Though vehemently denied by Malta’s power elites, the decision to adopt the euro in January 2008 was rushed and premature. Apart from all that could be said about the euro being a fair weather construct, from a Maltese perspective the reality was that, on joining the euro, the island locked itself into a cost-competitive structure that was disadvantageous.

The fragility of the Maltese economy could be severely exposed if the euro crisis deepens- Alfred Sant

To start from this point is not to indulge in schadenfreude but to recognise the base line from which an appreciation of Malta’s real interests must start as we face up to the pressures and problems the euro crisis holds for us. Its consequences could be extremely serious, even if the government prefers to gloss over the issue. The assessment of where we start from and where we can go to must be hard-nosed, unless we wish to inhabit a complacency trap.

No matter what the ruling elites say, the Maltese economy has become increasingly fragile in recent years. Growth is being fuelled by two sectors – internet gaming, about which the government prefers to keep mum (vide the latest pre-Budget document), and financial intermediation. Other productive sectors have declined, not least as measured in employment terms, which is still the best way by which to gauge economic performance.

Nor is it true that, say, for manufacturing or for hotels and restaurants, employment has only been hit by the 2008 crisis. A decline has been consistently occurring since 2002, at least. Meanwhile, we may be close to a tipping point for construction and real estate, always the leader of booms. The likelihood that here things will not go over the edge mostly stems from the vital interest of the banks not to pull the plug. Whether that state of affairs will hold depends too on how the euro crisis develops.

During the past few years, attempts to balance the government budget were mainly defined by privatisation and by seeking to make infrastructural services non-loss making. The target of promoting competitiveness was paid lip service. Privatisation has ensured that high costs still remain and translate into higher prices while profits go private. Increased prices for governmental services have had the effect of making productive enterprises and the public pay for ongoing inefficiencies, injecting a further round of upward price triggers. This mechanism was locked into the economy when Malta adopted the euro the way it did. Now, the government makes puzzled statements about the need for further studies to determine why the island is carrying an endemic inflation rate that is higher than the EU average, by more than the island’s diseconomies of scale would justify.

A related development has been that both public and private investment in infrastructural and directly productive enterprise stayed at dangerously low levels over past years.

This gets fudged because headline investment data includes the funds parked in Malta due to financial intermediation activities. While such funds are welcome, they in no way contribute to directly productive investment, which has lagged. Underinvestment (which can also take the form of the late start, rephasing or late termination of investment projects) is a major reason underpinning lack of competitiveness and the inefficiencies that fuel endemic inflation, plus the fact that the Maltese economy habitually performs at well below its potential capacity.

Employment is again a good measure of the latter point. Despite government complacency about the “low” rate of unemployment, were Malta’s unemployment data benchmarked to a labour participation rate equal to the EU average the island’s effective unemployment rate would run at over 17 per cent – among the EU’s highest.

The fragility of the Maltese economy could be severely exposed if the euro crisis deepens. It makes sense, therefore, to have a clear idea of how the different likely outcomes to the eurozone crisis could affect our standing. If the government has carried out any evaluation of the situation from this perspective, it has kept remarkably close-mouthed about it.

On the euro, we stand in the position of policy takers, not policymakers. This is true – has been true, despite much political rhetoric – for most policy areas that have an interface with the outside world. Under successive administrations, the narrow margins for manoeuvre defined for autonomous action under the Independence Constitution of 1964 have been progressively eroded, mostly because a majority of the Maltese people believed that there was no way the island could operate on a stand alone basis. Adoption of the euro was an extremely important stage of this ongoing process because the Maltese authorities accepted to become policy takers over their own national currency, surrendering all margins for autonomous action. The real problem is not that they did it, because that was a commitment under Malta’s EU Accession Treaty, but that they did it when they did.

So now, we must reflect about how to best protect our interests in full knowledge that there is nothing we can really do to fend off decisions that will be taken or not taken in the context of the eurozone, no matter how much we pretend to the contrary.

In this context, a few strategic guidelines for Maltese policymaking stand out. We need to secure as much space as possible to improve competitiveness. We need to rebalance our economic structures away from overdependence on financial intermediation and internet gaming without allowing these to be killed off or stifled. We need to trigger more investment initiatives. We need to mobilise more capital and then absorb it more cost effectively in productive and infrastructural ventures (not least education). Probably, all this could be summed up in one guideline: invest, invest, invest!

Yet, the options outside of catastrophe that seem most likely for the eurozone could inhibit our already restrained room for manoeuvre on all these points. Such options seem to be emphasising the priority for one-size-fits-all policies within the eurozone, regarding public spending, incentives to promote particular economic sectors and the conduct of social welfare policies. Many of the ideas being mentioned fit the Maltese context badly.

Here, therefore, are some comments that could define Malta’s corner within the euro camp as matters come to a head:

• a zero deficit Budget is of less importance to Malta over the medium term, compared to improving overall competitiveness and rebalancing economic growth; this can be done in part through selective increases in government spending, even if eurozone budget deficit criteria are breached;

• a constitutional change to make a balanced budget imperative might reassure the Bundesbank and the ECB but could be less than meaningful, indeed counterproductive, for a small island economy like Malta;

• in estimating how budget deficits turn out, it is crucial to make a distinction between recurrent and capital spending; special windows need to allow “excess” allocations of the latter for strategic reasons related to growth and improvements in competitiveness;

• contributions to euro support funding are not project tied; by way of quid pro quo, those participating in such support funding should be able to get their project counterpart capital funding from the EU streamlined and reduce drastically the involvement of the Brussels bureaucracy with all the delays this brings, subject to proper audit controls;

• there should be a clear ceiling set regarding national exposure for on-lending by euro support funds, whether in terms of straight transfer of monies or by way of guarantees; if such on-lending is being tied to collateral in the case of other eurozone members, why not for Malta too?

• harmonisation of tax and other incentives to businesses as Ireland is being pressured to accept – and as would be logical in a federally-organised economic system – must be regarded as toxic for Malta; a natural focus in this context would be financial transactions… which would affect one of Malta’s few lucrative sectors. Quite likely, similar measures could soon follow for internet gaming, where already a green paper for a harmonised Europe-wide policy was floated earlier this year by the EU Commission;

• any upcoming centralisation/federalisation of economic management at eurozone level, whether called governance or something else, will surely entail proposals for common taxation across the eurozone, with financial services as an early target; that would serve to further burden Malta’s uncompetitive cost structures.

There are other relevant considerations, which require lengthier description. More will emerge in coming weeks as the eurozone crisis takes its toll. Always eager to tranquillise public opinion, the government has claimed and will claim that it already took into account all the above points plus others and that it knows what it is doing. Perhaps. But then the government claimed likewise when deciding to join the euro so prematurely.

Surely, what is needed is not wishful thinking but a strategic vision, dovetailed to Malta’s present position as a policy taker in the mess that the eurozone has become. Curiously, if the government has followed such an approach, it has been kept under wraps. Why?

(Concluded. The first part of the article appeared yesterday.)