development in recent years – parts of the country that may otherwise have been left behind in the last 20 or so years. The sector was of fundamental importance in the recovery of recent years, and played a substantial part in ensuring that the gains from the recovery were broadly distributed. In the last decade forestry policy has been revised to ensure greater sustainability and diversity. 86 DISCUSSION AND CONCLUSIONS Comparing Finland and New Zealand Finland has enjoyed consistently higher GDP per capita growth than New Zealand since the end of the Second World War, but especially since about 1970. Although this may be partially due to New Zealand’s higher population growth over the period, there is evidence that total Finnish output has grown at considerably higher average rates than New Zealand’s. Since the recession, Finland has grown at an even faster rate – 5% per annum since 1994 – but much of this growth has been cyclical rebound in the wake of a very deep recession that occurred between 1990 and 1993. The 1994-99 growth is probably not sustainable – recent growth rates are expected to taper off somewhat once the Finns have fully recovered from the experience of the early 1990s. During the recession, unemployment rose from 3.5% to 18% in Finland between 1990 and 1993. It has since declined to around 10% and is experienced disproportionately by older, less skilled workers. During the recession, Finnish debt levels rose dramatically, from around 15% of GDP to around 60%. In the last few years this has tapered off – the Finns have used proceeds from asset sales to pay back debt. Now that they have lost monetary policy as an instrument, fiscal consolidation is expected to be used to tighten demand in the Finnish economy. In terms of productivity, the growth in output per worker achieved in Finland has substantially outstripped that achieved in New Zealand since 1960, by increasing amounts as time has passed. Strong growth in manufacturing has helped Finland’s economy since the war. As well as traditionally strong areas associated with the forestry sector, shipbuilding and engineering industries have grown strongly, probably in part because of the seeding these industries received as a result of the payment of war reparations to the Soviet Union. Bilateral trade agreements with the Soviet Union provided a counter-cyclical balance for the Finnish economy during the 1970s and 1980s, as the Finns could expand exports to the Soviet Union as part of the trade arrangements during periods of recession in other Finnish export markets. Finland has been well integrated in the European economy for the entire postwar period – although arrangements with the Soviet Union limited Finland politically, the Finns were free to trade with anyone. 87 The collapse of Soviet trade arrangements at the start of this decade contributed to the massive recession experienced by Finland between 1990 and 1993. Finnish firms have been successful in diversifying their markets in the 1990s, to the extent that the European Union share of Finnish exports has actually decreased since Finland joined in 1993, while the total volume of exports has risen considerably (from US$1.95 billion in 1994 to US$3.6 billion in 1998). The growth of Nokia Corporation has also contributed to recent Finnish growth. In fact, most of the astounding growth in telecommunications and electronics in Finland in the 1990s has been because of this firm or its affiliates. Nokia’s growth has been formidable – 25% per annum since 1994 – but it is difficult to generalise Nokia’s success to that of Finnish manufacturing in general. It is certainly impossible to attribute it to public policy, although the liberalisation of telecommunications in Nordic countries is often cited as a reason for the success of both Ericsson and Nokia. Finland’s industrial production in the telecommunications sector was about 16 times higher in 1997 than it was in 1987. This sector now accounts for around 16% of all industrial output in Finland, and is primarily an export industry. High-tech exports accounted for 19% of total Finnish exports in 1998. The share of high-tech products within total exports has increased almost four-fold in the last 10 years, from around 5% to 19%. This is a considerably faster rate of growth than that experienced in comparable countries. Elements of Finnish Economic Strategy Finnish economic policy has more constraints on it than does New Zealand’s. Harmonisation with European Union policies constrains Finland to a far greater extent than do New Zealand’s relationships with other countries. Finland is moving in the same broad direction as New Zealand inasmuch as it is attempting to: • integrate into a regional economy • promote macroeconomic stability • encourage the growth of a competitive private sector • build a knowledge-based skills base • promote openness and international linkages • foster social cohesion. Although Finland has also reformed parts of its public sector in a similar direction to the New Zealand (such as through a programme of asset sales), there are also significant differences (for example, wage setting tends to be carried out centrally in Finland). 88 One factor that seems central to Finnish success is education – the Finns perform well on international literacy and numeracy tests, and are in the process of reforming their tertiary education system to become more responsive to the needs of their economy. At the same time they are encouraging younger students to take an interest in the natural sciences (in spite of very high numbers of engineers and scientists in Finland, demand still exceeds supply). Industry policy The success of Finland’s high technology sector poses an interesting challenge for New Zealand. How much of Finland’s success is due to a different policy mix? The Finnish Government does not spend much more than New Zealand on R&D, however, it pursues an active policy of encouraging industry/Government joint ventures. Private sector spending on R&D is many times higher in Finland than in New Zealand. Other policy stances may also have contributed. As in New Zealand, the Nordic countries have liberalised telecommunications and this is often cited for the success of both Ericsson and Nokia. Finland also boosts a well-educated workforce with a higher concentration of engineering and science graduates. Finland is now encouraging more commerce graduates to develop the marketing and management skills required for further expansion. Policy making and social capital Another policy lesson that comes through quite clearly is the focus on coordination, consensus-building and evaluation of policy. The Finns seem very adept at accomplishing different aspects of a single goal through quite different policy mechanisms. For example, the goal to make Finland an information society involves aspects of: • education policy (generously funded tertiary education, an emphasis on academic quality, entrepreneurship and technical areas) • R&D funding (via TEKES, Sitra, the Academy of Finland) • tax and employment policy (lowering the compliance costs for small businesses) • agricultural policy (attempting to make up for “permanent disadvantages” through the clever use of advanced food technology). The variety of instruments used by the Finns to accomplish their goals is impressive in its breadth, although with a public service as large as theirs the need to keep everything from becoming unwieldy becomes paramount. Consensus-building seems another feature of the Finnish policy – and especially political – landscape. The parties forming the Government regularly represent more than 70% of Finnish voters, probably enabling them to debate policy subtleties in a more sophisticated way than is possible in more 95 Technology Development Centre http://www.tekes.fi/eng/technology/default.asp The Economist Intelligence Unit, Country Profile: Finland 1999-2000. The Finnish Government’s White Paper on Industrial Policy, Ministry of Finance, 1998. Waverman, L., and Sirel, E. European Telecommunication Markets on the Verge of Full Liberalization , Journal of Economic Perspectives , 11, 4, 113-126, 1997.