Cyprus' Accession to the EU and the Economic Challenges

Cyprus' Accession to the EU and the Economic Challenges

by Andreas Theophanous, Professor of Political Economy and Director General of the Center

When Cyprus applied to become a member of the EU in July 1990, most Cypriots were primarily concerned with the political benefits of EU membership. Socioeconomic issues were of no less importance even though this was not initially realized. During the accession negotiations and the final phase of accession itself, again Cypriots focused on the political objectives and more specifically on the Cyprus problem. Inevitably, socioeconomic issues did not receive their fair share of attention either during the negotiation process with the EU or within the framework of an internal debate.

Cyprus became a member of the EU on May 1, 2004, but there are pressing socioeconomic problems that have to be addressed. At the same time, there are opportunities that should be effectively exploited.

Cyprus must overcome its fiscal problems – the chronic fiscal deficits and the public debt. For years, the state has been spending much more money than the economy can sustain. It is this attitude and practice that has lead, among other things, to chronic deficits and a high public debt. In 2003 the fiscal deficit rose to 6,3% of the GDP before it was reduced to 4,1% in 2004. The public debt rose to 69,4% of GDP in 2003 and to 71,4% in 2004. If intra government borrowing is taken into consideration, then these indicators would be much worse. We should be reminded that the Maastricht criteria provide for a fiscal deficit no more than 3% of GDP and for a public debt no higher than 60% of GDP. The government is optimistic that by the end of 2005 or during 2006 the fiscal deficit and the public debt will be reduced accordingly and that all the relevant indicators for accession to the Eurozone – the Maastricht Criteria – will be successfully met.

Membership of the EU and the need to comply with the Maastricht criteria so as to successfully join the Eurozone by January 1, 2008 has been a strong incentive for the government to take the necessary measures to address these fiscal problems. In this respect it has been easier for the government to pursue a consistent policy of reducing the deficit and the debt; after all, Cypriot policymakers could invoke EU obligations for doing what they had to do anyway.

Furthermore, many sectors of the economy are facing structural problems. Improving productivity in the civil service and in the quasi-public institutions has been a major issue given their problems in the domains of effectiveness and competitiveness. Indeed, the on-going crisis of Cyprus Airways is rather a symptom of a broader problem. Likewise structural problems also exist in the private sector. Better management skills are required as well as an efficient utilization of human capital.

Accession to the EU has gradually enabled the government, public institutions, the private sector and Cypriot citizens to understand that they have to seriously address the issue of restructuring. It is understood quite clearly that they have to reassess some of the traditional ways with which they have conducted business thus far. There is still in many areas a gap between what should be done and what is really done. But the process of transformation has in one way or another started. What may be problematic in some cases is the rather slow pace of change.

On the employment side the overall record has been satisfactory. Nevertheless, behind a favorable record in comparison to the rest of the EU member states, there is concealed structural unemployment. Far more low value added jobs are created (that usually go to non-Cypriots), than high value added jobs. Cypriot society entertains high aspirations and young people sustain even higher expectations. This means that the economy must move forward with restructuring and diversification so that it would be in a position to generate more challenging jobs.

Accession to the EU coincided with a period of rising prices. This was partly the result of accession–induced adjustments to indirect taxation of specific goods and partly the result of sustained higher oil and commodity prices. Obviously, households have been adversely affected by this development. Public opinion felt that a major reason for the price increases – in addition to the increase of oil prices – was accession to the EU. Be that as it may, improved productivity and higher growth rates constitute the response to this challenge.

Cyprus is located in the Eastern Mediterranean, an area with great geostrategic and geoeconomic influence. It is possible, under certain conditions, for policymakers to take measures so that Cyprus is transformed into an international business center in the broader definition of the term. In this respect Cyprus stabilization policies could have been more successful had they also contained the dimension of diversification of the economic base. Tourism has been an engine of growth and if restructured it can lead to even better results. Furthermore, Cyprus has the potential to serve as a regional academic, medical and financial center and as a true hub which provides for the needs of the broader area. In this regard, if Cyprus is successful it will turn itself into an important asset of the Union.

Returning to the issue of the Cyprus question it is evident that it has absorbed most of the energy of policymakers and of Cypriots in general in both communities. One of the issues though that has not been adequately addressed is the economic dimension of the Cyprus question. Two aspects are worth addressing more closely: (a) Certainly, the political settlement will inevitably affect the economic structure and by definition economic activity and outcomes, (b) On the other hand, one cannot ignore the economic developments taking place since the partial lifting of obstacles to free movement across the Green Line. Indeed, following the developments of April 23, 2003 there is much more contact between the two communities and by extension enhanced economic activity. This has enabled the Turkish Cypriot community to substantially improve its standard of living.

In conclusion, accession to the EU has forced policymakers to begin to address issues and problems that in the past they had been reluctant to touch and, second, it is felt that there are issues and opportunities that could be addressed much more effectively. Cyprus is currently at a crucial turning point. The way and the pace with which policymakers will choose to address problems and the strategy they will adopt and implement to take advantage of opportunities, will eventually have a significant impact on the future of this island-state.

Research & Development Center - Intercollege