Finland: Selected Issues

Abstract

Finland: Selected Issues

Filling the Gaps: Labor Market Reforms to Promote Jobs and Growth1

Finland’s labor market is facing two main challenges: (i) a need for structural transformation and resource reallocation in the context of the decline of Nokia and the wood and paper industry; and (ii) a shrinking labor force due to population ageing and declining labor participation, and rising unemployment. To cope with the challenges, labor market reforms are called for to promote labor market participation and job matching, allow more wage flexibility, facilitate labor mobility from low to high productivity sectors and regions, and boost labor productivity. Using a scenario analysis, we find that implementing such reforms would have a large positive impact on employment and growth.

A. Structure of the Labor Market

1. Labor market institutions in Nordic countries are built around the idea of “flexicurity.” This so called “Nordic model” aims to combine a flexible labor market with protection of workers against labor market risk. In its essence, against labor market risk. In its essence, flexicurity—protect workers, not jobs—has three distinctive features: (i) flexible hiring and firing for economic reasons through low employment protection (EPL); (ii) a generous social safety net in the form of high unemployment insurance (UI) replacement rates; and (iii) active labor market policies (ALMP) to aid labor reallocation. The labor markets in all Nordic countries share these features, with varying degrees of relative importance and emphasis given to the different elements.

uA02fig01

Labor Market Protection

(Rate, X-axis; Index: 0–6 (6 indicates stricter regulation), Y-axis)

Citation: IMF Staff Country Reports 2015, 312; 10.5089/9781513517162.002.A002

Sources: OECD and Fund staff calculations.

2. Finland conforms to this model though long-term unemployment insurance tends to be more generous, and ALMP spending lower, than in Nordic comparators. The key features of the Finnish labor market are as follows (Figure 1):

  • Unemployment insurance (UI) replacement rates are high for the long-term unemployed. According to OECD indicators, while unemployment benefits net replacement rates for short-term unemployment are similar in all three Nordic countries with Finland in the middle, long-term unemployment benefits are significantly more generous in Finland. In addition, benefits are paid for a relatively long period (500 days). This has the potential to slow down structural adjustment by providing the unemployed with relatively weak incentives to seek employment in new sectors. In addition, in the absence of proper monitoring and other incentives, job searches might be less intensive than otherwise.

  • Spending on Labor Market Programs (LMPs), particularly ones focusing on out-of-work support, are amongst the highest in the OECD. LMP expenditure in Finland accounted for nearly 2½ percent of GDP in 2012, substantially above the OECD average of less than 1½ percent of GDP. However, the share of Active Labor Market Policies (ALMPs), at around 1 percent of GDP, is relatively low in Finland, for instance when compared to Denmark and Sweden. ALMPs, particularly those that seek to get people back to work such as training and matching programs are generally considered more effective than other passive policies. These passive policies, such as out-of-work support polices, are relatively extensive in Finland with a share close to 1½ percent of GDP. Moreover, the referral to an active labor market program in Finland takes place after 100 weeks, compared to mandatory referral after 60 weeks in Sweden and 40 weeks in Denmark (OECD, 2010). This implies lower incentives for the unemployed to search for jobs early.

  • Employment protection for regular contracts is higher than the OECD average, while for temporary contracts it is marginally lower. Finland has a relatively high share of workers on temporary contracts. While this provides a measure of flexibility by facilitating employment adjustment as contracts approach renewal, it also raises potential duality problems as firms tend to invest less in the human capital of temporary employees.

  • Disability benefits and sickness leave are generous. The number of weeks lost due to sick leave in Finland is the highest in the OECD and the expenditure on disability and sickness is over 3 percent of GDP – compared to the OECD average of around 2 percent (Figure 2). Disability benefits can in some cases be regarded as an additional form of unemployment insurance. Indeed, there is an inverse relationship among European countries between the unemployment rates and the disability benefit recipient rates; economies with low unemployment often have high disability rates, suggesting that the two forms of labor market insurance tend to be used as substitutes.

  • Incentive traps exist for effective early retirement. Despite the abolishment of unemployment pensions in 2005, older people are still entitled to an extended period during which they receive an unemployment allowance. A person who turns 61 and has received an unemployment allowance for less than 500 days is entitled to continue to receive it until the start of his or her pension or until the age of 65. This so-called “unemployment tunnel” serves as an incentive for early retirement. In addition, part-time pensions, while providing flexibility in working time to those who may postpone full retirement, are heavily subsidized and hence in fact reduce working times significantly.

Figure 1.
Figure 1.

Labor Market Institutions

Citation: IMF Staff Country Reports 2015, 312; 10.5089/9781513517162.002.A002

Figure 2.
Figure 2.

Disability Benefits and Sickness Leaves

Citation: IMF Staff Country Reports 2015, 312; 10.5089/9781513517162.002.A002

uA02fig02

Labor Market Program Expenditures, 2012

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 312; 10.5089/9781513517162.002.A002

Sources: OECD and Fund staff calculations.

3. Labor unions play a key role in the Nordic model. Nordic countries have the highest union density among OECD countries, and Finland is the second most unionized country in the sample. Finland has a strong collective wage bargaining system that is supported by the high union density and the mandatory extension rule of collective agreements (which are binding for all employees in an industry or occupation if more than half of them are unionized). This collective bargaining system, with varying levels of centralization, is a key feature in all Nordic countries and is thought to compensate for the relatively lighter regulation of the labor markets.

uA02fig03

Trade Union Density

(Percent, 2012)

Citation: IMF Staff Country Reports 2015, 312; 10.5089/9781513517162.002.A002

Sources: OECD and Fund staff calculations.

Collective Bargaining in Finland

Since 1968, collective bargaining in Finland has been mostly centralized with a broad national agreement setting the framework for industry and company level negotiations. Under a three-stage system, a periodic national level agreement is reached through a process of centralized wage negotiations between labor unions, employers’ federations and the government. The government plays a key active role in the negotiations, for example by offering changes in taxation or social security to facilitate agreement between the employers and the unions. The multi-year national comprehensive collective settlements cover not only wages, but also aim to secure improvements in working life and the social security system including through measures concerning gender equality, to the modalities of social welfare and pension schemes, taxation, working hours, holidays, sickness pay, and other aspects of the labor market (Asplund, 2007). Industry-level negotiators then use the national agreement as guideline to set rates and basic conditions for each individual industry. Subsequent company-level negotiations can further modify aspects of the industry settlement, though this is not common in practice and only restricted to non-wage aspects. In any case, if industry or company-level negotiations fail, the terms of the national agreement apply—the so-called fallback rule.

In 2007–10, the social partners tested a more decentralized system, with industry level agreements only and more room for company level bargaining. However the outcome was not satisfactory with uduly high wage growth overall and only limited improvements in local wage flexibility. Although local wage allowances increased as a share of the settlements, these were used in a mechanical way and therefore contributed little to aligning wages to local productivity conditions (Asplund, 2007). In 2011 the system reverted back to the national agreement framework. But unlike the earlier national agreement that covered the whole economy, the current centralized framework only applies to industries with existing collective agreements.

4. Centralized collective bargaining has resulted in limited wage flexibility. Centralized bargaining has contributed to the reliable Finnish business climate through wage agreements broadly in line with productivity growth. However, this has come at a cost of low wage differentiation—wages across industries and sectors are compressed and do not adequately reflect productivity diffrentials between industries, companies and regions. Finland has one of the lowest degrees of wage dispersion among OECD countries. Such wage compression can hamper the recovery and contribute to further unemployment (Holden and Wulfsberg, 2007). In addition, wage compression effectively introduces a relatively high minimum wage, which has likely lowered employment levels among marginal groups in the Finnish labor market. This may explain part of the high structural unemployment and the relatively low youth employment in Finland.

uA02fig04

Labor Compensation per Hour, 2007 & Latest

(Indexed, median=100)

Citation: IMF Staff Country Reports 2015, 312; 10.5089/9781513517162.002.A002

Sources: EU Klems and Fund staff calculations.
uA02fig05

Wage Dispersion

(Ratios of gross earning, decile 9/decile 1)

Citation: IMF Staff Country Reports 2015, 312; 10.5089/9781513517162.002.A002

Sources: OECD and Fund staff calculations.

B. Recent Developments in the Labor Market

5. Finnish labor costs have seen a strong upward trend relative to some of its peers. Although for long time periods collective bargaining has resulted in wage increases in line with productivity growth, unit labor costs (ULC) have risen faster than in Sweden and Germany since 2000, and sharply accelerated after the global financial crisis. The collective wage agreements of 2007–08 led to a surge in wage growth just prior to the crisis, and wages reacted only moderately to the rise in unemployment (Figure 3). The most recent wage agreement, negotiated in the fall of 2013, is set to slow wage growth. However continued growth in unit labor costs on account of slow productivity growth suggests that this may not be sufficient to restore competitiveness.2

Figure 3.
Figure 3.

Labor Market Developments

Citation: IMF Staff Country Reports 2015, 312; 10.5089/9781513517162.002.A002

uA02fig06

Unit Labor Cost, Post-Crisis

(Average ULC Growth, 2009–2014)

Citation: IMF Staff Country Reports 2015, 312; 10.5089/9781513517162.002.A002

Sources: OECD and Fund staff calculations.

6. Unemployment has risen sharply, with rising long-term and structural unemployment. Unemployment increased to 8.7 percent in 2014–0.7 percentage points higher than projected by Finland’s employment service statistics in early 2014. In August 2015 the seasonally adjusted unemployment rate stood at 9.5 percent. This exceeds the average level of unemployment in the OECD countries (Figure 3). The share of structurally unemployed people is close to 65 percent of total unemployment and continues to rise.3 In the first 6 months of 2015, structural unemployment increased by around 15 percent compared to one year earlier. This increase was primarily driven by the close to 20 percent increase in the number of people who had been out of work for more than a year. The number of people unemployed after participation in ALMP also increased by around 20 percent in the first 6 months of 2015, although the numbers on repeatedly unemployed and those repeatedly participating in ALMPs were stable.

7. Population ageing has resulted in a rapidly declining workforce. Finland’s working age population—those between 15–64 years—has been declining rapidly since 2011 and this is set to continue. The working age population as a share of total population has already declined by close to 2 percentage points since 2000 and projections from Eurostat suggests that this share will decline further to just over 60 percent by 2030 (from over 65 percent at present). Compared to the Euro Area and the other Nordics, the decline in Finland is earlier and more pronounced.

uA02fig07

Population Projections

(Share of working age (15–64) population to total population, percent)

Citation: IMF Staff Country Reports 2015, 312; 10.5089/9781513517162.002.A002

Sources: Eurostat and Fund staff calculations.

8. Labor supply is held back further by low participation rates. The labor force participation rate has recently fallen most particularly in the age group 25–54 years—from over 84 percent in 2008 to a little over 80 percent in 2014. At about 48 percent, the participation rate for those aged 60–64 is broadly in line with other OECD countries. However, only about 13 percent of the population aged 65–69 is working, compared to the OECD average of about 25 percent (numbers as of 2014). However, in the oldest age groups labor participation rates have risen in recent years, albeit from a low level, which is encouraging because in the future these age groups will account for a growing proportion of the labor force.

uA02fig08

Labor Force

(Percent of 15–64 population, left; Millions of persons, right)

Citation: IMF Staff Country Reports 2015, 312; 10.5089/9781513517162.002.A002

Sources: Statistics Finland and Fund staff calculations.

9. Short work careers further reduce labor supply. The pension reform of 2005 has created incentives for a longer working life. However the majority of workers retire as soon as they are legally eligible, shrinking the labor force as the population ages. At around 61 in 2014, the average effective retirement age remains considerably lower than in peer economies, despite increases in life expectancy. Projections by the United Nations suggest that life expectancy at birth in advanced economies will improve by 6 years between 2005–10 and 2045–50, lifting the expected retirement duration by 3 years for men and nearly 4 years for women.4 In this context, the current agreement to increase the effective retirement age by 1.5 years by 2025 may be insufficient to increase labor participation in the upper age bracket.

uA02fig09

Average Effective Retirement Age

(Years of age, 2007–12)

Citation: IMF Staff Country Reports 2015, 312; 10.5089/9781513517162.002.A002

Sources: OECD and Fund staff calculations

10. Study times are lengthy. Although the quality of education is high, despite some decline in recent years, Finnish students take a relatively long time to enter the labor force. This is partly due to cumbersome entrance processes that can delay entering university, followed by long tertiary study times—with less than half of the students completing their degrees in the targeted time. In addition, reflecting generous and lengthy government funding, Finland has one of the longest average durations of tertiary education in the OECD. Efforts to streamline university entrance requirements and shorten study times to accelerate the transition into the labor market are therefore necessary.

11. Net benefits from tertiary education appear relatively small. Reflecting in part wage compression, both private and public net benefits from education are relatively small in Finland. The net private benefits from tertiary education in Finland are less than 70 percent of the OECD average and the net public benefits are even lower at close to half of the OECD average (Figure 4). The main benefits from tertiary education (relative to upper secondary education) include the net present value of the estimated additional income and associated tax and social contributions, lower transfers and gains from lower incidence of unemployment. The corresponding costs are the direct costs of tertiary education as well as indirect costs such as foregone earning and taxes and the effect of grants (OECD 2014).

Figure 4.
Figure 4.

Costs and Benefits of Education

Citation: IMF Staff Country Reports 2015, 312; 10.5089/9781513517162.002.A002

C. Regional and Sectoral Developments

12. Restructuring has resulted in large numbers of job losses in traditional industries. At the peak of the ICT boom, Nokia’s business accounted for nearly 4 percent of Finnish GDP, and the ICT goods and services sector employed over 6.5 percent of the Finnish labor force.5 Nokia’s decline has brought in the need to reallocate factors of production. While Nokia will continue to produce and export network services, the sale of its mobile telecommunications business to Microsoft and its subsequent downsizing has affected nearly 4,700 workers, or about 0.2 percent of the labor force. The other structural challenge is the long-term decline of the wood and paper industry resulting from the contraction in the global demand for paper and competition from emerging markets.

13. The impact of these structural changes has been uneven across sectors and regions. The bulk of the job losses have been in the manufacturing sector, which has resulted in a disproportionately large impact on male employment. Since 2009, male unemployment has been close to 1.5 percentage points higher than female unemployment. In addition, the decline in the wood and pulp industry has had a larger impact on the North and East of the country compared with the Helsinki region.

uA02fig10

Employment by Industry

(percentage of hours worked)

Citation: IMF Staff Country Reports 2015, 312; 10.5089/9781513517162.002.A002

Sources: Statistics Finland and IMF Staff Calculations
uA02fig11

Unemployment by Region

(Percent, 2015Q1)

Citation: IMF Staff Country Reports 2015, 312; 10.5089/9781513517162.002.A002

Sources: Statistics Finland and IMF Staff Calculations.

14. Wage compression may have made adjustment more difficult by constraining regional labor mobility. Regional wage dispersion linked to local productivity and unemployment can encourage labor to migrate. However, in the absence of wage dispersion, workers may be reluctant to relocate. The lack of affordable housing in urban areas such as Helsinki, where unemployment is low, serves as an additional constraint to labor mobility.

uA02fig12

Total Earnings by Region

(Euro per month, 2013)

Citation: IMF Staff Country Reports 2015, 312; 10.5089/9781513517162.002.A002

Sources: Statistics Finland and Fund staff calculations.Note: Total earnings include all earnings for regular working hours as well as all bonuses and benefits in kind, but not one-off pay items, such as performance-based bonuses.

15. Collective wage bargaining has led to a decoupling of wage and productivity growth at the industry level. Real wage and labor productivity have historically moved together relatively closely for the industrial sector as a whole, before diverging after the collective wage agreements of 2007–08 (Figure 5). However, while the wage developments have been similar across all sectors, sectoral developments in labor productivity have diverged. In particular, productivity declined significantly in the wood and paper and the ICT and electrical equipment sectors, while wage developments there have been in line with the rest of the economy. This may have exacerbated the decline in these sectors.

Figure 5.
Figure 5.

Productivity and Wage Developments by Sectors

Citation: IMF Staff Country Reports 2015, 312; 10.5089/9781513517162.002.A002

16. This decoupling and the wage compression across industries may have constrained structural adjustment. Wage dispersion across industries, particularly when such dispersion is linked to productivity differentials, can facilitate adjustment by encouraging the workforce in declining industries seek employment in sunrise industries by retraining and acquiring new skills. However, the wage compression in the Finish labor market, coupled with generous long-term unemployment insurance replacement rates, have the potential to make workers unwilling to make such investments, hampering labor mobility.

D. Recent Policy Initiatives

17. The new government’s recent 2015 Strategic Program and the associated Action Plan outlined an ambitious reform agenda in a number of structural areas. Specifically,

  • Unit labor costs (ULC) and labor tax wedge: During its term, the new government plans to close one-third of Finland’s competitiveness gap with peers, or five percent of current ULC, via reducing labor tax wedge and holiday pay, and increasing unremunerated working hours.6 In the proposed 2016 budget, to encourage acceptance of work and reduce financial incentives to retire, the labor tax will be reduced, particularly for low and medium incomes, by increasing the earned income tax credit by EUR 450 million in 2016. The easing of taxation on labor will be funded by increasing excise duties. In addition, following failed negotiations with social partners, the government recently announced proposals for legislation of a package of exceptional measures, including (i) eliminating two paid public holidays, (ii) cutting holiday bonuses by 30 percent, (iii) reducing the generosity of sick leave pay by having the first day unpaid and the following eight days paid at 80 percent, (iii) lowering the upper limit of annual leave from 38 to 30 working days, and (iv) narrowing the labor tax wedge by reducing private employer’s social security contributions by 1.72 percentage points.7 The package, if legislated, would apply to the next collective bargaining agreement starting in autumn 2016.

  • Employment protection legislation (EPL): By mid-2016, the government plans to implement reforms to lower the threshold to employment and remove some employment protection by lengthening probationary periods, allowing fixed-term contract for employment of less than a year without separate justification, and easing the obligation to re-employ a worker in the event of redundancy. The impact on employers of sickness of employees during leave will also be reduced by including in annual leave of five weeks or longer a six-day personal contribution period for sickness during annual leave.

  • ALMPs: By the end of 2015, the government will develop a comprehensive reform proposal for employment services with the objective of enhancing service efficiency, easing labor market matching problems, especially for the least employable workers. Several measures are being considered, including (i) transferring and combining resources and employment responsibility to municipalities by commuting area, following the Danish model, which will make rapid reemployment of newly unemployed financially attractive to the municipalities, (ii) strengthening the role of private employment services and base their management and remuneration systems on job matching results, (iii) strengthening the link between ALMP and social assistance benefits such as housing and in-kind transfer benefits, and (iv) abolishing the job alternation leave system, or tightening it by making it means-tested and/or by changing the employment history condition. However, these efficiency-enhancing reforms are part of government’s plan to reduce overall funding for ALMPs.

  • Social and unemployment benefits: In the fall, the government plans to prepare, in dialogue with social partners, a reform proposal for social and unemployment benefits with a view to removing incentive traps, shortening unemployment duration, and reducing public unemployment spending. Measures considered include broadening the use of means-tested benefits, and tightening obligations to accept work and participate in activation measures.

  • Pension reforms: In early autumn 2015, the government will submit to Parliament new legislation to implement the reform agreement on earnings related pension that was reached with social partners in September 2014. The agreement aims to gradually increase the effective retirement age by 1.5 years (to a still low 62.4) by 2025, with the official pension age being raised gradually for those born in 1955, or later, until the minimum statutory pension age is 65 (now 63). Moreover, the pension age will be linked to life expectancy from 2025. In addition, the current highly-subsidized part-time pension will be abolished and replaced by a partial early old-age retirement. The legislative amendments will come into force on January 1, 2017.

  • Collective bargaining: The government has also started investigating the current setup of collective bargaining system, and appointed an internal expert to make specific reform proposals on the collective bargaining system later this year. However, the explorations are in an early stage and the scope of collective bargaining reform is yet to be defined.

  • Housing: To increase house supply in growing areas to promote employment, the government intends to streamline planning and development rules such as the zoning and construction authorization schemes. It also considers providing more state-subsidized housing targeting low-income households.

  • Education: Phased over the next ten years, there are plans to streamline university entrance requirements, enhance the link between skills attained by education and business needs, and improve the structure and quality of vocational and upper secondary education. These objectives would be achieved by reforming their governance and financing system and removing unnecessary overlaps in education and barriers between vocational education for young people and adults. Study times will also be shortened to accelerate the transition of students into the labor market. The government recently made a start with shortening the duration of financial assistance to students (while increasing the level).

  • Product market regulations: During the government term, in order to improve competitiveness and business conditions, market regulations and “red tape” will be reduced, via revisions of the Competition Act and procurement legislation, and by replacement of licensing processes with notification procedures. Also, sectoral regulation that prevents competition will be removed. While these are not labor market reforms, they would help improve labor market performance. As part of the retail market deregulation, the government has recently submitted to parliament a draft bill for liberalizing all restrictions on shop opening hours, which, if implemented, could have an immediate positive effect on employment and output.

18. The government’s reform program is promising, but needs to be further developed and could in some areas also be strengthened. The reform program envisages covers many relevant areas and envisages steps in the right direction. This said, at the present stage many of the reform plans still lack specificity and need to be fleshed out further. In certain areas, the agenda could also be strengthened. Concretely,

  • Collective bargaining and firm-level wage flexibility: It is welcome that the government has started investigating the collective bargaining system, but detailed plans should be quickly developed and implemented to facilitate the structural transformation of the economy. Allowing more wage differentiation across sectors and firms would help facilitate the reallocation of labor from low to high productivity sectors. In addition, more flexibility at the low end of the wage distribution can promote employment among the most vulnerable groups, including the young and the low-skilled. The literature suggests that a combination of national and firm-level bargaining could satisfy the needs for both flexibility and coordination in wage setting (see e.g., IMF, 2013). National agreements can set floors and, when needed, help the adjustment of wages and prices in response to major macroeconomic shocks. Firm-level agreements can adjust wages to the specific conditions faced by firms. Allowing a larger role for profit sharing or bonuses could also help enhance flexibility in the wage structure.

  • Unemployment benefit duration: The government’s plan to reform unemployment benefits through increased means-testing and strengthening eligibility requirements is welcome. However, it is also important to reduce the average replacement rates of long-term unemployment benefits—currently the highest in the Nordics and among the highest in the OECD. This could promote labor participation, reduce reservation wages, and help constrain excessive collective wage increases.

  • ALMP: While the planned efficiency-enhancing measures are welcome, with unemployment high and rising, ALMPs should be expanded rather than scaled back to increase retraining and skill development opportunities. Strengthening ALMPs would also help ensure that reforms that increase labor supply do not lead to higher structural unemployment. The government’s plan to cut ALMP funding therefore raises concern and should be reconsidered. In particular, some of the savings from unemployment benefits reforms should be used to strengthen ALMPs.

  • Duality of EPL: There is a need to tackle labor market duality. Strong protection of permanent contracts discourages firms from offering permanent contracts and from investing in the human capital of temporary employees. Empirical evidence (Banerji and others, 2015) shows that reducing the difference in contract provisions between permanent and temporary workers would help reduce unemployment, in particular for youth and women. In addition, employment protection should not become an impediment to resource relocation—for example, in the context of private sector structural transformation and local government reform.

  • Effective retirement age and benefits traps for effective early retirement: While the planned pension age reform is welcome, given the low starting level and the gradual nature of the reform, further efforts will likely be needed to close the existing gap in the effective retirement age of around two and eight years compared with OECD average and OECD frontier, respectively. In this regard, the impact of the pension reform should also be assessed over time to ensure it is achieving its aims. In addition, to make sure that the pension reforms yield the expected result, it is key to remove the existing benefits incentive traps for effective early retirement. These include phasing out the extended period of eligibility to unemployment benefits for older people and tightening the access to disability pensions.

  • Removing obstacles to regional labor mobility: Increasing the availability of affordable housing in growing areas would facilitate labor mobility away from regions with high unemployment. Besides the envisaged measures in the government’s reform program, this also requires increasing competition in the construction sector, making more land available for development, and enhancing associated public investments, especially in transportation infrastructure. Tax incentives can help as well—for example, by raising property taxes on unused land zoned for development or improving the treatment of income from investment in residential rental property.

E. Quantifying the Potential Impact of Structural Reforms on Labor Market Outcomes and Economic Growth

19. A scenario analysis is used to quantitatively illustrate the benefits from the implementation of key structural reforms. These benefits include increasing labor inputs, boosting labor productivity and total factor productivity, and ultimately reviving economic growth.

uA02fig13

Structural Policy Gap: Finland vs. OECD Frontier

(Index: 1=OECD frontier)

Citation: IMF Staff Country Reports 2015, 312; 10.5089/9781513517162.002.A002

Sources: OECD and Fund staff calculations.Note: For each indicator, OECD Frontier is set equal to 1, while the worst OECD performer is set equal to zero. OECD Frontiers for the indicators included in the table are defined as follows: the Danish level is used for ALMP per unemployed, OECD average for UI replacement rate and tax wedge, the average level of the three best-performing OECD countries for effective retirement age, the Swedish level for product market regula in retail trade, the Korean level for PISA score, and the average levels of the three best-performing OECD countries in terms of unemployment ra plus the USA for the rest of the indicators.

20. We use frontier analysis to quantify Finland’s structural policy gap in key structural areas. Following OECD (2013), structural indicator gaps are estimated as a country’s distance to the “frontier,” with the latter set by those OECD countries with the “best practice” in respective areas, as measured by their structural or macroeconomic outcome indicators. Countries with significant structural policy gaps can make large strides in terms of productivity, growth, and employment if they reform their policies to match best practices. To illustrate the likely impact of structural reforms on labor market outcome and economic growth, we assume that decisive implementation of the structural reforms proposed in the government’s recent strategic program and those recommended by the staff will close 50 percent of Finland’s structural policy gap with the OECD frontier.

21. Closing half of the labor market policy gap is estimated to potentially reduce the unemployment rate by 4.2 percentage points (Table 1). To estimate the potential impact of institutional reforms on labor market outcomes, we use elasticities of unemployment to labor market policies that were empirically derived by Schindler and others (2014) based on a panel, fixed effects model of OECD countries. The analysis suggests that closing half of the gap in Finland’s labor market institutions with the OECD frontier would bring significant gains, more than half of which would be coming from declines in UI benefits and the labor tax wedge. The rest of the estimated unemployment rate reduction could be equally credited to an increase in ALMP expenditures half way closer to the frontier (in this case, the Danish level), a reduction of employment protection on regular contracts, and an increase in wage flexibility in collective agreements (proxied by union coverage in the analysis).

Table 1.

Potential Gains from Adjusting the Finnish Labor Market Model

(Percentage points)

article image
Source: Fund staff calculations.

22. To quantify the potential impact of structural reforms on output, we use Finland-specific elasticities. Barnes and others (2013) evaluate the impact of various policy reforms in the areas of labor, product market, taxation and education on GDP per capita in the long run (or at steady state) in an accounting framework of a system of reduced-form equations. Their exercise links together coherently a range of empirical studies (mostly) by the OECD that estimate the partial effects of a number of structural policies on contributing factors to sub-components of GDP. One of the merits of this analysis is that it allows growth impacts of policy reforms to vary markedly across OECD countries by taking into account country-specific factors such as the composition of the labor force and employment, the demographic structure, and how far the economy is from its long-run potential labor productivity. Because this analysis only provides the long run growth impact of structural reforms, we use another study to translate the long run growth impact into the medium term (five year) impact. According to the GIMF model results from Anderson and others (2013), around one-third of the long run impact of structural reforms on output could be expected to materialize in five years. Using this result, the estimated impact on steady state output is translated proportionally into the growth impact in the medium term.

23. Estimation results suggest that closing half of the structural policy gap could raise Finland’s GDP by 4 percent after five years (Table 2). The largest GDP per capita gains would be obtained from reforms that reduce the level and/or duration of unemployment benefits, strengthen competition in product markets, cut tax wedges, reduce EPL on regular contracts, and increase the effective retirement age. Meanwhile, although the direct growth impact of enhancing ALMP, raising the quality of education, and increasing wage flexibility in collective agreements tend to be smaller than some other labor market reforms, such policies are expected to have stronger benefits in a period of rapid structural change, as is the case in Finland after the end of the ICT boom.

Table 2.

The GDP Impact of Structural (including Labor Market) Reforms

article image
Source: Fund staff calculations.

24. The results should be interpreted with caution. The point estimates of the impact of structural reforms presented here are subject to both model and statistical uncertainties. First, the growth impact also depends on the pace of implementation of reforms, price stickiness, and policy credibility (i.e. how quickly people believe the reforms are permanent and change their behavior). Second, the effects also depend on the economic context. For instance, reforms could be particularly effective if measures come into effect during a period of strong demand. In other words, if sluggish global demand continues, a weaker-than-estimated impact is expected. Third, there are risks of double-counting or missing the synergies of reforms (even though the applied empirical studies made efforts to minimize this). Finally, in the quantification exercise, we only evaluate the impact of the structural reforms that we are able to quantify with available data. In all, therefore, the results should be treated as illustrative and not as precise estimates.

F. Conclusion

25. The Finnish labor market faces important challenges. While its labor market setup seems to have served Finland well in the period before the global financial crisis, at present it faces two critical challenges. First, in the context of the precipitous decline of the once rapidly growing ICT sector and the secular decline in wood and paper industries, there is a need for structural adjustment and resource relocation across sectors, which requires enhanced labor mobility. Second, adverse demographic trends that are prompting a rapid shrinkage of the working age population, require higher participation rates to arrest the attendant decline in the labor force.

26. Overcoming these challenges requires deep labor market reforms. The recently announced reform agenda of the government is a welcome step. While the specifics of the proposed measures need to be worked out further, the envisaged reforms of labor costs and taxes, employment protection, ALMPs, social and unemployment benefits, and pensions, if decisively implemented, promise to improve work incentives and labor mobility. The government’s intention to reform the collective bargaining system is also welcome and should be quickly transformed into detailed proposals, to be implemented at the time of the 2016 wage bargaining round. Indeed, in this chapter we have argued that it is crucial to make the wage bargaining system more flexible, especially at the firm level and at the lower end of the wage distribution, to facilitate a closer link between productivity and wages, raise employment among the lower-skilled, and promote efficient labor allocation. In addition, further reaching measures to increase the availability of affordable housing in regions with relatively high employment and expanding ALMP with increased retraining and skill development opportunities would also aid labor mobility. Meanwhile, reducing the duality between temporary and permanent employment contracts could help reduce unemployment, while further efforts to promote participation of the young (through reduced study times) and the old (through weaker incentives for early retirement) would support labor supply.

References

  • Anderson, Derek, Bergljot Barkbu, Lusine Lusinyan, and Dirk Muir Andersen, 2014, “Assessing the Gains from Structural Reforms for Jobs and Growth,” in Jobs and Growth: Supporting the European Recovery, Chapter 7, eds. Schindler, Berger, Bakker, and Spilimbergo (Washington: International Monetary Fund).

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1

Prepared by Pragyan Deb and Nan Geng.

2

Contractual wages will rise by 0.7 percent in 2014 and 0.5 percent in 2015, compared to 1.4 percent in 2013 while the index of wage and salary earning will rise by 1.3 percent in 2014 and 1.2 percent in 2015, compared to 2 percent in 2013.

3

The Employment service statistics define structural unemployment as an aggregate of four mutually exclusive statistical categories: (i) long term (more than 12 months) unemployed; (ii) recurrent unemployed (unemployed for at least 12 months during the last 16 months); (iii) unemployed after participating in ALMP; and (iv) recurrent participant in ALMP. Note that Employment service statistics are based on data from TE offices’ customer register and is distinct from the labor force survey figures.

4

Estimation by OECD in “Economic Survey: Finland 2014.”

5

See Pajarinen and Rouvinen, 2013, “Nokia’s Labor Inflows and Outflows in Finland”.

6

The government estimates the competitiveness gap with peer countries at about 15 percent of Finland’s current ULC. Besides the one-third that is to be closed via increased working hours, another one-third of the gap is expected to be closed by zero nominal wage increase in the next round of collective bargaining in fall 2016, with the rest of the gap to be closed through reforms that raise private sector productivity.

7

This will be partially offset by the planned increase of one percentage points in unemployment insurance contribution in the proposed 2016 budget.

Finland: Selected Issues
Author: International Monetary Fund. European Dept.