Show me the exit

Labour’s share of the national income ─ that is, the amount of GDP paid out in wages, salaries, and benefits ─ has been declining in developed and, to a lesser extent, emerging economies since the 1980s. This has raised concerns about slowing income growth, inequality, and loss of the consumer purchasing power that is needed to fuel demand in the economy.

The decline has been much discussed and the rising power of companies vis-à-vis workers ─ whether from new technology, globalisation, the hollowing out of labour unions, or market consolidation ─ has shaped much of that discussion.

Concurrently, most nations’ march to greater economic inequality, which began after the financial crisis of 2018 and 2012, has proceeded over the years. It has been reversed in some countries since the onset of the COVID pandemic by government support measures, but most experts believe it will go back to “normal” once those measures are phased out.

Let’s look at our situation in the context of the larger EU dimension. In 2020, the COVID-19 pandemic had a significant impact on the shares of different income components. The share of employee compensation rose from 42.4% to 46.5%, though it appears to have fallen slightly in 2021. In fact, comparing the first nine months of the year with the same period a year ago, the share fell by 0.8 p.p.

But, compared with Malta’s 4.1 p.p. increase in 2020, compensation of employees in the EU, rose only by 1.5 p.p. over 2019. The share in 2021 fell slightly more sharply than Malta’s, by one p.p. This shows how Malta’s support measures were significantly more aggressive and would explain why, in spite of a higher GDP percentage decline in Malta than in the EU, Malta was able to avoid a high increase in unemployment.

Twelve Member States recorded a higher share of GDP than the EU average for compensation of employees.

In ten of them, the component accounted for over half the value of GDP, ranging between 50.2% in Austria and 55.2% in Germany. 15 Member States recorded a share of GDP that was below the EU average for compensation of employees, ranging from 27.4% in Ireland to 46.5% in Malta.

In the EU as a whole, the share of compensation of employees had a decreasing trend between 2000 and 2007, then increased significantly in 2008-2009 during the economic crisis, decreased back to its early 2000 levels during the decade to 2019, and then increased again in 2020 during the COVID-19 pandemic.

But overall during the last 20 years, this share slightly increased in the EU (+1.4pp) and in the euro area (+1.6pp).

Significant changes were noted across the Member States. Some countries had large increases of 10-11 p.p., whereas others recorded decreases ─ Ireland’s drop of over 11 p.p. was the most notable. In Malta, the share of compensation of employees rose by 2.2 p.p. over the 20-year period.

What is equally, if not more, striking is what happened to the operating surplus of enterprises. While in the EU and Eurozone, this did not show any significant change in comparison with 2019 – between 40.4%-40.7% of GDP ─ in Malta the share of operating surplus in GDP in 2020 rose slightly to 47.8% and is likely to finish 2021 marginally lower than the previous year.

In the first nine months of 2021, the share of operating surplus in Malta’s GDP maintained its edge over employee compensation, in spite of the large volume drop in the services sector as a result of the collapse of tourism. This shows the degree of support given by the Government to enterprises during the height of the pandemic.

Of course, something had to give. This was government revenue from taxes on production and imports. In 2020, the share of taxes (less subsidies) almost halved to 5.7%, the reduction being three times as much as that for the EU average. 

Were it not for the improved state of public finances achieved since 2013, this drastic reduction in government revenue would have been disastrous. As it is, the share edged up somewhat to 6.4% in 2021 and should return to its normal level once support measures to employees and industry start being phased out.

Of course, unwinding support measures requires graduality and flexibility, depending on the evolution the pandemic and its impact on different firms and industries.

For example, certain firms or industries may need prolonged forms of support, which however need to be designed accurately to mitigate the risk of moral hazard on the part of businesses and evergreening on the part of banks.

After the crisis, certain enterprises may be found unviable. But which ones will be allowed to bite the dust? Many bars and restaurant will probably have folded for ever and so may certain low-quality hotels, particularly if the profile of tourism changes. 

It would be foolish, apart from being unsustainable, for government to waste money on them. On the other hand, if some large manufacturing enterprises or high-graded hotels risk going to the wall, there may be a case for a more gradual and flexible unwinding of support measures.

At the core of the exit strategy lies a tension between what one might call “Keynes” and “Schumpeter”.

On the one hand, Keynesian support measures were put in place to help firms and households affected by the economic consequences of the public health shock. At the same time, continuous support can be justified with the attempt to avoid hysteresis, i.e., the risk that a continuing severe economic downturn and consequent high unemployment (in absence of support measures) would cause unemployed individuals to lose their job skills or become demotivated, turning into high rates of long-term or structural unemployment.

Such scaring effects would hamper not only economic recovery but ultimately result in lower longer-term growth rates. Such hysteresis effects do not only damage affected individuals but also permanently reduce potential output, thus reducing long-term growth perspectives. This is not only challenging from macroeconomic perspective, but also from social and political viewpoints.

On the other hand, the pandemic will have (possibly permanently) changed the returns on activity in different sectors and industries. There is thus a need for reallocation of resources within the economy post-pandemic. This requires a process of Shumpeter’s “creative destruction”, where some firms, even if viable before the outbreak of the pandemic, may have to undertake a profound transformation towards new products, services and/or markets, and new firms are created in sectors and industries with growth opportunities.

Such a process would be impossible, if support measures keep all firms in their current structure alive, independent of whether they are viable in their current structure in the long-run or not. Capital and labour would be tied in such firms and reallocation would thus become impossible.

What is our exit strategy? I, for one, do not know. Neither do many others. Typically of Malta, these things ─ if they are known ─ are kept under wraps. My suspicion is that we do not have an exit strategy as such, but that we will write it as we implement it. We may be the finest in cannabis reform, but our responses in other more important fields tend to be sub-optimal at best. 

Ideally, exit strategies need to be communicated clearly and in a timely manner, so as to enable economic operators and other stakeholders sufficient time to make plans and adjust their operations and financing accordingly. In the absence of this, the exit will be messy and unnecessarily painful.

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