Imprudent unions & weak industries of Nepal

This was published in Republica, August 27, 2011. For an earlier discussion on the same issue, please check this blog post.

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Imprudent unions & weak industries

The economy is in such a mess that we really don’t need any more negative news to further dampen market confidence. The political instability, deteriorating industrial relations, power outages, misplaced government emphasis on cooperatives, and strikes have been already enough to discourage investors. Now, add to that list the troubles caused by perennially insatiable labor unions that are bickering with industrialists time and again over unjustified demands related to wage and compensation. The latest victim of the trade unions’ irresponsibility and misguided judgment is Surya Nepal Private Limited’s (SNPL) Biratnagar-based garment manufacturing unit, which permanently ceased production.

The blame squarely goes to the unruly and militant trade unions that think more about reaping short-term gains to its top echelons than the welfare of its members and its institutional sustainability. The irresponsible stance and acts of opportunist trade unions and its leaders have cost direct and indirect employment of over 2000 workers, mostly women. Worse, it has sent a very bad signal about market conditions. Investors, foreign and domestic, will now think multiple times before they commit to invest in Nepal, let alone in the manufacturing sector.

Established in 2004 with an investment of approximately Rs 700 million, SNPL’s garment manufacturing unit was producing popular international brands like John Players and Springwood. It was established at a time when the Nepalese garment industry was fast losing its market abroad. It was not only successful in capturing the rapidly growing Indian market, but also exported garments to the US, Canada, and the EU. Needless to say, it was also popular in the domestic market. Finally, we had a manufacturing firm that could compete in the international market and also be successful in the domestic market. This was the kind of manufacturing firm we needed to help reduce ballooning trade deficit— by increasing exports and at the same time supply goods to the domestic market to substitute imported garments.

Alas, the unruly unions cost us an established garment manufacturing firm that was providing hundreds of jobs, and contributing revenue and foreign exchange reserves. At one time the garment industry was the stronghold of our industrial sector. Now, this beleaguered sector is struggling to survive amidst loss of competitiveness and markets, mainly attributable to erosion of preferences following the expiry of Agreement on Textiles and Clothing (ATC) in 2005, and increase in cost of production due to inefficient production, power outages, frequent strikes and persistent labor unrest, which particularly intensified after 2006.

Previously, the political instability and labor union militancy in the industrial sector led to exit of multinational companies (MNCs) that have been providing hundreds of jobs and supporting numerous households. The Maoist-affiliated labor unions, through their idiotic demands, chased away Colgate Palmolive and Dabur Nepal, and briefly stopped Varun Beverage Nepal Ltd—the bottler of Pepsi—from operation, leading to withdrawal of planned investment of approximately Rs 1 billion. The trade unions have failed to acknowledge the fact that locking up management staff, threatening businessmen, smashing equipment in factories, opening camps inside industrial zones, seizing land and making a mockery of private property right, demanding compulsory donation, and having my way or the highway attitude will do nothing but erode whatever meager confidence investors have on the Nepalese economy. No wonder, Nepal is consistently ranked as one of the less investor friendly destinations to do business. Its hire and fire policies are one of the most rigid in the world.

There is nothing wrong in having strong trade unions that care about its members and the firms where they are employed. But, in our case it is not so. Two fundamental problems inflict our industrial sector: policy inconsistency and stance inconsistency. First, there is policy inconsistency on the part of government, especially with regard to the methodology of fixing wage and compensation of workers in the industrial sector. The Ministry of Labour and Transport Management (MoLTM) does not have a structured industrial conflict resolution framework. Most of the decisions are taken in an ad-hoc basis, leading to policy inconsistency. For instance, the latest industrial strike flared up after the MoLTM unilaterally revised wage and compensation to please some trade unions and its leaders. This was against the agreement between the major trade unions and industrialists and was also being looked upon by the Supreme Court. Most of the time settlement of labor disputes has happened at the whim of influential political leaders, union bosses and ministers. In SNPL’s case, persistent labor dispute over wage and compensation and demand for salary even for days not worked (the company says it followed ‘no work, no pay’ principle) culminated into lock up of management staff of the garment factory. This led to cancellation of existing and future orders and ultimately closing down of the factory.

Second, and the biggest culprit of all, are the trade unions and inconsistency in their stance on major labor issues. The top echelon of trade union has become a bunch of selfish opportunists that care more about sucking concession and donations from the industrialists to please their political masters than advocate the welfare of hardworking workers in factories. At times, the ego problem and governance issues within trade unions have led to union break-ups—the seeds of more industrial disputes. It has led to ever-changing wage and compensation demands of trade unions. Even if the industrialists agree to jack up wages and compensation, one or the other trade unions object to it. It leads to a war in pressing for higher demand, undo the agreements already sealed, and hoodwink workers by making false promise of wages increase if they go for strikes. The wage rates have been revised multiple times this year alone. The question is: What is the final deal and stance? Moreover, what is baffling is that the demands of unions are not matched by labor productivity (see ‘Union Strikes & Productivity’, Republica, 24 March, 2011). How can you increase wage and compensation if marginal labor productivity does not increase proportionally?

No matter how far the industrialists stretch their neck to reach out to unions for an amicable and sustainable solution, they are unable to do so due to the unruly and always unsatisfied trade unions and their bosses, who are bestowed with the blessing of crooked political leaders. The unions are so illogical that even when struggling factories want to close down operation after paying due compensation and swallowing ‘sunk cost’, they are arguing that investors can’t do that. This is utter nonsense. There is no relief from unions before opening, during operation and after closing down a firm. The trade unions should digest the fact that investors are here to do business, not charity. The unions are there because workers are employed by factories. The one-sided action of unions is leading to strike-unemployment cycle (see ‘Strike-unemployment cycle’, Republica, 17 December, 2009). The Maoist-affiliated trade unions are on the forefront of this destructive process.

The closure of the SNPL’s garment manufacturing unit sends a frightening message to potential investors and MNCs. This threat is never acknowledged by trade unions mired in money and politics. Worse, the government is under-acknowledging the situation right now. It will have a disastrous impact on the already stagnating economic activities. The unruly and uncompromising trade unions and their bosses should be held responsible for the loss of over 2000 jobs in the garment manufacturing plant in Biratnagar.

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Impact of infrastructure spending on household welfare in rural Nepal

Did expenditure on access to rural roads irrigation infrastructure, and extension services have significant impact on household welfare over the period of Ninth Five-Year Plan (1997-2002) in Nepal?

A new research monograph by IFPRI shows that the effect of rural roads is robust across two different econometric strategies, while the effect of irrigation and extension services on household welfare is less robust. Access to rural roads improved households’ welfare as measured by land values, consumption growth, poverty reduction, and agricultural income growth. The research also shows statistically significant impacts of irrigation using a hedonic model, while an alternative panel data approach did not yield significant  estimates of the impact of access to irrigation or extension services. What explains this inconsistency? The authors point their fingers to measurement inaccuracies of the irrigation variable at the household level, which is aggregated from the plot level, rather than to true ineffectiveness.

The authors (Dillon, Sharma and Zhang) argue agriculture growth expectations was below the target set in the Ninth Five-Year Plan and large gains in poverty reduction have been largely driven by rural-to-urban migration and remittances. This is also somewhat corroborated by the latest findings of NLSS III and migration survey.

They argue that growth in rural areas can be attained by harnessing its comparative advantages, particularly those hinged on agro-ecological environment. Realizing this potential would require increasing connectivity of rural areas with roads, integrating farmers with markets and increasing their productive capacity by improving access to irrigation.

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In our hedonic estimates of the effect of extension on land values in 1995/96, we find that access to extension had a positive yet insignificant effect, while our 2003/04 estimates suggest a larger, statistically significant effect. However, in the panel household analysis, we find that access to extension in 1995/96 did not have a significant impact on growth in household welfare. Due to civil strife, the initial frequency of extension visits might not have been related to agricultural productivity and other welfare indicators seven years later. The inconsistency of the estimated impact of extension service between the two methods calls for more in-depth research in the future.

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The US Ambassador to Nepal reads Nepali economy better than our own policymakers and analysts

The US Ambassador to Nepal, Scott H Delisi, delivered a speech yesterday in Kathmandu. I did not attend the program but did go through his speech. He strikes at the heart of our (read political leaders and wonks) inability to connect economic prosperity with politics. We don’t have economic discourse as we should to create a “New Nepal”, which is still illusionary among most of the people. Very few analysts have raised the pertinent and pressing economic issues as bluntly and as precisely needed (self-advertisement: yours truly have tried to do that in many op-ed columns, research, events and blog posts!). 

Below are excerpts from Ambassador Delisi’s speech:

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[…] During my sixteen months here, I have been continually surprised how little public debate and discussion there is about Nepal’s economic challenges.  I have met with dozens of senior political leaders during my time in Nepal – from prime ministers to local party cadres – and invariably the discussion focuses on the peace process, the constitution, and, more often than not, their party's plans to retain or gain control of the levers of political power.

[…]my surprise, and at times dismay, that so many of those who aspire to lead the nation appear to have not devoted the same degree of attention to  the nation’s development strategy, the strengthening of the economy, and the creation of jobs, as they have to their political agenda. 

[…] I certainly believe that these issues give rise to fundamental definitional issues for the "new" Nepal.   What protections will you give to private property? How will you manage land reform?  What are the agricultural policies that can lead to food security?  How do you balance cooperatives and private enterprise?  How do you create jobs for the future?  How long can you sustain an economy built largely on customs revenue and exporting your youth to labor abroad? 

[…] I described these issues as "definitional" and I think they are.  When I ask young men and women here what it means to be a Nepali in the "new Nepal" they struggle to answer.   I think part of the reason is that these, and other issues related to fundamental values about governance and the purposes to which power should be put, have not yet been clearly articulated.  

At the same time, Nepal’s own business houses are focused only on short-term profits.  Many seek to avoid paying taxes and maneuver to sneak their money out of the country.  Young entrepreneurs who want to start businesses must deal with rent-seeking behavior from government officers who are supposed to help them.  Many State-owned enterprises -- which often are staffed through political favoritism rather than as a result of merit – are badly managed, draining resources from state coffers while failing to provide services.

[…] I was very disheartened to learn that Surya Nepal, one of the few companies that remain competitive in Nepal’s readymade garment sector, has closed down its operations due to labor problems. More than 2,000 people – mainly women –employed directly or indirectly through Surya's operation, have lost their jobs.  In my opinion, the closure was a setback for the country’s economic development and diminishes our efforts to convince foreign investors that Nepal is open for business. In a globalized world where countries have to compete for foreign investment and the success of a business depends on timely delivery of goods and services, labor disputes that hold companies' operations hostage for months inevitably lead to such unfortunate consequences.

Equally troubling, some political leaders seem to view businesses as sources of funding for their parties – or even worse – as targets to be exploited for their personal gain.  The private sector accepts the status quo as the price of doing business in Nepal.  Both the exploitation and the acquiescence undermine Nepal’s long-term economic prospects and ultimately democracy.

[…] Remittances may currently be the lifeblood of Nepal's economy but those who suggest that remittances are positive for Nepal in the long run fundamentally misunderstand economic realities. Like an addictive drug that feels good today but causes devastation in the long run, remittances provide a short term boost to the economy but only forestall the need to make tough economic choices – which are even harder to accommodate the longer government waits.  In Nepal today, remittance flows are fueling increased consumption but by all indicators, are not being channeled into productive investment.  Meanwhile, Nepal’s competitiveness and productivity continue to decline over the long term.

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He believes that prospects for a prosperous Nepal are not that gloomy. Sectoral opportunities exist if we have the will to exploit them. Some of the sectors identified by Ambassador Delisi are IT outsourcing, tourism, hydropower, reforming SOEs, and agriculture.

An excellent rundown of some of the economic challenges (precisely the process—socio-political-economic— of what hinders exploiting our potential) by Ambassador Delisi. I just wish that our political and industrial leaders and those at the top echelon of policymaking at least articulately state what the ambassador has said. These are well-known stuff, but people are failing to articulate and have debate over them.

For more on some of the issues, do check out my articles listed below:

• Labor issues cost another garment factory in Nepal
• Costs and benefits of remittances
• Changes are coming to Nepal
• Food security in Nepal
• Industrial Priority
• Remittance’s ugly face
• Future of Nepal’s exports
• Convenient Conclusions?
• Costs of Nepal bandas
• Don’t forget the starving poor
• Strike-unemployment cycle
• What’s holding back growth?
• Growth Strategies for Nepal
• Pay taxes, become responsible citizens
• Bust factors: Poor appropriability and load-shedding

Does high food prices cause political instability?

 Lagi, Bertrand and Bar-Yam show that the timing of violent protests in North Africa and the Middle East in 2011 as well as earlier riots in 2008 coincides with large peaks in global food prices. So, yes rising food prices (above a certain threshold) might induce riots and political instability.

They identify a specific food price threshold (the FAO’s Food Price Index of 210; the index as of June 2011 was at 234) above which protests become likely. It suggests “that protests may reflect not only long-standing political failings of governments, but also the sudden desperate straits of vulnerable populations.”

Below is a chart showing time dependence of FAO Food Price Index from January 2004 to May 2011. Red dashed vertical lines correspond to beginning dates of “food riots" and protests associated with the major recent unrest in North Africa and the Middle East. The overall death toll is reported in parentheses.

The researchers argue that food prices will permanently rise above the 210 threshold within a yea or two. They argue that the major causes of rise in food prices are investor speculation and ethanol production. Hence, they argue “reducing the amount of corn converted to ethanol, and restricting commodity future markets to bona fide risk hedging would reduce global food prices.”

The FAO food price index just below 220 in July 2012 would increase the changes of having more instability, they predict.

The chart above shows time dependence of FAO Price Index at current prices (upper black curve) and constant prices (corrected for inflation, lower blue curve) from January 2004 to May 2011. Red dashed vertical lines correspond to beginning dates of food riots and events associated with the major recent unrest in North Africa and the Middle East. Black and blue horizontal lines represent the price threshold above which riots are ignited in current and constant prices respectively. Index backgrounds are fitted with a third-order polynomial; intersection with the threshold (July 2012 at current prices, August 2013 at prices corrected for world inflation) represents the point of instability.

Retail prices of wheat and rice in South Asia

The charts below show retail prices of wheat and rice in one major city of each South Asian country (except for Maldives for which there is no data available).

Retail price of rice increased in all countries during mid-2008. It cooled off a little bit but is still high and rising. Overall, retail price of rice is highest in Pakistan. It is followed by Sri Lanka, India, Nepal, Bhutan, and Bangladesh. Retail price of wheat in Bhutan is rising rapidly even though it still has lower price than in Bangladesh. Price of rice is picking up since the beginning of this year.

As of July 2011, retail price of a kilo of rice was USD 0.59, USD 0.52, USD 0.51, USD 0.49, USD 0.47 and USD 0.44 in Pakistan, Sri Lanka, India, Nepal, Bhutan and Bangladesh respectively. In July 2008, they figures were USD 0.74, USD 0.58, USD 0.47, USD 0.54, USD 0.35, and USD 0.50 in Pakistan, Sri Lanka, India, Nepal, Bhutan and Bangladesh respectively.

Retail price of wheat spiked in mid-2008 and then cooled off a bit before rising again. As of July 2011, Sri Lanka has the highest retail price of wheat, followed by Afghanistan, Nepal, Bhutan, Pakistan, Bangladesh and India. Sri Lanka and Nepal are seeing a rapid rise in retail price of wheat.

As of July 2011, retail price of a kilo of wheat was USD 0.78, USD 0.52, USD 0.51, USD 0.43, USD 0.38, USD 0.38, USD 0.34 and USD 0.34 in Sri Lanka, Afghanistan, Nepal, Bhutan, Pakistan, Bangladesh and India. In July 2008 the figures were USD 0.69, USD 0.68, USD 0.43, USD 0.35, USD 0.41, USD 0.55, and USD 0.30 in Sri Lanka, Afghanistan, Nepal, Bhutan, Pakistan, Bangladesh and India respectively.

Nepal’s sovereign rating

Nepal does not have a sovereign rating. Standard & Poor’s, Moody’s, and Fitch, the three international rating agencies, have not rated Nepal. Altogether 58 developing countries are still not rated by them. Canuto, Mohapatra and Ratha of the World Bank followed the same methodology used by S&P to estimate the rating of the unrated developing countries.

As of April 2011, Nepal got CCC+, Maldives B+ to BB+, Bhutan and Bangladesh BB- to BB. Nepal falls under the "high default risk" category; Maldives “highly speculative”; and Bhutan “speculative”. The rating is based on a regression outcome with the independent variables GNI per capita, GDP growth rate, debt to exports ratio, reserves to imports to short term debt, growth volatility, inflation and rule of law.

Transatlantic economies whipsawed by globalization

Jeff Sachs writes:

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A failure of economic strategy and leadership lies behind the near simultaneous collapse of market confidence in the euro zone and US economies. No need to blame the rating agencies: governments in Europe and America have been unable to cope with the realities of global capital markets and competition from Asia – and deserve the lion’s share of the blame.

I’ve watched dozens of financial crises up close, and know that success means showing the public a way out that is bold, technically sound and built on social values. Transatlantic leadership is falling short on all counts. Neither the US nor Europe has even properly diagnosed the core problem, namely that both regions are being whipsawed by globalisation.

Jobs for low-skilled workers in manufacturing, and new investments in large swaths of industry, have been lost to international competition. Employment in the US and Europe during the 2000s was held up only by housing construction stoked by low interest rates and reckless deregulation – until the construction bubble collapsed. The path to recovery now lies not in a new housing bubble, but in upgraded skills, increased exports and public investments in infrastructure and low-carbon energy. Instead, the US and Europe have veered between dead-end, consumption-oriented stimulus packages and austerity without a vision for investment.

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Sachs outlines three fiscal policies for the US and the EU.

• Expand investments in human and infrastructure capital.
• Cut wasteful spending, for instance in misguided military engagements in places such as Iraq, Afghanistan, and Yemen.
• Balance budgets in the medium term, in no small part through tax increases on high personal incomes and international corporate profits that are shielded by loopholes and overseas tax havens.

Labor issues cost closure of another garment factory in Nepal

The beleaguered Nepalese garment industry has lost one of the top performs—Surya Nepal, which produces popular international brand John Players and exports to India, the US, Canada, France and other European countries—due to protracted labor problems.

The blame should squarely go to the trade unions that have been letting its members use militant behavior to press their demands (remember locking management staff and giving physical threats?), which has so far revolved around increasing wages (multiple times in a year) and social security (which is a newly introduced concept). When will the trade unions (read its bosses) get satisfied with wages? What is the final deal?  What happened to this deal between labor unions and FNCCI? Do the trade union leaders really represent their members (or trade union members honor agreements singed by their organization heads)?

The policy inconsistency of government and stance inconsistency of trade unions (that have been using extralegal means to press their demands) is bleeding the industrial sector. Vested interests of trade union bosses and their bosses of political parties are actually costing not only the industrial sector but also the naïve workers who think they are represented by the leaders are politicians who are past their retirement age. Closing down Surya Nepal will cost 650 direct and 1400 indirect employment. We already lost Colgate Palmolive, Dabur Nepal, Kodak and other MNCs due to labor and political problems. 

Established in 2004 with an investment of Rs 700 million, Surya Nepal was producing popular international brands like John Players and Springwood. The industry was directly employing more than 700 workers, of which majority were women. Likewise, it was providing employment to other 1,400 workers mainly by contracting out its production orders.

Also, read this article that explains how labor militancy is leading to strike-unemployment cycle. This statement is even valid right now: “If you have lost a job, are potentially going to lose, or cannot get one in the market, then blame the outrageous, militant youth wings and the politicians who incite the unions to go on a destructive path.” Read this article that explains the disconnect between outrageous labor demands not matched by labor productivity.

Poverty declined in Bangladesh from 40% to 31.5% in five years

Absolute poverty in Bangladesh dropped to 31.5 per cent in 2010, reflecting an 8.5 percentage point decline in the last five years, according to Bangladesh Household Income and Expenditure Survey (HIES) 2010. This is lower that in Nepal where absolute poverty declined to 13 percent of total population, down from 31.5 percent in 2003/04—an incredible 18 percentage point decline in poverty, or three percentage point decline each year.

According to the HIES 2010 data, poverty in the rural areas shrunk by 8.60 percentage points to 35.2 per cent in 2010 from 43.80 per cent in 2005. The last HIES survey in 2005 showed that 40 per cent of the people of Bangladesh, out of its total population, lived below the poverty line. According to the last survey data, the 43.80 per cent of the total rural population was poor while 28.40 per cent people in the urban areas lived below the poverty line.

One of the main factors is attributed to remittances, which was also the most crucial factor in reducing income poverty in Nepal. The Bangladeshi authorities attribute to this remarkable feat to increased remittances, spread of modern agricultural method, improvements in rural infrastructure and flow of micro-credit to the ultra-poor.

The present report is based on the final data sets of HIES 2010. The sample size was
12,240 households where 7,840 were from rural area and 4,400 from urban area.

South Asia continues to reap the benefits of remittances. The question is: can this be sustainable and can the money be channeled to productive sectors?

IMF’s assessment of Nepal’s economy in 2010/11

An IMF staff team has concluded 2011 Article IV Consultation in Nepal. The report is yet to be out but here is what the IMF sees going on in Nepal right now. Below are the major points copied from the IMF statement.

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• GDP growth is expected to remain below 4 percent in the near term but in the absence of other shocks, inflation should decline somewhat.
• The balance of payments should show a small surplus, though it will remain vulnerable to the weak global environment.
• The delayed adoption of the 2010/11 budget contributed to the weak economic outturn. The timely presentation of the 2011/12 budget to Parliament is therefore welcome.
• The authorities’ plans to limit domestic financing of the fiscal deficit to 2 percent of GDP is appropriately consistent with macroeconomic and debt sustainability. However, achieving the deficit target will not be easy. Despite the impressive gains in revenues in recent years, slower economic growth could result in lower receipts than envisaged. At the same time, current spending is budgeted to rise substantially, and additional unbudgeted spending pressures could arise, including for reintegrating former combatants. Taking into account all of the above, the authorities are advised to prepare contingency plans to ensure the domestic financing target is met. These should focus on collection of VAT arrears, further improvements in tax administration, and reductions in unproductive subsidies, while safeguarding spending on priority poverty reduction and infrastructure.
• At the same time, large losses that arose at the Nepal Oil Corporation (NOC) in 2010/11 are unsustainable. Adoption of an automatic price adjustment mechanism that ensures the NOC avoids future losses is strongly recommended.
• As regards monetary and exchange rate policy, the peg should remain the key policy priority. This requires that monetary policy be conducted in a manner that ensures interest rates in Nepal do not fall below those in India. In the current environment, generalized liquidity injections would be inconsistent with this objective.
• Risks in the financial sector have been building up for some time as financial institutions proliferated in an environment of weak supervision. Excessive exposure of banks and other financial institutions to the real estate sector, where an asset price bubble has now burst, have brought many of these risks to the fore. Well targeted and fully collateralized temporary liquidity support to solvent individual institutions at penalty interest rates is warranted.
• On the other hand, relaxation of prudential and accounting regulations or blanket provision of liquidity assistance would only postpone addressing the deterioration in financial institutions’ balance sheets, with potentially significant untoward consequences for the economy. The authorities are encouraged to put in place a comprehensive and multi-faceted program of financial sector resolution that includes, among other things, better diagnostic assessments, strengthened supervision and enforcement of prudential regulations, and stronger intervention powers for the NRB.

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Contribution of small and young firms to employment & growth

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This paper describes a unique cross-country database that presents consistent and comparable information on the contribution of the small and medium enterprises sector to total employment, job creation, and growth in 99 countries. The authors compare and contrast the importance of small and medium enterprises to that of young firms across different economies. They find that small firms (in particular, firms with less than 100 employees) and mature firms (in particular, firms older than 10 years) have the largest shares of total employment and job creation. Small firms and young firms have higher job creation rates than large and mature firms. However, large firms and young firms have higher productivity growth. This suggests that while small firms employ a large share of workers and create most jobs in developing economies their contribution to productivity growth is not as high as that of large firms.

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Full paper by Ayyagari and Demirguc-Kunt (2011) here.

Update: More from the paper and a chart:

• SMEs contribute more to employment in low-income countries than in high-income countries.
• Small firms not only employ the most people, they also generate the most new jobs. SMEs with 250 or fewer employees generate a median 86.01 percent of the jobs.

The emergence of India as a donor

India is planning to set up its own aid agency to distribute its own US$11 billion over the next five to seven years, according to The Economist. South-South aid is increasing and the aid dynamics is changing. Here is a post on South-South aid to Nepal (India being the largest donor).

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For decades, India was the world’s biggest aid recipient. Now, it is likely to join Brazil, Russia and China in using aid to win friends and influence people abroad. The rules of aid are being turned inside-out and long-standing donors—governments and non-governmental organisations (NGOs) alike—must change, too.

[…] But India’s proposal shows that donors, like generals, are still fighting the last war. The old binary division of the world—between rich countries which give aid and poor ones which get it—is gone. Fewer countries are poor and eligible for cheap loans. Two-thirds of the world’s poorest people—those with less than $1.25 a day—live in middle-income countries, such as India, which increasingly are donors as well as recipients.

[…] As India also shows, middle-income countries no longer need financial transfers to help their own people. That was clear before: India has a space programme and $300 billion of foreign reserves. A new aid agency would ram the point home. Once, Westerners could say they needed to help India’s poor because India’s own government could not afford to. Not now.

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Now, the Southern and the Northern donors should focus on their comparative advantage—the former in infrastructure and the latter in promoting good governance.

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In this new world the justification for aid and the behaviour of donors must change. For India and others, it is far from clear why the government should send aid abroad when it has so many poor people at home. No doubt, aid will be defended as a boost to global influence. The risk for India is that, just like the West did in the 1960s, it will pour money into grand projects which fail—and encourage bad government.

For Westerners, justifying aid will be harder. But there is a reason to give: like trade, aid benefits from specialisation and comparative advantage. Emerging countries, with recent experience to draw upon, might do a better job of infrastructure spending. The West should focus more on policies and good governance (something many poorer Indian states are crying out for). There is a new world of aid but over a billion people remain poor; they still need help, even if some of them live in countries that now give aid as well as get it.

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Costs and benefits of remittances in Nepal: Findings from two household surveys

This is published in Republica, August 13, 2011, p.6. It discusses the pros and cons of remittances at household and national level in Nepal. It is based on two key surveys, namely Nepal Living Standard Survey III and Nepal Migration Survey. Read my earlier posts on remittances here and here.

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Remittances account for 23 percent of the total value of goods and services produced in the country (generally termed as gross domestic product—GDP), according to estimates by World Bank economists. Remittances have been the backbone of our economy, especially after 2000 when remittance inflows started to skyrocket. So far the extent of its impact has been discussed based on anecdotes and observations. Lately, its true reach and impact at household and national levels are estimated in two forthcoming studies based on surveys, namely Nepal Living Standard Survey (NLSS) III and Nepal Migration Survey (NMS) 2009. The findings are startling, both positively and negatively, and they indicate the laxity of our politicians and policymakers in enacting the needed reforms for structural transformation.

First, let us start with NLSS III, whose full version is not released yet, and the blessing of remitters in helping to bring about the positive changes. Over the last six years absolute poverty declined to 13 percent of total population, down from 31.5 percent in 2003/04—an incredible 18 percentage point decline in poverty, or three percentage point decline each year. Nominal average household income and nominal average per capita income have increased by 153 percent and 175 percent respectively. Furthermore, nominal per capita consumption of the poorest households has increased by 165 percent while that of richest households by 66 percent only. Also, average household income of the poorest and richest 20 percent households has increased by 297 percent and 133 percent respectively. It has contributed to a decline in income inequality, measured by Gini coefficient, to 0.35 from 0.41 recorded in the second NLSS. The average daily wage in agriculture sector has increased by 127 percent between the two surveys, but that of non-agriculture sector by 98 percent only. Access to other facilities has also improved.

What has led to such an astounding positive results at the household level at a time when the major macroeconomic variables are either stagnating or deteriorating amidst increasing political uncertainty? The only convincing factor you can think of is remittance, which has increased by 327 percent (574 percent if you use NLSS data) between 2004 and 2010. These positive changes have not come about due to hard work of our policymakers and political leaders. They are due to high remittance inflows directly to households sent by hardworking Nepalese sweating and risking their lives in various employment destinations abroad.

The massive jump in average household income—particularly that of the poorest households which make up the most of the 55.8 percent of households that receive remittances—has nothing to do with the policies that were implemented in the last six years. So much resources and efforts have been invested to reduce poverty but its effect seems to have faltered in the face of the impact of remittance at the household level. In reality, the NLSS III results indicate a policy failure and a resounding victory of remitters in reducing income poverty and inequality directly and most efficiently than any initiative carried out in the past six years. Now, some might argue that access to roads, services (education and health) and wage increase might have led to that. But, the impact of these factors is not as fast and as deep as that of remittances, which directly bumped up household income. Also, since these factors have not contributed to boosting economic growth, it appears poverty has decreased without a convincing growth rate. May be it is about time to change policy strategies to fight poverty in Nepal.

Unfortunately, the positive changes in the short run have masked a dangerous trend at policy and macroeconomy levels. First, rising remittances and increase in income of the poorest lot have made politicians and policymakers, especially at Ministry of Finance (MoF) and National Planning Commission (NPC), complacent about the automatic changes at the household level. They should not claim credit for the positive changes outlined above because no substantial policy level initiative has been carried out over the last six years to reduce poverty expect for the customary efforts through Poverty Alleviation Fund (PAF). The only credit they should take is for their contribution to the exodus of remitters to destination abroad because of their failure to create enough employment opportunities at home. Meanwhile, equal blame goes to the insensitive, visionless, and selfish political leaders who have created a mess that has led to closure of factories, capital flight, and loss of employment and entrepreneurial opportunities, triggering migration of youths.

Second, the MoF and the NPC have been increasing the size of fiscal budget without any substantial impact on the economy, where still 76.3 percent of households depend on agriculture. In the last six years, the economy saw economic growth above 5 percent in 2007/08 only. This was not the result of any miraculous policy intervention, but due to blessing of monsoon that boosted agriculture production. The laxity in enacting real reforms has triggered consumption binge (only 2 percent of household remittance is spent on capital formation). Worse, since domestic production is insufficient to satisfy domestic demand, we are forced to import goods and services, resulting in ballooning trade deficit. Now, the increase in labor costs will further increase cost of production and make our products even more uncompetitive, forcing us to import even more. Note that the exodus of workers has created a shortage of labor and an increase of average daily wage in agriculture sector by 127 percent and that of non-agriculture by 98 percent between the two surveys.

There is even more dangerous trend directly attributed to remittances, as revealed by NMS 2009, at the macroeconomy level: symptoms of Dutch disease in the Nepalese economy. Simply, a Dutch disease occurs when an economy depends on one sector so much that it leads to decline in manufacturing sector. In Nepal, increasing remittances at the household level have led to high consumption demand, high imports, and appreciation of real exchange rate, resulting in the erosion of manufacturing sector and its competitiveness.

Allow me to simplify it further. As income increases due to remittance inflows, aggregate demand and spending goes up as well. This puts pressure on nontradables in the domestic market, leading to rise in demand and output. But, due to high demand wages also tend to increase in all the sectors, both tradable and nontradable. It increases cost of production throughout the economy, leading to squeezing of profits in the nonresource tradables sector (manufacturing), whose prices are pretty much fixed in the international market (prices of nontradables are fixed in the domestic market). This means customers will look for substitutes at cheaper price, thus increasing imports and reducing domestically produced nonresource tradables. This gradually erodes the existence of the whole manufacturing sector. Meanwhile, since incomes are higher from migration, capital and labor are attracted to this sector from other sectors of the economy, resulting in reduced output and labor supply in the latter ones. As mentioned above and as corroborated by both NLSS III and NMS, we are seeing all of these undesirable changes happening in the Nepali economy.

While we applaud the findings of NLSS III let us also not forget that the positive results, which might be short-lived, are primarily due to the remitters assiduously working and sweating outside the country, and not due to policy interventions by MoF, NPC and the political leaders. Kudos to the remitters. Congratulations to all for the positive results. Good luck to policymakers and politicians to manage the messy fallout from the overdependence on remittances in the days ahead!

[Published in Republica, August 13, 2011, p.6]

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For those who blindly say free trade is always good for all

I am reading Dani Rodrik’s latest book (The Globalization Paradox) and the more I proceed forward, the more interesting it gets. Just wanted to put up this one where Rodrik lists preconditions required for trade to be always good for all.

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The import liberalization must be complete, covering all goods and trade partners, or else the reduction in import restrictions must take into account the potentially quite complicated structure of substitutability and complementarity across restricted commodities. (So in fact a preferential trade agreement with one or a few trade partners is unlikely to satisfy the requirement). There must be no microeconomic market imperfections other than the trade restrictions in question, or if there are some, the second-best interactions that are entailed must not be too adverse. The home economy must be “small” in world markets, or else the liberalization must not put the economy on the wrong side of the “optimum tariff.” The economy economy must be in reasonably full employment, or if not, the monetary and fiscal authorities must have effective tools of demand management at their disposal. The income redistributive effects of the liberalization should not be judged undesirable by society at large, or if they are, there must be compensatory tax-transfer schemes with low enough excess burden. There must be no adverse effects on the fiscal balance, or if there are, there must be alternative and expedient ways of making up for the lost fiscal revenues. The liberalization must be politically sustainable and hence credible so that economic agents do not fear or anticipate a reversal.

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This alone will not raise the level of aggregate real income. Nothing can be said definitely about growth even with the above preconditions are fulfilled. Here is why

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In our standard models with exogenous technological change and diminishing returns to reproducible factors of production (e.g. the neoclassical model of growth), a trade restriction has no effect on the long-run (steady-state) rate of growth of output. This is true regardless of the existence of market imperfections. However, there  may be growth effects during the transition to steady state. (There transitional effects could be positive or negative depending on how the long-run level of output is affected by the trade restriction). In  models of endogenous growth generated by non-diminishing returns to reproducible factors of production or by learning-by-doing and other forms of endogenous technological change, the presumption is that lower trade restrictions boost output growth in the world economy as a whole. But a subset of countries may experience diminished growth depending on their initial factor endowments and levels of technological development. It all depends on whether the forces of comparative advantage pull resources into growth-generating sectors and activities, or away from them.

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Now, it indicates the answer to the question “Is trade good?” is not as simple as “Yes, trade is always good to all”. It is much more complex than that.

Employment guarantee scheme in Nepal

The Nepalese policymakers have drafted Employment Guarantee Act promising to provide a job to all the households living below the poverty line (BPL), reports Ashok Thapa in Republica daily.

• Guaranteed job as a critical part of socio-economic security and fundamental rights of citizens, and promises a job of at least 100 days per year to at least a member of poor families.
• At least one member of families living below the poverty line will enjoy a job, fetching income equivalent to minimum wage fixed by the government.
• Jobs will be provided in sectors like construction, infrastructure and other development projects.
• In case the state failed to provide jobs, the draft says the government will pay unemployment allowance to those families.
• Based on VDC-level data, the committee, which is drafting the Act, has suggested the government to issue cards to the beneficiary households.
• In order to ensure the effectiveness of the program, the draft Act asks the local bodies to hold public hearings every four months to dig out grievances and other anomalies.
• VDC, DDC and NPC to control possible leakage.

It seem the existing plan is almost fully in line with India’s Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA), the largest employment guarantee public works program in the world.Its cost as a share of GDP, total expenditure and revenue receipts is decreasing and is expected to be 0.45 percent, 3.19 percent, and 5.08 percent respectively in fiscal year 2011-2012. This social welfare program guarantees one hundred days of employment per year at the prevailing minimum wage rate for unskilled labor. When NREGA was implemented in 2006, eleven states saw a rise in minimum wages. The new revised wages, to be adjusted with CPI, is set to increase wages in twenty states.

Similar programs (public works) have been launched in the US, Ethiopia, Sengeal, Ireland and Bangladesh among other countries. I have batted for this kind of program to solve unemployment problems in the rural areas and to boost infrastructure work. Few things to keep in mind before enacting such program:

• Without strong local level institutions (VDCs) and representatives manning the local offices leakages will be pretty high. Else, fudging of muster rolls and manipulation of accounts will occur.
• It should be demand-driven by nature.
• It is necessary to identify the households below poverty line and then provide employment to one adult members from each household for a maximum of three months (usually during lean agriculture season).
• Public works should be carried out to boost local level infrastructure that can increase agriculture productivity and promoting local markets.
• The fiscal cost is a major issues. In India it costs around 0.5 percent of GDP. Almost 53 million households were provided employment in 2009-10. Around 2826 million persondays of employment was created. Women and those from indigenous and backward groups secured most of the employment.

Below I have calculated a rough cost estimate of employment guarantee scheme in Nepal. Based on the latest NLSS III results and assuming population of 30 million, the number of BPL population in Nepal is 3.9 million. If an adult member (working age population of 15-59 years) of BPL household is given employment, then around 4.3 lakhs persons will demand employment at the minimum agriculture wage rate of NRs 170 per day. The wage cost of such scheme per day would be at least Rs 0.07 billion. If employment is provided only during lean agriculture season (which means three months), then wage cost per year would be at least Rs 6.60 billion. If we assume that administrative cost to carrying out such scheme to be 25 percent of total wage cost, then the total cost (wage plus administrative) would be around Rs 8.25 billion. Administrative cost is aimed at 20 percent of total cost in India. In Nepal, it should be higher as we lack many functioning local level institutions and representatives.

Preliminary cost estimate of employment guarantee scheme
Number of BPL population (million)	3.9
Minimum agri wage per day (NRs)	170
Average household size	4.9
Number of households BPL	795,918
Potential employment demand (15-59 years)	431,388
Wage cost per day, billion	0.07
Wage cost per year (3 months of employment), billion	6.60
Administrative cost (25 percent of wage cost), billion	1.65
Total cost (wage plus administrative), billion	8.25
Total cost (share of budget for FY 2011-12)	2.14
Total cost (share of real GDP in producers prices, 2010-11)	1.29

This would be around 2.14 percent of budget (considering FY 2011-12 budget) and 1.29 percent of GDP in producers prices of 2010-11. This cost is higher than in India, where the cost is below one percent of GDP. The program should cost lower if administrative cost is lowered. Considering budget deficit of about 3.8 percent of GDP in 2010-11, enacting employment guarantee scheme in Nepal would increase deficit to 4.83 percent of GDP.

[Note that if you assume at least one member of each household, regardless of working age population, would get guaranteed employment, then the cost would be approximately double of what is estimated above.]

Changing pattern of global trade

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The past few decades have seen important shifts that have reshaped the global trade landscape. As a share of global output, trade is now at almost three times the level in the early 1950s, in large part driven by the integration of rapidly growing emerging market economies (EMEs). The expansion in trade is mostly accounted for by growth in noncommodity exports, especially of high-technology products such as computers and electronics. It is also characterized by a growing role of global supply chains and an ongoing shift of technology content toward EMEs. These developments in global trade have been associated with growing trade interconnectedness and carry important implications for trade patterns, in particular in response to relative price changes. The aim of this paper is to outline the factors underlying these changes and analyze their implications for the outlook for global trade patterns.

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Here is the full paper. The paper states that the expansion of global and regional trade was driven by trade liberalization, followed by vertical specialization and income convergence. Lower trade barriers and technology-led declines in transportation and communication costs facilitated regional and global supply chains. Meanwhile, convergence in income levels and factor endowments across countries pushed up trade, especially that of intra-industry trade.

The expansion in global (merchandise) trade is characterized by three trends

• The rise of EMEs as systemically important trading partners
• The growing importance of regional trade
• The shift of higher technology exports toward dynamic EMEs

Note that there is a difference in export contents of advanced and emerging market economies: advanced economies have less foreign (import) content in their exports and contribute towards other countries’ exports content, but EMEs tend to have relatively large shares of imported content in their exports (especially of those that involve heavily in assembly and processing trade). This affects sensitivity of trade patterns to relative price changes. The paper states that Asian supply chain is more dispersed compared to those in North America or Europe, rendering it more vulnerable to disruptions in trade flows. Also, check out the argument for judging trade and competition based on value-added during each step of manufacturing process than total value of final products imported or exported from countries.

 

The figure below shows trade interconnectedness between Japan and China and other countries from where it imports contents for its exports. The emergence of China as a global trade hub (and its prominence over Japan in over a decade) is clearly visible.

Major findings of Nepal Living Standard Survey III

Key findings of Nepal Living Standard Surveys
	NLSS I	NLSS II	NLSS III
Survey year	1995/96	2003/04	2010
Absolute poverty (% of population)	41.8	30.8	25.2 13
Demography (%)
Population aged 0-14 years	42.4	39.6	36.7
Population aged 15-59 years	50.8	52.8	54.2
Population aged 60+ years	6.8	7.6	9.1
Sex ratio (male to every 100 female)	95.5	92.3	85.6
Female headed households	13.6	19.6	26.6
Housing and household facilities (% of household)
House owner	93.8	91.6	89.7
House renter	2.2	5.4	7.8
Access to power	14.1	37.2	69.9
Access to drinking water	70.4	81.2	83
LPG for cooking	1	8.2	17.7
Access to toilet	21.6	38.7	56
Education
Literacy (6 + years)	37.8	50.6	60.9
Attendance in private school/collage	7.5	16.7	26.8
Remittances
Percentage of househoold receiving remittances	23.4	31.9	55.8
Total amount received (Rs billion)	13	46	310
From within Nepal	6	11	120
From outside Nepal	7	35	208
Use of remittance (%)
Daily consumption	-	-	78.9
Household property	-	-	4.5
Repay loans	-	-	7.1
Education	-	-	3.5
Capital formation	-	-	2.4
Income
Nominal avg household income (Rs)	43,732	80,111	202,374
Nominal avg per capita income (Rs)	7,690	15,161	41,659
Share of farm income in household income (%)	61	47.8	27.7
Consumption
Nominal per capita consumption (Rs)
All Nepal	6,802	15,848	34,829
Poorest (first decile)	2,152	4,183	11,093
Average (fifth decile)	4,777	9,230	24,238
Richest (tenth decile)	20,263	62,037	102,772
Consumption expenditure (share of total)
Food	-	59	61.5
Housing	-	9.5	11
Education	-	2.8	5.3
Other non-food items	-	28.7	22.2
Wage employment
Share of agriculture sector in wage employment	53	37	35
Mean daily wage (Rs)
Agriculture	40	75	170
Non-agriculture	74	133	263
Loans (% of total household)
Borrowing loans	61.3	68.8	65
Having standing loans	58.4	66.7	62.6
Loans from banks	16.2	15.1	20
Loans from money lenders	39.7	26	15.1
Loans from relatives	40.8	54.5	51.1

This table is sourced from Republica (2011-08-06). My initial comments on the findings are here.

Notice that all the changes are remittance- and migration-driven. More remittance money is spent on consumption than in any other heading. Only 2.4 percent of remittance money is spent in capital formation.

Households that owned houses have decreased while those renting houses have increased. Access to power has substantially increased. So, are households with safe drinking water and toilet. (One can guess the supply thought-- prolonged power cuts and taps running dry!). Households with LPG for cooking has also increased (which explains why the NOC is loosing out the most money on LPG).

Working group population has increased. But, those dependent (60+) has also increased. Dependent population below 14 years has decreased.

Nominal average household income and nominal average per capita income have increased by 153 percent and 175 percent respectively between NLSSII and NLSS III. In the same time period, nominal per capita consumption of the poorest households (first income decile) has increase by 165 percent while that of richest households (tenth income decile) has increased by 66 percent. The nominal per capita consumption of median households (fifth decile) increased by 166 percent.

Consumption expenditure on food, housing and education has increased but on other non-food items it decreased.

The average daily wage in agriculture sector has increased by 127 percent between the two surveys, but that of non-agriculture sector increased by 98 percent only.

More households are now borrowing from banks and curtailing loans from money lenders.