What Can Developing Countries Learn From Finland’s Industrial Transformation?
Markus Jäntti and Juhana Vartiainen
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.
The growth strategy has generally been considered a success since the country was able to undergo a remarkably rapid industrial transformation. Finland was definitely a late industrializing nation. In the 1930s, the economy was predominantly agrarian and, 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.
This article gives a brief overview of the development strategy followed by Finland to achieve this transformation, and examines lessons that can be learned from this.
Finland’s post World War II development strategy
It was only after the Second World War that Finland’s economic growth really took off. The most important engine for growth was simply an energetic accumulation of capital, reflected in an unusually high investment rate.
The outcome of the Second World War changed the political constellation of the country and paved the way for a long-standing political coalition of the centre-left parties. This political shift reinforced the preconditions for economic interventionism, but the Finnish dirigiste growth regime was never imposed on reluctant capitalists. Instead, under this phase of rapid capital accumulation, the state co-operated with banks and business organizations. 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.
The main economic and institutional elements of Finland’s high-growth policy regime were the following:
A high rate of capital accumulation in particular sustained by a high public saving rate. The public sector has been an important net saver in the economy. 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. With administratively set interest rates, bouts of high inflation have resulted in transfers from creditor households to debtor businesses. This setup, together with the state’s role in savings, helped to sustain the economy’s high investment rate. 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. As is typical in such corporatist regimes, many key decisions have been taken in a kind of twilight zone between private and public functions. Much of this policy set is hard to describe with well-established categories such as fiscal policy, monetary policy or industrial policy.
The political growth regime had to forge a compromise between capital owners and the working class. The outcome of the Second World War implied a political boost for the leftist parties in Finland. Astute politicians understood the need to integrate the working class, represented by the leftist parties and the trade unions, within the corporatist decision-making process. 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. There was a happy congruence of interest for such reforms at least in the 1950s and 1960s. Many of these obviously boosted labour supply, in particular that of women (primarily due, of course, to childcare and a proper pension system). The reforms also made market economy more palatable at the microeconomic level, thus enhancing the political legitimacy of the economic policy model in the eyes of the politically powerful working class. Finally, they alleviated the suspicions of the working class with regard to rapid structural transformation. If the government is trusted to provide social insurance to those who lose in structural transformation, it is probably easier to overcome the political opposition towards the growth-enhancing policies that create both losers and winners.
What lessons can we learn?
As was shown, Finland’s development strategy was interventionist without challenging basic property rights. It was preconditioned by the peculiar circumstances of Finland: The need to sustain a good economic outcome in a geopolitically hostile cold war environment.
The questions to which we now come are:
(i) Is the developmental model still applicable?
(ii) Can other, less developed countries, emulate Finland’s specific growth policy model?
(iii) Are there more general and indirect lessons for policymakers and scholars of other countries?
We would answer ‘no’ to the first two questions. 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. It has been argued even in the case of Finland that this original wave of investment generated a poor or negative rate of return.
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. For example, an increasing share of welfare expenditure in the future will be directed to pensions and health care for the elderly, and the implied higher tax rate may not be as easily accommodated with a need to uphold incentives for labour market participation and a high supply of working hours.
However, with respect to the third question (whether there are indirect lessons for policymakers of other countries), the answer is positive. 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.
About the authors
Markus Jäntti is professor of economics at Stockholm University, Research Director at the Luxembourg Income Study and Research Fellow at UNU-WIDER. His research interests center on international comparisons of and methods for the study of income inequality, income mobility and poverty and issues in applied labour economics.
Juhana Vartiainen is Head of the Research Division at the The National Institute for Economic Research, in Stockholm.
This article is based on a paper, written jointly with Markus Jäntti and Juhana Vartiainen, presented at the UNU-WIDER Conference ‘Country Role Models for Development Success’, held in Helsinki in June 2008. It is available online as a WIDER research paper RP2009-35 titled 'The Finnish Developmental State and its Growth Regime'.
WIDER Angle newsletter, October 2009