Sunday, August 18, 2013

Unusual Structural Transformation: Is Nepal stuck in a low growth trap?

The sectoral value addition and its movement against per capita GDP in the chart above indicates that high growth in Nepal won’t be sustained unless the industrial sector is strengthened along with the promotion of high value agriculture production and services activities. Else, growth will continue to be determined by the monsoon (agriculture sector) and remittances-backed consumption demand of mostly imported goods (low productive, low value added services sector activities such as wholesale and retail trade, real estate and housing, among others).

Interesting observations:

  • While the decline of agriculture sector is accompanied by the increase of services sector in Nepal, it is the opposite in India and South Korea, where the decline of agriculture sector was accompanied by rise of industrial sector. The intersection of these trends occurred at US$323 per capita GDP (in 1972) in South Korea and US$ 465 per capita GDP (in 2001) in India. This probably reflects the early industrialization drive along with steady accumulation of human and institutional capitals in South Korea. 
  • Services sector tends to grow consistently in both India and South Korea. However, there is a sharp increase in India circa 1980.
  • In China, though the decline of agriculture sector is accompanied by the increase of services sector, the industrial sector contribution is mostly higher than the contribution of agriculture and services sectors.
  • In Nepal, the decline of agriculture sector is accompanied by the increase of services sector (mostly low-value added activities like real estate, retail and wholesale trade, transport, etc— the demand for which is directly related to the remittance-backed consumption demand of imported goods traded in these sectors, implying that employment generation and domestic value addition are pretty low). Meantime, the industrial sector is continuously tanking. The intersection between decline of agriculture sector and increase of services sector occurred at around US$219 per capita GDP. It was circa 1998, the time when Nepal benefited favorably for a short time period from the Nepal-India trade treaty of 1996 (no value addition requirement in manufacturing goods exported to India). However, this was also the time when the Maoist insurgency started to heat up, forcing large number of people to migrate out of rural areas. Meantime, the inclement investment climate led to closure of many firms in the industrial sector, resulting in loss of jobs, high value production and productive activities. Consequently, those who migrated to urban areas and new entrants to the labor force either opted to seek employment overseas or engage in low value added, low paying services sector activities domestically. The high inflow of remittances has further fueled this process.
  • While in high growth and emerging countries, industrial sector plays a focal role in sustaining the transition from low value added production and productivity to high value added production and productivity, this whole feature is missing in Nepal’s case. Hence, the transition from low value added and low productivity agriculture production to low value added and low productivity services sector activities. This is resulting in a low growth trap, that too sustained by remittances-backed consumption demand of imported goods and the resulting trading activities. There is little domestic value addition and growth multiplier.

Overall, the message is that the ongoing structural transformation of Nepali economy appears abnormal and the economy is stuck in a low growth trap (mostly below 5%) sustained by robust remittance inflows and the monsoon. The only way to break free of it is to tackle head-on the binding constraints to economic activities, especially in the industrial sector.