Aid at a glance, Nepal (2006-2008)

Over the period 2007-08, humanitarian aid sector received the highest amount, followed by economic infrastructure & services, health and population and so on…. Here is an earlier post about the foreign aid in Nepal.

Tragedy in Japan

Donate for a noble cause and do you part in helping Japanese people overcome the misery brought by the earthquake and tsunami. Donate to The Nippon Foundation, an NGO working in a wide range of domestic and international activities, including health and welfare projects, educational and social issues, maritime development, and protection of the marine environment.

[FYI: My friend Shota Nakayasu is working in The Nippon Foundation.]

Political system and economic liberalization

Giuliano, Mishra and Spilimberg argue that economic reforms may scare politicians, but democracy and economic liberalization generally go hand in hand. Political liberalization and domestic financial, capital account, product markets (electricity and telecommunications), agriculture, and current account transactions tend to move together. But, look at political liberalization and trade. Trade seems to have increased, irrespective of political liberalization. Up until 1990, decrease in political liberalization actually boosted trade. Then political liberalization increased but trade performance continued increasing.

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The bottom line is that democracy is good for structural reforms, but the reverse is not true—economic liberalization introduced by autocracies does not cause a move to democracy. Moreover, there is no foundation for politicians’ fear that voters will punish policymakers who implement financial sector reforms or reduce fiscal deficits.

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The record of the Washington Consensus

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For 30 years, Washington has been shopping a trade-not-aid based economic diplomacy across Latin America and beyond. According to what is generally known as the “Washington consensus”, the US has provided Latin America loans conditional on privatisation, deregulation and other forms of structural adjustment. More recently, what has been on offer are trade deals such as the US-Colombia Free Trade Agreement: access to the US market in exchange for similar conditions.

The 30-year record of the Washington consensus was abysmal for Latin America, which grew less than 1% per year in per capita terms during the period, in contrast with 2.6% during the period 1960-81. East Asia, on the other hand, which is known for its state-managed globalisation (most recently epitomised by China), has grown 6.7% per annum in per capita terms since 1981, actually up from 3.5% in that same period.

The signature trade treaty, of course, was the North American Free Trade Agreement (Nafta). Despite the fact that exports to the US increased sevenfold, per capita growth and employment have been lacklustre at best. Mexico probably gained about 600,000 jobs in the manufacturing sector since Nafta took effect, but the country lost at least 2m in agriculture, as cheap imports of corn and other commodities flooded the newly liberalised market.

This dismal economic record prompted citizens across the Americas to vote out supporters of this model in the 2000s. Growth has since picked up, largely from domestic demand, and exports to China and elsewhere in Asia.

Interestingly, the only significant card-carrying members of the Washington consensus left in Latin America are Mexico and Colombia.

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More by Kevin Gallagher here.

Going beyond Keynesianism to avoid another global crisis

High income countries are facing a “new normal” (a combination of low growth, high unemployment and low returns on investment). Some of the European countries are facing sovereign debt crisis and may require restructuring. Middle-income countries are experiencing short-term capital inflows, putting appreciation pressure on currency and equity and real estate markets prices. Surge of food, fuel and commodity prices is hurting the poor. With these economic problems what can be done to avoid another global crisis?

Justin Lin argues that “a global push for investment along the line of Keynesian stimulus is the key for a sustained global recovery; however, the stimulus needs to go beyond the traditional Keynesian investment.” But the problem lies in avoiding the Ricardian trap—a situation where the government spending fails to boost aggregate demand as people expect increases in taxes in the future (and save now) to pay for existing deficit that funds government spending. Lin suggest:

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To avoid the Ricardian trap, it is important to go beyond conventional Keynesian stimulus of “digging a hole and paving a hole” by investing in projects which increase future productivity. So the investment will increase jobs and demands for capital goods now and increase the growth and government’s revenue in the future. The increase in revenue can pay back the cost of investment without increasing household’s future tax liability.

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Krugman argues that this still misses the point:

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It’s one thing to have an argument about whether consumers are perfectly rational and have perfect access to the capital markets; it’s another to have the big advocates of all that perfection not understand the implications of their own model.

So let me try this one more time.

Here’s what we agree on: if consumers have perfect foresight, live forever, have perfect access to capital markets, etc., then they will take into account the expected future burden of taxes to pay for government spending. If the government introduces a new program that will spend $100 billion a year forever, then taxes must ultimately go up by the present-value equivalent of $100 billion forever. Assume that consumers want to reduce consumption by the same amount every year to offset this tax burden; then consumer spending will fall by $100 billion per year to compensate, wiping out any expansionary effect of the government spending.

But suppose that the increase in government spending is temporary, not permanent — that it will increase spending by $100 billion per year for only 1 or 2 years, not forever. This clearly implies a lower future tax burden than $100 billion a year forever, and therefore implies a fall in consumer spending of less than $100 billion per year. So the spending program IS expansionary in this case, EVEN IF you have full Ricardian equivalence.

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Are Nepal’s policies “mercantilist/economic nonsense”?

Here is my latest piece about Nepal’s Industrial Policy 2010, Trade Policy 2009, and Nepal Trade Integration Strategy (NTIS) 2010, and how they are trying to address trade related problems in Nepal. It is largely based on criticism of a paper authored by Malcolm Bosworth, who argues that unilateral trade liberalization with an increase in imports should be the main trade policy agenda of Nepal. I find this (bad) recommendation not suited to Nepal’s context. He argues that Nepal’s existing industrial and trade policies are “mercantilist/economic nonsense”. I will have detailed, specific comments on other arguments raised by Bosworth in later posts.

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Mercantilist nonsense?

On February 28, 2011, the United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP) organized a high level national policy dialogue on Nepal’s long-term direction in global and regional trade policy in Kathmandu. High level officials and experts working on trade related issues participated in the program, which was aimed at increasing national awareness and knowledge on “trade policy options to increase engagement in global and regional trade and derive benefits from such trade for development.”

The main highlight was a paper authored by Malcolm Bosworth, international consultant for the study and visiting senior research fellow at Crawford School of Economics & Government, Australian National University. By interacting with high level Nepali officials for few days and banking on inputs from a national consultant, Bosworth has written and fiercely advocated trade policy agendas for Nepal that are suicidal and largely detached from the dynamics and ground realities of the Nepali economy.

Let me touch upon a few of the many outrageous and ludicrous recommendations emanating from Bosworth’s paper. His main message is that unilateral trade liberalization, especially those geared toward increasing imports, should be the main trade policy agenda of Nepal. He argues that imports are as important as exports and the former has to be at least equally promoted as the latter. Furthermore, Bosworth maintains the current industrial and trade policies – which he says are “mercantilist nonsense”—are discriminatory because they promote one sector/product over the other, and seek market concessions abroad to increase exports. According to him, the increase in trade deficit is not a trade policy problem, but that associated with saving-investment imbalance, particularly domestic investment being higher than domestic saving. He recommends Nepal to eschew attempts to address trade and balance of payments (BoP) deficits using trade policy. To Bosworth Nepal Trade Integration Strategy (NTIS) 2010 is against the spirit of ‘welfare enhancing’ trade policy, which to him is unilateral liberalization to increase imports and non-discriminatory in terms of sector or product promotion.

Given Nepal’s structural problems (which are very likely not related to saving-investment imbalance), macroeconomic fragility and socioeconomic dynamics, Bosworth’s arguments defy rational economic logic. He assiduously extols the discredited “one-size-fits-all” policy recommendations and the Washington Consensus.

The reality is that unilateral trade liberalization will further worsen our BoP deficit and deepen macroeconomic instability, which might force Nepal to knock on the door of the IMF once again. Nepal already imports almost six times more than it exports. In 1976, trade deficit on goods and services was negative 3.4 percent of GDP, which swelled to negative 21 percent of GDP in 2009. This is simply unsustainable even in the medium-term. So far remittances have been partly neutralizing the effect of rising imports on overall BoP. But, this too is volatile because any disturbances in remittances inflow would further exacerbate the already fragile macroeconomic situation. Just two years ago when the global economic crisis led to a decline in growth rate of remittances inflow, our BoP became negative.

In such circumstances, prescribing a policy to increase imports by unilaterally liberalizing trade (and if necessary going beyond the rules set by the WTO to increase imports) is suicidal. Trade liberalization in unproductive imports—especially on luxury goods and branded items— will not increase welfare in a country where approximately 78 percent of the population lives below $2 a day. It would sensible if we liberalized further on capital goods imports, which would at least contribute to the productive capacity of our economy.

Pretty much every country in the world uses trade and industrial policies in one form or the other to aid their industries and export-oriented sectors. For Nepal, the domestic welfare emanating from trade and employment, and increase in purchasing power matters more than the welfare of citizens of other countries, i.e. we should not make ourselves worse off by making someone else better off. If possible, we could make ourselves better off by at least not making others worse off. But, this is idealistic given that in reality there are always tradeoffs. Our policymakers should not believe in the ideology that unilateral trade liberalization creates high welfare gains and less deadweight loss globally. Even if they did, the welfare from such liberalization is not equally distributed across and within nations. The Nepali government has responsibility to think about enhancing welfare of its citizens by playing by the rules set under international treaties, including the WTO.

If trade and industrial policies, that do not violate WTO rules, increase welfare of Nepali people, then there is nothing wrong in implementing them. An ultra-liberalization policy recommendation that tries to unsuccessfully debunk established evidence on the effectiveness of trade and industrial policies to abet domestic industries/specific sectors and products adds no value to the ongoing discussion about and efforts to mainstreaming our trade policy into overall economic policy.

It seems that rather than doing exhaustive stocktaking and writing a report based on reality, the analyst has tried to use a template of trade policy report used elsewhere. In fact, Bosworth forgets to replace “PNG Government” with “Government of Nepal” in the report (page 79, para 2). It is very likely that he inserted some discussion about Nepal’s trade situation by getting inputs from a national consultant and then projected it on top of a trade policy report already prepared for Papua New Guinea. Unsurprisingly, if you look at the presentations of the lead author and national consultant Dr Pushpa Raj Rajkarnikar, the latter seems to have comprehended and reflected Nepal’s trade situation and constraints more clearly than the former.

One appreciable aspect of Bosworth’s report is that he acknowledges that no degree of market opening abroad will boost Nepal’s exports if the supply-side constraints are not addressed. Supply-side constraints such as intermittent blockades, labor disputes and lack of adequate infrastructures (road transport and electricity) are eroding our competitiveness and preventing diversification of exports basket. That said, he again fails to read what Industrial Policy (IP) 2010, Trade Policy (TP) 2009 and NTIS 2010 are trying to address, i.e. supply side constraints in key sectors that have high chances of being successful domestically and abroad, and also have high socioeconomic benefits.

These policies are trying to facilitate structural transformation and diversification that Bosworth wrongly claims will only happen if trade is fully liberalized. When markets are riddled with coordination failures and information externalities structural transformation will not happen just by swinging the wand of liberalization. It only happens in ideal situation, which is hard to get by in Nepal. The recent literature on product space and the role of state in facilitating structural transformation is inconsistent with Bosworth’s recommendations. The government’s role as a facilitator in reducing coordination and information hurdles in order to accelerate economic activities is equally important in bringing about structural transformation as is the role of the private sector.

No doubt, Nepal’s existing policies have shortcomings in terms of achieving the aims that they are supposed to. But, they definitely are not “mercantilist/economic nonsense”. Making such outlandish, baseless claim shows the shortcoming of analysts, especially those ‘parachute analysts’, who drop in on Nepal for few days, interact with few officials and experts, and write reports based on templates. If their remuneration is counted as a part of Aid for Trade (AfT) initiative, then it is better not having them because the net value addition is probably negative. And, for now, promoting exports is more important than encouraging imports.

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[Published in Republica, 2011-03-10, p.6]

Country specific effects of fiscal stimulus

Ethan Ilzetzki, Enrique Mendoza, and Carlos Vegh (2011) analyze a quarterly dataset on government expenditures for 44 countries (20 high-income and 24 developing) from 1960 to 2007 and argue that the impact of government fiscal stimulus depends on key country characteristics:

1. The output effect of an increase in government consumption is larger in industrial than in developing countries. Only after a lag of two to four quarters does output rise in response to an increase in government consumption, and the cumulative output response is not statistically different from zero. Furthermore, increases in government consumption are less persistent (dying out after approximately six quarters) in developing countries than in high-income countries. But, only in developing countries is the multiplier on government investment significantly higher than the multiplier on government consumption. Thus, the composition of expenditure may play an important role in assessing the effect of fiscal stimulus in developing countries.
2. The fiscal multiplier is relatively large in economies operating under predetermined exchange rate but zero in economies operating under flexible exchange rates.The differences in the responses to increases in government consumption in countries with fixed and flexible exchange rate regimes are largely attributable to differences in the degree of monetary accommodation to fiscal shocks in these nations. The results imply that the central banks' response to fiscal shocks is crucial in assessing the size of fiscal multipliers.
3. Fiscal multipliers in open economies are lower than in closed economies. Economies that are relatively closed, whether because of trade barriers or larger internal markets, have long-run multipliers of around 1.3 to 1.4, but relatively open economies have negative multipliers.
4. Fiscal multipliers in high-debt countries are also zero. When the outstanding debt of the central government exceeds 60 percent of GDP, the fiscal multiplier is not statistically different from zero on impact and it is negative in the long run.

This might mean that in a least developed country like Nepal, the government can do a lot to jack up growth rate. First, government investment has to be high as consumption level is already high in Nepal. This means investment in infrastructures, education, health and research & technology. Second, since Nepal has a fixed exchange rate with India, and if the central bank rolls out monetary policy that is consistent with fiscal stimulus, the resulting fiscal multiplier could be large. Also, given the idle resources and massive unemployment, fiscal stimulus (with good governance on the use of money) would produce sizable impact on the economy.

About, high-debt argument, Krugman disagrees with the 60 percent of GDP threshold (Reinhart-Rogoff argue that debt over 90 percent of GDP leads to drastically slower growth. Krugman dismisses this idea.)