The Political Economy of a Cyprus Settlement:

The Examination of Four Scenaria




Comments by Max Watson, Fellow of Wolfson College, Oxford







This new book by Andreas Theophanous makes a valuable and timely contribution to discussions on the Cyprus problem.  His analysis can help to sharpen our understanding and critical sense about a number of key issues, and in particular the relevance of economic questions to a successful settlement. One does not have to share all of the author’s analysis or his conclusions:  the book is surely designed to trigger discussion and to open a debate, and it is interpreted here in such a spirit.


This comment begins by discussing four areas of broad agreement with points that are made the in the book; it then emphasises some serious dilemmas posed by the analysis;  and finally it highlights a number of degrees of freedom in the design of a final settlement which might permit these dilemmas to be overcome in a positive manner.


The first point of agreement is that economic issues have on the whole been neglected in discussions of a Cyprus settlement.  Economic factors are typically not a driver of political events; but they can strongly reinforce positive or negative developments, or even undermine political plans.  This is certainly true in the Cyprus situation, and the book does a great service in underscoring this. 


Secondly, the book is right to underscore the potentially damaging nature of the status quo.  There are indeed two aspects to this.  One is in terms of incentives for economic actors:  the present situation, with its distortions of trade and investment, can foster rent-seeking activities that drive the two sides farther apart. In other words, the distortions can create vested interests in support of continuing division.  The other aspect lies in the opportunity cost of the status quo – the economic gains that are not being realized, in the absence of reunification. This aspect was underscored in the recent book by Fiona Mullen, Ozlem Oguz and Praxoulla Kyriacou:  “The Day After:  Commercial Opportunities Following a Solution to the Cyprus Problem” (PRIO, 2008)


A third valid point in the analysis is that many important economic questions were not fully addressed or answered in the Annan Plan.  The Plan developed a fully-articulated legal approach to the resolution of the Cyprus problem, but it was not underpinned by an in-depth analysis of the economic dynamics that might occur after a reunification. To some degree, there may have been an assumption that growth and economic convergence would follow automatically after an agreement, somewhat independently of the nature of institutions and their influence on economic policies and market incentives.  One does not have to share the specifics of Andreas Theophanous’ mapping of institutional factors to economic outcomes to accept the basic point that institutions will be hugely important for successful economic dynamics in a reunified island.


A fourth point of strong agreement with the author is that we need to seize the present opportunity to think through carefully this link between institutions and economic incentives as a process gets underway that should lead finally to a settlement of the Cyprus problem.


Against the background of these four points of agreement, it is important to be clear, however, that there are major dilemmas in crafting institutional approaches that will meet this test.  Even more than the author, this commentator would stress that there are very difficult trade-offs involved.  There are legitimate concerns in the northern part of Cyprus about a swamping of identity in the immediate aftermath of reunification, given that the south has a larger and richer economy.  The question is: how are those concerns to be effectively met without arresting the mechanisms that can help trigger strong economic growth as a result of reunification, including a rapid process of catching up in the north.


The reality of this dilemma is evident if one thinks about the mechanisms of economic catching up under the Acquis communautaire that have operated so successfully in the former transition economies of eastern Europe.  Their success has been based on a quite different model from recent experience in Asia and Latin America.  Rather than build up their foreign exchange reserves as a defence mechanism of economic sovereignty, they have imported savings from their neighbours on a massive scale, in an unprecedented opening to trade and capital. 


This points to the heart of the paradox.  The northern part of the island needs rapid economic catching up, yet successful catching up on an EU model has been squarely based on economic interdependency.  Ways need to be found of safeguarding key political, economic and social concerns in the northern part of Cyprus, yet of fostering growth mechanisms that satisfy the needs of the population and of balanced development.  The greatest problem of dependency would result from a failure of growth.


The experience in other Member States that joined the EU in 2004 and 2007 spotlights a further concern.  The tendency has been for wages in the less advanced economies to catch up quite rapidly.  But this has not always been reflected in a similarly fast catching up of productivity.  In other words, there is a potential problem of competitiveness that needs to be resolved, including through a shift in these economies towards higher levels of productivity a stronger role of the traded goods sector.  Again, this is an obvious potential challenge for the northern part of Cyprus, since the communication between labour markets across the island is already taking place across the Green Line. Wage pressures need to be paralleled by strong productivity growth, and this in turn implies a rapid and outward-looking restructuring of economic activity.


Can one think of alternative models of development?  This is hard to imagine, not just because of the institutional features of the Acquis communautaire, but because of the sectoral structure of the two parts of the economy.  The economies in the northern and southern parts of Cyprus are not complementary, in the sense of having different strengths and weaknesses.  Their future growth potential lies in the same areas, which involve the export of services such as tourism, education and business support functions.  In other words, what needs to be realised for an efficient economy is a high degree of synergy, not a counterbalancing of risks through different patterns of development.


How worried should one be about these dilemmas?  Do they mean that any acceptable political settlement would be economically damaging, and vice versa? 


That is not the view of this commentator. On the one hand, it is certainly right to pay strong attention to these dilemmas and to ensure that the political safeguards are adequate.  On the other hand, there are several degrees of freedom in any solution which, used with imagination, can open up space for a viable political economic framework.


  • First, as Andreas Theophanous himself notes, his four cases are constructs that are designed to help us analyse the situation. In reality, possible solutions extend on a continuum, with different characteristics of economic and political autonomy.  Indeed, he points out that his preferred solution of loose bi-zonality can be seen within such a continuum.  And this is a continuum in which the mapping of institutional to economic factors is quite complex, not mechanical.


  • Cyprus, moreover, is not to be viewed in isolation.  The economy is part of two overlapping regions – the European Union and the eastern Mediterranean. Its role as an EU hub the eastern Mediterranean can be hugely enhanced by reunification, with a great potential for dynamic trade and investment interactions in the years ahead.  So it is a mistake to think in terms of an economic zero sum game within the Cyprus economy.  Openness is not just of north to south, and vice versa.  Openness is to investment and trade across these regions.  And that is ultimately how, in eastern Europe too, any concerns about excessive dependency on large neighbours (in this case, separate countries) have been overcome, albeit with certain time-bound safeguards in specific cases regarding property ownership and movements of people.  This regional dimension is rightly stressed in the book and is surely one of the keys to a dynamic solution that also works well politically.


  • The Acquis Communautaire also is helpful in resolving some parameters of the debate and in offering valuable degrees of freedom in others. Since the time of the Annan Plan discussions, monetary policy has moved to the Euro Area level, resolving many issues.  In addition, many of the other aspects of economic policy are subject to directives or regulations, and the nature of a solution is to a high degree pre-defined, even if there are issues of timing of adoption. But there are also degrees of freedom in many institutional questions, and here there is the experience of other EU Member States to draw on – an accumulation of practice that is sometimes called the “soft Acquis.”  One example lies in the different forms of Internal Stability Pact that have been adopted to regulate internal fiscal relations within the framework of the Stability and Growth Pact. 


  • The final degree of freedom is time.  It may well take a fair period to arrive at the details of a settlement that works really well on the ground in terms of economic incentives.  Moreover, such a settlement might itself contain elements of freedom to vary or adapt arrangements over time as confidence grows in the course of implementing a balanced solution and fostering a common vision.  And, last but not least, time is already running:  we think of “transition periods” as dating from a settlement, but the case is for starting on reforms and restructuring at an early date, so that the economy can take full advantage of reunification when it comes – including through compatibility of frameworks with the Acquis communautaire.


This last point concerning reform and restructuring deserves emphasis.  In the southern and the northern parts of the island there are needs for economic reform, although they differ in their nature and scope.  In the southern part of Cyprus, the adoption of the euro has represented the culmination of a period of tough fiscal adjustment and successful nominal convergence.  Nonetheless, there are still challenges to face in terms of moving the economy further up the value added chain and ensuring that the current expansion does not end with a serious loss of competitiveness – as occurred notably in the case of Portugal.  Among other factors, it is crucial to foster productivity growth and to ensure that wages stay in line with productivity. In the northern part of Cyprus, the reform needs are more acute.  The top priority is to reform public expenditure and to restructure the role of the public sector in the economy.  Work on these challenges is now urgent as the economy faces a sharp downturn following a very strong economic boom.


In sum, Andreas Theophanous is right to direct our attention to economic issues, and to their interaction with a successful political settlement.  These are crucially important questions.  They do, however, raise very serious dilemmas, especially in light of the experience of successful catching up elsewhere in the European Union.  But these challenges can be met if we make full use of the degrees of freedom and the EU reference points discussed above.  On this basis also, one can seek to foster a genuinely national vision of economic policy to guide the development of infrastructure across the island and support for the functioning markets. In a framework where monetary policy is no longer national, and fiscal policy is constrained, this seems highly desirable.


The key is to take advantage of the present time to prepare sound solutions and initiate reforms; to look to European experience for practical solutions that fully use the degrees of freedom available; and to think in terms of Cyprus not in isolation but as embedded in two overlapping regions of huge economic promise.  This broader regional context, and its promise of accelerated economic growth for the whole island, is not only part of the economic prize of reunification:  it is also potentially part of the solution.