Cost of living allowance – analysis of economic repercussions

A widespread feature in today’s labour market of most advanced economies are shortages, notwithstanding the slowdown of economic growth, due to the pandemic and the Ukraine war. The main conducive factors are imbalances between demand and supply in low skilled occupations (i.e. tourism, construction, trade), as well as increases in early retirements.

So far, the labour shortages did not lead to excessive wage increases, despite the rapidly rising inflation, which affects the purchasing power of the employees.

Within these conditions, a social dialogue on the politically highly sensitive topic of Cost of Living Allowance (CoLA) policy is currently taking place in Cyprus.

CoLA has been in place for a relative long period. Until 2012, it covered 100 per cent of the inflation increase for the entire public sector and a relatively small percentage of the private sector and was granted twice a year.

In the context of the “Troika” adjustment program in 2013, CoLA was abolished. In 2017, the social partners agreed on reinstating CoLA, however, the coverage was contained to 50 per cent of the price increases.

CoLA contributes towards preserving the purchasing power of the employees. However, at the same time, it leads to a higher cost structure and a burdening of enterprises, in particular during periods of low growth or recession, and affects their competitiveness. Moreover, there are further drawbacks, i.e. the practical implementation of CoLA does not account for sectoral or company level specificities, while it provides less coverage for low-income earners, who are disproportionally affected by inflation.

Various proposals are under consideration as part of the ongoing dialogue, including retaining the coverage of CoLA at 50 per cent of price increases, while extending the coverage in the private sector. Such proposals should take into account the following parameters:

First, while CoLA contributes to sustaining private consumption, it leads, in a low growth high inflation environment, to unemployment and exacerbating inflation pressures (stagflation).

Second, any proposal should take into account the effects on economy-wide, sectoral and company level competitiveness. Therefore, any decision should be based on an independent impact assessment, its implementation should be closely monitored and adjustments should be made if deemed necessary.

Andreas Charalambous is an economist and a former director in the Ministry of Finance.