Cyprus Looks beyond Austerity

While Europe in general remains stuck in a structural recession, there are signs of hope on the horizon. Some political leaders are beginning to think outside the box to find a way out of the economic wasteland created by the austerity hurricane.

One of these new promising leaders is Finance Minister Georgiades of Cyprus. In a recent speech he pledge allegiance to austerity – a political must for a European – but his ambitions actually go beyond that. From Cyprus Mail:

The [Cyprus] government aims to reduce state spending by 10 per cent in 2014, and reduce the public deficit without imposing new taxes, Finance Minister Harris Georgiades told an audience of overseas Cypriots yesterday. Speaking at the 17th annual conference of Greek and Cypriot organisations abroad, Georgiades said this amounted to savings of around €700 million. The aim is to reduce the public deficit to around €500m next year and ensure a primary surplus by 2016, a step closer towards Cyprus returning to international markets for capital. He assured overseas Cypriots that the government’s policy focused on curbing spending, not imposing new taxes, adding: “We will secure taxation stability.”

Before we get to the good news in what Georgiades has in mind, let us first get a little bit of a background. The Cypriot government debt increased rapidly during the first four years of the crisis, from 48.9 percent of GDP in 2008 to 84.2 percent in 2012. One reason was that the nation’s banks were in struggling after having invested heavily in Greek treasury bonds. Partly as a result of the losses the Cypriot banks took on its loans to the Greek government, in the spring of this year the Cypriot government was strong-armed by the EU-ECB-IMF troika into stealing deposits from customers of the country’s banks. The Cyprus Bank Heist was sold as a rescue plan for the entire banking industry. In reality, there was never a need for that egregious an assault on private property rights, especially not when it came to helping the Cypriot government avoid yet more debt. The banks were, simply put, never in as bad of a situation as the EU-ECB-IMF troika suggested.

Back to Cyprus Mail:

“We lived beyond our means” both in the public and private sector, he told the audience. The Cypriot state was spending more than it earned, and not on development projects, creating continual deficits and a growing debt, said the minister. At the same time, banks were lending money beyond the means of the real economy, with the money directed towards consumption. “In just three years from 2005 to 2007, private lending doubled.”

Again, this sounds more like politically mandated rhetoric than anything else. From 2005 to 2009 private consumption in Cyprus grew by an average of 3.9 percent per year, adjusted for inflation. That is a healthy rate, though not exceptional. Poland experienced 4.1 percent consumption growth during that same period. Other countries saw even higher growth rates, such as Romania (5.8 percent per year), Slovakia (5.0) or Serbia (4.6). It is worth noticing that all these countries are emerging European economies, which during the years after 2000 reaped the harvests of deregulation and still having a relatively limited government. It is hardly surprising that Cyprus would be in the same group.

In other words, whatever consumption boom that generous bank lending could have led to, it did not cause any exceptional growth in private consumption. The prime minister’s point is therefore a moot one unless he can specify what the lending went to, if it created a mortgage crisis, etc.

The problem is if the Cypriot government now resorts to sustained austerity measures. It is understandable that they try to focus entirely on spending cuts: there are suggestions in current public policy literature that austerity packages with at least two-to-one spending cuts are much more successful than packages with more tax hikes in them. However, the evidence that such suggestions rest on is shaky in some cases and in other cases very limited in policy application. Overall, the current experience from Greece, Spain, Italy and Portugal (as well as Sweden in the ’90s) is that austerity in general is actually quite bad for the private sector.

This is not an argument for keeping big government. It is an argument for doing away with it entirely, not trying to save it by means of austerity.

And now for the good news. Attached to his pledge to austerity, Finance Minister Georgiades, according to the Cyprus Mail, made promises to match spending cuts with tax cuts down the road. This is a first on the European scene since the austerity assault began:

Once government got a grip on public finances and reduced expenditures it would also lower the tax burden, he said. The government also planned to make significant structural changes, referring to the new social welfare policy, new healthcare plan and “ambitious” reform of the public sector. Regarding Cyprus’ battered banking sector, the minister argued that it was stabilising day by day.

If the Cypriots do indeed move beyond mere austerity, there is a brighter tomorrow on the horizon for them. Let’s keep an eye on them and see what they come up with.