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Text File | 1994-05-02 | 17KB | 345 lines

<text> <title> Finland: Economic Policy </title> <article> <hdr> Economic Policy and Trade Practices: Finland </hdr> <body> 1. General Policy Framework Finland's economy has moved sharply into recession in 1991, with a projected GNP decline of at least five percent. The recession is the result of an overheated economy, excessive debt, declining productivity, overspending on the part of the government, businesses and consumers, economic difficulties in Finland's European export markets, and the collapse of Fenno-Soviet trade. The latter had accounted for as much as 25 percent of Finnish trade and is now below five percent of total trade. The recession has accelerated discussion about how to improve lagging Finnish competitiveness, including measures to promote foreign investment, privatization, wage restraint, decreased support to agriculture, and liberalization of Finland's largely closed service sector. Some structural change will be mandated in any event when the European Economic Area (EEA) agreement between the European Community (EC) and the European Free Trade Association comes into force. Eventual membership in the EC, an increasing possibility, would bring further changes. The current Finnish government, composed of the Center Party and the National Coalition (conservative) Party as well as two smaller parties, has not generally turned to major countercyclical spending to combat the recession. Widely expected to devalue the finnmark upon taking office in spring 1991, the government instead pegged the currency to the European Currency Unit (ECU) in June 1991. The intention was to impose monetary and fiscal discipline and force structural changes in the economy by bringing costs down through internal measures, and not by trying to restore competitiveness through devaluation. A concurrent aim was to keep labor costs down through wage restraint negotiated at the national level. The policy was not popular in all quarters, however, particularly among some of Finland's export industries and within some labor unions. In November 1991, following a massive outflow of foreign currency and sharply increased interest rates, the government agreed to a finnmark devaluation of 14 percent against the ECU. The government has not abandoned its aim of maintaining wage restraint and restoring competitiveness through economic restructuring. Finland's economy is a mixed one, with approximately 20 percent of manufacturing capacity, and four of the 10 largest companies, in government hands. Some 10 percent of banking services and 30 percent of the service sector are government-owned as well. A government committee has studied the question of privatization, but no final decisions have yet been made. The state petroleum company Neste may be the first fully state-owned company to be privatized, at least partially, under this scenario. Employment and regional development considerations may slow down the privatization of state-owned companies in the industrial sector, however. The government has generally eschewed industrial targeting or subsidization of production. An important exception is agriculture, where the government provides a network of production and export subsidies and protects against imports with variable levies. Finland's level of agricultural protection is among the world's highest. Government debt is rapidly increasing due to recession-induced decreases in revenue and increases in social spending. Total government debt in September 1991 was about 40 billion finnmarks from domestic borrowing, mostly through publicly-sold bonds, and about 30 billion finnmarks from foreign sources, almost exclusively through bonds. Most Finnish companies are affected by restrictions which limit foreign ownership to 20 percent or with special permission, 40 percent. However, exceptions to these restrictions are routinely granted. The current law is being amended so that permission for foreign investment would only be required for acquisition of firms with a staff over 200 people and annual turnover exceeding 500 million finnmarks. In the service sector, various forms of insurance, including automobile collision, pensions, and life insurance, can only be obtained through Finnish companies. These provisions are expected to be changed in accord with the EEA agreement. Finland undertook an extensive program of financial deregulation in the 1980's, including deregulation of domestic financial markets and relaxation of capital controls. Interest rate policy is the primary tool to support Finland's fixed exchange rate; Finland has maintained a positive interest differential with EC countries to attract capital. The Bank of Finland has raised commercial bank reserve requirements and undertakes open market operations to support higher rates. Prior to the November 1991 finnmark devaluation, interest rates climbed to extremely high levels and have remained in double digits in spite of a low inflation rate. While the end of the Fenno-Soviet clearing (barter) system at the beginning of 1991 undoubtedly dealt a severe blow to Finland's economy, it is by no means the only or even the principal cause of the current recession. It has, however deepened the recession by a percentage point or two. The products sold to the Soviet Union by the Finnish side were generally uncompetitive and have not found buyers in Western markets. 2. Exchange Rate Policies In June 1991, the finnmark was pegged to the European Currency Unit (ECU), which replaced a trade-weighted basket of foreign currencies which included the U.S. dollar. The finnmark was allowed to float within a three percent band of the established parity. The Bank of Finland actively intervened to support the finnmark by purchasing and selling foreign currency as necessary to keep the finnmark within its trading band and by ensuring that interest rates were set to keep foreign currency reserves at adequate levels. Continued uncertainty over economic policy and the lack of an agreement over wages, however, led to repeated speculation against the finnmark. The government was finally forced in November 1991 to float the finnmark, as rapidly increasing interest rates could not stem the outflow of finnmarks. The finnmark was floated for about a day, and an intitial parity with the ECU was set at 14 percent below the previous value, which shortly thereafter stabilized at about 10 percent. The government intends to undertake a vigorous economic restructuring program and intervene as necessary in money markets to prevent a subsequent devaluation. 3. Structural Policies The government is gradually changing its tax policies both to stimulate economic growth and investment and to bring Finland more into conformity with European norms. In October 1991, the base rate of the turnover tax was increased from 17.5 to 22 percent. However, since the basis for the calculating the tax was also changed, the effective increase in the tax was limited to 0.8 percent. The turnover tax is now calculated on the basis of the final selling price exclusive of excise taxes. It is expected that Finland will move to a value added tax in 1994. The automobile tax, currently averaging 127 percent of the purchase price, is expected to be lowered in stages to European norms within five years. As part of the incomes policy talks underway in November 1991, it has been proposed that various business taxes also be lowered and that pension fund payments, now the exclusive responsibility of employers, be shared with employees. In October 1991, the government submitted to Parliament a bill that would amend Finland's three-year old competition law by making it more difficult for companies to collude on prices and market shares. The maximum penalty for violations would be increased to FIM 4 million ($1 million) or 10 percent of a company's turnover. Further changes to competition law are expected