The Finnish economy has been hit by three shocks over the past decade:
- Nokia has more or less disappeared;
- The paper industry is in crisis;
- And recently the Russian crisis has hurt Finland's economy too.
These have all caused a very significant change in Finland's current account balance, which over the past 15 years has gone from a sizeable surplus (around 9% of GDP in 2001) to a small deficit (around -1% of GDP in past four years).
This would under normal circumstances require a (real) exchange rate depreciation to restore competitiveness. However, as Finland is a member of the euro such adjustment has not been possible through a nominal depreciation of the currency and instead Finland has had to rely on an internal devaluation through lower price and wage growth.
However, Finland's labour market is excessively regulated and non-wage costs are high, which means that the internal devaluation has been very sluggish. As a result growth has suffered significantly.
In fact, Finland's real GDP level today is around 5% lower than at the onset of the crisis in 2008. This makes the present recession – or rather depression – deeper and longer than the Great Depression in 1930 and the large Finnish banking crisis of the 1990s. Rightly we should call the present crisis Finland's Greater Depression.
European Central Bank policy obviously has not helped. First of all, the 2011 rate hikes from the ECB had a significantly negative impact on Finnish growth. Second, the shocks that have hit the economy are decisively asymmetrical in nature. This means that Finnish growth increasingly has come out of sync with the core Eurozone countries - such as Germany, Belgium and France.
Hence, Finland is a very good example that the eurozone is not an "Optimal Currency Area", where one monetary policy fits all countries.
Concluding, the crisis would likely have been a lot shorter and less deep had Finland had its own currency. This would not have protected Finland from the shocks – Nokia would still have done badly, and exports to Russia would still have been hit by the crisis in the Russian economy, but a currency depreciation would have done a lot to offset these shocks.
To illustrate this, compare the pegged economies (in red in the graph below) of Finland and Denmark with the free-floating economies of Sweden, Iceland and Norway (in green).
Should Finland leave the euro now? It's hard to say, but it seems clear that Finland shouldn't have joined in the first place.
Are there other options? Yes. Significant labour market reforms that weaken the power of labour unions and reduce non-wage costs would make internal devaluation easier. But such reforms are notoriously hard to implement politically and the discussion and the response from the Finnish government to the Greek crisis has shown the Finnish governing coalition is extremely fragile. This is hardly a government, which should be expected to be able to push through the needed reforms.
See also my three earlier blog posts on Finland:
http://marketmonetarist.com/2014/11/16/great-greater-greatest-three-finnish-depressions/
http://marketmonetarist.com/2015/07/23/peggers-and-floaters-the-story-of-five-nordic-countries/
Lars Christensen is a Senior Fellow of the Adam Smith Institute and blogs as the Market Monetarist.