It may not be possible to deflate our way out of crisis

 

OPINION:The Finnish government adopted the same response as ours in the 1990s – it did not work, writes JOHN McMANUS

AMIDST LAST week’s barrage of frightening economic reports, statistics and papers, arguably the most frightening of all was a paper presented at the ESRI conference last Thursday on the labour market in recession. It was entitled The Great Depression of Finland 1990-1993: Causes and Consequences and it was delivered by Jaakko Kiander a director of the Labour Institute for Economic Research, in Helsinki.

The parallels between the situation that faced Finland in the early 1990s and the situation we find ourselves in are well known at this stage. But what jumps out from Kiander’s paper is that the Finnish government initially adopted the same policy response as we have and it didn’t work.

“In response to the crisis, fiscal policy was tightened in 1992-95: public-sector expenditure and employment were cut, social benefits were frozen or reduced, and taxes on employment were increased. But in spite of these measures there were large government deficits in 1992-1994, and the cutbacks and increased taxes further reduced demand and employment,” says Kiander.

Finland attempted an “internal devaluation” through depressing demand and cutting wages to avoid devaluing its currency. But, according to Kiander, the consequences of the deflationary policies that were pursued were not understood by the policymakers, nor were the macro-economic consequences of falling asset prices.

It all sounds both familiar and extremely worrying as we embark on something of a national orgy of wage cutting – in the private sector at least – and property writedowns.

The obvious inference from all this is that it may not be possible for us to deflate our way out of the current competitiveness crisis, which is at the heart of our economic malaise. Indeed, we might be at the start of some apocalyptic economic death cycle.

The Finns only got out of the hole they were in when they devalued their currency, the markka, by 40 per cent. “This, combined with a shake-out of unproductive businesses, led to dramatic improvements in competitiveness,” which in turn lead to a pretty rapid recovery with unemployment falling from a peak of 18 per cent in 1994 to 6 per cent last year,” Kiander says.

Devaluation is not an option for us as it would require us to leave the euro zone. And that for the time being seems unthinkable, except for the more hysterical members of the commentariat. But it’s worth remembering that a global banking crisis and an economic reversal to rival the Great Depression were also unthinkable at one point.

For the time being at least we are committed to our course and indeed it is the only one open to us. The most useful lesson from the Finnish experience in this context is the need to make the competitiveness of the export sector as important a priority as stabilising the exchequer and sorting out the banks. The three issues are of course inexorably linked and competitiveness does not lend itself to the sort of big-bang approach being adopted towards the banks with the creation of Nama. Equally, while taxation has the potential to undermine competitiveness further, its ability to improve it is limited.

There are things that can be done and the Government is doing a lot of them: committing to retaining low corporation tax; maintaining funding for research and development, amongst others. Perhaps the biggest criticism that can be levelled at these efforts is that they don’t seem that cohesive or central to Government policy.

What is lacking from the debate at present is an understanding at a national level that all of the pain being inflicted at present will count for very little if it does not put us in a position whereby the price of Irish exports in Europe, America and further abroad comes down. That, if the Finnish experience is a true guide, is the route to lower unemployment.

Bringing this about requires direction and leadership. None of these are in oversupply at the moment but it’s unfortunate that at this particular juncture the key ministry, Enterprise Trade and Employment, it held by someone who seems to have lost the confidence of a great swathe of her own party, never mind the business community or the public at large.