The Service Sector as India's Road to Economic Growth

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While India is distinctive among developing countries for its fast-growing service sector, sceptics have raised doubts about the quality and sustainability of this service-sector growth and its implications for economic development. We show, consistent with the views of the sceptics, that while growth of the sector has been unusually rapid, it started 15 years ago from unusually low levels. That the share of services has now simply converged to the international norm raises questions about whether it will continue growing rapidly. In particular, whether service-sector output and employment continue to grow in excess of international norms will depend on the continued expansion of modern services (business services, communication and banking) but, also, on the application of modern information technology to more traditional services (retail and wholesale trade, transport and storage, public administration and defense ). The second aspect obviously has more positive implications for output than for employment.

We also show that the modern services that are growing most rapidly are now large enough where their future performance could have a significant macroeconomic impact. The expansion of modern service-sector employment is not simply disguised manufacturing activity. Finally, we show that the mix of skilled and unskilled labor in manufacturing and services is increasingly similar. It is no longer obvious therefore that manufacturing is the main destination for the vast majority of Indian labor moving into the modern sector and that modern services are a viable destination only for the highly-skilled few. We conclude that sustaining economic growth and raising living standards will require shifting labor into both manufacturing and services.

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That’s the abstract from Eichergreen and Gupta (2011) paper.

U-curve in economic development

Relative productivity of agriculture exhibits a U-shaped pattern over the course of development, argues Rodrik. Labor productivity first falls and then rises, as countries get richer.

Within countries as well, the trend is consistent.

Why does this happen? Because new, high-productivity activities (typically outside agriculture) are needed for development to happen. Relative productivity in agriculture falls. Labor tends to move from low to high productivity activities as economies grow. The gap between productivity in agriculture and non-agriculture reduces. Diminishing marginal returns (in terms of productivity) gradually kicks in on non-agriculture sector. Relative productivity in agriculture sector again rises and the curve starts to slope outward.

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economic development requires both new activities (diversification) and ongoing transfer of resources from traditional to modern activities. Some countries are stuck with no new industries, so they never grow. Others get a few new industries (e.g. mining and other natural resource-based industries), but these do not expand sufficiently and absorb much labor, so development gets stuck at an intermediate level of income. The real successful countries are those that pull off both tricks.

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Making fiscal policy effective

Abstracts of two latest working papers from the Levy Economics Institute.

Lessons from the Great Recession (Pavlina R. Tcherneva 2011):

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This paper reconsiders fiscal policy effectiveness in light of the recent economic crisis. It examines the fiscal policy approach advocated by the economics profession today and the specific policy actions undertaken by the Bush and Obama administrations. An examination of the labor market renders the contemporary aggregate demand–management approach wholly inadequate for achieving certain macroeconomic objectives, such as the stabilization of investment and investor expectations, the generation and maintenance of full employment, and the equitable distribution of incomes. The paper reconsiders the policy effectiveness of alternative fiscal policy approaches, and argues that a policy that directly targets the labor demand gap (as opposed to the output gap) is far more effective in stabilizing employment, incomes, investment, and balance sheets.

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Why aggregate demand management fails and what to do about it? (Pravlina R. Tcherneva 2011)

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This paper argues for a fundamental reorientation of fiscal policy, from the current aggregate demand management model to a model that explicitly and directly targets the unemployed. Even though aggregate demand management has several important benefits in stabilizing an unstable economy, it also has a number of serious drawbacks that merit its reconsideration. The paper identifies the shortcomings that can be observed during both recessions and economic recoveries, and builds the case for a targeted demand-management approach that can deliver economic stabilization through full employment and better income distribution. This approach is consistent with Keynes’s original policy recommendations, largely neglected or forgotten by economists across the theoretical spectrum, and offers a reinterpretation of his proposal for the modern context that draws on the work of Hyman Minsky.

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Trade & Food Security in Nepal

My latest piece is about the rising food prices in Nepal and what can be done about it. I tie up food security in Nepal with international trade (and to some extent with climate change). Nepal is a net food importer country since the domestic supply is insufficient to meet domestic demand. This production deficit is met by either imports or by food grains grant, especially via WFP. Here is an article on the same issue I wrote in 2009

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Food Security in Nepal

Recently, the Food and Agriculture Organization’s (FAO) Food Price Index surpassed the upper bound reached during the peak of the food crisis in 2008. The World Bank says global food crisis has reached “dangerous levels”. In Nepal, the World Food Programme (WFP) argues that about 3.7 million people are at risk of food insecurity. Rising food prices have triggered a wave of protests across the globe and forced countries such as India, Russia and Vietnam, among other countries, to impose food grains embargo. These events directly or indirectly affect food prices and food availability in Nepal. Already, domestic food prices have reached second highest level since 1990.

As a net food importer nation, is Nepal prepared to deal with any further rise in food prices, production, and supply shocks at both domestic and global levels? The answer is uncertain, given the virtual absence of discussion about this issue at policymaking level. Meanwhile, the political leaders, who seem oblivious of the dangers of looming food crisis, are more worried about securing ministerial berths than ensuring enough food on plate for the poor, vulnerable and food insecure people. It is crucial for policymakers and selfish political leaders to realize that a further rise in food prices could not only affect economic growth and poverty, but also engender a series of protests and political instability.

Domestically, food prices are fast outstripping overall general prices. The Food Price Index (FPI) has been continuously dragging up Consumer Price Index (CPI), whose annual percentage change is a popular measure of inflation. Since Nepal does not produce enough food to satisfy domestic demand, it has to import food equal to domestic production deficit. So, shocks in production, supply and prices of agricultural goods at the global level affect food prices in our local markets as well. There was 316,000 metric tons food deficit in 2010, an increase by 139 percent from 2009, according to the WFP. In 2009, agricultural trade deficit was US$270 million, up from US$157 million in 2003. As the demand for food is fairly price inelastic, even if prices increase, Nepal will be importing at least the same amount of food, but it will have to spend substantially more, which will further widen total trade deficit.

Globally, higher temperatures, shifting seasons, more frequent and extreme weather events, flooding, wildfire, and drought in Russia, Canada, Australia, Pakistan, China, Argentina, and Kazakhstan, among others countries have created production shocks. Meanwhile, supply shocks occur when major exporting nations take precautionary measures to curb exports or impose embargos on certain agricultural products so that their own domestic demand is met and prices remain below a threshold for their citizens. For instance, it recently happened when India, Russia and Vietnam, among other nations imposed food grains embargo. Additionally, speculation by brokers and investment firms, who bet on the future price of major agricultural items based on existing production, inventory, and future expected production level, have also contributed to price shocks.

All of these events have not only affected demand, supply, and prices of agricultural goods at the global level, but also, to some extent, in our own economy. Note that a Nepali spends, on average, 59 percent of his income on food. Of this about 58 percent and 15 percent are spent on breads and cereals, and fruits and vegetables, respectively. Since food prices are already high in the domestic market, any further price rise will force more people to scale back discretionary expenditures and savings, which will directly affect investment and economic growth.

What options do we have to mitigate the negative impact of rising food prices on the economy?

First, there should be higher investment geared towards increasing agricultural production and productivity so that domestic production deficit can at least be narrowed down. Meanwhile, domestic production of climate resilient varieties of food grains should be encouraged. Equally important are state subsidies on appropriate varieties of seeds and fertilizers, plus some sort of guarantee to facilitate transport of surplus production of each household to the market. The government and development agencies should provide sufficient infrastructure and policy structure to make this happen.

Second, to facilitate unhindered distribution of agricultural items in the market, carteling should be checked. The agricultural traders, who are mostly affiliated to one party or the other, purchase food items (especially veggies) from farmers at dirt cheap rates and sell them in the market with a wide margin. If prices start to come down, then they restrict supply to put upward pressure on prices. This sends deceptive, undervalued price signals to farmers, who are neither encouraged to produce more nor are motivated to seek innovative methods to produce improved varieties of food items crucial for food security and for putting downward pressure on prices. The supply-side bottlenecks have to be adequately addressed to not only encourage farmers to produce more and motivate them to seek innovative farming methods, but also to curb price manipulation and hoarding of agricultural goods.

Third, smooth regional agricultural trade is crucial to meet Nepal’s food demand. Since agricultural imports from India constitute over 40 percent of total agricultural goods imported by Nepal, it is in our interest to convince India—a net exporter of agricultural goods— to make an exception, or at least ensure a quota that is enough to meet our domestic needs, for food supply to Nepal even if it imposes ban on export to other countries. Since Nepalis and Indians consume pretty much the same kind of food items and the two countries share an open border with free flow of pretty much all goods and services, it is in both countries’ interest to smoothen trade. Else, the negative political and economic spillovers and black marketing will further haunt the regions on both sides of the border. Moreover, greater cooperation on agricultural trade among South Asian countries could also help to ease food deficit.

Fourth, a fully functional regional food bank is needed for emergency purposes. The 14th SAARC Summit held in New Delhi in 2007 agreed to establish SAARC Food Bank, which is expected to serve as a regional food security reserve for SAARC member countries during normal food shortages and emergencies. The food bank was authorized to start functioning with a total reserve of 0.24 million tons of food grains. Since this amount is not enough to ensure regional food security, Bangladesh recently proposed to raise the strategic reserve to 4 million tons. Sadly, the whole concept of SAARC Food Bank is yet to become functional. There is a need to address the issue of price incentive and access threshold to enable the release of grains from the reserve.

Fifth, and most importantly, it is high time political leaders, and officials at National Planning Commission, Ministry of Finance, Ministry of Agriculture & Cooperatives, and Ministry of Commerce & Supplies woke up and acknowledged the fact that rising food prices and a potential food crisis pose a real economic threat and could engender political instability. They have to plan and work in tandem to eschew a potential food crisis and its spillover on the economy and political front. Remember, in 2008 and early this year riots have broken hell loose and regimes have fallen around the world partly because of the hardship inflicted by rising food prices. We cannot discount similar fate in the Nepali economy if domestic food crisis spirals out of control.

[Published in Republica, February 22, 2010, p.7]

Trade balance in South Asia

In South Asia, Maldives has the highest trade deficit (% of GDP), followed by Nepal, Pakistan, Bangladesh, Sri Lanka, and India. Bhutan is the only country having trade surplus in South Asia. My wild guess is that the countries that have negative trade balance have high trade complementarity, i.e. they produce the same kind of goods and services and compete in the same section of the global market for customers. Bhutan stands out because of its high electricity export to India (something other countries are not doing despite having the potential. E.g. Nepal). It is high time governments thought about diversification of both products and markets. Exploring of products with comparative advantage based on resource endowment, and industrial and trade policies to steer production in that direction is needed. May be following the lead of India (and China) and getting on board its growth trajectory would help (definitely for Nepal).

Monopsony in factor market and monopoly in product market

What happens if traders directly purchase vegetables from farmers and then they themselves sell it in the market (and deprive of others from doing so, including the farmers)? Three things happen: (i) farmers either lose or gain; (ii) traders usually gain; and (iii) customers either lose or gain. Farmers will see gains if the traders pay high price for vegetables in the factor market (or they lose if the opposite happens). Traders mostly gain. Customers will see gains if traders purchase in bulk and sell it at a low price, largely accruing from economies of scale (or they lose if traders form a cartel and jack up prices in the product market).

What usually happens in a developing country is that traders pay low price to farmers, don’t let farmers directly sell produce in designated wholesale market set up by the government in cities, and traders form a cartel and jack up prices in the product market. Welfare of both farmers and consumers is reduced by traders by creating monopsony in factor market and monopoly in product market (they play with the quantity supplied in the product market to keep up high prices). This is what happens in Nepal and in other South Asian countries.

But, the story from Ghana is different. Traders in Ghana purchase tomatoes from rural farms and bring them to the large urban markets. A research by Robinson and Ngeleza 2011 shows that, in Ghana, the traders do operate a cartel but that farmers who sell to them receive higher prices than if they sell to the local market, even though there is little difference in quality compared with tomatoes sold to the local market.

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This suggests that traders share cartel rents with these farmers, resulting in lower prices in rural areas, higher prices in the cities, and a greater constriction of total market volume. Our paper suggests that policymakers would do better to focus on the full value chain and on opening up the urban markets rather than on strengthening farmers’ bargaining power with the traders, which restricts market volumes and harms farmers unable to sell to traders.

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What about the loss in welfare of consumers (due to high prices) in the product market? Does the welfare gains to farmers in the factor market offset the potential welfare losses to consumers in the product market?

The political J-curve

What happens when countries move from closed to open societies? Ian Bremmer argues that you get a “powerful political phenomenon” called the J-curve.

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The theory goes like this. If you plot the relationship between a country’s stability (on the vertical axis) and its social and political openness (on the horizontal axis) the points that mark every possible combination of openness and stability will produce a pattern that resembles the letter J. Most countries start off closed and stable (think: North Korea). Many end up open and stable (like Britain). But in between there is a turbulent transition. Some governments, such as post-apartheid South Africa, survive this transition. Others – the Soviet Union, Iran under the shah and the former Yugoslavia – do not.

The J-curve is a controversial idea. When I first floated it in 2006, it was used – in some ways hijacked – by those seeking to explain the unstable postwar environment in Iraq. But an intervention bringing democracy by force was always a poor example of the theory. The current upheavals in the Middle East, the result of internal dynamics of populations trapped between economic hardship and increasing political openness, make a much better test.

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There is a J-curve in economics as well. It refers to a situation when after a currency is devalued, the short-term relatively inelastic demand for imports persists and consumers pay more for the same goods and services. Meanwhile, exports become expensive for a short time, leading to worsening balance of trade. After some adjustments, the volume of exports will start to rise because of their lower more competitive prices to foreign buyers, and domestic consumers will buy fewer of the costlier imports. Eventually, the trade balance should improve on what it was before the devaluation. If there is a currency revaluation or appreciation there may be an inverted J-curve.

Trade in intermediates

Shim and Uri write: “The imported intermediate input content accounts for about one-quarter of OECD economies’ exports, and the European Central Bank (ECB) estimates that such imports accounted for about 44 percent of EU exports (or 20 percent for imports from outside of the EU) in 2000, ranging from about 35 percent in Italy to about 59 percent in the Netherlands. In the United States, imported intermediate input content in exports reached about 10 percent in 2005. Among emerging economies, imported content’s share in exports is particularly high in China―about 30 percent, or twice that for India and Brazil.”

With this sheer volume of trade in intermediate goods, they argue that (i) The importance of bilateral trade balances is exaggerated. Focusing just on bilateral trade imbalances would not address the underlying causes of imbalances as doing so would just redistribute trading costs across different partners; (ii) The importance of export-led demand is overestimated and that of trade as a source of efficiency (specialization) is underestimated. Policymakers fail to recognize that imported inputs feed into exports; (iii) Trade has become more volatile and a larger source of shocks as countries source intermediates from different destinations and are interlinked, magnifying the final impact of a shock. Fluctuations in trade is more volatile than that in GDP; and (iv)  The cost of protection is higher. Trade in intermediates means the cost of protectionism is higher than is generally understood, and rising.

Are services exports competitive than merchandise exports in Nepal?

The governor of Nepal Rastra Bank, Dr. Yuba Raj Khatiwada, argues that services exports are more competitive than merchandise exports in the context of Nepal. At a program organized by SAWTEE yesterday, he said that his confidence in merchandise exports is waning and that just looking at more market access in and preferences from the West will not be fruitful.

Well, he is right that focusing on more and more market access and surviving on preferential treatments offered by the West is not making our merchandise exports competitive. In fact, they are becoming increasing uncompetitive and are being displaced by competitive players in the international market. But, this does not mean that our service exports are competitive than merchandise exports. The former might have a larger market potential, but they might not be more competitive than the latter. The reason: the same constraints that ail merchandise exports persists in services exports sector as well.

Rising labor cost, high interest spread rate, power shortages, and lack of adequate infrastructures  are not the problems of merchandise exports sector only. These are very much obstinately persistent in the services sector (tourism, labor, IT, health, and education) as well. Meanwhile, high inflation and rise in real exchange rate (and the constraints that come with a pegged exchange rate regime) are also affecting both the sectors. High inflation domestically means that in nominal terms prices are expensive here. It means hotels, food, traveling and all other related services are relatively expensive here as compared to periods when there was low inflation. Furthermore, our services sector (except for low skilled labor) are not that competitive when compared to regional partners as of now.

To make them competitive, the government has to invest a huge amount of money in installing the prerequisites needed for these industries to take off. We do not have qualified human resource (or appropriate incentives in place) to take charge of the IT industry and spearhead cutting edge innovation. Meanwhile, the quality of our domestic educational system is far below the regional standard. Evidence: Just look at the number of students going to India and beyond for higher education. Remember how it took millions of dollars of investment in IITs and IIMs for almost a decade before they produced the kind of human resource needed for the Indian IT and management industries. Can Nepal emulate this success story given the existing political and economic constraints? May be, and may be not (look at the failure of the IT Park in Banepa). But, it still does not mean that services exports are competitive than merchandise exports.

As a whole, it sounds all good. The global services market are expanding and recent innovations in technology is facilitating this. But, the question is: how far can Nepal tap this given our domestic capacity right now? I believe not much. So, services exports might have the potential, if tapped rightly and timely, but it is not wholly competitive than the merchandise exports, which is, by the way, performing pretty bad since 1997. The belief that services exports is more competitive than merchandise exports is like plump fruit which one thinks of is sweet, but does not know if it is sweet or bitter without tasting it. Sometimes, perception and reality might differ.

What does data show?

Nepal has been having deficit in trade of goods for a long time. But, we are having deficit in services trade since 2005. We are importing more services than we are exporting in the the last five years. Also, the size of services trade deficit is also fluctuating, but still is negative. Competitiveness of services sector is not very strong than that of merchandise sector as of now. It might have the potential, but not right now.

In terms of employment, 65.7% of total employed are in agriculture sector, 13.4% in industrial sector, and 20.1% in services sector (data as of 2001). The value addition of agricultural sector, as percent of GDP, was 33.8% in 2009, with annual value added growth of 2.2%. The industrial sector value added (% of GDP) was 15.9% with annual value added growth of 1.78%. The manufacturing sector value added (% of GDP) was 7% with annual value added growth of –0.5% in 2009 (it was 2.6% in 2007). The services sector value added was 50.2% with annual value addition growth of 5.9% in 2009. Now, look at the employment being generated. Though the services sector contributes more than 50% of our GDP, it employs only 20% of the total employed.

The most influential economist over the past decade

Basically, Keynes’s followers prevailed. Here is more from The Economist.

Setting a deadline for the Doha Round

A “High Level Trade Experts Group”, co-chaired by Jagdish Bhagwati and Peter Sutherland, argues that passage of the Doha Round is doable in 2011, but this would require increased attention of world leaders. The Group has called for December 31, 2011 as the deadline for the passage of the Doha package.

• Doha is doable this year; rapid progress is being made in closing the negotiating gaps; this started in November 2010.

• Getting the deal done requires head-of-state attention; they must authorize, or personally negotiate the last trade-offs framed by the draft agreement that their WTO ambassadors hope to have ready for April.

• The window for this deal is the first half of 2011; after that all bets are off until 2013 at the earliest (due to elections in the US).

Major points from the document:

-A development friendly trade deal must demand less of countries in a way that is proportionate to their state of development. The final Doha package should be measured against this criteria.

-The Doha Round’s development mandate will be delivered in two key ways: (i) complete exclusion of all LDCs from any obligations except binding their tariff schedules at the current level (‘Round for Free’); and (ii) the concept of agreed ‘modalities’ for tariff cuts (subsidy reductions in agriculture) in principle agreed by all member, but in practice tempered by various forms of ‘flexibility’ for developed and developing countries. The last Doha negotiations in 2008 failed over differences in defining one of these flexibilities—a  special safeguard mechanism for agricultural exports to developing countries.

-The use of formula plus flexibility system is both the greatest potential strength and fatal weakness of the Doha Round. Positive in the sense that tariff landscape will be compressed across the board, with the highest farm tariffs in the developed world compressed. Also, industrial tariff in developing countries will also go down. Weakness in the sense that unless it is clear where all countries will exercise their flexibilities to shield tariff lines from cuts through exclusions or where the special safeguard mechanism will apply, it is impossible, or at least very difficult, to value a final package in a way that makes it possible to sell to domestic constituencies.

-Because completion of the Doha Round would demand political concessions, it cannot be completed solely by trade negotiators as it needs a much stronger and direct involvement of political leaders.

Why the Doha Round should be completed?

• It will act as an insurance policy against future protectionism. It will consolidate unilateral liberalization agreements since the end of the Uruguay Round in 1994.
• It will help reform global farm trade, particularly it will make the EU’s Common Agricultural Policy irreversible and seriously constrain any future US Farm Bill from increasing support should commodity prices fall. It would also eliminate all export subsidies for agricultural goods.
• It will provide new market access through tariff reductions and the contraction of market share of those countries whose agriculture subsidies will be withdrawn.
• It would protect the WTO and the multilateral trading system itself. A permanent collapse would likely provoke a wave of preferential trading agreements.
• Unless the Doha Round is finished and the WTO moves to 21st century trade issues, it will find itself stuck with out-dated disciplines while deeper disciplines are established by the EU’s, the US’s and Japan’s deep RTAs, with new sets added when China, India and Brazil internationalize their own supply chains
• Even if tariff reductions and the dismantling of non-tariff barriers can be achieved bilaterally, the multiplier effect of a multilateral agreement is considerably higher. Also, agricultural subsidy reform will be agreed multilaterally or not at all.

Structure of a final package

Agriculture

• Under current draft texts the EU would reduce its MFN duties on agricultural imports by close to 60%. The highest and most distorting tariffs will be cut proportionally more, with only 4% of tariff lines treated as sensitive and therefore subject to smaller cuts. As a compensation tor these partial exemptions import quotas amounting to 4% of domestic consumption must be opened and subjected to zero or very low duties. IT will translate into real new market access opportunities from day one of implementation. Agricultural exporters in developing countries, in particular Brazil and Argentina, and in developed countries, in particular Australia, New Zealand, and the US will likely benefit the most.
• The support to products like cotton and sugar in the US would be severely constrained, but negotiators still have to tackle this issue. Also, the form and functioning of the special safeguard measure for developing countries need to be worked out.
• Under trade distorting domestic support to agriculture, developed countries will reduce substantially the ceilings currently applied (by up to 80% in the case of the EU and up to 70% in the case of the US).
• The current text foresees the complete elimination of all forms of export subsidies by 2013 by developed countries, and by 2016 by most developing countries, with the remainder by 2021.

Industrial goods

• Among developed countries, which represent more than two third of the world’s final demand, tariffs would be virtually eliminated, with no tariff remaining above 6%. Duties levied by the EU on its total imports of industrial products would go down by 44%, more than in any previous round, amounting to $12.5 billion saved on exports to the US. On the US market, the amount of duties paid on imports would go down by $12 billion.
• For China, the current draft modalities would lead to a 22% reduction of duties levied on imports, well below the 36% cut that Chinese exporters would face on foreign markets.
• Other emerging countries need to make further tariff reductions.

-->Tariff reductions in particular sectors that are highly traded is needed as well. Sectoral tariff reduction would increase the gains for all countries.

--> The Doha Round should also include a new package on environmental goods and services, whose market is worth US 150 billion annually. The WB has already defined a list of 45 environmental goods that can form the basis for negotiation.

Services

• Given the fundamental role of services in the effective and efficient management of an economy, a strong outcome in services has huge potential spillover benefits for both developed and developing WTO members.

Package for LDCs

• The LDCs are not expected to implement any tariff reductions and are requested only to bind their tariffs at the level they currently apply. Since many of them depend on preferential market access to economies, multilateral liberalization erodes the preferential margin for their exports, which could pose as a challenge in the short-term as they will face stiff competition from advanced developing countries such as China and Brazil. This concern is partly addressed by eliminating tariff on certain products in a phased manner. Also, granting duty free quota free (DFQF) market access for all exports from all LDCs to all OECD countries and a set of major emerging economies would be helpful to LDCs. It could boost LDCs’ exports by 44% or US$ 7 billion a year.
• Since cotton is of crucial importance to several LDCs, the Doha Round will also have to address trade distorting subsidies to cotton farmers in developed countries.
• Aid for Trade (AfT) should be maintained as a necessary complement to boost LDCs’ productive capacity and help them reap the benefits of the Doha Round.

Trade facilitation

• Trade facilitation negotiation is a clear success story of the Doha Round. The WTO members have tabled more than 70 new proposals for improving the transit of goods between markets, charges levied for transit, penalties for minor breaches of customs regulations, the standardization of customs documentation and prompt publication of conditions for import and export.
• The proposed improvements in trade facilitation would increase trade by US$130 to US$450 billion annually. The benefits for developing countries could by far exceed the gains in other areas for negotiation. Meanwhile, the developing countries themselves should take initiatives to reform domestic policies and infrastructure to ease border-crossing for goods and services and the development aid that will be provided by developed countries to implement these reforms.

Here (the main paper by Antoine Bouet and David Laborde 2009) is an updated estimation of the potential costs of a failed Doha Round. The total cost of failure of the Doha Round is estimated to be US$ 1.171 trillion in forgone world exports if protectionist measures persist. Meanwhile, welfare loss are estimated to be US$ 193 billion. Here is earlier estimates of the Doha Round. Here is a piece about the industrial and export interests of Nepal in the Doha Round of trade negotiations. Here is a link to the recent WTO workshop on the Doha Round.

Links of interest about the latest on the Doha Round

• Roderick Abbott on how to revive Doha with some chance of success. He argues that “WTO members need to go back to the drawing board to come up with alternative approaches to the negotiations.”
• Peter Sutherland on a future for the WTO
• Peter Kleen compares the Uruguay Round and the Doha Round. He concludes that “negotiating trade agreements must remain the raison d’etre of the WTO, no matter how complicated it has become. Such negotiations, however, could take a less ambitious and more incremental form than these big rounds and must be able to muster support from the global business community if trade liberalisation is to continue advancing.”
• Stuart Harbinson on the main issues for a conclusion of the Doha Round

Here is a blog post about the need to finish the Doha Round by 2011.

Investment climate reform in Southern Sudan

Southern Sudan is a new country (official name not decided yet) with an overwhelming majority deciding to secede from Sudan. According to the final count, announced in Sudan’s capital, Khartoum, 98.83 percent of the more than 3.8 million registered voters in southern Sudan chose to separate from the north. In many parts of the country the vote was over 99 percent.

My good friend Abraham Akoi returned back to Southern Sudan and is working at the Ministry of Finance. Salva Kiir Mayardit, south Sudan's president, tapped Abraham to become the deputy director of administration and finance at the ministry. He argues: “Our political and financial institutions are weak. Civil liberties are not strong. There are no good hospitals and no good supply of medicines.And only 15 percent of south Sudanese know how to read and write. That's not very good for democracy."

An interesting question is that how the new country is preparing to spur economic growth and make it investor-friendly after over two decades of brutal civil war in the oil rich region? A number of development and multilateral agencies are working to help it better human development and business climate. The WB’s investment climate blog lists the initiatives taken so far in easing business environment.

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• Legal framework. Eight laws have been enacted enabling business entry, operations, and exit. Another nine that allow basic registration, contract, agency, property rights, and insolvency are ready to enact.
• Business entry. The business registry was strengthened and registration reinstated following suspension in December 2005. Businesses can incorporate within a day. About 8,000 businesses—most domestic and small or medium-size—have been registered since July 2006. A business-registration campaign resulted in an additional 1,100 businesses within the first six months of 2010.
• Investment policy and promotion. The new Investment Promotion Act 2009 established the Southern Sudan Investment Authority, resulting in the targeted, proactive pursuit of potential investors and re-investors.
• Public-private dialogue. The establishment of the Southern Sudan Business Forum enables consensual policy development. Through its working groups, the forum has helped revise the Micro Finance Policy being developed by the Bank of Southern Sudan and drafted and promulgated the Investment Promotion Act 2009.
• Trade logistics. As a result of improvements in the Customs Chamber since 2008, Sudan has significantly reduced the number of days traders need to complete import-export procedures. The time needed to import was reduced from 83 days in 2007 to 46 days in 2010, and the time to export from 56 days in 2007 to 32 days in 2010. The 2009 Customs Amendment Act was approved by the Council of Ministers. The customs clearing system has been automated and this will lead to even greater time and cost reductions. The system links 21 regional offices and the Tax Chamber, and it allows for electronic approvals and the submission of electronic manifests.

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A lot of work needs to be done. And, I hope that with dedicated youths like Abraham, it will be done soon.

Capitalism comes with open system and instabilities

A good rundown of the state of macroeconomics so far. Sourced from Alex Leijonhufvud’s CEPR Policy Insight No 53 “Nature of an economy”.

• Keynes proposed that flexible money wages would not lead to full employment. In fact, very flexible wages would produce financial catastrophe (The General Theory).
• IS-LM model showed that unemployment was due to sticky wages, i.e. downward inflexibility of money (nominal) wages.
• Then the problem came when the Phillips curve was pasted onto the IS-LM model. How can you have both rising inflation and rising unemployment? So, came the Quantity Theory of Money, which Friedman used to attack Keynesian economics. It gave logical reasoning to the conundrum faced when Phillips curve was combined with IS-LM model. The concept of ‘natural rate of unemployment’ came up.
• The Monetarists believed that flexible wages were sufficient to guarantee that the economy would converge to the natural rate of unemployment. Keynesians argued that if desired saving did not equal investment, then flexibility of wages would not make it converge to the natural rate of unemployment. Monetarists ignored S-I problem and also the role of credit markets in furthering or hindering the coordination of saving and investment. Monetarists were more interested in stabilizing price level.
• Robert Lucas argued that the instability of the Phillips curve and the Fisher premium could be explained while obeying the dictates of optimal choice theory (rational expectations). He believed that only “unanticipated” changes in the growth rate of the stock of money would cause unemployment to deviate from its natural rate. Friedman did not share this position. S-I problem was forgotten.
• Edward Prescott came up with Real Business Cycle theory, which showed variations in output and employment were optimal responses to exogenous (i.e. unexplained) variations in productivity growth. It became the main vehicle for the development of dynamic stochastic general equilibrium (GSGE) theory.
• New Classicals and New Keynesians converged on 'the ‘New Neoclassical Synthesis”, which incorporated some of the “frictions” of the Keynesians while the latter adopted the DSGE framework developed by the former.
• However, though advances were made in understanding the advances of markets, little progress was made in understand how an economy works. The Old Synthesis was wrong back then and the New Synthesis is also wrong today. It does not recognize the instabilities lurking in the economic system, argues Leijonhufvud. The behavior of individual agents and of the economy as a whole differ in a deep recession or high inflation from normal times.
• Leijonhufvud maintains that economists did not pay attention to their ontological presuppositions, i.e. they failed to grasp the nature of the reality (the object of study) and to adapt one’s methods of inquiry to it. Economists have imposed preconceived methods on economic reality in such a manner as to distort their understanding of it. They start from optimal choice and fashion an image of reality to fit it.
• A “closed” model (and optimal choice) in economics essentially implies that agents are automatons lacking free will and a choice. So, whatever happens, there is always equilibrium. It assumes that economic agents possessed the knowledge of the future required for the calculation of intertemporal optima. So, the present beliefs about the future induce actions that create the future (what George Soros calls “reflexivity”). Rational expectations is a special case of reflexivity. It makes the economy a closed system. Agents are supposed to possess (probabilistic) knowledge of an objective reality—a reality that they have been able to learn.
• The mathematical representation of the system closed by assuming rational expectations made it possible to prove a variety of propositions—such as Ricardian equivalence and other policy ineffectiveness theorems—that ran counter to the received wisdom of the time.
• The heterogeneity of expectations associated with the lack of synchronicity means that there will be a range of indeterminancy within which the market clearing price may temporarily settle.
• In the “open system” many prices will be indeterminate (albeit within limits), economic behavior has to be understood as fundamentally adaptive, behavioral time horizons are variable, and the sets of markets and relative prices may change endogenously.
• In economics crises, budget constraints are not “soft” but they are broken. In deflation or depression crises, the budget constraint violations are concentrated in the private sector. In high inflation or hyperinflation crises, it is the sovereign that violates equal-value-in-exchange. Standard general equilibrium theory, even in its modern dynamic stochastic variants, is not particularly helpful when budget constraints are violated.
• The image of a capitalist economy as a stable general equilibrium system somewhat hampered in its functioning by “frictions” is an inadequate guide to the realities we have to cop with. Instability is a part of the capitalist system.
• Government resources have to be used to bring the private sector out of a deep recession or depression. Resources have to be transferred from the private to the public sector to bring high inflation under control. It gets further troublesome if the finances of one sector are already strained when the other gets into trouble.

So, two main points: (i) Think of an economy as an “open system” in the ontological sense of Tony Lawson; and (ii) The economy is not globally stable but harbors instabilities.

Food price inflation fueling a sense of injustice

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But for all the noisy media coverage and declarations by senior policymakers, few people have remarked on the actual motives of those who, in 2008, destroyed property in Argentina, Egypt, India, Indonesia, and Peru and brought down Haiti's government and are currently causing havoc in Tunisia and across the Middle East. After all, food riots have occurred throughout history but have not usually correlated with hunger or food prices. For the most part, the planet's 700 million-900 million hungry people have suffered in silence. And price volatility does not necessarily lead to screaming crowds, either. There are many more examples of people accepting volatile prices than rioting over them. So there is more to the protests than the logic of the pocketbook. A key psychological element -- a sense of injustice that arises between seeing food prices rise and pouring a Molotov cocktail -- is missing.

It is not yet clear how big a role food riots played in the toppling of the Tunisian government. But if history is any guide, Tunisians' feelings of being cheated were more important than actual food prices. Take Cameroon's experience in 2008, for example. That year, this West African nation suffered one of the most serious and protracted food riots in the world, and scores were left dead after the crowds eventually dispersed. Remembering the crisis, Alexander Legwegoh, a Cameroonian academic and an expert on urban poverty and food security, and Bernard Motuba, an accountant who left Cameroon for Canada, said that it was not just bills that caused the violence: expensive fuel drove taxi drivers to strike and then, anger over merchants' profiteering on staple products broadened the protest. "The government knew a group of merchants was taking advantage of everyone and that this would grow to a political crisis." Yet, according to Legwegoh and Motuba, as the protesters' numbers swelled, the size of loaves of bread for sale in the markets shrank while their price tags remained the same.

The real culprits, then, were retailers who stockpiled grain in hopes that prices would continue to go up. This speculation spun Cameroon's food system further out of control and bred hatred. Motuba describes the food merchants as "cutthroat business guys who don't give a damn about people." When the government sent inspectors to grocery stores and warehouses to auction off any illicit surpluses, the public cheered. Prices had not returned to their earlier levels, but a seeming restoration of justice helped calm the rioters' tempers, whose fury, according to Motuba and Legwegoh, had been rooted more in a feeling of exploitation than a fear of starvation.

[…]Policymakers today must be mindful of the psychological causes of food riots when they discuss the correct mix of trade and protectionism that will safeguard our food security. If they simply embrace the efficiency of the market, public feelings of injustice may cause more trouble than the volatile price of food itself.

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More by Evan Fraser and Andrew Rimas in Foreign Affairs magazine here.

Status of the Doha Round negotiations so far

Adapted from WTO Director-General Pascal Lamy’s statement:

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On Agriculture, on templates and on the associated work on base data, Step 2 on drafts of actual proposed formats are being tabled and discussed in each of the three pillars.  Moreover, Members are meeting bilaterally and in small groups to come to an agreed understanding of some parameters, including OTDS.  Additional drafts are also in preparation and work on base data is progressing with the verification process.

On modalities, the Chair has continued his consultations.  Members are also meeting on clarification of certain technical aspects of the modalities.

In NAMA, on NTBs, one concrete, positive change has been the movement into text-based negotiation through the creation of small drafting groups to undertake work in three areas:  transparency, remanufactured goods and horizontal mechanism.  The process of cleaning texts on the Horizontal Mechanism and Transparency is advancing.  On remanufacturing, however, the small group is still facing serious challenges.  Concerning other NTB areas such as textile labelling, conformity assessment and international standards, the discussions are still at a more and too general level.

Concerning tariffs, discussions are taking place.  The sectoral proponents continue to organize meetings on their sectoral initiatives.  However, it is clear that the kind of engagement we are seeing on the NTB side is still missing on tariffs.  This needs to change if we are to get to the same place by Easter.

Regarding Services, in market access, the Special Session confirmed that the request/offer negotiations had to be focused and intensified and that the  first cluster of 14 February will focus on Modes 3 and 4, and the ICT group of sectors.  Of course, this would not be to the exclusion of any other sector or issue that Members wished to raise.

In domestic regulation, there was consensus for the Chair to prepare a revised text for March.  There is a real opportunity to make progress here, provided that the result is not a bracket-laden text that serves only to solidify existing positions.  In GATS rules focused on dedicated discussions on government procurement and subsidies.  The Working Party is also preparing for a discussion on services statistics for the purpose of the discussion on Emergency Safeguard Measures.

In response to requests from several delegations, the Chair of the Special Session has proceeded to establish a small consultative group to advance work on the text of the proposed LDC waiver.

In the Rules area, in December, the Chair appointed three Friends of the Chair, who have been asked to consult on specific bracketed anti-dumping issues with an eye to developing convergence, bottom-up texts for consideration by the Group.  These issues include product under consideration, material retardation and causation of injury.  The Chair intends to appoint further Friends in the anti-dumping area, and to extend the process to horizontal subsidies.  He is also considering naming contact groups on some of the most intractable anti-dumping and subsidy issues.  In the area of fisheries subsidies, the Chair has appointed co-facilitators to work on technical aspects of fisheries management.  The Group has also received five new proposals in this area, including substantial new proposals on both the scope of the disciplines and the nature of special and differential treatment.

On regional trade agreements, Members agreed to begin the review of the Transparency Mechanism for RTAs as required by the General Council Decision, with a view to making it permanent.  Two proposals have been received from the United States and Ecuador and are to be discussed by the Group starting on 4 February.  Other elements of the review include statements from the Chairs of the two implementing bodies:  the CRTA and the CTD, and the Secretariat, indicating their experiences with the Mechanism thus far.  Discussions on systemic issues which remain dependent on the submission of text-based proposals by Members are also to be taken up; in this regard, one new proposal from Bolivia has been received.

In the area of Trade facilitation, the newly established Facilitator-led process appears to be working well and has already produced results.  Negotiations in 14 different groups led to streamlined language and a lower number of square brackets.  There was a noticeable change in gear, delegations were focused and committed to cleaning-up the text.  Delegations appreciate the bottom-up mode of operation and the balance in treatment of the two main pillars (TF measures and S&D) and equally value the fact that there was no overlap in meetings and full interpretation of all events which is an issue on which notably, the African Group has been insisting on.

As regards Trade and Environment, on Paragraph 31(i), some Members are working together to build on specific texts or revisit existing one.  While a submission by the African Group on a roster of experts to assist developing countries with respect to specific trade obligations under multilateral environmental agreements gathered some support, further consultations will be held to refine the proposal.  On Paragraph 31(ii), Members have started with text-based negotiations.  Finally, on Paragraph 31(iii), a lot of work remains to be done to further define the “universe of environmental goods” and the related structure of the outcome, including modalities of treatment.  Members have also recently expressed renewed interest for the topic of environmental services.

As regards the negotiations on the establishment of a multilateral system of notification and registration of geographical indications for wines and spirits, intensive drafting sessions have been taking place by a small group of experts drawn from co-sponsors of the different proposals, the “W/52 Group”, the “Joint Proposal Group”, and Hong Kong, China, with the results reported to an open-ended informal consultations. 

On 27 January, the Chair circulated a paper on Notification and Registration, resulting from Member's own texts and the outcome of the drafting group.  This represents the current state of play, with full attributions of different wording, following a concerted effort to reduce square brackets.  This text is now “work in progress”.  Wok will now continue on the elements of Legal Effects/Consequences of Registration and Participation.

On the Work Programme on Special and Differential Treatment, discussions have been taking place on the basis of the most recent revision of the Chair's non-paper on the Monitoring Mechanism.  This work is being undertaken in small group informal consultations.  A number of constructive textual proposals have emerged during the consultations.

On Dispute Settlement, an updated draft legal text was presented and discussed on sequencing, and points of convergence were identified with respect to possible solutions to post-retaliation.  There has been more substantive engagement on effective compliance and time-savings.

Finally, let me take also the opportunity to report on my consultations, as DG and not as TNC Chair, on the two TRIPS implementation issues of TRIPS/CBD and GI extension.

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Exports prospect of Nepal

My latest piece is about exports prospects of Nepal in the fiscal year 2010/2011. I did a simple annual estimation from five months data of this fiscal year. The main point is that exports this fiscal year might not increase while imports will increase relative to previous two years. Nothing has fundamentally changed with regards to productive capacity and efficiency in the economy. So, the underlying problems that have been plaguing our export and industrial sectors still persist. Unless we solve these exogenous and endogenous problems, export prospects will remain gloomy.

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Nepal's exports prospect

The latest macroeconomic update released by the central bank shows a favorable growth in exports, and decline in both trade deficit (the difference between monetary value of exports and imports) and balance of payments (BoP), which basically is an accounting record of all the monetary transactions between Nepal and the rest of the world, deficit. While many marveled at the decline in trade and BoP deficits, a bitter truth about the state of our export and industrial sectors was pretty much ignored: We are still stuck in the same mess we have been for a couple of years now and growth prospect of exports and industrial sectors look as gloomy as it was last year.

During the first five months of this fiscal year, merchandise exports increased by 8.5 percent to Rs 27.3 billion, which is an improvement by Rs 2.1 billion over the same period last fiscal year. Meanwhile, imports increased by 0.6 percent to Rs 154.3 billion, which is an increase by Rs 0.9 billion over the same period. Hence, trade deficit amounted to Rs 127 billion, a decrease of Rs 1.4 billion. The decline in imports and an increase in remittances helped overall BoP deficit to shrink to Rs 3.4 billion from Rs 14.6 billion over the same period. In short, this is the story about the status of our external sector in the past five months of fiscal year 2010/11.

Now, an intriguing exercise would be to project the likely performance of exports and imports for the full year, which the central bank should have done but is not doing so far. Based on the trend in the last two fiscal years, the annualized figures for exports and imports for this fiscal year are expected to be Rs 63.3 billion and Rs 379.6 billion, respectively. Based on this calculation, the trade deficit will be between Rs 316.3 billion and Rs 318.4 billion. Simply, it means that Nepal will be importing six times as much as it exports by the end of fiscal year.

Rather than comparing five months figures as the central bank did, let us compare the annualized numbers with previous years’ data, which gives a better picture of the performance of exports sector. In a nutshell, the core message is that exports performance during this fiscal year will not be different from what it was in the last two years. The deepening of the global economic crisis severely affected exports last fiscal year, when it stood at Rs 61.1 billion as compared to Rs 67.7 billion in FY 2008/09. On an average, exports during the last two years was around Rs 64.4 billion, which is still higher than what is expected by the end of this fiscal year. Following the same methodology, imports this fiscal year will be higher than the average of last two fiscal years. It means that trade deficit will also be higher. Overall, the exports sector’s performance this fiscal year does not seem encouraging and there is little reason to bask on improved yet incomplete data for the first five months of this fiscal year.

Before going into the potential reasons for dismal performance of exports sector, let me first discuss a little bit more about how our exports are expected to perform until 2012. According to Global Economic Prospects (GEP) 2011, exports, as a share of GDP, are expected to continuously decline, reaching 9.9 percent in 2012 from 11 percent, 12.9 percent and 15.7 percent in 2011, 2010, and 2009, respectively. Meanwhile, imports are expected to continue increasing in pretty much the pattern it is doing so far. This means trade deficit is expected to further widen in 2012. Worse, due to weak foreign currencies, thanks to lose monetary policy in the West, our exchange rate is expected to appreciate, making our exports costlier abroad, which will put further strain in the performance of this sector. Add to this the impact of rising inflation rate in Nepal, our exports will be even more uncompetitive in 2012, if the underlying constraints that plague this sector are left unaddressed.

Now, you might be wondering what’s up with all these numbers and performance of exports sector? Well, the reality is that its performance largely determines the strength of our industrial sector, our external/macroeconomic balance, and to some extent our economic growth rate. With the existing state of exports and other economic fundamentals, Nepal’s real GDP growth is expected to be 3.7 percent and 4 percent in 2011 and 2012, respectively. It means that Nepal’s real GDP growth rate will be second lowest in South Asia in the next two years.

The main point is that despite a marginal increase in exports, slow growth rate of imports, and declining balance of payments deficit in the first five months of this fiscal year, we still are in a deep trench. Our economic fundamentals have not changed. The same problems that have been plaguing our exports sector are obstinately persistent. Supply-side constraints such as intermittent blockades, labor disputes, and lack of adequate infrastructures (primarily road transport and electricity) are further eroding our competitiveness. These constraints are mostly exogenous in nature. They are making our exports uncompetitive and are also preventing diversification of exports basket.

That said, some endogenous factors such as the lack of entrepreneurship and innovation in exports sector, the ignorance about the rapidly changing and globalizing market, and the inability to embrace a change in restructuring production, marketing and distribution structures of firms are some of the other factors ailing the growth of industrial and export sectors. This is corroborated by the World Bank’s projections in GEP 2010 and GEP 2011. The GEP 2010 projections showed higher growth rate in exports and in exports as a share of GDP, but they were revised down due to persistent negative impact of the above-mentioned constraints.

Most of these are non-economic constraints. So, the set of solutions are political consensus on national agenda regarding export and industrial promotion, amicable settlement of labor disputes, and simplification of rules and procedures regarding construction of infrastructures directly related to these sectors. It should be aided by promotion of entrepreneurship in and restructuring of exports sector. Else, our exports and industrial competitiveness will continue to decline, resulting in a widening trade deficit, prolonging of BoP crisis, further slowing down of growth rate, and stagnating employment opportunities.

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[Published in Republica, February 3, 2011, p7]

Persistence of Keynesian economics: 75th anniversary of The General Theory

February 2011 marks the 75th anniversary of one of the groundbreaking economics books written by JM Keynes in 1936: The General Theory of Employment, Interest, and Money. Luzzetti and Ohanian (full paper here) shed light on the influence of Keynes’s ideas in shifting economic paradigm and policy. They assert that the long-lasting clout of Keynes’s General Theory was due to the fact that Keynes was “in the right place at the right time”.

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As the Depression persisted for years in the UK and the US, it became increasingly difficult to reconcile chronically high unemployment with equilibrium theory that posited wage adjustments would reduce unemployment to normal levels. The General Theory was, in large measure, written in response to the inability of equilibrium theory to confront the Great Depression.

Furthermore, US macroeconomic time series following the publication of the General Theory appeared consistent with Keynes’s predictions. As government spending soared in the 1940s, rising from about 16% of GDP in 1939 to 48% of GDP in 1944, the unemployment rate plummeted from 17.2% to 1.2% (Margo 1993). This increased economists’ confidence in the Keynesian model, and the stable and prosperous economy of the 1950s and 1960s further solidified this confidence.

But perhaps the central factor behind the longevity of the General Theory was a series of breakthroughs in econometric methods that began in the 1940s. These methodological developments transformed the qualitative ideas of the General Theory into quantitative propositions. These breakthroughs included Haavelmo’s 1944 paper that integrated more formally probability theory with econometric methods, and other Cowles Commission classics on identification, estimation, and causal ordering.

These econometric developments formed the basis of the toolkit used to analyse business cycles following the General Theory both among university economists and policymakers. Throughout the 1960s, the economy continued to grow with remarkable stability, and for many observers, this stable prosperity was due in considerable part to the General Theory’s tenets.

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And, Keynesian economics started to lose steam by the early 1970s due to poor forecasting performance of Keynesian econometric models; increasing recognition of supply-side factors as drivers of fluctuations (Kydland and Prescott 1982); and the breakdown of the Phillips curve, the authors argue. Here is a partial rebuttal to this view as well.

But, Keynesian economics is back again after the recent global financial and economic crisis. It will persist.

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The notion of an inflation-unemployment trade-off and aggregate demand management remain at central banks, and the Keynesian vision provides a well-established framework for carrying this vision on within the context of policies that tie central bank behaviour to the joint mandate of promoting both low unemployment and price stability. This makes it politically unimaginable for a central bank, faced with a crisis, to argue it is unlikely they can increase output and trying to do so might make matters worse.

The General Theory will continue to have a large audience among policymakers as long as governments are pressed to boost nominal spending during periods of crisis, whether or not those efforts are effective.

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The Doha Round and drought

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The Doha Round — when completed — will oil the wheels of international trade in commodities, giving the developing world its fair share of the market.  It will improve the workings of what is no more, in the end, than a transmission belt, between countries where there is demand and countries where there is supply.  For food trade, the climate crisis makes a properly functioning transmission belt even more imperative.  Droughts, and other natural catastrophes, should not deprive parts of the globe from food.

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That’s Pascal Lamy pitching for the passage of the Doha Round and managing food price spikes.