Thursday, April 9, 2009

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).

[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.