In search of the smoking gun for trade collapse

One of the most striking aspects of the recent recession is the collapse in international trade. This paper uses disaggregated data on U.S. imports and exports to shed light on the anatomy of this collapse. We find that the recent reduction in trade relative to overall economic activity is far larger than in previous downturns. Information on quantities and prices of both domestic absorption and imports reveals a 40% shortfall in imports, relative to what would be predicted by a simple import demand relationship. In a sample of imports and exports disaggregated at the 6-digit NAICS level, we find that sectors used as intermediate inputs experienced significantly higher percentage reductions in both imports and exports. We also find support for compositional effects: sectors with larger reductions in domestic output had larger drops in trade. By contrast, we find no support for the hypothesis that trade credit played a role in the recent trade collapse.

See this paper looking for the smoking gun on the great trade collapse of this decade. Also see this blog for what economists think caused trade to decline more rapidly than the decline in GDP. This paper counter’s Barry Eichengreen’s point that disruptions to the supply of credit from international banks to some developing countries might have been the reason. Another reason economists point out is the disruption in the trade of intermediate goods. The degree of trade of intermediate goods is so high that disruption in one process has a domino effect on others, thus causing a near-complete collapse.

The diminished and still diminishing garment industry of Nepal

Bhuwan Sharma, Op-Ed editor of Republica, has an excellent article on the IPS on the demise of the garment industry. It is a refresher on how Nepal lost the glory of its garment industry after the end of MFA in 2005.

The tiny Himalayan nation’s garment industry in its heydays earned the highest foreign exchange for Nepal and was the biggest export-oriented manufacturing industry of the country.
Export of readymade garments (RMGs) that in 2002/2003 registered over 11.5 billion Nepalese rupees (165 million U.S. dollars) plummeted to about 4.5 billion rupees (65 million dollars) in 2008/2009. An industry that once provided direct employment to approximately 50,000 people, including a significant number of women, now just employs a few thousand people.

The phasing out of the quota system carried out in tune with the 1990 World Trade Organization (WTO) Agreement on Textiles and Clothing (ATC) (also known as Multi-Fibre Agreement), Nepal’s inability to restructure the sector, political instability and the rise of unionism dealt a near-lethal blow to the industry.

The quota reduction was implemented in four phases: 16 percent in 1995; 17 percent in 1998; 18 percent in 2002; and finally 49 percent in 2005, thus ending 40 years of quota-based trading on textiles and clothing.

"The quota phaseout under ATC began in 1995, but its impact on the Nepalese economy was not immediate. This was due to the fact that the RMGs were concentrated on a few products (mainly cotton casual wear), and these products were not under quota restrictions until the last phase of the Agreement," says a report published by South Asia Watch for Trade, Economics and Environment (SAWTEE) and ActionAid Nepal.

Chandan Sapkota, a regular newspaper commentator on trade and economic issues, says: "It was known two decades ago that all quotas in this sector would be abolished. There was ample time to invest and restructure the Nepali garment industry. However, both investors and policymakers turned a blind eye to the necessity for the reorganisation of this industry."

The phasing out of quotas and the country’s inability to prepare itself for a level-playing field has been devastating. While there were 212 manufacturing units in 2000/2001 manufacturing RMG for markets primarily in the United States, EU, Japan and Canada, now only a handful of units remain.

Questioning the estimates of Nepal’s three year investment plan (2010-2013)

Last month, I wrote about the three-year investment plan of the Nepalese government and raised some questions. I was unsure about the estimates because I had not read (and still have not) the original document. Dilli Raj Khanal, former member of National Planning Commission, touches this issue. He is skeptical of the estimates. Turns out the elasticities used in projections are outdated.

In the goal, by emphasizing on dignified and gainful employment, reduction of economic disparity and abolition of social deprivation aims at reducing poverty to 21 percent by the end of TYP from present level of 25.4 percent. It adds that by means of improved living conditions through sustainable growth, this will be possible.

To begin with, the targets of 21 percent based on new poverty estimates of 25.4 percent are highly questionable, which are simply based on income poverty elasticity that comes out at 0.25 based on a historical data.

If this could have been the case, during 1985-90 and 1992-97, poverty would have reduced drastically as the growth rate was above 4.8 percent at that time. But 1996 and 2004 survey data show that poverty remained at 42 percent throughout this period.

Despite so much propaganda on dignified or gainful employment in the approach paper, employment calculation is also simply based on historical employment elasticity of 0.60.

The method to calculate the investment requirement and techniques used to fix sectoral resource allocation pattern, including bifurcation between the government and private sector, are highly questionable. The fixation of plan outlay technique is the same as the first plan. Given the fixed sectoral target and calculated incremental capital output ratio again based on questionable investment and accumulated capital data, the investment requirement has been derived. It, as obvious, cannot address distributional and sustainable growth issues.

Leontief Prize 2010 Winners

Bina Agarwal

 

Daniel Hahnemann

How to target the poor in Indonesia?

In developing countries, identifying the poor for redistribution or social insurance is challenging because the government lacks information about people’s incomes. This paper reports the results of a field experiment conducted in 640 Indonesian villages that investigated two main approaches to solving this problem: proxy-means tests, where a census of hard-to-hide assets is used to predict consumption, and community-based targeting, where villagers rank everyone on a scale from richest to poorest. When poverty is defined using per-capita expenditure and the common PPP$2 per day threshold, we find that community-based targeting performs worse in identifying the poor than proxy-means tests, particularly near the threshold. This worse performance does not appear to be due to elite capture. Instead, communities appear to be using a different concept of poverty: the results of community-based methods are more correlated with how individual community members rank each other and with villagers’ self-assessments of their own status than per-capita expenditure. Consistent with this, the community-based methods result in higher satisfaction with beneficiary lists and the targeting process.

Thats from Targeting the Poor: Evidence from a Field Experiment in Indonesia by Abhijit Banerjee et al. This result is surprising. With a standard indicator there are more poor people than with perception-based poverty measure.

Book review: The Social Atom

Book review published in The Kathmandu Post

---

Bricks in the wall

There is a pattern to everything

Have you ever wondered why hundreds of thousands of people join protests and participate in riots? Or, why ordinary people plunge headlong into collective madness (ethnic cleansing, ethnocentric violence, and vandalism)? Also, why do some societies achieve results that others envy of (such as in 1991 Kerala became the world’s only 100 percent literate state)? Why human beings act in the way they do, i.e. they cooperate but at the same time fight with each other; they assume rationality but act based on pure instincts; and they adapt to different situations and imitate others.

To comprehend this range of confounding issues Mark Buchanan uses tools and insights from physics, economics and other social sciences in his book The Social Atom: Why the Rich Get Richer, Cheaters Get Caught, And Your Neighbor Usually Looks Like You. It is about what Buchanan calls “social physics”, which basically is social science along the lines of physics, i.e. trying to find mathematical regularities in social life. One of the core themes of the book is that there is a pattern to everything that happens in nature.

By viewing humans as “social atom”, Buchanan, a theoretical physicist and former editor of Nature and New Scientist, offers an enriching and stimulating discussion of events ranging from literacy campaigns in Kerala to sudden riots in the most unexpected regions of the world to natural segregation of societies along racial and ethnic lines to genocide in Rwanda.

The message directed at social scientists is simple: Understanding human behaviour might seem a daunting, complex task but, like in physics, if we go to the most simplest unit—treating each human being as atom, thus social atom—then it might not be as complex as it sounds. Complexity is rooted in simplicity.

He argues that by looking at patterns behind the origin and functioning of both usual and unusual events, social scientists can discover mathematical laws like the ones we find in physics. No wonder, the failure to look at patterns might have resulted in a lack of laws in economics and social sciences. This is not the case in pure sciences such as physics, chemistry and biology. By flatly assuming that people are self-interested and that they make rational decisions, the mainstream economists ignore the fact the human beings are a part of the nature and there is a pattern on how they learn, act and behave. In fact, human beings are not rational calculating machines, but biological pattern recognisers who are able learn from their mistakes.

He advises the mainstream economists to think of people as if they were atoms or molecules following simple rules in society. Failure to do this is clearly visible in economics: even the most sophisticated economic theory lacks the kind of understanding found in pure sciences. Humans are not rational calculators, but crafty gamblers. They are skilled at recognising patterns and adapting to changing world. Sadly, most of the economists have failed to recognise this simple behavioural pattern.

Interestingly, our collective behaviour follows mathematical patters of surprising precision. He argues that the most common one of them is power law. It emerges “naturally in systems that are decidedly not in equilibrium.”

The book is filled with enriching discussion about the occurrence of power law in the distribution of wealth and inequality, power and politics, class hatred, racial segregation, fads, fashion, riots, spontaneous outbreaks of goodwill and hatred within communities and financial markets.

There are three kinds of social atoms: (i) adaptive atom, (ii) imitating atom, and (iii) cooperative atom. Human beings are adaptive rule followers, not rational automations. The rationality assumption incorrectly presupposes that people do not learn, form hypotheses and tests, and change their decisions frequently.

People are fundamentally adaptive and their decision accords with reality, even if their choice might look irrational to economists. People have to make decisions in an uncertain and ever-changing setting of markets. Their decision, however irrational it may look like, comes from adaptive behaviour, i.e. they make mistakes, rectify their actions, and adapt to changing environment. It is not unusual that large movements in the market seem to take place in the absence of any big event, he argues.

In addition to being adaptive, we are also born imitators. Imitation does not generate any new information but it amplifies the consequences that a little bit of information can have. Coming back to the point of public protesting and rioting, it is by constant interaction and imitation that hundreds and thousands of protesters and rioters take on to the streets, irrespective of their awareness of the main causes of riots and strikes. This behaviour of social atoms is usually ignored by economists. Buchanan argues that what gets a riot going at the outset isn’t necessarily the same as what keeps it going or determines how big it eventually gets.

The decision of the first person to join riot might be his own but after 50 people start smashing things up, the decision for 51st to join the riot is completely different. It is not “nearly so hard to join in when everyone you know is doing it.” The imitative behaviour of Kerala resident in achieving high levels of education has made it one of the most literate states in the world.

Next comes the cooperative atom, who is an altruist defying the assumption of self-interested agents. Humans are not as self-interested and greedy as economic theorists assume. This has been well documented by game theorists and behavioural economists. The assumption of self-interested agents fails to account for selfless actions that millions of people undertake every day without any strategic hope of future reward. Many of us are “biologically predisposed to such altruistic acts.”

With a combination of adaptive, imitative and cooperative behaviours, human beings are equally skilled at making peace for the same reasons that they are skilled at making war. Even blind prejudice helps people to cooperate and participate in things that are usually not expected of them. This is why ethnocentric movements have large number of participants cooperating with each other even in the face of incomplete or manipulated information.

Repeated interactions between people of opposing ideals and values, and the imposition of effective social norms help to keep ethnocentrism at bay. May be this is what we need to defuse the tense crisis in Nepal right now!

The crux of the book is that social scientists need to view human beings as atoms and molecules following fairly simple rules, that there is a pattern to everything, and that even oversimplified models can go a long way “if social scientists can get right the few details that really matter.”

Perhaps economists need to pay more attention to realistic assumptions, simplify their models to reflect reality rather than to fit elegant mathematical models, and view human interactions as complex but having some pattern to it.

[Published in The Kathmandu Post, May 15, 2010, pp.7]

Industrial Policy of Nepal 2010 - II

So, the Nepalese government finally decided to endorse a new industrial policy, which replaces the old one of 1992.

Check out this blog post for details.

The new industrial policy would mean little if there is no political stability and policy consistency. Political stability has been the most binding constraint on economic growth and industrial activity in Nepal. Also, the sad truth is that policies are formulated but hardly implemented. We have to see how far the policies will be implemented in reality in the days ahead. But, for now, formulating a new, updated industrial policy is a good progress in an economy where pretty much everything variable seems to be in doldrums.