Friday, 7 August 2009

What Shape the Recovery

7th August 2009
The Malta Independent - Friday Wisdom

By all reasonable indications the international recession, which started in the 4th quarter of 2007 and went into a free fall in the second half of 2008, has probably bottomed out in the second quarter of 2009 and is currently on a path of recovery.

Malta’s economy works with a time lag of about six to nine months so will probably not experience any feeling of recovery before the first half of 2010.

The big question however remains about the shape of the recovery. Whilst any recovery can only start after a period of stabilisation where things stop getting worse, it will make a big difference for people’s way of life whether the recovery is quick or protracted.

In this regard economists speak in terms of an alphabet soup to define the shape of the recovery.

The optimists speak in terms of a V shaped recovery where the ascent will be as steep and as quick as the descent, meaning things will get back to normal pretty soon and we can look back at a rather longish recession stretching six or seven quarters as a salutary experience to iron out excesses in the financial sector, force corporate to get more efficient through determined cost cutting and form a solid basis for sustainable growth for the longer term.

The pessimists speak of an L shaped stabilisation rather than a recovery. They argue that the economy had grown unsustainably based on over-consumption fuelled by easy credit, which has brought about the near collapse of the banking system. Consequently the decline is in essence a return to a state of normality where consumers will have to save more and spend less in order to restore health to household budgets. This means that the ‘new norm’ is an economy operating at a permanently lower level than its peak of late 2006 early 2007, and any attempt to accelerate its recovery will be futile, as it will not give time for the formation of a solid base for a truly sustainable growth path. So the world must accept that recovery will be a very long and slow process.

The in-betweens speak of a W shaped recovery. They argue that the financial crisis caused the economy to go into an acute and abnormal freefall and that once credit is now slowly slowly flowing again, the recovery from the free fall part of the recession will be reasonably quick, but beyond that the economy will struggle to go back to the peaks of 2006/2007. Consequently, while we may develop some sense of quick growth, through restocking and resumption of suspended investments in the first part of the recovery, the path will not be a straight steep ascent. The in-betweens propose an escalator type of recovery with occasional vertical falls through economic lift shafts as mixed economic indicators will occasionally force investors’ and consumers’ fear to overtake greed.

So in a nutshell that is the alphabet soup of the recovery. Will it be a V? Will it be an L? Or will it be a W?

The ongoing domestic debate about the future of our COLA system of legislated wage increases can only be meaningful if we make certain assumptions on the shape of the international economic recovery.

If we believe like the optimists that recovery will be V shaped we may continue as we are, as resumption of strong economic growth can absorb the increased COLA induced costs without compromising competitiveness.

If we share views with pessimists that the (non) recovery will be L shaped than there is not much to discuss. The present COLA system will compromise our competitiveness forcing factory closures and a frightening rise in unemployment where Unions will drop their resistance to dismantling of COLA as job retention will become more important than wage benefits.

These are extreme views and the likelihood is that we will have a W shaped recovery, which however still allows for a great variety of dimensions from a flat oriented W to an ascending type of W.

It is here that the social partners who brokered the COLA with government approval way back in 1990 must ask themselves whether the existing mechanism is a help or a hindrance to smooth industrial relations and general competitiveness.

There is no doubt that elements of the COLA will have to be retained under all circumstances. Non-unionised employees have little protection to maintain the true level of their wages without COLA and joining a Union is not a free option for everyone in practical terms whatever the theory of constitutional rights.

It is furthermore difficult to see the Unions making concessions at this stage when the COLA mechanism is expected to deliver a substantial wage increase to all employees to make up for the spurt in post 2008 elections inflation.

Yet whilst hoping for the best we must be prepared for the worst. In the pre-budget discussion government should do more rather than merely express the view that it will not change anything unless there is the agreement of all parties. Government must be active in brokering such an agreement , which, whilst rewarding employees for the already suffered loss in the real value of their wages, also protects employers from drastic loss of competitiveness in a harsh economic environment.

Part of the restructuring of the COLA system may have to involve government making a one-off contribution to bring these conflicting objectives into a reasonable equation, but only if for the future the system is overhauled to reduce its own impact on future inflation and competitiveness.


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