Economic Prospects Ministry of Finance publications – 12b/2016 Economic Survey Spring 2016 Economic Prospects Ministry of Finance publications – 12b/2016 Economic Survey Spring 2016 MINISTRY OF FINANCE PO Box 28 (Snellmaninkatu 1 A) FI-00023 GOVERNMENT FINLAND Tel. +358 295 16001 Internet: www.financeministry.fi Layout: Government Administration Department / Information Support and Publications Unit / Anitta Türkkan Helsinki 2016 Description page Publisher and date Ministry of Finance, April 2016 Author(s) Ministry of Finance Title of publication Economic Survey, Spring 2016 Publication series and number Ministry of Finance publications 12b/2016 Parts of publication/ other versions released The publication´s language versions: Finnish: Taloudellinen katsaus, syksy (12a/2016) Distribution and sale The publication can be accessed in pdf-format at www.vm.fi/julkaisut. ISBN 978-952-251-765-4 (PDF) ISSN 1797-9714 (PDF) No. of pages 100 Language Finnish Abstract The Finnish economy posted GDP growth of 0.5% in 2015, after three years of recession. In early 2015 the main drivers of slow growth were exports and consumption, towards the end of the year the principal driver was investment. In 2016 the Finnish economy is expected to grow by 0.9% from last year. The growth outlook for the global economy and trade is modest. World trade will increase by 3% in 2016, accelerating only slightly to 5% in 2018. The performance of exports will remain weaker than global trade, and therefore Finland will continue to lose market shares. Lower energy prices, and oil prices in particular, are bolstering the growth prospects of energy-intensive economies such as Finland. The sharpest falls in energy and raw material prices have bottomed out, and the price of oil will start to move moderately higher. In 2017 consumer prices will accelerate to 1.3%. Nominal earnings will rise annually by around one per cent over the outlook period. Assuming that these projections are accurate, Finnish competitiveness will improve in comparison with Sweden and Germany, for instance. Investment will return to clear growth in 2016 and continue to grow on a broad base throughout the out- look period. Private consumption growth will be supported this year by moderate price trends. In 2017–2018 consumption growth will continue to outpace real income growth on the back on strengthening consumer confidence. Projections for 2017 and 2018 forecast muted GDP growth at 1.2%. During the forecast horizon the Finnish economy will grow slightly faster than potential output, and therefore the negative output gap will shrink. The number of persons employed will turn to growth of 0.3% in 2016 as the economy continues to rebound. Employment will improve throughout the outlook period, and the unemployment rate will drop back to 8.7% by 2018. Finnish public finances have been running a deficit since 2009. The general government budgetary posi- tion will improve in the years ahead in response to fiscal adjustment and rebounding economic growth, but nonetheless remain in deficit. General government debt to GDP has long been rising, and the same trend is set to continue. Finland’s budgetary deficit came within the 3% of GDP target as set out in the EU Treaty, but public debt remains in breach of the 60% limit. Central government has the largest deficit of all general government sectors, although its deficit is shrink- ing. Local government finances will also remain firmly in deficit, and other social security funds are gradually moving back to balance. Earnings-related pension institutions are running a deficit of around 1% of GDP. Preface The Spring 2016 Economic Survey is prepared as background material for the Govern- ment’s spending limits decision. It offers projections of Finland’s economic outlook for 2016–2018. In addition to short-term prospects, the Economic Survey includes medium- term projections extending to 2020. The forecast and trend projections in the survey are prepared independently by the Min- istry of Finance Economics Department based on the Act on the implementation of the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union and on multi-annual budgetary frameworks (869/2012). The forecasts are based on provisional national accounts data for 2015 published by Sta- tistics Finland in March 2016 and on other public statistical sources available on 22 March 2016. Both the short-term and medium-term projections take account of the decisions taken by the Government in its spending limits discussions on 5 May 2016. Helsinki April 2016 Ministry of Finance Economics Department Markus Sovala Director general Mika Kuismanen Mikko Spolander Director Director Forecasting unit Stability unit (Public finances) The source for all data on materialised developments is Statistics Finland unless otherwise indicated. SYMBOLS AND CONVENTIONS USED - nil 0 less than half the final digit shown .. not available . not pertinent ** forecast CPB CPB Netherlands Bureau for Economic Policy Analysis HWWI Hamburgisches WeltWirtschafts Institut IMF International Monetary Fund MoF Ministry of Finance Each of the figures presented in the tables has been rounded separately. Contens Summary.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 1 Economic outlook.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 1.1 Global economy .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23 1.2 Foreign trade. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .30 1.3 Domestic demand.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33 1.3.1 Private consumption.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33 1.3.2 Public consumption.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36 1.3.3 Private investment.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .38 1.3.4 Public investment.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47 1.4 Domestic production.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47 1.4.1 Total output.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47 1.4.2 Secondary production.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .50 1.4.3 Services.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .52 1.5 Labour force.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .56 1.6 Incomes, costs and prices.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .60 1.6.1 National income.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .60 1.6.2 Wages and salaries.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .61 1.6.3 Consumer prices.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .62 2 Economic policy and public finances.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 2.1 General government finances.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65 2.1.1 Estimates of fiscal policy impact.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .69 2.1.2 General government debt.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .72 2.2 Central government.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .74 2.2.1 Central government expenditure.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .76 2.2.2 Central government revenues.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79 2.2.3 On-budget accounts and national accounts.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .82 2.3 Local government.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83 2.4 Social security funds.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .88 2.4.1 Earnings-related pension funds.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .88 2.4.2 Other social security funds.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .90 2.5 Long-term sustainability of public finances.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .92 Supplementary statistics.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 Boxes: Calculating the effects of reducing business operating costs .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16 Euro area moves towards stability – but the threats remain.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29 Housing investment in Finland: a brief overview.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .42 Decomposing the forecast into shock contributions.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .54 Central government on-budget accounts and expenditure in 2017–2020.. . . . . . . . . . . . . . . .70 Impact of increasing number of asylum seekers on central government expenditure.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .77 11 Summary Economic outlook 2015-2017 After three years of recession, Finland returned to GDP growth of 0.5% in 2015, accord- ing to provisional Statistics Finland figures. In early 2015 the main drivers of this slow growth were exports and consumption, towards the end of the year the principal driver was investment. In 2016 the Finnish economy is forecast to post growth of 0.9% from last year. Projec- tions for 2017 and 2018 forecast muted growth at 1.2%. The forecasts do not factor in the effects of a possible social contract. Despite the slight rebound, the Finnish economy is expected to remain weak in the immediate future. It is predicted that GDP in 2018 will still be some 2% lower than in 2008, and that industrial output in 2018 will be about one-fifth lower than 10 years ago. The per- formance of exports will remain weaker than global trade, and therefore Finland will con- tinue to lose market shares in world trade. In the immediate future economic activity will be maintained primarily by private con- sumption and investment. In the medium term potential output growth, which reflects the level of output possible given the resources on hand, will be less than one per cent. The growth outlook for the global economy and trade is modest. World trade will increase by 3% in 2016, accelerating only slightly to 5% in 2018. In 2018 world economic growth will reach no more than around 4%. Growth prospects in China have continued to deteriorate, and the growth rate is forecast to drop back to 6%. Recently much concern has been expressed about the Chinese stock market, but we should not to read too much into its performance: the stock market structure and operation differ significantly from those of its western counterparts and do not reflect developments in the real economy in the same way. The slowdown of economic growth in China is clearly reflected in the outlook of other emerging economies, which will be heavily hit by the reduced Chinese demand for raw materials. The Russian economy is continuing to contract, and there is no growth in sight in 2017. Russian imports are continuing to fall, and the country’s growth potential is hampered by the rigidities of its economic system. It is expected that many of Finland’s major trade partners will see rather solid economic development. US economic growth has not reached the levels predicted earlier, but the pros- pects for growth are still good: over the next few years the economy will post growth of around 2.5%. The Swedish economy showed very strong growth last year at 4.5%. This will slow down over the next couple of years, but growth will nonetheless remain broad-based 12 and faster than in the EU area on average. In the UK, too, growth is broad-based and the economic situation is expected to remain strong throughout the forecast horizon. In Ger- many, growth will reach a healthy 1.5%. The euro area is also back on a track of moderate growth, and the annual growth forecast for the outlook period is around 2%. The monetary policies pursued by central banks are growth-supportive. The ECB has further expanded its exceptional monetary policy operations, and its reference rates will remain at historically low levels throughout the outlook period. Short-term interest rates will remain negative in 2017, and the three-month Euribor interest rate will only move into marginally positive territory in 2018. The ten-year interest rate will also remain low, aver- aging 1.6% in the last year of the forecast horizon. There is downward pressure on the euro to dollar exchange rate, and the forecast is that by 2018 the euro will be at parity with the dollar. The weakening of the euro will bolster the price competitiveness of exports in markets where payments are settled in dollars. Around 80% of Finnish exports are invoiced in euros or dollars. Lower energy prices, and oil prices in particular, are good news for the growth prospects of energy-intensive economies such as Finland. The sharpest falls in energy and raw material prices have bottomed out, and the price of oil will start to move moderately higher. The development of earnings is a major domestic cost factor with important implica- tions for competitiveness. Nominal earnings will rise annually by around one per cent over the outlook period. Assuming that these projections are accurate, Finnish competitiveness will improve in comparison with Sweden and Germany, for instance. The Finnish GDP growth forecast for 2016 is 0.9%. This moderate growth will mainly be driven by investment. It is predicted that private investment will increase by 5.8%. Invest- ment growth will be broad-based, but particularly strong in building construction. The growth of investment in machinery and equipment is particularly positive, even though most of it is attributable to a few major projects. In 2016 household real disposable income growth will pick up and private consump- tion will increase by one per cent. The growth of consumer demand will be focused on spending on durables. Household indebtedness will continue to increase, but at a slower rate than earlier. With imports growth outpacing exports growth, net exports will have a negative effect on economic growth. Imports will be driven by increasing investment and consumer demand. It is predicted that exports will rise by no more than 1.3%, and therefore Finland will con- tinue to lose market shares in world trade. It is predicted that the current account will be close to balance. The slide in industrial output is finally coming to a halt after five consecutive years of decline. It is forecast that industrial production will increase by 0.8% in 2016. Service production is also set to grow by almost one per cent. The number of persons employed is expected to be 0.3% higher than the year before, and the annual average unemployment rate is predicted to come in at 9.3%. The biggest problem in the labour market is the sharp rise in long-term and structural unemployment. Consumer prices are expected to rise mod- erately in 2016 by just 0.3%. 13 The GDP growth forecast for 2017 is 1.2%. This growth will again mainly be driven by investment and private consumption. Exports will begin to pick up in the wake of rebound- ing world trade, but the growth rate will remain historically subdued. Imports will margin- ally outpace exports, but the negative growth contribution of net exports will be smaller than the year before. Investment growth will slow somewhat from the current year, but all investment items will nonetheless continue to post positive growth. Private consumption volume growth will slow somewhat, but still remain relatively strong compared with disposable income growth. The forecast for private consumption growth is based on the assumption of improving consumer confidence, which will contrib- ute to reduce the household savings rate. It is predicted that industrial output will increase by some 2%, mainly on the back of strong metal industry performance. The 2% figure for output growth is still very modest indeed. No significant improvement is predicted in the labour market situation. The number of employed persons will increase by 0.4%, and the unemployment rate is expected to fall to 9%. Consumer prices will accelerate to 1.3%. The GDP growth forecast for the last year of the forecast horizon is 1.2%. Overall, the growth outlook for the 2016–2018 period is quite subdued. Ultimately the reason for this lies in the persistently sluggish performance of exports. In the short term domestic demand will continue to drive economic growth, but for a small open economy like Finland this is not enough to generate faster than projected growth. From the point of view of economic welfare and its underlying international division of labour, it is crucial that the country also has a competitive export sector. Projected cumulative growth in 2016–2018 will reach no more than 3.3%, and the GDP volume will remain lower than in 2008. The Finnish economy is in poor shape and faces huge challenges. During the forecast horizon the Finnish economy will grow slightly faster than potential output, and therefore the negative output gap will shrink. Finnish public finances have been running a deficit since 2009. The general govern- ment budgetary position will improve in the years ahead in response to fiscal adjustment and rebounding economic growth, but nonetheless remain in deficit. General government debt to GDP has long been rising, and the same trend is set to continue. Finland’s budget- ary deficit came within the 3% of GDP target as set out in the EU Treaty, but public debt will continue to exceed the 60% limit. Central government has the largest deficit of all general government sectors, although its deficit is shrinking. Local government finances will also remain firmly in deficit, and other social security funds are gradually moving back to balance. Earnings-related pension institutions are running a deficit of around 1% of GDP. The risks of the forecast for the international economy are skewed to the downside. In China, indebtedness has continued to grow rapidly, especially in the private sector. In the longer term it is also unclear how successful China will be in reforming its economic model and placing greater weight on domestic consumption and services at the expense of manu- facturing, investment and exports. The Chinese slowdown and restructuring may also cause greater than anticipated problems especially for emerging economies. In the euro area, too, the risks remain skewed to the downside. Russia’s economic situation remains precarious. Political tensions are fuelling high levels of uncertainty and may further deepen the recession in Russia. 14 It is thought that the sense of uncertainty will also continue in the financial market. Stock prices have fluctuated widely since the beginning of the year, and prices of banking shares in particular have fallen. The situation in the Italian and to some extent in the Ger- man banking sector is causing concern, and there is an apparent risk of contagion. It is impossible to offer an overall assessment of the consequences of an unconventional fiscal policy. In any event low interest rates in the current environment of light fiscal policy have fuelled a search-for-yield mentality, and investment flows have been channelled into the housing and stock market, partly as a result of the low demand for credit. Prices have risen sharply in the markets, increasing the risk of major corrective movements. The domestic risks are still predominantly related to the development of the real econ- omy and the labour market. The Finnish economy has shown poor performance in recent years, and over the next couple of years economic growth will remain slower than in com- petitor countries. Finnish competitiveness is still weaker than in those countries, and Fin- land will continue to lose market shares in global trade. The lesson learned from the past few years is that the health of the national economy can only be properly restored under conditions of a strong real economy. If the Finnish economy develops as predicted, this will not be enough to essentially improve the state of public finances, for instance. Priority focus should now be given to developing economic policy reforms that have genuine impact on household and business behaviour. The situation in the Finnish labour market looks less than promising. The proportion of the inactive population is too high, and the supply and demand match in the labour market needs improving. Decisions on business location and production activities are influenced by input price levels and their development. In a competitive marketplace these factors will have an increasingly pronounced influence. The best way to tackle the challenges facing the economy is by means of a predictable economic policy and a proactive approach to addressing structural problems. The develop- ment of the Finnish economy and the Government’s economic policy decisions are currently being closely monitored both inside and outside the country. The impressions of outside observers will for their own part influence the future course of the economy. 15 Table 1. Key forecast figures 2015 EUR bn 2013 2014 2015 2016** 2017** 2018** change in volume, % GDP at market prices 207 -0.8 -0.7 0.5 0.9 1.2 1.2 Imports 77 0.5 0.0 -0.4 2.6 3.0 3.5 Total supply 284 -0.8 -0.3 0.0 1.4 1.6 1.8 Exports 77 1.1 -0.9 0.6 1.3 2.9 3.6 Consumption 167 0.0 0.3 0.7 0.7 0.6 0.6 private 116 -0.5 0.6 1.4 1.0 0.8 0.9 public 51 1.1 -0.3 -0.9 -0.1 0.0 0.0 Investment 42 -4.9 -2.6 -1.1 5.2 3.3 3.0 private 34 -6.6 -3.1 -1.0 5.8 4.1 4.0 public 8 2.6 -0.6 -1.2 2.7 0.1 -1.3 Total demand 285 -0.4 -0.1 -0.4 0.8 1.1 1.3 domestic demand 207 -1.1 0.2 -0.7 0.6 0.4 0.4 2013 2014 2015 2016** 2017** 2018** GDP, EUR bn 203 205 207 211 215 221 Services, change in volume, % -1.4 -0.2 0.9 0.7 1.2 1.0 Industry, change in volume, % 0.0 -1.7 -0.6 0.8 2.1 2.4 Labour productivity, change, % 0.5 0.0 0.7 0.4 1.0 1.0 Employed labour force, change, % -1.0 -0.4 -0.4 0.3 0.4 0.4 Employment rate, % 68.5 68.3 68.1 68.4 68.8 69.1 Unemployment rate, % 8.2 8.7 9.4 9.3 9.0 8.7 Consumer price index, change, % 1.5 1.0 -0.2 0.3 1.3 1.5 Index of wage and salary earnings, change, % 2.1 1.4 1.2 1.2 1.0 1.2 Current account, EUR bn -3.3 -1.9 0.3 0.2 0.3 0.6 Current account, relative to GDP, % -1.6 -0.9 0.1 0.1 0.1 0.3 Short-term interest rates (3-month Euribor), % 0.2 0.2 0.0 -0.2 -0.1 0.1 Long-term interest rates (10-year govt. bonds), % 1.9 1.4 0.7 0.6 1.1 1.6 General government expenditure, relative to GDP, % 57.5 58.1 58.3 58.2 57.6 57.0 Tax ratio, relative to GDP, % 43.7 43.9 44.5 44.6 44.4 44.1 General government net lending, relative to GDP, % -2.6 -3.2 -2.7 -2.5 -2.1 -1.8 Central government net lending, relative to GDP, % -3.7 -3.8 -3.1 -2.9 -2.6 -2.2 General government gross debt, relative to GDP, % 55.4 59.3 63.1 65.0 66.7 67.4 Central government debt, relative to GDP, % 44.1 46.3 48.2 50.0 51.6 52.4 16 Calculating the effects of reducing business operating costs The MoF Economics Department has assessed the impact of a temporary reduction in busi- ness operating costs on the broader development of the economy using its macroeconomic model (Kooma). The analysis is conducted for the 2016–2021 period. The results are reported in relation to the steady state path, which may be represented by the current outlook for the Finnish economy. Operating costs are crucial to the potential of businesses to generate output and emplo- yment. Lower costs can pave the way to improved price competitiveness. Investment in intel- lectual capital, new products and new procedures and practices all contribute to improve busi- ness productivity and to reduce marginal costs (the cost that results when output changes by one unit). Longer working hours also reduce businesses’ marginal costs. The calculation compares two different types of shocks that lower businesses’ marginal costs. The overall productivity shock gives businesses access to better technology and increa- ses the volume of output. The labour supply shock primarily increases the number of hours worked; the number of jobs only increases later in response to increased output levels. The labour supply shock is derived from the household benefit function. A positive labour supply shock reduces the marginal rate of substitution in consumption relative to employment and creates an incentive to work more. Both shocks are temporary quarterly impulses, and both return equally quickly to the baseline. The productivity shock will lower the marginal costs of domestic production, and busines- ses will gradually re-price their products (see Figure 1 TFP). The lowered price level will boost exports. Exports will peak one year later when export companies have re-priced their products and when improved price competitiveness has bolstered exports. The demand for labour input and wages will fall as increased productivity will reduce the amount of labour input needed to generate the same amount of output. There will be a temporary decrease in consumption as liquidity-strapped consumers immediately cut back on their spending. Consumers who opti- mise over time, in contrast, will increase their consumption with falling price levels. Consump- tion will return to positive growth within one year, and the overall cumulative effect is distinctly positive. Exports will drive output to growth, and employment will begin to improve. The labour supply shock will increase the willingness to work, and the number of hours wor- ked will increase (see Figure 1 Employment). Costs per output unit, i.e. marginal costs will there- fore be reduced. As in the case of the productivity shock, reduced marginal costs will contribute to boost exports through more competitively priced products. The increased supply of labour will also have the effect of lowering wages. The wage reaction obviously has a major impact on the outcome. The less wage adjustment there is, the less will be the cumulative effects of redu- ced costs, and the less prices will fall and exports improve. On the other hand, consumption will also decrease less. The difference will be greatest in the case of liquidity-strapped consu- mers, who will respond more immediately to changes in their wages. The impacts of the wage reaction are also felt at the level of output. The sharper the slowdown in wages in comparison with steady state growth, the more output and overall employment will improve and the lon- ger lasting this improvement. The public sector deficit will show a temporary marginal increase, but overall the deficit will shrink. In other words, steps to create more favourable conditions for business through lowe- red costs will also benefit public finances. 17 2018 2021 −3 −2 −1 0 Marginal cost 2018 2021 −0.05 0 0.05 0.1 0.15 Output 2018 2021 −0.4 −0.2 0 0.2 Labor productivity 2018 2021 −0.2 0 0.2 0.4 Employment 2018 2021 −2 −1 Unit labor cost 2018 2021 −0.5 −0.4 −0.3 Price level 2018 2021 −0.2 −0.1 0 Private consumption 2018 2021 0.5 1 Export 2018 2021 −2.5 −2 −1.5 −1 −0.5 Wages 2018 2021 −0.2 0 0.2 0.4 0.6 Public sector deficit TFP Labor Lowering costs 18 Medium-term outlook Finland’s GDP returned to slight growth last year, after three consecutive years of decline. Apart from cyclical factors, the poor performance of the economy is due to an ongoing process of restructuring in industry and the economy as a whole, which has also under- mined longer term growth prospects. It is expected that economic growth will slightly accelerate this year and next. However it is thought that growth will remain historically slow even in the medium term. The medium-term outlook can be examined via potential output, which is thought to determine the economy’s medium-term growth prospects. In its assessments of potential output the MoF Economics Department uses the production function method as devel- oped jointly by the EU Commission and Member States, in which potential output growth is divided between projections of potential labour input, capital and total factor produc- tivity. Potential output is an unobservable variable and its assessment is highly challeng- ing, especially during a strong economic cycle and under conditions of rapid changes in the production structure. The labour input will decrease over the next years as the population of working age continues to shrink. At the same time, though, labour participation rates are expected to increase somewhat, especially in older age groups. Another factor determining labour input growth is the structural unemployment rate: this is the level of unemployment below which upward wage pressures begin to develop in the labour market. In practice this means that unemployment is above its structural level when real unit labour costs are falling, i.e. when wages are rising more slowly than productivity and inflation taken together. Using the EU’s common method, it is estimated that Finland’s structural unemployment level is around 8%. The medium-term forecast is that unemployment will begin to approximate this level as the output gap closes. The declining labour input will weaken potential output growth to some extent in the medium term. Increasing total factor productivity has been a major driver of economic growth in the past few decades. In recent years, however, total factor productivity has shown only modest growth. This slowdown is attributable to both cyclical and structural factors. Output has dropped significantly in high-productivity branches, and at the same time services have gained increasing prominence in the economy. The total factor productivity trend can be extracted from observed productivity based on the capacity utilisation rate and other cycli- cal indicators. In recent years total factor productivity trend growth has been around zero, and it is expected that in the medium term the growth rate will remain much slower than in the early 2000s. The economy’s potential output is dependent not only on labour input and total factor productivity, but also on the existing capital stock. Several years of low investment have contributed to slow capital stock growth and therefore undermined the economy’s future growth potential. An increased investment rate over the outlook period will strengthen the economy’s growth potential. Overall it is projected that the economy’s growth potential will only rise to just under one per cent a year by 2020. 19 The difference between total actual output and potential output, i.e. the output gap is negative when actual output is lower than potential output. This means there is idle capac- ity in the economy and output can grow more rapidly than potential output without cre- ating price pressures. It is estimated that in 2016 the output gap will stand at around 2% of potential output. In 2016–2020, it is predicted that the economy will grow at an average annual rate of just over one per cent. According to the EU’s common production function method, Finland’s potential output growth is slower, on average just over ½% a year. When GDP growth exceeds its potential, the output gap contracts, and according to the forecast the output gap will close in 2020. When the output gap closes, unemployment will approach its structural level, the labour participation rate will be at its trend level and total factor productivity growth will be equivalent to trend growth once all idle production capacity has been put to use. Finnish public finances have been running a significant deficit since 2009. Although eco- nomic growth is rebounding and the output gap is contracting, this growth is not enough to bridge the deficit in public finances. At the same time, population ageing is continuing to weigh down on public finances. General government revenue is no longer enough to sus- tain all the structures and functions of the public sector that were created on the founda- tions of stronger economic growth. Slow potential output growth is having an adverse effect on public finances as economic growth and therefore tax revenue growth are expected to remain subdued in the years ahead. Despite fiscal adjustment, public finances will remain in structural deficit. The public debt to GDP ratio exceeded the 60% threshold in 2015, but fiscal consolidation will contribute to slow the growth of the debt ratio during the next years. Table 2. Key forecast figures for the medium term 2014 2015 2016** 2017** 2018** 2019** 2020** GDP at market prices, change in volume, % -0.7 0.5 0.9 1.2 1.2 1.1 1.1 Consumer price index, change, % 1.0 -0.2 0.3 1.3 1.5 1.7 1.8 Unemployment, % 8.7 9.4 9.3 9.0 8.7 8.4 8.1 Employment rate, % 68.3 68.1 68.4 68.8 69.1 69.4 69.7 General government net lending, % of GDP -3.2 -2.7 -2.5 -2.1 -1.8 -1.4 -1.3 Central government -3.8 -3.1 -2.9 -2.6 -2.2 -1.7 -1.5 Local government -0.8 -0.7 -0.7 -0.6 -0.6 -0.7 -0.8 Social security funds 1.3 1.0 1.1 1.1 1.0 1.0 0.9 Structural balance, % of GDP -1.5 -1.3 -1.5 -1.4 -1.4 -1.2 -1.3 General government gross debt, % of GDP 59.3 63.1 65.0 66.7 67.4 67.4 67.2 Central government debt, % of GDP 46.3 48.2 50.0 51.6 52.4 52.6 52.5 Output gap, % of potential output 1) -3.0 -2.5 -1.9 -1.2 -0.7 -0.4 0.0 1) Estimated according the method developed jointly by the EU Commission and Member States. 20 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 01 03 05 07 09 11 13 15 17 19 Relative to GDP, % (right scale) EUR bn. (left scale) Central government financial balance Sources: Statistics Finland, MoF 0 10 20 30 40 50 60 70 0 20 40 60 80 100 120 140 91 93 95 97 99 01 03 05 07 09 11 13 15 17 19 EUR bn. (left scale) Relative to GDP, % (right scale) Central government debt Sources: Statistics Finland, MoF -3 -2 -1 0 1 2 3 4 5 -3 -2 -1 0 1 2 3 4 5 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 19 Total productivity Capital Labour Potential growth Contributions to potential growth Sources: Statistics Finland, MoF according to EU method, % 21 Fiscal policy General government expenditure is financed from revenue generated by economic activ- ity. Households and businesses pay taxes on their incomes, and households furthermore on their consumption. In addition, public ownerships generate property income. For this reason slow economic growth presents a major challenge for Finnish public finances. The Finnish economy has been in a difficult situation for the past few years, often record- ing negative GDP growth figures. Unemployment has increased, and unemployment spells have become longer. The downturn has been longer and deeper than anticipated. At the same time, the prospects for economic growth have been eroded by industrial restructuring, low investment, the prolonged unemployment becoming structural and population ageing. Demographic change will continue apace for the most part of the next two decades. During this period the main factor driving aggregate economic output growth will be total factor productivity. On this basis it is estimated that the potential for growth will be around 1–1.5% over the long term. Public finances have been significantly impacted by the challenging times. The general government budgetary position has deteriorated, and the debt ratio has increased rapidly. In 2014, the general government deficit was over 3% of GDP. The deficit decreased in 2015, but the debt ratio exceeded 60% of GDP. As the economic downturn recedes, the general government budgetary position will gradually improve. The steps taken by the Government to stabilise public finances will also contribute to strengthen the budgetary position. Nonetheless public finances are faced with the risk of persistent structural imbalance. The foreseeable economic growth will not be enough to finance existing public structures nor to guarantee the long-term provision of statutory benefits and public services. In this situation it is important that fiscal and other economic policy is geared to strik- ing a balance between supporting domestic demand through the recession, curbing the growth of public debt in the medium term, improving the conditions for economic growth and ensuring the sustainability of public finances in the long term. In order to make informed and appropriate economic policy decisions, it is crucial to have a clear understanding of the factors contributing to the poor performance of the econ- omy. In Finland, most of these factors are structural by nature. Steps to support domestic demand will not help to solve problems that are caused by shift- ing economic structures. Fiscal measures aimed at boosting demand make sense if they also promote economic restructuring and the conditions for future output. Sustainable growth can only be generated through innovations and productivity growth in business firms. The strong and stable institutions of Finnish society, including health care, education, public social insurance, the banking and financial system as well as our euro zone mem- bership all contribute to enhance households’ and businesses’ risk tolerance. These institu- tions provide a sound basis for innovations and productivity growth. 22 The key areas of economic policy focus for Prime Minister Juha Sipilä’s Government are competitiveness, employment and public service provision. The Government’s economic policy objectives are to curb the growth of public debt and to bridge the sustainability gap by means of savings as well as measures that support growth and improve the efficiency of public service provision. The Government’s immediate fiscal adjustment package to strengthen public finances consists of actions aimed at curbing public expenditure and reallocating expenditure. The net effect of these actions will improve the general government budgetary position by some EUR 4 billion by 2019. With the decisions announced by the Government on 5 April 2016, the planned package of actions has almost reached its full extent. The actions will be imple- mented as per the schedules set out in connection with annual state budgets. The Government is committed to improve the conditions for employment and eco- nomic growth by means of taxation and by strengthening competitiveness and produc- tivity growth. Central to these efforts will be moderate wage settlements, the introduc- tion of an export industry driven approach to wage formation, and labour market reforms designed to encourage local level wage bargaining. The target has been to generate enough new growth and jobs to improve the general government budgetary position by EUR 1–1.5 billion over the medium term. Key longer-term measures are those designed to cut public sector costs by easing munic- ipalities’ burden of statutory duties and obligations, by taking better advantage of digitali- sation, and by restructuring social welfare and health care services and funding, including the reform of regional and central administration. These reforms are now in the planning stage and are proceeding on schedule. By means of these actions, the Government’s aim is to curb public expenditure growth by some EUR 4 billion over the long term. Furthermore, Parliament has adopted the pension reform initiated by the previous gov- ernment. This reform will enter into force from the beginning of 2017 and will contribute to strengthen public finances in the long term. 23 1 Economic outlook 1.1 Global economy World economic growth remains slow The outlook for the world economy is multifaceted. The global picture is one of accelerat- ing growth, but there is marked variation in economic conditions and future prospects. In advanced economies, growth is slowly picking up, but the outlook for many emerging economies is challenging. The Chinese economy is set to slow after a sustained period of robust growth, and Russia and Brazil will remain in recession for at least the current year. The slowdown of growth and restructuring in China are overshadowing the prospects of many emerging economies and raw material producers, especially in Asia, Oceania and the Middle East, but growth in India will remain strong. The euro area has remained on a slow growth track, partly as a result of reduced prices of oil and many other imports and a weaker euro exchange rate. These tailwinds will dissipate by the end of the outlook period. The supply of credit and overall financing conditions have also improved, fiscal policy is hampering growth to a lesser extent than before, and monetary pol- icy remains expansionary. These factors are contributing to drive private consumer demand, and investment is also slowly rebounding. The exceptionally high level of immigration will provide a minor additional demand boost, but adversely affect the balance of public finances. In Spain, Ireland and elsewhere, earlier structural reforms have contributed to a return to brisk growth. Euro area growth is still hampered by persistently high unemployment. In the UK and Sweden, growth is still robust and employment is at a high level. Broad-based, but slower than anticipated growth is continuing in the United States. The rebound is supported not only by low energy prices, but also by stronger household balance sheets, favourable labour market conditions and a lighter fiscal policy. The rate of new job crea- tion is higher than the rates of resignation and recruitment. Both nominal and real wages are rising faster than ever since the financial crisis, and consumer confidence has returned to its historical median. Investment is also set to grow at a moderate rate. The dollar has strengthened with interest hike expectations, which will contribute to slow exports and increase imports. Productivity growth has slowed both in Europe and the United States, hampering prospects for supply growth. Productivity growth has remained strong at the technologi- cal forefront, but slowed significantly elsewhere. Productivity is set to play an increasingly significant role in the future, especially in the ageing European labour market. Structural reforms could help to improve the conditions for productivity growth. 24 The Russian economy continues to remain dependent on oil and gas exports. The coun- try has failed to transform itself or to use the revenue generated from raw materials to diver- sify its production. Its growth potential is effectively hampered by unmade investments and obsolete economic structures, such as public interference in private sector investment and production decisions. Post-recession growth in Russia will remain very muted. In China, growth in industry, construction and commodity exports has already slowed significantly, and this trend is set to continue. The Chinese economy is now in transition from an export and investment driven model to one led by domestic consumption and services. Historically, corresponding changes have resulted in a marked slowdown of growth. If the country is successful in its policy, this slowdown will be well controlled, initially to around 6%. Japan’s growth potential is less than 1%, and even minor negative shocks can push the economy into technical recession. Japanese exports have failed to recover despite persis- tent stimulus and a massive devaluation of the yen. Although the population is ageing rap- idly, the supply of labour has remained strong. The labour market remains tight, and rising wages over the outlook period will support household demand. World trade to remain modest World trade growth has slowed, among other reasons because of the slowdown of Chinese manufacturing and sluggish investment activity in industrial countries. Imports growth will remain exceptionally modest, especially in emerging economies. Before the financial crisis, trade growth was around twice as high as output growth, but at the moment trade is actually growing more slowly than output. Earlier, such slow rates of trade growth have only been seen under conditions of recession. Finland’s market share in world trade has continued to shrink, but this trend is now slowing. In the euro area, Finland has almost regained the same market share as it had before the crisis. In Sweden and Russia, on the other hand, Finland is continuing to lose market shares. Global trade will not provide a strong demand impetus for Finnish exports. -6 -4 -2 0 2 4 6 8 10 12 14 16 -6 -4 -2 0 2 4 6 8 10 12 14 16 06 08 10 12 14 16 18 China (not seasonally adjusted) United States (seasonally adjusted) Euro area (seasonally adjusted) Sources: Statistical authorities, MoF Gross domestic product change in volume, % 25 Inflation set to remain very moderate The price of crude oil has fallen sharply above all in response to the deteriorating outlook in emerging economies and persistently high US and OPEC supply. The supply of crude oil will expand further following the agreement reached in the Iranian nuclear dispute, and oil prices will rise only very moderately. As energy is an intermediate input in all products and services, the effects of the oil price shock will be felt throughout the economy. Slower than expected growth of demand from emerging economies and continued high supply have caused other industrial raw material prices to fall sharply, too. Raw material prices are apparently reaching a bottom. Furthermore, the slide in producer prices due to excess capacity in China has continued. Together, these factors have thrown world export prices into sharp decline. Inflation expectations are also extremely low, allowing central banks in industrial countries to persist with the current unusual monetary policy stance. However there is no real threat of a deflationary cycle in sight. In the United States, interest rates have begun slowly to move back to normal. Interest rates in the euro area will rise very slowly over the outlook period and for a long time remain at a clearly lower level than was normally seen during the pre-crisis period. 65 70 75 80 85 90 95 100 105 110 115 65 70 75 80 85 90 95 100 105 110 115 07 08 09 10 11 12 13 14 15 Spain Germany Italy Sweden Finland Sources: Macrobond, MoF Market share in goods exports¹ 2007=100, trend (HP) ¹ Ratio of goods exports growth to world trade growth -24 -20 -16 -12 -8 -4 0 4 8 12 16 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 -24 -20 -16 -12 -8 -4 0 4 8 12 16 World trade Finnish exports Sources: CPB Netherlands Bureau for Economic Policy Analysis, Statistics Finland, MoF World trade change in volume, % 26 Risks remain on the downside In China, indebtedness has continued to grow rapidly, especially in the private sector. The high and increasing debt burden coupled with slowing growth and economic restructuring may cause shocks that, because of the size of the Chinese market and global value chains, may have wide-ranging effects, particularly on raw materials and investment goods sup- pliers. In the longer term it is also unclear how successful China will be in reforming its economic model and placing greater weight on domestic consumption and services at the expense of manufacturing, investment and exports. The Chinese slowdown and restructur- ing may also cause greater than anticipated problems especially for emerging economies. In the euro area, too, the risks remain skewed to the downside. Households may strug- gle even more than anticipated to recover with the waning effects of the current favour- able conditions. It is also unclear how committed indebted member states are to the politi- cally-charged programmes of public sector adjustment, and adjustment may have the effect of reducing demand more than anticipated. The ability of the euro area to resist negative shocks will remain weak. The outlook remains overshadowed by geopolitical tensions in Ukraine, the Middle East and elsewhere. Confidence has not weakened to the same extent as in many earlier political and currency crises, but if tensions flare both trade flows and financing may be adversely affected. Russia’s economic situation remains precarious. Political tensions are fuelling high lev- els of uncertainty and may further deepen the recession in Russia. It is unclear how the country will adapt to the period of slow growth that lies ahead. Extremely low interest rates in industrial countries and a stronger search-for-yield men- tality have steered investment flows into the housing and stock market, which may have led to overvaluations. In Sweden, for instance, housing prices have risen very sharply. The winding down of unconventional monetary policy, the edging up of interest rates and the 20 30 40 50 60 70 80 90 100 50 60 70 80 90 100 110 120 130 06 07 08 09 10 11 12 13 14 15 16 17 18 EUR/barrel 2010=100 Industrial raw material index, euro area (left scale) Crude oil (Brent, global spot price, right scale) Sources: Hamburgisches WeltWirtschafts Institut, Macrobond, MoF Raw materials prices EUR 27 strengthening of the US dollar may cause strong reactions in the financial market. Many emerging economies in particular may see more strong movements of capital as they have taken out large amounts of dollar-denominated loans. Other upside risks are that lower oil prices may strengthen demand from oil-importing countries more than anticipated, or productivity may recover to stronger growth. 0 25 50 75 100 125 150 175 200 225 0 25 50 75 100 125 150 175 200 225 06 07 08 09 10 11 12 13 14 15 16 12-month 3-month Source: Macrobond Banking system risks difference between secured Euribor and unsecured Eonia interest rate swap yield, basis points 4 5 6 7 8 9 10 11 12 13 4 5 6 7 8 9 10 11 12 13 06 07 08 09 10 11 12 13 14 15 16 Euro area Finland Sweden Germany United States Sources: Macrobond, statistical authorities Unemployment rate seasonally adjusted, % 28 Table 3. Gross domestic product 2013 2014 2015 2016** 2017** 2018** change in volume, % World (PPP) 3.2 3.2 3.1 3.4 3.9 4.1 Euro area -0.5 1.0 1.8 2.0 2.0 2.0 EU 1.0 1.4 1.6 2.2 2.2 2.1 Germany 0.4 1.6 1.4 1.7 1.5 1.5 France 0.7 0.2 1.4 1.2 1.7 1.5 Sweden 1.6 2.0 4.5 3.2 2.5 2.2 United Kingdom 1.7 3.0 1.9 2.7 2.5 2.2 United States 1.5 2.4 1.9 2.7 2.5 2.2 Japan 1.6 -0.1 0.7 1.0 0.7 0.7 China 7.8 7.3 6.8 6.5 6.2 6.0 Russia 1.2 0.6 -3.7 -2.0 0.0 1.0 Sources: Eurostat, statistical authorities, IMF, MoF Table 4. Background assumptions 2013 2014 2015 2016** 2017** 2018** World trade growth, % 2.6 3.3 2.8 3.0 4.2 5.0 EUR/USD 1.33 1.33 1.11 1.08 1.05 1.02 Industrial raw material price index, EA, € (2010=100) 91.0 90.0 84.0 75 75 75 Crude oil (Brent), €/barrel 82.0 74.5 47.8 34.3 39 44 3-month Euribor, % 0.2 0.2 0.0 -0.2 -0.1 0.1 Government bonds (10-year), % 1.9 1.4 0.7 0.6 1.1 1.6 Export market share (2000=100) 1) 84 81 79 78 77 76 Import prices, % -1.7 -1.6 -3.2 -1.2 1.2 1.4 1) Ratio of export growth to world trade growth Sources: Statistical authorities, CPB, HWWI, Reuters, MoF 29 Euro area moves towards stability – but the threats remain Financial stability has increased in the euro area as Ireland, Spain, Portugal and Cyprus have persevered with rigorous fiscal adjustment and turned their economies back to growth, res- tored balance in public finances and regained competitiveness in the global marketplace. The easing of the Greek situation in the autumn, following the crisis last summer, has also had a beneficial impact. At the same time, several euro countries have had success in strengthening their banking sectors. It is paramount, though, that reforms are continued in all euro countries to generate economic growth. A highly indebted economy has limited fiscal room to maneuver and therefore limited capacity to absorb new external shocks. Profitability in the banking sector is weighed down by the deteriorating international economic outlook and persistently low interest rates. In the euro area the Portuguese and Italian banking sectors in particular have been overshadowed by uncertainty, and public intervention has been required to invigorate the banking systems. The volume of non-performing loans in the Italian banking system is relatively high. At the same time, the Italian state is carrying a heavy debt bur- den, and growth prospects are moderate. Italian banks hold a significant share of Italian govern- ment bonds, so any deterioration in the situation of these banks could compromise their ability to renew their holdings of those bonds. This would impact interest rates on Italian sovereign debt. For continued financial stability it is important that there is ongoing political commitment to reform in all programme countries. Portugal’s budgetary position has deteriorated in the wake of the country’s elections and increasing uncertainty about the commitment to reform and the state of public finances. It is crucial that the sense of political limbo following the parliamentary elections in Spain and Ireland can be resolved within the next few months. Continued political stability is a key factor in Greece as well. Greek economic recovery essential With Cyprus completing its own programme in March 2016, Greece is now the only remaining euro area economy with an ongoing economic adjustment programme. The recent Greek crisis led to an agreement on a new bailout deal under the European Stability Mechanism ESM in August 2015. Greece had slipped into a state of acute financial crisis, and it was at risk of insolvency. The flight of deposits that threatened the stability of the banking system was successfully stemmed by introducing restrictions on capital movements. Greece pushed ahead with reforms, opening the way to the release of EUR 16 billion in ESM payments to meet immediate financing needs. The prospects for continued stabilisation were improved by the consolidation steps taken by the Greek banks in the autumn. In order to strengthen their solvency position, they raised EUR 9 billion themselves and received EUR 5.4 billion in ESM financial assistance. The improv- ing stability in the Greek banking sector has reduced the need for ECB emergency funding. By the end of 2015, a total of EUR 21.4 billion was paid out in ESM financial assistance to Greece. Continued commitment to reforms is paramount to ensuring that stability is maintained in Greece. Although Greece’s financing needs in 2016 are significantly lower than last year, the country will still require financing through the ESM programme in order to meet its debt repay- ments. It is essential that the programme’s first review is concluded successfully during the early part of the year and that Greece continues on the path of reform. The performance of the Greek economy last year was better than feared. Crucially, it suc- ceeded to avoid significant economic contraction. However, progress is hampered by remain- ing restrictions on capital movement, low levels of investment and SMEs’ financing difficulties. Tourism is the bedrock of the Greek economy. Indeed, effective implementation of the EU- level decisions taken in March in a bid to contain the refugee crisis will be vital to ensuring that Greece continues to move towards greater stability. 30 1.2 Foreign trade Export growth slower than demand growth According to Statistics Finland’s preliminary national accounts data out in March 2016, exports increased by 0.6% in 2015. Goods and services exports growth slowed in late 2015. Sluggish exports growth reflects several factors, above all the structure of the export industry and Finland’s poor cost competitiveness. It is projected that exports will return to moderate growth, mainly on the back of a slight rebound in world trade and rebound- ing economic growth in Finland’s most important export markets. Improving price com- petitiveness will also support the growth of exports. Exports growth is expected to pick up to 1.3% in 2016. Euro area economic growth in 2016 will be faster than last year. Continued low oil prices will reduce costs and contribute to maintain world demand. Demand for Finnish exports will therefore increase. There are many different ways to measure competitiveness. Measured by the real trade- weighted exchange rate, Finnish competitiveness improved in early 2015, but since then has shown no change. When measured by unit labour costs, Finnish competitiveness improved slightly in 2015 compared with the euro area average. Over the outlook period Finnish unit labour cost competitiveness will continue to improve as wage growth remains moderate and as labour productivity starts to increase. In 2017 exports growth will reach 3% and in 2018 pick up further to 3.5% on the back of increasing global trade. Finland’s market share in global trade has continued to decline, but this trend is now slowing. In the euro area, for instance, Finland has almost regained the same market share as it had before the crisis. In the Swedish and Russian markets, by contrast, Finland is continuing to lose market shares. Preliminary national accounts data for 2015 show that the volume of imports declined by 0.4% from the year before. Imports will return to growth in 2016 as accelerating invest- ment growth will increase the use of imported inputs. Consumption will also strengthen imports growth in 2016. Exports will drive imports to growth in 2017 and 2018, while the role of domestic demand will fade somewhat. The contribution of net exports to GDP growth will be negative in 2016, but turn slightly positive over the outlook period as domestic demand growth gradually slows down. Table 5. Foreign trade 2013 2014 2015 2016** 2017** 2018** change in volume, % Exports of goods and services 1.1 -0.9 0.6 1.3 2.9 3.6 Imports of goods and services 0.5 0.0 -0.4 2.6 3.0 3.5 change in price, % Exports of goods and services -1.1 -0.8 -1.0 -0.4 1.1 1.3 Imports of goods and services -1.7 -1.6 -3.2 -1.2 1.2 1.4 31 80 90 100 110 120 130 140 150 160 170 180 80 90 100 110 120 130 140 150 160 170 180 05 06 07 08 09 10 11 12 13 14 15 16 17 18 Finland Sweden Germany Euro area Sources: Eurostat, MoF Exports of goods and services volume 2005=100, seasonally adjusted 96 100 104 108 112 116 120 124 128 132 96 100 104 108 112 116 120 124 128 132 05 06 07 08 09 10 11 12 13 14 15 16 17 18 Finland Sweden¹ Germany¹ Euro area¹ Sources: European Commission, Statistics Finland, MoF Unit labour costs 2005=100, nominal ¹ European Commission forecast 32 Current account close to balance In 2015 the current account surplus stood at EUR 0.3 billion, or 0.1% of GDP. The deficit decreased rapidly during 2015. Over the outlook period the trade and current account sur- pluses will remain close to balance. In 2018 the current account balance will show a sur- plus of EUR 0.6 billion, or 0.3% of GDP. The trade balance will remain positive. The deficit in the balance of services decreased by around one billion euros in 2015. The improvement in the terms of trade is the result of a sharp fall in oil prices. Export and import prices continued to fall in 2015, but will recover to marginal growth during 2016. In annualized terms, however, both export and import prices will fall in 2016. In 2017 and 2018, it is predicted that foreign trade prices will begin to edge up. Prices will only rise slowly, however, as sluggish world trade growth means that export prices in rival countries will increase only moderately and as oil prices will remain low throughout the outlook period. Over the outlook period export prices will follow the same trends as in rival countries. The improvement in the terms of trade will therefore come to a halt and therefore no longer contribute to improving the current account surplus. The development of domestic unit labour costs will also contribute to slow the rise of export prices. Table 6. Current account 2013 2014 2015 2016** 2017** 2018** EUR bn Balance of goods and services -1.8 -1.9 0.7 0.3 0.3 0.3 Factor incomes and income transfers, net -1.5 -0.1 -0.4 -0.2 0.0 0.2 Current account -3.3 -1.9 0.3 0.2 0.3 0.6 Current account, relative to GDP, % -1.6 -0.9 0.1 0.1 0.1 0.3 -4 -2 0 2 4 6 8 10 -4 -2 0 2 4 6 8 10 00 02 04 06 08 10 12 14 16 18 Current account Balance of goods and services Sources: Statistics Finland, MoF Current account relative to GDP, % 33 1.3 Domestic demand 1.3.1 Private consumption Private consumption growth to maintain economic activity Sluggish investment and disappointing export performance in recent years have added greater than usual weight to private consumption as a driver of economic activity. In 2015 exceptionally moderate inflation supported the growth of household real disposa- ble income. Indeed, private consumption growth reached 1.4% in 2015, the fastest rate in four years. Private consumption growth has also been driven by the growth of household indebt- edness, which is attributable in part to the persistence of low interest rates. The ratio of household debt to disposable income has continued to rise without interruption since the late 90s. Housing loans account for almost three-quarters of total household debt. In 2015 indebtedness was further accelerated by the 6–12 month loan repayment holidays mar- keted by banks to housing loan holders. Based on the evidence from the past few months it seems that even though the active marketing of these holidays has now been suspended, there is at least temporarily an increased willingness among consumers to postpone the repayment of their housing loans. In January the total amount of renegotiated housing loans stood at EUR 800 million, while the average monthly figure has been typically around EUR 200 million a month. In the last year households renegotiated their housing loans the total value of mortgage rearrangements totalled EUR 14.3 billion more than usually, while the total stock of housing loans at year-end 2015 stood at EUR 91 billion. It is estimated that in 2015, loan repayment holidays increased the ratio of household debt to disposable income by about one per cent. The Statistics Finland’s consumer survey data indicate that consumer confidence in personal finances remains weaker than the long-term average. This is explained above all by subjective uncertainty and fears about the employment outlook. Despite this climate of uncertainty, the results of the consumer survey suggest that consumers still feel this is a -40 -30 -20 -10 0 10 20 30 -40 -30 -20 -10 0 10 20 30 04 05 06 07 08 09 10 11 12 13 14 15 16 Industry Consumers Long.term average (industry) Long-term average (consumers) Sources: European Comission Industry and consumer confidence balance, seasonally adjusted 34 good time to make purchases of durables. Indeed the number of new car registrations, for instance, has continued to rise since last autumn. Low interest rates and the reduction of the motor car tax from the beginning of 2016 are also fuelling the demand for new cars. The ageing stock of cars in the country is also driving up demand for new cars. Oil and other raw material prices will continue to fall in 2016, which will be reflected in sluggish consumer price growth. Low inflation will help to bolster the growth of household real disposable income. Given the climate of consumer uncertainty, however, private con- sumption growth in 2016 will be slower than income growth. The increasing savings rate will contribute to slow private consumption growth to one per cent in 2016. Real wage growth set to slow, confidence set to strengthen The forecast for private consumption does not factor in the effects of a possible social con- tract. Following long-drawn-out negotiations, there is broad recognition among the social partners of the imperative to sharpen economic competitiveness. Indeed it is assumed that over the outlook period, collective wage increases will be lower than usual. Moderate wage increases will stimulate employment and at the same time dampen inflationary pressures. On average, household wage income will increase annually by some 1.5% in 2016–2018. The positive employment effects of increased competitiveness will show up after some delay. Labour income as a proportion of GDP will fall slightly over the outlook period. Improving business profitability will bolster the growth of property income. During the outlook period the average wage earner tax rate will rise slightly. In 2016 the insured employee’s unemployment insurance contribution will increase by 0.5 percent- age points, and in 2017 employment pension contributions will be raised by 0.25 percent- age points. Following a revision of central government income tax scales and changes to the earned income tax credit, the average wage earner tax rate will fall slightly this year, but rise in 2017. -6 -4 -2 0 2 4 6 8 10 -6 -4 -2 0 2 4 6 8 10 05 06 07 08 09 10 11 12 13 14 15 16 17 18 Wages Social transfers Other income, net Property income, net Taxes Social contributions Sources: Statistics Finland, MoF Households´ disposable income change and growth impact, % 35 Rebounding economic activity will increase employment and at the same time help to strengthen consumer confidence. Indeed, it is thought that the household savings rate will start falling next year. Nevertheless private consumption growth will slow to 0.8%. One underlying reason is that household real income will increase by no more than 0.4%, among other things because of the effects of rising inflation. Likewise, spending cuts aimed at strengthening the financial position in general government will slow the growth of current transfers received by households. Despite the freezing of the national pension index in 2016– 2018, the current transfers received by households will increase nominally by an average of 2.2% a year over the outlook period. One of the factors underlying this development is the ongoing process of demographic change, including the increasing number of pensioners. Private consumption growth will remain relatively strong compared to disposable income growth. The forecast for private consumption growth in 2017–2018 is based on the assumption of improving consumer confidence, which will be reflected in a reduced household savings rate in 2017–2018. The development of private consumption involves both upside and downside risks. Based on real income development, the growth of private consumption might exceed the forecast for the current year, but on the other hand the uncertainty stemming from unemployment concerns is undermining the propensity to consume. In other words, a faster than antici- pated recovery of confidence constitutes an upside risk to consumption this year. As for 2017–2018, the assumption that household confidence will rebound and that the savings rate will consequently fall constitutes a downside risk if the sense of uncertainty experi- enced by consumers does not dissipate as expected. 40 60 80 100 120 140 -4 0 4 8 12 16 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 Saving ratio (left scale) Debt ratio (right scale) Household savings and debt Sources: Statistics Finland, MoF % of disposible income 36 1.3.2 Public consumption Public consumption accounts for around one-quarter of GDP and for over 40% of total pub- lic expenditure. The biggest public consumption items are wages, employers’ social security contributions and intermediate consumption, i.e. the value of goods and services used as inputs in the public sector. Local government accounts for two-thirds of public consump- tion: this is mainly expenditure associated with basic municipal service provision. Central government consumption has hardly increased at all in recent years. In 2015 it stood at roughly the same level as in 2008. The price of consumption, on the other hand, has increased on average by over 2½% since 2008, mainly as a result of wage increases, although in recent years prices have risen slowly. The volume of central government consumption will not increase over the outlook period due to staff redundancies and other adjustment actions. The financing of asylum seeker reception centres will drive up consumption this year. In recent years local government consumption growth has been historically exception- ally slow. Consumption growth has been slowed not only by moderate price trends, but also by adjustment efforts by local and joint municipal authorities. Based on 2016 budgets, local authorities are looking to continue their fiscal adjustment efforts during the current year. Furthermore, the measures set out in the Government Programme to strengthen munici- pal finances will curb the growth of local government expenditure over the outlook period. There are, however, substantial expenditure pressures on local government finances as a result of population ageing, which is causing an increased need for services, and as a result of increased immigration. Expenditure by social security funds consists mainly of social benefits in kind paid out by the Social Insurance Institution Kela (reimbursements for medicines and travel and rehabilitation allowances) as well as wages. Savings measures announced by the Govern- ment will reduce expenditure on social benefits in kind in 2016–2017. 37 Table 7. Consumption 2015 share, % 2013 2014 2015 2016** 2017** 2018** Change in volume, % Private consumption 100.0 -0.5 0.6 1.4 1.0 0.8 0.9 Households 95.2 -0.6 0.4 1.6 1.0 0.8 0.9 Durables 8.2 -0.8 1.8 6.0 3.2 1.8 1.8 Semi-durables 7.9 0.3 -0.7 0.2 1.4 0.8 0.8 Non-durable goods 26.6 -0.5 -0.3 -0.2 0.8 0.2 0.3 Services 52.2 -0.8 0.1 1.6 1.1 1.0 1.1 Consumption by non-profit institutions 4.8 -1.6 3.4 -1.8 0.0 1.0 1.0 Public consumption 100.0 1.1 -0.3 -0.9 -0.1 0.0 0.0 Central government 26.7 4.3 -1.2 -2.8 0.7 -0.6 -2.0 Local government 66.1 -0.0 0.2 -0.3 0.1 0.6 0.7 Social security funds 7.2 0.0 -0.8 1.5 -4.8 -3.4 0.8 TOTAL 0.0 0.3 0.7 0.7 0.6 0.6 Individual consumption expenditure in general government 0.1 -0.4 -0.4 -0.4 0.2 0.6 Total individual consumption expenditure -0.4 0.3 1.2 -0.4 0.2 0.6 Households´ disposable income 2.8 0.5 1.2 1.6 1.6 1.8 Private consumption deflator 2.5 1.6 0.2 0.1 1.1 1.4 Households´ real disposable income 0.3 -1.1 1.0 1.5 0.5 0.4 % Consumption as proportion of GDP (at current prices) 79.5 80.1 80.4 80.0 79.6 79.3 Household savings ratio 2.2 0.5 -0.1 0.4 0.1 -0.4 Household debt ratio 1) 118.0 122.0 124.9 125.8 126.6 126.8 1) Household debt at end-year in relation to disposable income. 38 1.3.3 Private investment Towards investment-driven growth Investment rebounded to broad-based strong growth in the last quarter of 2015: annual- ised quarter-on-quarter growth reached 7%, in the case of private investment as much as 8.5%. Only R&D investment declined towards the end of the year. Investment growth has not increased at such a rate since Q2 2010, when the figures were swelled by a major stim- ulus package for residential construction. The main driver now is investment in machin- ery, equipment and transport equipment. In 2015 gross investment was about one per cent lower than the year before. The figures were significantly revised upwards under the new national accounts framework, both for earlier years and for last year. The revisions mainly concerned production-related building construction investment and, to a lesser extent, civil engineering investment and invest- ment in machinery and equipment. Updated investment forecasts for 2016–2018 predict healthy investment growth, driving GDP growth annually by 0.7–1 percentage points. It is estimated that investment growth will be fastest this year, reaching around 5%, then slowing to around 3% in 2017. This growth is being driven by major ongoing projects in which 2016 and 2017 will see the most active stages of investment. In 2018 it is projected that favourable global economic trends will boost the acceleration of investment, even though annualised growth will remain slightly slower than the year before. As private investment has declined for four years in succession, the private investment to GDP ratio has dropped back to the relatively low figure of 16.3%. By the end of the fore- cast period in 2018, the ratio will pick up to 18.6%. 0 5 10 15 20 25 30 0 5 10 15 20 25 30 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 Construction Machinery and equipment R & D Investments relative to GDP, % Sources: Statistics Finland, MoF 39 High number of residential construction starts offers unexpected surprise In 2015 the number of new housing starts reached 31,400, over 5,000 more than the year before and well above preliminary estimates and expectations. As a substantial propor- tion of these starts clustered towards the end of the year, housing investment growth in 2016 will climb to 5%. It is estimated that renovation investment will develop moder- ately throughout the outlook period, increasing by around 2% a year, as a large part of the building stock is now reaching renovation age. The projected number of housing starts for 2016 is 28,000. Low interest rates, ease of access to housing loans, migration into growth centres and high levels of activity among property investors will all contribute to drive housing investment. At the moment the main focus of this investment is in growth centres and especially in the metropolitan Helsinki area. It is estimated that the construction of detached houses will gradually plateau this year and next. The annual growth projection for housing investment in 2017 and 2018 is slightly more moderate, but nonetheless solid. Major projects driving investment in other building construction Investment in other building construction will increase at an estimated rate of around 8% this year. Growth is forecast for investment in the construction of commercial, indus- trial and public service buildings. A number of major commercial building projects have started up in 2015 in Helsinki and Tampere, for instance, and these projects are set to con- tinue for a number of years. On the public side, there is much ongoing work to renovate and build new hospitals, and industrial projects are also being launched, including pulp mills, power plants, data centres and waste incineration plants. Investment in commercial building construction varies widely in value from project to project. In some cases the value per square metre is relatively low; examples include warehouses and industrial buildings. Others can be extremely expensive; hospitals are a prime example. The impact of expensive buildings on the volume of building construction is significantly greater than that of cheaper projects, even if the number of cubic or square metres were the same. Civil engineering investment benefits from inexpensive oil Civil engineering investment increased very robustly last year, showing the highest rate of growth since the pre-crisis figures in 2007. Surveys in the civil engineering sector last year produced somewhat contradictory information about the cyclical outlook. The results sug- gested that price competition has intensified and that there is an increased willingness to tender. Furthermore, the capacity utilisation rate in the last quarter of 2015 was just 71%, the third lowest recorded since 2006. On a positive note, however, the rise in costs has slowed by virtue of low crude oil prices. In addition, strong building construction over the next few years will keep civil engineering investment on a growth path. The forecast for next year predicts accelerating growth, among other things because of the repair debt pro- gramme. The outlook predicts stagnating growth for civil engineering investment in 2018. 40 The only major investment project starting up in 2016 is the functional improvement of the railway yard in Helsinki. A number of transport investment projects will reach com- pletion this year and next, but on the other hand many projects that were launched in 2015 will only get properly off the ground this year. The repair debt programme will also con- tribute to offset investment projects that are winding down. Investment projects are start- ing up, among others, in the energy supply network, the water supply network, the rail and metro network, and at airports. Finland finally to see machinery and equipment investments The Confederation of Finnish Industries (EK) survey in January 2016 confirmed that investment plans in industry were positive for the second time in succession. The sur- vey results indicate that investment in industry and the energy supply sector is projected to show double-digit growth in 2016. Investment in capacity expansion is now expected to account for one-half of total industry investment, while last year the focus was still on replacement investment. During the past six months capacity utilisation rates have also returned to growth in industry, particularly in the forest and metal industries. Invest- ment plans in these industries as well as in the food industry show the strongest increase in 2016. The outlook predicts that the strong growth of investment in machinery, equipment, transport equipment and weapons systems will continue throughout the current year as well as in first half of 2017. This is attributable above all to the machinery and equipment acquisitions for the Äänekoski bioproduct mill, which are estimated at EUR 720 million, or 7.5% of the total investment item. It is estimated that 70% of the main equipment in the project will be procured from domestic suppliers. In the years ahead the rate of investment in machinery and equipment will slow appreciably, although still remain above its average growth rate, as the favourable global economic trends are expected to bolster demand for exports from Finland. -15 -10 -5 0 5 10 15 -15 -10 -5 0 5 10 15 95 97 99 01 03 05 07 09 11 13 15 17 Construction Machinery and equipment R & D Total Investments Sources: Statistics Finland, MoF change in volume and growth impact, % 41 R&D investment to turn to growth R&D investment has fallen for five years in a row at an annual rate of around 3.5–5%. The investment survey promises a strong return to R&D investment in industry and in the energy sector. Overall the forecast, which covers R&D investment in the whole economy, predicts only modest change, as central government investment in research and develop- ment will fall clearly this year. Table 8. Fixed investment by type of capital asset 2015 share, % 2013 2014 2015 2016** 2017** 2018** Change in volume,% Buildings 44.8 -5.0 -5.0 -2.9 6.2 3.3 3.3 Residential buildings 26.8 -5.3 -6.5 -2.4 5.0 3.0 3.4 Non-residential buildings 18.0 -4.6 -2.7 -3.7 7.9 3.8 3.1 Civil engineering construction 10.9 2.2 5.0 6.6 2.2 3.0 0.8 Machinery and equipment 23.4 -8.7 -0.1 2.7 7.4 2.8 3.0 R&D-investments* 20.9 -3.7 -3.5 -4.7 2.1 4.1 3.4 Total 100.0 -4.9 -2.6 -1.1 5.2 3.3 3.0 Private 80.2 -6.6 -3.1 -1.0 5.8 4.1 4.0 Public 19.8 2.6 -0.6 -1.2 2.7 0.1 -1.3 % Investment to GDP ratio (at current prices) Fixed investment 21.2 20.6 20.3 21.4 22.1 22.6 Private 17.0 16.4 16.3 17.3 18.0 18.6 Public 4.2 4.1 4.0 4.1 4.1 4.0 * Includes cultivated assets and intellectual property products 60 70 80 90 100 -10 -5 0 5 10 05 06 07 08 09 10 11 12 13 14 15 Investment in machinery and equipment, change in moving annual total, % Capacity utilisation rate, industry, 6-month moving average, % Source: Statistics Finland Investment in machinery and equipment and 42 Housing investment in Finland: a brief overview In 2014 construction investment accounted for around 55% of Finland’s gross domestic invest- ment. Investment in residential housing accounted for one-half of this, representing 27% of gross investment. Investment in residential renovation and in new housing construction are at roughly the same level. In Finland housing investment is at a higher level than in virtually all relevant comparative countries. In recent years housing investment has reached around 5–6% of GDP in just four countries: Germany, Belgium, France and Finland. International comparisons There is substantial scatter and variation between EU countries in levels of housing investment relative to GDP. In Finland, housing investment has remained at a relatively high level for the past 15 years, coming in consistently at around 5–6% (Figure 1). During the biggest housing bubbles, the figures even reached double digits. This was the case in Finland during the 1990s and in Spain and Ireland just before the financial crisis in 2008. Figure 1. Housing investment/GDP, % However in many EU countries the bulk of housing investment consists of repairs and reno- vation, and new residential construction accounts for only a small proportion of the total. In Germany, for instance, renovation accounted for almost 70% of total investment in 2014; in Denmark the figure was even higher. In Finland renovation accounts for roughly half of total housing investment. The proportions vary over time and from country to country because new construction is cyclically highly sensitive. As can be seen in Figure 2, Finland also has a much higher level of housing investment than the other Nordic countries. In Sweden and Norway, though, favourable economic climates and liberal bank lending policies have contributed to drive up housing investment in recent years. Economic sluggishness in Finland has reduced housing investment, although the investment to GDP ratio is still considerably higher than in the other Nordic countries. 2% 3% 4% 5% 6% 7% 2000 2002 2004 2006 2008 2010 2012 2014 Source: Eurostat Housing investment/GDP, % Germany Finland Euro area Austria United Kingdom Estonia United States Netherlands 43 Figure 2. Housing investment/GDP, % Shortage of housing in growth centres Finland was a relative late starter in urbanisation, and the process is still gathering pace. There is still a shortage of housing in growth centres to meet these needs. A recent survey by VTT Finland about housing needs through to 2040 and their distribution provides useful illustration of the impacts of urbanisation on housing investment (Vainio, 2016). In a scenario where the geographi- cal distribution of the population follows Statistics Finland’s projection, the survey shows that the overall demand averages 25,000 new housing units a year. The second, alternative scenario envi- sions a future where migration is concentrated in the 14 largest urban regions. It is assumed that growth in these regions will continue along the same trajectory as in 2010–2014, when in an envi- ronment of recession urbanisation growth was not particularly high. In this scenario the demand for housing is 30,000 new units a year. One key conclusion from these analyses is that the demand for housing exceeds the projections of recent years as well as current housing production levels. The overall demand for housing is higher in the urbanisation scenario because population growth in the growing urban regions requires a corresponding increase in the supply of hous- ing. Part of the housing stock is in regions with dwindling population bases, where there will be no primary demand in the future. The population projection assumes that net immigration will remain at around the same level as in recent years (17,000 persons a year). The impacts of the growing number of asylum seekers since last autumn are not included in the projections, but the VTT study estimates a 30% or 60% increase in net immigration from the levels recorded in recent years. The projected increase in net immigration would increase the need for housing production by 2,500–5,600 units a year. Compared with the previous estimate of housing demand, production in the Helsinki region in 2010–2014 fell short of the required level by 6,000 dwelling units. Elsewhere, production exceeded the required level by 6,000 units (Vainio et al. 2012). At a national level the housing production volume was more or less on target, but the regional allocation was clearly out of balance. The latest calculation suggests that in the Helsinki sub-region, the total shortfall in housing production is around 20,000 units, the equivalent of almost two years’ new residential construction in this region (Vainio, 2016). 2% 3% 4% 5% 6% 7% 2000 2002 2004 2006 2008 2010 2012 2014 Source: Eurostat Housing investment/GDP, % Finland Norway Denmark Sweden 44 Regulation, limitations of supply, scarcity of competition One of the factors impacting the ratio of housing investment to GDP is the price of housing investment. The Bank of Finland (2016) has compared housing investment prices across the euro area. Investment goods in Finland are amongst the most expensive in the euro area. Prices of transport equipment and construction are particularly high. In 2014 the costs of residential con- struction in Finland were 22% higher than in the euro area, while in 2003 Finnish price levels were still close to the euro area average. The Bank of Finland study does not directly address the reasons for Finland’s high prices, but other studies provide plenty of clues. It is important to note that although well-intended, regulation may drive up costs significantly. From a national economy point of view, a constant increase in costs as a result of building regulations or a shortage of housing supply, for instance, also puts upward pressure on wages and adversely affects competitiveness. Furman (2015) has studied the macroeconomic effects of regulation in the planning con- text. He points out that strict land use and planning regulation leads to excessive profits, higher house prices, lower productivity and employment, and increased social inequality. Finland has seen similar problems. A number of studies (e.g. Andersson et al. 2015, UN-Habitat 2014, World Bank 2009, Cheshire and Vermeulen 2008) have shown that high land use restrictions adversely affect the competitiveness of Helsinki and the Helsinki sub-region. Both international and Finnish studies have shown that an increased supply of building land contributes to increase housing production and to curb housing prices (for a literature review, see Laakso et al., 2011). Laakso has studied the associations between the resources available for land use planning and housing production in Helsinki and the Helsinki sub-region. His findings show how single detached and high-rise construction are dependent in different ways on price trends and how the supply of building plots, for instance, ranges from the market-driven sup- ply for detached houses to the municipal supply of plots for blocks of flats: in the latter case the supply is determined not by price but other factors. Laakso and colleagues conclude that the realistic supply of building plots in Helsinki is extremely limited, especially for blocks of flats, and that this scarcity presents a significant bottleneck for housing production. Schauman (2014) reviews the international research literature to assess the impacts of restricted supply on housing prices. The review indicates that almost all factors restricting the supply of housing contribute to increase the price of housing and that the effects are signifi- cant. In many cases the impact of regulation and restrictions on housing prices can amount to tens of per cents. Production of state-subsidised rental housing high in Finland State-subsidised housing production as a proportion of total new residential construction is higher in Finland than in many other European countries. Following the outbreak of the finan- cial crisis, in 2009 more than half of the new housing starts were state-subsidised. Since then the situation has normalised and state-subsidised production has accounted for 20–35% of annual housing production. In the favourable economic climate that prevailed in 2003–2007, market-financed housing construction was strong. 45 Figure 3. New residential housing starts in 2000-2015 In Sweden, most interest subsidies for social housing production were discontinued in the early 2000s. Following the cuts to these supply-side subsidies, new housing construction declined significantly (Lahtinen et al. 2014). The rate of housing investment has long been extremely low in Sweden and a cause for some concern. Even though that rate has now been rising, housing prices in Sweden have been soaring. In 2014 real prices were up by around 9% and last year by almost 15%. At the same time, Swedish household debt relative to disposable income has climbed to around 175%, compared to Finnish ratio at around 125% (Turk, 2015). Why did last year’s new housing starts come as surprise? In 2015 the number of new housing starts reached 31,400, over 5,000 more than the year before and well above preliminary estimates and expectations. There still remains some concern over the coverage and timeliness of construction output statistics. Procedures for the compilation of statistics on new housing construction were updated in autumn 2014, but there are still issues that need to be resolved. As a result the picture presented by construction statistics had not been a true reflection of reality, but possibly a significant underestimate. The introduction of a permanent building identifier will in the long term help to provide more accurate data on the building stock and on renovation activities. The number of residential construction starts in 2015 was up 20% from the year before. Meas- ured in terms of cubic volumes, the picture is rather different. While the construction of smaller blocks of flats has increased sharply in response to strong demand from real estate funds, and while starts of detached houses continued to fall, the volume of housing starts measured in cubic metres was up by just 9% from the year before. The number of residential construction starts was exceptionally high in the last quarter of 2015. Likewise, the number of reservations for state-subsidised dwelling units was clearly higher than in earlier years, reaching 8,600, an increase of 17%. One reason was the discontinuation at year-end 2015 of stimulus for state-subsidised housing production. This came at a cyclically opportune moment in that residential housing starts provided a much needed boost to an otherwise slow economy. - 5 000 10 000 15 000 20 000 25 000 30 000 35 000 2000 2002 2004 2006 2008 2010 2012 2014 Source: ARA New residential housing starts in 2000-2015 Loan against government guarantee Interest-subsidised Non-subsidised 46 Sources: Andersson Å, Andersson D, Loikkanen H & Andersson O: Stad vid havet. Stadsplanering för omvandling av centrala hamnområden. 2015. Cheshire P & Vermeulen W: Land Markets and their Regulation: The Welfare Economics of Planning. 2008. Furman J: Barriers to Shared Growth: The Case of Land Use Regulation and Economic Growth. The Urban Institute. 2015. Itkonen J & Mäki-Fränti P: Kuihtuva pääoma. Euro&Talous. Suomen Pankki. 2016. http://www.eurojatalous.fi/fi/2016/artikkelit/kuihtuva-paaoma/ Laakso S, Kostiainen E & Lönnqvist H: Kaavavarannon yhteys asuntotuotantoon Helsingissä ja Helsingin seudulla. Helsingin kaupunki, Kaupunkisuunnitteluvirasto. 2011. Lahtinen M, Alho E, Härmälä V, Noro K & Ronikonmäki N-M: Asumisen tarjonta- ja kysyntätuet: Kirjallisuuskatsaus. Pellervon taloustutkimus ry. 2014. Schauman, H (2014) Tonttimaan tarjonta, sääntely ja asuntojen hinnat. Kansantaloudel- linen aikakauskirja – 110. vsk. – 1/2014. http://www.taloustieteellinenyhdistys.fi/wp-content/ uploads/2014/09/schauman, 1.pdf Turk, R.A: Housing Price and Household Debt Interactions in Sweden. IMF Working Paper. 2015. United Nations Human Settlement Programme (UN-Habitat): The Economics of Urban Form: A Literature Review. 2014. Vainio, T: Asuntotuotantotarve 2015-2040 . VTT Technology 247. 2016. Vainio, T, Belloni K, Jaakkonen L: Asuntotuotanto 2030, VTT Technology 2. 2012. World Bank: Reshaping Economic Geography. World development report 2009. 2009. 47 1.3.4 Public investment Public investment in 2015 was unchanged from the year before, according to preliminary national accounts figures. Sales of real estates plunged investment by employment pension institutions deeply into the red. State real property holdings were also sold off, but overall central government investment increased marginally from the year before on the back of infrastructure projects and R&D investments. High levels of general government deficit will continue to hamper investment opportunities in the years ahead. However the public investment to GDP ratio is not expected to fall. The Government’s EUR 600 million investment in overhauling the transport infra- structure in 2016–2018 will contribute to maintain central government investment. Over- all, however, there will be hardly any increase in public investment because of the scarcity of new infrastructure projects and because central government R&D investment is declin- ing. Investment in weapons systems may increase to some extent. Following a sustained period of growth, local government investment expenditure no longer increased last year. Local government investment will nonetheless remain high over the outlook period as increasing demand for services and housing and infrastructure expansion in growth centres will require substantial investment. A growing debt burden will lead local governments to prioritise their investments, however. 1.4 Domestic production 1.4.1 Total output Economic growth gradually gaining traction Output turned to slight growth last year. On average gross value added for the economy in 2015 was 0.6% higher than the year before, marking the end of three years of declining output. That said, quarter-on-quarter growth in output was only recorded in the first half of the year. Annual growth was mainly driven by private service branches, particularly by ICT industries, financial intermediation and real estate services. Public service production and wholesale and retail trade declined, as did industrial production and primary production. Services are con- tinuing to make up a greater part of the economy, at the same time as the share of secondary production is falling. Furthermore, sluggish demand for intermediate goods and slow growth of purchasing power have adversely affected production in the domestic market. Gross value added is still 8.5% lower than before the financial crisis at year-end 2007. Despite last year’s growth, major ongoing restructuring in the economy has meant that output levels still lag well behind those recorded before the financial crisis, and the resources of the economy remain largely underutilised. Furthermore, production capac- ity has decreased in recent years as a result of plant closures and inadequate replacement investment. Investment i