Why can't Greece be more like Cyprus?

Agora Contributor: Nick Malkoutzis
Photo by Myrto Papadopoulos [www.myrtopapadopoulos.com]
Photo by Myrto Papadopoulos [www.myrtopapadopoulos.com]

During his visit to Nicosia last month, European Stability Mechanism managing director Klaus Regling was particularly praiseworthy of Cyprus’s efforts to exit the crisis.

He spoke of the “economic progress Cyprus has made over the last 12 months” and that Nicosia is “bearing the fruits from the reforms over the past years”. There were also warnings for Cyprus to “keep up the reform momentum”, especially in the public sector, and for banks to “use legislation fully” to bring down the level of non-performing loans. Overall, however, the assessment from the ESM chief was positive.

The comparison with Greece was stark. “We’ve assisted five countries during the crisis: Greece, Ireland, Portugal, Spain and Cyprus. Four of these are now success stories,” said Regling. While one may debate the levels of success actually achieved in the four countries mentioned, there is no doubt that in the odd one out (Greece), there is little cause for celebration.

One could look at the amount of loans needed to bailout the eurozone countries, with Athens taking up almost 250 billion euros (more than the other four combined), and the fact it is the only one still left in a programme and conclude that Greece is a basket case. Perhaps, though, going down this path tells us more about the past, the different natures of the crises in each country, the varying impact they had (Greece’s economy contracted by 26.2 percent against a 10.8 percent shrinkage for Cyprus) and the mistakes made in dealing with them than about what the future holds.

Surveying the current lay of the land, one sees that the Cypriot economy is on the bumpy road to recovery, while Greece is struggling to find where this exotic place is on the map. Cyprus’s GDP is expected to increase (according to the European Commission) by up to 1.7 percent year-on-year in 2016, while Greece’s economy is due to contract by another 0.3 percent of GDP. Unemployment in Cyprus is seen edging down to 13.4 percent this year, while the jobless rate in Greece is expected to hardly move, remaining at the shockingly high level of 24.7 percent.

The obvious observation to make is that Cyprus is doing something right and Greece is doing something wrong. This may well be the case but it would also be an oversimplification. There are particular reasons for the Greek economy remaining mired while Cyprus climbs out of the mess of the last few years. Identifying these key obstacles is the first step that must be taken if Greece can look to Cyprus for inspiration, help or know-how.

Doing business

We could start from the World Bank’s recent Ease of Doing Business report, which ranked Greece 61st and Cyprus 45th. The key areas in which Greece lags Cyprus are: registering property (141 vs 91), getting credit (82 vs 62), paying taxes (64 vs 34) and resolving insolvency (52 vs 16).

The World Bank says that since its last report Cyprus made starting a business easier by “merging the procedures to register for taxes and VAT, and making company name search and reservation faster”. It also made paying taxes easier and less costly.

To businesses in Greece, having a simpler tax process and lower taxation seems like a dream. “Greece made paying taxes more costly by increasing the corporate income tax rate,” says the World Bank report, as if to drive this point home and rub salt into the wounds of the Greek entrepreneur.

Taxes

Let’s stick with the issue of taxes for a moment because it serves as a useful illustration of the huge challenges facing Greek businesses, especially in comparison to firms operating in Cyprus, where the corporate tax rate is 12.5 percent.

Corporation tax in Greece has been increased from 26 to 29 percent, while repeated rises in value-added tax have seen the top rate land at 24 percent.

In this year’s Global Competitiveness Report published by the World Economic Forum, Greece ranks 136th out of 138 in terms of providing tax incentives for the promotion of domestic and foreign investment.

Also, according to the OECD’s Taxing Wages report for 2016, combined employee and employer social security contributions in Greece account for 82 percent of the total tax wedge, which is 19 percentage points above the OECD average of 63 percent.

Given this environment, it is no surprise that Greek firms have been flocking to Cyprus, reportedly in their thousands, to set up shop. There can be no doubt that the tax regime in Greece is a significant deterrent to economic activity and entrepreneurship. On this issue, there is plenty that Greece can try to learn from Cyprus.

The programme

There are many other examples at a macro- or micro- level where there can be a useful exchange on how to improve business conditions in Greece and Cyprus.

However, there is one overarching issue that sets the two countries apart. Unlike Cyprus, Greece is still under an adjustment programme. As long as this continues to be the case, the prospects for any significant change in the country’s economic fortunes are slim.

For instance, Greece continues to be under tremendous fiscal pressure. Earlier this year, the government voted through 3 percent of GDP in new fiscal measures as part of the third bailout’s first review but the negotiations as part of the second review have turned again to the need for Athens to find more savings – possibly as much as 400 million euros.

There is a constant debate in Greece about how much the economy has been damaged by constant tax hikes and whether the Greek governments since 2010 could have opted for more interventions on the expenditure side instead. Perhaps there was room for a better balance over the years but we’ve arrived at a point now where more than 80 percent of public spending is on wages and pensions, both of which have been slashed during the crisis.

Regardless of who is in power in Greece, the prospect of finding 400 million euros or more to cut from the budget is a politically toxic prospect. Seeking this money from tax revenues seems a more palatable option in the short-term. This brings us to the inherent problem that Greece faces, and which Cyprus seems to have overcome through its quick exit from the bailout, which is that the fiscal demands of the programme are so significant that they bring instability with it and it is this uncertainty (sometimes manifested in the form of Grexit speculation) that undoes any chances of a recovery.

The tax system is shifting constantly to keep up with fiscal targets, making it unwelcoming for businesses and anathema for taxpayers, the spending cuts erode voters’ trust and create unacceptable conditions (at public hospitals for instance) and governments that start out with decent majorities soon see support inside and outside of parliament dwindle to the point that their survival is in question.

Against this background, it is fanciful to expect structural reforms to deliver the kind of positive effect that can pull the country out of this negative cycle.

Cyprus suffered terribly as result of the fell swoop landed in 2013, but it is now able to shape policy as it sees fit. This was highlighted by Finance Minister Harris Georgiades being able to defend his government’s deficit targets in November when they were questioned by the European Commission during the semester consultation. If Nicosia was still bound by the terms of a programme, this would not have been possible.

In contrast, Greece is experiencing an extended period of pain that leaves negligible room for manoeuvre. Finding a way to overcome this is the single biggest factor that will determine Greek economic prospects. Getting out of the programme as swiftly as possible, while making the necessary changes, is the best lesson that Greece can learn from Cyprus.

*This article first appeared in a recent weekly e-newsletter, which are available to subscribers. More information about subscriptions is available here.

You can follow Nick on Twitter: @NickMalkoutzis

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