Finance-Trade-Growth nexus

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We study linkages between financial development, international trade, and long-run growth using data since 1880 for seventeen now-developed “Atlantic” economies and a set of cross-country and dynamic panel data models. We find that finance and trade reinforced each other before 1930, but that these effects did not persist after the Second World War. Financial development has positive effects on growth throughout the sample period, while trade affects growth strongly and independently after 1945. We attribute the rising importance of trade in explaining growth to major post-World War II changes in tariffs and quantity restrictions associated with the GATT, the establishment of the European Common Market, and the gradual elimination of capital controls after 1973. The findings are robust to the use of ‘deep’ fundamentals such as legal origin and indicators of the political environment as instruments for financial development and trade. Financial development, however, is more closely linked to these fundamentals than trade.

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Abstract from a paper by Bordo and Rousseau (2011). Read the full paper here.

Changes are coming to Nepal–The Youth Dividend!

[This was published in The Week, Republica National daily, May 20, 2011, p.10]

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Changes are coming to Nepal

Chandan Sapkota & Rita Shrestha

The prevailing perception right now is that whatever progress we’ve achieved so far is going down the drain. Try having an engaging conversation with people gathered at teashops or in restaurants. Most harbor pessimistic views of the country. Resigned remark such as “Kehi hunewala chhaina, dubayo desh neta harule” (Nothing is going to happen, the leaders have ruined the country) is deeply entrenched in the minds of the public.

As youth experiencing the undercurrents of hope and changes sweeping the society and economy, we’ll part away from the pessimistic views and argue that positive changes are happening, albeit gradually. The agents of change are the enterprising youth (for our case, consider the age group 15-34) who have pretty much lost faith in their political leaders.

This band of enterprising and energetic population is realizing that it’s in their hands to constructively bring about a positive change of hope in the society and dispel the fear that nothing is happening. Change and progress are happening by not talking only, but by putting ideas into action and showing best practices in a range of activities and vocations.

They are seeing hope amidst chaos and opportunities amidst challenges. The only constraint that’s slowing down this progressive change is the regressive ideas and actions of the selfish political leaders.

Changing landscapes

In August 2010, a group of energetic youth organized BarCamp Kathmandu, an ad hoc and informal gathering where youth discussed a range of issues pertinent to Nepal’s growth, innovation and development. Connecting with interested youth via Facebook and Twitter, the organizers were able to bring together over 600 participants of various age and nationalities. The networking, discussions, and outcome of the ad hoc gathering were more revealing, enchanting and inspiring than the finest and most productive day at the Constituent Assembly (CA).

“The CA Members should come and see firsthand how to make discussions productive, civilized and engaging,” remarked Shankar Pokharel, one of the organizers of the event, during tea break. The reaction from other youth was that the leaders will be humiliated to see how smoothly this kind of large yet ad hoc event runs without any drama. This is an example of how youth are constructively shaping socio-political-economy debates.

Take another example of a youth who is working on to provide drinking water in remote places cursed by altitude and dryness. Nirmal Adhikari and his associates at Kanchan Nepal—an organization based in Pokhara that focuses on water management in rural areas—visit remote places such as Doti, Dailekh and Jajarkot, study water availability, document lifestyle and help households install rainwater-harvesting tanks. Sharing a picture of such a tank on Flickr, he commented, “Apart from saving time and resources devoted to fetch water everyday, people are also using the conserved water to grow vegetables in places where you might just think it was impossible before the installation of the tank. Furthermore, it’s having an impact on household education and health standards.” Adhikari is making an impact by doing what he wanted to, not just pessimistically talk about the gloomy economic scenario of the country. This is an example of how youth are constructively engaged in development activities and making real impacts.

After completing undergraduate degree in the US, Vidhan Rana returned home with a market research outsourcing project that involves creating and maintaining client database for various state and local government agencies in the US. He has not only opened an office in Bag Bazaar and expanded his team, but is also hosting space for a local NGO, also run by youth, that is constructing schools and providing training to teachers and educational materials to schools it works with in remote areas. Rather than incessantly ranting about underdevelopment and directionless economy, youth like Rana are doing their part to ensure a direction for the services industry and making an impact by providing access to education for the disadvantaged and marginalized ones. Unlike “youth traders,”, i.e., those who make easy money by importing goods and selling them with a hefty margin without adding any value to the productive capacity of the nation, youth like Rana are the real entrepreneurs who are not only creating a foundation for future economic growth but are also giving others an opportunity to realize their potentials.

Similarly, enterprising citizens who have knowledge, experience and expertise about entrepreneurship have founded Entrepreneurs for Nepal (E4N) to encourage youth to become agents of change and real entrepreneurs. A group of conscious youth is leading a campaign against bandas. Another group of youth is engaged in cleaning public parks and airports during weekends. Even more are trying to mobilize citizens, via personal and social networking sites, to hold their elected representatives accountable.

These are some of the examples of how youth are voluntarily becoming agents of change because they have lost faith in political leadership and believe that change should come from within. These smart youth are slowly rising up in political sphere, banking sector, I/NGOs, intellectual circles, policymaking, and so forth. They are gradually changing the socio-political and economic landscapes.

Changing demographics

By the end of this decade, the number of people in the age range 15 to 34 is expected to be about 14 million, which is approximately 40 % of the estimated total population in 2020.

The number of people in the age group 15-24 will peak in 2017 and the 15-34 segments will peak in 2023. They will be the agents of change and a catalyst to the engine of growth.

Source: Computed from US Census Bureau’s population projection

With a sizable young population and low dependency ratio, the consumer market will see a huge rise in expenditure. Nepal will be one of the countries dubbed as “Young Asia” with low dependency ratio by 2050. Properly managing and encouraging the sheer number of people in this age group to constructively engage in socio-economic, development, and political activities will be of immense importance for the future of Nepal. They not only need predictable and bankable policy and political environment, but also jobs in virtually all sectors.

Hence, achieving high economic growth rate is necessary to accommodate the already enterprising youth as well as those who have zeal but lost faith in the economy. Returns to investment in this age group are enormous. Instituting an appropriate structure and policy to give direction, opportunities and jobs to the growing number of youth will be one of the most pressing economic challenges in the next few years. Else, we’ll see more migration of thousands of youth to the Gulf and other employment destinations in Asia and North Africa.

Changing challenges

The economic and political challenges faced by our nation are changing rapidly. On the economic front, our per capita income is increasing at a very slow pace and economic growth has been below 5% for years now. Compare this with the strides in growth rate and per capita income of not just India and China, but also Bhutan: they are galloping but we’re treading at snail’s pace and that too with great resistance. Meanwhile, the biggest macroeconomic challenges in the coming decade will be to rectify our trade deficit (i.e. bringing down exports to imports ratio of 1:6 to about even-even), accelerate economic growth, bring about structural transformation by reducing the number of people engaged in agriculture and finding them gainful employment in non-agriculture sector, relax the most binding constraints to economic activity (infrastructures and governance), tame surging prices of food, fuel and commodities, and provide safety nets to the most vulnerable population. With the existing pace of reform, it’s impossible to tackle these myriad of challenges. Its course has to change and it can’t be initiated by the existing political leadership who are in their 50s or more. It requires new energy, new people, new vision and enterprising youth that are less selfish than the existing leaders.

On the political front, the dynamics is changing so rapidly that it’s even hard for political analysts to correctly fathom the trend and where it’s heading to. Perhaps one reason for this is that the political rhetoric and superficial commitments of our politicians have no consistent logic as they change statements and commitments like anything. This is leading to disequilibrium in politics, policy, commitment and action. For instance, consider the commitments made by our leaders to bring out a Constitution within two years, integrate the PLA fighter within months, stimulate double-digit economic growth rate in a few years, produce 20,000MW of electricity in two decades, and not to impose bandas in 2011. All of these commitments are unfulfilled and repeatedly rebuffed by the same leaders who committed themselves to these pledges on paper.

Unchanging constraints

While youth are exploring opportunities amidst challenges in their own pace, it’s the responsibility of the state to further accelerate the novel exploration so that innovation and structural transformation occur at a speedy rate and sustainable fashion. Unfortunately, the biggest constraint to this change for the better is our political leadership, which has already shown its party-centered selfish, myopic, opportunistic and at times oppressive facades. They are not only ignoring but also undermining the changes happening in the country. Worse, they are averse to youth’ new ideas and demand for accountability and results. To counter this, even more conscious youth are needed in the political sphere.

Changing from within

Having that said, let us be mindful of the fact, however, that not all youth –such as the indoctrinated party cadres and illiterate and misguided ones – are acknowledging this change and the need to change from within. But it’s the duty of those who’ve realized this to ensure that those who haven’t realized are made aware by instituting best practices.

With all the undercurrents of change sweeping, albeit slowly, among the young generation, the country’s economic and development scenario isn’t as gloomy as is perceived by those who have lost faith in the political system. Change is coming to Nepal and is led by the young generation. The only unchanging constraint is the political leadership.

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[Published in The Week, Republica National Daily, May 20, 2011, p.10]

Food crisis: Simulation versus self-reporting

Derek Headey doubts the existing literature and analysis on food crisis and argues that the negative impacts of higher food prices in 2007-08 was more-than-compensated by economic growth (and insufficient coverage of China and India), something the existing models don’t take into account. Here is a paper (Was the global food crisis really a crisis?) by Headey.

Heady shows that global self-reported food insecurity fell during 2005 and 2008, with 60 million to 250 million fewer food-insecure people. The main reasons for this are rapid economic growth and very limited food price inflation in the world’s most populous countries, particularly China and India. Hence, he argues that food insecurity outcome shown by simulations do not match up with self-reported food insecurity level by countries. So, if the existing estimates are incorrect, then are the policy interventions designed to counter food insecurity misplaced?

Estimates of global trends in self-reported food insecurity, 2005/06 to 2007/08 (million)
Estimation scenarios	Estimated change
Raw results, 70 countries	-408
Raw results, 70 countries, plus assumptions for 16 omissions	-326
Raw results, 68 countries, after excluding China and India	9
Raw results, 69 countries, after excluding China	-132
Raw results, China and India trends adjusted by error margins	-250
Raw results, China and India reductions=3 percentage points	-63
Predicted change with econometric model, 88 countries	-87

Source: Headey (2011) estimates from Gallup World Poll data.

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In a new IFPRI discussion paper I show that these simulations suffer from serious flaws, and that their results are largely contradicted by self-reported food insecurity trends from the Gallup World Poll. The poverty simulations are often quite nice studies, but they are partial equilibrium studies with no wage adjustments, no changes in other commodity prices (like fuel, cotton, coffee, minerals), and no changes in incomes (which were growing all around the developing world from 2000-2008). Hunger simulations have more fundamental problems. Basically they count calorie availability, but the problem with a food or a financial crisis is that it is an access shock, not a production shock. Hence the FAO had to rely on a USDA model (which included reduced "calorie imports") to provide estimates of changes in hunger during the crisis. Yet in my paper I show that USDA's estimates of calorie availability (from early 2008) seem to be contradicted by USDA's own historical data on cereal availability.

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[Note that self-reported food insecurity varies from country to country: in Colombia it is 67 percent, but in Nepal it is just 9 percent. The figures discussed here are global level data, not country-specific.]

Impact of climate change on food prices

Duncan Green cites a new paper that shows that changes to the climate (higher temperatures, changed rainfall, increased CO2 concentration) has meant:

• global food prices have risen by 6.4%
• the world has spent an additional $50bn per year on food
• crops equivalent to one year’s production of maize in Mexico and wheat in France have been lost

Here is the abstract from David Lobell and Wolfram Schlenker’s (2011) paper:

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Efforts to anticipate how climate change will affect future food availability can benefit from understanding the impacts of changes to date. Here we show that in the cropping regions and growing seasons of most countries, with the important exception of the United States, temperature trends for 1980-2008 exceeded one standard deviation of historic year-to-year variability. Models that link yields of the four largest commodity crops to weather indicate that global maize and wheat production declined by 3.8% and 5.5%, respectively, compared to a counter-factual without climate trends. For soybeans and rice, winners and losers largely balanced out. Climate trends were large enough in some countries to offset a significant portion of the increases in average yields 16 that arose from technology, CO2 fertilization, and other factors.

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Green adds:

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These may seem like relatively small numbers so far, but the key driver identified in the study – temperature rises – is projected to increase at significantly faster rates in the coming decades than occurred in the period of this study (global average temperatures have risen by 0.13C per decade since 1950, and are projected to rise by 0.2C per decade over next 2-3 decades, according to IPCC, with higher rises likely in areas of cultivated land – so local impacts in food growing areas will be more extreme, even assuming that there are no tipping points along the way).

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NREGA wages first converging and then diverging

Full story here. The tussle between center government and state government might affect the performance of one of the most extensive and successful (so far) safety net interventions.  More about NREGA here. In short, the program offers 100 days of guaranteed employment per annum to at least one member of rural household; unemployment benefits are given if the state fails to provide jobs within 15 days of work demanded by workers; and wage is equal to minimum unskilled agricultural wage.

Fight of the Century: Keynes vs. Hayek Round II

Very interesting. This is Round II.

Here is Round I.

Inefficient SOEs of Nepal: The triumph of politics over economic imperatives

This article is a product of the productive usage of the banda last Friday organized by Nepal Federation of Indigenous Nationalities (NEFIN)! It is about the sorry state of three major inefficient state-owned enterprises (SOEs) of Nepal: Electricity Authority (NEA), Nepal Oil Corporation (NOC), and Nepal Airlines Corporation (NAC). The very presence and operation style of these SOEs is distorting market prices and incentives. Their condition shows the triumph of politics over economic imperatives in the public sector in Nepal. For specific sources for stats in this article, see this earlier blog post.

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Inefficient SOEs

The existing product market scenario is frustrating for consumers. A majority of the people cannot get petroleum fuel even if they are willing to pay higher prices. They cannot get enough electricity despite being willing to pay more to get extra power to light up their bulbs, and cooking and cooling devices. Furthermore, even after paying nominal charge they are still seeing dry taps in their houses. Also, those willing to fly on the national carrier are not being able to do so because of the failure of Nepal Airlines Corporation (NAC) to correctly fathom the evolving airline market.

These are some of the examples of the consequences of letting inefficient state-owned enterprises (SOEs) to either fully or partially control markets on which consumers heavily bank on to meet their daily needs. Out of a total of 36 SOEs, 18 are operating in loss and even more have negative net worth. The government’s loan investment in SOEs is over Rs 80 billion annually.

Instead of resuscitating these SOEs each time they run in fiscal trouble, squandering taxpayer’s money at the cost of development activities in rural areas and services delivery in urban areas, the optimal solution would be to either purge or reform or privatize most of the loss-making SOEs that are not strategically linked to vital security and national interests. The reason why most of these SOEs are surviving is not related to economics, but vested political interests.

Let me discuss the state of three major inefficient SOEs—Nepal Electricity Authority (NEA), Nepal Oil Corporation (NOC), and NAC—that are draining state resources each year without adding much value to productive capacity of the nation. Subsidizing and keeping these mammoth SOEs alive means that our fiscal deficit, which is 3.9 percent of GDP, will further widen and budget for a number of hospitals, schools, rural roads, and food and agriculture aid curtailed. A complete structural reform—with regards to market, price, management and operation—is essential to ensure that taxpayer’s money is efficiently utilized and that these enterprises delivery what they are supposed to.

The NEA was earning profit until FY 2058/59, but is incurring loss of about Rs 19.47 billion, which is several times more than its total assets, for a decade now. It is unable to supply electricity as per market demand. During FY 2009/10 the annual peak demand reached 885.28 MW, a 8.96 percent growth over the peak demand a year ago. Of this around 30 percent was managed by load-shedding and import from India. It is expected that total electricity demand will be around 1,400 MW by 2015. With the existing pace of power generation, it is virtually impossible to keep up with the growth in demand. The market situation is so pathetic that despite being naturally endowed with rivers having potential to power the entire country and even to supply surplus to India, we are compelled to import, at a high rate, approximately 15 percent of the existing electricity supply from India.

The state of NOC is even miserable. It is running a deficit of Rs 15 billion and monthly loss of about Rs 2 billion. Its creditworthiness is so bad that none of the financial institution is willing to lend money against any guarantee to settle outstanding debt owed to Indian Oil Corporation and to procure more fuel to satisfy increasing demand in the market.

Recently, it was reported that the government had to implore Employment Provident Fund to lend Rs 2 billion and request India to give Rs 3 billion line of credit to resolve fuel shortage for two months. This comes on top of approximately Rs 1.5 billion already given to NOC by diverting funds from a rural roads development project. The market is so distorted that even when people are willing to pay high prices they are not getting fuel as demanded. Already a liter of petrol costs over Rs 125 in the black market.

The state of NAC is heartbreaking. It is supposed to be a pride of Nepal, ferry domestic and international travelers on aircrafts with the iconic Nepali flag, and assist Nepal to achieve its tourism potential. Unfortunately, it is deeply embroiled in repeated scandals related to financial theft during purchase of badly needed aircrafts, appointment of staff, repayment of loans and so forth. It has become a hiring bank for supporters of major political parties. Its total asset is worth Rs 16.80 billion, but losses are over Rs 2 billion. It has just two big aircraft and three small aircraft. Note that at one time the NAC had 21 aircraft, including eight Twin Otters, two Boeing 727s and two 757s, and was one of the biggest foreign currency earners. With mounting losses, mismanagement, and competition from private players, NAC has lost its relevance.

A noticeable question is: How come the SOEs having a healthy balance sheet a decade ago go bankrupt and lose creditworthiness? It is because of myopic financial and operations management, poor governance and accountability, and most importantly the triumph of politics over economic imperatives. The fragile financial health of SOEs and their inability to efficiently and sufficiently satisfy market demand is a recurrent problem that cannot be resolved by applying band aid (such as providing loan sufficient to resuscitate them for few months). It requires sweeping structural changes, which may involve making painful decision of firing redundant politically-appointed staff and adjusting prices upward to reflect changing market dynamics and investment costs.

Unfortunately, this has not happened yet. The NOC is not allowed to adjust market prices. As of last week, it was incurring loss (per liter) of Rs 8.10 in petrol, Rs 23.42 in diesel, Rs 13.61 in kerosene, and Rs 322.6 in a cylinder of LPG gas. Its monthly loss is over Rs 1.96 billion. Similarly, NEA is not allowed to adjust market prices depending on market dynamics and investment costs. At present, per unit investment is Rs 8.97, but power is sold at Rs 6.57 per unit (a loss of Rs 2.40 per unit). Its total annual income is about Rs 1.5 billion but yearly operating expense is Rs 1.65 billion.

The country cannot afford to repeatedly bail out SOEs by slashing development expenditures. Worse, most of the subsidies meant for the poor are captured by the well-offs in urban centers. Effective market and product differentiation is one aspect of goods and services delivery to the targeted group. But, there is no simple fix to the inefficiencies of SOEs except for increasing ownership by management and exposing them to competitive market forces. The consumers should be the king, not the political leaders who dictate the SOE’s board to play to its pricing tunes, whose pitch depends on mood of party cadres.

Apart from stopping leakages and ensuring efficiency, allowing these institutions to adjust prices is one option in the short run to restructure their financial position, and facilitate adequate and timely delivery of goods and services. In the long run, political meddling in all SOEs should cease. They should be allowed to operate freely and competitively. If some of them fail to perform then we should let them exit the market. Meanwhile, NOC and NEA should be broken up into independent units responsible for procurement, production, distribution and retailing. It would help facilitate the entry of private players as well. They should not hold monopoly (market characterized by one seller, many buyers) and monopsony (market characterized by one buyer, many sellers) powers.

That said, subsidizing some SOEs that are vital to maintaining national and security interests are justifiable. But, NEA, NOC and NAC do not fall in this category. The more we bail them out of their financial mess and let politics overcome economics, the more inefficient will be our economic and public goods delivery systems.

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[Published in Republica, May 16, 2011, p.7]