Wednesday, October 28, 2009

Lessons for developing countries from Finland’s state-led growth success

Finland is one of the examples of successful state-led development, where the state helped in capital accumulation (reflected in an "unusually" high investment rate) in manufacturing industries while at the same time committing itself to upholding the market economy. With this it was able to smoothen coordination failures and informational externalities, thus aiding the process of specialization and production. In a research paper No. 2009/35 (The Finnish Development State and its Growth Regime), authors Markus Jantti and Juhana Vartiainen argue that the state acted as a net saver, and credit was rationed to productive investment outlays. They also argue that incomes policies and welfare reforms were important in sustaining the necessary political compromise that underpinned the Finnish development state.

Note that Finland was still an agrarian economy until 1930s. As late as in the 1950s, more than half the population and 40 per cent of output were still in the primary sector. Per capita GDP was only half of that of Sweden. Yet by the late 1970s, Finland had become a mature industrial economy.

Finland is an example of a late but successful state-led industrialization that was carried out rapidly. The economic policy strategy that achieved this was a judicious mix of heavy governmental intervention and private incentives. Governmental intervention aimed at a fast build-up of industrial capital in order to ensure a solid manufacturing base. At the same time, however, it was made clear that the aim of heavy-handed state intervention was not to establish a planned economy as a permanent solution. Rather, the government and the constitution made it clear that the basic property rights of capitalism would ultimately be respected. [...]From the 1950s onwards, as trade unions became stronger, the labour movement became a more active partner in this more or less implicit social contract. Thus, in a manner similar to that of Austria, Korea and Taiwan, decision-making has been quite corporatist.

Public savings accounted for as much as 30 per cent of aggregate savings during the 1950s and 1960s. This surplus was channelled partly to support private investments in capital equipment throughout the country, and partly to start public companies in some key sectors of the economy. State companies were established in the basic metal and chemical-fertilizer industries as well as the energy sector. As late as in the 1980s, state-owned companies contributed about 18 per cent of the total industry value-added in Finland. [...]Low and rigid interest rates and administrative rationing of credit to some areas of business investment, at the expense of depositors and households.In the period 1960-84, gross fixed capital formation was 26.3 per cent of GDP, a figure exceeded in the OECD area only by Norway. [...]A pragmatic cooperation between organized private agents (bankers and business leaders), on the one hand, and government officials and civil servants, on the other, has played a key role in enhancing economic growth.[...]The programme of rapid capital accumulation also presupposed wage moderation and the acceptance of higher taxes. Upholding industrial competitiveness and profitability thus acquired high priority on the economic-political agenda. The crude instruments to accomplish these were comprehensive income policy settlements as well as repeated devaluations.[...]The implicit social contract was not limited to upholding industrial competitiveness. Social welfare reforms were gradually introduced at the same time, which can also be interpreted as an attempt to buy wage moderation with the promise of welfare services.

The question now is: are these measures applicable to other countries or can they be emulated in other less developed countries? The authors say No but policymakers can derive "indirect" lessons form Finland's success!

The specific policy package described in this paper is hardly applicable today. We know now that the crude accumulation of physical capital is not the key to rapid economic growth. Instead, today’s leading doctrines of economic development and development assistance emphasize property rights, good infrastructure as well as education, particularly that of women. Using public funds to boost expensive physical investment projects is clearly no longer a relevant policy goal. Nor would such a programme be feasible since the regulation tools of the 1950s—credit rationing, soft monetary policy, public ownership of key industries—have become obsolete.

Furthermore, Finland’s success story may have been due to rather favourable but transitory circumstances. The crucial phase of state-led economic growth and the buildup of welfare services coincided with favourable demographics, so that reforms created more winners than losers. Once the demographic structure becomes less advantageous, it is less certain that there will be such a happy congruence between the demands of the market economy and the political aspirations of voters.

Finland’s example offers a general message of hope for many countries affected by conflicts and poverty. Consider Finland’s history up to the Second World War: a small, backward country colonized by more powerful neighbours, torn by a violent civil war just as independence was within reach, and subsequently limited in its political manoeuvring room by the geopolitically challenging Cold War environment. Yet, it was possible for the Finnish decision makers—the government as well as various corporatist organizations—to forge a political compromise that was deemed politically legitimate and exploited the global economy to undertake a rapid economic transformation. This could be the positive message for any aspiring, less developed country in which initial conditions seem uninspiring.

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