From a central banker’s viewpoint, moreover, a key benefit of euro area membership will be the elimination of the costs inherent in managing a small, vulnerable currency like the Maltese lira and their replacement by the greater security and credibility afforded by a strong international currency. Euro adoption necessary but not sufficient Viewed from this perspective, therefore, the euro is but one element in a continuum of changes necessary to enhance the international competitiveness of the Maltese economy. The benefits of the single currency will not suffice, especially in the presence of downside risks to global growth such as higher oil prices, a potentially disorderly unwinding of current account imbalances and the rise of protectionism. Although the ongoing preoccupation with the level of the external reserves will cease once we join the euro area, moreover, any imbalance between what we buy and sell abroad will continue to cause the depletion of assets or the accumulation of liabilities, and be reflected in the country’s international investment position. Any loss of competitiveness, therefore, will still result in slower growth. BIS Review 113/2006  1  Raising productivity a key challenge In setting out to overcome this challenge, a primary objective should be the correction of existing macroeconomic imbalances. Output growth must, therefore, match spending growth more closely, and a key element in bridging that gap is increased productivity. Put differently, since we are price takers in the markets that matter, notably those for electronics and tourism, we must have a cost structure that does not discourage investment.

Antonio Afonso, Ludger Schuknecht and Vito Tanzi, Public Sector Efficiency: Evidence for New EU Member Sates and Emerging Markets. ECB Working Paper No 581 (2006). 2  BIS Review 113/2006  result, the 6% of GDP allocated to capital spending had to be funded almost entirely by additional borrowing, which gives rise to further debt-servicing costs. Repeated year after year, this pattern pushed the debt/GDP ratio steadily upwards to a peak of 75% in 2004. This tendency for recurrent revenue to be matched by recurrent expenditure in the context of fiscal retrenchment has had a crowding-out effect on investment, and partly explains why the country’s investment/GDP ratio has been static at best in recent years. A more telling indicator of the relatively small investment in productivity-enhancing activities is the share of GDP devoted to R&D, 0.6% in 2004, compared with an average EU ratio of about 2%. It is doubtful whether the existing pattern of resource allocation is conducive to the desired improvement in Malta’s international competitiveness. The latter can only be achieved by increasing the size, flexibility and skill level of the labour force, while simultaneously creating an institutional and physical infrastructure more likely to attract high value-added foreign direct investment. And since the State must play a leading role in this effort, the question of financing arises spontaneously. Now in the context of a fiscal consolidation process that has not yet run its full course, increasing recurrent spending beyond the natural creep caused by existing commitments such as pensions is clearly not an option.