Oct 12, 2015

Sipilänomics, part 2: Unit labor costs, competitiveness and the export fixation

In my previous Sipilänomics post, I talked about how the Finnish ideology of national competitiveness continues to drive our economic policy to a short-sighted, if not actually ultimately disastrous, focus on reducing labor costs at the expense of cutting the deficit. Indeed, successive right-wing-led cabinets have cut public spending and immediately spent the dividend in reducing employers' labor costs, so that in spite of extensive cuts to the public sector, government spending has actually increased in real terms. I managed to provoke some macroeconomic analysis, which I urge you to read.

This time around, I want to look more closely at the specific issue of unit labor costs, and whether reducing them is a sensible goal for national economic policy or not.


First, to give some context, I want to throw out some ballpark figures on government spending that the current administration isn't cutting. Remember that our net deficit is around five billion euros.

Wealth transfers to corporations obviously start with direct corporate subsidies, which, according to the Cabinet office's report on corporate subsidies, total 1.3 billion euros a year. The current administration is not making any significant cuts. In addition, Finnish businesses receive six billion euros' worth of tax breaks every year.

Incidentally, total tax exemptions in Finland are a staggering twenty-three billion euros annually. Every third tax euro is exempt. You'd think the tax system could do with some streamlining.

This is a slightly artificial number, but if you want to talk about eliminating the deficit, we can total up all the money we're throwing at businesses. One billion in direct subsidies plus six billion euros' worth of tax breaks is already a larger sum than the entire central government budget deficit. Add to that the three billion dollars of tax and social security payment cuts I talked about in my previous post, and you can argue that as a ballpark figure, over the last decade or so we've been giving Finnish businesses ten billion euros per year.

Another massive money sink we're not touching is farm subsidies. The 2015 government budget lists some 1.8 billion euros in agricultural subsidies, 400 million to forestry and fisheries, and another 400 million to rural development, totalling about two and a half billion euros annually. We pay more in farm subsidies than we do in unemployment benefits.

Again, though, this two billion figure doesn't capture anything like the whole expense of Finnish "area policy". The cabinet office report on corporate subsidies points out that all subsidies and tax breaks are created for a variety of political reasons that are difficult to untangle. It's impossible to even estimate how much of the seven billion euros of corporate subsidies and tax breaks are in practice area subsidies. A far greater challenge would be in trying to come up with some notion of the opportunity costs of agricultural and area subsidies, as well as untangling municipal finances and state interventions in them. So the direct budget expenditure of two billion is barely scratching the surface of what our illusion of agricultural self-sufficiency and "area equality" actually cost. These subsidies have all been increased during our so-called austerity, including by the Sipilä cabinet.


So we're not cutting any of those expenses. We're not even really talking about them. Instead, the constant focus has been unit labor costs. In his farcical, patronizing televised speech last month, Sipilä again insisted that labor costs must be reduced by 5%; his cabinet and party have repeatedly made it clear that they're willing to negotiate on how this can be achieved, but not on the reduction itself. The idea of reducing vacation compensations and/or lengthening working times amounts to the same thing as the pay cuts the cabinet has suggested: reducing labor costs.

For a company, unit labor costs are an important figure. Obviously the less a company has to pay out in wages to produce a given quantity of product, the better. On the national level, though, unit labor costs are a completely different animal: effectively, national labor costs are the share of national income that goes to workers. So when a company says it wants to reduce labor costs, it's saying it wants to produce more efficiently; however, when you say that a country has to reduce its labor costs, what you mean is that income has to be distributed less equally: less needs to go to workers and more to, effectively, shareholders. So in a sense, the literal meaning of lower labor costs is greater income inequality.

What's more, as is explained in some detail here, unit labor costs are actually a terrible indicator of national competitiveness. Unit labor costs are in many ways an unreliable aggregate number that can give a serously misleading picture of the development and competitiveness of an economy.

The World Economics Association newsletter I linked to includes a graph of real unit labor costs in selected EU countries, including Finland (orange):

As you can see, real unit labor costs rose dramatically in 2008. At the same time, though, there was no corresponding rise in real incomes, which rose steadily until 2009 and have since plateaued.

So whatever it was that made Finnish unit labor costs suddenly rise in the late 2000's, it wasn't wages. It's also worth pointing out that in the context of plateaued real wages, the Sipilä cabinet's wage cuts combined with continuing insistence on extremely low raises will mean that real incomes will actually decline.

What happened, then? According to the Labour Institute for Economic Research, what happened was a dramatic decline in the electronics and paper industries, not to mention a global financial crisis. This would seem to be in line with the criticism of unit labor costs linked above, where change in one industry can give the misleading impression that the entire economy has become less productive. Elsewhere, aggregate productivity statistics have been misleading.

So effectively, what we're trying to do now is compensate for losing Nokia, and the continuing decline of our paper industry, by lowering everyone's wages.

Further, as Jesus Felipe and Utsav Kumar argued in 2011, unit labor costs don't explain Germany's strong exports, but rather, complexity and diversity of exports do. Attempting to compete with Germany solely by lowering unit labor costs is, in their view, completely misguided. Especially if our unit labor costs are actually already lower - it does strike me that most presentations on Finland's diminishing competitiveness focus on change in unit labor costs, which can be tremendously misleading; see also Haaparanta. Moreover, it's a generally accepted fact, known as Kaldor's paradox, that low unit labor costs don't correlate with increased output. Therefore, their conclusion is: "Wage reductions would do probably cause more damage through a compression of demand." When real incomes haven't risen for five years, this seems inevitable.


But if reducing unit labor costs isn't an effective way to boost exports, how do we do that, then? Because if there's one thing pretty much every political party and public commentator in this country agrees on, it's that we need to boost exports.

Here, from Finnish Customs, is our trade balance over the last couple of years:

Here are monthly figures for imports and exports:

What I am going to say now is so heretical that I need to warn any Finnish readers in advance. Make sure you're sitting down, not eating and drinking at the moment, and brace yourselves.

I don't see why we need to worry about exports.

Seriously. Our trade balance is all right. Other things being equal, exporting more would always be nice, so I'm certainly not in any way opposed to anything that can enhance our foreign trade, but there doesn't seem to be any reason at all why we should panic about the state of our exports. Certainly no reason to make massive cuts and depress domestic purchasing power in favor of a minute, theoretical boost to exports.

So to sum up, not only are lower unit labor costs not a sensible way to enhance our exports, but there isn't even anything in our foreign trade balance that suggests we should be particularly concerned about exports at all - especially when what we should be concerned about is our government deficit and national debt.

Unfortunately, our decision-makers seem to feel the opposite way. MTV3 interviewed the head of the Finnish Federation of Enterprises, and asked him to explain how cutting nurses' salaries helps Finnish exports. A good question! His reply was that cutting public sector salaries reduces the deficit, which will allow more tax breaks for exporters. So when I said in my previous post that we can only conceive of cutting the deficit through increasing exports, I may have been wrong. Instead, the only reason we want to cut the deficit is so that we can increase exports. This isn't so much putting the cart before the horse, but rather harnessing a horse to a cart so that we can lighten the cart to make the horse go faster. Amazing.

This is how deep the cultural fixation of prosperity through exports goes. As far as I know, not a single Finnish party questions the need for Finland to concentrate on exports and international competitiveness.


How bad is our competitiveness, then, since our cabinet constantly insists on such drastic measures to restore it? According to the World Economic Forum's Global Competitiveness Report published last summer, Finland is the second most competitive economy in Europe, ranking fourth worldwide. This is no fluke: Finland consistently ranks very highly in international competitiveness surveys. This makes the massive sense of doom propounded by the right about our competitiveness somewhat difficult to understand.

The World Economic Forum uses 12 pillars to assess a country's competitiveness. Some of these are being dismantled by our right wing. The third pillar, for instance, is the macroeconomic environment, prominently including government fiscal deficits and debt levels, which we've seen continue to get worse. The fourth pillar is health and primary education, both targeted for sweeping cuts. The fifth pillar is higher education and training - also cut. The twelwth pillar is innovation:

This progression requires an environment that is conducive to innovative activity and supported by both the public and the private sectors. In particular, it means sufficient investment in research and development (R&D), especially by the private sector; the presence of high-quality scientific research institutions that can generate the basic knowledge needed to build the new technologies; extensive collaboration in research and technological developments between universities and industry; and the protection of intellectual property, in addition to high levels of competition and access to venture capital and financing that are analyzed in other pillars of the Index. In light of the recent sluggish recovery and rising fiscal pressures faced by advanced economies, it is important that public and private sectors resist pressures to cut back on the R&D spending that will be so critical for sustainable growth into the future.

My boldface. Perhaps coincidentally, on the same day that the prime minister's pre-recorded speech was shown on television, the University of Helsinki announced they're cutting staff by approximately 15% over the next five years. Overall, university funding is being cut by half a billion euros annually. So our R&D spending is being cut quite massively.

The four pillars of competitiveness the Sipilä cabinet is so intent on toppling can be summed up in one concept: human capital. If there's one thing we do know correlates strongly with economic performance, it's human capital. If nothing else, a more highly skilled workforce is more productive and more innovative. Finland, for instance, can hardly claim to owe its present prosperity to abundant natural resources or other accidents of geography. Nokia came about because of the high level of human capital in the Finnish economy; if we want to see similar success in the future, we need more investments in human capital, not less. Unfortunately the Sipilä cabinet is committed to doing exactly the opposite. According to some statistics, the quality of Finnish exports is already so low that attempting to compete through cheaper labor is doomed to fail. Reducing our human capital would seem to be most likely to lower that quality even further. The new head of the government's economic research institute agrees, and points out that the few investments the government is making are minuscule and misguided.

The WEF report divides countries into three groups based on their economic development, in ascending order: factor-driven, efficiency-driven and innovation-driven. Right now, they place Finland at the very top of the innovation-driven economies, but the current administration's goals are focused on efficiency at the expense of innovation. In that sense, you could argue that they're actually trying to drastically reduce our competitiveness by downgrading the entire economy.


So, some conclusions. First of all, the Sipilä cabinet's monomaniacal fixation on reducing unit labor costs doesn't seem very likely to actually increase the competitiveness of our exports. What's more, it isn't at all clear why we so desperately need to enhance either our national competitiveness or our exports right now. I, for one, would much prefer trying to actually cut the deficit.

What makes everything much worse is that barring some completely unexpected chain of events, the negative effects of this labor cost policy are likely to be substantial. In the short term, cutting wages will necessarily reduce domestic demand, depressing the economy even further. In the long term, making large cuts to health care and education will severely diminish our human capital, which means that future growth will be less than it otherwise would have been. Furthermore, the hardships inflicted by the cuts, disproportionately borne by lower-income citizens, will rebound in larger problems in the future - just like after the last recession. At this rate, though, the deficit will land us in serious trouble before any long term effects make themselves felt. I strongly agree with Björn Wahlroos: our sustainability gap is never going to be a problem, because at this rate we'll go bust long before it hits.

In my previous post on the subject, I tried to demonstrate that there hasn't at any point been, and still isn't, any austerity or deficit-cutting going on in this country, because all Finnish parties agree that exports are more important than the deficit. In this post, I've done my best to examine the particular strategy of export-boosting adopted by the Sipilä administration. At the very least, there are strong doubts that a focus on unit labor costs is going to produce the results the cabinet claims; it seems far more likely that in the long and short term, this is a disastrous strategy. The only people who will benefit are corporate shareholders in the short term. That should make it pretty clear to everyone whose interests this cabinet represents.

In general, it's tremendously imporant to understand that right-wing rhetoric relies heavily on a srategy of depoliticizing economic policy, where political decisions and value judgements are presented as the only possible course of action, when in fact this is almost never the case. A further problem that arises from this is that too many critics of right-wing economic policies believe this, and imagine that politicians slavishly obey the dictates of some imaginary worldwide cabal of economists. This is complete nonsense, and dangeous, because it abandons the rhetorical playing field to the right. The economic policies of, say, the Sipilä administration, are very much open to challenge from the same paradigm of economics that they purport to draw on themselves. Don't let them get away with equating their policies with economics in general.

If there is an ideology that our current administration follows, it's the same one that the entire rest of the political field shares: national economic competitiveness through exports. My opinion is that both this strategy, and the specific means chosen to advance it, are disastrous for this country in both the short and long term, both in general as well as on its own terms. Our tragedy is that our political discourse needs to be fundamentally unpacked to address this, and this is far from easy.


It's definitely true that our fiscal deficit is a problem. However, the current administration, like several preceding ones, refuses to address this problem by looking at structural problems in the Finnish economy. Instead, their solution is to sacrifice our human capital and degrade our long-term competitiveness in order to, at best, improve our economic prospects in the short term. The current policy of cutting salaries, health care, social services and education to improve competitiveness is robbing the future to pay the present - and is entirely contingent on a growth of world trade that may not happen, and may pass us by. The damage will be done regardless. To call this kind of policy irresponsible is putting the matter very, very mildly.

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