Should Cyprus leave the euro?

Krugman argued yes and I am inclined to agree.  From fortheisland, here is a case for no:

All of Cyprus’ physical inputs are imported. Everything; from feed to steel and from fertilizers to computers. Raw materials are imported. Intermediary goods are imported. Capital goods also imported.

This is an island economy with a GDP smaller than Vermont and a population 200.000 short of a million. So, when I say, “imported”, I mean “close to 100%”.  While the primary surplus that Krugman mentions is a 2013 projection unlikely to materialize (again), the trade deficit spikes with GDP growth and declines rapidly with recessions. This is not unusual, and Krugman would say that it reflects FDI flows as well. But a closer look reflects the extreme dependence on imported factors of production.

This changes the entire picture and makes one wonder about the level of inflation under a new currency, as well of the impact that this would have. All of the obvious concerns about a nascent currency borne out of crisis are suddenly multiplied into a nightmare.

In fact, as if all of this weren’t enough, note that Cyprus is also 100% dependent on energy imports. Gas prices have been rising at a dizzying pace in the last two years, although from a lower starting point than in most other countries. Electricity is another issue –prices accurately reflect how profoundly reckless Cyprus has been in managing its infrastructure: We managed to blow up our main electricity plant by storing munitions outdoors, nearby. Ever been in Cyprus in the Summer?

Krugman notes that Cyprus has two main exports- tourism and banking services. And, he is right in saying that banking was wiped out overnight, at least as export. On the other hand, the main question about tourism isn’t so much whether a devaluation will help the industry; of course it will.

The question, though, is more basic than that: After the glorious 1980s, can the industry be revived? One wonders, after the sun-sea-and-sex tourist wave 30 years ago, what the prospects are for Cypriot tourism. With a few bright and special exceptions, the industry has been in a steady wane since the early 1990s.

Barkley Rosser makes some similar points.  If I’m not convinced, it’s because I don’t see how the current regime of “Cypriot euro with capital controls” will boost either tourism or enable significant imports.  Nonetheless, at the very least, you can take these paragraphs as a further indication of just how much trouble Cyprus is in.

For the pointer I thank Dries de Smet.


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