El rescate de Chipre (9)

Eurogroup Christine Lagarde (left) and Jeroen Dijsselbloem (right)

Troika shock therapy has killed our opportunistic economic model

By David Officer and Yiouli Taki – Cyprus Mail,  March 24, 2013

TO PUT it simply, the troika has potentially vaporised the Cypriot-based financial services sector and undermined its status as a tax haven, a deliberate act which aimed to police the wilder shores of capital flow in and out of Europe. But it was also aimed at shoring up the tax base of EU member states as they came under pressure from their own citizens to maintain comprehensive welfare systems as well as place a cap on future tax rises.

It must have looked so simple to follow this strategy last weekend with a Cypriot president who wanted to clearly distinguish himself from the previous incumbent and to resolve the economic emergency he inherited. Anastasiades tried to balance a response to the troika’s blunt demands whilst trying to preserve something of the conditions within which foreign capital has been attracted to Cyprus. He tried to spread the burden of the tax on all account holders so as to ensure that the tax on large companies, corporations and wealthy individuals does not exceed 10 per cent and maintain the Republic as a tax haven.

In attempting this balancing act, he assumed that the other parties would buy into this logic as a necessary means of preserving this status. But political parties felt that Cyprus needed to render substantial foreign capital deposits as ‘untouchable’. Further, ordinary citizens rejected the proposition that their accounts would also be raided. The political elite was now caught in a cleft stick, trying to balance the demands of ordinary voters whilst preventing any hit on wealthy depositors and all within parameters set by the troika.

The financial services sector may now prove dead in the water and the tax haven status of Cyprus has been swiftly and comprehensively compromised. This is not only because corporation tax has risen but the world now knows if you want to hide money and avoid taxes Cyprus is the last place to do business with. If you have money to hide, you are not going to park it in Cyprus any more. Capital of this sort abhors economic and political instability and the noise which accompanies this. Its preference is for a regime, which functioned until last week, characterised by quiet consensus that this was an economic model to follow, guaranteed confidentiality and a state whose regulatory function is both loose and inefficient.

The interest of the Cypriot political elite has, in large part, been tied to the financial services sector since the early 1990s with lawyers, accountants and others massively over represented in public life and wielding inordinate power – this to the extent that it is possible to talk of ‘state capture’. And we have seen a situation arise where the broader interests of the Cypriot economy have become, to a significant degree, dependent upon this economic regime which some German politicians have characterised as an ‘unsustainable economic model’.

The troika have now administered a shock to that system but with no attempt to suggest how a different course of economic development could proceed from here. What they hadn’t calculated was how the political elite and the citizen would cohere together – despite their diverse interests – in an effort to resist this imposition and defend their collective economic well-being. Neither should it be thought that those interests are fictive – they are substantive and a large part of the reason why Cyprus has experienced a long period of uninterrupted growth in affluence. Whilst other industries and services were crowded out by the ever expanding banking and financial services sector, enough money trickled down to others in the Cypriot economy for any serious reflection on what the longer-term consequences of this way of doing business might be.

This opportunistic economic model benefited directly from the failed transition to capitalism by Russia since the early 1990s. Capital first started to flow in from the former USSR as an outcome of the mass privatisation of previous state assets, itself encouraged by the World Bank and the IMF amongst others, which in turn created a class of oligarchs who sought a safe haven for their newly acquired assets. Cyprus was the perfect location given its Double Taxation Treaty, established as early as 1982, to complement its low tax and secrecy regime. It is plain that so much Russian money ends up in Cyprus since a successful transition to capitalism has yet to be achieved in Russia. The rule of law is arbitrarily applied there and the right to private property cannot be guaranteed. Cyprus guaranteed property rights and, by removing capital which originated in Russia and nominally converting it into Cypriot-registered capital, you were in a safer position to reinvest in Russia, a phenomenon known as round-tripping. Oligarchs and others who wished to dodge a rapacious state and the political vagaries of the Russian ruling elite found this both a convenient and confidential route through which to do much of their business

But the irony here is that prominent people in the financial services sector in Cyprus are well aware of the dangers of doing business with Putin and his friends since they have an interest in gaining access to bank account details of Russians using Cyprus, which, if conceded, would undermine the secrecy regime Cyprus cultivated for so long.

Why do they want to do this? Those on the levers of power in Russia want to control corruption and tax evasion – not to challenge these phenomena as such but to use charges of this sort as political weapons against any potential rivals to their power. Since many business people in Eastern Europe are potentially money-laundering and tax evading why some people are targeted and others are not is frequently determined by political criteria. Friends and supporters proceed unhindered whilst opponents are disciplined and their economic resources confiscated.

In this sense, Cyprus has offered a low tax, secrecy regime which has tried to play a complicated game of balancing interests between rich individuals and corporations, the demands of powerful states both east and west, international organisations intent on regulating the wilder shores of capitalism. Cypriots hitched their interests to attracting passing capital, made considerable sums of money out of this strategy, exploited gaps in the international system as they profited from the pitiful state of many eastern European countries and the socio-economic mess they remain mired in.

But the train has hit the buffers. Prominent players within the political elite and the banking and financial services sectors (frequently one and the same person) must know that the game is up as they struggle to come to terms with what has happened.

The Cypriot economy is on the verge of spectacularly failing as an outcome of shock therapy administered by the troika – a cruel and unusual punishment visited upon ordinary Cypriot citizens who have never been informed of the perpetual risks which have accompanied the tax haven strategy of economic development vigorously promoted by the political elite since the 1980s. The evidence of ‘state capture’ by those servicing finance capital is demonstrated by how an avowedly left-wing party such as AKEL has never raised any substantive issues about Cyprus as a tax haven, parasitic on the flow of foreign finance capital which passes through. Indeed, as Cyprus has sank further into a crisis AKEL was one of the prominent defenders of this way of doing business. Political consensus emerged around this model because it appeared to deliver the goods and common resistance was forged in opposition to any attempt by international organisations – World Bank, IMF, FAFT, EU,.the list goes on – to impose an effective regulatory regime which would undermine this particular cash cow.

However, those international organisations cannot be simply absolved of responsibility. They are themselves driven by the specific interests of powerful member states. So, for example, some British political forces tend towards a defence of the tax havens model in order to preserve the status of the of the City of London as a business centre whilst sections of the German elite see their interests as very different. The outcome is an incomplete and sometimes contradictory regulatory regime imposed on international capital – incompleteness and a set of contradictions which Cyprus has been adept at exploiting.

Yet, macro-economic policy in the eurozone is largely driven by the German elite, they call the shots and there is now no-longer any creative ambiguity to exploit. The plan was carefully laid and the Cypriot response lacked any strategic forethought. First you leak a German secret service report (that no one has actually seen) in order to prepare the ground to vaporise the Cyprus tax haven model. A smart move, since no one can be ‘in favour’ of money laundering. The response of the Cypriot political elite was frankly inept with the former president of the Republic standing in the European Parliament insisting that there was ‘no dirty money in Cyprus’ and he was joined by former presidents as well as MPs from all the political parties repeating the same mantra. Deploying representatives from MOKAS and the Central Bank to deflect attention away from the actual practice of the regulatory regime to the formality of the legislative framework ultimately proved unconvincing.

The local economy has become steadily compromised and Cyprus cannot be sure it has any friends or allies. There should be limited expectation that other small European states will show any sympathy for the Cypriot predicament. There you will find perpetual complaints in the Czech Republic, Slovakia, and Finland amongst others about how Cyprus has undermined their own tax base and provided a safe haven for those seeking to hide their money. However you will also see some countries – Luxembourg, Switzerland and others – which do function as tax havens looking askance at Cyprus for having brought the tax avoidance system into disrepute. The fear must be abroad that the ultimatum issued by the troika signals an important disciplining measure aimed at tax havens in general.

David Officer teaches sociology at the University of Nicosia. Yiouli Taki is senior researcher at INDEX: Research and Dialogue