Cyprus Mail
Opinion

The depressing truth behind our ‘economic growth’

Students at the University of Cyprus - Many young people, unlike their parents, cannot secure jobs commensurate with their education and skills

Intergenerational inequalities have been exacerbated by government policies that favour the rich

By Les Manison

The current Cyprus government continues to advertise its “successful” economic policy management by referring to the relatively high rate of growth of real GDP, falls in the official unemployment rate, the generation of surpluses in the government accounts, and its raising of large amounts of funds on international financial markets.

However, these so-called successes have been associated with the maintenance of extremely high levels of private debt and the failure to reduce public debt to prudent levels. In addition, while the composition of economic growth has benefitted handsomely limited segments of the population, disposable incomes of middle and lower level households have remained low perpetuating high income and wealth inequalities. And in particular intergenerational inequalities are mounting as younger persons continue to suffer from underemployment and low wages in the face of high and rising housing costs.

Indeed, the obsession of the Cyprus government with the growth of GDP as the yardstick for assessing a successful economy has hijacked policy-making, most notably in the failure to address the huge debt overhang and the socio/economic inequalities cited above, as well as in the cutting-back of development expenditures required to sustain healthy economic growth. Furthermore, with the pattern of growth pursued by the government based mainly on promoting private consumption, tourism and the high-end property market difficulties are likely to be encountered in sustaining the current pace of GDP growth.

 

Difficulties in sustaining growth

 

From the expenditure side, private consumption has been the main source of GDP growth being financed to a considerable extent by households not paying their debts and running down their savings. In fact Cyprus is the only EU member where households have recorded negative saving rates since 2014. And if debtors including the so-called strategic defaulters through policy measures are forced to save more and accelerate repayment of their loans and their saving balances become depleted as well, the growth of private consumption could be substantially curtailed.

In 2019 and 2020 the growth of the tourist sector is likely to slow down from its overestimated high level owing to the depreciation of the pound sterling against the euro, the great uncertainty over Brexit, and the increased competitiveness (price and security wise) of tourist destinations such as Tunisia and Turkey.

Policy measures to promote the property sector, especially through the investment for citizenship scheme, have boosted the construction sector and related services including those of lawyers, accountants and real estate agents. However, it is debatable whether the recent steep rise in construction and real estate activity can continue, particularly as the EU is putting much pressure on Cyprus to phase out the citizenship for investment scheme.

Policy neglect

But even without a substantial weakening in the main drivers of economic growth, the economy faces major problems in harnessing its medium to longer run potential to generate equitable growth. The foundations for sustaining economic growth in the form of physical infrastructure and human capital are being depleted through declining government development expenditures and quality outlays for education. And failure to effectively deal and reduce the huge amount of private debt, much of which is non-performing, means that banks have little scope for financing productive investments of creditworthy customers. Furthermore, many households burdened with debt do not have the financial capacity to invest in their families with good quality education and healthcare.

In essence it is the inequalities, particularly intergenerational, that are being fostered by government policies and the lack thereof that are damaging the potential of the Cyprus economy to enhance the well-being of the bulk of its population. More specifically, many young persons, unlike their parents, cannot secure jobs commensurate with their education and skills. Yes, the unemployment rate is declining, but most job-seekers cannot find decent employment. Youth are forced to either emigrate, to take on underemployed work with low wages, or be unemployed, in the process robbing Cyprus of their potential to contribute to economic growth.

Furthermore, with high housing costs in urban and tourist areas younger persons cannot afford decent housing and the bearing and raising of children, thus diminishing the growth of the Cyprus population. And the government with its debt management policies, subsidisation of the banks (gifting Hellenic Bank with the good part of the Co-operative Central Bank and the Estia scheme), and failures in protecting the physical environment, is passing on costs including the burden of debt repayments to the new and future generation of honest taxpayers.

 

Recommended policies

The government through its behaviour of favouring the rich and politically well-connected families in its policies has not only amplified inequalities, but has put itself in a position where it is incapable of  undertaking policies to reduce inequalities and deal productively with the large debt overhang.

Taxation

Take taxation policies for example. The government by tolerating and even implicitly encouraging tax evasion, especially by professionals, teachers and tradesmen, who have the ability to pay their fair share of taxes, is greatly restricting its financial capacity to lower taxes on middle and lower level households. Furthermore, abnormally low revenues make it difficult for the government to use its surplus to repay the considerable public debt, and instead it borrows large amounts of euros in international markets just to rollover the debt now at over107 per cent of GDP.

And in addition to gaining substantial revenue from seriously combatting tax evasion the government needs to increase the progressivity of the income tax system and reintroduce a progressive property tax more in line with other euro area members. This would also give the government greater fiscal space to provide households with the high quality public goods (education, healthcare, environmental protection etc.) and to undertake real development expenditures so that most residents can enjoy a standard of living more in line with an advanced European normal state.

 

Private debt

Policies with regard to the extension and management of private debt have been largely unproductive. By 2014 around 48 per cent of bank loans were defined as being non-performing which reflected among other things over-lending and poor credit risk assessment, misallocation of funds by borrowers, and strategic debt defaulting mainly by wealthier debtors. In many cases, debts of the rich and powerful including the church have been reduced by exchanges of over-valued property for debt write-offs and the rescheduling of debt repayments on very generous terms. In contrast many medium and small scale enterprises (SMEs) have not had their loans productively rescheduled, and like the majority of indebted households continue to be hindered in their normal operations by excessive debt obligations.

In a previous article it was pointed out that the least wealthy bottom 20 per cent of indebted households in Cyprus required an estimated 64 per cent of their income to meet their monthly debt repayments in 2014.  It is further noted that while the selling of bank loans to third parties at very large discounts reduces the NPLs of banks it does not decrease the overwhelming outstanding debt of the private sector estimated at just under 300 per cent of GDP at end-2018, and excluding the large debt of Special Purpose Entities at 216 per cent of GDP.

The Estia scheme aimed at providing debt relief to moderately wealthier borrowers should not be implemented. Serious efforts should be made to productively reschedule the loans of SMEs. Loans of poorer households (with equivalised disposable household incomes below 20,000 euros per annum) should be written-off. For households with higher annual incomes, but not above 50,000 euros there should be a partial writing-off of loans. And for clear cases of strategic debt defaulting, such as that of many politicians, the honouring of loan contracts should be strictly enforced. Hopefully, the increased repayments from strategic debt defaulters would be in excess of related bank provisions for losses, and would suffice to largely offset bank losses from the writing-off of loans.

 

Changing the drivers of growth

Although reducing inequalities and private sector debt can help advance the growth rate, the key drivers and pattern of economic growth need to be changed, among other things in order to provide decent employment opportunities for younger persons. And as real economic development results from investments in economically viable projects it is productive investments that should be the key driver of growth.

In Cyprus, where investment opportunities for creditworthy entities are scarce the government has not exhibited any competence in identifying, preparing and undertaking productive investments so as to be at the forefront of any new growth initiative. As argued convincingly by economist Savvakis Savvides this task should be assigned to a newly created Development Bank type institution with competent and apolitical personnel to lead the way in arranging the preparation and financing of economically viable projects. In this respect there are ample funds available to Cyprus from EU institutions for investments in establishing a “greener” and a more “digital-based” economy.

EU funds should be utilised also to develop research institutes around Cyprus universities so as to enhance research and innovation and to deploy more productively the skills of highly educated Cypriots. Tourism should continue to be a leading sector and achievement of this aim should be facilitated by investments in facilities and marketing to attract more elderly and culturally oriented tourists to Cyprus during the non-summer months.

 

 

 

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

 

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