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Finland: Selected Issues

Author(s):
International Monetary Fund
Published Date:
November 2001
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II. Labor Market Challenges: Job Creation IN THE Services Sector1

A. Introduction

1. Finland’s economy has undergone a fundamental structural change over the course of the past ten years. In the early 1990s, Finland experienced economic recession and a breakdown of its traditional patterns of external trade. In the aftermath, a strong information and communications technology (ICT) sector developed and forms today the backbone of the Finnish export-oriented economy. Over the period 1998–2000, the electronics industry alone (and in particular Nokia) contributed 1½–2½ percentage points to Finland’s average annual real GDP growth of 5 percent. However, despite the sector’s strong contribution to economic growth, it accounted for only close to 5 percent of total employment in 2000, and contributed little to lowering high unemployment in the low-skill segment of the labor force.

2. Notwithstanding strong economic growth into 2000, Finland’s unemployment rate remained among the highest within the OECD. Unemployment as a percentage of the total labor force was the fourth lowest in the OECD at the beginning of the 1990s. With the start of economic recession, the unemployment rate increased rapidly from 3.6 percent in 1990 to 16.7 percent in 1994 (the second highest rate in the OECD after Spain). Subsequently, it decreased to 9.8 percent in 2000, but it was still among the highest rates within the OECD and the EU, despite the strong economic upturn. At the same time, high-skill manufacturing businesses, and services at all skill levels, showed signs of emerging labor supply shortages according to survey information from the Employers’ Confederation of Service Industries in Finland.

3. Improving the functioning of the Finnish labor market would contribute significantly to economic growth and the soundness of the public finances. Changes in labor demand reflect the underlying evolution of skill requirements across the various sectors of the economy. The ICT sector has high skill requirements in both the industry itself and related business services. Meanwhile, the demand for lower-skill labor would be more pronounced in personal and other low-productivity services, but the compression of the wage scale inhibits wages from adequately reflecting productivity. This, combined with incentive traps that discourage entry into the labor force, aggravated by a high tax wedge, contributes to a gap between supply and demand in the market for low-skill labor. With the rapid aging of its population, Finland will be confronted with two challenges: pressures on fiscal spending will rise while the demand for personal services can be expected to increase. Market-based policies that improve the functioning of the labor market—and generally broaden the employment base—can help respond to these challenges.

4. Against this background, this paper assesses the services sector and its potential for employment creation, in particular in the area of personal services and other services with low skill requirements. Section B examines available data on the services sector, with a view to identifying categories of services with potential for future growth. In Section C, the paper assesses whether labor market and other factors impede employment growth in the services sector. Finally, in Section D, the paper offers concluding remarks, highlighting specific actions that could be considered to enhance the prospects for employment creation in the services sector.

B. A Closer Look at Some Relevant Data

Unemployment Developments

5. Unemployment remains very high among low-skill workers, despite the downtrend in the overall unemployment rate. At 9.8 percent in 2000, the Finnish unemployment rate had declined by 6.5 percentage points from its 1995 level. Unemployment varied considerably across regions, age groups, and by gender, but most notably across skill levels. Unemployment of low-skill workers2 was high by EU standards across all age groups, but it was particularly high among persons aged 15–24 years and 50–59 years, with unemployment rates of 40.4 percent and 11.9 percent, respectively.3 While younger workers could theoretically still acquire the skills and qualifications necessary for employment in high-productivity sectors, this is more difficult for the older unemployed. Indeed, the number of unemployed older workers fell by 7.5 percent between 1997 and 2000, compared with a drop of 21.5 percent for all unemployed. Moreover, the “effective” unemployment rate among older workers is much higher, in light of the readily available incentives to take early retirement.

6. The continued outward shift of the Beveridge curve suggests a growing share of structural unemployment in total unemployment Based on Finnish data for the 1990s, Figure 1 shows the Beveridge curve, which relates the vacancy rate to the unemployment rate. The outward shift of the curve during the past decade—implying higher vacancy rates coinciding with the same rate of unemployment—reflected both a growing mismatch in qualifications and skill-requirements, and disincentives for labor demand and supply, stemming from tax- and benefit-related distortions.

Figure 1.Finland: The Beveridge Curve

(1990–99)

Sources: Finnish authorities; IMF staff calculations.

Employment in the Services Sector—An International Comparison

7. The employment share of the Finnish services sector increased over the past decade, but remained low by international standards (Table 1). The services sector is today by far the largest sector in advanced economies, accounting for about 70 percent of total employment on average in a group of broadly comparable OECD economies, and a slightly smaller share of total value added. However, in 1999, the share of the services sector in total employment in Finland was 3⅓ percentage points below the average for other countries.4 The table also shows that Finland is the only country where the employment share of services decreased between 1994 and 1999.

Table 1.Finland: Employment Shares of the Services Sector(In percent)
198919941999
Austria63.065.367.0
Denmark71.473.274.4
Finland65.069.368.5
France68.271.573.6
Italy60.163.064.7
The Netherlands69.772.973.8
United Kingdom70.375.376.4
United States73.775.976.3
Average567.770.871.8
Sources: OECD (2000), IMF staff calculations.
Sources: OECD (2000), IMF staff calculations.

8. To assess the potential for employment creation in the Finnish services sector, this paper compares data on employment shares and the gross value added (GVA) per employee for Finland and the United Kingdom across 28 different groups of services.6 The services groups used in this analysis are listed in Table 2. They fall into three major categories, which can be described as distributive and logistical services, financial and business services, and social and personal services.7 Within these major categories, the degree of breakdown was determined by the availability of data for the different sub-categories. The services sector of the United Kingdom was chosen as a comparator because of the availability of data and the advanced development of the U.K. services sector (see Table 1 above).8

Table 2.Finland: Classification and Abbreviations of Services
OECD CodeServices sectorAbbreviation
1.1.1.1.Motor trade and repairsMOT
1.1.1.2.Wholesale and commission tradeWCT
1.1.1.3.Retail trade and repairsRET
1.1.2.Hotels and restaurantsHOT
1.2.1.1.Land transport, transport via pipelinesLAN
1.2.1.2.Water transportWAT
1.2.1.3.Air transportAIR
1.2.2.CommunicationsCOM
2.1.1.Financial intermediationFIN
2.1.2.Insurance and pension fundingINS
2.1.3.Auxiliary financial servicesAFS
2.2.1.Real estate servicesREA
2.2.2.1.Renting, etc.REN
2.2.2.2.Computer and related activitiesCPT
2.2.2.3.Research and developmentRES
2.2.2.4.1.Legal, accounting servicesLEG
2.2.2.4.2.Architecture, engineering, and other technical servicesARC
2.2.2.4.3.Advertising servicesADS
2.2.2.4.4.1.Other business servicesOBS
2.2.2.4.4.2.Industrial cleaningICL
3.1.1.Public administration and defensePUB
3.2.1.EducationEDU
3.2.2.1.Health and social workHSW
3.2.3.1.Sanitary and similar servicesSAN
3.2.3.2.Membership organizationsMEM
3.2.3.3.Recreational and cultural servicesREC
3.2.3.4.Other personal servicesOPS
3.2.4.Private households with employed personsPHO
Source: OECD (2001).
Source: OECD (2001).

9. A comparison of the data is summarized in a scatter plot of the difference in employment share and in GVA per employee for the various categories of services (Figure 2). These services are categorized as follows:

  • Quadrant 1: Services that have both a larger employment share and GVA per employee in Finland, suggesting that these services may be either already highly competitive (if they are tradable),9 or in strong demand (if they are nontradable).

  • Quadrant 2: Services that capture a greater share of total employment, but show a lower GVA per employee, suggesting that these services could experience a future decrease in the employment share, though this would be more likely for nontradables.

  • Quadrant 3: Services that are characterized by both a smaller employment share and GVA per employee, suggesting that these services are likely to be either uncompetitive (if they are tradable), or subject to weak demand (if they are nontradable).

  • Quadrant 4: Services that combine a small employment share and a large GVA per employee, suggesting that these services may be comparatively underdeveloped, and, therefore, have relatively strong market potential.

Figure 2.Finland: GVA per Employee and Employment Share in Relation to the United Kingdom

Sources: OECD (2001); IMF staff calculations.

10. With 12 of the 28 services categories falling in the fourth quadrant, there seem to be significant areas for employment expansion in Finland’s services sector. These include private households with employed persons, other personal services, hotels and restaurants, retail trade, and wholesale and commission trade (which can broadly be characterized as personal and distributive services). In addition, the categories in Quadrant 4 include computer-related services, renting services, legal and accounting services, financial intermediation, auxiliary financial services, education, and sanitary and similar services.

11. Other characteristics of the services sector are also relevant to assess its role for employment creation in Finland. In particular, it is important to keep in mind the significant role of public services in Finland and the crucial importance of business services in supporting economic growth related to the ICT sector. The role of public services is described in Annex I. In addition, Annex II provides an overview of the business services sector and its main characteristics in Finland.

The Low-Skill Segment of the Market

12. High unemployment among low-skill workers in combination with a low-skill services sector that is small by international standards raises questions about the functioning of the market for this category of labor. Figure 3 shows the evolution of the shares of six low-skill services in total employment over the past decade. In the face of increasing unemployment among low-skill labor, and total employment in 1999 at only 91 percent of its 1989 level, the employment share of the three largest categories of private low-skill services decreased over this period, from already low levels.10 While the employment share growth of the three smallest private low-skill services in Finland outperformed the corresponding growth rates in the other advanced economies, these services are catching up from internationally very low levels and, taken together, accounted for just over 2 percent of total employment in 1999, compared with more than 4 percent in other advanced economies.11

Figure 3.Finland: Employment in Low-Skill Services

Sources. OECD (2001); IMF staff calculations.

13. In a related vein, the share in employment of low-productivity services is much lower than in other advanced countries.12Figure 4 shows employment shares in comparison with advanced economy averages for the services with the lowest GVA per employee in Finland (below two-thirds of the average GVA per employee). All of these services are characterized by a significantly smaller employment share than in other advanced economies.

Figure 4.Finland: Services with Low Gross Value Added (GVA) per Employee

(below ⅔ of the average)

Sources: OECD (2001); IMF staff calculations.

14. The employment shares of private personal services are significantly below international averages. Figure 5 compares the employment shares of private personal services with those in other countries and provides additional information about the growth in employment shares. The category of personal services for the most part comprises low-skill, low-productivity services.13 Judging from their share in total employment compared with other countries, private personal services are underdeveloped in Finland.

Figure 5.Finland: Employment in Private Personal Services

Sources: OECD (2001); IMF staff calculations.

Survey Data

15. While the demand for private personal services can be expected to increase as a result of rising personal incomes and an aging population, recent labor surveys are already pointing to greater difficulties in hiring personnel. The Employers’ Confederation of Service Industries in Finland periodically conducts surveys among its members about the availability of trained personnel. During the past five years, an increasing number of private services companies encountered problems in recruitment and the availability of trained service personnel continued to deteriorate. In 1999, about 65 percent of all Finnish services companies viewed their number of staff as less than would be needed—a higher percentage than in any other EU country.14 Difficulties in recruitment seem to have increased the least in information technology (somewhat paradoxically, in view of reported shortages of skilled labor for the ICT sector) and social services, in which 25 percent and 30 percent, respectively, of all businesses thought that hiring trained personnel is more difficult than before.

C. What is Impeding Employment Growth in the Services Sector?

16. Labor demand in the services sector should be rising. The analysis in the preceding section has suggested that there is a higher demand for labor in several services categories. Looking ahead, the growing share of the population aged over 64 will increase the demand for personal services, in particular in health and social work, but also for distributional and recreational services, as well as for employed persons in private households. In a related vein, an aging of the population is associated with increasing public expenditure and decreasing tax revenues from labor income. The resulting pressures on the public finances could imply a reduction in the range of publicly provided services, and related demand incentives for private services providers to move into these areas. Furthermore, replacing an increasing number of retiring service sector employees has been (and will continue to be) an even greater challenge for the labor market than responding to the growing demand for personal services. According to estimates of Finland’s National Board of Education, the growth in new demand accounts for just 20 percent and the loss replacement for 80 percent of the required new labor force in services. In relation to the 1995 workforce in these services, the Board’s projections show, for example, a 65 percent loss in cleaning services and a 39 percent loss in social and recreational services until 2010.

17. Even in the circumstances described above, the centralized wage bargaining system tends to discourage the hiring of low-skilled workers. The Finnish wage bargaining system has been largely centralized since the 1980s. Agreements between the employers’ organizations and the employees’ unions regarding the rise in the average hourly cost of labor usually cover more than 90 percent of all employees—the second most comprehensive coverage within the OECD behind Austria.15 Generally speaking, this rise is currently defined as an absolute amount for monthly incomes below Fmk 11,000 (which is slightly below the average monthly wage) and as a percentage increase for monthly incomes above Fmk 11,000. In percentage terms, the increases for incomes below Fmk 11,000 are higher than for those above that level, leading to a continued compression of the Finnish wage scale. As the centralized wage bargaining system does not account for the considerable differences in productivity developments across sectors, it tends to contribute to a higher demand for labor in the sectors with the highest productivity and reduced demand for labor in the lowest-productivity sectors.

18. A high tax wedge on labor discourages both the demand for and the supply of labor in the services sector. Table 3a provides an international comparison of the effective tax burden on low incomes. The effective tax burden in Finland of more than 40 percent of the total labor cost is well above the EU average and considerably exceeds the ratio for the United States, increasing the cost of and, in consequence, decreasing the demand for low-productivity labor. In comparison with the effective tax burden, the average tax wedge is an even more comprehensive concept, covering income tax, consumer taxes, and the employer’s social security contribution. It is expressed in percent of gross earnings. The Finnish tax wedge, on this basis, is also high by international standards—at 58 percent for average incomes in 2001, and is only marginally lower in low-paid services, such as restaurants and personal services. Even more importantly, the marginal tax wedge can exceed 100 percent for lower incomes if the loss of income-related child-care and housing benefits is included in the calculation, which discourages the supply of labor.

Table 3a.Finland: Effective Tax Burden in Low-Paid Jobs(In percent of labor costs)
FinlandEUUnited States
Single person earning 67% of average wage level42.437.629.0
Family earning 67% of average wage level1640.836.326.8
Sources: Finnish authorities, OECD.
Sources: Finnish authorities, OECD.

19. High replacement incomes, which are especially prevalent at the low income levels, discourage the supply of low-productivity labor to the services sector. The replacement income is the publicly provided income that is available to an unemployed person. It can be expressed as a percentage of net earnings when employed. Table 3b provides an international comparison of net replacement rates. It shows that Finnish replacement income is high by international standards, in particular for low-income families. Moreover, the net replacement income increases with the duration of unemployment. It can reach 100 percent of the income from employment of low-income families after 60 months, providing strong disincentives to search for work. Considered in combination, the levels of taxes and replacement income provide strong disincentives to seek employment in low-skill services.

Table 3b.Finland: Net Replacement Rates for Low-Paid Unemployed(In percent of net earnings)
FinlandEUUnited States
Single person, 1st month727159
Family, 1st month17947951
Single person, 60th month795910
Family, 60th month181007761
Sources: Finnish authorities, OECD.
Sources: Finnish authorities, OECD.

20. At present, the procurement of private services is limited. This reflects the shortage of personnel and skills, including tenders for services and construction where the concern about appeals from competing bidders results in little or no procurement taking place at all. In fact, the latter impediment is an even broader issue because existing procedures imply that a large number of bidders must be evaluated for a procurement tender to proceed and that hampers the use of public procurement. Useful changes that might encourage greater use of procurement would include strengthening the skills of procurement authorities and boosting their numbers, and limiting the number of bids that need to be considered. In addition, the use of electronic marketplaces could be beneficial, though this may require changes in existing legal restrictions.

21. Legal restrictions on health care and subsidies to nonprofit social services providers also inhibit the development of private services. The reimbursement for private health care services is only 35–40 percent of the price of the services, favoring public over private services in health care. In addition, some subsidies that are distributed exclusively among non profit organizations providing social services leave little opportunity for commercial private providers to effectively compete.19

22. Labor regulations can discourage the emergence of small private enterprises that typically dominate the personal and social services sector. The structure of the private services industry is characterized by many small businesses (often just a single individual). The social services sector, for example, comprises 14,000 small companies. As extensive labor regulations are more difficult to deal with for small businesses, they tend to discourage the creation and growth of private personal services firms.20

D. Concluding Remarks

23. The services sector would seem to have considerable potential for employment growth, in particular in the low-skill segment of the labor market. However, there are several impediments to the development of services and policy actions should be considered to deal with them. In particular, greater wage differentiation and improved incentives to work by redesigning social benefits to deal with incentive traps would be beneficial. In addition, continued progress in reducing the tax wedge on labor would be helpful, as would greater efforts by the public sector to promote private services, including through better procurement practices.

Reference
ANNEX I: The Public Services Sector

24. Public services were primarily responsible for the increase in the share of services sector employment over the past decade. The share of Finnish public services in total employment is large by international standards. Publicly dominated services21 accounted for 35 percent of total employment or more than half of all services sector employment in Finland in 1999. Their share in total employment widened during the recession from 31½ percent in 1989 to 36% percent in 1994 and subsequently decreased only slightly, still accounting for the entire net increase in the share of services in total employment over the past decade. In absolute terms, employment in publicly dominated services grew slightly, while employment in other services and in non-services sectors decreased by 9 percent and 18 percent, respectively. Figure A.1 shows the evolution of employment in these three categories from 1989 to 1999. With already high levels of public sector employment, stronger employment growth in public than in private nonbusiness services during the 1990s suggests some crowding out of the private services sector.

Figure A.1.Finland: Employment in Different Economic Sectors, 1989–99

Sources: OECD (2001), IMF staff calculations.

25. The share of publicly dominated services is larger than in other advanced countries—in particular with respect to public health and social services. This is shown in Figure A.2, which also provides information about the growth of these shares in Finland and indicates that almost all publicly dominated services show above-average growth rates of their employment shares. With an average share in total employment of more than 14 percent, health and social work forms the main services subsector in Finland. Indeed, the subsector also employs a substantially larger part of the total workforce in comparison with other advanced economies, where it accounts, on average, for only 9½ percent. While Finnish municipalities are required by law to provide health, social, and educational services, these services have been allowed to be privately provided since 1993. However, only 1–2 percent of all health services and 9–10 percent of all social services provided by Finnish municipalities are currently provided by the private sector.

Figure A.2.Finland: Employment in Publicly Dominated Services Sectors

Sources: OECD (2001); IMF staff calculations.

ANNEX II: The Business Services Sector

26. The employment share of business services has increased substantially over the past decade and is converging toward international standards. This strong employment performance in business services, however, has taken place in the context of a low starting base level.22Figure A.1 compares average employment shares of Finnish business services with average shares across advanced economies and provides information about the growth of sector-specific employment shares in Finland. Almost all business services have increased their share in total employment considerably, with the greatest growth occurring in legal and accounting services (+94 percent), computer-related services (+75 percent), and industrial cleaning (+73 percent). Taken together, however, the seven business services displayed in Figure A.3 accounted for only 6 percent of total employment in 1999, which is still below the average across other advanced economies of 7 percent.

Figure A.1.Finland: Employment in Business Services

Sources: OECD (2001); IMF staff calculations.

27. The supply of business services in Finland generally supports the international competitiveness of the Finnish economy, but with important exceptions. Viewed in relation to other indicators, a comparison of the GVA per employee (assuming that average wages are correlated with the GVA per employee) can provide an indication of the cost of these services.

  • In both computer-related and research and development services, the GVA per employee is similar to that in the United Kingdom, and the strongly growing employment share—while lagging slightly behind that in the United Kingdom—is above the average for other advanced economies, suggesting strong competitiveness of these services in Finland.

  • In both renting and legal and accounting services, the GVA per employee is higher than that in the United Kingdom, which—in combination with a lower employment share—suggests that these services may be underdeveloped in Finland and thus have underserved the business sector relying on them.

  • In advertising services, both the GVA per employee and the employment share are only slightly below the corresponding ratios for the United Kingdom, suggesting that these services are available to businesses at competitive prices—especially since cross-border trade in advertising services is quite common, with a large number of internationally operating firms.

  • For industrial cleaning services, the relevant data for the United Kingdom were unavailable.

28. The compressed wage scale may discourage the supply of labor to high-productivity business services. This may be one reason, that the share of business services employment in total employment is smaller in Finland than in other advanced economies, notwithstanding the fact that Finland’s university level education is first rate and much of the Finnish workforce is highly qualified.23Figure A.2 shows employment shares in comparison with advanced economy averages for these categories of services, focusing on those categories with the highest GVA per employee in Finland (i.e., double the average GVA per employee in Finland).

Figure A.2.Finland: Services with High Gross Value Added (GVA) per Employee

(more than 100 percent above average)

Sources: OECD (2001); IMF staff calculations.

Prepared by Matthias Vocke.

Eurostat publications on unemployment by educational attainment level define an education of less than the upper secondary level as low skill, at the upper secondary level as medium skill, and at the third level as high skill.

OECD (2000) provides details and comparisons across advanced economies.

Interestingly, the inflow of labor from other sectors has persistently been a more important recruitment channel for manufacturing than for services. People hired for manufacturing from other sectors mostly came from nonservice industries (agriculture, forestry, mining, energy and water supply, and construction), while people hired in the services sector from other sectors came mostly from manufacturing. Data on intersectoral labor flows were only available until 1997. See Asplund (2001) for details.

Simple unweighted average of the listed countries.

The GVA per employee and the employment share of individual services were calculated from data presented in OECD (2001). The GVA per employee is defined—according to OECD standards—as the difference between the value of output and the value of intermediate consumption, before deduction of consumption of fixed capital, per employee. It is measured at basic prices. Output is defined as sales plus the net increase in stocks of finished goods and work in progress. Intermediate consumption is defined as the goods and services that are consumed in the production process.

Services with a large public component are excluded from the analysis, however, since it was felt that they are less driven by profitability considerations and that this would unduly bias the results, especially when using data on GVA.

U.K. data were unavailable, however, for industrial cleaning services, other business services, and private households with employed persons. The analysis used Danish data for the first two categories and German data for the last category.

Since tradable services are subject to international competition, a high GVA per employee combined with a large share in total employment can be taken as an indication of a high degree of competitiveness. With nontradable services, by comparison, a high GVA per employee and a large share in total employment can be taken as an indication of a strong domestic preference for these services, since the GVA is measured at basic prices.

These services were retail trade and repairs, hotels and restaurants, and land transport, which together accounted for 12 percent of total employment in 1999.

These services were industrial cleaning, other personal services, and private households with employed persons.

Low-skill services and low-productivity services are not necessarily identical, though the overlap between the two categories is considerable. There are, thus, some services that do not require high skill levels, but where technological progress and associated gains in labor productivity have allowed increases in the value added per employee. These services include, for example, transportation and sanitary and similar services.

While the ratio of low-skill to medium/high-skill employment for personal services is above the average across all services in Finland, this ratio is even higher for distributive services—unlike comparable ratios in most other OECD countries. See OECD (2000, p. 96).

Interestingly for the discussion that follows on impediments to employment growth, this percentage was also high in Sweden and Denmark—two countries with tax wedges and replacement incomes that are at similarly high levels.

During certain years, wage increases were negotiated at the sectoral level. However, wage differentiation across sectors was still rather small and the overall wage increases were often higher than in years when wage agreements were negotiated at the central level.

A family of two parents and two children.

See footnote 16.

See footnote 16.

The so-called Finnish Slot Machine Association dedicates some Fmk 1.4 billion in annual subsidies to non profit organizations. This is more than the entire turnover of the commercial private sector providing social services.

Kohi (2001) also emphasizes this argument.

Publicly dominated services in Finland include health and social work, public administration and defense, education, communications, recreational and cultural services, and sanitary and similar services.

Business services may be underestimated in the data to the extent that they are supplied in-house for manufacturing business. In consequence, some business services are not separately identified as services, but included in the data on the manufacturing sector. The same caveat applies to the data for other countries.

The 2000 World Competitiveness Yearbook, in comparing 47 advanced and emerging economies, ranks Finland highest for university education and in tenth place for availability of skilled labor.

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