2008 Nobel Prize in Economics and Nepali Economy

New Op-Ed in today’s The Kathmandu Post: Roads to progress: Nobel thoughts about the Nepali economy

I like to apply economics theories I learn in my classroom and from textbooks to the real world. I sometimes struggle to understand some awesome theories if I am not able to relate them with real world issues! O.K. I have been reading Krugman’s work since I first used his Microeconomics book in Econ 101 class during first semester of freshmen year. Since International Economics course has not been offered for some time now, I am following Krugman’s work freely (without order) and whenever I get time (there is always increasing returns while reading his work!). And, since his model on trade theory is relatively realistic than others (I mean the classics), I was wondering the application of his theory on the Nepali economy. I was also interested on policy implication of the theories.

I was thinking about writing an Op-Ed on the application aspect of his theory but kept on postponing the idea! Now, what an appropriate time to write about it. Paul Krugman was awarded the 2008 Nobel Prize in Economics on Monday for his work on the “analysis of trade patterns and location of economic activity.” And, I snatched this occasion (while enjoying no classes/free time during Fall pause!) to write an Op-Ed. Ya, finally! Note that I am just looking at his work that are relevant to the Nepali economy (based on my presumptions about the economy). Other factors like availability of credit, local and regional political situation, raw materials and intermediate inputs availability in a given locality, etc also influence the conclusion/analysis I have outlined in this Op-Ed. Nevertheless, I think the argument derived from the theory does justice to policy interpretation and prescription.

Check out the full piece titled Roads to progress: Nobel thoughts about the Nepali economy

Krugman's work on transportation costs and the role of geography in development has a direct present day relevance to the state of the Nepali economy. If we look at the location of firms in the country, it is not hard to realize that most of them are located in the tarai and in cities near the Nepal-India border. Why do most of them opt to establish factories in the tarai and in major metropolitan areas like Kathmandu and Pokhara? Why don't they establish factories in hilly districts like Syangja, Bajura, Rukum, Kabhre, Bhojpur and Gorkha, among others? It is because of high transportation costs and dim prospects for increasing returns to scale!

Profit-seeking economic agents and private firms always opt to invest and operate in areas where the cost of transportation is low and there is a chance to exploit economies of scale. Hence, we are seeing increasingly divergent episodes in terms of regional growth and development. Metropolises like Biratnagar, Birgunj, Pokhara and Kathmandu are the urbanised “core”, and places like Syangja, Rolpa, Rukum and Bhojpur are the less developed “periphery”.

The “cores” have better forward and backward linkages and a fairly higher concentration of purchasing power. Also, intermediate inputs are available with less hassle and at lower cost. Moreover, these areas are also transport hubs as major highways joining outlying districts with the capital and other major cities pass through them, leading to a lower per-unit cost of transportation. It becomes a self-reinforcing process, and the few cores always leap forward in terms of development while leaving the peripheries languishing in traditional activity with low wages. This might explain why the big cities mentioned above have more industries and firms than other areas in the country.

And some policy stuff:

What can the government do to encourage relocation of industries? The answer is build, build and build roads and other means of transportation! Only 43 percent of the population has access to roads, and six districts are still unreachable by surface transport. Most of the districts are connected by unpaved roads, and those that have paved roads are pockmarked by potholes -- a recipe for higher transportation costs. Given this situation, it is no wonder that investors are establishing new firms in the same cores that have already been swamped by firms and people. Constructing roads and other appropriate means of transportation to lower shipping costs will probably lead to the spread of industries to other parts of the country.

One way the government can expedite the process of achieving lower transportation costs, increasing returns to scale and spreading industries from the core to the periphery is by offering subsidies in the form of tax credits and sharing of risks. The government can involve the private sector in road construction by offering direct subsidies on machinery and equipment and by sharing financial and social risks. This will probably encourage the private sector to not only invest in infrastructure construction in different parts of the country, but also to establish factories in villages that will be connected with roads and other means of transportation. This might also lead to a relatively equitable spread of industries.

Meanwhile, for export-oriented industries, the government can fast-forward the process of establishing Special Economic Zones where transportation costs are significantly lower by providing tax incentives and readily available forward and backward linkages.

A pdf version of the page:

Keynesian Renaissance??

Steve Lohr writes intervention is bold, but has a basis in history.

The high-stakes program is intended to halt the worst financial crisis since the 1930s. If successful, it could long be studied by historians as a textbook case of the emergency role that government can play to rescue a teetering economy.

“The goal is to get the engine of capitalism going as productively as possible,” said Nancy Koehn, a historian at the Harvard Business School. “Ideology is a luxury good in times of crisis.”

David Brooks sees big government ahead.

we’re in for a Keynesian renaissance. The Fed has little room to stimulate the economy, so Democrats will use government outlays to boost consumption. Nouriel Roubini of New York University argues that the economy will need a $300 billion fiscal stimulus.

What we’re going to see, in short, is the Gingrich revolution in reverse and on steroids. There will be a big increase in spending and deficits. In normal times, moderates could have restrained the zeal on the left. In an economic crisis, not a chance. The over-reach is coming. The backlash is next.

Anthony Faiola paints a gloomy picture for the American Capitalism: The End of American Capitalism?

The worst financial crisis since the Great Depression is claiming another casualty: American-style capitalism.

Since the 1930s, U.S. banks were the flagships of American economic might, and emulation by other nations of the fiercely free-market financial system in the United States was expected and encouraged. But the market turmoil that is draining the nation's wealth and has upended Wall Street now threatens to put the banks at the heart of the U.S. financial system at least partly in the hands of the government.

"People around the world once admired us for our economy, and we told them if you wanted to be like us, here's what you have to do -- hand over power to the market," said Joseph Stiglitz, the Nobel Prize-winning economist at Columbia University. "The point now is that no one has respect for that kind of model anymore given this crisis. And of course it raises questions about our credibility. Everyone feels they are suffering now because of us."

To some degree, those calls are even being echoed by the International Monetary Fund, an institution charged with the promotion of free markets overseas and that preached that less government was good government during the economic crises in Asia and Latin America in the 1990s. Now, it is talking about the need for regulation and oversight. "Obviously the crisis comes from an important regulatory and supervisory failure in advanced countries . . . and a failure in market discipline mechanisms," Dominique Strauss-Kahn, the IMF's managing director, said yesterday before the fund's annual meeting in Washington.

Dionne disagrees with Faiola and argues that its the rebirth of American capitalism.

Acknowledging an important role for government in social and economic life is -- and always has been -- the American way. American capitalism has thrived in a mixed economy that accomodated a large role for the state. The exceptional period has been the last three decades, when truly radical doctrines took hold. It is actually radical to imagine that the economy will go forward smoothly if the government rips up the rules, deregulates willy-nilly, gets out of the way and stops investing in public goods (education among them) that the market tends to under-finance.

In our history, strong and active government has always helped make capitalism work. It goes back to Alexander Hamilton and Henry Clay’s “American System,” much admired by Abraham Lincoln. Clay thought it essential for the government to invest in “internal improvements,” including roads and canals, and he favored protective tariffs that would allow American industries to grow. Yes, for all the free trade talk today, American industrial might grew behind high and thick protectionist walls. You can argue about the merits of those policies, as Americans did at the time, but they are part of our history and they played an important role in our development as a manufacturing power.

What’s going away today, in other words, is not “American Capitalism” but a doctrine of pure laissez-faire capitalism that was deeply flawed and not in keeping with the traditionally American approach to markets. We are coming back to how we historically did business. And I am persuaded that we will be far better off with a less doctrinaire approach.

Kevin Gallagher predicts that the intellectual tide is turning against free trade:

Last Friday the New York Times quoted the World Bank as saying "There's no question the Washington consensus is dead," indeed it "died at the time of the $700bn bail-out." If the bail-out is death, then awarding Paul Krugman the Nobel prize for economics is the nail in the coffin.

In another classic book, Development, Geography, and Economic Theory, Krugman argued that the government should also play a role in connecting beneficiaries of strategic trade policy to the overall economy. Evoking the work of economists such as Albert O Hirschman and Paul Rosenstein Rodan, Krugman argued that developing countries often needed a "big push" of coordinated government investments to help strategic industries get off the ground and to link the growth of such industry to the economy as a whole.

We find that in general the world's trading system makes it much more difficult for nations to craft strategic trade and industrial policies for growth and development. Indeed, enshrined in virtually all trade agreements is the "national treatment" idea that says a nation may not treat its domestic industries any differently than foreign ones. That may make sense when rich nations compete against each other, but in a world where 57.6% of the population lives on less than $2.50 per day, one size can't fit all. This restriction is accentuated in provisions for foreign investment, intellectual property, and subsidies.

And, I like this pic:

And, finally Williamson takes on Rodrik to the real meaning of the Washington Consensus. Rodrik responds.