Exit While on Top

14^th July 2006

The Malta Independent - Friday Wisdom

Marcello Lippi gave us a perfect example of what it means to exit while on top. Just when he had the whole country at his feet heaping glory for the unexpected victory at the 2006 World Cup against many odds, Lippi wisely declared that his mission had been accomplished and that he needed to move on to different challenges.

He no doubt reasoned out that when at the top one can only go down.

It is a lesson that ought to be heeded by many leaders in different spheres, politics and business included. It applies in two particular situations.

Leading is a tiring job. If one tries to do it for an overlong period of time in the same job, there comes a point when personal objectives will start to over-ride the corporate goals of the organisation one leads.

Extended time in the hot seat inevitably allows over-confidence to seep into the decision-making process.

Blinded by familiarity which impedes an objective view of the organisation’s strengths and weaknesses, even the best leaders will start taking decisions subjectively.

“Let’s do this because I say so and I am usually right” starts to become the rational for charting the organisation’s way forward. Little heed is taken that past successes were sourced from objective decision making and that in the absence of such objectivity one can hardly expect future decisions, based on over-confidence verging on arrogance, to have the same success as past decisions based on objective analysis.

Margaret Thatcher has suffered a bruising exit during her third term when she should have exited just after scoring the third consecutive electoral victory.

Tony Blair is risking a similar fate. In business we have the contrasting examples between the leaders at Microsoft and Nokia. Bill Gates was the brains behind Microsoft in the eighties creating an operating computer system which stole market share from under the nose of more resourceful and established players until it practically formed an international monopoly with its Windows operating system and related office software.

Success easily breeds inertia. Microsoft has been getting slower in issuing updated versions and has been wasting more energy in packaging its products to protect its dominant market position rather than to keep refreshing its product lines. In the process, it has allowed newcomers to take leading positions in electronic advertising and search engines while Microsoft kept guarding its cash piles. Microsoft share price in fact now trades on multiples resembling a fatigued low-growth giant rather than an agile high growth new era winner, a business mantle now carried by Google and Yahoo. Bill Gates should have left earlier.

Jorma Ollila joined Nokia in 1985 when it was still basically a tyre factory. He became CEO in 1992, chairman and CEO in 1999 and in 2006 he left his CEO role and stayed on as non-executive chairman whilst making it clear that his energies will now be mostly devoted to his new chairmanship of Royal Dutch Shell.

He left while Nokia is on top having protected market share in sale of mobile phones and continually refreshing its product line taking the breadth away from competitors, possibly with the exception of Motorola.

Another scenario when leaders should exit is when they set themselves very clear and specific targets at the start of their tenure. Once these targets are achieved, continuing to lead an organisation which is itself transformed by the achievement of the objective could be a recipe for disaster as the leader could lack the skills needed to lead the company post-goal achievement.

Mintoff post-1979 is a typical example of someone who achieved the very specific objective he set himself at the start of his 1971 tenure but continued to lead in the old manner when in fact the country needed new skills to win its way through a competitive global economy. Post-1979 Mintoff became a rebel without a cause.

Lippi set himself the target of making a very good show in the 2006 World Cup. This was never specifically defined but every one understood that the minimum would be the quarter-finals and the probable maximum would be the semi-finals. With Totti coming from a serious injury and with most of his players serving with Clubs involved in Calciopoli, it would take a strong charismatic leader to keep the team focussed. Luck helped. France failing to win its group meant that Italy could reach the semi-final before clashing with a football giant. Compare that with France that had to clash with Brazil, Germany who matched Argentina and Portugal who had to overcome England before making it to the semi-final.

But luck on its own will not win you a World Cup. Beating Germany at home in the semis was a feat largely attributable to Lippi’s daring changes to play four attackers during extra time hoping to avoid a decision by penalty shoot-outs. Containing the brilliance of Zidane at its very best in the final needed skills and determination, even provocatory ones that eventually led to Zidane’s dismissal.

Pity Zidane did not understand the absolute need to exit on top. He was within minutes of it but ruined it by his senseless reaction in head-butting an adversary. Whatever Materazzi might have told him to cause such provocation it was between them. The head-but was shared with the rest of the world.

Clearly Italy’s success at the World Cup is in no small measure due to a proven leader who consolidated his fame by exiting while on top.

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.