IMF proposes new taxes on financial institutions

In the paper called "A Fair and Substantial Contribution by the Financial Sector", the IMF argues the case for two new levies to be applied on financial institutions in as many countries as possible: More here and here. The full document is here.

(1) A "financial stability contribution" to pay for "the fiscal cost of any future government support to the sector". The levy would be paid by all financial institutions, not just banks, initially at a flat rate but eventually refined so that riskier institutions paid more.

(2) A "financial activities tax", which would be levied on the sum of financial institutions' profits and the remuneration they pay.

Industrial Policy of Nepal 2010

Finally, the Nepali government is going to update its outdated industrial policy of 1992 with a new one. I have not got hold of the official document yet. The following is a brief highlight of what is coming:

• High priority industries: IT, cement, hydropower, vehicle and motor parts, chemical fertilizer, bio-technology and adventure tourism
• Priority industries: Agriculture, forest-based Ayurvedic and homeopathic medicine, manufacturing, minerals and handicrafts
• Finance support to construct infrastructures such as roads, electricity lines and water supplies up to factory sites.
• Promotional incentive package for export-oriented industries, specially SMEs. It promises 25 percent income tax concessions to small, medium and large industries that directly employ 100, 300 and 600 people, respectively.
• Industries promoted by women to get income tax incentives.
• Tax holidays for 10, 7 and 5 years to firms that invest respectively in highly underdeveloped, undeveloped, and underdeveloped industrial regions.
• Promotion of Special Economic Zones (SEZs) and Agro-Export Promotion Zone (AEPZ). Firms located within in these zones to be exempted from customs duty, excise duty and VAT.
• Income tax deductions for R&D and market promotion.
• Simple exit policy to promoters, freeing them from long-term labor and other liability.
• Subcontracting of production to promote specialization in the manufacturing process and to enable firms to meet international orders without investing further in its production units. This is expected to foster backward linkages.
• Differential tariff rates for raw material imports and import of finished goods. The protection rate (difference in tariff favoring local manufacturing over direct import) will be 25 percent.

It sounds all good. I will have to see the full document to comment on specific topics. But, a general observation reading this article is that there seems to be no sunset clauses for industries. Any policy to help domestic industries should have a clear end sight, i.e. sunset clause. Policy help cannot be for infinite time as this dampens competition and leads to inefficiency. There should be policies to deliberately promote domestic industries without violating international trade treaties but it also should have clear sunset clauses. More comments when I get and read the full document.

Meanwhile, here is a list of loss making public enterprises, which borrowed Rs 1.6 billion in ten months instead of the allocated Rs 800 million for the whole fiscal year, in Nepal.

Who is John Maynard Keynes?

Rob Johnson introduces John Maynard Keynes:


Advice to young economists:


Check out the Institute for New Economic Thinking (INET) for more interesting stuff.

Growth and Inequality in India

The Indian economy has been growing at a rate of more than 7 percent, on average since 2000, but it has not fully translated into the lives of poor people. Poverty and inequality levels are still high.

 

Poverty in rural areas fell from 37.3 percent in 1993-94 to 27.1 percent in 1999-2000, while in urban areas it fell from 32.4 to 23.6 percent, according to official estimates.

The HDI value was 0.427 in 1980, 0.556 in 2000, 0.604 in 2006 and 0.612 in 2007.

Percentage of population below different poverty lines:

• $1.25 a day: 41.6%
• $2 a day: 75.6%
• National poverty line: 28.6%; (National poverty line: rural is Rs 356.30 and urban is Rs 538.60, according to the National Planning Commission)

Share of income or expenditure of:

• Poorest 10 percent: 3.6%
• Richest 10 percent: 31.1%
• Richest 10 percent to poorest 10 percent: 8.6%
• Gini index: 36.8 (0 is absolute equality and 100 is absolute inequality)

Source: HDRs and Kakwani 2004 One Pager #2

Inclusive growth in India: Is it happening?

The Brookings Institution organized an event about Indian polity and inclusive growth at Carnegie on Tuesday. Tarun Das, former chief mentor of Confederation of Indian Industry, shared his optimism about the Indian economy and economic development.

According to Das, some of the main features of the Indian economy right now:

• Increasing number of CEOs of private companies are joining the public sector. Examples, Nandan Nilkani and Arun Maira
• Skill development: India plans to train 500 million people by 2022. The private sector is playing a key role in this initiative. It has established National Skills Development Corporation (NSDC). A large part of its skill development efforts are directed at the unorganized sector. It is a PPP initiative.
• Emphasis in innovation and technology, both in the urban as well as rural areas. Example: solar lamps and telecommunication
• Enhancement of efficiency in the public sector.
• Education sector has been open to the private sector. Private foundations such Azim Premji Foundation and Bharti Foundation are contributing to uplift the education sector.
• Health care sector: spread of mobile health clinics; new technologies with improved supply lines; with improved technology almost 30 percent of wasted food is now stored, thus increasing supply and preserving nutrients
• Young entrepreneurship: Emergence of self-employed youths; more than 100,000 successful SMEs…becoming more and more competitive…more will come
• Private sector is emerging as the driving force of growth and development…dynamic private sector
• Transformation of rural area: more rural connectivity, impact of TVs, ICT
• Prudent entrepreneurs: high savings rate (25 to 35 % of GDP) and increasing investment rate
• Government development schemes such as rural employment and rights to food act are helping the poor people that are not seeing the direct benefits of economic growth. Poor people and women are slowly getting empowered.
• New economic and social development model: India realizes that both private as well as government sector is needed. It has a centrist economic model. The liberal economic policies would stimulate the private sector and social development policies of the government would uplift the poor people, thus narrowing the gap. This would then help India achieve above 10 percent growth rate.

Few comments about Das’s comments:

Das did not go in detail about how India can achieve inclusive growth. Large swathe of the people are still poor and depend on agriculture. The discussion on agricultural sector was minimal. He focused more on the corporate-end of the growth equilibrium and talked about CSR-type development initiatives led by the private foundations. I had expected from him a little bit more discussion about NREGA, the largest public employment guarantee program in the world. Even the UPA government’s election victory in the last election is accredited to this reform. It seems that this would be one of the main vehicles to creating an inclusive society and possible inclusive growth.

Additionally, the rise of Maoists and the government’s lack of reach in the remote villages were not discussed. This obviously will have a strong bearing on the growth rate at some point in the future. Right now, the urban-led activities seem to lead growth. It will saturate at some point. Then, some of the variables of drivers of growth would be based on rural economic activities. This is where the Maoists insurgents could become villain to growth. It has been one of the main internal threats to the Indian democracy, according to Prime Minister Manmohan Singh.

There were many issues that were left out. The talk was heavily focused on how to achieve high growth rate, which could not be necessarily inclusive. The inclusive growth part was discussed very little. Also, sweeping generalization about the reach and impact of mobiles and TVs was a bit too much. It has its own limit!

Overall, the discussion was a good primer on the existing Indian political economy.

The idea of comparative advantage is not dead!

Pascal Lamy on Krugman, Samuelson and comparative advantage:

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“At the outset, let me recognize Paul Krugman’s intellectual contribution to international trade theory — the so-called “new trade theory” — in which he shows that, even in the absence of productivity differences between two countries, trade benefits them both. He focuses on the presence of increasing returns to scale, in which a firm’s average cost per unit declines as production increases and underscores that consumers value variety in consumption. While the new trade theory reduces the role played by comparative advantage, it identifies new sources of benefits from trade that were not emphasized or recognized by the classical economists. More trade benefits all countries because specialization in production reduces average cost and consumers gain access to a wider variety of products. In contrast, traditional theories of trade assume the variety of goods remains constant even after trade-opening.

 

There is a much-cited paper by Paul Samuelson in the Summer 2004 issue of the Journal of Economic Perspectives which showed theoretically how technical progress in a developing country like China had the potential to reduce the gains from trade to a developed country like the United States. This paper appeared to be a dramatic about-face against the idea that open trade based on comparative advantage is mutually beneficial.

There is a much-cited paper by Paul Samuelson in the Summer 2004 issue of the Journal of Economic Perspectives which showed theoretically how technical progress in a developing country like China had the potential to reduce the gains from trade to a developed country like the United States. This paper appeared to be a dramatic about-face against the idea that open trade based on comparative advantage is mutually beneficial.

I emphasize the word “appeared” because subsequent analysis by Jagdish Bhagwati, Arvind Panagariya, and T. N. Srinivasan contradicted this view. In that paper, starting from autarky, China and the United States open up to trade and experience the usual gains based on comparative advantage. In the following part of the paper, Samuelson considers how technological improvements in China will affect the United States. In the case where China experiences a productivity gain in its export sector, both countries benefit. China gains from the higher standard of living brought about by the increase in productivity while the United States gains from an improvement in its terms of trade. In the case where China experiences a productivity gain in its import sector, there is a narrowing of the productivity differences between the countries which reduces trade; and as trade declines, so too do the gains from trade.

So what Samuelson has showed is not that trade along lines of comparative advantage no longer produces gains for countries. Instead, what he has shown is that sometimes, a productivity gain abroad can benefit both trading countries; but at other times, a productivity gain in one country only benefits that country, while permanently reducing the gains from trade that are possible between the two countries. The reduction in benefit does not come from too much trade, but from diminishing trade. Furthermore, even in this case, Samuelson himself does not prescribe protectionism as a policy response since, as he put it ,“what a democracy tries to do in self defense may often amount to gratuitously shooting itself in the foot”.

In my view, the analysis by Bhagwati, Panagariya and Srinivasan should convince us that the principle of comparative advantage, and more generally, the principle that trade is mutually beneficial, remains valid in the 21st century.”

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Lamy attempts to debunk some fallacies in trade discussions:

• Fallacy #1: Comparative advantage does not work anymore
• Fallacy #2: It is unhealthy for trade to grow faster and faster compared to output (there is a problem with the way we interpret (and measure )volume of trade and value addition)
• Fallacy #3: Current account imbalances are a trade problem and ought to be addressed by trade policies.
• Fallacy #4: Trade destroys jobs
• Fallacy #5: Trade leads to a race to the bottom in social standards.
• Fallacy #6: Opening up trade equals deregulation

It is worth reading the full text.

Nepal-US Trade & Investment Framework Agreement (TIFA) & Exports

My latest column is about the implications of the US-Nepal TIFA. I make the point that there is little, if any, immediate gains in terms boosting exports. However, the pact is a right move in promoting Nepali exports industry and exports. A high level delegation led by Nepal’s commerce secretary was in DC. I met them twice last week.

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Nepal-US TIFA and Exports

There has been a lot of discussion about the proposed US-Nepal Trade and Investment Framework Agreement (TIFA). The Nepali delegation led by Commerce Secretary Purushottam Ojha is in Washington DC to finalize the pact, which the two countries will formally sign soon. The proposed new pact with the biggest economy in the world has reignited optimism among Nepali exporters. It is seen as a precursor to a free trade agreement (FTA) between the two countries.

Nepali investors and exporters should understand that TIFA is not a panacea for the ailing exports sector. In fact, nobody knows if the enactment of TIFA would boost exports to the US. It does not give additional tariff concessions for the beleaguered export-oriented industries, including ready-made garments. It is merely a pact that establishes a framework for enhancing trade, technical cooperation, and resolving outstanding disputes between the US and Nepal. It is not a silver bullet to regain the lost glory of Nepal’s exports to the US.

When the Nepali delegation floated the idea that Nepali ready-made garments be given the same preferential treatment that the US provides some African countries for quota and duty-free entry into the United States following the African Growth and Opportunities Act (AGOA) of 1992, the US representatives gave an apt advice: Improve domestic business environment and make it easier for the US companies that are already investing in other South Asian countries, mainly India, to invest in Nepal. Additionally, they asked the Nepali delegation to diversify exports basket. The probability of investment by a company that has experience of operating in South Asia is higher than a company that has no experience running business in the Indian sub-continent. The investors that are already investing in this region understand relevant business constraints better and, if given enough incentives, might invest in Nepal as well.

Source: USTR

Enough has been said about the demise of the garment industry in Nepal. But, no trade related discussion is complete without mentioning the downfall of this industry and its impact on the economy. Concerning the US market, the only notable item we were exporting with comparative advantage before 2005 was ready-made garments. This was possible not because our exports were price and quality competitive, but because the international market was not a level playing field for all garment exporters in the world. The end of Multi-Fiber Agreement (MFA)—which eliminated quotas on the trade of textiles and clothing— in 2005 crippled the domestic garment industry. It struggled to compete, both in terms of price and quality, with superiorly competitive garment producers from other countries. The message was loud and clear: We desperately need to enhance our competitiveness, diversify our export basket, and effectively market our goods and services abroad.

The policymakers need to realize that nothing will move forward unless there is political stability and cessation of incessant harassing of investors and entrepreneurs by militant labor unions and political youth wings. No matter how many TIFAs are inked, in the absence of security and political stability, there will be no substantial positive change in exports. The only direction exports and exports revenue can go are downward. Forget about foreign investors; even domestic investors will not invest if there is constant threat to life and private property.

To make TIFA effective, there is a need to look at binding constraints on investment and trade. Importantly, we need to upgrade technology and human capital capable of producing ‘nearby’ goods, which are in close ‘proximity’ with products that the economy is already producing. This would speed up transformation of not only the export-oriented industries but also the whole economy as rural and informal sector workers will be absorbed into the industrial and formal sectors. Furthermore, the country needs to address energy crisis and shortfall of infrastructure, which several studies have identified as the most binding constraint on Nepal’s economic growth.

Given this bitter reality, there is hardly any immediate tangible benefit out of the US-Nepal TIFA to the Nepali export-oriented industries. It does nothing except to implant optimism among investors that things are moving in the right direction and, if situation improves, trading opportunities will be much more reliable, secure and better.

What goods can we export with comparative advantage to the US market? Neither the policymakers nor the exporters have a definite answer. A comprehensive analysis of the potential for new exportable items to the US market is long overdue. In fact, a product-level and state-level analysis of the markets for Nepali goods in the US will be helpful to exporters because taste and preference of consumers in the $14 trillion economy are vastly different. The items under consideration right now are mostly a narrow set of agricultural and handicraft goods.

Not only there is a need to diversify our export basket, there is also a need to export goods that will help to increase exports revenue so that trade surplus with the US partly offsets overall trade deficit. The existing concentration of Nepal’s exports is extremely high, i e the export basket is composed of few goods upon whose international demand our export industry depends on. It is exposing the economy to greater trade and growth volatility. Studies have shown that the more diversified the export portfolio is, the lesser would be growth and export volatility. In addition, identifying and focusing on exporting goods and services that have high value-addition would mean sustainability of the export-based industries.

The US-Nepal TIFA will not provide immediate relief to Nepal’s ailing exports sector. However, this treaty is a right move in terms of smoothening and settling investment and trade issues, and enhancing trade and technical cooperation between the biggest economy in the world and the poorest country in Asia. There will not be any marked improvement in exports unless the binding constraints on investment and trade are addressed right away.

[Published in Republica, April 10, 2010, pp.6]