The Blues are a Safe Bet

9^th July 2006

The Malta Independent on Sunday

If there is a safe bet around it is that tonight the blues will win the World Cup. What remains to be seen is whether it will be Gli Azzurri or Les Bleus.

Your guess is probably as good as mine. While my heart tells me that the Azzurri should be home and dry following their stellar performance in the semi-finals against Germany, my head tells me that the way they achieved that win by scoring two goals in the last minutes of extra time, when all seemed destined for the penalty shoot out, means the Italians have probably peaked a step prematurely.

The French on the other hand had a much quieter passage through the semi-finals, where they rode on the back of a generous penalty award to coast home without undue risks, even though the Portuguese actually gave as much as they took.

An undeniably clear statistic emerging from this tournament is that those teams, which went through in extra time or on penalties, were defeated in the following round. It happened to Argentina, which went to extra time to knock out Mexico in the last sixteen round and were knocked out by Germany in the quarterfinals. The Germans were knocked out in the semi-finals after they had to go through on penalties against Argentina in the quarters. Portugal beat England on penalties in the quarterfinals but was knocked out in the semi-finals by the French.

The French reached the finals without having the half hour added time as they beat Spain, Brazil and Portugal in the knock out rounds during the normal 90-minute game. This is ominous for the Azzurri who had to toil an extra 30 minutes against the Germans in the semis. And what 30 minutes they were! It is semi-tragic that if the statistical trend persists, their greatest time achievement so far could be their downfall in the last match when it really matters. Did this not happen already in 1970 when the Italians went through a memorable semi-final with extra-time 4-3 against Germany only to be outplayed by Brazil in the final, who were clearly fresher and had more oxygen in the second half to beat the Italians 4 -1 after a score-line of 1-1 at half time.

There is still a ray of hope for the Azzurri. This time they had an extra day of rest compared to the French. Will this be enough to neutralise the disadvantage of having played an extra 30 minutes? I certainly hope so.

The blues however are no safe bet on Malta’s political scene. Not just because they have been losing all their friendly matches (local and EP elections) but because they are having to make good for their past budgetary excesses just when the consumer is already demoralised by the fuel surcharge.

These are handicaps enough on their own but the local blues seem bent to tilt even steeper their uphill climb for the general election. The changes to the development boundaries are a high stakes game that is bound to earn government many more enemies than friends.

Government obsession to proceed with such a project against very wide public opinion gives me the distinct impression, which probably is wrong and unreal, that the government’s objective in conducting this exercise is to please its friends before its time runs out. But if this is not so then the alternative is that the government is politically naïve. This is equally hard to accept.

Arguments that this is being done for social reasons do not impress and indicate that the government is searching high and low for excuses to justify what cannot be justified. Equally laughable is the argument that this is done to honour an electoral pledge in the 1998 manifesto. Of all electoral pledges that have been allowed to fall by the wayside without the slightest compunction, is this the one that the Blues’ heart is bleeding for? Why not for example the family law to provide for a fair legislative framework for families living out of wedlock?

The best piece of advice I can give on the issue is that once the government is in a hole it should stop digging. Digging will only push it deeper into the hole when it should use its energy to get out of it.

The only logical way forward is to abandon the project and re-propose it in due time within a framework that carries sufficient checks and balances to convince the majority that all is being done for a good cause.

I still need to be convinced.

Swapping Deficits

7^th July 2006

The Malta Independent on Sunday

Are we in the process of swapping a deficit in government’s fiscal position for a structural deficit in the balance of payment of the whole country?

Let’s establish the statistical facts. Between 2003 and 2006 the fiscal deficit has been coming down from the near double figures it was since 1996 to an expected outturn of under 3% of the GDP in the current fiscal year, nicely slipping below the Maastricht criteria for eventual Euro entry.

However during the same period the deficit in the current account of the country’s balance of payments has deteriorated from 4.53% of the GDP in 2003 to 7.58% in 2004 to 11.02% in 2005 and 14.95% in the first quarter of 2006.

Normally the fiscal deficit moves quite in tune with the balance of payments deficits. Structural fiscal deficits generally contribute to the development of structural balance of payments deficits. Fiscal deficits by their own nature increase purchasing power in the hands of the private sector as the government spends more than it takes in through taxes. This enables consumers to increase consumption which in open economies easily leaks externally through increased import consumption thus leading to development of balance of payment deficits.

Why is it then that in Malta we are seeing an inverse relationship of rapidly deteriorating balance of payments position in the context of steadily improving budget position of the public sector? Should not the improving budgetary position actually reduce consumption spending thus contributing to an improving balance of payments position?

I can think of two reasons why we seem to be going against the conventional trend. The first one relates to the way the budget deficit gets financed. Given that public sector budgetary deficits are financed internally through local borrowing without any resort to external borrowing means that the extra spending power caused by the deficits in the first place is generally neutralised by the borrowing function. Consequently when budget deficit start reducing it does not really impinge on consumption patterns as the need to borrow less internally would leave a compensatory amount of spending power in the hands of the consumers.

Another evident reason for this inverse relationship is that the improvement in government’s fiscal position is happening in the background of a substantial deterioration in Malta’s terms of trade with its trading partners particularly due to the increased cost of energy, the demand for which seems to be pretty inelastic i.e. not quite sensitive to price movements given that energy consumption is quite often a necessity without much discretion regarding its use.

Consequently we are having to pay much more for importing the same volume of energy and there is no compensating increase in the prices we charge for our exports of goods and services.

You can hear the painful moans of factories and hotels because they cannot pass on to their clients energy price hikes, causing deterioration in profitability unless they can extract better productivity from their work-force and their investments. Indeed making such investments will place further strain on the current account position of the balance of payments as imports of capital goods is a direct charge as normal merchandise imports whereas the productivity gains from such investments can only accrue over an extended future period.

So coming down to brass tacks is the burgeoning imbalances in the country’s external payments position worrisome? Is it sustainable and could it lead to unpleasantries as often experienced by countries that endure extended periods of such balance of payments deficits?

The answer to these questions depends on many factors that cannot be clearly foreseen. A few years of balance of payments deficits can be tolerated if they are followed by period of compensatory surpluses. The balance of payments current account deficits could be carried without developing into a crisis for quite an extended period provided they get compensated by surpluses on the capital account. The capital account is the funds flows regarding investment rather than trade payments and surpluses on the capital account means that deficit of the current account can be carried without loss of official external reserves which are indispensable in a comfortable measure to deliver a stable rate of exchange policy.

If the surplus on the capital account reflects long term investments into the country than the situation gets much more comfortable than if it reflects short term hot money seeking some temporary advantage. The latter could easily reverse at the slightest hint of macro-economic instability and could by themselves make a small macro-economic problems balloon into a full blown crisis as happened in 1997 to Asian economies, as happened to Iceland earlier this year and as is happening in developing European economies of Turkey and Hungary right at this very moment.

Whilst not alarming, three years of sharply deteriorating balance of payments position can only be neglected at our own peril. A problem does not just go away by pretending it does not exist. The monetary authorities ought to inform us whether they are concerned and what measures they counsel to return to a healthy balance of payments position in the shortest time possible.

The monetary authorities should also express an opinion whether they see any link between the surpluses on the capital account and asset price inflation in real estate and equity values experienced during these last three years. If there is, as I indeed maintain, then the monetary authorities have to explain whether control of assets prices to avoid asset price bubbles, which could cause financial instability when they unavoidably burst, is within the scope of their price stability mandate or whether they see such mandate limited to consumption prices.

You Can Be Too Rich

30^th June 2006

The Malta Independent - Friday Wisdom

The old dictum that one cannot be too rich was proved wrong this week when the world second richest man donated 85% of his estimated $44 billion fortune to the world’s richest man.

Warren Buffet has long indicated that he meant to leave most of his accumulated wealth for philanthropic purposes. In his twilight years, widower for the last two years and winding down his business appointments though very much in control of his core business of Berkshire Hateway, Buffet is regarded as solid gold in making value laden investment which deliver beyond the allure of temporary fads. People are prepared to half a million dollars for the privilege of sharing his wisdom over lunch, an auction for philanthropic purposes which Buffett launches annually over E-bay.

To his natural heirs he left part of the estate which should satisfy all their needs for a hundred lifetimes. In giving away most of his fortune he is following the steps of Andrew Carnegie and John D Rockfeller whose endowments have funded some of the greatest discoveries that have served humanity beyond description.

A century ago John D Rockfeller was the world’s richest man. His fortune from Standard Oil was endowed to the Rockfeller Foundation. While Alexander Fleming discovered antibiotics in 1928 it was only in 1938 when the Rockfeller Foundation funded the Oxford scientists Florey and Chaim to develop its commercial potential that Fleming’s discovery started to deliver the benefit we still enjoy today as it is still the basis of the modern pharmaceutical industry.

What is remarkable about Warren Buffet’s decision is that he did not form his own foundation to immortalise his name among the greatest philanthropists of all times. Instead he gives it to Bill and Melinda Gates, founder and largest shareholder of Microsoft, to add it to the $35 billion funds already held in the foundation that carries their name.

While these figures seem huge when considering they are being funded by a single private source, in macro-economic context the figures are a mere drop in the ocean. But such philanthropic funding fills a very important gap in development finance.

Certain very worthwhile projects with high risk of failure but with great potential for round breaking discoveries cannot find commercial funding, given the corporate world’s obsession with top and bottom line performance measurements from quarter to quarter.

Governments on the other hand have a rather poor record for financing such developmental research and a lot of the funding gets wasted in bureaucratic controls which are necessary for accountability purposes but are a barrier to seeing the funds applied as meant by founders of such philanthropic vehicles.

This gap is then filled by the Trustees of such philanthropic foundations. Because philanthropy accepts that projects fail they support innovation of economic significance that governments would not finance for fear of political liability in case of failure.

Bill Gates, having promoted software innovation which in one way or another has changed our lives these last twenty years, is now winding down his executive role in Microsoft to dedicate most of his time and experience in managing the application of funds of the Gates Foundation to deliver the maximum benefit for the under-privileged in the hope that in hundred years time he will be remembered more for his foundation rather than for the business that made his fortune.

Let me try to put this problem in a local context. If a liberal market oriented society like the USA has found it socially necessary to maintain inheritance taxes and on top of it the super rich to avoid paying such inheritance taxes simply donate their excess fortune to philanthropic foundations during their lifetime, is it not strange that a social democracy like ours has found it socially acceptable to repeal inheritance taxes except for transfer duty on inherited immovables? We further found it justified to reduce the tax impact on profits made from resale of inherited real estate. Is this fair when we tax earned income at 35% beyond the easily reached margin whilst we continue to give favourable tax treatment to unearned income and assets, at the expense of high taxes over earned income?

I can hear all those who are already arguing that inheritance taxes are a form of double tax as the donor would have already paid tax on the earnings leading to the estate being willed over to his or her heirs. While even such claims are dubious given that capital accumulation is in many instances tax free, I am not persuaded that it is fair for our society to continue to build excessive reliance for taxes collection on earnings and spending whilst exempting from taxation asset transfers through inheritance or donations.

Especially those who are tasked to protect those earning their way in life through work rather than capital, ought to make it their battlecry to review taxation to reduce taxation on earned income and shift the fiscal burden on those who acquire their wealth without working for it.