Cyprus: immigration, wage indexation and the adjustment in EMU

This study reviews the labour market in Cyprus, with the focus on immigration and wage indexation, in the context of euro area participation and the need to safeguard competitiveness. Assessed vis-à-vis the usual macroeconomic and Lisbon benchmarks the Cypriot labour market performs better than the EU average. However, labour supply shortages, particularly in low-skill occupations, and the automatic inflation indexation of the wage-setting mechanism constitute important challenges that need to be addressed. Given the tight labour supply conditions, maintaining the supply of labour, through immigration flows and enhancing the domestic labour supply, would be paramount for ensuring wage moderation. Moreover, Cyprus' euro area participation and the need to safeguard competitiveness, as potential losses in competiveness in the new environment have a severe impact on the real economy, call for the wage indexation system to be revisited. Although there is no conclusive evidence that the cost-of-living-allowance (COLA) has contributed to a self-feeding inflationary spiral, this might have been due to past low inflationary conditions which have prevailed in Cyprus. However, wage indexation could exacerbate inflationary pressures. This may result in inappropriate real interest rates and wrong private expectations, thus hampering macroeconomic stability. Furthermore, allowing wages to reflect sector or company productivity gains would not only safeguard Cyprus competitiveness but also be conducive to a more efficient allocation of labour.