Cyprus Becoming a Low Wage Economy

In a StockWatch opinion piece of April 25, 2023 it was argued that the economic system of Cyprus characterized by crony and financial capitalism was contributing importantly to the inefficient allocation of resources that in turn was resulting in a low value added and wage economy. As a follow-up the direct and indirect effects of the country’s corrupted capitalist system on labor market developments in Cyprus are addressed in this piece.

Income Distribution and Developments

The operation of the capitalist system In Cyprus over the last ten years has led to a spectacular increase in the share of national income going to profits at the expense of a falling share distributed to employees. National accounts data indicate that net operating surplus rose from 18.1 per cent of GDP in 2012 to 27.6 per cent in 2022, while over the same period compensation of employees declined from 48.3 per cent of GDP to 42.2 per cent.  

The rise in the profit share has been most pronounced since 2015 when it reached 21 per cent of GDP, that is, just before Cyprus exited the policy adjustment program with the “Troika” of international institutions in March 2016. Undeniably thereafter, the Anastasiades administration became freer to unleash its crony capitalistic policies with favors and corruption to help boost profits of politically connected businesses, while failing to support decent wages and work conditions for many private sector employees.

Following the years when wages and salaries were substantially reduced under the adjustment program imposed by the Troika average gross monthly earnings rose at an annual average rate of 2.5 per cent over the period 2015 to 2022 to around 2.200 euro, a level above such earnings prior the financial crisis of 2013.  In 2022 the average gross monthly earnings of government employees exceeded 3.000 euro, which compared with 1.400 euro, 1.150 euro and 1.700 for employees, respectively, in the retail, accommodation and construction sectors.

Capitalists have expanded resources into these low-wage sectors with investments in the construction of hotels, apartments and villas for foreign and domestic tourists as well as in retail and commercial establishments catering for the buoyant consumption of Cyprus residents. But most jobs in these sectors do not require much skill and add relatively little value and, accordingly, are low-paid. In consequence with the increased demand for labour in these sectors and many young highly educated Cypriots unwilling to take on lowly-paid unskilled jobs labor shortages have developed encouraging employers to increasingly employ foreign workers.

But other factors have kept wage and salaries of most employees in the private sector at relatively low levels, while the incomes of government and bank employees have been maintained at much higher levels. And this divergence and wide inequality has taken place despite an abundant supply of persons wanting to be employed by the government and banks. In theory wages in competitive labor markets should be set by the demand for labor being matched with supply. But in Cyprus strong unions representing government employees kept their average wages high, while crony capitalism ensured the appointment and promotion of many politically-connected persons to well-paid positions notwithstanding their incompetence.  And in the private sector where most employees apart from those working in banks are not represented by strong unions and in which large employers have monopsony power, average wages are suppressed to relatively low levels. In addition, at least two-thirds of workers in the private sector are not eligible for cost-of-living adjustments, while until 2023 many lowly-skilled workers were not covered by minimum wage legislation. Furthermore, the Government has tended to favor employers in often not enforcing regulations relating to employees’ rights and work conditions.

Unproductive and Unfair Bank Activities

 Activities by banks and other financial institutions operating in Cyprus have contributed to financing the large allocation of resources to the low wage sectors of the economy. Both before the financial crisis of 2013 and in recent years there has been excessive and generous financing of the activities of property developers and hoteliers as against the extension of loans for financing research and innovation and entrepreneurial initiatives in areas of the economy offering the potential for greater value added. It is noted that larger companies can borrow from banks at lower interest rates than smaller businesses and can earn much higher bank interest on their deposits than households.

Furthermore, banks have become pre-occupied with removing NPLs off their balance sheets through foreclosing the properties of small businesses and households and selling the properties at large discounts to third parties comprising mainly investment and equity funds. Banks have not only profited from such activities, but have transferred wealth from poorer to richer entities, leaving businesses and households with large amounts of unpaid debt. In fact, private sector debt of Cyprus totaled over 59 billion euro or nearly 220 per cent of GDP at end-2022.  And with overwhelming debt burdens and limited access to credit, businesses and households do not have the opportunities and funds to invest in education, re-training and capital projects.  

Concluding Remarks

The combination of crony capitalism and financial capitalism practiced in Cyprus has resulted in favors and generous bank treatment being given to the connected business “elite” as well as making the country a low value-added and wage economy that has enabled many inefficient (Zombie) businesses to survive and reap profits. And with private sector wages being kept low and many businesses and households remaining heavily indebted the scope for raising incomes and living standards and supporting real economic growth is very much constrained.

More recently, the surge in inflation including that of house prices and rents has eroded real incomes and decreased housing affordability rendering it even more difficult for lower-income earners including most younger persons to eke out a decent standard of living. Currently and in this connection, the government needs to restore and extend full cost-of-living adjustments only for employees with less than the average monthly earnings of 2.200 euro and ensure that employers pay the minimum wages decided by the Council of Ministers in September 2022.

But over the medium-to-longer term if Cyprus is to emerge from being a low wage economy with the politically-connected businesses and individuals uncompetitively extracting large rents and profits, its prevailing brand of crony and financial capitalism must be significantly reduced. Such a development would enable the economy’s resources to be allocated more efficiently into higher value-added activities, including social housing rather than towering apartments, that in turn would create decent and better-paid jobs for younger persons.

Furthermore, with new regulations, much better supervision by the Central Bank, and moral suasion, banks need to be induced and forced to devote more of their activity to extending, rescheduling and writing-off loans so as to finance real wealth creation and ease debt burdens, rather than engaging excessively in transferring wealth to richer entities through foreclosures and subsequent sale of property collateral at very large discounts to predatory third parties. In this connection there should be regulations giving original borrowers the option to purchase their properties at the discounted prices. This arrangement should be done on a case-by-case basis so as to exclude strategic defaulters from taking advantage of this regulation.

In addition, banks should lower interest rates and charges on smaller loans in line with those of non-financial corporations. And interest rates on saving and fixed deposits of households should be significantly raised and the defense tax on interest income reduced from 30 to 10 per cent.