Covid-19 pandemic and the current crisis have shown that the government’s ability to support the economy is crucial. Given the persistent fiscal deficit, the new government should begin with a credible fiscal adjustment plan. The tightening of EU-wide climate policy also affects Finland.

The war in Ukraine created an energy crisis in Europe, which has also raised the general price level. Due to this development, the forecast for Finland’s economic growth for the years 2022-23 has been significantly revised downwards.

Demand more targeted measures to mitigate the effects of crises

Additional spending on military and other security-related uses has likely been necessary, while certain measures to increase purchasing power, such as a temporary reduction in VAT on electricity, have not been necessary. Severely affected households must be helped. However, not all households and companies can be permanently compensated for the drop in profitability or disposable income.

Stimulus policies are not well suited to dealing with adverse supply disruptions such as the current crisis. By increasing aggregate demand in the face of a lack of supply, stimulative policy can continue to fuel inflation. In general, currently non-existent policy instruments enabling targeted, income-based, one-off payments should have been designed and made available for policy-making on aid measures.

Given the ongoing public deficit, some of the additional spending should have been financed by cutting public spending elsewhere or raising taxes. Tax increases can be applied for, for example, by waiving the taxation of certain goods with lower value added tax scales, by increasing real estate taxation and reforming the dividend taxation of unlisted companies.

The new government should start with a credible fiscal adjustment plan

Due to the size of Finland’s current deficit, a gradual and sustainable adjustment should be implemented. The goal should be to adjust the public finances by 0.4-0.6 percent in relation to GDP annually for two terms of government, which would turn the debt ratio to GDP on a downward trajectory.

Securing future fiscal room for maneuver is important, as Finland will likely face negative economic shocks for a long time to come. If the economic situation is not very unfavorable in 2024, it is worth starting with a large, front-oriented adjustment, and not postponing the stabilization until the end of the next government term.

Due to the required scope of stabilization, both expenditure and revenue measures are needed. The council proposes to establish a committee to evaluate how tax changes and prioritization of public spending can promote the necessary consolidation and at the same time secure the future development of the Finnish economy.

The employment targets were achieved, but the effect of the government’s own measures is yet to be seen

The employment target set by the current government was practically achieved in 2022. The rapid recovery of the labor market is similar to that in most other EU countries after the pandemic. The good development of the economy seems to be the decisive factor that explains the improvement in employment.

The 2017 pension reform has had a large positive impact on employment in recent years. Accordingly, some of the important measures decided by the current government will only be realized in the coming years. Achieving the employment targets does not, however, guarantee the achievement of the expected positive public finance effects.

Vacancies began to increase rapidly in 2021, and employers have repeatedly reported difficulties in recruiting employees. A pandemic can cause temporary problems. In some cases, short working hours or low pay can explain recruitment problems. In some fields, the reason may be that the initial entry into the education system is too small. Remedies must reflect the various reasons for the incompatibility or labor shortage.

The tightening of EU-wide climate policy affects Finland

Finland’s goal is to be carbon neutral by 2035, which is more ambitious than the EU’s overall goal. In recent years, the reported public expenditures and investments for the green transition have been considerable in Finland. However, preliminary assessments of emission reductions and actual political measures are still lacking. Agricultural environmental policy has not led to a reduction in greenhouse gases. Forestry and land use policies have contributed to the collapse of carbon sinks. The patenting of environmental technologies has decreased over the last 10 years.

In addition to relying on carbon sinks, Finland’s climate and energy strategies are built on the expected growth of low-carbon electricity supply, which has not materialized at the predicted pace. With the Fit for 55 reform, the costs of carbon dioxide emissions are expected to rise. The economic effects of this and the gradual termination of free emission rights and other subsidies remain to be seen.

Finland needs a credible plan to combat climate change. Traffic taxation should be reformed to improve incentives to reduce emissions and speed up the electrification of traffic. Infrastructure investments are needed in the energy sector. Private investments should be encouraged through carbon pricing, regulation and taxation. The distribution effects of reducing carbon dioxide emissions must also be taken into account. Undistorted one-off payments should be preferred so that carbon dioxide pricing reforms are more equitable and favor the poor.

The Finnish Economic Policy Council was established in 2014 to independently evaluate economic policy objectives and the effectiveness of selected policy measures. With its work, the council aims to improve the quality of economic policy decision-making and preparatory work, and to bring an independent and research-based perspective to the public economic policy debate.

HT

Source: Economic Council