«Abstract This paper reviews Finland’s growth strategy in the postwar decades. Finland was able to initiate an impressive mobilization of resources ...»
However, suppose now that there is an external threat that might lead to a loss of national sovereignty unless economic growth is high. Suppose, also, that sufficiently high growth can only be achieved if all industries invest a lot. The payoff matrix of the transformed game might then look like the one shown in Table 2 (assuming that the loss of sovereignty is as bad as the ‘miserable’ alternative). Since the somewhat worse outcome now became miserable for all parties, the Pareto-efficient outcome is now a Nash equilibrium.8 Thus, one equilibrium of this transformed game is ‘invest a lot’—‘invest a lot’. This example might seem naïve, but it captures the idea of how an external threat can improve the economic outcome by establishing a sense of national urgency. It is, of course, a factor that could not and should not be used as a basis of regular policy recommendations. In general, one would not like to live in a world so unsecure that economic outcomes would have to be legitimated by external security threats.
7 The social contract between state, capital and labour
We emphasized above the corporatist nature of the Finnish growth regime as well the challenge posed by the international tension of the cold war. Thus, the state and industrialists worked together and were certainly motivated to do so. Yet it is also clear that 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 decisionmaking process. The programme of rapid capital accumulation also presupposed wage moderation and the acceptance of higher taxes. Upholding competitiveness and profitability thus acquired high priority on the economic-political agenda. The crude instruments to accomplish these were comprehensive incomes policy settlements as well as repeated devaluations.
Thus, in Finland, Keynesian interventionism took the form of repeated devaluations and income policies. Devaluations typically occurred at ten-year intervals (1949, 1957, 1967, 1977-80), and were usually accompanied by ‘incomes policy’ settlements which restricted wage growth for at least 2-3 years, so that the profitability-enhancing effect of the devaluation would not evaporate immediately. With such a control mechanism for nominal wage costs in place, accommodating exchange rate changes became one instrument for upholding competitiveness.
That instrument required the acquiescence of the worker part of the labour market, of course. Inclusion of the trade union organizations and encouragement of unionization served other purposes as well, at least in the eyes of key political players. Foremost among these was President Urho Kekkonen, who sought to build a national consensus 8 So is the pair ‘seek rents—seek rents’ as well, of course.
on economic and social policy, so that no political contradictions on the domestic scene would undermine the country’s geopolitically limited elbow room.
Thus, a political demand for social corporatism—social partnership between business, trade unions and the state—arose quite naturally from the country’s external and internal challenges. Similarly to other policy areas, even here social corporatism got a practical boost from the war economy. Immediately after the war, the nation was confronted with rampant inflation as well as stringent war indemnity claims from the Soviet Union. Soon, export growth was rapid, in particular during the boom of the Korea war in 1950-51. In these circumstances, the government, the unions and the business representatives established a kind of improvised incomes policy.
Comprehensive agreements on wages and prices were concluded during 1950-51. The aim of these programmes was to get inflation in control as well as to avoid industrial conflicts that could have disrupted the promising growth of export income.
Trade union and leftist representatives were willing to cap the growth of nominal wages as long as the government promised to regulate key prices such as that of milk and of other necessities. In October 1946, an economic council had been established to provide one formal arena for this tripartite consultation. Although the council’s formal agenda was to discuss extensive economic planning, a pragmatic consensus soon emerged, which limited its role to the crafting of wage and price agreements. Thus, tripartite social contracts, or what has later become known as ‘incomes policy’, dates back already to the early 1950s. At that time, however, the trade unions were still rather weak. The very term ‘incomes policy’ was coined later, in the 1960s, both in Finland and the rest of Europe.
The early stages of this incomes policy were anything but harmonious. It was typical in the 1950s and 1960s to freeze or to limit wage increases to a couple of years only. Then, as inflation accelerated, possibly fuelled by devaluation, the unions would start claiming higher wages. The 1956 general strike became a large political event signalling substantial disagreement over the proper functional distribution of income. Different trade unions were often in disagreement, and many unions were internally divided between the two main parties of the left: the communists and the social democrats. The government had to act as a broker between many conflicting objectives—not only those of labour and business, but also those of the farmers who had an obvious interest in the prices of necessary foodstuffs and of timber. During this early phase, incomes policies eventually often ended in wage-price inflation and a new devaluation.
Unionization received a big boost in 1965-75, partly because it was actively encouraged by the government. For some state actors, such as President Kekkonen, the forging of such a broad consensus on economic matters played a positive role for the country’s external security. The 1970s were a period of intense cold war, and President Kekkonen probably thought that the broadest possible acceptance of economic policy was one safeguard against expansionary intentions by the Soviet Union. This was particularly true because a substantial minority of the workers’ organizations were inclined to follow communist politics. Thus, it was better to include the radical aspirations of these workers into a consensual model of economic policy rather than to alienate them altogether. Figure 5 depicts the growth in the membership of the main central trade union federation (in Finnish: Suomen Ammattiliittojen Keskusjärjestö, SAK) and its predecessors.
Source: Statistics Finland.
At the same time, purely economic factors made it attractive to establish a calmer industrial relations climate. As mentioned in section 4, this was the time when the economy of Finland was being gradually integrated with a series of trade agreements into the world economy. These agreements brought large potential benefits but also required that the country’s competitiveness be preserved with economic policy. Import regulation was gradually dismantled, and sound current account balance became the prominent policy objective in the 1970s (Vartiainen and Vredin 1994). This necessitated a proper functional income distribution. Employers soon realized that dealing with a large trade union federation resulted in more wage moderation than a multitude of collective bargains with rival unions. Finally, the intellectual underpinning of ‘incomes policy’ was being elaborated upon in the economic literature. The now infamous Phillips curve had become the accepted wisdom (Lipsey 1960), and direct control of nominal wage costs was being promoted by British policy advisors (such as Nicholas Kaldor) of Harold Wilson’s Labour government in the UK.
Thus, incomes policy became one main arena of economic policy, in which the government as well as business and labour organizations were active. Yet the outcome was seldom smooth. Wage drift usually accelerated a few years after devaluation, and a new devaluation eventually became necessary. Of course, this pattern was not unique to Finland. This inflationary cycle was not broken until a proper inflation target was set in the 1990s.
8 The long-term promise of the welfare state
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 also 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.
This insight is emphasized in a recent book on the Nordic economic model by Andersen et al. (2007), but it has been nicely formalized in a paper by Fernandez and Rodrik (1991). In their model, the reform in question is trade liberalization. Yet, the intuitive idea is applicable more generally and can be simplified as following: suppose that there are two sectors in the economy, one of which (the ‘modern’ sector) stands to benefit from modernization (like trade liberalization or comprehensive industrialization) while the other (the ‘traditional’ sector) is going to lose. At the initial state, the majority of the economy’s manpower is located in the traditional sector. Moreover, income is originally the same in both sectors (and same across individuals), whereas the modernizing reform would increase income in the ‘winner’ sector and shrink it in the ‘loser’ sector. The crucial but plausible assumption, however, is that the modernizing reform will also lead to a transfer of people from the traditional sector to the modern sector. Let the economic data of this example be summarized in the Table 3.
Thus, the modern-sector people gain from modernization, since their income grows from 90 to 120. The reverse is true for the traditional-sector individuals, as their income decreases from 100 to 90. Furthermore, ten people shift from the traditional sector to the modern sector. It is impossible to know ex ante who these individuals will be.
How will the people within this economy vote in a referendum on trade liberalization?
Suppose that all agents are fully rational and completely aware of the data of Table 3. A traditional-sector person understands that there is an one-sixth probability of increasing his or her income from 100 to 120. However, with a five-sixths probability income will shrink by ten units. The expected gain is (1/6) x (20) + (5/6) x (-10) = -5 0. Thus, the traditional people will vote against the reform. Since they form ex ante the majority of the voters, the reform will not gather the majority of votes (the modern-sector people will obviously vote for the reform, since their expected income change is positive). This is the outcome of the democratic process even if reform increases average income, and even if it increases the income of the majority.
Table 3 The argument of Fernandez and Rodrik
A salient feature of this model is that if the reform is eventually passed, it will gain popular support afterwards, and only a minority of voters would want to return to the original state of affairs. Even in this case, there is an obvious, constructive role for public redistribution of income. If the state can put up an income redistribution scheme that does not waste too much resources, it can introduce ex ante legislation that will ensure that the losers will be a minority (or even that there are no losers).
9 Is the growth strategy still viable, and can other countries learn from it?
We have reviewed the characteristics of the developmental growth regime of Finland.
The regime 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. In conclusion, it is
natural to ask the following questions:
i) Is the developmental model still applicable?
ii) Could 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?
In our view, 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 (see Pohjola 1996).
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.