The effect of global economic crisis on poverty

The World Bank estimates that as many as 53 million additional people could fall below the poverty line of $1.25 a day due to the impact of global economic crisis. Declining growth rates coupled with high levels of poverty would be a disaster in the developing countries. It argues that almost 40% of developing countries are exposed to the declining growth rates and high levels of poverty, and an additional 56% of the countries are exposed to decelerating growth or high poverty levels. Less than 10% of the developing countries face ‘little risk’.

It also paints a gloomy picture about infant mortality. It states that between between 200,000 and 400,000 more babies could die each year between now and 2015 if the crisis persists (this totals to 1.4 to 2.8 million).

What about the capacity of the developing countries to deal with the crisis on their own? A WB policy brief states that one-fourth of the countries have the ability to expand fiscal deficits to undertake significant countercyclical spending. Even one-third of these require aid to take this course of action. All others vulnerable countries are fiscally unable to tackle this problem on their own. The bad news is that only one-third of the countries have the institutional capacity to absorb increased spending even if there were external assistance.

Last week, the IDS complied views and analysis from wide range of experts from the developing countries on the fallout of global financial crisis on the developing countries. They identified six main ways the financial crisis will affect the developing countries: lower demand for exports, fall in portfolio and foreign direct investment, fall in exchange rate, rising risk premiums and interest rates, decline in remittances, and decline in foreign aid. On top of this, last year’s rise in commodity and food prices is expected to push over a 150 million people below the standard dollar a day poverty line. More on the impact of food prices here.

Taxes, revenues and expenditures in South Asia

This is how tax structure, revenues and expenditure looks like in South Asia.

Country	VAT (%)	Corporate income tax (%)	Total tax rate (% of profit)
Maldives	0	0	9.1
Pakistan	15	35	28.9
Nepal	13	20	34.1
Afghanistan	--	20	36.4
Bangladesh	15	40	39.5
Bhutan	--	30	39.8
Sri Lanka	15	35	63.7
India	12.5	30	71.5

Source: Doing Business Report 2009

Nepal’s tax rates are the third lowest in the SAARC region. My main point: appropriability concerns due to taxes are not a binding constraint on growth in Nepal. For my bet on infrastructure see this.

Meanwhile, this is what the revenues and expenditures (% of GDP) looks like in South Asia:

And, this is how fiscal balance looks like:

Source: ADB

The puzzle now is: despite having one of the lowest and simplest tax rates, why revenue is always low in Nepal? Tax evasion and inefficient bureaucracy to check evasion might answer a part of the question. I am still looking for the other part!

Lower taxes always does not mean higher revenue (supply-side econ???). Moreover, higher taxes also does not necessarily mean higher revenue. What comes into play? Other stuffs that affect revenue collection such as bureaucratic efficiency, corruption, level of tax evasion, depth of informal economy… What would be a good policy if first best policy options do not deliver intended outcomes? Well, second best policy options might help before going for first best policy options. This takes me to Lipsey and Lancaster’s 1956 paper and Rodrik and Hausmann’s growth diagnostics!

The other side of the crisis

Friedman writes in the NYT:

…the U.S. Senate unfortunately voted on Feb. 6 to restrict banks and other financial institutions that receive taxpayer bailout money from hiring high-skilled immigrants on temporary work permits known as H-1B visas.

It is a lose-lose strategy! It reminds me of a Sanskrit proverb: Bad times, bad decision!

Friedman has a solution:

When the best brains in the world are on sale, you don’t shut them out. You open your doors wider. We need to attack this financial crisis with green cards not just greenbacks, and with start-ups not just bailouts.

Note this as well:

…more than half of Silicon Valley start-ups were founded by immigrants over the last decade. These immigrant-founded tech companies employed 450,000 workers and had sales of $52 billion in 2005

Nepal: Poor Infrastructure, Poor GDP Growth Rate!

This is how Nepal stands in infrastructure rating in the world: out of 134 countries considered in Global Competitiveness Report 2008-2009, Nepal ranks 132. Deficient supply of infrastructure and poor quality of existing ones are the recipes for industrial retardation and slow economic growth rate. The figure below shows infrastructure rating of Asian and Sub-Saharan African nations plotted against GDP per capita of 2006 in constant 2000 US$.

I guess it is not surprising that Nepal is the poorest country in Asia (and twelfth poorest nation in the world) and has the one of the poorest infrastructure ratings (quality and quantity) in the world. The transportation costs (inland + international) is also the highest in South Asia. The transportation costs for textile and clothing industry is the highest in the region and is three times the cost prevailing in India.

Some people argue that this is expected because Nepal is a landlocked country. Well, there is no reason to believe that a landlocked country must be in short supply of good quality infrastructure (roads, rails, ICT, and airways). I wonder why Burkina Faso, a landlocked country in Sub-Saharan Africa, is able to have more road density and better infrastructure rating than Nepal!

My bet: the biggest binding constraint on growth in Nepal is bad infrastructure. This is what I claim in my new paper on growth diagnostics of the Nepali economy. That said, I also show why other constraints do not qualify to be the most binding constraint on growth. Full paper to be finished by the end of this month. More on this stuff coming soon!

Links of Interest (2/7/2009)

The impact of inflation targeting on employment

Nepal's connection to American banking

Global financial regulator? No, No!

Effective development writing

Fear and loathing in Davos

Votes and violence

Nepal plans to tap global coffee market

Worth watching video: Bill Gates's presentation at TED

Financial crisis and developing countries

The Globalisation Team at the Institute of Development Economics has a nice compilation of views and analysis on the fallout of global financial crisis on the developing countries. It has interesting perspectives from different countries.

They argue that the cause of the global financial crisis is not just restricted to the US subprime mortgage crisis. In fact, it was a result of the interaction between at least three factors: (i) excessive reserves in surplus countries and huge US fiscal and current account deficits, (ii) expansionary monetary policies in the OECD, and (iii) complex and flawed financial innovation in the developed countries.

Six ways the financial crisis will affect the developing countries:

lower demand for exports: In Bangladesh, orders for ready-made garments from Europe and the US dropped 7 per cent in September. In Kenya, the cut flower industry is suffering as European customers are hit by the crisis

fall in portfolio and direct foreign investment: Investors shy away from markets that are perceived to be riskier. The Ethiopian Electric Power Corporation has indicated that its investment plans will be severely affected due to the crisis

falls in exchange rate: The sudden withdrawal of foreign capital from several developing countries has caused dramatic falls in their exchange rate. Companies and governments with substantial foreign currency denominated debts may contract or even collapse as a result

rising risk premiums and interest rates for developing countries on global capital markets

decline in remittances from workers in recession affected countries

foreign aid decline: Richer countries will reduce aid as governments reassess their fiscal priorities during a downturn. This could have particularly negative consequences for Africa

 

It is a great compilation but the policy recommendations are kind of shallow! They propose increase in aid flows, enhancing social protection, and restructuring IFIs. It is incredibly difficult to do all of these at this time, especially when the major donor economies are in distress. I think rather than depending on foreign aid perennially, they should focus on streamlining governance and accountability, ease business restrictions and create a more investor-friendly climate so that domestic entrepreneurs become active in the economy. It does not make sense to prescribe policies that were/are the same  as before and during the financial crisis.

The dynamics has changed drastically and the developing countries should heed it and flow with it. Though aid is vital for the developing economies to sustain health care, development and education expenses, it should not be seen as an elixir to all the problems.