Strengths and weaknesses in Malta’s competitive position

Central Bank Governor Michael C Bonello recently delivered a paper to the EMCS Ltd conference 'Beyond Surviving: Competing to Succeed'. Following are extracts from his address, in which he stresses that the need to be competitive is a vital economic imperative for Malta

The purpose of this paper is to assess Malta’s competitive strengths and weaknesses as a small economy facing up to the challenges of regional economic integration and globalisation. In this context it is relevant to note that the process of globalisation has increasingly been driven by foreign direct investment (FDI), which has grown much faster than world trade in recent decades. For FDI host countries this has meant not only an increase in output and employment, but also a transfer of technology and know-how that has considerably strengthened their economies. Failure to compete in a globalise world, therefore, is likely to result not merely in lower sales but, more importantly, also in less investment and, therefore, in weaker growth prospects.

Having defined the challenge, I now propose to assess Malta’s performance with respect to factors that have been shown to be crucial to the competitiveness of nations. Such an assessment is, I believe, essential if we are to understand the adjustments that need to be made to improve the wealth-creating capacity of the economy. It can also help to build consensus among the social partners about the country’s economic priorities and objectives.

Among the many definitions of competitiveness available, perhaps the most comprehensive is that used by the OECD, which describes the concept as "the degree to which a country can, under free and fair market conditions, produce goods and services which meet the test of international markets, while simultaneously maintaining and expanding the real incomes of its people over the long term". This definition requires businesses to be successful in the long run without relying on protectionist measures, government subsidies or low labour costs. It thus highlights the roles of knowledge and productive efficiency as the crucial factors that are likely to contribute to the attainment of all of these objectives simultaneously.

In this sense competitiveness becomes a national issue as much as an enterprise concern. Enterprises, which are the main engines of national income creation, are at the front-line in the international markets where competitiveness is tested. On the other hand, the efficiency of resource allocation in a country and the availability of the skills, knowledge and innovative practices necessary to sustain the competitiveness of enterprises are national concerns.

National competitiveness a vital economic imperative

The need to be competitive is for Malta a vital economic imperative. Its small size and lack of natural resources translate into a high degree of openness. Malta depends heavily on imports for its consumption and investment needs, and equally critically on exports to generate the foreign exchange required to service its import bill. Imports and exports are each equivalent to around 100% of GDP. This openness could result in a high degree of vulnerability to external shocks if the economy is only competitive in a few niches that are susceptible to changes in market conditions. The impact of last year’s sharp decline in the global demand for electronic products and tourism services on Malta’s GDP growth rate was a sobering reminder of this truth.

On the other hand, such openness could become a source of economic resilience if it is backed by a strong competitive position that provides resistance against external shocks and allows successful participation in markets that are spread over different geographical regions and products. The degree of competitiveness is thus the key factor that could determine whether Malta’s inherent openness translates into a weakness or a strength.

At this particular point in time, the need to be competitive is accentuated by the current phase of the economic cycle. Against a background of feeble global demand growth, competition is becoming even more intense. The challenge implied by this unfavourable external environment is compounded by the fact that irrespective of whether Malta joins the EU, our exports would still have to meet the standards set in the European Single Market.

At the same time, the scenario for Malta’s exporters is rapidly changing with the arrival of new competitors from Central and Eastern Europe. These countries, together with Cyprus and Turkey, are vying to secure access to the EU market through membership of the Union. Competing against these countries is not going to be easy. Suffice it to say that although Malta enjoys a per capita income that is just under 60% of the EU average, making it the third most productive economy among the group of EU candidate countries after Cyprus and Slovenia, its price level is already around 90% of the EU average, making it the most expensive economy within the group. It is also probable that since Malta has a relatively low rate of unemployment and a high degree of capacity utilisation, productivity will in future grow at a slower pace than that of other countries possessing a larger pool of employable resources.

It is clear then that Malta is past the stage where it can attempt to achieve higher levels of economic activity on the basis of low labour costs. The way forward must involve a greater focus on knowledge and innovation-based investment. This is a challenge that spans the economic, social and cultural structures of the economy and therefore requires a holistic approach to promoting national competitiveness. Numerous country experiences suggest that this requires the fulfilment of ten basic criteria, which may be called the golden rules of competitiveness, and against which competitive strengths and weaknesses can be assessed.

Measuring Malta’s competitiveness

The Central Bank of Malta follows developments in the country’s international competitiveness closely, not least because it has a direct responsibility in setting exchange rate policy. Among other efforts, the Bank’s Economic Research Department has recently embarked on a project aimed at assessing Malta’s competitive position through a micro-analysis of various factors that determine the country’s performance relative to the standards set by the golden rules discussed earlier on.

One of the approaches being used is the adaptation to a small country context of the methodology of the World Competitiveness Yearbook published by the International Institute for Management Development based in Switzerland. This respected publication analyses and ranks the ability of nations to provide an environment that sustains the competitiveness of enterprises on the basis of economic, political, social and cultural dimensions. It includes over 300 criteria and currently covers the major economies including all EU members as well as seven of the economically larger EU candidate countries. Malta is currently not covered by the study and that is also why the Central Bank is undertaking a similar exercise.

As this work is still in progress, I will focus on some broad preliminary results pertaining to the four main competitiveness criteria considered in the study, namely economic performance, government efficiency, business efficiency and the adequacy of the infrastructure and their main determinants. Data used are for the most recent available indicators, generally for 2001. Rather than focusing on Malta’s competitiveness in a global ranking context, I will concentrate on domestic concerns by comparing Malta’s competitiveness to the average of the EU member countries and to that of the seven candidate countries covered by the Yearbook. In this way, Malta’s competitiveness is analysed directly in terms of developments in its principal partner and competitor countries for international business.

Economic performance

The assessment of economic performance is partly based on the premise that the current level of prosperity of a country reflects its past track record and can therefore be used as an indicator of future potential. The indicators stress the role of domestic market competition in sustaining competitiveness together with the export-orientation of the economy and its ability to attract FDI. The main measures of economic performance are the level of development, the extent of international trade and investment and movements in employment and prices.

On a scale that puts economic performance at 100 in the EU, Malta’s score is 83 whereas other candidate countries have an average score of 70. Thus, while Malta has much catching up to do in order to achieve EU competitiveness levels, it enjoys an advantage compared to other candidate countries. Indeed, Malta scores consistently higher than these countries in all aspects of economic performance, reflecting mainly its relatively high per capita GDP and low inflation and unemployment. Malta emerges as particularly strong in terms of its exposure to international trade, which means that it must sustain a competitive and dynamic export sector and can hardly afford to pursue inward-looking economic policies. The economy’s resilience also contributes to this relatively high score, as the export sector seems able to withstand substantial fluctuations in demand without excessive repercussions on employment or firm closures. Continues on page 21

And although Malta is a price-taker in world markets, the country appears to benefit from positive terms of trade effects as it tends to export goods and services whose international prices have been increasing relatively fast.

Malta’s main weaknesses in terms of economic performance emanate from two sources. One is the small size of the country that prevents activities from being substantially diversified while enjoying economies of scale. The other is a weaker performance in the attraction of FDI relative to the EU average. Malta’s score is 56, the lowest within the set of determinants of economic performance, in spite of offering an attractive incentive package. As observed earlier, these packages are equally attractive across FDI host countries such that they are no longer a sufficient condition for success in attracting investment. Investors to-day seek profitable opportunities in countries that offer the best prospects in terms of what we have called the golden rules for competitiveness.

With regard to employment, while Malta and other EU candidate countries have roughly similar scores, Malta’s score is sustained by a relatively low unemployment rate which offsets the effects of a relatively slower rate of employment generation. The latter is in good part a reflection of the former, in the sense that employment cannot grow substantially in a labour market that is already tight. However, to the extent that the tightness in the labour market reflects rigidities, Malta could well forego growth opportunities that are likely to be exploited by its competitor countries in the near future.

Thus, while Malta’s present economic performance indicates a relatively satisfactory level of competitiveness, its future growth rate may be sub-optimal due to the disadvantages of its smallness and insufficient FDI. Regional integration within the EU is one option that could contribute to overcoming these difficulties, but other corrective actions need to be taken nevertheless.

Government efficiency

The assessment of government efficiency reflects the principle that government should provide stable and predictable macroeconomic and social conditions and thus minimise risks for enterprises. Another important government role is to provide adequate and accessible educational and knowledge resources. Policies should, moreover, be flexible to adapt to changes in the international environment. Apart from these considerations, government intervention should be kept to a minimum. The main determinants included in the measurement of government efficiency are the state of public finances, the adequacy of fiscal policy and business legislation in encouraging enterprise activity, the strength of the institutional framework and the performance of the education sector.

Relative to the EU average, Malta’s score with respect to government efficiency is 82%, which is only marginally higher than that in other candidate countries. Malta fares poorly in terms of the state of its public finances. This is because, although considerable progress has been achieved in the reduction of the fiscal deficit, the deficit and debt levels in other candidate countries are typically lower. Government in Malta in fact continues to absorb a relatively large proportion of the nation’s resources.

On the other hand, Malta scores at a level comparable to the average of the EU and of other candidate countries in terms of the orientation of fiscal policy towards promoting competitiveness. This is a reflection of the commitment to reduce the deficit in the medium-term, as well as the programmes of privatisation and public sector restructuring, including early retirement schemes and the control of tax evasion. The relatively low marginal tax rates on incomes and corporate profits in Malta are other competitiveness – enhancing features.

Malta also scores well, especially in relation to other EU candidate countries, in terms of the adequacy of its institutional framework. I am pleased to note that the primary factor here is the stability in the country’s interest and exchange rates resulting from the policy actions of an independent Central Bank whose primary objective is the maintenance of price stability. Indeed, long gone are the times when economists used to advocate artificially low interest rates and exchange rate devaluations to promote a country’s competitiveness. The institutional framework in Malta could, however, benefit from more consensus regarding strategic policy directions, less bureaucracy and greater transparency in government and in public institutions.

Malta’s score measuring the adequacy of legislation for business is, at 73% of the EU average, lower than those for fiscal policy and the institutional structure, but is nevertheless higher than that of the other EU candidate countries. The degree of government intervention in the economy in the form of subsidies and direct controls weakens Malta’s score. Furthermore, the small size of the country complicates the effective implementation of the up-to-date competition legislation that is in place. On the other hand, Malta is strong in investment promotion and protection, the regulation and confidentiality of financial transactions, and the legal treatment of foreign companies.

The last dimension of government efficiency in relation to competitiveness considered here is the adequacy of the education sector. Malta scores a relatively low 61% of the EU average compared to 80% in other candidate countries. Although Malta has relatively high pupil-teacher and school enrolment ratios, it scores less well in terms of literacy and of the availability of engineering and business skills. There is also a gap in the knowledge transfer between educational institutions and industry, and this is hampering productive innovation.

Business efficiency

The assessment of business efficiency focuses on the entrepreneurship skills available in the country, the efficiency and effectiveness of the financial sector in sustaining business initiatives, as well as the skills, adaptability, attitudes and productivity of the labour force. In this area, Malta scores at 61% of the EU average compared to 72% in other candidate countries. This is clearly another source of competitive weakness, and is primarily determined by labour market practices, the use of financial resources, management practices and the extent to which the effects of globalisation have permeated domestic business.

Within the labour market, unit labour costs are found to be generally competitive and responsive to market conditions. A major weakness, however, is the disincentive effect of the relatively narrow wage differentials in Malta for improving labour skills and increasing effort. The low female participation rate, and the relatively large public sector employment figure combined with inflexible work practices are other important labour market weaknesses.

In the financial sector, Malta lacks adequate schemes for venture capital, while the response to such schemes as do exist is generally poor. This may reflect deficiencies in the entrepreneurial culture, especially in the domestically-oriented sector that has typically engaged in low–risk ventures such as real estate and importation, or relied on protectionist measures and tax evasion. Another shortcoming is the low-key role played by the stock exchange in financing business start-ups. The relative thinness and lack of liquidity of the market further contribute to limit its role in promoting economic competitiveness.

Malta’s relatively low score in the area of management practices in part reflects lacunae in the entrepreneurial culture just referred to. These may include the presence of family-owned businesses dependent on dominant market positions, and thus unlikely to pass the test of competitive international markets. There are also perceived shortcomings in business attitudes towards customer satisfaction and social responsibility. As regards the impact of globalisation, the main concerns stem from the continued sheltering of a number of sectors from international market realities, and the fact that Maltese business tends to react to external developments with a lag.

Adequacy of the infrastructure

The adequacy of the infrastructure is assessed in terms of the extent of the support it provides to business, including access to information technology, environment protection and research and development. The criteria used to measure this factor consist of an assessment of the state of various infrastructural amenities including basic services, as well as technological, scientific, health and environment facilities. The system of moral values in the country is also assessed as a measure of social cohesion.

Malta fares relatively badly in terms of the provision of basic infrastructure services, scoring 56% of the EU average compared to over 80% in other candidate countries. The reason for this are deficiencies in the provision of energy and water services in Malta, such as power and water cuts, and their relatively high cost. Transportation is another area of concern, where monopolistic arrangements are keeping port charges at unsustainable levels. The high cost of international telephone services is another reason for Malta’s low score.

Malta’s technological infrastructure is in a better shape and compares very favourably with that in other candidate countries. This reflects recent developments such as the proliferation of mobile telephony and internet usage, together with the high concentration of technological exports. On the other hand, Malta scores less well as regards scientific infrastructure, reflecting the dearth of research and development activity. The country has generally low scores for research and development expenditures, the publication of scientific articles and the generation of patents. In terms of the value system, as reflected by the quality of life, culture, discrimination and gender equality, Malta is at 70% of the EU average, which is slightly lower than the average score of other candidate countries. This is mainly due to the lower participation rate for women. On the other hand, health services in Malta are very satisfactory by international standards.

To sum up then, Malta’s relative strengths are: its past economic performance; exposure to international trade; monetary stability; fiscal reform efforts; and its technological infrastructure. The main areas of competitive weaknesses are: its insufficient attractiveness to FDI; lacunae in its education system; labour market rigidities; shortcomings in the entrepreneurial culture; excessive government intervention in the economy; inadequacies in basic infrastructure services; and insufficient research and development activity.

Conclusions

In today’s global economy a competitive edge cannot be built on the basis of protectionist measures or low-cost operations. National competitiveness is increasingly becoming a function of pervasive economic efficiency and of knowledge-based activities. These factors carry the promise of a sustained expansion in the wealth-generating capacity of an economy. If exploited, this potential could enable a society to fulfil its economic, social and political aspirations.

Malta needs to draw the necessary conclusions from this reality perhaps even more than other countries due to its extreme openness and dependence on international trade. This implies taking a critical look at all the factors that impinge on the country’s competitive position and then seeking to capitalise on the strengths and eliminate the weaknesses. Some of the more striking ones have been identified in this paper.

A number of desirable orientations for policy emerge clearly from this analysis. First, government should continue in its efforts to foster macroeconomic balance by reducing the fiscal deficit and absorbing fewer resources. At the same time, it must continue to redirect resources to where they are most likely to promote competitiveness, namely in education and the infrastructure. Second, domestically-oriented business should adopt a more outward-looking entrepreneurial culture that is focused on exports rather than relying on short-term advantages in the captive domestic market or sheltering behind protectionist measures. Third, labour market practices should be more oriented towards rewarding skills and effort and to linking remuneration to productivity. This implies an important role for labour unions in educating their members, both in the private and public sectors, about the challenges and requirements of a competitive global market-place.

It is furthermore important that competitiveness issues remain at the forefront of the national agenda. Research of the kind presented here needs to be undertaken regularly in order to gauge evolving trends. Ideally, this work would be undertaken by a technical expert group set up under the aegis of the Malta Council for Economic and Social Development. The Central Bank would be willing to contribute to such an effort.

I stress the need to take these policy prescriptions on board because, while the results of our research are only of a preliminary nature and should be interpreted with due care, they are consistent with other available evidence, and suggest that we do not enjoy any advantage relative to our main competitors, and that we are actually around only three-fourths as competitive as our main trading partners. This does not allow for complacency in attitudes towards competitiveness issues. If we do not actively strive to improve our position, then it is very likely that we will fall behind to the detriment of current and, even more so, of future generations.