Tackling The Last Mile

Very interesting talk by Sendhil Mullainathan.

Costs of strike/shutting down Nepal (bandas)

In my latest Op-ed I estimate the costs of strike or closing down a country. It is called banda in Nepali. Political parties, student unions, ethnic populations and anyone trying to show discontent over government policies call for banda and disrupt normal live and economic activity. There is only loss and pain (and no gain) from bandas.

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Costs of Nepal bandas

Organizing strikes (popularly known as bandas) have been the easiest way to either show discontent over government policies or to press for one that serves the interest of a certain group. The people dislike bandas because it never serves their interest. It costs them their freedom, vocation and income. Frustrated by the disruption of normal life, youths have initiated a campaign DIE Nepal Bandh DIE. Even Mother’s Groups in various cities have protested against bandas.

It has been a cancer to the industrial sector, whose contribution to the GDP has nosedived in recent years. A World Food Programme survey conducted last year in Tarai showed that 93 percent of food traders identified bandas as a major constraint to do business. Almost 14 percent of traders were forced to close down their businesses. According to Enterprise Survey 2009, 62 percent of enterprises think instability is the biggest constraint.

What are the costs of bandas to the country and importantly to the public? By looking at the cost incurred by each sector if it is shut down for a day, I did a quick back-of-the-envelope calculation. The numbers are startling: On an average, one day banda would cost Rs 1.96 billion, which is around 88 percent of the total value of goods and services produced in the country in a day. The industrial sector alone would suffer over Rs 346 million per banda day. Yes, you read it right. The country bleeds enormous amount in lost production and revenue.

The economy is divided into three major sectors: Agriculture, industry and service. The agriculture sector consists of two sub-sectors: Agriculture and forestry, and fishery. The industrial sector consists of mining and quarrying; manufacturing; electricity, gas and water; and construction sub-sectors. The service sector is composed of nine sub-sectors: Wholesale and retail trade; hotels and restaurants; transport, storage and communications; financial intermediation; real estate, renting and business; public administration and defense; education; health and social work; and other community, social and personal services. Each sub-sector’s contribution to GDP is different. Depending on the level of market integration, bandas impact these sub-sectors either fully or partially.

I look at two scenarios to estimate the cost of bandas. In the first scenario, agriculture and forestry; public administration and defense; education; and health and social work sub-sectors are not affected by bandas. In the second scenario, all sectors except 40 percent of agriculture and forestry sub-sector are affected by bandas. This is a reasonable assumption because bandas do not affect market transactions of all agricultural goods. No matter what, people do trade and consume bare minimum goods for survival. The rigidity value, which I define as the responsiveness of agricultural sector to bandas and assume it to be 40 percent, varies depending on the intensity and breadth of bandas. The less responsive the agricultural sector (i.e. the more rigid), the less it is affected.

Under the first and second scenarios, the cost would be at least Rs 1.23 billion and Rs 1.96 billion per banda day respectively. The second scenario is most likely when there is a nationwide strike. The first scenario is likely when there is a strike in certain parts of the country. Though these numbers might differ from other estimates with different assumptions, they nevertheless give a fairly good picture of the costs associated with bandas.

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On an average, one day banda would cost Rs 1.96 billion, which is around 88 percent of the total value of goods and services produced in the country in a day. The industrial sector alone would suffer over Rs 346 million per banda day.

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Based on the second scenario, let me put the costs in perspective. On average, one hour of banda would cost at least Rs 82 million to the economy. In other words, each person in the country would lose Rs 69 per banda day. If we consider the working population only, i.e. 15-64 years, then the cost would be Rs 117 per banda day. Furthermore, if there were a rural employment program that provides jobs and pays Rs 100 per day to people below the poverty line during the lean agriculture season, then one day of banda would have cost over 218,190 rural jobs.

The total cost would be even higher if we add indirect costs. For instance, bandas are complemented with destruction of public and private infrastructures, which costs millions to rebuild. Also, a few hours of economic activity are lost before the sub-sectors bounce back to full gear after bandas. Besides affecting the existing as well as future potential of tourism industry, one of the major sources of foreign exchange for the country, it also causes external migration and decline in exports. Rapid decline in exports is one of the reasons for Rs 20 billion balance of payments deficit in the first quarter of this fiscal year.

Frequent bandas trigger capital flight, which is detrimental to long-run economic growth. Partly due to bandas, multinational companies like Colgate Palmolive ceased production last year. The garment industry is near extinction. It is also putting upward pressure on general prices of goods and services, thus contributing to a double-digit inflation rate.

It is frustrating to see political leaders, who promised to develop Nepal like Switzerland, encouraging and initiating bandas. They are depriving citizens of the potential for an increase in per capita income, freedom to pursue one’s dream and vocation, and to live a peaceful life with a hope for a bright future. Bandas have ripped people off the very things that the organizers promised to bring them. Enough is enough. Say NO to bandas!

[Published in Republcia, January 30, 2010, pp.4]

Book Review - Unleashing Nepal: Past, Present and Future of the Economy

Liberating Nepal

In depressing times like these, Shakya offers a number of reasons to remain optimistic

Trying to grasp the multitude of problems that our economy faces is nearly an impossible task. The roots of these problems are all intricately linked, leading to multiple constraints on growth. In order to track the sources of these constraints, it might be helpful to go back to the time when Prithivi Narayan Shah spearheaded the unification campaign and look at how political, social, and economic lives were designed to facilitate the status-quo.

In his new book Unleashing Nepal: Past, Present and Future of the Economy, Sujeev Shakya, a business executive who writes the popular column Arthabeed in the Nepali Times, not only discusses economic and social issues from a historical perspective, but also examines the present economic climate and proposes ambitious reform agendas to unleash the potential of the economy.

Shakya explores the origins, causes, and consequences of the tumultuous economy and offers recommendations based on the centrist economic model, which he calls “capitalist welfare state”. According to this model, the state takes care of welfare related issues and regulates the market, while leaving the remainder of economic activities in the hands of the private sector. He sees the Nepali youth as the most likely candidates to steer Nepal into an era of high productivity, efficiency, and growth.

The most interesting part of the book is the discussion on how the economy was kept in isolation with a protectionist mindset before 1950. It led to preservation of the status quo, severely stagnating economic growth and depriving millions of people from rising above the poverty line. In the name of land reform, the Shah kings and the Rana rulers — who presumed that the economy belonged to them and that the citizens unreservedly served for their interests — arbitrarily distributed land for their own gain.

Liberal economic policies never became the main agenda of the Shahs, the Ranas, and the political parties. This, along with the lack of favorable social and institutional conditions, kept capitalism away from the economy. The rise of militant youth wings and their disruptive activities in industrial sites further distanced investors and entrepreneurs, costing low income people their jobs and the much-needed revenue to fund development and employment programmes.

Shakya argues that given the level of political interference, it is understandable that the public sector did not deliver on its promises. However, an indigestible fact is that the private sector also failed to live up to its promises.  It was driven by the level of concessions extracted from bureaucrats — often by paying bribes — and special treatment in markets. He contends that value addition, productivity, and efficiency were not the main variables of their business equation. A case in point is the fate of beleaguered garment and textile industry after the end of Multi-Fiber Agreement (MFA) of 2005.

Shakya also blames the aid industry for instituting a “business of development”. He argues that the aid industry, which has already spent over US$ 15 billion in four decades, has not only failed to deliver intended results, but skewed the human resource distribution. The great minds are drawn to the aid industry primarily because of high wages with respect to the one prevalent in public and private sector. Instead of creating a new model based on local condition, they ended up fitting local data with an alien model. Consequently, they produced more reports (approximately 270,000 in the past eighteen years) than results.  He also highlights success stories such as community forestry and biogas programs that were funded by donors.

Policymakers and politicians should seriously consider Shakya’s six reform agendas (land, tax, capital market, financial sector, labour, and fiscal) that will potentially help unleash the latent potential of the economy. The underlying themes are liberalization with strong oversight and regulation; promotion of incentives instead of corruption; and creation of a system where value-addition is paramount to yes-man chakari and jagire mentality. He asserts that attaining economies of scale in agro-based, hydropower, infrastructure, and tourism industries must be explored.

Shakya recommends that the private sector be ambitious; the government be pragmatic; and the development community be more supportive in aiding projects that would enhance efficiency and productivity. Furthermore, galvanising the youths’ energy and guiding them in the right direction should become Nepal’s economic focus. He advocates that the education sector reform be consistent with the demand of the globalising world, independent of politics, and free from the clutches of militant trade unions.

The past and present states of the economy as outlined in the book are crucial to understand the turbulent economic history. However, sweeping generalisations of the economy without adequate literature reviews and research makes some sections of the book a bit superficial. Comparing Nepali economic issues vis-à-vis Malaysia is hardly appropriate as these countries vastly differ in terms of geography, endowment, culture and mobility of labour across political, social and economic lines. Also, the reforms advocated in Nepal by the Bretton Woods institutions were nowhere close to the Keynesian model. They were more akin to Hayekian and Friedmanite principles. Furthermore, the highest GDP growth rate occurred in 1984 (9.2 percent), not in1994 (7.9 percent).

Despite these minor glitches, Shakya’s book sets out a baseline for people of all age, color, creed, race, ethnicity and political affiliation to see the past, present, and future of the economy in as clear terms as possible. In depressing times like these, Shakya offers plenty of reasons to be optimistic!

(Published in The Kathmandu Post, January 30, 2010)

Boom and Bust--Keynes and Hayek Rap Econ

 

Fantastic! Awesome!! More at EconStories

Is there limits to growth?

To make the argument, Growth isn’t Possible uses a hamster to illustrate what would happen if there were no limits to growth. Hamsters double in size each week until around 6 weeks old. But if it grew at the same rate until its first birthday, we’d be looking at a 9 billion tonne hamster, which would eat more than a year’s worth of world maize production every day. As things are in nature, so sooner or later, they must be in the economy. Growth is pushing the planet ever closer to, and beyond some very real environmental limits. Yet politicians and economists are seemingly convinced that the economy can grow without end in a finite planet, no matter what the costs.

Interesting stuff from The Impossible Hamster Club

RCTs, Micro and Macro tussle in development

"There is no magic bullet for sources of growth; growth regressions have not produced anything substantial to identify the sources of growth."

Thats from Bill Easterly an event in Brookings last week. Based on the title of the event, I thought it would focus on what works on development -- either a smaller grassroots development approach (micro approach) or a traditional top-down development approach (macro approach) or a combination of both. Unfortunately, the whole discussion focused on Randomized Controlled Trial (RCTs). Is RCT a grassroots development approach? Jessica Cohen and Easterly debated discussed the pros and cons of RCTs. To be very fair, Cohen's talk was extremely boring (may be thats the drawback of powerpoint-less presentation). She kept on forgetting questions asked by Raj Kumar, the moderator of the event, and the audience.

Meanwhile, Easterly was to the point narrating his dislike for top-down, expert-led approach in development. [After the event, one development economist asked me: “Ain't Easterly behaving like an expert himself despite his dislike for expert’s advise in development?”]. Basically, he favors (in fact, most of the economists do but they differ in the working modalities) bottom-up approach to development that is more attuned to market principles. There is (potentially) more accountability and transparency. However, micros do not add up to macro. So, we might need both approaches-- in fact, there are some complementariness between the micro and macro approaches.

Easterly repeatedly emphasized that the extensive use of RCTs to assess pretty much everything is turning into a social engineering project (he joked: you can do RCTs in pretty much everything but the ones who do it!). He cautioned against conflict of interest among donors who fund RCTs projects and the academicians who evaluate results. His warning: RCTs is going to fail if it gets captured by the aid agencies.

Cohen tried to defend RCTs by arguing that the way it is conducted and the results derived should be noncontroversial; it is a step in the right direction. It is the best way to test any theory. People can learn what works and what does not, paving a way to incrementally do better in implementing projects and increasing effectiveness. She argued that the strong feedback mechanism derived from RCTs could potentially help in aid effectiveness.

I was more interested in Easterly thoughts on HRV's Growth Diagnostics approach, a policy-oriented approach to growth studies that looks at a set of strategies to identify the binding constraints on economic activity and tries to figure out relevant policy to relax the constraints so that the resulting change in the objective function (growth) is the highest.

More precisely, "the strategy is aimed at identifying the most binding constraints on economic activity, and hence the set of policies that, once targeted on these constraints at any point in time, is likely to provide the biggest bang for the reform buck." This approach takes into account the fact that different countries have different binding constraints on growth and that the same policy used to relax a constraint in one country might not work in another country; it is time, context and country specific, in general. This approach to growth studies differs from other approaches like cross-country panel growth regression, growth accounting, and international rankings/benchmarking. It is heavily policy-oriented. It seeks answer to the question: "what is constraining growth?" instead of "what causes growth?" I find this approach very neat, easy to follow and reality-based.

I wanted to ask Easterly what he thinks of growth diagnostics approach as it basically addresses almost all the concerns he has with previous growth studies. Before I could raise my hand, someone from the Woodrow Wilson Center asked him the same question I had in my mind. Easterly's reply: "It is a good approach but if your whole point is that policy effect differs in countries, it does not lead too far." First, if it does not lead too far, then it also means that it leads somewhere, usually in the positive direction; it might not lead way too far on the expected long run growth curve but it does lead in that direction in the short run, which is what policymakers are concerned with. I was expecting a stronger and weighty response from Easterly. Got disappointed :((

Here is Rodrik:

I know from my own experience that there is still a lot that we need to learn about how to do this right. To those who say that the framework is difficult to implement in practice, my answer is "right, it is indeed hard to determine policy priorities, but this approach at least forces you to confront those difficulties in a systematic way."

Instead, Easterly said what he always says: "outside experts cannot figure out what drives growth... rather than experts from HKS and NY, local people know it better"--its a classic Easterly bash. I like his work but feel uncomfortable with his strong inclination to Hayekian principles. It reminds me of this paper where Samuelson and Hayek debate (not through emails but snail mails and publications) on the 'inevitability thesis' (a summary of the paper is here).

The event was organized to launch a book "What Works in Development?: Thinking Big an Thinking Small". The book has contributions from a range of eminent development economists. You can find papers presented at the Brooking Development Conference here.

• The New Development Economics: We Shall Experiment, But How Shall We Learn? by Dani Rodrik (Harvard University, Kennedy School of Government)
• Breaking Out of the Pocket: Do Health Interventions Work? Which and in What Sense? by Simon Johnson (MIT) & Peter Boone (London School of Economics, Centre for Economic Performance)
• Pricing and Access: Lessons from Randomized Evaluations in Education and Health by Michael Kremer (Harvard University and the Brookings Institution)
• The Policy Irrelevance of the Economics of Education: Is ‘Normative as Positive’ Just Useless, or is it Worse by Lant Pritchett (Harvard University, Kennedy School of Government)
• High Bandwidth Economic Policies: Strategies To Speed Up Productive Transformation by Ricardo Haussman (Harvard University, Kennedy School of Government)
• Big Answers For Big Questions: The Illusions of Macroeconomics by Author: Abhijit Banerjee (Massachusetts Institute of Technology)

The downfall of Nepalese garment industry

My latest op-ed is about the downfall of garment industry in Nepal (thanks to Theo Birch for helping to fine-tune the article!). The inability of the industry to foresee changes brought about by globalization and an outdated industrial policy are the main reasons. My earlier pieces on the garment industry in Nepal here, here, and here.

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Demise of garment industry

Few people realized that 2010 began with unfavorable news for the Nepalese economy. The garment industry, once the highest foreign exchange earner for Nepal, has almost disappeared. In fact, only one firm still exports readymade garments to the US, once the biggest market for this industry. The growing Indian market has been the focus of attention of the few remaining firms that are struggling to survive. The demise of the garment industry demonstrates the failure of our trade promotion policy and industrial policy. To avoid recurrence of similar event, it is vital that we assess the causes of the downfall of garment industry and learn lessons from our mistakes.

An article in Republica accurately reflects the importance of the garment industry: “Through the first 16 years of journey, the industry with over 1,200 active production units in 2000 occupied about 7.2 percent share of the total manufacturing sector, earned one-third of the total export income, witnessed investment climb to Rs 6 billion and directly employed 90,000 people, supporting livelihood of 450,000 persons.”

Alas, this glory is now lost. Exports to the US, which previously accounted for more than 80 percent of total garment exports have been insignificant this year. Less than ten firms remain in operation. Hundreds of thousands of employees have been laid off. The country has lost a reliable source of revenue. Worse, the failure of this industry has led to the collapse of the whole exports sector.

Where and how did it go horribly wrong? The answer lies in an inability to foresee the changes brought about by globalization. Policymakers and garment investors failed to notice quite obvious signs of change in the international market. They failed to design corrective policies to restructure the outdated domestic garment industry. Instead of addressing the constraints that were making the garment industry uncompetitive, they basked on the already secured preferential agreements and wasted valuable time and resources in securing more of them.

In 1990, the WTO’s member countries signed the Agreement on Textiles and Clothing (also known as the Multi-Fiber Agreement), which eliminated quotas on the trade of textiles and clothing. This was to be implemented in four phases; commencing with 16 percent reduction in quota of 1990’s imports. Thus it was known two decades ago that all quotas in this sector would be abolished. There was ample time to invest and restructure the Nepalese garment industry. However, both investors and policymakers turned a blind eye to the necessity for the reorganization of this industry.

Traditionally, the Nepalese garment industry grew not because its products were competitive and superior, but because it got preferential access to the markets in the US and the EU. The guaranteed market access for Nepalese garments and the imposition of quota on exports from countries that had advanced capital and competitive production mechanism meant that even if our products were not competitive in terms of price and quality, they were still exported without any restriction on quantity.

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Where and how did it go horribly wrong? The answer lies in an inability to foresee the changes brought about by globalization.

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Prior to the first phase of quota elimination in 1995, Nepal had five years to upgrade its production structure so that firms could expand their size and tap synergies to exploit economies of scale, i.e. as you produce more of the same good, the average cost would decline. This would, in principle, improve price competitiveness of Nepalese garments. Unfortunately, it never happened. Meanwhile, garment investors in countries such as China, India, Vietnam, Cambodia, and Sri Lanka, with the help of their governments, were already working to ensure the competitiveness of their products and the consolidation of their production. They were already preparing for the competitive international garment market after 2005.

The first phase of quota elimination in 1995 was followed by further quota eliminations of 17 percent in 1998, 18 percent in 2002, and finally 49 percent at the end 2004. The second phase of quota elimination hit the Nepalese garment industry and the overall exports very hard, leading to a collapse of total exports, which have not recovered to the level reached in 1997. Though this was a catastrophic blow to the whole export-based sector, it was not appropriately heeded by investors and government. During the ten-year transition phase of MFA, the production structure in Nepalese garment industry hardly changed. Most of the firms had small-scale production units with little cost advantage in production. Some of the intermediate goods that were used to produce final output were simply imported from third countries whose garments exports were subjected to quota restrictions, marginally redesigned, and stamped with ‘Made in Nepal’ tag for export. This meant that producers were merely acting as distributors to earn quick profits, often by gimmickry. There was very little creativity used in enhancing productivity, efficiency, marketing and distribution. Meanwhile, the investors paid little attention to product diversification and eroding competitiveness of their products.

While other governments actively engaged in upgrading their garment industry by establishing Garment Processing Zones, Export Promotion Zones, increasing consultancy for better management, and extending capital and credit to their garment investors, the Nepalese government ignored the aggressive steps taken by other countries and did pretty much nothing. It simply requested more preferential agreements. It also failed to encourage and help investors find niche markets abroad. In addition, the government was unable to ensure the security of investors and the smooth flow of goods across the Nepalese border. Frequent strikes along the main highways led to an increase in transportation cost. This also increased the risk of delivery problems, leading to an escalation in the final price of garments. It further eroded the price competitiveness of Nepalese garments. To make matters worse, trade unions and militant youth wings made a mockery of property rights by occupying and confiscating private property, and forced an increase in wages and allowances, irrespective of labor productivity. The lack of a regular power supply also aggravated the situation.

The downfall of the Nepalese garment industry illustrates some important lessons which could be used to avoid a similar fate befalling other export-based industries. The Nepalese government should not be hankering after preferential export terms; it should be investing and ensuring that domestic firms are competitive in terms of price and quality and are constantly innovating to keep up with cut-throat competition in the international market. Meanwhile, it is imperative that the government keep investors and supply chains away from the clutches of the militant youth wings and the unions. An industrial policy and trade promotion policy designed to address these issues is a need of the hour to keep our industrial base intact.

[Published in Republica, January 19, 2010, pp.5]