On Course with the Germans

The Malta Independent 

I quote the Financial Times editorial of May 17^th, 2004 dealing with Germany structural fiscal deficit problem. I have highlighted some phrases and put next to them in brackets their adaptation to Malta’s situation.

Quote:

Each year since the beginning of the downturn in 2001 (1996), Mr Eichel, Germany's (our) finance minister, has persistently overestimated the rate of economic growth and underestimated the size of public sector deficits. The latest official estimate is for a €61bn (??) shortfall in tax revenues until 2007. Public finances are a mess, and neither the government nor the opposition has a coherent strategy to fix the problem.

Gerhard Schröder, the chancellor, rightly rejected Mr Eichel's ( Malta’s Prime Minister gladly accepted his Finance Minister’s) proposed remedy, a big value added tax rise. At a time when the economy is severely constrained by weak domestic demand, high consumption taxes are about the most counter-productive policy imaginable. The present economic recovery is driven entirely by exports.

There are fundamentally two reasons for the perilous state of public finances. Neither is fixable in the short term. The first is the public finance system itself. The proportion of discretionary spending in relation to total public sector spending has fallen persistently, thanks to off-budget programmes including those to finance unification (inefficiencies and political accommodation). Mr Eichel ( Dr Gonzi) has too little room to manoeuvre to deliver budgets that comply with the Euro zone’s stability and growth pact. The country is set to breach the deficit ceiling of 3 per cent of gross domestic product in 2005 for the fourth (tenth) year running.

The second - and probably more important - reason is the persistent fall in economic growth rates. Germany's council of economic advisers (Ministry of Finance) estimates the potential annual economic growth rate at about 1.5 (1.3) per cent. Some estimates put it at 1 (0) per cent. Behind the decline in potential growth are rising real interest rates as a result of economic and monetary union (need to protect foreign reserves) and falling productivity growth in some sectors.

Economic growth this year is forecast to return to close to potential. This would normally be expected to improve the budget deficit. But the rate of potential growth itself means this is not happening. An average of about 2 (5) per cent is needed if the public sector and the country's welfare systems are to be sustainable in the long run. Low potential growth rates and the future obligations of German's (Maltese) unfunded pension systems have dramatic consequences for the public finances.

The correct response would be a programme of product and labour markets reforms to raise growth and reforms to reduce the growth rates needed to achieve long-term sustainability of public finances. One urgent measure would be to scrap early retirement schemes, a key factor that knocked the pension system off-balance.

After last year's controversial welfare reforms Mr Schröder has made a more activist industrial policy to create national industrial champions his economic policy priority. He also wants to change the stability pact to legitimise Germany's deficits. (After years on years of financial neglect we now pretend to be capable of taking on the discipline of the Stability and Growth Pact to join the Euro at an early date while paying just lip-service to real reform. Our pretensions are as big as our problems) Neither will change the fact that, with present policies and public finance structures, Germany (Malta) is on course for insolvency.

Unquote

Rather than joining the EU with the bubbling enthusiasm of sovereign youth and with a store of manoeuvrability in our fiscal policy to ensure we can take the restrictiveness of monetary union, we are in the discomforting company of a mature economy fatigued by the need to finance unification of one-third of its territory following 45 years of communist economic stagnation. Our fatigue instead come from unsustainable growth policies based on debt and consumption rather than saving and investment. Pity that economic fatigue, structural deficit and painful slow reform are probably the only things regarding which we are on course with the Germans.