Productivity and long term growth

Economic Survey of Finland 2010: Coping with the job crisis and preparing for ageing

 

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The following OECD assessment and recommendations summarise chapter 3 of the Economic Survey of Finland published on 7 April 2010.

Contents

 

A sustainable recovery calls for moderate wage settlements in line with economic conditions and greater flexibility at the local level

Relative wage flexibility in Finland has been low, partly reflecting a long–standing centralised wage bargaining system. In the 2007/08 round, wage negotiations were decentralised to the industry level to increase wage flexibility. The overall outcome was unsatisfactory however. While the resulting high wage outcomes were in part due to a booming economy, they may also reflect the inability of the less centralised industry–level wage framework to rein in excessive wage increases beyond those justified by economic conditions. Progress on increasing local wage flexibility has also been slow. If the ongoing negotiations, under a broadly similar framework, are unable to achieve reasonable aggregate wage outcomes and improved local wage flexibility, particularly in light of the current dire economic situation, the negotiating framework may need to be reassessed. Moving back to a centralised bargaining system with government income policies should not be considered. Instead more co–ordination among and between employers and unions may be needed. Such co–ordination should, however, be limited to achieving reasonable overall wage outcomes and ensuring international competitiveness, and it should not in any way hinder progress towards greater local wage flexibility.


While co–ordination in wage negotiations is largely in the hands of employers and unions, the government should insist on other avenues being taken to increase wage flexibility. These can include reforms aimed at lowering the currently high replacement rates for the unemployed and generous early retirement schemes (see below). Given that union members only pay a fraction of the total costs of the unemployment insurance, incentives to curtail wage increases that create excessive unemployment are low. The government and the social partners should therefore consider implementing mechanisms that strengthen these incentives, for example, through experience ratings.


Together with the compressed wage structure, the lack of flexibility may weigh especially on the labour market outlook for younger and older workers. Allowing for more wage dispersion by lowering negotiated minimum wages for marginal groups could improve the bleak labour market prospects for young unskilled workers. Partial loosening of employment protection (EPL) beyond the minimum retirement age can help raise labour demand for older workers.


Swift action is needed to minimise the potential for long–term labour market damage from the crisis and to boost labour supply

Activation policies need to be improved to avoid a jobless recovery. Inevitably the downturn has propagated into the labour market, where employment is falling and unemployment climbing. However, as in many other OECD countries, the labour market response so far has been less severe than patterns from previous recessions would suggest. To some extent this reflects the success of the layoffs scheme in Finland, which now encompasses roughly 3% of the labour force. However, given the slow recovery ahead, these layoffs are likely to eventually spill over into unemployment and inactivity. 

 

Active labour market programmes   

Source: OECD (2009), OECD Employment Outlook, Figure 1.18 and Ministry of Employment and the Economy, Employment Service Statistics.


The government should act quickly to hinder a repetition of the recession in the early 1990s which led to a substantial increase in long–term unemployment and inactivity for an entire generation. While the government cannot fully replace the fall in labour demand, especially as the shock to a large extent is affecting the export sector, policies can mitigate the shock. The extra funds put forward to maintain the quality of labour market policies are useful in this context. However, the government should ensure that sufficient resources are made available to the Public Employment Service (PES) to make sure that it is adequately staffed and that the existing profiling system is used to free personnel for activation measures. In the longer run, the PES needs to become more efficient, which would require a higher degree of coordination at the central level.


Finland spends less on activation measures, and the unemployed are typically referred to active labour market policies later than in other Nordic countries. The late activation contributes to inactivity. While recent reforms to bring forward activation for youth and removing upper age limits are steps in the right direction, more is required. To maintain the employability of individuals, mandatory activation of the unemployed should take place at 50 weeks or earlier rather than 100 weeks, and refusal should always lead to sanctions. Individuals who face a high risk of long–term unemployment should be activated earlier.


Fiscal sustainability and labour supply should also be boosted by restricting incentives to early exit and lowering replacement rates 

Finland has one of the most generous benefit systems for long–term unemployed in the OECD, especially for low income groups. The combination of generous benefit systems and late activation raises particular concerns and is likely to contribute to high rates of joblessness, inactivity and dependency on transfer systems. As the generous benefits will be particularly problematic when labour demand starts to pick up, the government should signal now that unemployment benefits will be lowered as the recovery takes hold. Further tapering of unemployment benefits should also be implemented. The government needs to ensure that current reforms to the housing benefit efficiently address the existing inactivity trap and provide support better targeted to the poor. Aligning the Basic Income Support (BIS) with the Labour Market Support (LMS) would increase incentives to work. To enhance accountability, the institutional framework should also be reconsidered. Municipalities should bear full responsibility for both the BIS and the LMS.


Earnings–related unemployment benefits are provided by funds associated with unions, but mainly paid for by employers and the central government. The separation of financing and benefit provision may lead to a too lenient treatment of members in relation to existing rules and higher administrative costs. The government should therefore consider replacing the current system of unemployment funds with a government–administered and–financed system with appropriate experience rating mechanisms.


Entry into various early retirement schemes should be restricted to minimise the long–term consequences of the recession for labour supply and fiscal sustainability. The past practice of alleviating temporary labour market imbalances by providing ample and generous exit opportunities for older workers has proved to be costly over time. Despite recent improvement, participation rates of older workers in Finland are relatively low in the Nordic context. With unemployment mounting, the pressures on the disability pension system, the ‘unemployment pipeline’ and early exit into regular retirement are increasing. The success so far with partial reforms of the unemployment pipeline should be followed up with its full scale abolition. Entry into the disability pension should only be allowed on medical grounds under tighter assessment procedures. The focus on rehabilitation has so far yielded little in terms of outflow from disability, and sheltered employment may be a better way forward. Lower replacement rates in the disability pension should be considered to reduce incentives for early exit from the labour market. 

    
Further pension reform is needed to deal with escalating costs of ageing and the relatively low effective retirement age 

To accommodate the challenges from ageing, Finland should take a multi–faceted approach. Over the next two decades, old–age dependency will increase faster in Finland than in almost any other OECD country. Pre–funding should be enhanced so that the accumulation of net assets, before dependency ratios become too high, mitigates the pressure to raise taxes later. To deal with increasing longevity, working lives need to be extended. In the Finnish pension system introduced in 2005, benefits will be adjusted downwards in line with improving longevity. Although this adjustment clearly reinforces the robustness of the system, further reforms are needed to ensure that sustainable public finances can be achieved without crippling tax increases.


The setup of the disability pension and the unemployment pipeline create strong incentives to leave the labour force before the minimum retirement age in the old–age system. Once an individual has entered any of these streams, the incentives to remain there until taking up the old–age pension are strong. On top of this, individuals face strong incentives to take up the earnings–related pension at the earliest possible age (63). This has led to low employment rates among the 65–69 age group compared to other OECD countries, and especially other Nordic countries, as few workers remain employed after 63. While the average retirement age has increased since the introduction of the new pension system and on the back of a strong labour market, the recession is likely to undo some of these recent gains.


Reforms to the pension system are required to increase sustainability and lift old–age employment rates towards the levels of the other Nordic countries. Firstly, the government should consider raising the minimum retirement age from 63 to 65. The maximum retirement age could also be abolished, although adjustments in employment protection may be needed to ensure that demand for older workers is not affected adversely. Furthermore, incentives to stay employed beyond the minimum retirement age need to be improved. The increased accrual rate after 53 is costly and should be abolished, although the interaction with disability pensions and the unemployment pipeline should be carefully examined to minimise spillovers. The government should also consider lowering accrual rates during unemployment, parental leave and study. These reforms would lower fiscal costs and increase labour supply among older age groups significantly.

 

 

How to obtain this publication

The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations.

The complete edition of the Economic Survey of Finland is available from:

Additional information

For further information please contact the Finland Desk at the OECD Economics Department at eco.survey@oecd.org.

The OECD Secretariat's report was prepared by Henrik Braconier and Petar Vujanovic under the supervision of  Piritta Sorsa. Research assistance was provided by Isabelle Duong.

 

 

 

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