Case for cautious optimism?
Businesseurope, the Confederation of European Business, incorporating 39 central industrial and employers' federations, among which the Malta Federation of Industry, and which represents more than 20 million companies, has just issued its economic...
Businesseurope, the Confederation of European Business, incorporating 39 central industrial and employers' federations, among which the Malta Federation of Industry, and which represents more than 20 million companies, has just issued its economic outlook for spring 2008. Its main message is that while significant risks to EU business performance have rapidly materialised in recent months, a cautious degree of optimism remains warranted, with there being no perceptible risk of a recession in the EU economy. These conclusions are based on the results of a survey among Businesseurope member federations undertaken in March 2008.
The risks to EU business performance
Risks to business performance have increased markedly in recent months. The sharp slowdown of the US economy is leading to a global contraction in aggregate demand with consequences for EU business. The turmoil in the financial markets, which has been on-going since the summer of 2007, is having negative repercussions not only on demand but also on business financing possibilities. Rising prices of oil and food are also hampering business activity in the EU, as is the significant depreciation of the US dollar against the euro. Another risk is that the consequent inflationary upsurge would lead to unsustainable wage increases which will hurt competitiveness, growth and ultimately employment. In the light of these considerations, real GDP growth in the EU is expected to decelerate from 2.9 per cent in 2007 to 2 per cent in 2008, while inflation is projected to rise from 2.2 per cent to 2.8 per cent over the same period (see Chart 1).
Reasons for cautious optimism in the EU
In spite of these issues, the GDP growth rate expected for 2008 for the EU should outstrip that of the US economy. EU growth is expected to remain at levels which provide a sufficient margin of safety against the risk of a recession. Moreover, expectations for 2009 point to a stabilising rate of growth and a deceleration in inflation in the EU. Businesseurope believes that the following six factors will contribute to the resilience of EU business in the coming months:
• Growth in the EU has been robust in recent years and indeed stronger than that of the US, indicating underlying competitiveness strengths which should serve EU business well in the current scenario;
• Labour markets have improved substantially across the EU, especially with the introduction of practices based on flexicurity, which aim at enhancing job security through increased flexibility in work practices, including those related to working hours and performance-related pay - as a result, two million jobs are expected to be created across the EU in 2008;
• EU business in general rests on sound financial foundations which can withstand a drop in profitability in the short term, with business investment expected to increase by over 3 per cent in 2008;
• Despite a deteriorating external environment and an overvalued euro exchange rate, EU exports are expected to enjoy robust demand from emerging as well as oil-producing economies and are expected to rise by 5 per cent in 2008;
• European business is significantly affected by rising oil and commodity prices, but a strong euro and improved energy efficiency are expected to attenuate their exposure to oil price volatility compared with global competitors; and
• Relatively high household savings and a less exposed banking sector make the European economy less vulnerable to the present financial market turmoil than the US.
Implications for Maltese business
The openness of the Maltese economy to international business implies that developments in the global economic environment are very relevant to its performance. As Chart 2 shows, Malta's real GDP growth is expected to decelerate from around 4 per cent in 2007 to 3.4 per cent in 2008, while inflation is projected to rise markedly to 3.1 per cent in 2008. Both these indicators are expected to move to more favourable levels in 2009. These developments are very much in line with expectations for the entire EU block.
On the other hand, the economic structure and policy framework in Malta impacts on the extent to which positive global developments spill over into our economy and conversely, negative external shocks dent the performance of local business. Within this context, there are two questions which are worth considering. To what extent are the justifications for optimism regarding EU business performance applicable to the Maltese economy? What other specific causes for optimism and concern can be identified in the case of Malta?
As was the case in the EU, Malta's GDP growth was relatively strong in recent years. It accelerated in 2005 to fluctuate between 3 per cent and 4 per cent since then. This is in good part attributable to the fact that the brunt of fiscal tightening had been taken by 2004. The extent to which this reflected an improvement in the economy's fundamental competitiveness and productivity is debatable, but an indication in this respect may be obtained through an analysis of the main sectors contributing to GDP growth.
In 2007, personal services, real estate and manufacturing were the principal contributors to economic growth. Within the personal services sector, there has been significant growth in the activities of international remote betting companies, which may indicate a competitive strength for Malta. However, part of the increase was due to inward-oriented services driven mainly by local demand. Within the manufacturing sector, most of the growth was driven by the budding pharmaceutical sub-sector, while the potential of a number of other sub-sectors, including those that underwent substantial restructuring in recent years, remains to be unleashed. Growth in the real estate sector is not directly indicative of improved competitiveness if it was driven mainly by higher prices on transactions undertaken between residents. It may thus be concluded that while the upswing in growth in recent years was in good part based on an improvement in the competitiveness of the economy, there remain vulnerabilities to downside shocks.
As opposed to developments in the EU, the labour market in Malta has not significantly benefited from improved arrangements based on the flexicurity concept. Within this context, Malta enjoys a system of enterprise-based collective bargaining, which allows a degree of sensitivity of negotiations to enterprise-specific competitiveness issues. There has also been a marked improvement in labour training schemes. On the other hand, the system of automatic cost of living adjustment which is granted irrespective of affordability has a deleterious effect, as do working time arrangements and practices which are not geared to today's international market realities.
As in the case of the EU outlook, Maltese business may be said to enjoy a sound financial basis which would enable it to withstand short-run downswings in profitability. The component of profit within GDP in Malta fluctuates around 40 per cent, which is comparable to those of EU countries with a similar level of development. There are however sectors which may be vulnerable to profitability declines: in the hotels and restaurant sector, profits amount to 16 per cent of the sector's GDP, while the comparable figure for manufacturing is 32 per cent as shown in Chart 3. On the other hand, Malta enjoys a strong degree of financial stability, which would allow the financial system to continue providing the capital and liquidity necessary for domestic business to overcome short-term stresses.
Considerations made earlier on regarding the competitiveness fundamentals underpinning growth also apply to the extent to which Malta can continue to rely on export activity within a deteriorating external environment. The issue of the strengthening euro may pose additional problems for Malta compared to the average situation within the EU. Although most of Malta's international trade transactions take place with euro area countries, microchips, which are an internationally-traded commodity priced in US dollars, constitute a significant part of manufacturing exports, value-added and employment.
The appreciating euro is to an extent sheltering EU economies from the increase in the price of oil. Enhanced energy efficiency and a diversification of energy sources is however essential to overcome the effects of higher oil prices. In these respects, Malta is currently less well-placed than other EU states, as the country has one of the highest ratios of use of oil per euro of GDP generated and is among the States with the lowest capability for alternative energy generation.
Finally, in terms of vulnerability to financial market turmoil, Malta does not appear to be facing more pronounced problems compared to other EU states.
Within the specific context of the Maltese economy, there may be other causes for concern or optimism which are not strictly encompassed by the Businesseurope analysis. For instance, EU funding under the current budgetary process and the introduction of the euro can be expected to start exerting positive effects on economic growth in Malta's economy in 2008, although the full impact of these benefits will occur mainly in the medium term. Some significant new business investment is also expected, including the SmartCity project but also in a number of high value added manufacturing activities. The brunt of the effects of downsizing of private sector unproductive activities has now been taken, although there remain areas calling efficiency-oriented reforms in the public sector. On the other hand, the country remains vulnerable to issues such as the need to secure cost-effective and reliable cargo shipping connections to northern Europe and the challenges of improving the level of education in the population and the workforce.
Policy responses
The policy orientations advocated in the Businesseurope Economic Outlook for Spring 2008 point to the need to curb inflationary pressures. In turn, this must be accompanied by responsible action on the part of trade unions in their wage demands, in order to avoid price-wage spirals. Governments must remain committed to fiscal discipline most notably in countries where consolidation efforts have been insufficient.
Priority actions advocated by Businesseurope with respect to inducing economic growth across the EU include:
• Promoting market competition, particularly in transport and energy;
• Boosting innovation and skills development through better coordination of EU and national policies. Reaching the 3 per cent of GDP target for research and development spending as set by the EU could increase real GDP growth by 0.5 per cent a year for a decade; and
• Implementing flexicurity principles in national labour market strategies in order to enhance adaptability, provide new forms of security and modernise social protection systems.
Businesseurope is advocating progress on each of these policy areas in spite of its optimism, however cautious, with regard to the development of the EU economy. It is also obvious that these policy prescriptions are also to a large extent essential for Malta. While significant economic progress has been registered by Malta in recent years, the smallness and specificities of our economy may render us more vulnerable, compared to other EU countries, to the downturn in the international economic situation. Now more than ever, we cannot afford to be complacent in the face of the need for decisive action in order to safeguard and continue to improve our competitiveness, and ultimately, our livelihood.
• Mr Cordina is economic adviser of the Malta Federation of Industry.
The risks to EU business performance
Risks to business performance have increased markedly in recent months. The sharp slowdown of the US economy is leading to a global contraction in aggregate demand with consequences for EU business. The turmoil in the financial markets, which has been on-going since the summer of 2007, is having negative repercussions not only on demand but also on business financing possibilities. Rising prices of oil and food are also hampering business activity in the EU, as is the significant depreciation of the US dollar against the euro. Another risk is that the consequent inflationary upsurge would lead to unsustainable wage increases which will hurt competitiveness, growth and ultimately employment. In the light of these considerations, real GDP growth in the EU is expected to decelerate from 2.9 per cent in 2007 to 2 per cent in 2008, while inflation is projected to rise from 2.2 per cent to 2.8 per cent over the same period (see Chart 1).
Reasons for cautious optimism in the EU
In spite of these issues, the GDP growth rate expected for 2008 for the EU should outstrip that of the US economy. EU growth is expected to remain at levels which provide a sufficient margin of safety against the risk of a recession. Moreover, expectations for 2009 point to a stabilising rate of growth and a deceleration in inflation in the EU. Businesseurope believes that the following six factors will contribute to the resilience of EU business in the coming months:
• Growth in the EU has been robust in recent years and indeed stronger than that of the US, indicating underlying competitiveness strengths which should serve EU business well in the current scenario;
• Labour markets have improved substantially across the EU, especially with the introduction of practices based on flexicurity, which aim at enhancing job security through increased flexibility in work practices, including those related to working hours and performance-related pay - as a result, two million jobs are expected to be created across the EU in 2008;
• EU business in general rests on sound financial foundations which can withstand a drop in profitability in the short term, with business investment expected to increase by over 3 per cent in 2008;
• Despite a deteriorating external environment and an overvalued euro exchange rate, EU exports are expected to enjoy robust demand from emerging as well as oil-producing economies and are expected to rise by 5 per cent in 2008;
• European business is significantly affected by rising oil and commodity prices, but a strong euro and improved energy efficiency are expected to attenuate their exposure to oil price volatility compared with global competitors; and
• Relatively high household savings and a less exposed banking sector make the European economy less vulnerable to the present financial market turmoil than the US.
Implications for Maltese business
The openness of the Maltese economy to international business implies that developments in the global economic environment are very relevant to its performance. As Chart 2 shows, Malta's real GDP growth is expected to decelerate from around 4 per cent in 2007 to 3.4 per cent in 2008, while inflation is projected to rise markedly to 3.1 per cent in 2008. Both these indicators are expected to move to more favourable levels in 2009. These developments are very much in line with expectations for the entire EU block.
On the other hand, the economic structure and policy framework in Malta impacts on the extent to which positive global developments spill over into our economy and conversely, negative external shocks dent the performance of local business. Within this context, there are two questions which are worth considering. To what extent are the justifications for optimism regarding EU business performance applicable to the Maltese economy? What other specific causes for optimism and concern can be identified in the case of Malta?
As was the case in the EU, Malta's GDP growth was relatively strong in recent years. It accelerated in 2005 to fluctuate between 3 per cent and 4 per cent since then. This is in good part attributable to the fact that the brunt of fiscal tightening had been taken by 2004. The extent to which this reflected an improvement in the economy's fundamental competitiveness and productivity is debatable, but an indication in this respect may be obtained through an analysis of the main sectors contributing to GDP growth.
In 2007, personal services, real estate and manufacturing were the principal contributors to economic growth. Within the personal services sector, there has been significant growth in the activities of international remote betting companies, which may indicate a competitive strength for Malta. However, part of the increase was due to inward-oriented services driven mainly by local demand. Within the manufacturing sector, most of the growth was driven by the budding pharmaceutical sub-sector, while the potential of a number of other sub-sectors, including those that underwent substantial restructuring in recent years, remains to be unleashed. Growth in the real estate sector is not directly indicative of improved competitiveness if it was driven mainly by higher prices on transactions undertaken between residents. It may thus be concluded that while the upswing in growth in recent years was in good part based on an improvement in the competitiveness of the economy, there remain vulnerabilities to downside shocks.
As opposed to developments in the EU, the labour market in Malta has not significantly benefited from improved arrangements based on the flexicurity concept. Within this context, Malta enjoys a system of enterprise-based collective bargaining, which allows a degree of sensitivity of negotiations to enterprise-specific competitiveness issues. There has also been a marked improvement in labour training schemes. On the other hand, the system of automatic cost of living adjustment which is granted irrespective of affordability has a deleterious effect, as do working time arrangements and practices which are not geared to today's international market realities.
As in the case of the EU outlook, Maltese business may be said to enjoy a sound financial basis which would enable it to withstand short-run downswings in profitability. The component of profit within GDP in Malta fluctuates around 40 per cent, which is comparable to those of EU countries with a similar level of development. There are however sectors which may be vulnerable to profitability declines: in the hotels and restaurant sector, profits amount to 16 per cent of the sector's GDP, while the comparable figure for manufacturing is 32 per cent as shown in Chart 3. On the other hand, Malta enjoys a strong degree of financial stability, which would allow the financial system to continue providing the capital and liquidity necessary for domestic business to overcome short-term stresses.
Considerations made earlier on regarding the competitiveness fundamentals underpinning growth also apply to the extent to which Malta can continue to rely on export activity within a deteriorating external environment. The issue of the strengthening euro may pose additional problems for Malta compared to the average situation within the EU. Although most of Malta's international trade transactions take place with euro area countries, microchips, which are an internationally-traded commodity priced in US dollars, constitute a significant part of manufacturing exports, value-added and employment.
The appreciating euro is to an extent sheltering EU economies from the increase in the price of oil. Enhanced energy efficiency and a diversification of energy sources is however essential to overcome the effects of higher oil prices. In these respects, Malta is currently less well-placed than other EU states, as the country has one of the highest ratios of use of oil per euro of GDP generated and is among the States with the lowest capability for alternative energy generation.
Finally, in terms of vulnerability to financial market turmoil, Malta does not appear to be facing more pronounced problems compared to other EU states.
Within the specific context of the Maltese economy, there may be other causes for concern or optimism which are not strictly encompassed by the Businesseurope analysis. For instance, EU funding under the current budgetary process and the introduction of the euro can be expected to start exerting positive effects on economic growth in Malta's economy in 2008, although the full impact of these benefits will occur mainly in the medium term. Some significant new business investment is also expected, including the SmartCity project but also in a number of high value added manufacturing activities. The brunt of the effects of downsizing of private sector unproductive activities has now been taken, although there remain areas calling efficiency-oriented reforms in the public sector. On the other hand, the country remains vulnerable to issues such as the need to secure cost-effective and reliable cargo shipping connections to northern Europe and the challenges of improving the level of education in the population and the workforce.
Policy responses
The policy orientations advocated in the Businesseurope Economic Outlook for Spring 2008 point to the need to curb inflationary pressures. In turn, this must be accompanied by responsible action on the part of trade unions in their wage demands, in order to avoid price-wage spirals. Governments must remain committed to fiscal discipline most notably in countries where consolidation efforts have been insufficient.
Priority actions advocated by Businesseurope with respect to inducing economic growth across the EU include:
• Promoting market competition, particularly in transport and energy;
• Boosting innovation and skills development through better coordination of EU and national policies. Reaching the 3 per cent of GDP target for research and development spending as set by the EU could increase real GDP growth by 0.5 per cent a year for a decade; and
• Implementing flexicurity principles in national labour market strategies in order to enhance adaptability, provide new forms of security and modernise social protection systems.
Businesseurope is advocating progress on each of these policy areas in spite of its optimism, however cautious, with regard to the development of the EU economy. It is also obvious that these policy prescriptions are also to a large extent essential for Malta. While significant economic progress has been registered by Malta in recent years, the smallness and specificities of our economy may render us more vulnerable, compared to other EU countries, to the downturn in the international economic situation. Now more than ever, we cannot afford to be complacent in the face of the need for decisive action in order to safeguard and continue to improve our competitiveness, and ultimately, our livelihood.
• Mr Cordina is economic adviser of the Malta Federation of Industry.