As a share of GDP, private investment amounted to 16% on average between 2000 and 2009, among the lowest ratios in the euro area. Given Malta’s track record in attracting foreign direct investment, this shortfall is probably more a reflection of a relatively low level of domestic private investment. The latter is unlikely to be related to the cost and availability of finance. Interest rates are at historic lows and, contrary to the experience elsewhere, credit to the private sector continued to expand during the recession. As for possible structural factors, the diversification of the economy away from manufacturing towards services is also unlikely to have been a factor. Similar sectoral shifts elsewhere did not result in a declining investment share. Rather, the relatively low level of private investment could, in part, be a legacy of the past, when firms in protected sectors could survive without the need to invest to face up to competition. In addition, in key sectors such as tourism and the wholesale and retail trades, the operating surplus has fallen, on average, over the past decade. Weak profitability, which is partly due to labour costs rising faster than productivity, reduces both the incentive to invest and the internal funds available to do so. Hence the emergence of a perverse cycle of weak profitability, low investment, poor productivity growth and a loss of competitive strength. These weaknesses are reflected in persistent current account… These structural weaknesses show up in a persistent deficit on the current account of the balance of payments.
BIS Review 156/2010  3  the Bank on price and wage setting in Malta shows that although just over half of respondents would cut prices if their competitors did so, 36% would not. Unsurprisingly, the most flexible firms were those in the manufacturing and tourism sectors, where foreign competition is strong. This suggests that there is still scope for increasing the degree of domestic market competition. Sometimes, the connection between market liberalisation and exports may be indirect. As the recent experience in the communications sector has shown, liberalisation drove down costs and prices. This opened up new export opportunities outside the communications sector itself, for example, in financial services and remote gaming. The importance of keeping costs under control cannot be overemphasized. Malta’s inflation performance over the last ten years illustrates this point. Whereas the euro area inflation rate averaged 2.1% between 2000 and 2009, domestic inflation averaged 2.5%. The record for inflation excluding energy prices shows a similar unfavourable trend. It is an established fact that in a currency union rates of inflation consistently above the average result in a loss of competitiveness. Apart from more competitive markets, containing domestic inflation implies a need for wage moderation. For many years employee compensation has grown faster than real labour productivity. Whereas the former increased by around 31% since 2000, productivity rose by only 2.5%. The resulting rapid growth in unit labour costs, more than 28%, compares with an average of 20% in the euro area.