Public expenditure and productivity puzzle: The case of Northern Cyprus

Abstract

Since 1974, Northern Cyprus has experienced very low productivity and very slow economic growth, which has further been declining in recent years. In searching for the causes of this poor economic performance emphasis is placed on the lack of investment in infrastructure and education. The present study intends to investigate the hypothesis that “the poor economic performance of Northern Cyprus is due to low levels of investment in infrastructure and education”. In establishing the relationship between output and publicly provided inputs, we specify various Cobb-Douglas production functions by using aggregated and disaggregated time series data on public capital for the period of 1977-1998. Also, recently developed econometric techniques, such as cointegration and the error correction mechanism are used to test the validity of the data. Results indicate that both the long run and short run elasticities of GNP with respect to infrastructure and human capitals are very low and in most cases statistically insignificant. This implies that Northern Cyprus’s poor economic performance in the past is not due to low investments in infrastructure and education, and that further investments in these sectors would not perform a miracle for the economy.