Simon-Erik Ollus & Heli Simola
RUSSIA IN THE FINNISH ECONOMY
Sitra Reports 66

Conclusions: The effect of Russia on the Finnish Economy

Economic effects on Finland

It is quite obvious that Finland has benefited from the strong economic growth of Russia during the pre-sent decade. Finnish exports to Russia have increased considerably during the past years and Russia has risen back to being among the most important trading partners of Finland. In 2005 already 12% of Finnish foreign trade was with Russia. According to our calculations, exports to Russia increased the Finnish out-put by more than EUR 5.5 billion, accounting for slightly over 2% of the total output in 2004. In some industrial sectors the effect was even larger. Among the EU25, Finland has become the most dependent on Russia in its exports. The significance of Russia as a trading partner for Finland has also been fortified as Russia has become increasingly more important source of energy and raw materials for Finnish industries.

Also transit traffic through Finland has grown rapidly since the fall of the Soviet Union. If we calculate together the value of transit traffic and exports to Russia, a quarter of Russia's total imports already go through Finnish territory. Transit traffic certainly has an effect on the Finnish economy, especially in Southern and Southeastern Finland. The effect of transit business for Finland mainly concerns the har-bours and facilities around them and seems to be limited for the rest of the economy. The transit business, however, brings entrepreneurs to Finland from Russia and a significant share of the SMEs in Southeastern Finland is Russian owned and involved in trading and transportation business to Russia. These enterprises employ people and pay taxes to Finland.

Finnish firms have also increased their investments in Russia. So far most of the Finnish investments have gone to the Northwestern and Central federal districts, but today Finnish firms are increasingly looking for investment objects further away from Finland close to the million cities, where market potential is large. It is notable that Finns invest mainly for establishing production for the Russian market, rather than because of cheap labour. Finns also mainly invest in sectors that are not considered strategic from the Russian perspective, where the political risk is smaller.

Finnish firms have already profited from their investments in Russia. In 2000–2005 the income from the investments has been larger than the investment flows. Russia is also currently the fastest growing desti-nation for Finnish industrial firms' investments abroad. Hence, Russia offers Finnish enterprises a pros-perous growth market, which supports the firms' global competitiveness.

Russia has also become one of the most important markets for Finland in service exports and a moderately important trading partner for Finland in imports of services. Russians were the largest tourist group visiting Finland in 2005 and the one that consumed the most. Also trade of construction and transport services to Russia are significant income sources and employers in Finland.

Russian employment effect in Finland

The interesting question is how many people these economic activities with Russia employ in Finland. We have only focused on the trade of goods and services, transit and investments. Of course there are more fields of co-operation, but these are the main ones. We calculated that in 2004 the total employment effect of the goods exports to Russia reached to over 34,000 persons, whereas that of transit business reached to roughly 4,000 persons in 2003. Moreover the NBT register told us that the Russia-related firms in Finland employed 8,100 persons in 2005. Finally, we estimated that the trade in services (inc. tourism) employed 10,500 persons in 2004.

The figures are from various years and trade figures include also the indirect effect, while the others are the direct effect. The situation has probably changed over time in some fields, so of course the comparability of the numbers can justifiably be criticised, but they still serve our goal; to give a rough picture of the situation. The figures concerning Russia-related firms are especially difficult, as those Russia-related firms participating in trade with Russia are also included in trade and transit statistics and hence need to be excluded from the total employment figures. Therefore in Table 5.1 we present a rough estimation of 48,500–56,600 persons in Finland who are employed by economic activities conducted with Russia. Rus-sia-related firms participating in trade of goods and services and transit form about little more than half of the firms, so the average of the range is probably quite exact. Consequently, about 50,000 persons earn their income from Russia's current prosperity. This is equal to about 2% of total employment in Finland.

Table 5.1 The Russian employment effect in Finland, number of employees
xx	Year of data	Employment
Trade of goods	2004	34,000
Tourism	2004	3,500
Other trade of services	2004	7,000
Transit traffic	2003	4,00
Russia-related firms in Finland	2005	8,100
Employment related to Russia	xx	48,500 - 56,600
Total employment in Finland	2005	2,401,000
Russian employment effect, share of total employment, %		2,0 -2,4

Italic = Russia-related firms employment effect included in figure
Source: Authors' own calculations.

While comparing the share of Russia-related workplaces in Finland to other fields, the employment effect is slightly less than for the consumer durables industry (57,000) and slightly higher than the banking and insurance sector (47,000) and mail and telecommunication services (47,000). Hence, the Russia-related business in Finland is notable and as co-operation is increasing on all fields, the effect will probably be much higher in the future.

The effect is, however, still much smaller than during the bilateral trade regime with the Soviet Union and its best days in the early 1980s. In 1985 the employment effect was nearly 150,000 persons, which was equal to 6% of the total workforce. The effect at that time was concentrated only on trade of goods and services. Now it is much broader and includes transit traffic and many Russian firms in Finland.

The negative effects are mainly related to the grey economy

The increased trade and transit traffic through Finland also has some effects on the economy that can be considered worrying. An increasing share of the growth of exports has been attributable to re-exports. We estimated that in 2004 at least a quarter of Finnish exports to Russia were de facto re-exports. Their im-pact on Finnish income and employment is significantly lower than the impact of "real" exports actually produced in Finland. For example the volume of Finnish exports to Russia was nearly as much as to Ger-many and Sweden in 2004, but the employment effect only 2/3 due to re-exports. Currently, a majority of the largest product groups in Finnish exports to Russia are partially or totally of re-exported goods. Mostly the same product groups have also been growing fastest during the past years. There are various reasons why goods head through Finland as re-exports. Partly, it is a side effect of transit traffic, partly an option for Finnish exporters to fill the Russian import demand in products that Finnish industry does not produce and partly – unfortunately – also related to the grey economy. By trading the goods a number of times before importing them to Russia, it becomes harder for authorities to follow the shipment and easier to implement various grey schemes in imports.

Russian trade has already been afflicted by grey schemes since the demise of the Soviet Union. Despite various authorities' efforts, it has not yet been possible to root out grey trade. In 2005 the discrepancy between Finnish and Russian customs statistics was 57% and after we excluded our estimate of re-exports the discrepancy was still 32%. The discrepancy is of course also large on other Russian borders, but that is not a reason to ignore it. The evident economic effects of grey trade are realised as lost tariff and tax income of the Russian Federation, but it also has indirect effects on Finland, such as increasing biased competition and introducing unhealthy business practices in Finnish business. Grey trade should not be regarded as solely a problem of Russia. The problem of grey trade should also be tackled at the European level in order to assure effective results.

The fast growth of Russia-related trading and transport firms can also be partly seen as worrying. The Russia-related firms' number increases rapidly and e.g. in the Kotka-Hamina region their share of new enterprises was already about a tenth. And we know that these business fields are those dominated by grey schemes. The whole transport business to Russia is mainly dominated by Russian firms, and the use of double invoicing is more a rule than an exception. Hence, we have a strong suspicion, which was also supported in our discussions with customs authorities, that there is a lot that is dubious in some of the Russia-related trading firms' records. Of course most of the Russia-related firms in Finland are by no mean dirty, but some still are and on those firms' activities the Finnish authorities need to put more focus on.

The situation is difficult, as most of the grey schemes are used for avoiding high Russian import tariffs. If the Russian Federation lowered significantly its custom duties and other tariffs on imported goods, the grey activities around the trade would decrease. However, it is quite unlikely to happen as the Russian Federation is currently earning a third of its budget incomes from custom duties. Even when Russia be-comes a member of the WTO, it is unlike to change the current situation significantly.

What about the future?

What are the future perspectives for economic co-operation with Russia? On average, the Russian econ-omy has grown over 6% annually since the 1998 economic crisis. Economic growth is driven greatly by the unprecedentedly high price of crude oil as well as consumption-led growth in the production sector. Most forecasters do not expect any sudden falls in overall Russian growth in the short and medium terms, as oil prices are largely assumed to remain high. Of course there are structural problems and certain un-certainty in the economic policy, but over all the economic policies seem to be stabilising. We assume the economy will continue to grow at a brisk pace for the rest of the decade. Optimism in the economy also predicts continued fruitful development of Finnish-Russian economic relations.

Trade will probably continue to grow at a rapid pace, but as Finnish direct investments also increase, there are doubts how long the growth of exports can continue at its current pace. Russia will probably sta-bilise its position as Finland's largest trading partner, but the trade will probably never again account for a quarter of Finnish foreign trade as it did with the Soviet Union in the early 1980s. There are also some worrying elements in trade that need to be focused on; especially part of re-exports and grey schemes. If re-exports continue to grow at their current brisk pace, re-exports will already be larger than Finnish pro-duced exports to Russia in 2009.

Also transit traffic to Russia is expected to continue to grow rapidly, as Russia's total imports are ex-pected to continue to grow at a fast pace and Russia lacks own import harbours in the Gulf of Finland. The growth of passenger car transit is expected to slow down after 2008, while the transit of consumer electronics is expected to remain high and probably still increase. Strategically, Russia aims for inde-pendence in its foreign trade logistics, which has been seen so far in Russia's exports. In the long term we will probably also see it in imports. However, the current strong position gives space for manoeuvre for the Finnish authorities and enterprises to sharpen strategies to keep their current positions.

The prospects for investment growth look positive. There are no direct clouds visible and optimism among firms regarding the Russian market, as reported by various surveys, indicates that investment growth will continue for a while. Although Russia is seen as risky and insecure market, Finnish firms in-creasingly invest and succeed there. Finnish firms have also repatriated nearly all investments as income from Russia. When the Russian economy and politics have become more stabilised, investments growth will probably even accelerate.

Russian investment to Finland will probably also continue to grow. Currently the stock of investments is only slightly larger than the stock from Finland to Russia, but Russians' are increasingly using Finland as a hub for the European markets. The number of Russian firms will probably continue to grow, especially in Southeastern Finland.

In terms of trade in services, Russia will probably keep its position among the most important markets, as tourism and construction are expected to continue growing. The demand for construction services is likely to stay on a high level, as there still exists an extensive need for both new buildings and the renovation of the existing ones. As for tourism, there is a vast yet unrealised client potential in Russia, as at present merely a fraction of Russians can afford to travel abroad at all. Finland is close and has a great natural environment, efficient logistics and service and good shopping possibilities. However, the future looks more pessimistic for the transport service sector. In transport services Russian firms have gradually gained market shares and at present clearly dominate the market.

With right actions the perspectives are fruitful

Relations with Russia have always been complicated and a double-edged sword for Finland. Finland could not fully integrate into Europe before the fall of the Soviet Union. Since then integration has been rapid and Finland has changed considerably. Today the country is one of the most competitive in the world and has benefited fully from internationalisation and integration in the world economy. Now, it is time to see the new opportunities Russia offers for Finland.

In the previous decade there was very little Russian influence on the Finnish economy, and the engine behind the growth was largely internationalisation and integration in the world economy. During the pre-sent decade the Russian effect has again increased. The effect is mainly positive, and partly an engine be-hind the current economic growth in Finland. However, worrying tendencies also exist, which need to be tackled. With right polices of authorities and enterprises the negative effects can be limited and Finland can fully benefit from the positive effects of Russia on the economy.

What about the future? It could be even better than today. If the employment effect in trade for example grew by half during the present decade, it could also do so in the future. Moreover, the Russian market offers Finnish firms a fast growing emerging market, close by, which supports Finnish enterprises' growth and continuing competitiveness in the world economy. Finland is a significant transit corridor to Russia, which helps development of especially the southeastern region of Finland and Russian firms increasingly invest in Finland. These are opportunities for Finland to gain more from the emerging Russian market and with right actions by firms and coherent policies by authorities the perspectives will be fruitful. The op-portunities offered by the fast growing Russian market cannot be defaulted. Russia is a chance Finland cannot miss.

or:
Heli Simola
Economist
Institution for Economies in Transition
Bank of Finland
phone +358 10 831 2834
fax +358 10 831 2294

www.sitra.fi