Executive summary 1

1. Scenesetter: economic situation and outlook 3

2. Imbalances, risks and adjustments 11

2.1. External sustainability 12

2.2. Competitiveness challenges 18

2.3. Indebtedness, deleveraging pressures and housing market developments 36

3. Other structural issues 46

3.1. Taxation, debt sustainability and fiscal framework 47

3.2. Labour market and education 50

3.3. Products and services market 57

3.4. Efficiency enhancing reforms in the public sector 59

AA. 62

AB. Statistical annex 68

LIST OF Tables

1.1. Key financial, economic and social indicators 8

1.2. MIP scoreboard indicators 9

2.3.1. Financial flows involving banking sector, 1-10/2014 - Finland 32

2.3.2. MFI Soundness Indicators - Finland 32

2.3.3. Non-financial corporations debt to profits and debt to capital -distribution 39

AB.1. Macroeconomic indicators 63

AB.2. Financial market indicators 64

AB.3. Taxation indicators 65

AB.4. Labour market and social indicators 66

LIST OF Graphs

1.1. Real GDP growth by demand component 3

1.2. Components of potential growth 4

1.3. Current account, export market share (EMS) 4

1.4. Net international investment position and external debt 4

1.5. Real effective exchange rates 5

1.6. Breakdown of debt by sector (non-consolidated) 6

1.7. Public finance indicators 6

1.8. Employment, unemployment and activity rate 7

2.1.1. Breakdown of the Finnish external position (current and capital accounts) 11

2.1.2. Trade balance, EU-28 11

2.1.3. Recent current account and trade developments, Finland, 12-month moving sum, quarterly data 12

2.1.4. Net lending/borrowing by sector, Finland 12

2.1.5. Saving and investment of sectors, Finland (% of GDP) 12

2.1.6. Breakdown of net international investment position, Finland 13

2.1.7. Domestic value added content of exports, EU-28, 2009 14

2.1.8. Share of top-10 export goods in total export (%) 14

2.1.9. Concentration of export good structure, 2013 14

2.1.10. Share of top-10 enterprises in total export, 2011, (%) 15

2.2.1. Structure of gross value added by industrial aggregates, 1975-2013, Finland 16

2.2.2. Gross value added in basic prices, current prices, 1990-2013 16

2.2.3. Real gross value added in basic prices in manufacturing 1990-2013 16

2.2.4. Productivity growth in manufacturing industries (%, y-o-y) and growth contributions by sub-industries (percentage points), Finland 17

2.2.5. Change of GDP deflator (%, y-o-y) and contributions to growth, (pps.) - — Finland 18

2.2.6. Change in competitiveness (%, y-o-y) and contributions from nominal effective exchange rate and total economy nominal unit labour costs, percentage points (pps.), — Finland 19

2.2.7. Ratio of export price deflated REER to manufacturing unit labour cost deflated REER, 1999-2014 19

2.2.8. Ratio of export price deflated REER to total economy unit labour cost deflated REER, 1999-2014 20

2.2.9. Export market share development (%) 20

2.2.10. Export market share, Finland, annual change (%) 20

2.2.11. Export market share, Finland, compared with the export market share of the euro area, (%) 21

2.2.12. Domestic value-added content of export, Finland (% of GDP) 21

2.2.13. Domestic value added of foreign demand, change between 2000 and 2009, % of GDP 21

2.2.14. Export developments by product category between 2000 and 2013 22

2.2.15. Nokia's contribution to the Finnish GDP (%) 22

2.2.16. Components of change of Finnish export market share between 2000 and 2013 23

2.2.17. Consumption of households and net exports (% of GDP) 23

2.2.18. Export and import component, EU-28, change between 2000 and 2011 (% of GDP) 25

2.2.19. Export and import component, Finland (% of GDP) 25

2.2.20. Export and import ratio as well as foreign value-added content of exports, Finland (% of GDP) 25

2.2.21. Finnish foreign direct investment vis-à-vis the world and EU-28 (%) 26

2.2.22. Export of goods and services, Finland (% of GDP) 26

2.2.23. Innovation and specialisation on top-quality export products 27

2.2.24. Age composition of small businesses (%) 28

2.2.25. Share of employment in firms never growing above one employee (manufacturing) 28

2.2.26. Start-up rates 29

2.2.27. Growth expectation of early-stage entrepreneurs in innovation-driven economies 29

2.3.1. Breakdown of debt by sector (non-consolidated) — Finland 31

2.3.2. Lending to households (HH) and non-financial corporations (NFC) in Finland 31

2.3.3. Household sector loans by type of loan 33

2.3.4. Average mortgage rates - selected countries 33

2.3.5. Nominal house prices by region, 1990=100 — Finland 34

2.3.6. Growth of house prices and loans by monetary financial institutions for house purchases — Finland 34

2.3.7. Leverage, households — Finland 34

2.3.8. Household debt — Finland 35

2.3.9. Housing market valuation — Finland 35

2.3.10. Real house prices — selected countries 36

2.3.11. Falling residential investment associated with higher housing valuations, regional data 36

2.3.12. Incentives to invest fail to increase residential investment 37

2.3.13. Leverage, non-financial corporations — Finland 37

2.3.14. Balance sheet, non-financial corporations - Finland 38

2.3.15. Breakdown of year-on-year changes in debt-to-GDP ratio, households (ESA 2010) — Finland 38

2.3.16. Breakdown of year-on-year changes in debt-to-GDP ratio, non-financial corporations (ESA 2010) — Finland 39

3.1.1. General government total revenue, total expenditure and net-lending /net-borrowing, % of GDP , Finland 43

3.2.1. Labour market indicators 45

3.2.2. Tax rate for an individual (single, no children) to take up work at 67 % of the average wage 48

3.3.1. Restrictions on retail trade 52

LIST OF Boxes

1.1. Economic surveillance process 8

2.2.1. Foreign direct investment, trade linkages and especially energy tie Finland close to Russia 25

LIST OF Maps

No table of contents entries found.

Structural adjustments still weigh on Finland’s economic performance, but a slow recovery is taking hold. After contracting for two consecutive years, Finland’s output stabilised in 2014. An increase in net exports helped to soften the negative impact of a further large decline in investments. Consumption was held back by declining employment, low wage growth and tax increases. However, economic growth gained momentum in the second half of the year and the recovery is expected to continue in 2015 and 2016. Several factors support this expectation. First, the shakeout in the electronic and paper sectors seems to have run its course. Second, with the conclusion, in 2013, of a moderate wage agreement, Finnish wage developments have moved, albeit belatedly, into line with the new post-crisis reality, supporting the restoration of cost competitiveness. Third, a gradual improvement in external demand, together with the decline in imported fuel prices and the exchange rate, should support exports. Finally, credit conditions remain supportive of an increase in economic activity. On the other hand, weak labour market conditions and wage moderation will continue weighing down on private consumption.

This Country Report assesses Finland’s economy against the background of the Commission’s Annual Growth Survey which recommends three main pillars for the EU’s economic and social policy in 2015: investment, structural reforms and fiscal responsibility. In line with the Investment Plan for Europe, it also explores ways to maximise the impact of public resources and unlock private investment. Finally, it assesses Finland in the light of the findings of the 2015 Alert Mechanism Report, in which the Commission found it useful to further examine the persistence of imbalances or their unwinding. The main findings of the in-depth review contained in this country report are:

· Following a steady deterioration from 2003 until 2011, the Finnish current account has stabilised at a small deficit. The goods balance is expected to have turned back into surplus in 2014 and is projected to improve further in the coming years. Finland’s net international investment position deteriorated in 2014, but remains in positive territory. In addition, while the economy remains exposed to asymmetric shocks, its vulnerability to external developments has decreased. Overall, Finland’s external sustainability is not a concern.

· The rapid decline of some manufacturing industries (electronics and forest) has largely ended. The impact of the collapse of the electronics and paper industries on GDP and exports has not yet been overcome. GDP remains below its pre-crisis level and potential growth has declined. Yet, there are signs that the process of economic restructuring has started, albeit very gradually. The information and communication-technologies service industry and professional and other support services to the private sector, have been clearly expanding for over a decade. In manufacturing, the chemical industry especially has been growing steadily over recent years. In addition, new investments in the hard-hit electronics and paper industries should support the launch of new products. The rate of start-ups is low in comparison with other peer economies. This does not favour the dispersion and spillover of Finland’s high innovation potential.

· The productivity of Finnish companies is in line with its Nordic peers and recently the growth in labour productivity started to accelerate. Cost competitiveness deteriorated in 2008-12, partly due to the decline in high-productivity industries and partly due to wage rises above productivity growth, with other domestic costs also increasing. More recently, both wage moderation and productivity growth have started to gradually improve cost competitiveness relative to competitor countries.

· While public investment is relatively high, private investment is low. Private-sector incentives to invest into new machinery and equipment have diminished by relatively rapid growth of wages and other production costs. Low equipment investment can reduce Finland's competitiveness and growth potential. However, relative cost competitiveness has started to improve gradually and consequently investments are assumed to gradually recover in the coming years.

· Private-sector debt does not appear to be a source of immediate concern, but it needs to be closely monitored. Private-sector debt has stabilised at a level just above the EU average. However, there appear to be no urgent deleveraging pressures, given the sound financial sector and low debt-servicing costs. The increase in house prices seems to have stopped, lowering the probability that household debt will increase in the near future.

The country report also analyses other macroeconomic and structural issues and the main findings are:

· Finland’s debt-to-GDP ratio is on a rising trend and will exceed 60% in 2015. Ageing-related costs imply risks for the sustainability of public finances in the medium to long term. Finland has limited room to increase tax revenues, as the tax ratio is already high. However, the efficiency of the public sector can be improved further, particularly in areas that face cost-pressures in the future from ageing — mainly healthcare and long-term care.

· Recent labour market performance has been weak, but still compares favourably with the EU-average. Unemployment has been increasing. Early exit from the labour market occurs mainly through disability or through the extended unemployment benefits available for older workers.

· The Finnish retail sector remains highly concentrated, being dominated by two local retail groups. The dominance is strengthened by planning rules and strict regulation on large-scale outlets. The regulations have a negative impact on productivity growth and constitute market entry and market expansion barriers for new operators.

Overall, Finland has made some progress in addressing the 2014 country-specific recommendations. An important development is the agreement reached between the social partners regarding implementation of the pension reform from 2017. In addition, reforms of the social and healthcare sectors have been initiated to better control expenditure growth in these areas. Some steps to increase the growth-friendliness of the tax system have been taken. Other positive action, such as measures to improve employment of the elderly, has been taken in the labour market. The government took new measures to diversify the economy, notably though the promotion of innovation and investment in digitalisation, biotechnology and clean technologies. Furthermore, public support focuses on promoting exports of SMEs and on risk capital. Some recommendations have not been fully addressed. For instance, while the new bill amending the land use and building act incorporates competition as an objective, the restrictions regarding large-scale outlets have not been addressed.

This country report reveals the policy challenges stemming from the analysis of macro-economic imbalances, namely:

· Earlier losses to cost competitiveness would recover further if careful control of the development of costs continued in the future. Over recent years, cost pressures in the non-tradable sector have had a negative impact on cost competitiveness.

· Despite a business environment that has many strong points, Finland is missing out on some opportunities to improve its non-cost competitiveness. Finnish enterprises, including start-ups, tend to remain small and do not actively seek to grow or internationalise. There is room to improve the capacity of universities in turning research into innovations.

· Households faced a relatively quick increase in their debt burden. Household debt mainly takes the form of mortgage debt. Recent declines in interest rates have reduced the burden of servicing the debt, but also reduced the incentives to deleverage. Further macro-prudential measures could help to stem a further increase in household indebtedness.

In addition, other policy challenges are ensuring the sustainability of public finances in view of pressures from ageing-related costs and, linked to this, using better the full potential of the labour market.

Growth drivers and outlook

Structural adjustments are weighing on Finland’s economic performance. Apart from suffering from the weak global economy following the financial and economic crisis, Finland has also had to cope with an asymmetric shock in the form of the loss of external demand for mainly electronic and paper products. This led to substantially lower exports and a loss in output that could not easily and quickly be replaced by other products. Wages were slow to react to the lower output because Finland had gone into the crisis with a generous multiannual wage settlement reflecting pre-crisis conditions. Combined with the loss in output in the highly productive electronics sector (dominated by Nokia), this led to an increase in unit labour costs and an erosion of cost competitiveness. The changing economic conditions led to a decline in growth, the emergence of a negative output gap, an increase in unemployment, an evaporation of Finland’s current account surplus, and deteriorating public finances. Inflation steadily declined while remaining positive.

Graph 1.1: Real GDP growth by demand component

Source: European Commission

The Finnish economy seems to be slowly turning the corner. Following a decline in economic activity in 2012-13, the Finnish economy bottomed out in 2014 and is expected to start recovering in 2015 (Graph 1.1). Several factors explain this development. First, the shake-out in the electronic and paper sectors seems to have run its course. Second, although belated, Finnish wage developments have moved into line with the new post-crisis reality through the conclusion, in 2013, of a moderate wage agreement. This agreement, which is possibly to be extended for the coming years, supports the restoration of cost and export competitiveness through lower growth in unit labour costs. Third, a gradual improvement in economic prospects should support Finnish exports, especially as these are centred on intermediate and capital goods for which demand can be expected to increase during a recovery phase. Fourth, the decline in energy prices and the exchange rate should support exports. Finally, credit conditions remain supportive to an increase in economic activity. On the other hand, weak labour market conditions and wage moderation will continue weighing on private consumption. A fuller discussion of Finland’s near-term economic outlook is contained in the Commission’s winter 2015 economic forecast.

Medium-term challenges remain. Finland’s growth potential is affected by the decline in its working-age population. Growth potential is estimated at slightly below 1 % in the medium term and close to 1 % in the longer term, contingent on productivity gains (Graph 1.2).([1]) The long–term sustainability of public finances is not yet secured and savings in expenditure will have to made, for example through the control of expenditure growth, as the scope for increasing the already-high tax burden seems limited.([2]) The effect on GDP and exports of the decline in the electronics and paper industry has not yet been overcome. A large negative output gap has opened up and GDP remains below its pre-crisis level. Nevertheless, there are some encouraging signs in the form of new investments in the paper and pulp industry that should raise productivity and support the launch of new products. Also, after the demise of its mobile phone business, Nokia is re-inventing itself and contributing again positively to Finnish growth.

Graph 1.2: Components of potential growth

Source: European Commission

External sustainability

Finland’s external position deteriorated, but remains sustainable. While posting a record 8 % of GDP current account surplus in 2002, the current account progressively turned into a moderate deficit in 2011 and broadly stabilised thereafter.

Graph 1.3: Current account, export market share (EMS)

Source: European Commission

These developments were driven by the substantial losses in export market shares that peaked in 2010, before getting smaller in subsequent years (Graph 1.3). While the current account deficit worsened Finland’s international investment position, this remains positive thanks to assets accumulated in previous years (Graph 1.4). Notwithstanding the deterioration of its net lending position, the likelihood of an abrupt adjustment in Finland’s external position appears very low. External sustainability issues are further discussed in section 2.1.

Graph 1.4: Net international investment position and external debt

(1) BPM6/ESA2010 (reserve assets excluded) Source: European Commission

Competitiveness

Competitiveness has declined in recent years, but the conditions for a recovery are in place. The significant decline in Finnish exports up to 2011 was due to declines in both price and non-price competitiveness. Cost competitiveness suffered from wage settlements failing to adjust to the new economic reality in combination with declining labour productivity. In addition, despite the government’s efforts and the business environment that has lots of favourable features, the low rate of start-ups and other small businesses prolonged the restructuring process of the economy to regain its competitiveness. There are reasons to believe that things could get better going forward. Wage agreements changed and provide for a more favourable development in unit labour costs. The important restructuring in the electronics and paper industries should position them better to take advantage of future growth. A big part of the Finnish competitive edge has also been dependent on the highly educated labour force. The current situation presents considerable challenges to ensure that sufficient investments continue to be made into human capital to maintain the high quality of the Finnish labour force and to provide it with new skills to adapt to the changes in the economy. Competitiveness issues are further discussed in sections 2.2 and 3.3.

Graph 1.5: Real effective exchange rates

Source: European Commission

Investment

Investment in Finland is currently below the levels observed in recent years. However, the proportion of investment stood at 21.2 % of GDP in Finland in 2013, above the euro area average of 19.6 %. Due to a lack of demand, investment in equipment and non-housing construction (which is around half of overall investment in Finland) is below the level that prevailed before the crisis. Government spending cuts are restraining infrastructure investment, although there are some major projects ongoing such as the extension of the metro line and the airport railway connection in Helsinki.

The main investment challenge is related to the need to increase the restructuring and diversification of the production side of the economy. Investment (not including construction) has been lower than in similar economies over the past decade. Although investment in R&D is among the highest in EU, the country still faces challenges to convert high R&D investment into successful export products and services. Limited investment in production capacity over recent years could be one possible explanation for the lack of success in converting the R&D inputs into viable products. Recent success stories can be found mainly in the ICT-related services sector, such as the gaming industry. These industries invest modestly in physical capital, but a well-functioning infrastructure for companies in the service sector is a necessity. There are also particular strengths in manufacturing, which is still driving a large part of growth in real production. In manufacturing, much of the focus has recently been on investing in clean technology products and a better use of ICT in manufacturing processes.

There are also clear investment needs in infrastructure. Finland could benefit from diversifying its energy supply, particularly as it relies on a single gas source — Russia. Investment in liquefied natural gas (LNG) terminals could be one way of diversifying energy supply in the medium term.

Private sector indebtedness

Private sector indebtedness stabilised at a high level. Private sector debt increased steadily over the first decade of this century reaching levels close to 170 % of GDP (Graph 1.6) and therefore above the Macroeconomic Imbalance Procedure scoreboard indicator. Since 2010, private sector debt has been broadly stable. Non-financial corporate debt accounts for about two thirds of private sector debt (or about 120 % of GDP). The main driver of corporate debt has been investment. Household debt increased noticeably before the crisis. This stemmed from a rapid growth in mortgage loans linked to rising house prices that could be attributed to increasing disposable income and favourable financing conditions (low interest rates, tax incentives, lengthening of maturities, increasing loan-to-value ratios). Since 2010, household debt has stabilised at around 65 % of GDP. While high, debt servicing does not seem to pose problems for corporates and households and deleveraging pressures seem to be low. Private sector debt is further discussed in section 2.3.

Graph 1.6: Breakdown of debt by sector (non-consolidated)

ESA 2010 Source: European Commission

Public finance

Government finances deteriorated as economic activity declined. Public finances have been in deficit since 2009, not only nominally but also structurally, and public debt has been increasing. Finland’s expenditure-to-GDP ratio has continued increasing significantly since the beginning of the crisis while revenues have stagnated. Policy makers had to strike a balance between maintaining market confidence and credit ratings and not causing additional loss of output due to overly restrictive fiscal policies as economic performance worsened. Even if the government plans to reduce its deficit in 2015 and 2016, government debt is set to exceed the 60 % reference value as from 2015.

Over the medium term, consolidation efforts and structural reforms are necessary to close the sizable sustainability gap. The fiscal sustainability risks are considered as medium in the medium term and high in the long term. The sustainability gap is mainly caused by the future ageing-related expenditure on pensions and healthcare and long-term care.

General government revenue, in proportion to the GDP, is already among the highest in the EU, so the scope for increasing it further for fiscal consolidation purposes seems limited. Therefore, savings on the expenditure side, for example through efficiency-enhancing reforms in the public sector, appear warranted (see section 3.4). The growth friendliness of the tax system could be enhanced (see section 3.1).

Graph 1.7: Public finance indicators

Source: European Commission

Labour market

Unemployment has increased by less than economic developments would suggest. Despite the increase, unemployment (8.7 %) remains clearly below the EU average (Graph 1.8). The labour market situation and related challenges are further discussed in section 3.2.

Graph 1.8: Employment, unemployment and activity rate

Source: European Commission

Box 1.1: Economic surveillance process

The Commission’s Annual Growth Survey, adopted in November 2014, started the 2015 European Semester, proposing that the EU pursue an integrated approach to economic policy built around three main pillars: boosting investment, accelerating structural reforms and pursuing responsible growth-friendly fiscal consolidation. The Annual Growth Survey also presented the process of streamlining the European Semester to increase the effectiveness of economic policy coordination at the EU level through greater accountability and by encouraging greater ownership by all actors. In line with streamlining efforts this Country Report includes an In-Depth Review — as per Article 5 of Regulation no. 1176/2011 — to determine whether macroeconomic imbalances still exist, as announced in the Commission’s Alert Mechanism Report published on November 2014. Based on the 2014 IDR for Finland published in March 2014, the Commission concluded that Finland was experiencing macroeconomic imbalances requiring monitoring and policy action. In particular, the weak export performance during the last years, driven by industrial restructuring, cost and non-cost competitiveness factors, deserve continued attention. This Country Report includes an assessment of progress towards the implementation of the 2014 Country-Specific Recommendations adopted by the Council in July 2014. The Country-Specific Recommendations for Finland concerned public finances, administrative reform, labour market, market competition and competitiveness.

Table 1.1: Key financial, economic and social indicators

(1) domestic banking groups and stand-alone banks. (2) domestic banking groups and stand alone banks, foreign (EU and non-EU) controlled subsidiaries and foreign (EU and non-EU) controlled branches. (*) Indicates BPM5 and/or ESA95 Source: ECB, Commission services

Table 1.2: MIP scoreboard indicators

Note: Figures highlighted are the ones falling outside the threshold established by EC Alert Mechanism Report. For REER and ULC, the first threshold concerns Euro Area Member States. (1) Figures in italic are according to the old standards (ESA95/BPM5). (2) Export market shares data: the total world export is based on the 5th edition of the Balance of Payments Manual (BPM5). Source: Commission services

Current account and net external position

The Finnish current account has been fluctuating in moderate negative territory since 2011. This followed a gradual deterioration from an exceptionally high current account surplus of around 8 % of GDP at the start of the millennium In the last two decades, the current account benchmark, i.e. the estimated current account balance explained by fundamentals, was slightly positive. That implies that both the much higher surplus amounting to around 8 % of GDP in 2000 and the recent negative balance reflect other factors (Graph 2.1.1).

Graph 2.1.1: Breakdown of the Finnish external position (current and capital accounts)

(1) BPM6/ESA2010 (2) * European Commission Calculation, BOX 2.1.1. in the 2015 Country Report of Germany contains further information on the applied methodology Source: European Commission

The external balance has been largely driven by the trade balance. While Finland recorded the third-highest trade surplus in the EU in 2000 on account of the preceding surge of its export competitiveness, it vanished in the ensuing decade giving rise to the largest cumulative deterioration in the EU-28 between 2000 and 2014 (Graph 2.1.2). Since 2011, the trade balance has been slowly improving. In particular, according to trend balance-of-payments data, the goods balance turned into a slight surplus in the Autumn of 2014.([3]) It has partly reflected positive terms-of-trade developments, mainly on account of falling oil prices (Graph 2.1.3).([4])

Graph 2.1.2: Trade balance, EU-28

(1) Only Luxembourg and Ireland had a higher trade surplus in the EU-28 in 2000 Source: European Commission

The improving competitiveness in the 1990s resulted in increasing national income and an improving current account. However, the private sector’s saving ratio has not improved accordingly since higher incomes were largely channelled into government savings. The budgetary balance improved in structural terms and its solid surplus, together with the high current account surplus, led to the accumulation of buffers to offset potential adverse shocks.

The current account deteriorated for two reasons from the start of the millennium. First, external factors — including financial integration, low real interest rates and an improving growth outlook until 2008 — strengthened private sector investment. Second, in response to the fall in external demand for various Finnish products after 2008, Finland smoothed its domestic absorption (consumption and investment together) by reducing domestic absorption by less than the decline in national income.

Graph 2.1.3: Recent current account and trade developments, Finland, 12-month moving sum, quarterly data

(1) Balance of payments statistics (2) Customs statistics (3) Higher figure indicates improvement Source: Statistics Finland

Just as for the previous boom period, the government sector played a smoothing role in the adjustment process to the external shocks that hit Finland, in particular after 2008. The private sector has remained a net lender in most years in view of the solid saving position of the corporate sector (Graphs 2.1.4 and 2.1.5). Corporate sector investment ratio dropped broadly in line with their declining saving ratio, while households kept their saving ratio broadly stable, supported by increasing wages and labour hoarding and by increased income transfers from the government. This also allowed households to uphold their housing investment ratio, which remains high in comparison with the EU (see section 2.3. on the housing market). The bulk of the external shocks were absorbed by the public sector via the increasing public expenditure ratio while the revenue ratio remained broadly stable. The fiscal balance even turned into deficit in 2009 and has remained in the red since then. This reflected both the impact of automatic stabilisers as well as some fiscal stimulus. The latter resulted in the amortisation of the previously accumulated budgetary surplus in structural terms.

Graph 2.1.4: Net lending/borrowing by sector, Finland

(1) ESA 2010 Source: European Commission

Graph 2.1.5: Saving and investment of sectors, Finland (% of GDP)

(1) ESA 2010 Source: European Commission

Finland’s net international investment position (NIIP) remains in positive territory, although it has worsened since 2010. The NIIP turned positive in 2009 on account of past current account surpluses and favourable valuation effects, mainly related to equity holdings. Since 2010, the decline of the positive NIIP has reflected the recently recorded moderate current account deficits (Graph 2.1.6).

Graph 2.1.6: Breakdown of net international investment position, Finland

(1) BPM6/ESA2010 (reserve assets excluded) Source: European Commission

Current account developments also affect economic growth. In fact, declining external demand and net exports and the fall in corresponding investment, reduce economic growth. The underlying developments that resulted in the worsening external position also have adverse effects on potential growth (see section 2.2. on non-price competitiveness developments).

Assessment of external sustainability and vulnerability

The Finnish external sustainability is not a concern. The likelihood of an abrupt adjustment to Finland’s external position is very low, despite the deterioration of its net lending position over the last decade. First, Finland’s net international investment position remains positive. Second, the current account deficit over the last three years was relatively small, i.e. between 1 % and 2 % of GDP. Third, a temporary increase in government net borrowing can be justified as a shock- absorbing reaction, while the persistent net borrowing position of the households sector mainly reflects increases in the cost of housing, which has a flipside in a higher asset position. Finally, according to the European Commission’s winter 2015 economic forecast, some improvement in the external balance is expected in the coming years on account of recovering trade performance and favourable terms-of-trade developments.

However, the sharp deterioration of the external balance in the 2000s highlights Finland’s vulnerability to external shocks. It partly reflected the fall in global demand for products in which Finland was heavily specialised. Against this background, an assessment of the current vulnerability to external shocks is made in the following paragraphs. It takes into consideration the openness of the Finnish economy as well as the specialisation of its export sector.

Finland is an open economy, however, not more open than other countries of a similar size. Total Finnish trade (i.e. export and import together) is around to 80% of GDP, which is lower than in some other Nordic countries (such as Sweden and Denmark) or even in Germany. This finding is confirmed by a comparison based on the domestic value added content of exports (Graph 2.1.7). Also, both the inward and outward foreign direct investment stock was close to the EU average in 2013. Although the outward activity of Finnish multinationals is high, it is comparable to multinationals from other Nordic countries. While openness exposes a country to external shocks in general, the vulnerability to external shocks is mainly determined by the degree of specialisation of the export sector and the corresponding exposure to country-specific, i.e. asymmetric external shocks.

Graph 2.1.7: Domestic value added content of exports, EU-28, 2009

(1) Data is not available for Croatia and Cyprus Source: OECD, European Commission

The Finnish export sector has recently become more balanced while it was highly concentrated at the turn of the millennium. This mainly reflects the impact of negative global demand shocks, which hit sectors and products (like mobile handsets) that previously accounted for highly disproportionate shares of Finnish exports. The proportion of top-10 export goods in total Finnish exports decreased to 44 % in 2013 from 57 % in 2000. Even so, it still exceeds the corresponding indicators in Sweden (35 %) and Denmark (29 %) (Graph 2.1.8). Similarly, the Herfindahl-Hirschmann index of export goods suggests that the concentration of the Finnish export structure has decreased to a level that is similar to other small economies in the EU-28 (Graph 2.1.9). In addition, the share of top-10 firms in exports has also decreased to 32 % in 2011 from more than 40% in 2008, although this ratio is still among the highest in the EU-28 and exceeds the figures for several other small economies, like Austria, Latvia and Slovenia (Graph 2.1.10).

Graph 2.1.8: Share of top-10 export goods in total export (%)

(1) Based on SITC Rev 3, which includes 255 product categories Source: UNCTAD, European Commission

Graph 2.1.9: Concentration of export good structure, 2013

(1) Various years for Finland (2) Specialisation is measured by Herfindahl-Hirschmann (HH)index, based on SITC Rec 3 categories Source: UNCTAD, European Commission

Graph 2.1.10: Share of top-10 enterprises in total export, 2011, (%)

Source: OECD, European Commission

Another reason of the vulnerability of Finland to asymmetric external shocks is its export sector’s specialisation in products that has relatively low share in international trade. In 2013, Finland’s diversity index of goods was 0.54 compared with the rest of the world, which was the sixth highest among the EU-28 countries and which has not changed significantly in recent years.([5]) Although this diversity index cannot be assessed as exceptional, the diversity indicator of various other smaller economies in the EU-28, including Sweden, Denmark, Austria and the Baltic countries, is lower — flagging an export product mix that is more similar to the world export market structure. In particular, the share of wood, paper and basic metal production is relatively high in Finnish exports, according to the revealed comparative advantages indices calculated based on both gross export values and domestic value added for foreign demand.

Overall, Finland continues to be relatively exposed to asymmetric external shocks due to its still relatively high specialisation, even if it turned to be less exceptional.([6]) In the short term, the contraction of the Russian economy may adversely affect Finnish exports, as Russia is Finland’s third-largest export destination (see Box 2.2.2. on the impact of Russian economic developments on Finland). Yet, by the same token, an eventual recovery in Russian economic growth would benefit Finland in the medium term. Currently, the global economic cycle is having a strong effect on Finnish export performance due to the high proportion of investment and intermediate goods in its total exports, for which demand is more cyclical than for consumer goods. Also, Finnish exports are concentrated on high-quality products, which more closely follow the economic cycle than lower-quality products.([7])

Nonetheless, Finland’s shock-absorbing capacity decreased due to the amortisation of previously achieved external and budgetary surpluses. Therefore, the importance of powerful adjustment to external shocks has further increased. Adjustment is necessary to regain export competitiveness and to accumulate buffers, such as current account surpluses, in good economic times that can be used for absorbing external shocks in bad economic times. Accordingly, in the following sections the first encouraging signs of the current economic restructuring are documented, followed by analyses of the cost and non-cost factors, a part of which compromise Finland’s adjustment capacity.

Economic restructuring

Services have gradually increased in importance while secondary production — including manufacturing, — has decreased. In 2000, secondary production ([8]) reached its highest share in Finnish gross value added (GVA) over the past 30 years. In contrast to global trends, the share of secondary production remained relatively stable at about one third of GVA between 1990 and 2008 while the share of private services increased from roughly 40 % in 1990 to 45 % in 2008 (Graph 2.2.1). During the 2008-09 recession, the secondary production fell below 30 % and has been steadily declining since then. Partly due to the fall in secondary production, private services account for roughly 50 % of GVA. Public services in GVA have remained relatively stable at around one fifth.

Graph 2.2.1: Structure of gross value added by industrial aggregates, 1975-2013, Finland

Source: Statistics Finland, European Commission

In 2000, the largest industry within secondary production — manufacturing (NACE code C) — reached its highest level (27.6 % of GVA) over the past 40 years. Although real production in manufacturing has decreased rapidly in recent years, the latest data shows that manufacturing still accounts for 16.6 % of GVA in Finland, which is slightly above the euro area average of 15.9 %.

Graph 2.2.2: Gross value added in basic prices, current prices, 1990-2013

Source: Statistics Finland, European Commission

Graph 2.2.3: Real gross value added in basic prices in manufacturing 1990-2013

Source: Statistics Finland, European Commission

The real GVA of manufacturing decreased by nearly 30 % between 2008 and 2012, mainly due to downsizing of electronics. In this period roughly two thirds of the electronics sector production disappeared, largely on account of the contraction of Nokia’s handset unit. The decline of the electronics sector has come to an end in 2013 when the industry was able to increase the GVA volume by 3.6 %. Although the changes in 2008-12 were significant and had negative economic effects, the electronics industry still produces twice as much real GVA than it did 20 years ago. It has also generated a lot of accumulated knowledge and skills in the economy that could be reallocated to new companies and productive jobs either in manufacturing or for example in ICT service industries. The firm churning rate by industry — that is sum of firm creation and destruction rates — was at end-2013 above the 2010-12 average in the production of electronic and electrical products, and in several information and communication services industries.

Forest industries (woodworking and paper industries) in Finland have reduced their production capacity between 2007 and 2012 as a response to lower global demand. This led to a 25 % loss of real GVA of this industry. However, the production of forest industries has remained rather stable since 2010. Over recent years, forest companies have increased their R&D expenditure to close to 3 % of their gross value added. The R&D expenditure has thus roughly doubled compared with 2000 and as a result, new marketable products such as wood-based biofuels have already emerged. Furthermore, it is reasonable to assume that the most intensive downsizing period has passed in forest industries. In addition to the increase of the production of new forest based products, there are plans to increase the production of softwood pulp, for which the global demand is projected to increase.

Expanding industries are found in manufacturing and in the private services sector. Within manufacturing, the chemical industry has especially been growing steadily over recent years. The metal industry has had difficulties since the global investment boom ended in 2009, but in 2014, among manufacturing industries, companies in the metal industry were able to increase their order books the most. In the private service sector, the information and communication services industry has clearly been expanding. Its real GVA almost doubled between 2000 and 2013 and the 2008-09 recession went largely unnoticed by the industry. In addition, professional, scientific, technical, administration and support-service activities have continued to grow. Overall, in 2012, the real GVA of private service industries regained their pre-crisis level. In 2014, following a slight decline in 2013, private services are expected to have grown again.

Graph 2.2.4: Productivity growth in manufacturing industries (%, y-o-y) and growth contributions by sub-industries (percentage points), Finland

(1) Labour productivity growth is measured as change in ratio of real gross value added at basic prices to total hours worked by industry. Source: Statistics Finland, European Commission

The steep fall in production of the electronics and forest industries depressed labour productivity substantially with an adverse impact on competitiveness indicators, but recently, productivity has started to recover. The electronics industry was the largest positive contributor to labour productivity growth between 1995 and 2008. In 2009, only chemical industries were able to increase labour productivity while other manufacturing industries recorded deep falls in production relative to labour input. After the crisis, most of the industries recovered and especially the chemical and forest industries saw their productivity increasing in recent years.

Plant-level micro-data on labour productivity trends shows that productivity within Finnish firms is not lagging behind Nordic peers. The productivity of Finnish manufacturing companies has moved broadly in line with Swedish or Danish peers over 1995-2011. For example, both Finnish and Swedish manufacturing companies enjoyed a long period of increasing labour productivity up until the global economic downturn in 2008-09. After the downturn, productivity recovered in both countries. Since 2005, the change in the company structure within industries has increased in Finland. This has accelerated the growth of labour productivity. The phenomenon known as ‘creative destruction’ has accelerated the growth of labour productivity in Sweden and Norway already since 1995. It means that less productive firms lose their market share while firms that are more productive gain and through the process, resources, such as labour, are allocated more efficiently than before, thus increasing aggregate labour productivity.([9])

Overall, recent developments suggest that the structural change of production is in a phase where production is no longer declining rapidly in certain industries. However, it will take some time before the expansion of industries fully makes up for the recent fall in gross value added.

Price and cost competitiveness

Since 2005, the price level in Finland measured by the GDP deflator has increased at one of the highest rates in the core euro area, although the nominal price level in Finland is relatively high. In recent years, compensation of employees and indirect taxes net of subsidies have pushed costs higher while operating profits, mixed income and returns on capital have been squeezed (Graph 2.2.5). Compared with 37 industrial competitor countries, the real effective exchange rate based on the GDP deflator shows that the relative cost level has risen over the past five years.

Graph 2.2.5: Change of GDP deflator (%, y-o-y) and contributions to growth, (pps.) - — Finland

Source: European Commission

The wage agreement in 2013 set moderate wage increases for the period 2014-15 and helped to halt the deterioration in relative nominal unit labour costs. Against the background of the deterioration in cost competitiveness over recent years, the recent stabilisation could be regarded as a first step in the right direction. Graph 2.2.6 also shows that in recent years the nominal effective exchange rate for Finland has appreciated. Although the EUR/USD exchange rate has depreciated recently, the euro has appreciated strongly against the Russian rouble and against the Swedish krona, two of Finland’s largest trading partners. Hence, in the case of Finland, the nominal effective exchange rate might not support cost-competitiveness as much as it supports some other euro area countries.

Graph 2.2.6: Change in competitiveness (%, y-o-y) and contributions from nominal effective exchange rate and total economy nominal unit labour costs, percentage points (pps.), — Finland

Source: European Commission

While labour productivity growth more than offset wage increases and falling export prices in the Finnish manufacturing sector prior to 2008, cost competitiveness deteriorated afterwards. In 2003-10, Finland witnessed falling export prices compared with competitor countries due to rapid price falls in the electronics sector. The fast growth of labour productivity in relation to competitor countries, and the consequently falling relative unit labour costs in manufacturing, helped to sustain market shares in the international market. The ratio of relative export prices to relative manufacturing unit labour costs for Finland and peer countries is shown in Graph 2.2.7. For example, a falling curve indicates that a rise in relative unit labour costs has been larger than a rise in relative export prices, squeezing the profits of the manufacturing firms. Lower profits-to-turnover ratio reduces the economic incentives to invest in new production capacity.

Before 2008, Finnish manufacturers were able to keep their unit labour costs in check with respect to export prices (Graph 2.2.7). Afterwards, especially in 2009 and 2012, Finnish unit labour costs increased rapidly relative to competitor countries and relative to export prices. In 2013-14, the increase in unit labour costs and consequently deterioration in the Finnish cost competitiveness came to halt. The downsizing of the electronics sector and consequently the rapid deterioration in relative unit labour costs in manufacturing, explains most of the deterioration in export prices relative to manufacturing unit labour costs in 2008-12.

Graph 2.2.7: Ratio of export price deflated REER to manufacturing unit labour cost deflated REER, 1999-2014

Source: European Commission

The non-traded sector has added to the deteriorating cost competitiveness. For Finland the ratio of the export-price-deflated real effective exchange rate (REER) to the total economy unit-labour-cost-deflated REER (Graph 2.2.8) falls below the ratio vis-à-vis manufacturing unit labour-costs-deflated REER (Graph 2.2.7). This indicates that unit-labour costs of the total economy have risen faster than in 37 industrial competitor countries. Although the indicator in Graph 2.2.7 suggests that the manufacturing sector has recently been able to stem the loss in competitiveness, the divergence of the open sector and developments regarding total economy unit labour costs reveals that cost pressures on exporting firms stemming from the economy’s closed sector could still weigh on external competitiveness. Compared with peer countries, Finland’s position deteriorated especially in 2008-2009.([10])

Graph 2.2.8: Ratio of export price deflated REER to total economy unit labour cost deflated REER, 1999-2014

Source: European Commission

Non-price competitiveness

External competitiveness challenges

The deterioration of Finland’s trade balance after 2002 indicates underlying weaknesses with regard to competitiveness. The trade indicators have reflected three simultaneous developments. Understanding them requires distinguishing export and import changes as well as separation of country-specific and global developments.

The first development that had a decisive impact on the trade balance is the worsening export performance, mainly on account of decreasing demand for selected Finnish products. This can be detected in the fall in the Finnish export market share. Although its deterioration has recently became smaller, it was especially significant in 2009 and 2010. The cumulated loss in market shares amounts to more than 32 % between 2008 and 2013, which is the largest in the EU-28, as also indicated by the latest Macroeconomic Imbalance Procedure scoreboard (Graphs 2.2.9 and 2.2.10). Importantly, before 2008, figures for the Finnish and the euro area export market share changed in line with each other, except for the crisis period in Nordic countries at the beginning of the 1990s; the Finnish market share started to suffer more only in 2009 (Graph 2.2.11).

Graph 2.2.9: Export market share development (%)

(1) Data for five year cumulative change are not available for Spain, Greece and Slovenia Source: European Commission

Graph 2.2.10: Export market share, Finland, annual change (%)

Source: Eurostat

Graph 2.2.11: Export market share, Finland, compared with the export market share of the euro area, (%)

(1) Total economy without Nokia is an illustrative estimation by the European Commission Source: UNCTAD, European Commission, Ali-Yrkkö, Jyrki (ed.), Nokia and Finland in a Sea of Change, 2010, ETLA B 244. updated, http://www.theglobeandmail.com/report-on-business/economy/economy-lab/how-finlands-economy-became-hooked-on-nokia/article618622/

The decline in the Finnish export market share mainly stemmed from the collapse of the export market share of goods, which decreased by 34.5 % (i.e. from 0.68 % to 0.45 %) between 2008 and 2013. In 2013, Finland seems to have made gains in its export market shares in goods for the first time since 2007. But since this was outweighed by a further deterioration in the export market shares of services, overall a further drop was recorded in 2013. In addition, not only did exports decline but also the domestic value-added content of exports (Graphs 2.2.12 and 2.2.13).

Graph 2.2.12: Domestic value-added content of export, Finland (% of GDP)

Source: AMECO, OECD, European Commission

Graph 2.2.13: Domestic value added of foreign demand, change between 2000 and 2009, % of GDP

Source: OECD, European Commission

Finnish export market shares decreased in most product categories between 2000 and 2013. Importantly, products with the largest export share in 2000, i.e. electrical and electronic equipment, paper, selected machineries and wood products, were among those that witnessed the biggest decline in their market share. The same sectors explain the fall of value added in final foreign demand amounting to 5 % of GDP between 2000 and 2009, which was only partly counterbalanced by the improving performance of business services. These products were also among those that globally lost the largest share in trade (Graph 2.2.14).

Graph 2.2.14: Export developments by product category between 2000 and 2013

(1) Based on Harmonised System of World Customs Organisation, 2-digit level categories (2) Surface of bubbles represents the share of product category in Finnish exports in 2000 Source: Comtrade, European Commission

Similarly to its decisive role in the boom period, the collapse of Finnish mobile handset exports accounts, in itself, for around half of the total decrease in the Finnish export market share of goods. The share of mobile handsets in the Finnish goods export declined from 13 % in 2000 to 1 % in 2013. This also reduced the share of high-tech products in Finnish exports from around 20 % at the beginning of the 2000s to around 5 % in 2013. Filtering out the impact of the trade in mobile handsets, the accumulated market share decline would have been close to 20 % between 2008 and 2013, i.e. still the largest in the EU-28. It illustrates that the loss in export market shares also concerned other goods and reflected an adverse change in the international demand structure from a Finnish point of view. The specialisation of the economy in products whose share decreased in total world trade, i.e. the composition effect stemming from the changing structure in world demand, explains one-third of the total fall in the export market share (Graph 2.2.16).

Although Nokia still has a significant impact on the Finnish economy, its role in the Finnish economy had been much more significant before it was severely hit by competitors on several fronts as of 2007. Around the turn of the millennium, Nokia directly made 3-4% of the Finnish GDP and accounted for around 30% of R&D, 1% of employment and more than 20% of total export of the country (Graph 2.2.15). Also, e.g. in 2003, it paid close to 23% of the total corporate tax. Despite the dominant role of Nokia in mobile handset production, the Finnish mobile telephone export never exceeded 10% of the world export. It suggests that the majority of the manufacturing and final assembly of the Nokia mobile phones took place abroad. Yet, Nokia usually created and recorded 40-50% of the total value added of its mobile handsets.([11]) In addition, the bulk (around 80%) of the value added created by Nokia was recorded in Finland in the first half of 2000s. Nevertheless, Nokia's share in the global value chain decreased over time and in the case of basic models, which targeted emerging markets and which were not only produced but also designed overseas, Nokia's share decreased to around 20%.

Graph 2.2.15: Nokia's contribution to the Finnish GDP (%)

Source: Ali-Yrkkö, Jyrki (ed.) Nokia and Finland in a Sea of Change 2010, ETLA B 244. updated

A shift-share analysis of factors behind trade developments, which also takes into account geographic factors, can nuance the picture further. It shows that the bulk of the fall in the export market share between 2000 and 2013 stemmed from the deteriorating performance in product and geographical markets. Initial product specialisation also negatively affected the export performance. These factors were slightly counterbalanced by the initial specialisation in fast growing economies. However, these data have yet not reflect the impact of the current contraction of the Russian economy, to which Finland is more exposed than most of other EU countries (Box 2.2.1 contains further details on the economic relationships between Finland and Russia.).

Graph 2.2.16: Components of change of Finnish export market share between 2000 and 2013

(1) Extended slices represent positive contribution Source: Comtrade, European Commission

The second main driver of the deteriorating current account and trade balance is the growth in imports for domestic demand purposes, although this factor is often overlooked. Import growth was boosted by the increasing consumption of households, in particular after 2008 (Graph 2.2.17) and by the growing import intensity of domestic demand from 23 % in 2000 to 26 % in 2011. Between 2000 and 2008, the increasing consumption ratio has reflected growing real consumption. Although real consumption of households declined in 2009, it quickly recovered in 2010 and 2011 and broadly stabilised afterwards. This, in parallel with a GDP that is still below its pre-crisis level, resulted in an increasing import ratio. After 2009, consumption was supported by improving real gross disposable income, which increased until 2011 and stabilised afterwards in light of the slow labour market adjustment (in both wages and employment) to deteriorating growth developments and due to enhanced current transfers to households. In short, despite the decline in national income, households could maintain their real consumption without decreasing their saving ratio.

Graph 2.2.17: Consumption of households and net exports (% of GDP)

(1) Net export (national accounts) is presented on inverse axis Source: European Commission

Export and import developments contributed broadly equally to the deterioration in the trade balance after 2000. This is suggested by the calculation that filters out from the foreign value-added content from exports and the export-related imports from the total import.([12]) In most countries, increasing specialisation lifted both export and import ratios. Also, the improvement of the export component usually over-performed the import component and so net exports typically improved in this period (Graph 2.2.18). However, in Finland, in parallel with the worsening export performance, imports for domestic demand kept growing and net exports became negative by 2011. Overall, the deterioration of net exports by 10 % of GDP reflected a lower export component of 4.8 % of GDP and a higher import component of 5.2 % of GDP (Graph 2.2.19).

Box 2.2.1: Foreign direct investment, trade linkages and especially energy tie Finland close to Russia

· Finnish foreign direct investment in Russia has increased over the last decade and at a faster rate than the total outward Finnish FDI stock. This has been a reflection of the business opportunities with above average profits seen in Russia. In 2013 the stock of direct investment stood at 1.4% of Finnish GDP, Russia being the 6th largest destination of FDI from Finland. Finnish companies operate mainly in Russia in retail, construction and manufacturing industries. The Russian investment stock in Finland has remained stable at 0.4% of GDP over the past 5 years. In 2013, Finland generated net primary income from direct investments in Russia of about 0.3% of GDP (in line with a very high rate of return of 24% in 2013). · Russia is Finland's third-largest export destination. Finnish exports to Russia consist of various manufactured products, from food stuff to capital goods. They amounted to about 10% of total exports in 2013. Russia accounts for around one fifth of total foreign imports of intermediate inputs used in producing Finnish exports. In services trade Finland generates most of the income in tourism. · Russia is Finland's first source of imports, mainly of raw materials, especially of crude oil and natural gas. In 2013, the value of crude oil and natural gas imports amounted to roughly 70% of total imports from Russia. Finland imports 100% of its natural gas and nearly 90% of its oil and coal from Russia. · Oil refineries in Finland are specialized in refining Russian oil. Russian oil is somewhat cheaper, but requires more processing than other oils in the market. The majority of transport fuels used in Finland are refined domestically, and more than half of the output of the refineries is exported. Net exports of refined petroleum products derived from petroleum coming from Russia stood at 1.4% of GDP in 2013. · Overall, energy dependency on Russian energy commodities amounts to around 40%. Domestic energy sources such as hydro power and wood fuels account for about 35% of the energy mix. Oil represents roughly one fifth, while natural gas in Finland's energy mix is currently below 10%. Close to 70% of Finland's gas consumption is used for district heating and electricity; in urban areas, district heating is virtually the only way in which households warm their homes.

Graph 1:Foreign Direct Investment from Finland to Russia and Energy Imports tie Finland close to Russia.

Source: European Commission, Statistics Finland, Customs Finland

Graph 2.2.18: Export and import component, EU-28, change between 2000 and 2011 (% of GDP)

(1) Distance from the red neutrality line indicates net export change Source: European Commission

Graph 2.2.19: Export and import component, Finland (% of GDP)

Source: Eurostat, European Commission

Finally, some global phenomena have affected Finnish gross trade numbers, but not the trade balance. In particular, world trade has permanently increased in light of the growing specialisation and international division of labour. Consequently, both the export and import ratios of Finland roughly doubled over the last two decades. Also, exports represent an increasing share of value added in other countries (Graph 2.2.20). In addition, the export market share of developing countries has increased at the expense of the developed countries. Specifically, the export market share of developed countries fell from 66 % in 2000 to 51 % in 2013.

Graph 2.2.20: Export and import ratio as well as foreign value-added content of exports, Finland (% of GDP)

(1) % of export Source: WIOD, European Commission

Furthermore, as a reaction to supply-side shocks, many Finnish companies restructured and relocated their production in order to optimise their participation in global value chains. This required initial foreign direct investment abroad, which took place primarily at the turn of the millennium (Graph 2.2.21). Also, the relocation of production, other things being equal, reduced Finnish gross trade indicators and the net export of goods. In line with this development, the Finnish goods export ratio lost its impetus after 2000. At the same time, this strategy enhanced the export of services, which kept growing between 2000 and 2008 and doubled in this period (Graph 2.2.22). In this way, despite the globalisation of production, companies could still create and record the bulk of the value added in their Finnish headquarters. Consequently, until 2008, the contribution to Finnish GDP of the domestic value added in exports remained broadly stable (Graph 2.2.12). Overall, relocation had only a limited impact on the GDP and trade balance of Finland. It also explains the limited improvement in the income balance of the current account, since the record of value added in subsidiaries abroad and the subsequent profit transfer to the home country was probably not dominant in the case of Finnish multinational companies.

Graph 2.2.21: Finnish foreign direct investment vis-à-vis the world and EU-28 (%)

Source: OECD

Graph 2.2.22: Export of goods and services, Finland (% of GDP)

Source: European Commission

Assessment of entrepreneurship

In advanced economies, beyond the traditional production factors, entrepreneurship capital has become an essential element of comparative advantage and growth. Depending on some conditions, entrepreneurship capital — i.e. the milieu of agents and institutions that is conducive to the creation of new firms — has a favourable impact on growth. It creates knowledge spillovers, increases the number of businesses, enhances competition, and instils more diversity among firms. Nevertheless, even among developed countries, the level of entrepreneurship and the distribution of firms by size can be different from country to country because of various reasons, including the business environment and cultural aspects.

The role of entrepreneurship and start-ups has recently increased, following a long downward trend, in particular in innovation-driven economies, according to studies. This is because of the way dispersion of innovation has changed and the role of entrepreneurs in it has increased. The increasing role of entrepreneurship capital reflects that it is not straightforward that knowledge or R&D always spills over due to its mere existence and the capacity to harness new ideas by creating new enterprises is also essential to economic output. In other words, ‘entrepreneurship capital may be a missing link in explaining variations in economic performance’.([13])

Young businesses tend to create a disproportionate number of jobs, in particular in the course of their start-up phase. Conversely, the largest contribution to job destruction comes from the group of small and mature firms. Importantly, while less than 10 % of start-ups grow above 10 employees, they provide a large part (sometimes even the majority) of total net growth of employment.([14]) Also, empirical analyses suggest that the high turnover rate of firms may increase competitiveness and growth potential for those who survive.

Overall, Finland has structural competitive strengths on which to build. Comparing the competitiveness indicators of various international organisations shows that Finland tends to do well when long-term structural indicators like education, R&D investment and quality of public administration are used. Thus, the country is consistently among the top performers for example in the World Economic Forum (WEF) rankings. However, the country scores less well (landing in the middle) when short-term cost competitiveness indicators are emphasised, like in the rankings of the Institute for Management Development (IMD). Ideally, for a country to be an attractive investment destination, both structural factors and the cost basis should be competitive. ([15])

The basic environment for entrepreneurship is good. According to the Global Entrepreneurship Monitor (GEM), entrepreneurship continues to benefit from Finnish governmental policies, easy access to financing and exceptional education. In addition, according to the latest GEM report, Finnish people perceive good business opportunities, even if there has been some decline in perceptions in line with adverse economic growth developments. In addition, the perception of entrepreneurial capabilities needed for starting a business in the adult population in Finland (33 %) is similar to the average for Nordic countries (35 %), although lower than the average in innovation-driven economies (41 %).

Finland is among the innovation leaders, and its export sector is specialised in top-quality products (Graph 2.2.23). Its innovation performance increased up until 2011 and remained stable afterwards, according to the European Commission’s Innovation Union Scoreboard 2014. Finland performs above the EU average for most scoreboard indicators. Compared with other EU countries, relative weaknesses relate to the involvement of smaller firms in innovation and in joint private-public co-publication and the openness of the research system.

Graph 2.2.23: Innovation and specialisation on top-quality export products

(1) EU-28, China, United States and Japan Source: Innovation Union Scoreboard 2014, European Commission calculation based on COMEXT (EUROSTAT) and ORBIS data

Nevertheless, the favourable business environment, the quality of institutions and the corresponding cultural and entrepreneurial attitudes cannot by themselves ensure higher levels of entrepreneurship.([16]) Currently, less than 10 % of small businesses ([17]) — i.e. businesses that employ 50 people or less — are start-ups in Finland, which is the second-lowest ratio in the DynEmp database.([18]) Conversely, close to 60 % of small businesses are older than 10 years, which is also an exceptionally high ratio (Graph 2.2.24). Compared with other countries, that means a relatively large share of small companies represents businesses that do not grow but still survive. Also, around 40 % of firms (around 38 % in manufacturing and 42 % in services) never grow above one employee in Finland, which is the highest ratio among the 18 countries studied (Graph 2.2.25.).([19]) The high share of small businesses that are also relatively old in general may indicate a misallocation of resources and may limit productivity growth as suggested by studies on misallocation.

Graph 2.2.24: Age composition of small businesses (%)

(1) Average over time, firms below 50 employees Source: C. Criscuolo, P. N. Gal and C. Menon (2014a), “The Dynamics of Employment Growth: New Evidence from 18 Countries”, OECD Science, Technology and Industry Policy Papers no. 14

Graph 2.2.25: Share of employment in firms never growing above one employee (manufacturing)

Source: C. Criscuolo, P. N. Gal and C. Menon (2014a), “The Dynamics of Employment Growth: New Evidence from 18 Countries”, OECD Science, Technology and Industry Policy Papers no. 14

The proportion of young companies — i.e. less than five years old — in small businesses is low in Finland for various reasons. First, the start-up rate, i.e. the fraction of start-ups among all firms, is the second lowest in the DynEmp database for every year since 2001 (Graph 2.2.26). Second, the growth potential of firms measured by employment is low compared with other countries.([20]) Third, a relatively large proportion of young Finnish firms does not grow bigger in terms of employment and still survive. Overall, in Finland, the contribution of young small and medium-sized firms to gross job creation is the lowest among the observed countries. Also, Finland and Italy are the only countries where the contribution from entry of firms to job creation is smaller than the contribution from young incumbents’ growth.

In addition to these long-term indicators, Finland’s small and medium-sized enterprises (SMEs) have been slow to recover from the 2008 crisis, in particular in employment terms. For value added, Finland´s SMEs have recovered relatively well from the initial shock; however, the number of employees fell by more than 2.1 % between 2008 and 2013. The jobless recovery of the Finnish SME sector is forecast to continue at least in 2015. While value added is expected to continue to grow slightly, SME employment is forecast to decrease by more than 1 %.The number of SMEs is expected to continue to fall.

Against this background, the Finnish government has implemented several measures to increase entrepreneurship and support start-ups. Finland´s profile in implementing the Small Business Act (SBA) continues to be one of the strongest of all Member States.([21]) The results of these efforts cannot be assessed ex-post yet since hard data are available only up until 2011. Nevertheless, soft — i.e. survey data — are accessible for recent years. According to the latest GEM survey, only 9 % of the non-entrepreneurial adult population has entrepreneurial intentions in Finland. This is significantly below the 14 % average of innovation-driven economies (for instance, USA 17 %, Sweden 11 %). Although established business ownership in Finland is at the average of innovation-driven economies, nascent entrepreneurship ([22]) is one of the lowest among the innovation-driven countries (2.7 % against 4.7 %). Also, early-stage entrepreneurial activity and non-established renewal of entrepreneurship are below the average.([23])

Graph 2.2.26: Start-up rates

(1) The graph reports start-up rates (defined as the fraction of start-ups among all firms) by countries, averaged across the indicated three-year periods. Start-up firms are those firms which are from 0 to 2 years old. Source: C. Criscuolo, P. N. Gal and C. Menon (2014a), “The Dynamics of Employment Growth: New Evidence from 18 Countries”, OECD Science, Technology and Industry Policy Papers no. 14

Even more striking is that few Finnish entrepreneurs plan to expand employment significantly. In 2014, only 15.7 % of early-stage entrepreneurs intend to employ at least 5 people in the next five years. This figure is below the average for the innovation-driven economies and the average of the previous years (Graph 2.2.27).

Graph 2.2.27: Growth expectation of early-stage entrepreneurs in innovation-driven economies

(1) Percentage of early-stage entrepreneurs who expect to employ at least five employees in five-years'’ time (2) For 2001-2008 and 2009-2014, figures are indicated only if at least two data points are available Source: Global Entrepreneurship Monitor

Similarly, only 22 % of early-stage entrepreneurs were innovatively oriented in 2013. This is again clearly below the average for innovation-driven economies. This represents a further deterioration since 2012. This is surprising since, based on GEM surveys of 30 countries, there is a positive relation between innovative entrepreneurship and tertiary education, self-confidence, opportunity perception — and a positive impact of GDP per capita on the probability of innovation among nascent entrepreneurs, i.e. the very that factors are among the strengths of the Finnish economy.([24])

Also, the international orientation of Finnish early-stage entrepreneurs is low. Only 11 % of them expect the share of international customers to be more than 25 %, which was one of the lowest values among the innovation-driven economies in 2013. This is again remarkable, since the relevant literature ([25]) revealed (i) significant positive relationship between measures of export-oriented early-stage entrepreneurship and the level of per capita income for various Asian countries and (ii) positive correlation between high-growth expectation entrepreneurial activity and per capita income ([26]). The relatively low intention of Finnish early-stage entrepreneurs to expand internationally does not seem to reflect the cyclical position of the economy since similar figures also characterise the pre-crisis period.

Surveys reveal some reasons behind the relatively low entrepreneurship capital in Finland. In Finland, only 24 % of respondents say they favour self-employment, according to the latest Eurobarometer survey on entrepreneurship, which was carried out in 2012. This ratio is lower than the EU average of 37 % in 2012 and also substantially lower than the previous Finnish ratio of 41 % recorded in 2009. Although the increasing preference in recent years to being an employee was a common development among EU Member States and may be related to negative economic conditions, the fall of 17 percentage points is twice as high as the reduction of 8 percentage points at EU level. The preference to being an employee opposed to being self-employed is a structural characteristic in Finland: it was already revealed in good economic times by previous surveys, such as the 2007 Entrepreneurship Survey of EU-25.

With regard to setting up a business and becoming self-employed, Finnish people have various concerns. They are more afraid of having irregular or non-guaranteed income (41 % against 33 %) and devote much more energy or time to the actual setting-up (33 % against 13 %) than the EU average.([27]) A third of respondents said that becoming self-employed in the next five years would have been feasible, which slightly exceeds the EU average. Those Finns who preferred self-employment identified the most frequent advantages to be independence and self-fulfilment, and freedom to choose the place and time of working. The reference to the latter significantly exceeded the EU average (47 % against 30 %). However, better income prospects were a less dominant motive than at EU level. These results in the 2012 entrepreneurship survey confirmed the outcome of previous surveys. It is interesting to note that among those who had left Nokia, fewer people choose companies that are less than two years old (start-ups). While this ratio was 34 % between 1995 and 2000, i.e. at the time of an IT-boom never seen before, it decreased to 15 % between 2008 and 2010 ([28]). This supports the findings of the attitude survey.

The 2013 Global Entrepreneurship Monitor report for Finland concluded that entrepreneurial activity in Finland ‘struggled to maintain its position in the middle-league. Despite the supportive policies and environment for entrepreneurship, positive perceptions on business opportunities and needed competences do not turn into start-ups and new businesses. Finland may have potential entrepreneurs with new ideas and skills, but lacks the ones who take the initiative and exploit the opportunities.’

In conclusion, the low birth rate of start-ups and the large number of businesses that stay small imply that the process of creative destruction is less powerful. It also limits the favourable impact of the generally outstanding business environment.

Indebtedness

Private sector debt has stabilised at a high level. The increase over the past decade was particularly pronounced during 2007-09. Over 2010-13, the debt ratio was stable between 169-170 % of GDP. Private sector debt is mainly (close to two thirds) composed of non-financial corporation debt (NFCs), as indicated in Graph 3.3.1. Finnish households and non-financial corporations are relatively highly leveraged as seen in the high debt-to-assets ratios. However, these ratios have not increased in Finland in recent years.

Graph 2.3.1: Breakdown of debt by sector (non-consolidated) — Finland

Source: European Commission

High levels of debt do not appear to be posing near-term risks or challenges to the economy. Although the level of debt is relatively high, servicing costs are currently low thanks to the very low interest rates. High levels of corporate debt have not been a factor hampering the restructuring of the economy, as access to finance remains good. The Finnish corporate sector, on aggregate, is a net lender in national account terms.

Assessment of the financial sector

Risks to financial stability are likely to be limited as the Finnish financial sector appears strong. In November 2014, the last month for which data is available, credit to households grew 2 % year-on-year (Graph 2.3.2). The growth in mortgage loans remained moderate (1.6 %), while consumer credit increased rather well, by 4.4 % year-on-year. Loans to corporations increased by 4.6 % year-on-year in November. This is a minor slowdown compared to earlier in 2014 when growth ranged from 5-6 %. The ratio of corporate credit to GDP remained rather constant, at about 35 %. Corporate sector deleveraging in Finland has been relatively small and brief, happening only in 2009. Finally, lending to government increased by 11.1 % in November 2014. Bank credit to the government has been growing fast since 2009, increasing its share in GDP from 3 % to 6 %.Thus, credit continued to expand despite the recessionary environment. Low interest rates have been among the key factors supporting this trend. The credit expansion suggests that both private and public borrowers benefit from the ample liquidity in the market and have no significant problems in accessing finance. Surveys provide similar indications.

Graph 2.3.2: Lending to households (HH) and non-financial corporations (NFC) in Finland

Source: European Central Bank

In 2014, the 7.7 % of GDP net financing of Finnish banks to the economy was the highest in the euro area. In nominal terms, it amounted to EUR 15.7 billion, including EUR 2.8 billion for the government, EUR 8.2 billion for the private non-financial sector and EUR 4.7 billion for other assets (Table 2.3.1). In addition, Finnish banks were net lenders to other euro-area banks (EUR 3.9 billion) and non-euro area economies (EUR 1.1 billion). These claims were financed by the increased issuance of capital and debt on financial markets (EUR 8.8 billion) and a further reduction of cash reserves deposited at the Eurosystem (EUR 11.7 billion)([29]). Regarding the latter, bank deposits at the central bank fell from their peak of EUR 80 billion in 2012 to EUR 10 billion by 2014. This constitutes a normalisation as the 2012 figure was inflated due to the inflow of liquidity to Finland in 2011-12, driven by the safe-haven effect during the euro-area sovereign-debt crisis.([30])

Table 2.3.1: Financial flows involving banking sector, 1-10/2014 - Finland

Source: European Central Bank

Financial soundness indicators remain at comfortable levels. The supervisory data showed a certain increase in loan impairments during 2014, breaking a long-standing downward trend.([31]) Nevertheless, the average non-performing loan ratio below 1 % is among the lowest in the EU (Table 2.3.2). Capital adequacy ratios also deteriorated slightly in the first half of 2014, but recovered again in the third quarter. Profitability indicators for the sector are close to European averages. The European Central Bank’s October 2014 Comprehensive Assessment confirmed that the three largest banks, which account for more than three quarters of the market by assets, have sufficient capital buffers to withstand tough conditions. Under the stress test's adverse scenario, the average market capital-adequacy ratio would decrease to a Common Equity Tier 1 ratio of 11.6 % by 2016.([32])

Table 2.3.2: MFI Soundness Indicators - Finland

(1) 2014 refers to data up to 2014-Q2 Source: European Central Bank

Household debt and the housing market

The main driver of the rising household debt was the rapid growth in mortgage loans before the financial crisis, but recently the growth in debt has decelerated markedly. Household debt has reached 120 % of household (net) disposable income. The substantial increase in household debt occurred between 2002 and 2009 when the ratio of loans to net disposable income rose from 70 % to 110 %. The average proportion of mortgage debt in total household debt over the past 15 years was about 89 %. As the ratio has remained relatively stable, other debt components also increased. Reflecting the renovation needs of existing urban dwellings, related loans were mostly taken out by housing associations. But ultimately, these have to be paid back by households. They are therefore included under the headline household sector long-term loans in Financial accounts.([33]) The latter have continued to grow rapidly compared with the growth in mortgage loans: Currently, loans taken by housing associations are growing by more than 10 % year-on-year while mortgage loans are increasing by slightly below 2 %.

Graph 2.3.3: Household sector loans by type of loan

(1) Type F4 Loans include short-term and long-term loans (F42). Type F42 includes housing associations' loans, for which households are responsible. Type F429 loans include other long-term loans including households' mortgages. Source: Statistics Finland, European Commission

The interplay of increasing disposable income and real house prices, lower interest rates, and longer mortgage maturities, explains the rapid growth in mortgage debt in 2002-10. In Finland, the majority of mortgages are tied to variable interest rates. That is why almost without exceptions in the 2000s, average interest rates for mortgages have been below the euro area average and were gradually decreasing. The increase in reference rates just before the financial crisis slowed down the growth in mortgage debt to some extent. According to surveys,([34]) the maturity of new mortgages increased from an average of 11 years in 1998, to around 16 years in 2005 and to 17 years in 2014.

Graph 2.3.4: Average mortgage rates - selected countries

Source: European Central Bank

Finally, nominal and real house prices continued the rapid increase that started in the mid-1990s until the financial crisis in 2008. After the crisis and subsequent recovery with a house price rally in 2010, the increase in nominal house prices has gradually turned into a slight decline observed very recently (Graph 2.3.6). Real house prices have declined since latter half of 2011 in line with a weak economic situation. Despite the fall in house prices during the crisis in the early 1990s, house prices in Finland over the 1990-2014 period, rose altogether by 80 %. In the capital region, nominal house prices have roughly doubled over the same period (Graph 2.3.5). This reflects the inland migration towards metropolitan Helsinki and other urban regions. However, the ratio of nominal house prices to household disposable income remained below the 25-year average between 1994 and 2009. This is explained by the fact that households enjoyed a period of good income growth during the robust economic times as both employment and wages grew.

Graph 2.3.5: Nominal house prices by region, 1990=100 — Finland

(1) The capital region includes Helsinki, Espoo, Kauniainen, Vantaa. Source: Statistics Finland

Graph 2.3.6: Growth of house prices and loans by monetary financial institutions for house purchases — Finland

Source: Statistics Finland, Bank of Finland, European Commission

The ability of households to service their debts is currently assessed as adequate. Although household debt has increased, interest expenditure, as a share of disposable income, has decreased significantly from the peak reached in 2008. By the end of 2013, interest expenditure amounted to less than 2 % of disposable income. This is lower than in 2004 when the debt level was 40 percentage points lower compared with the net disposable income. As a risk controlling measure, many Finns prefer fixing their monthly loan payments. A rise in interest rates often translates into a lengthening of the loan maturity rather than an increase in the monthly payments. In 2012, 46 % of households taking mortgages opted for this solution.([35])

Graph 2.3.7: Leverage, households — Finland

Source: European Commission

Household assets include financial and non-financial assets. Household assets included, at the end of 2013, EUR 85bn in the form of currency and deposits, EUR 97bn in shares, and receivables worth EUR 46bn in insurance and pension plans. Non-financial assets amounted to EUR 413bn, most of this being comprised of dwellings and land. Altogether, household financial assets thus accounted for 112 % of GDP compared with debt of 69 % of GDP. Household leverage has increased, although the increase in financial assets has held back the increase in the debt-to-financial assets ratio, which currently stands at 52 %.

Graph 2.3.8: Household debt — Finland

Source: European Commission

Current house prices are somewhat above the long-term average. House prices in Finland, when seen in relation to the private consumption deflator, disposable income per capita or the index of wages and salaries show that the valuation of housing is currently somewhat above the 25-year average. House price developments have decoupled especially from developments in the private consumption deflator, as currently the house-prices-to-private-consumption-deflator ratio is more than twice as high as ratios calculated with respect to disposable income per capita or the index of wages and salaries. All these indicators are, however, currently converging towards their long-term levels, but no sharp adjustment is expected.

Graph 2.3.9: Housing market valuation — Finland

Source: Statistics Finland, European Commission

Prior to the financial crisis, a rather rapid increase in inflation-adjusted house prices was observed in several countries, including Finland. However, real house prices have remained relatively stable in Finland over recent years. Earlier analysis suggests that, generally, the current valuation of housing in Finland has responded to supply and demand factors in the market.([36]) On the demand side, inland migration towards urban areas and net-immigration into Finland should support the demand for housing. In the capital region, especially in Helsinki where prices appear more dynamic than in the rest of the country, homebuyers prefer central locations. Because an increase in supply of new housing is nearly impossible in these areas, house prices are pushed higher.

Graph 2.3.10: Real house prices — selected countries

Source: European Commission

Regional data suggests that higher housing valuations seem to be linked to lower residential investment. In many Finnish regions, the average ratio for residential investment per capita between 2008 and 2011 was below the average in 2004-07. The regions that witnessed the largest fall in the ratio also witnessed the largest increase in the overvaluation of housing measured as the ratio of regional house price to disposable income. Residential investment adjusted for population fell especially in the greater Helsinki region, where overvaluation is one of the highest. On the other hand, regions that have suffered from downsizing of forest or electronics industries have seen their housing valuations fall.

Graph 2.3.11: Falling residential investment associated with higher housing valuations, regional data

Source: Statistics Finland, European Commission

The ratio of house prices to building costs also indicates some shortfall in residential investment. The observed increase in the ratio should imply more profitable residential building projects for producers (Graph 2.3.12), thereby increasing residential investment. However, the ratio of residential investment to GDP has remained rather stable at 5-7 % of GDP in recent years.

Graph 2.3.12: Incentives to invest fail to increase residential investment

Source: Statistics Finland, European Commission

Debt of non-financial corporations

At the end of 2013, the debt of non-financial corporations totalled around 120 % of GDP. While it had increased during the crisis, the ratio remained relatively stable over recent years. The debt-to-financial assets ratio has remained stable. The structure of non-financial corporation debt is diversified. Around 40 % of debt stems from lending by Finnish monetary financial institutions In terms of the origin, 25 % of the debt stems from the issuance of long-term bonds. Other elements include lending from the rest of the world, lending from Finnish non-banks, lending from employment-related pension-insurance institutions, lending from the public sector and short-term bonds (a very small share).

Corporate indebtedness does not derive from specific legal norms giving preference to debt financing over other forms of financing. Over recent years, low interest rates have facilitated access to, and use of, credit. Finnish companies access credit for investment, and for working capital purposes. Loans from Finnish monetary financial institutions loans have mainly (49.4 %) gone to finance real estate activities (including loans to housing corporations). A total of 11.2 % of the loans are for manufacturing companies, and 5.2 % for the retail sector. However, bond debt is mainly issued by large manufacturing companies.

Graph 2.3.13: Leverage, non-financial corporations — Finland

Source: European Commission

Finnish SMEs have relatively good access to bank lending, although about 40 % of firms making use of external financing have noticed that loan conditions have tightened. The continuing uncertainty about export prospects has kept investments low and external funding has mostly covered working capital needs. To promote the growth of innovative firms, the government has considerably increased the availability of venture capital, having invested EUR 105 million in 2014 and planning to invest the same amount in 2015, with a further EUR 55 million both in 2016 and 2017 through Finnish Industry Investment, Finnvera and Tekes. The target is to leverage more than EUR 1 billion of total venture capital investment. Increased venture capital investment requires better exit opportunities for investors. This has been identified as an area requiring improvement, including through changes in the tax treatment of listed firms. Furthermore, there have been increases in tax incentives for business angel investments and an industry-led initiative to standardise the terms of bond issuance. Furthermore, a corporate bond marketplace was introduced in 2014. Firm growth is also promoted through a programme of ten accelerators comprising about 100 portfolio firms in total.

Graph 2.3.14: Balance sheet, non-financial corporations - Finland

(1) A stands for assets, L stands for liabilities Source: European Commission

Deleveraging

In Finland, the household deleveraging process has not taken hold so far. The debt of non-financial corporations appears to have peaked in 2010, but household debt is still on an increasing trend. Since then, some de-leveraging has occurred, although the debt level has not declined significantly. Credit flows were positive over the 2008-2013 period for non-financial corporations and for households and real GDP decreased. Inflation has been rather modest. Thus, credit flows and real GDP growth have increased the debt-to-GDP ratio while nominal GDP growth has reduced it through the denominator effect.

Graph 2.3.15: Breakdown of year-on-year changes in debt-to-GDP ratio, households (ESA 2010) — Finland

Source: European Commission

Potential deleveraging pressures are likely to be limited in Finland. Household deleveraging needs are not found to be significantly big while non-financial corporations have recently recorded a slight decline in their indebtedness. Especially if seen in the light of its steady increase over the 2000s, the rather high level of indebtedness of households could point to some potential deleveraging needs for Finnish households. However, the strength of the Finnish financial sector implies that the private sector faces low deleveraging pressures from the credit supply side. In addition, micro-level data on the distribution of household debt in Finland does not point to concentration on the more fragile parts of the population. Similarly, corporate indebtedness is not concentrated in low-profit, or low-capitalised firms (Table 2.3.3). This can be seen as a mitigating factor for what is on the surface the relatively high level of overall indebtedness. Thus, if any deleveraging is to be expected, it will likely be gradual, driven by the nominal debt stock increasing at a lower rate than nominal GDP growth rather than negative net credit flows, implying no substantial drag on aggregate demand and lower stress for asset markets. However, should overall economic conditions worsen (including, for instance, through adverse shocks to the financial sector or to the housing market) estimated excess indebtedness of households or firms could materialise in negative credit flows and a nominal contraction of balance sheets. These risks, however, are assessed as contained since the financial sector is healthy and mortgage interest rates are likely to remain low.

Graph 2.3.16: Breakdown of year-on-year changes in debt-to-GDP ratio, non-financial corporations (ESA 2010) — Finland

Source: European Commission

Table 2.3.3: Non-financial corporations debt to profits and debt to capital -distribution

(1) The results on the distribution of corporate debt are based on a firm-level dataset from the Bureau Van Dijk's Orbis database. The data refer to the fiscal year 2013, which on the date of the download (December 2014) were available in Orbis for a large majority of firms, but not for all. Subsidiaries of resident companies with consolidated financials were excluded to avoid double-counting. Firms operating in finance and insurance, public administration, health and social services, and education, were excluded. Debt is defined as the sum of loans and non-current liabilities. Capital employed is the sum of debt and equity. Earnings before interest, taxes, depreciation and amortization (EBITDA) are directly taken from the database. The thresholds for debt/capital employed (70 % and 90 %) and the debt/EBITDA (6x and 12x) are approximately equal to the 75th and 90th percentile across the pooled sample of firms from fifteen EU countries (which include vulnerable and core countries). Reported figures represent the share of debt held by firms in a given solvency bucket, as a percentage of the total amount of debt. Source: Orbis, European Commission

An important factor determining deleveraging among households is the distribution of debt across households. Aggregate measures of debt at the level of the sector could hide deleveraging risks if debt is more concentrated among households with few assets and low incomes. Another important element is the level of debt-servicing costs relative to incomes, which will drive the short-term sustainability of debt. In Finland, 45 % of households did not have any debt at all in 2012. One in four households have a debt burden that does not exceed 100 % of their annual income and 10 % are in the range between 100 % and 200 %. About 15 % of households have debt between 200 % and 400 % and only a small number of households have higher debt. The low non-performing loans ratio suggests that the banking sector has been successful in allocating loans to customers who have been able to service their debt. In the current environment of low interest-rate, even households with debt at 500 % of their disposable income use less than 10 % of their disposable income for interest payments.

Overall, the analysis in this section indicates that risks associated with the debt burden are limited. Since the crisis, households have faced a relatively quick increase in their debt burden. The debt burden has broadly stabilised at a level that is slightly above the euro-area average, but is lower than in other Nordic countries. Household debt mainly takes the form of mortgage debt and tends to be linked to variable interest rates. Recent declines in interest rates have reduced the burden of servicing the debt, but also reduced the incentives to deleverage. Housing market indicators do not raise any concern for strong over-valuation in this market. Corporate sector debt has also stabilised. Lending decisions by banks appear to be prudent, as demonstrated by thy low amount of non-performing loans. Strong capitalisation of banks implies that there is no pressure to deleverage from the credit supply side.