One of the issues that has been the subject of various economic studies in both Europe and the United States is whether the business climate and the gross domestic product move in synch or not. In Malta the issue is becoming of interest because there are still those who claim that the business climate is not so positive, while statistics are showing an improvement in various economic indicators.
Business confidence and, its twin, consumer confidence, which together make up the business climate, are known to be rather indefinable, very intangible and quite hard to put into concrete terms, while GDP data is as concrete and tangible as you can get. However, economists expect very rightly that one should be a reflection of the other.
Let us start with the GDP data. The Economic Survey published with the budget shows that year-on-year, GDP at constant prices (that is after accounting for inflation) increased in June 2006 by 2.6 per cent. This follows an increase of 2.2 per cent in 2005, a zero per cent increase in 2004 and a 2.4 per cent decrease in 2003.
The Central Bank of Malta, in its Quarterly Review, has confirmed this situation as it estimates that the economy will grow by two to 2.6 per cent in 2006, an improvement on its earlier projections. Other data published by the National Statistics Office also demonstrate an improving economic situation. The Business Statistics for the manufacturing sector show a growth in turnover, employment and wages and salaries over last year, even if some segments within this sector have experienced a decline.
On the investment front we have had increases every year from 2003 to 2006, in spite of a drop in GDP in 2003 and a flat GDP in 2004. Investment is at times taken to mean an indication of the business climate - essentially if the business climate is negative, there is very little incentive for the business sector to invest. Thus the first contrast emerges, in that over a four-year period an indicator of the business climate showed a positive trend in each of these years, while GDP showed a negative trend at first and a positive trend in the latter part of this period. A partial explanation of this contrast could be that, since GDP is an aggregate figure, any growth or contraction would hide what is happening in the various sectors of the economy.
Another indicator of business climate is the Business Perceptions Survey undertaken by the Central Bank. The most recent one was held in July and August of this year and was also commented upon in the CBM Quarterly Review.
This survey showed a small improvement in forms' expectations about the general economic situation. This was mainly driven by better economic sentiment among export-oriented firms, even though projected exports were expected to experience a reduction. This is yet another contrast between trends in business climate and trends in a very significant component of GDP.
Assessing consumer confidence, this contrast emerges even more. The public's perception of the economic performance of the country was positive in 2003, when the country had a reduction in its GDP, while this same perception is rather negative this year and last year, when we had a growth in our GDP. We had the same trend with regard to the public's perception about their own financial situation. The conclusion is fairly clear - business climate and gross domestic product do not move in synch.
Why would this be so? Other countries have been through a similar experience, while in others the positive or negative trends in one have reflected themselves in the other. The answers to this dilemma may be various. As I have already written, business climate may be something rather hard to define in very concrete terms. The climate is a result of a number of intangible and even emotional factors. Hence it is very difficult to achieve commonality between hard economic data, which is very rational and very easy to measure, and something that is based on emotions.
Moreover there may be a time lag in the way business climate reacts to what is actually happening in the economy. So even when things are going well, it may take some time before businesses and consumers convince themselves of this. It could also be that, because bad news travels fast while good news takes a lot longer, business climate reacts much more quickly to negative economic data. It is quick to show a negative trend but not so quick to show a positive trend. Putting it crudely, one can talk an economy into a bad mood but it is very difficult to talk it out of it.
Business climate is also linked to expectations. So an economy may be experiencing a negative business climate not so much because its performance is bad but because businesses and consumers expect it to be better than it is. One may add to this discussion the employment data of the last months, where it becomes very evident that the economy is overcoming the negative impact of the international economic slowdown of the first half of this decade.
The debate continues - should one let economic data speak for itself or should one rely on the business climate pervading in an economy to make an assessment of the state of the economy?