**The crisis is an opportunity to act **
Published 8 February 2011. The Cyprus economy needs a new strategic direction if it is to tackle the big challenges facing it in the coming years and the current crisis should be treated as an opportunity to do this.
These were the conclusions of an expert panel of economists hosted by the Financial Mirror who attended their first private discussion last Wednesday.
The Financial Mirror’s aim in these discussions is to “give something back” to society, by bringing together respected economists and fleshing out ideas that can improve the economic environment in which we all work.
The economists work in both the private sector and academia and many of them take part in the Financial Mirror’s quarterly consensus forecast.
While the panellists agreed that the Cyprus economy has many strengths, such as a more flexible, younger and more educated work force than many EU countries, an attractive tax system and, most recently natural gas, they also identified a number of weaknesses that need to be addressed if we are not to lose market share to nimble competitors such as Malta.
Invasion, EU accession, now what?
First and foremost, the panel identified the need for a new strategic direction from the top. In the past, the government did not have to ask what the economy’s strategic direction should be. It came from outside.
The Turkish invasion in 1974 created an urgent need to house masses of refugees and reorient the economy after the loss of 50% of the agricultural land. To encourage investment, the government introduced a 100% deprecation allowance and a 30% investment allowance.
Fourteen years later, in 1988, EU accession negotiations began. Again the strategic direction was provided externally.
Everyone knew what to do: the government, regulatory bodies and businesses all had to prepare themselves for EU membership.
Another fourteen years later, we are dealing with economic stagnation, rocketing unemployment and an economy undergoing deep structural changes, not to mention risk emanating from the eurozone.
But perhaps because the government is distracted by the need to cut spending and deal with the new prospects for gas, no one seems to know what to do about the immediate problem.
The crisis is an opportunity
Panelists agreed that the crisis should be seen as an opportunity. In certain areas, the government has been forced to take this opportunity by making structural changes to the public sector, such as introducing pension contributions.
But more needs to be done.
It was noted that a key measure of Cyprus’ competitiveness–the real effective exchange rate based on unit labour costs–rose together with some of the most troubled economies of the eurozone in recent years, while Germany’s rate continued to fall.
The large current-account deficit is also symptomatic of a loss of competitiveness.
To correct this we need to generate more domestic saving and cut production costs.
While reform of the COLA wage indexation mechanism is one way of tackling this, other measures to raise productivity need to be taken , such as policies that encourage investment.
Focus on business services, tourism and energy
The three sectors which stood out as having good potential were business services (legal and accounting services), tourism and, of course, energy.
However, panellists agreed that the government’s role was not to get involved directly in these sectors but simply to lay the right conditions for growth.
For example, the government could find ways of encouraging winter tourism, to avoid the closure of hotels in winter and the spike of unemployment that occurred last December.
A faster legislative response to gaming companies would have prevented them moving overnight to Malta.
All agreed that entrepreneurship exists in Cyprus and needs to be encouraged.
But there was a sense that current methods, such as hi-tech incubators, did not seem to have gained much traction.
Further work is needed to identify the conditions for flourishing entrepreneurship.
Learn from Malta
A number of panellists spoke with admiration about how Malta, a country of just over 400,000 inhabitants, is making its mark in the world.
Malta’s tiny island of Gozo, for example, makes the chips in our credit cards.
A key strength of Malta is its innovation.
One panellist noted that instead of using EU structural funds to build roads, Malta made a deal with Microsoft to give everyone an advance copy of Windows 7.
So by the time the new software was rolled out everywhere else, Maltese programmers and users had a head start against their rivals.
In the next EU financing period from 2013, Cyprus could follow Malta’s lead and focus on improving intangible assets such as skills and know-how, rather than simply rolling out more tarmac.
Study the implications of the euro crisis
Since it is still an open question how the euro crisis will be resolved, we need to study carefully the implications and impact of the debt crisis in Greece and the eurozone more broadly.
In that context, the rating agencies have not been convinced that Cyprus is determined to do whatever it takes to improve its ratings, therefore the focus needs to shift from attracting voters to attracting investors.
This also means working on off balance sheet liabilities as well as the visible imbalances such as the budget deficit and public debt.
Put the crooks away
Fiona Mullen
Fiona Mullen is Director of Sapienta Economics Ltd and a regular contributor to the Financial Mirror.
