Friday, July 31, 2009

Market players screwing up prices in the Nepalese market

At a time when price level in the Indian economy is in downslide, the opposite is going on in Nepal. This is pretty uncommon because the Nepalese market follows price trend of the Indian economy. Unfortunately, price level  in the Nepalese market is over 13 percent right now. Something fishy is going on in Nepalese food and commodity market. Who is to blame? Well, the speculators and retailers who are holding back inventories, thus creating an artificial rise in price level! The government is clamping down on these by directly intervening in the supply side of the market. Some times the market forces is detrimental if left to operate wildly and unchecked! So, the government has to tighten loose screws so that it operates as it should!

Studies by the government and other entities show that price rise is caused primarily by hoarding and black-marketeering (30%), stockists and wholesalers (20%), bandhs and strikes (10%) and the Indian market (40%).

District Administration Office raided 13 godowns of three businessmen on Saturday under Black Marketeering and Certain Other Social Offences Act, 1978. Meanwhile, the Department of Commerce got active in implementation of the price-list (wholesale and retail) in retail shops of Kathmandu.

According to Kailash Kumar Bajimaya, acting director general at DoC, “hoarding is storage of large quantity of food commodities and failure to send them back to the consumer market to make profit, creating artificial scarcity of the items.” Warehousing of the food commoditiesby agents, dealers and retailers exceeding one month without any transaction is punishable by existing law. Bajimaya said the raid conducted by the DAO was targetted at the black marketeers and DoC’s price-list campaign is to educate the consumers. He said market intervention would continue until the consumers got respite from the unethical trade practices.

The commodities market has around 25 players — at least 20 business organisations and traders, including KL Dugar, Pawan Bansal, Chandreshwor Prasad Kalwar, Pawan Kumar Agrawal and Murarka Group.

“We have asked their import/purchase papers, customs papers, VAT papers and general account,” said Surendra Prasad Paudel, administrative officer. According to Paudel, the businessmen have to show their papers and prove their innocence within a week.

Thursday, July 30, 2009

Social programs and inequality in Brazil

Brazil has made improvements in reducing inequality despite growing at a good rate in recent years. Inequality, measured by the Gini coefficient, fell from 0.59 in 2001 to 0.53 in 2007. How is it possible that inequality fell despite high economic growth? The authors of this one pager#89 from IPC argue that it is because of good social policies, mainly two possible causes:

  1. Improvements in education (universal admission to primary schooling and lower repetition rates). The authors estimate that the impact of improved access to education on primary income distribution was 0.2 Gini points per year from 1995 onwards.
  2. Direct cash transfers from the state to families and individuals. An often cited example is a conditional cash transfer program called Bosla Familia. The authors estimate that cash transfers contributed to reductions in inequality of another 0.2 Gini points per year.

These social programs have stimulated aggregate demand, especially through an increase in consumption.

The main point is that two-thirds of the decline in inequality is explained by relatively successful social policies. The remaining third is attributed to “a virtuous cycle of increased income, expansion in domestic market and rising demand for labor.”

Tuesday, July 28, 2009

Few details about the remittances market in Nepal

Recently World Bank researchers presented their analysis on the remittances market in Nepal. The presentations and a policy note are very informative. This blog post draws in information from their analysis.

Around two to five million Nepalese workers are working abroad. Officially recorded new migration increased dramatically during the last decade, from 36,000 in 1999/2000 to 229,000 in 2007/08. Unofficial estimates of stock of Nepali migrants range from 400,000 in Malaysia, 300,000 in Qatar, 60,000-70,000 in South Korea, and 2 to 5 million in India. 125,000-275,000 Nepali migrants are estimated to be working in United Arab Emirates (UAE), of which half are in construction, hospitality, tourism, and security. An estimated one-third of male population are working abroad.

It constituted 17 percent of GDP in 2008 ($2.3 billion). Remittances also have large multiplier effects on sectors such as construction, cement and furniture. Migration played a crucial role in reducing poverty between 1994 and 2004. The WB estimates it to contribute between one-fifth to one-half of the decline in poverty. Within South Asia, remittances as a share of GDP is highest in Nepal.

Remittances sent by Nepali migrants from India, which is the largest migration destination, are larger than the bilateral trade deficit with India and underpin the exchange rate peg with the Indian rupee. Remittances have helped finance the trade deficit and maintain a positive current account balance over the last decade.

The onset of the financial crisis in the second half of 2008 has led to a significant decline in construction, hospitality and other sectors in the Gulf countries in which a large number of South Asian migrants are employed. As a result, the growth of remittances to Nepal has decelerated significantly in recent months and remittances flows are expected to decline modestly in 2009.

The decline in remittances (WB researchers estimate remittances would decline by a two-and-a-half percent to four percent in 2008/09 in Nepal) due to global economic slowdown will depend on projected economic growth rates of destination countries, the kind of work Nepalese migrants do and demand for such work in destination economies, and how secure their jobs are through contracts. The growth rate in Gulf countries is expected to slowdown but the good news is that remittances flows out of GCC are not correlated with oil prices. As long as infrastructure investment continues, drawing in from their large reserves, demand for migrant, cheap labor is going to increase or at least not decline. It is reported that some Gulf countries are replacing Bangladeshi workers with Nepali workers for “various reasons”. Furthermore, new countries like Libya, Romania, and Poland have agreed to take in Nepali workers. This means that demand for Nepali labor in the international market is not going to decline drastically despite the global economic slowdown.

Nepal’s remittance market is competitive and the remittance infrastructure is well-developed, with money transfer operators and banks able to deliver remittances reliably even in remote areas. But there are market inefficiencies in destination countries that ought to be addressed by policy makers. Bilateral negotiations with the authorities in destination countries can improve access of migrants to remittance services. Within Nepal, there should be efforts to encourage banks and finance companies to link remittances to consumer loans, housing loans, and small business investments. Post offices in destination countries and Nepal can play an important role in providing cheap and convenient remittance services. Mobile phone companies can also provide fast, convenient and cheap remittance services within Nepal.

The destinations of migration will likely change over time. It has nearly saturated in East Asia.The destinations that will increase in importance are the Gulf and India since these countries will grow and will need new workers. The Gulf countries have abundant financial resources to continue the construction and tourism projects (hotels, resorts, and restaurants) and investments in infrastructure which have been temporarily suspended since the onset of the current crisis. For example, Abu Dhabi, one of the seven United Arab Emirates, is building Khalifa City, which will need 150,000 new workers from abroad. India has also been relatively less affected by the current crisis and will remain an important destination, especially for seasonal migration, and also a source of migrants. In the long-term, Poland and Romania and other new members of the EU and possibly Russia are also likely to need migrant workers from Nepal.

According to data reported by Nepal’s central bank in a recent survey, 20 private commercial banks, 3 state-owned banks, 12 micro-finance institutions, the postal service, 4 other financial institutions and 36 non-financial institutions (such as Western Union, Moneygram, Prabhu, International Money Exchange etc.) are authorized to receive and deliver remittances. These commercial and state-owned banks have together 574 branches in the country, while MFIs have over 320 branches, the post office has 75 district offices and the non-financial money transfer operators have over 2,500 branches.

Commercial banks, money transfer companies and the post office are allowed to receive inward remittances. Microfinance institutions cannot send or receive remittances, but are only allowed to distribute remittances, acting as sub-agents of the firms authorized to receive inward remittances. No mobile phone operator in Nepal is authorized to send or receive remittances.

Nepalese banks typically act as distributors of remittances for partner money transfer companies. Unlike the major banks in India, very few Nepali banks promote other financial products such as savings deposits, home loans, health and life insurance to remittance senders or recipients. This may reflect relatively low banking penetration, the prevailing high levels of inflation and the uncertain macroeconomic environment, which might make Nepali banks unwilling to extend credit to retail borrowers in general, including to non-resident Nepalese.

Bringing remittances into formal (banking) channels and mobilizing remittances for savings and investment remain key challenges for Nepal. There are only 1.8 branches per 100,000 people in Nepal in 2006, compared to 4.7 in India, while ATM access is 0.28 per 100,000 people. More than 70 percent of people do not access to commercial banks. More than two-third of recipients in rural areas received international remittances (including from India) through informal channels such as hand-carry or through friends and relatives, compared to 34 percent of recipients in urban areas.

Increasing remittances have been driving real wages in the country. Agricultural wages rose 25 percent in real terms and nonagricultural unskilled wages increased by 20 percent. Meanwhile, skilled wages tripled, out-migration reduced labor supply and aggregate demand increased. With increasing remittances, income has grown and so has inequality-- a potential research area because it is not clear yet if increase in consumption fuelled by consumption (not domestically earned income) has actually increased inequality. Some argue that due to higher aggregate demand of remittance-receiving households, remittances can be linked to inequality.

The consequences of reduced remittances in Nepal are:

  • Some people could fall back into poverty again. If the decline in remittances is between two to four percent, it would cost between $50-100 million to mange the additional people that fall below the poverty line.
  • Reduced foreign exchange flows, leading to decline in consumption and imports. A small impact on BOP situation.
  • Potential soft landing of real estate bubble as investment in real property would decline.
  • Banks that are taking excessive risks in real estate market and margin lending may be strained.
  • Departures would decline, putting tremendous pressure on the already stagnant domestic job market. It could fuel social tension. Note that approximately 500,000 people enter labor force each year at a time when the public and private sector are not hiring in the same rate.

What could the government do to mitigate the impact of declining remittances in the country?

  • Create business environment conducive to private investment (it is the most popular recommendation but hardly realized!)
  • Accelerate existing public investment and maintenance work that are labor intensive (question mark on effective implementation-- if it were possible, then with those millions of aid dollars, something substantial would have already been achieved in this sector!)
  • Increase labor-intensive public and maintenance work (this sector has never been capital-intensive-- otherwise the state of Nepal’s infrastructure would not have been so dismal!)
  • Start fiscally sustainable, high priority public work programs for the vulnerable (big problem in identification and demand for such work in places where vulnerable people live!)
  • The banking sector might feel a pinch, leaving the central bank to encourage consolidation of an over-crowded sector (good if competitiveness and efficiency of the banking sector is further improved!)

Wednesday, July 22, 2009

World Trade Report 2009: Finding a balance between contingency measures and commitments

The WTO has released ‘World Trade Report 2009: World Trade Policy Commitments and Contingency Measures’  warning nations not to fall for protectionist measures despite the current global crisis. The report estimates that trade growth will be strongly negative this year-- world merchandise trade is expected to decline by 10 percent in 2009. It warns that resorting to protectionist measures to aid domestic producers may prolong and deepen the crisis.

The report argues for “trade contingency measures” that would give some policy maneuver for countries to deal with domestic pressure to prop up domestic markets affected by the crisis. This highlights the need for policy space in trade deals because of the possibility of unanticipated market conditions that are not under the purview of existing trade models and agreements. With this the WTO is arguing for some form of policy space for developing countries that would help them respond to pressing needs of their population, even if the responses are not fully in line with ‘free trade’ principles. Failure to do so in the earlier Doha Round of negotiations (remember special safeguards measures demanded by the developing countries) is holding back its passage. The report reflects a mix of ideas long argued by Rodrik, Krugman, Dixit, game theory stuff--in general, doubting the existence of a completely free international trade market and that “second-best” policies might increase overall welfare in certain conditions--, and market principles.

The delicate debate in the Doha Round of negotiations over the design of anti-dumping provisions or over the special safeguards measure on agriculture is an effort to align views on the question of balance…

The analysis of economic effects of the use of contingent measures reviewed in the World Trade Report suggests two main conclusions. First, the design of such measures should aim at limiting the circumstances when they can be used as a protectionist device. Second, the design of contingency measures should not undermine the role of trade agreements. Contingency measures should not be designed in a way that upsets the balance of a trade agreement nor which undermines governments’ objective of making a binding commitment to the private sector.

[…]the Report focuses primarily on safeguards, such as tariffs and quotas, which may be introduced to counter increased imports deemed injurious to domestic industry, anti-dumping duties which can be imposed to respond to alleged injury caused by “dumped” imports, and countervailing duties which can be used to offset foreign subsidies considered injurious to the domestic industry. The Report also discusses alternative policy options, including the renegotiation of tariff commitments, the use of export taxes, and the increases in tariffs up to their legal maximum ceiling or binding.

The contingency measures discussed in the report include safeguards measures, anti-dumping and countervailing measures, the re-negotiation of tariff commitments, the raising of tariffs up to their legal maximum levels, and the use of export taxes. These are needed because too little flexibility in trade agreements may render trade rules unsustainable. At the same time, too much flexibility may weaken the value of commitments and trade rules. An appropriate balance between flexibility and commitment is required for the success of trade agreements.

Contingency measures may be thought of as a safety valve mechanism, a form of insurance, or an instrument of economic adjustment. They may simply be there to strengthen the rule of law. They may entice governments to open their markets further than they would in the absence of these mechanisms, creating a greater quantum of openness than would otherwise be forthcoming. Or they may simply reflect the reality that we lack perfect foresight and therefore cannot write complete contracts for regulating future behaviour under any conceivable set of circumstances.

Some of the key points:

  • Trade agreements define rules for the conduct of trade policy. These rules must strike a balance between commitments and flexibility. Too much flexibility may undermine the value of commitments, but too little flexibility may render the rules unsustainable.
  • Governments have good reasons for signing trade agreements, but effective agreements must strike an appropriate balance between flexibility and commitments.
  • Two largely complementary arguments are put forward to rationalize flexibilities in trade agreements: the “benefit” approach and the “incomplete contract” approach.
  • Abstracting from terms-of-trade considerations, the economic case for employing measures of contingent protection rests on the emergence of market failures, such as negative external effects (externalities) or imperfect competition. Alternatively, political economy arguments may explain a willingness to contemplate an agreement that allows for the suspension of commitments.
  • When markets are not functioning well, measures of protection can be justified in terms of a “second-best” argument.
  • A categorization of the circumstances that might justify government intervention can be made on the basis of the type of external event (shock) and its sectoral/country coverage.
  • Safeguards in the WTO enhance the willingness of governments to undertake commitments, but the temporary nature of such measures is crucial to the attainment of their objectives.
  • In economics only “predatory” dumping results unambiguously in welfare-reducing effects for the importing countries.
  • Economists have also raised some questions about provisions dealing with material injury and suggested the use of economic concepts and models in the causality and non-attribution analyses.
  • Duties imposed to countervail subsidies will generally not raise aggregate welfare in the country that imposes them. Two exceptions are circumstances when a terms-of-trade argument can be made and when markets fail. Political economy considerations help to explain why governments might use countervailing duties.
  • Countervailing duties can serve two main purposes in trade agreements. First, they may be used by governments to neutralize negative external effects (externalities) arising from subsidies. Second, the prospect that countervailing duties might be used could deter the use of subsidies in the first place.
  • A lack of binding commitments on export taxes on the part of most members reflects the incompleteness of the WTO Agreements and provides members with a largely uncontrolled form of flexibility.
  • Export taxes may be used for a variety of reasons, but generally they do not amount to first-best policy under perfect market assumptions.
  • Evidence on antidumping, countervailing duties and safeguards is generally consistent with the view that these measures are tools of flexibility to confront difficult situations. The evidence is less clear for increase in applied tariffs, export taxes and the modification of tariff commitments.
  • Existing empirical evidence on the economic impact of adopting measures of contingent protection shows that there are costs associated with the use of these measures, but the magnitude of these costs is uncertain.
  • Restraints in the use of restrictive trade measures will contribute to a more rapid recovery in the world economy.

Tuesday, July 21, 2009

A review of The Return of Depression Economics and the Crisis of 2008

The following is a review of Krugman’s book The Return of Depression Economics and the Crisis of 2008 published on Trade Insight, Vol5, No2, 2009, SAWTEE. Couldn’t find text version of this article for now. Please download the PDF file or view it on full screen!

Review of Return of Depression Economics_Trade Insight_Vol5No2_SAWTEE


Here is the full edition of Trade Insight Vol5,No2, 2009

Trade Insight Vol5No2 2009

Monday, July 20, 2009

Nepal’s fiscal year 2009/10 budget-- Macro issues in mammoth budget

My latest op-ed is titled Budget lacks focus: Macro issues in mammoth budget. It is a review of Nepal’s fiscal year 2009/10 budget. There are many issues in the budget that need explanation. Here, I look at major macro issues only.


Budget lacks focus: Macro issues in mammoth budget

Finance Minister Surendra Pandey presented the coalition government’s budget for the fiscal year 2009/10 using a spray gun approach to tackle almost everything but without any concrete direction and clarity. He broke Dr Bhattarai’s record by presenting a mammoth budget of Rs 285.93 billion, which is approximately Rs 50 billion higher than last year’s budget. For the sake of being distinct, the finance minister has simply morphed the Maoist government’s popular and populist programs to fit UML’s economic and political philosophy. However, unlike his predecessor, Pandey avoided setting a highly unlikely target of a double-digit growth rate.

The budget has rightly focused on the need to develop infrastructure for sustained economic growth. The increase in education budget, youth employment and expansion of social welfare programs, including pecuniary incentives for inter-caste marriage of Dalits, is definitely in the right direction. Though some of the programs are designed with good intention, they nevertheless will be used as a tool to get more votes in the next election. There are several programs that look not only implausible but also overly populist and ambitious. I will limit this discussion within the macroeconomic aspects of the budget.

As mentioned earlier, the budget is excessively big for a tiny economy that is reeling with supply bottlenecks and mounting price level. The targeted growth rate of 5.5 percent is a modest projection but will be difficult to attain if the monsoon does not favor our farmers (agriculture sector is expected to grow at 3.3 percent) and the current state of lawlessness, power crisis, undersupply of infrastructure, lack of credit to farmers and manufacturing slackness continues unabated. It will be difficult for the government to manage the economy if these issues are not addressed swiftly and decisively, something that the budget promises but is unclear about.

The Economic Survey 2009—an analytical exercise which takes stock of the economy, identifies constraints and suggests a way forward— which was released a day before the budget was announced clearly lays out the limitations of the government and carcinogenic problems that have been plaguing the economy for a long time: “A big question mark has emerged on our skill of overall economic management in a situation where the Nepalese economy entangled in the vortex of economic sluggishness amidst the double-digit price rise thereby adversely affecting the purchasing power and living standard of the Nepalese people. […] national imperative is making sufficient legal arrangements and ensuring effective enforcement of those provisions for completely banning bandas, strikes especially against transportation and movements of the people.” It is not that we do not know the problems that are restraining growth; it is just that the politicians are not able to forge political consensus to deal with these problems by rising above party lines and by forming a national agenda, irrespective of political ideology. This aspect is not addressed in the budget.

One of the biggest highlights of this budget is the ambitious revenue target. Buoyed by the success of Dr Bhattarai’s campaign to increase revenue mobilization, Pandey is overly optimistic about revenue generation. The revenue target is Rs 176.5 billion, which is more than Rs 36 billion than what the Maoist administration achieved. There are two plausible reasons to doubt if Pandey’s administration will be able to achieve this target. First, the jolt in revenue collection last year occurred primarily because of an aggressive move by the government to incriminate those who were evading taxes. Novel approaches like Voluntary Disclosure of Income Scheme and taxes on education institutions along with a reformed revenue department with incentives to perform better were enforced. This is a one-shot move and not sustainable. Second, the evaders paid lump sum as a penalty for years of tax evasion. Pretty much all the big tax evaders complied with the new ruling. Hence, the stream of tax revenue will be thinner than last year’s. Furthermore, the government has raised income tax exemption level, thus increasing disposable income of people. This will further narrow the revenue stream. A better way to create sustained revenue stream would be to hinge revenue projections with economic growth rate.

Probably the most important issue that will be looked upon closely is the impact of high deficit financing on the already high inflation rate. Inflation rate is expected to be over 13 percent in FY 2008/09. For the next fiscal year, it is projected to be 7.5 percent. Initially, the sudden rise in price level in the domestic market was triggered by rising global food, fuel and commodity prices and internal supply bottlenecks. However, this sudden, transitory price hike became a permanent stamp in the domestic market as retailers began stacking up inventories and withholding supply to the market, thus creating an artificial price rise. There is something fundamentally wrong in the system because a double-digit price level in Nepal is unexpected when the Indian economy is in deflation. The budget has done little to address these underlying issues. Hence, a drop in price level to the tune of five percentage points is very unlikely unless Nepal Rastra Bank (NRB) hikes up interest rates and squeezes credit flow. If the NRB is compelled to tackle rising inflation, which will erode purchasing power and scare away investors, then it will add one more hurdle in achieving Finance Minister Pandey’s modest growth target.

There are no concrete plans for SEZs and private sector development. The much talked about public-private partnership to finance infrastructure projects lack focus and clarity. Except for scrapping scrap tax, institute third-party insurance to reduce risks associated with supply bottlenecks and reduction in capital gains tax to 10 percent from 15 percent, which pleased investors at NEPSE, there is not much for the private sector in the budget. Nepal desperately needs to prop up its exports industry. The budget is mum on formulating a comprehensive industrial policy that would systematically and deliberately engage in aiding those institutions and sectors that would help to attain a sustained growth rate of over 7 percent for over a decade. An updated industrial policy is needed to absorb surplus labor from the agriculture sector and to successfully transition to manufacturing and service-dependent economy. Moreover, there should have been a plan to either divest or to privatize loss-making public enterprises, whose marginal cost of operation is far higher than marginal benefit to the society.

Though the determination to improve on the dismal condition of infrastructures is rightly placed, the plans laid out to move forward on this direction are not. The country needs short-term projects that would be completed in a year or two rather than mega projects that will take a few years to start construction work and a decade for completion. For instance, rather than mega hydropower projects, it would have been fruitful to aggressively go for small- to medium-size projects so that existing pressing demand could be satisfied. This would at least help to assuage the intermittent power crisis. Aiming for projects whose “study phase” would be longer than the life of the coalition government itself is just a waste of resources and time. Meanwhile, there was no need to introduce another ambitious, redundant plan to generate 25,000 MW of electricity in two decades at a time when there already was a plan to generate 10,000 MW in 10 decades.

Overall, Pandey’s budget lacks focus and direction and does not address the most pressing macro issues in the economy.


Here is more about the budget.

Here are the targets of the budget for fiscal year 2009/10:

Growth rate 5.5%
Agriculture sector growth rate 3.3%
Non-agriculture sector growth rate 6.6%
Total outlay Rs 285.9 billion
Recurrent expenditure Rs 160 billion
Capital formation Rs 106 billion
Revenue generation Rs 175 billion
Revenue-expenditures gap Rs 109 billion
Foreign grant Rs 57 billion
Foreign loan Rs 21.6 billion
Domestic borrowing Rs 30.91 billion

Joe Stiglitz profiled

Newsweek magazine has a profile of one of my favorite economists-- Joe Stiglitz

Stiglitz is perhaps best known for his unrelenting assault on an idea that has dominated the global landscape since Ronald Reagan: that markets work well on their own and governments should stay out of the way. Since the days of Adam Smith, classical economic theory has held that free markets are always efficient, with rare exceptions. Stiglitz is the leader of a school of economics that, for the past 30 years, has developed complex mathematical models to disprove that idea. The subprime-mortgage disaster was almost tailor-made evidence that financial markets often fail without rigorous government supervision, Stiglitz and his allies say. The work that won Stiglitz the Nobel in 2001 showed how "imperfect" information that is unequally shared by participants in a transaction can make markets go haywire, giving unfair advantage to one party. The subprime scandal was all about people who knew a lot—like mortgage lenders and Wall Street derivatives traders—exploiting people who had less information, like global investors who bought up subprime- mortgage-backed securities. As Stiglitz puts it: "Globalization opened up opportunities to find new people to exploit their ignorance. And we found them."

[…] "I was struck by the incongruity between the models that I was taught and the world that I had seen growing up," Stiglitz said in his Nobel Prize lecture in 2001. In the same speech he declared that the invisible hand "might not exist at all." The solution, Stiglitz says, is to move beyond ideology and to develop a balance between market-driven economies—which he favors—and government oversight.

Here is Krugman on Stigltiz:

Yes, Joe should be playing a bigger role — he’s an insanely great economist, in ways you can’t really appreciate unless you’re deep into the field. I’d say that he’s more his generation’s Paul Samuelson than its John Maynard Keynes: as with Great Paul, almost every time you dig into some sub-field of economics — finance, imperfect competition, health care — you find that much of the work rests on a seminal Stiglitz paper.

Saturday, July 18, 2009

Economics after the crisis

A very interesting piece about the ideological debate on economics, especially after the current financial crisis. Its a refresher in history of economic thought.


Although the crisis has exposed bitter divisions among economists, it could still be good for economics.

ROBERT LUCAS, one of the greatest macroeconomists of his generation, and his followers are “making ancient and basic analytical errors all over the place”. Harvard’s Robert Barro, another towering figure in the discipline, is “making truly boneheaded arguments”. The past 30 years of macroeconomics training at American and British universities were a “costly waste of time”.

To the uninitiated, economics has always been a dismal science. But all these attacks come from within the guild: from Brad DeLong of the University of California, Berkeley; Paul Krugman of Princeton and the New York Times; and Willem Buiter of the London School of Economics (LSE), respectively. The macroeconomic crisis of the past two years is also provoking a crisis of confidence in macroeconomics. In the last of his Lionel Robbins lectures at the LSE on June 10th, Mr Krugman feared that most macroeconomics of the past 30 years was “spectacularly useless at best, and positively harmful at worst”.

These internal critics argue that economists missed the origins of the crisis; failed to appreciate its worst symptoms; and cannot now agree about the cure. In other words, economists misread the economy on the way up, misread it on the way down and now mistake the right way out.

On the way up, macroeconomists were not wholly complacent. Many of them thought the housing bubble would pop or the dollar would fall. But they did not expect the financial system to break. Even after the seizure in interbank markets in August 2007, macroeconomists misread the danger. Most were quite sanguine about the prospect of Lehman Brothers going bust in September 2008.

Nor can economists now agree on the best way to resolve the crisis. They mostly overestimated the power of routine monetary policy (ie, central-bank purchases of government bills) to restore prosperity. Some now dismiss the power of fiscal policy (ie, government sales of its securities) to do the same. Others advocate it with passionate intensity.

Among the passionate are Mr DeLong and Mr Krugman. They turn for inspiration to Depression-era texts, especially the writings of John Maynard Keynes, and forgotten mavericks, such as Hyman Minsky. In the humanities this would count as routine scholarship. But to many high-tech economists it is a bit undignified. Real scientists, after all, do not leaf through Newton’s “Principia Mathematica” to solve contemporary problems in physics.

They accuse economists like Mr DeLong and Mr Krugman of falling back on antiquated Keynesian doctrines—as if nothing had been learned in the past 70 years. Messrs DeLong and Krugman, in turn, accuse economists like Mr Lucas of not falling back on Keynesian economics—as if everything had been forgotten over the past 70 years. For Mr Krugman, we are living through a “Dark Age of macroeconomics”, in which the wisdom of the ancients has been lost.

What was this wisdom, and how was it forgotten? The history of macroeconomics begins in intellectual struggle. Keynes wrote the “General Theory of Employment, Interest and Money”, which was published in 1936, in an “unnecessarily controversial tone”, according to some readers. But it was a controversy the author had waged in his own mind. He saw the book as a “struggle of escape from habitual modes of thought” he had inherited from his classical predecessors.

That classical mode of thought held that full employment would prevail, because supply created its own demand. In a classical economy, whatever people earn is either spent or saved; and whatever is saved is invested in capital projects. Nothing is hoarded, nothing lies idle.

Keynes appreciated the classical model’s elegance and consistency, virtues economists still crave. But that did not stop him demolishing it. In his scheme, investment was governed by the animal spirits of entrepreneurs, facing an imponderable future. The same uncertainty gave savers a reason to hoard their wealth in liquid assets, like money, rather than committing it to new capital projects. This liquidity-preference, as Keynes called it, governed the price of financial securities and hence the rate of interest. If animal spirits flagged or liquidity-preference surged, the pace of investment would falter, with no obvious market force to restore it. Demand would fall short of supply, leaving willing workers on the shelf. It fell to governments to revive demand, by cutting interest rates if possible or by public works if necessary.

The Keynesian task of “demand management” outlived the Depression, becoming a routine duty of governments. They were aided by economic advisers, who built working models of the economy, quantifying the key relationships. For almost three decades after the second world war these advisers seemed to know what they were doing, guided by an apparent trade-off between inflation and unemployment. But their credibility did not survive the oil-price shocks of the 1970s. These condemned Western economies to “stagflation”, a baffling combination of unemployment and inflation, which the Keynesian consensus grasped poorly and failed to prevent.

The Federal Reserve, led by Paul Volcker, eventually defeated American inflation in the early 1980s, albeit at a grievous cost to employment. But victory did not restore the intellectual peace. Macroeconomists split into two camps, drawing opposite lessons from the episode.

The purists, known as “freshwater” economists because of the lakeside universities where they happened to congregate, blamed stagflation on restless central bankers trying to do too much. They started from the classical assumption that markets cleared, leaving no unsold goods or unemployed workers. Efforts by policymakers to smooth the economy’s natural ups and downs did more harm than good.

America’s coastal universities housed most of the other lot, “saltwater” pragmatists. To them, the double-digit unemployment that accompanied Mr Volcker’s assault on inflation was proof enough that markets could malfunction. Wages might fail to adjust, and prices might stick. This grit in the economic machine justified some meddling by policymakers.

Mr Volcker’s recession bottomed out in 1982. Nothing like it was seen again until last year. In the intervening quarter-century of tranquillity, macroeconomics also recovered its composure. The opposing schools of thought converged. The freshwater economists accepted a saltier view of policymaking. Their opponents adopted a more freshwater style of modelmaking. You might call the new synthesis brackish macroeconomics.

Pinches of salt

Brackish macroeconomics flowed from universities into central banks. It underlay the doctrine of inflation-targeting embraced in New Zealand, Canada, Britain, Sweden and several emerging markets, such as Turkey. Ben Bernanke, chairman of the Fed since 2006, is a renowned contributor to brackish economics.

For about a decade before the crisis, macroeconomists once again appeared to know what they were doing. Their thinking was embodied in a new genre of working models of the economy, called “dynamic stochastic general equilibrium” (DSGE) models. These helped guide deliberations at several central banks.

Mr Buiter, who helped set interest rates at the Bank of England from 1997 to 2000, believes the latest academic theories had a profound influence there. He now thinks this influence was baleful. On his blog, Mr Buiter argues that a training in modern macroeconomics was a “severe handicap” at the onset of the financial crisis, when the central bank had to “switch gears” from preserving price stability to safeguarding financial stability.

Modern macroeconomists worried about the prices of goods and services, but neglected the prices of assets. This was partly because they had too much faith in financial markets. If asset prices reflect economic fundamentals, why not just model the fundamentals, ignoring the shadow they cast on Wall Street?

It was also because they had too little interest in the inner workings of the financial system. “Philosophically speaking,” writes Perry Mehrling of Barnard College, Columbia University, economists are “materialists” for whom “bags of wheat are more important than stacks of bonds.” Finance is a veil, obscuring what really matters. As a poet once said, “promises of payment/Are neither food nor raiment”.

In many macroeconomic models, therefore, insolvencies cannot occur. Financial intermediaries, like banks, often don’t exist. And whether firms finance themselves with equity or debt is a matter of indifference. The Bank of England’s DSGE model, for example, does not even try to incorporate financial middlemen, such as banks. “The model is not, therefore, directly useful for issues where financial intermediation is of first-order importance,” its designers admit. The present crisis is, unfortunately, one of those issues.

The bank’s modellers go on to say that they prefer to study finance with specialised models designed for that purpose. One of the most prominent was, in fact, pioneered by Mr Bernanke, with Mark Gertler of New York University. Unfortunately, models that include such financial-market complications “can be very difficult to handle,” according to Markus Brunnermeier of Princeton, who has handled more of these difficulties than most. Convenience, not conviction, often dictates the choices economists make.

Convenience, however, is addictive. Economists can become seduced by their models, fooling themselves that what the model leaves out does not matter. It is, for example, often convenient to assume that markets are “complete”—that a price exists today, for every good, at every date, in every contingency. In this world, you can always borrow as much as you want at the going rate, and you can always sell as much as you want at the going rate.

Before the crisis, many banks and shadow banks made similar assumptions. They believed they could always roll over their short-term debts or sell their mortgage-backed securities, if the need arose. The financial crisis made a mockery of both assumptions. Funds dried up, and markets thinned out. In his anatomy of the crisis Mr Brunnermeier shows how both of these constraints fed on each other, producing a “liquidity spiral”.

What followed was a furious dash for cash, as investment banks sold whatever they could, commercial banks hoarded reserves and firms drew on lines of credit. Keynes would have interpreted this as an extreme outbreak of liquidity-preference, says Paul Davidson, whose biography of the master has just been republished with a new afterword. But contemporary economics had all but forgotten the term.

Fiscal fisticuffs

The mainstream macroeconomics embodied in DSGE models was a poor guide to the origins of the financial crisis, and left its followers unprepared for the symptoms. Does it offer any insight into the best means of recovery?

In the first months of the crisis, macroeconomists reposed great faith in the powers of the Fed and other central banks. In the summer of 2007, a few weeks after the August liquidity crisis began, Frederic Mishkin, a distinguished academic economist and then a governor of the Fed, gave a reassuring talk at the Federal Reserve Bank of Kansas City’s annual symposium in Jackson Hole, Wyoming. He presented the results of simulations from the Fed’s FRB/US model. Even if house prices fell by a fifth in the next two years, the slump would knock only 0.25% off GDP, according to his benchmark model, and add only a tenth of a percentage point to the unemployment rate. The reason was that the Fed would respond “aggressively”, by which he meant a cut in the federal funds rate of just one percentage point. He concluded that the central bank had the tools to contain the damage at a “manageable level”.

Since his presentation, the Fed has cut its key rate by five percentage points to a mere 0-0.25%. Its conventional weapons have proved insufficient to the task. This has shaken economists’ faith in monetary policy. Unfortunately, they are also horribly divided about what comes next.

Mr Krugman and others advocate a bold fiscal expansion, borrowing their logic from Keynes and his contemporary, Richard Kahn. Kahn pointed out that a dollar spent on public works might generate more than a dollar of output if the spending circulated repeatedly through the economy, stimulating resources that might otherwise have lain idle.

Today’s economists disagree over the size of this multiplier. Mr Barro thinks the estimates of Barack Obama’s Council of Economic Advisors are absurdly large. Mr Lucas calls them “schlock economics”, contrived to justify Mr Obama’s projections for the budget deficit. But economists are not exactly drowning in research on this question. Mr Krugman calculates that of the 7,000 or so papers published by the National Bureau of Economic Research between 1985 and 2000, only five mentioned fiscal policy in their title or abstract.

Do these public spats damage macroeconomics? Greg Mankiw, of Harvard, recalls the angry exchanges in the 1980s between Robert Solow and Mr Lucas—both eminent economists who could not take each other seriously. This vitriol, he writes, attracted attention, much like a bar-room fist-fight. But he thinks it also dismayed younger scholars, who gave these macroeconomic disputes a wide berth.

By this account, the period of intellectual peace that followed in the 1990s should have been a golden age for macroeconomics. But the brackish consensus also seems to leave students cold. According to David Colander, who has twice surveyed the opinions of economists in the best American PhD programmes, macroeconomics is often the least popular class. “What did you learn in macro?” Mr Colander asked a group of Chicago students. “Did you do the dynamic stochastic general equilibrium model?” “We learned a lot of junk like that,” one replied.

It takes a model to beat a model

The benchmark macroeconomic model, though not junk, suffers from some obvious flaws, such as the assumption of complete markets or frictionless finance. Indeed, because these flaws are obvious, economists are well aware of them. Critics like Mr Buiter are not telling them anything new. Economists can and do depart from the benchmark. That, indeed, is how they get published. Thus a growing number of cutting-edge models incorporate one or two financial frictions. And economists like Mr Brunnermeier are trying to fit their small, “blackboard” models of the crisis into a larger macroeconomic frame.

But the benchmark still matters. It formalises economists’ gut instincts about where the best analytical cuts lie. It is the starting point to which the theorist returns after every ingenious excursion. Few economists really believe all its assumptions, but few would rather start anywhere else.

Unfortunately, it is these primitive models, rather than their sophisticated descendants, that often exert the most influence over the world of policy and practice. This is partly because these first principles endure long enough to find their way from academia into policymaking circles. As Keynes pointed out, the economists who most influence practical men of action are the defunct ones whose scribblings have had time to percolate from the seminar room to wider conversations.

These basic models are also influential because of their simplicity. Faced with the “blooming, buzzing confusion” of the real world, policymakers often fall back on the highest-order principles and the broadest presumptions. More specific, nuanced theories are often less versatile. They shed light on whatever they were designed to explain, but little beyond.

Would economists be better off starting from somewhere else? Some think so. They draw inspiration from neglected prophets, like Minsky, who recognised that the “real” economy was inseparable from the financial. Such prophets were neglected not for what they said, but for the way they said it. Today’s economists tend to be open-minded about content, but doctrinaire about form. They are more wedded to their techniques than to their theories. They will believe something when they can model it.

Mr Colander, therefore, thinks economics requires a revolution in technique. Instead of solving models “by hand”, using economists’ powers of deduction, he proposes simulating economies on the computer. In this line of research, the economist specifies simple rules of thumb by which agents interact with each other, and then lets the computer go to work, grinding out repeated simulations to reveal what kind of unforeseen patterns might emerge. If he is right, then macroeconomists, like zombie banks, must write off many of their past intellectual investments before they can make progress again.

Mr Krugman, by contrast, thinks reform is more likely to come from within. Keynes, he observes, was a “consummate insider”, who understood the theory he was demolishing precisely because he was once convinced by it. In the meantime, he says, macroeconomists should turn to patient empirical spadework, documenting crises past and present, in the hope that a fresh theory might later make sense of it all.

Macroeconomics began with Keynes, but the word did not appear in the journals until 1945, in an article by Jacob Marschak. He reviewed the profession’s growing understanding of the business cycle, making an analogy with other sciences. Seismology, for example, makes progress through better instruments, improved theories or more frequent earthquakes. In the case of economics, Marschak concluded, “the earthquakes did most of the job.”

Economists were deprived of earthquakes for a quarter of a century. The Great Moderation, as this period was called, was not conducive to great macroeconomics. Thanks to the seismic events of the past two years, the prestige of macroeconomists is low, but the potential of their subject is much greater. The furious rows that divide them are a blow to their credibility, but may prove to be a spur to creativity.

The state of economics after the crisis

Some links from The Economist about the state of economics especially during the aftermath of the global financial crisis.

What went wrong with economics

There are three main critiques: that macro and financial economists helped cause the crisis, that they failed to spot it, and that they have no idea how to fix it.

The first charge is half right. Macroeconomists, especially within central banks, were too fixated on taming inflation and too cavalier about asset bubbles. Financial economists, meanwhile, formalised theories of the efficiency of markets, fuelling the notion that markets would regulate themselves and financial innovation was always beneficial. Wall Street’s most esoteric instruments were built on these ideas.

But economists were hardly naive believers in market efficiency. Financial academics have spent much of the past 30 years poking holes in the “efficient market hypothesis”. A recent ranking of academic economists was topped by Joseph Stiglitz and Andrei Shleifer, two prominent hole-pokers. A newly prominent field, behavioural economics, concentrates on the consequences of irrational actions.

So there were caveats aplenty. But as insights from academia arrived in the rough and tumble of Wall Street, such delicacies were put aside. And absurd assumptions were added. No economic theory suggests you should value mortgage derivatives on the basis that house prices would always rise. Finance professors are not to blame for this, but they might have shouted more loudly that their insights were being misused. Instead many cheered the party along (often from within banks). Put that together with the complacency of the macroeconomists and there were too few voices shouting stop.

The other-worldly philosopher

Efficient-markets hypothesis after the crisis

Also, two good links:

Microcredit may not work wonders but it does help the poor

Justin Lin on fostering small, local banks in the developing countries

Thursday, July 16, 2009

Global financial crisis, developing countries and global governance reform

I attended two interesting events today in DC. The first one was about a report by Stiglitz Commission (UN) and how the fallout of the global financial crisis on the developing economies. Jomo KS, Assistant Secretary-General for Economic Development in the United Nation’s Department of Economic and Social Affairs (DESA) went over the Stiglitz Commissions’ recommendations and the way forward in the aftermath of the global financial crisis. As some economists have been arguing earlier, the crisis was expected and world leaders were warned, even by the United Nation.

However, the IMF and the WB largely ignored the warning and downplayed pessimistic assessment of the economy before the crisis, he argued. The belief on excessive deregulation and self-regulation (including that of capital account liberalization and leaving little fiscal and monetary space for domestic policy maneuver) promoted by the IFIs and BWIs, without adequate and appropriate regulation set the stage for the crisis. After the aftermath of the crisis, the policy responses have been inadequate, mainly in the part of the developing countries, and the IMF has been using double standards in dealing with the affected countries (like the one in Costa Rica, where it argued for stimulus and at the same time ‘forced’ the central bank to hike interest rate, leading to little effect on stimulating the economy). The whole discussion somehow focused on how the IMF is screwing up things, how it needs to do things, and how it can be a part of the solution after being a part of the problem.

Some of the recommendations by Stiglitz Commission (immediate measures):

  • Stable additional funding (SARs, regional liquidity schemes) without conditionalites, for developing countries
  • Additional development funds via new credit facility
  • Developing countries need more policy space (including financial policy to pursue countercyclical policies)
  • Rectify lack of coherence between trade and finance policies
  • Meaningful regulatory reforms urgent for financial stability, growth, inclusion, and development
  • Financial support measures need to be globally coordinated

Systemic reforms recommended by Stigltiz Commission

  • Create new Global Reserve System (multi-country system with greatly expanded SDRs)
  • Reform governance of BWIs and other IFIs
  • Better and more balanced surveillance
  • Reform central bank policies to promote development (rather than just being too obsessed with controlling inflation)
  • Financial market policies (create Financial Products Safety Commission, Comprehensive financial regulation, Regulate derivatives trading, Regulate Credit Rating Agencies, Host country regulation of foreign subsidiaries)
  • Crate sovereign debt restructuring mechanism, improve framework for handling cross-border bankruptcies
  • Need for more stable and sustainable development finance

Jomo argued that developing counties responses are constrained by their exposure to systemic, market, and institutional pro-cyclicality, monetary policy is less effective (made worse by independent central banks???), IMF’s fiscal requirement for stimulus and its consistent drumbeating on the highly likelihood of developing economies failures, restricted policy space, and loss of productive capacities due to openness. He argued that there has been a high disconnect between NY (UN) and Washington (IMF and WB), despite the latter being under the UN system. The emphasis should be on sustaining growth, employment creation, reconstruction, development and not just financial stability.

Another speaker Johannes Linn, Executive Director of Wolfensohn Center at Brookings Institution, was a bit skeptical about the policy recommendations by Stiglitz Commission because he thinks most of them are not politically feasible. He argued that tax financed ODA is not likely to be increased and most of the leading would be loans. He thinks there has to be reform in IMF governance and soft-loan windows were needed to finance stimulus in developing countries. It is possible to give more policy space to developing counties but it is unlikely that conditionalities would be eliminated. Also, the talk about replacing the dollar as a reserve currency at a time of this crisis would further destabilize the markets. He argued for a need to focus on linking G8, G20 and the UN and also create secretariat offices for representation. While arguing for more financial regulation, he argued that it is not good to kill a goose by plucking more and more feathers!

Steve Suppan, Senior Policy Analyst at Institute for Agriculture and Trade Policy, talked about financial crisis and commodity price volatility. He made pretty interesting notes:

  • Net capital outflows in 2008 from developing countries to developed countries equaled between $1 trillion (WB) to $2 trillion (UN)
  • Global unemployment by 2010 is expected to reach 100 million
  • More than 30 developing countries have reserves to fund imports for less than three months
  • Between June 2008 and November 2008, commodity prices dropped by 60 percent
  • In 2007, food import bill of 37 percent of LDCs increased

He argued that commodity price volatility is caused primarily because of low reserves, high demand and tight supplies leading to more speculation; and over the counter “weight of money” from financial institutions that bet on commodity prices in the international market.

The other event was about the reforms needed at the IMF and was organized by New Rules for Global Finance. The speakers pretty much repeated the same stuff from an earlier event.

Two good events!

Wednesday, July 15, 2009

Nepal’s fiscal year 2009/10 budget

There have been a lot of unfavorable reviews of the fiscal year 2009/10 budget presented by Nepal’s Finance Minister Surendra Pandey yesterday. Here is a link to some of the interesting media highlights of the budget. The budget should have been based on the findings of Economic Survey 2008/09, which was released by the government a day before the budget was presented in the parliament.

I think the Finance Minister Surendra Pandey presented the coalition government’s budget for the fiscal year 2009/10 using a spray-gun approach to tackle almost everything but without any concrete direction and clarity. He broke Dr. Bhattarai’s record by presented a mammoth budget of Rs 285.93 billion, which is approximately Rs 50 billion higher than last year’s budget. For the sake of being distinct, the finance minister has simply morphed the Maoist government’s popular and populist programs to fit UML’s economic and political philosophy. However, unlike his predecessor, Pandey avoided setting highly unlikely target of a double-digit growth rate. I will elaborate what I mean by this in the next op-ed. :)

Here are the targets of the budget for fiscal year 2009/10:

Growth rate 5.5%
Agriculture sector growth rate 3.3%
Non-agriculture sector growth rate 6.6%
Total outlay Rs 285.9 billion
Recurrent expenditure Rs 160 billion
Capital formation Rs 106 billion
Revenue generation Rs 175 billion
Revenue-expenditures gap Rs 109 billion
Foreign grant Rs 57 billion
Foreign loan Rs 21.6 billion
Domestic borrrowing Rs 30.91 billion


Below are the annex and full text of the budget:

Budget Speech 2009-10 Annex Budget Speech 2009-10 by FM Surendra Pandey

Tuesday, July 14, 2009

Trade facilitation and corruption at customs in Nepal

My latest op-ed is titled “Dismal progress in trade facilitation”. It is based on The Global Trade Enabling Report 2009, published by World Economic Forum. Last year, I wrote a similar piece (Leaking customs and weak trade)and argued that trade facilitation process in Nepal is one of the worst in the world. Sadly, there has not been much improvement this year as well.


Dismal Progress In Trade Facilitation

Three weeks ago when the Commission for Investigation of Abuse of Authority (CIAA) directed employees at the Tribhuvan International Airport (TIA) to wear uniform without pockets in order to control theft and corruption, the news made quite a buzz in the media and blogosphere. This move came after numerous reports of irregularities and corruption – though not surprising – at the airport were reported in the media and to the CIAA.

Corruption and irregularities are not exclusive to TIA checkpoints; it is like a pandemic plaguing almost all the sectors in the economy. One of the places where such activities are excessively rampant is at custom departments, which are the key points for trade facilitation and revenue generation. An efficient border administration, supportive business environment and well-developed transport and telecommunication infrastructures help reduce transaction costs, ensure timely delivery of goods and services and realize the benefits of trade and aid growth.

Despite being a member of WTO in 2004 and of two other regional trading blocs, the benefits of trade Nepal has reaped so far are horribly low. The value of merchandise imports are more than three times the value of exports—in 2008, exports and imports amounted to US$ 887.7 million and US$2904.4 million respectively. More than 50 percent of trading activities take place with India alone. Exports to other countries have been decreasing, chiefly because of internal labor disputes, supply bottlenecks and inefficient ‘enablers’ of trade. Note that Nepal does not produce many goods and services that could be exported with comparative advantage. Worse, on the current ‘product space’, there are only a few goods and services that could be potentially exported with comparative advantage, provided that institutional, regulatory and financial conditions are right and relevant infrastructures adequately supplied.

Given this situation, the main task for now is to make the most out of existing goods that are traded through our customs. How successful have we been on this front? Latest evidence shows that we have not made satisfactory progress and a lot needs to be done to facilitate trade across borders. Nepal has barely improved in the trade enabling rankings complied by the World Economic Forum. The Global Trade Enabling Report 2009, which ranks countries based on their efficiency at border administrations and business environments that are conducive to trade, ranks Nepal 110 out of 121 countries considered in the report.

This means that high costs, opaque and prolix custom clearance procedures, and inefficient administrative difficulties in an overly bureaucratic environment have been serious barriers to trade. In the latest rankings, Nepal ranks 113 in border administration, 107 in transport and communication infrastructures and 117 in business environment required for promotion and facilitation of trade. Compare these dismal standing with the impressive ranking on domestic and foreign market access (29 out of 121). This implies that despite good ranking on market access, Nepal’s trade facilitating infrastructure, institutions and regulatory structure are so miserable that they overshadow potential gains from increased market access.

The Enabling Trade Index measures institutions, policies and services facilitating free flow of goods over borders and to destinations by looking at performance of individual countries in four key areas: Market access, border administration, transport and communication infrastructure, and business environment. The top 10 countries that have the necessary attributes for enabling trade are Singapore, Hong Kong, Switzerland, Denmark, Sweden, Canada, Norway, Finland, Austria and Netherlands.

Specifically, Nepal’s ranking in efficiency of customs administrations, efficiency of import-export procedures and transparency of border administrations are 119, 105 and 100 respectively. Transparency is crucial for gaining faith of traders and promoting trade across borders. Regularly publishing and distributing entry and exit rules, notifying trading community in advance about any changes to existing rules and publishing Department of Customs’ data and analysis in a timely manner would help to promote transparency and accountability. In terms of effectiveness and efficiency of clearance at customs, Nepal ranks third from the last (119).

An equally important factor in facilitating trade is the supply of infrastructure. However, Nepal’s ranking in quality and availability of transport and communication infrastructures is not that encouraging—availability and quality of transport infrastructure (101), availability and quality of transport services (88) and availability and use of ICTs (120). The availability of adequate and quality infrastructure is vital for reducing transportation costs, linking markets and production sites, increasing investment and stimulating growth. In fact, a recent study done by this author (and a separate one done by ADB) showed that bad infrastructure is the most binding constraint on economic growth in the Nepali economy.

In addition, given the level of disturbances and supply bottlenecks in the economy, it is not surprising that Nepal’s rank is 104 in regulatory environment and 121 in physical security, the worst among countries incorporated in the report. Between January and June 2009, there were 532 transport obstructions and bandas (closures) in different parts of the country. The inability of traders to supply goods, mainly because of supply bottlenecks and insecurity, in time has already cost the garment and textile industry, once the major foreign currency earning sector, dearly.

In the Doing Business Reports ranking as well, Nepal’s position is not that encouraging. There has not been any improvement in ranking under the heading ‘trade across borders’ in the past three years (157 out of 181 countries). It still takes nine documents, 41 days and US$ 1764 per container for completion of a normal export process. Meanwhile, it takes 10 documents, 35 days and US$ 1900 per container for completion of import process.

Improving trade facilitation would help reduce transaction costs, effectively monitor border controls, enhance trade competitiveness, discover new tradable goods and attract FDI, among others. At a time when the economy is losing grounds on price and quality competitiveness in the international market, promoting and reforming trade facilitation procedures would at least help to aid the struggling exports industry. Properly addressing these issues in the upcoming fiscal budget would not only foster confidence in our corrupt and inefficient customs but also realize the benefits of trade.

Source: Republica, July 14, 2009

Links to news about Nepal’s fiscal budget 2009/10

Nepal’s Finance Minister presented Surendra Pandey fiscal budget 2009/10 yesterday. The total budget is Rs 285.93 billion, which is a record-breaking amount. I will write a review of the budget tomorrow. Below are some of the links to news about the budget from the Nepalese media.

Text of budget speech

What the budget means for you

Budget 2009: Nothing but promises

Hydropower gets huge budget boost

Mixed bag in borrowed template

Govt promises ‘half-hearted’ reforms

25,000 MW hydroelectricity in 20 years

A budget with many upsides

Income tax exemption raised

FM steps on higher ground than Dr Bhattarai

The year of the roads

Ambitious budget, populist thrust

Monday, July 13, 2009

Nepalese economy in trouble-- Economic Survey 2008/09

Almost all the economic indicators registered negative growth rate in the last fiscal year, according to Economic Survey 2008/09 release by the Ministry of Finance (see the tables below). The forecast for this fiscal year does not look any better. The plunge in manufacturing and agricultural sectors is very troubling for a struggling economy. Troubles in growth rate, balance of trade deficit, inflation rate, national debt…

The economy grew at 3.8 percent against a forecast of around 7 percent (last year the growth rate was 5.3 percent). GDP growth rate is estimated to be 4.7 percent next fiscal year (2009/10). GDP per capita reached US$473 (Thank God, Nepal remittances inflow continued to increase!). Agricultural sector grew at 2.1 percent (last year it was 4.7 percent) and non-agricultural sector grew at 4.8 percent (last year it was 5.7 percent). Inflation rate hit 13.1 percent in mid-March 2009 as against 7.2 percent in mid-March 2008. GDP deflator (a measure of the level of prices of all new, domestically produced, final goods and services-- expressed as (nominal GDP/real GDP)/100) rose from 6.3 percent to 12.2 percent.

Summary of macroeconomic indicators:

Annual growth rate of GDP by economic activities:

As a percentage of GDP, domestic savings is down to 8 percent from 11.21 percent last fiscal year. Thanks to increasing remittances gross national savings has increased to 32.32 percent (% of GDP) from 31.53 percent last fiscal year. Exports have increased by around three percentage points to 15.70 percent from the first eight months of last fiscal year’s 12.08 percent. However, imports have increased to 37.42 percent from last fiscal year’s 32.66 percent, thus increasing the hole in balance of trade (BoT). Note that balance of payments (BoP) has been in positive territory. Revenue/GDP increased to 14.8% from 13.2% last fiscal year but total government expenditure/GDP increased to 22.2% from 19.7% last fiscal year. Budget deficit/GDP decreased to 3.8% from 4.1% last fiscal year.

Gross fixed capital formation as a percentage of GDP barely increased to 21.25 percent from 21.11 percent from last year. On gross fixed capital investment front, government investment/GDP was 4.1 percent (up from 3.1% last fiscal year) and private investment/GDP was 17.1 percent (down from 18% last fiscal year). Gross investment/GDP stood at 29.7 percent (down from 32.8% last fiscal year). Similarly, the gap between gross domestic savings and gross investments/GDP increased to -21.7% from -21.6% last fiscal year. The resource gap-- saving-investment gap (gross domestic savings minus gross domestic fixed capital formation)-- (% of GDP) was 2.60 percent from -0.26 percent last fiscal year (again, thanks to increasing remittances).

The ratio of investment to GDP decreased to 29.7 percent to 31.8 percent from last fiscal year. Exports/GDP increased to 21.7 percent from 20.6 percent from last year. Due to impressive revenue collection, revenue mobilization/GDP increased to 14.8 percent against 13.2 percent last fiscal year. Outstanding debt/GDP increased to 41 percent from 39.6 percent (first eight month of fiscal year), showing that expenditure continue to outweighed national income. Foreign debt/GDP also increased to 28.5 percent from last fiscal year’s 26.4 percent. Meanwhile, domestic debt/GDP actually decreased to 12.5 percent from 13.2 percent in last fiscal year.

Well, the government admits that it is doing a bad job managing the economy:

A big question mark has emerged on our skill of overall economic management in a situation where the Nepalese economy entangled in the vortex of economic sluggishness amidst the double-digit price rise thereby adversely affecting the purchasing power and living standard of the Nepalese people. Hence, there is the necessity of wider reform initiatives on development efforts, investments, and regulatory areas for expanding the economy. The nation is also being made to bear adverse supply shock due to frequent Bandhs, chakka jams, strikes etc. For this, national imperative is making sufficient legal arrangements and ensuring effective enforcement of those provisions for completely banning Bandhs, strikes especially against transportation and movements of the people for allowing the country's economy move ahead in a smooth and natural way, and also providing relief to the people's livelihood.

Sunday, July 12, 2009

The impact of exports delay on trade

On average, each additional day that a product is delayed prior to being shipped reduces trade by at least 1 percent. Put differently, each day is equivalent to a country distancing itself from its trade partners by 85 km on average. Delays have an even greater impact on developing country exports and exports of time sensitive goods, such as perishable agricultural products. In particular, a day’s delay reduces a country’s relative exports of time-sensitive to time-insensitive agricultural goods by 7 percent.

More here. Due to road obstruction and closure (bandhs), the Nepalese export-based manufacturing firms have been unable to supply pre-ordered goods in time. It led to cancellation of contract from companies in the West. This is having a severe impact on the whole exports industry, leading to closure of several firms. Between January and June 2009 alone, there were over 500 road obstructions and closures in different parts of the country. This has been a cancer affecting the whole industrial sector in Nepal.

Saturday, July 11, 2009

Links of Interest (07/10/2009)

$20 billion to boost food supplies to the hungry committed by the G8

Olivier Blanchard explains “the perfect storm

World Economic Outlook July update (economic growth projected to be 2.5 percent in 2010)

More agricultural subsidies for poor farmers in Nepal (the more subsidies Indian farmers receive, the more Nepali farmers need to compete in the heavily integrated market)

Female time poverty reinforces the persistent female income poverty (because the gender division of labour between paid and unpaid activities, distinct from childhood, seems to have important implications to female accumulation of capital)

Friday, July 10, 2009

The reason for an ever-growing Nepal’s fiscal budget is…

… because

“there has always been a holier-than-thou attitude of the government in power and its finance minister. As one of the architects of Nepal´s fiscal budgets says, whoever is the finance minister at the helm, he does not want to be seen as chicken-hearted but rather a lion-heart, no matter what negative consequences his budget may cause to the economy.”

More here. Last year, the fiscal budget presented by the Maoist finance minister was 45% higher than the year before. But real expenditures fell short of the allocated budget. Why inflate fiscal budget when we cannot spend it?

Nepal’s central bank gets active, finally!

So, the central bank of Nepal,for the first time, is doing what it is supposed to do long ago. After liquidating Nepal Development Bank (NDB), it is now going after its promoters, who swindled almost Rs 1.08 billion while ruining the bank’s balance sheet. Some of the promoters are Madoff of Nepal!

Wednesday, July 8, 2009

Collier on development in dangerous places

Paul Collier makes a case for intervention (military and aid) because of lack of security (internal rebellion) and accountability. A mouthful of discussion and provocative recommendations that sound as bizarre as it could get but is probably one in the right direction.

Chad is not alone. It is one of a group of about 60 small, impoverished, post-colonial countries that “came unnatural into the world.” With neither the social unity needed for cooperation, nor the size to reap the benefits of larger scale, they are structurally unable to provide the public goods—such as security—that are critical for decent quality of life and imperative for economic development. They have diverged from the rest of mankind. They will never tap their vast reservoir of frustrated human potential unless the international community, at least for a time, supplies basic public goods that go beyond the typical aid agenda. This, stated baldly, is the thesis of my new book, Wars, Guns, and Votes. It is a troubling thesis. I have come to it reluctantly, and the international community has shied away from it, as have the societies of the bottom billion themselves.

Size matters: the production of public goods, by nature, is characterized by economies of scale.Security and accountability are two public goods that make economic development possible. […]Poverty, stagnation, abundance of valuable natural resources, and ethnic diversity made rebellion easy. Further, governments faced a dilemma: a large and well-equipped military might help to discourage rebellion, but it might also increase the risk of a coup d’├ętat.

[…]The costs of civil war are, as Hobbes observed, enormous: life is solitary, poor, nasty, brutish, and short, and even the possibility of war is enough to deter investment and stunt growth. Thus, without security, economic development is extremely difficult. […]for the bottom billion the accountability of government to citizens may be more than a nice bonus: it may substantially improve the chances of development. If countries of the bottom billion are structurally unable to supply security and accountability, then some form of international supply is required. Below a threshold per-capita income of around $2,700, democracy actually appears to increase the risks of many forms of political violence, including rebellion. The societies of the bottom billion are way below this threshold. This is not an argument against the pursuit of democracy, but it does imply that security and accountability are distinct needs.

[…]ordinary people are still befuddled by an outdated rhetoric: international pressure for accountability is presented by threatened elites as a return to colonialism. Protected by this conveniently emotive assertion, presidents grandly claim that they are defending national sovereignty. However, since they are usually not accountable to citizens, what they are really defending is presidential sovereignty. […]As public goods, security and accountability are like that malaria vaccine: those who need them cannot adequately supply them.

[…]Any international intervention should be acceptable both to the citizens of the recipient society and to citizens of the providing societies, and most suggestions for action fail this test. Most, but by no means all. […]Peacekeeping and “over-the-horizon guarantees” (a promise of military intervention if it becomes necessary) are effective ways to provide security.

Making aid conditional on government actions can also help. But those actions should relate to the accountability of government to citizens rather than to the adoption of economic policies, which was the past practice of donors. Policy conditionality detracts from the accountability of government to citizens because it relives government of responsibility for some economic decisions.

Bill Easterly argues that Collier “wants to de facto recolonize the “bottom billion”” and that his research is based on “one logical fallacy, one mistaken assumption, and a multitude of fatally flawed statistical exercises.” When Easterly uses the word “recolonize”, I feel he is speaking like a desperate leader in developing country who wants to cling to power by any means, often by drumming up support for his rule by blaming ‘foreigners attempting to recolonize their nation and sovereignty’ (say, blame-of-last-resort argument). Collier (indirectly) addressed this issue in his piece. Easterly fails to see it.

Given that Collier’s evidence base collapses when subject to scrutiny, it is all the more disturbing that his policy recommendations are remarkably interventionist. Collier tells bottom-billion societies that are recovering from civil war that they must accept international “peacekeepers” (a nice euphemism to help us forget that these are soldiers who kill people), whose deployment is decided by the Western powers.

Foreign armies invade and control the whole political process—yes, the word “neocolonial” is overused, but with Collier’s recommendations I think one could drop the “neo.” Such aggressive interventions will almost certainly have unintended negative consequences. Will Western violence beget more local violence? Will there be a violent backlash against foreign intervention? Foreign armies will likely kill some innocents in the process of peacekeeping. The motto “first, do no harm” puts the burden of proof on the academic interveners. Collier falls short by intercontinental ballistic missile range.

Larry Diamond disagrees with Collier:

None of these endemically poor countries can climb out of misery without better governance. Collier appreciates this, but he does not fully grasp the vital distinction between Asia’s developmental dictatorships and Africa’s dictatorial disasters. The classic authoritarian Asian tigers—Korea, Taiwan, Singapore, Indonesia—all had near-death experiences with communism that led them to realize it was time to “develop or die.” None faced ethnic complexity as daunting as in Nigeria or Ethiopia, but Singapore and Indonesia did have to work to forge an overarching national identity. Whatever their other faults, all of these countries’ ruling elites (and later the regimes in China and Vietnam) came to identify their own political interests with generating the public goods necessary for transformative development.

By contrast, the typical African ruling elites have settled into a different pattern of behavior and expectations. Security—for the individual ruler and his family, clique, and party—derives from generating private goods and stashing them away in real estate and numbered bank accounts abroad. To say that the West has indulged this pattern does not begin to capture our complicity in the problem. When foreign aid funds up to half the recurrent budget of many of these morally bankrupt states, it is not hard to draw a nearly straight line from aid to venality.

Nancy Birdsall likes three S’s-- sovereignty, size and security-- but is skeptical about over-the-horizon military guarantee.

I am less confident, however, about Collier’s endorsement of over-the-horizon military guarantees. I would recommend other interventions, less exciting but better grounded in experience and evidence.

An arrow towards Easterly:

[..]speaking of evidence, there has been plenty of grousing about Collier’s reliance on econometric results to “prove” that one thing (peacekeeping, democracy) causes another (growth, increased violence). I am inclined to be more tolerant. He is putting big issues on the table, and in reality the issues get more attention because he is purporting to show they matter. Would there be a Collier TED talk and an essay in Boston Review if he had never published a “scholarly” article?

The kind of internal security guarantees Collier suggests need not be off the table. Even if the empirical work behind his assertions is flawed, the story he constructs starts from first principles and is compellingly consistent with history and current experience. You never know where and under what conditions over-the-horizon military guarantees would be the best solution. But there are other proposals the development community should advocate as well, and first. Even though they do not involve guns and war, we ought not ignore and underfund them.

Edward Miguel’s note of dissent:

Africa is still lagging behind the most successful Asian countries, and many of its gains are fragile. Still, I disagree with Collier: the past decade surely offers hope.

Mike McGovern’s disagreement:

Culture and history interact with political economy, regional and international political dynamics, and the personalities of key actors in complex ways. This is why, even though I suggested for Liberia and Sierra Leone many of the recommendations Collier proposes, I reject his strategies when applied generally to the “bottom billion.” […]Rather than coercing potentially rogue leaders into governing responsibly, this policy primarily emboldens military officers to stage coups.

Collier’s response to these criticisms here (especially directed at Easterly)

In presenting his own optimistic case for autonomous recovery and convergence, William Easterly utterly misrepresents the argument of The Bottom Billion as being that of a “poverty trap” and then argues at length that there is no such trap. Indeed, he is so eager to criticize that he appears to have confused me with Jeffrey Sachs, the true evangelist of the poverty-trap thesis, which I explicitly reject. Certainly, growth is complicated. My argument is that a few salient factors have been important in the persistent divergence between rich and poor countries, while in no sense suggesting that this is an exhaustive account. An example is dependence upon natural-resource wealth, which makes the politics of development more difficult. Another is being landlocked without natural resources and surrounded by bad neighbors. Does Easterly deny that these are intractable problems that have contributed to the current stark disparity in living standards? […]It is important to recognize that behind expressions of statistical fastidiousness lurks a recognizable philosophical hostility to public action that has no statistical foundation whatsoever. In critiquing the scope for international action, Easterly simply trots out disaster stories.

But since Easterly has mounted an aggressive critique, I will take a moment to defend myself. Eight years ago my colleague Anke Hoeffler and I proposed that three economic characteristics—low income, slow growth, and dependence upon natural resources—all made conflict more likely. Each of these propositions has since become considerably more robust. The balance of the statistical evidence suggests that the propositions are correct.

As to method, my colleagues and I adopt the statistical approach of “general-to-specific,” in which insignificant variables are systematically and progressively deleted by the rule of stepwise deletion: this is not data mining. If it were, our results would not have been accepted by professionally refereed economics journals. Easterly’s twists on my remarks concerning new results—where a doubling of the sample and other improvements led to a minor refinement in our previous results on the effect of ethnic diversity—typify his bias. If doubling a data set should not lead to any changes in results, he should not have titled one of his papers, “New Data, New Doubts.” Our more recent results on peacekeeping are, as we readily admit, a first attempt. We very much hope to encourage or provoke other researchers to work on the question. But it should be said that in 2008 this work was assessed by a panel of Nobel-laureate economists who found it a sufficiently solid basis for their policy recommendation: peacekeeping was a good use of public money.

Nothing could better illustrate the true nature of the disagreement about peacekeeping than Easterly’s accusation of colonialism. This accusation is founded on coarse thought, not statistical rigor. Colonialism was an oppressive system in which non-democratic empires conquered territories and ran them according to the interest of their own elites. International peacekeeping is temporary, sanctioned by democratic governments whose electorates have no appetite for empire, and aimed at establishing governments that are accountable to their own citizens. Conflating peacekeeping with colonialism is too crude to constitute abuse.