Cyprus Mail
Guest Columnist Opinion

How government policies are driving growing inequalities

The rich hotel owners have gained the most from the steep rise in tourism.

By Leslie Manison

A number of studies have concluded that Southern European countries in particular have experienced growing inequality since the beginning of the financial crisis in 2007.

“Since the start of the crisis, market processes have been primarily responsible for the worsening of income inequalities in all European countries, and especially in Southern Europe,” says economist Michele Raitano. And a recent IMF paper states that “Our (IMF) results also show that corruption and poor governance are associated with higher inequality and lower inclusive growth”.

This article looks at the inequalities that have developed in Cyprus in recent years and the role government policies has played in influencing these developments.

Since 2008 there has been a distinct increase in income inequality in Cyprus with the European Commission stating in its 2017 Country Report on Cyprus that “Inequality has been rapidly increasing in recent years and remains a source of concern” and add that “the widening inequality has been caused by the faster income growth of the richest”.

The Gini coefficient – a summary statistic measuring inequality – for Cyprus household incomes, excluding social transfers, rose by over 27 per cent between 2008 and 2015 to 50.2, with the rise in inequality mainly reflecting market forces.  The closer the Gini is to 1, the more unequal is the distribution of income or wealth.

Indeed, the largest increase in this indicator occurred in the difficult post-crisis years of 2013 and 2014 when sharp falls in employment and wages worsened income distribution. The Gini coefficient for household disposable incomes including social transfers also exhibited an upward trend up to 2013 to reach 34.8, a level well above the Euro area average. But it fell to 32.1 by 2015 owing to the new Guaranteed Minimum Income (GMI) scheme exerting a redistributive and equalising impact.

More detailed data show that the richer echelons of Cyprus society increased their share of income and wealth over the last decade, especially in the years from 2008 to 2013 when the total income share of the top 10 per cent of household income earners rose from 24.1 per cent to 28.7 per cent thereafter the income share of these upper income households decreased to 25.8 per cent by 2015. Most notably, Cyprus households with the top 20 per cent of incomes raised their income share by 4.5 percentage points between 2008 and 2014 to 43 per cent, this rise being by far the largest increase for the rich among 28 EU countries.

The rising income share of the rich of Cyprus has been mainly at the expense of lower middle income households driving many into the ranks of lower income households. Indeed, the shrinking of the middle class in Cyprus in terms of income seems to be compatible with similar developments in the United States and in many countries of Europe. Cyprus, however, differs from other European countries that experienced sharp post-crisis falls in household incomes such as Ireland, Portugal and Spain in so far as Cyprus households largely defended their pre-crisis “excessive” consumption levels, by running down their saving balances. In contrast households in Ireland, Portugal and Spain cut back their consumption significantly by among other things raising their saving to repay debt. In fact, Cyprus households recorded a savings rate of minus 2.6 per cent over the four years from 2012 to 2016, whereas Irish, Spanish and Portuguese households all had positive saving rates exceeding 6 per cent.

In regard to developments in wealth inequality in Cyprus there is limited information. Data from the 2009 and 2014 waves of the Eurosystem’s Household Finance and Consumption Surveys (HFCS) showed that all groups registered large falls in their net wealth with the richest 10 per cent at least maintaining their 57 per cent share of total household wealth. In their latest report on the Cyprus economy the European Commission state that “wealth inequality remains among the highest in the euro area. The Gini coefficient of net wealth (assets minus liabilities) was 0.72 in 2014, reflecting a high proportion of indebted households.”

Reflecting the pattern of growth and policies of the government and banks there is evidence that income and wealth inequalities have remained high and probably increased after 2014/2015. In the more dynamic growth sectors of the economy such as “accommodation and food service activities”, “construction”, “real estate” and “retail and wholesale trade” revenues have been on a strong upward path since 2014, but average earnings of employees in these sectors apart from in real estate have stagnated or fallen following earlier steep income declines.

In the tourism sector it is the rich hotel owners that have gained most wealth from the estimated rise in tourism revenues of more than 30 per cent over the period from 2014 to 2017. Hoteliers have benefitted disproportionately from their offering of “all-inclusive packages” in the process diminishing the earnings of local businesses including restaurants and car hire agencies. At the same time they have kept the wages of hotel employees virtually flat at low levels, averaging six to seven euros per hour.

In recent years government taxation policies have become increasingly regressive through greater reliance on indirect taxes, particularly the VAT, and together with the abolition of the progressive property tax have contributed importantly to growing wealth inequalities. Furthermore, with the government largely turning a blind eye to tax evasion by the professional and business elite including doctors, lawyers, accountants, major hoteliers and property developers, income and wealth inequalities have been exacerbated. In addition, banks with their traditional emphasis on extending loans on the basis of property collateral and in their more favourable treatment for the wealthy in debt restructurings and write-offs, let alone in tolerating their strategic debt defaulting, have helped fuel growing wealth inequality.

Consequences of Growing Inequalities

But what are the consequences of growing income and wealth inequalities? Why should the European Commission express concern?

There is much debate in the economic literature about whether income and wealth inequalities are beneficial or detrimental to economic growth. On the one hand it is argued that inequality impacts positively on economic activity and output as far as income differentials provide incentives and reward personal effort, entrepreneurship, risk-taking and innovation. On the other hand income and wealth inequalities can harm growth, especially that of an inclusive and equitable type, by depriving less wealthy persons of access to decent health care and education, thus robbing them of the opportunity to realise their full potential to contribute to economic growth. And most importantly, these inequalities create socio-economic divides that can fuel financial instability.

In Cyprus, economic inequalities have induced many less wealthy households to take on more debt to keep up with the conspicuous consumption of their wealthier neighbours and friends, in the process amplifying net wealth inequalities. Indeed, it is striking that according to the latest HFCS the poorest 20 per cent of indebted households in Cyprus by 2014 required 64 per cent of their income to meet monthly debt repayments, while middle income earners required 37 per cent, problems now reflected in the very high level of non-performing loans (NPLs) of households.

Need for new policies and reforms

To mitigate the aforementioned inequalities and promote more equitable growth the government needs to undertake a number of policy initiatives. Firstly, a reform of the tax system is required to render it more progressive. This can be accomplished by restructuring the personal income tax rates in favour of lower and middle-income earners and bringing back a progressive tax on immovable property.

Secondly, serious efforts should be made to tackle the widespread tax evasion through the political authorities acquiring the will and courage to do so and by substantially improving tax administration. If rich tax evaders are forced/induced to pay taxes not only will disposable income and wealth inequalities be reduced, but the increased revenue would enable the government to better meet priorities such as providing improved and more affordable healthcare and education.

Thirdly, the European Commission argues that redistributive measures, such as the GMI, have only had limited success, at least compared with the better results of benefits systems achieved in reducing income inequality in many other Euro area members. It is thus recommended that social benefits be better targeted and their levels including the GMI raised, especially for families where parents have low skills and where there is the increased risk of child poverty.

And, fourthly, in the labour market, there is a need to strictly implement existing regulations such as paying minimum wages and overtime rates and contributing to social security for workers.

More generally, government policies, which are often reflected in weak governance, corrupt practices and nepotism have resulted in a lack of genuine competition in the capitalist system of Cyprus that in turn has led to inequitable differences between the compensation and fortunes of firms and individuals. Corruption and nepotism are causing young people to underinvest in skills and education, because securing a decent job and “getting ahead” depends on who you know not what you know. Indeed, the proportion of young people (15-24 years) in Cyprus not in employment, education, or training remains one of the highest in the EU at I6 per cent and continues to grow.

To enhance competition and largely eradicate the favourable treatment afforded to politically well-connected corporations and individuals in the handing out of licences, permits, EU/government grants, special tax breaks, in the award of public sector contracts etc., as well as in the appointment and promotion of personnel in public institutions, it is paramount that laws and regulations be applied strictly and evenly across business units and individuals.

Banks can also level the playing field by extending loans on the basis of the client’s intangible assets and ability to generate income in the real economy so as to effect repayments rather than on the physical collateral or wealth of the borrower. And to vastly improve the management of private debt the political authorities should enact urgent legislation (for example, amendments to foreclosure and insolvency laws) and exercise the will to resolutely enforce the loan contracts of strategic debt defaulters, many of whom are among the “rich and powerful”.

Finally, rectifying inequitable government policies as suggested above and changing the pattern of growth to be based less on excessive consumption and property development should help to achieve more sustainable and equitable growth. With an improved competitive environment, the pattern of growth would change enabling Cyprus to utilise better its comparative advantages and resources including its many unemployed and underemployed educated and skilled persons.

These attributes would in turn provide the opportunity for Cyprus to develop its role as a regional hub for transportation, trade and professional services as well as in providing affordable high-quality health care and education to both domestic residents and foreigners.

Such development would be compatible with more equitable and inclusive growth enabling a much greater number of Cyprus household members to benefit more evenly from and participate more productively in the economic growth process.

 

Leslie G Manison is an economist and financial analyst, specialising in macroeconomic policy analysis, bank viability assessments, and international financial relations. He is a former senior economist at the International Monetary Fund, an ex-advisor in the Cyprus finance ministry and a former senior advisor at the Central Bank of Cyprus.

 

References

Raitano Michele, “Income Inequality in Europe Since the Crisis” Intereconomics, March 2016, Volume 51, Issue 2.

European Commission, “Country Report Cyprus 2017”, SWD (2017) 78, final, Brussels, February 2017.

European Commission, “Country Report Cyprus 2018”, SWD (2018) 211 final, Brussels, March 2018.

The Statistical Service of Cyprus, “National Accounts, 1995-2017”, March 16, 2018.

Manison Leslie G., “Lack of Adjustment in the Cyprus Household Sector: Results from the Eurosystem’s Household Finance and Consumption Surveys”, October 2016. Available at SSRN http: ssrn.com/abstract=2975802.

The Statistical Service of Cyprus, “At risk of poverty and social exclusion indicators, 2008-2016”, October 2017.

European Investment Bank, “Inequality in Europe”, January 2018.

Manison, Leslie G., and Savvides, Savvakis C., “Neglect Private Debt at the Economy’s Peril”, World Economics Journal, Vol. 18, January-March 2017.

International Monetary Fund Blog, “Shining a Bright Light into the Dark Corners of Weak Governance and Corruption”, April 2018.

Manison, Leslie G. and Savvides Savvakis C., “Towards Sustainable Growth (Rebuilding the Foundations of the Cyprus Economy)”, May 2016. Available at SSRN: https://ssrn.com/abstract=2784802.



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