Macro-economic Convergence in Cyprus By Dr. Mustafa Besim Member of the Economic Committee in the Cyprus Talks ECONOMIC CONVERGENCE AND A CYPRUS SETTLEMENT 6 February 2007 LONDON SCHOOL OF ECONOMICS

2 Objective & Scope of the Presentation Focus will be on the macro-economic convergence and its contribution to a settlementFocus will be on the macro-economic convergence and its contribution to a settlement The scope will cover:The scope will cover: –Convergence and its link to settlement –Recent history on the economies (up to 2000) : Convergence or Divergence ? –Contribution of Economics to the Referenda –Integration and convergence –Does convergence contribute to a settlement?

3 Convergence Concept for Settlement Convergence:Convergence: – of incomes of citizens within an economy and with other economies; – of institutions, sectors ( interdependence), macro- prudential indicators and market structures; –criterions of EU for those members recently acceded to EU ( i.e. inflation, interest, budget deficit) The model for convergence for Cyprus:The model for convergence for Cyprus: –importance of economic integration within the island –Model that would improve economic interractions

4 Economic History of Cyprus (1960)- Republic of Cyprus : A Power sharing partnership between two ethnic communities, Greek Cypriots (G/C) and Turkish Cypriots (T/C)(1960)- Republic of Cyprus : A Power sharing partnership between two ethnic communities, Greek Cypriots (G/C) and Turkish Cypriots (T/C) –Rapid growth mainly in the agricultural economy, export oriented (1963)- Inter-communal conflict led to collapse of the partnership. T/C set up a separate administration (1963)- Inter-communal conflict led to collapse of the partnership. T/C set up a separate administration –Income gap started to widen as T/C did not have much access to be active in economics as the G/C (1974)- Up to 1974 there was one economy:(1974)- Up to 1974 there was one economy: – GDP : $ 600 M with per capita income close to $1,000 for G/C and – Among T / C per capita income was $500 Following a G/C coup d’etat with backing from Military junta in Greece, Turkey militarily intervened and divided the island into two: G/C in South and T/C in the NorthFollowing a G/C coup d’etat with backing from Military junta in Greece, Turkey militarily intervened and divided the island into two: G/C in South and T/C in the North

5 South Cyprus Economy Moved from agriculture-based towards service-oriented structure; tourism, shipping and financial activities including “off-shore” sector.Moved from agriculture-based towards service-oriented structure; tourism, shipping and financial activities including “off-shore” sector. Low interest and inflation rates. Highly developed financial sector with a credible exchange regime from fixed to a currency basket and now towards EURO.Low interest and inflation rates. Highly developed financial sector with a credible exchange regime from fixed to a currency basket and now towards EURO. A flexible labour market; shortages and wage pressures overcomed by seasonal immigrants.A flexible labour market; shortages and wage pressures overcomed by seasonal immigrants. As the EU membership approached the liberalization process speeded up, transforming the economy into a modern, market-based and liberal economy.As the EU membership approached the liberalization process speeded up, transforming the economy into a modern, market-based and liberal economy.

6 Growth Rate in South Cyprus (2) Stable growth with close to 5% between Stable growth with close to 5% between Main source of growth have been tourism, construction, business and financial servicesMain source of growth have been tourism, construction, business and financial services The challenge ahead: Sustainability of the growth and the macroeconomic stability: control of the budget deficit....stability and growth pact and adoption of Euro.The challenge ahead: Sustainability of the growth and the macroeconomic stability: control of the budget deficit....stability and growth pact and adoption of Euro.

7 North Cyprus Economy (1) After 1974, Northern Cyprus did not fulfil its potentials:After 1974, Northern Cyprus did not fulfil its potentials: –External factors: non-recognition, economic isolation, trade mainly with Turkey. –Decision of the European Court of Justice limited the trade of agriculture products (citrus, potatoes) (Certificate of origin). –No trade integration, economy was not liberalised and market conditions were very much distorted –Depended on the aid from Turkey, which was in fact helping to enlarge the public sector. –Admistration did not push for a proper institutional settings for the private sector and governance –Market based but economy has been relying on public sector; public has been the producer as well as the employer, crowding out private sector. –Poor political will to have a private sector driven economy

8 North Cyprus Economy (2) Private and public (infrastructure) investments were not sufficient....uncertainty, weak banking sectorPrivate and public (infrastructure) investments were not sufficient....uncertainty, weak banking sector Using TL =  High and unstable inflation and interest ratesUsing TL =  High and unstable inflation and interest rates

9 Growth Rates in North Cyprus (3)  Most shocks originating from Turkish economy  After the crises between and the stabilization of TL, the growth started to pick-up as high as 10%s the growth started to pick-up as high as 10%s  Export oriented services: tourism, universities and construction turned out to be major sources of income

10 Meanwhile: Economic relations between T/C and G/C.....  Inter-communal conflicts in 1963 have worsen the economic conditions for T/C  By the time of de facto division (1974) per capita GDP in the North was about half that in the South.  For almost 30 years, Green-Line stood as the internal border with no traffic and/or trade at all  High volume of smuggling through certain channels: Mainly through Pile and Sovereign Base Area of Britain  Commuting workers with permission  T/C have been very depended on trade with Turkey, whereas G/C have been trading with the world 

11 Diverging Economies ! Diverging Economies !  No freedom of movement. No grounds for economic interaction.  Two diverged economy. North not converging to South and to EU. South converging to EU.  No convergence of institutional and market structures between North and South.  Economics did not have incentives for supporting a political solution.  Diverged economies stoned separation GNP T/C (Cyp M) GDP G/C (Cyp M) 4,0895,407 GNP T/C Per Capita 2,0272,650 GDP G/C Per Capita 6,2837,791 TC / GC per Capita Income 32 % 34%

12 New Economic Environment for Cyprus New Economic Environment for Cyprus November 2002, UN proposal for a Comprehensive settlement (Annan Plan)November 2002, UN proposal for a Comprehensive settlement (Annan Plan) Rallies led to opening of the gates (23 April 2003)Rallies led to opening of the gates (23 April 2003) T/C demonstrated explicitly their will for a united Cyprus in EUT/C demonstrated explicitly their will for a united Cyprus in EU Free movement of people have allowed considerable amount of economic interaction even without any institutional setupFree movement of people have allowed considerable amount of economic interaction even without any institutional setup –Retailing –Services (Tourism, casino, hospitals) –Labour (commuting workers)

13 Economics Did not Contribute to Referenda UN Plan (1.Versin November 2002) did not pay enough attention to economics..(2003 wasted)....but by 2004 with revised versions more economics were included.UN Plan (1.Versin November 2002) did not pay enough attention to economics..(2003 wasted)....but by 2004 with revised versions more economics were included. Four sub-economic committees prepared tremendous work and had most of what needed to run a Federal State.Four sub-economic committees prepared tremendous work and had most of what needed to run a Federal State. Since there was no work or proper studies done at all before the UN talks, and no interaction between economies, it was very difficult to observe the cost but more importantly the benefits of a settlement.Since there was no work or proper studies done at all before the UN talks, and no interaction between economies, it was very difficult to observe the cost but more importantly the benefits of a settlement.

14 Economics and the Referenda Economics uncertainties and risks, such as: Economics uncertainties and risks, such as: –“who will pay the bill?” for a united Cyprus (Territorial adjustments, fiscal federalism) –How would businesses be affected from such a settlement? (Competitiveness of the tourism and other industries) –The income gap myth! From the economic perspective only the cost and risks of unification were challenged not benefits at allFrom the economic perspective only the cost and risks of unification were challenged not benefits at all

15 After the Referenda: Non-recognized State with a Legal Status UN plan did not enter into force due to the Greek Cypriots solid ‘NO’ vote in their referendumUN plan did not enter into force due to the Greek Cypriots solid ‘NO’ vote in their referendum Protocol 10 is suspended the application of EU acquis, in NorthProtocol 10 is suspended the application of EU acquis, in North However, Article 3 provides that “nothing in this Protocol shall preclude measures with a view to promoting the economic development of the North CyprusHowever, Article 3 provides that “nothing in this Protocol shall preclude measures with a view to promoting the economic development of the North Cyprus Legal statues of the Turkish Cypriots are defined as the areas where the “Government of ROC” does not exercise effective controlLegal statues of the Turkish Cypriots are defined as the areas where the “Government of ROC” does not exercise effective control EU Council on 26 April 2004 invited Commission to bring forward proposals:  Green Line Regulation: Intra-trade (In action since August 2004)  Financial support Regulation (In action recently)  Direct Trade Regulation enabling the North to trade directly with the EU countries. Important challenge for business people as well as public to succeed institutional convergence. (Not in action yet)

16 Integration Triggered the Growth Integration Triggered the Growth oEven though technical, legal problems still exists, green line regulation is in action and contributing a lot especially to the North economy A very first step towards a modest economic integration between non-recognised entity and EU.A very first step towards a modest economic integration between non-recognised entity and EU. The Annan Plan process, opening of the North to the world, even with modest integration has reflected significantly to the economicsThe Annan Plan process, opening of the North to the world, even with modest integration has reflected significantly to the economics * South North Real GDP Growth Rates in N/C and S/C

17  No indication of change in the share of economic activities relative to whole economic size of the island from 1980 to 2000 > North’s economic size have shown tremendous increase recording a 12.5% of whole island

18 Converging Economies Converging Economies -The substantial increase in the income of the North reduced the gap tremendously -Integration has helped not only incomes to converge but to an extend to retail prices as well. Some convergence of institutional and market structures between North and South (Göçekuş, 2006) -Economics do have incentives for supporting a political solution. With a more converged incomes shed some light to a settlement GNP T/C (M $ ) ,328 GNP G/C ( M $) 8,23410,56816,958 GNP T/C Per Capita 4,1674,40910,567 GNP G/C Per Capita 12,65314,91321,571 T/C / GC per Capita Income 32 % 30%49%

19 Steep Convergence Note: World Bank reports suggest that the living standards in North is as much as three quarters of the South Ratio of TC’s per capita income / GC’s per capita income Ratio of TC’s per capita income / GC’s per capita income

20 Economic Convergence and Prospects for a Settlement Economics is not everything for a settlement but converging economies provides fertile grounds for political dynamicsEconomics is not everything for a settlement but converging economies provides fertile grounds for political dynamics The convergence have speeded and the income gap has been shrinking fastThe convergence have speeded and the income gap has been shrinking fast More focus should be on the economic incentives and opportunities that may be created with a settlement. (i.e. tourism, higher education and other business services)More focus should be on the economic incentives and opportunities that may be created with a settlement. (i.e. tourism, higher education and other business services) Willingness for a settlement is positively correlated with more economic incentives and opportunitiesWillingness for a settlement is positively correlated with more economic incentives and opportunities This can be eliminating many of the pessimisms that individuals had about the economics of unificationThis can be eliminating many of the pessimisms that individuals had about the economics of unification

21 The Way Ahead: Challenges and Opportunities (1) The Way Ahead: Challenges and Opportunities (1)  Policies and measures that would increase the integration process to push for steeper convergence (institutions, markets and income): Labour market is already converging, some frameworks have to be coordinated with South for different types of benefits and regulations. (Role of trade unions)Labour market is already converging, some frameworks have to be coordinated with South for different types of benefits and regulations. (Role of trade unions) Revised GL regulation to allow more flow of goods and servicesRevised GL regulation to allow more flow of goods and services Financial aid; (help adapt acquis, improve infrastructure)Financial aid; (help adapt acquis, improve infrastructure) Direct trade; (for converging institutions and markets)Direct trade; (for converging institutions and markets)  Economic reform agenda should be to enhance the constituencies for unification  North will have to speed up with adopting the acquis communautaire,. This will help North to better convergence institutionally as well as for market structure. Shadowing the acquis also helps for coordinating reforms.

22 The Way Ahead: Challenges and Opportunities (2)  Eliminating the income gap between the G/C and T/C faster contribute to the solution process of the Cyprus issue better.  BUT ! Economic convergence can only contribute to a settlement if there is more integration with the Southern economy and EU.  If the present status continues and there is no better economic integration with South Cyprus and only per capita convergence is realized to an extend, then this will only be an “Artificial convergence” and will not contribute to a settlement at all. ===  divergence  Support to UN initiative ( Gambari’s process) to establish bi- communal technical communities to look into key and operational issues (criminal, legal as well as economics) that may reinforce economic integration

23 Thank you … Thank you …