VZCZCXRO0378
PP RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHNC #0621/01 2131258
ZNR UUUUU ZZH
P 311258Z JUL 08
FM AMEMBASSY NICOSIA
TO RUEHC/SECSTATE WASHDC PRIORITY 9022
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE PRIORITY
RUEHAK/AMEMBASSY ANKARA PRIORITY 5249
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUEHBS/USEU BRUSSELS PRIORITY

UNCLAS SECTION 01 OF 02 NICOSIA 000621 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN CY
SUBJECT: THE PROBLEMS OF ECONOMIC CONVERGENCE IN A REUNITED 
CYPRUS 
 
¶1. (SBU) Summary.  Thirty-four years of separation have 
created two distinct economies on Cyprus.  The ROC is fully 
integrated into the global trading system and the EU, and 
enjoys a relatively high level of human capital. The north, 
primarily because of the policies (both G/C and T/C) that 
isolated it, have a substantial number of mid-level civil 
servants and office workers without the skill set necessary 
to compete in a fully competitive European economy. The same 
can be said for many T/C businesses. With reunification 
likely to end Turkish government financial support, the 
government of the north Cyprus entity will need to mobilize 
funds from the south and internationally to fund an extensive 
retraining program during a transition period leading to full 
economic integration. End Summary. 
 
Reunification: Rising Tide Will Lift Some Boats; Sink Others 
--------------------------------------------- --------------- 
¶2. (SBU) There is little doubt that reunification would be an 
economic boon to the island. More tourists would visit the 
north, more trade would be conducted with Turkey, land prices 
in the north would appreciate to approach those in the south 
(i.e., perhaps 40 percent for pre-1974 Turkish-titled 
property, 70 percent for pre-1974 Greek-titled property) and 
consumer prices in the north would decline as competition 
increased. The south would benefit especially from the 
reconstruction of Varosha, the ghost-city that prior to 1974 
was the tourist playground of the island. In 2003, the ROC 
Planning Board estimated that reconstruction of Varosha would 
cost US$2.5 billion (about 17 percent of GDP.)  Note: We 
believe it would cost considerably more to raze and rebuild a 
city occupied by about 60,000 people in 1974. End Note. The 
biggest risk to the island's economy as a whole would be 
inflation from all the new construction activity. The 
question is whether a less-skilled T/C workforce and a 
largely unsophisticated and uncompetitive T/C business 
community would have the wherewithal to take advantage of the 
increased wealth, or if an inordinate percentage would accrue 
to the G/C community. 
 
A Tale of Two Economies 
----------------------- 
¶3. (U) The economy of the Republic of Cyprus is a 
post-industrial model of an open, internationally integrated, 
services-based system supported by large tourism and 
property-development sectors.  A long-term government effort 
to make Cyprus attractive as an off-shore base within the EU 
(10 percent income tax rates, numerous bilateral tax and 
investment treaties, relatively high technical skill levels - 
especially in the financial services sector - and widespread 
use of English) have provided a sustainable base for the 
ROC's continued economic viability. A measure of this success 
is a forecast 3.7 percent GDP growth rate in 2008 in the face 
of the current global economic uncertainty (Q1 2008 GDP grew 
at an annualized 4 percent.) 
 
¶4. (U) The economy of northern Cyprus is a largely artificial 
construct based on an extremely large public sector supported 
by generous subsidies from Turkey and cheap labor imported 
from eastern Anatolia. The business community has little 
interaction internationally and, despite the relatively high 
cost of inputs and low productivity, lives off the high 
margins that result from limited domestic competition and 
government contracts. Exports in 2007 totaled only US$81 
million, mostly unprocessed fruit and vegetables, building 
materials, and a few simple manufactured products such as 
aluminum window frames. The mass tourism sector (about 80 
percent of all visitors are Turkish) is increasingly 
controlled by Turkish equity, and the housing boom that 
ignited the economy 2003-2006 has reversed course, with 
thousands of empty homes that developers can't sell. Tourism, 
a major contributor to the north's economy, is especially 
weak as evidenced by a mere 28 percent occupancy rate in the 
north's hotels in June.   As a result, the GDP shrank about 
2.1 percent in 2007 and anecdotally (since quarterly macro 
economic statistics are not compiled) has continued to 
decline. 
 
¶5. (U)  North Cyprus' GDP in 2007 was US$3.3 billion, 
US$12,021 per capita, assuming a population of 300,000. The 
per capita number, however, is inflated by the official 
inflows from Turkey (around US$400 million/year). One local 
economist reckons that, if all Turkish aid, loans, military 
spending, and spending by Turkish companies (using Turkish 
government money) were subtracted out, a more accurate GDP 
per capita figure would be around US$7000. The corresponding 
GDP figures for the ROC in 2007 were US$21.3 billion; 
US$27,078 per capita; 93 percent of the EU's average. 
 
 
NICOSIA 00000621  002 OF 002 
 
 
Things Are Tough in the Real World 
---------------------------------- 
¶6. (SBU) Various studies over the years have all concluded 
that a reunified Cyprus would generate additional economic 
growth across the island. One study undertaken by local 
economists (on both sides) this spring concluded that, over 
the medium-term, GDP per capita would increase Euros 5500 
largely from increased Cyprus-Turkey trade and investment. 
The concern of many T/C businessmen is that they may not 
directly benefit from this increased trade and, in fact, may 
suffer from the increased competition from G/C business. A 
major accounting firm in the north noted that his association 
with Price Waterhouse in Turkey would come to an end with a 
reunified Cyprus because Price Waterhouse in the ROC would 
become the sole PWC presence on the island. He believed that 
PWC Cyprus would only work with him if he agreed to sell his 
company to the G/C partners. There is considerable concern 
that, notwithstanding long relationships with Turkish 
suppliers, the Turks will prefer to do business with the 
larger G/C firms and their potentially more lucrative market. 
Furthermore, individual T/Cs are not typically as adept at 
English language, computer usage, or finance as their G/C 
brethren. This makes them less competitive in a single market 
workplace. As civil servants are made redundant from the 
current padded "TRNC" rolls, and businesses in the north 
consolidate or disappear under pressure from southern 
competitors, there will be a significant number of T/Cs who 
will find that they do not have the skills to land a position 
similar to the ones they enjoyed under "isolation." The 
result could be considerable social pressure as G/Cs in 
general (along with better-educated or skilled T/Cs) enjoy 
the benefits of the general economic expansion, but a 
significant minority of middle-class T/Cs find themselves 
moving down the social ladder. 
 
¶7. (SBU) Under the Annan Plan, the T/Cs were provided a 
three-year period of protection from their larger, better 
capitalized, and more aggressive G/C competitors. Presumably, 
the current T/C negotiating demand for permanent derogations 
to the acquis communautaire requirements for free movement of 
capital and labor will be dropped in favor of a limited 
period of protection during which T/C business will 
restructure and prepare for life outside isolation.  To the 
extent that continued protection prevents or delays T/C 
business from proceeding with the necessary adjustments, it 
will cause only further pain in the adjustment process. At 
least one economist argues that instead of negative 
prohibitions on G/C business to protect T/C economic 
interests, an "affirmative action" policy be utilized 
allotting some share of public sector contracts and 
procurements throughout the united Cyprus to be set aside for 
T/C contractors or sub-contractors. This might also speed the 
creation of joint ventures between the communities. 
 
¶8. (SBU) Comment: The creation of a single federal Cyprus 
will probably require the Turkish portion of the Cypriot 
federation to find replacement income for most, if not all, 
of the financial support previously provided by the Turkish 
government. Some T/C economists suggest large transfers from 
the G/C entity, largely replicating West Germany's approach 
in integrating East Germany. We have doubts that this would 
be politically possible for a G/C leader. In any case, the 
cost of preparing T/C business and workers for reunification 
cannot be managed by the north alone, but without a focused, 
comprehensive (and therefore expensive) effort on upgrading 
language and technical skills during a period of protected 
transition, the newly-united nation runs the risk of social 
instability based on apparent differences in job 
opportunities and income levels between ethnic groups. The 
irony is that the dearth of skills among T/Cs is largely the 
result of the longstanding ROC policy of economically and 
politically isolating the north, and the somewhat 
self-isolating T/C response.  Going forward, the consequences 
of the isolation policy could rebound against the reunified 
entity the policy was designed to bring about. 
 
 
 
 
SCHLICHER