Creative destruction

This article was published in The Malta Independent on Sunday - 7th September, 2014

Creative destruction is a term coined by Joseph Schumpeter in his work entitled Capitalism, Socialism and Democracy (1942) to denote a “process of industrial mutation that incessantly revolutionises the wasted by economic structure from within, incessantly destroying the old one, incessantly creating a new one.”

Failure is an essential part of a market-based economy. If resources are wasted, keeping failed ventures away from the scrap heap where they truly belong, then the green shoots that keep the economy fresh and vibrant will not emerge.

Failure must be respected. Silicon Valley is replete with success stories that followed an initial failure or even a string of failures. Japan, on the other hand, is in its third decade of deflation resulting from its escapism from reality that its banks were essentially bankrupt after suffering huge bad debt losses in the eighties when a strongly leveraged real estate and stock market bubble burst.

Malta can hardly be considered a true market economy in the absence of an effective bankruptcy mechanism respecting genuine failure that does not involve fraud. Effective bankruptcy procedures are essential to offer cleansing from the consequences of market failure. I would suspect that one of the reasons why Malta is failing to break up the ladder of international competitiveness is its failure to provide for modern bankruptcy legislation.

Indeed, I find it strange that in the firmament of financial legislation promulgated over recent years to render Malta an internationally recognised financial centre, bankruptcy legislation has never been given its rightful place.

Without such modern bankruptcy legislation, our financial markets will never deepen enough to make space for private equity and similar risk capital sources.  Banks will continue to demand high collateral security for the provision of commercial loans and such demand for collateral suffocates young entrepreneurship that is energy rich but asset poor.

Two recent examples show that even the state is suffering from the absence of effective and modern bankruptcy legislation. Take the Arriva public transport debacle. Whilst Arriva can be crucified many times over for their failure to provide an efficient public transport service, it is a fact that, in the process, it suffered commercial losses that were largely financed by internal financing from its parent group. When they decided to pull the plug and cut their losses it was more than gentlemanly that Arriva agreed to transfer the shareholding to the government and to forfeit all their financing. Any other arrangement would have thrown the Malta company into complicated liquidation or bankruptcy which would have disrupted the public transport service as the assets of the Company, including the buses, would have been frozen pending their proper sale through long-winded bids or auction.

Take also the sensible move, clearly in the national interest, for government to recover the title to Cafe Premier which is a historical building much needed to offer space to the Bibliotheca national archives library. The Premier was given by title of emphytheusis to private interests that failed and delivered commercial losses leaving substantial unpaid creditors. In the absence of modern and effective bankruptcy legislation, the government was forced to dish out more than €4million to repay the full amount due to the creditors and re-possess itself of the title of the premises without risking court challenges  that would have frozen the property out of use for God knows how many years.  

If we had proper bankruptcy laws, the company owning the title to Cafe Premier could have sought court approval for protection from its creditors (like Chapter 11 mechanisms in the US) while it put together a financial plan to sell its assets or its business, forcing incontestable haircuts on creditors as part of the rescue operation. Through bankruptcy procedures, the government could have re-acquired the Premier at much lesser cost and much more quickly, while creditors would have suffered a loss for their misjudgement in extending credit to a business venture that failed.

The expectation that creditors, including banks, bondholders and trade suppliers, will in all circumstances recover their credit leads to the serious mispricing of risk that creates a serious misallocation of resources in the economy. It is a culture that acts as a barrier to creative destruction.

Just as a barrier to creative destruction is the disproportionate resources which, as a country, we are being forced to channel into handling the problems of illegal immigration. It is more than a bit rich for Commissioner Malmström to tell us that Malta’s systemic use of detention of irregular migrants is a matter of concern that needs to be addressed. She told us we must work harder to address the detention policy problems and to make sure that unaccompanied migrants are treated well.

What Commissioner Malmström failed to mention is that Malta has the highest ratio per capita of irregular migrants in the entire EU and that, given our size, there is a clear limit as to how much we can do even if we want to.

It is a false argument made by the Commissioner that Malta has received generous EU support and that Northern Countries were still the member states that received most asylum seekers.

The problem with Malta’s handling of irregular immigrants is not simply financial. It is not a problem that can be solved by the EU simply writing us a cheque. It is a problem of capacity, a fact that so many irregular immigrants in such a small space create problems of character and harmonisation. Any tourist passing from Marsa and seeing so many asylum seekers awaiting to be picked up for a day job will assume that we are back to the slave market, which is out of synch with a place that tourists should visit for their enjoyment.

Northern countries take asylum seekers in a tempo that could be quickly assimilated within their economic structures in an orderly manner. Immigrants practically start contributing to the economic well-being of their host country from day one. On the other hand periphery countries like Malta and Italy have to take irregular immigrants in a tempo dictated by the weather and the number of boats arriving on our shores loaded with innocent souls. Until they can be vetted and gradually recycled or sent back they are not only a financial burden on Malta but also a serious stress on our social, educational, and labour structures.

Of course Malta can do more. But it is the EU and the Northern Countries that can also do much more. They have to share in the immediate burden of irregular immigration and they have to make it a priority on the EU agenda to address the problem of illegal immigration at its source. The more we improve conditions for giving a welcome to asylum seekers worthy of human beings and children of the same God, the more we are motivating others to risk their lives in illegal boat crossings, in the process enriching the merchants of death who organise such human trafficking. By helping the ones that come ashore we would be risking the lives of those who would be motivated to follow suit.

It is the same argument used in kidnapping. If one meets kidnappers’ demands for ransom, one could be saving the hostage’s life but in the process putting at risk the lives of many innocent people who could become victims of kidnapping as the criminals become emboldened to enrich themselves by expanding their activities. The principle is generally that there should be no negotiations with criminals and we have seen the brutal killing of journalists at the hands of heartless Islamic fundamentalists in the pursuit of this principle.   Why should it be different in the case of irregular immigration? Why should the EU not organise programmes in the sources countries to make immigration organised and safe?

Malta needs a regular inflow of migrants. As our economy develops and we invest in the skills of our young people, there will be jobs (especially the low skilled or very physical) which we correctly prefer to fill with immigrants as we employ our resources in better paid brain intensive jobs. Like the Northern Countries, it would be in our interests to take in a regular flow of immigrants worthy of being given asylum in an orderly manner. But in the meantime, the Dublin Agreement currently makes the immediate impact of irregular immigration a complete burden on countries at the point of entry. The Dublin Agreement is an insult to the concept of solidarity on which a Community should be built. It is a serious obstacle to the proper evolution of creative destruction.