Economic Growth Under Embargoes in North Cyprus: An Input‐Output Analysis

Abstract

The North Cyprus economy, under economic embargo since 1983, has been struggling to eradicate the income difference with South Cyprus with extremely limited resources. This paper examines the North Cyprus economy with a particular emphasis on its response to economic embargoes. It also examines how important economic embargoes would be (or have been) to the North Cyprus economy. For this purpose, total economic growth is decomposed with respect to different components of demand. The results show that despite the presence of embargoes, external demand and the availability of import flows are detrimental factors for economic growth. Domestic final demand is an equally important source of growth in the North Cyprus economy.

Acknowledgements

The authors are grateful to the president of North Cyprus, Mehmet Ali Talat, and the prime minister, Ferdi Sabit Soyer, for sparing their valuable time to discuss various issues regarding North Cyprus. They gratefully acknowledge the constant support and encouragement of Bayram Karaman, member of the parliament of North Cyprus. They also thank Mehmet Başel for providing access to different data sources and staff with experience in the North Cyprus economy; Işılay Yılmaz, undersecretary of the State Planning Organisation of North Cyprus for sharing her experience about the North Cyprus economy and allowing the use some of the data presented in this paper; and Ali Korhan of the State Planning Organisation for providing data and answering their tiring questions. Remaining errors are, however, the sole responsibility of the authors.

Notes

ⁱFor example, see Günçavdı and Küçükçifçi, “Financial Reforms and the Decomposition of Economic Growth.”

1. The military intervention to resolve the political dispute in 1974 led to the partition of the island into two separate administrations, and from then on both sides started to follow different development paths. However, the international community has continued to recognize the administration in the South as the legitimate government of the two societies on the island.

2. The TNC economy is highly dependent on Turkish aid. Under the latest protocol between Turkey and TNC signed in January 2001, Turkey undertook the provision of Turkish Cypriots’ loans and financial assistance, totaling $350 million for the purpose of financing public projects, tourism, banking, and privatization. Turkey also agreed to provide a supplementary amount of $140 million to entrepreneurs in the form of low‐interest loans to support export‐oriented industries and tourism.

3. R. Read, “Growth, Economic Development and Structural Transition in Small Vulnerable States,” World Institute of Economic Development Research (WIDER), Discussion Paper No. 2001/59, United Nations University, 2001.

4. B. Eichengreen, R. Faini, J. von Hagen and C. Wyplosz, Economic Aspects of the Annan Plan for the Solution of the Cyprus Problem: A Report to the Government of the Republic of Cyprus (Nicosia, 2004), p. 35.

5. State Planning Organisation, Economic and Social Indicators (Nicosia: SPO, 2003).

6. Eichengreen, et al., Economic Aspects of the Annan Plan.

7. R. Ayres, “The Economic Costs of Separation: the North–South Development Gap in Cyprus,” Ekonomia, Vol. 6, No. 1 (2003), pp. 39–52.

8. The unification under the Annan Plan was expected to boost income in North Cyprus by almost 12 percent; in 2015, for example, income in the TNC would be 100 percent larger than in the absence of unification. However, in comparison with the Greek side of the economy, income per capita in the North Cyprus economy appears to be 40 percent of its value in the South. Eichengreen et al. find that the same figure would have risen to 60 percent of its value in the South in 2020, and income disparity between the two sides of the island would prevail even after unification (see Eichengreen et al., Economic Aspects of the Annan Plan, p. 42). Mehmet, on the other hand, indicates that this finding of Eichengreen et al. could be the reason for the incorrect perceptions on the Greek side of the island regarding the UN efforts for unification. In this view, Mehmet indicates three major reasons why the Annan Plan failed. First, both sides lacked information on what federalism is and how it can be made to work. Second, the plan was deficient in terms of power‐sharing, providing forthe collection and allocation of indirect taxes. The third is the incorrect perception, particularly in the South, that economic inequalities would require large and persistent subsidies to the Turkish side by the Greek Cypriots. See Ö. Mehmet, “Required Investment for Convergence of Growth Rates and Incomes per capita in a Possible Federal Cyprus: A Harrod‐Domar Model, 2005–2025,” paper presented at the workshop on North Cyprus at Wolfon College, Oxford University, October 22, 2004.

9. See Ayres, “The Economic Costs of Separation” and Eichengreen, et al., Economic Aspects of the Annan Plan.

10. Ghafoor and Yorucu empirically examined the role of physical and human capital investment in explaining the low productivity of the TNC economy. Their time‐series investigation, however, failed to find any statistically significant relationship between these variables. See A. Ghafoor and V. Yorucu. “Public Expenditure and Productivity Puzzle: The case of Northern Cyprus,” METU Studies in Development, Vol. 29, Nos.1–2 (2002), pp. 69–85. See also R. Levine and D. Renelt, “A Sensitivity Analysis of Cross‐Country Growth Regressions,” American Economic Review, Vol. 82 (1992), pp. 942–63.

11. In an empirical examination Çiftçioğlu shows that inflation has a negative effect on economic growth. A 10 percent increase in inflation seems to lead the economy to a 0.9 percent decline in economic growth. See S. Çiftçioğlu, “Kuzey Kıbrıs ekonomisinin yapısal analizi ve hızlı büyüme için politika önerileri,” [Structural Analysis of the North Cyprus Economy and Policy Suggestions for High Growth] METU Studies in Development, Vol. 27, Nos. 1–2 (2000), pp. 71–90.

12. Of course, this growth performance should not be seen only as the outcome of good macroeconomic management. The North Cyprus and the Turkish economies are highly integrated with each other, and the use of Turkish currency on the Turkish side of the island has exposed it to the positive and negative shocks in Turkey. Starting from 2002, Turkey adopted an inflation‐targeting policy to curb and reduce the long‐standing high and chronic inflation rate. Additionally, the international market condition that allows Turkey easily to access international liquidity, the implication of various sound macroeconomic reforms with the guidance of international institutions, and the beginning of the accession talks to the EU has allowed Turkey to attain a high growth rate and achieve its disinflation program. The North Cyprus economy has also benefited from the success of the Turkish economy in the early 2000s, which helped it to accomplish a high growth rate in the same period.

13. Economic embargoes left no option for North Cyprus other than adopting the TL as the national currency. With no access to export markets and the international capital market, the country developed foreign trade with Turkey or other countries via Turkey. However, this feature of the foreign trade of the country improves the capability of the North Cyprus economy to generate foreign exchange earnings overwhelmingly in TL rather than other currencies, and this therefore constituted the major reason for the adaptation of the TL as the national currency.

14. There is another peculiarity that was observed in the data on export earnings of the country. According to the Statistic Office of North Cyprus, foreign exchange earnings through non‐tradable sectors, namely higher education and tourism, are recorded as export earnings. Expenditure on domestic trade by foreigners is also regarded as export earnings in the classification of the data. Therefore, despite the presence of an export relationship in the common sense with some trade partners, its quantity is very limited and the trade, most of the time, takes place via Turkish ports with added costs.

15. Despite the low productivity sector of labor, particularly in the public sector, the general income level has been kept relatively high in the North Cyprus economy, and the deficits that occurred through this unsustainably high income policy have been financed by Turkey, obviously not by income that could have been generated through increasing total factor productivity on the island.

16. Turkey has a large young population and is unable to provide sufficient supply capacity in higher education. This presence of the large young population together with the lack of sufficient supply of higher education capacity in Turkey has presented an attractive opportunity for the North Cyprus economy and urged the policy‐makers, not only in North Cyprus but also in Turkey, to invest in the higher education system and create new supply capacity on the Turkish side of the island. However, by allowing the private sector to establish universities in Turkey, the number of students coming to Cyprus from Turkey has begun to decline and has initiated severe competition with Turkish private universities.

17. H. Chenery, S. Shishido and T. Watanabe, “The Pattern of Japanese Growth 1914–54,” Econometrica, Vol. 30, No. 1 (1962), pp. 98–131.

18. See also Ö. Günçavdı and S. Küçükçifçi, “Financial Reforms and the Decomposition of Economic Growth: An Investigation of the Changing Role of the Financial Sector in Turkey,” Review of Middle East Economics and Finance, Vol. 3, No. 1 (2005), pp. 63–86; M. Gregory, B. Zissimos and C. Greenhalgh, “Jobs for the Skilled: How Technology, Trade, and Domestic Demand Changed the Structure of UK Employment, 1979–1990,” Oxford Economic Papers, Vol. 53 (2001), pp. 20–46; J.M. Albala‐Bertrand, “Structural Changes in Chile: 1960–1990,” Economic System Research, Vol. 11, No. 3 (1999), pp. 301–19; J. Schumann, “On Some Basic Issues of Input‐Output Economics: Technical Structure, Prices, Imputations, Structural Decomposition, Applied General Equilibrium,” Economic System Research, Vol. 2, No. 3 (1990), pp. 229–39; H. Chenery, S. Rabinson and M. Syrquin, Industrialisation and Growth: A Comparative Study (Oxford and New York: World Bank and Oxford University Press, 1986).

19. V. Bulmer‐Thomas, Input‐Output Analysis in Developing Countries (New York: Wiley, 1982).

20. See Ö. Günçavdı, S. Küçükçifçi and A. A. Bayar, “Economic Development and Structural Change: The Role of the Agriculture Sector in Turkey,” Mimeo, Faculty of Management, Istanbul Technical University, 2008, for the detailed technical explanation and mathematical derivations of this scenario analysis.

21. The technical coefficients and output are assumed to remain constant after any hypothetical change occurs in the economy.

22. This output level is calculated by the variant of equation (1), which is derived by imposing zero constraints on the first row of the selected industry. This implies that the other industries available in the economy demand no intermediate goods from this selected industry.

23. This output level too can be calculated by the variant of equation (1), which is derived by imposing zero constraints on the first column of the selected industry. This indicates that the selected industry demands no intermediate inputs from the other industries in the economy.

24. See also G. Günlük‐Şenesen and S. Küçükçifçi, “Decomposition of Structural Change into Technology and Price Components: Turkey, 1973/1985,” Economic Systems Research, Vol. 6, No. 2 (1994), pp. 199–215.