Austerity Backlash Hits Finland

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Includes: EFNL
by: Global Risk Insights

Finland's economy is underperforming, but the leadership's ideas to get things back on track aren't popular. Will the government be able to push through reforms, or will there be a change in policy?

The Finnish economy is in a sticky state. Unemployment is swelling towards 9%, whilst growth is lagging behind the rest of the Eurozone at 0.2%. Debt is also creeping near 70% of GDP, well above the EU target of 60%. The ruling coalition, headed by Prime Minister Juha Sipilä, is in full battle mode to get things back on track.

The situation is made especially unpleasant by the fact that Finland used to be doing pretty well. But a combination of the euro crisis, two-way sanctions against Russia (a major trade partner), and the decline of key powerhouses such as Nokia (NYSE:NOK) and the paper industry have taken a visible toll.

To be sure, these problems are nothing new, and had the previous government taken more action, things might stand a bit better. Indeed, it was a reaction to the old leadership's incompetence that helped Mr. Sipilä win a stunning victory in May.

Finnish Thatcherism

But despite a strong mandate, Sipilä's most recent attempt to fix the economy is facing tough resistance. After two failed attempts to negotiate a labour reform deal with union leaders, Mr. Sipilä's government decided to take matters into its own hands.

In a taboo maneuver, the government made unilateral calls to cut workers' benefits. Finnish labour unions are used to negotiating their own working conditions and reacted acidly. By snubbing the unions, Mr. Sipilä - in a slight exaggeration - has been crowned the Maggie Thatcher of Finland.

The proposed cuts seek to reduce public holidays, sick leave benefits, and overtime wages. Because this would mainly affect employees in the public sector, the government claims it could save up to €177 million in labour costs. It would also make it cheaper for firms to hire. However, critics, such as the head of Finland's Central Bank Erkki Liikanen, say this is unfair towards certain lower income workers, e.g. in the health sector.

In a dramatic move, the union leaders - representing 2.2 million people in a country of 5.4 million - called for a massive strike on Friday, September 18. This was set to be one of the biggest demonstrations since the 1950s.

Mr. Sipilä responded with an emotional (for Finnish standards) televised address to the nation, trying to evoke a sense that Finland is going through tough times, and "if we don't make painful changes now, we're going to have to make even more painful changes later".

As a clear carrot for union leaders, he offered to abandon the unpopular cut proposals if workers would work longer days (by 20 minutes) and cut half their vacation money instead. He claimed there was still time to come up with a united agreement and gave the unions until the end of the month to reach a deal.

Austerity or augmentation?

The proposed cuts follow the dominant narrative that Finland is seriously lagging in competitiveness compared to its main trade rivals, Germany and Sweden. But without the option to devalue the national currency (Finland adopted the euro in 2001), the leadership is backing the idea of 'internal devaluation' instead.

But many economists - including Joseph Stiglitz, who visited Finland during the strike - claim outright austerity is the wrong move. Mr. Stiglitz argues that Finland should stop obsessing over debt and focus on growth instead.

Though Finnish debt seems high, it is clearly lower than public debt in the UK or even Germany. Internal devaluation runs the risk that domestic demand may shrink faster than exports grow, resulting in deflation.

Meanwhile, the credit rating agency Fitch maintained Finland's AAA-rating on September 19, meaning that Finland still enjoys a high level of confidence. Taking advantage of cheap debt now to fuel economic growth would in turn support debt sustainability, argues Mr. Stiglitz.

Even forecasts for growth aren't as bad as some people feared. There were many worries that the economy would contract again in the second quarter of 2015, but it beat expectations by 0.6%. Finland even enjoys a minor trade surplus.

Back to the table

In the end, the strike was relatively harmless. About 300,000 protestors participated across the country with only minor hindrances to transport, day cares, and paper factories. The Confederation of Finnish Industries' estimate that the stunt cost €100 million to the economy is largely dismissed as propaganda.

Indeed, some analysts believe that the strike could have a positive effect as it allowed unions to blow off some steam, making it easier to return to the negotiating table. According to a poll conducted during the strike, nearly 70% of the public is in favour of accepting the Prime Minister's new alternative cuts and union leaders have already expressed interest in exploring the idea.

But despite newfound political will, finding an agreement that suits all stakeholders will be tricky. The Prime Minister is stiff on reaching a 5% cut to labour costs, a figure that is very difficult for union leaders to swallow.

What is more, tensions will rise again when the parliament votes on the proposals in the coming months. Other contentious cuts, such as slashing unemployment benefits, are in the pipeline for the near future.

But in all, the good news is that something is actually being done to address Finland's meager economy - a welcome improvement from the previous government's lethargy. Mr. Sipilä is right that Finland needs to curb spending - it has a speedier debt rate than Greece - but it would do well to avoid puritanical austerity. A more balanced approach will not only satiate investor confidence but will boost domestic spending as well.