Cost of finance in Nepal

This is a part of a series of analysis on growth diagnostics of Nepali economy. For discussion of other constraints see these blog posts.

In the growth diagnostics methodology, high cost of finance is divided into two parts: (i) Bad international finance and (ii) Bad local finance (which includes low domestic savings and poor intermediation). Below I discuss all of them.

1.1. Bad international finance

Access to international finance sources seems not to be an important issue for the Nepali economy. It has been consistently drawing out loans and credits from major donor agencies (mainly the IMF and the WB’s IBRD loans and IDA credits) at a comfortable medium and long term interest rate.

The international reserve situation is also comfortable as compared to other LICs. Since 1970, total external debt (% of GNI) consistently increased up until 1993. It then decreased until 1997 and rose again, reaching a peak of 60% in 1999. However, this has declined after that and now it is below 40% of GNI. This level is pretty good as compared to other countries with similar income level. The encouraging news is that it is in a decreasing trend. Moreover, CPIA debt policy rating is 3.5, above the average rating for LIC (ranking goes from 1 low to 6 high).

The central government debt (% of GDP) was alarmingly high before 2002. Though this is still high, it is in a decreasing trend in recent years. The good thing is that external debt is decreasing, government debt is also decreasing, and CPIA rating is well above the average for LIC. These indicators are inconsistent with a hypothesis that bad external finance is a binding constraint on economic growth.

Bad local finance

1.2. Poor intermediation

In the domestic front, it appears that investment is not responsive to interest rate, i.e. investment is roughly insensitive to interest rate.

From 1998 to 2006, interest rate was decreasing but the response on investment was not as expected. As lending rates declined, gross fixed capital formation also declined, indicating the unresponsiveness of investment to changes in interest rates. This indicates that it was not the cost of finance (interest rate) that brought down investment, but rather the low level of expected returns. Even when lending rates were declining, businesses were not willing to take out loans because of appropriability concerns engendered microeconomic risks, particularly high corruption and cumbersome labor and business regulations. Importantly, it was also due to low returns caused by deficient supply of infrastructure. As for investment in the economy, it has been consistently increasing over the past decade.

 

Getting credit from the banking system is not difficult in Nepal when compared to high growth economies like Maldives and Bhutan. Though getting credit rank has increased by seven positions (i.e. it is becoming harder to get credit) between 2008 and 2009, it is not unique to Nepal’s case. In fact, getting credit became difficult more or less in the same proportion in all the countries in South Asia.

Source: Doing Business Reports

Meanwhile, the increasing inflow of remittances and less investment opportunities in the economy has led to accumulation of excessive liquidity in the banking sector, which has partly inflated the real estate sector recently. Additionally, the previously high Non Performing Loans (NPL) are decreasing these days, thanks to strict measures taken by the central bank and the government. The level of NPL (% of total loans) was 60% in 2002, 30% in 2003, and 15% in 2006. The domestic banking sector is also in a good shape after the government initiated banking reforms five years ago. The two largest national banks with huge NPLs were handed over to private management companies four years ago. Since then they have recovered substantial loan payments from willful defaulters and turned the otherwise negative balance sheets into positive one. The central bank has been proactive in regulating the banking sector. It has even taken over ailing commercial and development banks.

Bad finance due to poor intermediation is not an issue at least in the present context. It, therefore, cannot be a binding constraint on growth.

1.3. Low domestic savings

Looking at savings, though domestic savings is fluctuating and is not that different from the level in 1976, gross savings is increasing since the past decade. As discussed earlier, this is aided by huge inflow of remittances to the tune of over 16% of GDP in 2006 and 18% of GDP in 2007. Moreover, the interest rate on savings deposit is also very low, indicating that banks have comfortable reserves and liquidity. On the lending front, the lending rate has been record low in recent years, indicating the willingness of banks to lend money to the private sector.

These data and analysis are inconsistent with the hypothesis that bad finance caused by low domestic saving is the binding constraint on growth, at least for now.

This shows that high cost of finance (bad international finance and bad local finance) is not the binding constraint on growth. However, this does not mean that it is not an issue of concern in the economy. What it means is that this issue is not as strong and important in terms of kick starting GDP growth rate as is the binding constraint—bad infrastructure.

What really is poverty reduction?

Owen Barder argues that poverty reduction should not be understood just as a wholesale concept of decreasing poverty through economic growth. He argues that donors should not focus on a narrow dimension of poverty reduction (growth) as it marginalizes other legitimate objectives such as chronic poverty or provision of social services in countries that cannot otherwise afford them. Chronic Poverty Research Center has been publishing chronic poverty reports that more or less is similar to Barder’s emphasis on objectives other than just growth in reducing poverty.

Poverty reduction has other dimensions, including enabling the poor to live better lives through long-term, redistributional transfers while their country is developing, even with programs that might not contribute to growth. The focus on poverty reduction through growth ignores such key tradeoffs as that between reducing current and future poverty, and between addressing the causes and symptoms of poverty.

Because donor agencies do not recognize these different objectives explicitly, there are important negative consequences for the choice and management of individual aid programmes, and for donors’ ability to make transparent and evidence-based decisions about the composition of their portfolio. Aid could be more effective if there were greater recognition of the different dimensions of poverty reduction and if this was recognized in the objectives for and incentives in aid agencies.

There is an ethical case for a global system of social justice that provides long-term, redistributional transfers of resources to the world’s poor, to enable them to lead better lives while their country is developing, even if there is no expectation that these transfers will accelerate economic development. Reasonable people can disagree about whether this is desirable but the existing hegemonic definition of poverty reduction does not sufficiently acknowledge this as a legitimate goal or permit a meaningful discourse about how it might be achieved.

Growth strategies for Nepal

That’s the title of my latest op-ed published in Republica, the print version of www.myrepublica.com. I am not satisfied with the content and analysis done by the policymakers for the Nepal Development Strategy Paper (NDSP). I discuss seven points that would potentially help Nepal attain a modest growth rate and would like them to be addressed in the final NDSP before it is presented to the donor community on May 15 this year.

First, given the geographical disadvantage, domestic policies should be synchronized with India’s and China’s economic policies in order to maximize neighborhood growth spillovers. Statistical evidence shows that the faster neighbors grow, the faster the landlocked country will grow. …

Second, rather than exclusively focusing on markets in the EU and the US, policies should be designed to maximize trading with our neighbors, India and China—the two emerging giants in the global economy. Tapping the untapped markets along the bordering states, where the transportation costs are low, by producing goods and services that are within the reach of the people residing there would be a fruitful exercise. …

Third, design policies to entice FDI in transport infrastructure and large- and small-scale hydropower projects. The government could substantially ease regulatory structure, ensure security of returns to investment and consistency of hydropower policy, resolve labor disputes, build grids to enhance connectivity and share risks with the private sector, among others. …

Fourth, to give the struggling industrial sector a breathing space so that they can compete in price and quality in the international market, the government should implement the provisions outlined in Investment Board and SEZ ordinances, which were recently passed by the cabinet. …

Fifth, the government should facilitate foreign investment in the tourism sector. Increasing visibility in the international tourism market, easing of visa restrictions, ensuring security, and, most importantly, improving tourism infrastructure such as road transport, airways, and ICT would help a lot. …

Sixth, the government should also facilitate foreign employment and inflow of remittances.  Not much needs to be said about the role of remittances, which already account for almost 20 percent of GDP.

Seventh, the policymakers should not forget that the high population growth rate is also constraining increase in GDP per capita. Either jobs creation in the industrial sector should be rapid enough to outpace the rate at which youths are entering the job market or the government should initiate measures to lower population growth rate.

Read the full op-ed for full discussion on these seven points.

The impact of global recession on poverty

It is estimated that an additional 55 to 90 million people will be trapped in extreme poverty in 2009 due to the worldwide recession. The number of chronically hungry people is expected to climb to over 1 billion this year, reversing gains in fighting malnutrition and making the need to invest in agriculture especially urgent.

The number of people living on under $1.25/day in the developing world in 2005 was 1.375 billion, or 25% of the population. The MDG target is to halve the 1990 poverty rate (41.7 percent) to 20.9% by 2015. With extreme poverty projected to fall to15% by 2015, it still appears the target will be met, but this may change as the poverty reduction rate slows with declining growth. Sub-Saharan Africa will not meet MDG1.

That’s from the Global Monitoring Report 2009: A Development Emergency. The report says that MDG of halving extreme poverty by 2015 from its 1990 level is still reachable but “risks abound”.

Links of Interest (04/22/09)

Is the Washington Consensus dead?

Duflo on what works for AIDS prevention: abstinence or risk reduction

Property rights and economic development

Girl sold for $40 (for prostitution)

Tracking violence using texting and GoogleMaps

Microfinance and gender returns to investment

Interesting finding coming out of this paper, which shows greater returns among men than among women (in the microenterprise sector). This difference is not explained by differences in ability, risk aversion, and entrepreneurial attitudes. It potentially resulted from the way money was invested by men and women.

This paper analyzes data from a randomized experiment on mean returns to capital in Sri Lankan micro-enterprises. The findings show greater returns among men than among women; indeed, returns were not different from zero for women. The authors explore different explanations for the lower returns among female owners, and find no evidence that the gender gap is explained by differences in ability, risk aversion, or entrepreneurial attitudes. Differential access to unpaid family labor and social constraints limiting sales to local areas are not important. However, there is evidence that women invested grants differently from men. A smaller share of the smaller grants remained in the female-owned enterprises, and men were more likely to spend the grant on working capital and women on equipment. The gender gap is largest when male-dominated sectors are compared with female-dominated sectors, although female returns are lower than male returns even for females working in the same industries as men. The authors examine the heterogeneity of returns to determine whether any group of businesses owned by women benefit from easing capital constraints. The results suggest there is a large group of high-return male owners and a smaller group of poor, high-ability, female owners who might benefit from more access to capital.

Crazy Nepali policymakers

How on earth is Nepal supposed to increase exports by 50% in five years? Never mind, this is another criticism of the Maoist government’s hi-fi but shallow strategy!

Few days after presenting a very unrealistic and bombastic development strategy paper, the policymakers in Nepal think they can link trade and poverty (the benefits of trade have gone to corrupt officials and few industrialists in the past) and increase exports by 50% in the next five years!

The government has set an ambitious target of increasing exports of goods and services by 50 percent in the next five years, at an average of 10 percentage points per annum. It has also set a plan of reducing country’s trade deficit by 15 percent in the same period.

“In order to boost exports, we are now trying to identify at least 15-20 potential products and services that have demand in the international market,” Commerce Secretary Purushottam Ojha told the consultation meeting of Nepal Development Forum in Kathmandu on Friday. “In this regard, the government is soon conducting Nepal Export Potential Study.”

The Study is not only expected to identify products and services of competitive and comparative advantage but also determine the impact export of those products and services can have on poverty reduction – the overarching goal of the country.

I doubt this will happen because of this analysis of Nepal’s product space and this condition of export dynamics. Aiming high is good but realistically, living within one’s reach and means is the best way to not build unnecessary expectations that cannot be met.

Crazy policymakers! Anyway, good luck to those who are tasked to come up with a paper to fulfill this purpose. The funny thing is that this claim has been made without first studying the potential of attaining this goal! It is like stating that a hypothesis is correct, and then proceeding to prove it assuming that it is right!!

Stiglitz on global stimulus

Stiglitz argues for a global stimulus package with grants made available to the poor countries, else as much as 200 million people will go down the poverty line, plus rethinking on having a new global reserve system.

if we are to avoid winding up in another debt crisis, some, perhaps much, of the money will have to be given in grants. And, in the past, assistance has been accompanied by extensive "conditions," some of which enforced contractionary monetary and fiscal policies – just the opposite of what is needed now – and imposed financial deregulation, which was among the root causes of the crisis.

One of the more important medium-term initiatives urged by the UN commission is the creation of a global economic coordinating council, which would not only coordinate economic policy, but would also assess impending problems and institutional gaps. As the downturn deepens, several countries may, for example, face bankruptcy. But we still do not have an adequate framework for dealing with such problems.

And the US dollar reserve-currency system – the backbone of the current global financial system – is fraying. China has expressed concerns, and the head of its central bank has joined the UN commission in calling for a new global reserve system. The UN commission argues that addressing this old issue – raised more than 75 years ago by Keynes – is essential if we are to have a robust and stable recovery.

Nepal floats very unrealistic development strategy paper

I wonder when the policymakers in Nepal will realize that high investment will guarantee high economic growth only when there are complementary factors in place to ensure that the investment is properly utilized, i.e. creating an ‘equilibrium’ of demand for and supply of goods and services being produced.

I say this because the Maoists government has released National Development Strategy Paper (NDSP), which it will present as the main strategy paper in the upcoming Nepal Development Forum (NDF) scheduled to take place in May. The NDF is a forum for donors to review NDSP and determine if the donor community wants to invest in some of the projects outlined by the government of Nepal. What’s in NDSP? The main theme of the paper is INVESTMENT. The government will tell donors to pour in money, cough up some of its own, and make (unrealistic) promises that it will deliver growth! How many times have this kind of forums been successful in delivering the outcomes? Has anyone tracked the efficiency of donors- say, output and investment ratio in the sectors they are investing in? (The drama of donor community in Nepal, its activities, outcomes, and efficiency deserves an extended analysis in another blog post!).

The NDSP, which also forms the second part of the Three-Year Interim Plan, has set a target to achieve an average economic growth rate of 7.6 percent and lower the national poverty level to 21.5 percent over a period of the next three years starting from mid-July 2009. According to the strategy paper, the government plans to invest Rs 1151.6 billion (US$ 14.5772 billion) from domestic resources for formation of fixed assets (in 3 years time). Of this, private sector is expected to invest Rs 324 billion (US$ 4.10127 billion) while remaining Rs 827.7 billion (US$ 10.4772 billion) is anticipated to come from government´s sources. Note that planned total investment is double the size of GDP of Nepal. If this is not overly ambitious and unrealistic, then I need to relearn the difference between reality and dream! Also, I doubt if the private sector would invest US$ 4.1 billion at a time when the very existence of their survival is in question.

Among the sources of funding, the strategy paper aims to mobilize Rs 532.2 billion (US$ 6.69362 billion) worth of revenue, Rs 233.3 billion (US$ 2.93422 billion) of foreign aid and Rs 70.8 billion (US$ 0.890453 billion) worth of internal loans. I doubt on the calculation of these numbers. What are the assumptions and facilitation process?

What else? The strategy paper also aims to achieve agriculture growth of 5.2 percent and non-agricultural growth of 8.8 percent during the period. At a time when the whole industrial sector is going bust and there is a decline in agriculture production, I am surprised how the guys at the National Planning Commission (NPC) came up with these numbers. Again, this projection does not reflect reality. The Maoists government has a tendency to talk highly but deliver poorly. See this and this.

It is very unlikely if the government will be able to garner the proposed amount of investment. Additionally, we simply do not have the complimentary factors that are needed to realize the fruits of this investment. The biggest hurdles are poor institutional setting and bad infrastructure, corruption and appropriability concerns. Moreover, the industrial sector has never been this uncompetitive (blame labor disputes, increasing competition, power cuts, defunct supply chains, …). Mend these, and the fallout will be favorable!

The WB has rightly criticized NDSP as being ambitious. They also should say it is unrealistic and seek a complete revision of the objectives, revise long-term projects and include more short-term projects heavily focused on infrastructure, governance aspects, and, most importantly, make the government clearly identify how it is going to boost private sector confidence and not let its militant cadres disrupt their business activities.

Regarding the proposed investment, Goldmark, country director of Nepal’s largest lender, said that it would be challenging to mobilize the planned investment as long as investors do not feel considerable improvements in the environment for doing business. The strategy paper should pay due attention to checking erosion of business confidence and this can be done by improving the law and order situation, she said.

Apart from a long-term energy development program, Goldmark also urged the government to bring in short-term projects to develop hydropower and added that the NDSP needs to have different case scenarios to address future global and domestic economic conditions, which are difficult to predict.

She also said the NDSP is silent on public finance management and public procurements and stressed the need to focus on issues and to improve government accountability towards the people. “Promise less and improve deliveries,” she advised the government.

I will write more on this issues in the next op-ed. The bottom line: the whole paper should be revised and the goals should be made realistic. All the procedures and steps should be clearly identified so that tracking the progress of projects and investment flow is rational and accountable.

Washington Consensus and Latin America

The historic backlash against the Washington consensus is not without justification. According to a soon-to-be-released study by the Inter-American Development Bank, trade and investment liberalisation in Latin America has had only a small impact on economic growth and has accentuated inequality in the region. Indeed, only one country has had a faster growth rate since nations in the region began experimenting with Washington's prescriptions in the early 1980s. That country is Chile, which has strayed from the Washington consensus in significant ways.

A recent report by our Working Group on Development and Environment in the Americas found that investment liberalisation is partly to blame for the slow economic growth in the region. According to our statistical analyses, foreign investment in Latin America increased significantly over the past 20 years but wiped out many local firms and contributed to an overall decrease in total investment. Despite a tripling of foreign investment in the region since the 1970, total investment as a percent of GDP has declined from 24% in the 1970s to 19% today – far below the 25% recommended by the recent Spence Commission for sustained economic growth in developing countries. Rather than locating in Latin America and spurring new economic activity, foreign firms largely operate as enclaves with limited connections to the domestic economy.

That’s Gallagher and Wise in this opinion piece

Poverty, geography and armed conflict in Nepal

My latest opinion piece is based on a paper by Iyer and Do. They show that poverty determines the onset of conflict and geography determines the variation of conflict intensity within a country. According to their working paper, a 10 percentage point increase in poverty is associated with 25-27 additional conflict-related deaths and geographic condition such as elevation and the presence of mountains and forests explain a quarter of the cross-district variation in conflict intensity. I discuss some policy implications and tie it up with the Maoists’ ideology.

Most of the researches on poverty and conflict are based on cross country analysis. Iyer and Do, however, do a within country study by comparing data on conflict related deaths from different districts in Nepal. Their results corroborate the view that lower economic development is associated with more conflict. More on poverty and conflict here and here and here

The increase in the number of PLA recruits and its sympathizers might have little to do with political culture and bourgeois-proletariat drumbeat started by the Maoists. The truth is that conflict is significantly higher in places with greater poverty and lower levels of economic development. The study shows that at any given time, poor areas are significantly more likely to experience the onset of conflict, contingent on the fact that they did not experience the onset in previous period.

The Maoists recruited more militants from districts where the opportunity cost – the cost of next best alternative forgone – of recruiting new members was the lowest. People residing in districts that were socially and economically backward (irrespective of geographic landscape) were drawn into insurgency easily and earlier than residents from other districts because the opportunity costs of joining the armed rebellion was low for them and the economic and political gains for the Maoists was high.

The study also shows that ethnic and caste polarization, land inequality, linguistic diversity and political participation are not significantly associated with violence. This finding raises questions over the real motive of the Maoists’ push for land redistribution reforms. Is it just a populist move to entice more voters or are they genuinely considering scientific land reform that would help accelerate productive activities? Furthermore, in light of this research, it is hard to believe if the Maoists’ rhetoric on the existence of the tussle between bourgeois and proletarians and the need to dismantle the former holds any ground. The Maoists are yet to clearly identify how big of a problem the bourgeois productive structure, if any, pose to economic activity.

This has an important policy implication—policies aimed at increasing the opportunity cost of joining armed outfits should be of paramount importance in order to stop the onset of armed conflict. It can be done by investing in formal, informal and vocational education. This would potentially ensure that the returns to labor (wages) earned by engaging in formal economic activity is higher than the returns from joining armed outfits. Additionally, increasing employment opportunities and livelihood generation activities would also help to serve this purpose. This would potentially give rise to a tendency to deter – even by poorer communities –the emergence and spread of disruptive activities.

Akerlof and Shiller on animal spirits

The housing market touched on all aspects of the animal spirits identified by Keynes — confidence, fairness, corruption, storytelling, and money illusion. It's clear, in this market and many others, that those animal spirits help drive the economy and that, to steer it safely, economists and policy makers will have to study such behaviors further and take careful account of them in devising new incentives and reforms.

From The Chronical Review, Vol.55, Issues 32, ppB6

Where's the water source?

A kid in search of water for his mother who manually grinds stones in Ratnapur, Bara. Stone grinding is one of the main occupations for poor families, especially women. A long shortage of rainfall has created severe shortfall of water in this region. Source: www.myrepublica.com

Being a Searcher = Successful aid

Bill Easterly writes:

One approach to a successful aid project just is to immerse yourself in the local community, put local people in charge who are themselves highly motivated, be adaptive and flexible to respond to whatever the local people think about how they can help themselves, so that you customize the “standard project designs” to fit local circumstances. Most aid projects fail because there is nobody in the field making all these necessary adaptations and fixing unanticipated problems as they arise. The moral of the story is: be a Searcher and not a Planner.

He also writes that the secret to successful aid “is that there is no secret.” He does not believe in RCT methodology applied to aid effectiveness.

This kind of aid project is based on a lot of personal, face to face interaction, developing trust and a shared vision, so it is small scale, it has to let things proceed at their own pace, it can’t meet rigid pre-set output targets, it could never be judged by a rigorous “randomized controlled trial” methodology. In short, it involves the kind of tacit knowledge and individual adaptation that could never be converted into a routinized project implemented by the official aid bureaucracies. It breaks all the rules, and it works.

US capitalism and government involvement

The US was a developmental state with numerous cases of successful government investment to stimulate entrepreneurship , writes William Lazonick.

In all the advanced economies over the past century, first and foremost the United States where the ideology of ’free market’ entrepreneurialism is most virulent, successful entrepreneurship  has depended heavily upon government investment in the knowledge base, state sponsored protection of markets and intellectual property rights, as well as state subsidies to support business investment strategies.  Scholars of the developmental state have tended to see it as a Japanese, and by extension East Asian, phenomenon, while neglecting the role of the developmental state in the United States, the world’s largest and arguably the most entrepreneurial of the advanced economies. Yet, during the twentieth century, the US state has been far more developmental than the Japanese state. Scholarly works have been written on the evolution of particular US industries – for example, agriculture, airliners, aircraft engines, computers, the Internet, biotechnology- that support this proposition. Biopharmaceuticals provide a case in point.

As a precondition for absorptive capacity and hence indigenous innovation, a nation has to have already made the most strategic and most expensive investment of them all: investment in a public system of primary, secondary and tertiary education.

It is a mistake, therefore, to associate growth enhancing entrepreneurship with free market individualism. There is no shortage of entrepreneurial individualism in American-style capitalism, but its transformation into higher standards of living has depended critically on investments, protections and subsidies provided by the developmental state… The state must be regulatory, but it also must be developmental. At the same time, the instability and inequity that accompanies economic growth under American-style capitalism should lead policymakers in developing countries to seek to identify those varieties of capitalism in the advanced nations that can serve as superior models for generating stable and equitable economic growth.

Links of Interest (04/09/2009)

Causes of the financial crisis by Viral Acharya and Matthew Richardson

Vegetable self-dependency in Nepal

The G20’s uncertain roadmap

Social mobility and statistical immobility

Remittances and the Philippines’ economy

Africa open for business

5.5 million telephone subscribers in Nepal

That’s 45% increase from last year, yet the telephone penetration is exceedingly low when compared to other counterparts in the region (see the figure below). A news report says that the current telephone penetration rate is around 20.45%. Good news? Probably yes, but still there is a lot to be achieved. There is tremendous demand of telephone services, however supply has not been consistent with demand. The government still tightly controls this industry and has only allowed two private firms to enter the market.

Nepal’s telephone penetration rate also shot up to 20.45 percent from less than 1.5 percent seven years ago on the back of easy availability of mobile phone lines. The country now has a total of 4.7 million mobile phone users and they make up almost 85 percent of telephone users in the country.

It is not surprising that even with the entry of new players in the market, profits and subscribers for all the three telecom providers (including the state-owned NTC, which used to enjoy monopoly until few years back) have increased by multiple folds. There is nothing to lose by further liberalizing this sector. More subscribers, more penetration, more firms, more employment, more revenue, more connectivity, more (probably) productive economic activity…its all win-win-…-win situations.

India, which has been adding 8 million new customers to its telephone network every month for the last two years, has a tele-density of 33.28 percent. Maldives has already attained 100 percent telephone penetration. Pakistan, Bangladesh and Sri Lanka are also ahead of Nepal. And even a closed country like Bhutan attained a tele-density of 20.6 percent back in 2007.

The state of corruption in Nepal

This is a part of growth diagnostics exercise on the Nepali economy I did in the past three months. Low appropriability due to corruption is one of the strongest constraints holding back economic activity in the Nepali economy. Here are similar posts on diagnostics of the economy.

This analysis shows that corruption is the second strongest constraint on economic activity in Nepal. In almost all the standard ratings and analysis on corruption and regulatory regime so far, Nepal has not fared well when compared to countries with similar income level. Similarly, a survey of business personnel, conducted by the World Economic Forum (WEF), shows corruption as the third most problematic factor for doing business in Nepal.

Source: World Governance Indicators 1996-2007[1]

In the figure above, the data correspond to 95% confidence level. In 2003, Nepal was better than 50% of the countries on control of corruption. This slid down to 30% in 2007, meaning that control of corruption has become less effective and 70% of the countries considered in the report have better anticorruption measures in place than Nepal.

In CPIA transparency, accountability and corruption index in the public sector, Nepal had a score of 2.5 in 2006 and 3.0 in 2007 (1=low and 6=high). The figure below shows how Nepal compares with other low income countries in this rating. The Country Policy and Institutional Assessment (CPIA) rates countries against a set of 16 criteria grouped in four clusters: (a) economic management; (b) structural policies; (c) policies for social inclusion and equity; and (d) public sector management and institutions. The World Bank produces it.

Even though Nepal’s rating in transparency and corruption in public sector is not that different from other lagging low income countries, the median (and also mean) score of 3.0 is still not considered to be business-friendly.

The Corruption Perception Index 2008, published annually by Transparency International (TI), also shows corruption to be at a high level. Among the members of SAARC bloc, Nepal is ranked as the country with the fourth highest level of corruption. Overall, Nepal was ranked 124 out of 180 countries included in the report.

Source: CPI 2008 (1=highly corruption and 10=highly transparent)

In regulatory quality for controlling corruption, Nepal fares pretty bad. In fact, as shown by WGI, Nepal’s regulatory quality in 2007 was not that different from that in 1996. Still more than 70% of the countries have better regulatory quality than Nepal.

Source: World Governance Indicators 1996-2007

Moreover, in a survey conducted by the WEF for Global Competitiveness Report 2008-2009, business executives ranked corruption as the third most problematic factor for doing business in Nepal. The business sector is more worried about corruption than macroeconomic risks such as tax rates and regulations and human resources.

Source: Global Competitiveness Report 2008-2009

In addition, there is evidence that firms are taking alternative routes to avoid corruption and taxation at customs. It is estimated that 40% of trade with India occurs through informal channels.This shows that traders are bypassing the normal system- a feature of a binding constraint.

All these reports and rankings show that corruption is one of the strongest constraints on stimulating entrepreneurial activity in Nepal.

In an earlier post I argued that bad infrastructure is the most binding constraint on growth in Nepal (well, after that post I have refined my argument further with much better information and analysis. I will post the whole discussion on bad infrastructure later in a different blog post). However, corruption also seems to be equally binding.

It is easier for policymakers to zero in on policies to relax constraints if we can identify the most binding one so that relaxation of that constraint would lead to largest change in the objective function (i.e. growth rate).Taking note of this argument and WLOG, it is consistent to argue that bad infrastructure is the biggest constraint because improving on this constraint in the short term is much easier (and faster) than clamping down on corruption, which is already institutionalized in the economic and social system. This constraint (corruption) cannot be relaxed in the same time as is the case with infrastructure. Therefore, it cannot produce bigger change than relaxation of infrastructure does in the same period. Based on this argument, I argue that bad infrastructure is the most binding constraint on economic growth in Nepal. (However, this does not mean that we do not tackle corruption, which is equally strong constraint as is bad infrastructure. I am just trying to be a little bit more practical in terms of optimal use of resources in the short run. Moreover, the main purpose of this exercise is to identify the most binding constraint on economic activity in Nepal).

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[1] ^{The chart shows the percentile rank of Nepal on control of corruption, one of the governance indicators considered by Kaufmann and Kraay. Percentile rank indicates the percentage of countries worldwide that rate below the selected country. Higher values indicate better governance ratings. Percentile ranks have been adjusted to account for changes over time in the set of countries covered by the governance indicators. The dashed lines indicate the statistically-likely range of the governance indicator. For instance, a percentile rank of 75% with the dashed lines at 60% to 85% has the following interpretation: an estimated 75% of the countries rate worse and an estimated 25% of the countries rate better than the country of choice.}

Discussion about heterodox economics with Prof. Garnett

A majority of the stuff we learn in econ classes are the neoclassical stuff, which is fascinating and stimulating with rich insights on the markets and economy. However, as we start with (unrealistic) assumptions and build on the theory and prove them in a slick way by using equations and analysis, we are never told about its actual applicability in the real world. This is kind of frustrating but still learning the theory itself is stimulating! A relevant question is: how can realism be brought to the standard stuff we learn in econ so that it has some life? Can learning heterodox economics fulfill this purpose?

We were discussing these kind of issues with Professor Rob Garnett, an economics professor at Texas Christian University (TCU), who is visiting Dickinson College to share his knowledge on the important issue of heterodox economics and how it relates to academic freedom and philosophy of economics. We had an open, frank discussion with Prof. Garnett and Prof. McPhail about these issues yesterday evening. The whole discussion centered on how to bring realism in the study of economics and why there is a need to open up the enclosed box of economics, which is so far dominated with insights from just one school of thought--neoclassical economics, which is more stimulating theoretically but lacks practicability. He argued that there is a need to bring pluralistic views on the study of economics so that stuff we learn are real and that we are exposed to contending school of thoughts. This is kind of interesting to me because I am interested in policy-oriented research in economics, which has to be as close to reality as possible. And, all of the stuff I believe in are not explained by one particular school of thought.

We know that most of the stuff we learn in econ courses in school are not realistic and even then we force ourselves (or are forced) to learn them. Is there is way to break this up so that more realistic stuff is learnt along with the standard stuff? If we know that there is no perfect information, then why do we still learn complex models whose basic assumption is that there is perfect information? Same with the assumption of rationality. It is stimulating to learn the models despite shaky assumptions! However, what good would it do if it is not real? I have been struggling to find an answer to these questions. That being said, now I enjoy learning the models more than ever. It the end, I always ask: what’s its relevance to the world I live in? Sometimes, the very subject I love and care so much leaves me utterly disappointed for not being able to find an answer to a simple question!!

Here is Prof. Garnett’s paper on the future of heterodox economics. He combines Sen’s and McCloskey’s ideas and relates it with the need for heterodox economists to practice pluralism (after all, they all are going after the unrealistic assumptions of the mainstream economics!).

… paper proposes a philosophical framework for an egalitarian pluralist economics, combining Deirdre McCloskey’s vision of science as a pluralistic conversation (McCloskey 1998 and 2001) with Amartya Sen’s capability-centered view of human development (Sen 1999). From a Sen/McCloskey standpoint, the principal goal and tool of economic inquiry is intellectual freedom, defined in a dual Smithian sense: negative freedom from the tyranny of a prescribed Method for economic knowledge production, and positive freedom to live a choice worthy intellectual life.This freedom-centered, capabilities-minded view of academic discourse as a “civilized conversation among equals” (McCloskey 2001, 107) opens the door to a liberal rethinking of science in which the paradigmist and pluralist impulses of contemporary heterodoxy can be productively reformulated and rejoined. Such an approach is one that all economists, especially heterodox economists, can and should embrace.

I just had a good lunch and more discussion about these issues with Prof. Garnett. I will be having another dinner discussion with him in the evening.

G20 Summit, global recession, and Doha Round

So, the G20 Summit concluded today passing a communiqué that laid emphasis on fighting global recession ($1.1 trillion worth of arsenal at their disposal now), arming the IMF with more money and power, creating a strong regulatory framework, and resisting protectionism and promoting global trade and investment, among others. [Did you hear that British PM Brown said "the era of Washington Consensus is over."]

Here are new funding pledges:

• $500bn for the IMF to lend to struggling economies
• $250bn to boost world trade
• $250bn for a new IMF "overdraft facility" countries can draw on
• $100bn that international development banks can lend to poorest countries
• IMF will raise $6bn from selling gold reserves to increase lending for the poorest countries

Rodrik argues "the era of the World Bank and the IMF being run by Americans and Europeans, respectively, is over. And good riddance too." Here is a post by Green. Krugman is happy that the outcome was better what he expected. Meanwhile, Dadush feels that it fell short of agreeing on "measures needed to respond to the grave global situation." Here is Subramanian on the G20 Summit.

This caught my attention:

We remain committed to reaching an ambitious and balanced conclusion to the Doha Development Round, which is urgently needed. This could boost the global economy by at least $150 billion per annum. To achieve this we are committed to building on the progress already made, including with regard to modalities.

The estimation of benefits of Doha Round has been of a considerable debate among researchers. Generally, it is now agreed that the earlier estimations were inflated. Here is a research done by Sandra Polaski from Carnegie Endowment for International Peace (CEIP) about the winners and losers from the Doha Round under different scenarios. The general equilibrium model showed that total gains from trade to be between $32-55 billion, with rich nations getting $30 billion; middle income countries like China, Brazil and SA getting $20 billion; and poor countries getting $5 billion (about $2 per head). Here is my earlier post on this issue. Check this one as well.