CYPRUS: PROMOTING PRIVATE SECTOR DEVELOPMENT PROGRAM

Large budget deficits diverted capital from private investment, causing productivity and output to fall. Going forward, it will be necessary to increase domestic saving to finance private investment in the productivity-enhancing activities that are critical to achieving sustainable improvements in living standards. The TC economy faces several geographic, demographic, and political challenges. The economy inhabits less than 1,300 square miles of land, has limited natural resources, and serves less than 300,000 people. In contrast to other small economies that depend on international trade to compensate for their small size, political factors have limited the TC economy's integration into the global economy. Over the last 37 years, the Turkish government has served as the TC economy's primary source of capital, compensating for difficulties the economy faces in accessing international capital markets. The combination of a small economy with scarce natural resources finding itself largely cut off from world markets and a seemingly insatiable appetite for capital from one source makes the design and implementation of appropriate and effective economic policies even more important for enhancing TC economic competitiveness. To design and implement economic policies that will promote long-term sustainable improvements in TC living standards, policymakers should shift focus from where capital comes from to how it is used; and from the level of economic activity to the composition of that activity. Contrary to conventional wisdom, the TC economy is not unique by nature of its size alone. An analysis of 200 economies finds that in almost half the cases, there is a positive relationship between an economy's size and its landmass, i.e., small economies tend to be associated with a small landmass and larger economies tend to be associated with a larger landmass. A similar correlation is found between landmass and population, i.e., in almost half the cases, a small landmass hosts a small population. By contrast, the analysis finds virtually no correlation between landmass, population, or GDP level and economic performance, as measured by average GDP growth over the decade. The TC economy is more unique due to political factors that place considerable burdens on the economy. Due to its political status, the TC economy experiences significant barriers to commercial and financial ties with the rest of the world. Uncertainty also hurts its ability to attract foreign investment. Although Turkey has tried to mitigate these burdens by providing significant financial support and encouraging Turkish business to invest in the TC economy, that relationship has not come without its costs. The TC economy is not completely unique with regard to its political status, as the Palestinian economy in the West Bank and Gaza also faces significant barriers accessing international markets and most of its trade is shipped through Israeli ports. Enhancing competitiveness is critical for the TC economy. Competitiveness can be defined relative to firms, industries, and economies. The competitiveness of a firm is determined by its ability to provide higher quality products at lower prices than its competitors. Firm-level competitiveness can be measured by long-term growth in sales, employment, and profits, as well as by increasing market share. Industry competitiveness is primarily determined by the technology embodied in its goods and services, and the efficiency by which they are produced in order to capture a dominant market position. Economy-wide competitiveness is defined as the capacity to produce goods and services that meet the test of international markets while at the same time, earning a standard of living that is both rising and sustainable over the long run at home. This definition has three elements: (a) the capacity to produce goods and services, (b) meeting the test of international markets, and (c) achieving sustainable improvements in living standards. In other words, although international markets are at its core, competitiveness begins and ends at home. An economy's ability to sustain a high standard of living depends on the efficiency by which it transforms its resources - land, natural resources, workers, capital, and technology - into output, otherwise known as "productivity." It takes more than just increasing the number of hours worked to increase productivity. Improving the allocation of capital, introducing new technologies, and employing a highly skilled workforce are all means of enhancing productivity. Raising productivity does not mean working harder; it means working better.