Permafrost

THE harbour may be frozen, but that does not stop a ferry with a few intrepid tourists on board from making its way through the ice to Suomenlinna, a former fortress and popular sightseeing spot near Helsinki. Finns, whose country stretches from the Baltic Sea to the Arctic, are inured to hostile conditions, but their economy seems less hardy. It is stuck in an unrelenting freeze. A centre-right coalition government formed last spring is trying to break the ice, but has not yet got far.

After thriving for several years both before and after joining the euro in 1999, Finland ran into trouble after the financial crisis of 2007-08. Output plunged by 8.3% in 2009. Although GDP grew in 2010 and 2011, it then declined for the following three years—and may have contracted again in 2015. Short-term data suggest that the economy will be flat in early 2016, says Jussi Mustonen, chief economist at the Confederation of Finnish Industries.

Erkki Liikanen, governor of the central bank, explains that Finland has suffered an extraordinary combination of adverse shocks. The most important of these was the decline of Nokia, once Finland’s biggest company and the world’s biggest maker of mobile phones. Just as the rise of Nokia did much to propel the Finnish economy in the decade before the financial crisis—accounting for nearly a quarter of growth—so its fall in the smartphone era has contributed to subsequent weakness. Another problem was that wages carried on rising despite sagging productivity: unit labour costs are 10-15% higher than those of Finland’s trading partners.

Meanwhile the workforce is shrinking as an especially pronounced post-war baby boom and subsequent bust takes its toll. The number of Finns aged 15-64 is falling by almost 0.5% a year. Markku Kotilainen of ETLA, an economic think-tank, reckons that potential growth has halved from around 3% a year before the financial crisis to less than 1.5% now. On top of all of this, exports to Russia have plunged by a third in the past year, owing to an economic slump there as well as trade sanctions. Russia now buys just 5.8% of Finland’s exports, down from 10% in 2012. The Finnish economic and social model is being challenged, says the OECD in a new survey.

Faith in Finn tech

Finland is well-placed to find new sources of growth. According to a report on competitiveness from the World Economic Forum, it ranks second globally for innovation. Startups are an ideology among young Finns, says Mr Kotilainen. Encouraging them is a priority of the government. Much of a €1.6 billion ($1.8 billion) initiative to promote growth over the next three years will foster the use of new technology.

Overall, however, the government, which has been running a deficit of around 3% of GDP, is administering the same medicine of austerity and structural reforms that countries in southern Europe have had to swallow. The austerity programme, only partially offset by the temporary growth package, will eventually realise savings of €4 billion—around 2% of GDP—in 2019, mainly through spending cuts. Even then, further parsimony will lie ahead for a country whose public expenditure is 58% of GDP, the highest in the European Union (the average is 47%).

The most important reform is an overhaul of the labour market, says Olli Rehn, the economy minister, who as a former European commissioner used to prescribe similar treatment elsewhere in the euro area. Finland’s system of national collective bargaining was once a strength, enabling wage agreements to take into account overall economic constraints, but it is now keeping wages too high. The government advocates a more flexible system, in which firms will have greater freedom to reach their own deals with workers.

This should help to restore Finland’s lost competitiveness by ensuring that wage increases stay below those in the rest of the euro area and through higher productivity at individual firms. A more immediate boost should come from reforms that bring down costs by increasing working time—for example, by scrapping two national holidays and curbing public-sector leave. The government wants employers and unions to agree upon such a package, but they have failed four times. If they cannot reach a deal, the government will impose measures in the spring, warns Alexander Stubb, the finance minister.

One obstacle to Finland’s revival goes largely unmentioned. Had the country retained its own currency, the long, hard adjustment that it is now seeking to achieve by lowering domestic costs could have been attained much more easily by allowing the markka to depreciate. Finland’s economic woes stand in contrast with the robust performance of its neighbour, Sweden, which kept the krona. Finland’s output is now 7.3% lower than at its previous peak—worse than in Spain or Portugal (see chart). Sweden’s, in contrast, is 8.6% higher.

But there is more to the outperformance of Sweden, whose economy is twice as large and more diversified, than keeping its own currency. And lamenting the constraints of the euro is not much help to the Finnish government. If one thing has been learnt during the euro crisis, it is that leaving the single currency would be hazardous and costly. The only path for Finland is to regain lost ground within the monetary union, however painful that may be.