EUROPEAN COMMISSION Brussels,7.3.2018 SWD(2018) 224 final COMMISSION STAFF WORKING DOCUMENT Country Report Finland 2018 Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP 2018 European Semester: Assessment of progress on structural reforms, prevention and correction of macroeconomic imbalances, and results of in-depth reviews under Regulation (EU) No 1176/2011 {COM(2018) 120 final}





Contents Executive summary 1.Economic situation and outlook 2.Progress with country-specific recommendations 3.Reform priorities 3.1.Public finances and taxation 3.2.Financial sector 3.3.Labour market, education and social policies 3.4. Investment 3.5. Sectoral policies Annex A: Overview Table Annex B: Macroeconomic Imbalance Procedure Scoreboard Annex C: Standard Tables References LIST OF Tables Table 1.1:Key economic, financial and social indicators - Finland Table 2.1:Progress with Council's Country Specific Recommendations Table 3.2.1:Financial soundness indicators, all banks in Finland

Table 3.3.1:Inactivity rates in Finland and the EU in 2008 and 2016 — Stock in percentage of total 25-49 age population Table B.1:The MIP Scoreboard for Finland Table C.1:Financial market indicators Table C.2:Headline Social Scoreboard indicators Table C.3:Labour market and education indicators Table C.4:Social inclusion and health indicators Table C.5:Product market performance and policy indicators Table C.6:Green growth LIST OF Graphs Graph 1.1: External and domestic demand — Contribution to growth — Finland Graph 1.2: Contributions to potential growth — Finland Graph 1.3: Quarterly harmonised index of consumer prices, Finland, year-on-year %-change Graph 1.4: Breakdown of real effective exchange rate (REER), nominal effective exchange rate (NEER), relative harmonised index of consumer prices (HICP) — Finland Graph 1.5: Nominal unit labour costs in total economy — Denmark, Germany, Finland and Sweden (2005 = 100) Graph 1.6: Export market shares (EMS) of goods and services — Finland Graph 1.7: Breakdown of external position (current and capital accounts) — Finland (to be updated) Graph 1.8: Breakdown of the international investment position (NIIP) in % of GDP — Finland Graph 2.1: Overall multiannual implementation of 2011-2017 CSRs to date Graph 3.1.1: Debt projections according to social and healthcare reform proposals and Debt Sustainability Analysis (DSA)

Graph 3.1.2: General government consumption, as a share of GDP and as broken down by function, 2005, 2010, 2015, Finland and the EU Graph 3.1.3: Tax revenues from environmental taxes, 2010 and 2015 Graph 3.2.1: Lending to the private sector — Change in stock of loans (y-o-y) Graph 3.2.2: Overvaluation gap for price/income, price/rent and fundamental model valuation gaps — Finland Graph 3.2.3: Share of dwelling construction in GDP — Annual change in % Graph 3.2.4: Gaps to prudential thresholds and fundamental benchmarks for non-financial corporations and households Graph 3.2.5: Leverage of households (households’ debt stock to GDP ratio) (1) Graph 3.3.1: Labour market indicators Graph 3.3.2: Evolution of employment by sector Graph 3.3.3: Labour shortages Graph 3.3.4: Beveridge curve Graph 3.4.1: Export market share growth by type (goods or services) Graph 3.4.2: Breakdown of the balance of trade for goods (fuels included) 2001-2017 — Cost and non-cost competitiveness impact Graph 3.4.3: Breakdown of rate of change of nominal ULC in Finland by change in inflation, real compensation of employee, productivity contribution), rate of change of nominal ULC in EA — Finland Graph 3.4.4: Total factor productivity (total economy) — EU28, Germany, Finland and Sweden Graph 3.4.5: Intellectual property product investment in volume — EU (28), Denmark, Germany, Estonia, Finland and Sweden Graph 3.4.6: Research and development gross capital formation — Net capital stock by industry and year Graph 3.4.7: Non-financial corporations surplus redistribution — Finland Graph 3.4.8: Share of high, medium-high, medium-low and low technology in total manufacturing exports — UK, Denmark, Netherlands, Germany, Sweden, Belgium, Austria, Finland

LIST OF Boxes Box 2.1: Tangible results delivered through EU support to structural change in Finland Box 3.3.1: Monitoring performance in light of the European Pillar of Social Rights Box 3.3.2: Policy highlight: Ohjaamo: from a pilot project to a structural reform to provide support to young people Box 3.4.1: Investment challenges and reforms in Finland Executive summary The positive economic outlook paves the way for further reforms which could lift Finland's growth potential and improve resilience. Economic activity is expanding owing to external demand and improved cost competitiveness as well as increasing investment. Despite the recently adopted measures, the recovery in the labour market could be hampered by skills shortages and low labour market participation. A higher employment rate and cost efficient public services are key issues to securing the long-run sustainability of public finances and the welfare system. Addressing these challenges would improve the resilience of the economy. () Finland is emerging from a protracted crisis. The country exited from economic recession in 2016 as real GDP expanded robustly and in 2017 economic activity is expected to have increased even more. In 2016, the expansion was quick-started by increasing investment, initially construction, supported by cheap borrowing for households and recovering profits for enterprises. In 2017, higher demand from abroad led to a vibrant revival in exports and strong equipment investment. The current account was moving close to balance and is set to reach positive territory this year. After a long stagnation, labour productivity started to improve, while enterprises consolidated profits. At the same time, labour participation increased, and unemployment declined only modestly. Despite the recent upturn, the economy is still affected by the legacy of the double-dip recession. Overall economic activity is poised to pass its previous peak level of 2008 only in 2018 — four years after the EU as a whole. Employment is still below pre-crisis levels, while unemployment is still higher. Labour productivity declined in Finland between 2008 and 2016, while in the EU as a whole it increased. The volume of Finland's exports of goods and services was 10% lower than in 2008, while total EU exports increased by a quarter in the same period. Potential growth has recently accelerated but is not expected to return to pre-crisis growth rates in the medium term. Equipment investment has picked up, but investment in R&D and intangible assets is lagging behind. Equipment investment rebounded in early 2017, as capacity utilisation increased, supported by the recovery in external demand, but remained one of the lowest in the EU as a share of GDP. After several years of decline, investment in R&D and intangible assets was close to the EU average, but, in 2017, started expanding again. The electronics sector is expected to record positive operating results for the first time since the start of the recession, creating scope for new investment in intangible assets. Finland’s stock of inward FDI remains low among the EU Member States, but recent developments in greenfield investment are encouraging and the business environment is generally good. Finland's cost competitiveness is recovering, but non-cost competitiveness is a concern. In the late 2000s, cost competitiveness deteriorated as a result of high wage increases. Cost competitiveness relative to the rest of the euro area has improved since 2016, thanks to the Competitiveness Pact agreed in tripartite social dialogue. The wage deals which have been concluded for the next two years are quite moderate. With respect to non-cost competitiveness, Finland experienced a shift in specialisation from higher value added goods towards intermediate goods after the setback of its electronics sector. Exports of services have become increasingly high-tech and are expanding. The labour market is gradually recovering. More people have moved into the labour force, as confidence about the economy increased. However, this has not yet translated into strong employment growth. Structural unemployment remains high, which could reflect low incentives to accept work, lack of targeted and sufficient activation measures, skills shortages and lack of affordable housing in the growth centres. However, on the back of the positive economic outlook and reforms implemented recently, employment growth is expected to accelerate in 2018. The overall private debt burden is unwinding and the public sector has started to reduce its debt. Owing to continued consolidation efforts, the public deficit is expected to remain below 3 % of GDP in the near future. After a peak at 63.6 % of GDP in 2015, the gross public debt ratio has been on a decreasing path and is expected to fall below 62 % of GDP in 2019. The ratio of the private debt stock to GDP decreased in 2016. However, unlike the non-financial corporations' debt, the household debt has been moderately on the rise and the household saving rate is expected to remain exceptionally low. The Finnish Financial Supervisory Authority has adopted measures to contain the high indebtedness of households. The banking sector remains sound overall, but structural weaknesses persist. Finnish lenders remain profitable, well capitalised and have a high loss absorption capacity. However, the risk weight for mortgages in capital ratios calculation was fairly low. Also, banks rely heavily on wholesale funding. The Finnish Financial Supervisory Authority has recently targeted these risks. The Parliament has strengthened macro-prudential supervision also by adding a Systemic Risk Buffer to the existing toolkit. Nevertheless, the banking sector remains rather concentrated and refinancing risks persist. Overall, Finland has made some ( ) progress in addressing the 2017 country-specific recommendations. Recent measures to reform unemployment benefits have already resulted in greater incentives to accept work, though challenges persist. Action has also been taken to facilitate (self-) employment and regional mobility. Wage negotiations for 2018 and beyond are ongoing and so far the outcomes are in line with productivity developments. The bill for social and healthcare services reform is expected to be approved by Parliament in spring 2018 so that the reform would enter into force in 2020. Furthermore, Finland has also made progress in other areas covered by the 2017 recommendations, including on reducing the administrative burden; improving the regulatory framework; increasing competition in services; and promoting investment. As for progress in reaching the national targets under the Europe 2020 strategy, developments in 2017 were generally positive. Regarding the employment rate of 20-64 year-olds, Finland’s goal is 78 % while in 2016 the rate stood at 74 %, improving from previous years. The poverty rate is low compared to the EU average and has been gradually decreasing recently. The early school leaving rate fell slightly below the target of 8 % for the first time in 2016 while Finland’s tertiary educational attainment rate stayed above the target. The very ambitious R&D investment target of 4 % of GDP is likely to be missed, as R&D investment has decreased in recent years, standing at 2.8 % in 2016. Finland is broadly on track to reach its climate and energy targets. Finland performs relatively well on the indicators of the Social Scoreboard supporting the European Pillar of Social Rights. Finland displays low levels of income inequality and few people at risk of poverty or social exclusion. It is recognised for its high quality and inclusive education system. A reform of the social and health care system is being prepared. This reform could have the potential to address the high self-declared unmet need for medical care. The main findings of the analysis in this report, and the related policy challenges, are as follows:

·The public debt-to-GDP ratio is projected to start increasing again in the early 2020s. The age-related healthcare and long-term care services expenditure are expected to expand with a knock-on effect on public finances. An overhaul of the services accompanied by a reform of the local and regional administration, currently in the Parliament, is yet to be adopted. The reform aims at increasing the role of the private sector in the provision of social and healthcare services. Cost savings are expected through increased competition and better integrated service provision. The reform has the potential to increase productivity of social and healthcare services and therefore lower the expenditure pressure. However, despite the planned savings, the cost pressure from population ageing keeps medium-term debt projections on an increasing path. ·Despite a recent increase, the employment rate at 69.7% of 15-64 year-olds remains low when compared to Finland's Nordic peers. For some unemployed or people outside the labour force, particularly among those aged 25-49, taking up work is still not financially rewarding enough despite the action already taken. The efficiency of some of the activation measures are hampered by a lack of service integration. Another challenge is to ensure the long-term integration of refugees and other migrants in the Finnish labour market and society. ·Wage setting practices are changing, and it is not yet known how the new model will keep wages and productivity aligned. Cumulated losses of cost competitiveness have almost been compensated following years of wage moderation. Wage setting appears to move away from the centralised agreements made in 2013 and 2016 towards sectoral and local level bargaining. It has given some first positive results. Under the latest wage agreements, organized employers have more opportunities to carry out local bargaining while for non-organised employers some obstacles persist. However, it is yet to be seen whether a coordinated model will emerge, whereby the non-tradable sector follows the tradable one in keeping wages aligned with productivity and thus ensuring cost competitiveness as well as optimal employment outcomes. ·The debt level of households remains high and rising. Gross household saving rates are at half the level prevailing in the euro area as a whole and active debt reduction is not taking place. Several measures have been introduced to strengthen the stability of the financial sector and promote sustainable household lending. Despite the measures, and amid low interest rates, a significant decline in households' indebtedness in the coming years is not likely. ·The expected move of Nordea's headquarters to Finland by end-2018 would significantly increase the size of the banking sector. Following the expected relocation, the total assets of the country's banking sector are expected to reach about 420% of GDP and the deposit base is expected to expand from EUR 50 billion to EUR 140 billion. Due to strong regional interconnections with other Nordic and Baltic countries, this calls for reinforced supervision and strong regional supervisory cooperation. The Finnish Deposit Guarantee Fund will become responsible for deposits also at Nordea's foreign branches. 1. Economic situation and outlook GDP growth Finland’s economic growth accelerated in 2017, confirming the brisk recovery of 2016 (Graph 1.1). In 2016, the economy grew by 1.9 %. In 2017 the Commission expects GDP growth to have accelerated to 3.3 %, supported by an upswing in exports and sustained growth in investment, especially in equipment. Investment growth is supported by favourable financing conditions and above-average business confidence. Private consumption growth remained positive, supported by high consumer confidence and improved employment prospects. The economy is projected to continue expanding by 2.8 % and 2.5 % in 2018 and 2019 respectively. Domestic demand is expected to remain the main growth driver. The contribution from net exports to growth will remain positive, as external demand continues to expand and Finland benefits from its recovered cost competitiveness. Graph 1.1:External and domestic demand — Contribution to growth — Finland Source: European Commission (autumn forecast 2017) Graph 1.2:Contributions to potential growth — Finland Source: European Commission — Directorate-General for Economic and Financial Affairs Potential GDP growth Potential growth has accelerated recently but is not expected to return to pre-crisis growth rates in the medium term (see Graph 1.2). The crisis years and the setback faced by the electronics sector have considerably reduced the expected contribution of total factor productivity ( ) to potential growth in the years to come. The low resilience to shocks in the recent past can partly be attributed to (i) the then relatively rigid labour market practices, although changes are under way (see Section 3.3); and (ii) limited diversification in higher-tech products (see Section 3.4). In the years to come, the decrease in the size of the country’s workforce is expected to keep growth potential rather low, despite longer working hours and higher employment in 2018 and 2019. Contributions from capital and total factor productivity are projected to compensate partly for the loss in numbers of workers, as recovering external demand and higher cost competitiveness are leading Finland to higher capacity utilisation, higher investment and further positive developments in total factor productivity. However, Finland is performing less well than its EU peers in most categories of investment (share of investment in GDP). The one exception is construction, which is the least productive category. This is particularly true for intellectual property investment, which had constantly declined since end-2014, even though it started expanding again in 2017. At the same time, businesses are continuing to build up sizeable precautionary financial buffers, which may act as a brake on further investment. The economy risks therefore being trapped on a rather low-growth path (see Sections 3.4 and 3.5). Graph 1.3:Quarterly harmonised index of consumer prices, Finland, year-on-year %-change Source: European Commission Inflation Inflation is expected to remain moderate. In 2016, inflation recovered from its negative levels of 2015 (see Graph 1.3) and reached 0.8 % in 2017. Looking forward, it is set to increase only slowly in a context of higher price competition on the retail market and modest increases in housing expenses and fuel prices. Nevertheless, higher services prices, a strengthening US dollar and the low, but rising, interest rate are expected to pull inflation slightly upwards to around 1.4 % in 2018 and 1.6 % in 2019. Labour market Employment reverted to growth, supported by increased demand, rising investment and export growth. However, it still responded rather slowly to cyclical upswings. After several years of negative developments, in 2016 and 2017 employment grew by 0.5 % and is projected to continue to grow in 2018 and 2019. However, the unemployment rate only fell by 0.2 pps year-on-year to 8.7 % in 2017, as labour supply increased, with more previously inactive people actively looking for employment. In line with these developments, the employment rate (20-64) increased from 72.9 % in 2015 to 74 % in 2017. Nevertheless, skills shortages on the labour market, already visible for some sectors, are expected to intensify, with businesses reporting greater difficulties in filling vacancies for certain types of occupations, mainly in construction, health and specific niches of the ICT sector ( ). The recent positions of the Beveridge curve ( ) highlight difficulties in matching the unemployed to job vacancies (see Section 3.3). Similarly, high structural unemployment (around 7.3 % in 2017) suggests that the labour market is still some distance away from being flexible and efficient. Possible reasons for this include low incentives to accept work. Also, the long distances and lack of low-cost housing in the growth centres of Finland contribute to labour rigidity (IMF, 2017a and 2017b). Social developments Like its Nordic peers, Finland has one of the lowest levels of income inequality in the EU. The richest 20 % of the population had 3.6 times the income of the poorest 20 % in 2016, compared with 5.2 times in the whole EU ( ). Owing to the redistribution of incomes via taxes and benefits, income equality has remained stable in Finland in recent years. Finland's ranking among the EU countries in terms of market income has deteriorated slightly since 2010.

Graph 1.4:Breakdown of real effective exchange rate (REER), nominal effective exchange rate (NEER), relative harmonised index of consumer prices (HICP) — Finland Source: European Commission The risk of poverty has continued to decline since its peak in 2011, but inequality in access to healthcare remains a challenge. The latest information ( ) on poverty and income inequality indicates that for Finland no significant changes are expected in the at-risk-of-poverty rate for income reference year 2016. In 2016, the at-risk-of-poverty rate after social transfers or pensions was among the lowest in the EU at 11.6%, about 5.5 pps lower than the EU average. However, the economic downturn has led to an increase in the inactive population and long-term unemployed. In addition, the the situation has been worsening in terms of self-reported unmet needs in medical care, in particular for low socio-economic groups (see Box 3.3.1). Competitiveness In recent years, moderate labour cost increases have markedly improved cost competitiveness, but non-cost competitiveness has deteriorated (see Section 3.4). Since 2015, the country's real effective exchange rate has fallen each year, reflecting the moderate wage increases reached in the 2013 wage settlement (see Graphs 1.4 and 1.5). In 2016 and 2017, the Competitiveness Pact enabled unit labour cost to decrease (see Graphs 1.5 and 3.4.3). In 2017, productivity was higher than in the year before. As compensation of employees ( ) was stable, nominal unit labour costs declined by 1.6 %, considerably more than in other euro area economies. The positive trend is expected to continue in 2018 and 2019 ( ). Overall, this has resulted in improved cost competitiveness, while the long-term decline in the market share of exports has come to an end (see Graph 1.6). At the same time, following the setback experienced by its electronics sector, Finland has experienced a rapid shift in specialisation towards intermediate goods and from high-tech industries towards medium-tech. This implies that having competitive cost structures is more important than previously for Finnish firms. This resulted also in negative or stagnating productivity growth, which remains the main challenge for competitiveness. The small number of exporting SMEs is another challenge. Graph 1.5:Nominal unit labour costs in total economy — Denmark, Germany, Finland and Sweden (2005 = 100) Source: European Commission Current account Finland’s current account deficit narrowed in 2017. The strengthening of external demand and decline in the country’s unit labour costs since 2015 (see Graph 1.4) has enabled the trade balance to revert to surpluses in 2017. The latter remained, however, largely below those registered before the financial crisis and the 2008-2009 crisis in the electronics sector. In 2017, however, the recovery in exports was broad-based, benefiting sectors such as metal production, petroleum, chemicals, machinery and equipment. In parallel, high equity investment returns and low interest payments kept primary income in surplus. Secondary income balance (contributions to EU — 0.19 % of GDP in 2015, overseas development and military aid) remained largely negative (see Graph 1.7). As a result, in 2017 the current account remained in deficit, but was expected to narrow to 0.2 % of GDP. The current account balance is expected to revert to positive values in 2019 and to consolidate in 2019, as the external balance of goods and services turns increasingly positive. Graph 1.6:Export market shares (EMS) of goods and services — Finland Source: European Commission Graph 1.7:Breakdown of external position (current and capital accounts) — Finland (to be updated) Source: European Commission Overall external position The net international investment position (NIIP) was stable and expected to remain close to balance in 2018-2019. After a few years in which the NIIP deteriorated somewhat on the back of depreciating assets held abroad (valuation effects), it improved from -6.1 % of GDP in 2015 to -2.3 % in 2016 as net foreign direct investment strengthened. However, in 2017, with net borrowing expanding and lower net investment, the NIIP was expected to deteriorate again, but to remain very low in an EU comparison (see Graph 1.8). Higher borrowing and lower investment abroad are consistent with the present recovery and the higher investment levels currently registered in the country. Despite the expected improvement in the current account balance, the NIIP is expected to remain in deficit in 2018-2019 at around -5 % of GDP. Graph 1.8:Breakdown of the international investment position (NIIP) in % of GDP — Finland Source: European Commission Financial sector High private-sector debt creates vulnerabilities, but the financial sector remains stable and strong. In 2016, loan flows to households started expanding again. Also, the gross household saving rate is low and active debt reduction is not taking place. Furthermore, the share of new mortgages with variable rates is high. Fiscal and prudential measures are being applied, namely phasing out the tax deductibility of mortgage interest payments, introducing a maximum loan-to-value ratio for new mortgages, and having a minimum risk-weight level of 15 % for the average risk weight on mortgage loans to credit institutions. However, amid persistently low interest rates, a significant decrease in households’ indebtedness is not likely. Banks appear well capitalised and profitable despite the currently low interest rate margins (see Section 3.2). The high reliance of banks on wholesale funding is a structural vulnerability. Housing market After negative growth in 2014-2015, real house prices remained broadly stable in 2016, but housing cycle developments suggest that prices are bottoming out. The nominal and deflated house price indices do not show clear signs of increases yet, and house prices relative to rent levels and relative to income are still on a declining trend. Nevertheless, developments in prices point to an upward trend in recent quarters, despite the sizeable number of dwellings completed and the rising number of building permits granted. This is particularly true for the Helsinki metropolitan area. Public finances The government has consolidated public finances mainly through expenditure cuts, while the improved economic outlook helps to reduce debt. The current government agreed in 2015 on a consolidation plan aiming for expenditure savings of about EUR 4 billion or 2 % of GDP by 2019. The cuts in the taxation of personal income in 2016 and 2017 have mitigated the impact of the expenditure-side measures, but all in all, consolidation has improved the general government balance. Expanding employment and higher economic activity are set to improve public finances further. With the agreed fiscal measures, the general government balance is projected to improve further, to 0.8 % of GDP in 2019. The general government debt-to-GDP ratio peaked in 2015 and is expected to continue to decrease in the short run but to start increasing again in the medium term. The Commission projects the debt ratio to start increasing and reach about 68 % of GDP by 2028. This points to high fiscal sustainability risks over the medium term. The main driver for higher debt is the increase in age-related costs, in particular healthcare and long-term care expenditure. Therefore the reforms to improve productivity in the provision of these services are important. However, the implementation of the planned social and healthcare reform is surrounded by risks that could cause further delays.

Table 1.1:Key economic, financial and social indicators - Finland Source: Eurostat and ECB as of 30 Jan 2018, where available; European Commission for forecast figures (Winter forecast 2018 for real GDP and HICP, Autumn forecast 2017 otherwise) 2. Progress with country-specific recommendations Progress with implementing the Council recommendations addressed to Finland in 2017 ( ) has to be seen as part of a process which started with the introduction of the European Semester process in 2011. Looking at the multi-annual assessment of the implementation of the CSRs since these were adopted, 90 % of all the CSRs addressed to Finland recorded at least 'some progress'. 10 % of these CSRs recorded limited progress, but none of them recorded "no progress" (Graph 2.1). Over the past years, Finland has been addressing the challenges in the area of the long-run sustainability of public finances by adopting a pension reform that came into force in 2017. External sector challenges have abated and cost competitiveness has improved, in particular owing to the measures in the Competitiveness Pact of 2016. Finland has also taken action to increase incentives to accept work and to strengthen active labour market policies. Graph 2.1:Overall multiannual implementation of 2011-2017 CSRs to date Source: European Commission Finland has been given recommendations to improve the long-run sustainability of public finances. In particular, the challenges for Finland have been the sustainability of the pension system and increasing expenditure on long-term healthcare given the aging population. On the one hand, the reform of the earnings related pension system, which linked statutory retirement age to life expectancy, was legislated in late 2015. In accordance with the reform, the lowest statutory retirement age has gradually started to rise as of 2018 from 63 to 65. This should consequently raise the actual retirement age, which was 61.1 in 2016, towards the target of 62.5 years. On the other hand, efforts to improve cost-efficiency of the provision of public healthcare services are still ongoing. The gradual improvement of cost competitiveness has been supported by the implementation of the CSRs since 2014. Progress has been made in aligning wage growth with productivity developments which has resulted in a slower increase of unit labour costs and improved cost competitiveness relative to competitor economies. In 2016 the social partners agreed on measures that would reduce labour costs further in 2017. This so-called Competitiveness Pact increased annual working time without additional compensation, included a wage freeze of 12 months and shifted social security contributions partly towards the employees. In addition, policy action to boost non-cost competitiveness, such as export and investment promotion under Team Finland, has been taken. Reforms in the labour market have been advanced. In order to increase incentives to work, the earnings-related unemployment insurance has been shortened. Also several measures to activate unemployed job seekers, such as increasing the conditionality of the benefits, have been introduced. Measures to increase entrepreneurship were also introduced. Several measures to improve the functioning of the services market have also been implemented. The rules governing retail trade establishment, including local and regional planning and zoning, have been amended. Opening hours of retail outlets were liberalised. Taxi services regulation has been streamlined and modernised, and a regulatory framework for collaborative economy service providers is in place. Table 2.1:Progress with Council's Country Specific Recommendations Source: European Commission To address the Council recommendations 2017, Finland has taken measures in several policy areas. To improve the long-run sustainability of public finances, work to reform the social and healthcare services continued in 2017 as Parliament started to discuss the reform bills. However, formal adoption is expected in 2018. If legislated, the reform moves into the implementation phase and temporary administration of future counties is expected to start working in July 2018. On addressing labour market and social challenges, new measures to activate jobseekers and to introduce incentives to work have been introduced as of 2018: a wider scope of the mobility allowance, financial sanctions for jobseekers who do not demonstrate "being active". Childcare fees were lowered for low and middle income families from 2018. The government has allocated more resources to the public employment service (PES) to support the above-mentioned measures and to facilitate employment in South-West Finland where shipbuilding and car assembly are experiencing labour shortages. The unemployed are now allowed to receive unemployment benefits during the first four months when starting a business. In addition, jobseekers now have the possibility of enhancing their skills during a period of six months without losing unemployment benefits and some changes have been made to the rules of housing allowance. The wage negotiations concluded in autumn 2017 and early 2018 indicate that cost competitiveness is maintained or marginally improved in 2018. Addressing CSR 2 is in line with Recommendation 3 on the labour market for the euro area. Substantial progress has been made in reducing the administrative burden and in improving the regulatory framework. Competition in services is expected to increase on the back of revised rules for retail establishments. The first phase of the regulation of transport services has been adopted with higher regulatory support for the collaborative economy. The government has implemented measures to promote entrepreneurship and start-ups and it has also improved the availability of loans and export guarantees for small and medium-sized enterprises which should also promote investment. The state support systems for innovations and exports are being merged for synergies. In addressing CSR 3, the Finnish authorities are also solving issues highlighted in the 2018 Recommendation 1 on the Single Market for the euro area. ESI Funds are important in addressing key challenges to inclusive growth and convergence in Finland, notably by supporting competitiveness and boosting research and innovation, creating employment and facilitating education and training. ESI Funds also contribute to enhancing labour market access for migrants and other vulnerable groups. Box 2.1: Tangible results delivered through EU support to structural change in Finland Finland is a beneficiary of European Structural and Investment Funds (ESI Funds) support and can receive up to EUR 3.7 billion until 2020. This represents around 5 % of public investment ( I ) annually over the period 2014-2018. By 31 December 2017, an estimated EUR 2.1 billion (57 % of the total) was allocated to projects on the ground. Some 1 900 enterprises have been supported, with over 630 enterprises to introduce new products to the markets; 840 start-ups were supported; enterprises are supported for the creation of 8 900 new jobs; the access for over 11 000 long-term unemployed to labour market has been facilitated or they have been helped to gain a qualification; people at risk of poverty or social exclusion have been provided assistance; over 2 200 agricultural investment projects have received support, over 1.8 million ha farmland was under measures improving water protection, 2.7 million people in the countryside benefit from better infrastructures and services and over 40 broadband projects are being realised. Finland adopted a new financing instrument under ESI Funds: the SME Initiative, which started its operation in 2017. This instrument addresses the gap in SME finance opportunities and it has already provided over 240 guarantees for SME loans. ESI Funds help address structural policy challenges and implement country-specific recommendations. The ESI Funds support competitiveness and boost research and innovation. They create employment and facilitate education and training. ESI Funds contribute to making use of the full potential of the workforce by enhancing labour market access for the unemployed and inactive as well as migrants and other vulnerable groups. Operations funded by ESI funds promote social inclusion and bring people furthest from the labour market back to activity and employment. The implementation of the youth guarantee is partly funded by the ESI Funds through one-stop guidance centres. In the area of research and innovation ESIF support has helped 900 enterprises to launch R&D&I activities with research institutes in their areas of excellence. Reforms were undertaken already as precondition for ESI Funds support ( II ). Smart Specialisation Strategies for research and innovation were developed to focus efforts on specialisation with strong market potential. This has also helped improve cooperation between enterprises and public research institutions and encouraged regions to participate in European smart specialisation platforms. Finland is advancing the take up of the European Fund for Strategic Investments (EFSI). As of December 2017, the overall financing volume of operations approved under the EFSI amounted to EUR 1.4 billion, which is expected to trigger total private and public investment of EUR 5.6 billion. More specifically, 26 projects involving Finland have been approved so far under the Infrastructure and Innovation Window (including 13 multi-country projects), amounting to EUR 1.3 billion in EIB financing under the EFSI. This is expected to trigger about EUR 5.2 billion in investments. Under the SME Window, two agreements with financial intermediaries have been approved so far. European Investment Fund financing enabled by the EFSI amounts to EUR 35 million, which is expected to mobilise approximatively EUR 369 million in total investment. Energy ranks first in terms of operations and volume approved, followed by RDI. 3. Reform priorities 3.1. Public finances and taxation 3.1.1.Sustainability of public finances Sustainability risks have diminished as the economic outlook has improved. In the short run, there are no fiscal or competitiveness-financial risks to the sustainability of public finances. In the long run, the risks are assessed as ‘medium’ as the S2 indicator ( ) is estimated at 2.8 %. The estimate has improved by 0.4 percentage points from a year earlier, owing to an improved initial budgetary position and a more favourable estimated contribution from pension expenditure. The medium-term risk assessment has improved too. The objective of the assessment scenario is to reach a 60 % of GDP debt ratio by 2032 (taking into account the increasing costs of ageing) by adjusting the general government primary balance over 5 post-forecast years, i.e. 2020-2024. As the short-run economic outlook has improved, the estimated additional cumulative adjustment has also declined from 2.8 % to 1.5 %. However, due to the increase in the government debt ratio in the baseline projections, the overall fiscal risk in the medium-run is still assessed as ‘high’. The costs of ageing will continue to weigh on public finances in the medium term and the long run. On the basis of the Commission 2017 autumn forecast and commonly agreed assumptions on debt sustainability analysis ( ), the debt ratio is first projected to decline to about 61 % of GDP (around 2021) and then to rise to about 68 % of GDP by 2028. If the costs of ageing (pensions, long-term care and health expenditure) were left out of the debt projections, the debt ratio would gradually decline to about 57 % of GDP by 2028 (Graph 3.1.1). Under the 2017 pension reform, the lowest old-age retirement age will gradually rise from 63 years in 2017 to 65 years in 2027. Over the same period, the upper age limit until which people can continue working will rise from 68 to 70. These changes are expected to reduce the large impact of the strongly ageing population by 2030. However, according to the Economic Policy Committee's Ageing Working Group (EPC-AWG) projections, pension and other age-related costs expenditure are expected to increase steadily through to the end of the 2020s. Graph 3.1.1:Debt projections according to social and healthcare reform proposals and Debt Sustainability Analysis (DSA) Source: European Commission

Social and healthcare services reform and administrative reform Finnish healthcare and social care systems perform relatively well. The health status of the population ranks in the highest third among EU countries if measured as life expectancy. Moreover, 70 % of the population report being in good health, a slightly higher percentage than the EU average (of 67 %). As for expenditure, at 9.4 % of GDP in 2015, Finland is just below the EU average of 9.9 % of GDP while per capita expenditure is slightly above the EU average. Weaknesses stemming from decentralised primary healthcare service provision and uneven access to services are visible. The healthcare system has three parallel providers: occupational, private and public healthcare. Finland's 300+ municipalities fund and organise the provision of primary healthcare, and form 20 hospital districts to fund and provide (secondary) hospital care. The most demanding treatment is provided by five university hospitals. The occupational healthcare and private services exist alongside the public services. However, the system appears not to treat residents equally. First, people who are not employed have no access to the occupational healthcare system which offers quick access to primary healthcare services in private hospitals. Secondly, private clinics might require high out-of-pocket payments or private insurance, excluding lower income households. Therefore for some patients, such as most of the retirees, the public primary healthcare is the only option. Due to long waiting times ( ), Finns, especially low-income patients, report more unmet needs of healthcare services than in the rest of the EU (see Box 3.3.1). The parliament is expected to adopt this spring a legislative reform package for the social and healthcare services with a reform of local and regional administration. Under the reform, a new level of regional public administration, to be called counties, will be set up. The plan is that these will take care of the social and healthcare services from 2020. Responsibility for the organisation of these services, public healthcare facilities and staff would be moved to the counties. The amount municipal taxes and central government transfers to municipalities would be reduced accordingly given their reduced responsibilities. Instead, the central government would collect more taxes and finance the counties via a ‘county transfer system’. In parallel, emergency services and specialised medical care are undergoing structural reform. Under this reform, the division of tasks between the hospitals at secondary and tertiary healthcare levels will be reviewed. At the secondary level, the reform will reduce the number of hospitals offering the most demanding emergency healthcare services, from 19 to 12. At the tertiary level, university hospital profiles are reviewed and some fields of medicine centralised. The main aim of the reforms is to improve the sustainability of public finances through more cost-effective service provision. The reform pools resources that can be used more effectively at county level in future. The integration of primary and specialised healthcare as well as healthcare and social care should be more effective in the hands of a larger organiser. In addition, increased use of digital and electronic services should also increase productivity and improve cost efficiency. From 2021, social care and primary healthcare services would be available from a county or private social and health centre. This would give patients increased freedom of choice between the service providers operating in their region. The competition between service providers is expected to yield savings for the tax-payers. Most of the measures are expected to increase productivity in healthcare services possibly reducing waiting times. However, making sure that this objective is reached will require careful monitoring in the implementation phase of the reform. The possible efficiency gains from improved integration of primary and higher level healthcare services and integration of service chains that involve both social and healthcare services could be compromised if the increased freedom to choose is not implemented carefully. This is particularly the case for the incentives to provide services also in remote areas, and also to avoid that some service providers ‘cherry-pick’ patients with better health status. An effectively implemented budget framework for the counties should slow down the increase in public debt. On a projected baseline, healthcare expenditure is projected to grow by 2.4 % in real terms per year but the reform would reduce the growth rate to 0.9 %. The target for reducing expenditure growth is ambitious given Finland’s past performance. Sustaining such a real growth rate for a longer period would also be an achievement (compared with the rest of the EU), but not necessarily exceptional. If taken at face value, the planned savings would result in a 3 pps lower debt-to-GDP ratio by 2028 compared to the Debt Sustainability Monitor baseline scenario (see graph 3.1.1) (European Commission 2018b). Therefore, if the reform is implemented successfully, it also has the potential to improve fiscal sustainability in the medium run. However, there is a risk that the actual savings will fall short of expectations as they seem to have been derived using a top-down approach rather than from specific efficiency-increasing actions. In addition, some municipalities in more remote areas of the country have recently become afraid of services moving to a handful of central cities in the future counties. To prevent this, they have started to outsource their healthcare services to private hospitals under multiannual service contracts. These agreements could complicate the implementation of the reform. 3.1.2.Quality of public finances and taxation Increased social protection expenditure has driven public expenditure in Finland to one of the highest levels in the EU and has crowded out other spending. Total government expenditure was 56.9 % of GDP in 2015, nearly 8 pps higher than 10 years earlier. About 6 pps of this increase is driven by higher social protection spending, including on old-age pensions ( ) as the number of old-age pensioners increased by one-third from 2005 to 2015. Adequate pension insurance guarantees a decent quality of life after retirement and brings stability to households’ disposable income and consumption, both of which have increased constantly since 2005. The relative shares of other government consumption categories have remained broadly stable. In 2016, the tax-burden was 44.3 % of GDP, up by 1.8 pps of GDP from 2005. Since 2009, the general government has recorded primary deficits. Consequently, Finland's gross debt-to-GDP ratio increased from 40 % in 2005 to 63.6 % in 2015. Finland spends 50 % more than the average EU country on state aid. According to the Commission State Aid Monitor, Finland allocated about 1 % of GDP to State aid whereas the average EU Member State used 0.7 % of GDP in 2015. In a recent study by the Ministry of Economic Affairs and Employment (Rothovius 2017) the annual expenditure on business subsidies was estimated at EUR 4 billion (about 2 % of GDP). Of this expenditure about EUR 2.9 billion is granted through the tax system in the form of tax deductions, exemptions and reduced rates on specific industrial activities and fuels. Subsidies solely aimed at supporting the cost competitiveness of non-innovative, established, business structures and activities are particularly inefficient in supporting long term productivity growth. In addition, they do not contribute to economic renewal and tend to distort resource allocation (investment, finance and labour) (Maliranta et al., 2016, Rauhanen et al., 2015). Graph 3.1.2:General government consumption, as a share of GDP and as broken down by function, 2005, 2010, 2015, Finland and the EU Source: European Commission Finland remains a relatively high-taxation country. In 2016, the total tax burden amounted to 44.3 % of GDP. The gradual easing of personal income taxation while increasing indirect taxation has contributed to a tax shift from labour towards other tax bases. This has improved the growth-friendliness of the tax structure. Nonetheless, the level of personal income taxation (13.3 % of GDP) remains among the highest in the EU. The high personal income taxation is accompanied by social contributions, accounting for almost 13 % of GDP in 2015 (mainly paid by the employers). These were recently driven up by increases in pension contributions. When the Finnish government presented its latest pension reform, which came into force in 2017, it was indicated that there would be no need to increase the contribution rates further to safeguard the sustainability of the earnings-related pension system. According to the latest projections endorsed by the EPC-AWG, contributions to pension insurance are forecast to increase in the future to guarantee the financing of the pension system. These would push the tax burden higher. Graph 3.1.3:Tax revenues from environmental taxes, 2010 and 2015 Source: European Commission Finland faces the challenge of supporting investment that meets the long-term needs of the economy. While investment levels in Finland remain slightly above the EU average, they have been declining during the past few years. The share of private investment is lower than elsewhere in the EU, on average (European Commission, 2017a). The design of the tax system can help to stimulate productive investment. However, an expert group set up by the Ministry of Finance to review the level and structure of corporate taxation, concluded in early 2017, that in international comparison the corporate tax system was competitive as it is. Substantial reform has therefore not been planned. The group proposed certain changes to the taxation of dividends (from unlisted companies) and earned income. These changes aim to increase the efficacy and neutrality of taxation, thus boosting productivity and economic growth (Järvikare et al. 2017). While recurrent property taxation is low, environmental taxation in Finland is high compared to other EU countries and continues to increase. In 2015, at 0.8 % of GDP, revenues from recurrent immovable property taxation, one of the least distortive taxes to economic growth, were considerably below the EU average of 1.7 % of GDP. By contrast, at 2.9 % of GDP, the revenue from environmental taxation was above the EU average of 2.4 % (see graph 3.1.3). The share of environmental taxes in tax revenues has also gradually increased, while the composition has changed: taxes on CO2 from heating, power plants and machinery gradually increased as well as the waste tax. Fiscal framework Finland is the only euro area country where the macroeconomic forecasts underpinning the budgetary planning are prepared by the Ministry of Finance. The management of the Economics Department of the Ministry is separated from the Budget Department and according to the law adopted in spring 2015, the Economics Department is independent in its forecasting activities. However, in the 2017 stability programme the macroeconomic projections for 2018-2020 were based on the ‘development according to the targets of the government programme’. Thus, it appeared that instead of proposing concrete measures enabling the government to achieve its fiscal targets, the macroeconomic scenario underlying the stability programme was calibrated so that the government's fiscal targets were met. This raised questions about the realistic and unbiased nature of the macroeconomic scenario, and thus the compliance of the latter with the Two-Pack Regulation ( ) to prepare medium-term fiscal plans on the basis of independent macroeconomic forecasts. 3.2. Financial sector 3.2.1.BANKING SECTOR The financial soundness indicators show that the banking sector is overall in good condition. Finnish lenders remain remarkably well capitalised and have high loss absorption capacity. At end-2016, the average Tier 1 capital ratio ( ) was 23.1 %, one of the highest in the EU (Table 3.2.1) and Tier-1 instruments accounted for the majority of capital. Also, the largest banks achieved good results in the 2016 European Banking Authority stress test, with resilient capital levels in both baseline and stress scenarios. Furthermore, the ratio of non-performing loans to gross loans remained low ( ). The sector also performs generally well in terms of profitability, albeit with some variation among banks ( ), with return on equity hovering around 9 %. In the current low interest rate environment, net interest income fell about 4 %, while the operating costs of the sector, particularly IT investments, increased. Nonetheless, the system’s cost-to-income ratio remained fairly stable and well below the EU average ( ). The banking sector is large (10 banks in total), but rather concentrated, with the three largest banks controlling a combined 72.2 % of lending and 77.7 % of deposits.

Table 3.2.1:Financial soundness indicators, all banks in Finland Source: ECB CBD The high reliance on wholesale funding has recently been targeted by the Finnish Financial Supervisory Authority, but refinancing risks persist. The share of private-sector deposits in the domestic banking system remains low ( ). Instead, Finnish banks rely heavily on borrowing from merchant banks, so-called wholesale funding, albeit extensively in the form of covered bonds with average maturities above one year. As a result, the banking system’s loan-to-deposit ratio is rather high, at close to 140 % (2016). However, given the low interest rate environment and Finnish households’ low saving rate, there is limited room to expand the deposits base. Therefore, banks maintain large portfolios of liquid assets available for sale to generate emergency cash. Also, as wholesale funding remains a volatile funding source, the Finnish Financial Supervisory Authority has recently recommended that banks extend funding maturities, reduce short-term funding and prepare adequate contingency plans. Nevertheless, many lenders remain exposed to the risk of a freeze in unsecured wholesale funding. This could still generate funding gaps in the event of major market stress. Graph 3.2.1:Lending to the private sector — Change in stock of loans (y-o-y) Source: European Central Bank Strong interconnections with other Nordic and Baltic countries create a risk of spillover effects through the financial system (see European Commission, 2018a). Sweden faces sources of imbalances in the form of high private debt and overvalued house prices. The elevated private indebtedness, in particular of households, makes the economy vulnerable to macroeconomic shocks. In the event of a large, disorderly downturn in the housing market, there is a risk of negative spillover effects to other Nordic countries through the financial system, including Finland. In September 2017, the board of Nordea took the decision to move its headquarters from Sweden to Finland by end-2018. The decision still needs to be confirmed by the bank's shareholders. While Nordea's operations in Finland are not expected to markedly change in terms of size and interconnectedness, the move will have implications for the supervisory and the resolution framework. It puts Nordea, the Nordic region’s only globally systemically important bank, under the supervision of the European Central Bank (ECB) and the Single Supervisory Mechanism (SSM) and on a level playing field with its peers ( ). For Finland, given the size of the bank, hosting Nordea’s headquarters creates both opportunities and risks. Following the move, the total assets of Finland’s banking sector are expected to reach about 420 % of GDP, and by assets Nordea will be the biggest company operating out of Finland. If the move of Nordea's headquarters to Finland materialises, a buffer requirement for global systematically-important institutions (G-SII) will automatically come into play. Also, a systemic risk buffer has been added to the Finnish regulator's toolbox. 3.2.2.ACCESS TO FINANCE Credit has continued to expand modestly in Finland. Lending to the economy is on a stable upward trend, along with GDP. By September 2017 lending to firms (loans stock — moving annual average) was growing by 5.4 % year-on-year, while the mortgage loans segment kept increasing by 2.0 % year-on-year (Graph 3.2.1). Changes in loan flows to households were even stronger (6.9 % in September 2017 — moving annual average), suggesting an acceleration. These developments reflect the low interest rates and improving consumer confidence, in particular consumers’ increasingly favourable view of their personal finances. Banks play a key role in financing the economy. In general, businesses and retail clients can afford bank lending, since the banking system rapidly passes the record low interest rates on to the real economy. Large firms are able to obtain financing through equity and debt issuers, whereas bank lending is the main source of funding for small and medium-sized businesses. Access of SMEs to finance has remained easy compared with most other EU countries. In 2016, SMEs in Finland did not face restricted access to bank financing and obstacles to financing appeared limited. Banks appeared more willing to lend, particularly thanks to the improving general economic outlook. That said, the cost of borrowing was rising and the presence of collateral most often required. On the face of it, bank financing appeared less attractive for SMEs than other forms of financing such as crowdfunding, peer-to-peer lending or business angels funding (ECB, 2017), but more easily accessible. In 2015, the total amount of annual venture capital investments in Finnish companies was stable at 0.05 % of GDP and remained the second highest in the EU after Luxembourg (0.08 % of GDP). 3.2.3.HOUSING MARKET Real house prices have bottomed out. Real house prices recovered slightly in the first half of 2017 (+0.8 %), after negative growth in 2015-2016 and a somewhat more rapid decline in 2013-2014. Also, the valuation gap appears to have closed (see Graph 3.2.2), even though prices in the Helsinki region continue to increase. There are no signs of a price overvaluation overall at national level. Graph 3.2.2:Overvaluation gap for price/income, price/rent and fundamental model valuation gaps — Finland Source: European Commission calculations The Finnish housing market has very large regional disparities. In the greater Helsinki area, the average price per square metre in 2017 was twice the level registered elsewhere. Most new jobs are created in the greater Helsinki area. The move from the countryside to urban areas is continuing. Housing demand is therefore large in the greater Helsinki area and housing supply in Finland does not always keep up with increasing demand (Marrez et al., 2013). As a result, house prices are increasing faster than income there. In many other areas, prices have actually dropped relative to income and market rents, as the population migrates to urban centres and declines (Nordea, 2017). This appears to be an impediment to labour mobility, especially for lower-skilled workers and families with limited revenues. Graph 3.2.3:Share of dwelling construction in GDP — Annual change in % Source: European Commission Since 2015, dwelling construction has been on the rise. In the three Nordic countries (Denmark, Finland and Sweden), dwelling construction has a strong cyclical character. It is closely linked to interest rates and so evolves in line with the ECB’s monetary policy decisions and the EU business cycle ( ). Along the cycle, the share of dwelling construction in GDP oscillates between 5 % and 6.7 % in Finland ( ). In 2017, construction growth seemed to be levelling off, with the share of dwelling construction in the country’s GDP nearing its peak (see Graph 3.2.3). However, more residential building permits (in m² of useful floor area) were still granted in the first three quarters of 2017, suggesting that a larger supply of new dwellings can be expected in 2018. At the same time, policies that push households’ preferences towards house purchases, most notably tax incentives on mortgages, are being phased out (see Section 3.2.1). In parallel, from 2018 the ECB’s monetary policy is expected to become progressively less accommodative with a negative impact expected on household investment and thereby on dwelling construction in Finland and elsewhere. 3.2.4.Private-sector debt The overall private debt burden is unwinding, but household debt may slowly be building up. In 2016, the private consolidated debt stock in Finland declined by 3.6 pps. At 149.3 % of GDP, it remained significantly above the macroeconomic imbalance procedure (MIP) indicative threshold of 133 %. On the other hand, credit growth to the private sector slowed to 2.2 % of GDP, far below the MIP threshold of 14 %. Nevertheless, the slowly rising household debt deserved closer monitoring (see section 3.2.6). 3.2.5.Non-financial corporations’ (NFC) debt and financing Risks related to the NFCs debt appear limited and decreasing. At 82.1 % of GDP in 2016, the consolidated debt of the NFCs remained quite high, but stable and even slowly contracting. As for the new benchmarks developed by the LIME working group ( ) (European Commission, 2017b, Philiponnet et al. 2017), the non-financial corporations’ debt was slightly above its prudential threshold (75 % of GDP), but largely below its fundamentals-based benchmarks (99.4 % of GDP) ( ). Moreover, in recent years, the positive gap to the prudential threshold has been rapidly decreasing, while the negative gap to the fundamentals-based benchmark has been widening (see Graph 3.2.4). Graph 3.2.4:Gaps to prudential thresholds and fundamental benchmarks for non-financial corporations and households Source: European Commission

3.2.6.Household debt At 67.1 % of GDP in 2016, the debt level of Finnish households was high and moderately on the rise ( ) (see Graph 3.2.5). In terms of debt-to-gross disposable income ratio, in Q1-2017 (three-year average) Finland ranked eighth in the EU-28 ( ). However, households’ assets, both financial and non-financial (mainly real estate assets), were also sizeable, at 138 % of GDP and 205 % of GDP respectively. Household debt stock increased only moderately (2.5 %) in 2017. The household savings rate is low, and there is no active process of debt reduction. Consumption has risen faster than disposable income in recent years, supported by higher consumer confidence and low interest rates. As a result, consumer credit is growing rapidly, and a large share of mortgage loans is held by highly indebted borrowers. That said, in 2016 the non-performing loan ratio remained one of the lowest in the EU, even though slightly on the rise. The gross household saving rate is low at about 6 % only, half the level prevailing in the euro area. Graph 3.2.5:Leverage of households (households’ debt stock to GDP ratio) (1) Source: European Commission Households seem to be moving slowly away from their debt fundamentals-related benchmark. According to the benchmarks for assessing private debt, Finland’s household debt appears slightly above both its prudential threshold (59.1 % of GDP in 2016) and its fundamentals-based benchmarks (63.1 % of GDP in 2016). In 2016, the positive gap to the prudential threshold was rapidly contracting, but the positive gap to the fundamentals-based benchmark appeared to be widening (see Graph 3.2.4). Also, the rather high medium-term and long-term debt sustainability indicators (respectively S1 and S2) ( ) highlight that the excessive households' indebtedness derives from a low savings rate (S1) and could be aggravated in the long-term due to demographic changes and other long-term factors (S2). Variable-rate mortgage lending to households is the dominant category of credit in Finland. Mortgage lending accounted for 75.3 % of the total household credit. The share of new mortgage lending with variable rates was very high (97%). In June 2017 the average interest rate on housing loans was low at 1.54 %, with an average rate of 1.07 % for new housing loans. However, interest rates can be expected to rise in the medium term. A risk for households and for banks therefore exists, especially as, recently, only 27% of new mortgage loan contracts with variable rates are loans with fixed instalments, while, for the others, monthly payments would increase. Several measures have been introduced to contain risks related to the high and rising household indebtedness. In November 2016, the European Systemic Risk Board published a set of warnings on medium-term vulnerabilities in the residential real estate sector for eight Member States, including Finland. The key vulnerabilities in the country include the uneven distribution of mortgage-related risks among households, the high loan-to-value ratios and the low risk weight of mortgages in bank balance sheets ( ). The Finnish government is phasing out the tax deductibility of mortgage interest payments, with the deductibility limited to 35 % of the interest rate payments in 2018 and to 25 % in 2019. Also, since July 2016 a law imposes that banks apply a maximum loan-to-value ratio for new mortgages (90%, 95% for first home buyers). In addition, from January 2018 an institution-specific minimum level of 15 % shall be applied for the average risk weight on mortgage loans to credit institutions that have adopted what is called the internal ratings-based approach. However, amid persistently low interest rates, a significant decrease in households' indebtedness in the coming years is not likely. Consumer lending practices are a source of concern. A rising share of this lending is granted by banks or companies that are not registered as banks in Finland (banks registered abroad, non-financial companies e.g. those selling consumer goods and peer-to-peer lending, and crowdfunding). In this respect, the lack of a comprehensive credit registry collecting both positive and negative information on debtors could prevent banks from having a clear overview of households’ actual indebtedness (IMF, 2017a). 3.3. Labour market, education and social policies 3.3.1.labour market Labour market The labour market situation has been improving since 2016. The number of people in employment grew by 0.5 % in both 2016 and 2017 and is expected to continue to rise in 2018 and 2019 (Graph 3.3.1). Increasingly confident about economic expansion, more inactive people have started looking for work and move back to labour force. This explains the slow decrease in the headline unemployment rate, from 8.8 % in 2016 to 8.7 % in 2017. The employment rate has gradually increased from 68.5 % in 2015 to close to 70 % in 2017, still below Nordic peers, and mainly driven by older workers ( ). In 2016, the youth unemployment rate contracted markedly by 2.3 pps to 20.1 %, approaching the EU average of 18.8 %. The rates of 15-24 year olds not in employment, education or training started to improve as well, at 9.9 % after 10.6 % in 2015. Graph 3.3.1:Labour market indicators Source: European Commission Labour market trends and matching The moderate rate of job creation since 2016 is characterised by increasing regional and sectoral differences. Recently the biggest increases in the share of employment year-on-year are observed in manufacturing and non-tradable service sectors, including business services and construction (Graph 3.3.2) while tradable services have lost some jobs. Among the growing regions, South-West Finland especially is currently doing particularly well thanks to its shipbuilding and car assembly industries. To alleviate specific skill shortages in South-West Finland, a new cooperative university education venture for the manufacturing sector called FITech is being established, which will provide tailored support for industrial growth in the region. In addition, there is a need to ensure sufficient housing and transport links in that part of the country (Aho, 2017) (see also Section 3.2.3). Graph 3.3.2:Evolution of employment by sector Source: European Commission While the job vacancy rate continues to increase, recent survey data point to labour shortages especially in construction and services. Companies are increasingly looking for new workers as indicated by an increasing number of vacancies registered at the public employment service (Graph 3.3.3). In 2017 the job vacancy rate continued to increase to 1.8 %, just slightly below the EU average of 2 %. The competition for jobs should have eased, as recently there were about 7 unemployed job seekers per open vacancy, down from about 10 job seekers 2 years ago. Box 3.3.1: Monitoring performance in light of the European Pillar of Social Rights The European Pillar of Social Rights, proclaimed on 17 November 2017 by the European Parliament, the Council and the European Commission, sets out 20 key principles and rights to benefit citizens in the EU. In light of the legacy of the crisis and changes in our societies driven by population ageing, technological change and new ways of working, the Pillar serves as a compass for a renewed process of convergence towards better working and living conditions. Finland performs relatively well on the indicators of the Social Scoreboard ( III ) supporting the European Pillar of Social Rights. 76 % of the population have basic or above basic digital skills, Social transfers effectively address poverty. Self-reported unmet needs for medical care suggest challenges. Access to services in the healthcare system is currently uneven and the proportion of people reporting unmet medical care needs due to the waiting time is relatively high, 4 %. The current organisation of the healthcare system results in a strong contrast between occupational healthcare with fast access and public healthcare with long queues. At the same time the need for social and health services is growing as the population is aging. The upcoming social and health care reform (see section 3.1.3) aims to address some of the reasons for uneven access to healthcare. Finland has a generally well performing education system. The quality of education is shown by particularly good educational outcomes, even if they have seen some decline in in science and mathematics (OECD 2016b). There is a high degree of equity as the influence of socioeconomic background on educational outcomes is relatively weaker. The system benefits from well-educated and motivated teachers as well as a high level cooperation among all the relevant stakeholders. However, in 2017, approximately one construction or service sector company in four said that labour shortage limited their production. In manufacturing also labour shortages are on an increasing trend, although the level is still relatively low. In addition, since late 2016 the reduction of unemployment has almost come to a standstill while more jobs are vacant (Graph 3.3.4), implying that vacancies are more difficult to fill than before. According to the Beveridge curve, matching problems increased until 2015. Matching has remained broadly unchanged since then. To some extent this could also either reflect the fact that typically previously inactive workers started looking for work after the recession, resulting in a gradually decreasing unemployment rate. Another possible explanation is that the structure of the economy has changed meaning that some workers’ skills would need updating to improve employment prospects. Graph 3.3.3:Labour shortages Source: Calculations based on Eurostat data and European Commission data of business surveys for Business Climate Indicators

Graph 3.3.4:Beveridge curve Source: European Commission Wage developments and collective bargaining Wage negotiations are ongoing for the year 2018 and beyond, and the first results are promising. The sectoral collective agreements in the largest exporting sectors (technology, forest industries, chemical) concluded so far point to continued moderate wage increases in 2018-2019 (see section 3.4). The wage level agreed so far could ensure that the competitiveness gains made in the context of the Competitiveness Pact are not lost, while securing a potential increase in the purchasing power of households. It remains to be seen whether the sectors that will negotiate in early 2018 will limit their wage increases to the anchor set by the exporting sectors. Under sectoral agreements concluded in late 2017 and early 2018, certain industries were given the opportunity to carry out local bargaining for collectively agreed wage increases. Under the main exporting sector agreements, a part of the agreed total wage increase takes the form of a general increase to all workers of the sector, while part of the increase can be agreed locally at the firm-level ( ). The exact share of the part subject to local bargaining varies by industry ( ). In some sectors, this local allocation of part of the wage increases has been in place for some time (Tulo- ja kustannuskehityksen selvitystoimikunta, 2014). To some extent, the possibilities for local bargaining were opened up in the context of the Competitiveness Pact in 2016 (European Commission, 2017c). Companies that are not members of employer organisations cannot use some of the available local bargaining possibilities. These employers (mostly SMEs) are bound by the sectoral collective agreements. Currently, some 75 % of all employees work for organised employers, and some 89 % are covered by these collective agreements (Ahtiainen, 2016). Non–organized employers are currently prohibited from using certain possibilities (e.g. on working time) for local bargaining included in the collective agreements. This may make it harder for such firms to ensure that real labour cost increases are aligned with their productivity growth. In general, capacity building of employees and employers, especially in non-organized companies, appears as a prerequisite for successful local bargaining. Labour supply The shrinking of the labour force and the decline in activity in prime working age population (30-44) presents challenges to the Finnish labour market policies. The working age population (15-64) has been shrinking since 2010. This phenomenon, coupled with inactivity rates among the prime working age population (30-44) which have increased faster than in the rest of the EU, could challenge the sustainability of the Finnish welfare state. While activity rates have been improving for the general population 20-64, they have been deteriorating for specific age groups. The phenomenon is not limited to Finland, as the activity rate among prime age workers of category 30-44 across the EU has gone down from 94.1 % to 93.3 % between 2008 and 2016. However, the fall was sharper in Finland (from 93.6 % to 90.8 %) and continued in 2017 (90.3 %), resulting in the fourth lowest activity rate in the EU in this age group. While the activity rate for the higher skilled appears constant across time, it declines markedly for the low and medium skilled ( ).The economic dependency ratio is thus at risk to increase in the medium and long term. The reasons for the increase in the inactivity rate of the prime working age group are multiple (see Table 3.3.1). The main drivers seem to be education and training, especially for the medium skilled. Disability and illness are also reasons for inactivity. Moreover, the share of discouraged workers has increased from 2008 to 2016. Women have moved from employment into inactivity even more than men, due mainly to family duties and caring responsibilities. However, education and training as a reason for inactivity increased over the same period ( ). Overall, women in Finland are more likely to be present on the labour market than in other EU countries ( ), as they tend to return to work after the inactivity period related to family duties. However, the recent trend has been for women’s participation in the workforce to decrease more. This explains the increased gender employment rate gap (see Box 3.3.1). Table 3.3.1:Inactivity rates in Finland and the EU in 2008 and 2016 — Stock in percentage of total 25-49 age population Source: European Commission Labour market outcomes of the non-EU born people are worse than for natives. In 2016, the employment rate gap was one of the highest in the EU (at 20.9 pps) and particularly high for women (27.6 pps), mainly due to the low activity rate among non-EU born women. There is also an above average difference in school performance of natives and non-EU born, which affects second generation pupils as well. This translates into a high at-risk-of-poverty or social exclusion gap ( ). Incentives to accept work and activation measures While some inactivity traps remain, Finland took considerable action in 2016 and 2017 to encourage jobseekers to accept work. Reforms of unemployment benefits were implemented as from 2017, shortening the duration of earnings-related unemployment benefits and tightening the conditions for granting unemployment benefits. Currently, as for unemployment benefits, Finland is above EU average regarding the coverage, adequacy and length (European Commission, 2018c). From the beginning of 2018, a revised benefit scheme with financial sanctions for those jobseekers who do not demonstrate "being active" for 18 hours in a 3-month period (i.e. working or being self-employed) or for five days in employment services entered into force. The scope of the mobility allowance is also widened to better cover part-time work There are plans to enable jobseekers to enhance their skills related to entrepreneurship or areas with high labour demand during six months without losing unemployment benefits. However, there has been less progress to address the bureaucratic traps, which cause uncertainty regarding both the level of benefits and the duration of waiting times before the reinstating of benefits. A real-time income register, which may address some of the bureaucratic traps, is expected be in place in 2019. The activation measures could have a positive impact if coupled with good and sufficient activation services. The measures introduced so far include interviews with all unemployed as of 2017. The impact of the interviews has been deemed to be positive, but may be limited to updating the statistics as many unemployed registered as jobseekers have been found no longer to be looking for work. Furthermore, not all jobseekers have yet been interviewed at all, and the target of interviews every 3 months is not reached. This measure may also be diverting public employment services resources away from catering the services to those who need them most. The public employment services offices do not currently appear to have sufficient staff to provide adequate activation services to all unemployed. The requirement to "demonstrate being active" aims at active job search during the whole period of unemployment insurance but could direct jobseekers to accept even very short-term work or training courses. Increases of some EUR 10 million in the budget for active labour market policies are planned to accommodate these requirements, but it is unclear whether this is sufficient to ensure activation measures to all those who need them. This could reduce the income of the most vulnerable jobseekers in regions where no work or active labour market measures are available. In view of the increasing employment, integrated services for the inactive and unemployed are important. Many of the currently existing integrated services are aimed at certain groups only, such as young people or the long-term unemployed. The services could be combined with measures improving the employability of the unemployed, paying special attention to vulnerable groups (e.g. rehabilitation). The range of services is appropriate but the services are dispersed among a number of separate providers and the coordination is not good enough to produce a seamless services chain. Therefore, the vulnerable claimants are falling between different measures. Services for certain groups (young, long-term unemployed) appear to be adequate. Some recent policy decisions may have negative effects on women's earnings. The gender pay gap in Finland is higher than the EU average: 17.3 % in 2015, while the EU average is 16.3 %. Long family leaves, mainly taken by women, together with a gender segregated labour market, contribute to this. A reform of the parental leave system was explored to increase the employment rate of women and to promote gender equality (European Commission, 2017) but no reform is expected to take place during this parliamentary term. The Competitiveness Pact, which entered into force in 2017, contains measures such as the 30 % reduction in holiday bonuses only for the female-dominated public sector. This is likely to increase the pay gap further. The migrant population could contribute to a more balanced economic dependency ratio in the long run, provided that migrants are well integrated into the labour market. As the number of asylum seekers has fallen since the peak in 2015, the key challenge now is to ensure the long-term integration of not only the refugees, but of all migrants in the Finnish labour market and society. Previously, integration policies have been focused on language trainings, with little emphasis on early labour market integration. Finland has made some efforts to take a more comprehensive approach to integration, through faster and more flexible study paths and recognition of existing qualifications. Nevertheless, in practice, it often takes years from arrival to move into the labour market. The Social Impact Bond model and the Skills Centre of the City of Helsinki are good pilot examples of a more comprehensive approach to integrating migrants. Integrated services that make it possible to follow appropriate education and training paths while also developing language skills alongside other studies could be helpful. The government is also trying to attract more highly skilled migrants and better utilise the skills of those already in the country through the Talent Boost programme. Self-employment and social protection There are some weaknesses in the social protection of entrepreneurs and self-employed and entrepreneurship is generally not considered an attractive career choice. In Finland self-employment rates and the number of self-employed people were significantly above pre-crisis levels in 2016, although recent trends are pointing downwards (OECD, 2017a). Necessity-driven entrepreneurship is relatively low in Finland (15 % of all entrepreneurs), as is transition from unemployment to self-employment (European Commission, 2015). However entrepreneurship is considered a good career choice only by 40 % of people in Finland, one of the lowest ratings in the 65 countries surveyed (Global Entrepreneurship Monitor, 2016). The relative risk of poverty for the self-employed in Finland is seven times higher than that of employees. This is the second highest poverty risk gap in the EU (Eurostat, 2015). In some cases, the self-employed are inadequately insured to cover old-age, sickness, work accidents, pregnancy and unemployment (Suomen Yrittäjät, 2016).

The Finnish government has introduced new inclusive entrepreneurship measures to encourage the unemployed to start businesses. As of 2018 it will be possible for the unemployed to receive their unemployment benefit in the first 4 months after starting a business. This scheme is most likely to be successful if combined with training and coaching (EEPO, 2014), but the short duration can limit its impact. Furthermore, a recent working group has been evaluating possibilities of combined unemployment benefits for those combining part-time work with part-time entrepreneurship, enabling them to ensure that both their wages and income from self-employment contribute to their unemployment benefits. There are also plans to prepare a new bankruptcy law, to enable a new start for bankrupt entrepreneurs. 3.3.2.Social policies Income equality In general, social safety nets in Finland contribute to reducing poverty and to guaranteeing adequate social protection for all. Finland has a strong legislative basis under the Constitution. Those who cannot obtain the means necessary for a life of dignity have the right to receive indispensable subsistence and care. The Finnish income transfer system consists of three different parts: income-related social insurance, flat-rate basic security benefits administered by the Social Insurance Institution and additional and preventive assistance benefits delivered by municipalities To qualify for social assistance, the claimant is required to apply for all other social benefits. The risk of poverty has continued its declining trend since its peak in 2011. The risk of poverty and social exclusion is one of the lowest in the EU and Finland has one of the lowest income inequalities (measured by the income quintile ratio). However, the national Europe 2020 target, of no more than 770 000 people at risk of poverty or social exclusion, seems unlikely to be reached. In 2016, the corresponding number in Finland was 896 000, a decrease of 14 000 since 2008. Recent policy decisions to freeze certain benefits could have an impact on the very good performance. It is expected that the government budgetary plan and freezes on certain benefits will have a detrimental impact on equality in the coming years (2017-2019) (Mukkila et al, 2017). Inactivity traps and social benefits The high inactivity traps constitute an obstacle to a more extensive use of the labour force. Nearly half of the inactivity trap consists of the social assistance, with housing allowance forming a substantial component thereof. Despite the design of the social assistance as a temporary ‘last resort’, an increasing share of the population relies on it as income support on a regular basis. The number of recipients with no other income (excluding housing allowances) almost doubled during the first half of 2017 (Kela, 2017). Two recent decisions have likely contributed to this trend: i) the transfer of the administration of this assistance from the social office of the municipalities to the Social Security Institution (or KELA), reducing its stigma and ii) the cuts and freezing of most other social benefits, which is likely to encourage recipients to seek social assistance to supplement their income. The phasing out of the social assistance in particular is currently problematic, as this heavily means-tested benefit is fully phased out as the income increases. Box 3.3.2: Policy highlight: Ohjaamo: from a pilot project to a structural reform to provide support to young people A few years ago the Public Employment Services of the City of Vantaa launched a pilot project funded by the European Social Fund to bring employment, educational, social and health services under one roof to help young people between 17 and 24 years to find a job, a place to study or to provide assistance in social and health issues. The project supported over 4000 people out of whom approximately 1800 found a job, internship or a place to study. Numerous people were directed to health, mental health or social services. The pilot project prepared the ground for a nationwide project to launch one-stop guidance centres throughout Finland. Approximately 40 one-stop guidance centres called Ohjaamo are currently operating in different parts of Finland and a majority of them received support from the ESF until February 2018. Currently aggregated data on national level is not available on the number of clients received by Ohjaamos. However, the Ohjaamo in Helsinki received almost 4000 clients in 2016, 75% of whom found employment, a place to study or other service. In 2017 the government decided to grant national funding for Ohjaamo services, thus securing their continuation and making them as permanent structure for implementing the youth guarantee in Finland. The approach of this successful reform could also be used to provide tailored services to support jobseekers through integrated service chains. Reforms are being planned to address some aspects of the inactivity traps. Housing benefit reform is being planned for 2018, with partial changes in the capping and indexation of the benefit. Lower childcare fees for low and middle income families will enter into force in 2018 freeing more than 6 000 families from childcare fees. However, these planned changes in benefits are expected to precede a more comprehensive reform of the social security system (Ministry of Finance, 2017). The basic income experiment, running 2017-2018 with first results expected in 2019, could provide some information for the revision of the social security system (European Commission 2017c). 3.3.3.Education Finland has a generally well performing education system, although there has been some decline in the performance and divergence between different groups has been detected. Early school leaving rates have declined from about 9 % in 2012 to 7.9 % in 2016, but foreign-born young people have much higher rates than natives (15.1 % against 7.6 %). This is combined with the worsening performance of second generation pupils ( ). This points to deep integration challenges likely to impact on labour market integration. At the same time, slowly increasing differentiation is observable between regions and between schools. The causes for this increasing inequality in education are yet to be fully understood (European Commission 2017c). Education outcomes in Finland remain among the best in the EU but declined slightly in science and mathematics. International IEA-PIRLS testing in reading confirmed the important performance gap between boys and girls (IEA, 2017). According to the 2015 OECD programme for international student assessment tests, Finland continued to remain among the countries with the smallest number of low achievers in basic competences. However, in science, low performance increased and high performance declined (European Commission, 2017c). The 2012 Survey of Adult Skills (PIAAC) test placed the numeracy and literacy skills of Finnish adults among the best of all participating countries. Nevertheless some Finnish participants ( ), showed markedly lower results. The education system has been subject to considerable public spending cuts, but the government is taking some measures to promote equality. Recently, the government allocated EUR 105 million additional funds for education and research for the financial period 2017-2019. However, this did not really reverse the longer term downward funding trend (European Commission 2017c). A continued negative trend in education spending risks undermining competitiveness, reducing equity and education outcomes. Reducing the number of education outlets particularly in VET, can reduce easy access to and even the provision for all in a country of the size of Finland. Finnish universities perform as well as their Nordic peers in terms of, for example, completion rates (OECD, 2016c), skills of tertiary graduates (Kivinen et al., 2016a) and student satisfaction (Eurostudent, 2017). The employment rate of recent graduates has been below the EU average during the last few years, which might be due to the unfavourable economic conditions. When adjusted for the small size of the country, the number of international publications by researchers based in Finnish universities is significant (), but not higher than in other well performing Nordic countries (Academy of Finland, 2016; Kivinen et al. 2016b). Collaboration on innovation between firms and universities is one of the highest in OECD countries (OECD 2015). In recent years, Finnish universities have become more international (Vipunen, 2017). The new vision for higher education and research in 2030 aims at raising tertiary attainment to 50 %. The government’s new funding model since 2017 encourages higher education institutions to become more productive and internationally-oriented. The financial pressure caused by the funding cuts from 2015 onwards had an initial positive effect by facilitating the sharpening of research and teaching profiles of higher education and fostering cooperation between institutions. However, some universities had to reduce their staff ( ), which arguably diminishes the breadth of the academic offer, and may have an important impact on drop-outs and study quality. Bachelor-level studies are being made more generic and suitable for several careers and specialisation should, increasingly, happen at master’s level. The University of Helsinki, with its ‘Big Wheel’ reform is an example for this. Finland is implementing a comprehensive reform of its vocational education and training system as of 2018. This is a key reform to address the need for new skills and strengthen provisions for life-long learning. It has the potential to address existing problems of skills shortages in some industries. VET for young people and adults will be consolidated, forming a single system with its own steering, regulation and financing model. VET will become competence-based and customer-oriented: each student will be offered the possibility to follow an individually appropriate path towards finishing an entire qualification or supplementary skill modules for re-skilling and upskilling. Digital and workplace learning will also be increased. The new funding model will encourage VET providers to improve the effectiveness and quality of learning. If implemented successfully, the reform could contribute to reduce skills mismatches and increase the employment rate. The success of the VET reform in guaranteeing access to education is crucial. This is the case especially in the context of the relatively high inactivity rate of the working age population and the low employment rates of the low-skilled, who are the target of the Upskilling Pathways Recommendation. Ensuring sufficient access and study place in VET for each cohort is particularly important. However, successful implementation of the reform could be challenging due to the significant cuts in the VET budget. It will be essential to monitor the reform and have the possibility to take corrective action on several aspects of it ( ). Additional funding of EUR 60 million is allocated for the reform for the period 2017-2020. 3.4. Investment 3.4.1.competitiveness developments Market share developments Over the 2008-2015 period, Finland experienced a sharp decrease in its export market shares for goods and services (Graph 3.4.1). In addition to the global economic slowdown, the country was hit by several severe external shocks: electronics exports and demand for paper shrank. Also, exports to Russia fell dramatically as the Russian rouble depreciated sharply and a set of sanctions and countersanctions affected EU trade with that country. Finland’s exports of goods fell sharply, whereas exports of services, although affected as well, behaved comparatively better. Also, from 2007, ill-timed wage increases enforced by broad collective agreements prevented companies from adjusting swiftly, while productivity fell. In this context, overall both cost and non-cost competitiveness deteriorated (see Graph 3.4.2). As a result, in the past 10 years, Finland has registered a 40 % cumulative decrease in its share of the global export markets for goods and services.

Graph 3.4.1:Export market share growth by type (goods or services) Source: European Commission In 2016, the long-term decline in export market shares seems to have come to an end. This was largely on the back of a progressive improvement in cost-competitiveness conditions ( ) (Graph 3.4.2). The improvement appeared relatively strong in the equipment sector and in textiles. Without taking trade flows of fuels into account ( ) as fuel prices are generally volatile and their weight in trade is rather large, the improvement of the trade balance originating in cost competitiveness appeared even clearer. In 2017, Finland’s trade balance is expected to have reverted to positive values, especially as wage moderation and recent productivity gains have led to a fall in unit labour costs. Graph 3.4.2:Breakdown of the balance of trade for goods (fuels included) 2001-2017 — Cost and non-cost competitiveness impact Source: European Commission calculations By contrast, non-cost competitiveness remains a source of concern. The trade balance surplus originating in non-cost competitiveness has been declining rapidly since 2009 (see Graph 3.4.2) and is now close to balance. This both reflects and explains the negative or stagnating productivity growth over the last decade, which remains the main challenge for Finland’s competitiveness (see below). Wage trends and cost competitiveness Cost competitiveness has become of particular relevance to Finland. After the setback faced by its electronics sector, the country has increasingly specialised in intermediate goods (Ali-Yrkkö et al. 2016). As exporters of intermediate goods tend to compete chiefly on price, Finnish firms need to have competitive cost structures more than previously in order to remain part of global value chains and to capture value added (Ali-Yrkkö et al. 2016). Similarly, more rapidly rising service prices than in the rest of the euro area may be a cause for concern (Bank of Finland, 2015). In the late 2000s, high multi-year wage increases deteriorated cost competitiveness. Wages continued to progress steadily after the onset of the 2008 global crisis, even when productivity growth fell sharply (see Graph 3.4.3). This pushed Finland’s unit labour costs growth far above that of the euro area, Denmark, Germany and Sweden (see Graph 1.5). As a result, cost competitiveness declined sharply. This had a clear negative impact on the trade balance (see Graph 3.4.2). However, more recent wage agreements and labour market policy measures have progressively reversed the trend. The wage agreement reached in 2013 led to negative growth in real compensation per employee (see Graph 3.4.3), and wage moderation continued: in summer 2016, the government and social partners signed the ‘Competitiveness Pact’, which is intended to improve the cost competitiveness of Finnish economy ( ). It has been agreed that collective agreements will increase opportunities for local agreements. The current status of the wage negotiations points to an outcome with a broadly neutral impact. Major agreements have been reached in the technology, forest and chemical industries (1.6 % annually over the 2018-2019 period) (see Section 3.3). Graph 3.4.3:Breakdown of rate of change of nominal ULC in Finland by change in inflation, real compensation of employee, productivity contribution), rate of change of