Globalisation may soon accelerate again – time to get domestic policies right

Richard Baldwin, Vesa Vihriälä

Despite the setbacks globalisation has faced in recent years from reactionary politics, the advent of artificial intelligence and robotisation are set to ensure its continuation. Domestic policy must therefore be designed in such a way as to reap the rewards of globalisation while avoiding its pitfalls. This column uses the case of Finland to show how this can be done. Finland has grown faster than its peers over two waves of globalisation, despite enduring substantial setbacks. In both its successes and challenges, it is an important example of the need for deliberate policies to prepare for future disruptions.

Globalisation has been encountering headwinds in many developed countries for several years. The perception that globalisation does not benefit but rather harms ordinary people has contributed to major political upheavals, such as Brexit and the election of Donald Trump as US president (Rodrik 2017, Guiso et al. 2017).

These are understandable reactions, but misguided all the same. First, the technological forces that drive globalisation cannot be halted but may in fact soon make further leaps – triggered by artificial intelligence and ‘robotisation’ – that could pose a major challenge to existing economic structures. Second, as in the past, policy will determine how well new opportunities can be seized and the downsides handled.

Globalisation always means more opportunities for a nation’s most competitive firms and more competition for its least competitive ones, and new artificial intelligence technologies are likely to amplify this. Trying to reverse these changes is a fool’s errand. The right solution lies in implementing the right complementary domestic policies to help distribute the gains and pains of progress.

Finland is a good example of success despite challenges

Useful insights into the importance of economic openness, the challenges associated with it, and the role of policy can be gained by looking at individual countries that have participated in globalisation and which have not been saved from serious disruptions along the way. Finland is a very good example of such a country.

In the middle of the 19thcentury, Finland was a very poor peripheral part of Europe. Based on solid institutions such as rule of law and well-defined property rights, in the 1860s it started to make use of new technologies and trading opportunities brought about the first wave of globalisation. Finland first grew at the same rate as its western peers but accelerated significantly after WWII. By 1990, Finland’s GDP per capita reached a typical western European level. Throughout these years of ‘old globalisation’, Finland was a textbook example of how a country can benefit from trade based on its comparative advantages – in Finland’s case, primarily in the forest industry (Ali-Yrkkö et al. 2017).

A new phase of globalisation unfolded in the 1990s (Baldwin 2016). This was based on advances in information technology, which allowed the different phases of production to be coordinated from far away. Together with the opening up of China and the collapse of communism in Europe, this produced a new way of organising economic activity, into global value chains. Within these chains, low-productivity tasks were offshored to low-cost countries while the high-cost countries specialised in high-productivity activities in which skilled labour played a central role. Finland took advantage of the new opportunities, internationalised, and again grew faster than its peers, becoming a model country for the knowledge-based economy.

Finland did not benefit from the openness because of exceptional natural resources, an exceptionally favourable location, or by being spared from external shocks. On the contrary, the country has been struck by huge shocks since the advent of industrialisation. WWI resulted in the deepest recession ever registered in Finnish statistics, and the country paid a high human and economic cost to survive WWII. The post-war period of convergence was characterised by economic instability and ended in one of the worst economic crises of the OECD countries at that time. And even the period of rapid growth since the 1990s crisis ended in a stubborn recession.

The key role of policy

Good long-term growth performance despite all this adversity suggests that Finland must have done something right. From the beginning of industrialisation, expanding and improving education has been a key element of Finnish policy. The benefits of the investments in education have not only materialised in the form of a competent labour force, but have also contributed to low static income disparities and high intergenerational mobility.

The high priority given to investments in manufacturing after WWII boosted the capital stock quickly and was instrumental in the rapid GDP growth achieved during the post-war decades, even if the very high investment ratio also contributed to inefficiency at the margin. The social safety nets built since the 1960s allowed people to take risks and contributed to social cohesion and popular support for economic openness, despite the associated disruptions.

Policy reorientation in the 1990s helped Finland not only to recover from the deep crisis but also to become a great beneficiary of the new phase of globalisation. Innovation policies, a reduction in the distortions of the tax system and a further opening-up of the economy (by joining the EU) all supported economic transformation and efficiency.

Striking a balance between protection and renewal is the key

Over the last decade Finland has been hit by a series of shocks, including the decline of Nokia’s cell phone business, the decline in demand for paper, lower demand for investment goods, and reduced Russian purchasing power (Suni and Vihriälä 2016). That the economy started to recover only in 2016 reveals the vulnerability of a small specialised economy, even when many of the fundamentals are in a good shape.

The shocks that have struck Finland involve features which are highly likely to typify future technology shocks – suddenness and unpredictability, as well as the fact that they will also impact on the highly educated. No one knows for sure how much and in what precise ways artificial intelligence and robotisation will disrupt the developed economies and their labour markets in, say, ten years. However, it is more likely than not that the disruptions will easily be of the scale that Finland has twice encountered in the last quarter of a century.

Leaving the adjustment to market forces alone is not a sensible option. Deliberate policies are needed. The key issue is finding the right balance between protecting people on the one hand and, on the other, ensuring that various actors have the capacity and incentives to change. It seems to us that, particularly in the UK and the US, too little attention has been given to sharing risks while in some other countries, such as Finland, stronger incentives to adjust would be needed.

References

Ali-Yrkkö, J, M Lehmus, P Rouvinen, and V Vihriälä (2017), “Riding the Wave: Finland in the Changing Tides of Globalisation”, Taloustieto Oy.

Baldwin, R (2016), The Great Convergence: information technology and the new globalisation, Harvard University Press.

Guiso, L, H Herrera, M Morelli, T Sonno (2017), “The spread of populism in Western countries”, VoxEU.org, 14 October.

Rodrik, D (2017), “Economics of the populist backlash”, VoxEU.org, 3 July.

Suni, P and V Vihriälä (2016), “Finland and Its Northern Peers in the Great Recession”, ETLA Reports No 49.