The Finnish miracle

From teetering on the brink of disaster to a knowledge-intensive economy, Finland has much to teach the rest of Europe.

by Soumitra Dutta and Poul Funder Larsen
Last Updated: 23 Jul 2013

The Finns have a word sisu, meaning the will to succeed under difficult circumstances, which aptly describes the drive behind this Nordic nation of just 5 million citizens. It's a unique blend of stamina and determination that, over the past 15 years, has enabled Finland to reinvent an economy that in the early 1990s teetered on the brink of disaster. The stellar rise of mobile phone giant Nokia from a plodding conglomerate to a global technology powerhouse is the most striking embodiment of the changes that have helped the country build a world-class knowledge economy.

How did a country, formerly best known for its minimalist architecture, timber mills and pristine lakes, turn itself into a model for knowledge-based growth and technological development? The answer is by focusing on innovation, education, and information and communication technologies (ICT), a focus that has helped it to move into top position in many global rankings. In the process, it has moved away from its concentration on raw materials, and capital and energy-intensive production to a knowledge-intensive economy.

Many reasons for these changes are specific to Finland, but the intricacies of the process and the challenges ahead have relevance well beyond its borders. The successful development of Finland's knowledge economy suggests that it should be able to teach the broader EU a lesson or two. Although Europe has made much progress over the past couple of decades in both overall economic development and sustainable geopolitical stability, it has not yet achieved the goals it set itself.

The Lisbon Agenda, signed in March 2000, set out to achieve pretty much what Finland has managed over the preceding decade - namely to make it "the most competitive and dynamic knowledge-based economy in the world, capable of sustainable economic growth with more and better jobs and greater social cohesion". All this by the year 2010. But so far, it has been a bumpy ride. Europe lags behind the US in many key measures, such as average growth rates of real GDP, labour productivity and total factor productivity.

Europe invests just under 2% in R&D compared with 2.6% in the US and 3.2% in Japan.

Something is missing in the equation, it seems - and who better than a prominent Finn to diagnose the problem? A committee chaired by former Finnish prime minister Esko Aho concluded in a recent report on creating a competitive Europe: "There is a large gap between the rhetoric of a political system that preaches the knowledge society and the reality of budgetary and other priorities that have shown little shift in preparing to engage with it."

This is not the first critical analysis of the EU's relatively slow and uneven progress towards the creation of a dynamic and competitive knowledge-based economy. In a November 2004 report, a committee chaired by former Dutch prime minister Wim Kok painted a gloomy picture of the state of the EU economy and lamented the Lisbon Agenda's lack of focus.

"Lisbon is about everything and thus about nothing. Everybody is responsible and thus no-one. The end result of the strategy has sometimes been lost.

An ambitious and broad reform agenda needs a clear narrative in order to be able to communicate effectively the need for it," the committee concluded.

It will take political leadership of a different calibre to speed up the movement towards creating a knowledge economy within a pan-European framework. As Aho said earlier this year: "You need to create reforms that are not the lowest common denominator - like we did in the late 1980s and and early 1990s, when the single market was implemented."

Looking at Finland's prosperity today, it's hard to imagine that 15 years ago it was in the throes of an economic downturn almost unparallelled in post-war Europe. Growth for 2006 is forecast at more than 3%, nearly twice the expected level in the eurozone and a continuation of the pattern seen in recent years. "The 3% annual growth that the Finnish economy has experienced over the past few years is a fine achievement when compared with the modest figures for the euro area as a whole," says Erkki Liikanen, governor of the Bank of Finland.

Analysts are optimistic about the prospects for the Finnish economy, with credit rating agency Standard & Poor's awarding it a triple-A long-term rating. "The government's consistently prudent macroeconomic policy ensures a strong fiscal position and sustained economic growth, despite a worsening demographic trend," says S&P analyst Eileen Zhang.

However, an unprecedented slump in the early 1990s dealt Finland several economic bodyblows that cut GDP by more than 10%. According to Petri Rouvinen and Pekka Yla-Anttila, economists at ETLA, the Research Institute of the Finnish Economy, the country was hit by "a downturn in the forestry-related industries that were vital to the national economy; disruption to the country's sizable eastward trade due to the collapse of the Soviet Union; a speculative bubble in the domestic securities and real estate markets, fuelled by uncontrolled credit expansion and favourable terms of trade, and mismanaged financial liberalisation".

The country embarked on a large-scale structural transformation that changed the face of its manufacturing sector. In the process, it not only built on foundations laid since the 1960s (notably in the form of a strong educational sector), but also broke new ground. "Faced with deep recession, the Finns simply could not afford inflexibility or bureaucracy," Rouvinen and Yla-Anttila explain. This strategy was highlighted by the approach to innovation.

Even in the throes of crisis, Finland boosted research spending, rather than making knee-jerk cuts. "During the crisis, it increased its expenditure on R&D to support business R&D and to stimulate the transformation of the economy from natural resource-based to knowledge-based," notes Carl Dahlman, an economist at Georgetown University, Washington DC. At 3.4% of GDP, investment in R&D is among the world's highest.

Finland became the first country in the world to introduce the concept of a national innovation system in policy formulation. Networking and cooperation became the norm for public-private partnerships and governance of the country in general. Councils were set up to develop the policy, giving precedence to the 'pull' from industry, rather than the 'push' from science that had historically dominated. This change is led at the very highest level. The national Science and Technology Policy Council, for example, is chaired by the prime minister and includes seven other ministers.

The growth in R&D has had a knock-on effect in several areas; for example, patent applications. "Finnish individuals, research teams and companies file around 2,000 patent applications annually, of which 70% result in patents," says Kari Sipila of the Foundation for Finnish Inventions. "Per capita, this places Finland in the number four spot worldwide, after Japan, the US and Germany."

Finland's emphasis on R&D has paid off handsomely, allowing the economy to piggyback on the digital revolution from the mid-1990s onwards. In 1990, electronics and electrical equipment lagged far behind historically dominant manufacturing sectors, such as chemicals, metal and engineering, and pulp and paper, but by the turn of the century it had emerged as the largest single industry.

The changing dynamics of Finnish policy gained further momentum when the country joined the EU in 1995. Compared with its more reluctant Nordic neighbours, Finland embraced the European project. Increased openness has also attracted capital, which historically has been scarce; the growing prominence of the stock market during the 1990s enabled Finland to overcome the legacy of a crippling banking crisis at the beginning of the decade.

The digital revolution, increased global capital flows and a new openness to technological change have all helped the Finnish economy, but the foundations of its stability had been established much earlier.

Additionally, Finland's commitment to building a world-class educational system has proved crucial. The OECD's Programme for International Student Assessment (PISA) has consistently ranked Finland at the top for 15-year-olds' skills in maths, science and reading. "It is perhaps the educational system that has played the most critical role," says Dahlman.

There are several parallels between the trajectory taken more broadly by Finnish society, and the way that mobile phone giant Nokia has developed into a world leader. Both faced serious trouble in the early 1990s and took largely similar routes, focusing on innovation as a means to overcome the crisis. Nokia shed its forestry-related activities and rapidly reduced its dependence on Soviet trade in much the same way as Finland reduced its dependence on the forestry sector (although this remains a key industry) and reoriented trade flows westwards.

Today Nokia is a towering presence in Finnish business, contributing some 20% of manufacturing exports and 40% of R&D spending of Finnish businesses.

It also makes up roughly one-third of the market capitalisation of the Helsinki exchange. But while Nokia is Finland's most visible technology company, it is not alone; the ICT sector contains about 5,000 firms and is one of the most open and competitive in the world. According to the OECD, ICT commands the highest shares of business employment and value added in Finland.

Ironically, Finland seems to have benefited from the absence of a single national telecoms equipment manufacturer before the 1990s. Unlike Sweden's Ericsson, or Germany's Siemens, there was no dominant provider and this enabled a multitude of smaller companies to develop and compete. Thus, the Finnish telecoms sector has historically been characterised by fierce competition among smaller, independent firms. These are still some 40 wireline and wireless operators in the country.

Equipment manufacturers received an important early boost in the 1970s, with the launch of the Nordic mobile standard, NMT, aimed at creating a pan-Nordic market for mobile telephony. By the early 1980s, the region was the world's leading mobile market, and Mobira - a joint venture between Nokia and electronics firm Salora - clinched the top spot in this emerging, but still relatively limited, market. The company was well established by the time the GSM digital standard for mobile communication was launched in 1991 (incidentally, with a call placed in Finland). The following year the first commercial GSM network was deployed, using Nokia equipment.

The communications equipment industry has played a crucial part in the spectacular growth in Finnish labour productivity: while overall manufacturing productivity rose by about 100% over the period 1985-2000, productivity in the equipment industry jumped more than 10-fold. Having scaled the heights of competitiveness, however, Finland has realised that it can be cold at the top. For much of the past century it played catch-up with more developed economies (while benefiting from first-mover advantage on the mobile phone front), but now it is leading the pack - and in the coming years a growing number of challengers will be snapping at its heels.

Past experience shows that advanced technology and a strong competitive position is no guarantee of future growth - witness the Japanese economy from the 1980s onwards. High general costs and expensive wages make Finland vulnerable to competition from low-cost destinations that are increasingly benefiting from the globalisation of technology and knowledge. Moreover, several of these - including Estonia (see box), Poland and Russia - are on Finland's doorstep.

The onus, therefore, is on further technological development - not an easy task given the R&D capabilities of the US and many Pacific Rim countries - and on identifying under-served niche markets. In several areas Finnish industry is now the most productive in the world, which creates challenges that cannot be overcome by old solutions. "We can't imitate others any more. We need to shift the global frontier of productivity in order to improve," says ETLA's Rouvinen.

This throws up other challenges: observers point, for example, to the relatively weak state of the Finnish incentive regime as a possible constraint to the rapid adoption of new technologies and modernisation of existing companies. Although Finland's welfare state - which is modelled along the lines of its Nordic neighbours - has been instrumental in securing consensus building and mitigating social unrest during the economic downturn, it has been less effective at stimulating entrepreneurial activity.

And even though the Finnish system has been highly successful at fostering technical innovation, its performance has arguably been less impressive when it comes to developing those innovations within a commercial framework.

Nokia's global success speaks for itself, but a slew of other Finnish innovations have not found a commercial outlet and have been subsequently overtaken. The country's scientists, for example, had an internet browser with a graphical interface ahead of Mosaic in the US, and engineers also invented a router in the early 1980s, but neither project came to fruition.

Despite this, the Finnish experience proves that change is possible and that it can be enacted swiftly if there is sufficient political will.

"The case of Finland shows that it is possible for a small, peripheral country to transform itself in a relatively short period from a natural resource-based economy into a knowledge economy," a recent World Bank report pointed out.

In future, the EU will discover whether this applies as much to larger, sprawling entities as to smaller, nimbler counterparts. As for Finland, it seems it will have to call on its reserves of sisu again if it is to maintain its leading position.

ROLES PLAYED BY FORESTRY, ICT AND NOKIA IN THE ECONOMY Forestry ICT Nokia (incl Nokia) Number of firms 5,576 5,063 1 Share of GDP (%) 3.9 9.9 3.7 Share of employment (%) 2.9 5.2 1.1 Share of manufacturing employment (%) 15.4 8.0 5.0 Share of manufacturing exports (%) 25.3 19.6 21.0 Share of business R&D (BERD) (%) 2.8 58.0 42.5 Share of market capitalisation (%) 12.4 51.5 34.2 Source: Statistics Finland, OECD/ANBERD.

THE RISE OF A BALTIC TIGER

Tallinn is just 18 minutes by helicopter across the Gulf of Finland from Helsinki, and every day scores of Finnish business people flock to the capital of Estonia. This small Baltic country has many cultural and linguistic affinities with Finland, and has successfully emulated elements of the Finnish model in technology deployment and innovation.

Estonia stands out in a recent detailed study, The Information Society in an Enlarged Europe, which looks at how the member states of the EU measure up against a vision created to stimulate the creation of a knowledge-based economy in Europe. Estonia has just 1.4 million people, yet outdoes larger and more established EU member countries such as France, Spain and Italy.

The country has become something of a Baltic tiger by leveraging the potential of the digital economy. In 2005, its economy grew by over 8%, and Estonia's central bank expects growth to stay at about 7% this year and next. When Estonia regained independence in 1991, the government embarked on a project to bring the nation into the digital age. "We understood that technologically we were in a very bad situation," Mart Laar (above), Estonia's prime minister from 1992-94 and 1999-2002, told World Business.

"This made it possible for us to act." Estonia centred its IT strategy on providing broad-based connectivity and leveraging its human resources to expand economic growth. Its telecoms network is one of the most modern in Europe, and its low connectivity costs are reflected in the high rate of computer literacy.

Internet access is free and nearly 65% of the population uses the internet, including all schools and more than 80% of all companies. Strategic investment in wiring the entire country has led to an explosion in ICT applications in banking, education, health, transport and public administration: online filing of tax returns is common and multi-function personal ID cards have been introduced. As the country's natural resources are limited, the government has put major efforts into developing its human capital and creating a knowledge-based society.

Estonia has also placed strong emphasis on reform, embarking on an ambitious programme of deregulation and privatisation that has made it a highly attractive destination for foreign investors and resulting in substantial inflows of foreign direct investment, Currently, Estonia is the highest recipient of per-capita investment among the new EU member states.

Could other countries follow Estonia's positive example? Certainly, says Laar: "You can do it, if the political leadership makes it a priority." The Information Society in an Enlarged Europe, eds: Soumitra Dutta, Arnoud De Meyer, Amit Jain and Gerard Richter (Springer, 2006).

- Soumitra Dutta is the Roland Berger chaired professor in business and technology systems at INSEAD.

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