OECD Economic Outlook, Volume 2022 Issue 2

Finland

Economic growth is projected to slow sharply because of Russia’s war of aggression against Ukraine, with a 0.3% contraction in 2023, before recovering to 1.1% in 2024. Consumption will weaken in response to falling real wages but subsequently recover as inflation moderates and wages rise. Export growth will decline markedly with weaker demand in export markets but then pick up as they strengthen. The unemployment rate will increase to 7.9% in 2023 and remain elevated in 2024. Inflation will fall to 3.1% in 2024, when the energy shock will have passed.

Fiscal consolidation is needed both to support monetary policy tightening and to put medium- and long-term public finances on a sustainable path. A comprehensive public spending review should be undertaken to identify consolidation measures. State aid to companies that does not enhance productivity should be reduced. Labour market regulations should be made less restrictive to facilitate greater employment and innovation.

An economic downturn has begun

Growth surged during the first half of 2022 following the removal of COVID-19 restrictions but has slowed sharply since because of Russia’s war of aggression against Ukraine. Energy prices have soared, boosting annual headline HICP inflation to 8.2% in the third quarter of 2022. Core inflation rose to 4.5% as higher energy and food prices fed into other HICP components. Increases in the wage and salary index also strengthened but, at 2.6%, lagged far behind price increases. Retail sales volumes are falling and consumer confidence has dropped to a record low. The residential construction cycle turned down during the second quarter of 2022 and the number of issued building permits is falling. Business investment has also started to weaken as has business confidence. Strong employment growth abruptly ceased in the third quarter of 2022, when employment was flat and the unemployment rate jumped to 7.3%.

Finland

Source: Statistics Finland; OECD Economic Outlook 112 database; and European Commission.

Statlink

Finland: Demand, output and prices

Statlink

Following Finland’s application to join NATO in May, Russia terminated gas and electricity exports to Finland. While most gas was imported from Russia, gas only represents 5% of total energy consumption and plans are advanced for sourcing most of it elsewhere, in LNG form. This transition will be challenging for some industries but not for households as their gas consumption is minor. Additional electricity from local and neighbouring sources has replaced imports from Russia (10% of consumption). A new nuclear power plant will supply 14% of Finland’s electricity when it reaches normal operating capacity this winter. Finland no longer imports oil from Russia. To contain energy price increases, the VAT rate on electricity will be reduced from 24% to 10% over December 2022-April 2023 (EUR 209 million) and targeted assistance to households will be provided over this period (EUR 600 million). The government has also implemented other targeted measures focused on transport that expire at the end of 2023 (EUR 900 million).

Fiscal policy is mildly expansionary but will become neutral in 2024

Fiscal policy was mildly expansionary in 2022, despite a large reduction in COVID‑19 expenditures, and will be again in 2023 (the underlying primary deficit is estimated to increase by 0.7% of GDP in both 2022 and 2023) and neutral in 2024. Additional expenditures related to the war in Ukraine have added 0.8% of GDP to the structural budget deficit in 2022 and 2023, but will add somewhat less in 2024. Compared with 2022, most of the increase in the structural budget deficit in 2023 is attributable to the setting‑up costs of the health and social services reform and the measures to contain energy price increases.

The economy is heading into a short-lived recession

The economy is set to stall in 2023, weighed down by high inflation and tightening monetary conditions, but to recover in 2024 as these headwinds diminish. Consumption will weaken in response to falling real wages but subsequently strengthen as wages rise. Business investment will be depressed by low demand growth and tighter monetary conditions but begin to recover in late 2024 as domestic and international economic conditions improve. Export growth will decline markedly with demand in export markets, which are being hit by the large reduction in gas supplies from Russia, but pick up as these energy sources are replaced and external demand recovers. The unemployment rate should peak at around 8% and only fall slightly by the end of 2024. Inflation will fall to 3.1% in 2024, when the energy shock will have passed. Key domestic risks are that industry fails to fully replace Russian gas imports by other energy sources, that the new nuclear power plant does not reach normal operating capacity by the end of 2022 and that electricity imports are limited in coming months by a drought-induced decline in hydroelectricity production in Norway, all of which would reduce economic growth.

Further measures are needed to enhance fiscal and environmental sustainability

Fiscal consolidation should resume in 2024 to rebuild buffers and put public finances on a more sustainable path. It should aim to reduce the structural budget deficit to the medium-term objective of 0.5% of GDP. Further labour market reforms to increase work incentives and labour market flexibility would not only contribute to higher employment and productivity, but also to fiscal consolidation. The biofuels mandate, which results in very costly abatement, should be reduced to the minimum level required by EU regulations and compensated for by aligning the carbon price used to calculate carbon tax rates on heating fuels with that used for transport fuels and, if necessary, increasing this carbon price. Instruments should be created to guide the cultivation of peatlands (16% of emissions) towards paludiculture (i.e., the cultivation of wetted peatlands). Policies to reduce car dependency in cities should be strengthened while support for low-carbon cars should be focused on areas with limited public transport options.