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”. The sad part is that the low income countries have been unable to enhance sophistication of manufactured and service exports, which would act as a “catalyst for broad-based economic growth”. The authors not only look at production and export of goods, but also services.

The whole concept of computing export sophistication comes from the idea that what a country produces and exports matters for growth and as countries become richer, they move to producing and exporting more sophisticated goods. The impact (knowledge spillovers, backward and forward linkages, and those that offer easier transition from production of one product to another) of production and exports of some products is greater than others. Sophistication comes from either increasing the quality of currently produced goods or from a move into new and more sophisticated products. It induces structural transformation. [Sophistication is measured based on whether the products exported by any given country are those typically exported by high-income or low-income economies.]

Three main points to take home from the paper:

• LICs and SSAs export basket consist of high share of natural resources and relatively low share of manufactures. They have moved production and exports into very few new products. Also, though services have become an important part of trade, they have failed to capitalize on the growth as other countries have done.
• Sophisticated exports (of both manufacturing and services) bring broad based growth if the economy is liberalized, the exchange is not over-valued, and there are goods information flows.
• An educated workforce, external liberalization, and good information flows are vital for development of sophisticated exports of goods and services. Interestingly, for sophistication of goods, the impact of tertiary education was not statistically significant. For sophistication of services, all measures of schooling were significant. If developing economies raised total years of schooling or external liberalization to the level observed in advanced economies, the gap in the sophistication of goods exports between advanced and developing economies would shrink by, respectively, 15 percent and 8 percent. Furthermore, if developing economies raised tertiary schooling or information flows to the level observed in advanced economies, the gap in the sophistication of service exports between advanced and developing economies would shrink by, respectively, 42 and 53 percent.

The composition of Indian service export basket, and its sophistication, was similar to other countries at its income level in the early 1990s. But, it began changing after 2000 and the share of computer information services grew from 0 to 51 percent of total export basket by 2009. India is seeing a shift from traditional to modern activities (business and computer services) in its composition of service exports.

The study finds that a one standard deviation increase in the sophistication of goods or services is associated with a, respectively, 0.6 or 0.4 percentage points increase in the average annual growth rate. Or, if developing countries were to increase the sophistication of their goods or services to the levels observed in advanced economies, their per capita growth rate would increase by, respectively, 1.1 or 0.5 percentage points. The initial export sophistication of both goods and services is associated with subsequent output growth, even after controlling for financial development, human capital, and external liberalization.

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In the figures above, see Nepal’s and India’s position. On services sophistication, Nepal’s existing state is miserable. Meanwhile, India has top-notch services sophistication. In goods sophistication as well, Nepal has a low value.

1.29 billion people below US$1.25 a day in 2008

The latest update by the WB shows that an estimated 1.29 billion people in 2008 lived below $1.25 a day (2005 PPP), equivalent to 22 percent of the population of the developing world. In 1981, 1.94 billion people were living in extreme poverty.

But, at the current rate of progress there will still be around 1 billion people living below $1.25 per day in 2015. Additionally, the number of people living between $1.25 and $2 has almost doubled from 648 million to 1.18 billion between 1981 and 2008.

The $1.25 poverty line is the average for the world’s poorest 10 to 20 countries. A higher line of $2 a day (the median poverty line for developing countries) reveals that there was only a modest drop in the number of people living below $2 per day between 1981 and 2008, from 2.59 billion to 2.47 billion, though falling more sharply since 1999.

It argues that though food, fuel and financial crises over the past four years slowed the rate of poverty reduction in some countries, global poverty kept falling. According to the WB, preliminary survey-based estimates for 2010—based on a smaller sample size than in the global update—indicate that the $1.25 a day poverty rate had fallen to under half of its 1990 value by 2010. It means that the first Millennium Development Goal of halving extreme poverty from its 1990 level has been achieved before the 2015 deadline. However, only three regions have reached MDG1 using $1.25 a day line, namely East Asia, Eastern Europe and Central Asia, and the Middle East and North Africa.

In South Asia, the $1.25 a day poverty rate fell from 61 percent to 39 percent between 1981 and 2005 and fell a further 3 percentage points between 2005 and 2008. The proportion of the population living in extreme poverty is now the lowest since 1981. In 2008, there were 571 million people below the $1.25 a day (2005 PPP) poverty line in South Asia. For Nepal, the estimate is based on NLSS II (2003/04). We will have to wait for estimate based on NLSS III (2010/11).

South Asia	$1.25 a day (2005 PPP)		$2 a day (2005 PPP)
Year	% of population	Number (million)	% of population	Number (million)
1981	61.1	568.4	87.2	810.6
1984	57.4	573.8	85.6	854.8
1987	55.3	593	84.5	905.9
1990	53.8	617.3	83.6	958.8
1993	51.7	631.9	82.7	1010.4
1996	48.6	630.8	80.7	1047.3
1999	45.1	619.5	77.8	1068.8
2002	44.3	640.5	77.4	1119.7
2005	39.4	598.3	73.4	1113.1
2008	36	570.9	70.9	1124.6

Looking back to the early 1980s, East Asia was the region with the highest incidence of poverty in the world, with 77% living below $1.25 a day in 1981. By 2008 this had fallen to 14%. In China alone, 662 million fewer people living in poverty by the $1.25 standard, though progress in China has been uneven over time. In 2008, 13% (173 million people) of
China’s population still lived below $1.25 a day.

In the developing world outside China, the $1.25 poverty rate has fallen from 41% to 25% over 1981-2008, though not enough to bring down the total number of poor, which was around 1.1 billion in both 1981 and 2008, although rising in the 1980s and ‘90s, then falling since 1999.

The report notes that the number of poor declined between 2005 and 2008. But, let us also note that there was a net increase in poverty to the tune of 44 million people, who fell below the extreme poverty line due to the impact of food price changes between June and December 2010 in twenty-eight low and middle income countries.

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UPDATE (2012-03-09): Looks like the country level data with latest survey year is also available. For Nepal, its NLSS III (see this updated one as well). Check it out here.For Nepal, the poverty headcount at $1.25 a day (PPP) was 24.8% in 2010 [7.4 million people] and 53.1% in 2003 [13.9 million people]. It was 68% in 1995 [14.7 million people]. See this blog post.

Where is the danger of political polarization and extremism greater?

It is greatest in countries with:

• relatively recent histories of democracy,
• existing right-wing extremist parties, and
• electoral systems that create low hurdles to parliamentary representation of new parties.

But, the greatest threat is when depressed economic conditions are allowed to persist. Read more here.

Creeping prices: What determines food and nonfood prices in Nepal?

[It is published in today’s Republica, p.6].

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Creeping prices

In the mid-term review of monetary policy, the central bank argued that inflation, which is a measure of the increase in general prices of goods and services over a period of time, target of 7 percent for this fiscal year won’t be met. Instead, it stated that inflation will be around 8 percent. Unsurprisingly, it is not the first time inflation target has been revised upward. The dynamics of the causes of price fluctuations in the economy has discombobulated Nepalese experts and policymakers for a long time. Given the unique yet evolving market integration between Nepal and India, the ineffectiveness of monetary tools to tame rising prices, and the increasing influence of oil prices on general price level, tackling inflation in Nepal would require both policy tools as well as earnest political commitment to correct market distortions.

Generally, inflation is determined by money supply in long term. In short term, it is determined by demand and supply pressures, which are in turn affected by the relative elasticity of wages, prices and interest rates. In Nepal’s case, monetary tools such as increase in interest rates and decrease in money supply have not been used specifically to control inflation because there is hardly any correlation between M2—a broad measure of money supply and a key indicator used to forecast inflation—and prices of goods and services. Instead, our prices have historically been following the prices in the Indian economy, thanks to the pegged exchange rate and free flow of goods and services across the open border. Furthermore, policy interventions (mostly fiscal tools such as taxes and expenditure) have been more or less consistent with changes in the Indian economy. Interestingly, this link has been weakening following the global food, commodities and fuel prices hike after 2007 for two main reasons: increasing imports of petroleum products and domestic market distortions. Policy makers preparing firepower to tame rising prices should take note of these evolving changes.

A recent study by the IMF economists showed that almost a third of the variability in domestic inflation can be attributed to the prices in India and movements of international oil prices. While food price increases contributed to about three-fourths of overall rise in price level, monetary factors mattered more for nonfood price inflation than for food price inflation. It indicates rampant domestic food market distortions and rise in domestic financing for imported durables. Overall, food prices have been more volatile than nonfood prices in the economy. The study found that the responsiveness of food price inflation was significant and quick to spillovers from India’s food prices and the global oil price fluctuations before 2007. However, after 2007 the impact of fluctuating oil prices is more persistent than the spillovers of food prices prevalent in the Indian economy. Even though petroleum prices do not change readily in our economy as they do in the international market, the price fluctuations are seen directly and indirectly in the cost of imported inputs (and final products) used by agricultural, industrial and service sectors.

These findings are not in line with an earlier held belief and research finding (including a 2007 study of similar nature by Edimon Ginting of the IMF) that inflation in India and inflation in Nepal tend to converge and the pass through of inflation from India to Nepal takes about seven months. With the changing composition of imports from India and the large share of petroleum products in import basket, this has been changing since 2007, thanks to increasing demand for fuel to power machines, generators and vehicles. Currently, the pass through time of food and nonfood prices from India to Nepal has shortened and international oil prices have greater impact than what it was thought to have before.

It is not that the prices are entirely determined by external factors. Domestic supply-side factors also matter, particularly market distortions. Note that when global food prices spiked in 2007 and 2010, being a net food importing country, domestic food prices also went up. But, when global food prices moderated, domestic prices did not normalize accordingly. Why did prices remain stubbornly sticky at high level? Well, it is because of supply-side factors such as strikes, hoarding, black marketeering, deliberate withholding of supplies and inventory, distortion of agriculture prices by middlemen, and agricultural trade hurdles imposed by our neighbors, among other factors. These have increased uncertainty and expectation of future rise in input cost. The inflationary expectation arising from the uncertainty over supply of fuel and cooking gas, its rising prices at global level, and supply-side constraints have primarily contributed to the series of food and nonfood price hikes in recent months. That said, prices are also pushed up by demand factors, especially consumption demand fuelled by high remittance inflows. However, consumption has been high (around 92 percent of GDP) for a long time, so it does not justify the stubbornly high and sticky prices.

The changing pattern of the impact of oil prices, inflation in India and the uncertainty over supply conditions have important policy implications. First, the policymakers need to factor in the volatile oil prices when they estimate targets for inflation rate as domestic prices are deviating from the prices in the Indian market. Second, monetary tools have little traction on inflation and inflationary expectation in the short term. Fiscal tools such as lowering levies on petroleum products and subsidizing inputs might help to moderate prices. However, these too have drawbacks as they tend to widen budget deficit, and confound policymakers in managing the tradeoff between taming high prices and maintaining fiscal space. Third, resolving supply-side constraints seems to be the most promising, yet most difficult, intervention to lower rising prices. Promising because it will correct markets and link production with demand, but difficult because it requires more political than policy action. Fourth, prices will continue to remain volatile and high unless the government reduces load-shedding hours and matches power generation with power demand. Else, people will continue to demand more fuel each year, which means more shortages as the government cannot procure enough of it because of its inability to supply adequate funds to NOC without a substantial increase in revenue generation and reduction in allotted expenditure for other sectors. Note that the import of petroleum products increased by around 50 percent last year and the total earning from merchandise export was Rs 10 billion short of the total value of petroleum import.

The evolving factors that are pushing food and nonfood prices up have to be well comprehended to better design macro policies aimed at reducing high inflation, which is eroding real purchasing power of people. Along with the prices in the Indian economy, international oil prices, and domestic supply-side constraints (including market distortions) are having strong bearing on inflation in Nepal. To bring down inflation back to the desired level, effective monetary and fiscal policies have to be formulated and enacted by considering these factors.

[Published in Republica, February 28, 2012, p.6]

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Why Nations Fail?

I am waiting for this book by Acemoglu and Robinson to come to my desk. Here is a blog devoted to the book. And, below is the summary of what is in the exciting book:

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Is it culture, the weather, geography? Perhaps ignorance of what the right policies are?

Simply, no. None of these factors is either definitive or destiny. Otherwise, how to explain why Botswana has become one of the fastest-growing countries in the world, while other African nations, such as Zimbabwe, the Congo, and Sierra Leone, are mired in poverty and violence?

Daron Acemoglu and James Robinson conclusively show that it is man-made political and economic institutions that underlie economic success (or the lack of it). Korea, to take just one of their fascinating examples, is a remarkably homogeneous nation, yet the people of North Korea are among the poorest on earth while their brothers and sisters in South Korea are among the richest. The south forged a society that created incentives, rewarded innovation, and allowed everyone to participate in economic opportunities. The economic success thus spurred was sustained because the government became accountable and responsive to citizens and the great mass of people. Sadly, the people of the north have endured decades of famine, political repression, and very different economic institutions—with no end in sight. The differences between the Koreas is due to the politics that created these completely different institutional trajectories.

Based on fifteen years of original research, Acemoglu and Robinson marshal extraordinary historical evidence from the Roman Empire, the Mayan city-states, medieval Venice, the Soviet Union, Latin America, England, Europe, the United States, and Africa to build a new theory of political economy with great relevance for the big questions of today, including:

• China has built an authoritarian growth machine. Will it continue to grow at such high speed and overwhelm the West?
• Are America’s best days behind it? Are we moving from a virtuous circle in which efforts by elites to aggrandize power are resisted to a vicious one that enriches and empowers a small minority?
• What is the most effective way to help move billions of people from the rut of poverty to prosperity? More philanthropy from the wealthy nations of the West? Or learning the hard-won lessons of Acemoglu and Robinson’s breakthrough ideas on the interplay between inclusive political and economic institutions?

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Estimates of informal agriculture trade between Nepal and India

The official data shows that out of total merchandise exports of Rs 64 billion in fiscal year 2010/11, export to India was Rs 43.36 billion (around 67.63 percent of total merchandise exports). This covers official data only. A recent estimate shows that the value of informal imports of agriculture goods alone from India is close to Rs 54.75 billion.

Meanwhile, the estimated value of Nepal’s informal agriculture exports to India is estimated to be Rs 9.86 billion. In total, the value of informal agriculture trade between India and Nepal is close to Rs 65 billion. The data is based on a recent survey (perceptional survey with informal traders, government officials, carriers and knowledgeable persons) along the major adjoining border towns -- Kakarbhitta, Biratnagar, Birgunj, Bhairahawa and Nepalgunj.

The cause for opting for informal channels: tariff differential on third country goods between Nepal and India (and its reflection on retail prices), export restriction of certain agriculture products by India, additional duties and non-tariff barriers are some of the factors, and hassle at custom points.

Here is more:

• Birgunj customs accounts for 60 percent of total informal import of farm products, followed by Biratnagar and Nepalgunj customs with share of 14 percent and 11 percent respectively. Such trade at Kakarbhitta and Bhairahawa customs stands at 9 and 6 percent of total informal trade of agro-products respectively.
• Informal import of farm products through Birgunj and Biratnagar customs was worth Rs 32.65 billion and Rs 7.46 billion respectively. Similarly, agricultural products worth Rs 5.07 billion, Rs 5.91 billion and Rs 3.63 billion were estimated to have been imported through informal channels via Kakarbhitta, Nepalgunj and Bhairahawa customs respectively.
• Paddy is the major agriculture item imported through informal channels from India. Its share in total informal agriculture imports from India stands at around 27 percent. Similarly, rice (21 percent), sugar (12 percent), edible oil (8 percent), and lentil, fish, poultry, powdered milk and oilseeds (3-4 percent) are the other agriculture products imported from India through informal channels.
• Informal exports through Biratnagar customs account for half of Nepal´s informal exports of farm products to the southern neighbor, followed by Biratnagar (around 30 percent). Nepalgunj, Kakarbhitta and Bhairahawa customs come third, fourth and fifth in the list.
• Betel nuts top the list of farm products traded through informal channels. It accounts for 47-52 percent of Nepal´s total farm exports to India, followed by hides and skins (18-21 percent), apple (11-12 percent) and garlic (11-12 percent).
• Informal trade of ginger, orange, big cardamom, onions, turmeric, pig, poultry, powdered milk and jute products is on the rise.

Links of Interest (2012-02-18)

Industrial policy works for smaller firms (If governments must provide investment subsidies to domestic firms, there is a much larger bang for their buck if they target small businesses rather than larger ones.)

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Demand composition and the trade collapse of 2008–09 (The Great Trade Collapse was mainly caused by the crash in global demand.)

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Non-tariff measures and supply chain (NTBs may add many trade costs along the supply chain and, in a world where production is fragmented across countries, they are associated with development traps.)

The figure below shows traded goods prices along the supply chain. Different policies apply to each part of the supply chain. Market distortions in international shipping specifically affect the difference between the free-on-board and cost-insurance-and-freight prices; import customs procedures then affect the landed duty-paid price; and restrictions on the size or hours of retail operations affect the difference between the wholesale and retail price.

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The impact of natural disasters on developing countries' trade flows (Due to natural disasters such as earthquakes, floods, and volcanic eruptions exports of disaster-hit small developing countries decline by 22 percent and the observed impact tends to last for about three years. Exports of larger developing countries, on the other hand, are not significantly affected.)

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What explains high unemployment? The aggregate demand channel (The decline in aggregate demand driven by household balance sheet shocks accounts for almost 4 million of the lost jobs from 2007 to 2009, or 65% of the lost jobs.)

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Preferential trade agreements and the world trade system

• Despite the proliferation of PTAs in recent years, the actual amount of liberalization that has been achieved through PTAs is actually quite limited.
• At least a few studies point to significant trade diversion in the context of particular PTAs and thus serve as a cautionary note against casual dismissals of trade diversion as a merely theoretical concern. Equally, adverse effects on the terms-of-trade of non-member countries have also been found in the literature.
• While the literature has found mixed results on the question of whether tariff preferences help or hurt multilateral liberalization, the picture is different with the more elastic tools of trade policy, such as antidumping duties (ADs); the use of ADs against non-members appears to have dramatically increased while the use of ADs against partner countries within PTAs has fallen.
• Despite the rapid expansion of preferences in trade, intra-PTA trade shares are relatively small for most PTAs; multilateral remain relevant to most member countries of the WTO.

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Conditional versus unconditional cash transfers in Burkina Faso

Compared with control group households, conditional cash transfers significantly increased the number of preventative health care visits during the previous year, while unconditional cash transfers did not have such an impact. For the conditional cash transfers, money given to mothers or fathers showed beneficial impacts of similar magnitude in increasing routine visits.

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China's Growing Role in Africa: Myths and Facts

China’s emergence as a major player in Africa’s trade, investment, and aid has led many to question the nature of its involvement. Critics say that China is only interested in resources, its exports to Africa threaten local industries, and it is displacing Africa’s traditional partners, like the United States. True, China is a large user of commodities and has a vital interest in developing Africa’s natural resources, but it is not just on a resource hunt. Moreover, the adverse impacts on Africa of China’s increased exports, both in internal and external markets, appear to be limited to specific industries such as garments. And despite their differences in priorities and approaches, China and the United States can complement each other in some areas. Africa has much to gain if it uses its leverage wisely.

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Beyond Keynesianism : Global infrastructure investments in times of crisis

As the world recovers only slowly from the 2008 financial crisis and Europe is facing a looming debt crisis, concerns have increased that the "new normal" -- a period of high unemployment, low returns on investment, high risks, and low growth -- may become protracted in advanced economies. If growth remains weak, unemployment rates and debt levels will be slow to recede. Consequently, the global recovery may continue to be fragile for years to come. What the world needs now is a growth-lifting strategy. This strategy could take the form of a global infrastructure initiative. Since debt levels are high, governments in the United States and Europe could increase demand and support growth through investments in bottleneck-releasing infrastructure projects that are self-financing. An infrastructure initiative should, however, go beyond the borders of advanced countries and include developing countries. Economic and social returns to infrastructure investments tend to be high in developing countries, which have become increasingly important drivers of global growth. At the same time, infrastructure investments require capital goods, most of which are produced in high-income countries. Scaling up infrastructure investment in developing countries could therefore help generate a virtuous cycle in support of a global recovery.

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