ECONOMICS: Finland's downturn of the 1990s offers some useful insights to deal with our own recession
WE ARE not entirely without the help of historical precedent in trying to figure out how long we will have to wait for economic recovery in Ireland, what shape that recovery might take and, perhaps most crucially, what needs to be done to ensure that a sustained recovery occurs.
As mentioned before in this column, Finland, another small open European economy, fell victim to the double whammy of a collapse in export market and a property market crash in the early 1990s with devastating effect.
There are enough parallels with the current Irish experience to suggest that the Finnish case offers some useful insights.
The Finnish recession of the early 1990s was deep and prolonged. The peak to trough decline in GDP was over 13 per cent per cent, economic activity contracted for three years in a row and another four years passed before the pre-recession peak was reached again. In the meantime, the numbers at work fell by a cumulative 18 per cent and the unemployment rate rose from 4 per cent in 1989 to 18 per cent in 1994, a Finnish record and a level from which unemployment subsequently retreated painfully slowly.
The recession was felt to different degrees by different sectors. As is typically the case, investment spending was especially hard hit, falling for five successive years and by a cumulative 50 per cent.
In contrast, the decline in exports was shortlived and relatively mild: export volumes fell in just one year (by 7 per cent in 1991), and then recovered strongly to lead the overall economy out of the slump. The performance of exports was all the more impressive considering that demand collapsed in the former Soviet Union, Finland’s main trading partner.
The similarities between the Finnish downturn of the early 1990s and Ireland’s current recession in terms of its origins, severity and dynamics are clear from this brief account, but there are also important differences which caution against slavishly using Finland as a template.
For one thing, although Finland’s public finances deteriorated sharply, they did so from a very healthy starting position. The Finns were running a budget surplus of almost 7 per cent of GDP when recession hit.
As a result, they were able to defer budgetary consolidation until the green shoots of economic recovery were well-established.
The behaviour of interest rates indicates another policy-related difference. Finnish interest rates remained high in nominal terms (in the range 13-14 per cent) through most of the recession, and it was only at a very late stage in the downturn that interest rates fell appreciably. By contrast, interest rates in Ireland are currently almost as low as they can possibly go and may well be rising as the cyclical trough in activity approaches.
Another difference relates to labour market openness and population. Finnish population dynamics were not much altered by deep recession; there was no material change in net migration in the early 1990s, no significant outflows of people in response to the very tough labour market conditions that prevailed. The downside of this was that unemployment remained higher for longer than would otherwise have been the case. The upside was that domestic demand was afforded a measure of support from a broadly stable population.
Given the openness of the Irish labour market, the risk is that falling employment/rising unemployment will prompt net migration to turn negative in the period ahead, possibly by enough to trigger a fall in the adult (if not the overall) population. This would help to cut unemployment, but would also tend to weaken domestic demand, especially in areas like housing.
But the biggest difference between Finland then and Ireland now is that the Finns had a currency of their own in the early 1990s. This meant that they were able to devalue to boost competitiveness, which they did to great effect. In the 1992-93 period, the Finnish markka depreciated by a cumulative 20 per cent in trade-weighted terms which paved the way for the surge in exports noted above (export volumes rose at an annual average rate of 10 per cent from 1992 through 1995). Because of its membership of EMU, Ireland, of course, no longer has the option to devalue. But this does not mean that it does not have the ability to significantly improve its competitiveness even in the short run.
Which brings me to this week’s stand-out publication: the latest report* from the National Competitiveness Council. This is a really impressive piece of work, not least because of the wonderfully informative and comprehensive suite of charts in it, but more importantly because of the rigorous analytical framework used to assess Ireland’s competitive position. Its message is clear, though by no means relentlessly negative. The point is strongly made that Ireland retains a wide range of competitive strengths, as evidenced by the relatively healthy performance of exports and the continuing attractiveness of the country as a destination for foreign direct investment.
On the other hand, these strengths are not represented as cause for complacency. The point is that the existing levels of competitiveness, whatever strengths they incorporate, will not be sufficient to enable the internationally trading sectors of the economy to grow fast enough in the period ahead to offset the inevitable weakness in other sectors, and act as an effective locomotive for overall growth in output and employment.
Much needs to be done to reduce costs of production across the full range of inputs, and that injunction applies as much to non-pay as to pay costs.
[ www.competitiveness.ie/publications/2009/title,4530,en.phpOpens in new window ]
