Finland : Fiscal consolidation key to restoring growth
The next Economic Survey of Finland will be prepared for end 2011.
An Economic Survey is published every 1½-2 years for each OECD country. Read more about how Surveys are prepared.
The OECD assessment and recommendations on the main economic challenges faced by Finland are available by clicking on each chapter heading below.
The Policy Brief (pdf format) contains the OECD assessment and recommendations.
Finland was among the most affected OECD countries during the crisis as demand for its mainly capital–goods intensive exports collapsed. The financial sector weathered the shock well, but credit contracted, reflecting both demand and supply factors. Employment has been aided by the scheme of subsidies for temporary layoffs, as well as labour hoarding. Despite supportive fiscal and monetary policies, recovery has been slow. This is likely to reflect a muted pick–up in world capital goods trade, structural rigidities in the labour market, potentially weakened competitiveness due to the strength of the euro and large wage increases prior to the downturn, and a slowdown in productivity growth. While the largely appropriate fiscal stimulus and active labour market policies are likely to have mitigated the impact of the crisis on demand, the post–crisis fiscal outlook has substantially worsened due to a largely permanent fiscal stimulus and lower potential output. Consolidation plans should be announced as soon as possible, to be implemented as the recovery takes hold. More attention to structural reforms to increase labour market flexibility and boost competitiveness and productivity would help to restore stronger growth and raise living standards over the longer term.
The costs of the recession and ageing are a challenge to fiscal sustainability. The estimated fiscal sustainability gap has increased from 3 to 8% of GDP due to a sizeable permanent stimulus and lower potential output. A consolidation plan should be articulated now to ensure a smooth exit from stimulus once the recovery firms. Consolidation should encompass efficiency–enhancing tax measures such as an upward harmonisation of the value added tax (VAT) and higher property taxes, and constrain rising expenditures in municipalities. As discussed in Chapter 3, sustainability would also benefit from pension reforms that include tightening of benefits and eligibility conditions which would lower overall spending and boost labour supply. Tuition fees and a switch from grants to loans in tertiary education would also alleviate expenditure pressures (Chapter 1). A major overhaul of the municipal system could increase efficiency in service provision. Consolidation would be facilitated by revising the currently over–targeted fiscal framework and linking it more to long–term sustainability targets. This should include a lengthening in the fiscal planning horizon and linking structural annual deficit targets to long–term sustainability targets as well as setting up a fiscal council to monitor fiscal policies.
Maintaining high participation and employment in the face of the current recession and a rapidly ageing population are major challenges for policy makers. The recession of the early 1990s showed that high unemployment can leave long–lasting scars on labour markets, while rapid ageing requires longer working lives to ensure sustainable public finances. Minimising the effect of the recession on the labour market calls for nominal wage increases in line with economic conditions, greater flexibility in wage setting, ensuring earlier activation of unemployed and reforming unemployment and social benefits to better support work incentives. Finland has an unusual combination of elevated unemployment replacement rates and late referral to labour market activation, which contributes to high levels of inactivity and a large number of beneficiaries. This combination risks building up greater structural unemployment over time. More ambitious activation needs to be accompanied by lower replacement rates in the unemployment insurance and related schemes to support labour market participation, job search and employment. Institutional responsibilities in labour market policies should be simplified and made more transparent. With an already low effective retirement age, additional early permanent exit from the labour market needs to be discouraged. The recent success of restricting access to the unemployment pipeline should be followed up by a complete abolition of the system. Stricter criteria for entry into disability pensions should also be applied. The 2005 pension reform was a step in the right direction, but the old–age retirement system should be further adjusted to lower fiscal costs, raise the minimum retirement age and increase work incentives for older individuals.
Income distribution in Finland remains among the most equitable in the OECD, although, as in a number of other countries, disparities have widened considerably over the past decade. While the tax and transfer system has been effective in reducing income inequality, changes made to the income tax system in the early 1990s have contributed to rising disparities by encouraging income shifting among high earners. Disparities have also been increasing across regions, particularly in labour market outcomes. This reflects the dramatic structural change that has occurred since the early 1990s, and the lack of policy success in tackling this transition. These growing disparities in regional labour market outcomes have contributed to serious demographic imbalances building up in the regions. These are especially prevalent in the smaller municipalities and challenge the very sustainability of these entities. Misuse of the tax system by high income earners should be addressed, and regional labour market discrepancies should be tackled by increasing the flexibility of the labour force. This includes sharpening incentives for retraining that would promote sectoral and regional mobility. Sustainability of the municipalities system requires further rationalisation, including forced mergers.
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The OECD Secretariat's report was prepared by Henrik Braconier and Petar Vujanovic under the supervision of Piritta Sorsa. Research assistance was provided by Isabelle Duong.