World Economy

EU Liable for Nordic Divergence

EU Liable for Nordic DivergenceEU Liable for Nordic Divergence

Finland has been in recession for just about all of the last four years. Austerity is an utterly self-defeating policy for an economy which has a damaged supply side due to exogenous shocks. In short, Finland is in a bit of a mess. A series of nasty supply-side shocks has devastated the economy.

When Nokia collapsed in the wake of the 2007-8 financial crisis, ripping a huge hole in the country’s GDP, the government responded with substantial fiscal support. This wrecked its formerly virtuous fiscal position: It switched from a 6% budget surplus to a 4% deficit in one year, and although its deficit has improved slightly since, it is still outside Maastricht limits, Seeking Alpha reported.

Because of this, the current government—under pressure from the Eurocrats—is implementing fiscal austerity to bring the budget deficit back below 3% of GDP. For an economy which has suffered a serious reduction in its productive capacity, this is disastrous.

Finland has been in recession for just about all of the last four years: What it needs is expansionary fiscal policy, not bloodletting. Austerity is an utterly self-defeating policy for an economy which has a damaged supply side due to exogenous shocks.

The one thing that is keeping the Finnish economy from imploding is the ECB’s expansionary monetary policy. Negative rates and quantitative easing may be a weak stimulus, but they are better than nothing. Without ECB support, Finland would be in deep trouble.

  Recovery Difficult

Like Finland and Sweden—and interestingly, not like Norway—Denmark suffered a deep recession after the financial crisis, hitting the bottom in the second quarter of 2010. But unlike Sweden, it did not recover. The pattern of its GDP growth is much more like Finland’s. Yet, it did not have the supply-side shocks that Finland suffered.  

Most people focus on Denmark’s generous welfare state and relatively high taxation. High taxation stifles enterprise, while the welfare state discourages productive work, apparently. So what Denmark should do is cut taxes and shrink its welfare state.

Sweden also has a generous welfare state and relatively high taxation. So does Norway. Indeed, so does Finland. All the Nordic states do. And all of them have made serious attempts in recent years to improve the efficiency of their welfare systems and reduce their cost. Denmark, in fact, ranks higher up the OECD’s list of countries by reform effort than any other Scandinavian country. Yet their economic performance differs enormously.

Finland and Denmark are performing poorly. Norway and Sweden are performing well—and Norway did not suffer the deep recession of the post-crisis years, either. It is hard to see that Scandinavian welfare and taxation causes this. No, there is some exogenous reason.

  Stringent Rules

Finland, the worst-performing of these countries, is a member of the euro. Not only does this prevent it from managing its own monetary policy, including devaluing to protect its economy from exogenous shocks, but it also chains its fiscal policy to the provisions of the Stability and Growth Pact. Finland is in the Excessive Deficit Procedure, and as a euro member, that means it must comply with the actions required under that procedure or face sanctions—even if those actions are directly harmful to its economy.

None of the others is a euro member. But Denmark is a member of the Exchange Rate Mechanism (ERM II) which is a precursor to euro member. It is obliged to maintain the value of its currency within agreed bands around the euro. Its monetary policy is, therefore, determined to a large extent not by local conditions, but by the decisions of the ECB—whether or not they are appropriate for the Danish economy.

In contrast, Sweden is not a member of ERM II. It is supposed to join the euro at some point, but persistently fails to meet convergence criteria. The Swedish krona floats against world currencies including the euro, giving Sweden much greater control of its monetary policy than Denmark or Finland. On the fiscal side, although Sweden ratified the Fiscal Compact, it refused to allow itself to be bound by its provisions while it remains outside the euro.

Eurozone fiscal authorities have little autonomy once the country is in the Excessive Deficit procedure; for those outside it, avoiding Brussels supervision can become an overriding concern. For eurozone countries, the real monetary target is not inflation but deficit/GDP. The ECB is fighting a losing battle trying to raise inflation against the determination of the Brussels bureaucracy to force 19 fiscal authorities to depress demand in the name of balancing the books.

There seems little doubt. Welfare states, taxation and structural reforms…. The great Scandinavian divergence is principally caused by the euro.