The Corner

National Security & Defense

It’s Long Past Time For Fixit

Finland’s economic woes are not news for anyone who follows the news from that part of the world, but, as the Daily Telegraph’s Ambrose Evans-Pritchard highlighted earlier this week, they illustrate the point that the euro doesn’t only punish the ‘guilty’:

A full six-and-a-half years into the current global expansion, Finland’s GDP is 6pc below its previous peak. It is suffering a deeper and more protracted slump than the post-Soviet crash of the early 1990s, or the Great Depression of the 1930s. Nobody can accuse Finland of being spendthrift, or undisciplined, or technologically backward, or corrupt, or captive of an entrenched oligarchy, the sort of accusations levelled against the Greco-Latins.  The country’s public debt is 62pc of GDP, lower than in Germany. Finland has long been held up as the EMU poster child of austerity, grit, and super-flexibility, the one member of the periphery that supposedly did its homework before joining monetary union and could therefore roll with the punches…..

As Evans-Pritchard points out, the country has been hit by a series of ‘asymmetric shocks’ including a crisis at Nokia and recession in Russia, but:

The relevant point is that it cannot now defend itself. Finland is trapped by a fixed exchange rate and by the fiscal straightjacket of the Stability Pact, a lawyers’ construct that was never intended for such circumstances. The Pact is being enforced anyway because rules are rules and because leaders in the Teutonic bloc have an idee fixee that moral hazard will run rampant if any country in the EMU core sets a bad example. Finland’s output shrank a further 0.6pc in the third quarter and the country’s three-year long recession is turning into a fourth year. Industrial orders fell 31pc in September. “It’s spooky,” said Pasi Sorjonen from Nordea.

Rubbing salt in Finland’s wounds, neighboring Sweden is doing relatively well. Its GDP stands, Evans-Pritchard notes, about 8 percent above its pre-Lehman peak, a painful divergence given the similarities between the Finnish and Swedish economies. An important reason for this is that in 2003 Swedish voters ignored the advice of their political and business elites and (often, ironically, for the ‘wrong’ reasons) rejected the euro in a referendum. That meant that Sweden retained a degree of flexibility that has helped it navigate the economic storms of recent years far more successfully than Finland.

Evans-Pritchard is not quite right on the legal and historical background, however. He writes:

Voters in Sweden and Denmark stopped their governments abolishing their ancient currencies. Finnish voters were never given a referendum. The decision to join the euro was rammed through against widespread opposition, and was camouflaged as a national security issue.

Yes and no. Denmark negotiated an opt-out from the obligation to sign up to the euro at the time the basis for the currency was being put together. Sweden and Finland joined the EU quite a bit later (1995), by which time all new entrants were obliged to adopt the new currency as soon as (a) it was introduced and (b) they satisfied the necessary economic criteria. The Swedish referendum simply ignored that obligation. The Finns, a law-abiding lot, did things differently. Around 57% of them voted to join the EU. Membership was seen by many as a definitive break with a past in which Moscow had played too much of a role, and the euro was just a price to be paid for that. If Finns had been given a separate vote on adopting the single currency, they would almost certainly have rejected it, but they were not, so that was that.

And it didn’t take long for most Finns to reconcile themselves to the euro. That was a mistake. Firstly, it landed them with a hefty (if largely contingent) liability for the euro zone bailouts. Secondly it did hurt their (still excellent) competitiveness. Thirdly, as Evans-Pritchard explains, it has deprived them of many of the tools they could use to ease their current woes.

Back to Evans-Pritchard:

Finland’s centre-Right coalition is determined to press ahead with an ‘internal devaluation’, the very policy that tipped half Europe into debt-deflation four years ago and caused debt ratios to rise even faster through the denominator effect. This is likely to be self-defeating for Finland as well, even on its own crude terms, given that household debt is over 100pc of GDP….

Finland is digging itself into an ever deeper hole. The International Monetary Fund warned this week against austerity overkill and “pro-cyclical” cuts before the economy is strong enough to take it.  The IMF spoke softly but the message was clear. Finland should not even be thinking of a “front-loaded” fiscal contraction or slashing investment at a time when its output gap is 3.2pc of GDP. The Finnish authorities admitted in their reply to the IMF’s Article IV report that they had no choice because they had to comply with the Stability Pact. This is what European policy-making has come to.

One size doesn’t fit all. It doesn’t now. It didn’t before.

Interest rates were too low for Finland’s needs during the commodity boom, causing the economy to overheat. Unit labour costs spiralled up 20pc from 2006 onwards, leaving the country high and dry when the music stopped. Public debt was low but private debt was high (somewhat like Spain and Ireland). The crisis hit later merely because the commodity bubble did not burst until 2012.

Some Finnish politicians are trying to do something:

The Finnish parliament is to hold ‘Fixit’ hearings next year on exit from monetary union and a return to the Markka, the currency that saved Finland in the early 1990s (once the ill-judged hard-Markka policy and the fixed ECU-peg was abandoned).

A Fixit would be far easier than a Grexit. If I had to guess, the new Markka would depreciate a little, but not by so much as to hurt the ability of the country to service its debt. On the other hand, Finland would gain from the boost to its large export sector (roughly 40 percent of GDP) and the ability to set a monetary policy suited to its needs rather than an agenda set by Brussels and Berlin.

The Finns should go for Fixit, but they won’t. Rocking the boat (at least beyond a certain point) is not their style, and they are also keenly aware of the more restive Russia to their east. They are not in NATO, and so the EU is all (not much, admittedly) they have. Under the circumstances they are unlikely to opt for a policy that puts them at odds with their euro zone partners.

That’s a pity. 

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