Adding value is the way forward

Do we have a vision, a mission, a plan? I haven’t seen any. What targets will we be aiming for? There seems to be an alarming lack of any.

In recent months, there has been much talk about changing Malta’s current economic model from a claimed “population growth” one to a new one based on higher-value-added.  Listening to what some people who should know better have said, the common man might think that this can happen at the flick of a switch or overnight.  Nothing could be further from the truth, in terms of the complexity, the ease, and the speed with which such a transition could occur.  

For the uninitiated, value added is defined as the gross receipts of a firm minus the cost of goods and services purchased from other firms. Value added includes wages, salaries, interest, depreciation, rent, taxes, and profit.  The total value added in the economy Gross Value Added (GVA) – is based on the market prices of the final products or services and only counts production within a specified time-period.

Fine, but how exactly does higher added value come along?  It can be realised by maximising that differential, be it through reducing input costs (e.g. reducing material, labour, or process costs, etc) or increasing the price that can be realised (e.g. through brand association, improved quality, innovative features, faster delivery, higher specification, etc.), or some combination of the two.

The global accessibility of inexpensive labour means that Malta-based businesses cannot compete in markets for internationally traded goods and services on the basis of low labour costs alone.  Labour in Malta is not inexpensive. Importing inexpensive foreign labour as a substitute for the more expensive local one would have been a solution had the foreign workers concerned been highly-educated and skilled ones.  But, instead, we imported thousands of unskilled and less-educated workers who added a couple of euros to the price of goods and services.  This greatly expanded the GVA in volume terms but left the GVA per person employed low.  In fact, while GVA per employee rose by 25 percent between 2013 and 2017, the increase in the next five years declined to 17 percent. 

A look at the evolution of GVA per head in nominal prices in the EU reveals that, over a decade, Malta has made negligible progress towards the EU average and has lost ground compared with Germany.  Our GVA per head is nowhere near that of Ireland, whose GVA per head has grown by leaps and bounds.  It is a sorry story and confirms that the growth in the economy has been in low-paid/low-value jobs for which we have had to import cheap labour.

On the other hand, if one looks at a GVA volume index with a value of 100 in 2010, Malta’s index has grown by 6.85 percent per annum, compared with just 1.73 per cent p.a. in the EU.  In mighty Germany, what was a decent growth in the early part of the decade was reversed in the latter part such that the overall GVA index increased by a mere 1.23 percent per annum.  This contrasts sharply with Ireland’s remarkable growth of 9.72 percent per annum, most of it in the last five years. 

One aspect that requires a comment is the decline of production in the economy.  Over a nine-year period, production value-added has declined from 17.7 percent of total GVA to 14.6 percent.  This has been entirely due to the near-death of manufacturing, which had declined to 7.6 percent of GVA by 2022.  The Maltese economy is increasingly geared on services, which now account for 85.4 percent of GVA.

One can understand better what is going on by disaggregating the data and analysing the contribution of each economic sector to overall value-added.  This allows us to see which activities in either goods or services are contributing most to gross value-added and observe what changes have occurred over time. 

The top five private sectors account for 63.5 percent of GVA, but they do not necessarily have the highest value added per person employed.  The five sectors that have the highest value added per employee have improved their value added at a rate of 6.3 percent per annum over almost a decade, compared to just 4.3 percent on average in the economy.  The best was in the category that includes utilities and waste (13.5% p.a.), while the lowest was in financial & insurance activities 3.6% p.a.).  Manufacturing’s value added grew by 4.6% p.a., but the worst value-added sector (trade, transport, hotels and food) grew by a miserly 2% p.a.  The latter is where thousands of foreign workers are employed in low-productivity jobs.

In the current debate about a new economic model, the need to create a higher value-added economy is being widely taken as a given in public policy debate – but what exactly does this apparent platitude mean?  Just as policy interventions can only be considered appropriately with an understanding of the real context, so it is necessary to understand exactly what the desired outcome, in this case a higher value-added economy, might be.

I have not seen any national targets. Could it be that the policy-makers and private sector have looked reality in the face and given up?   Mind you, not that I would necessarily blame them.  We have a mountain to climb.  The increase in gross value added per employee we would have to churn out is around 25% to reach the EU average, 49% to reach the German one, and a miraculous 243 percent to match Ireland.

Do we have a vision, a mission, a plan?  I haven’t seen any.  What targets will we be aiming for? There seems to be an alarming lack of any. What is the timeframe?  Currently, it ranges between the idiotic next year to sometime in the future.  Who is framing the strategy and with whom?  The less we know, the better.  In a nutshell, it is the usual make-it-up-as-we-go-along story.  

Adding value requires knowledge, access to technology, infrastructure and other inputs.  Participating in a production chain is one way to add value.  Given our size, it is unlikely that we would ever have the like of a home-grown Microsoft in Malta, so the likeliest route would be to share in a chain and join the global production network of a large foreign firm, without needing to participate in and be competitive at all stages of production and marketing.  This possibility offers opportunities, yet also poses some challenges.

The type of diversification to be pursued must be carefully thought through.  A pepper-gun approach will not work, apart from being a waste of scarce resources. The selection of new sectors must be analysed together with the available capacity in Malta, in order that priority may be given to those new sectors that employ the experiences, resources and services already or imminently available, over those that require greater initial investment.

A combination of vertical and horizontal diversification may be used, though it could also be qualitative diversification.   Naturally, human capital is key to any successful diversification strategy, and therefore it does not make sense to invest in trying to attract value-added activities to our shores unless the education system is producing the right knowledge and skills which would be needed by them.  Macroeconomic stability is an important factor in value addition and diversification, and at least this is already a plus point for us.

Which potential sectors could we aim for?  Some obvious ones would be R&D, pharmaceutical development (of which we already have some), advanced engineering, bio-technology, and AI.  However, a higher value-added economy may encompass a far wider range of activity.

Normally, a higher value-added economy needs a strong manufacturing sector.  This is unlikely to be an option for Malta considering the size of the local market and that we would fly right into the high barrier to entry posed by the financial cost of taking part, the level of technology required and the customer knowledge requisite. 

Precisely because of this, over the years manufacturing in Malta has dwindled fast since 2013.  However, that does not necessarily mean that Maltese companies or offshoots of foreign ones could not participate in manufacturing through, for example, the development of applications and innovations.  We have seen researchers in Malta coming up with applications of technology in aerospace, for example, and this kind of activity should be greatly encouraged.

People always resist change, yet sustained growth relies on a continuous shift in resources to more efficient use. Employment in Malta will have to shift towards higher skilled jobs to maintain economic growth.  The more we delay this shift taking place, the more we risk being left behind.

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