Are services exports competitive than merchandise exports in Nepal?

The governor of Nepal Rastra Bank, Dr. Yuba Raj Khatiwada, argues that services exports are more competitive than merchandise exports in the context of Nepal. At a program organized by SAWTEE yesterday, he said that his confidence in merchandise exports is waning and that just looking at more market access in and preferences from the West will not be fruitful.

Well, he is right that focusing on more and more market access and surviving on preferential treatments offered by the West is not making our merchandise exports competitive. In fact, they are becoming increasing uncompetitive and are being displaced by competitive players in the international market. But, this does not mean that our service exports are competitive than merchandise exports. The former might have a larger market potential, but they might not be more competitive than the latter. The reason: the same constraints that ail merchandise exports persists in services exports sector as well.

Rising labor cost, high interest spread rate, power shortages, and lack of adequate infrastructures  are not the problems of merchandise exports sector only. These are very much obstinately persistent in the services sector (tourism, labor, IT, health, and education) as well. Meanwhile, high inflation and rise in real exchange rate (and the constraints that come with a pegged exchange rate regime) are also affecting both the sectors. High inflation domestically means that in nominal terms prices are expensive here. It means hotels, food, traveling and all other related services are relatively expensive here as compared to periods when there was low inflation. Furthermore, our services sector (except for low skilled labor) are not that competitive when compared to regional partners as of now.

To make them competitive, the government has to invest a huge amount of money in installing the prerequisites needed for these industries to take off. We do not have qualified human resource (or appropriate incentives in place) to take charge of the IT industry and spearhead cutting edge innovation. Meanwhile, the quality of our domestic educational system is far below the regional standard. Evidence: Just look at the number of students going to India and beyond for higher education. Remember how it took millions of dollars of investment in IITs and IIMs for almost a decade before they produced the kind of human resource needed for the Indian IT and management industries. Can Nepal emulate this success story given the existing political and economic constraints? May be, and may be not (look at the failure of the IT Park in Banepa). But, it still does not mean that services exports are competitive than merchandise exports.

As a whole, it sounds all good. The global services market are expanding and recent innovations in technology is facilitating this. But, the question is: how far can Nepal tap this given our domestic capacity right now? I believe not much. So, services exports might have the potential, if tapped rightly and timely, but it is not wholly competitive than the merchandise exports, which is, by the way, performing pretty bad since 1997. The belief that services exports is more competitive than merchandise exports is like plump fruit which one thinks of is sweet, but does not know if it is sweet or bitter without tasting it. Sometimes, perception and reality might differ.

What does data show?

Nepal has been having deficit in trade of goods for a long time. But, we are having deficit in services trade since 2005. We are importing more services than we are exporting in the the last five years. Also, the size of services trade deficit is also fluctuating, but still is negative. Competitiveness of services sector is not very strong than that of merchandise sector as of now. It might have the potential, but not right now.

In terms of employment, 65.7% of total employed are in agriculture sector, 13.4% in industrial sector, and 20.1% in services sector (data as of 2001). The value addition of agricultural sector, as percent of GDP, was 33.8% in 2009, with annual value added growth of 2.2%. The industrial sector value added (% of GDP) was 15.9% with annual value added growth of 1.78%. The manufacturing sector value added (% of GDP) was 7% with annual value added growth of –0.5% in 2009 (it was 2.6% in 2007). The services sector value added was 50.2% with annual value addition growth of 5.9% in 2009. Now, look at the employment being generated. Though the services sector contributes more than 50% of our GDP, it employs only 20% of the total employed.

The most influential economist over the past decade

Basically, Keynes’s followers prevailed. Here is more from The Economist.

Setting a deadline for the Doha Round

A “High Level Trade Experts Group”, co-chaired by Jagdish Bhagwati and Peter Sutherland, argues that passage of the Doha Round is doable in 2011, but this would require increased attention of world leaders. The Group has called for December 31, 2011 as the deadline for the passage of the Doha package.

• Doha is doable this year; rapid progress is being made in closing the negotiating gaps; this started in November 2010.

• Getting the deal done requires head-of-state attention; they must authorize, or personally negotiate the last trade-offs framed by the draft agreement that their WTO ambassadors hope to have ready for April.

• The window for this deal is the first half of 2011; after that all bets are off until 2013 at the earliest (due to elections in the US).

Major points from the document:

-A development friendly trade deal must demand less of countries in a way that is proportionate to their state of development. The final Doha package should be measured against this criteria.

-The Doha Round’s development mandate will be delivered in two key ways: (i) complete exclusion of all LDCs from any obligations except binding their tariff schedules at the current level (‘Round for Free’); and (ii) the concept of agreed ‘modalities’ for tariff cuts (subsidy reductions in agriculture) in principle agreed by all member, but in practice tempered by various forms of ‘flexibility’ for developed and developing countries. The last Doha negotiations in 2008 failed over differences in defining one of these flexibilities—a  special safeguard mechanism for agricultural exports to developing countries.

-The use of formula plus flexibility system is both the greatest potential strength and fatal weakness of the Doha Round. Positive in the sense that tariff landscape will be compressed across the board, with the highest farm tariffs in the developed world compressed. Also, industrial tariff in developing countries will also go down. Weakness in the sense that unless it is clear where all countries will exercise their flexibilities to shield tariff lines from cuts through exclusions or where the special safeguard mechanism will apply, it is impossible, or at least very difficult, to value a final package in a way that makes it possible to sell to domestic constituencies.

-Because completion of the Doha Round would demand political concessions, it cannot be completed solely by trade negotiators as it needs a much stronger and direct involvement of political leaders.

Why the Doha Round should be completed?

• It will act as an insurance policy against future protectionism. It will consolidate unilateral liberalization agreements since the end of the Uruguay Round in 1994.
• It will help reform global farm trade, particularly it will make the EU’s Common Agricultural Policy irreversible and seriously constrain any future US Farm Bill from increasing support should commodity prices fall. It would also eliminate all export subsidies for agricultural goods.
• It will provide new market access through tariff reductions and the contraction of market share of those countries whose agriculture subsidies will be withdrawn.
• It would protect the WTO and the multilateral trading system itself. A permanent collapse would likely provoke a wave of preferential trading agreements.
• Unless the Doha Round is finished and the WTO moves to 21st century trade issues, it will find itself stuck with out-dated disciplines while deeper disciplines are established by the EU’s, the US’s and Japan’s deep RTAs, with new sets added when China, India and Brazil internationalize their own supply chains
• Even if tariff reductions and the dismantling of non-tariff barriers can be achieved bilaterally, the multiplier effect of a multilateral agreement is considerably higher. Also, agricultural subsidy reform will be agreed multilaterally or not at all.

Structure of a final package

Agriculture

• Under current draft texts the EU would reduce its MFN duties on agricultural imports by close to 60%. The highest and most distorting tariffs will be cut proportionally more, with only 4% of tariff lines treated as sensitive and therefore subject to smaller cuts. As a compensation tor these partial exemptions import quotas amounting to 4% of domestic consumption must be opened and subjected to zero or very low duties. IT will translate into real new market access opportunities from day one of implementation. Agricultural exporters in developing countries, in particular Brazil and Argentina, and in developed countries, in particular Australia, New Zealand, and the US will likely benefit the most.
• The support to products like cotton and sugar in the US would be severely constrained, but negotiators still have to tackle this issue. Also, the form and functioning of the special safeguard measure for developing countries need to be worked out.
• Under trade distorting domestic support to agriculture, developed countries will reduce substantially the ceilings currently applied (by up to 80% in the case of the EU and up to 70% in the case of the US).
• The current text foresees the complete elimination of all forms of export subsidies by 2013 by developed countries, and by 2016 by most developing countries, with the remainder by 2021.

Industrial goods

• Among developed countries, which represent more than two third of the world’s final demand, tariffs would be virtually eliminated, with no tariff remaining above 6%. Duties levied by the EU on its total imports of industrial products would go down by 44%, more than in any previous round, amounting to $12.5 billion saved on exports to the US. On the US market, the amount of duties paid on imports would go down by $12 billion.
• For China, the current draft modalities would lead to a 22% reduction of duties levied on imports, well below the 36% cut that Chinese exporters would face on foreign markets.
• Other emerging countries need to make further tariff reductions.

-->Tariff reductions in particular sectors that are highly traded is needed as well. Sectoral tariff reduction would increase the gains for all countries.

--> The Doha Round should also include a new package on environmental goods and services, whose market is worth US 150 billion annually. The WB has already defined a list of 45 environmental goods that can form the basis for negotiation.

Services

• Given the fundamental role of services in the effective and efficient management of an economy, a strong outcome in services has huge potential spillover benefits for both developed and developing WTO members.

Package for LDCs

• The LDCs are not expected to implement any tariff reductions and are requested only to bind their tariffs at the level they currently apply. Since many of them depend on preferential market access to economies, multilateral liberalization erodes the preferential margin for their exports, which could pose as a challenge in the short-term as they will face stiff competition from advanced developing countries such as China and Brazil. This concern is partly addressed by eliminating tariff on certain products in a phased manner. Also, granting duty free quota free (DFQF) market access for all exports from all LDCs to all OECD countries and a set of major emerging economies would be helpful to LDCs. It could boost LDCs’ exports by 44% or US$ 7 billion a year.
• Since cotton is of crucial importance to several LDCs, the Doha Round will also have to address trade distorting subsidies to cotton farmers in developed countries.
• Aid for Trade (AfT) should be maintained as a necessary complement to boost LDCs’ productive capacity and help them reap the benefits of the Doha Round.

Trade facilitation

• Trade facilitation negotiation is a clear success story of the Doha Round. The WTO members have tabled more than 70 new proposals for improving the transit of goods between markets, charges levied for transit, penalties for minor breaches of customs regulations, the standardization of customs documentation and prompt publication of conditions for import and export.
• The proposed improvements in trade facilitation would increase trade by US$130 to US$450 billion annually. The benefits for developing countries could by far exceed the gains in other areas for negotiation. Meanwhile, the developing countries themselves should take initiatives to reform domestic policies and infrastructure to ease border-crossing for goods and services and the development aid that will be provided by developed countries to implement these reforms.

Here (the main paper by Antoine Bouet and David Laborde 2009) is an updated estimation of the potential costs of a failed Doha Round. The total cost of failure of the Doha Round is estimated to be US$ 1.171 trillion in forgone world exports if protectionist measures persist. Meanwhile, welfare loss are estimated to be US$ 193 billion. Here is earlier estimates of the Doha Round. Here is a piece about the industrial and export interests of Nepal in the Doha Round of trade negotiations. Here is a link to the recent WTO workshop on the Doha Round.

Links of interest about the latest on the Doha Round

• Roderick Abbott on how to revive Doha with some chance of success. He argues that “WTO members need to go back to the drawing board to come up with alternative approaches to the negotiations.”
• Peter Sutherland on a future for the WTO
• Peter Kleen compares the Uruguay Round and the Doha Round. He concludes that “negotiating trade agreements must remain the raison d’etre of the WTO, no matter how complicated it has become. Such negotiations, however, could take a less ambitious and more incremental form than these big rounds and must be able to muster support from the global business community if trade liberalisation is to continue advancing.”
• Stuart Harbinson on the main issues for a conclusion of the Doha Round

Here is a blog post about the need to finish the Doha Round by 2011.

Investment climate reform in Southern Sudan

Southern Sudan is a new country (official name not decided yet) with an overwhelming majority deciding to secede from Sudan. According to the final count, announced in Sudan’s capital, Khartoum, 98.83 percent of the more than 3.8 million registered voters in southern Sudan chose to separate from the north. In many parts of the country the vote was over 99 percent.

My good friend Abraham Akoi returned back to Southern Sudan and is working at the Ministry of Finance. Salva Kiir Mayardit, south Sudan's president, tapped Abraham to become the deputy director of administration and finance at the ministry. He argues: “Our political and financial institutions are weak. Civil liberties are not strong. There are no good hospitals and no good supply of medicines.And only 15 percent of south Sudanese know how to read and write. That's not very good for democracy."

An interesting question is that how the new country is preparing to spur economic growth and make it investor-friendly after over two decades of brutal civil war in the oil rich region? A number of development and multilateral agencies are working to help it better human development and business climate. The WB’s investment climate blog lists the initiatives taken so far in easing business environment.

---

• Legal framework. Eight laws have been enacted enabling business entry, operations, and exit. Another nine that allow basic registration, contract, agency, property rights, and insolvency are ready to enact.
• Business entry. The business registry was strengthened and registration reinstated following suspension in December 2005. Businesses can incorporate within a day. About 8,000 businesses—most domestic and small or medium-size—have been registered since July 2006. A business-registration campaign resulted in an additional 1,100 businesses within the first six months of 2010.
• Investment policy and promotion. The new Investment Promotion Act 2009 established the Southern Sudan Investment Authority, resulting in the targeted, proactive pursuit of potential investors and re-investors.
• Public-private dialogue. The establishment of the Southern Sudan Business Forum enables consensual policy development. Through its working groups, the forum has helped revise the Micro Finance Policy being developed by the Bank of Southern Sudan and drafted and promulgated the Investment Promotion Act 2009.
• Trade logistics. As a result of improvements in the Customs Chamber since 2008, Sudan has significantly reduced the number of days traders need to complete import-export procedures. The time needed to import was reduced from 83 days in 2007 to 46 days in 2010, and the time to export from 56 days in 2007 to 32 days in 2010. The 2009 Customs Amendment Act was approved by the Council of Ministers. The customs clearing system has been automated and this will lead to even greater time and cost reductions. The system links 21 regional offices and the Tax Chamber, and it allows for electronic approvals and the submission of electronic manifests.

  ---

A lot of work needs to be done. And, I hope that with dedicated youths like Abraham, it will be done soon.

Capitalism comes with open system and instabilities

A good rundown of the state of macroeconomics so far. Sourced from Alex Leijonhufvud’s CEPR Policy Insight No 53 “Nature of an economy”.

• Keynes proposed that flexible money wages would not lead to full employment. In fact, very flexible wages would produce financial catastrophe (The General Theory).
• IS-LM model showed that unemployment was due to sticky wages, i.e. downward inflexibility of money (nominal) wages.
• Then the problem came when the Phillips curve was pasted onto the IS-LM model. How can you have both rising inflation and rising unemployment? So, came the Quantity Theory of Money, which Friedman used to attack Keynesian economics. It gave logical reasoning to the conundrum faced when Phillips curve was combined with IS-LM model. The concept of ‘natural rate of unemployment’ came up.
• The Monetarists believed that flexible wages were sufficient to guarantee that the economy would converge to the natural rate of unemployment. Keynesians argued that if desired saving did not equal investment, then flexibility of wages would not make it converge to the natural rate of unemployment. Monetarists ignored S-I problem and also the role of credit markets in furthering or hindering the coordination of saving and investment. Monetarists were more interested in stabilizing price level.
• Robert Lucas argued that the instability of the Phillips curve and the Fisher premium could be explained while obeying the dictates of optimal choice theory (rational expectations). He believed that only “unanticipated” changes in the growth rate of the stock of money would cause unemployment to deviate from its natural rate. Friedman did not share this position. S-I problem was forgotten.
• Edward Prescott came up with Real Business Cycle theory, which showed variations in output and employment were optimal responses to exogenous (i.e. unexplained) variations in productivity growth. It became the main vehicle for the development of dynamic stochastic general equilibrium (GSGE) theory.
• New Classicals and New Keynesians converged on 'the ‘New Neoclassical Synthesis”, which incorporated some of the “frictions” of the Keynesians while the latter adopted the DSGE framework developed by the former.
• However, though advances were made in understanding the advances of markets, little progress was made in understand how an economy works. The Old Synthesis was wrong back then and the New Synthesis is also wrong today. It does not recognize the instabilities lurking in the economic system, argues Leijonhufvud. The behavior of individual agents and of the economy as a whole differ in a deep recession or high inflation from normal times.
• Leijonhufvud maintains that economists did not pay attention to their ontological presuppositions, i.e. they failed to grasp the nature of the reality (the object of study) and to adapt one’s methods of inquiry to it. Economists have imposed preconceived methods on economic reality in such a manner as to distort their understanding of it. They start from optimal choice and fashion an image of reality to fit it.
• A “closed” model (and optimal choice) in economics essentially implies that agents are automatons lacking free will and a choice. So, whatever happens, there is always equilibrium. It assumes that economic agents possessed the knowledge of the future required for the calculation of intertemporal optima. So, the present beliefs about the future induce actions that create the future (what George Soros calls “reflexivity”). Rational expectations is a special case of reflexivity. It makes the economy a closed system. Agents are supposed to possess (probabilistic) knowledge of an objective reality—a reality that they have been able to learn.
• The mathematical representation of the system closed by assuming rational expectations made it possible to prove a variety of propositions—such as Ricardian equivalence and other policy ineffectiveness theorems—that ran counter to the received wisdom of the time.
• The heterogeneity of expectations associated with the lack of synchronicity means that there will be a range of indeterminancy within which the market clearing price may temporarily settle.
• In the “open system” many prices will be indeterminate (albeit within limits), economic behavior has to be understood as fundamentally adaptive, behavioral time horizons are variable, and the sets of markets and relative prices may change endogenously.
• In economics crises, budget constraints are not “soft” but they are broken. In deflation or depression crises, the budget constraint violations are concentrated in the private sector. In high inflation or hyperinflation crises, it is the sovereign that violates equal-value-in-exchange. Standard general equilibrium theory, even in its modern dynamic stochastic variants, is not particularly helpful when budget constraints are violated.
• The image of a capitalist economy as a stable general equilibrium system somewhat hampered in its functioning by “frictions” is an inadequate guide to the realities we have to cop with. Instability is a part of the capitalist system.
• Government resources have to be used to bring the private sector out of a deep recession or depression. Resources have to be transferred from the private to the public sector to bring high inflation under control. It gets further troublesome if the finances of one sector are already strained when the other gets into trouble.

So, two main points: (i) Think of an economy as an “open system” in the ontological sense of Tony Lawson; and (ii) The economy is not globally stable but harbors instabilities.

Food price inflation fueling a sense of injustice

---

But for all the noisy media coverage and declarations by senior policymakers, few people have remarked on the actual motives of those who, in 2008, destroyed property in Argentina, Egypt, India, Indonesia, and Peru and brought down Haiti's government and are currently causing havoc in Tunisia and across the Middle East. After all, food riots have occurred throughout history but have not usually correlated with hunger or food prices. For the most part, the planet's 700 million-900 million hungry people have suffered in silence. And price volatility does not necessarily lead to screaming crowds, either. There are many more examples of people accepting volatile prices than rioting over them. So there is more to the protests than the logic of the pocketbook. A key psychological element -- a sense of injustice that arises between seeing food prices rise and pouring a Molotov cocktail -- is missing.

It is not yet clear how big a role food riots played in the toppling of the Tunisian government. But if history is any guide, Tunisians' feelings of being cheated were more important than actual food prices. Take Cameroon's experience in 2008, for example. That year, this West African nation suffered one of the most serious and protracted food riots in the world, and scores were left dead after the crowds eventually dispersed. Remembering the crisis, Alexander Legwegoh, a Cameroonian academic and an expert on urban poverty and food security, and Bernard Motuba, an accountant who left Cameroon for Canada, said that it was not just bills that caused the violence: expensive fuel drove taxi drivers to strike and then, anger over merchants' profiteering on staple products broadened the protest. "The government knew a group of merchants was taking advantage of everyone and that this would grow to a political crisis." Yet, according to Legwegoh and Motuba, as the protesters' numbers swelled, the size of loaves of bread for sale in the markets shrank while their price tags remained the same.

The real culprits, then, were retailers who stockpiled grain in hopes that prices would continue to go up. This speculation spun Cameroon's food system further out of control and bred hatred. Motuba describes the food merchants as "cutthroat business guys who don't give a damn about people." When the government sent inspectors to grocery stores and warehouses to auction off any illicit surpluses, the public cheered. Prices had not returned to their earlier levels, but a seeming restoration of justice helped calm the rioters' tempers, whose fury, according to Motuba and Legwegoh, had been rooted more in a feeling of exploitation than a fear of starvation.

[…]Policymakers today must be mindful of the psychological causes of food riots when they discuss the correct mix of trade and protectionism that will safeguard our food security. If they simply embrace the efficiency of the market, public feelings of injustice may cause more trouble than the volatile price of food itself.

---

More by Evan Fraser and Andrew Rimas in Foreign Affairs magazine here.