OECD Economic Outlook, Volume 2024 Issue 1

Finland

The Finnish economy contracted by 1% in 2023, with weakness carrying over into a further year‑average 0.4% decline in 2024. However, a slow recovery is under way, and growth is projected to reach 1.9% in 2025. Elevated interest rates will continue to weigh on private consumption and residential investment in the short term. Inflation is falling quickly, due to lower commodity prices and weak demand, and will drop further in 2024. This will support real income growth and private consumption. Exports are set to pick up gradually with a recovery in external demand. Unemployment will rise in 2024, reflecting weak labour demand, especially in construction, but edge down in 2025.

Steady fiscal consolidation is essential, given rising public debt. Proactive immigration policies and strengthening R&D investment would help attract skilled workers and enhance innovation amidst decreasing fertility rates and stagnant productivity growth. Investment in low GHG emissions energy sources and better management of Finland’s vast forests remain crucial for achieving the carbon neutrality target by 2035.

High interest rates continue to weigh on private consumption

The economy contracted in the second half of 2023 due to weak private consumption, housing investment, and services exports. Tighter financial conditions, including elevated mortgage interest rates, continue to depress private demand. Nominal house prices were down by 4.5% in late 2023 from a year earlier and by 11.2% from their peak in mid-2022, further weakening the incentive to build. Headline and core inflation continued to fall, helping to improve consumer purchasing power, with real wages in late 2023 up by 1% over a year earlier. Weak activity has pushed the unemployment rate up from 7% in the first half of 2023 to 8% in the first quarter of 2024.

Finland: Inflation and confidence indicators

Source: European Central Bank; Bank of Finland; and European Commission.

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Finland: Demand, output and prices

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Rising shipping costs from the conflict in the Middle East have had only a limited impact so far in Finland. Russia’s ongoing war of aggression against Ukraine is straining the economy by undermining confidence, increasing import costs and affecting foreign tourism, though foreign tourist arrivals picked up in January 2024. In November 2023, Finland closed all passenger crossings at the border with Russia due to Russia’s facilitation of undocumented migrant flows.

Fiscal policy remains expansionary in 2024, but will tighten in 2025

Higher interest rates continue to shape domestic financial conditions, given the high share of mortgages with variable or adjustable rates and high household debt, at around 150% of disposable income. The fiscal deficit expanded in 2023 and is expected to widen further in 2024, mainly due to increased security and defence spending, and reduced unemployment insurance contributions, despite the package of cost-cutting reforms to social welfare coming into effect from April 2024. The government announced a medium-term fiscal plan to raise tax revenues notably by increasing the standard VAT rate by 1½ percentage points to 25.5% by 2025, and to further reduce social security benefits. The fiscal stance is projected to ease by about 1% of GDP in 2024 but is set to tighten by ½ per cent of GDP in 2025. Achieving the government’s objective of lowering the overall fiscal deficit to 1% of GDP by 2027 – from a projected deficit of around 4% of GDP this year – remains challenging and hinges on the successful implementation of the planned fiscal consolidation.

Growth is expected to pick up but downside risks remain

Tighter credit conditions, elevated unemployment and lower house prices are expected to restrain activity in early 2024. However, the projected easing of financial conditions and improved real income growth should lead to a pick-up in private consumption and investment in late 2024. Increased domestic demand will boost imports, but export growth is projected to resume as external markets recover. The unemployment rate is expected to average 8% in 2024, primarily due to the sluggish construction sector, but to fall as labour demand recovers in 2025. Headline inflation is expected to decline further in 2024, partly due to lower commodity prices, but will gradually rebound as domestic demand recovers. The expected increase of the standard VAT rate will also provide a temporary further increase in inflation in early 2025. Core inflation, excluding food and energy, is expected to remain above headline inflation, before converging towards it in 2025. Risks to the outlook are skewed to the downside. High interest rates may depress the economy for longer than expected. Given its border with Russia, Finland is relatively vulnerable to an escalation of tensions in the region. This would raise uncertainty and undermine confidence.

Reviving productivity is crucial for sustainable growth

Productivity growth has stagnated, and a shortage of skilled workers and declining fertility rates add to longer-term challenges. Policy action is needed to attract and integrate highly skilled foreign labour, increase R&D investment, and strengthen tertiary education participation thus boosting sustainable productivity growth. Fostering employment growth and raising participation of women and the elderly are also important. This should include monitoring, and further adjusting as necessary, reforms already introduced to achieve these goals. Steady fiscal consolidation is a priority to build a fiscal buffer for future shocks and allow increased spending for a sustainable and inclusive recovery. The government needs to regularly review tax expenditures to identify potential efficiency gains and increase targeting of welfare support, while also considering faster normalisation of reduced VAT rates. Enhanced investments in low greenhouse gas emission energy sources, such as wind and nuclear, and improved management of Finland's extensive forests, are critical to achieve the 2035 carbon neutrality goal.