Cyprus- Why Krugman got it wrong

Much like the the last time I disagreed with Krugman, disagreement is of the “yes, but” variety. The last time, he was telling off austerity, but I doubt he had in mind economies in which (shockingly wasteful) state spending reaches 54% of GDP. This is taxes and spending on a very long list of things like the 42 architects employed for 30 years -with regular pay hikes and promotions- to build dams.

We were done building dams 20 years ago.

Likewise, everything he says about Cypexit, stands correct on its face. There is no doubt that the Euro translates to deep recession for Cyprus, especially after the horrific Eurogroup idea to propose losses on depositors in order to stave off a banking crisis. I’ve wondered before if this was sheer stupidity or bad intentions.

But then again, Krugman suggests that “leaving the euro, and letting the new currency fall sharply, would greatly accelerate…rebuilding.” Well, it does, usually. Except, there are a few concerns in the case of Cyprus.

Bailed in...
Bailed in…

All of Cyprus’ physical inputs are imported. Everything; from feed to steel and from fertilizers to computers. Raw materials are imported. Intermediary goods are imported. Capital goods also imported.

This is an island economy with a GDP smaller than Vermont and a population 200.000 short of a million. So, when I say, “imported”, I mean “close to 100%”.  While the primary surplus that Krugman mentions is a 2013 projection unlikely to materialize (again), the trade deficit spikes with GDP growth and declines rapidly with recessions. This is not unusual, and Krugman would say that it reflects FDI flows as well. But a closer look reflects the extreme dependence on imported factors of production.

This changes the entire picture and makes one wonder about the level of inflation under a new currency, as well of the impact that this would have. All of the obvious concerns about a nascent currency borne out of crisis are suddenly multiplied into a nightmare.

In fact, as if all of this weren’t enough, note that Cyprus is also 100% dependent on energy imports. Gas prices have been rising at a dizzying pace in the last two years, although from a lower starting point than in most other countries. Electricity is another issue –prices accurately reflect how profoundly reckless Cyprus has been in managing its infrastructure: We managed to blow up our main electricity plant by storing munitions outdoors, nearby. Ever been in Cyprus in the Summer?

Krugman notes that Cyprus has two main exports- tourism and banking services. And, he is right in saying that banking was wiped out overnight, at least as export. On the other hand, the main question about tourism isn’t so much whether a devaluation will help the industry; of course it will.

The question, though, is more basic than that: After the glorious 1980s, can the industry be revived? One wonders, after the sun-sea-and-sex tourist wave 30 years ago, what the prospects are for Cypriot tourism. With a few bright and special exceptions, the industry has been in a steady wane since the early 1990s.

Already, its share of the GDP has declined significantly. But more importantly, lower-end hotels have been sitting idle for years. Upper-end hotels have been lingering between high debts on the one hand, and declining quality on the other.

Part of the explanation why this happened, is that most hotel owners were too busy frantically building mansions for British retirees- and in the process unwisely taking massive loans that the banks unwisely extended to them. This was a traditional banking fumble, where real estate loans were based on collateral: The real estate development itself. But that’s another story.

The problem with Cyprus tourism is that supply is too massive and quality is too low. What it needs is fewer and better hotels. Krugman makes a reasonable point and he had no way I can think of to examine the industry. Besides, this is not macroscopic analysis; this is formerly five-star hotels with chipped ceilings and decaying swimming pools. The ones making profits in the last years are the exception. The competition –Egypt, Israel, Turkey, Greece- have more and better hotels. Oh, and more and cheaper flights, not to mention better overall service.

So even this hope is far from likely to come to anything.

All of this, of course, comes on top of the traditional concerns about currency devaluation. And it comes with none of the perks. In fact, the very vibe in the international markets right now makes the Central Bank’s total reserves a very much relevant issue: A total of 19 billion euro, not enough to squeeze a single bear, let alone hold off for anything resembling an attack on the new currency.

So Cyprus is one of those places that will have to slug it out.

And slug it out we will.

There are lots of good ideas, even investor interest, for new industries, for better and more orthodox government action and for ways to give growth a nudge.

Above all, a new currency would be the easy way out. And, by now, we Cypriots ought to know pretty well where the easy way leads after a while.


  1. A few comments:

    1. The example of the architects and dam infrastructure is not an an argument *for* austerity but for re-organization and more flexibility/efficiency in the public sector. There are seasonal jobs (every time an application for e.g. agricultural subsidies has to be done) and there are under-staffed sectors (yes in the public sector!) e.g. the IT sector (which is more again more an issue of better organization/flexibility/efficiency). It is not cost-cutting i.e. austerity that is necessary, it is better allocation of resources and the productivity of these resources relative to their cost.

    2. Apart from an increase in prices due to the fact that we are an importer and not a producer what else will destroy the economy if we change the currency. What more than the lack of loans and credit that is certain to follow? What more that the mistrust between suppliers? The closure of companies that will not be able to stay afloat without credit? Will any b2b operations function in the short run? What will be more painful and more prolonged? A 5 to 10 recession is what we are expecting now – will leaving the euro be so prolonged in spite of the sudden shock?

    3. I see your point, but I argue that Kruman’s point is valid as well. And you can never KNOW anything in theory. All we are have are hypotheses and assumptions. I also agree that our tourism need re-structuring and better planning – clear goals of who to attract and incentives that will lead to more profitable tourism.

    4. One point that I argue, is that either way, being a small state the rebound will be swifter than most expect. There are disadvantages and advantages to being a small state but I do believe that – either way – we will rebound much faster than any other bailed out state and definitely will not follow in the footsteps of Greece.

    5. Finally, there are other points in this whole fiasco that beg answering – why no ESM bailout for the banks? Why go through all this for 5.8 billion on the side of the troika? Well they can bully us – by leaving the euro there is no more bullying (in the long run). If only 5 years into this monetary union all we managed is another bubble (we tend to be good at those… stock market, property, banking – a testament to our lack of vision and planning) then… maybe we are better off «alone» with our currency… The we can laugh it all off – the «eurozone crisis» … just like the Brits 🙂

  2. Tourism can be revived, but will need a wholesale restructuring.
    Cypriots got complacent, the «kopiaste» went out of tourism.
    Unfortunately Cyprus is an expensive destination, without being exotic.
    Cyprus can and should offer high end tourism, cash in on its culture and attract smaller numbers of wealthier tourists rather than the mass tourism it decided was the future.
    That would maximise the income and minimise the ecological impact per tourist.

  3. [sorry for writing in English]

    Two additional arguments in favor of an exit now:

    (i) an early exit is better than a late one
    Anastasiades got elected to fix this. He didn’t. He wont last long once the scale of the problem is fully appreciated. The next government will likely exit under worse conditions. An early exit now has a chance to preserve parts of the economy that will be needlessly destroyed by the forced haircuts.

    (i) an early exit now will deliver political capital to drive structural reforms
    There is a willingness on the part of the people and also political parties to do ‘whatever it takes’ to get rid of the onerous terms of the eurogroup conditions. Privatizations, opening up elecoms, removal of restrictive practices, setting up real casinos we may as well have a real casino economy) to boost tourism, agri-exports, etc will have a much better chance of happening now.


  4. I have a few questions for all of you and all Cypriots:
    How many tourists do you think would come for holidays to a country where they know there’s no or little gasoline to allow them drive around??
    How many tourists do you think would imagine visiting a country where they won’t be able to eat what they like/choose/need??
    How many tourist do you think will decide to spend their, so little and precious fun time, in a country where they know won’t find any or very little trustworthy alcohol??
    Ask and answer these questions to yourselves and then forget the Krugmans of this world and go on and do what Cypriots do best:
    Work and get your country out of the harsh times, once again.

    • Obviously you know nothing about Cyprus – no gasoline? no food? no trustworthy alcohol?
      Where did you get all this? The cartoon network?
      Good food and top quality alcohol are a few of the many reasons to visit Cyprus – you ignorant poop.

      • Setting aside your kindness and good upbringing I can’t miss how knowledgeable and educated you are on the subject. Have you EVEN THOUGHT of what happens to a country that introduces a new, rather unreliable, currency? Have you even read the post we are commenting on?
        Looks like I’ll have to get it into your thick skull, genius.
        I was referring to the hypothetical case of a Euro exit, you master of perception. All these goods (along with almost everything else as correctly the author notes, medicines included) are imported to Cyprus. In the case of a Cyprus exit from the common currency NO ONE will export anything to it but with hard currency paid CASH; which the Democracy won’t have anymore. EVERYTHING will be available in daily, weekly, monthly rations
        Go open a book on Argentina, dear “professor”. Then when you, PERHAPS, be able to discuss serious issues as this!
        PS. You would be surprised of how much I know about Megalonisos but this is a completely different matter and none of your bloody business

  5. Marketelf where did you get your information from?
    We are talking about the Republic of Cyprus, the southern half where there is no shortage of anything.
    Even in the occupied North there are neither petrol (as we call it) nor alcohol shortages.
    Please do come and visit before slagging us off

  6. I was NOT slagging Cypriots off. I would never do such a thing. I respect and love Cyprus and Cypriots way too much for that.
    Please have a look at the answer to milaz above. This is the case with Cyprus in the Eurozone and in present time. Won’t be if Cyprus is to leave the common currency area All evidence points to that (Thank God we haven’t had any exact same example)
    Your answer is kind and good mannered so I feel obliged to disclose I visit the island more often than one would imagine:-)
    If I can help on any point please do not hesitate to spot it so I can clarify.

  7. This may be a good place to request more reliable information regarding a euro exit. I understand what Marketelf said but would still like to see some numbers regarding the _necessary_ imports and foreign currency income. For example:
    1. Annual cost of oil import for electricity generation and transportation/heating (very important)
    2. Annual cost of medicine and necessary equipment and parts
    3. Please feel free to add other _necessary_ import items
    4. Projected foreign currency income from tourism and exports (1.5 bn euros in 2011?) taking into account a devalued currency

    I believe that Cyprus can be _made_ self sufficient in terms of food.


Εισάγετε τα παρακάτω στοιχεία ή επιλέξτε ένα εικονίδιο για να συνδεθείτε:


Σχολιάζετε χρησιμοποιώντας τον λογαριασμό Αποσύνδεση /  Αλλαγή )

Φωτογραφία Twitter

Σχολιάζετε χρησιμοποιώντας τον λογαριασμό Twitter. Αποσύνδεση /  Αλλαγή )

Φωτογραφία Facebook

Σχολιάζετε χρησιμοποιώντας τον λογαριασμό Facebook. Αποσύνδεση /  Αλλαγή )

Σύνδεση με %s

Ο ιστότοπος χρησιμοποιεί το Akismet για την εξάλειψη των ανεπιθύμητων σχολίων. Μάθετε πως επεξεργάζονται τα δεδομένα των σχολίων σας.