Global trade forecast: Trade to expand by 6.5 percent in 2010

The WTO has estimated that global trade would increase by 9.5 percent in 2010. Last year, trade plunged by 12.2%, the sharpest decline since the WWII. The last time global trade volume fell were in 1975 (-7%), 1982 (-2%), and 2001 (-0.2%). Trade in US dollar terms declined even higher (-23%) than in volume terms. Meanwhile, global output fell by 2.3% last year.

 

Volume of world merchandise exports, 1965-2009 (Annual % change)

Exports from developed countries are expected to increase by 7.5% in volume terms. Meanwhile, shipments for the rest of the world are expected to increase by 11%. This projection is based on the assumptions that global GDP growth would be 2.9% at market exchange rates and the will be stability in oil prices and exchange rates. The WTO warns that a 9.5% growth rate for trade is not sufficient to attain pre-crisis levels of trade volume next year. But, two years of growth at the same rate (12.2%) would surpass the peaks of 2008 for developing countries. The developed countries would require three years of growth at the same rate (9.5%).

 

Despite the decline in trade and a severe recession, governments around the world, in most cases, refrained from imposing trade barriers. The WTO warns that persistent unemployment might intensify protectionist pressures.

The main reason for the sharp fall in global trade was a contraction in global demand. The complex web of supply chains led to a synchronized drop in trade across countries and regions. The source of all these: global recession triggered by the sub-prime mortgage crisis in the US. A fall in wealth caused households and firms to cutback expenditure on consumer durables and industrial machinery.

 

Ratio of world exports of goods and commercial  services to GDP, 1981-2009 (Index 2000=100)

What could dampen the optimistic trade forecasts? The WTO lists increases in oil prices, appreciation or depreciation of major currencies, and additional adverse developments in financial markets as the possible factors that could dampen global trade. But, if the unemployment rates fall quickly, trade could recover faster than expected. [This is not going to happen though, according to economists such as Krugman and Stiglitz because the stimulus packages around the world have not been in proportion to the severity of the crisis.]

Q&A: Fixed Exchange Rate between Nepali Rupee (NRs) and Indian Rupee (IRs)

Following the previous op-ed on the pegged exchange rate between Nepali rupee and Indian rupee, here are some of the questions/ comments raised by readers. The replies are very raw!

Question 1: " Devaluation – a deliberate downward adjustment in the official exchange rate – will reduce the currency’s value. By making exports less expensive, and discouraging imports, devaluation can indeed help reduce current account deficit." less expensive or more expensive ??

Adnan: Once you devalue, one Indian rupee now buys more of Nepali rupees. The exports are now relatively less expensive for foreigners. And imports more expensive for domestic users as it now takes more Nepali rupees to buy one Indian rupee.

Chandan: In other words, devaluation would increase the demand of Nepali goods (i.e. exports less expensive), decrease demand of Indian goods (decrease imports) = net effect would be a positive effect on balance of trade and potentially on balance of payments as well if negative net transfers are not higher than positive net exports.

Question 2: I would think that 'higher interest rates' will increase foreign investment.I agree with the idea of “growing” itself out of this crisis...Also focusing on areas where Nepal has comparative advantage will help.

Adnan: My own thinking has been, for some time now, that money attracted at higher interest rates cannot be loaned at lower interest rates. At the end of the day, any govt wants to provide affordable financing to its small businesses or consumers. In a small and poor country like Nepal, there aren't that many opportunities for businesses to overcome the high hurdle rate and make profit.

One argument can be that govt should subsidize the interest payments which will be "due" to these investors and offer cheaper loans to struggling industries or key sectors like agriculture. But this approach also comes back to bite the govt. Those subsidies will have to be financed by raising taxes. But if the businesses will be taxed through the nose to fund the subsidies, less incentive for businesses to make profits and ultimately less incentive to borrow money from bank. Ultimately, govt do not need to attract those higher interest rate investments. One has to assess the risk appetite of the domestic economy.

In other words, some of these countries may not have the capacity to absorb all these investments. 

Chandan: Usually, high interest rates entice "hot money", not foreign investment....

Question 3: What happens if Indian currency switches to fully convertibility ? Government of India is gradually planning to do that ...

Chandan: There are talks about India switching to full currency convertibility. This issues emerged after an Indian mobile company was unable to buy a South African telephone firm primarily due to restrictions on currency convertibility. The Indian finance minister said that they will slowly move in that direction. It will take some time before that happens. Meanwhile, Nepal can still opt to stay with the peg. I think the Indians will have no problem with that. :)

Question 4: Great stuff - though one thing is confusing me. The Marshall-Lerner Condition? Can you help me out?

Chandan: The sum of price elasticity of exports and imports seems to be definitely greater than 1. It means that devaluation might actually improve BOT and, given the conditions I mentioned above, possible BOP. So, M-L condition is satisfied. But, it says nothing about inflation, which is already high. (The J-curve effect also looks applicable in this context.)

Exchange rate of NRs vs IRs: Stay the Course

I co-authored my latest piece with Adnan. It is about the issues surrounding balance of payments deficit and the pegged exchange rate between Nepali rupee (NRs) and Indian rupee (IRs). Looking at the options available to the Nepali central bank, neither revaluation is good nor devaluation is good. Given the dire state of the Nepali economy, sticking with the existing peg is the best option. Here is an additional blog post on the issue.

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Exchange rate: Stay the course

ADNAN KUMMER and CHANDAN SAPKOTA

There are rumors about potential change in exchange rate of Nepali rupee (NRs) with Indian rupee (IRs), with which Nepal has pegged its currency at a rate of NRs 1.60 equal to IRs 1.00 since 1993. While some analysts are wondering why Nepal’s currency cannot be changed, or appropriately revalued, others are calling for devaluation at the rate of NRs 2.00 equal to IRs 1.00. Some people say that change in exchange rate is essential because the existing peg set almost two decades ago does not reflect changing trading environment and widening productivity gap undergone by these economies. Others point out a little more convincing situation relating to soaring trade deficit with India and the need to contain it.

The rumors about possible change in exchange rate picked up much steam since the economy experienced approximately Rs 20 billion hole in the balance of payments (BOP) in the first half of this fiscal year. To douse potential speculative attack on the currency, the finance secretary and the finance minister had to put out statements saying that exchange rate will not change as of now. Even the central bank is being pressured to come up with a formal statement. Given the state of our economy right now, staying the course, i.e. sticking with the existing exchange rate peg, seems to be the best option.

The most pressing macroeconomic problem right now is to find ways to narrow current account deficit and close the hole in BOP. The surge in imports and decline in remittances and exports have triggered this unfortunate situation. A revaluation of the currency is out of question because it would not address the core problems. In fact, it would widen current account deficit as imports from India become relatively cheaper to domestic consumers. Meanwhile, imports of Nepali items by Indian consumers would become expensive. It makes sense to revalue Nepali rupee against the Indian rupee if the demand of Nepali export items by Indian consumers is inelastic, i.e. no matter by how much prices change, Indian consumers would demand Nepali items. This is clearly not the case. In fact, the Indian market already has close substitutes of almost all the items Nepal exports.

Devaluation seems to be the most favored option among analysts of the Nepali economy. At present, it is definitely a better case than revaluation but a weaker case than status quo. There are short-term gains and long-term dangers associated with devaluation. Devaluation – a deliberate downward adjustment in the official exchange rate – will reduce the currency’s value. By making exports less expensive, and discouraging imports, devaluation can indeed help reduce current account deficit. If things turn out this way, then devaluation is not bad for the Nepali economy.

However, once the monetary and trade engines set in motion, it does not stop there; devaluation is not devoid of dire economic consequences. First, by increasing the price of imports and stimulating demand for exports, devaluation potentially increases economic activity but aggravates inflation. But, high inflation rate will force government to raise interest rates to control spiraling price rises, which is already hovering around 12 percent in Nepal.

As a consequence, the higher interest rates will cause a slower rate of economic growth by discouraging consumption and reducing investment by firms. Moreover, once the inflation genie is out of the bottle, we will have to let go a lot of economic growth before inflation can be contained again. The story of inflation is a little more complicated than what some are arguing simply that devaluation will result in a short-term high-inflation, but a long-run low-inflation. Economists and policymakers would have a simpler life if it was this straight-forward.

It makes sense to revalue Nepali rupee against the Indian rupee if the demand of Nepali export items by Indian consumers is inelastic, i.e. no matter by how much prices change, Indian consumers would demand Nepali items. This is clearly not the case.

There are a number of factors that affect inflation. We need to figure out what will be the greater source of inflation after devaluation: Demand-pull or cost-push inflation. Given such a high rate of unemployment and excess capacity in the economy, it is unlikely that inflation will come from the demand side. Moreover, if the demand is relatively inelastic in the export sector—which seems to be the case if we look at the level of exports to India in the past several years—the increase in volume of exports will be rather small. Instead, a greater fall will occur in the total value of exports. This avails no effective solution in addressing the pressing macroeconomic challenge.

A greater likelihood is that more inflation will creep into the economy from the supply side, both imported and domestic. Though it has changed a little bit recent years, historically, inflation in Nepali economy has followed the inflation pattern in the Indian economy. The increase in the price of imported goods and domestic supply constraints—both production-related and nonproduction related—will cause cost-push inflation. Note that Nepal imports almost 60 percent of total imports from India. According to NRB, the wholesale price inflation increased by almost 19 percent compared to 10.1 percent a year ago. Moreover, the exporting firms, for their part, now will have less incentive to cut their costs as devaluation will make their products more competitive in the export sector. Hence, in the long-run, both costs and inflation will increase. Inflation coming in from the supply side is sure to have long-term effects, and not just short-term. This will also undermine investor confidence in Nepal’s economy and diminish the ability to attract foreign investment.

With reserves to fund more than six months of imports, the central bank can comfortably sterilize pressure on the Nepali rupee. Generally, the IMF recommends reserves that can fund three months of imports. Right now, we are better off staying the course, i.e. no change in the exchange rate.

To address the current account deficit, which has deteriorated by around 245 percent in the first half of this fiscal year, Nepal should aim to “grow” itself out of this crisis rather than through currency manipulation. How? For the short term, one possible way is to make Nepal Tourism Year 2011 a success and generate substantial foreign exchange to ward off the pressure from surging imports and receding exports. Also, increasing price and quality competitiveness of Nepali goods will help increase exports. Meanwhile, increasing remittances inflow would provide a badly needed band aid to the economy.

The central bank has a very difficult task ahead. It has to rein in rumors about change in exchange rate, tame double-digit inflation, tighten liquidity in the real estate and ease in productive sectors, and effectively sterilize any pressure on the Nepali rupee. It has to take very cautious and pragmatic steps. In terms of NRs exchange rate with IRs, staying the course is the best option for now.

(Kummer is a graduate student at Johns Hopkins School of Advanced International Studies & Sapkota is a Junior Fellow at Carnegie Endowment for International Peace.)

[Published in Republica, March 23, 2010, pp.6]

Robert Wade on Industrial Policy

Duncan Green summarizes Wade's argument on industrial policy, particularly the distinction between 'leading the market' and 'following the market':

Leading the market is South Korean style picking winners – we want a steel or chip industry, so we’re going to spend big time and just make it happen. That worked in the Korean case, but has failed in many others. Following the market, on the other hand, is a much less risky form of industrial policy, based on systematically ‘nudging’ firms to upgrade their technologies through incentives, performance requirements, or the state playing a brokering role putting firms in touch with foreign investors. Robert saw this as a third way (sorry) between the command and control of South Korea, and the passive laissez faire of the traditional World Bank view that governments should stick to sorting out the ‘enabling environment’ of property rights and keeping the bureaucracy in check. Robert held up Taiwan as a model of successful following-the-market type industrial policy.

Barry Eichengreen on the next MD of the IMF

Barry Eichengreen argues that selection of the next managing director of the IMF should be based on merits, not geographic location.

The obvious choice is Asia, home to the most dynamic emerging markets. It is the region to which the world’s economic center of gravity is shifting. If you ask Asian leaders what would make them consider again approaching the Fund after their traumatic experience with IMF “assistance” in 1997-1998, they will answer: an Asian managing director.

In fact, this is precisely the wrong way to think about the problem. The IMF’s problem in the past has been parochialism and lack of accountability. The best way to ensure that the Fund remains open to new ideas is by selecting the person with the best ideas to lead it. The best way to ensure that the IMF’s management is accountable to all of its governmental shareholders is to prevent the top job from becoming the sinecure of any region, whether Europe or Asia.

The next managing director should be selected on the merits, not on the basis of nationality. There should be an open competition, in which the best candidate wins on the basis of his or her ideas.

The next managing director should be selected on the merits, not on the basis of nationality. There should be an open competition, in which the best candidate wins on the basis of his or her ideas.

Asia has plenty of competent economic officials who might be considered as the next managing director of the IMF. But just because they are Asian is not reason enough to select them.

R.I.P. GPK!

Girija Prasad Koirala: A very important Nepali statesman who became prime minister for four times, supported for free press and liberal economic policies, convinced the Maoists to join democratic process thus playing a crucial role in ending the decade long civil war, staunchly opposed the Royal coup, lead the country during the immediate transition from autocratic Royal regime to a republic secular nation, and so on… passed away yesterday. R.I.P. GPK!

Obituaries here, here, here, here, here and here. Here is a piece about economic reforms during GPK’s time. His life in pictures here.

List of RTAs in the World (as of 2010-3-20)

 

Download it from here (PDF). I compiled it from the WTO website.

Daron Acemoglu profiled in F&D magazine

An interesting profile of Daron Acemoglu in IMF's Finance & Development magazine:

Governments are often barriers to the functioning of markets, but if you really want markets to function you need governments to support them—with law and order, regulation, and public services.

“We have done a lot of empirical work that shows a very clear causal link between inclusive economic institutions—those that encourage participation by a broad cross section of society, enforce property rights, prevent expropriation—and economic growth,” Acemoglu asserts. “The link to growth from democratic political institutions is not as clear.”

The textbook contends there was no sustained growth before 1800, first, because no society before that date had invested in human capital, allowed new firms to bring new technology, and generally unleashed the powers of creative destruction; and second, because all societies before 1800 lived under authoritarian political regimes. And economic takeoff started in western Europe because international trade rose after the discovery of the New World and the opening of new sea routes. The trade uptick boosted commercial activity and vested more economic and political power in a new group of merchants, traders, and industrialists, who then began to operate independently from European monarchies.

There will be three obstacles to growth under authoritarian regimes: there are always incentives for such regimes to be even more authoritarian; these regimes tend to use their power to halt Schumpeterian creative destruction, which is key to sustaining growth; and there is always infighting for control of authoritarian regimes, which causes instability and uncertainty.

“Dysfunctional societies degenerate into failed states,” asserts Acemoglu, “but we can do something about it. We can build states with infrastructure and law and order in which people are confident and comfortable going into business and relying on public services, but there is no political will to do that. You would not need armies to implement such a scheme—just a functioning bureaucracy to lay down the institutional foundations of markets.”

Hunger in the developing world after the crisis

Food and economic crises increased the number of hungry people to one billion in 2009.

Reasons: people's inability to afford food due to high prices and a slightly low harvests

 

Solutions:

In the medium and long term, the structural solution to hunger lies in increasing agricultural productivity to increase incomes and produce food at lower cost, especially in poor countries. The importance of longer-term measures is evidenced by the unacceptably high number of people who did not get enough to eat before the crises and are likely to remain hungry even after the food and economic crises have passed. In addition, these measures must be coupled with better governance and institutions at all levels.

Real Exchange Rate and Economic Growth

There is good reason and much evidence to suggest that the real exchange rate matters for economic growth, but why? The "Washington Consensus" (WC) view holds that real exchange rate misalignment implies macroeconomic imbalances that are themselves bad for growth. In contrast, Rodrik (2008) argues that undervaluation relative to purchasing power parity is good for growth because it promotes the otherwise inefficiently small tradable sector. Our main result is that WC and the Rodrik views of the role of misalignment in growth are observationally equivalent for the main growth regressions he reports. There is an identification problem: Determinants of misalignment are also likely to be independent drivers of growth, and these types of growth regressions are hard-pressed to disentangle the different channels. However, we confirm that not only are overvaluations bad but undervaluations are also good for growth, a result squarely consistent with the Rodrik story but one that requires some gymnastics from the WC viewpoint. 

Source: IMF WP 10/58

Constraints on Nepal Tourism Year (NTY) 2011

In my latest column, I look at constraints on making Nepal Tourism Year (NTY) 2011 a success. I am a little bit skeptic if Nepal would be able to draw in a million visitors in 2011, given the unaddressed constraints as of now. I hope my prediction is wrong and at least one million tourists visit Nepal in 2011. For my previous piece on Nepal’s tourism industry, see this. For an amazing promotional video of NTY 2011, check this out.

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Constraints on NTY 2011

With the aim of attracting one million tourists, the government announced its intention to launch the Nepal Tourism Year (NTY) 2011 campaign last year. Finally, the heat is picking up this year. The major parties—yes it includes UCPN(Maoist) as well—have promised to not resort to bandas, which severely crippled the tourism industry after 1999. The last time such a mega campaign was launched was in 1998 when around 464,000 tourists visited Nepal, earning US$24.8 million in revenue. The Nepali tourism industry has come a long way since 6,179 visitors visited Nepal in 1962. It increased to 509,752 (378,712 by air and 131,040 by land) in 2009.

The government is planning to attract 40 percent of the targeted visitors from India and China. Considering the constraints to increasing the number of tourists and per capita visitor spending, it seems unlikely that one million tourists will visit Nepal in 2011. Getting more visitors than in 2007 and more receipts per visitor than in 2003 would require timely response to containing the constraints ailing the travel and tourism industry. Furthermore, to make it relevant to the public, the government should try to make the outcomes of this national campaign pro-poor, i.e. making sure that the poor people reap benefits of NTY 2011.

A healthy tourism industry is the need of the hour for the entire economy. Due to receding exports, surging imports and rapidly declining remittances, balance of payments (BOP) is in negative territory. Since there is little hope for increasing exports and growing remittances at pre-crisis rate, increasing revenue from tourism industry could be an alternative (but temporary) fix to deteriorating BOP situation. Importantly, revival of this industry would have a strong positive bearing on economic growth as agricultural and manufacturing sectors are underperforming right now. If the constraints are appropriately addressed in time, it could lead to promotion of small-scale local enterprises and increase in low- and medium- skilled jobs.

There are multiple constraints to growth and competitiveness of the travel and tourism industry. The major ones are weak regulatory regime, inadequate and poor infrastructure, frequent and fickle bandas, labor strikes, and disincentive-increasing factors such as pollution, garbage disposal and uncontrolled ancillary service-related activities within the travel and tourism industry.

There constraints are strongly reflected in the latest Travel & Tourism (T&T) Competitiveness Report. Nepal’s T&T industry’s competitiveness is weak, ranking 118 out of 133 countries. Particularly, Nepal ranks 131 in visa process, 103 and 125 in ground transport infrastructure and road quality respectively, and 114 in air transport. These are long running problems of the T&T industry. For decades, Nepal has been relying on a single international airport, which is now expected to grace one million visitors in 2011. The national flag carrier has been in terrible shape for a long time: It is bankrupt and lacks aircraft. Similarly, the condition of domestic airports is unsatisfactory.

Frequent bandas and labor strikes are the bane not only to the manufacturing sector but also to the T&T industry. Pictures of tourists ferrying luggage to hotels (and to airports) in rickshaws not only discourages potential visitors but also compels existing tourists to cut short their stay in Nepal. One can only hope that the political parties will keep their promise of making 2011 banda free.

Meanwhile, ad hoc, inconsistent and astronomical price of taxi ride from the airport to hotels is a huge incentive-killer. The moment tourists get out of Tribhuvan International Airport, they are greeted by cunning taxi drivers who charge ridiculously astronomical amount for a ride to hotel that is less than two kilometers away. One of my friends who recently visited Nepal argued that the cost of taxi ride from the airport to a nearby hotel was higher than in his native country.

The recurring power crisis has its own legacy. No one knows how we are going to provide uninterrupted electricity and internet access to visitors. Tourists definitely would not like to enjoy their holiday in dark! Additionally, stinking garbage in tourist hotspots deters visitors, leading to a potential decline in business activity in local economy. Among other issues, failure to manage garbage disposal in the Kathmandu Valley and other major urban areas is encouraging tourists go to rural areas, which are relatively cleaner. This has two disadvantages. First, the longer tourists stay in urban areas, the better it is for the urban economy. With increasing migration of rural unemployed youths to urban areas, it is in the country’s interest to increase per capita visitor spending in urban areas so that more jobs are created in places where it is needed the most. Second, the more tourists frequent rural areas, the less would be per capita visitor spending. This problem will get only worse because the only landfill site for Kathmandu Valley—Aletar landfill at Okharpauwa in Nuwakot district—is going to be full in six months, according to Kathmandu Metropolitan City office.

These constraints are not insurmountable. With strong political will, financial backing, and good planning, we can overcome them on time. Note that the number of visitors is correlated with the attractiveness of packages and incentives offered by the T&T industry. The private sector and the government should attempt to make Nepal’s tourism sellable in the international market. What kinds of competitive packages can Nepal provide? How would it be different from the ones provided by our neighbors? What are the advantages to visitors? Honestly and correctly answering these questions would also give clues to contain the constraints.

Irrespective of whether or not the constraints are addressed on time, it is in every citizen’s interest to promote NTY 2011 and try to make it a success. Good luck to all of us!

[Published in Republica, March 14, 2010, pp.6]

Nepal Tourism Year 2011 preview

Sub Saharan Africa rising!

Source: The Economist

The global recession was slow to reach Africa, but the continent did suffer from dampened demand for its commodities exports and from shrunken venture-capital funds. Economies of countries south of the Sahara together grew by less than 2% in 2009. But recovery is coming sooner than expected. Sub-Saharan Africa's economy is forecast to grow overall by 4.5% this year, in part because of the economic recovery in Asia. This is still slower than the 6% that many development economists reckon is the minimum to enable countries with rapidly increasing populations just to stand still.

 

 

End of an era in finance…

Dani Rodrik argues that the IMF’s new found philosophy that 4 percent inflation rate and capital controls are not bad policy tools marks an end of an era in finance.

In the world of economics and finance, revolutions occur rarely and are often detected only in hindsight. But what happened on February 19 can safely be called the end of an era in global finance.

On that day, the International Monetary Fund published a policy note that reversed its long-held position on capital controls. Taxes and other restrictions on capital inflows, the IMF’s economists wrote, can be helpful, and they constitute a “legitimate part” of policymakers’ toolkit.

The IMF’s policy note makes clear that controls on cross-border financial flows can be not only desirable, but also effective. This is important, because the traditional argument of last resort against capital controls has been that they could not be made to stick. Financial markets would always outsmart the policymakers.

The IMF’s change of heart is important, but it needs to be followed by further action. We currently don’t know much about designing capital-control regimes. The taboo that has attached to capital controls has discouraged practical, policy-oriented work that would help governments to manage capital flows directly. There is some empirical research on the consequences of capital controls in countries such as Chile, Colombia, and Malaysia, but very little systematic research on the appropriate menu of options. The IMF can help to fill the gap.

Now, it is time for international transaction tax (Robin Hood tax):

With this battle won, the next worthy goal is a global financial transaction tax. Set at a very low level – 0.05% is a commonly mentioned rate – such a tax would raise hundreds of billions of dollars for global public goods while discouraging short-term speculative activities in financial markets.

No change in NRs. exchange rate with IRs., for now!

I was contemplating writing an article on why the pegged exchange rate between Nepalese currency and the Indian currency should be kept as it is at least for now. A recent IMF mission to Nepal observed the same:

“The peg should remain the key macroeconomic policy priority, and monetary policy needs to be fully consistent with this objective. Interest rates need to be maintained above those prevailing in India and the Nepal Rastra Bank’s (NRB) liquidity management needs to be strengthened. When a general liquidity injection is not needed for the system, liquidity provision to sound individual banks with liquidity shortages should take place at penalty rates or at the bank rate under heightened supervision.

“Risks in the financial sector have been building up and need to be addressed urgently. Over the past years, accommodative monetary policy, weak supervision, and proliferation of financial institutions have led to rapidly rising asset prices and overextension of banks. Going forward, the financial system needs to adapt to an environment of slower growth and is likely to see deteriorating asset quality. The mission welcomes the NRB’s directives regarding prudential limits on credit-to-deposit ratios, real estate exposure, loan-to-value ratios, as well as the reintroduction of a minimum Statutory Liquidity Ratio. However, it is critical that these limits are enforced, and not diluted. In this respect, appointing a new governor who can provide strong and stable leadership for the NRB going forward is urgent. The authorities should also pass the revised Banking and Financial Institutions Act (BAFIA), encourage bank consolidation, refrain from issuing new licenses for the time being, and proceed with the restructuring of state-controlled banks.

FTAs in Asia in a chart

Source

Export-led growth 2.0

A very interesting note about the future and trend of export-led growth by Canuto, Haddad and Hanson from PREM division at the World Bank. Does the slackening of import demand due to the global financial crisis from the world’s biggest importers, the US and the EU, mean that export-led growth model is dead? Not really. In fact, a new model is emerging out.

The increasing import demand from rapidly growing economies like China, India, and Brazil is filling up the slack left by weak import demand in the US and the EU. This means that South-South trade is partly picking up the slack. In fact, BRIC import share nearly doubled, from 9 percent to 17 percent, between 1996 and 2008. Other low and middle income counties increased their share of import demand from 8 to 19 percent. Meanwhile, import demand from high-income countries declined from 88 percent to 69 percent in the same time frame. The world trade flow is changing and South-South trade is picking up. Also, middle-income countries are driving export diversification of low-income countries. The export diversification index (concentration index) of low-income countries has seen an improvement of 10 percent between 1997 and 2007 (this means exports moving from being spread evenly across four products to seven products; note that three sectors namely petroleum products, food, and iron and steel accounted for 76 percent of low-income countries’ trade between 1998 and 2006). Is this a sign of export-led growth 2.0?

Due to the global financial crisis world merchandise imports fell by 36 percent between 2007Q4 and 2009Q2. It was thought that the slackening import demand from the main importers would imperil growth in the developing countries. However, they argue that most of the recent growth in low-income developing countries’ export was driven by import demand in other developing countries. This means that low-income developing countries will continue to rely on developing countries for export growth. To increase South-South trade further, they recommend reduction in non-tariff barriers, which account for nearly two-thirds of the protection faced by low-income exporters and upper-middle-income markets.

Recession in the big importers

Due to the intensity of financial crisis spilling into the real economy in the US and the EU, low-income countries that depend on exports of oil and apparel to these economies will suffer more. Mexico and Central American countries rely heavily on the US final demand. Similarly, Nigeria might feel a stronger pinch as it exports most of its oil to the US. Also, the 39 Sub-Saharan African countries that have preferential access in export of apparel to the US market under the AGOA might see decline in demand. Meanwhile, developing Europe, Central Asia, and MENA region might see slackening import demand from the EU. Between 2000 and 2008, the US and the EU-25 absorbed about 20 percent of low-income countries’ export growth. Of this 20 percent, nearly half comes from petroleum products. Apparel accounts for an additional 4.3 percent.

South-South trade is picking up

As the prominent importers’ import demand slow down, it is increasing in low- and middle-income countries. Between 1996 and 2008, import share from BRIC is up from 9 to 17 percent; from low- and middle-income countries up from 8 to 19 percent; and from high-income countries down from 88 to 69 percent. What is driving export growth in low income countries? It is rapid growth in the emerging economies (BRIC). They argue that higher growth rate in low- and middle- income countries explain 51 percent of export growth in low-income MENA region, 42 percent in low-income EU and Central Asia, and 21 percent in low-income Sub-Saharan Africa.

All this means that selective industrial policy could still be an important element of national economic policy in the low income countries. Also, there is already some form of rebalancing happening in global exports and imports.

For an earlier piece on the past and future of export-led growth model see this blog post.

Why do bad governments persist?

The military junta of Burma, Robert Mugabe of Zimbabwe, Mahmoud Ahmadinejad of Iran, Kim Jong Il of North Korea and (the former King of Nepal) and so on. Why do these regimes persist even when there are severe crises in their country? Why do they not include more talented individuals in the ruling bodies, which is comprised of old, conservative leaders who are completely oblivious of the changing world and changes brought about by globalization? Even in democratic societies why do incompetent politicians once appointed remain in power for long periods of time?

 

Acemoglu et al. argue that it has to do with a “degree of incumbency veto-power”, i.e. the extent of retention of current members of government in the next government.

We emphasise that many regimes, ranging from shades of imperfect democracy to various forms of autocracy, afford a degree of incumbency veto power to current key members of the government. Once they are in power, they can be removed, but they are also in a position to be part of a new government that replaces some of the other members of the government.

The degree of incumbency veto-power loosely corresponds to how many of the current members of government need to be part of the next government. In an ideal democracy, there needs to be no overlap between today's government and tomorrow's. An imperfect democracy would, on the other hand, give some degree of incumbency veto power. For example, out of several key members of a cabinet, one would need to remain in power to create continuity ("somebody who knows how to turn off the lights"), or to prevent the entire cabinet from seizing power.

Our argument is that even this type of minimal incumbency veto power can lead to the persistence of highly inefficient governments, consisting of several incompetent members. Moreover, such governments would be unwilling to include more competent members, even if this would greatly increase the efficiency of the government and the incomes of both the citizens and the members of the cabinet.

The reason is that the inclusion of a more talented new member might open the door for several more rounds of changes in the composition of government, ultimately displacing those currently in power. For example, applying such ideas to the Iranian context, the supreme leader Ali Khamenei and Mahmoud Ahmadinejad would be afraid of including more talented technocrats in the regime, because then they could be part of a move to form another, better government that might exclude Ali Khamenei or Mahmoud Ahmadinejad.

Even though this mechanism looks at first as if it can only have a small impact on the competence level of the government, we show that even a minimal amount of incumbency veto power can make the worst possible government emerge and persist forever. The logic is again the same. The worst government would remain in power when all of its members prefer to be part of the ruling government rather than live under a more competent government, and anticipate that the inclusion of even a slightly more talented politician would destabilise the system.

But,

It appears that authoritarian regimes such as the rule of General Park in South Korea or Lee Kuan Yew in Singapore may be beneficial or less damaging during the early stages of development, while a different style of government, with greater participation, may be necessary as the economy develops and becomes more complex.

Is Nepali export passé?

In my latest column, I discuss Nepal’s exports sector; what specific products Nepal was exporting, is exporting, and could produce and export with comparative advantage. For this column, I rely on the analysis of product space and a study I had done before.

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Is Nepali export passé?

The exports sector is rapidly loosing its foothold in the economy, leading to closure of firms, unemployment, and loss of revenue needed to finance key development projects. With hopes of reviving rapidly declining exports starting 1997, the government is lobbying for trade treaties with the US and regional partners. Before wasting time and resources in signing trade pacts that have little relevance to Nepal’s exports sector, we need to seek answers to fundamental questions regarding our exports capability. 

How competitive are Nepali products in the international market? Do we still have or can produce goods that could be exported with comparative advantage? How connected is production structure of different products, i.e. their ‘proximity’? Can we use the existing inputs (labor and capital) used in production of one good to produce a new exportable product (i.e. ‘nearby’ good)? These questions need unequivocal answers before we sign new trade treaties. Remember that no matter how many concessions we give and trade treaties we sign, if they do not aid our exports sector, it is of no use. Just opening up the economy does not mean that our exports and economy will grow. What we export determines the future of Nepal's exports sector and economy.

Studies have shown that assets and capabilities needed to produce a particular kind of product are imperfect substitutes for the inputs needed to produce other goods. Though the degree of asset specificity needed for the production of imperfect substitutes differ, they nevertheless can be used in one way or the other in production of both goods. A country's capability to produce one good is somehow tied with the installed capability in production of other similar goods, i.e. 'nearby goods'. 

Sustained growth in exports is achieved by upgrading production of existing items to production of products that are not wholly different from them in terms of the use of inputs. It is easier to upgrade production if there is a high degree of input and structural complementarities in production of existing goods and services. The overall connectedness of an economy’s export basket, i.e. similarity in use of inputs (labor and capital) used to produce different exportable goods, affects the pace of upgrade and structural transformation of the economy.

How 'connected' are inputs of the products produced in Nepal? Are there any 'nearby' exportable products? Answers to these questions would reveal what products Nepal is exporting and, importantly, could export with comparative advantage.

Analysis of Nepal's 1985 'product space', which is a network of relatedness between products, shows that it had comparative advantage in production of labor-intensive goods. Specifically, it had comparative advantage in production of trousers, breeches of textile fabrics; skirts of textile fabric for women; undergarments of textile fabrics for women; textile men shirts; other textile outer garments; sacks and bags of textile materials; twine, cordage, ropes & cables; and women dresses of textile fabrics. In garments and textiles sector, the two most promising products, based on global market size and proximity of products, were undergarments knitted of cotton and footwear. Furthermore, the most promising products for the upgrade of export mix were in machinery industry. The products that had relatively large market size abroad and a fair degree of proximity in domestic production structure were electronics microcircuits; radio broadcast receivers for vehicles; and photographic cameras, parts & accessories.

Nepal was producing very few agricultural goods with comparative advantage. The agricultural goods that had comparative advantage were leather of other bovine cattle & equine leather; leather or other hides or skins; shellac, seed lac, stick lac, resins, gun resins, etc; art, collector species & antiques; fresh or dried grapes; fixed vegetable oil; beans, peas, lentil & other legume vegetables; and other cereal meals & flours. The proximity between agricultural products was very low, signaling the fact that ‘connectedness’ in this sector was weak and transition to new exportable agricultural products was difficult.

In 2000, the number of products produced with comparative advantage was higher than in 1985. In fact, pretty much all products that could be manufactured using the installed capacity used in production of comparatively advantageous goods in 1985 were produced in 2000. This means that there indeed was some upgrade in Nepal's exports mix. Some of the products were undergarments excluding shirts of textile fabrics; other outer garments & clothing knitters; other made up articles of textile materials; blouses of textile fabrics; suites & customs made of textiles for women; knitted jerseys, pullovers twin sets; and knitted synthetic undergarments, among others products. Not surprisingly, due to lack of nearby products and low proximity, the agricultural sector did not contribute new exportable product in 2000.

Analysis of Nepal’s latest product space shows that the following products are 'nearby' and could be produced and exported with comparative advantage: prepared or preserved crustaceans; frozen fish fillets; pyrotechnic articles; potatoes; electrical transformers; candles & matches; sinks & wash basins;  fresh and chilled fish; statuettes & other ornaments; travel goods, handbags, briefcases and purses; frozen vegetables; footwear; building & monumental stone; art & manufacturing of carving or moulding materials; leather apparel & clothing accessories; manufactured goods;  oranges, mandarins, clementines and other citrus; and temporarily preserved fruits, among other products. Based on domestic total production and global market size, there are very few promising exportable agricultural products. Note that the existing products in the export basket are outside of the clusters of goods that would enhance value-addition and utilize sophisticated technology.

Between 1985 and 2000, there was some form of transformation in production structure of the economy. Unfortunately, during this decade, the economy failed to keep up with the previous pace of transformation. Why? It is potentially because of strong constrains such as a lack of adequate infrastructure and low appropriability arising from labor disputes, corruption and strikes. Unless these constraints are addressed with decisive public policy, it will be hard to produce new exportable products and accelerate economic transformation.

[Published in Republica, February 28, 2010, pp.6]