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April 2006 Growth, Convergence and
Reunification Are the Dynamics
Encouraging? Max Watson (Oxford University,
Adviser to the European Commission) This paper
does not represent views of the European
Commission
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The Convergence Concept In Cyprus, convergence
refers to 3 principles, with the potential to be
mutually reinforcing
Convergence of incomes CY gt EU
average Convergence of incomes north gt
south Convergence of the real economy and of
institutional frameworks north gt south
Economic dimensions not everything, but
affect political dynamics via incentives
(referenda) Context for EU aid, Green Line,
Technical talks
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Operational Questions

• Focus here on recent income trends, and then
• 4 issues on which we may stand at crossroads

Role of economics in Spring 2004 failure? Are
there major synergies to unlock in a converging
intra-Cyprus economy? Can economic reform
approaches contribute importantly to
convergence? If we miss present opportunity, will
economic gravity pull in divergent directions?
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Recent Income Trends

• Since 2002, convergence has accelerated
  intra-Cyprus and vis-à-vis EU

Real GDP ( change) 2001 2002 2003
2004 2005 South 4.1 2.1 1.9
3.8 3.9 North 5.4 6.9 11.4
15.4 10.6 Policy frameworks in south
Maastricht, Lisbon Policy frameworks in north
Mixed incentives
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Intra-Cyprus Income Gap

• Image during UN discussions also needs to be
• revised as regards levels

Perception of a steep, persistent gap added to
tensions on convergence strategy/federalism Ayres
2003, while warning on measurement hazards, cited
EIU p.c. 2000 of 6k v. 13k Mehmet 2004 assumed
starting disparity 60 Eichengreen et al 2004
Report on Annan Plan assumed 60 project
(benign) 38 in 2020
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World Bank PPP Estimates of n/s Gap

• 
  Nominal WB Atlas PPP
• 
  (US dollars 000s)
• North 8.1 7.2
  14.8
• North rev. base 9.2
  8.2 16.9
• South 19.4 17.6
  22.3
• Ratio (north south) 42 41
  66
• Ratio (rev. base n.) 48 47
  76
• Gap ns (rev. base) 52 53 24
• Ratio (n EU rev. base) 40 39
  64
• Is PPP factor right? And north receives large
  transfers (15-20 of GDP). Size of informal
  economy (20-35)

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Medium-term Challenges

• Sustainability/competitiveness challenge - some
• parallels, but far more serious in north

Short- to medium-term fiscal adjustment Address
long-term social security imbalance Achieve
continuing shift to higher value added exports,
with growing globalisation of services and
monetary union with competitive
partners gtReforms in north not underway so
bottlenecks, as well as distortions to trade and
investment
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Economics and the 2004 Talks
There was little time to prepare
underlying Issues - and are we using time well
now
Income gap convergence strategy
framework Credible fiscal federalism in EU
framework Reunification cost (including
resettlement, balance sheet issues in north
which cannot be left unresolved if incentives are
to go right) But not neglecting market dynamics
winners losers among corporate labour market
groups
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Intra-Cyprus Synergies

• The island faces a huge strategic opportunity
• as well as new competitive challenges

• It is an EU service sector hub in the Eastern
  Mediterranean exploiting scope to upgrade value
  added in a globalised service economy
• So concept not intra-Cyprus complementarity
• but synergy in services (tourism education
• and a very wide range of business services)
• continued restructuring in manufacturing

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Economic Reforms Convergence

• The north will be compelled to embark on far-
• reaching reforms by a range of pressures
• Economic history points to role of effective
  frameworks or risk distortions affecting all
• Acquis communautaire offers an opportunity
• to shape this process realise externalities
• But reforms such as social security need more
• co-ordination, and help set market framework
• Plus other public finance, competition reforms

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Economic Gravity

• Intra-Cyprus convergence or divergence will
• play out on the ground in several markets, eg
• Labour market Integrating, but over which areas?
  Framework? Net skill flows? Tensions?
• Goods Distorted and underperforming?
• Services Tourism gridlocked by property,
  psychology? Health hazardous integration?
• Financial flows Same gridlock?
• Real estate Problematic, pervasive impact

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Constituencies for Reunification

• Economic exchanges may embed interests in
• rent-seeking distortions, or open-market flows
• So pattern of exchange in markets can affect
  strength of constituencies for reunification
• Clearest in property holdings, trade channels
• Also, Turkey reforms change many trade-offs
• Economic convergence across Cyprus in
  frameworks/structures as well as income levels
• as a pervasive Confidence Building Measure

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Opportunities Dynamics

• At present time, risks of creeping political
• economic divergence need to be squarely faced
• Can evolving initiatives be steered in a ways
• that lead toward greater convergence not just in
  incomes but in economic cultural life?
• Can economic exchanges, including reform
• ideas embed constituencies for reunification?
• How fully can communities in Cyprus realise
• the immense promise of their regional role?

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End of Presentation ?



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