Fight of the Century: Keynes vs. Hayek Round II

Very interesting. This is Round II.

Here is Round I.

Inefficient SOEs of Nepal: The triumph of politics over economic imperatives

This article is a product of the productive usage of the banda last Friday organized by Nepal Federation of Indigenous Nationalities (NEFIN)! It is about the sorry state of three major inefficient state-owned enterprises (SOEs) of Nepal: Electricity Authority (NEA), Nepal Oil Corporation (NOC), and Nepal Airlines Corporation (NAC). The very presence and operation style of these SOEs is distorting market prices and incentives. Their condition shows the triumph of politics over economic imperatives in the public sector in Nepal. For specific sources for stats in this article, see this earlier blog post.

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Inefficient SOEs

The existing product market scenario is frustrating for consumers. A majority of the people cannot get petroleum fuel even if they are willing to pay higher prices. They cannot get enough electricity despite being willing to pay more to get extra power to light up their bulbs, and cooking and cooling devices. Furthermore, even after paying nominal charge they are still seeing dry taps in their houses. Also, those willing to fly on the national carrier are not being able to do so because of the failure of Nepal Airlines Corporation (NAC) to correctly fathom the evolving airline market.

These are some of the examples of the consequences of letting inefficient state-owned enterprises (SOEs) to either fully or partially control markets on which consumers heavily bank on to meet their daily needs. Out of a total of 36 SOEs, 18 are operating in loss and even more have negative net worth. The government’s loan investment in SOEs is over Rs 80 billion annually.

Instead of resuscitating these SOEs each time they run in fiscal trouble, squandering taxpayer’s money at the cost of development activities in rural areas and services delivery in urban areas, the optimal solution would be to either purge or reform or privatize most of the loss-making SOEs that are not strategically linked to vital security and national interests. The reason why most of these SOEs are surviving is not related to economics, but vested political interests.

Let me discuss the state of three major inefficient SOEs—Nepal Electricity Authority (NEA), Nepal Oil Corporation (NOC), and NAC—that are draining state resources each year without adding much value to productive capacity of the nation. Subsidizing and keeping these mammoth SOEs alive means that our fiscal deficit, which is 3.9 percent of GDP, will further widen and budget for a number of hospitals, schools, rural roads, and food and agriculture aid curtailed. A complete structural reform—with regards to market, price, management and operation—is essential to ensure that taxpayer’s money is efficiently utilized and that these enterprises delivery what they are supposed to.

The NEA was earning profit until FY 2058/59, but is incurring loss of about Rs 19.47 billion, which is several times more than its total assets, for a decade now. It is unable to supply electricity as per market demand. During FY 2009/10 the annual peak demand reached 885.28 MW, a 8.96 percent growth over the peak demand a year ago. Of this around 30 percent was managed by load-shedding and import from India. It is expected that total electricity demand will be around 1,400 MW by 2015. With the existing pace of power generation, it is virtually impossible to keep up with the growth in demand. The market situation is so pathetic that despite being naturally endowed with rivers having potential to power the entire country and even to supply surplus to India, we are compelled to import, at a high rate, approximately 15 percent of the existing electricity supply from India.

The state of NOC is even miserable. It is running a deficit of Rs 15 billion and monthly loss of about Rs 2 billion. Its creditworthiness is so bad that none of the financial institution is willing to lend money against any guarantee to settle outstanding debt owed to Indian Oil Corporation and to procure more fuel to satisfy increasing demand in the market.

Recently, it was reported that the government had to implore Employment Provident Fund to lend Rs 2 billion and request India to give Rs 3 billion line of credit to resolve fuel shortage for two months. This comes on top of approximately Rs 1.5 billion already given to NOC by diverting funds from a rural roads development project. The market is so distorted that even when people are willing to pay high prices they are not getting fuel as demanded. Already a liter of petrol costs over Rs 125 in the black market.

The state of NAC is heartbreaking. It is supposed to be a pride of Nepal, ferry domestic and international travelers on aircrafts with the iconic Nepali flag, and assist Nepal to achieve its tourism potential. Unfortunately, it is deeply embroiled in repeated scandals related to financial theft during purchase of badly needed aircrafts, appointment of staff, repayment of loans and so forth. It has become a hiring bank for supporters of major political parties. Its total asset is worth Rs 16.80 billion, but losses are over Rs 2 billion. It has just two big aircraft and three small aircraft. Note that at one time the NAC had 21 aircraft, including eight Twin Otters, two Boeing 727s and two 757s, and was one of the biggest foreign currency earners. With mounting losses, mismanagement, and competition from private players, NAC has lost its relevance.

A noticeable question is: How come the SOEs having a healthy balance sheet a decade ago go bankrupt and lose creditworthiness? It is because of myopic financial and operations management, poor governance and accountability, and most importantly the triumph of politics over economic imperatives. The fragile financial health of SOEs and their inability to efficiently and sufficiently satisfy market demand is a recurrent problem that cannot be resolved by applying band aid (such as providing loan sufficient to resuscitate them for few months). It requires sweeping structural changes, which may involve making painful decision of firing redundant politically-appointed staff and adjusting prices upward to reflect changing market dynamics and investment costs.

Unfortunately, this has not happened yet. The NOC is not allowed to adjust market prices. As of last week, it was incurring loss (per liter) of Rs 8.10 in petrol, Rs 23.42 in diesel, Rs 13.61 in kerosene, and Rs 322.6 in a cylinder of LPG gas. Its monthly loss is over Rs 1.96 billion. Similarly, NEA is not allowed to adjust market prices depending on market dynamics and investment costs. At present, per unit investment is Rs 8.97, but power is sold at Rs 6.57 per unit (a loss of Rs 2.40 per unit). Its total annual income is about Rs 1.5 billion but yearly operating expense is Rs 1.65 billion.

The country cannot afford to repeatedly bail out SOEs by slashing development expenditures. Worse, most of the subsidies meant for the poor are captured by the well-offs in urban centers. Effective market and product differentiation is one aspect of goods and services delivery to the targeted group. But, there is no simple fix to the inefficiencies of SOEs except for increasing ownership by management and exposing them to competitive market forces. The consumers should be the king, not the political leaders who dictate the SOE’s board to play to its pricing tunes, whose pitch depends on mood of party cadres.

Apart from stopping leakages and ensuring efficiency, allowing these institutions to adjust prices is one option in the short run to restructure their financial position, and facilitate adequate and timely delivery of goods and services. In the long run, political meddling in all SOEs should cease. They should be allowed to operate freely and competitively. If some of them fail to perform then we should let them exit the market. Meanwhile, NOC and NEA should be broken up into independent units responsible for procurement, production, distribution and retailing. It would help facilitate the entry of private players as well. They should not hold monopoly (market characterized by one seller, many buyers) and monopsony (market characterized by one buyer, many sellers) powers.

That said, subsidizing some SOEs that are vital to maintaining national and security interests are justifiable. But, NEA, NOC and NAC do not fall in this category. The more we bail them out of their financial mess and let politics overcome economics, the more inefficient will be our economic and public goods delivery systems.

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[Published in Republica, May 16, 2011, p.7]

Per capita GDP and dependent population in 2050 in South Asia

In a new ADB report (Asia 2050—Realizing the Asian Century), Nepal’s per capita GDP (PPP) in 2050 is estimated to be US$3400 and 65 plus population is expected to be 10.6 percent of the total population in 2050. See the table below for corresponding figures of other South Asian countries.

South Asian per capita GDP and 65+ population in 2050
Country	per capita GDP (PPP, US$)	65+ population
Bhutan	48,600	15
India	41,700	13.7
Sri Lanka	34,700	21.4
Bangladesh	14,200	14.9
Pakistan	7,900	10
Nepal	3,400	10.6
Afghanistan	2,800	3.6

Nepal is one of the “Young Asia” that will have a large working age population compared to other nations in 2050, thus increasing potential for reaping demographic dividends. One of the lowest per capita income and one of the highest number of working age population would mean that it will have potentially cheaper factors of production. It indicates a good reason for investors to plan their investment strategy of investing in Nepal and other young South Asian nations accordingly. Additionally, Nepal’s geopolitical location (between China and India) will be attractive as well because as these nations become richer, wages will increase and markets will expand. Nepal will become the perfect location to manufacture and provide services to the Indian and Chinese population.

Land grabs in Africa

An interesting article about land grabs in The Economist:

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Land grabs have been strikingly popular. Preliminary research by the International Land Coalition, a non-governmental organisation, reckons almost 80m hectares have been subject to some sort of negotiation with a foreign investor, more than half in Africa (see chart). This estimate is far higher than a previous one, by the World Bank, which last year said that foreign investors had expressed interest in 57m hectares. It is higher still than one by the International Food Policy Research Institute (IFPRI) which put the figure in a 2009 study at 15m-20m hectares. It would be wrong to draw a line between these numbers so as to conclude that land deals have grown fourfold. Since most are secret, knowing what to count is difficult, and the figures refer to different periods.

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Note that when land deals are initially proposed four main benefit0s are offered to the host countries (apart from the benefits to the deal seeker): more jobs, new technology, better infrastructure and extra tax revenues. None of these promises seems to have been fulfilled according to the article.

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So why are land deals popular? That is surprisingly easy to answer: strong demand and willing suppliers. The big investors tend to be capital-exporting countries with large worries about feeding their own people. Their confidence in world markets has been shaken by two food-price spikes in four years. So they have sought to guarantee food supplies by buying farmland abroad. China is by far the largest investor, buying or leasing twice as much as anyone else.

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Here is info about conference related to land grabbing and related papers.

Growth bottlenecks: India vs. China

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Although it had a lower income level than India in 1980, China's 2006 per capita gross domestic product stands more than twice that of India's. This paper investigates the role of the business environment in explaining China's productivity advantage using recent firm-level survey data. The analysis finds that China has better infrastructure, more skilled workers, and more labor-hiring flexibility than India, but a worse access to finance and higher regulatory burden. Infrastructure appears to be a key constraint for India: it lags significantly behind China, yet it has important indirect effects for the effectiveness of labor flexibility. Labor flexibility is also likely a major constraint for India, as evident in the predominance of small firms, the importance of firm size in accounting for India's disadvantage in productivity, and the complementarity of proxies of labor flexibility with infrastructure and access to finance. Interestingly, regulatory uncertainty has adverse effects in India but not in China. The empirical analysis suggests that it is important to consider country-specific growth bottlenecks and the indirect effects of policy reforms.

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Full paper by Li, Mengistae and Xu (2011).

South-South aid to Nepal

The share of South-South aid (i.e. aid flow between developing countries) in total ODA committed to Nepal is increasing. Total ODA amounted to around US$1 billion in 2009.  Most of the ODA Nepal receives is from Northern donors. The five Southern donors are China, India, OPEC Fund, Saudi Development Fund, and Kuwait. India is by far the largest Southern donor (over 67 percent of total South-South aid commitment). Overall, it contributes about 10 percent of the total ODA received by Nepal. [India is allowed to directly spend up to NRs 50 million (around 0.7 million USD) in development/welfare activities without informing the Nepalese authorities.]

South-South aid commitment to Nepal (US$ million)
Fiscal year	2004/05	2005/06	2006/07	2007/08	2008/09	2009/10	2010/11
China	0.14	0.14	12.07	1.39	36.60	29.41	35.48
India	8.65	4.75	61.91	38.61	95.45	100.70	92.55
OPEC Fund	4.99	7.90	7.23	3.14	-	-	8.11
Saudi Development Fund	5.30	0.89	1.25	3.06	3.45	6.01	3.57
Kuwait	3.96	0.91	-	-	-	-	-
Total	19.08	13.68	82.46	43.37	135.49	136.12	139.71
Share of South-South aid in total aid commitments (%)	4.12	2.97	14.61	6.97	14.83	12.48	11.49

The above table is adapted from Chandra Ghimire’s forthcoming paper (New Age of South-South Development Cooperation: A Case Study of Nepal). He is a joint-secretary at Ministry of Commerce & Supplies (MoCS). Exchange rate used is USD 1= NRs 72. (Note: Read Ghimire’s paper when it is publicly available. It has valuable information about South-South donors and aid received by Nepal.)

Infrastructure sector receives the biggest share of South-South aid. It received 83 percent of total South-South aid commitment over FY 2006/07-2010/11. Trade and industry, and finance and agriculture received 7 percent each. Social sector received 3 percent.

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Here is excerpt from a previous blog post about foreign aid to Nepal:

Foreign Aid to Nepal (total, million, current US$)
BA & ODA	1960-2008	1992-1999	2000-2008
Net bilateral flows	7582	2002	3116
Net ODA and Official Aid received	11732	3205	4289
Net ODA per capita (current US$)	561	147	160
GDP	159823	34859	70847
Net bilateral flows (% of GDP)	4.74	5.74	4.4
Net ODA (% of GDP)	7.34	9.19	6.05

Top bilateral donors (1960-2008):

• Japan has been the largest bilateral donor so far (1960-2008): US$ 2.06 billion
• Followed by the UK (1960-2008): US$ 1.03 billion
• Followed by Germany and the US (1960-2008): US$ 974 million and US$ 940 million
• Other top donors are European nations; the Scandinavian countries are very generous
• In this decade (2000-2008), top donors have jacked up bilateral assistance.

Average annual bilateral flows have been increasing. On average (annual), it was US$ 346 million between 2000 and 2008. The average annual net ODA flows during the same period was US$ 477 million.

Net ODA per capita (current US$) has been US$ 561 between 1960 and 2008, and US$ 147 over 1992-1999, and US$ 160 over 2000-2008.

• Net bilateral flows between 1990 and 2008 have been 4.74 % of GDP.
• Net bilateral flows between 2000 and 2008 have been 4.40 % of GDP.
• Net ODA between 2000 and 2008 have been 6.05 % of GDP.

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Over the period 2007-08, humanitarian aid sector received the highest amount, followed by economic infrastructure & services, health and population and so on…. It looks like the Southern donors are more interested in investing in infrastructure and productive sectors.

(Note that total ODA figure depends on which database you are looking at. But, there isn’t much variation if you just look at the shares from various sources.)

Now, the effectiveness of aid received by Nepal is another question. Here is discussion (needs update now) on the issue.

Total factor productivity (TFP) in South Asia

The figure shows total factor productivity (TFP) in 2007 and TFP growth (annual percent change) over 1985-2007. Nepal (in red circle) has the lowest TFP in South Asia (and in Asia). TFP of other South Asian countries is indicated by brown circle in the chart. The countries with high TFP are the ones the frontier economies (with high and sustained growth rate and per capita income) where entrepreneurship and innovation occurred.

The South Asia countries in the fourth quadrant shows that there is little TFP growth and are not competitive (plus low growth rate, low per capita income, low innovation and lack adequate entrepreneurship). Bhutan’s TFP growth is the highest in South Asia. India’s TFP growth rate is also impressive in South Asia. First, India succeeded in catch-up entrepreneurship and subsequently added frontier entrepreneurship to its development toolkits. More explanation in this recently released ADB (draft) report (Asia 2050 — Realizing the Asian Century). Frontier entrepreneurship requires substantial government support and intervention (because of extraordinarily long gestation period). India did this in the education sector (with the establishment of IITs and IIMs) and in the pharmaceutical industry in the early 1970s.

Government intervention is sought in areas of “human capital development through quality education at all levels; a commitment to science, technology and R&D; the rule of law with an effective regime for intellectual property rights as well as for exit/bankruptcy; the availability of financing for entry and the subsequent phases of entrepreneurial activity; and an overall policy framework that is based on competition and rewards innovation.”

Meanwhile, the draft report argues that the global economy’s center of gravity is shifting toward Asia, and the region could account for about half of global output in 2050, up from the current 27%, as well as half of global trade and investment. It the potential outcomes for Asia under two competing scenarios: the Asian Century and the Middle Income Trap.

In the more optimistic Asian Century scenario, the region’s gross domestic product (GDP) would soar to $148 trillion and account for 51% of global output in 2050. On a purchasing power parity basis, GDP per capita in Asia would rise to $38,600, compared with the projected 2050 global average of $36,600. The alternative scenario assumes that Asia’s fast-growing economies—the PRC, India, Indonesia, and Viet Nam—will fall into the middle income trap of slowing growth rates and stagnating income levels over the next 5 to 10 years. Furthermore, none of Asia’s slow-growing economies would manage to accelerate its growth rate under this scenario. If these events occur, Asia would account for only 32%, or $61 trillion, of global GDP in 2050. On a purchasing power parity basis, GDP per capita would rise to only $20,300, or just over half of that under the Asian Century scenario.

The report identifies six key drivers of transformation in the region:

1. technical progress
2. capital accumulation
3. demographics and the labor force
4. the emerging middle class
5. climate change mitigation and the competition for resources
6. the communications revolution.

The challenges of Asia include modernization of its governance systems and retooling of its institutions to ensure transparency, accountability, and the enforceability of rules and regulations. It advises Asian leaders to devise bold and innovative national policies while pursuing regional and global cooperation to successfully manage regional public goods, energy security, infrastructure connectivity, food supplies and water resources, and to maintain long-term peace and stability.

[TFP is is a variable which accounts for effects in total output not caused by inputs. If all inputs are accounted for, then total factor productivity (TFP) can be taken as a measure of an economy’s long-term technological change or technological dynamism.TFP can not be measured directly. Instead it is a residual, often called the Solow residual, which accounts for effects in total output not caused by inputs.]