Economic growth slowing from peak rates
This year is shaping up to be the best year in the current economic cycle. In its economic survey published on 14 September 2018, the Ministry of Finance forecasts economic growth to accelerate to 3.0% this year. In the following years, however, Finland’s economic growth will slow to just over 1.5%.
Finland’s economy will grow by 1.7% in 2019 and by 1.6% in 2020. Investment will continue to support economic growth, even though construction investment will decline next year. Growth in exports will level off in line with growth in world trade, and economic growth will no longer be supported by net exports as strongly as before. Household consumption demand will be constrained by the fact that real disposable income will not grow at the same pace as before. Over the medium term, in 2021–2022, the economy is expected to grow by 1% per year, corresponding to the growth rate of potential output.
Good economic development and the consolidation measures taken in accordance with the Government Programme will restore the balance of general government finances in the next few years. The general government budgetary position will return to surplus at the turn of the decade and the debt to GDP ratio will fall.
“The economy is now pushing ahead at the peak of the economic cycle. Employment is growing rapidly, and general government finances are strengthening. In the next few years, however, we should prepare for significantly more subdued conditions. Action to free up existing resources in society to full use must continue,” says Mikko Spolander, Director General of the Economics Department.
Employment now at a record high
In the early part of 2018, the rate of employment growth has even been faster than could be assumed on the basis of economic activity. There are currently more people in employment than ever before. In June, the employment trend exceeded its previous record level, seen at the cyclical peak in 2008, and reached 71.8%. Continued strong economic growth will increase the number of employed people by 2.6% this year compared with a year earlier. Despite the slowdown in economic growth, growth of employment will continue throughout the outlook period and the employment rate will rise to 73% in 2020.
The acceleration of economic growth this year is explained by the fact that manufacturing enterprises’ outlook for output is positive, construction of major building investment projects is still continuing and sales expectations in the service sector have improved. On the other hand, there are also signs of growth constraints. Surveys of enterprises report that shortages of skilled labour and production capacity are becoming more common.
In 2019, the highest phase of investment will have passed and economic growth will slow. Construction investment is expected to contract in the next few years, because housing production has risen to an exceptionally high level. The number of building permits granted has fallen compared with last year. Private investment growth will continue to be reasonable, however. There are several very extensive investment projects being planned in Finland, particularly in the forest industry. It is assumed that these will support the development of investment during the outlook period.
Growth of private consumption will be supported by rising earnings as well as by the improvement in employment. An increase in the total wage bill and pension income will maintain the rapid growth in household disposable income. In real terms, growth of household disposable income will slow down, however, as inflation picks up.
Global economy growth levelling off
The upswing in the global economy will continue, but the fastest growth phase has already passed. Europe, in particular, is showing signs of slowing economic growth. Unemployment is decreasing, however, and consumer confidence is strong. Inflation has picked up during the current year, but core inflation remains low.
The US economy is growing rapidly and unemployment is very low. US economic growth has been driven by private consumption. Inflation is picking up due to employment and consumption growth, and the Federal Reserve is expected to continue tightening monetary policy.
World trade growth will slow during the outlook period. Growth is set to be modest, particularly in the euro area. World trade growth will be supported by emerging economies. Positive economic development has pushed up the price of oil during the current year, and in the next few years oil prices will rise due to production constraints and strong demand.
Strong world trade growth will provide good prospects for Finnish exports. Net exports will continue to support growth, even though imports of production inputs will increase. Forest industry investments and the introduction of new capacity are already boosting export growth. The relatively low share of imported inputs in the forest industry improves the growth impact of net exports.
Despite improvements, the foundation of general government finances is not sustainable
General government finances have strengthened significantly in recent years, supported by measures in accordance with the Government Programme and good economic conditions. The improvement will continue in the next few years, and the balance of general government finances will be restored at the turn of the decade. In addition, public debt in ratio to GD will fall. It appears that the targets set by the Government for general government debt and budgetary position will be largely reached.
Although the balance of general government finances as a whole will be restored, central government and local government expenditure will continue to exceed revenue. Of the sectors of general government finances, only the social security funds are in surplus. In euro terms, public debt will therefore continue to grow.
When assessing the real robustness of general government finances, we must look beyond individual economic cycles. Despite the strengthening of recent years, the capacity of general government finances to withstand future recessions, unpleasant surprises and projected expenditure pressures is still significantly weaker than in the period that preceded the recession. The debt ratio is still around 60% and structurally, i.e. excluding cyclical effects, general government finances are in deficit.
The sustainable financing of general government finances over the longer term is not secured. Population ageing will increase public expenditure, reduce the size of the working-age population and weaken opportunities for economic growth. The revenue for general government finances generated by economic growth will not be sufficient to finance public services and benefits.
Trade war poses the biggest threat to economic growth
The risks seen in the economic outlook are more strongly skewed to the downside than earlier. A key risk is trade war escalation. Trade barriers between key economies have a broader impact than appears to be the case at first glance. Tariffs imposed by an individual state will also most likely have an adverse impact on the country’s own industry. An escalation of the trade war would slow growth in world trade and consequently global economic growth.
Household indebtedness relative to disposable income will continue to grow. This trend will be supported by low interest rates, the positive development of the labour market and strong growth in housing construction. The problems of indebtedness will be heightened, however, when interest rates rise in due course and households have to make hard choices about their other consumption.
Mikko Spolander, Director General, tel. +358 2955 30006, mikko.spolander(at)vm.fi
Jukka Railavo, Senior Financial Adviser, tel. +358 2955 30540, jukka.railavo(at)vm.fi (real economy)
Marja Paavonen, Senior Financial Adviser, tel. +358 2955 30187, marja.paavonen(at)vm.fi (general government finances)