Two economies, one island

A comment often quoted by the late Stephen Hawking, Lucasian professor of Mathematics at the University of Cambridge, captures a risk that extends well beyond physics and into public policy: “The greatest enemy of knowledge is not ignorance, it is the illusion of knowledge.” This observation resonates because it speaks to moments when figures appear authoritative, yet obscure deeper realities.

Cyprus’ recent economic headlines are such a moment.

The island has been widely praised for recording the lowest inflation rate in the eurozone – just 0.1 per cent. The figure is accurate but incomplete. To truly understand what is happening, one must confront a basic fact that is often left unstated: Cyprus does not function as a single economy, but as two increasingly divergent economic systems sharing the same geography.

Two economies, two price systems

In the Republic of Cyprus (RoC), prices are linked to the euro, influenced by EU monetary stability, fiscal and VAT policies and access to European markets. In the north, prices are tied to the Turkish lira, a currency that has been in prolonged depreciation, with significant downstream effects. Inflation in the north has remained around 39 per cent, meaning the cost of everyday necessities – food, electricity, transport, education – has been rising at a pace that steadily erodes household purchasing power.

These are fundamentally different inflation realities. The island is living with two price regimes, not one. Supporters of the current narrative may point out that both economies are growing. The RoC growth continues at around 3-3.5 per cent, supported by tourism, professional and financial services, shipping and technology. The north has also recorded strong growth, with international institutions reporting growth of over 6 per cent, moderating to around 4 per cent.

But growth does not automatically translate into economic well-being. In the north, growth often reflects construction activity, public-sector wage adjustments, or consumption responding to inflation itself. When prices rise faster than incomes, growth feels hollow.

Inflation is an index of how fast prices rise on average, not whether life feels affordable.

A low inflation rate can exist alongside high rents, costly service, and widespread household stress – especially when income distribution is uneven. This is exactly what happens in the RoC. Figures reported by the Cyprus Mail show that in 2024, the average (mean) gross monthly salary was €2,483, while the median salary – the income earned by the largest number – was only €1,881. When a typical household has limited purchasing power, businesses that serve the market face resistance to raising prices, even as unemployment drops, according to reports. This helps explain how the RoC can have tightening labour markets while still experiencing very low inflation. In this situation, low inflation indicates constraints on pricing power, not widespread comfort.

As a small, import-dependent economy, the RoC benefits directly when global energy prices soften or when imported goods become cheaper. Temporary policy measures, such as reductions in VAT on household energy bills, further lower the prices consumers pay – precisely what EU inflation statistics record. Today’s low inflation reflects favourable external conditions and policy cushioning, rather than the absence of domestic cost pressures.

The contrast with the north is reinforced by a fact often mentioned but rarely explained: the informal economy.

An informal economy refers to work that takes place outside full social protections: jobs without written contracts, wages paid in cash, employers avoiding social insurance contributions and workers lacking pension rights, sick leave or effective legal recourse. In such systems, wage increases further struggle to keep pace with inflation. When the currency weakens, as it has, imports immediately become more expensive. Food, fuel, electricity, and medicine rise in price regardless of whether households can afford them. Inflation becomes a daily lived reality. Growth continues, but purchasing power steadily declines.

A narrowing path for BBF 2.0

The EU assesses Cyprus almost entirely through RoC indicators: Eurostat inflation, labour-market data, fiscal balances and housing initiatives. Strategically, this is increasingly elusive. The Cyprus problem is not economically static; it is moving in the wrong direction. Two monetary regimes, two inflation paths and two labour-market systems drifting further apart.

When Europe treats RoC macroeconomic stability as synonymous with island-wide stability, it unintentionally normalises divergence. Stability in the south is measured and welcomed; instability in the north is treated as external.

This is not a call for Europe to “take sides”. It is a call to recognise that economic divergence, left unattended, will further consolidate political destiny. If Europe continues to rely on selective metrics while ignoring the island’s widening internal economic gap, it risks mistaking short-term stability for long-term sustainability. A viable BBF 2.0 is not merely a constitutional design; it is also an economic engagement and convergence project.

Without engagement, such convergence will not occur on its own, and Cyprus will likely drift apart toward deeper structural divergence. In that context, a two-state outcome arises not from ideology, but from accumulated economic neglect. Unless Europe – and Cypriot leadership – look beyond the illusion of knowledge that such pleasurable indicators can create, the economic foundations required for reunification will continue to erode, quietly, painfully, and in full view of those who choose not to see.