Food Price Index surpasses the spike in 2008

The FAO Food Price Index has surpassed the upper bound reached in 2008. Commodity-wise, price of sugar has been spiking since May 2009. Similarly, prices of cereals and oil & fats are also going up. Price of meat is stabilizing but still is higher than in December 2008. The price of dairy is reaching the level reached in December 2008. Here is an explanation of why we are not seeing riots and disruptions around the world as we saw in 2008: due to weak dollar as $ is used for world food prices, and people are used to higher food prices. Here is more on the FAO predicting the next food price shock.

Free markets and food security

WB president Robert Zoellick argues that free markets can still feed the world and reduce food market volatility. To enable vulnerable countries access to food, he proposes the following measures be adopted by the G20:

• Increase public access to information on the quality and quantity of grain stocks.
• Improve long-range weather forecasting and monitoring, especially in Africa.
• Deepen our understanding of the relationship between international prices and local prices in poor countries.
• Establish small regional humanitarian reserves in disaster-prone, infrastructure-poor areas.
• Agree on a code of conduct to exempt humanitarian food aid from export bans.
• Ensure effective social safety nets.
• Give countries access to fast-disbursing support as an alternative to export bans or price fixing.
• Develop a robust menu of other risk management products.
• Help smallholder farmers become a bigger part of the solution to food security.

One comment: Easier said than done!

Does remittances increase consumption and investment?

Anupam Das and John Serieux say not necessarily. They argue that a significant portion of remittances is no longer available for domestic resource mobilization when they are used for debt amortization, capital flight, or reserve accumulation (reverse flows). Their empirical evidence from 36 developing countries shows over the period 1980 to 2006 that a one percent increase in the rate of remittance flows increased the rate of consumption by roughly 0.8 percent, and had no statistically discernable effect on the rate of investment. Their results also indicate that approximately 20 percent to 27 percent of remittance flows have been diverted to finance reverse flows. Furthermore, changes in the rate of remittance flows tended to be positively correlated with changes in debt service payment-to-income ratios and the rate of reserve accumulation relative to income.

Below are tables of variables and expected sign of coefficient used by the authors in their  investment and net exports functions.

Determinants of the Rate of Investment
Variables	Relevance	Expected Sign of Coefficient
Total external debt/GDP	Import compression and debt-related disincentive effects	Negative
Log of rate of inflation	Proxy for macroeconomic instability	Negative
Per capita income	Affects profitability and, therefore, the rate of return on capital	Negative
Index of real exchange rate	A depreciation (increase in the index) improves the competitiveness of domestically produced goods	Positive
Remittances/GDP	Increased access to resources beyond that derived from domestic output	Zero or positive
Private capital flows/GDP	Direct contributions of commercial credit for investment	Positive
ODA/GDP	Increased access to resources beyond that derived from domestic output	Zero or Positive

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Determinants of Net Exports
Variables	Relevance	Expected Sign of Coefficient
OECD income to domestic to domestic income index	Affects the demand for net exports	Positive
Index of relative prices	Affects the demand for imports and supply of exports	Positive
Foreign exchange reserves/GDP	Influences the feasible supply of imports	Negative
Remittances/GDP	Influences the feasible supply of imports	Negative
Private capital flows/GDP	Influences the feasible supply of imports	Negative
ODA/GDP	Influences the feasible supply of imports	Negative

I think the same effect is reached if remittances are largely used to finance consumption of imported goods, which will have minimal effect on domestic investment and exports. The results is that remittances will have little impact, if any, on economic growth. It is happening in Nepal. There is also not a significant impact on foreign exchange reserves, debt level is pretty much the same, and capital flight is directed by the interest rates differential prevailing in the Indian and Nepali financial sectors. But, the story remains the same, i.e. domestic investment level is not affected by remittances. How to ensure that remittances are used for domestic investment in the productive sector and not in financing imports or investment in unproductive sectors?

Hypocrisy of Nepali banking sector

Just yesterday the bigwigs of the Nepali banking sector were making a high pitch about the central bank being anti-market, forcing the governor to make a statement that he and the central bank are not market unfriendly. He argued that the central bank is just trying to regulate markets to encourage healthy competition. The central bank has capped executives pay, set loans to realty sector at 10 percent and to housing sector at 30 percent, and directed banks to ensure that interest rate difference on various kind of saving accounts is not more than 2 percentage points.

Now, we have first hypocrites of 2011: bigwigs of the Nepali banking sector! The same bankers who were complaining about “market-unfriendly” practices of the central bank are behaving like masters of cartel by capping savings interests at 4-6 percent. The Nepal Bankers’ Association (NBA) said that “a gentleman’s agreement” has been reached to cap savings rate between 4 and 6 percent. Gentleman’s agreement—WHAT? That is deliberate collusion to manipulate competition and is nothing less than CARTELING, which is infinitely market unfriendly than the central bank’s decision to bring about healthy competition in the banking sector. They played the same anti-market game in May 2010 when they agreed to limit interest rates on fixed deposits at 12 percent.

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New commercial banks, however, have been given permission to fix higher rate by a margin of as much as 1.5 percentage point, he said, adding that the NBA will soon hold a meeting of chief executives of all 30 banks this week to formalize its implementation. Once the new decision comes into effect, depositors who were already enjoying as much as 10.5 percent annual interest returns on savings will find their return drop to 6 percent.

This will also reduce the prospect of salary account holders and other accounts holders enjoying far better returns than now. So far, the banks were providing just 2 percent annual interest returns to such accounts holders.Some of the bankers, however, noted that the new move could be risky particularly given the latest trend of customers becoming more interest sensitive and their competitors like development banks and financial institutions offering as much as 13.5 percent.

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They increasingly look like gangsters (albeit gentleman-style!) when one looks at the way they have been pressing their demand, resisting regulation, and trying to circumvent central bank’s directives. When will they realize that they are fostering unhealthy competition. They are digging their own hole deeper and deeper by offering too much loan to the real estate and housing sector without properly assessing if the loans are normal or subprime (in fact, they find no difference). They are charging high interest on loans and are in desperation to attract deposits by offering flamboyant schemes, just to meet unsustainable profit targets. First, they attract depositors offering them promises of high interest rates. When money is deposited, they change interest rates without even informing the depositors. Likewise, with the borrowers, who will have no option but to default if the same dirty trick goes on for a year or two.

The real estate and housing sector is going to cool down as supply will far outstrip demand soon. This urban-centric bubble will create ‘ghost houses’ waiting for customers to either rent them or buy them. Prices will come down and the borrowers will not be able to honor principal and interest payments on time. The banks will be in deep trouble due to their proportionally high exposure to one particular sector. Additionally, since the growth of the number of BFIs has proportionately outpaced the growth of depositors base, some of the BFIs will surely go down or will be forced to merge. The entire economy is going to suffer because of the unhealthy competition among BFIs and market-unfriendly acts of the banking executives. The sooner the central bank further clamps down on them, the better it is for the economy. We must be ready to let go some troubled BFIs.

The heads of BFIs have to realize that there are simply too many of them running after more or less the same corporate and non-corporate customers. Some of the BFIs have to either merge or go down under. There is no other option. Playing with interests on loans and capping interest on savings are just attempts to buy time before the inevitable disaster hits them. Wake up before it is too late (actually, it is already late!).The day of reckoning is coming soon.

We are looking for a major financial disaster in Nepal soon, if they go with business-as-usual approach of playing with interests on deposits and loans to attain unsustainable profit targets, urban-centric operation, favorable lending to bubbling sector that has weak foundation, and encouraging trading rather than entrepreneurship. The tendency to seek short term gains over long term sustainability is a recipe for disaster with severe negative externalities, i.e. it will not only affect the BFIs, but also the public who are not a direct party to the activities of BFIs.

One of my senior and a reputed policymaker says, “Can the banks (collude in fixing) play with interest rates as the Nepal Oil Corporation (NOC) plays with the price of petroleum products? What is the difference between BFIs and NOC?” Couldn’t have put the situation any better! They gotta be responsible citizens. Their hypocrisy has to stop.

Lessons for developing countries from China’s and India’s growth successes

Amelia U. Santos-Paulino and Guanghua Wan argue that the growth successes of China and India offer three main lessons for the developing countries: (i) absorption of surplus labor, (ii)raising of domestic and foreign investment, (iii) and support for R&D.

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Surplus labour from traditional agricultural sector has shifted to the progressive industrial sector, promoting industrialization. Characteristics of China’s labour market include an extensive rural-urban inequity, rapid rural-urban migration despite various restrictions, and high and rising real wages in the formal sectors. Furthermore, China’s comparative advantage in labour-intensive activities—alongside the scaling-up of its production and export baskets—has iterated with an improvement in the investment climate. This is steep with a continuous, virtuous circle of growth. 

Foreign investment has not only helped in overcoming the shortage of capital, but also in stimulating economic growth through various spillover effects. Accompanying FDI is the expansion of the private firms and multinational corporations (MNCs). In India and China, labour-intensive firms tend not to locate in mid-sized or large cities as compared to smaller ones, due to higher wages, training and attrition costs. Although labour regulations in China and India deter firms from locating in the larger cities, firms in the export sector prefer to be in large cities. Proximity to inputs within the city has a positive impact on firm location. These findings have important policy implications for urban governance, infrastructure, labour and environmental policies, which are key issues for growth and development.

China and India’s export productivity and specialization patterns are in line with those of wealthier and more advanced economies. This empirical finding challenges the traditional assumption that knowledge creation is exclusively the domain of advanced economies. Drivers of such change include investment in knowledge and innovation activities and the growing link between high-tech companies and local research. FDI and multinational enterprises’ investment in knowledge-creating activities, such as R&D, is concentrated in a few emerging countries. China and India are considered two of the top ten destinations for foreign R&D expansion. China has experienced the strongest growth in scientific research, surpassing any country, whether developed or developing. India has also built up prominent research records, with an extraordinary expansion of peer-reviewed studies in material sciences.

The exports of information, communication and technology (ICT) have been key in driving the Southern Engines’ economic success, mostly in China and India. Empirical analysis shows that Chinese exports have experienced rapid growth since the early 1990s; the country’s market share in both Japan and the USA has risen sharply; most of the Chinese ICT exports are attributed to foreign firms; and the shrinking market shares on third markets (i.e., other Asian developing countries) may be the result of multinationals’ relocation rather than intensified competition from Chinese exports. India’s experience reveals an unparalleled paradigm of the role of technological progress, and the transmission channels through which macroeconomic fundamentals can explain the country’s economic success, primarily by inducing changes in productivity. Changes in labour market antagonisms and investment market frictions (such as taxing labour income) did not play a significant role. The Indian experience in targeting productivity evokes that of other successful Asian economies such as Japan in a similar stage of development, or during the take off process.

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The role of government has been crucial in bringing about this change.

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First, a key lesson from China’s experience is the adoption of a pragmatic approach to economic reforms (which was the turning point in China’s economic development), and the adaptive capacity of the countries’ economic agents to this process. Second, industrial policy has been at the heart of development policies and strategies in developing countries, although not particularly so in India. As in the case of other strategies and economic reforms, this policy’s implementation produced varied outcomes, and with different levels of success. Third, trade and the liberalization of commercial policies have played a primary role in the Southern Engines’ growth success.

The interface of trade liberalization and domestic reforms has contributed to their success, akin to developing and transition countries. Decentralization and privatization of state-owned enterprises is another area of policy accomplishment. Also, the formulation of economy-wide development strategies should be a balanced outcome of the government and private agent decisions and choices, reflecting at the same time the country’s evolving and comparative advantages. These policies and processes should also adjust to the continually changing global economy.

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Profile of Avinash Dixit in F&D magazine

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Dani Rodrik, professor of international political economy at Harvard, says Dixit was the best classroom teacher he ever had—he never treated anything as silly or obvious. “No matter how stupid a question seemed, he would stop, raise his hand to his chin, narrow his eyes, and think a long time about it, while the rest of us in the classroom would roll our eyes at the stupidity of the questioner,” said Rodrik. “Then he would say, “Ah, I see what you have in mind . . . ,” and he would roll out an answer to a deep and interesting question the student had no idea he had asked.”

“What makes him special,” says former student Kala Krishna, now an economics professor at Penn State, “is that more than anyone else I know, he sees economics as an inescapable part of life: from books, movies, negotiating with a taxi driver—everything has economic content. He truly loves economics, and you can see how much he is enjoying himself doing it.”

Others praise his wit. “Avinash Dixit is one of my favorite economists, in part because he has a trait that is extremely rare among economists: a good sense of humor,” said Steven D. Levitt, coauthor of the best-selling book Freakonomics.

[…] What became known as the “Dixit-Stiglitz” model underpins a huge body of economic theory on international trade, economic growth, and economic geography—a model tapped by Paul Krugman, who won the Nobel Prize in 2008.

The model, first published in 1977, became a building block for others in the new fields of endogenous growth theory and regional and urban economics—what journalist David Warsh described as “one of those economical and easy-to-use ‘Volkswagen’ models that were the hallmark of MIT”.

[…] Apart from game theory and his eponymous model, Dixit is known for seminal work on microeconomic theory, international trade and growth, and development. But his varied interests have moved him to write extensively about governance, the role of institutions, law, and democracy in development, and political polarization. He says his most cited work is Investment under Uncertainty, written in 1994 with Robert Pindyck of MIT, about how firms make investment choices.

That book points out the inherent irreversibility of most business investment decisions. Dixit and Pindyck suggest a way to deal with the risks posed by irreversibility: wait before acting. Waiting is valuable because with time comes additional information whose value would be lost had the irreversible decision already been made.

Dixit has advocated the same approach in other fields, and it is at the heart of a paper based on an episode of the popular TV show Seinfeld, in which a young woman must make decisions about using her finite supply of contraceptive sponges.

[…] While Dixit acknowledges the importance of democracy, property rights, contract enforcement, and the provision of public infrastructure and services that support private economic activity, he is scathing about attempts to draw up a menu of items that underpin development in low-income countries.

“There’s a long, long tradition of people offering recipes which don’t work out,” he says. He stirred things up with a lecture at the World Bank in 2005 that he said he hoped would be provocative and critical, but “evenhandedly so.”

In many cases, he argued in that lecture, the accumulated research on the role of institutions in development stopped short of giving useful or reliable policy prescriptions. “I hope to give everyone some incentives to think further and harder.”

In a subsequent talk at the Reserve Bank of India, he said that in general “bottom-up and organically generated reforms will work better than imposed top-down ones.”

[…] “Going forward, I think some of the most fruitful research will come from a better integration of financial theory and macroeconomic theory. It may be supplemented by better recognition of rare major events, something that already exists in financial theory, but is less assimilated into financial practice than it should be.

“But the real fault was not so much in economic theory as, if you like, in the political and business world, where people actually swallowed some of the simplistic views about the wonder of markets too much without recognizing the hundreds of qualifications that Adam Smith and a number of others have told us about, and we should all have known about.”

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Read more of Dixit’s profile here

Sources of revenue in the Nepali economy

The total revenue in FY 2007/08, 2008/09, and 2009/10 was Rs 107.6 billion, Rs 143.5 billion and Rs 179.9 billion, respectively. Between FY 2008/09 and 2009/10 total revenue increased by 25.4%.

Revenue derived from VAT is the highest (29.7% of total revenue = Rs 53.46 billion), followed by customs (19.5% =  Rs 35.03 billion), income tax (18.7% =  Rs 33.65 billion), excise (13.5%), registration fee (3.1%), vehicle tax (1.4%), educational service tax (0.1%), and non-tax income (14% = Rs 25.28 billion). These are provisional figures for fiscal year 2009/10, sourced from the macroeconomic indicators 2009/10, NRB. Between 2008/09 and 2009/10, revenue from excise increased by 49.6%, vehicle tax by 38.8%, educational service tax by 1036.2%, value added tax by 35%, customs by 31.6%, income tax by 22.4% and non-tax revenue by 23.3%.