The subsidy trap: Afraid to live without it

There is a temptation when discussing Malta’s energy and fuel subsidies to reduce the debate to a simple question: Can we afford them? That is increasingly the wrong question. The more important question is what we are buying with them; what we are giving up in return; and whether a policy that has successfully protected the Maltese economy from an extraordinary external shock can remain sustainable if that shock becomes part of the new normal.

The starting point should be an acknowledgement that is sometimes missing from this debate. Malta’s energy subsidies have worked. They have protected households from a dramatic increase in electricity and fuel costs, insulated businesses from part of the increase in their operating costs, contained inflationary pressures and helped prevent an international energy crisis from transmitting fully into the domestic economy.

The stability Maltese consumers have experienced while energy markets elsewhere have been extraordinarily volatile did not happen by accident. Government effectively transferred a substantial part of the external shock from household and corporate balance sheets onto its own.

The scale of that protection is becoming clearer. The Economic Policy Department has estimated that without the energy subsidies Malta’s GDP would be almost €630 million lower over the coming three years. Consumption would fall by €312 million, investment would suffer, more than 3,000 jobs could be lost by 2028 and household disposable income would decline by around 6%. The same estimates suggest that a household with two cars is effectively saving around €2,000 a year through the policy. These are not marginal effects.

They suggest that abruptly removing the protection would constitute a significant contractionary shock to an economy that has become accustomed to stable energy prices.

This matters because it changes the nature of the argument. It is too easy to describe subsidies simply as wasteful public expenditure. In Malta’s case they have effectively operated as a macroeconomic shock absorber. An external increase in energy prices would normally work its way through the economy.

Fuel and electricity rise, businesses face higher costs, transport becomes more expensive, workers seek compensation for declining purchasing power, wage pressures increase and some of those costs feed back into prices. For a small, highly open and energy-dependent economy, that transmission mechanism can be particularly powerful.

Government interrupted part of that process. It bought stability. The issue now is what happens when we have to keep buying it.

The bill is becoming substantial. Energy subsidies are expected to cost €392 million in 2026, the highest amount yet, taking cumulative expenditure over the past five years to around €1.3 billion. This is occurring as international energy conditions have again deteriorated and previous expectations that the subsidy burden would gradually decline have been overtaken by events. The fiscal deficit, previously expected to continue falling, is now projected by the finance minister to rise from 2.2% of GDP in 2025 to 2.8% this year.

Malta is not facing an immediate debt crisis and that is an important point to remember. Public debt remains relatively contained by European standards, at just under 46% of GDP. The argument, therefore, should not be that the country suddenly cannot afford to protect its population. It is about something more subtle and ultimately more important—fiscal space.

Every government faces choices about how it deploys finite resources. Hundreds of millions spent insulating the economy from energy prices cannot simultaneously finance infrastructure, education, healthcare, public transport, renewable energy generation and storage, digitalisation or climate adaptation. This does not mean that the €392 million being spent on subsidies could simply be transferred euro for euro into investment. Removing the subsidies would itself affect consumption, employment, tax revenues and economic growth. The finance minister has made precisely this argument, suggesting that apparently saving €20 million on subsidies could ultimately result in a €50 million loss of income.

But opportunity cost does not disappear simply because an intervention is economically justified.

Shock absorber and engine change

Indeed, this is where the warnings coming from the Malta Fiscal Advisory Council become particularly relevant. Strong expenditure growth is gradually reducing the room available for additional spending. When governments face increasingly rigid expenditure commitments, new priorities either require additional revenue, savings elsewhere or more borrowing. Fiscal sustainability is therefore not simply about remaining below a particular deficit or debt threshold. It is also about retaining sufficient room to respond when the next shock arrives.

This is where the debate should move beyond whether subsidies are good or bad. The real distinction is between spending public money to absorb vulnerability and investing public money to reduce vulnerability.

For the past several years, absorbing vulnerability was understandable. Malta did not create the war in Ukraine, instability in international energy markets or the geopolitical shocks affecting oil and gas supplies. Allowing the entire adjustment to pass immediately to households and businesses would have imposed significant economic and social costs. Governments exist partly to absorb shocks that individual citizens cannot reasonably manage themselves.

But a shock absorber is not the same thing as an engine of transformation.

This distinction also lies behind the IMF’s repeated calls for Malta to rebuild fiscal buffers while creating greater space for productive investment. Its assessment has acknowledged Malta’s strong economic performance and relatively sustainable public debt position, while simultaneously arguing for the gradual withdrawal of broad energy support as conditions permit, coupled with continued protection for vulnerable households. The logic is not difficult to understand. Temporary intervention can be entirely justified during an exceptional shock. The difficulty begins when temporary intervention becomes embedded within the normal functioning of the economy.

The events of recent years also demonstrate why timing matters enormously. Removing support in the middle of another international energy shock would be very different from gradually reforming it during a period of relative stability. Economic policy cannot operate independently of circumstances. A rigid timetable for withdrawal would make little sense when the underlying international conditions can change so quickly.

Yet the underlying structural concern remains valid. Permanent price suppression weakens the signal that scarcity is supposed to send through an economy. Consumers have less incentive to reduce consumption. Businesses have less incentive to improve energy efficiency. The economics of renewable investment change when conventional energy prices are insulated from international markets. Government, rather than households and firms, increasingly carries the volatility.

This creates an unusual paradox. The policy that protects Malta from energy insecurity can, if maintained indefinitely without accompanying structural reform, reduce the pressure to become less energy insecure.

That is the subsidy trap.

The trap

It is not that Malta made a mistake by introducing the subsidies. On the contrary, the available evidence increasingly suggests that they played an important role in protecting economic stability. The trap emerges when a successful crisis intervention gradually becomes an expectation, and eventually an entitlement, without a credible pathway towards reducing the underlying exposure that made the intervention necessary.

There is also a political economy problem. Introducing a subsidy is relatively easy. Removing one is extraordinarily difficult. Once households and businesses organise their spending decisions around a particular fuel or electricity price, the subsidised price becomes psychologically perceived as the normal price. The market price becomes the increase. The longer this continues, the larger the economic and political adjustment associated with normalisation becomes.

This is why an abrupt withdrawal would make little sense. After years of insulating the economy, suddenly exposing households and businesses to the full international price would itself create precisely the shock the policy was designed to prevent. The government’s own modelling illustrates the potential consequences. The choice is therefore not between maintaining every subsidy indefinitely and eliminating everything tomorrow.

There is a third path.

Subsidy as a bridge

Malta needs to treat the subsidy as a bridge between vulnerability and resilience. The protection should create the political and economic space within which the country reduces the exposure that necessitated it. That means accelerating renewable generation, strengthening the electricity grid, expanding storage, improving energy efficiency and diversifying energy sources. Every euro that reduces Malta’s structural exposure to imported energy also reduces the potential fiscal cost of protecting the economy from the next international shock.

Transport must form part of that conversation. Malta cannot indefinitely separate fuel policy from transport policy. If the strategic objective is to reduce congestion, encourage public transport, improve air quality and reduce dependence on private cars, permanently suppressing the price signal associated with fuel pulls in the opposite direction. This does not mean motorists should suddenly face international prices in full. It means that the long-term architecture of energy support must eventually become consistent with the country’s transport and environmental objectives.

The same principle applies to businesses. Instead of thinking only about subsidising the energy they consume, policy should increasingly help firms consume less of it, generate more of their own and invest in technologies that make them more resilient to future price shocks. Support can gradually migrate from subsidising consumption towards subsidising transition. The state would still be helping businesses, but it would increasingly be helping them escape the vulnerability rather than continuously compensating them for it.

This would also change the way we think about the €1.3 billion already spent. It should not simply be viewed as money lost. It purchased stability during one of the most disruptive periods for global energy markets in decades. It protected disposable incomes, businesses and employment while reducing the domestic transmission of international inflation. Those are real economic returns.

The next billion

But the next billion should ideally buy something more than another period of stability. It should also help buy independence from the need for the billion after that.

The broader issue is therefore one of fiscal resilience. Malta has benefited from strong economic growth and a debt ratio that remains comparatively manageable. That fiscal capacity has allowed government to respond aggressively to successive shocks. But buffers matter precisely because nobody knows what the next shock will be. Over a remarkably short period governments have dealt with a pandemic, wars, inflation and energy disruption. Climate events, demographic pressures, geopolitical fragmentation or another financial shock may define the next decade. Permanently committing significant fiscal capacity to suppressing one source of volatility inevitably reduces the room available to confront another.

This is perhaps the most important trade-off. The subsidy protects today’s economy, but fiscal space protects tomorrow’s.

The success of the policy should therefore make the discussion about its future easier rather than harder. There is no need to rewrite history or pretend that the intervention failed. It did what it was supposed to do. It shielded purchasing power, supported businesses, contained part of the inflationary shock and helped preserve economic stability. The question facing Malta now is how to preserve those achievements while gradually changing the mechanism through which resilience is delivered.

The debate should move away from the binary language of keeping or removing subsidies. The real objective should be to reduce Malta’s need for them. That requires a long-term transition in which protection remains where genuinely necessary, particularly for vulnerable households, while investment progressively attacks the structural causes of our exposure. Any eventual normalisation should therefore be gradual, predictable and accompanied by alternatives. Otherwise, reform simply transfers risk back from government to households.

There is an important difference between protecting an economy from a crisis and protecting it permanently from reality. Malta was right to do the former. It must be careful not to drift into the latter.

The danger is therefore not that the subsidy failed. The danger is that it worked so well that we become afraid to live without it.