Sustainability of the Nordic model:
The Role of the State
Introduction
Since the mid-1990s, and prior to the current global economic downturn, Finland has enjoyed an encouraging economic position. GDP has grown strongly in a low-inflation environment, with rising employment and a sound fiscal position. Critical to this success was the public administration’s role in supporting Finland’s remarkable transformation from an economy specialised in traditional industries to a diversified and modern economy, and in helping the country to navigate the Nordic economic crisis of the early 1990s. As a result, the Finnish citizenry today has a high level of trust in its public administration and sees it as a key partner for service delivery and economic development, as well as the mechanism to realise key Finnish values of social solidarity and equality through its crucial re-distributive role.
The role of Finland’s public administration has increased due to complex policy challenges which threaten the sustainability of the Nordic model, including shifts in the global economic environment and, more recently, the impact of the global economic and financial crisis and the ageing population. In addition, internal migration from rural areas due to urbanisation – a more recent phenomenon in Finland than in other European countries – is also posing geographic challenges for public service delivery. In this context, rising demands and expectations from citizens concerning both the quality and equality of public services are increasing pressures on the public administration to improve its efficiency and responsiveness, and to be innovative and flexible in responding to longer-term issues.
This chapter describes the economic and demographic context in Finland and identifies the rationale for reviewing Finland’s public administration. It starts by highlighting Finland’s characteristics and policy approaches, which are shared with four other countries, through the use of the Nordic model.1 These common features are crucial to understanding Finland’s successful economic and social performance until the recent global economic and financial crisis. Recent challenges which pose a threat to the sustainability of the Nordic model have provided an opportunity to review the operation of the public administration with the view to fine-tuning its operations to maximise its future efficiency and effectiveness. These will be explored in depth throughout the subsequent chapters of this report. In providing the context underlying this report, this chapter:
● describes the key elements of the Nordic model;
● provides an overview of Finland’s economic and financial position;
● discusses the challenges threatening the sustainability of Finland’s Nordic model; and
● presents a rationale for reviewing the response of the public administration.
The Nordic model’s common characteristics, and its application in Finland:
A successful combination of economic and social policies
Nordic countries’ social and economic systems are based around a common set of basic values. While country approaches may not follow each other exactly, sufficient
similarities among Nordic countries have invoked the establishment of a recognisable Nordic model. The Nordic model refers to the common socio-economic aspects shared by the five Nordic countries: Iceland, Denmark, Finland, Norway and Sweden. Because their common features, policy approaches, and success stories distinguish them from other comparable groups of industrialised countries, they are often examined as a group.
Public administrations in all the Nordic countries have created economic and social policies intended to strengthen and sustain economic growth and social well-being. The main characteristic of Nordic countries has been the ability to attain strong economic growth by combining openness and adaptability to globalisation through economic policies, with collective risk sharing through social policies in a mutually supportive and inter-connected way. The intrinsic components of the Nordic model should therefore be understood as complementary and inter-related elements of a comprehensive and, to some extent, coherently articulated system.
The similarities among Nordic countries can be considered key features leading to the model’s relative success. However, while these similarities are important, they are not in themselves the essence of the Nordic model – its crucial characteristics are more difficult to capture, and relate to intangible and systemic features.2 That said, the success of the Nordic model can generally be captured by understanding the key elements of the model, which include: openness to trade and competitiveness; labour market institutions and policies; social protection and the welfare state; and fiscal policy.
Globalisation: Openness to trade and competitiveness
As relatively small economies characterised by a constrained resource base, a peripheral location and a resulting dependency on imports, it is understandable why Nordic countries have followed a traditional commitment to free-trade policy. With the objective of high standards of living, Finland and its neighbouring countries relied on their relative competitiveness in international trade. Barriers to trade – except for agricultural products – and foreign investment are low, and Nordic countries have historically participated strongly in international trading systems. Furthermore, Nordic countries have created competition-friendly regulation in markets for goods and services. In this respect, the role of the public administration in Denmark, Finland and Sweden was crucial in successfully preparing the regulatory environment for EU membership.
However, after financial liberalisation in the 1980s and deep economic recession in the 1990s, the Nordic countries profoundly re-structured their economic policies towards deeper market-oriented measures. Special consideration was given to policies supporting R&D and innovation to develop competitiveness in the information and communication technology (ICT) market, leading Nordic economies towards knowledge-intensive activities. The biggest contribution to economic growth in Nordic countries has been an increase in productivity levels, mostly as a consequence of high levels of R&D and investment in ICT.
Competitiveness thrives within the Nordic economic environment for many reasons. Innovation is stimulated within an environment of strong economic equality, so the consequences of economic failure are somewhat more bearable. In addition, transaction costs are lower in an environment where there is a high degree of mutual trust among economic agents. Thus, it is not surprising that Nordic countries today score remarkably well across international competitiveness rankings. According to the 2009-10 Global
Competitiveness Index,3 Finland ranks fifth among OECD countries, behind Sweden and Denmark, third and fourth respectively. Additionally, the World Bank’s Ease of Doing
Business Indicator4 ranks Nordic countries within the top 12 OECD countries.
Two factors may explain why Nordic countries have successfully harnessed globalisation for higher productivity and higher living standards. Firstly, public authorities had the strategic insight to specialise early in the production of fast-growing and relatively profitable skill-intensive products, such as conducting strong innovation frameworks in ICT markets. This shows their strategic agility in adapting to a new environment by building capacity to lower their risk of exposure to globalisation. Secondly, Nordic countries benefited from a self-reinforcing cycle: innovation frameworks for human capital to develop and maintain high levels of education throughout the workforce, combined with high-quality public institutions that inspire citizens’ confidence. A highly educated and relatively content workforce renders economic and social policies more politically acceptable, and clearly demonstrates the dividend reaped from high levels of trust in government.
While globalisation offers numerous beneficial opportunities for economic growth, it also opens many unpredictable risks and threats – such as increased factor mobility and off-shoring activities and layoffs of workers. These new risks and threats put pressure on labour markets and social safety nets. To counter-balance the potentially negative effects of these new threats, the welfare state and labour market institutions work together via the public administration to guarantee the Nordic type of “social contract”: in exchange for a strong public sector, a large share of national income is absorbed and re-distributed through social expenditures. Finland and its neighbouring Nordic countries have managed to set up systemic inter-relations between economic policies, such as R&D for new technologies or environmental policies, and key institutions, such as labour market institutions and the welfare state. In a sense, the Nordic approach may therefore be characterised as a response to the challenges of globalisation.
Labour market institutions and policies
Nordic countries share similar labour market structures. Public authorities offer relatively low employment protection and high unemployment protection, combined with high income-support benefits, strict activation policies and a high degree of centralised wage co-ordination. Labour markets in Nordic countries are also characterised by high participation rates, relatively low long-term unemployment and high job mobility. For example, in 2008, all Nordic countries except Finland ranked among the top five OECD countries in terms of labour force participation. Finland still ranks very well, in 10th position with 76.7% compared to an OECD average of 70.8%.5
Finland and the other Nordic countries have been very successful in their attempts to benefit from the opportunities of globalisation and to contain the spread of threats and risks to the social contract. Nordic economies are top performers in terms of egalitarian criteria in labour markets such as women’s labour force participation, with an average of 81.1% across the five countries, over 10 percentage points above the OECD average of 70.8% (Finland ranks 10th among OECD countries with 76.7%).6 However, what specifically distinguishes them from other OECD countries is their comparatively high achievement on most societal outcome indicators. They have managed to concurrently contain inflation and unemployment, provide first-class access to health facilities and offer an excellent education environment.
Social protection and the welfare state
While it is difficult to depict a unique Nordic model in practice, Nordic countries’ public administrations share common successful approaches. For example, social benefits and public services are provided in a more comprehensive way than in other OECD countries. The Nordic experience has proven that social protection and economic development can work in tandem, in a mutually reinforcing way. High economic growth has been combined with a reduction in poverty and income inequality, coupled with close to full employment. A strong welfare state is compatible with strong economic growth.
The Nordic countries have also shown that social protection can play a crucial role in economic development. Social policies were originally introduced to assuage the difficulties faced during the process of transforming an agrarian society into an industrial one. Social and housing policies smoothed the agrarian labour force’s migration from rural to urban areas. In addition, social policies helped to reduce income disparities between rural and urban areas while family policy programmes supported dual-earning households, promoted gender equality by enhancing women’s labour force participation and smoothed economic growth.
Nordic countries’ economic and social success is by no means accidental. It is the result of the public administrations’ successful implementation of national social policy programmes; the public sector in Nordic countries has been particularly open to the idea that social policy can go beyond a protective guarantor against social risks. It is also believed that social policy strengthens social interactions within society. Successful universal social programmes, such as in education and healthcare, both unify people and social groups, and promote stability and predictability within society.
Fiscal policy
The effectiveness of the large re-distributive feature of Nordic public sectors depends on efficient and effective public expenditure. The high tax burden in Nordic countries is well established. In 2006, the average level of taxation for general government revenue as a share of GDP for Nordic countries was 37.9%, which is high compared to the OECD average of 27.0%. Finland has the lowest tax burden among Nordic countries with 31.1%, and Denmark’s rate of 48.5% is the highest. The only non-Nordic country with a similar level of taxation is New Zealand, with 35.5%. General government revenue as a percentage of GDP in Nordic countries is also very high, with an average of 54.6% compared to an OECD average of 42.8%. Finland’s government revenue represented 52.9% of GDP in 2006.7
This relatively high level is justified in order to finance the large majority of public expenditure, and also the comprehensive social spending on education and healthcare programmes. General government expenditure in Nordic countries represented 47.4% of GDP in 2006, compared to 42% for OECD countries on average. Nordic countries’ 2006 average fiscal position of 7.2% is considerably stronger than the other 24 OECD countries’ 1.1%.8 These figures, though static, give a very positive indication that the high-quality public services in Nordic countries are delivered efficiently, or at least without incurring budget deficits. Nordic countries therefore not only differentiate themselves from other OECD countries by their relatively high levels of taxation and government revenue, but also by their relative success in delivering public services efficiently and effectively – in other words, by the capacity of public administration to put government revenue to efficient use.
Together with the common approaches described above, this success plays a key role in both offering a collective mechanism for risk sharing, and in safeguarding the political acceptability of structural reforms. The public administration plays a crucial role in effectively collecting taxes and re-distributing these revenues for efficient public service delivery. The public sector in Nordic countries has therefore helped to expand the size of the “economic pie”, but even more so, to share the distribution of the “pie”. This is reflected by the nature of the tax and welfare systems. It is culturally and socially accepted, and expected, that the “winners” of structural reforms share their gains with the “losers” – the collective risk-sharing mechanism. Income equality and poverty rates are below the OECD average in all Nordic countries except Iceland. The recent strong economic performance of Finland and other Nordic countries is fully recognised. (Performance data is presented in the following section of this chapter, on Finland’s economic and financial position.) However, in light of the recent global economic and financial crisis, questions have been raised as to whether incentives associated with high taxes and a generous social security system are sustainable over the long term.
Finland’s economic and social performance
The Nordic model describes characteristics of Finland’s economic and social structure, and provides guidance to understanding its economic and socio-demographic experience and performance. Though Finland differs from other Nordic countries in various economic and social aspects – for example, it is the only Nordic country that is a member of both the EU and the EMU – understanding its economic and social performance can sometimes be facilitated by comparing it to both Nordic countries (Norden) and the OECD.
Finland has a strong economic history. Its first significant phase of economic development occurred under Russian rule, when Finland embarked on the path of industrialisation with the rise of the wood processing industry in the 1870s. Following independence in 1917 and the subsequent loss of Russian markets, Finland experienced its second phase of economic development, which led to the expansion of the pulp and paper industries in the 1930s. During the period of the Second World War until the late 1970s, Finland was under constant pressure from a consultation agreement with the Soviet Union which influenced the composition and some actions of governments. However, as economic and social conditions improved during the late 1970s and into the 1980s, successive Finnish governments were able to retain power throughout their whole four-year terms without difficulty. During this period, Finland gradually became a Western market economy, with the Soviet Union accounting for only 20% of exports. However, Finland’s economic system continued along traditional lines, where ownership was closely guarded and cartels played an important role. The expanding economy allowed the Nordic welfare state system to develop. Employers and trade unions concluded nationwide collective bargaining agreements, which the government supported through tax and social welfare incentives. Nevertheless, Finland’s foreign policy had to be balanced very cautiously during the Cold War, as it participated both in progressive Western trade liberalisation and bi-lateral trade with the Soviet Union.
Finland experienced a severe economic recession in the early 1990s, due in large part to the loss of export markets with the collapse of the Soviet Union, but also influenced by the Western European recession and difficulties in adjusting to the new liberal order of international capital movement. GDP fell by 7.1% between 1990 and 1992, and the unemployment rate rose to 16.7% in 1994.9 To survive, the country had to shift from a low-skilled industry-intensive market towards a skill-intensive economy. The public
administration played a large part in transforming the economy with considerable reforms such as privatisations and innovation-led financing in targeted areas of research and development, but also by entering the EU in 1995 (by referendum). As a result, Finland’s economy prospered.
Finland’s ability to adapt to a changing economic environment (as noted during the early 1990s recession), and a tradition of fiscal responsibility put Finland in a good position going into the recent global financial crisis. Between 1995 and 2005, Finland’s GDP grew at a real average annual rate of 3.5% while public expenditure grew at a real average annual rate of only 1.1%10 (see Figure 2.1). The difference in the evolution of these two indicators demonstrates Finland’s success in achieving a public budget surplus nearly every year over the same period. General government expenditure as a percentage of GDP in 2006 was 48.9%, ranking seventh in the OECD29 and slightly above the average of 42% – but significantly less than the 61.6% level of 1995, at the time when Finland and Sweden were the highest relative public spenders (see Figure A.1 in Annex A). However, Finland ranked 10th in terms of government expenditure per capita in 2006, with USD 15 992 in purchasing power parity (PPP) terms (see Figure A.2 in Annex A). Between 2000 and 2006, the annual real percentage change of government expenditure per capita was 2.8%, ranking 10th in the OECD29 and slightly above the average of 2.1%.11
Throughout recent history, Finland has been a relatively robust economic performer, particularly in terms of economic growth, when compared to OECD countries. During the period between 1995, when Finland became a member of the EU, and 2008, before the global economic and financial crisis, Finland’s economic growth was always stronger than the OECD average. And except for a short period between 2003 and 2006, it was also more dynamic than the average of Nordic countries (see Figure 2.2). However, despite these past strong figures, growth in Finland is expected to be affected more than most OECD countries by the global financial and economic crisis.12
Figure 2.1. Average annual growth of real GDP and public expenditure, 1995-2005
1. 1998-2003 2. 2002-2004 3. 1996-2005
Source: OECD Statistical Database. 8 7 6 5 4 3 2 1 0 -1 % Irel and Luxe mbou rg Kor ea Icel and Slov ak Republi c Hun gary Turk ey Pol and Greece Aus tralia Me xico Spa in Finl and Can ada 1 Uni ted S tate s New Zeal and No rway Uni ted K ingdom Swed en Ne ther lands Por tugal Bel gium Den mar k Swit zerla nd Fran ce Ge rmany It aly Japan 3 Cze ch Re publ ic2 Aus tria Real GDP growth Real public expenditure growth
In addition to strong economic growth, Finland has also managed to keep inflation (as measured by CPI) under control. Since 1995, inflation has been kept in check, following a cyclical path around the euro area average. Inflation was significantly below the euro area