ECONOMIC CONVERGENCE
AND A
CYPRUS SETTLEMENT
Macro-economic Convergence
in Cyprus
By
Dr. Mustafa Besim
Member of the Economic Committee in the Cyprus Talks
6 February 2007
LONDON SCHOOL OF ECONOMICS
Objective & Scope of the Presentation
• Focus will be on the macro-economic
convergence and its contribution to a settlement
• 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?
2
Convergence Concept for Settlement
• Convergence:
– of incomes of citizens within an economy and with
other economies;
– of institutions, sectors ( interdependence), macroprudential 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:
– importance of economic integration within the
island
– Model that would improve economic interractions
3
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)
– 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
– 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:
– 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 North
4
South Cyprus Economy
• 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.
• 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.
5
Growth Rate in South Cyprus (2)
Growth Rate (%)
20
15
10
5
0
1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006
Years
•Stable growth with close to 5% between 1977-2000
•Main 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.
6
North Cyprus Economy (1)
• 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
7
North Cyprus Economy (2)
• Private and public (infrastructure) investments were not
sufficient....uncertainty, weak banking sector
• Using TL = High and unstable inflation and interest rates
Inflation Rate in North Cyprus
100
Inflation rate (%)
90
80
70
60
50
40
30
Inflation Rate (% Change in CPI) in North
20
10
0
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
Years
8
Growth Rates in North Cyprus
(3)
20
Growth rate (%)
15
10
5
0
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
-5
-10
Years
Most shocks originating from Turkish economy
After the crises between 1999-2001 and the stabilization of TL,
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
9
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

10
Diverging Economies !
1995
GNP T/C (Cyp M)
367
GDP G/C (Cyp M)
4,089
GNP T/C Per
Capita
2,027
GDP G/C Per
Capita
6,283
TC / GC
per Capita Income
32 %
 No freedom of movement.
No grounds for economic
2000
interaction.
 Two diverged economy.
659
North not converging to
South and to EU. South
converging to EU.
5,407
 No convergence of
institutional and market
2,650
structures between North
and South.
 Economics did not have
incentives for supporting a
7,791
political solution.
 Diverged economies stoned
separation
34%
11
New Economic Environment for
Cyprus
• November 2002, UN proposal for a Comprehensive
settlement (Annan Plan)
• Rallies led to opening of the gates (23 April 2003)
• T/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 setup
– Retailing
– Services (Tourism, casino, hospitals)
– Labour (commuting workers)
12
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.
• 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.
13
Economics and the Referenda......
• 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 all
14
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 referendum
Protocol 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
Cyprus
Legal 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)
15
Integration Triggered the
Growth
o Even 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.
• The Annan Plan process, opening of the North to the world, even
with modest integration has reflected significantly to the economics
Real GDP Growth Rates in N/C and S/C
2001
South
North
4.1
5.4
2002
2.1
6.9
2003
1.9
11.4
2004
3.8
15.4
2005
3.9
10.6
2006*
4.0
7.0
16
Economic sizes
(1991-2000)
Economic Sizes
(1980-1990)
8.8%
8.9%
91.1%
91.2%
Economic Sizes (2005)
12.1%
87.9%
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
17
Converging Economies
1995
2002
2005
GNP T/C (M $ )
756
941
2,328
GNP G/C ( M $)
8,234
10,568
16,958
GNP T/C Per Capita
4,167
4,409
10,567
GNP G/C Per Capita
12,653
14,913
21,571
T/C / GC per Capita
Income
32 %
30%
49%
-
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.
18
Steep Convergence
6060
Percentage (%)
Percentage (%)
5050
4040
3030
4949
Ratio of TC’s per capita
income / GC’s per capita
income
3030
5151
3838
3232
2020
1010
00
2002
2002
2003
2003
2004
2004
2005
2005
2006
2006
Years
Years
Note: World Bank reports suggest that the living standards in North is
as much as three quarters of the South
19
Economic Convergence and
Prospects for a Settlement
• Economics 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 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)
• Willingness for a settlement is positively correlated with
more economic incentives and opportunities
• This can be eliminating many of the pessimisms that
20
individuals had about the economics of unification
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)
• Revised GL regulation to allow more flow of goods and
services
• Financial aid; (help adapt acquis, improve infrastructure)
• 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.
21
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 bicommunal technical communities to look into key and
operational issues (criminal, legal as well as economics) that
may reinforce economic integration
22
Thank you …
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