Tuesday, July 14, 2009

To The Finland Station And Back Again

This post accompanies my recent piece on Sweden. I have been scratching my head and trying to see what could be learnt from making a comparison between Finland and Sweden. Some of the differences are obvious - one is in the euro, and the other isn't, once can adjust monetary policy and currency values, and the other can't. Others are less so. Finland's goods trade surplus has been declining steadily since joining EMU while Sweden's has remained relatively constant. And Swedish males live on average three years longer than their Finnish counterparts. So what is important here, and why? And if convergence theory has anything positive to be said for it, shouldn't we be able to observe so sort of convergence going on here.

First, and just to remind ourselves, here is the chart from Claus Vistesen which shows what the relation between population ageing and current account balance might look like. The key point is that as populations age beyond a certain point, a tendency to run a current account surplus emerges, as domestic demand steadily weakens, and becomes insufficient to drive growth. Evidence for this phenomenon can be found in Germany, Japan and Sweden.

The idea is that as median population age rises the current account dynamics of a country change. The last ageing phase shown to the right of the diagram is purely speculative at this point, although theory suggests that if the underlying momentum of ageing is left unaddressed it may well be what happens. But it is a development which is to be strongly avoided since although we do not yet know what happens when a society starts to dis-save at an advanced median age, the longer we can put off finding out, the better.

Which is why looking at Finland is important, since unlike the three aforementioned "ideal type" agers, Finland has in fact seen a deterioration in its external position over the last decade, and even though it has, up to now, remained a surplus country, the trend is certainly towards deficit, and this trend needs to be halted and reversed. Indeed this is the most pressing policy problem facing the Finnish authorities during the current recession.

Now, as in Finland, Sweden's external position underwent a structural shift in the mid 1990s, just as Claus's model predicts. First positive balance - the submarine breaks water - in 1994, meadian age 38.4 (quite young in international comparisons so interesting). So so far so good.

So Sweden is a sort of normal case, now let's look at Finland. Once more the mid 1990s "transition" is clear. Finland moves from deficit to surplus. But unlike the Swedish case the surplus peaks around the turn of the century, and since then has been steadily weakening.

There can be a number of explanations for this. The pattern of ageing could, for example, be different in Finland. Or the euro might be a factor, with the loss of control over monetary policy leading to a steady deterioration in the level of international competitiveness. As we will see below, some part of the explanation may be provided by each of these, but first, lets take a look as some of the empirical aspects of Finland's present recession, since it is evident that Finland, like many other countries, has entered a strong recession on the current back the global crisis.

Strong Decline In Finland's GDP

In the first three months of this year GDP was down by 2.7% when compared with the last three months of last year (an 11.2% annualised rate of contraction).

And it was down by 7.5% when compared with the first quarter of 2008 (Eurostat data).

One significant difference which can already be noted between Sweden and Finland is that while the last three months of 2008 were definitely much worse than the first three months of 2009 in Swedan, in Finland, as in many other Eurozone economies, Q1 2009 was definitely much worse than Q4 2008. And indeed, while Sweden's economy shows some definite signs of small green shoots in Q2 2009, as far as we can see, Finland's economy still remains deeply mired in recession. Finland does not have a local variant of the ubiquitous Purchasing Managers Surveys, but the statistics office does maintain a monthly gross domestic product (GDP) indicator. Now, while the methodology is very different (the PMI composites are survey based and qualitative, and much more reliable) for what it is worth Finland's GDP indicator fell 9.2 percent in April in comparison with April 2008, that is to say, the year on year contraction was greater than in the first quarter, but it is difficult to draw any definitive conclusion from this, since there are many statistical factors at work here.

According to Statistics Finland building and manufacturing industry were the hardest hit.

The April data showed production in construction and manufacturing - both key contributors to the Finnish economy - down around 17 percent year-on-year. Production in April was down 0.6 percent from March. Output in agriculture and forestry showed slight growth on an annual basis of just below two percent, while services fell six percent.

And the outlook for the rest of this year does not look much brighter. The OECD forecasts growth in the Finnish economy will fall by 4.7 percent in 2009 with a return to 0.8 percent growth next year. Significantly the OECD also stressed that uncertainty in the evolution of international trade poses the greatest risk in the outlook for the Finnish economy.

The IMF currently expects the economy to shrink by 5.2 percent this year and again by 1.2 percent next year, while the latest finance ministry forecast is for a 6.0 percent shrinkage this year followed by 0.3 percent growth next year. All the 2009 forecasts seem to be subject to downside risk, while the 2010 ones are no better than guesses, since the level of uncertainty is so high, and Finland is so dependent on external trade, but further contraction seems more probable than growth at this point.

Short Term Indicators

Industrial output fell again in May (year on year) for the seventh consecutive month, and was down by 23.2 percent over May 2008. This follows a revised fall of 21.3 in April.

Month-on-month, industrial production also fell - by 2.2 percent from April when it fell by 3.8 percent over March. So the industrial situation is deteriorating, not improving at this point. Output fell in all main sectors, with metal industry reporting the biggest decline around 28 percent, while the paper industry production also shrank by nearly 28 percent year-on-year.

Over the January to May period, industrial output decreased by close on 22 per cent from the corresponding period in the previous year. And there seems to be little improvement on the horizon. According to Statistics Finland, the value of new orders in manufacturing was 39.6 per cent lower in May 2009 than in May 2008, slightly above the January to May average decrease of 38.9 per cent year-on-year.

As in earlier months, the decline in new orders was strongest in the metal industry (47.5 per cent). In the chemical industry new orders fell by 30.7 per cent, in the textile industry by 28.5 per cent and in the manufacture of paper, and paper and board products by 19.4 per cent.

Construction activity is also well down, falling by 14.4% year on year in March (the latest detailed data we have), and by around 17% in April according to the GDP indicator.

Finland did not have a massive construction boom. The construction of new dwellings shows no obvious surge in the first decade of the century.

On the other hand rate of household indebtedness is up, with the ratio of debt to disposable income rising to 101.4 percent in 2007, from 70.3 percent in 2002. Significantly, the rate of indebtedness among households composed of persons in the key 25 to 34 age range reached 189 percent in 2007. House prices seem to be a story of one long steady march upwards since 1995, but prices did start to fall in 2008, and this trend now seems set to continue.

Retail sales, which give us a measure of domestic demand, are also falling, if still only moderately. According to Eurostat, retail trade sales fell by 2.99 percent year on year in April. According to the Finnish Statistics Office, sales between January-April were down by 1.6 percent over a year earlier. During the same time period, motor vehicle trade sales were down 31.8 percent and wholesale trade sales down 17.5 percent.

Finland's unemployment rate continues to rise, and at an accelerating pace. The increase in those unemployed from April to May alone was greater than that in the whole of last autumn, according to Statistics Finland. From January to May the seasonally adjusted jobless rate was up by two percent and there were more than 300,000 people recorded as without work in May, 60,000 more than in May 2008, taking the national unemployment rate as measured by Finland Statistics to 10.9 percent.

Using the EU (ILO compatible) methodology, Eurostat report the May unemployment rate as 8.1 percent. The OECD expect unemployment to continue to rise in Finland, and forecast an unemployment rate of 8.7 percent this year, rising to 10.8 percent next year (ILO methodology).

The OECD is also worried about employment in Finland in the longer term, and point out that while the country has taken important steps to remove the barriers to employment of older workers (see the OECD publication Ageing and Employment Policies in Finland) more needs to be done. Since the early 1990s, Finland has introduced programmes to support the employment of older workers, notably the National Programme on Ageing Workers. It has also recently undertaken a major reform of the old-age pension system and will phase out early retirement schemes.

However, Finland’s median age is rising steadily (see chart above) and the old-age dependency ratio (population aged 65 and over as a proportion of the population aged 20-64) is projected to increase from 25% in 2000 to 43% in 2025 compared with an OECD average of 22% in 2000 and 33% in 2025. This is a very steep rise, and raising employment rates among the older population is going to be the key to meeting the challenges presented by the need to find export lead growth.

According to the OECD, only around 30% of people aged 61 are currently working – a drop of more than 50 percentage points compared with 51 year olds. This steep drop in employment rates can primarily be explained by the fact that Finland has too many pathways to early retirement, notably unemployment benefits, unemployment pension, disability pension and individual early retirement pension. Already at the age of 50, 18% of individuals are receiving either unemployment or disability benefits, increasing to more than 46% by the age of 60. Moreover, in the age group 60-64 most unemployed persons transfer to the unemployment pension with a further 20% relying on disability benefits and about 10% rely on the individual early retirement pension.

Deflation dynamics

Like Sweden, the inflation data also throws into the limelight the disparity between the EU HICP measure (which does not include housing interest) and the national CPI (which does). Year-on-year inflation, calculated by Statistics Finland dropped to 0.0 per cent in May, while in April it was still 0.8 per cent. According to Statistics Finland the drop was primarily due a fall in food prices and interest rates. Between April and May, consumer prices fell by 0.2 per cent. On the EU HICP index, however, year on year inflation is currently running at 1.5 percent. Thus, in a time of falling house prices and lowered interest rates, the HICP totally underestimates the deflation danger.

It is important to remember here that two-thirds of Finland’s housing stock consists of owner-occupied homes, and home ownership is widespread in all forms of housing, including apartments as well as detached houses and row houses. Normally falling interest rates would produce rising house values, due to the affordability effect, but under current conditions we are observing the opposite. I can't help feeling that European monetary policymakers need to think more about this type of thing.

More evidence for deflationary headwinds is offered by producer prices for manufactured products, which fell by 8.1 per cent year on year in May. Export prices were down 9.8 per cent and import prices fell by 11.7 per cent. The year-on-year change in the wholesale price index was -8.9 per cent.

So Where Are We?

Finland's economy faces important challanges in both the short and long terms. Finland's state debt is low at the present time, which gives the capacity for short term stimulus and bank bailouts. But it is rising, and reached a record high of 70.6 billion euros by the end of the first quarter of 2009. General government debt, calculated according to Eurostat methodology, grew by 7.5 billion euros in January-March, and reached 38 percent of 2008 gross domestic product (GDP). Still, there is plenty of stimulus ammunition left, the important thing is to use it wisely, and try to engineer an economic transition.

The severe contraction in the Finnish economy is also likely to take its toll on bank credit fundamentals, according to the credit rating agency Moody's. The agency recently reaffirmed its negative outlook for the Finnish banking system. Up until now the Finnish banking sector - lead by Pohjola Bank and local branches of Nordea and Danske Bank - appear to have been weathering the storm without undue difficulty due to minimal exposure to toxic assets and a focus on traditional banking activities, according to Moody's. However:

"Given that the crisis on financial markets has now spread extensively into the real economy, Moody's expects Finnish banks to be adversely affected," according to the latest report. Moody's said an increase in bankruptcies was indicative of the weakened credit environment.

Corporate bankruptcies increased 33 percent in January-May from a year ago, according to Statistics Finland.

The Finnish government has already approved one supplementary budget for 2009 including a special stimulus package. The overall impact is estimated at around €2 billion (although new spending is estimated at only €1.2 billion), and includes about €140 million in transport infrastructure projects. The government has committed itself to implementing a guaranteed pension from the beginning of March 2011. This will cost around €111 million a year, and will raise the lowest pensions by about €100 a month - affecting about 120,000 people.

There have also been a number of measures aimed directly at helping corporate finance. The government now offers banks operating in Finland both deposit guarantees and capital, and will also invest its pension funds in corporate bonds, offer companies financial support through the specialised state-owned finance company, Finnvera, and provide partial financing for the construction of thousands of new homes through the state-owned credit institution Kuntarahoitus (Municipal Finance).

Overall, the government has pledged about €60 billion in guarantees, loans and investments, and is expecting a boost of €45 billion in corporate financing. Prime Minister Vanhanen described the decisions as ‘massive, even gigantic’. The largest sums of money are in the bank support package, which aims to secure the continuity of corporate credit. In fact, the Finnish parliament has already approved guarantees of €40 billion to help banks to raise capital.

But in the longer term the issues raised at the start of this post need to be addressed. Competitiveness needs to be restored to the Finnish economy, and exports boosted, as illustrated by the REER chart below. In particular the situation pre 2007 needs to be restored. The change is not massive (maybe only 5% or so), so it is doable, and it needs to be done, especially since the Swedish Krona has been significantly devalued.

As mentioned previously, the goods trade balance has been deteriorating, and the earlier positive balance now needs to be restored.

One of the things that stands out is Finland's differential preformance vis a vis Sweden. Using data prepared by Eurostat which shows the volume indexes of GDP per capita as expressed in Purchasing Power Standards (PPS) (with the European Union - EU-27 - average set at 100) it is apparent that a gap exists (see below) and that it is not being closed. In fact, after 1998 the two lines move tantalisingly in tandem, but with Finnish per capital GDP stuck just short of the Swedish level. Any reading on these indexes of over 100 implies that the country's level of GDP per head is higher than the EU average and vice versa, and relative movements in the indexes imply that the rates of change in GDP per capita are either improving more or less rapidly than the EU average. The basic data behind the charts is expressed in PPS which effectively become a common currency eliminating differences in price levels between countries making possible meaningful volume comparisons of relative GDP per capita. Since the index is calculated using PPS figures and expressed with respect to EU27 = 100, it is only valid for cross-country comparison purposes and not for individual country inter-temporal comparisons, nonetheless charts based on such data are extraordinarily revealing.

So the real reason is why (given some sort of loose convergence expectation) this gap is not being closed. There can be several explanations. One may be differences in institutional quality (education systems, for example), another might be the impact of euro membership: it could be, for example, that, as OECD economists Jorgen Elmeskov and Romain Duval argued in a suggestive paper (Structural reforms in product and labour markets) presented at the 2005 ECB conference "What effects is EMU having on the euro area and its member countries?", that membership has up to now slowed down rather than accelerating the reform process. Thirdly, the issue could be differential demographics. Few economists seem willing to investigate this possibility in any depth, despite mounting evidence that it may be important.

One demographic indicator that springs to mind immediately when I think about these two countries is the differential in life expectancy. Swedish males live on average around 3 years longer than Finnish males (see below). Now this may be important, although no one has started to calibrate this effect yet. The economic intuition for the importance would be, think of investment in a machine (physical capital), then obviously the value of the investment is greater (other things being equal) if the machine keeps running five years longer.

Things cannot be that much different with human capital. The education and on the job training costs are similar, but the person is able to work three years less. Is it mere coincidence that labour market exit at 61 is so typical if the health outlook is worse? Here are the relative labour force participation rates for me between 55 and 65. It is my contention that this alone accounts for a substantial part of the GDP per capita difference between the two countries.

But the solution to this problem is not an easy one, and the OECD and others really need to think much more seriously about this phenomenon when they indisciminately propose raising higher-age participation rates across the board as a solution to the declining workforces problem.

What is involved here is a complex mix of health provision, lifestyle and genetic differences, and any response needs to take account of all of these.

Raising the health and life expectancy of the Finnish population would be one sure way to raising GDP per capita, another way (in the longer term) would be raising fertility back up to replacement levels, and a third path would be extending the younger labour force by encouraging immigration (which interestingly has been on the rise in the Helsinki area in recent months, although if many of the newcomers simply arrive from equally affected Estonia this is nothing more than moving the deckchairs around). Whichever way you look at it though, in both the short and longer term the deterioration in Finland's trade surplus needs to be addressed. If it isn't the outcome will not be a pleasant sight.

Sweden's Economy At A Glance

Basically this post accompanies the Swedish monetary policy and devaluation post I have recently put up on the Global Economy Matters Blog. But first some theoretical structure from Claus Vistesen.

As we can see above, the idea is that as median population age rises the current account dynamics of a country change. The last ageing phase of the diagram is purely speculative at this point. Basically we simply do not know what happens after a society starts to dis-save at an advanced median age. We have, as yet, no experience with this phenomenon.

Now, as is well known, Sweden's median population age has been rising steadily, and reached 41.3 in 2009 according to the latest estimates from the US Census Bureau. This makes it a little younger than Germany and Japan (ma circa 43) but still over the critical 41 threshold (which is itself a tentative first estimate, and still needs calibrating from case to case).

Wednesday, July 01, 2009

The Global Manufacturing Contraction Eases Again In June

Global manufacturing took another step towards growth in June - but the process was, as ever, uneven. The JPMorgan Global Manufacturing PMI posted 46.9, its highest reading since last August. The current output component even expanded slightly following a year-long period of contraction. The PMI has now remained below the neutral 50.0 mark for thirteen successive months.

The principal factors weighing down on the level of the PMI in June were declines in new orders, employment and inventories. However, rates of contraction in new work and employment eased to their weakest for thirteen and eight months respectively. Looking ahead, the new orders to inventories ratio – which tends to move in advance of the production cycle – rose for the sixth month running to its highest since April 2004. Only 4 PMIs - those for China, India, Turkey and Sweden posted growth readings in June (although Sweden is not included in the JP Morgan survey). There was a general easing in the rates of contraction recorded elsewhere. The next two to three months will now be critical in order to decide whether the sector is going to move over to expansion mode, and if it does, at what pace?

Two general themes seem to stand out in this months PMI report. Firstly the key role being played by some emerging market economies, and secondly the important nudge upwards that some national industrial sectors have received from currency devaluation - with the UK and Sweden being the most obvious cases.


Some people have been saying in response to warnings that this recovery will be export lead, "exports what exports"? What a load of tripe! Without exports there will be no recovery. The next lesson in abc economics: in times of crisis relative currency values matter more. And to prove it, Swedens PMI just poked into the growth zone, 50.5, following 43.7 last month. The 17% odd devaluation with the euro would have nothing to do with this, would it? Welcome Sweden, the worlds fourth 50+ PMI.

Here's a twelve month chart for the Euro vs the Swedish Krona.


I don't have a nice chart here, but the UK manufacturing PMI figure rose for the fourth consecutive month to post its highest reading in over a year, and was up more than anticipated to 47.0 in June from 45.4 in May. Still contraction though, and the relations between output levels and destocking have still to sort themselves out.


Activity in the 16-nation euro zone's manufacturing sector continued to fall in June, but contracted at the slowest pace in nine months, according to the Markit manufacturing purchasing managers index released Wednesday. The PMI rose to 42.6, up from 40.7 in June and slightly higher than a preliminary estimate of 42.4. The PMI has been in negative territory for 13 consecutive months, the longest stretch since the survey began.


Germany's manufacturing sector shrank for the 11th month in a row in May, but the severity of the contraction was the least marked for any month since October, and the PMI at 40.9 was up from 39.6 last month, and better than the flash reading of 40.5. This still represents a very strong contraction, however, and Germany has a long road ahead before it returns to expansion.


The decline in French manufacturing activity also eased in June, although firms reported they continued to slash jobs at a rapid pace. The final Markit/CDAF manufacturing purchasing managers' index rose for the fourth straight month in June, hitting 45.9 compared to 43.3 in May. Much better than Germany, but not as good as the UK. UK industry is evidently benefiting from the devaluation effect at this point.


One of the great mysteries for people in Spain is why the German economy seems to be doing even more badly than theirs is. In this sense June was not a disappointment, since the Spanish PMI, which rose to 42.8 from 39.8 in May, the highest reading since May 2008 and well off December's record low of 28.5, also was above Germany's 40.9, and Germany has no housing bust.


Irish manufacturing PMI data for June pointed to another sharp deterioration of operating conditions. However, the rates of decline of output, new orders and employment all eased over the month. The seasonally adjusted NCB PMI rose to 42.5 in June, from 39.4. Although the sector continued to deteriorate at a considerable pace at the end of the second quarter, June's contraction was the slowest since last September. Even so this was the sixteenth month in a row that output at Irish manufacturers has decreased.

June's fall was driven by fragile demand (particularly from domestic sources) and the negative impact of this on new orders. New export business decreased at a weaker pace than overall new orders, although the reduction was still solid. The relative strength of the euro against sterling made new orders from the UK harder to secure, according to the report.


Greece's seasonally adjusted Markit Manufacturing PMI came in at 47.7 in June, up from 46.1 in May, the PMI rose further from March’s record low to its highest position since October 2008. Employment, however, fell for the fourteenth successive month, by far the most sustained period of workforce reduction in the survey history.

Eastern Europe

In Eastern Europe, the Polish manufacturing PMI rose slightly to 43.0 in June, from 42.5 in May. This is still quite a weak performance for an economy which, in theory, is holding up rather well, and was below consensus expectations for a rise to 43.2. Still, the PMI was at its highest level since October 2008.

Czech Republic

The Czech PMI also inched up to a nine-month high in June but still registered its 12th straight month of decline. The reading rose to 41.9 from 40.5 in May and a record low in January. The Czech economy shrunk by 3.4% in the first quarter from the previous three months but the PMI has now been for for five months in a row. May industrial output fell 21.7% y-o-y, and new orders fell 27.6%.


Hungary's contraction is more or less moving sideways at the moment. The June PMI came in at 45.8 in June, a slight uptick from 45.4 in May. The output improvement is almost all due to the export sector. Hungary is in deep recession but June exports offer a slight positive sign. The government projects that GDP will contract this year by nearly 7% as Germany also contracts. Germany and central europe are in lockstep.


Russia’s manufacturing industry shrank last month at the slowest pace since September, and VTB’s Purchasing Managers’ Index advanced to 47.3 in June from 45.3 in May. Russia’s industrial production has now stabilized at between 15 percent and 17 percent below last year’s level, according to Prime Minister Vladimir Putin last month. The government currently expects an 8.5 percent GDP contraction this year.


Well Turkey is the fourth in the 50+ growth group since PMI data surprised positively – reading 53.9 up from 51 in May. This result is good news for Turkey following yesterday’s very disappointing GDP numbers, which showed that the Turkish economy contracted by a whopping 13.8% y/y. The immediate future looks a bit more promising than Q1.



The pace of contraction in Japanese manufacturing activity slowed for a fifth straight month in June, a survey showed on Tuesday, as companies gradually recover from Japan's deepest postwar recession. The Nomura/JMMA Japan Manufacturing Purchasing Managers Index (PMI) rose to a seasonally adjusted 48.2 in June, the highest since 48.6 in April 2008, from 46.6 in May.

However, the figure remained below the 50 threshold that separates contraction from expansion for the 16th straight month. The current output component of the PMI index gained for the fifth straight month, to 50.6 from 47.9 in May, edging above the boom-or-bust line for the first time since February 2008. The index for new export orders rose to a seasonally adjusted 51.2 in June from 49.8 in May, also the fifth month of improvement. That also marked the first growth in export orders in almost a year and a half as global trade recovered from last year's sharp declines.


China's manufacturing expanded in June, adding to signs the world's third-largest economy is rebounding from the collapse in global trade, but few new jobs were created, according to both the Chinese PMI surveys. Brokerage CLSA Asia-Pacific Markets said its purchasing managers index rose to 51.8 from May's 51.2. The government-sanctioned China Federation of Logistics and Purchasing said its own PMI edged up slightly to 53.2 from May's 53.1.


Manufacturing activity in India slowed slightly in June but still expanded for a third straight month, reflecting strong local demand, according to the survey, even as exports showed some creeping signs of improvement. The Markit PMI fell back slightly - to 55.34 in June from May's 55.7, the highest in eight months. The Indian PMI hit a trough of 44.4 in December and has steadily risen since.

South Africa

South Africa’s industrial output continued to fall sharply, although the PMI gained for the second month in a row in June. The seasonally adjusted index increased to 37.9 from 37.3 in May, Kagiso Securities said in the statement released in Johannesburg today. The index has now been below 50 since May 2008.


United States

The U.S. manufacturing sector shrank once more in June, but again at a slower pace than in May.The Institute for Supply Management said its index of national factory activity edged up to 44.8 to in June from 42.8 in May. This was slightly above Reuters economists median expectation for a reading of 44.5. So we continue to improve, but the next 3 months will still be critical to confirm or otherwise the improvement.


Well, just about to wind the day up on the PMIs now. Brazil is in and posted 48.1 in June. That was the highest reading for nine months, and means the Brazilian industrial sector is nudging its way back towards expansion. However, the index rose only 0.3 points from 47.8 in May, so the recovery rate which we have seen since the end of the first quarter stalled somewhat in June.

Methodological Note

The Global Report on Manufacturing is compiled by Markit Economics based on the results of surveys covering over 7,500 purchasing executives in 26 countries. Together these countries account for an estimated 83% of global manufacturing output. Questions are asked about real events and are not opinion based. Data are presented in the form of diffusion indices, where an index reading above 50.0 indicates an increase in the variable since the previous month and below 50.0 a decrease.