Tuesday, February 24, 2015

Increasing public investment is critical to support aggregate demand and economic growth

Nobel laureate Michael Spence lays out the case for higher productivity-enhancing public investment when aggregate demand is weak, as negative demand shocks continue to emerge from: (i) excessive debt used into unproductive activities, or that they have not led to much productivity gains, leading to excess debt and falling asset prices; and (ii) demand suppressed by high unemployment in Europe along with the excessive regulation of non-tradable sector in Japan, both constraining economic activities.

Structural reforms are hard to implement in the short-term. Stabilization measures are usually the medicine for short-term demand deficiency.

The solution for now: jack up productivity-enhancing public investment.


That brings us to the third factor behind the global economy's anemic performance: underinvestment, particularly by the public sector. In the US, infrastructure investment remains suboptimal, and investment in the economy's knowledge and technology base is declining, partly because the pressure to remain ahead in these areas has waned since the Cold War ended. Europe, for its part, is constrained by excessive public debt and weak fiscal positions.

In the emerging world, India and Brazil are just two examples of economies where inadequate investment has kept growth below potential (though that may be changing in India). The notable exception is China, which has maintained high (and occasionally perhaps excessive) levels of public investment throughout the post-crisis period.

Properly targeted public investment can do much to boost economic performance, generating aggregate demand quickly, fueling productivity growth by improving human capital, encouraging technological innovation, and spurring private-sector investment by increasing returns. Though public investment cannot fix a large demand shortfall overnight, it can accelerate the recovery and establish more sustainable growth patterns.


And, monetary policy alone won’t be sufficient. Fiscal policy together with structural reforms are essential:


Though monetary stimulus is important to facilitate deleveraging, prevent financial-system dysfunction, and bolster investor confidence, it cannot place an economy on a sustainable growth path alone – a point that central bankers themselves have repeatedly emphasized. Structural reforms, together with increased investment, are also needed.

Given the extent to which insufficient demand is constraining growth, investment should come first. Faced with tight fiscal (and political) constraints, policymakers should abandon the flawed notion that investments with broad – and, to some extent, non-appropriable – public benefits must be financed entirely with public funds. Instead, they should establish intermediation channels for long-term financing.

At the same time, this approach means that policymakers must find ways to ensure that public investments provide returns for private investors. Fortunately, there are existing models, such as those applied to ports, roads, and rail systems, as well as the royalties system for intellectual property.


The way to do this would be: (i) G-20 nations increase public investment; and (ii) multilateral and regional development institutions mobilize private capital to fund public investment.


That is why the G-20 should work to encourage public investment within member countries, while international financial institutions, development banks, and national governments should seek to channel private capital toward public investment, with appropriate returns. With such an approach, the global economy's “new normal" could shift from its current mediocre trajectory to one of strong and sustainable growth.


A lesson for Nepal: Increase both the quantum and quality of capital spending first. It is just 3.3% of GDP right now. It need to be increased to at least 8% of GDP in the medium term and also GFCG has to be bumped up to around 30% of GDP. The other associated point is that such investment has to be productivity-enhancing.

Tuesday, February 3, 2015

Higher productivity growth holds the key to sustained economic and per capita income growth

A new study (PDF here) by the McKinsey Global Institute looks at the scenario where population growth slows down (as is happening right now in developed countries and some emerging economies) and working age population declines. The report finds that global growth will depend on how fast productivity rises in the scenario when number of employees peak and starts to decline. Higher growth in productivity will push an economy’s GDP potential in the long run as employment growth slows down.

Productivity has to grow by at least 3.3% annually (80% faster than its average rate over 1964-2014) to compensate for the slower employment growth. The study found that about three-quarters of the potential productivity growth will come from broader adoption of existing best practices (or catch-up improvements). The remaining one-quarter will come from technological, operational or business innovations that go beyond current best practices.

According the MGI, the ten key enablers of growth are as follows:

  1. Remove barriers to competition in service sectors
  2. Focus on public and regulated sector efficiency
  3. Invest in physical and digital infrastructure
  4. Foster R&D demand and investment
  5. Exploit date to identify transformational improvement opportunities
  6. Improve education and skill matching, and labor-market flexibility
  7. Open up economies to cross-border economic flows
  8. Boost labor-force participation among women, young people, and older people
  9. Harness the power of new actors through digital platforms and open data
  10. Craft regulatory environment, incentivizing productivity and innovation

Broadly, countries need to enable catch-up by creating transparency and competition; help to push the frontier by incentivizing innovation; mobilize labor to counter the waning of demographic tailwinds; and open up economies to cross-border economic flows, from trade in goods and services to flows of people.

In follow-up commentaries, Ricardo Hausmann argues that there has to an adequate supply of productivity-enhancing public goods (when markets don’t supply such goods), and its effectiveness may be rated by an independent ration agency. Justin Lin argues that China should be able to benefit from “latecomer advantage” by achieving technological advances through innovation, importation, integration and licensing (a lower-cost and lower-risk path to productivity improvement).

Saturday, January 31, 2015

Base year revision: Indian economy grew by 6.9% in FY2014 (2011-12 constant prices)

India recently revised its base year to better reflect structural changes in the economy since 2004-05, which was the earlier base year. Now, the new base year is 2011-12. Accordingly, FY2014 GDP growth has been revised upward to 6.9% against 4.7% estimate based on 2004-05 base year.

Here is an infographic sourced from Hindustan Times that illustrates the major changes:

Full details about the new series estimates of national income, consumption expenditure, savings and capital formation here.

While doing base year revision, three important changes are made: (i) shift in reference year to measure GDP growth, (ii) conceptual changes, and (iii) statistical changes (revision of methodology, adoption of latest classification systems and inclusion of new and recent data sources). Systems of National Accounts, 2008 has been followed. In current prices, there hasn’t been much change in GDP estimate, meaning that the standard GDP ratios (fiscal deficit, public debt, investment, etc.) are unlikely to change drastically.

The table summarizes the latest estimates based on the base year revision.

Monday, January 26, 2015

Why is global poverty so intractable?

World Bank Chief Economist Kaushik Basu explains:


[…] it remains largely out of sight for those who are not living it, safely somebody else’s problem. The fact that most participants in discussions about global poverty – the readers of this commentary included – know few, if any, people who live below the poverty line is an indication of the extent of the world’s economic segregation. If poverty were communicable, its incidence would be far lower by now.

[…]Another reason poverty endures is persistent – and, in many places, widening – inequality. The current level of global inequality is unconscionable. […]To be sure, there will always be a certain amount of inequality in the world; in fact, as with unemployment, a limited amount is desirable as a driver of competition and growth. But the deep and pervasive inequality that exists today can only be condemned. […] Extreme inequality is, ultimately, an assault on democracy.


On employment for all agenda for post-MDG framework (SDGs):


This is an impossible target. All economies of any reasonable size will have some unemployment. In fact, a limited amount of unemployment can help to promote development. To declare “employment” a right is to divest the word “right” of its meaning.


On macroeconomic impact of micro-interventions:


[…]a government policy in which subsidies, funded with newly printed money, are handed out to residents of 1,000 villages. This will not necessarily be a boon for the economy as a whole. Injecting money might improve the living standards in the villages receiving the funds, but doing so may well drive up the cost of food throughout the country, causing residents of non-subsidized villages to fall into poverty. The macroeconomic impact of micro-interventions is an important reason why poverty has persisted, despite well-meaning interventions to combat it.


Thursday, January 15, 2015

Very large electricity losses in Nepal (34% of total output)

Electricity losses in Nepal (transmission and distribution) are really large in Nepal (over 34% of total output in 2011). The chart below is extracted from the latest World Bank update on economic prospects.

Nepal faces a double whammy (low generation leading to large and growing gap between demand and supply, and large transmission and distribution losses further exacerbating the shortages) due to (i) low investment as well as low capacity to fully execute/utilize available budget productively, and (ii) shoddy construction and substandard appliances increasing inefficiency of the system, and low operations & maintenance budget and capacity. Fortunately, a large number of hydropower projects are ongoing and are expected to generate enough electricity to bring load-shedding to almost zero during wet season. The economy will likely continue to face electricity rationing during dry season in the absence of storage-type hydropower projects.

More on hydropower condition in Nepal here and on the potential demand for electricity in India here.

Below is a chart showing the top ten countries with the largest electricity losses. Nepal comes at number 4 in the world. Electricity losses are increasing (signals massive inefficiency)— 28% in 2005 and 34% in 2011.

Wednesday, January 14, 2015

Modi-nomics explained in one paragraph

The one paragraph from an article in The Economist that appropriately describes “Modi-nomics” and differentiates it from those of Thatcher and Regan:


A focus on basic infrastructure and public goods; a drive to make civil servants honest and accountable; a penchant for IT; a flair for marketing to business investors. The elements of Mr Modi’s brand of economics are not obviously those of Margaret Thatcher or Ronald Reagan, to whom he has been compared by some commentators. Thatcher wanted a small state. Reagan is held to have said that “the nine most terrifying words in the English language are: ‘I’m from the government and I’m here to help.’” Mr Modi, by contrast, believes government can be made to work better.