Maoists-induced trade deficit in Nepal

I seem a little bit harsh on the Maoist party and its leaders in my latest op-ed. I am not taking sides and won’t do it. This column is not political; it is based on what the data shows and what I think explains the trend in trade deficit with India. I avoid politics as my domain is economics and economic policy.

To be fair, I see YCL's and the unions' disruptive activities as nothing but a problem for the industrial sector. I don't care what they do in other sectors and in politics, but browbeating the investors and chasing away multinationals would do no good to the Nepalese economy. The industrial sector is bleeding, hence the high trade deficit, because of the militant activities in and around production sites, where production should take place, not destruction. I am clarifying this because I have received several emails saying that I have been particularly biased against and harsh towards the Maoists. Well, I am not. I have written articles supporting the Maoists government’s economic policy and have also criticized not only their’s, but also other party’s policies.

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Dahal's trade deficit

CHANDAN SAPKOTA

Recently, Maoist Chairman Pushpa Kamal Dahal laid out five agendas for talks with India. Two of them are related to trade. He wants trade deficit with India to be “corrected” and “prompt strategy” taken to help Nepal gain from the growth of the two giants economies between which she is ‘sandwiched’. (By the way, was that also a “satire”?)

High trade deficit with India is not a new phenomenon at all. It has been increasing in line with our excessive dependence on the Indian economy. What is surprising this time around is that the balance of trade – the monetary value of exports minus imports of output over a certain period of time – with India has increased dramatically (see the figures). This is alarming because a high trade deficit and an unfavorable balance of payments situation signals troubles in an economy—especially its capacity to ensure exchange rate and macroeconomic stability, and to sustain imports levels to support rising domestic demand for foreign goods and services.

Total trade deficit with India in the first quarter of this fiscal year was Rs 38.9 billion, a 38.8 percent increase from the same period last year. Total exports to India decreased by 11.4 percent and total imports increased by 25.2 percent in the same period. Overall, total trade deficit is increasing rapidly since the Maoists intensified their insurgency at the beginning of this decade. The rate of increase of trade deficit has been especially high after the Maoists joined the government and started messing up with the industrial sector with demands that are inconsistent with the present state of our economy.

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Rather than blaming India for increasing trade deficit, Dahal needs to do some soul-searching to realize to what extent his party has contributed to the demise of the manufacturing sector, export-oriented production, and export potentials.

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There is consensus among policymakers and analysts that the rising trade deficit is unsustainable. It needs to be rebalanced. But, how? Dahal pointed his finger towards India and indirectly blamed her for increasing Nepal’s trade deficit. Either he does not comprehend what causes trade deficit and our inability to benefit from the booming economies of neighbors or he is blaming India to arouse unnecessary nationalistic feeling to consolidate party and voter base.

A high trade deficit is caused when the total monetary value of exports is lower than the total monetary value of imports. This is exactly what is happening right now. The share of and monetary value of imports from India are higher than exports to India. Is this India’s fault, like Dahal is hinting, or are we too dependent on the Indian economy for daily needs? Undoubtedly, whatever Dahal says, the latter is the case.

What are the factors that are causing high imports and low exports? At a time when the economy is stagnating, high imports from India are primarily driven by high demand arising from increasing remittances. The inability to utilize remittances in productive investment at home, except for producing bubbles in real estate and housing markets, is a prime factor for diversion of remittance money to India.

In principle, the government could raise tariffs and impose non-tariff barriers to slowdown imports from India. However, this might be counterproductive because the problem here is not oversupply from India; it is excess demand of Indian goods and services by Nepali consumers. An increase of tariffs on agricultural goods, of which domestic demand is higher than domestic supply, would be devastating as it poses a real danger of flaring up general prices.

Meanwhile, a marginal increase of tariff on non-agricultural goods would not be effective because middle-class consumers would effortlessly adjust consumption pattern to suit their fascination for non-agricultural goods and services imported from India. Additionally, there is nothing the government can do to decrease oil imports from India because the demand is going to be far greater as power shortage escalates in coming days. So, in terms of slowing down imports, there is little room left for policy maneuver that would be independent of general prices.

The only way we can ‘correct’ trade balance with India is to increase exports. India has already opened up its market for most of the goods exported by Nepal. Unfortunately, Nepal has failed to take advantage of the opportunities. Whose fault is it? Going by Dahal’s interpretation, it is India’s fault! Quite contrary to his misguided opinion, it is primarily the Maoists’ fault.

Allow me to explain how. Think of the major constraints on exports to India: An increase in cost of production in the domestic market; a decline in total production of goods and services; and the inability to deliver goods on time.

First, the pressure to increase wages and allowances, lack of regular supply of electricity and increasing strikes in and around industrial complexes have shot up cost of production, making Nepali goods and services relatively uncompetitive in the Indian market.

Second, persistent strikes demanding for life-long permanent employment status irrespective of labor productivity and efficiency, and forced closure of firms have compelled investors to involuntarily shut down factories. Not only domestic firms but multinational firms have stopped production due to stupid, business-unfriendly drama orchestrated by militant Maoist-affiliated trade unions and YCL cadres. This has led to decrease in manufacturing activities, total production, and employment.

Third, due to numerous transportation strikes and insecurity along the main trade routes, delivery of goods to the Indian market have been severely hampered, leading to a loss of faith and demand from Indian clients.

In each of the three constraints outlined here, the Maoist- affiliated sister organizations have played a crucial role in strengthening them, thus costing the nation billion of rupees in export revenues. This has resulted in low monetary value of total exports and widening of trade deficit.

Rather than blaming India for increasing trade deficit, Dahal needs to do some soul-searching to realize to what extent his party has contributed to the demise of the manufacturing sector, export-oriented production, and export potentials. It is essentially Dahal’s trade deficit!

[Published in Republica, December 29, 2009, pp4; http://bit.ly/6ZfTSf]

Copenhagen and the Economics of Climate Change

This is a guest post by Greg Shinsky from Monash University, Australia . It is based on a paper Greg is working on right now. He talks about the role of public goods, coordination games, free riding and the sufficiency of the current international response under the United Nations Framework Convention on Climate Change. An earlier blog post from Greg can be found here.

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Economists view climate change (CC) as a market failure, derived from under provision of the global public good represented by a stable atmosphere. This in turn is manifested as a negative externality which is neither time nor location specific.

At its source, this market failure stems from the inability of governments to coordinate policies that equalise the marginal private and social costs of greenhouse gas (GHG) usage. This is, however, no easy feat as the diffusive nature of GHGs means that the level of emissions from any one State will ultimately be borne by all other States. Therefore, the amount of the global public good per se that any one State receives is dependent on how many (and how much) GHGs the largest emitter or, in the context of CC, the weakest link emits.

Hence, the coordination game of CC approximates a weakest link type global public good. That is to say, the overall level of GHG concentration is only as good as the worst (or highest) level of emissions in any given State. Accordingly, provision of this global public good represents a sequential game where any attempt to free-ride in the long-run is inefficient and irrational due to the inevitable harm that results if agents receive a ‘payoff’ less than their subjective valuation. Therefore, at least according to economic theory, international policy cooperation will ultimately be invoked in order to avoid a Pareto-inferior outcome.

The recent summit at Copenhagen demonstrates that mere goodwill and benevolent intentions, without market based mechanisms, will not solve the CC problem. Resolution of CC issues demands market-based approaches because there is a profound insufficiency of knowledge on how to deal with a problem of such unprecedented complexity. Ultimate resolution of the CC coordination game thus requires a common price signal which in turn permits the efficient equalisation of the marginal social cost of GHG usage with the marginal abatement cost. Such a mechanism, however, must also satisfy the additional hurdle of actual State participation. Such participation is likely to be forthcoming when an excludable stream of private goods, which necessarily mitigates prospects of free-riding, is associated with involvement.

It is questionable whether the 1992 United Nations Framework Convention on Climate Change (UNFCCC), its associated protocol and accord, are the requisite geopolitical policy solution to avoid a Pareto-inferior outcome. Firstly, although the UNFCCC might demonstrate some incremental progress, both the Kyoto and Copenhagen summits have failed to reach a much needed comprehensive legally binding agreement. Furthermore, seventeen years of discussions have only yielded some unilateral commitments to reduce emissions to levels which current science suggest, even if adopted collectively, are manifestly insufficient. These points are given particular salience due to the possible dire consequences associated with further protracted policy responses.

Whether the weakest link theoretical prediction of a CC resolution holds is uncertain. This stems from the unique characteristic of possible ‘irreversible consequences’ associated with CC – which is not normally associated with the provision of other public goods. With time literally being ‘of the essence’, it is essential that any positive mitigation action is collectively supported by the international community. However, any such policies must continue to adhere to the long held international legal principle recognising the ‘common but differentiated responsibilities’ of developed and developing States.

Poverty and the numbers game

Consider an economy in which the incidence of poverty has been falling 1 percentage point a year. This is a good rate of decline, especially for an African country. At this rate, depending on the initial poverty level, an economy would be well on its way to achieving the first Millennium Development Goal, which is focused on reducing the incidence of income poverty.

But suppose the population in this economy is growing 2 percent a year. In this case, although the proportion of those living below the poverty line is declining by 1 percentage point a year, the absolute number of poor people is increasing by 1 percentage point a year. This explains why soup kitchens are fuller than ever, there are more street children than ever, and there are more distressed farmers than ever, even though official “headline numbers” suggest declining poverty.

The disconnect is sharpest in economies where poverty incidence is declining relatively slowly and where the population is growing relatively quickly—as in many countries in Africa. But the tendency is present in all economies. Even in China, which has seen a spectacular decline in both the incidence of poverty and the absolute number of poor people in recent years, the rate of decline of poverty incidence is greater than the rate of decline of the number of poor people.

That’s Ravi Kanbur arguing why poverty statistics may not fully capture discontent among the poor (that things have not really improved despite a fall in overall incidence of poverty).

NAFTA: Trade Policy ≠ Development Policy

The outcome of Mexico’s development strategy under NAFTA has been a disappointment despite success in increasing trade, foreign direct investment and productivity, according to a report published by Carnegie Endowment. It assesses the impact of NAFTA on Mexico and recommends developing countries to avoid pitfalls from NAFTA-style trade agreements. Under NAFTA, Mexico’s annual growth of GDP per capita has stagnated; there is not much change in total investment; macroeconomic vulnerability has increased; and progress in job growth has been weak. NAFTA’s promise of broad-based dynamic growth has fallen short of its stated goals.

Eduardo Zepeda, senior associate for Trade, Equity & Development program at Carnegie, Kevin Gallagher, an associate professor of International Relations at Boston University, and Timothy A. Wise, director of the Research and Policy Program at the Global Development and Environment Institute, Tufts University authored the policy outlook. A new complementary report, “The Future of North American Trade Policy: Lessons from NAFTA”, to Carnegie’s policy outlook was also released. Here is the event summary (fyi, I provided research assistantship for the report and wrote the event summary! :)).

More failures, less success

• Mexico’s export increased 311 percent in real terms between 1993 and 2007 and non-oil exports increased 283 percent.
• FDI, mostly coming from the US, more than tripled between 1992 and 2006.
• Inflation was tamed down below 5 percent from over 80 percent in 1980s.
• Rising competition forced Mexican firms to be more efficient, leading to an increase in productivity by about 80 percent in manufacturing sector.

However, there are profound shortcomings of the ‘NAFTA model’:

• Annual GDP per capita growth rate was just1.6 percent between 1992 and 2007. This is low by Mexico’s own standards as average real per capita growth rate was 3.5 percent between 1960 and 1979.
• Despite high FDI, the domestic investment has receded, resulting in total investment levels (foreign plus domestic) below 20 percent, which is lower than 25 percent prescribed by the Growth Commission to achieve dynamic growth.
• Macroeconomic vulnerability has increased as the country remains heavily dependent on oil exports for government revenues. Tax revenues amount to less than 15 percent of GDP.
• Limited employment gains in manufacturing and services sectors have been offset by large employment losses in agriculture sector. There is meager gain in employment in maquiladora sector. Employment in non-maquiladora sector was lower in 2008 than it was in 1994. Agriculture sector lost more than 2.3 million jobs between 1990 and 2008.
• Wages in maquiladora sector are up by only 8 percent while wages in the non-maquiladora sector has stagnated at low level.
• NAFTA contributed to growing geographical inequality between Mexico’s southern and northern states.
• Commitment to environmental protection in the post-NAFTA period has not been strong.

“The collapse in employment in agriculture coupled with a fall in producers and real prices of staple foods, mainly corn, due to import competition is partially feeding migration out of Mexico,” said Zepeda.

Lessons for developing countries

• Avoid NAFTA’s prohibitions on policies for industrial competitiveness
• Careful liberalization of sensitive goods
• Promotion of dignified labor conditions and a sustainable environment
• Include funding for development like the EU does
• Trade policy is not a development policy and is not a substitute for coherent national economic development strategies

“Future trade agreements between the US and the developing countries should pay close attention to the shortcomings of NAFTA and realize that trade policy is not the same as development policy,” Zepeda argued.

Gallagher also pointed that NAFTA has been a disappointment and is in need of a comprehensive review. “Trade agreements should focus on creating more jobs, meeting ILO core labor standards and protection for migrants. It should also expand the role of North American Commission for Environment Cooperation (NACEC) and North America Development Bank (NADBANK) and reform intellectual property (IP) provisions,” said Gallagher.

Wise emphasized on the need to promote industrial development by enhancing competitiveness; reviewing and reinforcing regional rules of origin; and expanding development financing through institutions like NADBANK. On the issue of agriculture, he argued, “NAFTA should borrow from the WTO some provisions like SSM to protect domestic market against sudden input surges, give extended protection to ‘special products’, and include special and differential treatment for less developed trading partners.”

In response to a question on if it is fair to wholly blame NAFTA for disappointing progress in the Mexican economy and not discount for the impact of the Peso crisis in 1994 and the lack of competitiveness of Mexican firms, Eduardo argued that while it is not fair to blame NAFTA for all the problems in Mexico, it is, however, true that it did not help Mexico achieve its development goals. “Arguing that without NAFTA, Mexico would have had even worse outcome is a wrong approach to access the gains from such trade agreements,” argued Zepeda. Gallagher opined that NAFTA basically “crowded out” domestic investment as FDI began to increase rapidly. “A binding constraint on the Mexican economy has been declining investment,” he said.

Nepalese economy in 1Q of FY09/10-- Unfavorable BOP situation

A new quarterly update (1Q-2009/10) from the central bank of Nepal shows sings of potentially unstable macroeconomic situation. Nepal has basically become an import nation funded by remittances.

Highlights:

1Q-2009/10 with 1Q-2008/09	3 months of 2009/10	3 months of 2008/09
BOP	-Rs 19.45 billion	Rs 7.70 billion
Current account	-Rs 11.38 billion	Rs 4.31 billion
trade deficit	up by 48.6%	up by 35.7%
net income	down by 15.6% (Rs 2.49 billion)	382.1% (Rs 2.95 billion)
Remittances	up by 11.1%	up by 67.3%
(Transfers) grants	down by 21%
BOT
with India	up by 38.8%	up by 29.1%
with other countries	up by 61.4%	up by 45.4%
Export/Import
with India	17.8	27.8
with other countries	16.2	28.8
Total exports	15.1%	21.8%
Total imports	84.9%	78.2%

 

The change in total foreign exchange reserve in the first quarter of this fiscal year and the first quarter of last year was -11% and 8.5% respectively. It is sufficient to finance merchandise imports of 8.5 months and merchandise and service imports of 7.2 months. Also, the Nepalese exchange rate appreciated by 5.96 percent in mid-October 2009. It has depreciated by 11.50% in the corresponding period last year. This might partly explain the drop in exports and rise in imports. The main factor is imports financed by rising remittances.

Nepal needs to find a way to better channel remittances in the domestic market (other than the bubbling real estate market) rather than smoothening remittance money back to the destination. Tax imports of vehicles; not food (it will further drive up inflation--subsidize agriculture production, especially staple food crops). Prem Khanal raises an alarm (not sure how far this is going to ring the bell as the bad BOP situation in 1Q might might be countered by improvements in other quarters, leaving the average BOP figure in a comfort zone) and offers some options. One thing that is certain and requires urgent action from the NRB and the government is narrowing down of the widening balance of trade (BOT) hole. Thought it has been increasing for some years now, what is alarming is that the rate of increase in trade deficit is much higher in recent years. Ameet Dhakal offers interesting perspectives on this issue and how the government can help the economy dig out of hole it is in right now (again, I am not going to speculate yearly BOP and macroeconomic trend and if they are going to be in the red, creating macroeconomic instability--except for BOT-- just depending on first quarter figures).

UPDATE: Raghab Pant explains why it is not new thing. I concur.

I don’t see any new problem emerging; it is the continuation of the same old problem except that the government is not yet ready to change the exchange rate of the Nepali currency. On the contrary, they are trying to find a way to impose some restrictions on the import of goods and services from India to maintain current exchange rate. In fact, the central bank, according to newspaper reports, has already issued several directives to the commercial banks to impose restrictions on financial transaction with India. Otherwise, it is not a new problem and the Ministry of Finance is well aware of the situation of the banking system as it has representation in the Board of Directors of the Nepal Rastra Bank too. So the main question is: What were the members of Board of Directors of the Nepal Rastra Bank doing when the country was certain to hit the iceberg?

Labor disputes leading to strike-unemployment cycle in Nepal

Why I think the militant youth wings, unions and politically motivated disruptive activities in and around industrial complexes and manufacturing plants are creating more unemployment, which is feeding more of such destructive activities, more closure of firms, more unemployment … the process is developing like a vicious strike-unemployment cycle in Nepal. Read the op-ed here for more discussion.

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Strike-unemployment Cycle

Amidst abysmal political bickering and numerous days of sudden, undeclared holidays, thanks to regular bandas and strikes, the country has lost track of economic activities that provide jobs and contributes revenue to the government. The political leaders hardly show interest in economic issues that foster jobs creation, increase investment, and absorb the increasing number of youths and migrants into the workforce. Unsurprisingly, due to poor appropriability, the inability of investors to retain returns on investment, investors have lost faith in the economy.

Why is there stalemate on new investment and winding down of existing economic activities, leading to loss of jobs and revenues? The answer is a no-brainer: Labor militancy and strikes, whose causes transcend economic reasoning and ground reality in the industrial sector. Forcefully shutting down production and operational activities has been the most popular form of industrial strikes. This is probably the prime cause of industrial decline in Nepal. What the politically affiliated militant labor unions and youth wings do not realize is that the more they engage in such disruptive activities, the greater would be the probability of them being laid off ultimately.

This is how it works. Labor unions devise ridiculous demand and pressure firms to fulfill them. In most cases, the management would not want to yield to unjustified union demands on wage, bonuses, and employment status. The unions forcefully shut down production. The firms lose income and profits, and pay less revenue to the government. After profits nosedive to negative domain, the management shuts down factories and lays off workers. Thus, beings the demise of productive and efficient industries!

At the end of the day, the workers lose the most. Due to freeze in hiring in the industrial sector, the laid off workers won’t find new jobs. Additionally, the government, having lost a major source of revenue, cannot employ laid off workers in public sector. The unemployed, idle workers resort to strikes of various forms, disrupting production of existing firms. This further scares away investment from the economy. Slowly, firms begin to stop production. More unemployment and idle workers, more strikes and disruptive activities. The process develops as a vicious strike-unemployment cycle.

The political instability and labor union militancy in the industrial sector have chased away multinational companies that have been providing hundreds of jobs and supporting numerous households. The Maoist-affiliated labor unions, through their idiotic demands, chased away Colgate Palmolive, a multinational company, from Nepal. Now, they have stopped Varun Beverage Nepal Ltd, the bottler of Pepsi, from operation and expansion. Worse, the company said that it is not making further investments worth around Rs 1 billion. This has deprived labors from securing potential new jobs. At a time when the country needs more foreign investment, the drama led by the Maoist-affiliated trade unions and militant youth wings is further scaring away not only existing companies but also potential ones. Their activity is already contributing to the demise of the garment and textile industry, once the main component of Nepali exports. Unjustified demand for wage increase and insistence for permanent employment status disrupted production at a time when the industry was losing markets abroad.

Recently, the Maoist-aligned All Nepal Trade Union Federation (Revolutionary) put forward preposterous demand of increasing salary by 40 percent and dearness allowance by 100 percent. Note that the previous Maoist government had already increased minimum salary in consultation with the private sector. Now, after revision of salary, the unions are again demanding an increase in wages, which will do nothing but increase cost of production. One of the most ludicrous things about the trade union’s demand is that they want an increase in wages irrespective of worker’s qualification, productivity, and efficiency. In general, wages are paid on the basis of marginal productivity of labor. However, in our case, wages are determined not by labor’s productivity but by how violently the unions can put pressure on the board of directors. Furthermore, the unions want workers to be given permanent, life-long employment status without even considering their productivity and longevity of firms they are working in. This runs contrary to all the economic logics associated with labor and wages. Also, how can dearness allowance increase by 100 percent when general prices have not even increased at the same rate?

Add to this the war on private property waged, again, by the Maoist-affiliated sister organizations. The infamous land grab incidents and occupation of various industrial complexes by YCL have further scared investors. They are building their own enterprise out of the profits gained from such unlawful, disruptive activities. There is no stability in contract enforcement and upholding of property rights, one of the most important factors required for a sustained economic growth.

Not surprisingly, these incidents are also reflected on key international reports like Doing Business Reports and Global Competitiveness Reports, which are looked upon by investors before considering investment. Nepal ranks 123 among 183 countries in terms of ease of doing business. Hiring and firing regulations are the most investment-unfriendly in South Asia. In terms of competitiveness of the economy, Nepal ranks 125 out of 133. The standing in labor market efficiency is 122 out of 133 countries.

Investors have lost faith in the Nepali economy not because there is no potential business opportunities but because there is no guarantee of property rights, stability of policy reform, and business-friendly labor laws and regulations, among others. Maoist leader Baburam Bhattarai knows how hard it is to coax investors to invest in the economy. He spent the last few months of his stint as finance minister trying to convince domestic and foreign investors to invest in Nepal. He failed! It will take years to convince potential investors to invest in the economy where instability prevails and unions rule the industrial sector.

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. By corollary, if you are getting poorer each day, due to loss of purchasing power triggered by loss of jobs, blame the youth wings and their dirty drama staged in and around industrial complexes!

[Published in Republica, December 17, 2009, pp5]

The impact of aid on manufacturing exports

Aid tends to depress the growth of exportable goods.

We categorize goods by how exportable they could be for low-income countries, and find that in countries that receive more aid, more exportable sectors grow substantially more slowly than less exportable ones. The numbers suggest that in countries that receive additional aid of 1 percent of GDP, exportable sectors grow more slowly by 0.5 percent per year (and clothing and footwear sectors that are particularly exportable in low-income countries grow slower by 1 percent per year).

We also provide suggestive evidence that the channel through which this effect is felt is the exchange rate. In other words, aid tends to make a country less competitive (reflected in an overvalued exchange rate) which in turn depresses the prospects of the more exportable sectors. In the jargon, this is the famous “Dutch Disease” effect of aid.

Paper by Subramanian and Rajan here