INSIGHT-Once Europe's lead preacher of budget prudence, Finland loses righteousness

HELSINKI Sun May 11, 2014 5:00am EDT

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HELSINKI May 11(Reuters) - Vesa Vihavainen is worried. Merivaara, his Finnish-based hospital bed-making business, is struggling - just like the economy that Finns once held up to debt-laden Greeks as a model of what national thrift can achieve.

Weak sales mean Merivaara has had to lay off staff as Finland fails to find an exit from a two-year recession. That spiral of lost jobs and income is also wrecking the country's cherished reputation for sound public finances.

Finland's school-masterly advice, prominent in a chorus of northern European criticism when euro zone debtors asked for bailouts, may come back to haunt its policymakers as they struggle to agree on reforms from taxes to pensions.

While southern Europe starts to win back investors after years of donor-imposed job losses and welfare cuts, Finnish welfare costs and taxes have risen as jobs are lost. Government levies as a share of gross domestic product (GDP) have jumped to a European Union high, piling costs onto the private sector.

Finnish exports, investments and retail sales are all tumbling and firms are putting out profit warnings.

"The Finnish economy has drifted into the same reference group with Italy and France," the EU's top economic official Olli Rehn said, referring to the two big euro zone economies whose finances linger outside the bloc's fiscal limits.

"We have no time to lose," said Rehn, a Finn, last month.

But with parliamentary elections in a year's time and Prime Minister Jyrki Katainen due to step down next month, serious cost cutting looks unlikely for now.

"We would need a brave government to implement the needed reforms," Danske Bank economist Pasi Kuoppamaki said.

But the chance of that happening decreased further on Friday, when social democrats replaced their leader, Finance Minister Jutta Urpilainen, with union boss Antti Rinne, who has advocated state take a bigger role in the economy.

And with the opposition talking mainly about small cuts to welfare and incremental changes, elections are unlikely to produce anything beyond policy fine-tuning.

Finland's GDP is still about 5 percent below its 2007 level, a bigger lag than the euro zone average and well below its main export competitors, Sweden and Germany.

The economy shrank 1.4 percent last year, and on Monday, the European Commission forecast it to grow 0.2 percent this year and 1.0 percent next - the second-weakest in the euro zone on both counts, beating only bailed-out Cyprus.

Netherlands, another debt-crisis hardliner, also has seen economy contract, but its struggles are smaller than Finland's and has returned to export-led growth.

In the euro zone, only Malta and Estonia are less competitive than Finland on pricing. Companies such as Merivaara produce less, but labour costs have not fallen nearly as much.

While Finnish leaders are worried, about half the deficit trimming has been achieved by raising taxes. Government revenue as a share of GDP rose to 56.3 percent this year, the highest in the EU and more than 10 percentage points above the EU average.

"The question is: How can Finland finance a public sector of this size, and the answer is: 'It really can't, at least if it wants the economy to grow'," Nordea analyst Jan von Gerich said.

ERODING COMPETITIVENESS

Merivaara's sales of hospital beds and surgical tables show rising domestic costs coupled with the strong euro are increasingly hampering exports, which go mainly to Scandinavia and Russia, where the economy has stagnated.

"Price competitiveness is getting tougher all the time," Merivaara's Vihavainen said. "Labour here is expensive, and we are far from markets, which adds to transportation costs."

Besides, health care spending across the globe is being squeezed by cuts in public budgets - a cause Finland championed.

"Why would we listen to countries that are not taking care of their own public finances?" said its EU minister Alexander Stubb in 2011.

He could become prime minister next month.

Even after two years of recession, there are few empty storefronts. Unemployment has risen, but is still well below the EU average, which has made it easier to delay reforms.

Finland has kept its top triple-A credit rating, earned by reforms undertaken after a deep recession in the early 1990s. But its pristine fiscal reputation "is more the past than the present," Pimco portfolio manager Andrew Bosomworth said.

Foreigners hold 90 percent of its sovereign debt, and Finland may find its cost of borrowing drifting higher as debt investors look more closely at its current performance.

"When investors think next time whether they should buy more or reduce Finland's weight (in their portfolios), it may be that they'll act differently," Nordea's von Gerich said.

LOST RECIPE FOR GROWTH

Finland, with 5.5 million people, has lost about 100,000 industrial jobs in 10 years. Phonemaker Nokia's woes have grabbed global headlines, but traditional Finnish strongholds of machinery and paper sectors are shedding jobs too.

In a February report to government, economists Bengt Holmstrom, Sixten Korkman and Matti Pohjola called the current crisis "to some extent even worse" than that of the early 1990s, when unemployment rates were close to 20 percent.

"Productivity growth has stopped in a never-before-seen manner and there is a lack of ideas to speed it up. The recipe for growth has been lost," they said.

Finns must shrink their welfare state and, put simply, work harder, they said. The OECD has just given a similar message.

In Finland, Sweden serves as a yardstick for almost anything, and Finland has fallen well behind. Sweden has rebounded from the financial crisis well and its economy is expected to grow about 3 percent this year and next.

Mobile games have often been touted as a Finnish success story, with global hits including Clash of Clans and Angry Birds. But the sector employs only about 2,000 people at home.

Finland also lags on reform: Sweden has cut taxes and brought the welfare state to an affordable level.

With many Finnish export-goods makers training their workers to perform highly specialised tasks, they have sought to keep the staff employed. Now lay-off notices are more frequent, and with capacity use at less than four-fifths, even an export upswing is unlikely to mean more hiring or investments.

"There is no positive news for Finland in any scenario, at least not in the near future," Nordea's von Gerich said. (Editing by Alistair Scrutton/Ruth Pitchford)

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