Impediments to trade across the Green Line in Cyprus

Cyprus is a divided island. Despite the lack of a comprehensive peace agreement reunifying the country, in 2004 trade commenced across the Green Line that separates the Greek and Turkish Cypriot communities. The volume of trade has grown steadily since, but has it reached its full potential? First, a gravity equation is estimated by using an ‘out-of-sample’ estimation strategy to predict potential trade for the period from 2004 to 2009. We observe a sizable gap between potential and actual volumes of trade. We then attempt to account for this gap by analyzing economic, legal, and social-psychological barriers that can explain this difference. It is found that (1) actual trade has only reached around 10% of its potential, with (2) legal constraints accounting for 35% of the missing trade, (3) extra transportation costs for about 5%, and (4) unmeasurable and social-psychological barriers for a significant amount of between 48% and 60%, depending on the year. The findings suggest that attention must be paid to the objective barriers to trade as well as the subjective interpersonal and intercommunal perceptions that can affect trade and ultimately, peaceful resolution of the conflict. These findings have implications for other conflicts in which divided communities with the potential for trading across a shared border seek to maximize the joint economic and political gains of emerging interdependence.