The Finnish Utopia

In many societies, an expanding disparity exists between the official truth stated by the governmental apparatus and the reality that is experienced by the people. Current societal developments in Finland aptly epitomize such a phenomenon. Official government statements in Finland are constructed with data that is often dubious and politically motivated. In other words, such system is designed to appease nervous people, who are starting to doubt the sustainability and logic of the welfare system. Consequently, it is a matter of time before the people in Finland realize that the "King of Finnish Welfare" in fact had not clothes to begin with.

 A troubling dichotomy between the bureaucratic and public domain in Finland is best exemplified in tax-payers' perceptions of the state as an effective generator of economic growth. More specifically, it is widely accepted that the public sector ought to be responsible to create jobs through higher state-led investments. An independent Finnish right-wing think tank Libera showed how since 1950 the quantity of public sector jobs has quadrupled. Reversely, the current share of private sector jobs is less than in 1950 even though the population in Finland has increased by 1.4 million people. Advocates of the public sector argue that the share of government jobs has in fact declined. However, they fail to note that a large fraction of government jobs have been moved to state-owned enterprises (SOE). Furthermore, it must be noted that public sector employment is largely financed through higher taxation of the private sector. This poses an important question: How can public sector employment be sustained if the tax-revenue for financing such jobs is dependent from the private-sector, which is diminishing? The obvious answer is that it can't be sustained. And this is a pivotal point that government bureaucrats are purposefully avoiding to admit.

The latest reports on unemployment show that the current unemployment rate in Finland stands at 7.6%. Such rate is an egregious fallacy. Even though the rate at first appears to be low, the bureaucratic apparatus does not elaborate on the current trends of labor participation. This particular rate is consistently decreasing on a monthly basis, suggesting that the real unemployment rate is much higher than the official 7.6% estimate. The unemployment statistics show how the quantity of people, who are capable of productive work, but not in the labor force, stands at 1,337,000. This particular group consists of people, who are recipients of unemployment benefits, early retirees, in education or simply discouraged people not looking for a job. Therefore, let us add another dimension to our original question: How can the government sustain an expensive welfare system with diminishing private-sector and aggressively declining labor participation rate accompanied by increasing number of entitlement recipients?

Again, the answer is simple: It can't. The only way to feed the Leviathan is to increase the tax-burden of the private sector businesses and entrepreneurs. In other words, larger share for financing the welfare system must be collected from the private manufacturing and service industries. Again, such strategy is stated as feasible only by government officials. The main problem of such approach is the fact that the service industry in Finland counts for 73.4% of all jobs. Furthermore, out of the 73.4% service industry, 37.3% is public-sector service jobs. Basic math concludes that increasing the tax-burden on private-sector will be detrimental due to the fact that service industries are not the main sources of wealth generating exports. Consequently, extracting larger tax-revenues from private (73.4%-37.3) sector service businesses is unfeasible. Obviously, increasing the tax-burden on service industry decreases the profitability of service-oriented businesses, which are forced to raise prices to maintain competitiveness. Therefore, should the narrowing manufacturing industry bear the burden instead?

The government bureaucrats see the narrowing manufacturing sector as a potential financier of the welfare-system. However, globalization has dramatically decreased Finland's export competitiveness. Another explanation on Finland's decline in exports can be traced to basic monetarist theory. Current production costs in Finnish manufacturing sector are high due to high wages, government monopolies and price-controls. Strong trade union power prevents flexible labor laws from lowering fixed production costs. Therefore, increasing the tax-burden on the narrowing manufacturing sector, which is already suffering from a lack of competitiveness, is bound to exacerbate the problem. Again, the government officials are reluctant to admit something that the public is clearly aware of. 

Let us again modify our original question: How can the welfare-system be sustained if the employment in private-sector industry is gradually declining and leading to decreasing tax-revenues, manufacturing industry is perishing due to stringent labor costs and higher taxes, which lead to unemployment, hence increase social security costs?

Like all irresponsible governments, Finland decided to rely on debt and increased taxation in order to finance the cornerstone of the welfare system. Current government debt-to-GDP stands at 53% and is approaching the critical 60% limit. What must be noted, however, is the speed of debt accumulation, which has doubled over the past 5 years. Furthermore, the debt is largely in the hands of foreigners, which poses serious risks in balancing liabilities to the holders of Finland's debt. Even though Finland's credit-rating is still AAA, such fast growth of debt burden is likely going to change the rating's existing views. Increased taxation will put an enormous pressure on small and medium-size businesses, which must pass on the burden of adjustment to consumers through higher prices. Unfortunately, due to the direct and indirect influence of the growing public sector, a large share of consumers' incomes derive from public sector employment or finances. Such pernicious cycle is simply unsustainable.

Our prima facie point holds. To quote Milton Friedman, "[the bureaucrats] are seeing the hole in the barn door, but they are not looking at the door itself." What is more disturbing is the fact that these topics and observations are not discussed in the public domain. Any attempt to challenge such government inertia is labeled as populism. And as Hayek's "Road to Serfdom" profoundly argued, such silencing of critiques is one step closer to a controlled socialist society. It seems that Finland did not learn anything from the 1991 collapse of its neighboring regime.

Author: Henri Erti

The views of the author do not necessarily represent the views of the LVMI-Europe. 

The Global Monetary Status Quo (part II of III)

In the first part, a grim diagnosis of the international monetary system (IMS) under the dollar paradigm was established. Global competitive devaluations- ignited largely by the Federal Reserve's accommodative monetary policies- are undermining global economic stability. Consequently, stabilizing the IMS requires more disciplined monetary policies dictated by sound principles, instead of politically motivated zeals. 

Central banks have resorted to expanding the money supply in order to spur domestic economic growth. Such printing of money, however, merely steals growth from the future without addressing the existing inherent anomalies of the system. By setting artificially low interest rates, central banks are creating illusionary perceptions of wealth, which inevitably lead to booms and "malinvestments", thus macroeconomic busts. When such central bank policies, characterized by cheap credit, are multiplied at the global level, solemn uncontrollable imbalances arise. Therefore, it is pivotal to understand that such undisciplined macroeconomic policies, or quantitative easing (QE) programs, are meant to delay essential and fundamental reforms to the IMS. Most importantly, loose monetary policies enable rent-seeking politicians to build political platforms on unsustainable fiscal programs, which are only possible through inflationary monetary policies. Evidently, the pursuit of a stable and efficient IMS is compromised due to reckless domestic political interests. 

How can we take concrete steps towards a system of disciplined monetary policies? The inherent problem has been identified, but a more theoretical explanation is required. The adherents of the Austrian school of economics have developed a comprehensive theory of the business cycle, which explains how central banks' credit-expansion unbacked with real savings consistently generates boom-bust cycles. In practice, when the Federal Reserve uses the open market operation (OMO) to manipulate short-term interest rates, markets and agents pay close attention to what the Federal Reserve is doing or even just saying. Most importantly, when the Federal Reserve pumps $85bn to the economy every month by purchasing government bonds, investors and businesses gain access to excess liquidity. An image taken from the Federal Reserve database aptly illustrates this trend.

The private sector is interpreting that the economy has more potential to grow. Consequently, firms and businesses take out loans to expand production by increasing investments and/or employing people in order to supply the new level of demand. With increased demand for goods and services, companies need also more raw materials. Therefore, the suppliers of raw material are simultaneously expanding their production, which leads to further expansion of the suppliers' suppliers. As a result, the whole supply chain has falsely interpreted growth indicators and is exacerbating the cycle of malinvestments. When the purchasing power of consumers begins to decline due to higher prices and weakening currency, decreasing aggregate demand forces suppliers to also downsize production. As a consequence, businesses that have used excessive credit to expand production are now forced to cut-back on fixed costs. Unfortunately, often these cuts are felt by employees, whose working hours are cut or positions terminated.

As unemployment increases, government officials advocate for aggressive stimulus programs, which are masqueraded political tools and not economic principles. Even worse, government may deem certain industries or businesses "too big to fail" and pump additional liquidity to save these companies. Unfortunately one can't fight fire with massive amounts of kerosene. Inevitably, the economy must readjust by "cleansing" itself with austerity. However, austerity as a policy-tool is a political hara-kiri, thus politicians are by nature reluctant to admit the necessity of such painful readjustments. As a result, nominations to key economic positions are dictated by pure political interest and not sound monetary economic principles. The only argument politicians need to make is the one that starts the printing machine at the central bank in order to sponsor irresponsible, but politically profitable programs. Voters naturally are inclined to blame economic downswings on the greediness of the private sector, whilst politicians loudly exploit the band-wagon effect with raucous anti-business rhetoric.

Federal Reserve's commitment not to taper the QE yet is going to keep the game of musical chairs going with limited chairs. With virtually no discipline in monetary policy, the Federal Reserve with its new pro-stimulus Chairman is choosing to ignore Milton Friedman's profound statement:" inflation is everywhere and always a monetary phenomenon." With certainty, we can expect the next boom-bust cycle to be similar to the one prior to the crisis. Or even worse. 

Author: Henri Erti

The views of the author do not necessarily represent the views of the Ludwig von Mises Institute-Europe.