The current strategy of the Maltese government is succeeding in restoring public debt sustainability, albeit perhaps too slowly, and maintaining macroeconomic stability in the context of an economic growth rate that is considerably higher than that in the EU as a whole.
Critics of the government accuse it of being profligate. Another criticism is that its high recurrent expenditure comes at the expense of capital spending. Are these accusations true? Whatever they are, it is legitimate to ask questions about the adequacy of how public money is spent. This is a key issue not just for the government but also for the citizens who ultimately finance such expenditure through their taxes.
There are two aspects to this: one is the growth path of government expenditure; the other is the allocation of such expenditure to productive purposes, which might increase the growth rate of the Gross Domestic Product, versus unproductive aims that would lower economic growth. The first aspect raises the issue of whether too high a rate of government expenditure starves the private sector of resources, whereas the second relates to the efficiency of government expenditure.
It is difficult to argue that the Maltese government's expenditure is too high when its ratio to GDP is the second lowest in the EU. In 2023, it was 36.6% (second to Ireland's 22.7%) vs the EU's 49.0% (France's rate is the highest at 57.0%). The ratio is back to pre-Covid levels. Not only: the ratio last year was almost five p.p. lower than in 2011.
On the other hand, one could reasonably argue that the Maltese government should allocate more resources to gross capital formation, rather than to recurrent spending. In 2023, the ratio was 3.4% ̶ that's the 15th lowest in the EU. It is half Estonia's ratio. Although, the share of total expenditure allocated to capital formation has increased by 2.5 p.p. since 2011, it is lower than what it was in 2015.
An equally serious point relates to the composition of public expenditure by economic classification. Compensation of employees and social benefits remain the two biggest components, accounting for 45% of expenditure (down from 60% in 2011), intermediate consumption is next highest at 20% (up from 15%), and capital formation and investment grants make up 13.8% (up from 8.2%). The remaining 22% are accounted for by subsidies, interest on public debt, and other miscellaneous spending.
In my view, the most problematic is the subsidies element at 9.8%, which is unsustainably high, compared to just 1.7% in 2011. It is not surprising that the European Commission and the International Monetary Fund harp on the need to reduce energy subsidies and recalibrate them towards the most vulnerable members of society. There is scope for introducing a family solidarity allowance that compensates for high household costs (therefore including utilities). The resulting social benefits ratio would increase by some eight p.p. but still be below the 2011 ratio.
Another problem arises because there is no consensus when it comes to identifying the types of public expenditure most conducive to GDP. It is curious, to say the least, that there has been little discussion in Malta of the purposes to which Next-Generation EU funds are allocated. Which of the investments and reforms will contribute most to enhance growth performance, and by how much. Assuming that government expenditure will automatically contribute to growth is fallacious.
Having said that, the majority of economic experts agree that the most growth-inducing recurrent spending by government is that on education, health, transport & communications, and R&D. Using these yardsticks, we find that in 2023 the government spent €2.48bn, which is a huge increase (163%) on 2011. Most of this expenditure was on health (43%) and education (34%), followed by transport & communications (19.5%) and R&D (3.5%).
Many economic authors have argued, based on their empirical research, that expenditure has a positive impact on human capital and long-term economic growth. A group of authors used data from the World Bank covering the period 2002 to 2020 to demonstrate that a rise of a mere 0.1 in the Bank's education index increases the growth of real GDP per capita by 0.5 p.p. Consider that, for example, the percentage of the population aged 15+ with no education in Malta fell from 34.25% in 1960 to 1.64% in 2010.
Similarly, the positive relationship between improvements in health and economic growth has long been advanced in the literature. David Bloom and others from the Harvard School of Public Health estimated, based on a panel of countries in the Penn World Tables observed every 10 years between 1960-1990, that a one-year improvement in a population's life expectancy contributes to a 4% increase in output. Life expectancy in Malta between 1980 and 2023 rose by over 11 years.
While there is no doubt that the government is spending a lot on growth-inducing sectors, the share of expenditure in these sectors in proportion to total expenditure has increased only marginally to reach 33% in 2023. In a study by Alessandra Cepparulo and Gilles Mourre for the European Commission in 2020, the growth-friendliness of public spending (expenditure on the four categories mentioned above as a percentage of total expenditure) between 2007-2016 was estimated to be just 0.28 in Malta versus 2.28 in Germany. By 2023, we were in negative territory with a drop of 0.23%.
There is also no doubt that spending on transport and communications needs a substantial boost. As to R&D, the amount is piddling. It explains the low amount of innovation in the economy.
The question is whether this heavy expenditure is having the desired outcomes. Here, we are on more shaky ground. The same authors found that, when they examined seven areas of public expenditure in 20 member states, Malta was one of the best performers in only one area whereas most of the others were best in 2 or more areas.
In a more detailed assessment, they computed the relative efficiency of public spending and the so-called Malmquist productivity index to measure the increase or decline in efficiency. Malta was found to be comparatively efficient in three spending categories, namely infrastructure, public services, and education, with scores over 1. In the public order and R&D categories, our scores were quite low, while for one other no data was available.
At a time when Malta is increasingly subject to pressures on public finances, stemming from demographic trends (higher spending on pensions and long-term care), it is imperative that public resources be used most efficiently and effectively. Moreover, considering that resources in the public sector are financed through taxes that can distort the allocation of resources and thus constrain economic growth, public expenditures must be used to improve long-term growth perspectives and societal equity.
Frans Camilleri is an economist. He studied at Oxford and University of East Anglia, is a former corporate head at Air Malta, and has served on various public and private boards.