Sovereign borrowing in Finland in historical perspective

Net borrowing of the Finnish government is currently sharply increasing. The deficit and the gross debt of the general government are approaching the critical values set by the EU Stability and Growth Pact, at 3 and 60 per cent of GDP, respectively. The central government deficit alone is expected to remain substantially higher in 2014, at 3.5 per cent of GDP, and decrease, under an unchanged policy assumption, only slowly towards 2 per cent of GDP in the forthcoming years.
Such a high level of government indebtness is rare in the economic history of Finland. War times notwithstanding, the Finnish government has generally been a net lender.  Even during the Great Depression of the early 1930s, the budget deficit of the Finnish government remained keenly under control, and the share of central government debt in relation to GDP peaked at around one quarter of GDP in 1932–33. Thanks to substantial surpluses, the debt decreased rapidly thereafter to a level of less than 10 per cent of GDP in 1938.

After the peak caused by Finland’s participation in the Second World War, the public debt diminished rapidly in post-war Finland. Substantive central government surpluses contributed to financing the levels of investment maintained under a tight current account constraint. It was not until the deep recession and banking crisis of the early 1990s that a sharp increase in the public debt was experienced once again in Finland. The central government net borrowing alone amounted to more than 10 per cent of GDP in three consequent years in 1993–95. But again, thanks to prudent fiscal policies and the period of vigorous growth that lasted from the latter part of the 1990s well into the first decade of the new millennium, the central government deficits were eliminated while the general government accounts showed a healthy surplus.

The aftermath of the global financial crisis at the end of the last decade meant an abrupt change in the above favourable development pattern. Although the banking sector remained healthy and limited the direct financial impact of the international crisis on Finland, the consequences of the international recession turned out to be exceptionally high and long lasting. The global slowdown in investment has hurt the markets for traditional machinery industries in Finland. The export backlash has been made worse by the idiosyncratic structural crises in paper industry and in the Nokia-centred mobile telecommunications sector, both of paramount significance for Finnish exports. Further weakened by a sharp deterioration of the cost competiveness of the economy after 2008, the overall outcome of these negative developments has been a fall in the volume of the manufacturing output by about one quarter from its previous peak in 2008. Even the aggregate GDP remained in 2013 more than 5 per cent below its 2008 level.

The sharp setback in output has been badly felt in the public finances. A combination of falling output and increasing age-related public expenses has increased the share of public expenditure in relation to GDP by 9 percentage points from 2008 to 2013. While the increase in the gross tax rate has remained at about 2 percentage points in the same period, the general government net lending has decreased by more than 6 per cent of GDP.

What marks a difference, in a historical perspective, in the recent upswing in the public debt in Finland is that it is not likely to turn around quickly. With a stagnating labour force and lowered levels of productivity growth, the outlook points towards permanently lower output growth figures than before. The possibilities for simply growing out of the public debt do not seem to be there this time.

Currently a series of measures is being taken by the government to enhance the long-term sustainability of the public finances in Finland. The first steps towards an ambitious pension reform, due to go into effect in 2017, have been taken. This reform, together with additional measures to shorten various breaks in labour careers, should enhance labour supply. A thoroughgoing productivity-driven reform of the health care and social services is also substantially under way. Measures have also been taken to restore balanced local government finances.

All in all, while the Finnish government is aware of the fact that the challenge of breaking the public debt cycle is more demanding this time than before, it is determined to meet it through a consistent long-term strategy for restoring the long-term sustainability of public finances. There are also encouraging signs that this objective is being increasingly understood by the general public and the parties in opposition. One might thus in an optimistic mood conclude that while the task is this time likely to be more demanding and long lasting than before, a broadly based and enduring support for it is mounting among the nation.

Jukka Pekkarinen
Economic Policy Coordinator
Ministry of Finance

Published 2014-03-05 at  14:56 , updated 2014-03-05 at  15:54
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