NEPAL: Product space, export sophistication and structural transformation

Here is a combo of interesting figures that shows the evolution of merchandise export sophistication (or production sophistication) of Nepal since 1970. Overall, it shows that there has been little enhancement in the sophistication of Nepali exports or production. It is clearly seen in the product spaces, which are the network showing global similarities in production knowhow required by products. The nodes represent products, which are colored according to the color legend of the product communities they are in. The node size is proportional to global trade in that product and the links connect products that tend to be exported by the same countries.

The black square dots indicates that those products are exported with comparative advantage (RCA>1). Nepal’s export is concentrated in low value products, mainly textiles and garments. The USA’s export is concentrated in high value products, which require more advanced capabilities, such as machinery, chemical, health and electronic products. Though India’s export is slowly moving and diversifying to the core of the product space, i.e. high value products, it is also producing textiles and garments and other low value products with comparative advantage (also more competitively than Nepal).

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It is argued that the assets and capabilities needed to produce a good are imperfect substitutes for those needed to produce another good “but their degree of asset specificity will vary” (Hausmann & Klinger, 2007). The probability that a country makes a new product is strongly related to the proximity of the product with other products the country already makes. It means that a country’s capability to produce one good is somehow tied with the installed capability in the production of other similar goods, i.e. “nearby goods”. Bailey Klinger provides an interesting metaphor: “products are like trees and firms are like monkeys.” Structural transformation involves the movement of monkeys from the poor part to rich part of the forest. It is easier for monkeys (firms) to jump short distance (i.e. to change products that use similar pre-existing factors).

The level of sophistication of exports determines the income level of a country and its growth rate. Importantly, the level of economic complexity indicates the nature of future economic growth and the ability to produce new goods and move from low-value added to high value-added goods. Sophistication comes from either increasing the quality of currently produced goods or from a move into new and more sophisticated products.

New capabilities to usher structural transformation are not acquired suddenly. It takes time and is more “easily accumulated if they are combined with that already exists”. Again, a country can diversify its production by moving from the products that it already produces to others that require a similar set of embedded knowledge. Think it of this way: it is easier to move production from undergarments to pants than from undergarments to engines. We can figure out how far products currently not exported with comparative advantage are from the ones that are exported with comparative advantage and are within nearby range of existing production capacities of an economy. It is easier to produce “nearby” products than a product that is “far away” because the capabilities to produce similar but slightly differentiated products already exists in the economy. Eventually, what a country exports matters in determining its future course of growth and pace of structural transformation.

So, the capability to produce higher value products is accumulated over time based on the existing capabilities. In Nepal’s case, export-oriented sectors have not added much new capabilities. Worse, even the existing capabilities are being lost due to a slew of internal (lack of innovation, R&D and survival based on margin of preference in export destinations) as well as external constraints (mainly supply side constraints, including lack of adequate power and infrastructure, labor problems, policy inconsistency and policy implementation paralysis). More on Nepal’s problems with exports here, here and here (for services sector sophistication, see here)

Now, what drives sophistication of production and exports? Anand, Mishra and Spatafora argue that “an educated workforce, external liberalization, and good information flows are important prerequisites for developing sophisticated goods and services”. Meanwhile, manufacturing competitiveness (in turn sophistication) is determined by

• Government forces (education policies; energy policies; economic, trade, labor, financial and tax policies; science and technology policies; manufacturing and infrastructure policies)
• Capabilities (innovation; technology; process; infrastructure)
• Market forces (demographic, macroeconomic)
• Resources (human, materials, energy, financial)

Alcohol imports and consumption in Nepal

Interesting stats:

• Total alcohol import: Rs 4 billion
• Domestic production by importing raw materials: Rs 11.70 billion
• Export of Khukuri beer to 13 countries

Here is a news story related to this in Karobar Economic Daily. Now compare this with total garment export—one of Nepal’s top export items— of Rs 4.08 billion in 2010/11. [Btw, I checked in official data sources for beverages, spirits and vinegar (HS Chapter 22) imports and it was Rs 2.024 billion in 2010/11. Exports was close to Rs 1.023 billion. Anyway, though the figures given by Nepal Alcohol Production Association and as reported in the media might be a bit inflated, the fact is that the market for alcohol is increasing.]

There is a huge market for alcohol and the demand is increasing each year due to rise in household income, thanks to high remittance inflows. There are instances where most of the remitted money in some districts is spent on imported, high premium liquor. To bridge growing demand-domestic production gap, imports are surging. Since this also increases custom duties, the MoF is disinclined to take any corrective measures on this front (like promoting domestic firms to produce premium liquor). In fact a major portion of revenue growth is coming from duties on imports, which is rising each year.

Why not let domestic producers produce liquor by importing raw materials from abroad if consumer demand for liquor is going to grow unabated? Morality aside (for which government needs to regulate the market strictly), this would add some value to production domestically and increase job opportunities. While the investors need more fiscal incentives, the government needs more revenues from the industry. How can we create an equilibrium between these two forces?

Anyway, are we thinking right when we talk about increasing domestic revenue? How long can the MoF rely on revenue growth on the back of rising imports? This is not a sustainable approach. In fact, it’s a destructive approach—you increase imports and consumption, add little to domestic productive capacities, drain remittances on imports that could be produced domestically if given the right policies and regulatory mechanism, foster lackluster behavior and complacency right from households to bureaucracy, add little to economic growth by promoting services and trading activities in place of industrial activities, …. Where is this loop leading us to?

Is large-scale investment in infrastructure sufficient to reduce logistics delays?

Raballand, Refas, Beuran, and Isik argue it is not. The collusion among various stakeholders/agencies at ports is a major part of the problem.

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The international community has been increasing investment in projects that promote trade facilitation and improve logistics in the developing world, including in ports. In Africa, a key motivation for such projects has been a presumption that poor infrastructure and inefficient border control agencies are the major causes of extended delays in sub-Saharan Africa (SSA) ports. Based on new data and analysis, this note argues that collusion between controlling agencies, port authorities, private terminal operators, logistics operators, and large shippers is an important part of the problem. Decreasing dwell times in ports requires governments to combat collusive practices between the private sector and public authorities and recognize that large-scale investments in infrastructure are not sufficient to reduce logistics delays.

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Meanwhile, here is the latest Logistics Performance Index (LPI) published by the WB. Nepal has the fifth worst logistics efficiency in the world. With a score of 2.04, it ranked 151 out of 155 countries in 2012. Chad, Haiti, Djibouti and Burundi have worse logistic performance than Nepal’s. Compared to previous rankings, Nepal’s performance is sliding downward. In 2007 the ranking was 130 (out of 150 countries) with a score of 2.14 and in 2010 its ranking was 147 (out of 155 countries) with a score of 2.2.

Why do public service delivery fail?

Shanta Devarajan argues:

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Teachers in Tanzania are absent 23 percent of the time; doctors in Senegal spend an average of 39 minutes a day seeing patients; in Chad, 99 percent of non-wage public spending in health disappears before reaching the clinics.

These and other service delivery failures have been widely documented since the 2004 World Development Report, Making Services Work for Poor People.

But why do these failures persist?  Because they represent a political equilibrium where politicians and service providers (teachers, doctors, bureaucrats) benefit from the status quo and will therefore resist attempts at improving services.  For instance, teachers are often the campaign managers for local politicians.  They work to get the politician elected, in return for which they get a job from which they can be absent. Powerful medical unions ensure that their members can work in the private sector and neglect their salaried government jobs.  The losers are the poor, whose children don't learn to read and write, or get sick and die because the public clinic is empty.

[…] How can we disrupt this equilibrium to improve services for poor people? One possibility is to provide them with information.  We saw that community monitoring (poor people obtaining the information directly) had an effect on teacher performance.  But more broadly, poor people do vote.  If, with information, they vote along service delivery lines--rather than for politicians from their own ethnic or religious group, or who promise them private goods such as a job building roads--then it would be more difficult for politicians to ignore service delivery failures. 

[…] Information may not be the only solution.  The underlying problem is that politicians are behaving "clientelistically"--more interested in handing out private goods to their "clients" rather than public goods that benefit society, especially the poor--and getting away with it (they get elected).  And if most politicians behave this way, it's in every politician's interest to follow suit.  How can we move from clientelism being the norm to one where it is the exception?

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This reasoning also perfectly fits the state of service delivery in Nepal. Eventually, there is continued supremacy of extractive political and economic institutions over inclusive ones.

NEPAL: Prime Ministers and the economy

Here is a snapshot of how the economy (related one here as well) fared during various prime ministers since 1990/91 in Nepal. The highest GDP growth rate was 7.9 percent in 1993/94. Fiscal deficit widened the most in 2008/09, which shows how much Nepal is unable to match rising expenditure with revenue. FDI committed by authorized firms at DoI was the highest in 2010/11 (annual FDI growth rate was the highest in 1992/93). Initially due to conflict and now due to lack of job opportunities (new investors are reluctant to come and existing ones are perishing due to labor problems, high cost of production resulting from inadequate supply of electricity and supply-side constraints), the number of migrants is increasing.

The soaring expenditure and the inability to match it up with revenue (see widening fiscal deficit) is resulting in a situation where the economy is increasingly reliant on foreign aid to fund most of its reform programs and development works. Inflation was the highest in 1991/92 (due to the turmoil in the Gulf then and its impact on oil prices, the shock the economy got following economic blockade by India in 1989, and sudden change in economic structure following liberalization in 1992).

Based on the figures seen here, make you own judgment regarding which leader/party delivered growth and prosperity to the Nepali people.

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Prime Ministers and Economy
		billion					%
Prime Ministers	Fiscal year	Fiscal balance	FDI-authorized firms	Remittance	Aid disbursement	BoT	Inflation
KPB	1990/91	-10.66	0.41	2.13	5.99	15.03	9.81
KPB/GPK	1991/92	-11.26	0.60	2.32	7.80	16.32	21.05
GPK	1992/93	-11.96	3.08	2.99	9.24	17.15	8.86
GPK	1993/94	-11.62	1.38	3.47	11.56	31.66	8.95
GPK/MMA	1994/05	-10.55	0.48	5.06	11.25	45.64	7.66
MMA/SBD	1995/96	-13.82	2.22	4.28	14.29	56.14	8.13
SBD/LBC	1996/97	-14.36	2.40	5.60	15.03	70.01	8.09
LBC/SBT/GPK	1997/98	-17.78	2.00	6.99	16.46	61.49	8.33
GPK/KPB	1998/99	-17.99	1.67	10.31	16.19	56.49	11.38
KPB/GPK	1999/00	-17.67	1.42	12.66	17.52	64.13	3.39
GPK	2000/01	-24.19	3.10	47.22	18.80	63.54	2.43
SBD	2001/02	-22.94	1.21	47.54	14.38	61.25	2.89
SBD/LBC	2002/03	-16.44	1.79	54.20	15.89	78.22	4.75
SBT/SBD	2003/04	-15.83	2.76	58.59	18.91	81.89	3.96
SBD/KG	2004/05	-18.05	1.64	65.54	23.66	89.85	4.54
KG	2005/06	-24.78	2.61	97.69	22.04	100.90	7.96
KG/GPK	2006/07	-30.09	3.23	100.14	25.85	138.60	6.4
GPK	2007/08	-33.41	9.81	142.68	29.30	178.56	7.7
PKD	2008/09	-49.80	6.26	209.70	36.35	222.40	13.2
PKD/MKN	2009/10	-41.20	9.10	231.73	49.77	314.66	10.5
MKN/JNK	2010/11R		10.05			332.97	9.60
JNK/BRB	2011/12P

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Few caveats:

• Depending on the nature of expenditure (especially capital expenditure) there is a lag of few months to years. So, expenditure in n^th year might only show its effect after n+k years, where k>=0. It means GDP growth figure during the tenure of a certain prime minister might not fully reflect the impact of his (no female PM yet!) expenditure programs or reforms.
• That said, over 50 percent (70 percent in 2010/11) of total expenditure is recurrent expenditure. Capital expenditure is well below 20 percent. It means the impact of most of the expenditure is more or less reflected in the figures.
• The increasing fiscal deficit shows the difference between expenditure and revenue. We are spending beyond our means!
• FDI is related to those committed by firms registered at Department of Industry. It doesn’t mean that the committed money is actually invested. Nevertheless, it reflects investors’ confidence on the economy.
• High remittance inflows could be viewed as a proxy for high number of migrants seeking jobs abroad. It then means the lack of employment opportunities in the economy. Note that it is also affected by the openness of government policies regarding foreign employment and the demand for Nepali workers abroad.
• The aid dependency is increasing as Nepal is unable to satisfy its expenditure with domestic revenue. The table shows aid disbursement, i.e. how much of the committed money actually came to Nepal. Note that the discrepancy between commitment and disbursement might also be because of low absorption capacity of our system.
• The balance of trade (merchandise goods only) shows the difference between value of imports and value of exports. The high figure means imports outpacing exports. It points to our inability to produce goods demanded in the market, the lack of export competitiveness, eroding strength of manufacturing sector, and high dependence on imported items (primarily financed by remittances).
• Inflation is the least understood beast in our economy! It is mainly affected by prices in India (due to pegged exchange rate), prices of petroleum products, domestic supply constraints and increase in demand due to rise in income arising from high wages and remittance inflows.

NEPAL: Fertilizer shortage during planting season

At the height of the planting season, there is acute fertilizer shortage in Nepal. The delay in monsoon has already affected production (maize) in some districts. Add to that the shortage of fertilizer for paddy cultivation, which contributes the most in agriculture GDP (around 21 percent) and also has substantial weight on overall GDP growth. The expected good GDP growth this fiscal year is largely attributed to favorable monsoon last year and high paddy production.

Two versions for the shortage of fertilizer in the market:

• Farmers allege that the shortage is due to black marketeering of chemical fertilizers and middlemen manipulating the market
• The government says that the uncertainty over procurement of fertilizers is affecting delivery and supply.

The Agriculture Inputs Company (AIC) is responsible for procuring fertilizers, which are distributed through cooperatives. Previously, Indian Potash Ltd (IPL) was barred from supplying fertilizers after farmers complained of underweight sacks (50 kg per sack) of chemical fertilizers. Of 630,000 sacks of fertilizer procured from IPL, about 430,000 sacks were underweight by between 2 kg and 10 kg.

The government subsidizes chemical fertilizers (about 20 percent of actual cost is subsidized). It allocated Rs 2.5 billion for subsidy for 2011-12 in order to supply 150,000 tons of subsidized fertilizers to farmers. Annual demand for fertilizers is around 700,000 tons while government supplies just about 150,000 tons at subsidized price.

The picture shows farmers queuing up to get hold of fertilizers in Taplejung. It is reported that farmers walked two days to reach the district headquarter to get fertilizer. While demand for fertilizer is around 1200 tons in the district, supply is just about 240 tons.  

Few things to note here:

• The longer the shortage of fertilizers, the more it will impact agriculture production, which in turn will affect both GDP growth rate and food security situation.
• The AIC’s negligence in monitoring weight and quality of procured fertilizers should be not treated lightly. The truth needs to come out.
• The proper utilization of subsidized fertilizers should be a matter of concern to all because these are primarily financed by domestic taxpayers. Even donor’s money might have gone to subsidizing fertilizers. Agriculture subsidy is given with an intent to increase production, boost farmer’s income and support their livelihood, reduce food insecurity, promote agriculture employment, reduce poverty and boost economic growth. While all kind of subsidies impact fiscal balance, fertilizer subsidy is a bit different than subsidy on petroleum fuel and LPG. Technically, it is targeted to poor farmers and leakage is lower than in fuel subsidy.
• However, there are cases where subsidized fertilizers are being sold not via government depots or cooperatives, but though retail shops. The government officials or agencies take money/commission and supply subsidized fertilizer to private players in district headquarters. Farmers are told that the government depots are running short of fertilizers and are recommended to seek supplies from private players, who charge high price. The collusion between private players and government agencies at the district level impacts supply and leads to mis-utilization of subsidy meant for a good purpose.
• The immediate priority of the government, also MoF and MoAD, should be to procure adequate fertilizer and supply it to the market.

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UPDATE (2012-06-22): Recommended readings on the same issue:

• Dr. Prakash Chandra Lohani: Political economy of fertilizer shortage
• Akhilesh Upadhaya (Editor-in-Chief of The Kathmandu Post): Farmers’ enemies
• Sangam Prasain: Nepal at risk of sliding back to food deficit status

Rio+20: Climate Change and Nepal

The figure below compares CO₂ emissions, projected annual temperature change and projected change in hot days/warm nights (2045-2065).

As expected, emission levels are very low in Nepal. But, annual temperature change between 2045-2065 (relative to the control period 1961-2000) is projected to be higher than in even Bangladesh, China, India and the USA. Hot days and warm nights are expected to increase by 2.5 days and 8 days respectively between 2045-2065 (relative to the control period 1961-2000).

Data source is here. The definition of CO2 emissions per unit of GDP, CO2 emissions per capita, and the projected temperature and annual hot days/warm nights is as follows:

• Carbon dioxide (CO₂) emissions per units of GDP are carbon dioxide emissions in kilograms per $1,000 of GDP in 2005 purchasing power parity (PPP) terms. PPP GDP is gross domestic product converted to international dollars using PPP rates. An international dollar has the same purchasing power over GDP that a U.S. dollar has in the United States.
• Carbon dioxide (CO₂) emissions per capita are carbon dioxide emissions divided by midyear population.
• Projected annual temperature change is the projected change in annual temperature in the years 2045-2065, relative to the control period 1961-2000.  The range reflects the 10th and 90th percentiles of results from nine general circulation models (GCMs) at a standardized 2-degree grid, employing the A2 storyline and scenario family. Values are aggregated at the country level.
• Projected change in annual hot days/warm nights are the projected changes in the annual incidence of "hot days" and "warm nights" in the years 2045-2065, relative to the control period 1961-2000.  Hot days and warm nights are those that exceed the 90th percentile of maximum temperatures and those that exceeded the 90th percentile in minimum temperatures, respectively, in the control period. These indicators are useful to understand potentially critical thresholds related to heat stress in different sectors such as agriculture and energy.  The range reflects the 10th and 90th percentiles of results from nine general circulation models (GCMs), employing the A2 storyline and scenario family. Values are then calculated at the country level from 2-degree gridded data.

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Rio+20 and Nepal

High-in come countries, with one sixth of the world’s population, are responsible for nearly two thirds of the greenhouse gases in the atmosphere. Methane and nitrous oxide produced by the agricultural sector account for about 10 percent of anthropogenic warming. Most of it comes from the guts of cattle and sheep. Globally, agriculture and land-use change and forestry contribute 14 percent and 17 percent of CO₂ emissions, respectively. Read more here.

Though Nepal’s emission levels are very low, irrespective of the unit of measurement, it is disproportionately affected by the vagaries of climate change/weather. The low contribution of enablers of climate change and its high impact on economy and livelihoods call for a balanced approach to meet growth and development needs while keeping low its impact on environment. As of now, there is a tradeoff between these two and the challenge for policy makers is to find a suitable point (say country-specific Pareto optimal point for sustainable development) based on a slew of factors such as endowment, institutional capabilities, livelihood options, infrastructure necessities (including roads, ICT, irrigation, energy) and others. The impact of climate change will alter comparative advantage on agriculture trade (and also of the industrial sector that depends on agriculture sector for raw materials), reduce livelihood options, increase or decrease the average number of warm or cold days and nights, endanger communities living in mountain and low-lying areas and impact their livelihood options, engender distress migration and may induce conflict, among others. Against this backdrop, the Rio+20 (United Nations Conference on Sustainable Development) is a crucial platform for countries like Nepal to voice their concern and seek options to balance growth (jobs enriching) and environment necessities.

Nepal will propose focusing on the following key areas of sustainable development:

• Food security and sustainable agriculture
• Water and sanitation
• Energy
• Sustainable cities
• Natural disaster
• Green job and social inclusion
• Mountain ecosystem

Nepal expects Rio+20 to:

• Renew commitment of Member States for preserving the Rio principles
• Foster implementable consensus for fulfilling the implementation gaps in the Rio declaration and other associated commitments
• Address new and emerging challenges in a fair and equitable manner based on the principle of common but differentiated responsibilities (CBDR)

Specifically, it wants developed countries to fulfill ODA commitment, ease transfer of technology, waive debt, ease trade barriers, and enhance capacity of LDCs. It expects an agreement on the Mountain Agenda adopted in 1992. It expects focus on green economy, especially support for harnessing its hydro-generation potential. It expects the Rio+20 Conference to “fully integrate the IPoA into its outcome document and underline renewed and scaled-up global commitment to achieve sustainable development in the LDCs.”

Read an earlier piece on Rio+20 Summit here.