Exploratory behavior

Part of current day problems that I believe I observe both in my professional life in the industry, as well as from the sidelines of looking at the political and social discourse happening in Finland, may stem from a similar source. My pet peeve for a long time has been the overt theoretization of problems, in practice characterized by the old wisdom that boxing is not a purely theoretical exercise. In boxing, one also needs to be prepared to put theory in practice and apply pragmatism and evolve one's thinking as the empirical evidence starts pouring in.

What this means in the context of companies is that especially in turbulent situations where power has become institutionalized into structure and process, a lot of energy and time seems to often be wasted on contemplating things, planning, and strategizing. All of these are good, but at the end of the day one must be prepared to take a step forward, test out the thinking, and adapt as required. However, in very turbulent environments the cycles may get so short that in practice no practical steps are ever taken and the cycles consist of only theoretically pondering over and over again. It sounds like a caricature, but seems to be rather prevalent.

I fear that a similar dynamic may have also found its way to the political landscape of present day Finland, perhaps elsewhere as well. The previous government was a case study of a very broad-based and heterogenous bunch, incapable of getting very many initiatives from the drawing table into execution. This has been clearly called out by very many observers, and the newly elected government has taken clear steps to rectify the rampant indecisiveness of the previous one. Interestingly enough, however, the discussion has again immediately found its way into a mode where all views are heavily polarized and argued from ideological positions without a hint of real, tangible empirical evidence. And more worryingly it seems like not too many are even interested in honest testing of ideas and would much rather sling mud and have rhetorical arguments rather than attempt to solve problems.

In my very limited experience of how the world seems to work, I have tended to take the stance that is roughly in line with empiricism, where possible. This may stem from the mindset of a mere engineer, but I find that at the end of the day I value getting things done more than being right or wrong. Unfortunately it often seems people would rather not do anything than risk being wrong, or even worse, look silly. Hence, I suppose, it is a lot safer to sling rhetorical arguments back and forth without worrying about stepping into the empirical world to test out and adapt accordingly.

The current mess

What are the issues with the current day Finland? Attempting to boil it down to the essentials, a layman could note the following:

• Our economy is not really doing too hot and a big part of this is coming from the difficulties in our export industries. Probably the major contributing factors to this are, in no specific order:
1. The downfall of telecommunications and the pulp/paper industry
2. The EU/Russia situation and the impact on Finnish companies doing business in/with Russia
3. Lack of competitiveness of the Finnish companies compared to competitors
4. ... and probably a long tail of other things...
• Finland is a relatively small country, so managing with only the internal markets isn't probably feasible. This further emphasizes the importance of solving problems in the export sector.
• The aggregate of most of these issues can be in a stagnating, or even decreasing GDP.

So, this in essence means that for some reason or another, our businesses aren't doing too hot. Sure, the profits have been surprisingly decent in many parts of the world over the duration of the financial crisis, but these are probably hardly relevant indicators as they probably just demonstrate that companies are aggressively reducing costs to try to stay afloat, and actually doing a very good job of that, from the perspective of the companies. What this leads to, however, is probably the following:

• A significant cost of companies stems very likely from the cost of labor. Hence, in reducing costs, companies will often shed a lot of employees. This leads to increased unemployment.
• Increased unemployment has probably a couple of major immediate impacts on the economy: immediate loss in taxable income (shrinks the money available to the government to take care of entitlements, etc.), relatively immediate change in stance towards consumption (the unemployed individuals probably will stop consuming, which impacts companies in lower sales and the government in lower value add tax), and immediate increased costs in the form of unemployment benefits and costs associated in handling the related bureaucracy, as well as the activities aimed towards attempting to get the individual employed again. Over a longer period of time it probably increases e.g. healthcare costs, and so on.

So from the view of the government, it's very likely that entitlements go up while income goes down. This is what is commonly probably called a non-sustainable situation, especially if it extends for longer periods of time, since now the situation is that overall GDP stagnates, absolute amount of tax euros goes down (consumption and income taxation), entitlements go up, etc. And there is probably an added issue of a perception of increased inequality, which leads to unhappiness in the population (i.e. "the amount of people suffering is increasing, some people are doing well off, why isn't the system changing to support the people who suffer, shouldn't we increase taxes on the ones who still do well, etc.").

What should, then, be done about this?

• If it is expected that the less than ideal situation of the economy is a temporary blip and unrelated to structural issues, then probably the situation will eventually sort itself out, fingers crossed, and for the time being the government can bridge the gap by just bearing the brunt of the expenses via debt, and then managing the debt when the situation improves.
• However, if the economy suffers for 1) an extended period of time due to reasons beyond your control and/or 2) you have structural issues impacting, then probably at some point bridging the gap via debt will explode your debt (and if GDP stagnates or decreases, you start breaching politically agreed limits in e.g. the EU), your interest rates go up ("hey, these guys may not make it, I want more return if I give them money"), and as a corollary your absolute interest amount significantly goes up, and this will just cause the whole system to implode.
• Traditionally this could be fought against by devaluing your currency, which causes two beneficial things: your companies should receive a boost from a weak currency (it becomes cheaper for other countries to buy from you) and debt denominated in your currency will essentially be wiped.
• If you can't devalue your currency, then you might always just default on your debt. This probably means that your interest rates significantly increase, so most likely in the short term your access to money from the markets will be relatively heavily impacted, i.e. better get ready to bear the hangover from the withdrawal effects from being cut off of debt. This may also cause a fair bit of bad feelings in the international landscape.
• You could always invite the Chicago boys, but then you probably will defer all decisions to them and for better or for worse no longer need to too much worry about doing any thinking yourself. Just implement whatever is prescribed to you, and probably your citizens won't really like too much.

So if we assume that the problem is of the latter kind, i.e. won't go away by closing your eyes. What then?

1. Fix the economy. In this case export industries need to start pulling again.
2. Manage government spending

Looking at the economy, there are a couple of things:

• Devaluing the currency would be nice. Unfortunately thanks to being bound to the Euro, that can't be done. So scratch that.
• "Innovate" your way out of the mess. Invent new technologies, products, push the boundaries, and conquer the world with your brilliance. Probably more difficult than it sounds. In practice it probably means encouraging a lot more failure to happen, since the search of a new "innovation" goes heavily hand-in-hand with failing. So encourage the formation of new companies (reduce bureaucracy, simplify rules, taxation, hiring/firing, and make sure that in failure the entrepreneur is not ostracized too badly).
• Improve efficiency in operations so your costs in companies go down. Won't probably yield immediate results (you need to invest to improve efficiency, and you risk being bankrupt by the time your investments yield results in the company). Additionally increasing efficiency may often put people out of work ("I'll replace you with a very small bit of software").
• You could try to make sure that the costs don't go up, i.e. keep wage increases to the minimum, which would theoretically improve the competitiveness of your company when compared to companies in countries where the wage costs do increase. Cut salaries or freeze increases. Note: increasing taxes is not a valid solution here, since you want to treat the competitiveness of the companies, and while increased taxes give the government more income, it doesn't help the companies and their costs.
• You could try to decrease the inertia impacting your companies. Big words, but in practice it would mean making sure that companies have more freedom to move. Reduce or optimize mandatory bureaucracy so the companies can spend less time filling forms and more time doing value adding work. Make it easier for companies to hire and fire employees (this allows companies to take more risk when they know that if things go bad, they can always adjust, and as a corollary it should mean that more people might get employment).
• ... and so on...

The second problem is the one that obviously upsets people even more:

• By simplifying heavily, the public sector expenses could probably be grouped into: 1) entitlements (giving out benefits, etc.), 2) providing services (maybe could be rolled into entitlements?), and 3) the overhead required the coordinate and manage the previous two.
• Starting from the last, it's not a big surprise that public sector officials are probably not the most efficient bunch. There are examples where the Finnish government has been able to improve efficiency (surprisingly the tax officials have managed to streamline and automate their processes). The immediate negative thing is that this will probably make some public sector employees redundant, but over a longer term it's probably more worthwhile to try to encourage movement towards private sector jobs anyway. This area bleeds into the first two categories, so probably worth to tackle them still separately.
• The levers to pull when managing service costs include: breadth of service recipients, service quality, and efficiency at which services can be provided. Short of going towards a total overhaul, probably beneficiaries will observe a change in the service being provided and this will not be fun.
• Dipping into entitlements is not fun either, but similar dynamics are present there: adjust the entitlement amounts, narrow the group of beneficiaries, reduce the overhead (e.g. simplify the structure of the entitlements), or then just axe entitlements.

Overall I think the current government is doing a reasonable job of attempting to address the above situation. This has of course, rather predictably, caused an uproar in the opposition. Of course navigating the mess described above is not a simple thing, so the risks are quite high and chance of failure is equally high. I'm personally, however, withholding judgement for now and waiting to see what will in fact happen. But in the meanwhile I think it would be interesting to think a bit about some of the comments and objections being flung around:

•  "The poor are being impacted more than the well off in cutting the public sector": Of course; by definition the poor are on the receiving end of entitlements and services from the government more often than the well off. There's not as much to cut from the well off, and even if you cut generally across the board, probably the poor will be more impacted, on average. I'm not saying whether this is right or wrong, this just seems to be the dynamic of how governments work.
• "Because the poor are impacted, the rich should be impacted as well, e.g. by increasing their taxes if we can't cut from them": The social justice argument probably is more related to just venting understandable frustration. Increasing the income taxes does increase, temporarily, the income that the government gets. However, increasing taxes adversely affects the competitiveness of companies. Pay cuts and freezes are better at decreasing the costs of companies, so pay cuts of more well off would be better than increasing their taxation, from a company competitiveness standpoint. Also, progressive taxation means that the more earning individuals are already bearing more of the costs.
• "Well, then lets force the companies to cut the compensation of the better off people": A worthy objective, but probably the only way of doing this is via voluntary cuts. What would the alternative be? Companies are privately held by their owners and short of the owners cutting executive compensation, there's probably very little that the government can do but plead this case. The discussion about private ownership and similar is a different discussion, and overhauling that system is of course possible, but probably causes so much hassle that in the short term it's not feasible. Interestingly enough the pay cuts of the well off will probably adversely impact taxes, since for every Euro cut, the government would lose around 50 cents.
• "The inequality will increase as a result of these measures": It very likely will, at least in the short term, and I imagine there's really no way around this, either. But, looking at the inequality figures is also something that is a bit misleading for me: if the assumption of a smaller Gini coefficient is considered to be more preferred than a high one, then by definition a small coefficient can be obtained by just destroying the system. However, the system would probably not work very well after that.
• "The capital gains taxation needs to be increased and/or made even more progressive": Part of the problem with Finland is that Finns tend to put their wealth to bricks and mortar in the form of houses. Ownership of companies is rather small in Finland, and from the perspective of a layman, if the middle-classes don't start accumulating wealth and owning companies, then we risk foreign investors taking over our companies, in which case the profits will bleed outside of Finland. Increasing taxes on capital gains will probably decrease the incentive of individuals to invest in these types of assets. Also, increasing capital gains does not address the situation that a bulk of invested capital resides in funds and other instruments which are exempt from capital gains taxation until they pay funds out, so effectively increasing capital gains taxation will probably have a lower impact than expected (it will hit low net worth individuals who cannot incorporate their investments into funds). Finally, increasing taxation will probably drive capital abroad, and even for individuals the breakeven point will become lower for offshoring their investments (e.g. into companies which allow incorporation of investment portfolios more easily, or which may have lower corporate taxation). Capital is more fluid than buildings or people, so flight of capital is probably a realistic risk.
• "Education is being cut, which will impact the country in the future and is very shortsighted": Probably very true, but again I'm withholding my judgement until I see what exactly is being proposed. Knowing quite many researchers and having heard of the amount of rigidity and bureaucracy associated with the university landscape, I'm very biased to believe that things could be done more efficiently. As for potentially cutting student allowances, my understanding is that in practice this would just drive the students to either work more (which in case of e.g. engineers is often considered a good thing, since it gets a foot in between the door of the industry and turbocharging learning by allowing students to apply learnings to practice even during studies) or fund their studies with increased debt (for non-Finns, Finland has free education and with the student allowances and later tax breaks on student loans, it's very much possible to achieve Masters' level education with little to none costs; and for Finns, further education should be considered as an investment into the future, so comparing students and government-backed loans plus allowances to unemployed individuals doesn't really work). Furthermore, and this is a shortcoming on my part for not knowing the literature, I have an intuitive feeling that there are probably diminishing rates of return to education, i.e. it's important to have everyone go through primary schools, but the further we go, the less benefit we gain from educating everyone. In my mind it's completely fine to try to shift the default university degrees to Bachelor degrees, rather than automatically having everyone study Masters degrees. Those who wish to pursue higher degrees can naturally do that, but if we have to save somewhere, shifting costs from higher education to guarantee the breadth and quality of primary education is, based on my intuition, more prudent. Yes, I am of course slightly worried about what will come of this, but I think it's only intellectually honest to not have taboos.
• "Economics tells us that instead of austerity we should be using government debt to jumpstart our economy": Sure, Keynesian theory would probably imply this. My question is that where should these investments be directed to? Historically governments have had a notoriously bad track record of picking winners in e.g. technologies. If there's cheap debt available, of course it might be prudent to fix infrastructure. However, if the issue is with competitiveness in export markets, pumping companies up with more debt may not solve the underlying issues creating the competitiveness. If the alternatives are between the government actively driving an agenda and speculating using debt to finance companies or using similar amount of money to reduce boundaries to entrepreneurship, I think the latter is probably more sustainable. But ultimately I think it's a bit premature to say that economics ultimately says one thing or another, since everything is dependent on the actual problems and whether they have been appropriately diagnosed and understood. Curing the slightly wrongly diagnosed illness may not be too good either.

There are probably many other viewpoints to all of this, but I just wanted to try to clarify my thinking. And as such, I am not entirely ready yet to proclaim the Armageddon just yet. Sure, the upcoming years will be painful in Finland, but after the last government's inability to get anything done due to internal bickering, the thing I fear more than our current direction is having another round of no direction or momentum at all. Instead of saying that nothing can work, we should probably be trying different things and being pragmatic: if after trying something doesn't appear to be working, let's then eject it and replace it with something else. Sitting and theorizing doesn't create movement and without movement the situation won't improve.

Finally it should be said that I'm not an economist, so this is just layman's logic. At the same time I outscoped the "softer" aspects from the analysis. Sure, the picture can be changed by applying different schemes of values, but my logic is roughly that without solving the hard problems, the softer problems don't really matter.