Friday, 23 February 2007

The euro is Eight Years Old

23rd February 2006

The Malta Independent - Friday Wisdom

The euro’s eighth birthday passed largely unnoticed on 1 January, despite the announcement a few days earlier by the European Central Bank that there are now more euro bills in circulation than US dollars.

Six out of 10 Germans want their deutschemark back and shopkeepers in
Spain routinely display prices in pesetas as if they are taking precautions for their national currency to come back in circulation. The Italians blame their economic stagnation on euro adoption which has taken away the past safety valve of devaluing their currency back to international competitiveness.

Monetary union depends for its success on a commitment for a political union. History shows that monetary unions that were not under-pinned by a political union proved short-lived. The Latin Monetary Union involving
Italy, France, Belgium, Switzerland and Greece collapsed in 1920 after 60 years because of lack of fiscal discipline among its members. A Scandinavian monetary union in 1873 proved short-lived as political circumstances pulled countries apart rather than closer together.

The German Central Bank used to argue in the 1980s that monetary union was to be the end result of a political union. Eventually this view changed and the Germans accepted that monetary union could be a catalyst to bring about a political union. The official view is that monetary union can survive and function well without a political union if three conditions prevail: fiscal discipline, central bank independence and a high degree of product and labour market flexibility.

Two of these three basic conditions are currently unobtainable and the one which seems to prevail, at least nominally, that is, the independence of the central banks, is often challenged by national politicians who seem willing to put pressure on the ECB to avoid measures that could produce negative political ripples within national boundaries, even if these would be justified on a supranational basis. Furthermore the independence of central banks can only be effective if set in context of a shared identity embedded in common political institutions.

One could therefore be tempted to argue that the euro is still too young to guarantee its perpetual existence and that if the EU itself does not evolve into a political union over the next decades the long-term sustainability of the single currency could be brought into question.

This thesis begs a proper definition of political union. If it is understood as the establishment of an entity resembling the traditional member states I doubt if we will ever get there even over several decades. If it is understood as a dense network of integrated policies, common rules and established procedures with strong and active supranational institutions, common symbols and common identity, then the EU already exhibits many of these features.

After all, growth differentials between regions, even states, of the
US are just as big as those between member states. The political bond between US states is much stronger and makes a monetary breakdown unthinkable and impossible. Within the EU, the political bond may not be strong enough to resolve the tensions and arguments that at times emerge. It follows that this may result in member states exiting the monetary union and still remaining as EU members gaining the same status as member states that opted to stay out of the monetary union, that is, the UK, Denmark and Sweden.

This argument is false.
UK, Denmark and Sweden opted to stay out because they have a strong and highly competitive economy. They did not need the discipline of monetary union to check chronic fiscal deficits, excessive public debts and out-of-control inflation. In all three cases unemployment is low and international competitiveness is high.
Italy is the exact opposite. Since 2000, unit labour costs in Italy rose by 21.4 per cent while unit labour costs in Germany have fallen 5.9 per cent. Blaming the euro for it is easy but unreal. Leaving the euro would make Italy’s problem worse, much worse.

Competitive exchange rate devaluation of the re-adopted lira would raise the value of private and public debt through “the balance sheet effect”. Interest rates on the re-adopted currency would be significantly higher causing the public deficit to reach dramatic proportions leading to emergency monetary tightening which could choke off any growth generated by the devaluation. Inflation would increase significantly entailing a sharp drop in real wages which is often the contra effect desired by those militating for
Italy’s exit from the euro monetary system.

In short, the real option to leave the monetary union is for the strong not for the weak. It is more likely that the
Netherlands can handle an orderly exit rather than Italy.

Whether the euro is forever or not, it is a safe bet that it will be with us for a very long time and that we can only benefit from it if we do not harbour any expectations that it can sort out all our problems without further internal discipline. What the euro can and should do is to discipline our politicians to run a sustainable fiscal position as close to neutral as possible over an economic cycle. This would ensure that economic restructuring at the base continues without relapse to short-term fiscal extravagance for partisan political advantage.

Friday, 16 February 2007

Auditing the Auditor

16th February 2007

The Malta Independent - Friday Wisdom

The Auditor General kindly sends me a copy of all publications produced by his office. This week I received a copy of the annual report for 2006 detailing the works of the National Audit Office (NAO) for last year.

Nothing in the report convinces me that the NAO is achieving its mission of “promoting accountability, propriety and best practices in government operations”.

Let me put my cards on the table. I am biased against the NAO under its present set-up as I have had a first-hand experience which convinced me that the NAO was a mere tool in the hands of the PN, then in opposition. Unavoidably this first-hand experience still colours my judgment of the NAO.

It was the time when I was chairman of Mid-Med Bank in 1997-1998. The bank’s operations centre, then known as Centru Ruzar Briffa (CRB) in Qormi, was bursting at the seams trying to accommodate an ever-increasing number of operations and employees as the bank unavoidably was on a process of centralising all back office processes, leaving its branches as mere points of sale and points of contact with clients.

The bank had been locked in never-ending negotiations to acquire a building next door to CRB for several years. All the bank’s executive agreed on the urgent need to conclude these negotiations and get on with the job of extending CRB.

The building next door belonged to an organisation for whom I had acted as consultant for several years before being appointed chairman. I distanced myself from the negotiations process to avoid any perception of conflict of interest but when the process was continuing to drag on, I had to take the bull by the horns. I publicly terminated all consultancy with the prospective vendor, got involved in the negotiations, obtained improved terms and price discount and got board approval to proceed with the project.

As the bank was still then a publicly-owned organisation, it was important not just to take such decisions with propriety and transparency, but to appear to be doing so in the eyes of the general public. I therefore requested the Finance Minister to ask the NAO to vet the integrity of the process and the appropriateness of the price agreed with the vendor before concluding the deal. In spite of the urgency, I thought that a few more weeks would be affordable in the interest of protecting the bank’s reputation of integrity.

The unbelievable then happened. The NAO took nothing less than nine months to do a job which could have been easily done in nine weeks, if not nine days. Furthermore, although the price negotiated was confirmed as fair by three independent architects appointed by the NAO, the latter still did not deem it appropriate to issue a clean bill of health, arguing that the bank should have decided to relocate its operations centre to a more posh location involving massively increased expenditure and unbelievable disruption to the bank’s operations.

What brief did the NAO have to challenge the strategic decision taken by the bank to extend its CRB operations centre? Since when does any audit office take on an executive role and supplant its opinion over that of the executive of the organisation being audited rather than confirm or deny that the organisation is managed with integrity and with proper financial housekeeping standards leading to value-for-money investments?

What was extremely suspicious was that the NAO issued its report in August 1998, right in the middle of an election campaign. Common sense would suggest that after taking nine months to mull over a very simple exercise, it should have avoided the sensitive election campaign period to issue the report.

Time is the best judge. A few years later, the bank, now under HSBC wrapping, spent far more money than what Mid-Med was proposing, in order to re-develop CRB on its existent footprint. The result is that operations that were meant to be centralised at CRB are still spread around with additional costs and reduced efficiency in spite of the increased investment to respect the confines of the CRB footprint. The NAO argument that CRB was not posh enough to locate the bank’s operations centre impressed no one. So much so that Bank of Valletta opened its own operations centre less than one kilometre away from CRB.

So yes, I have an axe to grind with the NAO. But for goodness’ sake, one needs not have such an axe to be critical of NAO. They attend all sorts of conferences overseas, something like two a month as an average. They run with a staff of 53, a not inconsiderable complement. In their publications they try to impress us with their skills to perform Value for Money Audits.

In its 10 years of existence, what has the NAO been doing to protect the citizens’ interest in the most crazy waste-of-money project we have ever seen on this land? I have said it several times before and I say again.

Excluding the medical equipment contract, the Mater Dei Hospital is costing at least three times what a super five-star hotel of similar size would have cost to build on the same site with today’s money. Can there be a bigger offence to the principle of value for money?

Yet the NAO which found the courage to denigrate during an election campaign the only executive that ever sent it a process for auditing before it got executed, has lost its teeth in front of the massive destruction of value that has taken place over the last 15 years in the Mater Dei project.

They remain silent on many other things as well but then find the time to perform a value-for-money audit of the Occupation Health and Safety – the Construction Industry, where budgets are minimal and the scope for financial misdemeanor is pretty negligible.

A true case of being strong with the weak and honest, and weak with the strong and wasteful.

The NAO needs some auditing itself.

Friday, 9 February 2007

Fiscal Reform

9th February 2006

The Malta Independent - Friday Wisdom

Last week I argued that our economy is continuing to perform below its true potential and registering much inferior growth rates than what is being achieved by the new members of the EU with whom we have to compete both for trade as well as for attraction of foreign direct investment.

I argued that the main reason for this is the lack of flexibility in our labour market and the discrimination we scandalously permit whereby public sector employees enjoy the best job protection while private sector employees with a much higher record of efficiency operate with little or no job protection.

This week I propose to push the argument one step further and suggest that a second condition necessary to achieve growth rates approaching our true potential, has to be a fiscal reform which almost no one seems willing to discuss, let alone implement. I am not referring to pre-election trimming changes to income tax bands and allowances meant to return some spending power back to the consumer after being tax oppressed in the post-election years. These peripheral changes in no way address the core need of a deep fiscal reform.

It is not possible for the state to provide free universal social services, including free education right up to university, stipends to all university students, free health services in state hospitals and health centres, and state pensions to all post-retirement without time limits until death and many other social payments, without incurring unhealthy and unsustainable fiscal deficits, or without levying a rather high level of taxation from the private sector in order to fund these expensive services.

In the not too distant future we will have to face the economic reality that these services can only be affordably provided by the state on a means-tested basis for those who really need them.

The Prime Minister was asked last weekend whether the transfer of hospital services from St Luke’s to Mater Dei would still allow health services to remain universally free as at present. The answer given was a well-organised fudge where the Prime Minister, in this highly sensitive pre-election period, reiterated that his government gives priority to keep such services universally free.

The journalist should have been more demanding and asked the Prime Minister whether he was giving a guarantee that they will remain so for the next legislature, or whether he was keeping the door open for the introduction of a system of co-payments by consumers of health services as has long been suggested by the monetary authorities for the sake of achieving a permanent state of health for public finances.

I feel quite sure that in a post-election mode, reality will prevail over wishes and many services which are currently universally available free of payment will only remain so to those who pass some form or other of a means test.

Means-testing will become the centre-piece for the distribution of social payments. But how can this be realistically and fairly possible when we still have a very low level of tax enforcement and tax compliance making means-testing on a tax-declared basis a very unreliable measure of who truly deserves to receive social assistance?

Without a fairly high degree of tax compliance, means-testing as a basis for social payments could create grave injustices giving further incentive for tax evasion. We could well finish up denying social assistance to who really deserves it and needs it, and instead issuing social payments to those who do not really need them but may appear so through their facility to avoid tax compliance.

Taking this argument further how can we achieve a high degree of tax compliance in a relatively short time in order to achieve a reliable system of means-testing on which to base future social payments to meet actual needs?

One option is to hire an army of tax inspectors, auditors and investigators. This will be counter-productive. It will cost too much, reduce the incentive to invest and ultimately work against the ultimate objective of reaching higher rates of economic growth.

A more effective way would be to reform taxation on a flat-tax basis reducing the marginal rate of tax to a level low enough to make it cheaper for the tax-payer to comply than to evade.

I can hear all sorts of arguments that flat-rate taxation is regressive and unsocial. This could well be so.

But I argue that it is less regressive than the present system we have where tax compliance is sub-standard and low-income earners finish up paying in tax a much higher percentage of their earnings than others who earn much more but declare much less.

The case for flat-rate taxation should not be aborted simply because it is theoretically tax repressive.

It has positive features mostly in stimulating tax compliance and investment and in providing a reliable platform for reforming social payments on a means-tested basis.

Friday, 2 February 2007

Running on the Spot

2nd February 2006

The Malta Independent - Friday Wisdom

The problem is not so much that a property developer who is investing in a real estate development, won by public tender from the government, is forcing employees he has agreed to take over to perform jobs unrelated to their skills as hotel workers. It is more that we have so much inflexibility in the labour market that skilled hotel workers prefer to hold on to a job they are unsuited for rather than seek new employment which matches their skills.

The economy cannot move forward if we deploy chefs as labourers, waiters as painters and hotel managers as security officers. The economy should be growing robustly to permit re-allocation of surplus labour in one micro-unit, that is undergoing restructuring or transformation, to other units that need to recruit labour with proper skills in order to grow and expand.

We are wasting too much energy expecting a property developer to keep in employment hotel workers for whom he has no job opportunities to suit their skills, instead of directing our efforts to make the economy more flexible and labour more mobile.

We seem unable to accept that whether we like it or not we have to play the globalisation game where the job for life is extinct. In order to compete successfully in this harsh globalisation game labour mobility must be a way of life. Which means that we need to evolve our labour legislation to oblige employers to keep retraining their employees to preserve their employability; to provide a fund for due compensation in case of redundancy, which fund has to be spent in retraining to ensure that redundant employees can acquire refreshed skills to safeguard their employability.

Our ingrained quest to preserve the status quo is leading us to economically run on the spot while our competitors are sprinting ahead of us. Only last week the governor of the Central Bank of Malta, who is nearing the end of his term and therefore gains added freedom to criticise openly without having to use guarded coded language, explained how poorly our economy is performing when benchmarked to that of Slovenia.

A country that until 15 years ago we used to regard as inferior and way behind us in terms of economic growth and performance is now leaving us breathless as we marvel at their competitiveness and ability to attract investment and win in the globalisation game.

Many would argue that given my leftist political inklings I should be defending workers’ rights to job protection and job-for-life security. It is because of my leftist political inklings that I argue that the greatest right for workers is to have a job and the second greatest right is to have the ability to choose which job to have. For these rights to have practical effect we must have a robustly growing economy that is competitive in the global economy.

No government of left, right or centre can offer jobs in the old Keynesian way when tariffs and trade barriers were the order of the day and most economies were inward looking with little international trade to speak of. Reality has changed.

It is high time for the economic profession to stand up to our standards and speak more clearly about the fact that the political class is misleading us when they sing themselves glories for anaemic growth rates, which are half or less than those of our major competitors.

It is high time for pressure to be made on our political leaders demanding that they speak clearly and explain in facts and figures, before the election so as to avoid unpleasant surprises after having won the electorate’s mandate, whether universal free health services are sustainable in the light of the prospected relocation from St Luke’s to Mater Dei, whether universal social services are sustainable or whether means testing for entitlement would have to be introduced to keep such social payments within general affordability.

And this applies as much to the government as to the opposition. The opposition should be afforded full access to the government’s financial state of affairs so that they can include in their manifesto only policies and measures which can be financed without compromising the rules of good financial housekeeping which we must adhere to as part of our euro adoption obligations.

Unless we render our economy more flexible and our labour market more mobile we will economically continue running on the spot and will gradually lose sight of our competitors as they continue racing ahead. If we continue to argue about whether we should continue to pay hotel workers for nothing during re-development of their former hotel, or whether we should employ them in temporary jobs for which they have no skills, we will just get nowhere. The labour market has to be bubbly enough to offer our redundant employees an easy choice of a better job in their industry.

This can hardly be expected to happen if we continue to tolerate the apartheid in our labour market where public sector employees continue to be rewarded with job protection for a low efficiency job whilst private sector employees have to face the full rigour of the free labour market in spite of performing at much higher levels of efficiency.

Some levelling off of the rights and obligations across the whole labour market is a pre-requisite for strong economic growth to release us from the lock of economic running on the spot.