The declining labour share and its impact on Malta’s current account position : an error correction model

Abstract

The aim of this dissertation is to study the main structural features influencing the saving and investment decisions that shaped the behaviour of the current account in Malta, which is a key economic indicator for assessing external account sustainability. Malta has been registering current account deficits from the early 1990s up to 2011, with a few exceptions. This reflected a steady decline in government saving which offset the impact of lower investment. Albeit, since 2009, Malta’s current account position has improved substantially to nearly 14% of gross domestic product (GDP) in 2017. Against this backdrop, the labour share of income has been registering a decline, while private saving as a percentage of GDP has reached unprecedented levels. The empirical model, which theoretically rests on the intertemporal approach, treats the current account as the difference between domestic saving and investment. Based on an error correction model (ECM) for the period between 1980 to 2017, this study examines the behaviour of the current account in the short-term and long-term and accounts for the effect of the declining labour share of income. The results are consistent with the Keynesian theory and with previous empirical literature which suggest that there exists a negative long-run relationship between the current account and the labour share of income. A discussion on possible reasons for the declining labour share in Malta and policy options which may be adopted to restore the country’s external sustainability are explored based on the estimated equilibrium model.