A theory of economic growth, unions, politics and Cyprus

A British soldier observing the prosperous German countryside a decade or so after WWII commented to his colleague: “Makes you wonder who won the war”. Only a few years earlier, most of German industry and many of its cities were in ruins. How was it, then, that the country appeared more prosperous than victorious Britain which had not been occupied and had not suffered the same degree of damage?

This was the question that also puzzled Mancur Olson, an economist with degrees from both Harvard and Oxford. The German post-war economic miracle was eventually followed by similar economic “miracles” in a number of the other defeated countries: Italy, France, Japan and even Greece.

Common sense indicated that Britain, as well as those countries whose industrial structure emerged more or less intact from the war, should have been the growth leaders. But this was not the case. Olson’s theory of economic growth developed out of this apparent paradox. His explanation: The defeated countries grew more rapidly not despite the destruction of World War II but because of it. These “miracle” economies grew faster precisely because their pre-war economic and social infrastructure had been destroyed.

Mancur’s view is that social stability gives rise to the formation of groups and associations aimed at promoting the special interests of group members. Over time, workers, doctors, lawyers, teachers, etc., will form groups to promote their special interests. These provide preferential benefits for their members, much like a cartel. These benefits may take the form of higher wages, prices, reduced working hours and other forms of preferential treatment, often gained through their influence on the legislative process.

Insofar as these groups succeed in securing higher wages, prices and other benefits beyond those merited within a freely competitive situation, there is a misallocation of resources. They gain at the expense of the general public. Furthermore, the regulations, laws and other restrictions promoted by such groups to protect their privileged positions impede and slowdown economic activity. Both the special privileges and the complexity of the bureaucracy and regulations designed to protect these privileges adversely affect economic growth.

The theory predicts that there will be a period of rapid economic growth after major destabilising events which reduce or eliminate special interest groups. The rate of economic growth gradually diminishing as these groups gradually increase their presence and effectiveness.

Cyprus was not directly involved in World War II but the Turkish invasion of 1974 may be considered as an analogous destabilising event. The invasion destroyed much of the infrastructure of pre-invasion Cyprus, disrupting the economy and the social structure. A good portion of the island was occupied. Many thousands became refugees, losing not only their jobs but their homes. Did Cyprus experience the rapid economic growth and subsequent slowdown predicted by Olson?

National statistics show quite clearly that shortly after the Turkish invasion, Cyprus experienced its own economic miracle. After a brief downturn in 1975, in 1976 the Cypriot economy experienced an astonishing 18% GDP growth rate, followed by a 15% increase in 1977. In the five years between 1975 and 1980, GDP grew at an average of over 11% annually. The decade of 1980-1990 saw average annual growth of 6.5%. During the decades 1990-2000 and 20002010 the economy grew at an average annual rate of 5% and 3%, respectively (all in constant prices).

Olson also predicts that special interest groups will actively lobby governments to forward their special interests. Such activity is routinely observed in Cyprus. Political influence and the political life of the island revolve about such pressures and the influence of special interest groups. The government goes out of its way to protect the jobs, pensions, working hours etc., of public sector workers, organised labour and other groups with hardly a mention of the thousands of unorganised workers who have lost both jobs and pensions. Politicians outraged by the thought of small shop keepers working seven days a week show no concern for the general shopping public or the thousands of hotel workers for which this has been normal practice for years.