NICOSIA – Central bankers have stirred controversy in Cyprus by urging the island to overhaul a complex wage indexation system blamed for fanning inflation. With only a month before the island joins the eurozone, European Central Bank Vice President Lucas Papademos and Cyprus’s central bank governor urged the island this week to ditch a system its defenders say has safeguarded labor peace and its detractors say causes a loss of competitiveness. «(It) should be overhauled and ultimately eliminated in order to reduce the risk of inflation inertia that eventually will have adverse effects on real income,» Papademos told a conference in Nicosia on Monday. First adopted for civil servants’ salaries in 1946, wage indexation is fiercely guarded by labor unions. «Wage indexation is misunderstood by all foreign and local businessmen and economists who do not understand the importance of this institution,» economist Costas Apostolides told Reuters. «World Bank and IMF reports have always insisted that wage indexation had to be abolished because it creates inflationary pressures even though with Cyprus using wage indexation all the time we never experienced in reality significant inflation rates,» he added. According to official figures, average inflation from 1995 to 2004 was 2.8 percent, while real salaries increased by 2.9 percent on average. Thanks to the wage indexation, however, nominal salaries increased by 5.8 percent. Wage indexation is prescribed by law in the public sector but is not applied in all economic sectors in the island. Analysts say this contributes to distortions in the labor market and to an inflated public sector wage bill. From 1980 to 2005 average nominal rates of pay increased by 600.9 percent. The average pay for government employees increased by 685.5 percent, well above all other economic sectors, with the exception of the finance, insurance and real estate sectors. As a result, while the average salary in the economy stood at 1,062 Cyprus pounds a month in 2005 ($2,738.5), almost the average salary of a male bookkeeper in the island’s hotel industry, a comparable job in the public sector would yield 1,592 pounds a month. This is explained, according to academic economist Marios Mavrides, also by the lack of productivity incentives to Cypriot workers. «Workers in Cyprus do not get their pay rises according to their productivity. Our economy is dominated by small enterprises, which lack modern systems linking salary rises to performance. «Wage indexation contributes to the stagnation of real incomes. The problem is not the wage indexation itself but the absence of incentives to increase productivity,» Mavrides said.