How about Development Impact Bonds?

The Development Impact Bonds (DIB) Working Group (co-chaired by Owen Barder, Center for Global Development) has put out an innovative idea to enhance the effectiveness of development interventions by taking into account two crucial aspects: the complexity of delivery and the need for adaptation and flexibility.

DIBs are “outcomes-based contract that can bring together the private sector, civil society organisations, governments and donors, in a way that captures and complements the strengths which each player can bring to achieve development  outcomes, and buttressing their respective weaknesses.”

Excerpts from the Working Group’s report:

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Development Impact Bonds (DIBs) respond to both of these  imperatives. They use private investment flows to provide upfront risk  capital for development programmes, only calling on donor funding  to repay that capital (plus a potential return) once clearly defined and  measured development outcomes are achieved.

Under a DIB, all interested parties agree a desired social outcome and a metric for measuring success. Private investors bank-roll a programme to achieve the outcomes. The programme itself is carried out by specialised service providers, and investors are paid back by an outcome funder (usually a donor agency) if – and only if – independently verified evidence shows that the programme has been successful.  The greater the measured success of the programme, the greater the return to investors, up to a cap. Typically, an intermediary organisation will coordinate between investors, the outcome funder, and service providers, representing the parties not in the room and negotiating an agreement that fits the needs of all.

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Recommendations by the DIB Working Group:

• Donors should establish a DIB Outcomes Fund and investors should establish DIB Investment Funds, which would enable these actors to share risks and pilot a range of DIB models.
• DIB pilots should be evaluated rigorously and a group of donors and philanthropic organisations should set up a DIB Community of Practice to share and accelerate learning.
• DIBs should be open by design. Openness will accelerate confidence in DIBs for investors, governments, service providers and taxpayers and help to build a high quality market. Donors and foundations should establish a research data protocol which would provide a standard of data and facilitate information-sharing.
• DIB parties will have to accept the high transactions costs of early DIB pilots. Foundations should consider subsidising these costs by providing funding to catalyse the development of a DIB market.

Monsoon and agriculture production in FY2013 in Nepal

FY2013 has been a disappointing year for Nepal, both politically and economically. Political disagreement continues (though with a slightly optimistic pointer following a technocratic government and its mandate to hold elections by December 2013). 

On the economic front, it has been even more disappointing. Real GDP growth (at basic prices) is projected to drop to 3.6% in FY2013, down from 4.5% in FY2012 (ADB projected it to be 3.5%; the IMF says it might be even below 3%), thanks to the unfavorable (late and low) monsoon, shortage of chemical fertilizers during peak planting season, a slight decline in growth of remittances, and the continually weak industrial sector. 

GDP_NEPAL	FY2011	FY2012R	FY2013P
GDP growth rate (basic prices)	3.85	4.48	3.56
Primary Sector	4.48	4.98	1.31
Secondary Sector	4.4	2.96	1.49
Tertiary Sector	3.42	4.51	6.03
Composition of GDP (%)
Primary Sector	37.37	36.31	35.32
Secondary Sector	14.94	14.30	14.35
Tertiary Sector	47.69	49.39	50.33

The Ministry of Agriculture Development (MoAD) has come up with new estimates for agriculture production for FY2013. And, its not good (more here), thanks mostly to the unfavorable monsoon:

• Production of paddy and maize declined to 4.5 million tons and 1.99 million tons, respectively (a drop by 11.3 percent and 8.3 percent, respectively).
• Production of millet also went down by 3 percent to 305,588 tons.
• Production of wheat, barley and buckwheat increased by 2 percent, 6 percent and 0.3 percent, respectively to 1.88 million tons, 36973 tons and 10,056 tons.
• Total food surplus will decline to 408,000 tons this year from 8 86,000 tons recorded in the last fiscal year.
• Total food available for consumption in the form of milled rice and flour will remain at 5.64 million tons. Around 5.24 million tons of food is needed to feed an estimated 27.5 million people whose per capita consumption has been recorded at 191 kg.
• Rice deficit of 900,000 tons, but  maize and wheat surpluses of 262,000 tons and 1.05 million tons, respectively.
• Number of districts facing food deficit has increased by six to 33 in FY2013.
• Food production in Tarai expected to drop to 429,238 tons in FY2013 from 777,600 tons in FY2012.
• Similarly, mountain and hilly regions to record deficit of 15,767 tons and 5,029 tons respectively in FY2013.

The importance of agriculture for inclusive development and to support modest economic growth cannot be overstated. About 76.3 percent of households in Nepal depend on agriculture for livelihood and 83 percent of the population lives in rural areas, which is mostly agriculture dependent. Furthermore, the agricultural sector constitutes about 35 percent of the country's GDP.

With a normal monsoon in FY2013 and timely availability of chemical fertilizers, agriculture sector might post a growth rates close to 5%. This combined with a rise in growth of remittance inflows, which supports services sector growth, might push overall GDP growth (at basic prices) well above 4%.

Low capacity utilization of Nepalese industries

The figure shows the capacity utilization, which is the realized portion of total production potential in the review period, of major industries in Nepal. The data for it are sourced from the survey  carried out twice a year by the Nepal Rastra Bank in key industrial areas such as Kathmandu, Biratnagar, Janakpur, Birgunj, Pokhara, Siddarthanagar, Nepalgunj and Dhangadi.

The latest survey findings reveal that the capacity utilization of domestic industries has improved to 45% of potential capacity in the first six months of FY2013, up from 38% in the same period in FY2012. However, this level is still low and indicates that Nepal’s industries are operating far below the potential capacity. Capital and labor employed by industries have not been able to use their potential fully to meet the actual production capacity. Capacity utilization of industries tends to be higher towards the end of the fiscal year, when there is also more electricity supply due to higher electricity production during wet season. The full year capacity utilization in FY2012 and FY2011 was 58% and 54%, respectively.

In the first six months of FY2013, six industries had capacity utilization above 50% of total potential production capacity. These are beer (77%), pashmina (77%), suti clothes (63%), soap (55%), processed tea (51%) and cement (50%). The capacity utilization of four industries was below 30% of total production potential capacity. These are vansapati ghee (27%), biscuit (26%), cigarette (23%) and sugar (11%). Note that production is seasonal for some products and hence production is either low or high depending on the planting and harvesting season. Looking at full year figures, garment, bricks, electric wire, and noodles had capacity utilization over 80% of total production potential in FY2012. Similarly, lowest capacity utilization was that of iron (29%), cigarette (24%), and vansapati ghee (22%).

Not only is the capacity utilization of industries is low, total production capacity of most industries itself is decreased. The production capacity of biscuit, sugar, beer, paper, soap, bricks, cement, electric wire and process leather decreased between FY2012 and FY2011. Meanwhile, production capacity of noodles, suti clothes, and iron increased. Looking at production capacity in the first six months of FY2013 and FY2012, production capacity of biscuit, noodles, beer, paper iron and electricity wire increased.

What is contributing to the low capacity utilization of Nepal’s industries? It has to do with persistent supply-side constraints and structural bottlenecks.

First, the lack of adequate supply of electricity is the major binding constraint. The long hours of power cuts, especially during dry season, severely curtails the operation hours of industries. This limits production below the potential. For those who can afford for it, diesel run generators are the savior. But, it comes with high per unit cost as well. It means uncompetitive production, resulting in loss of market. Ultimately, the lower market demand due to high per unit cost (slightly differentiated imported products become relatively cheaper) means lower production and below potential capacity.

Second, the recurring labor-industry disputes over wages, allowances and facilities have led to either closure or partial operation of manufacturing plants. Labor disputes prolong for days and this not only shuts down machineries, but also forces employers to incur higher cost of operation (capital stays idle and workers have to be paid even if they go on a strike). Nepal faces a situation where minimum wage in manufacturing sector is the highest in South Asia, but productivity is one of the lowest.

Third, the lack of innovation and research and investment leads to less than optimal utilization of available stock of capital. Workers are not adequately trained to operate and supervise operation of newly introduced machineries. Furthermore, the industry hardly invests in R&D and hence there is barely any innovation in production as well as marketing of products.

Some of the constraints are long running and immediate solutions are impossible. These include supply of adequate electricity and R&D leading to innovation. If Nepal wants to have a strong industrial sector in the medium term (say 5 to 10 years from now), then the groundwork has to be started in a war footing. This should include urgent preparation of all the necessary policy, regulatory, legal and institutional frameworks. With an earnest dialogue and assessment of the (un)competitiveness of Nepali production among labor unions, employers and government, labor-industry relations can be improved. It would help in enhancing capacity utilization in the short-term itself.

Overall, political stability and good governance are paramount to effectively utilize the potential of our industries.

Nepal fixes minimum wage at Rs 8000 per month, the highest in South Asia

Following tripartite negotiations involving representatives from the government, trade unions and employers, minimum wage in the formal sector has been increased to Rs 8,000 per month, up from the revised Rs 6,200 in 2011. It includes Rs 5,100 as salary and Rs 2,900 as dearness allowance. Previously, the basic salary was Rs 3,550 and the dearness allowance was 2,650.

Basic monthly salary is up by 43.7%, dearness allowance by 9.4%and daily wage by 37.7%. Overall, minimum monthly wages is up by 29 percent. Inflation was 9.6% in FY2011, 8.3% in FY2012 and is estimated to be above 10% in FY2013.

With the new revised wage rate, Nepal will continue to have the highest minimum wage in South Asia. Here is a more detailed look at comparative minimum wage in South Asia.

Now, the challenge is to boost productivity accordingly. Else, Nepal will continue to see the erosion of competitive edge, loosing the already shrinking markets abroad. The cost of production is already high compared to regional competitors. For instance, the cost of production of 60-knot carpet hovers around $80 per square meter in Nepal, but the production cost of the same variety hovers around $45 per square meter in India. It is mainly due to the compulsion to run diesel generators because of lack of adequate supply of electricity, high labor cost, high cost of raw materials, skills gap, strikes, lack of R&D within the private sector, etc. Realistically, some of these supply-side constrains and structural bottlenecks is hard to overcome in the short term. But, some hiccups like skills enhancement, strikes, and labor cost (which is potentially settled for the next two years) can be addressed in the short term itself.

The Minimum Wage Determination Committee has recommended the revised minimum wage to the government for its final approval. As per the Labour Act 1992, workers’ minimum salary is reviewed every two years. According to some estimate, formal sector constitute around 300,000 workers only.

Credit constraints faced by youths and structural transformation

Blattman et al. worked with the Ugandan government and World Bank to randomize large, relatively unconditional cash transfer program in Uganda (Youth Opportunities Program of the Northern Uganda Social Action Fund), and followed nearly 2500 people two and four years afterwards. They found that credit constraints are holding back youths. Excerpts from Blattman’s blog and paper below: 

• Most start new skilled trades like metalworking or tailoring.
• Labor supply (employment hours) increases 17%. Those new hours are spent in high-return activities, and so earnings rise nearly 50%, especially women’s.
• Earnings rise nearly 50%, especially women’s.
• The people who do the best are those who had the least capital and credit to begin with.
• Credit constraints seem to be less binding on men, since men in the control group start to catch up over time. Female controls do not, partly because they have worse access to starting capital. With the grant they take off, further even than men. Without it, they stagnate, even more so than men.
• Despite huge economic effects, there is little impact on cohesion, aggression, and collective action (peaceful or violent). So, public spending on the grounds of social stability cannot be fully justified. But the impacts on poverty and structural change alone probably justify big public investment.
  
  

China’s and India’s dominance on saving and investment in 2030

The latest Global Development Horizons, published by the World Bank, report titled ‘Capital for the Future: Saving and Investment in an Interdependent World’ projects developing countries’ share in global investment to triple by 2030 to three-fifths, from one-fifth in 2000. It states that improvements in institutional factors will co-evolve with ongoing regional and global integration of developing countries’ financial markets, rendering developing countries much more significant sources, destinations, and potentially also intermediaries, of global capital flows.

By 2030, half the global stock of capital, totaling $158 trillion (in 2010 dollars), will reside in the developing world, compared to less than one-third today. Also, the report estimates the developing world’s infrastructure financing needs at $14.6 trillion between now and 2030.

China and India will be the largest investors among developing countries, with the two countries combined representing 38 percent of the global gross investment in 2030, and they will account for almost half of all global manufacturing investment.

The report notes that productivity catch-up, increasing integration into global markets, sound macroeconomic policies, and improved education and health are helping speed growth and create massive investment opportunities, which, in turn, are spurring a shift in global economic weight to developing countries. It finds that:

1. Developing countries’ employment in services will account for more than 60 percent of their total employment by 2030 and they will account for more than 50 percent of global trade.
2. This shift will occur alongside demographic changes that will increase demand for infrastructural services. Indeed, the report estimates the developing world’s infrastructure financing needs at $14.6 trillion between now and 2030.

South Asia: Saving and investment 

• One of the highest saving and highest investing regions until 2030.
• In a scenario of more rapid economic growth and financial market development, high investment rates will be sustained while saving falls significantly, implying large current account deficits.
• By about 2035 is likely to have the highest ratio of working- to nonworking-age people of any region in the world.
• The region’s share of total investment in manufacturing expected to nearly double, and investment in the service sector to increase by more than 8 percentage points, to over two-thirds of total investment.

Policy implications

• National policy makers seeking to support investment activity in their economies should concentrate their efforts on establishing a favorable investment climate.
• Financing for infrastructural projects will pose a major challenge. To meet their future infrastructure financing needs, policy makers in developing countries will need to leverage private sector financing through public-private partnerships as well as tap structured financing from global capital markets.
• Governments will have to sustainably manage public finances with an eye toward the forthcoming demographic changes.
• Demographic shifts due to changes in household structure will increase the importance of financial markets in providing for income support during old age.
• Policy makers in developing countries have a central role to play in boosting private saving through policies to raise educational attainment, especially for the poor.
• Policy makers will need to prepare for a greater role of capital markets in international financial intermediation and promote the development of domestic capital markets.

Links of Interest (2013-05-17)

Are microcredit participants in Bangladesh trapped in poverty and debt ?

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Both participants and non-participants have gained as the economy has grown; however, the rates of poverty reduction have been higher for participants.The paper's econometric estimates show significant welfare gains resulting from microcredit participation, especially for women. They also show that the accrued benefits of borrowing outweigh accumulated debt. As a result, households' net worth has increased, and both poverty and the debt-asset ratio have declined.

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Rethinking the state's role in finance

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There is now evidence that, for example, lending by state-owned banks has helped in mitigating the impact of the crisis on aggregate credit. But evidence also points to negative longer-term effects of direct interventions on resource allocation and quality of intermediation. This suggests a need to rebalance the state's roles from direct to less direct involvement, as the crisis subsides. The state does have very important roles, especially in providing well-defined regulations and enforcing them, ensuring healthy competition, and strengthening financial infrastructure. One of the crisis lessons is the importance of getting the basics right first: countries with complex but poorly enforced regulations suffered more during the global crisis. Evidence also suggests that instead of restricting competition, the state needs to encourage contestability through healthy entry of well-capitalized institutions and timely exit of insolvent ones

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Rainfall shocks and tariff setting in the agricultural sector

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The impact of a negative rainfall shock on optimal import tariffs is generally ambiguous, depending on the weight placed by the domestic policy maker on tariff revenue, profits and the consumer surplus. The more weight placed on domestic profits, the more likely it is that the policy maker will respond to a rainfall shortage by reducing import tariffs. These findings are robust to alternative assumptions about market structure and the timing of the game. Using detailed panel data on applied tariffs and rainfall for 70 nations, the authors find robust evidence that rainfall shortages generally induce policy makers to set lower tariffs on agricultural imports.

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Political economy aspects of fuel subsidies

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A political process is modeled whereby a promise of low fuel prices is used in democracies to attract voters, and in autocracies to mobilize support among key groups. Subsidies to fuels are viewed as either easier to observe, easier to commit to, easier to deliver, or better targeted at core groups, than other public goods or favors offered by rulers. Easier commitment and delivery than for regular public goods can explain the high prevalence of such policies in autocracies, and also in young democracies where the capacity to commit to or deliver complex public goods is not yet fully developed.

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Growth and structural transformation

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Structural transformation refers to the reallocation of economic activity across the broad sectors agriculture, manufacturing and services. This review article synthesizes and evaluates recent advances in the research on structural transformation. We begin by presenting the stylized facts of structural transformation across time and space. We then develop a multi–sector extension of the one–sector growth model that encompasses the main existing theories of structural transformation. We argue that this multi–sector model serves as a natural benchmark to study structural transformation and that it is able to account for many salient features of structural transformation. We also argue that this multi–sector model delivers new and sharper insights for understanding economic development, regional income convergence, aggregate productivity trends, hours worked, business cycles, and wage inequality. We conclude by suggesting several directions for future research on structural transformation.

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