Clyde is right. But the incentives are wrong

There was something refreshing about Finance Minister Clyde Caruana’s candour during the pre-budget discussion. At a time when political communication too often reduces economic policy to announcements, slogans and lists of measures, Caruana was unusually willing to expose some of the tensions beneath Malta’s economic model. 

Employers have relied too heavily on relatively cheap labour rather than capital. Government departments have accumulated “fat” that now needs trimming. Energy subsidies inevitably contain some waste. Tax evasion remains sufficiently significant to justify using artificial intelligence to identify unexplained discrepancies between declared income and accumulated wealth. Perhaps most strikingly, the finance minister acknowledged that he has yet to see the studies underpinning a €2.8 billion light rail proposal announced before the election and will only pronounce himself once he has seen the numbers. Whatever one’s politics, such candour deserves recognition. Malta needs more of it. 

Importing labour 

Caruana is also right about the central economic challenge. Malta cannot continue indefinitely meeting every increase in demand by importing more labour. He estimates that the native labour supply is around 3,000 people annually while demand is north of 10,000. 

The gap has to come from somewhere, and for much of the past decade migration has filled it. That model allowed businesses to expand, supported public finances, increased consumption and helped Malta achieve extraordinary rates of economic growth. But its limitations are becoming increasingly visible in congestion, housing, infrastructure, public services and, most importantly, productivity. 

The pre-budget document itself shows productivity growth slowing from 2.2% in 2023 to 0.2% in 2024 and turning marginally negative in 2025. Caruana is therefore right when he says that Malta needs less reliance on labour and more on capital, technology and machinery. The disagreement is not with the diagnosis. It is with where responsibility for that outcome should primarily lie. 

It's the incentives, stupid 

Employers certainly make production decisions, but businesses respond to incentives. If an additional worker is cheaper, easier and less risky than investing in machinery, technology, automation or organisational transformation, many firms will choose the worker. That is not necessarily a failure of entrepreneurship. It is rational behaviour within the economic architecture they face. 

For years Malta has made labour expansion relatively easy while capital deepening has remained more difficult. Investment requires finance, confidence, management capability, skills and a willingness to accept risk. Technology requires people capable of using it. Automation requires sufficient scale to justify it. Meanwhile, an economic model capable of supplying additional workers allows firms to postpone some of those harder decisions. If we want businesses to behave differently, exhortation will not be enough. We have to change the incentives that shape their choices.  

This is where the political economy becomes uncomfortable because the incentives extend far beyond employers. Businesses want access to labour because it allows them to grow. Property owners benefit from additional demand. Government benefits from additional tax revenue and social security contributions. Consumers benefit from businesses remaining open and services remaining relatively affordable. Politicians benefit from an economy producing strong headline GDP growth and from avoiding reforms that impose visible costs today in return for less visible benefits tomorrow. Ministries naturally defend their budgets. 

Beneficiaries defend subsidies. Industries defend incentives. Voters understandably prefer benefits that can be felt immediately to reforms whose returns may materialise years later. No individual actor needs to be behaving irrationally for the collective outcome to become unsustainable. That is precisely what political economy teaches us: individually rational choices can produce a collectively suboptimal equilibrium. 

Government ‘fat’ 

Government itself cannot stand outside this analysis. General government expenditure increased by almost €490 million in 2025 to around €9.1 billion. Employee compensation rose by more than 8%, intermediate consumption by 16% and social benefits and transfers in kind also increased strongly. The deficit nevertheless improved because revenues grew even faster. Malta is not facing an immediate fiscal crisis. But buoyant revenues can hide inefficiency. 

When an expanding economy continuously generates additional income for government, difficult choices can be postponed. New programmes can be added without old ones disappearing. Departments can expand without being forced to demonstrate proportionately better outcomes. It is therefore encouraging that the finance minister is willing to identify “fat” in ministerial budgets. But trimming expenditure through the personal intervention of a determined finance minister is not a system. Malta needs an institutional mechanism that continuously asks whether public money is achieving what it was intended to achieve. Caruana himself said he has upset colleagues by cutting into their budgets while trying to keep the deficit below 3%. That tells us something important about the incentives operating within government itself.  

This is why performance budgeting and impact evaluation should become central to the next phase of Malta’s fiscal framework. Ministries should increasingly be required to explain not simply how much they spent, but what changed because they spent it. Major programmes should begin with measurable objectives and baselines, carry predetermined evaluation dates and, where appropriate, contain sunset provisions. Programmes that work should be expanded. Those that underperform should be redesigned. Those that repeatedly fail should eventually disappear. This would represent a profound change in political incentives because government would gradually move from rewarding the announcement of activity towards rewarding the achievement of outcomes. The annual budget would cease to be primarily a catalogue of what government intends to give and become a statement of what government intends to achieve. 

Deteriorating outcomes 

Education makes the case particularly powerfully. The pre-budget document contains no shortage of initiatives: Curriculum reform, literacy interventions, digital skills, AI literacy, inclusion and measures addressing early school leaving. Yet the latest PISA results are deeply concerning. Malta performed below the OECD average in mathematics, reading and science, and performance deteriorated from 2022 in all three areas. Only 52% of Maltese 15-year-olds achieved at least baseline proficiency in reading, 56% in mathematics and 63% in science. 

The point is not to blame teachers, nor to conclude that every educational programme has failed. It is that a system can be extremely busy while its outcomes deteriorate. More programmes, more technology and more expenditure do not automatically create more capability. Education policy therefore needs the same discipline Caruana is asking of businesses: What are the inputs producing? If Malta wants firms to substitute capital for labour, it must also produce workers and managers capable of deploying that capital productively. Human capital and physical capital are complements, not substitutes. 

Electoral politics 

The light rail discussion illustrates the same principle from another direction. Malta desperately needs to address transport, and a mass transit system deserves serious consideration. But Caruana’s insistence that he wants to see the numbers before committing himself is precisely the discipline major public investment requires. A project costing €2.8 billion cannot be assessed according to whether people like the idea, whether an attractive rendering can be produced or whether it makes a compelling electoral announcement. It needs rigorous appraisal of demand, financing, construction risk, operating costs, alternatives and the economic value created. 

If the finance minister has not yet seen the underlying studies for what was presented as the largest infrastructure project in Malta’s history, the issue goes beyond light rail. It raises a question about sequencing. Serious public policy should normally move from problem to evidence, from evidence to options, from options to appraisal and only then from appraisal to political commitment. Electoral politics has a tendency to reverse that process.  

The same incentive logic applies to taxation. Caruana deserves support for using technology and AI to identify discrepancies between declared income and observable wealth. A system capable of analysing multiple parameters across the taxpayer population and flagging someone declaring very low income while purchasing substantial assets is an example of technology being used to improve state capability rather than simply digitise an existing process. Before asking compliant taxpayers to shoulder ever greater burdens, government has an obligation to improve compliance with taxes already due. 

But if new taxes are eventually introduced, their purpose should extend beyond filling fiscal gaps. Good taxation changes incentives. It can discourage activities generating social costs, encourage productive investment and make the overall allocation of resources more efficient. The question should therefore not only be how much revenue a tax raises, but what behaviour it rewards or discourages. 

Energy subsidies dilemma 

Energy subsidies expose perhaps the hardest version of this dilemma. Here I would part company slightly with the finance minister’s categorical position. He is right that removing subsidies abruptly would transmit a substantial external energy shock directly into household bills, inflation, wage demands, business costs and economic sentiment. The subsidies have worked as a shock absorber and their contribution to Malta’s recent economic stability should not be underestimated. But acknowledging that a subsidy works is different from declaring that it should remain uncapped indefinitely. 

Caruana himself accepts that some money is being wasted, while arguing that the opportunity cost of withdrawal would be greater. That may be true today. The longer-term objective, however, should be to use the stability purchased by subsidies to reduce the vulnerability that makes them necessary. Otherwise an emergency intervention becomes another permanent feature of the political economy, defended because removing it becomes progressively more painful. 

This is ultimately the thread connecting labour, migration, education, subsidies, taxation, infrastructure and public expenditure. Malta does not suffer from an absence of economic actors making rational decisions. It suffers from an incentive architecture that too often makes the easier short-term decision rational. That is why Caruana’s candour should be welcomed. A finance minister publicly saying that some spending contains fat, that some subsidies contain waste, that businesses have relied excessively on labour and that he wants to see the numbers before backing a major infrastructure project is opening the door to a more mature economic conversation. But the next step must be to move beyond identifying the symptoms and redesign the incentives producing them. 

The next transformation 

Malta’s first great economic transformation succeeded because the country became exceptionally good at mobilising more resources. The next one requires us to become better at allocating them. That means capital instead of simply more labour, capability rather than simply more spending, outcomes rather than announcements, and evaluation rather than assumption. It also means accepting that government cannot ask the private sector to become more productive while exempting itself from the same question. 

Perhaps Budget 2027 should therefore be judged against a deceptively simple test. Not how much more government spends, how many new measures it announces or even how much growth it forecasts, but whether it begins changing the incentives that determine how Malta’s people, businesses and government behave. 

Clyde is right that the model has to change. But models do not change because we ask people to behave differently. They change when behaving differently becomes the rational thing to do. And that is driven mainly by incentives.