News • December 07 2003

A poor economic performance

Charles Mangion hits out at this year’s budget, accusing the government of lacking vision and solutions

“The Maltese economy is in dire need of both reform and restructuring in its economic and financial fundamentals to meet the challenges of globalisation and European Union membership. Market imperfections in the goods, money, labour and external sectors of the economy as well as the government mismanagement of the state finances are all contributing to the downward trend in the economic performance of the nation and the deepening national debt problem.
The latest figures on economic performance published by the NSO show that our economy is at the threshold of a recession, growing only by 0.3% in real terms between January and September 2003. Between January and September, private consumers’ expenditure declined rapidly from 3.2% in 2002 to 1% in real terms while in sharp contrast government consumption rose by 9.4% for the same period. Similarly, the savings ratio continued its downward trend falling to 1.8%. Unemployment continued to rise with over 8,000 registered unemployed persons with the Employment and Training Corporation in October 2003, of which more than 45% are under 30 years of age. The external balance also deteriorated with a fall of 1.6% in the exports of goods and services and a rise in imports of 4.3% in real terms. The structural deficit increased from Lm85 million in 2002 to Lm135 million for the same period. Simultaneously the cost of adjusting to EU membership continued to rise. All economic indicators clearly point out to an under performing economy tilting towards a recession unless fundamental issues are addressed.
Although international factors such as a slow European economic recovery and the war in Iraq and terrorism may have had an impact on our economic performance, they cannot on their own explain the bad shape of our economy. In spite of these factors Asian economies continued to grow steadily while the United States economy boomed at 7%. If we assume a growth rate of 0.8% in real terms in 2003 for the Maltese economy, this falls well below the EU average and much lower than other EU accession countries where according to published Eurostat statistics the growth rate in real terms was for Cyprus 2%, the Czech Republic 2.2%, Estonia 4.4%, Hungary 4.3%, Latvia 6%, Lithuania 6.6%, Poland 3.3%, Slovakia 3.8% and Slovenia 2.2%. In deed, we have to look elsewhere for an explanation. The reality is that structural issues such as economic and institutional reforms as well as micro and macro restructuring of the economy have not been properly addressed. The consequences of long-term inertia and economic and financial mismanagement on the part of government are clearly visible in terms of poor economic performance, loss of competitiveness, problems in the balance of payments, a sharp decline in local and foreign direct investment, rising unemployment and a spiralling public deficit. One would have expected that the government would have used fiscal policy through its budgeting exercise for 2004 to address these issue by taking adequate measures to stimulate the economy, facilitate industrial as well as economic restructuring while at the same time keeping the structural deficit under control.
Unfortunately, the budget for 2004 aims at achieving neither restructuring nor reform objectives but myopically drives at increasing tax revenue, ignoring the plight of our industry and the economy. In total the government intends to increase tax revenue by over Lm59 million in 2004 on 2003, through the various, now well known tax measures it proposed to introduce.
These fiscal measures will certainly impact the economy but nowhere in the budget does the government introduce mitigating instruments to soften the negative effects on a fragile economy. Focusing on resolving the national debt problem solely on the basis of raising tax revenue at the expense of all the other macro economic objectives is both myopic and self-defeating. The increase in the VAT by 3 percentage points will reduce real income, private consumption, sales and output. Competitiveness will be further eroded if trade unions use the VAT increase to justify wage claims which would burden industry if this is not compensated by corresponding increases in productivity. Via the multiplier effect it will further reduce national income and increase both prices and unemployment. Falling incomes will reduce tax revenue and increase transfer payments diluting significantly tax measures to reduce the structural deficit.
The government is also failing to acknowledge that a significant across the board increase in the VAT will put a higher tax burden on the lower and middle income groups defeating the principle of fairness in taxation. Similarly, substantial increases in the registration tax of used cars tend to act against the lower, income groups of society.
Attempting to raise revenue by over Lm1.3 million by forcing elderly persons living in government financed homes to pay 80% of their pension is anti-social and effrontery to the dignity of the weaker members of society.
To compound the issues further, these budgetary measures have created a ‘feel bad’ factor among the people and the business community. Negative expectations generated by these budgetary measures will further contribute to the economic decline with business leaders postponing investments and consumers cutting on their personal consumption. If the people perceive that government remedies as advocating paying more for less, they become more resistant to reform. The negative reaction of the majority of the social partners to the budgetary measures only serve to underline the lack of conviction by civil society in the government’s economic and fiscal direction.
The government must acknowledge in real terms that we have a problem with competitiveness. The declaration by the now defunct WET Company and the current problems with Malta’s largest exporting company should have been an eye-opener on the state of competitiveness of our industries. Government must reduce induced costs to industry. The efficiency of the public sector must rise. This could be achieved by proper redeployment of personnel, greater flexibility in work practices and the elimination of subcontracting to private contractors when this could be done by government employees. It makes no economic or financial sense to leave your employees idle to give work to the private sector. There should be a gradual meaningful reduction in the size of the public sector. There must be some rationalisation of government entities through synergies or eliminations. It is about time to introduce regular operations audit in the public sector.
Incentive packages must be given to industries to set up or restructure. It is inconceivable that the MDC/ Malta Enterprise has been left in limbo when there is such a problem with attracting new investments. How can you influence investment decisions and provide business leadership without a proper functional institution? The effects always follow with a time lag. The education system must also be reformed to be consistent with industry needs. The setting up of MCAST is a step in the right direction. However, more effort is needed to align our educational system more with the country’s present and future human resource requirements especially in the technical field.
Rather than opting for tax solutions to the deficit problem the government should have used fiscal policy to stimulate reform and encourage economic restructuring. The crises in the state finances can be better resolved if government reduced its expenditure particularly its operating outlays. The Mater Dei hospital is a case in point of project mismanagement. Government should take steps to reduce its operating costs. It should reduce unnecessary spending on new embassies, corporations and public entities. New work contracts particularly in management and consultancy fees as well as site embellishments should be strictly controlled. The rate at which expenditures are increasing in public entities should be effectively monitored.
By far, this is the most uninspiring budget ever with no ideas on how to bring about the reforms needed to face the new challenges ahead and helping to create an environment conducive to industrial and economic restructuring. The obsession to tackle the structural deficit in the shortest time possible to meet the Maastricht criteria by concentrating only on the revenue side of the equation has made the government oblivious to alternative remedies and fundamental macro and micro economic considerations. Such policy decisions may crate more problems than it sought to achieve. The government should be flexible enough to change its policy stance to address meaningfully our economic and financial woes unless it wants to take full responsibility for a major economic recession.
Economic recovery ought to be our topmost priority, expanding our tax base in order to generate more revenue whilst at the same time endeavouring to control the public sector ever expanding operating costs and this without undermining the welfare state.”