Testing the dependency theory on small island economies: The case of Cyprus

Abstract

This paper empirically tests the validity of dependency theory in the small island setting of Cyprus, to establish whether a periphery/patron relationship exists between each of the island's two economies and their respective mainland partners of Greece and Turkey. Using data for the 1978-2013 period, we first test for the necessary condition, i.e. whether there is a long-run cointegrating relationship in the economic development of the Republic of Cyprus (RC) and Greece, and the Turkish Republic of Northern Cyprus (TRNC) and Turkey. We then test for the sufficient condition, i.e. whether periphery-economy per capita income series to be weakly endogenous, while those of patron economies are weakly exogenous. Our results indicate strong dependency within the periphery/patron economy pairs of the RC/Greece and the TRNC/Turkey. Further, we show that economic growth in the periphery economies is largely driven by that of the patron economies. Using a Markovswitching vector autoregressive (MS-VAR) model of the short-run business cycle, we demonstrate that the RC/Greece and the TRNC/Turkey co-move in the short-run, and that business cycles with each pair are synchronized. The policy implications of these findings are then discussed.