Saturday, May 16, 2009

Is self-discovery an issue in the Nepali economy?

This post should be viewed in relation with other blog posts on growth diagnostics of the Nepalese economy. It a part of a series of analysis on growth diagnostics of the Nepalese economy. For discussion of a set of constraints on economic activity in Nepal see this post. Also, see this column and this blog post.


Low appropriability arising from market failures such as information externalities/“self-discovery” could potentially be a factor constraining growth[1]. Markets in an economy might fail to discovery or shift to new productive activities despite strong price signals such as loss of price competitiveness in the international market or unfavorable terms of trade. A lack of self-discovery arises if countries fail to follow price signals and shift production of goods and services accordingly. For instance, a shock in international prices of primary export items of a country should serve as price signal to public and private sectors that it now needs to shift production to more favorable goods and services, which potentially could be exported with comparative advantage.

In the case of Nepal, the terms of trade is declining since 2000. This price signal has failed to induce entrepreneurs to shift to new productive activities. The list of top five primary export items[2] has hardly changed since the downward fall in TOT. Could this be a sign of a lack of self-discovery? This should be seen in the light of the availability of infrastructure in the country because shift to new productive activities might itself be hindered by the lack of basic infrastructure that would help reduce transportation and transaction costs. This means that self-discovery itself could be a function of the available basic infrastructures like road and transports, communication and electricity. This is what seems to be the case with Nepal’s inability to discover and shift to new productive activities.

Even if new comparatively advantageous goods and services are discovered, they might not make it to the market due to lack of basic infrastructure. This means that if a country already has a stock of high-value exportable goods and services relative to its income level[3], the case for lack of self-discovery might be weak. It is not that Nepal does not have high-value exportable goods and services. The irony is that despite having high-value goods, they hardly make it to the international market. For instance, yarsagumba[4], a high-value herb and medicinal plant found at high altitudes, is hardly exported to markets where its final price is high. Why is this the case? It is because of the lack of infrastructure, chiefly road transport. It is not surprising that most of the yarsagumbas harvested during its peak growing season are smuggled to the bordering Tibetan and Indian markets.

Similarly, hundreds of tones of surplus apple produced at high altitudes go wasted due to lack of infrastructure to transport them to the urban areas, where its demand and price are very high. The price of imported apples is lower than the price of the domestically produced apples that have to be transported from the mountain regions to the urban market. High transportation costs in the case of domestically produced apples accounts for its high price in the domestic market as opposed to lower price of imported apples.

Horticulture could be another promising sector for the economy, as is the case with cutflower market in Colombia. It can be argued that one of the main reasons why this sector is not making headway despite huge international market potential is due to lack of appropriate infrastructure, which limits transportation of final goods and distribution of fertilizers and machinery required for high yield. Moreover, an acute lack of cold storage facilities has led to stymied development of the dairy industry.

Tourism is another sector that has one of the highest potentials to increase growth rates. Nepal is famous for its mountains (eight of the ten highest peaks in the world are in Nepal) and its rich flora and fauna. The basic necessity for this industry is transport infrastructure. The country has 44 domestic airports, of which only two-thirds are operational, and one international airport. The poor quality of Nepal’s tourism infrastructure is reflected in the low rankings (118 out of 133 countries) in the Travel and Tourism Competitiveness Report 2009. The rankings in the quality of air transport infrastructure and ground transport infrastructure are 114 and 125 respectively.

This shows that there is a huge potential in the agro-processing and tourism sector. Since the economy already has the potential stock of high-valued exportable goods and services, lack of self-discovery cannot be a binding constraint on growth.

[1] See (Hausmann & Rodrik, Economic Development as self-discovery, 2003)

[2] (i) Carpets, (ii) Garments, (iii) Jute goods, (iv) Pulses, and (v) Raw jute and jute cuttings

[3] Hausmann and Rodrik call this export sophistication and use EXPY index to quantify the sophistication of a country’s export basket. It represents the income level associated with a country’s export package. A low EXPY value for a country means that it exports goods typical of countries poorer than itself. Constructing EXPY for all the countries for comparison with Nepal’s export sophistication is beyond the capacity of and resources at the author’s disposal. However, by using other available resources, I still argue that lack of self-discovery is not a binding constraint on growth of the Nepali economy.

[4] Note that there are some restrictions on its harvesting. But, systematically and lawfully trading in this good could earn Nepal substantial foreign exchange.