This 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.
The fact that manufacturing sector is losing competitiveness both in the domestic and international market at a time when there is an increase in urban population and improvement in educational attainment suggest that the current labor market rules and regulations are playing a role in constraining economic activity in the economy. In fact, one of the standard indicators for measuring business regulation and labor activity, Doing Business Indicators, shows that the quality of business regulations is bad and the country is mired with red tape and labor restrictions.
If the current trend of political interference continues, then labor and business regulations will be the most binding constraint in the coming years. Politically indoctrinated labor unions and youth wings are at loggerheads with the industrial sector right now. They have been demanding higher minimum wages, which was revised in 2009. The tension between the youth wings and labor unions and industries has led to closure of many firms. Worse, this has forced multinational companies to close down factories and has aided capital flight from the country. Colgate Palmolive, a multinational company, was forced to shut down operation due to labor disputes. Meanwhile, due to labor disputes and energy shortage, industrial productivity has declined by over 50%.
In WB’s Doing Business ranking, Nepal has slipped in ranking by 10 positions from 111 to 121 between 2008 and 2009 (see Figure 1). This means that the cost of doing business in Nepal is rising, particularly due to complex labor disputes. Note that this has been a recent phenomenon, especially after various youth wings and unions started forcefully closing down factories demanding higher minimum wages and better working conditions. As stated earlier, this could potentially be the strongest constraint in the future but it still is not strong enough to qualify as the binding constraints as bad infrastructure and corruption did in our earlier analysis.
Source: Doing Business Report 2008 and 2009
Nepal has one of the most cumbersome hiring and firing practices in the world. The difficulty of hiring index and firing index are the highest in the region. Firing provision is very rigid and employers are required to hire temporary workers as permanent after 245 days of work. This has fostered disincentives among investors. Hiring regulations have slightly improved in the last four years but it is still considered unfriendly to business. There has been no attempt to ease firing regulations. Nepal’s firing index is the highest in South Asia (see Figure 3).
Source: Doing Business Reports
Starting a business is also not that easy in Nepal. There has been hardly any improvement in this front in the past four years. It still takes 7 procedures and 31 days to start a business. These figures have not changed since 2004. The cost of starting a business remains pretty high but the good news is that it is decreasing in recent years.
Source: Doing Business Reports
Labor and business regulations (inflexibility of the labor market and industrial relations) do not necessarily threaten the economy as the most binding constraints because most of them are being relaxed since 2004. The existing labor dispute is a recent phenomena and it is expected to subside in the coming months because the government has already revised the minimum wage, the main cause of conflict between the unions and the private sector. Change in the labor regulations has not have a substantial effect on industrial productivity and GDP growth rate. Hence, labor and business regulations do not qualify to become the binding constraint on growth.
 The seven procedures are: (1) Verify the uniqueness of the proposed company name, (2) A professional verifies and certifies the memorandum and articles of association, (3) Buy a stamp to be attached to registration form, (4) File documents with the Company Registrar’s Office, Department of Industry, (5) Make a company seal/rubber stamp, (6) Register with the Inland Revenue Office, the Ministry of Finance, and (7) Enroll the employees in the Provident Fund.