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Reducing poverty and improving social inclusion have been important goals of the government over the last five years.

In November 2014, the government published a document summarizing its strategy for social inclusion. Important policy initiatives included gradual reduction (tapering) of social security benefits when a beneficiary takes up work, in-work benefits for the longterm unemployed who return to the labor market, free childcare for working parents, senior citizens grant, incentives for people with disability to join the workforce and more generally measures to “make work pay”.

And indeed, the participation of female, elderly and long-term unemployed to the labor market has increased, and poverty risk has declined significantly since 2014.

However, since this improvement took place against the backdrop of a sharp acceleration in GDP, it is difficult to disentangle the effects of the cycle from those of policy.

This short note sets out to assess the marginal impact of s those policies.

More specifically, we use a macroeconomic model developed in the research department (RES) of the IMF to isolate the impact on employment, potential GDP, productivity, wages, the current account, and debt ratios (among other variables) of i) increasing childcare and after care benefits, ii) extending working lives, and iii) upskilling the labor force. Simulations will show that policies that are primarily aimed at improving social inclusion also end up boosting potential output, thereby mitigating the fiscal cost of such policies in the long term. Recent declines in poverty rate can partly be ascribed to the cycle, but recent structural reforms likely have had a significant impact on growth.

Poverty risk has been dropping at the aggregate level in recent years, reflecting both cyclical improvement and structural reforms.

The share of people at risk of poverty or social exclusion (AROPE) in Malta had been rising following the Global Financial Crisis, but the trend turned around in 2014. The proportion of underemployed people suffering from material deprivation (particularly related to living standards and financial arrears) has since dropped rapidly as average income surged. Poverty or social exclusion risks in Malta were below the EU average in 2017, a significant improvement from the situation in 2013. 

The reduction of absolute poverty has been accompanied by rising inequality.

At the same time as the share of population suffering from material deprivation has been declining (absolute poverty), the proportion at risk of relative poverty, i.e. earning less than 60 percent of the median income, has been increasing continuously.3 This is confirmed by the Gini coefficient that has also been increasing since 2012 in Malta, while remaining at a lower level than in the rest of Europe. More importantly, the relative risk of poverty has remained high for vulnerable groups (single earners, unemployed, elderly, refugees and tenants), and has been rising recently, even after social transfers, suggesting some scope for further action.

Certain subgroups are particularly vulnerable to poverty risks.

Female single earners with children: The gender overall earnings gap in Malta is among the highest in Europe. This largely reflects the fact that women (especially low-skilled, single mother and relatively older) tend to remain outside of the labor market in Malta. Recent economic growth and policies to promote female participation in the labor market have helped close part of the gap, and the participation rate of the younger cohorts of female has caught up with EU averages. Further encouragement and an extension of these policies is needed to ensure that recent gains are made permanent.

Elderly people: As pensioners’ income has failed to keep up with other incomes, relative poverty risk has increased among elderly. This points to the need to recalibrate social transfers for elderly, but fiscal implication of raising pension or social benefits would need to be considered carefully in light of existing concerns on pension sustainability in an aging society (IMF 2016). Ongoing changes in the statutory retirement age to 65 by 2027, from 61 for men and 60 for women in 2013, will be an important step to mitigate both fiscal and poverty risks in the long term.

Low skilled workers: Early school leaving rates are particularly high in Malta, well in excess of the EU average. Against a background of strong growth, labor participation of low skilled workers has improved recently. However, the relatively low proportion of tertiary educated workers is responsible for relatively low labor productivity and income, and is one of the most commonly cited reason by firms to explain the levels of investment.

Refugees: The poverty risk is high and rising among low-skilled immigrants from outside of the EU. Among these immigrants, refugees, which represent a sizable share in total population (about 2 percent), are particularly vulnerable.

Tenants: The poverty risk is rising among tenants, mainly low income households, and their poverty risk is compounded by rapidly rising rents in the unregulated rental market. This points to the need to improve housing affordability, including through social policies targeted at low income households.

A large multi-country simulation model, the IMF’s Flexible System of Global Models (FSGM) calibrated for Malta, is used to analyze the macroeconomic impacts of ongoing and potential future reforms.

The FSGM stands for a collection of multi-country dynamic general equilibrium models widely used at the IMF to analyze a vast range of policies and their implications for growth, inflation, and the public and external accounts. Its multi-country structure allows a general equilibrium analysis of global interdependences and spillover effects of alternative policies, including through financial spillovers associated with the effect of debt on global interest rates. The simulations presented below are based on the Euro Area module (EUROMOD) of FSGM, which contains a block for each of the 11 major euro area countries, an aggregate of the rest of the euro area, including Malta, and 13 other blocks.

Fiscal policy is anchored on a deficit stabilization rule, ensuring convergence to a (exogenously given) long-term debt objective.

However, in the short-term deficits can fluctuate to accommodate the impact of the business cycle, allowing automatic stabilizers to operate, akin to what happens in a structural balance rule. To ensure convergence to the long-run debt objective, lump-sum transfers are assumed to adjust over time.

Notably, the model reflects important features of the monetary union.

Monetary policy is run at the euro area (EA) level and based on an interest rate rule that responds to EA output gap and inflationary pressures. This allows wage and price inflation to be different across EA countries depending on their respective cyclical position. In the model, wages are sticky and set by labor unions at a markup over workers’ marginal rate of substitution (the rate at which they would optimally trade a unit of leisure against a unit of consumption in a competitive labor market). Wages are then adjusted with a lag to situation of excess demand of labor.