Trade facilitation & exports: Hard & soft infrastructures

Trade facilitation—which basically is aimed at reducing export and import costs—measures such as investment in physical infrastructure and regulatory reform to improve the business environment improve the export performance of developing countries, shows a paper by Portugal-Perez & Wilson (2010). The authors compute illustrative exports growth for developing countries and ad-valorem equivalents of improving each indicator halfway to the level of the top perform in the region. For instance, they compare if improving quality of infrastructure or cutting tariffs faced by exporters would increase exports the most.

The authors construct four new aggregate indicators related to trade facilitation from 20 indicators of different sources: Doing Business (DB), World Economic Forum (WEF), World Development Indicators (WDI) and Transparency International (TI). Here is their trade facilitation indicators dataset (unfortunately, they don’t have figures for Nepal).The database contains four new indicators related to trade facilitation covering 112 countries over 2004-2007. The indicators are scaled on a range of 0 (lowest performer) to 1 (top performer) and are obtained using factor analysis (PCA), a statistical modeling technique that explains the correlation among a set of observed variables through an unobserved “common factor”. It circumvents multicolinearity to reduce the dimension of data by aggregating highly correlated indicators into a single indicator.

They group trade facilitation indicators in two broad dimensions: (i) hard infrastructure (physical infrastructure-- the level of development and quality of ports, airports, roads, and rail infrastructure; and ICT—the extent to which an economy uses information and communications technology to improve efficiency, and productivity as well as to reduce transaction costs. It contains indicators on the availability, use, absorption, and government prioritization of ICT.); (ii) soft infrastructure (Border and transport efficiency—quantification of the level of efficiency of customs and domestic transport that is reflected in the time, cost, and number of documents necessary for export and import procedures; and Business and regulatory environment—the level of development of regulations and transparency. It is built on indicators of irregular payments, favoritism, government transparency, and measures to combat corruption.). They assess the impact of different aspects related to trade facilitation on export performance by estimating a gravity model.

Among others, the results show that:

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South Asia appears to receive better returns to investment in the business environment. The results show that Bangladesh, the country with the lowest value for the business environment index, would experience the highest export growth after improvement in this indicator halfway to that of India. The increase in trade (38.4 percent) due to improvement in the business environment would be equivalent to a 26.3 percent reduction in the value of current tariffs on goods from Bangladesh.

If Bangladesh were to improve its level of infrastructure quality to half the level of India, exports would increase by 17.6 percent. This increase in exports would be equivalent to a reduction of 12.1 percent in the value of import tariffs.

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Overall, they show that improvement in infrastructure quality would bring the greatest benefits in terms of export growth. Furthermore, among the four indicators, physical infrastructure has the greatest impact on exports in almost all specifications and samples. The impact of physical infrastructure decreases with the income level, but the richer the country, the greater its marginal impact on export performance from ICT. So, least developed countries (LDCs) are relatively better off focusing on physical infrastructure to promote trade. That said, due to the large costs associated with physical infrastructure, developing countries are also better off improving soft infrastructure such as border and transport efficiency.

Meanwhile, here is a paper by Vela, Aadot, and Wilson (2010), who find that private inspection of international shipments positively and significantly affect trade facilitation, with a rise in import volumes for countries using them by approx 2-10 percent.

Oh, the Nepali economy! Still in troubled waters

[Adapted from Prem Khanal’s article published in The Week, Republica daily, January 7, 2010, p.1. A good rundown of the major macroeconomic issues in the Nepali economy.]

Oh, the economy! yet more jitters

Prem Khanal

As the realty sector slips deeper into financial distress and the law and order situation weakens further in a highly fluid political landscape, a new threat of painful economic slump is gathering force in the Nepali economy, indicating gloomy days ahead.

Like 2010, which was marked as a year when the Nepali economy was confronted with two unfamiliar headwinds – hefty deficit in the balance of payment, and an alarming rise in banks’ exposure to risky loans – the half-yearly indications give little convincing hope that the sluggish economy will make a headway to growth and expansion in 2011.

Grim economic data coming from such previously promising sectors as the financial sector has also deepened fears that the Nepali economy is heading to a crisis more rapidly than many were expecting. Weakening governance, worsening lawlessness, deepening power shortage, and shrinking realty sector are the four deadly toxics that will be the major ills of Nepal’s economic sickness in 2011.

Weak governance, which is breeding corruption in almost every segment of the society, is the foremost challenge that the country is facing since of late. As a result, along with the monetary corruption that has been Nepal’s chronic problem since long, policy level corruption has also lately become rampant, according to government officials familiar with the development. In fact, the deadly coexistence of weak governance and lawlessness is the single biggest barrier to the country’s economic development.

Further impacts of weakening governance have been directly reflected on the worsening law and order situation, thanks to the weak morals of law enforcement agencies wracked by long-running political maneuverings. Organized extortion in tie-ups with political cadres and personnel of law enforcement agencies is rampant, which is fuelling prices of goods and services, thus weakening investor confidence and polluting business environment. The shrinking flow of fresh loans to the private sector and sliding share market – the two quick barometers to gauge investor confidence – clearly reflects what a bad business climate Nepal has at present.

Likewise, power shortage, which is expected to reach a climax of 14-hour cuts a day in the summer, though less than last year’s horrible 16-hour load shedding, will continue to slice off productivity and efficiency of Nepal’s industrial and service sectors. As a result, few entrepreneurs have been able to install expensive diesel power plants of their own while leaving many others, mainly medium- and small-scale electricity-dependent businesses, to no other option than to limit their productive activities during power-on hours. In either case, the cost of production unnaturally swells, due to which many domestic products, which are doing pretty well at least in the internal market, are fast losing their market share to cheep Chinese imports, forcing Nepali entrepreneurs in turn to squeeze their production and cut labor force.

Seriously, too, the lethal coexistence of politically mollycoddled militant laborers and power cuts will further drag the Nepali industrial sector, whose contribution to the national economic pie has shrunk to 6.25% from 9% in 2001/02 and even more painful downturns are to be expected in the days to come.

The obvious impacts of a shattered private sector will be more distinctly visible in the economy. There will be no expansion of the existing productive capacity, let alone prospects of new ventures coming in, thereby resulting in further squeezing of the job market. So there will be a further weakening of much-needed competition in the job market for labor due to which laborers are unlikely to see their pay being raised. This, in turn, will instigate migration of unskilled and semi-skilled as well as highly skilled manpower that are the most essential factors to bring momentum to Nepal’s long-stalled development. As it is, the trend of mass exodus of unskilled and semi-skilled laborers to Malaysia and the Gulf States and highly skilled manpower to the US will continue to accelerate.

The current recession in the construction sector that is not only a major job provider after agriculture and industry but also the sector with the strongest backward and forward linkages, is adding many new challenges to the yawning economy. The side effects of the realty slump will emerge. First, loss of jobs will shrink the disposable income of laborers, weakening overall effective demand, while lack of cash-rich buyers will bring a prospect of ready-to-move apartments being remained unsold for months, if not years. Secondly, the downturn of construction industry will bring a spillover effect to construction-dependent sectors, ranging from cement factories to steel rolling mills to sanitary fittings to paint industry and other suppliers.

In both cases, banks will face extreme heat as they will face great difficulties in recovering their loans from the borrowing sectors. This will fuel loan defaults and expose the non-performing aspects of the banking system which will not only put new strains on banking health but also lower the banks’ profitability. These will as well add jitters to an already shrinking stock market. Though it may be a little earlier to say, but many familiar with the inside stories of Nepal’s banking system believe that a time bomb has already started ticking.

The shrink in consumption due to the looming economic slowdown will ease imports, which will be a good development for the central bank that is fighting hard against the deficits seen in the balance of payment – the balance between inflow and outflow of foreign currency – as a decline in imports will help lower trade deficit and the whopping current account deficit.

However, lower imports, particularly of durables goods and vehicles, will have a negative impact on the government’s target of notching revenues up by 20% to Rs 216 billion. Predictions show that slowing vehicle imports and other durable household goods, due mainly to rising lending rates together with squeezing consumption, will make the government’s task of achieving its revenue target indeed difficult for the first time in recent years.

So, how to deal with the situation?

One of the tools widely prescribed and practiced to deal with such a situation is to bring a stimulus package to pump huge amount of money into the economy through expansionary fiscal and monetary policy, so as to generate jobs and raise effective demands.

However, there are many constraints to such measures to improvise the Nepali economy. The first challenge is inflation, which is already close to 9%. Undoubtedly, it will soon jump to double digits when the economy fully realizes the impacts of the recent fuel price hikes along with rising prices of staples in India, from where Nepal imports these increasingly priced goods in the coming weeks. In such a scenario, any additional pumping of money into the economy will fuel inflation, thereby sprouting many economic as well as social ills.
Another risk is, as the domestic industrial base is extremely weak to immediately respond to rise in demand, such a measure will fuel imports and end up in bringing some additional revenue to the government’s coffer rather than creating jobs at the domestic front. Likewise, a stimulus policy will flare up budget deficit, which is already on the borderline, bringing devastating effects to fiscal balance.

Like in other countries, the stimulus fund can be used in infrastructure development which can immediately generate a large number of jobs. But Nepal’s implementation capacity is so weak, lengthy and complicated that it may take years to initiate a project launched to fight looming recession on the doorstep.

Yet behind the grim outlook, some faint hopes flicker on the horizon. Undoubtedly, remittances – the backbone Nepal’s present economy – will continue to grow as worker-hosting countries recuperate from the past year’s painful global economic recession. In fact, there will be a huge demand for labor, among other hosts, from the United Arab Emirates (UAE) when it starts its major constructions for the 2018 Olympics.

Good news has also emerged from the nastily erratic agriculture sector. Reports that paddy production, which alone contributes 7.5% to Nepal’s GDP, has increased by an encouraging 11% this year, along with the healthy growth in maize and millet production also means that the agro-based rural income will grow this year, along with overall agricultural yield that is estimated to hover around 2% against last year’s 1.1%.

So, the combined effects of the rise in disposable income among rural farmers along with the continuing, albeit moderate, growth in remittance economy, most of which is used in consumption, will help float an overall demand. But it will certainly be weaker than what the economy saw last year. Despite some slackness in the wholesale and retail business and financial intermediation sectors, the non-agricultural sector is expected to maintain a moderate growth of 3.5-4.5%, thanks to a healthy growth expected from the hospitality and tourism sector as well as transport and communication sectors.

So the overall economic growth is expected to remain at around 3.5% – almost at the same level as of last year’s. So, be ready for yet another “glorious year” to be marked in Nepal which, after all, is the slowest growing economy in South Asia.

The World in 2050–PwC Jan 2011 update

PricewaterhouseCoopers (PwC) has published an updated version of its earlier projections of the world economy and has ranked countries based on the size of their economy. The new update takes into account the economic shift that has occurred after the global financial crisis, which has further accelerated the shift in global economic power to the emerging economies. It compares between the seven fastest emerging economies (E7)-- China, India, Brazil, Russia, Indonesia, Mexico and Turkey-- and the G8 economies.

Measured by GDP in purchasing power parity (PPP) terms, which adjusts for price level differences across countries, the largest E7 emerging economies seem likely to be bigger than the current G7 economies by 2020, and China seems likely to have overtaken the US by that date. India could also overtake the US by 2050 on this PPP basis. GDP at PPPs is a better indicator of average living standards or volumes of outputs or inputs, because it corrects for price differences across countries at different levels of development.

The World in 2050 -- GDP at PPPs Rankings
PPP 2009 Rank	Country	GDP at PPP(constant 2009 US$bn)	PPP 2050 Rank	Country	Projected GDP at PPP(constant 2009 US$bn)
1	US	14256	1	China	59475
2	China	8888	2	India	43180
3	Japan	4138	3	US	37876
4	India	3752	4	Brazil	9762
5	Germany	2984	5	Japan	7664
6	Russia	2687	6	Russia	7559
7	UK	2257	7	Mexico	6682
8	France	2172	8	Indonesia	6205
9	Brazil	2020	9	Germany	5707
10	Italy	1922	10	UK	5628
11	Mexico	1540	11	France	5344
12	Spain	1496	12	Turkey	5298
13	South Korea	1324	13	Nigeria	4530
14	Canada	1280	14	Vietnam	3939
15	Turkey	1040	15	Italy	3798
16	Indonesia	967	16	Canada	3322
17	Australia	858	17	South Korea	3258
18	Saudi Arabia	595	18	Spain	3195
19	Argentina	586	19	Saudi Arabia	3039
20	South Africa	508	20	Argentina	2549

However, John Hawksworth and Anmol Tiwari, the authors of the report, also rank countries based on  GDP at market exchange rates (MERs), which does not correct for price differences across economies but may be more relevant for practical business purposes. Ranking with MERs show that the E7 overtaking process is slower but equally inexorable. The Chinese economy would still be likely to be larger than that of the US before 2035 and the E7 would overtake the G7 before 2040. India would be clearly the third largest economy in the world by 2050, well ahead of Japan and not too far behind the US on this MER basis. In 2009, India’s share of world GDP at MERs was just 2%. By 2050, this share could grow to around 13%. MERs factor in the likely rise in real market exchange rates in emerging economies towards their PPP rates. This could occur either through relatively higher domestic price inflation in these emerging economies, or through nominal exchange rate appreciation, or (most likely) some combination of both of these effects.

The World in 2050 -- GDP at MER Rankings
PPP 2009 Rank	Country	GDP at MER(constant 2009 US$bn)	PPP 2050 Rank	Country	Projected GDP at MER (constant 2009 US$bn)
1	US	14256	1	China	51180
2	Japan	5068	2	US	37876
3	China	4909	3	India	31313
4	Germany	3347	4	Brazil	9235
5	France	2649	5	Japan	7664
6	UK	2175	6	Russia	6112
7	Italy	2113	7	Mexico	5800
8	Brazil	1572	8	Germany	5707
9	Spain	1460	9	UK	5628
10	Canada	1336	10	Indonesia	5358
11	India	1296	11	France	5344
12	Russia	1231	12	Turkey	4659
13	Australia	925	13	Italy	3798
14	Mexico	875	14	Nigeria	3795
15	South Korea	833	15	Canada	3322
16	Turkey	617	16	Spain	3195
17	Indonesia	540	17	South Korea	2914
18	Saudi Arabia	369	18	Vietnam	2892
19	Argentina	309	19	Saudi Arabia	2708
20	South Africa	286	20	Australia	2486

This well could be a return to the historical norm:

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In many ways this renewed dominance of China and India, with their much larger populations, is a return to the historical norm prior to the Industrial Revolution of the late 18th and 19th centuries that caused a shift in global economic power to Western Europe and the US – this temporary shift in power is now going into reverse. This changing world order poses both challenges and opportunities for businesses in the current advanced economies. On the one hand, competition from emerging market multinationals will increase steadily over time and the latter will move up the value chain in manufacturing and some services (including financial services given the weakness of the Western banking system after the crisis).

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The report notes that India’s trend growth is expected to overtake China’s trend growth at some point during the coming decade due to India having a significantly younger and faster growing working age population than China and due to it having more potential for growth as it is starting from a lower level of economic development than China and so has more catch-up potential. However, India will only fully realize this great potential if it continues to pursue the growth-friendly economic policies of the last two decades.The authors argue that particular priorities should be in maintaining a prudent fiscal policy stance, further extending its openness to foreign trade and investment, significantly increased investment in transport and energy infrastructure, and improved educational standards, particularly for women and those in rural areas of India.

The model’s assumption is that long-term trend growth is driven by the following four factors:

• Growth in the labor force of working age (latest UN population projections)
• Increase in human capita (average education levels across the adult population)
• Growth in the physical capital stock (capital investment net of depreciation)
• TFP growth (technological progress and catching up)

In terms of per capita income, the US will still lead the way.

Currency war and the future of dollar

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The one thing that could jeopardise the dollar’s dominance would be significant economic mismanagement in the US. And significant economic mismanagement is not something that can be ruled out.

The Congress and Administration have shown no willingness to take the hard decisions needed to close the budget gap. The Republicans have made themselves the party of no new taxes and mythical spending cuts. The Democrats are unable to articulate an alternative. 2011 will see another $1 trillion deficit. It is hard to imagine that 2012, an election year, will be any different. And the situation only deteriorates after that as the baby boomers retire and health care and pension costs explode.

We know just how these kind of fiscal crises play out, Europe having graciously reminded us. Previously sanguine investors wake up one morning to the fact that holding dollars is risky. They fear that the US government, unable to square the budgetary circle, will impose a withholding tax on treasury bond interest – on treasury bond interest to foreigners in particular. Bond spreads will shoot up. The dollar will tank with the rush out of the greenback.

The impact on the international system would not be pretty. The Canadian and Australian dollar exchange rates would shoot through the roof. A suddenly strong euro would nip Europe’s recovery in the bid and plunge its economy back into turmoil. Emerging markets like China, reluctant to see their exchange rates move, would see a sharp acceleration of inflation and respond with even more distortionary controls.

With exorbitant privilege comes exorbitant responsibility. Responsibility for preventing the international monetary and financial system from descending into chaos rests with the US. How much time does it have? Currency crises generally occur right before or after elections. Can you say November 2012?

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More by Barry Eichengreen here. He argues that until the next currency crises arises (and an alternative currency found), dollar will remain the dominant currency at the global level because of capital controls in India and Brazil; relatively small scale of Canadian loonie and Australian dollar; and China’s capital control plus worry among investors about its opening of financial markets, enhancing their liquidity, and strengthening the rule of law. But, the dollar will be in crisis due to political economy ups and downs in the US. Eichengreen hints that it could be in November 2012, after the US presidential election.

How to make migration a win-win-win strategy?

By ensuring that the whole initiation has

• a sustainable migration management system that takes into account the interests of the various stakeholders involved;
• a clear identification and articulation of objectives and interests in migration by key stakeholders, based on a common conceptual framework for migration and development:
• regional and bilateral coordination mechanisms to balance these (potentially divergent) objectives and to reach compromise under labor agreements and policies; and
• effective, evidence-based polices, and public and private sector interventions to achieve the objectives that are known and applied at the levels of sending, receiving, returning, and circulating.

Here is more by Holzmann and Pouget (2010). Quite a mouthful of recommendations! Win-win-win scenario is for labor, migrant’s country, and host country.

Is aid (development) THE problem in Nepal?

Jeremy Rappley thinks that aid/donors is the problem in Nepal’s development. He criticizes the aid industry for distorting Nepal’s development path by imposing their own models that have failed to produce tangible outcomes. He is critical of the development activities carried out in Nepal since the first development donor (apart from India and colonial Britain), i.e. USAID arrived here.

It is a very stimulating piece. I largely agree with his socio-political analysis. But, regarding econ, he’s got some explaining to do.

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But, as with the earlier fall of the Ranas, Nepal’s own vision of its future – inclusion, democracy, equity – was quickly overtaken by international donor demands. By the late 1990s, Nepal’s own vision had all but been turned almost completely around: An exclusive focus on efficiency, cost-effectiveness and a consumer logic. In fact, from ‘citizen to consumer’ characterize rather well the two decades since Janaandolan. Again, consider education. The National Education Commission (1990-1992) inaugurated in the wake of Janaandolan stated that the goal was to create an educational system “consistent with the human rights enshrined in the constitution and the democratic values and norms as well as social justice.”

Ten years later, the main themes are decentralization and private schools – the exact same policies we see the donors promoting in every other country of the world. It is little wonder then that it has brought to Nepal the exact same results: A massive spike in inequality, growing exclusion along class lines and the breakdown of democracy.

[…] Loading-shedding has increased, fuel shortages, garbage piling up in the streets, traffic, pollution, and dance bars offering poor Nepali girls to rich Indian tourists. Considering what Kathmandu looked like 50 years ago, what will it look like 50 years in the future? And this is just Kathmandu, where most people still believe in ‘development’.

[…] Venture beyond the rim of the valley and that is where the real future of Nepal lies. It is here that the vast majority of the ‘twice-passed-by’ people live and they are losing patience. Fast. The genius of bikas is that it promised that inequalities would be lessened over time. This was true both within the country and across the world: Poor people were told by donors and local elites to wait patiently, do the right thing, and they would ‘catch-up’. Being twice-passed-by, however, has created a disbelief in ‘development’.

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However, his claim that donor’s development agendas and funding resulted in “a massive spike in inequality, growing exclusion along class lines and the breakdown of democracy” does not hold much ground in terms of evidence. The efforts of donors might not have produced the desired outcomes, but this does not mean that the involvement of donors has led to massive spike inequality, exclusion and breakdown of democracy. First, inequality (measured by Gini coefficient) tends to rise, to some extent, with income per capita (remember Kuznets curve?) and it has got little to do with donors’ development agenda. Second, the claim that growing exclusion along class lines being engendered by aid/donors is dubious. Third, donors’ development agendas might have favored some political regimes, but I don’t think there is evidence that it has directly led to a breakdown of democracy in Nepal.

Furthermore, I don’t think the existing loading-shedding, fuel shortages, garbage, pollution, and dance restaurants have got too much to do with the aid industry and donors’ development agenda. We can make a case that the donors failed to fund the activities sorely needed by the country, but this does not mean that the present day economic ills are caused by donors’ development agendas and priorities. That said, I am not being wholly supportive of the donors as well; I have already been very critical of the aid industry in Nepal.

Rather than the donors’ development agendas, it is the failure of our domestic institutions to deliver on the development promises, which the donors’ did little to help reform. It is not the loss of faith in development, but the loss of faith in domestic institutions that is forcing people to ‘exit’ the political system. Largely, the sorry state of the domestic institutions is our own (both politicians and citizens) bringing. Now, what is the solution? This is unanswered by Rappley.

The effectiveness of donors’ activities should be judged in terms of their contribution to poverty reduction, economic growth, and employment generation at the macro level. These objectives are always the aim of donors. In some, they have utterly failed, while in others they have pretty much shown satisfactory results. For instance, the progress in attaining primary and secondary education and reducing maternal mortality, among others, is pretty good. It wouldn’t have happened at this pace without donors’  assistance. But, they have also failed to counter health emergencies (remember a number of deaths due to diarrhea in Jajarkot in 2009?).

I like this:

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[…] Blame is perhaps the only growth industry in Nepal; finger-pointing advances in lockstep with stagnation. So we must be careful. Nevertheless, donors need to bear some of the blame.

Yet, having seen this happen before, Nepali policymakers must also take responsibility. But the biggest finger needs to be pointed right back at many of the current readers, those who continue to believe in the idea of ‘development’ amid the obvious stagnation of the country. Those who try to carve out a ‘first world’ existence through private schools, luxury hotels, satellite television, and curtains on their SUVs to block out the putrefying stagnation of Nepal deserve the most blame because they are the ones educated enough to see things clearly. Here is the beginning of a solution: Viewing not the future ideal but the current reality of bikas in Nepal, coming to terms with the country’s place in the global economy, and recapturing some of the equity, inclusion, and social justice goals that Nepal committed itself to in 1950 and 1990. This may sound radical, but no more radical that what is likely to occur in the very near future if Nepali elites do not voluntary move in that direction.

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A good analysis. Highly recommended to read the whole article.

Fiscal policy, private consumption & unemployment

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This paper uses the old-Keynesian representative agent model developed in Farmer (2010b) to answer two questions: 1) do increased government purchases crowd out private consumption? 2) do increased government purchases reduce unemployment? Farmer compared permanent tax financed expenditure paths and showed that the answer to 1) was yes and the answer to 2) was no. We generalize his result to temporary bond-financed paths of government purchases that are similar to the actual path that occurred during WWII. We find that a temporary increase in government purchases does crowd out private consumption expenditure as in Farmer (2010b). However, in contrast to Farmer's experiment we find that a temporary increase in government purchases can also reduce unemployment.

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Full paper by Farmer and Plotnikov here. Overall, they find that a temporary increase in government purchases crowds out private consumption expenditure, but also reduces unemployment.