BOORED students, lacking concentration and unprepared for complicated economic reasoning, react sleepily to their teachers who, in frustration raise their voices in reprimand: “You cannot sleep in my class”, to reap in return “If you didn’t talk so loud we could”.
When such stories circulate in universities, pointing to the danger of tedium in the subject of economics, it may seem rather courageous to try to tempt newspaper readers, who consider the medium more for relaxation than for learning, to pay attention to an economic issue. Yet the importance of the euro is such that it raises the hope that apathy may be shaken off, if not in one sitting, at least after a short nap, so they may get the gist of certain aspects when presented in as a simple and straightforward manner as possible.
In essence, the euro and the pound are pieces of paper which become valuable only when by law they become legal tender and as units of account are used in price quotations.
The law, by taking away the property of means of exchange from the pound, renders it a useless piece of paper. By force, everybody will adjust to the reality of seeing prices quoted only in euros.
Immediate beneficiaries from this change will be tourists and traders operating within the euro zone, who will no longer be charged with bank conversion commissions. How the banks deprived of this revenue source will react, what new charges they will devise and how they will justify them will be seen in the future. This benefit should not be construed as necessarily benefiting Cyprus as a whole. If foreign tourists are encouraged to visit Cyprus, Cypriot travellers will also respond equally in the opposite direction, probably to neutralise the foreign exchange outcome. The increasing cost structure of the local tourist industry, in contrast to tourist industries in our comparatively advantaged neighbour countries, is unlikely to get even a breathing pause from the elimination of currency commissions paid by visitors.
Cyprus should not also count on another benefit proclaimed for the euro zone, which is of no relevance even to large European economies, emanating from the encouragement of large capital transfers to move at reduced financial costs among countries. In the first place, transfers of the envisaged magnitudes are not deterred by the negligible commissions paid, nor do they materialise unless their expected returns are considerable. Consequently, reductions in financial costs and the charges in convertibility changes are not decisive factors in inter-country capital mobility.
To expect that pools of hundreds of millions of euros will magically emerge for investment in Cyprus (where?) after the adoption of the euro, encouraged by reduced commissions and lower currency fluctuations, is nothing short of daydreaming. The exuberance of political personalities but more strikingly of Cypriot bank representatives on recent television shows are demonstrative of empty rhetoric and unfounded theoretical reasoning.
These benefits, which do not appear sizeable, must be compared to two categories of anticipated losses of euro zone members from (a) the seignorage loss to high inflation countries and (b) the loss of the foreign exchange rate as a tool of macroeconomic stabilisation by each member country.
At the risk of oversimplification, the inflation tax (a) arises from budget deficits financed from increases in money supply that force prices upward to be paid back by government in money of lower purchasing power in the future. Clearly, the higher the inflation rate, the higher the benefits to governments. It should be pointed, however, that membership in the European Union is attained only after a period of successful stabilisation policies, as envisaged by the Maastricht convergence criteria, so in a rather price stable euro zone the loss of seignorage is accordingly minimised. This loss to Cyprus cannot therefore be threatening to government finances. The same can also be said of the loss from fluctuations in exchange rates intended to bring equilibrium in the balance of payments when needed. Since in the euro zone there is only one currency, the euro in one member country is exchanged at par with a euro in another country.
The changes in currency rates alter the relative international prices, rendering the prices of a country more or less attractive vis-?-vis the rest of the world, in our case of the world outside the euro zone. A small country of Cyprus’ dimensions, even if it were to change alone its currency, would not have the productive capacity to expand its exports to benefit from lower prices. So it must concentrate on restricting imports by raising import taxes, something that is not allowed by the unity of the European market. By market criteria, Cyprus will not suffer noticeably by surrendering the foreign exchange tool, which is of paramount importance in large, flexible, and diversified countries.
Roughly, without any guidance from statistical studies, at first sight Cyprus appears to remain more or less economically unaffected by its participation in the euro zone, in the absence of major shocks. Under normal conditions in the short run as a small boat in the ocean, as always, it will go along the ebb and flow of international forces. Yet in the long run by its evolution into a high cost economy, characterised by a high power union structure it propagates hazardous rigidities which engender continuous upward price pressures.
These pressures, in the recent few years, were mainly manifested in the real estate market, but slowly they engulfed in different degrees the entire economy. As long as foreigners buy houses and land either in the south or the north of the island, and as long as tourism remains healthy, the inflows of funds from there will keep the economy on an even keel.
When these flows dry out, since the island is handcuffed by its size, its economic structure, and the European Union rules, problems will arise in attempts to protect the standard of living of its people. There is a fear that because of internal rigidities, which usually do not change easily, something has to give, and that something is likely to be the sale of assets, i.e. land and houses, at gradually falling prices. But this will not happen overnight.
So if the thoughts of this piece have confused you and sent you to sleep, by all means go for another nap. And always remember that this also happens even to dedicated economics students in university classes.
Dr. Panayiotis C. Afxentiou is Professor Emeritus of Economics at the University of Calgary (Canada)
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