Is the Recession Over

28^th August 2009

The Malta Independent - Friday Wisdom

History books will show that this was the most violent recession since the War, distinguishable by the speed and the depth of the decline in economic growth in the last two quarters of 2008 and the first quarter of 2009.

Normally recessions set in more gradually and arrive with a degree of predictability. This one was deep and sudden. Normally recessions are the result of the normal cyclicality of economic activity. During recessions the banking sector remains strong and acts as a catalyst, through the supply of cheaper and easier credit, to pull the economy out of its lethargy by stimulating investment leading to sustainable economic growth. This recession is different because it was the banking crisis, especially following the Lehman collapse on 14 September 2008 that led the general economy into a recession. This time round the banking system is still very fragile to offer much support to the general economy.

So all prognoses is that this recession will be harsh and prolonged and recovery will be gradual and fragile with considerable risks of relapse. The argument was that growth before the collapse was fuelled by cheap and easy consumer credit, especially in the Anglo Saxon countries where domestic savings was negative as households spent more than they earned by borrowing second and third mortgages to cash in for consumption the rising values of their residential properties.

Now that the recession forced property values to collapse many households in the Anglo Saxon world are left with negative equity on their residences and consumers have to shift from negative savings to substantial positive savings in order to rebalance their finances. This is good, indeed necessary, for building future growth on sustainable foundations but in the short term it does not help a speedy recovery. In western economies consumer spending is a major part of the economy and if the consumer has to go slow it is likely that the whole economy will have to go slow. Unless....!

Unless the absence of growth in retail consumption in the Anglo Saxon economies is compensated by foreign demand from countries like China, India, Germany and Japan where traditionally the consumer has been more conservative and has capacity to increase consumption without incurring unsustainable debt.

The problem is that these countries are traditionally exporting countries and their economic growth has for decades been built on competitive export industries to meet foreign demand rather than on vibrant domestic consumption. So changing their economic model from export led growth to domestic demand growth, though crucially necessary for sustainable global recovery, necessitates a culture change that cannot be engineered just like flipping a switch.

So by all logic the recovery will be slow. The improvement in the financial asset prices since last March is mainly because last March the markets were pricing the end of the world. Now that governments’ intervention has stabilised financial markets markets can merely price a recession. So whilst the financial markets have shown great improvement since last March going forward to the peak levels of October 2007 will take much longer.

Given this scenario how does the news that Germany and France have seen economic growth in the second quarter for 2009 and are now technically out of the recession, fit into this big picture? Strange as it may seem it does!

Germany and France have not suffered a collapse in their property markets like the economies of the US, UK, Ireland and Spain. Their consumers have always maintained healthy savings ratios. So their consumers have much more capacity to increase consumption if they get incentivised to do so like for example through incentives to accelerate the changeover to more fuel-efficient cars.

But what is particularly relevant is that the growth registered in the second quarter was very minimal, some 0.1 per cent or 0.2 per cent and follows two quarters of sharp contraction.

So when it is said that Germany and France are out of recession it does not mean, as many seem to have understood, that their economy is back to pre-recession levels. It means that following two quarters of contraction their economy has started growing again but from a very low base.

Especially following two quarters of sharp contraction in growth as experienced between September 2008 and March 2009 re-establishment of small growth between April and June 2009 could possibly mean that manufacturing economies like France and Germany, who in the previous six months had suffered lack of orders as retailers and wholesalers run down their stock levels, have seen an influx of orders as stock levels were rebuilt.

Welcome as the news that Germany and France are technically out of recession is, reality does not change much as their economies are still knocking along a low bottom. But at least they are no longer in freefall and it helps to improve the psychology of the consumer. After all the recovery has to start from there!   

Shock During the Lull

23^rd August 2009
The Malta Independent on Sunday

Mid-August is normally a time when regular columnists struggle to find topics of interest to keep their readers engaged. Last week proved anything but a typical dry wilderness for interesting news. Let me share three topics with you, which shocked me at a time when I should have been relaxing.

I have been following the serialisation by Labour MP Evarist Bartolo of the process which led to the award of the new power station equipment contract to a Danish firm proposing diesel powered equipment, which is anything but cutting edge in green technology. Bartolo utters no platitudes and surely avoids generic unsupported allegations typical of many cross-political accusations where wrongdoing is suspected but not proven.

Bartolo gave a detailed chapter and verse account of how the successful bidder, through their Malta agent, had privileged, unfair and inappropriate access to internal Enemalta personnel, which, at the very least, gave them additional time to prepare their bid but, more probable and more seriously, helped them influence the technical specifications of the tender to their advantage.

What was particularly shocking in the latest revelations was how government shifted from its original position insisting on gas fired green technology that could be expected to stay well within emissions limits, as they may be tightened up over the lifetime of the equipment, to diesel powered equipment that could well breach such emissions limits as they are expected to evolve during the economic lifetime of such equipment.

Such revelations in a country where good governance has any meaning would have led to either an outright denial accompanied by legal proceedings for slander or libel, or to full scale open and rigorous investigations. But because our governance standards still make many Third World countries surpass us, the only reply we got was perfect silence.

It is the same perfect silence that accompanies claims of schools using their pricing power to increase fees far higher than is justified by the rate of general inflation. I have experienced this as I have been notified that next year’s fees of a private school will be increased by 10 per cent across the board. The school is also seeking to finance new investment for expansion through donation type of contributions, which will knocked off the last bill when the child reaches school leaving age. This “donation” or “advance payment” is not obligatory but, strangely, has to be “opted out” rather than “consented in”. Is this not a deliberate attempt to embarrass parents that opt out? Is this fair when many parents have to struggle in these hard economic days to keep up with current commitments let alone take on new ones?

Schools have pricing power. Parents who typically put their children’s interest first, will make whatever sacrifices are necessary to provide continuity in the children’s educational process rather than shop around for the cheapest alternative. But it is not fair that schools treat parents like sitting ducks without any protection from any regulatory agency that should authorise increase in fees beyond the level of general inflation.

How can we on one hand expect workers to dismantle the partial indexation of their wages through the COLA and then allow operators who have pricing power to use it without any inhibition? The argument that many schools are run on a non-profit basis is no justification for a free hand in price setting. Like all commercial organisations that lost their pricing power during these recessionary days, the focus of their economic survival has to be cost cutting and innovation. Those who simply take the pricing power route need to be regulated.

The last shocker for the week was Minister Austin Gatt finding time in his busy schedule to proclaim in an op-ed in The Times that the establishment of the Malta Transportation (Regulatory) Authority, through the consolidation of the Malta Maritime Authority, the ADT and the Dept of Civil Aviation, will, next year, solve all the travails we have been suffering for decades in our public transport services.

The Minister assures that next year we shall see a radically transformed public transport service, with modern buses, a more efficient bus network, and a private operator with ability and motivation to improve the service and increase patronage. The reform of the unscheduled and taxi service will be completed (with true liberalisation I hope), water taxis will be introduced and the intra-harbour ferry service will be strengthened and extended. All this while building the most important road arteries from the Freeport to San Lawrenz in Gozo.

Why was I shocked at such good news, you may ask? I was shocked because it reminded me of my days at the bank when regular loan defaulters used to demand as of right fresh accommodation, promising free drinks tomorrow to wipe clean yesterday’s faults.

This government is not exactly a new kid on the block. What the Minister is promising for next year has been promised before and should have been in place a long time ago. This government has an inverted sense of priorities. All that the Minister is promising should have been introduced before speed cameras, wardens, VRTs and all the rigmarole that is giving us the worst of both worlds, i.e. expensive discipline on sub-standard roads without any real alternative to private transport.

And before embarking on such grand projects, the new Authority should first solve the problem of reserved parking for residents. Until the time comes when residents start paying local taxes, this concept should be abolished. There is no taxation without representation; equally there should be no rights without taxation. Unless the residents pay something that I don’t pay for, I should have the same right to park anywhere like they do.

What is also shocking is any expectation that the mere merger of various authorities will deliver what was elusive when they operated separately. Set-up and structure are important, necessary, but not sufficient. Equally important are the attributes of determination, managerial ability, transparency and a sense of urgency in efficient execution with political support to do what’s right rather than what’s popular.

Enough shocks for August please! 

Politicians in Denial

21^st August 2009

The Malta Independent - Friday Wisdom

Healthcare is back in headlines. As the global financial crisis loses its power to surprise and the financial confusion and economic softness become a state of normality, healthcare is dominating the news.

In the USA healthcare reform was President Obama’s key campaign pledge and there is no surprise that he is showing a sense of urgency in delivering the reform as early as possible in his mandate. He knows this is an issue which would ruffle the feathers of the many who have vested interest in the status quo; a situation where millions of US workers and their dependants are living without health insurance and without the comfort of free or subsidised public health care service as we are used to in ‘socialist’ Europe.

President Obama is experiencing a live confirmation of Macchiavelli’s advice to The Prince that “there is nothing more difficult, more powerless to conduct, or more uncertain in its success than to take the lead in the introduction of a new order of things because the innovators have for enemies all those who would have done well under the old system and lukewarm defenders from those who might do well under the new system.”

The Republicans know that if they block Obama on the healthcare reform, they can render him a lame duck for the rest of his term. Added to the problems of sorting out an inherited financial mess of gargantuan proportions, this would give the Republicans a fair chance of turning Obama into another Jimmy Carter. For the Republicans it is relatively easy to whip up public sentiment against the reform, even from those who voted Obama into his presidency, if they convincingly argue that creating a public health care system which offers cover to the uninsured will involve raising taxes on those who are already insured or force on them reduced benefits as private insurers will have to compete with publicly subsidised competition.

In the UK we had a Conservative spokesman, speaking in support of the Republican campaign against Obama’s healthcare reform plan, who described the British NHS as a disgrace which he would not wish on his worst enemies. He urged Americans to obstruct Obama’s plan to create an American sort of NHS.

This was quickly picked up by UK Labour Prime Minister Gordon Brown, who faces an election in less than nine months, warning the British public that a Conservative government in waiting would dismantle the NHS. UK Conservative Leader of the Opposition David Cameron was quick to distance his party from the comments from one he described as an eccentric outlier, and re-affirmed that a Conservative government would not only defend the NHS but would ameliorate it and strengthen its benefits.

In Malta we have a strange situation. Our politicians are the only ones who overtly profess that our health service, with its universally free entitlement benefits, is sustainable for the long term. Any suggestion coming from economists, central bank, international rating agencies, civil society, political observers as well as retired politicians is politely pooh-poohed. This week we had Dr J. Psaila Savona, a former PN Parliamentary Secretary, publicly arguing that our health system in its present format is unsustainable.

Could it be that our politicians are right and all the rest are wrong? Could it be that while the strongest country in the world is struggling to offer some sort of cover to many who are excluded, and the contributions for those that have cover average about USD12,000 per annum (of which two-thirds are funded by employers), we in tiny Malta are so clever that we can keep a cutting edge health service as a universal social entitlement?

Could it be that in Switzerland, the State only subsidises the health insurance premium of those who are in poor social conditions that cannot afford to pay it and that all health service are then rendered commercially at a charge to the insurance company who normally imposes stiff annual excess limits on the insured (similar to the excess on the motor insurance), and that we in Malta have discovered a formula which has escaped everyone else?

Most unlikely I would say! It is more likely that Maltese politicians read Macchiavelli more attentively and therefore prefer to do what’s popular rather than what’s right.

Someone must however explain that this artificial story cannot have a happy ending. We can pretend for some time but not forever. Reality finally catches up.

Unless we reinvent our health system, one, or a mix, of three things could happen. The government may have to raise taxes to spread the cost of ‘free’ services on the generality of taxpayers. Or government could finance the spiralling cost of free health care, as the population ages and medical intervention would be more like expensive heart surgery rather than run of the mill appendicitis, by running higher budget deficits. Or government will leave everything as is but ration the service rendering it nominally free but practically inaccessible because of long waiting lists, overcrowded wards, and similar deterioration in delivery of health services forcing many to seek private healthcare services.

Raising taxes is unpopular and governments will resist it as hard as imposing fees on health services. Running higher deficits runs foul of our Euro obligations. So by default we will see unofficial rationing of health services. Indeed we are already experiencing it with the roll-back of primary services at regional health centres, long queues at Emergency Dept., and years’ long waiting list for non life threatening surgery.

By default our health service will go down the same route as pour pension system which remains universally applicable but inadequate for most. Just as most have to save separately for addressing inadequate public pensions, most already have or will soon have to take out private health insurance to protect their families from the inevitable rationing of public health services.

And our politicians will continue to crow that they honoured the pledge of keeping public health service universally free. And most of us will continue to smile wryly at our politicians in denial.