Skidelsky on economics and Keynes

The FT interviews Robert Skidelsky, the biographer of Keynes. Some interesting perspectives:

Skidelsky on if economists failed to foresee the dangers posed by uncontrolled capitalism hinged on mathematical models and detached from reality:

Skidelsky believes economists missed the danger signs ahead of the financial crisis. They were preoccupied with sophisticated mathematical models – a serious weakness, he says, in academic teaching of the discipline – and they were over-confident in self-regulation of the market.

He blames this mindset on the revival of anti-Keynesianism in the 1970s when government intervention in the economy made way for supply-side theory of tax cuts and labour market deregulation. But Keynesians, too, were guilty of overreaching: they assumed the state was capable of fine-tuning demand to mitigate the effects of the economic cycle. Today, Keynesianism has reasserted itself through multi-billion pound government interventions to stimulate the economy and recapitalise the banking system. Skidelsky is no statist but he says the crisis has exposed serious weaknesses in economic policy, from the Bank of England’s inflation targeting (“They did not have the tools”) to the Labour government’s belief in light-touch regulation.

A famous quote from Keynes:

The long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy a task ... if they can only tell us that when the storm is past the ocean is flat again.

Hans Rosling’s new presentation

Hans Rosling gave a fantastic presentation (combining academic substance plus technology) at a talk show. Watch the interesting presentation about growth, healthcare, and infant mortality.

 

Equally interesting are his 2006 talk and 2007 talk.

Chang calls for constructive debate on industrial policy

Ha-Joon Chang has a new paper on industrial policy (I think it is still a draft), which he presented at ABCDE conference in South Korea recently. He tries to push the debate over industrial policy in a constructive path, i.e. how to make industrial policy work better rather than wholly criticizing it despite knowing that every country in one way or the other, even under the WTO rules, engages in industrial policy. Below is a summary of main point of the paper.

Chang argues for "selective industrial policy", which basically is a policy that deliberately favors particular industries over others, against the dictates of market, to enhance (not necessarily) efficiency and promote productivity growth. Almost all industrial policy measures involve selectivity and targeting; the real difference lies in the degree of targeting. A more targeted industrial policy would mean easier monitoring and lesser "leakages".

He argues that the state can sometimes “beat the market" because it designs policies based on a national and long-term perspective, rather than sectional, short-term perspective. This is close to the development experiences of Japan, South Korea, Taiwan, and Singapore in the post WWII period. [Rodrik also makes a similar argument for selective intervention to clear information externalities and coordination failures in the market. For instance Brazil directly aided its steel, aircraft and shoe industries (high levels of protection and public ownership, R&D investment and subsidized credit); Chile aided its grape, forestry, and salmon industries (R&D investment), and Mexico aided its motor vehicle and computer industries (ISI initially followed by preferential tariff policies under NAFTA)].

Chang shows evidence that industrial policy had been practiced for a long time, even in the existing bastions of free market economy. The US government ran a huge industrial policy-- between 1950 and 1980, 47-65% of national R&D spending was financed by the US government as against approximately 20% in Japan and Korea and 30% in Europe. The US and Britain had the world's highest levels of tariff protection during their respective catch-up periods (45-55%). The successful countries right now provided subsidies to promote targeted industries, set up state-owned enterprises or public-private joint ventures for risky projects and regulated FDI, among other measures. In the post-WWII period, Japan was the first country that used the term industrial policy (sangyo seisaku) to mean selective industrial policy.

According to Chang, industrial policy measures in East Asia included:

1. coordination of complementary investments (Big Push)
2. coordination of competing investments through entry regulation, "investment cartels", and (in declining industries) negotiated capacity cuts
3. policies to ensure scale economies (e.g., licensing conditional upon production scale, emphasis on the infant industries starting to export from early on, state-mediated mergers and acquisitions)
4. regulation on technology imports (e.g., screening for overly obsolete technologies, cap on technology licensing royalties)
5. regulation on FDI (e.g., entry and ownership restrictions, local contents requirement, technology transfer requirements, export requirements)
6. mandatory worker training for firms above a certain size, in order to resolve the collective action problem in the supply of skilled workers due to the possibility of "poaching" [It is like reducing information externalities by publicly investing in industries-oriented/job-oriented education.]
7. the state acting as a venture capitalist and incubating high-tech firms
8. export promotion (e.g., export subsidies, export loan guarantees, marketing help from the state trading agency)
9. government allocation of foreign exchanges, with top priority to capital goods imports (especially for export industries) and the bottom priority to luxury consumption goods imports.

He maintains that industrial policy cannot be measured purely in terms of financial transfers because the effect of many of industrial policies (especially at the sectoral level and the economy-wide level) are not quantifiable. Also, the impact of a country's industrial policy cannot be fully measured in few years because of "super-sectoral" policy measures that address issues like complementarities, linkages, and externalities-- all of these take years, even decades, to come to full shape. For instance, Korea's resurgence in steel trading took years after Heavy and Chemical Industrialization (HCI) was launched in 1973. Chang rejects the notion that the East Asian countries could have grown even faster if there were no industrial policies. He also dismisses the argument that East Asian countries were more productive because of culture (high savings rate, strict work ethic, high-quality bureaucracy).

These countries must have had some country-specific "countervailing forces" that were so powerful that they cancelled out all the harmful effects of market-distorting industrial policy and still generated the highest growth rates in human history (6-7% annual growth rate in per capita income over four decades). I find this highly implausible. Are these skeptics really seriously suggesting that, without industrial policy, these powerful countervailing forces would have made the East Asian countries grow at- what?-9%, 10%, or even 12%, when no country in history has ever grown at faster than 7% for an extended period, industrial policy or not?" [...] "Korea's savings rate on the eve of its economic miracle was barely 5% and started rising after growth took off. At the end of colonial rule, literacy rate in Korea was only 22% and its industrial base was smaller than that of Ghana. After 1950s, Korea and Taiwan did not get an exceptionally high amount of foreign aid.

He believes that industrial policy did work in East Asia and its relevance has not died yet.

If industrial policy is so bad, how is that in every era, the fastest growing economies happen to be those with a strong industrial policy- Britain during the mid-18th century and mid-19th century, the US, Germany, and Sweden during the late 19th and the early 20th century, East Asia, France, Finland, Norway, and Austria in the late 20th century, and China today.

Chang argues that industrial policy should be taken as a standard policy measure rather than an extreme argument intended to generate a fear of government takeover of industries. Rather than wholly rejecting or criticizing it, it is helpful to debate on how it can be improved and really targeted at reducing market inefficiencies. For this to happen, developing countries need the institutional reforms that would aid the objectives of a good industrial policy. This way industrial policy can be disassociated with past ISI policies , which did not produce as good a result in Latin America as the selective industrial policy produced in East Asia. In order for industrial policy to work, there has to be some experimentation at home (Chang calls it "trying at home"), i.e. policies should be tried at home rather than copying from somewhere else. Even if bureaucratic capability is weak, industrial policy can be tried, i.e. you don't have to wait for first-order conditions to implement industrial policy.

He opines that export-oriented industrial policy helps to inculcate better discipline in bureaucracy because the “objective, hard-to-manipulate” performance indicator is pretty much free of lobbying and special interest pressure, i.e. export performance indicators are less open to manipulation by the recipients of state support than domestic performance indicators.

Economic development is impossible without good export performance. He argues that the failure to promote enough exports is one of the reasons why Latin American stint with ISI was not successful as those in East Asia. Balance of payments could be a strong constraint to economic growth.

Even if a country can export some goods with comparative advantage, industrial policy is still needed because there might be other sectors that could turn out to be more favorable if productive capabilities are built in time (with state support). For long run growth, it is not enough to rely on comparative advantage-conforming industries. For instance, a small rise in wages, which in turn could be caused by rise in exports of narrow set of goods, could undermine the balance of an economy. Avoiding this would require upgrading from export industries to comparative advantage-defying industries, which requires even stronger industrial policy. Example: Heavy and Chemical Industrialization (HCI) program in South Korea. He thinks that globalization has not diminished the role of industrial policy as some form of tariff structure, however minimal, always exist in WTO rules.

Export policy would require a mixture of free trade, export promotion, and infant industry protection—all part of an industrial policy. He argues that many proponents of industrial policy do not fully appreciate how critical export is for the success of industrial policy, while many opponents do not fully appreciate how export success also requires industrial policy.

After over 8 years, where does AGOA stand?

Africa Growth and Opportunity Act (AGOA), signed in May 18, 2000, provides Sub-Saharan African exports (mostly textiles and apparel) duty and quota free entry into the US markets and also provides for trade facilitation and technical assistance to African producers. After more than eight years, how much has African countries actually benefited and if it is helping them achieve what AGOA was supposed to. Mwangi Kimenyi, Brookings Institution, argues that though trade volume has increased multiple folds, the AGOA's impact on stimulating growth and increasing employment have been limited. It is not good news since AGOA is usually touted as one of the best trade and investment strategies offered by US to the Sub-Saharan African countries. At present, 37 countries are AGOA-eligible.

What's the impact of AGOA? First, there is always an increase in volume of trade whenever there is free trade or trade under preferential trading agreements. The imports to US from Sub-Saharan Africa (SSA) increased by multiple folds-- in 2008, the US imported $81 billion of duty free goods from AGOA-eligible countries, up from $7.6 billion in 2001. Kimenyi argues that though there has been an increase in trade volume, the African countries have not been able to exploit fully the opportunities given to them by AGOA. The share of African countries' exports in global trade is very low.

In 2008 total apparel imports to the U.S. were valued at $93 billion, of which SSA accounted for $1.1 billion (1.26 % of the total market). In the same year, Bangladesh alone exported $3.5 billion worth of apparel (3.79 % of total market)—more than double the entire exports from SSA. Also of concern is that African exports under AGOA have declined in recent years. For example, African AGOA exports in 2004 and 2007 accounted for 54.5% and 36.5% of total exports to the United States respectively.

Also, AGOA has not fully helped the African countries diversify their production structure. Some of the goods that are exported now are the same covered under Generalized System of Preferences (GSP). Importantly, almost 96 percent of the exported items are energy related, which would have been exported anyhow due the continuing rise in demand for energy in the global market.

Of the AGOA exports, $52.8 billion of exports (95.7 percent) consisted of energy related products (mainly crude oil). Thus, the real benefits of AGOA to African countries are much lower than what aggregate numbers show—about $3.5 billion of exports.

He argues that since the African countries have been unable to exploit the opportunities provided by both GSP and AGOA, emphasis should be put on helping the countries overcome their trade-related shortcoming. Two important recommendations are:

-Cutting down the cost of doing business: SSA countries are not competitive because of a lack of infrastructure, ports, electricity; regulatory burden and licensing procedure. The Doing Business Report shows that the ease of doing business in SSA is the lowest when compared to other regions.

-Investing in value addition: Economic transformation is required for development and policies should be designed to help in diversification of production and export goods so that increased production also means increased value addition.

Other recommendations include simplifying the approval process (especially on health and safety standards while importing to the US); evaluating proposed preferences to less developed countries (providing similar access to other developing countries that are already established in the field destroy SSA investment and exports); revocation of status (investors might pull back investment if there is a possibility that a given AGOA-eligible country could be stripped off the AGOA benefits due to political reasons); harmonizing member positions (African countries should have a collective, concerted voice through the African Union so that they are well represented and well heard during trade negotiations).

A demand-determined economy

A country-specific policy package that recognises economies to be demand-determined would have the following components: (i) an expan fiscal budget, consistent with the rule that the overall deficit not exceed public investment; (ii) an accommodating monetary policy that tolerates moderate inflation in order to achieve higher growth by providing subsidised credit for poverty reduction programmes (the target could be that the real interest rate equals the sustainable growth rate of per capita income—the Golden Rule); and (iii) a managed exchange rate regime that seeks to promote exports and alter the relative price of tradeables and nontradeables without causing unmanageable inflation spirals.

That's from Degol Hailu and John Weeks on IPC's One Page#92. The point is that low income countries can implement counter-cyclical economic policies if they adopt a demand-determined economy framework instead of price-determined economy framework.

Quality of education and economic growth

Here is a short piece about why the quality of education matters more for growth than just quantity of education (high enrollment rates). The authors argues that this (quality of education) might provide answers to the Latin American puzzle-- despite high school enrollment (partly also due to quantitative goals set by MDG--to ensure universal primary education by 2015), why Latin American is lagging in terms of economic growth. Good quality of human resource with high cognitive skills matter more to economic growth than simple quantitative goals. Not a very surprising result but they do statistical tests to provide more validity to this line of argument.

What has been missing is a focus on the quality, rather than quantity, of education – ensuring that students actually learn. While Latin America has had reasonable school attainment, what students in fact know is comparatively very poor. Latin American countries have participated infrequently in worldwide student achievement tests, but their students always rank near the bottom of worldwide comparisons.

Source: Hanushek and Woessmann (2009b). Added-variable plot of a regression of the average annual rate of growth (in percent) of real GDP per capita in 1960-2000 on the 1960 level of real GDP per capita and average scores on international student achievement tests (mean of the unconditional variables added to each axis). Region codes: Asia (ASIA), Commonwealth OECD members (COMM), Europe (EURO), Latin America (LATAM), Middle East and North Africa (MENA), Sub-Saharan Africa (SSAFR).

As the figure makes patently clear, considering this low level of cognitive skills is sufficient to reconcile the poor growth performance of Latin America with outcomes in the rest of the world over the past four decades. Our interpretation is simple. Even though many things enter into economic growth and development, the cognitive skills of the population are extremely important for long-run growth.

The crucial missing link in explaining why Latin America went from reasonably rich in the early post-war period to relatively poor today is its low cognitive skills. […] Our results using the regional test data support the important role of cognitive skills in understanding Latin American growth. These test scores are statistically and quantitatively significant in predicting economic growth differences in intra-regional growth regressions. They increase the explanatory power of standard growth models considerably and render the effect of years of schooling insignificant. In sum, schooling appears relevant for economic growth only insofar as it actually raises the knowledge that students gain as depicted in tests of cognitive skills.

Why China is growing faster than India?

Why are China and India growing faster than other countries? Also, why is China growing faster than India? T.N. Srinivasan argues (via Chris Blattman) that it is because of:

First, productivity growth is king. Sustained growth in both countries comes from learning to make better things more efficiently.

Second, reforms stimulate productivity growth. In both nations, a period of intense economic and political restructuring (mostly towards markets) led to takeoffs in growth.

Third, the reforms followed major crises. In China, reform followed the failures of the Great Leap Forward and the Cultural Revolution, while in India it was the balance of payments crisis in the early 1990s.

So why did China take off sooner and faster than India? Because the crisis hit earlier. Today’s fruits of prosperity grew from the seeds of Mao’s disastrous policies.

Srinivasan asserts that in the future India has higher potential for higher growth than China does because (contingent on right reforms in India):

India is younger, more rural, and engaged in lower productivity activities. A shift into higher productivity activities will only accelerate their growth.India’s economy is more market oriented, has a more efficient financial sector, and more experience in domestic innovation and entrepreneurship. China has less room for improvement; the population is aging, is already better educated and healthier than India, and has less capacity to innovate. Growth will continue, but it may have peaked.

Interesting perspective!

Why decline in global trade is faster than decline in global GDP?

The IMF projects a decline in international trade of as much as 12 percent in 2009 in comparison to 6 percent fall in 2008. It all started with bursting of housing and asset markets bubble, which is not particularly related to international trade. However, with a financial crisis in the US, the world economy went in a downward spin, contracting global trade. Why would global trade, which has been growing on average 11 percent since 1957 as opposed to 4 percent growth of global output, collapse all of a sudden and inflict so much harm to major exporters? The ratio of fall in trade to fall in GDP has been 4:1 Economists and analysts hunt for the reasons (published in Spring 2009 edition of International Economy):

Barry Eichengreen, UC, Berkeley

He argues that we really don’t have an adequate understanding of the causes of collapse in world trade. However, few factors can be singled out.

1. The most important one is the disruption in global supply chain, i.e. something like a domino effect in the form of decreasing demand for goods from one country leads to decline in exports of final goods from another and further decline in demand for intermediate goods from another country and so on. The growth of global supply chains has magnified the impact of declining final demand on trade.
2. Another reason might be the disruptions to the supply of credit from international banks to some developing countries and industries.

Fred Bergsten, PIIE

He offers solutions rather than reasons for why trade declined more than GDP.

1. There should be new protectionist measures (G20 needs to honor this pledge). Competitive currency devaluation should be avoided.
2. Policy needs to correct large global trade and current account imbalances.

Gary Hufbauer, PIIE

Two reasons why developing world trade collapsed: prices and volume

1. Commodity prices have been volatile instead of being a shock absorber.
2. Exports volume is down because most of the developing countries export consumer goods, which has contracted severely due to global recession. He argues, “Any country that sees its exports drop less than 7 percent in 2009 can count itself lucky.”

Ronald McKinnon, Stanford University

1. Intensive trading of manufactures went down as people cut back on purchase of durables.
2. The credit crisis limited financing associated with international trade.
3. Forward exchange transacting became more difficult and expensive because of disruption in the foreign and domestic interbank markets. Traders found it difficult to hedge themselves from currency fluctuations.

Jagdish Bhagwati, Columbia University

1. He argues that drying up of financial credit is the main reason for decline in global trade. Btw, he refers to Naomi Klein as “a fount of many economic fallacies.”

Richard Erb, University of Montana

1. The decline in tradeables generally decline more rapidly than the demand for services during a recession.
2. The finanical crisis intensified this process.

Steve Hanke, Johns Hopkins University

1. World trade is elastic with respect to global GDP. So, when global GDP slumps, we should expect an outsized plunge in world trade. And, the panic of 2008 has intensified this process.

Marina Whitman, University of Michigan

1. It is because of a severe pull-back in financing added to—and interacting with—the global recession. Almost 90 percent of merchandise trade is dependent on trade finance.
2. Intra-firm trade slows down more than GDP during financial crisis of this kind because this kind of trading activity is hinged on financing.
3. Protectionist measures have so far had far less impact on the decline of trade than the other factors.

William Brock, Former US Trade Representative

1. Recession led to less money available for investment, less capital to finance new technologies and greater production domestically, and less financing for exports or imports.
2. He argues that a large part of the answer lies in the habit of making things worse (politically by engaging in protectionist measures) when times are tough.

Tadashi Nakamae, Nakamae International Economic Research

1. There are multiple transactions involved in completion of a final good. When demand for that good falls, then the whole chain of transactions collapses, thus reducing world trade drastically. i.e. the fall in global trade is greater than the fall in global GDP.
2. World trade is collapsing because American consumers are not spending, spreading large ripples across the globe.

Sylvia Ostry, University of Toronto

1. We really don’t know what caused this because we have a new trading system and no data that tracks multiple trading of the same goods across borders.
2. It also could be a widespread recession, a shortage of trade finance, and a rise in protectionism (although Bhagwati argues that there is no evidence that protectionist moves/threats so far have had any dent on trade flows).

Bernard Connolly, Connolly Global Macro Advisers

While there is no direct evidence that protectionist measures are the main cause, Conolloy argues that “protectionist measures, overt or covert, were one.”

1. Reduced trade finance was another reason.
2. Misallocation of resources and brining forward future spending.

Andrew Szamossezgi, Capital Trade

1. Decline in manufacturing output has exceeded the decline in global GDP.
2. Trade has suffered due to lowering of inventories and an effort to conserve cash.
3. Disruption in global credit markets has restricted flows of credit needed to support trade.
4. Commodity prices are falling and inventories of such items are piling up in ports.

Clayton Yeutter, Hogan & Hartson

1. Decline in demand globally and businesses focusing more on domestic markets.
2. Credit crunch hit trade financing.
3. Risk, uncertainty and rising volatility (exchange rate) pulled back commerce.
4. Protectionist measures in stimulus packages shrunk trade.

Norbert Walter, Deutsche Bank Group

1. The current economic crisis is hitting countries all over at the same time, magnifying the decline in trade.
2. Destocking of commodities, which were stocked heavily when prices went up in 2007 and 2008, created massive downturn in trade.
3. The fall of Lehman Brothers brought money markets and the markets for short-term corporate credit to standstill.

Nicolas Veron, Bruegel

1. Trade shock is a direct consequence of the events that wrecked the financial system because finance and trade are so deeply interdependent that it is impossible to consider one without the other.

William Caldwell, Advanced Cell Technology

1. International production sharing or the internationalization of manufacturing supply chains is a major part of the story. When demand for a product shrinks, the multiple trade flows are terminated; not just the final trade flow.

Paul Romer argues for “charter cities”

Paul Romer argues for a new method to alleviate poverty. It is based on stimulating economic growth (thus reducing poverty overall) by developing “charter cities”, which is a city-scale administrative region governed by a coalition of nations and has a rules-based system that will attract investors and people who want to live in a stable, secure and progressive society. It is like creating commerce hotspots and stable (rules-based) cities like like Hong Kong (administered by British until 1997) or several key costal hot spots like in China. He argues for creating new cities where people can go to escape from bad rules and governance and opt in to new and better ones.

From TED blog:

He shows a picture from NASA of the Earth at night, clearly showing the electric lights of cities and town. He points out that North Korea looks like a black hole compared to neighbors, and reminds us that North Korea and South Korea began identically but made choices that led to very divergent paths. He points to the Caribbean. He shows how dark Haiti is compared to the Dominican Republic and that they're both dark compared to Puerto Rico. Haiti warns us that rules can also be bad when governments are weak, as opposed to the strong government of North Korea.

Romer asserts that we must preserve choices for people and operate on the right scale. A village is too small and a nation too big. Cities give you the right balance. The proposal is he conceives of is a charter city with investors to build infrastructure, firms to hire people and families who will raise children there. All he wants is some good rules, uninhabited land and choices for leaders, which he thinks should translate to partnerships between nations.

I wonder how the issues related to sovereignty and occupation would be resolved with this new model. Also, if implemented, for how long will this model, which seems more or less like an export-based or trading hub model revolving around SEZs last? Everything is hinged upon having a political will and consensus, which by the way are the most difficult things to have in most of the developing countries. If it were so easy, then aid would have worked better, leaders would have been more responsive to their voters than to donors, governance would have improved, the probability of conflicts and coups would have decreased drastically, market-friendly policies would have actually been implemented in reality, and a democratic, people-centered process have flourished. There would be no need for any special cities with special facilities and characteristics.

More about Romer and his new initiative here.

Sticky inflation and policy options for Nepal

In my latest op-ed, I discuss why general price level is so sticky in Nepal and why inflation rate is not fully consistent with the growth rate in money supply (M2). I argue that higher inflation rate in the Nepalese economy is not due to demand side factors but because of supply side factors, mainly supply bottlenecks. There is little the central bank can do without severely disrupting economic activity, which has been at a very low level. In order to tame down sticky inflation at high levels, the government has to use political, regulatory, and diplomatic means at its disposal.

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Sticky inflation & policy options

The inflation rate right now is around 13 percent. The government plans to bring it down to 7 percent this fiscal year. With an aim to attain this target, the central bank also announced monetary policy immediately after the finance minister presented this year’s fiscal budget. It should be noted that the planned policies of the government (and the central bank) to bring inflation rate down by about five percentage points in a year are not fully clear and so far have failed to convince investors that they have necessary tools and plans to meet the target. The factors that are causing unabated rise in general price level are supply side and there is very little the central bank can do given the nature and causes of rising general price level, which appear as sticky as wages are.

Let’s recall significant inflation peaks and troughs and associated money supply in the past. In the last five decades, the highest inflation rate—measured by consumer price index (CPI)—of 19.8 percent was recorded in 1974. In 1986 and 1992, the inflation rate was 18.9 percent and 17.1 percent respectively. The growth rate of M2, a broad measure of money supply and a key economic indicator used to forecast inflation, was 17.1 percent in 1974, 19.4 percent in 1986 and 20.7 percent in 1992. The lowest inflation rate of negative 3.1 percent was recorded in 1976 with growth of M2 approximately 28.9 percent. In the past eight years, the highest inflation rate of 7.6 percent was recorded in 2006 with a growth of M2 equal to 14.7 percent. Meanwhile, the lowest inflation rate in the past eight years was 2.5 percent in 2000 with a growth of M2 equal to 18.9 percent. Nepal has been facing inflationary pressure since the third quarter of FY 2007/08. The average annual percentage growth in inflation rate between 2000 and 2007 was 5 percent. It was 7.7 percent in 2007 with growth rate of M2 equal to 18.6 percent.

Note that in an economy like ours where economic and financial institutions are just starting to take shape coupled with substantial lags in policy implementation, it is not surprising that the trend in inflation rate is not fully consistent with growth in money supply. This means the factors causing rising price level are outside the boundary of traditional monetary instruments at the disposal of the central bank. The inflation rate of approximately 13 percent at present is the highest in this decade and, importantly, out of sync with monetary and exchange rate policies. What raises eyebrows is that the price level in Nepal is not consistent with the one prevailing in the Indian economy. The price level in Nepal is supposed to move in tandem with that of the Indian economy mainly because of close integration of the two economies, fixed exchange rate between Indian and Nepali currency and easy currency convertibility in the Nepali market.

In the previous years, the price level was not sticky as it is right now. The high inflation rate in 1974 was caused by global fuel crisis in the 70s but it quickly plunged down as fuel prices stabilized. Similarly, the rise in price level in 1992 was primarily due to a surge in investment following liberalization of the economy under a new industrial policy. Again, price level quickly fell down in the following years. This time, the story is different. Initially, domestic prices shot up due to high global food, fuel and commodity prices and an intensification of domestic supply bottlenecks in the beginning of 2008. Despite decline in global food, fuel and commodity prices, the general price level in Nepal is still on the rise. What could be the cause(s)?

In the past five years, gross consumption on average has been 90 percent of GDP and it has not changed radically. So, its pressure on general price level is more or less the same in the past several years. Similarly, investment level in the economy is also not increasing as alarmingly as price level has. Furthermore, the changes in imports and exports are also not as dramatic as the rise in price level. This means that the continuing rise in prices cannot be fully explained by demand side factors.

It appears very likely the main driving force behind rising price level is supply bottlenecks. Some studies reported in the media indicate that hoarding and black marketeering is contributing 30 percent to the rise in price level. Similarly, stockists and wholesalers are contributing 20 percent, bandas and strikes 10 percent while export hurdles from the Indian side are contributing 40 percent. All of these factors have created supply shock in the domestic economy, causing prices to spiral up quickly and remain sticky at a high level. For instance, transport obstructions and strikes hinder supply of essential goods and commodities, leading to short-term shortage and quick rise in prices. Note that between January and July 2009 alone, there were 612 transport obstructions and closures in different parts of the country.

It is ironic that despite being a monetary variable, the solution to rising inflation rate in the Nepali economy right now is beyond the realm of monetary instruments at the disposal of NRB. The central bank has already done what it could do (the NRB kept cash reserve ratio (CRR) and bank rate unchanged at 5.5 percent and 6.5 percent respectively) without severely disrupting economic activity. Even if it engages in aggressive open market operations, the supply side constraints won’t be relaxed easily.

The spiraling price level has to be checked and dragged down through regulatory, political and diplomatic means. First, it is a collective responsibility of all the political parties to forge a consensus in discouraging road blockades, the most popular form of protest against whoever is governing the country. This would help smoothen supply and control short-term price volatility in local markets. Second, the government has to aggressively use its regulatory power to raid shops and castigate wholesalers and retailers that are deliberately holding back inventories and artificially jacking up prices. It could also engage in rationing and reducing import taxes on essential goods that command more weight in the basket of goods and services consumed in the economy. Third, the government has to pursue diplomatic means to convince the Indian government not to ban exports of or impose high export tax on essential items that are widely used in Nepal. Prime Minister Madhav Kumar Nepal should raise this issue with his Indian counterpart during his trip to India in two weeks.

The rising price level is eroding purchasing power of people and is making them poorer in real terms. To restore investor confidence in the economy, controlling rising inflation rate is essential. And, since there is little the monetary authorities could do, it is up to the coalition government and the opposition parties to find ways to control rising prices because the causes clearly are supply side and quick solutions lie in how well our politicians and policymakers use political, regulatory and diplomatic means at their disposal.

Financial crisis, globalization and South Asia

Here are the main points from Ejaz Ghani’s presentation:

• Foreign capital inflows—remittances, international syndicated bank lending, private capital investments, and bond issues—to South Asia had surged in recent years, but collapsed in the aftermath of the crisis.

• South Asia, even with lower capital flows, will suffer less compared to other regions because of its particular features because (i) South Asia’s investments are largely driven by domestic savings, (ii) South Asia is unique in attracting capital flows that are less volatile. The region relies more on remittances inflows than for example portfolio flows and bank loans.

• Given the high domestic savings and less dependence on volatile capital inflows, South Asia is likely to bounce back faster.

• (This is probably the most most surprising one for South Asia) Given that the current crisis is synchronized and global in nature, there is less room for an export led recovery.

• South Asia’s economy is largely service driven.Service exports are less volatile compared to goods exports. Globalization of services is still at an early stage.

• A service-led export growth strategy will likely enable South Asia to recover quicker and sustain high growth over the medium term. But not all countries will benefit as there is tremendous diversity within South Asia. (Nepal is clearly the nation which will not see the light of service sector-led growth as this sector is yet to emerge!)

• South Asia is the largest net importer of commodities (food, metal, and oil) in relation to GDP. The sharp decline in commodity prices, especially oil could reduce large commodity-related subsidies. Such savings could be used to finance discretionary fiscal stimulus.

• Recovery will depend on the composition of capital flows, trade, and economic management.

(Usually, when ‘South Asia’ is studied, researchers look at India, Sri Lanka, Maldives, Pakistan and Bangladesh only. They forget about Nepal, Bhutan, and Afghanistan). So, the conclusions and recommendations of these kind of study might not necessarily apply to the neglected economies. Btw, these are also the most poorest ones in the world.)

Diarrhea and death in Nepal

After a field visit to Jajarkot, a diarrhea affected rural village in Nepal where more than 200 people have died in three months, doctors from Nepal Medical Association write:

Dali. A women fell ill due to diarrhoea in a village six hours' walk from the Dali health post. Her daughter, who was working in the field, came back home due to diarrhoea and found that the mother was sick. None of the villagers helped to take her and her mother to the health facility. The mother died. The villagers locked the daughter in a dark room with husk and covered her with a blanket and took the mother to the river to perform the last rites, a two-hour walk from the village. Across the river lies Rari, Rukum where a health camp has been set up to tackle the epidemic. After the mother had been cremated, policemen saw the villagers putting out the fire. They asked them why they were putting out the fire. The villagers answered that they were saving wood as another person was ready to be cremated in the village. Luckily, the police rushed to the village and found the daughter in the dark room barely breathing and rescued her. While running to the health camp, the policemen said that the girl's blanket was drenched in stool which was falling in drops. The girl received treatment and survived.

Dhime. The team in Dhime heard that Gyanendra Sharma, a leper who had been previously kept at the District Hospital at Khalanga for one year to treat his rotting foot four years ago, was suffering from diarrhoea. On reaching the house to rescue the old man, volunteers saw no one in the house. They found the old man in a dark room, naked and covered in faeces. They asked the family to clean him up so that they could rescue him; the family refused and he died.

Seriously, where is all the aid money on health services going? Also, where are all those NGOs and INGOs at this time of crisis? Importantly, what the hell was the government doing in all these years? It is pity that in this century, people die of diarrhea at the rate of 100 per month. Its not because they don’t have clean water but because they are not educated well enough to use clean water, practice proper sanitation measures, and dispel some untrue, self-perpetuating health-related fears.