Executive Summary
The COVID-19 pandemic plunged Finland into a deep recession. The government provided substantial financial support to protect jobs and help households and businesses get through the crisis. However, 25% of temporarily laid-off workers were not eligible for earnings-related unemployment benefits.
Finland’s GDP contracted by 5% in the first half of 2020. While large by historical comparison, this economic contraction was among the smallest in the OECD, partly thanks to more targeted confinement measures and a relatively small loss of mobility (Figure 1). Finland managed to bring the first wave of the coronavirus under control quickly through a combination of voluntary mobility reductions and timely containment measures and is on track to do the same for the second wave.
1. % difference between 2019Q4 and 2020Q2 GDP levels. 2. Fall in mobility from the baseline between 1st of March and 27th of June.
OECD, National Accounts database; Google LLC, Google COVID-19 Community Mobility Reports, https://www.google.com/covid19/mobility/.
The temporary layoff scheme played a key role in protecting jobs and incomes. Temporary layoffs increased far more than permanent layoffs during the first period when containment measures were implemented, limiting the increase in unemployment (Figure 2). Employers have few incentives to limit temporary layoffs to jobs they believe can be restarted after the crisis.
A weakness highlighted by the crisis is that only those people temporarily or permanently laid-off who are members of unemployment insurance funds are entitled to earnings-related unemployment benefits despite the funds only paying 6% of benefit costs. Non-fund members are entitled to flat-rate basic unemployment benefit (EUR 32.40 per working day) that can be supplemented by housing allowance and/or social benefits.
The government also mobilised financial support for SMEs and microenterprises and provided support for hard-hit industries. It also reduced firms’ tax burdens and social security contributions temporarily, easing cash flow, and temporarily limited creditors’ right to petition for bankruptcy on the basis of a debtor’s temporary insolvency. These measures helped avoid mass bankruptcies.
The general government budget deficit is projected to increase by 6.5% of GDP in 2020 and the European Central Bank (ECB) has supplied vast amounts of liquidity and supported increased bank lending. However, some of these measures risk reducing banks’ risk-bearing capacity. Activity will gradually return to its pre-COVID-19 level by 2022.
Three quarters of the 3.5% of GDP in discretionary measures that increase the 2020 budget deficit were in response to COVID-19. As the measures unwind and the economy recovers, the budget deficit is projected to fall to 3.5% of GDP by 2022, with 40% of the decline reflecting automatic stabilisers. General government debt will increase sharply in 2020 and slowly thereafter.
To complement expansionary monetary policy measures, the ECB has lowered bank capital requirements, introduced flexibility in the treatment of non-performing loans, and reduced solvency and collateral requirements, enabling banks to accept lower quality collateral. While these measures have increased domestic lending capacity, they risk reducing banks’ risk-bearing capacity.
Measures are being taken to slow the growth in household debt, 70% of which is housing loans (including rapidly growing housing company loans, which are ultimately a household liability). However, the recent reduction in loan-to-value ratios for housing loans was reversed this year to support recovery from the COVID-19 crisis.
Real GDP is projected to drop by around 3% in 2020 and to recover slowly, especially in light of the second coronavirus wave (Table 1). The recovery will be led by private consumption and exports. Unemployment and bankruptcies are likely to rise in the short run, as relief measures run out towards the end of 2020. Inflation pressure will be weak, reflecting the sizable output gap and labour market slack.
The recovery would be delayed if the recent resurgence of coronavirus infections were not soon reined in or there were to be further serious outbreaks, external demand remained weak owing to a prolonged global pandemic or banking losses were greater than expected, leading to tighter credit conditions.
The government aims to stabilise the general government debt-to-GDP ratio by the end of the decade. A significant part of consolidation is to come from increasing employment. The rest will have to come from increasing productivity and consolidation measures, especially expenditure restraint as taxation is high.
Debt stabilisation will entail reducing the structural budget deficit by around 2% of GDP. Increasing employment by 80 000 by the end of the decade as foreseen by the government would contribute around 40% of this reduction. Extending working lives is critical to achieving this target.
The employment rate for older workers in Finland is much lower than in the Scandinavian Nordics, where access to early retirement schemes is considerably more limited. The extension of the unemployment benefit from age 61 until 65, combined with a longer entitlement to the unemployment benefit for persons aged 58 or more, results in a spike in layoffs from the late-50s (Figure 3). The other main early retirement route is disability benefit, for which the inflow probability soars when individuals turn 60 and more lenient eligibility criteria apply. To increase the employment rate of older workers, it is vital that routes to early retirement be progressively closed.
Ministry of Finance, Ministry of Economic Affairs and Employment and Ministry of Social Affairs and Health (2019), Selvitys eläkeuudistuksessa sovittujen lisäpäiväoikeuteen ja ikääntyneiden aktivointiin tehtyjen muutosten vaikutuksista.
While reducing the home-care allowance for taking care of children aged less than three years at home would not contribute to fiscal consolidation –childcare and unemployment benefit costs would offset savings – it would contribute to reducing Finland’s large gender wage-rate gap by shortening absences from the workforce that negatively affect career prospects and earnings mobility.
The health and social services reform before Parliament has considerable potential to contribute to fiscal consolidation by increasing efficiency in provision by centralising care chains at the regional level and reducing their fragmentation. There is also scope to increase the efficiency of public administration, including through greater digitalisation, and the cost-effectiveness of public expenditure.
Reducing subsidies and tax expenditures and increasing taxes that do not impose large economic distortions would also help. The standard-rate VAT tax base is narrower than in many countries and recurrent real estate taxation is lower. Peat (12% of greenhouse gas (GHG) emissions) is taxed at a lower rate than other fossil fuels used for heat production.
Productivity growth remains low. Skills shortages, high regulatory barriers to competition in some sectors and the exclusion of many firms from flexibility clauses in collective agreements are holding back efficient resource allocation.
Labour productivity growth fell to only 0.6% per year in the past decade, lower than in most other European economies. A factor that undermines productivity growth in Finland is skills shortages, largely resulting from relatively low tertiary education attainment. This makes it difficult for more productive firms to hire the qualified workers needed to innovate and expand market shares. Furthermore, relatively high regulatory barriers to competition in upstream service sectors, such as transport, energy and retail hold back incumbents’ efforts to reallocate resources more efficiently.
To boost the supply of tertiary educated workers, the government plans to streamline the resident permit process to attract more high-skilled immigrants. While study places in the highly selective tertiary education admission system are being increased, many secondary graduates are rejected, slowing the transition from secondary to tertiary education.
Finland is on track to meet its 2020 EU-burden-sharing objective for reducing GHG emissions but will need to implement further cost-effective measures, including making full use of available flexibility mechanisms, to realise its future objectives.
The government plans to meet half of its 2030 EU-burden sharing objective from emissions reductions in the transport sector. To achieve this, additional measures need to be taken to reduce transport emissions by 30%. The main planned measure is to increase the bio-fuel content of road transport fuels. However, the share of electric vehicles will also need to rise markedly, noting that 78% of electricity production in Finland is from non-fossil fuel sources. There would also need to be an expansion in wind power generation, which is the most economical renewable energy source in Finland, both to meet increased demand for charging EVs and to enable the substitution of electricity for fossil fuels in residential and commercial heating and in industry. A factor holding back the expansion of the EV fleet is the shortage of recharging facilities.
Agriculture in Finland, which accounts for 20% of GHG emissions, receives amongst the highest support payments in Europe. Progressively replacing these subsidies by payments for environmental benefits, such as carbon sequestration, would reduce emissions and yield budget savings.