Corporate Research 23 February 2017 Contents Finland: How to rise from the abyss? 1 How Finland plunged into the abyss 2 Finding a way out of the abyss 9 Interview: Finland in a view from the top 13 Interview: Finland (and Russia) through the eyes of the big retailer 17 Interview: Finland, how did it get so bad? 20 Disclaimer and legal disclosures 25 Nordea Markets Corporate Research Equity Research 23 February 2017 Finland: How to rise from the abyss? Fallen angel Before the global financial crisis in 2008, Finland's economy matched or beat its Nordic neighbours', but then it all went horribly wrong. The end of the commodities supercycle put pressure on important Finnish industries such as Metals, Mining, Capital Goods and Paper. Digitalisation is sounding the death knell for the Finnish paper industry and the ascent of Apple with its iPhone and iPad struck a mortal blow to former global no. 1 mobile phone maker Nokia, which alone represented perhaps 4% of Finnish GDP 15 years ago. Finland's GDP declined for three consecutive years and is today lower than in 2007, in stark contrast to Swedish growth of 20% over the same period. Finland has the highest unemployment and the highest unit labour costs of the Nordic countries, plus the highest share of government spending to GDP (58%) in the entire OECD. When the going gets tough, the tough get going The going has been tough for years in Finland, and it is arguably high time to acknowledge and forcefully address this. A reluctance to see challenges as structural rather than cyclical has meant that until the past few years – when Finland suffered yet another blow from the collapse of key trading partner Russia's economy – no ambitious structural reforms for restoration of public finances and competitiveness were launched. We see no quick fix for Finland's economy. Monetary policy (and consequently to a great extent also the exchange rate) is set by the ECB, and is in any case already incredibly loose. We argue that Finland needs to consider a more flexible labour market, to institute measures to boost innovation, entrepreneurship and R&D, and to address the challenge of its ageing population by reviewing its pension system and work immigration policies. A view from the top: Interviews with the CEOs of Nordea and Stockmann Nordea's CEO Casper von Koskull and retailer Stockmann's CEO Lauri Veijalainen share their views on Finland's economic woes and the possible ways forward, as does Pasi Sorjonen, Chief Economist at Nordea Markets Finland. Finland lagging: Nordic and Eurozone GDP indexed to 2005 = 100 130 125 120 Finland Sweden 115 Norway 110 Denmark Euro Zone 105 100 2005 2007 2009 2011 2013 2015 Source: Thomson Reuters and Nordea Markets Markets IMPORTANT INFORMATION AND DISCLOSURES AT THE END OF THIS REPORT Corporate Research 23 February 2017 How Finland plunged into the abyss Like its Nordic neighbours, Finland's economy was hit hard by the global financial crisis in 2008. Although it recovered strongly in the next few years, it has since lagged dramatically, with Finnish GDP growth even turning negative in 2012-14. The reasons for this include its great dependence on industries (and companies such as Nokia) in structural and cyclical decline, the collapse in demand in top-three trading partner Russia, high labour costs in a comparatively rigid labour market and weakened public finances burdened by a rapidly ageing population. Post-crisis recovery smothered by home-grown challenges Since the global financial crisis of What is wrong with Finland? It may seem like a silly question, but it 2008-09, Finland's economy has captures the essence of this month's Nordea On Your Mind. All four sharply underperformed those of its Nordic countries suffered badly during the global financial crisis of late Nordic neighbours 2008 and 2009, but their economies recovered sharply from 2010, with their GDP now above pre-crisis levels. Except for Finland. Coming from the strongest GDP growth among the Nordic countries in 2007, Finland saw the sharpest decline during the crisis, and has since underperformed its neighbours and the Eurozone. Following a rebound immediately after the financial crisis, Finnish GDP growth turned negative in 2012-14, levelling out in 2015, and Finnish GDP remains some 5% below its 2007 peak. Finnish unemployment and labour costs are higher than in the other Nordic countries, its state finances are weaker and its population is older. In this report, we explore how this could happen, and what Finland could do about it. GDP growth in the Nordic countries in 2005-15 8% 6% 4% 2% 0% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 ‐2% ‐4% ‐6% ‐8% ‐10% Denmark Finland Sweden Norway Source: IMF Nordea Markets 2 Corporate Research 23 February 2017 GDP for Nordic countries and the Eurozone in 2005-16, indexed to 2005=100 130 125 120 115 110 105 100 2005 2007 2009 2011 2013 2015 Finland Sweden Norway Denmark Euro Zone Source: Thomson Reuters Finland lost its last external top Finland is a wealthy, industrialised country with high living standards and credit rating in June 2016, when a highly educated population. Despite this high starting level, it has seen Moody's downgraded from Aaa to dismal economic momentum for several years, sharply lagging its Nordic Aa1 and European peers. This poor performance is also starting to show in Finland's creditworthiness. S&P downgraded it back in 2014, with Fitch and Moody's following suit in March 2016 and June 2016, respectively, meaning all three major rating institutes have cut Finland from its prior absolute top rating. How could Finland end up in such dire straits? There is no single explanation for the stagnation, but we highlight and later review what we consider to be the key drivers: Heavy reliance on struggling industries such as Paper, Shipbuilding and Steel The demise of formerly world-leading Finnish telecom equipment maker Nokia Collapse in demand from Finland's former largest trading partner, Russia High labour costs and a comparatively rigid labour market Ageing population putting pressure on public finances. "Steve Jobs took our jobs" The iPhone killed Nokia, and This quote is from Finland's Prime Minister in 2014, Alexander Stubb. He digitalisation is destroying the paper was referring to digitalisation in general, and specifically to former industry – both important for Finnish global telecom equipment icon Nokia, implying that Apple (co- Finland founded and for many years led by Steve Jobs) championed products that sounded the death knell for both Nokia (whose smartphones were quickly marginalised after the launch of the first iPhone in 2007), and for Finland's very sizeable Paper and Forestry industry (where both newsprint and fine paper are rapidly being substituted by digital media, not least on Apple's iPads and computers). As in most developed economies, services account for the bulk of Finland's GDP, at roughly 70%. The remainder is manufacturing, where the biggest industries in Finland are: Metals, Mining and Machinery ~30% Paper & Forestry ~10% Electronics (including telecom equipment) ~6%. Nordea Markets 3 Corporate Research 23 February 2017 Machinery and materials industries As highlighted by Mr Stubb's remark, paper and electronics have declined also struggling, owing to the shift significantly in importance in the past ten years. Materials and machinery from investment-led to consumption- have also faced headwinds. As drivers for global GDP growth have shifted led global GDP growth from investment- to consumption-led, many Capital Goods niches are battling with subdued demand, and some are also seeing overcapacity issues. Examples of significant Finnish industrial sectors that are struggling include Shipbuilding and Steel. Moreover, there is a loss of Finnish competitiveness from an unfavourable labour cost trend, which we also review. Finnish GDP growth in 2007-16 was We could see in the chart from the IMF above that Finnish GDP in 2016 zero versus Sweden's 20% had been virtually flat since 2007, in sharp contrast to Swedish GDP, which had grown nearly 20% in the same period. An OECD report (OECD Economic Survey, FINLAND, Jan 2016) estimates the impact on Finnish GDP from what we could call the "Jobs effect": Reduced value added from the electronics sector since 2007: -3% Reduced output in wood and paper production since 2007: -0.75% Without the declines in wood and In other words, had the electronic and paper industries not faced their paper and in electronics, Finnish respective structural challenges, Finnish ten-year GDP growth would have growth would have been nearly 4% been nearly 4% instead of zero. Nokia – The rise and fall of a titan Nokia evolved from a conglomerate Like any good drama, the story of Nokia contains both triumph and in the 1980s to the global no. 1 despair. Founded in 1865 as a paper mill, and named after the Nokianvirta mobile phone maker by 1998 river, by the early 1980s Nokia had grown into a widespread Finnish conglomerate whose businesses included aluminium, cable, chemicals, paper, rubber, power generation, hunting rifles and TVs. A venture into mobile telephones in 1982 really took off after the launch of digital GSM phones in the early 1990s, making Nokia the global no. 1 mobile handset maker by 1998. Thanks to this, Nokia focused on its telecom business (handsets and network equipment), and shed the rest. In 2000, Nokia represented 70% of Nokia's profit almost quintupled from USD 9.5bn to USD 45bn between the market value of the Finnish stock 1996 and 2001. By 2000, the company accounted for 70% of the total market, and 20% of Finland's market cap on the Finnish stock market, plus 20% of Finland's exports and exports 14% of the country's corporate tax revenue.