Political Capitalism Thriving in Cyprus: The ”Elite” Dominate Economic Policies

Political capitalism broadly defined is an economic system in which the business elite and the political elite cooperate for their mutual benefit. The business elite influence the government to use regulation, government spending, and the design and administration of the tax system to support and maintain their elite status in the economy. The political elite that implements those policies are then supported by the business elite, which helps the political elite maintain their status and power. Indeed, this situation exists in Cyprus where the political elite design and implement economic policies for their own benefit at the expense of the general population. The elites determine public policy, while the ordinary citizens of Cyprus are governed by it.

 In truth, resources in the capitalist system of Cyprus are allocated more by the exercise of political power rather than by market forces to the detriment of the attainment of key socio/economic goals. Insiders and cronies benefit immensely from this corrupted economic system, while entrepreneurship, innovation and development are discouraged and hindered by the lack of genuine and fair competition.

Government spending and taxation

Apart from the strict EU fiscal rules on the targeting of budget balances, domestic political forces in Cyprus have a strong influence on the expenditure and revenue composition and execution of government budgets. In budgets taxes are kept quite low and expenditure generously allocated to favored contractors and consultants and an expanding army of well-compensated politically-loyal employees and advisors in order to satisfy the business elite and gain political support. Indeed, this is the situation embodied in the recently approved government budget for 2024 in which a large overall surplus of 2.2% of GDP is targeted as well as a spectacular increase of 15% in the payroll for government employees.

Under pressures from the political and business elite, revenue to finance budget expenditures is suppressed by a system that does not tax wealthy property owners and high-income earners near enough, and by an administration that turns a blind eye to prolific tax evasion. In fact, the central government progressive tax on immovable property was abolished in 2016.

The obsession of the Cyprus government in targeting sizable budget surpluses to impress the EU and credit-rating agencies together with keeping taxes low, as well as currying favor with the business elite and political loyalists by spending big on them, has meant that resources available for public expenditure on essential investments such as the substantial upgrading of the electricity grid and outlays for strengthening the care economy are continually depleted.  This lack of funds to co-finance investment projects and programs with the EU along with its feeble institutional capacity, have substantially curtailed the government’s ability to undertake worthwhile investments. Notably, the Recovery and Resilience plan agreed with the EU in 2021 earmarked 1.2 billion euro of funding for Cyprus to be used by August 1, 2026. Yet by September 1, 2023 less than 5% of these funds had been taken up in financing investment projects and structural reforms.

Weak institutions and regulations

Moreover, it seems that the business and political elite of Cyprus do not care about economic development and enhancing social welfare, but are intensely interested in maintaining their status at the top of the political and economic hierarchies. In doing so the elite seek to preserve their wealth and influence on policies by retaining low-quality institutions and conducting regulatory capture.

More specifically, the elite are strongly against reforming the appallingly poor state of tax administration as it would disproportionately expose the tax evasion of top political and business “leaders” and also would be politically unpopular in forcing a great number of persons and corporations to pay higher taxes. And the elite like to keep the oversight of supervisory and regulatory institutions weak so that they can engage in and profit from unlawful and shady activities, such as certain professionals richly benefitting from money laundering operations.

The market economy of Cyprus should be best regulated for the public interest. But the elite seek government regulations and oversight to foster their own interests and preserve the status quo. They want to stabilize the existing state of affairs through the design and enforcement of regulations and make it difficult for those outside the elite to displace them. And companies that have captured the agencies that regulate them, are dependent on those who control them for their continued profitability. In this connection, regulators such as top tax administrators, for example, often join private firms to which they have granted favors, following their departures from the tax department as part of the “revolving door policy” of Cyprus.

Structural and regulatory reforms

Indeed, ongoing government policies including those incorporated in the 2024 budget indicate that political capitalism is thriving in Cyprus. But progress in achieving the key socio/economic goals of “balanced and sustained development” and “mitigating economic and social inequalities” as stated by Minister of Finance, Makis Keravnos, in his budget speech is not being met.

Undeniably, in the sense that budget surpluses and a steady reduction in the government debt are taking place fiscal responsibility is being exercised. But sizable budget surpluses and keeping tax revenues relatively low come at the cost of failing to implement investments to help ensure the sustained and balanced development of the economy as well as enabling adequate expenditure on social protection and the care economy. Indeed, with the crowding out of funds and the lack of the institutional capacity to effectively implement high-quality investments the official goal of creating a more digitized and greener economy is being held back.

 And in so far as fiscal policies and the design and weak enforcement of regulations are directed at supporting the political and business elite to the detriment of the general population, the government is only giving lip service to the goal of mitigating economic and social inequalities. If the government was serious in narrowing inequalities in wealth such as between the older generation of property owners and the younger generation of rentiers it would be instituting measures to get the rich to pay their fair share of taxes and make more funds available for expenditure on social housing and protection as well as creating jobs for the highly educated young through, among other things, much greater spending on research and development.  

The increasingly regressive tax system and its administration should be reformed through reintroducing a progressive tax on immovable property and making the structure of personal income tax rates more progressive as well as taking really serious measures to combat tax evasion. Such reform would substantially boost government revenue. In turn more funds would be available for redistribution to finance priority government spending on essential hard and soft infrastructure and social protection.

But more funding is not enough. There must be the institutional capacity to ensure that worthwhile investment projects can be properly financed and effectively implemented and that deserving persons are better targeted with adequate social assistance.

The institutional capacity of the government can be enhanced by changing its employment policy to recruit and train skilled and qualified persons instead of most disproportionately placing more politically loyal casual workers on its payroll[1]. In addition, in view of the very limited capability of both public and private institutions in project financing there is a compelling need to set up an independent development- type bank or agency to lead the way in evaluating and financing large-scale projects, including PPPs and the many investments proposed under the Recovery and Resilience plan.

 In Cyprus, an urgent need exists to improve or eliminate the many regulations that provide unnecessary obstacles to competition, innovation and development. One example is the cumbersome regulations of the Tenders Review Authority that allow unlimited and low-cost appeals against the award of public works contracts to initial and subsequent successful bidders. Such regulations require reform so that the lengthy delays in implementing many investment projects and in absorbing related EU funds do not continue.

But, it is the failure to enforce regulations, especially on the political and business elite, that contributes most importantly to the political capitalism of Cyprus. The Cyprus authorities turn blind eyes to the violation of environmental regulations and building codes by certain leading property developers, to blatant cases of tax evasion by many wealthy professionals and cronies, to the illegal sale of the property collateral tied to NPLs by banks, and to many other irregularities.

In response to alleviate irregularities, the oversight authorities such as the Tax Department need to be staffed with competent and moral employees that with crucial political backing can bring about the stricter and even-handed enforcement of regulations. Furthermore, harsher penalties for regulatory violators and a simplification and centralization of procedures in submitting applications and documents, such as tax returns, for government vetting could contribute significantly in enhancing compliance with regulations.