A custom made CGE Model for an isolated, politically non-recognized small island economy: Exogenous income shock to the North Cyprus Economy

The objective of this study is to construct a 2-goods “tradable and non-tradable”, 4-factors, 13-industries, single-country general equilibrium model with references to the case- specific features of North Cyprus and explore the impact of external income shock on the economy as a whole. The value added of this paper is that, it is the first comprehensive model describing the economic activities in North Cyprus. The model is constructed using a 3-level nested CES function in production, a 2-legged utility maximization structure in consumption, a constrained optimization function for investment demand, endogenously determined government sector, and a trade closure is determined by Armington and CET functions for import demand and export supply of goods and services. North Cyprus economy is a small island economy hence, it faces high international transportation costs; indirect taxes and duties are also relatively high. Hence imported goods used for manufacturing and consumption are costly. Significant trade barriers exist primarily due to unrecognized status of the Turkish Republic of North Cyprus as a sovereign state. Therefore the unstable political environment makes the North Cyprus economy highly vulnerable to external shocks. In this model, characteristics of the North Cyprus labor market are reflected to take into account the international mobility of both its skilled and unskilled labor forces. There exist large numbers of skilled Turkish Cypriot workers in the North that have no restriction towards moving to other countries in the EU. Also, part of the labor force of skilled workers move with little restriction between Turkey and North Cyprus. Thus, labor supply is controlled through a system of temporarily work permits. The only factor that is truly fixed in supply is the land. In the case of unskilled or lower skilled workers, there is a relatively free movement of such workers who are ethnically Turkish Cypriot to work in South Cyprus while such skills are available in large numbers. Those who work in the south spend their earnings in the north and thus, such non-factor income shock influences main macro-economic indicators. The study presents results of the external income shock with different scenarios. For example capital is led free internationally while reducing the labor supply by 33%. Then labor supply is increased by 5%, 10% and 15% from its benchmark equilibrium and the results are compared. External income shock first increased the final demand and factor prices. The work is still in progress for the rest of the mentioned shocks.