Tourism competitiveness after a cost shock
Malta's tourism sector is price-sensitive and highly dependent on euro-area visitors. In the past year, average hotel wages rose 4.5%, while productivity rose 1.0%; unit labour costs therefore increased faster than in competing Mediterranean destinations. The euro has appreciated 6% in effective terms. Tourist arrivals from Germany are down 5%, although arrivals from Poland are up 9%. Hotels report that energy and food costs are 12% higher, and many are operating at 78% occupancy. The government is considering a €40 million package for tourism: a wage subsidy for hotels that keep staff, a marketing campaign in new markets, and a cut in VAT on accommodation from 7% to 5%. The central bank warns that the current account surplus of 5% of GDP could narrow. Hoteliers say they cannot cut prices further without reducing service quality.
1. Assess how the rise in unit labour costs and the euro appreciation affect Malta's tourism competitiveness and current account. Use the concepts of unit labour costs, the real exchange rate and expenditure-switching.
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Unit labour costs rose by roughly 4.5% − 1.0% = 3.5 percentage points. If competitors' costs are stable, Malta's relative unit labour costs have risen, so its real exchange rate has appreciated. The 6% effective euro appreciation adds to the foreign-currency price of Maltese tourism, although hotels may absorb some in lower margins. German arrivals down 5% while Polish arrivals up 9% suggests both price sensitivity and some market diversification. Expenditure-switching means foreign visitors may switch to cheaper destinations and Maltese residents may switch to foreign holidays. The current account surplus of 5% of GDP gives a buffer, but a sustained loss of competitiveness would narrow it. The judgement should be cautious: not all of the German fall is caused by costs, since German demand may be weak. A blanket subsidy could therefore be an overreaction; the priority is to identify how much is cost-driven.
2. Evaluate the three elements of the €40 million package. Which would you prioritise and why?
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A wage subsidy preserves jobs and service quality, but it is costly, may keep inefficient hotels alive and can weaken pressure to raise productivity. It should be time-limited and tied to training or productivity improvements. A marketing campaign can attract new markets and has a measurable return if targeted; the growth in Polish arrivals shows diversification can work. A VAT cut from 7% to 5% may be passed through to prices, but hotels may keep the margin; it is costly and poorly targeted. Prioritise marketing in new markets plus a temporary wage subsidy linked to training and energy efficiency. Consider a VAT cut only if evidence shows full pass-through and a strong price response. Use sunset clauses and evaluate after 12 months. The package should build competitiveness, not simply subsidise existing costs.
3. The government cannot use exchange-rate policy. Discuss two supply-side measures that could restore competitiveness without reducing wages.
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First, skills and training can raise productivity per hour, so wage increases are offset by lower unit labour costs. Hotels could train staff in multi-skilling, languages and digital service, reducing seasonality and improving quality. Second, energy efficiency and digitalisation can lower operating costs and make the offer less price-dependent. For example, grants for heat pumps, insulation and online booking systems reduce bills and improve the visitor experience. Infrastructure and extending the season can also raise capacity utilisation. These measures improve non-price competitiveness and unit labour costs without cutting wages. A social pact linking wage growth to productivity would spread the adjustment fairly. Exchange-rate policy is unavailable, and internal devaluation through lower wages would hurt living standards; productivity is the sustainable route.