A few weeks ago the Statistical Service Cystat produced the latest national accounts data for 2014, showing gross domestic product (GDP) both by sector and by expenditure.
The sectoral accounts show manufacturing, construction etc, while what is called the expenditure approach lists consumption by households and the government, then ‘fixed capital formation’ (investment), then exports and imports and a couple of other items.
A developed economy cannot compete with Asia on price, therefore it has to compete on the basis of productivity. And that requires investment.
To give you an example you will recognise, remember how slow the internet was back in the dial-up days. If you are in the economic research business, as I am, it might have taken you an hour to download raw data from the internet.
Then it would take you longer to play around with Excel or other programmes analysing the data, because your computer had less processing speed.
Today it still takes time to analyse the data. But I can download the raw statistics in five minutes. I get more output out of one hour of input, because I produce more in one hour than I did before.
My productivity has risen as a result.
But everyone else has also got faster computers and internet speeds now, so to keep up my productivity I have to keep investing. In fact, looking at my company accounts, that is what I have spent most money on: various gadgets to help me work faster.
Investment is critical for job creation
Take that to the country level, and you can see that ‘fixed capital formation’ – investment in technology and infrastructure (think traffic jams and poor air connections) – is critical to staying competitive and thereby growing and creating jobs.
This is why I am so alarmed at the figures for Cyprus.
Typically a developed economy should be investing 20% of GDP per year to keep going and ideally 25% to be really competitive.
In 2014 fixed capital formation in Cyprus was only 10.9% of GDP. This was the lowest ratio in the EU and even lower than Greece, at 11.6%.
Being a small peripheral country is no excuse. Little Estonia had the highest rate in the EU at 25.8%, while even littler Malta recorded 18.8%.
Being a bailout country is no excuse either. Despite an enormous banking problem, Ireland invested 16.4% of GDP last year. The EU average in 2014 was just under 20%.
How did it get so low?
Investment has not always been so low. In the decade 2001-2010, investment ratios in Cyprus were above 20% every year except for 2001, averaging 22.8% for the whole period. But the ratio has halved since.
There are a few reasons why this is the case.
First, and somewhat unfortunately, pouring concrete to build holiday villas that no one will buy counts as ‘fixed capital formation’ as much as investment in solar energy does. This is why we see ‘investment’ peak at 27.3% of GDP in 2008 – the height of the unsustainable housing boom.
Economists have ways of detecting whether investment is productive, however. If you have a high investment ratio but your current-account deficit also remains high over a long period, it is a good sign that the investment is not productive.
Sure enough, our current-account deficit grew and grew till it reached 14.8% of GDP in that peak year of 2008. A healthy current-account deficit ratio is less than 5% of GDP, so this is the kind of level that could have triggered a currency crisis had we not joined the euro that year.
If you look into the disaggregated figures, which break down investment into housing construction, other construction, transport and machinery and equipment investment (the important one) we can see that machinery and equipment investment has also been falling.
When we joined the EU in 2004 machinery and equipment investment accounted for 5.3% of GDP. In 2009 it had risen to 6.1% of GDP. But by 2014 it had shrunk back to 4.4% of GDP.
Similarly, transport investment rose from just 1.3% of GDP in 2004 to 5.9% of GDP in 2010. In 2014 it was actually recorded as negative, implying that value was taken out of the country (presumably through the sale of a big item such as a ship).
So we have also been disinvesting where it matters – in machinery and equipment investment and in transport – both of which raise productivity.
How can we increase investment?
As you will see on other pages in the newspaper this week, Hellenic Bank Chairwoman Irena Georgiadou says that allowing banks to sell their bad loans to specialist entities will attract big investors to the country. That is one way forward.
The government has also announced around €200 million of its own investments.
But since it has been topical this week, it is worth remembering that there is one other sure-fire way of boosting investment on the island, and that is by solving the Cyprus problem.
When writing the PRIO Cyprus Peace Dividend Revisited report with Alexander Apostolides and Mustafa Besim, we were told by developers with lots of international experience that if Cyprus had a “big idea” for Varosha and the wider Famagusta, it could attract investment of €15 billion.
The figure was so big we did not use it in our forecasts. But it is just one instance of the unlocked potential that we are sitting on, if only we could find the key to open it.