Fuelling inflation – A sure way to erode competitivity

As always, macroeconomic issues are likely to end up being tackled by politicians who are more interested in their latest popularity rating than how to sustainable tackle such macroeconomic issues.

It is obvious that the heightened inflation we are facing is eroding purchasing power, with the greatest negative effect being on the low-wage earners. However, it seems that the political class is pushing to implement short-terms solutions, that are akin to having someone enter a burning house while holding a filled up petrol can.

I will once again reproduce the analysis provided by the Central Bank of Malta in its Outlook for the Maltese Economy, issued last August, which states: “The latest CBM business dialogue suggests that firms this year are increasingly worried about their ability to maintain strong profitability levels. In part this reflects very high wage pressures due to inflation compensation and high labour market tightness. During the projection horizon, we expect unit labour costs to increase markedly and exceed their historical growth. This is projected to be driven by a sharp rise in nomi­nal wage growth, which reflects the prevailing high wage pressures. Meanwhile, productiv­ity growth is expected to remain subdued over the projection horizon, as demand for employees is still expected to remain strong. In view of the expected sharp increase in labour costs over the projection horizon, as well as the projected moderation in price pressures, we expect profitability to be weak. This implies that over the projection horizon, the rise in costs will be distributed between both labour and businesses. In particular, profit mar­gins are projected to decline throughout the projection horizon.”

The above analysis means that businesses are already projecting a decrease in their profitability as they are seeing an increase in wage costs due to the tight labour market. This means that any further increases in wages, fuelled by increases in the minimum wage, are very unlikely going to be absorbed by businesses and will likely pass this onto clients through increased prices, leading to further inflation – this time internally generated inflation. Let us also move away from the disillusionment that some seem to be under, that any increase in minimum wage, beyond COLA, will only affect the few remaining employees in Malta earning the minimum wage. It will not. Various studies show the ripple effect this will have on various wages. Just to mention a statistic, we have some 47,000 workers in Malta earning up to €1,000 per month. There are then certain important sectors of our economy, like manufacturing, that are export-oriented, that cannot just raise prices and will likely be forced to reduce employee headcount if wage costs keep rising, to safeguard their competitiveness. As I have been saying repeatedly through these articles, our focus should be at fighting inflation and not in fuelling further, as fuelling inflation will erode our competitiveness. We should have tackled the issue of minimum wage increases when our economy was growing at breakneck speed and inflation was non-existent. Doing so now poses more risks than benefits and will likely end up hurting the whole economy, especially those, said increase, is trying to help, as this will lead to even more inflation and possible certain job losses, especially in the lowest and unskilled levels.

Linked to all this was the recently issued half-yearly report by the Malta Fiscal Advisory Council. As a side note, this report also mentions that “recent developments indicate that inflationary pressures could be higher than projected”. However, what is most interesting here is one of the recommendations being put forward by this council, which states, that “government should strive towards achieving a medium-term sound fiscal position combined with efforts to achieve sustainable growth. In relation to the fixed-energy-price policy, an adequate exit strategy should be prepared, adopting a more targeted approach and enhancing incentives for energy savings”.This is very much in line with recent pronouncements by the Finance Minister, warning everyone, that we should not expect that energy subsidies should be normalised and hence remain in existence forever.

So going back a full circle, if in Malta we are going down the road of increasing the minimum wage, which will affect the vast majority of wage levels in Malta and terminating the energy subsidies at the same time, we would be pushing towards fuelling internally generated inflation and thus eroding Malta’s competitivity. While tapering off energy subsidies is understandable as ultimately, we also need to achieve sustainability in public finances, pushing to increase the minimum wage in the current scenario is ill advised, if we are serious at fighting inflation and preserving our competitiveness.

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