Is the foundation of the upcoming upswing weakening?

A societal speculative debate is currently underway regarding the signals and timing of the onset of an economic upswing. Many observers, including Labore, assume that the start of strong growth will unfortunately be delayed once again.

Innocent parties as scapegoats

Statistics show that consumers are currently almost exceptionally frugal. As a result, private consumption is subdued. In addition, public consumption is being restrained as part of fiscal consolidation measures. It is therefore no surprise that production capacity is underutilised, particularly in firms operating in domestic markets. Companies exhibit a kind of reluctance to invest that is difficult to revive with tax incentives and impossible to restore with rhetorical encouragement.

On the other hand, industrial export orders have been increasing for some time, albeit on a very uneven path. If this development continues along the same trajectory, exports will in time provide relief to our cyclical difficulties. This requires sufficiently strong cost competitiveness and favourable international economic conditions. Thus, these matters are only partly under our control.

There is no point in blaming consumers for this bleak economic cycle. Economic theory assumes that each consumer is the best expert on their own financial situation. It is therefore unjustified to criticise them for feeling uncertainty and a need to prepare for the future. Even recent tax cuts may not help if households simultaneously face upcoming fiscal tightening and the risk of unemployment. In this context, consumers are behaving rationally according to standard economic theory.

It is equally unproductive to criticise firms for distributing large dividends instead of investing. If there are no identifiable investment opportunities that are expected to generate high value added and sufficiently strong returns, the rational course is to distribute funds to owners. If the market mechanism functions properly, these funds will be channelled into investments by firms with better investment opportunities. This avoids the “curse of inefficient capital” in the national economy and helps create conditions for sustained long-term growth.

Recessions erode the foundations of long-term growth

From the perspective of living standards and public finances, the more important question than the exact timing of the end of a recession is how strong and long the future growth period will be. As unemployment becomes prolonged, there is a risk that human capital—i.e. the capacity for productive work—will begin to deteriorate.

Prolonged recessions are particularly harmful to intangible investment in young firms. This is concerning because an economy emerging from a productivity slump requires especially radical innovations that renew the economy. According to research, such innovations are primarily generated in young firms with capable young managers. In these firms, productive ideas emerge that are transformed through investment into high value-added production. This creates new productive jobs, upon which Finland’s long-term economic growth is built.

Concerning signals in the labour market

Labore’s earlier analyses indicate that highly educated workers were in strong demand in the Finnish labour market in the latter half of the 2010s, particularly in young firms in high-technology sectors. This is also reflected in wage developments among the highly educated. This has been a positive signal for the national economy, indicating that these firms have been investing in future productivity—that is, in the factor on which the strength and duration of the growth period largely depend.

However, Labore’s most recent wage analyses provide worrying signals of a reversal in this trend (see also separate text). It appears that demand for highly educated workers has recently weakened significantly more than for others. This does not bode well. The less firms invest in the skilled labour that generates future productivity, the fewer ideas there are for productive expansion investments in the coming years. This also reduces demand for, among others, vocationally trained workers. This is of course detrimental to public finances as well.

There are also worrying signs in unemployment statistics. Long-term unemployment has risen to such a high level that the risk of human capital erosion is evident. This is unfortunate both for the well-being of the unemployed and for the economy’s growth prospects. There is a risk that, in the coming years, growth in many firms will be constrained earlier than expected by a shortage of skilled labour.

Attention and focus for policymakers

There is therefore a troubling creaking sound in the foundations of future economic growth. Policymakers should pay close attention. This is their responsibility, and they may even be held accountable for potential policy errors. Given the tight state of public finances, attention should be focused on the most critical elements of future growth: the operating conditions of innovative young firms that drive economic renewal, and the rapid reduction of youth and long-term unemployment. (AI translation)

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