What should post-2015 development framework include?

Varun Gauri of the WB argues that the post-MDG goals and targets should be “easier to grasp and have embedded within them a causal narrative about the causes and remedies of global poverty”. Excerpt from the latest working paper:

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The Millennium Development Goals, which expire in 2015, were a global agreement to promote human development and reduce poverty. But they did not create a legalized institutional regime, in which precise obligations would be delegated to specific actors, nor were they, in many respects, compatible with the incentives of the countries whose heads of state endorsed them. They most resembled international human rights treaties, which are also not legally coercive, and which achieve their effects largely through their role in social and political mobilization. But unlike human rights treaties, the Millennium Development Goals' targets and goals were not psychologically, morally, and politically salient. The goals and targets for the proposed second round of Millennium Development Goals should be easier to grasp and embed within them a causal narrative about the causes and remedies of global poverty. Their formulation and implementation should also draw on national institutions and processes, which most people find more persuasive than discussions at the international level. The paper develops these ideas and presents examples for how post-2015 development goals and targets might be presented in ways that are more compelling.

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The future of manufacturing

Excerpts from a very important report on the future of manufacturing, which approximately constitutes 16% of global GDP and 14% of employment, by the McKinsey Global Institute.

State of manufacturing:

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[…]manufacturing remains critically important to both the developing and the advanced world. In the former, it continues to provide a pathway from subsistence agriculture to rising incomes and living standards. In the latter, it remains a vital source of innovation and competitiveness, making outsized contributions to research and development, exports, and productivity growth. But the manufacturing sector has changed—bringing both opportunities and challenges—and neither business leaders nor policy makers can rely on old responses in the new manufacturing environment.

[…]in today’s advanced economies, manufacturing promotes innovation, productivity, and trade more than growth and employment. In these countries, manufacturing also has begun to consume more services and to rely more heavily on them to operate.

[…]We find that when economies industrialize, manufacturing employment and output both rise rapidly, but once manufacturing’s share of GDP peaks—at 20 to 35 percent of GDP—it falls in an inverted U pattern, along with its share of employment. The reason is that as wages rise, consumers have more money to spend on services, and that sector’s growth accelerates, making it more important than manufacturing as a source of growth and employment.

[…]The largest segment by output (gross value added) includes industries such as autos, chemicals, and pharmaceuticals. These industries depend heavily on global innovation for local markets—they are highly R&D intensive—and also require close proximity to markets. The second-largest segment is regional processing, which includes industries such as printing and food and beverages. The smallest segment, with just 7 percent of global manufacturing value-added, produces labor-intensive tradables.

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Future of manufacturing:

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[…]By 2025, a new global consuming class will have emerged, and the majority of consumption will take place in developing economies. This will create rich new market opportunities. Meanwhile, in established markets, demand is fragmenting as customers ask for greater variation and more types of after-sales service. A rich pipeline of innovations in materials and processes—from nanomaterials to 3-D printing to advanced robotics—also promises to create fresh demand and drive further productivity gains across manufacturing industries and geographies.

[…]In some low-cost labor markets, wage rates are rising rapidly. Volatile resource prices, a looming shortage of highly skilled talent, and heightened supply-chain and regulatory risks create an environment that is far more uncertain than it was before the Great Recession.

[…]Labor-intensive industries will almost always follow the path of low wages, but others, with more complex needs, must weigh factors such as access to low-cost transportation, to consumer insights, or to skilled employees. The result could very well be a new kind of global manufacturing company—a networked enterprise that uses “big data” and analytics to respond quickly and decisively to changing conditions and can also pursue long-term opportunities.

[…]For policy makers, supporting manufacturing industries and competing globally means that policy must be grounded in a comprehensive understanding of the diverse industry segments in a national or regional economy, as well as the wider trends affecting them.For example, shapers of energy policy need to consider which segments will be affected by higher or lower energy costs, how great the impact is likely to be, and what magnitude of difference will trigger a location decision. Policy makers should also recognize that their long-term goals for growth, innovation, and exports are best served by supporting critical enablers for manufacturers (such as investing in modern infrastructure) and by helping them forge the connections they will need to access rapidly growing emerging markets.

[…]Two key priorities for both governments and businesses are education and the development of skills.

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Based on the chart above, it appears Nepal will benefit if it focuses on processing (food, beverage and tobacco; fabricated metal products) and labor intensive tradables (textiles, apparel, leather; and furniture, jewelry, toys and others). Reasons: they are labor intensive and have high trade intensity.

Can the very poor people be transformed into basic entrepreneurs with skills and capital?

A study done by Bandiera, Rasul and Burgess in Bangladesh shows that occupational transformation is possible. They randomized the roll-out of the Ultra Poor program (an asset transfer and skills training components), initiated by BRAC, across 1,409 communities. Half of them received the program in 2007 (the treatment group), and half of which did not receive the program until 2011 (the control groups). 

They also argue that the program, which costs roughly US$300 per household, has greater poverty impact that an unconditional cash transfer of the same magnitude. About expansion of such programs elsewhere, the authors argue that the effectiveness would depend on the implementing agencies and whether a lack of capital and skills are binding constraints to determining occupational choices.

Excerpts from their article in Ideas for India.

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To help extremely poor people overcome the complex barriers they face, one idea is to encourage them to become entrepreneurs who are able to acquire skills and make use of productive capital themselves. The question is whether it can be done. Key to this question is whether giving these people cash or assets (asset transfers) can spur them on to change their occupational choices, as opposed to simply giving them more money to spend in the short term. These questions become more salient as the world is littered with examples of anti-poverty programmes that, despite their best intentions, fail to have any appreciable effect on their intended beneficiaries. 

In recent research (Bandiera et al. 2012), we evaluated an entrepreneurship programme in Bangladesh – the Ultra Poor programme, operated by the Bangladeshi NGO BRAC. The Ultra Poor programme provides asset transfers and skills training to the poorest women in rural communities. The programme aims to move these typically asset-less and unskilled women from low-wage and seasonal jobs to the more secure, self-employment based occupations, which are the choice of middle class women in these communities. We found that the very poor can be transformed from labourers into basic entrepreneurs and that this occupational transformation is associated with dramatic improvements in their economic lives, bringing them closer to the middle classes in their communities on measures such as wages and spending.

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More from their results:

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We find that BRAC’s Ultra Poor programme transforms the occupational choices of the targeted women. In doing so, our research supports the claim that there is indeed a causal link between lack of capital and skills to occupational choice and poverty. We look at the women in 2011 - four years after the programme began - and find that: 

• Labour force participation rises. Ultra poor women who participated in the programme are 7 percentage points more likely to be engaged in at least one income generating activity – in other words, a job. 
• Programme beneficiaries also increase total labour supply (hours per year), by increasing hours in self-employment (by 92% after four years) and reducing hours devoted to insecure wage work (by 26% after four years). 
• They also increase the number of days they work each year by 36 days after four years (a 15% increase), while they decrease the average hours worked per day by 1.15 hours after four years (a 26% decrease).
• Crucially, the programme enables women to spread their labour supply more evenly across the year, and in doing so brings them closer to full employment.

This change in occupational structure is associated with a 15% increase in productivity (measured as hourly earnings) and a 38% increase in yearly earnings, which translates into a substantial increase in per capita expenditure self-reported life satisfaction. All estimated effects are either stable or more pronounced after four years, compared with after two years, indicating that the programme sets beneficiaries on a sustainable path out of poverty.

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Nepal's structural transformation, declining industrial strength and erratic growth rate

The picture speaks volumes about the tumultuous years since 1995/96 and its impact especially on industrial sector (within it manufacturing activities).

Financial sector exposure to real estate and housing markets in Nepal

The sharp drop in real estate prices (conservatively estimated at 30% triggered by the slowdown in growth of remittances in 2011) put much of the financial industry in trouble. Since then the NRB has mandated BFIs to limit real estate and housing loan exposure to 25% of total loans. The commercial banks have more or less complied with the directive (which goes into effect end of FY2013 after a year’s extension to give a breathing space to real estate and housing markets).

Overall, commercial bank’s direct exposure to real estate and housing has declined from 19.4% in FY2009 to around 16.9% percent in FY2012. Indirect exposure through collateral (land and buildings) has also declined from 71.7% percent to 56% over the same period. However, the level of exposure is still high. The development banks and finance companies have even higher exposure to real estate and housing (around 20% and 30% respectively).

Regarding non-performing loans (NPLs), commercial banks have lowered NPLs from as high as 28.8% in FY2003 of total loans to 2.6% in FY2012. The major contributions came from the sharp decline in NPLs of two state-owned banks after their restructuring and the rise in collateral value of real estate/land (as prices rose by six times from 2007 to Jan 2010), which turned many NPLs to good loans without actual repayments.

NBL and RBB together account for 13% of deposits and 11% of banking sector assess. Still, NPLs of RBB and NBL remains at 11% and 6% respectively. NPLs of development banks increased from 4.4% in FY2011 to 5.7% FY2012. Finance companies are believed to have even higher NPLs. Looking forward, the downward correction of real estate and housing prices could directly increase NPLs. Also, indirectly NPLs could increase if clients, who have taken (speculative) loans depending on inflated value of collateral, fail to honor principal and interest on time.

A stress test carried out among the 32 commercial banks showed that a standard credit shock would push capital below the regulatory minimum in 20 banks. Also, a third of commercial banks would be under-capitalized if 25% of performing loans to real estate and housing loans are downgraded to loss loans. If an interest payment is overdue up to 3 months, the loan is classified as “good” and provisioning rate is 1%; for overdue interest of 3 to 6 months, the loan is “substandard” (25% provisioning); for 6 months to 1 year, “doubtful” and 50% provisioning; more than 1 year is “bad”, with 100% provisioning. The term non-performing loans cover all loans except “good”.

Despite a sort of normalcy right now (thanks to rise in demand deposits as a result of high remittance inflows), the structural weaknesses of the financial sector and the NRB remain the same. The BFIs have been approaching the NRB for merger (of the 40 merger requests, 19 have been granted approval since May 2011) as significant consolidation will have to take place in the coming days in order to have a strong financial sector that will genuinely contribute to the drive to creating a high and inclusive economic growth and development outcomes.

So, what is the cost of a potential financial crisis (could be triggered by slowdown in remittance inflows, worsening balance sheet risks of cooperatives and its impact on BFIs, and further slowdown in real estate and housing markets)? The IMF estimated that the cost of intervention under the three scenarios is as follows:

• Real GDP loss could reach 30% in the first four years of a financial crisis before growth recovers to the baseline trend.
• Reserves could fall by 50% in the first two quarters of the crisis through the widening current account balance and capital flight.
• Fiscal cost could be about 23% of GDP, leading to rapid deterioration of debt dynamics.

Green growth and poverty

Abstract of a very interesting paper that attempts to shed more light in the discussion surrounding green growth.

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The developing world is experiencing substantial environmental change, and climate change is likely to accelerate these processes in the coming decades. Due to their initial poverty, and their relatively high dependence on environmental capital for their livelihoods, the poor are likely to suffer most due to their low resources for mitigation and investment in adaptation. Economic growth is essential for any large-scale poverty reduction. Green growth, a growth process that is sensitive to environmental and climate change concerns, is often seen to be particularly helpful in this respect, leading to a win-win in growth and poverty reduction terms, with additional gains for the cause of greening the planet and avoiding further disastrous environmental change. This paper argues that such a view ignores important trade-offs in the nature of "green growth" strategies, stemming from a poor understanding of the sector and spatial processes behind effective poverty reduction. High labor intensity, declining shares of agriculture in gross domestic product and employment, migration, and urbanization are essential features of poverty-reducing growth. The paper contrasts some common and stylized green-sensitive growth ideas related to agriculture, trade, technology, infrastructure, and urban development with the requirements of poverty-sensitive growth. It finds that they may well cause a slow-down in the effectiveness of growth in reducing poverty. The main lesson therefore is that trade-offs are bound to exist; they increase the social costs of green growth and should be explicitly addressed. If not, green growth may not be good for the poor and the poor should not be asked to pay the price for sustaining growth while greening the planet.

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The state of cooperatives in Nepal

The financial sector in Nepal is still adjusting to the jolt it experienced after the decline in real estate and housing prices in mid-2011, triggered by slowdown in remittances growth as a result of global economic slowdown. Several corrective measures by NRB and MoF have been fairly successful in containing the situation for now. Note that the core structural, governance and operational problems of the BFIs remain the same. Minor adjustment is not the way to sustainable financial sector in Nepal. More here.

Anyway, beyond the developments in the BFIs, the activities of cooperatives have largely been ignored. Since the NRB is not mandated to supervise and monitor cooperatives, the Department of Cooperatives— which severely lacks technical capabilities and resources—is facing a hard time managing them. Bankers and government officials are worried that the risky deposit and lending activities of cooperatives might hit the whole financial sector hard.

A lot of information is still muddy due to the lack of clear and consistent data on the activities of cooperatives. Better understanding of the nexus between BFIs and cooperatives, lending activities, risk portfolios, state of NPLs, operational efficiency, viability and sustainability is urgently needed in order to not only avoid a potential financial turbulence, but also to ensure an improved access to finance, and inclusive growth and development.

The chart and table give an initial grasp of the state of cooperatives in Nepal. Nearly half of the cooperatives are Savings and Credit co-ops (whose share of total lending and deposits is 78.78% and 70.52% respectively). And, almost 20% of co-ops are in Kathmandu Valley. Most of their lending is in real estate and housing sectors and loans are usually given without satisfying internal due diligence process.

The table shows the financial state of cooperatives vis-a-vis the BFIs. Its amazing that cooperatives have larger deposit and lending volume than development banks and finance companies.

State of cooperatives and BFIs in FY2012
Financial institution	Deposit (Rs bn)	Lending (Rs bn)	Number
Cooperatives (2012)	139.54	134.03	26501
Bhaktapur	6.07	6.13	525
Lalitpur	13.52	13.25	929
Kathmandu	80.55	60.22	3578
BFIs (mid-July 2012)	1071.39	779.56	213
Commercial	867.99	612.32	32
Development	127.3	100.61	88
Finance	76.14	66.63	70
Microcredit	5.18	17.75	23

The proliferation of cooperatives (about one cooperative per 1000 people) and their lending concentration in sectors that might see drastic price adjustments (or is happening right now) could trigger a financial crisis within this loosely regulated semi-banking sector. Worse, the crisis might seep into the BFIs (Class A, B and C institutions) and eventually the real sector. Uncertain times ahead for the financial sector in Nepal!