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EMU and the Labour Market – The Finnish Case1)


A common currency will have implications for the labour market. This was made clear already in Robert Mundell's (1961) analysis of optimal currency areas. Mundell analysed Friedman's (1953) argument, that countries with rigid price and wage structures need flexible exchange rates. Thus, in an optimal currency area, prices and nominal wages must be flexible and/or the workforce must be mobile.

The price for the monetary stability and predictability offered by a currency union would thus, according to many economists, be instability especially in the labour market.

The trade union movement in Finland questioned this "common wisdom". Instead of nominal wage flexibility, what is needed is a flexibility in total labour costs by altering payroll taxes, thus giving room for more predictable and stable developments in nominal wage, consumption and tax revenues.

The social partners - with support from the government - managed to negotiate a national agreement on EMU-buffers in the social insurance system. The buffers make it possible to level out cyclical fluctuations and give time for real economic adjustment in case of severe asymmetric shocks by altering employers payroll taxes (see also Calmfors, 1998). At the same time the risk, that EMU leads to a weakening of the social security system, has been reduced.

Some employers saw the common currency as a way to get rid of trade unions. But it was not that easy. The Finnish buffer fund agreement in fact strengthens tripartite co-operation, the role of the social partners and the tradition of centralised and incomes policy agreements, in force since 1968

1) An earlier version of this paper has been published in September 1998 in Bologna at the 11th World Congress of the International Industrial Relations Association (IIRA) in Kauppinen (1998).

The EMU-buffers agreed upon are not especially big, only about 7 billion FIM or 1 per cent of GNP. This amounts to about 2 per cent of the total wage bill. If the lending facility in the unemployment insurance system is includes, the buffers amount to about 10 billion FIM or 3 per cent of the wage bill. They are thus big enough to level out pro-cyclical variations in the Finnish employment pension and unemployment insurance systems.

In the case of mayor external shocks they give more time for real adjustment. There is thereto a common understanding between the social partners, that in case of severe economic disturbance, it may be necessary to change legislation to allow the partial use of the normal pension funds, now about 180 billion FIM.

The EMU-buffer fund in the employment pension system will be, at maximum, about 2.5 per cent of the wage bill in the private sector or about 3.5 billion FIM.

The ceiling for the buffer fund in the unemployment insurance system is an amount equal to the cost of an increase of unemployment of 3.6 percentage points, approximately 3 billion FIM, but the system is allowed to lend an equal amount. Thus, unemployment might rise by 3.6 percentage points without requiring employers’ and workers’ unemployment insurance contributions to be raised. Employers’ and workers’ contributions finance only the income-related part of the system. The state budget functions as the buffer for the basic, flat-rate unemployment insurance part of the unemployment costs.

Thus, these seemingly small buffers make it possibly temporarily to lover the private sector employers payroll taxes by about 3 percentage points during two consecutive years. For the public sector total wage costs can be lowered by about half of that.

In Finland an "internal devaluation" where payroll taxes are cut by 3 - 4 percentage points gives the same employment effect (the trade balance effect is of course not especially relevant in a currency union) as a 10 per cent currency devaluation, according to Holm, Kiander and Tossavainen (1997), without adverse effects on inflation. This model does not affect imports adversely as would a currency devaluation. Over the cycle, payroll taxes will be raised again, to safeguard the social security system. Thus this is not a "beggar thy neighbour"-policy or a start of a "race to the bottom".

The added value of this system, compared to just making the automatic stabilisers of the financial policy more effective, is the link to wage formation. When the payroll taxes are increased in the good years, the risk for too high pay increases and wage-wage inflation is lowered. Cutting pay-roll taxes during bad times gives room for better employment and wage developments. It makes the social partners, employers and trade unions alike, more aware of their responsibility for low inflation and employment.

The Finnish experience shows that centralised agreements and national consensus is still a strength. Different kinds of Social Contracts have in fact been quite common during recent years in Western Europe, especially in smaller or peripheral countries, (Fajertag & Pochet (1997), Pochet & Vanhercke (1998)). In December 1998 the Economic and Social Committee of the EU proposed in an own-initiative opinion, that all EU member states should create a system allowing grater total labour cost flexibility without nominal wage flexibility and without endangering social security systems (ESC, 1998)

About Finland's economic history

Finland's monetary history since World War II has been one of cycles of inflation and currency instability. All in all there have been eleven devaluation's, three revaluation's and one period of floating. Finland's industrial structure, the heavy dependence on pulp and paper, the trade patterns and also the cyclical rhythm differ from those of the "core" EU-Member States. This, plus our location on the periphery of Europe, makes Finland more exposed to external, asymmetrical shocks than most of the other EU-Member States.

And Finland has indeed experienced such shocks. Finland ran into a most severe economic crisis in the beginning of the 1990´s. Unemployment rose from 3.5 per cent to almost 20 per cent or 500 000 persons within a few years. The main reasons for this development were an external shock - the collapse of the Soviet Union - and an uncontrolled deregulation of Finland's financial markets in the late 80's. The Russian market accounted for almost a quarter of Finland's total merchandise exports in the early 80´s. This market collapsed in 1990 - 91.

The experience from the late 80's stresses the need to make it absolutely sure, that the implications of changing central economic relations are fully understood. The effects of the deregulation of the financial markets in the 80's was not anticipated even by the Bank of Finland or the Bank Inspection. This led to an financial bubble and the bank crisis, the cost of which is about 10 billion ECU's for the Finnish tax payers.

In addition, the timing of the monetary and exchange rate policies by the European Central Bank may make the cyclical changes in Finland, which are out of phase with the "core" EU countries even more volatile (see e.g. OECD, 1998). In contrast to the social partners in the core EU-Member States, Finns cannot expect the European Central Bank to take Finland's special problems into account in its monetary policy.

The composition of the euro area has its own important consequences for Finland. Trade with UK, Denmark and Sweden, all "outs", account for 24 per cent of Finland's total merchandise export, whereas all the other EU-countries account for about 30 per cent.

What flexibility does a common currency demand?

According to textbook economics, the right thing to do when confronted with an external, asymmetrical shock, is to devalue. As this is impossible within the EMU, what can be done? The trade unions cannot, of course, support a Finnish participation in EMU if, as many economists say, when the exchange rate is fixed, then employment and nominal wages must fluctuate in response to external shocks, and that employers must retain the right unilaterally to lower agreed wages. This would effectively destroy the negotiating structures and bargaining systems.

The loss of important markets, a possible "mad wood disease" or other unexpected problems must be anticipated. The right thing to do cannot be to cut wages and domestic demand, which just would deepen the crisis. According to the SAK analysis, the possible economic risks can be tackled - if there is a social consensus to do so.

Employers and right wing economists argue, that without the possibility of exchange rate realignment the only way to react to external shocks is to accept a fall in agreed nominal wages or a rise in unemployment. To make this possible, negotiating structures should be decentralised and labour markets deregulated.

In particular, the general applicability of collective agreements, i.e. the extension of the collective agreements to bind also unorganised employers, was seen as an obstacle for the "smooth" functioning of the labour market in the monetary union. Now we know, that all participating countries have generally applicable collective agreements with only one exception, Ireland (OECD (1997) p. 72). The three countries which left themselves outside the common currency, i.e. UK, Denmark and Sweden , do not have generally applicable collective agreements.

For the trade unions this position was of course unacceptable. Cutting wages would in fact just add to the economic difficulties, caused by external shocks, by cutting internal demand, tax revenues and employment further.

Normally, state budgets, i.e. fiscal policy, are used as buffers. The Finnish Minister of Finance frequently stated, that the only buffer needed with EMU is sound public finances. However, the strict limitations agreed upon in the Stability and Growth Pact means, that fiscal policy alone is an inadequate method for dealing with major economic disturbances.

From the employers side, the economic situation of the firms, and especially sufficient own assets, has been mentioned as the only buffer really needed.

Sound public finances are of course important and so are sufficiently big own assets in the firm, but in the trade union judgement, they are not enough.

SAK's strategy

Given the lack of appropriate EU-level automatic stabilisers between nations participating in the currency union, the Finnish Trade Unions in 1995 started to discuss national measures to make economic adjustment easier within EMU. The new government's growing interest for joining EMU also made the question more urgent to answer.

This forced SAK to discuss not only whether or not EMU is a good thing for Europe but also to discuss the practical solutions needed for tackling possible problems the day the third stage of EMU begins.

The Finnish trade union's EMU-strategy has been to look for national labour market solutions which could help stabilise the economy, protect the social security system and protect their members whether employed or unemployed. SAK´s EMU-strategy has been to concentrate on such national decisions which it can influence. As can be seen in Foden (1998), such a pragmatic approach has not been especially common in Europe. But now the Finnish example is discussed at least in Sweden, Ireland, Spain and Portugal.

The trade union debate started in October 1995 at the SAK general assembly. In December 1995 the first SAK discussion paper about national EMU-buffers was published.

In SAK's Congress, held in June 1996, it was stated that SAK will oppose joining EMU if it is linked to demands for the dismantling of the bargaining structures or nominal wage fluctuations. SAK also demanded the development of buffer funds and the development of agreed rules for dealing with economic disturbances.

In March 1997 SAK launched nation-wide EMU-discussions and seminars for shop-stewards and other trade unionists. SAK's positions and demands concerning EMU where supported by 9 shop stewards out of ten.

SAK also managed to deepen and broaden the debate. SAK 's demands were central for the work in the Incomes Policy Commission and the negotiations on the Joint Opinion as well as for what questions the Group of Professors looked at in their work.

Can funds function as buffers?

In Finland, as in most EU-Member States, labour costs are considerably higher than the direct wage costs, because of the so called non-wage labour costs or payroll taxes. The most important of these are the employers' pension contributions which are equivalent to about 17 per cent of the wage bill. Together with the other (statutory or by agreement) contributions, they add some 30 per cent to the wage cost. This creates a possibility to influence the total labour costs without touching the nominal wages at all. According to the latest estimates (Holm et al, 1997) , the lowering of total labour costs by 3 - 4 per cent, an "internal devaluation", gives the same employment advantages as a 10 per cent exchange rate devaluation - without creating inflationary pressures - and time for real adaptation to change.

In order not to endanger the social security system's capabilities to meet future needs, if non-wage labour costs are actively used to influence total labour costs, buffer funds must be established. In fact one already exists. There is about FIM 180 billion ( ECU 32 billion) in the pension funds at present. This is equivalent to about 30 per cent of GNP. SAK proposed that additional buffer funds should be established.

In 1990, the unemployment benefit contribution paid by employers was 0.6 per cent of total wages. In 1994 the figure was 6.0 per cent as unemployment rose from 3.5 per cent to almost 20 per cent. If there had been a buffer fund, the resulting increase in total labour costs, in the midst of the most severe economic crisis in modern times in Finland, could have been softened and the number of unemployed could have been about 50,000 lower.

Usually companies have no time to train or re-train their personnel during the good times. And when the times change and there is nothing but time, the companies have no money for training and education and have to resort to compulsory redundancies. Would it not be better, to build buffer funds - national, sector or even company based - to enable companies to take care of their "most important asset" - their personnel and their personnel's skills, also during the bad times? This proposal was not accepted by the employers.

These funds could, trade unions proposed, be maintained outside the public sector and thus be used without restricting the latitude for fiscal policy manoeuvring. Now it seems probable, that they will be counted as part of the public sector in national accounts. But also if they are counted as part of the public sector, greater public surpluses in the boom years as a result of creating the EMU-buffers leaves more room for financial policy expansion in the slow-down.

According to SAK, external shocks can be softened by creating buffers and other "shock absorbers", but there must be consensus concerning their use. The Government and the social partners must agree on how to utilise them. They must also agree to build up the funds during the good years so that there will be resources available when the bad times come.

Wage formation and low inflation

External difficulties are not the only aspect which must be taken into account when Finland joins the EMU. The social partners stresses, that internally there must be a willingness to adhere to the low inflation target. Wages and salaries are of course not the only factors behind price increases, but they are by far the most important cost component in society.

How can the pay structure be organised so that wage increases are compatible with the inflation target ? In a balanced situation, real labour costs cannot rise by more than the average rate of labour productivity without causing inflation, which ultimately causes unemployment.

Within a centralised wage policy it is possible to agree upon a system, in which increased social security contributions or other payroll taxes, paid by employers, keep wage demands lower, as a response to the growing total labour costs. When the economic development decelerates, the social security contributions paid by companies can be lowered in order to make companies more competitive and help them maintain their workforce intact. Wage developments - and the whole economy - will be more stable over the economic cycle.

The Report from the Incomes Policy Commission

At the beginning of May 1997 the Incomes Policy Commission - established in 1971 and composed of economists from the employers and trade union confederations and from the Ministry of Finance - published a report on EMU and the labour market. The unanimous report states that the national bargaining system has proved its capacity to tackle serious economic difficulties and also managed to produce wage increases compatible with low inflation.

According to the report there is a need to increase real economic stability - and not only monetary stability - especially in the labour market. Incomes policy or centralised agreements lead to more predictability and diminish fluctuations in wages, employment and consumption. According to the report external shocks and severe cyclical fluctuations should - if Finland joins the EMU - be met by a number of measures, from macroeconomic stabilisation policies, to measures aiming at strengthening the capacity of an individual enterprise to meet downturns without need to dismiss personnel. According to the Incomes Policy Commission different temporary measures used to lower total costs of labour, might offer a functioning buffer against major economic difficulties. This can be achieved by reducing e.g. the employers pension or unemployment contributions, without lowering nominal or agreed wages and salaries. In this way Finland can gain time for real adjustments in the economy, including real wage adjustment, without over impeding employment possibilities.

This thinking is largely based on the fact that the labour market is quite well organised - the trade union density is over 80 per cent and the collective agreements are binding for almost the entire labour market. Since 1968 wage settlements have mainly taken the form of centralised agreements between employers and employee confederations or even tripartite incomes policy agreements. There has been a tradition to look at total labour cost development, i.e. if employers social insurance fees have been rising, nominal wage demands has been lowered accordingly.

The wage model developed by the Incomes Policy Commission in 1995 states, that the room for labour cost increase is defined by the inflation target and the average productivity growth in the whole economy, i.e. some 4 - 5 per cent per annum. But agreed nominal wage increases must reflect the fact, that the wage drift will occupy part of the room for increase, on average about one per cent during the 90's. Also rising employers social insurance fees will press down the room for nominal increases. This model is thus a model for wage formation compatible with low inflation, when the economy is in balance and the functional distribution of incomes between wages and profits is kept unchanged.

The Final Report from the Group of Professors

In mid-May 1997 the Group of Professors, which Prime Minister Lipponen announced at SAK:s General Assembly in November 1996, in an attempt to react to SAK:s EMU-criticism, published its final report. According to this report, the fears and uncertainties to which SAK drew attention to, must be taken seriously.

The Group of Professors, chaired by Jukka Pekkarinen, the Director of the Labour Institute for Economic Research, mainly focused on the economic and employment effects of the two main alternatives: joining EMU as quickly as possible, or staying outside with a floating exchange rate. The Group made no recommendation either in favour of nor against joining EMU, but stressed, as had SAK, the necessity to analyse and understand the changes in the rules of the game that both alternatives will bring.

According to the report, Finland has been, and will also in the future be, more exposed to external asymmetric disturbances than most the other EU-member States. The report stressed the need to develop more - not less - automatic stabilisers in the economy, but found the Stability Pact problematic at least for countries like Finland.

The Group also looked at the effects of a single currency for regional development in Finland, for gender equality and for the future of social policy. These themes have rarely been touched upon during present EMU-analyses in other countries.

The Joint Opinion of May, 1997

On May 22nd, the social partners agreed on a 10-point paper, in which the starting point is that "The European Union should co-operate in order to increase monetary stability; encourage effective, long-term economic growth; improve the employment situation and promote the construction of a Social Europe."

This joint opinion of the social partners, concerning the effects of the Economic and Monetary Union on the functioning of the labour market was signed by all the three trade union confederations, i.e. SAK, STTK and AKAVA, and all five employers confederations, from both the private and public sectors. The social partners stated that "The possible monetary union will not affect the basic structure of Finnish labour markets". The joint opinion thus met one of the major demands expressed during SAK's Congress in 1996.

In the joint opinion the social partners also agreed to study SAK's proposals for EMU buffer funds, the other major issue which SAK´s Congress demanded. This work started in June and continued till November 1997.

The central labour market organisations consider it important that the inflation objective of the European Central Bank should be determined in such a way that it would not bring about deflation, and that the necessary changes in relative wages can be implemented in practice and also, that the specific conditions in Finland will be taken into account when applying the forthcoming EU Stability and Growth Pact that restricts public sector deficits.

The Joint Opinion states, that the tripartite co-operation, to which both the Government and social partners are committed, will grow in importance and that Finland shall have a functioning system of bargaining also in the future. And EMU-membership will not change the minimum requirements of the collective agreements for both civil servants and workers, or change the universal validity of collective labour agreements. Neither will it lower nominal wages.

Of particular importance is the employers commitment to ensure that in their operations, alternative forms of agreement including incomes policy and centralised agreements, will remain possible. The organisations emphasise the importance of the possibilities offered by the Finnish bargaining system in the conditions of the EMU.

In the Joint Opinion the social partners once again commit themselves to low inflation, and state that adjusting to a permanently low level of inflation is a central challenge to the bargaining system in the conditions of the EMU, and that this is possible within the current bargaining systems.

There is unanimity about the need to increase the economy's resistance to disturbances i.a. by diversifying the structure of the economy and by fiscal policy, within which the room to manoeuvre might become more restricted by the EU Stability and Growth Pact. The financial solidity of firms will facilitate their adjustment to economic fluctuations. The organisations state that national, as well as branch- and company-level, stabilising buffers should be created in order to prepare for economic disturbances. Useful buffers could be created in connection with social insurance and in support of human resources development. Also the organisation state that personnel funds and other profit-based components (Pepper schemes) should promote the personnel's commitment to the operations of their workplace and reward them according to the success of the company.

The Buffer Fund Agreement, November 1997

After lengthy discussions and negotiations, the social partners agreed in November 1997 to set up two national EMU buffer funds which will stabilise the economy when Finland joins EMU. The buffer funds in the pension insurance system and the unemployment insurance system will make it possible to level out normal cyclical fluctuations. SAK's proposal to build a fund for training and retraining was rejected by the employers. The agreement includes also a common understanding on how to develop the national collective agreement system and how to handle severe external shocks.

The agreement on the use of the employment pension funds, unemployment insurance funds and personnel funds as counter-cyclical buffers was reached. The deal on unemployment security is part of a wider framework where, in addition to buffer funds, agreement was reached on the long-term principles for financing as well as administrative reforms.

All eight labour market central organisations signed the agreement, namely The Confederation of Unions for Academic Professionals in Finland - AKAVA, The Church of Finland Negotiating Commission, The Commission for Local Authority Employers - KT, The Employers' Confederation of Service Industries - PT, The Central Organisation of Finnish Trade Unions - SAK, The Confederation of Finnish Industry and Employers - TT, The Finnish Confederation of Salaried Employees - STTK and the State Employers' Office - VTML.

The November agreement establishes two national EMU-buffer funds. They are designed to be big enough to level out normal cyclical fluctuations in the employers social security contributions. Thus the stability and predictability of the economy will be increased. In the case of big external shocks they give time to react and time for real adjustment.

The Common Unemployment Insurance Fund

The central labour market organisations reached agreement on the principles by which the financing of unemployment security will be safeguarded and fluctuations in the employers unemployment insurance contributions will be smoothed. The solution does not change unemployment allowances or the status of the trade unions' unemployment benefit funds.

On the basis of the decision, the central government will contribute an amount to the financing of unemployment security equivalent to the basic daily compensation starting in 1999 (in 1998 FIM 120 per day per unemployed beneficiary). Some transitory arrangements are agreed not to increase the governments expenditures immediately. The unemployment benefit funds will continue to contribute to the financing of unemployment security an amount equal to 5.5 per cent of their benefit expenditures.

A social partners' Common Unemployment Insurance Fund will be established. Two thirds of the seats on the administrative board of the fund are held by the employers and one-third by trade unions. The Common Unemployment Insurance Fund will be responsible for the expenditures not covered by the State or the unions unemployment benefit funds. The benefits cover unemployment allowances, adult re-training programmes, voluntary education programmes for the unemployed, compensation for persons on sabbatical leave, supplementary employment pensions as well as the training and severance pay fund. The expenditures of the Common Unemployment Insurance Fund are financed by employers' and employees' insurance contributions and by the returns on investments. In 1998 the employer's contribution is 2,8 % of the wage sum and the employee's contribution is 1,4 % of wages/salaries. Starting in 1999 the insurance contributions of employers and the obligatory contributions of employees will be adjusted. In 1999 the contributions are 2.7 and 1.35 per cent respectively.

The Ministry of Social Affairs and Health will set the level of insurance contributions on the basis of the proposal of the Common Unemployment Insurance Fund.

In order to smoothen the fluctuation in contributions stemming from economic developments, a counter-cyclical buffer fund of about FIM 3 billion will be accumulated in the Common Unemployment Insurance Fund. The buffer may be as big as the systems cost of an rise of unemployment by 3.6 percentage points. The state budget will act as a buffer for the basic unemployment allowances.

The buffer will be collected when the decline in unemployment and benefit expenditures make it possible. The target level was projected to be reached in the years 2002-2004. But according to the latest estimates, the fund will grow by over 2 billion FIM in 1999. Under conditions of economic disturbances the fund can also borrow to cover its expenditures. The agreement is expected to buffer the unemployment benefit system not only from economic but also from political fluctuations. Whether the fund will be counted in national accounts statistics as part of the private or the public sector is still open.

The Buffer Fund in the Employment Pension System

The labour market organisations and the employment pension institutions, which in Finland are private, have agreed upon the use of employment pension funds to smoothen cyclical fluctuations in employment pension contributions. The aim is to use and expand the already existing stabilisation fund. The purpose of the fund is to ensure the undisturbed payment of pensions.

When implementing the buffer scheme, the intention is to expand the stabilisation fund in line with growth in the total wage sum in boom years. During a recession the stabilisation fund would be allowed to decrease. This will reduce pressure to raise employment pension contributions stemming from the slow growth or even a decrease in the wage sum. It is estimated that the buffer necessary for smoothing ordinary cyclically related fluctuations in the contributions would be about 2.5 per cent of the wage sum in the private sector, i.e. about 3,5 billion FIM. In the end of 1999 this buffer fund will reach at least half of that target, according to recent estimates.

The scheme will not require any changes in legislation. The accumulation and depletion of the buffer fund will be decided upon by the labour market organisations and the pension insurance institutions in annual negotiations on employment pension contributions.

In the negotiations on the buffer funds it was noted that in times of severe economic disturbances, it may be necessary to impose changes in the legislation to allow use of the entire capital of the employment pension fund, now about 180 billion FIM and to ease upward pressure on employment pension contributions.

Joint Recommendation on Personnel Funds and Results-based Pay

According to the negotiating group that studied the use of personnel funds as EMU buffers, it is important for all parties concerned to evaluate the effects of EMU on the functioning of the labour market. The organisations note that the significance, for the enterprise and for its personnel, of companies personnel funds and payment-by-results schemes must be determined locally. It is also necessary to develop other forms of co-operation for motivating personnel and promoting work incentives.

The organisations recommended that firm-specific personnel funds and payment-by-results schemes must be negotiated locally. It is also necessary to develop other forms of co-operation for motivating personnel and promoting work incentives.

The organisations recognise that financially sound enterprises and firm-specific solutions facilitate the adjustment to economic shocks and foster economic stability. The personnel funds in companies and various kinds of payment-by-results schemes can function as buffers smoothening fluctuations in profitability. When the profitability of enterprises is high, part of the earnings can be channelled to employees via these schemes if desired.

The negotiating group emphasised the importance of information. The organisations have jointly produced information material for use by enterprises and personnel. The organisations will also supply their member unions and member companies with information about the joint statement by the end of this year. Information about personnel funds and payment-by-results schemes will be intensified.

In the joint statement it is noted that the ability of the economy to withstand cyclical disturbances can be improved by, among other things, diversifying the industrial structure. Wage developments compatible with steady low inflation will also foster economic stability.

The national decision

The November 1997 agreement on counter-cyclical buffers made it possible for all Trade Union Confederations to support Finland joining the third stage of EMU from the beginning 1.1 1999, together with the majority of the EU member states. Also those parties in the coalition government, which had been most critical towards EMU could thereafter accept joining the euro. Finland's final decision, concerning participation in EMU, was made in spring 1998 by the Finish Parliament.
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