Prime Minister Matti Vanhanen at a seminar organised by ETLA

“Small open Nordic Economies” Publication
Nordics in Crisis – the perspective of a political decision maker

(check against delivery)

Ladies and Gentlemen

The book published today deals with an important theme: how do we - by we I mean the Nordic and other advanced, economically open countries - remain successful in a world that has proved unexpectedly volatile.

There have been two big surprises for us in the past two years. First, how could a several-decades-long period of continuous high growth of the global economy so suddenly end in a crisis. Second, how could our own economies suffer so much even if we by so many measures have been among the strongest in the world.

The book gives us explanations. China and some other emerging economies saved too much of their incomes which they earned thanks to globalisation. Those savings they used to finance excessive consumption and bad investments in the West. Banks and other financial institutions in the developed world, in the US in particular, took and induced the economy as a whole to take too much risk. Policymakers trusted far too much on markets and their capacity to control risk without regulation.

The issue what to do was never more pressing than in the weeks following the Lehman bankruptcy in mid-September 2008. That was also an occasion on which the experience we in Finland had from our own crisis in the early 1990s was very useful. One thing simply was that we knew roughly what type of decisions need to be taken to manage an acute financial crisis when liquidity is drying up and key institutions are about to collapse; there was no need to panic.

From a domestic perspective the immediate situation was in fact not too bad. Our banking system was, as it still is, solid. The only serious immediate problems pertained to the Icelandic banks which had presence in Finland. Those could be solved relatively easily, with only minor intervention from the Finnish Government’s side.

More important was that our experience was useful for decision-making more broadly in Europe. When I met with Prime Minister Gordon Brown on 8 October, he was very interested in how we had approached banks’ problems in securing funding in our own crisis.

Similarly, in the preparation of the extraordinary meeting by the euro area Heads of State in Paris on 12 October, our experience of bank recapitalisation received a lot of attention, and I would argue, shaped the outcome of the meeting.

I would also claim that the strong decisions in Paris on offering large capital injections and debt guarantee schemes in all countries were central in calming down the global panic. The US authorities in fact took the same line on bank recapitalisation soon after our decisions in Paris had been taken.

The economic developments over the past year have shown that the crisis policies have been successful at all levels, domestically, at the European level and at the global level. A new Great Depression has been avoided globally and our own economy has also started to recover. However, this is just a short-term success which is largely based on huge public sector deficits both in Europe and overseas.

Here we face a genuine dilemma. The fiscal stimulus that has been essential in arresting the fall of activity and in getting us on the recovery path has to be turned into fiscal consolidation at some point. From the point of view of fiscal sustainability, this should happen sooner rather than later. At the same time, we should keep growth going. Remember that unemployment is not just high but still increasing.

In my view the only way to square this circle is to find and implement policy packages that increase productivity through material and immaterial investments and encourage labour supply, while they at the same time very strongly limit the overall growth of expenditure and produce additional tax revenues.

I know that higher taxes are not good for growth per se. But in my view we must learn the lessons of the last crisis and therefore increasing taxation is unavoidable. The fiscal equation is too difficult to avoid it. That the Nordics have been able to prosper with relatively high tax levels, and that the Finnish tax ratio is the lowest in this group, tells me that there is some room for manoeuvre.

This brings me to a central issue of policy-making: policies must address the real problems effectively – which often means a lot of pain for many people – while they at the same must be acceptable to the people in a democratic decision-making process.

In my mind, two things are essential to meet these easily conflicting objectives: honesty about the problems and fairness in solutions. The gravity of the situation and the options – however unpopular – must be laid out clearly to the people. At the same time, we must seek solutions that truly can be perceived, to be fair.

Particularly in the Nordics, a substantial share of public expenditure benefits the poor, while the tax system is broadly-speaking progressive. Therefore, basing fiscal consolidation only on the expenditure side measures would be unfair, even dangerous.

The unbalanced management of the last crisis marginalised thousands of Finns, especially young ones – stimulating a completely new unfortunate socio-cultural development in this country. Meantime we have also changed our immigration policies implying further risks of marginalisation. Now we simply cannot afford to create a new wave of marginalisation in this country. The better-off people, in fact all of us, must bear their share of the burden.

When implementing necessary but painful measures, free-riding by the few privileged ones poses a particular problem. I well understand the outrage of the people in many countries who have to tighten their own belts when they read about the huge bonuses that bankers are paying themselves, particularly when many banks continue to exist only thanks to the support from the government.

The issue is not whether the bonuses provide appropriate incentives to the executives and dealers, which I guess depends on how the bonus systems are designed. The point is the discrepancy in how people get treated.

The crisis we have experienced raises a more general issue of how deeply the government should intervene in the workings of the market economy. I consider private initiative and well-functioning markets key prerequisites for a dynamic economy. Nevertheless, in my mind, there is no doubt that the positive role of the State will increase from what we have been used to have. In some countries the financial market regulation in existence has been inadequate to limit risk-taking sufficiently. Many processes are underway to change that, and by and large, I think, it is a good thing.

But I also think that the role of the State will not be confined to financial regulation. Neither is the government returning to the last century models of activity. On the contrary we must find the instruments that respond to the needs of the decades to come.

When the center of gravity moves in the technologies and in the whole economy, the government must guarantee that the universities and the educational system respond early to the emerging needs. For example, today we can see that yesterday’s innovations are becoming tomorrow’s mass production and tend to leave us. Therefore government must be active in developing dynamic preconditions for new production. In the global economy it means often focusing in the early creative stages of the value chain, which can produce sustainable value in Finland. This is why we have, for instance, reformed our university system and founded Aalto University.

Or it may quite well be that private investors consider risks in investing in new technologies to combat climate change too big. If the private sector cannot act, the government cannot shy away from the responsibility in an appropriate way. Also, speaking about infrastructure investments does not mean a U -turn to last century but gearing forwards to create conditions for mobilising all our bio-, nature- and mineral resources to serve the welfare of the nation.

Similarly, I’m sure that policy makers will be more willing than in the past to use macro policies to prevent financial bubbles, difficult as it may be.

You may call it the reformed Nordic model or the third way. I am open to use both of these terms. And I might add to them neo modern partnership between government, society and business.