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September 2015

Examining Sipilä's "Fake Austerity" via an Economics Framework.

Commentary, Finnish Economy

Hi guys! Long post ahead, make some coffeeee <3

Today I will be blogging an Keynesian perspective on the current Finnish protracted recession. There are only few sound economic analysis I’d found thus far, and I think one great blog post examining this phenomena from an economic lens is– Sipilänomics: Finland’s fake austerity . So this post is a further economic supplement to that excellent analysis, because here I illustrate the AD-AS macroeconomic framework and use a globally acknowledged simple macro-economic equation to illustrate the phenomenon.

I am taking time to blog this post because I love Finns and Finland, and I DO wish the best for the country. There is a high possibility that my future kids will grow up in Finland.  I want to provide an economic perspective so that any commoner who can read English can consider what is happening in Finland from an economic perspective, because I know that most Finns aren’t really educated in Economics. Many with a keen interest in society instead choose to study sociology.

I did Economics with honours for four years at the National University of Singapore, ranked 12 this year on the global distinguished QS ranking. I also did a year of Econometrics at Waseda University in Japan, one of the top private universities in Japan, and got a A+. With these credentials, I humbly try my best to make as informed an economic perspective on the state of the Finnish economy as possible. Obviously, don’t accept everything I say at face value. Read with a critical mind, and feel free to challenge me if you want to.

This economic post is divided into three parts:

  1. Explaining the Keynesian AD-AS macroeconomic model
  2. Why the current fiscal policies cannot be categorised as a lump “austerity measures”.
  3. [The Future] What then, is the sound economic solution?

Part I. Explaining the Keynesian AD-AS macroeconomic model.

According to John M. Keynes, there is this concept known as the aggregate demand, defined as:

” The total amount of goods and services demanded in the economy at a given overall price level and in a given time period. It is represented by the aggregate-demand curve, which describes the relationship between price levels and the quantity of output that firms are willing to provide. Also known as “total spending”.”

Aggregate Demand/GDP of a country can be measured according to this formulae:

AD= C+ I + G + (X-M)

where C = consumer expenditure; I = Investment, G= Government expenditure, X= export revenue and M = import expenditure and (X-M) = net exports. Any increase in each component will cause an increase in AD, and cause a multiplied increase in real output. Real output is commonly denoted by Y on the AD-AS model.

There is also such a thing called the aggregate supply, AS. Aggregate Supply is defined as:

“The total supply of goods and services produced within an economy at a given overall price level in a given time period.”

Factors that would affect the aggregate supply are investment in human capital, investment in technology, increase in the number of human beings, investment in infrastructure.

So Keynesian AD-AS model looks like that graphically:


(Source: Wikipedia)

Simply put, to get out of recession, you need to either increase your AD, or increase your AS. This is so that the employment level, measured by real output Y, can be higher.

Part II. Why the current fiscal policies cannot be categorised as a lump “austerity measures”.

Let’s start with the definition of two terms: “fiscal policies” and “austerity measures”.

“Fiscal policies” is defined as:

“The means by which a government adjusts its spending levels and tax rates to monitor and influence a nation’s economy. It is the sister strategy to monetary policy through which a central bank influences a nation’s money supply.”

NOTE that Finland has limited control over monetary policy (That is, to control the supply of Euros in the economy, because the demand and supply of Euros is not an intra-Finland issue; it’s dependent on EU as a whole), so monetary policy is effectively crippled. This implies that they will more often than not, have to fall back on SOUND fiscal policies.

“Austerity” is defined as:

“the measures taken by governments to reduce (fiscal) expenditures in an attempt to shrink their growing (fiscal) budget deficits.”

So why on earth do governments want to embark on austerity measures? The answer is clear from the definition: In the past, the said government has been taking too much debt, and therefore there might be some perception that such debt is getting too high and unsustainable. “Unsustainable” means that there is fear that the debt cannot be paid back.

Let’s take an educated look on what has been proposed so far by the Sipila’s government. For the sake of objectivity, I base my analysis on notions cited in his televised speech:

  1. Statement that austerity measures is NOT enough, or even the point: “Finland will not rise simply through spending cuts or tax increases.”
  2. Statement that measures are needed to increase competitiveness of work, in addition to possible austerity measures, if any: “This country needs more jobs. In order to create them, the Government has adopted measures to improve the competitiveness of Finnish work.”
  3. Disapproval over increase in value-added tax. “It would have cost every Finn if value-added tax would have been increased by several percentage points. Value-added tax is a flat tax and it would impact people’s finances insidiously.”
  4. Assumption that the global economy will continue growing, and in Finnish context, assuming that China will keep on growing and doing business with Finland: “The global economy has been growing for the last few years, but we have not managed to board that train. And we cannot, unless we seriously want to and take action to do so.”
  5. Statement that the main competition are from Germany, Sweden and Denmark. “We are reforming the labour market, because only in that way can we get back into the global markets alongside competing countries such as Germany, Sweden and Denmark.”
  6. Statement that red-tape will be reduced. “We are significantly reducing red tape and bureaucracy in order to get the wheels turning again.”
  7. Statement that there will be an increase in G, which goes against austerity. “We are investing in key Government projects, because change also needs investment.” Also, note that these “key Government projects” are not specified in any way.

Now, I refer to other sources not cited in his speech, but refer to the policies his government is doing or planning:

8. Statement that there would be large immediate spending on refugees, but in the long term refugees will contribute to the welfare state IF they can assimilate well. “Liikanen: Asylum applicants will help finance the welfare state one day”.  What is not stated, however, is that in the long run, due to a higher pool of labour in the market, the wages for Finns will be suppressed anyway. Yet, the higher pool of labour indicates an increase in aggregate supply for the country, something which is positive for the welfare state since it makes more potential growth and output possible, which implies a higher level of tax revenue for the government.

9. Negative impact on investment in human resource.Government considering cutting unemployment benefit by 100-250 days.

10. Decrease in funding for tertiary education. This marks a decrease in aggregate supply, something that is negative in the longer-term, and leads to lower innovation and lower quality of human resource. “Helsinki University to possibly cut 1200jobs, save 86million”. 

11. Point that the three labour unions are damn powerful. 30,000+ demonstrators turned up for the strike last Friday, Sipila had two prior negotiation with the labour unions and failed, for instance.  And demonstrators were not happy. 

So actually, evidently so far the public discourse had mixed two concepts up: “austerity”, and “increasing labour competitiveness”. Freodom has done right so far that the Finnish government isn’t doing much austerity at all–the government is mostly focusing on increasing the competitiveness of the labour they have.

So actually, the Finnish government here has two objectives:

  1. To have SOME austerity measures so as to balance government budget; but more importantly,
  2. To increase labour competitiveness, so as to increase aggregate demand. And in the immediate term, this means they want to make average wage lower than its current level. 

Here’s my analysis of what these proposed policies do to the above two objectives. You will see that these policies are not usually the wisest in reaching both objectives:

  • Points 1, 3, 7, 8 are antiausterity measures, because they mark an INCREASE in government expenditure, a no-change in value-added tax, and an indication that the government’s focus isn’t even on austerity at all. Point 8 on refugees actually does have a positive benefit in the longer term, because your aggregate supply will increase, so this will actually make the workplace more competitive in the longer term, since wages (=price of labour) will go down. This means that instead of working towards balancing the government budget, these policies will actually increase the government budget deficit.
  • Points 9, 10 are austerity measures. However, both measures directly go against the goal of increasing labour competitiveness.
  • Point 11 definitely is a huge threat against labour competitiveness, especially when workers are obviously incompetent and can never be sacked. However, strong unions are necessary if you want to guard your labour against exploitation by capitalists.
  • Points 2,5 and 6 are for increasing the competitiveness of labour. On point 6 is an implication too that they want more foreign direct investment into Finland, and/or for more non-Finns to set up companies in Finland.
  • Point 4 is an assumption that the world economy will continue to grow at an optimistic rate in the next 5-10years, because it had been growing in the past. This is a rather dangerous assumption, because many have predicted an impending global recession with slow growth for the next 5-10 years. What this means is that the Finnish export market will be badly hit, thus affecting the Finnish aggregate demand.

So all-in-all, what does this imply for Sipila’s government? Answer: he is actually trying to invite more foreign investors INTO Finland by creating a strongly pro-business environment, while trying his best to protect the Finnish farmers and big Finnish national firms. According to the AD-AS framework, his government is trying to increase the investment component (“I”) via foreign direct investment.

What is the meaning of a “pro-business environment”? The meaning is this: Finland will have more foreigners in, the wage of Finns will be depressed for sure due to more labour supply, there would be more competition for limited jobs. Obviously the strong unions will not be happy. Their workers will also have to work longer hours for the same pay.

At this rate, is there a possibility that nothing will change/happen? The answer is YES! Because nobody is willing to compromise! And I don’t think Sipila will be able to force a lot of things down the throats of Finns at all, having come from a society which values democracy so much!

Nobody ever spoke much about the DOWNSIDES to democracy, yes? Well this is it.

Part III: [The Future] What then, is the sound economic solution?

In my opinion, really, the solution is to spend more on things that will increase the aggregate supply. Because any investment on aggregate supply will increase aggregate demand too. I concur greatly with Joseph Stiglitz on the point that the government should consider being growth-focused, not debt-focused. The current government policies focuses too much on increasing competitiveness of labour BY decreasing the cost the companies have to pay to employ workers. Why not work further towards increasing the productivity of workers?

For example, spending more on education, research and a sound infrastructure such as good buildings and transport systems (NOT LESS, LIKE WHAT THEY ARE DOING!) will increase BOTH AD and AS, leading to a higher equilibrium growth and output, which will get Finland out of its recession. This will also lead to greater innovation, which might lead to the next big economic driver/ next NOKIA of Finland, won’t it? This directly increases the Investment “I” component in the AD-AS framework too.

Also, investors will see that Finland is incurring debt to spend on the right places, responsibly. This will help it retain its credit worthiness, and help keep its borrowing interest rates low. If that is the case, taking on debt is not too much of a problem. Debt after all, is a problem if and only if a country has severely corrupted leaders, or anyhow spend the borrowed money.

Personally I think wage-competitiveness though possible, is not a long-term method, nor a sustainable one. There are three reasons:

  1. The cost of living in Finland is relatively high as compared to other European countries. Decreasing real wage will directly decrease the purchasing power of citizens. This directly decreases the Consumption “C” component of the AD formulae, and may lead to protracted recession;
  2. Decreasing wages might not even increase revenues for export industries, which the government wants to focus on, since domestic industry is weak. This is because the performance of export industries depends on global income and how well the global economy performs. If spending globally is depressed, then it won’t make sense to make your export industries cost-competitive VIA the lowering of wages, would it? The best way out is to focus on how to make the debt sustainable.
  3. Decreasing wage and therefore saving costs for ANY company in Finland, large or small, does not necessarily translate into the overall decrease in prices for goods or services. It might simply imply bigger profits for shareholders. If this is the case, it will NOT make goods more price-competitive, but only fatten the pockets of people who are already rich.

Overall, even if in theory focusing on sustainable debt instead of a balanced government budget is sound– Sipilä’s government would still face huge problems in any execution, because in such a democracy, everybody has their own ideas and are convinced that only they are right. So decision-making is damn slow!!

Furthermore, most Finns don’t really understand economics, because if they are interested in society and how it works, they’d be taking sociology instead of economics at tertiary level. In a sheltered welfare state where everybody’s needs is being taken care of too, there really isn’t a need to think or understand macroeconomics. But times have changed…so I also hope for a higher Economic literacy for Finland.

Wishing the best for Finland, of course, and I hope for a possibility that my future kids can stay in Finland, since The Boyfriend is Finn.