Port of Helsinki
12.5.2022 12:23:34 //
Juha Peltonen
Eemeli Sarka

War ends rapid growth

The war in Ukraine is accelerating both good and bad trends in the global economy, such as inflation, the green transition, and the relocation of production from Asia. The greatest impacts on the Finnish economy will be knock-on effects from our most important market area, Europe.

If Russia had not invaded Ukraine, all forecasting institutions would probably have raised their estimates of economic growth in 2022. That’s how good the situation was at the start of the year. According to Director General Mikko Spolander, at least Finland’s Ministry of Finance would have done so. The price of the war for the Finnish economy cannot, therefore, be measured solely in unrealised economic growth of 1.5 percentage points.

“Without the war, growth would have been even greater than we previously predicted,” he says.

At the outbreak of the war, the Ministry of Finance was predicting economic growth of three per cent for Finland in 2022. On 13 April, the Ministry published its review of the
economic impacts of Russia’s war on Finland’s national economy. In the baseline scenario, Finland’s economic growth will be 1.5 per cent this year.

“This is the scenario we’ll use as a basis for public finances. It assumes that sanctions will remain in place and largely unchanged,” says Spolander, who heads up the Economics Department at the Ministry of Finance.

Sanctions will not mean that imports of energy and raw materials from Russia to western markets will stop altogether – they will continue to some extent at least.

“Imports may be disrupted, and some product groups may fall by the wayside, but a complete ban on imports is not part of the baseline scenario,” says Spolander.

Yet a more unfavourable scenario has also been drawn up. In this scenario, all energy imports to Europe from Russia will cease very quickly. This would cut an additional percentage point from Finland’s economic growth both this year and next.

A legacy of strong growth from last year

The Ministry predicts that Russia’s invasion of Ukraine will affect the Finnish economy via three channels. The first is through the price and availability of energy and raw materials, which will lead to rising inflation and weaker purchasing power for Finns. The second is the end of all other trade with Russia. The third is a hit to consumer and entrepreneurial confidence. The impact of all three is included in the scenarios. Spolander says that the full year growth forecast for 2022 can be thought of as a legacy of growth from last year.

“We’ve made a very swift recovery from the pandemic slump. All forecasters were no doubt especially surprised by last year’s trends in employment.”

The employment rate among older people in particular has risen sharply in Finland. In business surveys, labour shortages were also a significant factor during 2021 and early 2022.

“We started the year in a really good position, which I believe will be reflected at our ports as well. Economic activity was at full steam, foreign trade was booming, order books were full, households and companies had confidence in the future, and employment was soaring. An influx of people from outside the workforce also boosted the labour market,” says Spolander.

Last year’s vitality has carried forward to this year in both Finland and the rest of Europe.

“At the end of last year, we were already in such a good position that, even if the economy does not grow any further this year, our average output will be 1.5 per cent higher than in 2021.”

Although Finland’s output is forecast to remain at the same level throughout 2022, the graph will not necessarily have a smooth gradient. The sanctions imposed on Russia as a consequence of the war are driving the country into a deep recession. Finland’s chances of exporting goods to Russia are also fading, as companies are voluntarily ceasing to trade with Russia.

“There will be at least some kind of dip in the Finnish economy during the second quarter. But as we’re still only partway through the second quarter, its magnitude can only be guessed at,” says Spolander.

Finland’s economy on par with Europe

The Ministry has broken down its 1.5 per cent economic growth forecast for this year into three components. The first is a legacy of growth from last year. The second is a Q2 downswing caused by the collapse of the Russian market, the withdrawal of companies from Russia, and the general shock to confidence. Things will then start to recover.

“If the situation stays like this – that is, the war is confined to Ukraine and the sanctions are not quickly extended to energy – it will be possible for the economy to recover during the second half of the year.”

That is to say, growth will return tothe baseline after a dip.

“Although, on the face of it, no economic growth is forecast for this year, there was growth in the first quarter – and this is being followed by a dip in the second, and renewed recovery in the third and fourth quarters. 2023 will also be a year of recovery,” says Spolander.

He thinks that the greatest impacts of the Ukraine crisis on Finland will not stem directly from an end to Russian exports, but will instead be knock-on effects from Europe.

“Russians will not be able to buy products from Europe, as their purchasing power will collapse, because their wages won’t increase, even though the rouble is weakening and inflation is rising,” says Spolander.

When Russian demand wanes in Europe, which is Finland’s main export market, European demand will likewise decline in Finland.

“Europe is, after all, an essential market for Finland. What happens there will determine how the Finnish economy will even theoretically be able to recover,” says Spolander.

This impact would be heightened in the Ministry’s most unfavourable scenario in particular, in which sanctions would also extend to energy.

“Our view is that ending energy imports would hit the European economy very hard, and would also have an unfavourable impact on Finland.”

Completely different crises

Spolander says that the two crises that have ravaged the economy in quick succession are completely different.

“The pandemic was a shock that led us to close down services. Elsewhere factories were also closed. In itself, the pandemic did not affect foreign trade other than as a disruption to production chains. Demand in our export markets did, of course, contract, but goods were still able to move as long as components were available.”

The effects of the Russian invasion will not, however, affect services other than as an end to Russian tourism.

“This will specifically hit the goods trade with Russia. It will also be reflected at some ports, depending on how much of this trade has been passing through each port.”

Spolander says that the differing natures of the two crises are reflected in forecasts for both Finland and Europe: service sectors will continue to recover from the pandemic slump, while industrial manufacturing will take a back seat.

“You can visualise this as a recovery in passenger traffic at ports.”

Different paths for Europe and the US

Before Russia’s invasion of Ukraine,Europe and the US were experiencing the same kind of rapid economic growth. The war has now sent them down different paths.

“The US economy is currently experiencing both massive demand and an employment boom, which has resulted in galloping inflation. That is, vibrant growth is being reflected as increased inflationary pressure,” says Spolander.

The Ukraine war is not really affecting the US economy. As the US has its own shale oil, Americans don’t need to import much fossil fuel. However, due to the demand-driven inflation problem, the US Central Bank has had to cool down the overheating economy and rising inflation with an interest rate policy that has been considerably
steeper than in Europe. Inflation in the Old World is stemming from rising energy prices and a stagnation in supply. And this is eroding consumer purchasing power.

“This is difficult to remedy with interest rate policy, because interest rates will not affect the root cause, that is, energy prices,” says Spolander.

In his opinion, the European Central Bank (ECB) is in a difficult position. The fear is that supply inflation will lead to a cost spiral, which itself will begin to drive up inflation even further. And this is exactly the kind of situation in which the ECB needs to intervene.

“Except it hasn’t happened yet. Inflation in Europe has to date remained on the supply side, in energy prices and to some extent also in food prices. Food production costs have increased on the back of a rise in fertiliser prices.”

If the ECB were to tighten financing conditions by raising interest rates, it would not impact energy prices – but it would break the cost spiral. Although this would also further weaken economic growth. The European Central Bank is therefore aiming to treat energy prices as a temporary spike in inflation that does not warrant demanding higher wages or increasing consumer prices.

War changes the grounds for inflation

Inflation was already rising in Europe before the war.

“The war changed the grounds for inflation, and gave it a little boost.”

The changes in the global economy arising from the new crisis are structural, and will not vanish in the same way that we have seen the impacts of the pandemic dissolve. Even in the most favourable scenario, the Russian market will not recover. Even if the war ends in some kind of peace treaty, Spolander finds it hard to imagine that sanctions would be completely lifted or that companies would return to Russia.

“The most favourable outlook is more about eliminating fear of the more unfavourable alternatives, so that people could breathe a sigh of relief that there was no World War Three. In practice, this structural change means that when export markets are being sought, they will be markets other than Russia.”

Mikko Spolander valtionvarainministeriö
Mikko Spolander reminds us that the pandemic and Russian invasion are only temporary hits to the global economy compared to climate change, ageing populations and technological transformations.

A solid level of competitiveness will be required to replace this lost market with other markets while simultaneously implementing a technological transition away from fossil fuel dependence in production structures.

According to Spolander, this means that social structures will need to promote research and product development, infrastructure must function (that is, sufficient energy must be available), and ports and routes must be attractive and cost-competitive.

“The lost market must be replaced by winning market shares in other highly competitive markets – and others will also be looking for those markets. Economic policy in particular must focus on providing the conditions that will enable Finnish businesses to seize new opportunities.”

Will the new situation accelerate the relocation of production from Asia?

“Distances will inevitably increase, as it’s no longer possible to fly over Russia and there would be major risks involved in transporting goods through Russia by rail. This means yet another cost factor to take into consideration with Asian production,” says Spolander.

He says that the difference in costs between various production alternatives is now making Asia a less favourable option.

“This change works against production located in Asia.”

Green transition gains momentum

Although the economy has been hit by two major shocks – the coronavirus and the war – Spolander reminds us that they are only temporary hits.

“In the longer term, the major forces driving change will be climate change and phasing out fossil fuels, changes in demographic structure throughout the world, and a technological transformation. These three megatrends will largely shape economic structure.”

Acute crises accelerate the impact of megatrends. The war started by Russia will cause a huge leap forward in clean energy and the green transition.

“All sectors that generate solutions for clean energy production will get an additional boost from this. And public funding will also be allocated to it.”