Cyprus Mail
Guest Columnist Opinion

The virtues and perils of a small open economy

The burden placed on the private sector is so acute that it is essentially subsidising the public one

 

By Dario Pontiggia

 

THREE years after stepping back from the brink of bankruptcy, the Cyprus economy has returned to real growth, with deflation abating. On the supply side, internal devaluation has resulted in lower unit labour costs and the prolonged and sustained fall in the price of oil has resulted in lower electricity costs, with all the benefits that it entails for the wider economy.

On the demand side, lower prices have ameliorated the fall in incomes and made Cypriot products and services more interesting for foreign buyers. This coupled with exogenous positive factors, such as favourable exchange dynamics and, above all, tourists preferring Cyprus to other increasingly more unstable touristic destinations, have played a major role in boosting tourist arrivals and revenue, with both reaching all-time highs.

As such, the tourism sector as well as business services have played a major role in bringing the economy back to growth. Notwithstanding the long-term – transition to a new normality will take time, given how profound the starting imbalances were- challenges of high levels of debt, both non-performing and performing, and unemployment, particularly long-term and among the young, the Cyprus economy has shown the resilience typical of a small open economy, especially when buffeted by a series of exogenous positive shocks.

Unfortunately, the perils of a small open economy are equally evident and keep Cyprus and the recovery and restructuring of its economy on a shaky footing. Looking at the programme of economic policy conditionality key objectives, it is fair to conclude that while the first two, namely restoring the viability of the Cypriot banking sector and consolidating public finances, have been tackled head-on, the third, relating to structural reforms that will support competitiveness and sustainable and balanced growth, has so far proved elusive. Put differently, if the Cypriot economy has exceeded expectations and forecasts, growth has been mainly due to exogenous factors, rather than endogenous ones. The question is then why the Cypriot economy cannot help itself.

The main reason seems to be an overriding concern on the present and a complete lack of focus on the future. Objectives and goals often remain just intentions and, time and time again, political leaders find it easier and more convenient to safeguard and preserve the status quo, in terms of incentives – few -, disincentives -many – and guarantees. And, because large vested interests do very well within the existing status quo, they continue to devote abundant lobbying resources to resisting efforts to ensure that the system does not change.

For instance, despite the efforts of Finance Minister Harris Georgiades, and Undersecretary to the President and Reform Commissioner, Constantinos Petrides, fiscal-structural reforms have been largely unfulfilled. Indeed, speaking about the need for the reform of the public service Georgiades rightly pointed out that “Apart from budgetary considerations, there are others such as social justice which make going ahead with this reasonable adjustment an imperative”. Moreover, Petrides equally rightly stated that failure to pass the reform would amount to assert that Cyprus is fine with a broken system. Question is then what prevents social justice and results in a broken, in the sense of divided, system?

Two are the big divides that characterise the Cyprus economy and hinder social justice. While the first one is indeed more specific to Cyprus as it has been tackled in other European countries through multiple reforms of the Public Administration, the second is instead widespread and common to many other developed countries.

The first is the one between public and private sector. Labour conditions in the two sectors are very far apart, thus resulting in dual labour markets. In the public sector, jobs for life go hand-in-hand with remuneration and benefits that are way above what productivity would command. In the private sector, the exact opposite is the norm: low remunerations and benefits are associated with job insecurity and in some cases, complete disregard for basic rights and guarantees.

Put differently, if the public sector looks like the West End, overprotected and pampered, the private sector looks a lot more like the wild-wild West, dynamic but unregulated. The iron-strong unions of the public sector are exceptionally good at negotiating, surely with a much-less-strong State, and invariably achieve the best outcomes for the only agents they care about, namely their fee-paying members. Yet, such outcomes and conditions do not come free and, in maximizing the return to the public sector, they place a heavy burden on the private sector.

Overall, a large and unproductive public sector rides on the back of a private sector, which, although characterized by inefficiencies and distortions, has been vital in the recovery of the economy. The problem here is major as the competitiveness of the Cyprus economy is hindered by essentially having the public sector dissipating any productivity gain that are realized in the private sector.

The burden placed on the private sector is indeed so acute that the private sector is essentially subsidising the public one. The winner not only takes it all, but also creates an additional cost to the private sector as a whole in that foreign companies perceive civil service and bureaucracy as the biggest obstacle to job-creating investment. This is indeed a textbook example of what economists refer to as a vicious circle, with distortion self-reinforcing and creating further ones. The reform of the civil service, notwithstanding its limitations, is surely a step in the right direction, but should be the first of a series of steps on the long journey to the normalization of labour markets.

The second divide, which may be less evident but it is equally detrimental to social justice, is the one between young and old generations. This, unlike the previous one, is a divide that is common to most developed countries. Indeed, the impact of only focusing on the present is particularly severe in an inter-generational context. The losers at the ballot box are undoubtedly the young, whose political apathy, if not endorsed, can at least be understood.

The winners at the ballot box are surely the old, with some commentators even suggesting that they are in essence colonizing the economic future of younger generations. In the second half of the twentieth century, rapid and sustained economic growth entailed that each generation could reasonably expect and achieve a better future than the previous generation. Today, by contrast, widespread economic difficulties and forecasts of secular stagnation make promises about a better future appear much less reasonable and obtainable.

If, on the one hand, young generations face worse life opportunities than older generations, these, on the other hand, are transferring to their successor ever increasing levels of debt. While the scale of this burden has skyrocketed following the economic crisis, it could be reduced substantially by implementing those same structural reforms that will support competitiveness and sustainable and balanced growth. Yet again, the focus on the present takes its toll: by the time the needed reforms are implemented, they will be the next generation’s problem and they will cost much more.

To conclude, as much as the public sector is imposing a heavy burden on the private sector, older generations are also imposing a heavy burden on their successors. Expecting altruism, either of the older generations or of the public sector, is not an option. Indeed, in today’s self-centered culture, it is difficult to expect people to put anything before their own interests. For now, safety valves, such as labour mobility and the Mediterranean welfare system (i.e. family), have prevented clashes between sectors and across generations. Yet, how and when we tackle and resolve these two divides constitutes one of the greatest challenges ahead. On a positive note, younger politicians and officials seem to be fully aware of the trends and dynamics at work and the hope is that, eventually, they will get their way.

 

Dr. Dario Pontiggia is a Lecturer in Economic at Neapolis University in Paphos. He holds a Ph.D. in Economics from Glasgow University and a Doctorate in Political Economy from the University of Milano –Bicocca. He also holds a Master’s Degree in Economics from the University of Edinburgh.

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