Developments in the Global Economy

1. Developments in the Global Economy Implications for Malta Presentation to GRTU National Business Conference Gordon Cordina University of Malta 16 December 2008

2. Contents • Economic recession: definition and causes • Medium-term economic fluctuations • The drivers of expenditure growth • Macro-econometric model simulations • Some opportunities for growth • Conclusions and policy implications

3. Economic Recession Definition and Causes

4. Definition of a Recession “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales” National Bureau for Economic Research

5. The Causes of a Recession • Aggregate Supply Issues • amount of resources available • productivity and efficiency • competitiveness • Aggregate Demand Issues • household and government consumption • business investment • external demand

6. The Causes of a Recession • Market failure leading to mismatches between aggregate demand and supply • irrational perceptions of wealth • inadequate information and uncertainty • inappropriate policies • Aggregate demand issues are mainly relevant at the global level - contagion of demand drop from one large economy to another • At the domestic level, aggregate supply issues are of major importance - small size may either expose or insulate an economy from global demand shocks depending upon its competitiveness

7. Medium Term Economic Fluctuations in Malta

8. Economic fluctuations during this decade Average long-term growth: Malta 1.9% EU15 2.0% Source: Eurostat

9. Economic fluctuations during this decade • Business cycle fluctuations in Malta tend to coincide with those in the EU15 • Fluctuations in Malta are typically three times as strong as those in the EU15

10. GDP growth in Malta accelerated in a sustained manner in recent years but the peak growth for this decade will probably be in 2007 Source: Eurostat

11. Short-term Forecasts for Malta • A slowdown in economic growth is highly probable • economic vulnerability emanates out of dependence on exports and imports • economy has not sufficiently restructured towards sectors that are immune from cyclical fluctuations • these considerations should be used to stimulate pro-active business and restructuring rather than to fuel a downturn through irrational fear

12. Short-term Forecasts for Malta • Forecasts for economic growth are however highly uncertain: • uncertainty in global economic forecasts • dependence on single sectors of activity subject to unpredictable shocks • relatively weak links between different sectors (GDP is a sum of unrelated parts) • speed of effectiveness of countercyclical fiscal measures (at domestic and EU levels)

13. Uncertainty in Global Growth Forecasts Credit crunch will lead US into mild recession Credit crisis not as bad as expected – oil price record Weaker growth but well short of global recession Major downturn with US and EU in recession Source: IMF

14. The Drivers of Expenditure Growth in the Maltese Economy Exports Consumption Investment

15. The Generation of Income in Malta - 2007 Imports Lm2.1 bn (+3.5%) Exports Lm2.0 bn (+5.6%) Consumption Lm1.9 bn (+3.6%) Local Income Lm2.3 bn (+6.1%) Wealth and perceptions thereof Domestic Competitiveness; External Conditions Investment Lm0.5 bn (+6.2%) Strong causality Weak causality Source: NSO

16. The Drivers of Expenditure Growth in the Maltese Economy Exports Consumption Investment

17. Export-oriented activity generated the 2007 growth peak Source: NSO

18. Composition and Growth of Total Exports Exports of services have in 2007 become as large as those of goods and have grown at a much faster pace. Source: NSO

19. Composition and Growth of Manufacturing Exports Traditional major export products are in decline, with the only noticeable growth in the expanding sector of pharmaceuticals. Source: NSO

20. The Drivers of Expenditure Growth in the Maltese Economy Exports Consumption Investment

21. Consumption is tending to fall in relation to income Various factors lead to this and are likely to continue impinging in the near future. Source: NSO

22. The necessary progressive reduction in the fiscal deficit curbed consumption growth Source: NSO

23. Some unpleasant oil price arithmetic Every US$10 increase in the price per barrel consumes approximately 1% of Malta’s GDP Source: NSO

24. Malta’s economy is relatively energy intense and fully dependent on fossil fuels

25. Developments in Real Estate Prices and Activity Real estate prices continued to increase, albeit correcting the exceptional rise in 2004 and 2005 A stable development of real estate prices is essential Activity remained stable downwards following the 2005 peak

26. The Drivers of Expenditure Growth in the Maltese Economy Exports Consumption Investment

27. Malta’s Competitiveness Strengths for Investment * Average of Cyprus, Greece, Portugal and Slovenia (EU economies that are most comparable to Malta)

28. Malta’s Competitiveness Weaknesses for Investment * Average of Cyprus, Greece, Portugal and Slovenia (EU economies that are most comparable to Malta)

29. Investment Performance Malta’s strengths relate to: • activities of a small number of relatively large hi-tech FDI companies • factors relating to ICT penetration Malta’s weaknesses relate to: • SME innovation performance • education The fundamental question is whether the strengths compensate for the weaknesses in investment attraction

30. Simulations from a Macro-econometric Model Exports Consumption Investment Run Model Simulations

31. Opportunities for Growth Developing an International Real Estate Sector Speed of Restructuring

32. Vacant Properties • The stock of vacant properties rose by 50% in a period of ten years • Increase in potential supply did not avert the affordability problem • An excessive accumulation of vacant property may constitute a threat to the proper development of market prices • The stock of vacant properties is above all a valuable asset which may be exploited to generate income from abroad

33. Opportunities • The stock of vacant properties has an estimated imputed annual income of €535 million (10% of the country’s GDP) • Selling vacant properties in holiday areas to foreigners over 15 years would bring an extra €250 million per year to the Maltese economy • This would not crowd out resident buyers. There would still be around 20,000 vacant properties available to residents, whose annual demand is around 6,000 units per year while 11,000 new units are being built each year

34. Opportunities • These opportunities would be realised if Malta were to capture 0.8% of the UK market • Scandinavian markets also present considerable potential

35. Opportunities • A possible approach would be to identify developed areas with a potential for international real estate marketing involving: • possible redevelopment employing the construction sector • favourable tax regime for property in target areas • a sustainable development approach • opportunities for earnings and internationalisation of the economy

36. Opportunities

37. Opportunities for Growth Developing an International Real Estate Sector Speed of Restructuring

39. The Speed of Restructuring Real Estate Chemicals Services Electronics Textiles Slope of trend line indicates that speed of restructuring towards higher value added activities is taking place, albeit at a somewhat slow pace

40. Conclusions and Policy Implications Some Strategic Considerations regarding the 2009 Budget

41. Conclusions • Malta is likely to be strongly susceptible to the downturn in global economic activity • Export growth is vulnerable - international economic turmoil - competitiveness issues • Moreover, domestic consumption growth is likely to be restrained - fiscal consolidation - higher prices - slowdown in real estate prices • Competitiveness issues may curtail investment potential, which is particularly vulnerable in the current international environment • Restructuring is taking place • Indicators point to a probable slowdown in economic activity in the coming quarters

42. Policy Implications • The reduction of the fiscal deficit should no longer be the primary focus of fiscal policy: medium term fiscal sustainability however remains imperative • An increase in fiscal expenditure aimed at inducing productivity improvements towards long term growth (innovation, education, production costs, etc) is needed: • ideally by shifting resources from unproductive expenditure • but also by increasing overall expenditure within the constraints of fiscal sustainability if necessary

43. Budget 2009: Some Strategic Considerations • the difficulties in the international situation which significantly impacts the local economy and the Government’s revenue • an unavoidability and indeed a desirability for an increase in the fiscal deficit compared to the projected path • the need for medium term sustainability - the Government’s target to achieve a balanced budget has been postponed by a year to 2011

44. The Fundamental Question Is the 2009 budget and increase in deficit (compared to the original path) helping productivity and lower costs? The economy will emerge stronger if the increase in deficit takes the form of investment and productivity Lower production costs to face the immediate short-run difficulties are also required (especially for SMEs) On the other hand, the economy will emerge weaker if the increase in deficit merely stimulates consumption

45. Main productivity enhancing measures in the Budget 2009 • Incentives to enterprise need to be holistic and supported by adequate capacity and will probably not yield short run dividends • Support to tourism industry calls for proper focus to be effective immediately • Alternative energy and environmental proposals: can these be used to stimulate local production? • Capital expenditure should stimulate construction activity, which has several multiplier effects: sustainable development remains imperative

46. Areas requiring further attention • It may be better to retrench, nurture and strengthen current business, rather than dedicate resources towards attracting new investment in a difficult international scenario • Emphasis needs to be placed on business cost-cutting measures, including better regulation • Restructuring towards efficiency in the economy should continue to be pursued in spite of economic difficulties • All unsustainable subsidies to be phased out in a pre-set manner and according to a pre-defined timetable

47. Thank you