Political Risk in Finland: Does the financial crisis in 1990’s consist of political risk?

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Uppsala University

Department of Business Studies Management of International Business Thesis

Spring 2007

Supervisor Rian Drogendijk

Political Risk in Finland

Does the financial crisis in 1990’s consist of political risk?

By Jukka Davidsson

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Summary

Thesis political risk in Finland will explain the real nature of the financial crisis in Finland in the beginning of 1990’s. Before 1990’s Finland used to be a closed and controlled market. The liberalisation of the financial market began in 1980’s. This process caused the depression in Finland. Partly there is truth behind this statement. The restructuration of Finnish economy and state policy needed more. The government formed collaboration with the legal system and major actors in Finland. Financial institutions and large corporations were provided a

parachute. The mentioned companies got a different treatment in front of the law than small and medium size companies. Government together with financial institutions made a plan for solving the problems what the market faced. They signed secret agreements upon execution of the plan.

Actually, the three actors made a plot for the rest of the people in Finland.

This is a thesis of political risk in a developed country called Finland. Political risk is

not only concentrated on undeveloped countries. The existence of political risk is increasing

throughout the world. Therefore, it is important to point out the possibility of political risk in

developed world.

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Table of Content Page

1. Introduction 4

2. Problem description 5

3. The Objective of Thesis 6

4. Theory 6

5. Method 9

6. Presented data 11

6.1 The research of economics 11

6.2 Government related matters 12

6.3 Economic freedom in Finland through

the years 15

6.4 Legal system in Finland 16

6.5 Summary of different comments of people 19

6.6 The bankruptcy rate 20

6.7 The accounting of Banks 20

7. Analysis 21

8. Discussion 27

9. Conclusions 29

References 30

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1. Introduction

The phenomenon risk is related to local business as well as to international business.

Research of risk is mostly focusing on direct risks like choices of corporate strategy and

competition. Different studies concerning international business are, at least, indirectly related to risk of any kind. Political risk has been studied less. However, the more the economical agenda will be part of international geopolitics or power politics, the more political risk plays an important role.

One resent example is the behaviour of the Kremlin toward Ukraine, Georgia and Belarus

¹

. Using energy supply as political tool against states is clear sign of increased political risk

²

.

The definition of political risk is not clear. The researchers are pointing out, that there are differences between political risk and business risk. However, most of the articles are defining the political risk as actions of political forces causing drastic changes in a country’s business

environment, which is affecting the goals and profits of international companies

³

. In this context we have to recognize the cooperation of political powers and local companies, as the case is in Russia

⁴

.

The political risk is related to several issues. The source of political risk might be the problems in country’s legal system. Furthermore, the level of legislation is for importance, when scrutinizing the political risk concept in one country. This might even cover the economical risks in this specific country. The protection of property is matter of legislation. Political risk could be the source of different business cultures and ethics resulting in some countries in corruption and violations of human rights.

The behaviour of a specific government is the power and source for political risk. All governments are driving own agendas when ruling the country. They are protecting domestic market and its local actors or trying to invite foreign direct investments to the market. Each country has its backbone industries to protect. Therefore, governments are using instruments for trade policy and government interventions

⁵

. Typically, trade policy acts are related to different tariffs, subsidies, import quotas, export restraints, local content requirements and administrative and antidumping policies

⁶

. Instruments for trade policies are effective, if the government implements the different requirements in volume and on different levels of legislation. Foreign companies shall use a lot of energy to meet all the required standards. Government interventions are more often used as tool for

1 CSIS Euro-Focus, January 24, 2007.

2 Ibid.

3 Hill, Charles W.L., 2005. p. 79

5 Hill, Charles W.L., 2005. p. 180-193

6 Ibid.

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protecting jobs and industries

⁷

. In addition, the national security is one explanatory to this

behaviour

⁸

. Even human right and consumer protection are behind the interventions. Increasingly, the foreign policy objectives seem to be on the agenda.

Finland used to be a closed and controlled market, protecting its major industries like the forest cluster. Finnish government maintained a policy of inflation and revaluation in order to boost export industries

⁹

. The Finnish State was by itself one of the biggest owners of large

corporations. The trade in Finland was mainly based on the bilateral agreement with Soviet Union.

On that market competition was an almost unknown phenomenon. The only competition that occurred was the struggle of Finnish companies to access to the barter trade system and organization. This was government controlled area

¹⁰

.

2. Problem description

Developed countries are considered as safe markets in the context of political risks.

Such countries are trying to maintain the reputation of risk free market for foreign direct investments. However, the existence of political risk in world market is increasing

¹¹

. This is

because of the political involvement into different industries. The economy is used as tool in foreign policy

¹²

. Even, the globalization of financial market will bring up risks for politically motivated actions

¹³

. Therefore, the political risk as phenomenon will be more important for businesses in the global market. Governments can affect the business environment dramatically

¹⁴

.

In the beginning of the 1990’s the Finnish economy experienced a financial crisis.

Research available is focusing only on macro economical issues. Research of political risk in the same period does not exist. Discussion of the financial crisis in Finland is mostly based on external factors. In the beginning of 1990’s Finland wasn’t the only country facing the economical problems.

Finland did actually ‘’suffer due to German financial policy

¹⁵

’’. This argumentation is popular among the political parties in Finland. The prospective existence of political risk in Finland is still in present situation without answers. The research which is not concentrating on confidential issues or on politically sensitive matters is as such ‘political risk’ in Finland. It is important for any

7 Ibid.

8 Ibid.

9 Kiander, Jaakko & Vartia, Pentti, 1998.

12 Ibid.

13 Cato Policy Report, Jan/Feb 2007.

14 Robock Stefan H., 1971.

15 Kiander, Jaakko & Vartia, Pentti, 1998.; Honkapohja Seppo; Koskela Erkki; Gerlach Stefan; Reichlin Lucrezia, 1999.

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business owner to have full knowledge about the reality in Finland. If there is political risks in Finland the story should be studied and told.

Economical freedom and security are central for international business and direct investments. Financial crises are normally explained as exceptions. The elements of such crisis are described in terms of international business cycles. The outcome of the Finnish depression was shocking. The amount of bankruptcies, transferred properties, suicides and unemployed people was enormous. From the private company point of view it is important to study, whether the depression in Finland can be explained as a regular economical crisis or as the result of political risk. This is also vital information for companies planning investments in Finland. The worst possible outcome because of the political action is the lost of company and private freedom, that is bankruptcy of own company and criminal sentencing.

3. The Objective of Thesis

The aim of this thesis is to study the phenomenon of political risk in Finland. The Finnish example is interesting because of the financial crises.

There are some limitations in the thesis. This thesis will concentrate only on the period of 1990 – 1997. This is because of the limited time available for the study. In order to minimize the presumable critics, the thesis will present information in discussion part. This data will take into account the timeframe from 1980’s to present. Legislation in the country will have major effects in business environment. Legislation in Finland will be excluded.

4. Theory

The expression political risk is a widely used term among executives in corporations as well as governmental civil servants. Although the usage of this term, a common definition of this concept does not exist in political risk literature or research articles. The academics are using different approaches defining the political risk. Stefan H. Robock defined the political risk, when 1) discontinuities occur in the business environment, 2) when they are difficult to anticipate, and 3) when they result from political change

¹⁶

. He discussed the term political risk in a framework of industry based risks, political risk vs. business risk and political risk vs. economical risk

¹⁷

. He argued political risks in favour to clear defined causes of risks explained either on the

macroeconomic or microeconomic level

¹⁸

. ‘’The risk is of a macro nature when unanticipated and

16 Robock Stefan H., 1971

17 Ibid.

18 Ibid.

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politically motivated environmental changes are broadly directed at all foreign enterprise. The risk is of micro nature when the environmental changes are intended to affect only selected fields of business activity or foreign enterprises with specific characteristics’’

¹⁹

. Robock also considers the macro risk as more dramatic and the micro risk as more prevalent. Causes of risk are described more as pains in a process when a country is developing. To this category fits social unrest and disorder as well as internal rebellion and attaining independency. Further relevant issues, that are discusses in this article are ineffective law enforcement and other risks as result from the political influence of local business interests. Finally, this article explains also the possibility for both losses and gains in political risk.

Kobrin made a comprehensive review of literature concerning political risk studies.

Kobrin discussed the phenomenon political risk as action or event

²⁰

. Risk can also be understood as uncertainty, where the political risks should be separated from environmental risks. The uncertainty is subjective, depending on the perceptions of the decision maker. He pointed out, that the political risk seems to be related only to downsize, i.e. negative outcome of the firm. In contrary, the

political risk is like a coin with two sides. There are, or at least might be, gains to someone else.

Further, he argues, that executives round the world are not using any sophisticated methods to estimate or calculate the political risks, when entering new markets. Kobrin also claims that business leaders are using data from newspapers for market evaluation as political risk. Managers are not using real research in this context. Finally, he concludes the article with following statement – ‘we need better definition of the phenomena, a conceptual structure relating politics to the firm, and a great deal of information about the impact of the political environment. The three are, of course, related’

²¹

.

Simon made his contribution to research of political risk with an article in the middle of 1980’s. In addition to the existing theories he presented the need for joint studies among

economists, political scientists, business management scholars, legal experts and sociologists.

Simons argued that the political risk may have the roots not only in host government behaviour, but also in plans of the local business groups or in host country’s social environment. This might be violent behaviour of certain groups in the region. In this sense he gets support from peace and conflict researchers. Luke and Tuathail define one of the presumable reasons to political risks as failed state, that is, ‘states that had experienced a spectacular breakdown in the functioning of their governmental apparatus and the disintegration of their civil institutions’. They also argues, that

19 Ibid.

20 Kobrin, Stephen J., 1979.

21 Kobrin, Stephen J., 1979

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such countries are in a number of cases involved with ‘contraband commerce’ defined as ‘trade in illegal and/or prohibited goods, practices and services’

²²

. Collier and Hoeffler investigated the outbreak of civil conflict. They found, that one explanatory factor for rebellion is the availability of finance

²³

. In this context, it would be of interest to mention studies focusing on private gains during uncertainty or violent periods. Fortunes made in very short period of time might be based on illegal or criminal activities motivated with greed

²⁴

. Simon divides the risk in four categories. Host country risks are stemming from government actions and policies, societal actions and attitudes, local business community actions, legal community rulings. Home country actions are the same as the ones in host country. Further, Simon divides the flow of risk in four categories – direct internal and external as well as indirect internal and external

²⁵

. Simons is combining in his article political risk studies with peace and conflict studies i.e. conflict management.

Miller discussed the political risk in context of risk management and uncertainty in strategic management. He divided the risk concept in three categories, 1) general environment, 2) industry and 3) firm specific variables

²⁶

. The general environment uncertainties cover political, government policy, macro economic, social and natural uncertainties. Miller refers in the article to industry and firm specific variables. In this context most of researchers consider this kind of uncertainties as normal business risks. However, he also discusses in the article financial and strategic responses to uncertainties. This section refers also to the political risk factors. Strategic risk management as well as the financial risk management are tools to cope with political risk. The weakness with his approach is the definition of political risk and business risk. In case the political risk is more unexpected events or causes of risk, the management tool is not the right approach. In order to be able to forecast political risk in specific market there is need for more research.

Globerman and Shapiro made an important contribution to the field of political risk research with studies focusing on attributes of legislation, regulation and legal system affecting the freedom of transacting, security of property rights and transparency of government and legal processes

²⁷

. The purpose of the study was to assess whether and to what extent governance infrastructure attributes of national economies influence US FDI flows. The results indicated that governance infrastructure plays a critical role in the determination of the volume of US FDI flows across countries. In particular, the classification of legal systems of former socialist countries was difficult. The results indicate that countries that fail to achieve a minimum threshold of effective

22 Luke, Timothy.W. & Tuathail, Gearóid Ó., 1998

23 Collier, Paul and Hoeffler, Anke, 2004

24 Duffield, Mark, 1998; Collier, Paul, 2000; Keen, David, 2000

25 Simon, Jeffrey D., 1984.

26 Miller, Kent D., 1992

27 Globerman, Steven and Shapiro, Daniel, 2003

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governance are unlikely to receive any US FDI

²⁸

. They also found that market size is statistically the most important predictor of whether a country will receive FDI and, if so, the amount.

The study will concentrate on theories of Robock, Kobrin, Simon and Globerman &

Shapiro. All of the above presented theories focus on same issues. There are three parties dealing with political risk (A). The political risk in one country is illustrated with (A). The major party – government including country politics – is named with (C). This corner will include the legislation in that country. The (B) is the country economics including all actors dealing with issues of

economics. Finally, the (D) is the legal system. All the parties are in interaction with each others.

Theories concerning the political risk are related to actions or events. They are unforeseen action or events. In this context we have to separate the normal business risk from political risk. In this thesis theories will be applied in interaction between the different actors in the triangle. The cause of political risk seems to be a sum of actions. Different actors are causing the outcome in cooperation. To illustrate this we might assume collaboration between local business owners with government bodies. In this example the corner C and B are in relation. If the legal system supports the cooperation then the political risk will be a complete ‘plot’.

5. Method

This thesis of political risk in Finland is based on secondary data. Presented

documentation consists of domestic and foreign articles and research rapports. The articles cover macro economics in Finland and financial issues in depression. The data part will cover major government events during the chosen time. Presented material is well documented and copies exist.

The data concerning the legal system is presented mainly from external sources. All the mentioned data will be analyzed only in qualitative terms. Studies of political risk will be applied.

Presented data consist of major part of the published articles. Legal studies are excluded. The economical data will be presented briefly in the thesis. Only major findings from

28 Ibid.

C

B A

D

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each study will be noted. The economical data will be presented briefly. This data will be analyzed qualitatively i.e. the structure of studies will be criticized due to some weaknesses in presented data.

The outcome of this analysis will operate as base information for further research in this report.

The government data presented in the thesis represents the most important pieces of data during the chosen period. Data concerning legislation will be excluded, due to limited resources. The analysis of government events, agreements and decisions will be done separately.

The focus in analysis will be on major issues in each data group. The analysis will be qualitative in nature. Major focus and interest is in elements of political behaviour. Finally, all the presented data parts will be analyzed as a total chain of events. This exercise will be carried out in order to find trends or patterns from data.

Data of economical freedom is chosen due to its relation to the legislation in Finland.

This data is presented as external information in order to bring a quality point of view from Finland.

The second purpose of this data is to present also a broader understanding of potential political risk in Finland. The analysis of the presented data will focus on trends from 1980’s to present.

The legal system is presented in the thesis because of the central role of judiciary in political risk research. The presented data concerning the qualitative part of legal system is collected from external sources. External parties are more reliable to analyse the system than the local ones. The figures of criminal sentences are presented as accurate available internal

information. Further, the figures are presenting trends, which can be analyzed against other information presented in the thesis.

Data concerning bankruptcy rate as well as data concerning the banks are presented as evidences of outcomes of the depression. There will be trends, which can be analyzed as such, but also against other presented data. The analysis will be qualitative.

The documentation and data used in this thesis is collected with means of

investigative journalism. The presented data is the core of financial crisis in Finland. In addition the documents are confidential in nature. The presented data is something which has not been published in any other research reports. The material is the key documents for the research of political risk in Finland. The official documentation like research reports is not covering the issues of confidential nature. As an example the secret agreement between the State and banks is not analyzed or

mentioned in any report.

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6. Presented data

Data presented in this section is divided in different categories. Government actions are presented in chronological order. Status of legal system is discusses from point of view of foreign actor statements. Some economical research reports will be explained and other data related to economical freedom is published. The political risk in Finland will be scrutinized only in 1990’s.

We can separate different periods from 1980’s. The 1980’s and especially the second half of the decade is time for liberalization of the monetary market. The first years in 1990’s can be described as a planning phase for reconstruction of the Finnish economy and politics. Most active period of actions is the years between 1993 and 1997.

6.1 The research of economics

The summary of the research material – ‘’In the 1990s, Finland underwent a deep depression as its GDP dropped about 14% and unemployment rose from 3 to almost 20%. This is a story of bad luck and bad policies. Bad luck took the form of external shocks: the collapse of trade with the former Soviet Union in 1991, but also sharp cycles in the OECD area’’.

²⁹

‘’However, bad luck is far from being the whole story. In the absence of bad policies, Finland would have experienced a recession, not a depression. Bad, policies included a poorly designed financial regulation and mistaken reactions to the onset of the crisis. Of particular interest is the role of financial factors in triggering the crisis and aggravating the effects of bad policies.

Not only were consumption and investment spending hurt by the credit crunch, but there is evidence that the private sector's indebtedness has increased structural unemployment, which explains why the recovery is proceeding with firm job creations. A number of general lessons emerge. They concern the deregulation of financial markets, the policy reaction to massive capital inflows and the role of employment policies’’.

³⁰

The main diagnosis in this study is, that the depression was a

29 Honkapohja Seppo; Koskela Erkki; Gerlach Stefan; Reichlin Lucrezia, 1999. pp. 400

30 Honkapohja Seppo; Koskela Erkki; Gerlach Stefan; Reichlin Lucrezia, 1999. pp. 400 1980's

liberalization of Finnish monetary

system

1991‐ 1993 planning phase of

financial crisis

1993 ‐ 1997 execution of the

chosen plan

1997 ‐ cover up of the plan

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financial crisis

³¹

. The reason to that are the timing of liberation of financial market

³²

, disregard in legislation and finance supervision, tax system and mismatch of lending and deposit rates

³³

.

The ending of Soviet trade in 1991 had only minor effects on the exports volumes. On the contrary, the export developed rapidly from 1992. The major reason to the deep depression is the total failure of specialists to estimate the effects of chosen economical policy

³⁴

. The practiced financial and economical policy took the state economy in tail spin process. Inflation decelerated, all property prices declined, debt problems escalated and the demand shrank

³⁵

.

One study, which is comprehensive and covers a historical account of Finnish depression is called Suuri Lama i.e. Great Depression. This book describes the background and elements of the financial crises in Finland. This account of the financial crisis is focusing on macro economics and on behaviour of different actors

³⁶

. The analysis of the crisis is not concentrating on elements which effected the development of crisis. This book is analyzing the Finnish economy since early days of independence of Finland. The subject of financial policy is scrutinized in 1980’s as well as during the time of crisis. Authors are giving accurate account of the events and decisions made in the economical and financial policy sector. For an unknown reason researchers are not dealing with secret information like the agreement signed in 1993. This is a clear weakness in the report. However, this can be understood again as ‘country habit’.

6.2 Government related matters Rohto Group founded

In May 1991 the Rohto

³⁷

group was founded with objective to plan different matters concerning the financial crises. The group was composed of representatives from Bank of Finland, Ministry of Finance and Finance Inspection. The Rohto group was supported by other governmental organizations

³⁸

. The created documentation of the group remains still confidential

³⁹

.

31 Honkapohja Seppo; Koskela Erkki; Gerlach Stefan; Reichlin Lucrezia, 1999.

32 Ibid.

33 Ibid.

34 Kiander Jaakko, Ed., 2001. pp. 36-39.

35 Ibid.

37 Kiander, Jaakko & Vartia, Pentti, 1998. (Rohto is a dialect word meaning medicine)

38 Kiander, Jaakko & Vartia, Pentti, 1998. Bank Of Finlanf year book 1991

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Task Force of banking sector

The Government in Finland asked the President of Bank of Finland to provide an analysis of the state of banking sector in Finland. The report was accumulated and written by CEO’s from all major banks in collaboration with Bank of Finland. The report was handed over to Prime Minister in the middle of March, 1992.

⁴⁰

The report points out several issues. First, the focus in the report was on the solidity of banks as well as the capability of banking industry to continue financing the customer base. The major reasons to the problems was the so called ‘interest rate trap’, that is the bank management strategic failure to estimate the development of interest rates in Finland and throughout the world.

The capital used in banking sector was more costly i.e. higher interest rate, than the received interests from Finnish customers.

⁴¹

Second, the estimated credit losses were a danger for major banks. The survival of financial sector was on brink

⁴²

.

Third, banking sector faced the increased requirement in solidity due to new international legislation of BIS i.e. Bank of International Settlement. All Finnish banks had to be able to present solidity up to 8 percent.

⁴³

Finally, it is stated the in the reports, that bad profitability is due to strategic mistakes in bank management. Partly the government authorities are responsible to the situation. To point out the blameable people will not solve the problems. The report concluded that both the banking sector and government must realise fast actions in order to maintain the financial capabilities in banking sector

⁴⁴

.

President Mauno Koivisto meets the top management from different banks

President Mauno Koivisto had an economical seminar with top management of all major banks. This seminar took place in March 2, 1992. Several issues were presented during the meeting. One specific issue was important for banking industry. The degree of solidity in all banks had to be changed to the BIS 8% level. The top management of banks presented the requirement of banking sector to remove chosen liabilities out from the assets of the banks. This requirement was motivated because of the drop in real estate prices. The amount of needed transfer was about FIM

40 Valtioneuvoston kanslia 1992 (Task Force in Banking Sector).

41 Ibid.

42 Ibid.

43 Ibid.

44 Valtioneuvoston kanslia 1992. (Task Force in Banking Sector).

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180 billion. This amount equals about 45% of the total liabilities in banking sector

⁴⁵

. The documentation used in seminar remains confidential.

President Koivisto meets the judges and professors in law

President Mauno Koivisto invited several judges, lawyers and professors in law to the presidential premises on May 6, 1992. The purpose of the seminar was to discuss the exercise of power and independence of court of laws. Further, the themes covered the assessment and critique of operations in courts

⁴⁶

. The structure of the meeting was designed on presentations and

discussion. The invitation letter reflects the idea of President Koivisto that also the courts have to be in collaboration with other actors when they are solving the problems in depression

⁴⁷

.

Several participates have confirmed in writing, that the purpose of the seminar was to press the judicial system to act according to the economical situation in Finland, not according to the law. President Koivisto writes in his memoirs, that the lawyers must have their responsibility in the society

⁴⁸

.

Securitisation Task Force

The government nominated a group to collect a plan for securitisation in a report. The basic structure of the process is to transfer loans or other assets from bank to an investor

⁴⁹

. This report was realized between September 1992 and May 1993. The report is a full legal account, how this process would be accommodated in Finland. The report states, that the securitisation is a cost effective method to direct state support to banking sector. The process of securitisation was supported by major Investment banks

⁵⁰

.

Secret agreement sign in October 1993

⁵¹

State of Finland signed an agreement with banks in October 1993

⁵²

. The government meeting concerning the agreement was held starting 2.50 at night. Ministers used backdoor, when entering the state building. Every minister in the meeting was able to read the contract including government documentation. The package consisted of more than two hundred pages. Ministers were

45 Koivisto, Mauno, 1994.

46 Invitation letter of President Mauno Koivisto

47 Ibid.

49 Bank of International Settlement, 1992.

50 Ympäristöministeriö Asunto-osasto, 1993.

51 Secret agreement signed between State of Finland and major banks in Finland.

52 Pilkkomissopimus, 1993.

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allowed to read but not take the package with them

⁵³

. The acceptance of the agreement was a unanimous decision. The agreement as such consists of several additional agreements i.e. legal corrections and enhancements. In 1994 the agreement was renewed entirely. This was needed due to legal aspects. Parties agreed that the banking sector was able to transfer liabilities from their assets to the state owned ‘bad bank’ called Arsenal Oy. The agreement consisted of two parts – the

customers and liabilities subject to immediate transfer and large customers subject to later transfer.

Parties agreed that among other things the banks were allowed to transfer specified lines of businesses (industries) or ‘’force’’ them to bankruptcy. In this agreement parties agreed, that such industries were investments in real estates, and all companies close to real estate business, other investments, construction, retail business, hotel and restaurant sector, leisure sector.

It is also of interest to mention that the structure of this contract follows the securitisation process. The definition of line of business as well as ownership of a company was composed according to large volumes of liability transfers. Finally, the parties agreed upon contribution of the authorities through the political process.

6.3 Economic freedom in Finland through the years

Besides, the legal system, it is important to analyse the financial market and freedom to trade internationally as well as domestically. The overall review of market economy in Finland is based on indexes from the Economic Freedom report 2006

⁵⁴

:

1985 1990 1995 2000 2001 2002 2003 2004 Finland

A 7,8 9,3 9,6 9,5 9,6 9,6 9,6 9,7

B 6,7 6,1 8,2 8,4 8,2 8,1 8,1 7,9

C 5,8 5,8 7,1 7,1 6,9 6,8 6,7 7,2

In this table the A index – Access to sound money - describes the state monetary policy, inflation rate and freedom to operate with several currencies. B index – Freedom to exchange with foreigners - indicates the status of low cost communication and transportation as well as freedom to exchange across the national borders (including tariffs, quotas, hidden administrative restraints and capital control). Finally, C index – Regulation of credit, labour and business – illustrates the level of restrictions for market entry and the politically motivated

53 Oral discussion with former minister Kankaanniemi

54 Gwartney, James and Lawson Robert, Economic Freedom 2006, p. Chapter 2 pages 85, 144 and 155

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interferences with the freedom to engage in voluntary exchange

⁵⁵

. The chart is illustrating the trend from 1985 to present days. The maximum index figure is 10.

6.4 Legal system in Finland CATO institute report

Cato institute in US is publishing every year a report concerning the economic freedom from each country. This report gives an overall image, among other things, from legal structure in each country. The Finnish figures are published since 1970. The maximum index is 10 and the trend is partly presented from 1975. The majority of trends are giving information from 1995.

Finnish legal system at glance

⁵⁶

A= Judicial independence B= Impartial courts

C= Protection of intellectual property E= Integrity of legal system

55 Gwartney, James and Lawson Robert, Economic Freedom 2006, p. Chapter 1 page 11

56 Gwartney, James and Lawson Robert, Economic Freedom 2006 0

2 4 6 8 10 12

A B C

0 2 4 6 8 10 12

A B C E Overall

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Overall= Legal structure and security of property rights

The Cato report gets support from top Finnish lawyers. The President of

Administrative Supreme Court Mr. Pekka Hallberg stated in his presentation

⁵⁷

in 2006, that Finland might lose investments because of low quality legal system.

Reports of United Nations Human Rights Committee

In its eightieth session the UN Human Rights Committee list a number of issues for Finland. This report is following the capabilities and responsibly of a country according to the UN international conventions. The UN committee made remarks about the Finnish legal system. It pointed out problems on right to an effective remedy, right to a fair trial and principle of non- discrimination.

⁵⁸

In its eighty-second session UN Human Rights Committee listed many of the issues for Finland. The report holds the following statement: ‘’The Committee notes with concern the overt attacks made by political authorities (members of the Government and Parliament) on the

competence of the judiciary with a view to interfering in certain judicial decisions. The state party

should take actions at the highest level to uphold the independence of the judiciary and maintain public trust in the independence of the court (arts. 2 and 14 of the Covenant)’’.⁵⁹

Transparency International reports

TI published in July 2003 a Global Corruption Barometer survey. This survey carried out in collaboration with Gallup International. A total of 40,838 people were surveyed in 47

countries. People were asked: If you had a magic wand and you could eliminate corruption from one of the following institutions, what would your first choice be? Choices were – business

licensing, courts customs, education system, political parties, utilities, medical service, immigration, police, private sector, tax, other.

The result reveals, that Finnish people would choose courts and political parties. Wit reference to courts only Cameroon, Indonesia and Peru got worse results in the survey

⁶⁰

.

57 Seminar ’’Oikeusvaltio, perusoikeudet ja tuomioistuinratkaisujen perusteleminen’’, September, 20, 2006.

58 United Nations, Human Right Committee, 2004.

59 United Nations, Human Right Committee, 2004.

60 Transparensy International, Global Corruption Barometer 2003.

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⁶⁵

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he same pat his thesis.

f the amoun 989 1990 131 156

ion, accoun

1994 267 77

an Rights

ud normal reme

9 1990 1991

g State of F Rights and F d.

efore and af al act starte L 39). In th A, B and C.

ttern is used

nt of judgme 1991 1

171 30 201

nting and bu

1995 401 189

1992 1993 1

inland are m Fundamenta

fter financi d in the end he table as w The figure d in all statis

ents:

992 1993

262 469

33 42

295 511

usiness in cr

1996 19 1000 48 293 36

994 1995 19

motivated as al Freedoms

ial crises d of 1980’s.

well as in the gives the to stics concer

1994 1

9 650

2 80

730 riminal act (

997 199 84 478 66 313

96 1997

s breaches o s

⁶¹

. This is

The crimes e chart the d otal amount rning differe

995 1996 752 801 70 52 822 853

( sections R

8 1999 521 271

A B C Total

of article 6 a failure in

s of debtor different

of ent

6 1997 639 2 24 3 663

RL 29 and

2000

516

292

(19)

C

⁶⁷

3 D

⁶⁸

1 E

⁶⁹

6 6.5 Summ

former pre to the over depression depression minister M objective w controlled theme was in society a

Koivisto as

67 Criminal a

68 Criminal a

69 Criminal a

70 Kullberg R

71 Pietilä Ant

72 Kiander Ja

73 Helsingin

05 413 54 546 7 116

mary of diffe

The natu sident of Ba rheated econ n

⁷⁰

. Mr. Aho n is homema Mr. Soininva was to incre by the plan discovered and product Presiden sked in one

act 30:9 and 10 act 29:2 Taxat act 30:1-8 Oth Rolf, 2000 p. 1

tti-Pekka Pres aakko, Ed., 20 sanomat 2.11.

0 200 400 600 800 1000 1200

3 533 6 420 6 49

erent comm

ure of Finni ank of Finla nomy i.e. in o, former Pr ade and we aara confirm ease the une nners and the d by research tion will inc nt Mauno K

discussion

0, Crime of ac ion breach her crimes in b

129.

sidentin pankk 001.

.2001. The mi 0

0 0 0 0 0 0

1991 1992

560 512 56

ments of pe

sh financial and, Mr. Ku ncreased dem

rime Ministe have to be a med, that the

mployment e unemploy hers in a stu crease amon Koivisto is ci that there i

ccounting business ki, 1994, p. 16

istakes of the 2 1993 1994

825 336 58

eople

l crises has ullberg, wro mand. The s er, stated du able to solv e financial c t up to 250.0 yment went

udy. The de ng the incre ited in sever

s no such le

61.

decision make 1995 1996 1

1098 10 329 22 71 62

been explai ote in his me

solution wo uring his ele ve it by own crises was a

000 people.

up to level ecision make

ment of the ral publicat egislation in

ers drowned F 1997 1998 19

082 966 27 287 2 75

ined by seve emoirs, that ould be a fab

ection camp means

⁷¹

. F ccomplishe The depres

of 600.000 ers confirm e unemploym

ions includi n Finland, w

Finland down 999 2000

836 202

59 eral people.

t he was des bricated, rat paign in 199 Further, the f ed on purpos ssion was n

people

⁷²

. T med that the

ment

⁷³

. ing his own which would

to depression A B C D E

842 148 41

. The sperate due ther deep, 92, that the

former se. The ot The same

efficiency

n memoirs.

d provide

n

(20)

the lawful that the pri business

⁷⁵

. where the p difficult po

6.6 The ba

represents private pro billion

⁷⁹

.

Bankruptcy

6.7 The ac

agreement deposits an the rashnes The value

74 Koivisto M

75 Ibid.

76 Kiander, Ja

77 Statistics F

78 Statistics p

79 Lahti, Arto

80 Statistics F

81 Suomen Sä

82 Ibid.

2 3 4 5 6 7 8

control of t ivate compa . Further, th protection o olitical and m

ankruptcy The priv about 20 pe operty transf

y rate

⁸⁰

ccounting o

The maj was the so nd loan agre ss the menti of unbooke

Mauno, 1994 p aakko & Vart Finland provided by B o, 1999.

Finalnd and ST äästöpankki –

0 1000 2000 3000 4000 5000 6000 7000 8000

1986

the banking anies were f he official st of property moral quest

rate

vate sector w ercent of the ferred from

of Banks

or Savings called secre eements too

ioned assets ed assets wa

pp. 383 tia, Pentti, 199

ank of Finlan TAKES – SSP Oy Ann

1988 1990

crises

⁷⁴

. He forced in ba tate finance of chosen p tion

⁷⁶

.

was in probl e total amou

original ow

Bank, Suom et agreemen ok place imm

s were not b as about FIM

98.

d and Pankkie

nual Report 19

1992 1

e continues ankruptcy an

is used for people is bet

lems. The a unt of opera wners to new

men Säästöp nt signed by mediately af booked in th M 50 billion

en ja vakuutus

993

1994 1996

by saying, nd new own

banking aid tter, than th

amount of ba ational comp w ones is es

pankki – SS y the parties fter signing he accountin n

⁸²

. The Uni

slaitosten tase

1998 200

that there a ners are foun

d under suc he one of oth

ankruptcies panies in Fi stimated to F

SP Oy, was s in October g the contrac ng system o itas / SYP b

eanalyysit vuo

00 2002

are correct su nd to take o h circumsta her people.

s - 42.400

⁷⁷

inland. The FIM 256

⁷⁸

-

divided in 1 r 1993. The ct. However of the buyer bank did not

osille 1991-199

uspicions, over the ances,

This is a

-

value of - 300

1993. This transfer of r, due to

banks

⁸¹

. t book the

94.

Bankruptcies

(21)

loss about FIM 2 billion in 1991, KOP bank did not either book FIM 2 billion loss in its income statement in 1991. The insurance company Sampo participated one of the major speculative deals in takeovers of banks. The loss from this deal in billion figures was simply left out from the books of the company

⁸³

.

7. Analysis

The macro economics studies concerning the Finnish depression in the beginning of 1990’s is comprehensive. Different research reports are describing the development of depression from various points of views. However, there are some weaknesses as well. First, one of the major reasons to the depression is the liberalisation process of financial market in 1980’s. The same pattern is found in several other countries, as well. Research reports do not present any data

concerning the fact that the same problems are occurring at the same time in each country. How is it possible that all economists are doing same mistakes at the same time in different countries.

Second, Cato institute report describes as follows – ‘All crises of one-way-option speculation

involve capital movements, of course. Speculative outflows of recent years, perhaps especially those from Mexico, Argentina, and Thailand, had been preceded by not particularly speculative capital inflows. These had been more or less predicated on the perception that the destination country had made itself attractive to investors by reforming its earlier bad ways’

⁸⁴

. There was in the end of 1980’s a capital inflow from Soviet Union to Finland

⁸⁵

. This capital created in Finland a new capital market i.e. grey capital market. This capital consisted of payments of Soviet companies. That

capital remained in Finland or more specific in Finnish banks as deposits. The Soviet capital created a specific type of financial market i.e. loan product to small and medium size companies

⁸⁶

. After the collapse of Soviet Union in 1991 the mentioned companies were privatized by oligarchs. They ordered the Finnish banks to transfer the company capital to new banks in Switzerland,

Luxembourg, London and New York

⁸⁷

. The collapse of the Soviet state was due to financial

‘bankruptcy’

⁸⁸

- Soviet Union had lack of foreign capital

⁸⁹

. Although, lack of capital the Soviet companies were able to make large capital payments to Finland. The official reports of DEA (US Drug Enforcement Agency) reveals, that the banks in Russia are ‘’cleaning’’ international capital in

83 Pankkien ja vakuutuslaitosten taseanalyysit vuosille 1991-1994.

84 Yeager, Leland B., 2003.

86 Ibid.

87 Busch, Gary K., 2003.; Email with Dr. Busch, 2003.

88 Ibid.

89 Ibid.

(22)

their system

⁹⁰

. The economic and financial research doesn’t cover the essential subject in the articles. Following questions still remain unanswered - What was the origin of Soviet capital, what happened with the Russian capital, did the capital transfers have effects on financial sector in Finland, and finally, did the Finnish authorities have a knowledge of the origin of the Soviet capital?

Rohto group started the planning process in May 1991. There are two matters worth to mention in this context. The group started the planning in early states. This means, that the state authorities have had knowledge about a political goal, which was not known in public. The work of this group was and still remains secret. Transparency in governance is the central issue

⁹¹

. Theories are emphasizing the need for transparency. Therefore, planning of state policies in secrecy suggests a risk for business owners

⁹²

. This kind of behaviour should be understood in some degree political risk

⁹³

.

The banking Task Force reviewing the situation in Finnish banks made a complete account of problems in financial sector. The group pointed out, that the strategic plan of all banks was a total failure. They failed in estimation of interest rates as well as future requirements in solidity. Problems of this kind are business uncertainties more than any political risks. The only political risk concerning the banking solution is the cooperation between banks and the State. The confidentiality of plans is source of political risk

⁹⁴

. Governance is in relationship with legal system and state policy. In case the government fails to follow the requirements of good governance then there is possibility to political risk

⁹⁵

.

The documentation used in the banking seminar in 1992 remains confidential.

Different sources present the highlights of the seminar. The purpose of this meeting was to inform the President Koivisto of the problems banks were facing. The important political factor was the political acceptance of President Koivisto. The solution for the problems in banking sector needed the political involvement and state resources. Therefore, the meeting, de facto, is a political

meeting. The need to transfer certain liabilities from banking sector refers to the same pattern used in the Enron case. To protect politically one specific industry, in this case the banking industry is a direct involvement in market operations. In addition, the meeting and its content is confidential.

Theories are defining the political risk as event or action of different actors

⁹⁶

. One more

90

Ibid.;

DEA Congressional Testimony 1996.; DEA Congressional Testimony 2002.; Dale Scott, Peter, 2005.

91 Globerman, Steven and Shapiro, Daniel, 2003.

92 Robock Stefan H., 1971.;

95 Ibid.

(23)

requirement is the hidden nature of the event

⁹⁷

. Miller also explains the political risk from the general environment and industry point of view. This is, general environment or industry uncertainties affecting the actors on the market

⁹⁸

.

President Koivisto invited judges, academic professors in law and representatives of legal research institutions to a seminar with him. Again, this seminar and the documentation used in the meeting remain confidential. Testimonies of participants supports the comprehension, that the purpose of the meeting was to ‘press’ the legal system to act according to the wish of the President Koivisto and the economical need of the country

⁹⁹

. The judges shall have the economic

responsibility in the society

¹⁰⁰

. One of the major causes of political risk is the ineffective law enforcement

¹⁰¹

or weak legal system

¹⁰²

. It is clear, that legal system acting illegally or misleading is a cause of political risk

¹⁰³

.

Securitisation of loans is used in the US market as well as in few countries in Europe.

The basic structure of the process is to transfer loans or other assets from bank to an investor

¹⁰⁴

. BIS report describes the securitisation process with following words – A number of concerns have raised in connection with asset securitisation. The main ones are that credit risks could remain with the bank...securitisation could damage the asset quality of a bank...demand close attention by bank supervision in order to ensure that banks conduct this business in a prudent manner. BIS report also notes, that the country legislation is important for a complex process as securitisation

¹⁰⁵

. In Finland did not exist any legislation for securitisation. It was not used before. The model of securitisation offered a suitable tool for the authorities to organize the asset transfer from Finnish banks to elsewhere. Although the securitisation task force published the report it was not publicly known. In contrary, the process has been a ‘secret’ of the administration. The process is not

transparent

¹⁰⁶

. Securitisation is a complex legal process. There should be legislation concerning the model if used in a country. Protecting one actor on market suggests more increased political risk

¹⁰⁷

.

Finally, the secret agreement signed in October 1993 consisting of the package of agreements is more as a political process, than a pure contractual relationship. In the mind of

97 Miller, Kent D., 1992.

99 Email from Professor Heikki Ylikangas, 2002; Email from Professor Jukka Kekkonen, 2002; Email from judge Olli Karikoski.

101 Robock Stefan H., 1971

107 Robock Stefan H., 1971. ; Miller, Kent D., 1992.

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different parties there must have been a goal. The large number of agreements describes more a process to reach the goal. The State of Finland as one party in the agreement used its political powers and resources for the process. This confidential agreement described the final solution for the needs of different parties. The solution consisted of two major elements. First, definition of person(s) (legal and people), who did not have protection of property

¹⁰⁸

. Second, structure how to transfer assets from owners to new actors i.e. securitisation

¹⁰⁹

. This agreement was not transparent.

Several items in the contract did break the law. There are serious criminal elements in the process concerning the contract. The agreement and the political and economical process described in it, is political risk defined in theories

¹¹⁰

.

Cato institute is publishing a study of economic freedom in about 150 different countries. The method used in the report is complex and consist of large number of parameters.

There is information collected from each country since 1980’s. The index figures as a trend

describes the development of parameters through the years. Finland has improved both index A and B, i.e. access to sound money and freedom to exchange with foreigners. The index C illustrates the level of politically motivated interferences in the country. This figure is improved in Finland only from 5,8 to 7,2. Research reports

¹¹¹

have characterised Finnish market as a closed one. The market structure was changed towards open since beginning of 1990’s. However, the index has not

increased more than one point between 1990 and 1995

¹¹²

. The figure deteriorated between 1995 and 2004

¹¹³

. The trend suggests still a controlled market. There is political involvement in market. This can be explained as general environment or industry specific uncertainty

¹¹⁴

.

Robock includes the ineffective law enforcement in causes of political risk

¹¹⁵

.

Likewise, Miller and Simon describes the legal factors important in this context. The research report of Globerman and Shapiro

¹¹⁶

explains the legal system as central when choosing investment

markets. Authorities in Finland agree to the values of various studies in context of FDI’s

¹¹⁷

. Cato institute presents in the economic freedom report also the status of legal system in countries. Since 1970’s they have information available in about 50 countries. Finland is one of them. As we can note they have changed the parameters in the report in 1990. Old data has been recalculated for the

108 Ibid.

109 Ibid.

110 Miller, Kent D., 1992.; Robock Stefan H., 1971.; Globerman, Steven and Shapiro, Daniel, 2003.; Kobrin, Stephen J., 1979.

112 Cato Policy Report, Jan/Feb 2007.

113 Ibid.

116 Miller, Kent D., 1992.; , Steven and Shapiro, Daniel, 2003.

117 Seminar ’’Oikeusvaltio, perusoikeudet ja tuomioistuinratkaisujen perusteleminen’’, September, 20, 2006.

(25)

new structure. Therefore, we can even use the old figures in trend analysis. Before the financial crisis Finland used to have figures below 8, which suggests a poorly functioning legal system. The improvement took place between 1990 and 2000. Thereafter, the index figures for almost all measurements are declining. Quality of legal system in Finland is hitting the level of 1980’s. This development suggests again increased political risk in Finland

¹¹⁸

.

The UN committee in Human Rights has published a clear message. Legal system in Finland is influenced by political people. Same pattern is found in the study of Transparency International. Although, the TI study has a different method message is clear. Legal system has a poor quality. Statistics in ECHR court provides a similar pattern. There are difficulties to organize fair trials in Finland. Once again, the results support the existence of political risk in Finland

¹¹⁹

.

Statistics from criminal sentences is important for understanding the outcome of political risk. It is not novel, that legal system is used for political purposes. The value of this information is the trend of sentences. The depression started in the beginning of 1990’s. Economists claim, that the real crisis started in 1992

¹²⁰

. The secret agreement was signed in 1993. All the

criminal records are increasing in number of sentences from the year 1993. This will show us the relationship between government actions and outcome of several business owners. In this context political risk is representing government actions in a combination of the secret agreement and criminal trials.

Political risk is related to actors in government. Statements of the actors describe the foundation for the crisis. First, several actors state, that the financial crisis is organized on purpose and increased unemployment will bring up the productivity. Statements indicate a planning process.

In this context we have to think about the Rohto group and its confidential work. The State of Finland had political and economical objectives, which were met with the outcome of the crisis.

Second, illegal means to carry out the financial crisis is the execution part. By controlling the state engine any plans can be executed without further negative consequences. Third, there is a

connection between the bankruptcies, criminal sentences and illegal behaviour of State authorities.

Finally, professor Kiander has found a ‘’crime and punishment theme’’ in the process

¹²¹

. That is, the outcome of the financial crises including the government decisions was kind of punishment to business owners

¹²²

.

120 Honkapohja Seppo; Koskela Erkki; Gerlach Stefan; Reichlin Lucrezia, 1999.

121 Kiander Jaakko, Ed., 2001.

122 Ibid.

(26)

Finland lost about 20 percent of operative companies during the financial crisis. This equals about 42.000 companies. The amount of bankruptcies started to increase in 1990 and turned back to its average figure in 2000. This trend can be explained as process of two waves. The first cycle was due to problems in Saving Banks and the second because of the confidential planning process. The secret agreement sealed up the political process. Interesting combination is the trend in bankruptcies and the criminal sentences. The trend of bankruptcies began to increase in 1990. The outcome, criminal cases and sentences increased just couple of years later. There is a logical connection in legal process.

Enron is in liquidation. This is because of fabricated accounting. They moved liabilities out from the company books. Exactly the same pattern can be found in Finland. The banks and insurance companies fabricated financial statements. The only difference found is, that the authorities and auditors knew this or they had to have knowledge of the issue. Although, the illegal proceedings no one made any actions to reveal the unlawful behaviour. The problem we are facing here is the criminal sentences. Why were only chosen people put under a control of criminal investigation and trial. The protection for chosen people was provided by authorities and

government. Therefore, this process only can be explained as political risk. The system in Finland was not transparent and it was discriminative i.e. companies was treated differently. The fabrication of accounting and behaviour of auditors are examples of bad governance and therefore considered as political risk

¹²³

.

To summarize the analysis, some issues shall be addressed. Globerman and Shapiro mention in their article, that in broad terms, governance infrastructure represents attributes of legislation, regulation, and legal systems that condition freedom of transacting, security of property rights, and transparency of government and legal processes. The presented data and analysis show clearly, that Finnish government and legal system damage all the attributes presented above. The secret agreement destroyed the property rights and demands for fair trials. Transparency was sacrificed when declaring the documentation of Rohto group

¹²⁴

, Banking seminar

¹²⁵

and legal seminar

¹²⁶

confidential. To this group should also be included the secret agreement. Lack of transparency can be found from banking documentation. Banks did plan in advance a ‘shot-down’

of liabilities

¹²⁷

. They planned bankruptcies and processes, how to handle this kind of issues

¹²⁸

.

123 Robock Stefan H., 1971.; Globerman, Steven and Shapiro, Daniel, 2003.

125 Decision of President Tarja Halonen, A/10773/2006 in Helsinki May 11, 2006

126 Decision of President Tarja Halonen, No 3/30.07.2002 in Helsinki July 30, 2002

127 Keskipohjan Aluesäästöpankki 15.7.1992 documentation

128 Ibid.