Saturday, December 31, 2011

Does interest rate channel work? Evidence from Ghana

In short, it won’t work as expected. Why? Because of information asymmetries and imperfect markets. Here is the abstract from a recent paper by Arto Kovanen.

This paper analyzes interest rate pass-through in Ghana. Time series and bank-specific data are utilized to highlight linkages between policy, wholesale market, and retail market interest rates. Our analysis shows that responses to changes in the policy interest rate are gradual in the wholesale market. Prolonged deviation in the interbank interest rate from the prime rate illustrate the challenges the Bank of Ghana faces when targeting a short-term money market interest rate. Asymmetries in the wholesale market adjustment possibly relate to monetary policy signaling, weak policy credibility, and liquidity management. In the retail market, pass-through to deposit and lending interest rates is protracted and incomplete.

Friday, December 30, 2011

Nepal’s problems with exports

[It published in The Week, Republica, December 30, 2011, p.9]

Nepal’s problems with exports

Trade is one of the most vital components of our economy. Exports and imports have a strong bearing on macroeconomy, employment opportunities and the pace of structural transformation. We depend so much on foreign goods to satisfy increasing domestic demand and a shortfall in production that imports are six times higher than our exports. This has resulted in a huge trade deficit (value of imports minus exports), which has already reached unsustainable level. Fortunately, high remittance inflows are helping financing it for now.

To address this situation, since 1983, when the first trade policy was introduced, our government has been rolling out numerous exports promotion schemes and import substituting measures. Unfortunately, they have failed to boost exports and reduce trade deficit, thanks to a slew of domestic problems, including supply-side constraints.

Trade performance

Exports of goods and services have been declining since it reached approximately 26 percent of gross domestic product (GDP) in 1997. Last year, it dropped to 9.8 percent of GDP. In contrast, India’s and Bangladesh’s exports are increasing, mainly because of successful implementation of reforms, targeted promotion of exportable items, and timely management of supply-side constraints. Last year, exports (share of GDP) were 21.5 percent and 18.5 percent respectively in India and Bangladesh.

Meanwhile, imports are ever-increasing, resulting in trade deficit of around 22 percent of GDP. In 2010, while Nepal’s imports were equal to 37.4 percent of GDP, India’s was 24.8 percent of GDP and Bangladesh’s was 24.9 percent of GDP. No wonder, Bangladesh and India had average economic growth rate of over 5.8 percent over 2001-2010 while Nepal had just 4 percent. Over the same period, Nepal had a negative growth of exports, but Bangladesh and India had growth of over 8.5 percent.

Despite joining the WTO in April 2004 and being a member of two regional free trade blocs (SAFTA and BIMSTEC), Nepal’s trade composition and destination have not changed much. It is still heavily dependent on the Indian market for both exports and imports. About 67 percent of total exports go to India and 66 percent of total imports come from India. Last year, the revenue generated from total exports of goods was still Rs 10 billion short of total petroleum imports. Our ballooning imports are financed by remittances, which are estimated to be US$3.9 billion in 2011. This is about US$2 billion higher than the total export of goods and services.


In contrast, India’s and Bangladesh’s trade is pretty diversified. The top two export destinations of India are the US and the UAE, where it sends just 13 percent and 12 percent of total exports respectively. Bangladesh’s top two export destinations are the US and Germany, where it sends 22 percent and 11 percent of total exports respectively. As for imports, India’s top two destinations are China and the US (13 percent and 6 percent of total imports respectively) and Bangladesh’s China and India (22 percent and 12 percent of total imports respectively). Our high dependence on the Indian market means that a small fluctuations and policy changes there would have a substantial impact on our economy.

Regarding export and import composition, nothing much has changed though garment and textiles have lost their significance in the export basket. The demand for our exports is price elastic to consumers in destination markets, meaning that as retail costs of our exports increase due to exchange rate fluctuation and high cost of production, quantity demanded decreases. However, the demand for imported items is relatively price inelastic, implying that change in price does not affect much our demand for imported items. It is so because the import demand for petroleum products, low range durables and food items is increasing each year due to low domestic production and high remittance inflows.

Trade reform

The government has rolled out a number of export promotion schemes to boost exports and foreign currency reserves. While updating trade policy in 2009 and industrial policy in 2010, it made a slew of commitments to promote exports. Additionally, the government listed 19 products having export potential and outlined detailed time bound strategies for their promotion in Nepal Trade Integration Strategy (NTIS) 2010. In the latest Three Year Interim Plan 2010/11-2012/13 as well, there is a long list of programs aimed at implementing the recommendations of NTIS.

Despite the updated policies and high priority given to exports sector, why are they performing miserably at a time when our neighbors’ exports are increasing at an impressive? Well, it is not because we have bad policy documents, but rather the inability to implement the policies and strategies promised to boost exports. For instance, even after the construction of Special Economic Zone (SEZ) in Bhairahawa is near completion, the parliament is yet to pass the SEZ bill. The success of India’s and Bangladesh’s export sector owe much to the construction and effective operation of SEZs and the effective implementation of policies designed to address binding constraints.


No number of export promotion schemes is going to work unless our politicians and policymakers put the house in order, i.e. address domestic supply-side constraints that are eroding competitiveness of our products.

First, the most binding constraint to economic activities in Nepal is the lack of adequate infrastructure. The supply of road network, electricity and irrigation facilities has not matched the growth in demand for them. There is still a demand-supply gap of around 450MW of electricity during dry season, leading to operation of industries below their capacity. Worse, investors are compelled to run their machines using imported diesel and petrol. For fear of protest and further rise in inflation rate, the government is subsidizing diesel, inflicting losses to the state-owned Nepal Oil Corporation. Additionally, many industries and production sites are not linked with good roads, leading to delay in delivery despite adequate production on time. In the agriculture sector, farmers are not supplied with adequate fertilizers and irrigation. These have led to increase in cost of production, wastages, and operation below capacity. Note that Nepal’s infrastructure ranking is the second worst out of the 142 economies in the latest Global Competitiveness Report (GCR).

Second, political strikes (bandas) are disrupting production, supply and distribution of goods and services. Just a few years back, big retailers such as Wal-Mart and Gap withdrew planned orders of garment due to our producers’ inability to supply goods on time, thanks to repeated strikes along the main trading routes and highways. This was/is further impacted by the violence and strikes during and after the Maoist insurgency, leading to a sharp rise in cost of production and loss of cost and quality competitiveness. These problems rarely affect the export-oriented sector in our neighbors.

Third, labor issues have been the thorniest since 2006. The UCPN (M)-affiliated trade unions have wreaked havoc on the industrial sector by incessantly demanding hike in wages and other services that at times are inconsistent with labor productivity. Investors are scared of the militant trade unions and their aggressive cadres. Even after multiple rounds of wages and compensation revision, the unions are still not satisfied. Several hotels, manufacturing plants, and factories with foreign investment are already closed due to labor problems. Note that labor cost in Nepal is already the highest in South Asia. These have hit exports the most and nearly wiped off of the garment and textiles sector.

Fourth, our exporters relied more on market concessions in destination markets than investing on research and development. A prime example of this is the near demise of garment industry after the end of Agreement of Textiles and Clothing (ATC), which eliminated quotas on the trade of textiles and clothing, in 2005. The end of ATC was known in 1990 itself and quota was phased out in successive four phases starting 1994. But, still neither our exporters heeded to it nor our government proactively worked to reorganize and restructure this sector to confront intense competition in the international market. Countries such as China, India, Cambodia, Bangladesh and Viet Nam that invested heavily to promote innovation in these sectors gained after 2005.

Fifth, our policymakers were inept to comprehend the ever-evolving force of globalization. While talking about structural transformation and high growth rate, they failed to implement reforms promised in voluminous documents and lofty speeches. New policies were introduced without looking at coherence with the already existing ones, leading to confusion and paralysis in implementing the already agreed ones. Innovation and self-discovery (i.e. learning by making mistakes and taking risk) were never promoted. There is a lack of coordination among government, investors and producers to foster innovation and competition.

Tackling constraints

Given the limited amount of resources at our disposal, we cannot address all the problems at the same time. The most binding constraints have to be addressed first. To bring down costs, the industries need good roads, uninterrupted supply of electricity and other facilities, security, network of firms producing similar range of products in the same space and attractive incentives. All of these cannot be provided to each firm scattered across the country. But, at the same time, without these facilities our firms cannot produce efficiently. The government could immediately pass SEZ bill, construct such zones in strategic locations like India and Bangladesh are doing, and then provide the required facilities to firms operating inside such zones. This positive discrimination is the most cost effective way to deal with our industrial and export woes at present.

Apart from this, what is really needed is serious implementation of the already committed reforms in trade and industrial policies. It will do a lot in boosting production and exports and in making our products competitive in the international market. Additionally, we need to successfully negotiate with neighbors to reduce trade barriers that are increasing production, transaction and transportation costs. Importantly, to boost production and exports, we need to make Nepal a better place to do business in and provide the necessary enabling conditions for smooth operation of firms and stimulation of entrepreneurial activities.

Tuesday, December 27, 2011

Companies pulling out of SEZ after incentives were scaled down in India

Looks like companies are pulling out of SEZs after the Indian government pruned benefits given to companies locating and operating inside SEZ. Below is a story published in The Economic Times.

But this February, finance minister Pranab Mukherjee pruned some of those benefits to SEZs, leaving entrepreneurs like Sonthalia fretting. "Having already made a significant investment of Rs 200 crore, we couldn't have pulled out," says Sonthalia, vice-chairman & managing director, Sonthalia Group of Companies. Sonthalia represents India Inc's growing disenchantment with SEZs -- the previous government's big idea to drive exports and, in turn, employment and growth.

China was reaping the benefits of such a policy crafted in the eighties and UPA-I felt SEZs could redefine India's status as an exporter. It rolled out a 15-year SEZ plan in 2006. Land on a platter. Speedy approvals. No income tax for five years and concessions for another 10 years. No tax on inputs.

Except after two years, the promises started coming unstuck, like the one on income tax. "We don't know what the government might do next," says Sonthalia. Faced with a harsher business climate and a government that is wavering on SEZ laws, companies are unsure whether they can plan for 15 years. About one-third of companies that held the rights to build an SEZ -- 202 of 583 -- have raised their hands and walked away.

The pace of withdrawals is increasing, with 60 leaving in the past two years alone. These include companies that were looking to set up SEZs for captive purposes (Bata, Dr Reddy's and Essar) or to lease it out (DLF, Omaxe and Unitech). It's no different for tenants. "Most units are evaluating their tax arbitrage before deciding whether to go to an SEZ," says Anshuman Magazine, managing director, CB Richard Ellis, a real estate consultancy.

About one-third of India's exports come from SEZs. Impressive as that headline number is, it is boosted by some migrating exporters -- for example, IT companies moved from software technology parks to SEZs. Further, it hides the skew of just five states and five sectors account for 90% of exports from SEZs. It hides the fact that SEZs are anything but nonurban and manufacturing conclaves, as they were conceived to be.

Of the 583 SEZs the Indian government had approved till October 2011, only 143 were operational. The running SEZs are operating under capacity as well. The government recently changed land acquisition, incentives and taxation provisions. In 2008, the Indian government transferred the responsibility of land acquisition from government to developer itself. In 2009, the government changed the basis of incentives from profits to investments in the draft of the direct tax code (DTC). In 2011, the budget removed income tax exemption for 15-year period and slapped 18.5% minimum alternate tax and 15% dividend distribution tax. Investors argue that once the DTC is enacted, SEZs won't be an attractive option. Why did this happen? It is because  of the tussle between two ministries for long-term plan (commerce) and short-term imperatives (finance).

The perils of having consumer groups in the absence of elected local bodies

A latest study by United Nations Capital Development Fund (UNCDF), reported in Nagarik Daily, states that budget leakage in Mountain and Terai regions is as high as 80 percent. The figure for Hilly region is 25 percent. On average, the leakage of allocated budget  by ministries and income of local authorities is close to 50 percent. Consumers committee in local authorities are misusing the money (by showing investment in local roads that are redone multiple times).

This raises doubt over the hypothesis that efficiency is enhanced if power is given to consumer committees to come up with priority projects and also allow discretionary power to them to spend budget allocated to local authorities. It raises question over the effectiveness of decentralization in the face of rampant corruption, vested interests of leaders, and illiterate committee members. The study states that without local elections and elected local representatives, real decentralization is unimaginable.

Here is an editorial on the same issue published in Republica:

The study has found that every year, over Rs 20 billion is being embezzled from state funds going into local development. According to the study, the money funneled down to the local level is misappropriated, right from the planning to the implementation stage of local projects. The problem is most acute in the Hill and Tarai regions with up to 80 percent of the allocated sums going missing.

[…]The latest revelations have also questioned a hallow principle among development experts in Nepal. Of late, a consensus has been building that local people are the best equipped to bring meaningful changes in the society. Thus, the local consumer groups have been given more and more say on how the money going into local bodies is spent. But the ground realities hint that things are not so straightforward. It was quite a stretch of imagination to assume that consumer groups that do not need license to operate, that do not pay taxes and most surprisingly, cannot be held accountable for their actions, would maintain self-discipline without any oversight. It is bizarre because no human being is immune to the base motives induced by a potentially endless source of money.

Monday, December 26, 2011

The need of fiscal tools for short run stabilization

David Romer argues that fiscal tools are needed for short run stabilization, especially when the economy is in a liquidity trap (zero lower bound on nominal interest).

The first lesson is straightforward: we need fiscal tools for short-run stabilization. Before the crisis, there was broad agreement among macroeconomists and policymakers that short-run stabilization was almost exclusively the province of monetary policy. Monetary policy is more flexible; it is more easily insulated from political pressures; and it can more easily be put in the hands of independent experts. We thought that the zero lower bound would bind infrequently and not sharply; and that in the unlikely event that it did bind sharply, monetary policymakers had other tools they would use in place of reductions in the policy interest rate.

We now know that this view was wrong. We suffered shocks larger than what almost anyone thought was within the realm of reasonable possibility. The constraint imposed by the zero lower bound turned out to be huge (for example, Rudebusch, 2009). And central banks did not use tools other than the policy rate on a scale even remotely close to large enough to make up for the loss of stimulus caused by the zero lower bound.

Perhaps this lack of aggressiveness in using those tools reflects an understanding of the costs of using them that has eluded conventional analyses. But central bankers have yet to provide evidence of such costs. A more likely possibility, in my view, is that the culture of central banking makes it much easier to take unusual steps when the financial system is at risk than when the threat is “merely” one of years of exceptionally high unemployment. But regardless of the reason, monetary policy was not used aggressively enough to prevent very large demand shortfalls.

So, countries needed other tools. And the alternative to monetary tools is fiscal ones. For that reason, almost every major country adopted substantial discretionary fiscal stimulus in the crisis (U.S. Council of Economic Advisers, 2009). Given that we could face another major demand shortfall in the future, it follows that we need instruments of discretionary fiscal stimulus as part of the macroeconomic toolkit.

After reviewing available evidence on the effectiveness of fiscal policy, Romer argues that when monetary policy does not respond, conventional fiscal stimulus is effective. Also, when monetary policy is constrained, austerity measures do not lead to expansion. He also makes a point that to understand fiscal policy responses to the crisis, political economy considerations are central.

Thursday, December 22, 2011

Defense versus foreign aid: Which one to cut during trying times?

Here is an interesting article in The Economist that looks at why the public support slashing foreign aid but not defense spending during austerity era. The stimulating debate is over the spending on fighter jets to bomb dictators and free the repressed people and slashing spending on providing anti-Malaria bed nets to the same repressed people.

The author argues that with the drumbeating of ineffectiveness of aid in reducing poverty and spurring growth, the public is more willing agree to slash foreign aid that is supposedly not working than defense spending. And, the debate usually drags like the never-ending battle between Sachs and Easterly over aid’s effectiveness. It is ideological belief most the time. A belief that the government should concentrate more on defense and law enforcement (i.e. smaller government, not smarter!), and let the markets determine the rest. Read the full article.

Congress is slashing foreign aid to fight malaria in large part because the one category of government spending that the American public actually wants to slash, by a wide margin, is foreign aid. Meanwhile, the public opposes cuts to the defence budget (though they oppose cuts to education, Medicare and domestic anti-poverty programmes even more). So the fact that the political sphere is debating whether or not to bomb Muammar Qaddafi's tanks, rather than whether or not to raise spending on anti-malarial bed nets in Malawi, isn't really that surprising. But why does the public want to cut foreign aid, rather than defence? One reason is that for the past decade and more, both serious development experts like William Easterly and unserious politicians, mainly on the right, have been strenuously arguing that most foreign aid doesn't work. In fact, in Mr Easterly's case, one of the things he argued didn't work (in his excellent book "The White Man's Burden") was centrally planned efforts to distribute anti-malarial bed nets. He thought this was one of those things that would work better with a market solution: we should subsidise at most $8 of the cost of each $10 bed net, but let the rest of the distribution work itself out via market mechanisms.

Again, it's not surprising that the public doesn't want to spend more on foreign aid for anti-malarial bed nets, when people keep telling them such aid doesn't work. What makes the situation more piquante is that, as Jeffrey Sachs argued in a 2009 article in Scientific American, in the specific case of bed nets, the claim appears to be completely wrong. The reason anti-malarial bed nets hadn't been much of a success in Africa before 2005 or so was that donors and executing agencies hadn't spent enough money buying them, and hadn't yet figured out how to distribute them.

[…]Mr Easterly and Mr Sachs have a long-running and intense debate on this and other development issues. I usually agree with Mr Easterly more than Mr Sachs, but in the specific case of bed nets he's had to retreat; more recently he's been sensibly pointing out that even if free distribution works better, you have to figure out a reliable way of identifying organisations that will actually do the distribution for free (rather than selling them illicitly, failing to distribute, etc), and there's no obvious scalable way to do that. But this only raises a further problem for the "bomb Libya or fight malaria" paradigm: how can you even ask the question if spending more on anti-malaria campaigns may not have any effect, since it's about the quality of the agencies, not the amount of funding? If there's no fungible way to shift effort from bombing Libya to fighting malaria, how can there even be a trade-off here?

Still, let's stipulate that shifting spending from the government bombardment of Libya to government anti-malaria efforts in the developing world would work. Certainly, few public-health experts would dispute that many health problems can be most efficiently addressed by having the government undertake preventive measures and distribute them for free. But here's the thing: you will hear approximately no voices on the right-hand side of the political aisle making this case in the United States today. The strategic direction of conservative political thought over the past 30 to 50 years has been to minimise the consensus on the extent of public goods: to argue that there are almost no areas of the economy or society in which government has a constructive role to play,except for national defence, and a few other areas such as law enforcement. Certainly not health.

I would suggest that if we're wondering why the American public devotes so much of its political attention to wars, and so little to anti-malarial bed nets, we might want to consider the role played by consistent efforts over the past 30 years to convince the public that government has almost no legitimate or positive role to play in society apart from a few narrow categories, including law enforcement and national defence, and not including health care. People who believe that virtually all social and economic endeavours, apart from defence and law enforcement, are best addressed by leaving them up to market forces and private industry will not naturally see much else for political discussion to focus on apart from military activity and law enforcement. To put it another way: if we don't think peaceful humanitarian interventions (like anti-malaria campaigns in Malawi) work, then, yes, military humanitarian interventions (like bombing Libya) are the best possible use of American resources towards humanitarian ends. If we do think government humanitarian programmes like anti-malaria campaigns in Malawi work, then I would expect to see a rather different attitude towards foreign aid and public health-care spending than I have seen in American politics these last few years.

To put things in one last way: it simply isn't true that we aren't faced with calls for peaceful humanitarian interventions as often as we are faced with calls for military ones. We are faced with calls for peaceful humanitarian interventions all the time. People are asking for more money for USAID. People are asking for more money for UN peacekeepers. People are asking for more money for the United States Institute for Peace. They're asking for more money for the Global Fund to Fight AIDS, Tuberculosis and Malaria. If you want America, collectively, to be doing more of this sort of thing and less of the bombing sort of thing, then what you need to do is to argue that those sorts of activities are central missions of the United States government, because the most powerful political forces in America over the past couple of decades have been arguing that they aren't, and that's why we're not doing more of them.

Tuesday, December 20, 2011

Relevance of Nepalese PM’s Economic Advisory Council

[It was published in Republica, December 18, 2011, p.6]

Programmed to fail

When former finance secretary Rameshwore Prasad Khanal agreed to be an economic advisor to Prime Minister Baburam Bhattarai there was euphoria in one circle but disappointment among well-wishers who were skeptic of the Maoist leaders. Euphoria in the sense that amidst frustrating political turnaround and decision logjam at least someone who fathoms the importance of accelerating economic progress was attempting to give direction to the PM’s economic agenda. This was enough to rekindle hope among frustrated youth and public.

But skeptics argued that Khanal is committing a ‘career suicide’ not because they doubted his competence but because they thought his good image would be unfairly used by the UCPN (Maoist)-led government to drum up support for its political agenda. They argued that his position is basically defunct for all practical purposes and there is very little he can do.

Several people, including myself, were elated and offered help in whatever way possible because after a long time the PM had an official economic advisor and wanted to drive his economic agenda with inputs from informed experts. Importantly, people expected Khanal to convene a small team to stay focused on key economic issues, provide strictly technical advice on mitigating the impact of existing economic ills, and lay out various policy options for and consequences of the PM’s core economic goals. So far the progress on these fronts has been as elusive as the double-digit growth rate.

With the administration’s slackness in resolving labor disputes plaguing the industrial sector, forecast of high load-shedding hours, increasing trade deficit, unstable financial sector and lofty talks of high growth rate without a credible and workable plan, the optimists are already turning into skeptics. They are looking for answers as to why the PM’s and government’s economic agenda are no different than what had been trumpeted in the past. Also, if the advisory council is to repeat the already tested and redundant ideas, then what is its relevance in terms of value addition to the ongoing debate on economic transformation?

With the announcement of a huge 16-member advisory team, which consists of people from a range of backgrounds as well as those with vested interests, it’s very likely that it will veer from the intended objectives. Worse, it is likely to continue advocating the failed economic ideas and programs that did not take a critical look at our binding constraints to economic growth. Given the huge number of members and their background, the advisory council has already lost its focus. It has become no better than the jumbo cabinet, both in terms of relevance and likely effectiveness..

Khanal argues that the advisory council is modeled along the US’s National Economic Council (NEC), which advices the President of the United States on economic affairs. The NEC assists in coordinating policymaking for domestic and international economic issues, gives economic policy advice to the president, ensures that policy decisions and programs are consistent with the president´s economic goals, and monitors the implementation of the president´s economic policy agenda. Policy specialists and economic analysts work in the NEC and coordinate with different agencies of the public administration responsible for the execution of the government’s economic agenda. Unfortunately, the PM’s advisory team is not even close to the objectives of the NEC, even in its composition.

First, why would the PM need a jumbo advisory team when we already have the required agencies to offer advice on economic planning and policy execution? It would be understandable if the PM had a team with members capable of advising him on matters related to his government’s economic policy agenda and coordinating with other relevant government agencies to execute them.

This is the primary function of an advisor and the advisory council under his chairmanship. To some extent it is already being done by National Planning Commission (NPC), which advises the government on economic affairs and helps it execute them by coordinating with various bureaucracies. Also, we have Nepal Rastra Bank (NRB) to advice the government on all matters related to monetary policy. It is unclear what different role this jumbo advisory council would play and how it is going to differentiate itself from the function of NPC and NRB. The answers to these questions have not been adequately vetted.

It brings me to my second argument on the origin of the very concept of an advisory council. The skeptics who argue that Khanal was tapped by PM Bhattarai to boost his image have a point. A substantial chunk of the intellectual circle, analysts and public servants has a generally good opinion of Khanal and PM Bhattarai was very shrewd to win their sympathies by convincing Khanal to join his administration. Now, in the name of incorporating views and ensuring representation of stakeholders, the advisory team is expanded to include people from almost all fields. It would help silence criticism and cement support even if things go wrong or nothing substantial happens at all.

Notably, they have completely overlooked conflict of interest of the members. The advisory team has representatives from various sectors such as business community, NRN, aid, financial, education, energy and tourism, among others. It is beyond doubt that the well-known names in these sectors will have vested interest while advising the PM on economic affairs. They represent sensitive sectors that have a direct bearing on our budgetary, taxation and development agenda. Most of the members won’t be able to add much value to the debate on economic transformation and workable policies required for this because if they have some, then it has either already been spilled out or have come through their associations.

It cannot be ruled out that the members will use the platform to further their own personal and business agenda and influence policy to suit their needs. This will be disastrous as no new ideas will come out of this advising exercise and few would gain at the expense of many. Consequently, the planned monthly meeting might be no better than the multiple ‘focus group discussions’, which hardly are focused on core topic, and are held pretty much every week in major cities around the country. At the end of the day, neither will there be any new actionable ideas coming out of the meetings nor will adding more members germinate new ideas out of the blue.

To save whatever integrity they have let us hear from them, or via the PM's team, what credible plan they have to lower high food prices, solve energy crisis, abolish regulatory hurdles for businesses, tackle labor disputes, stabilize financial market, increase competitiveness of our exports, and solve impending petroleum shortage and its impact on inflation. The country needs short term solution to these problems as well as long term plans to avert economic hardships engendered by these. Importantly, to stay relevant the team should concentrate on advising the PM on furthering his core economic goals, coordinate with relevant administrations to execute them, sell effectively the PM's economic vision to the public, and not encroach upon the function of NPC and NRB.

Else, the meeting of the jumbo advisory team, which could still be expanded if the PM wants, would be like a jamboree where there will be loud and lofty talks, no germination of new ideas, mundane discussion based on perfunctory analysis, and collection of allowance from the state coffers. Eventually, it will be looking for the relevance of its own existence. Good luck!

[Published in Republica, December 19, 2011, p.6]

Thursday, December 15, 2011

Total illicit financial outflows from Nepal was US$6.04 billion over 2000-2009

Total illicit financial outflows from Nepal over the period 2000-2009 is estimated to be US$6.040 billion, according to a new report titled ‘Illicit Financial Flows from Developing Countries over the Decade Ending 2009’ by Global Financial Integrity (GFI). It is an average of US$604 million each year between 2000 and 2009. If you consider normalized figures, then it is estimated to be US$5.921 billion. The study tracks the amount of illegal capital flowing out of 157 different developing countries over the 10-year period from 2000 through 2009, and ranks the countries by the magnitude of illicit outflows.

It is strange to to see a drastic decline in illicit financial outflows in 2009. I am still hunting for reasons. Some of the possible reasons could be a decrease in trade volume, FDI and new external loans. All of these variables (except FDI) saw downslide in 2009, but I still have to look at them carefully to be sure why there is so much of decline in 2009.

The cumulative figures for illicit outflows are computed based on official balance of payments (change in external debt, net FDI, current account balance, and change in reserves) and trade (exports and imports) data reported to the IMF by member countries and external debt data reported to the World Bank by those countries. It has normalized and non-normalized data for GER (Gross Excluding Reversals-Trade Mispricing) method and CED (Change in External Debt- Balance of Payments) model. Adding these two gives the estimation for illicit financial outflows. Normalization for GER is done by considering outflows in at least 6 years over the 10 year period and has to be great than 10% of exports that year. And, normalization for CED is done by considering outflows greater than 10 percent of exports that year. Unrecorded capital leakages through the balance of payments (CED component) capture illicit transfers of the proceeds of bribery, theft, kickbacks, and tax evasion. The GER method captures the outflow of unrecorded transfers due to trade mispricing.

Anyway, lets look at non-normalized figures only. Nepal ranked 83rd our of 157 countries in terms of the amount of cumulative illicit financial outflows over 2000-2009. In South Asia, Nepal is ranked fourth with US$6.04 billion illicit outflows. India (US$128.43 billion) ranked first, followed by Bangladesh (US$16.28 billion), and Pakistan (US$14.49 billion). Illicit financial outflows from Sri Lanka over the same period was US$2.99 billion, Afghanistan US$1.71 billion, Maldives US$1.35 billion, and Bhutan US$0.16 billion.

The main drivers of illicit financial outflows are bribery, proceeds of corruption, and trade mispricing. In Nepal’s case, trade mispricing cost US$4.940 billion to the nation over 2000-2009, an average of US$494 million each year. Rather than the discrepancy in balance of payments (in other words, unrecorded leakages), trade mispricing is the primary contributor to illicit financial outflows. Between 2000 and 2009, approximately 82 percent of the total illicit financial outflows from Nepal was due to trade mispricing. The same figure for developing countries over the same period is 53.9 percent.

No wonder there was furor over the fake VAT bill scam, import over-invoicing (illicit outflows from a country will be indicated if the country’s imports are overstated with respect to world exports to that country), export under-invoicing (illicit outflows from a country are indicated whenever exports of goods from that country are understated relative to the reporting of world imports from that country adjusted for the c.i.f. factor), and misappropriation of Indian currency. Lately, the Inland Revenue Department (IRD) has completed investigation against 413 of the total 518 cases under investigation. The IRD´s crackdown against the fake VAT receipt scam in December 2010 had revealed widespread use of fake VAT receipt and had estimated the cost to be around Rs10 billion (over $135 million). Hopefully, the latest anti money laundering initiatives will help stem illicit financial outflows from Nepal.

If you are wondering what this means, let me put it in perspective: The total sum of illicit financial outflows from Nepal over 2000-2009 is 7.25% of GDP, 46.31% of exports of goods and services, 415.48% of public health expenditure, 84.75% of all ODA received, and 156.25% of public education expenditure over the same period.

More from the report:

Illicit financial outflows from developing countries in 2009 was between US$775 billion and US$903 billion. This figure is actually a drop from previous illicit financial outflows of between US$1.26 trillion and US$1.44 trillion in 2008. It was caused mainly by a decrease in international trade volume, FDI and new external loans. The report argues that the decrease in illicit outflows has nothing to do with government action to stop it. The report states that the illicit outflows are approximately 10 times the amount of official development assistance (ODA) going into developing countries.

The main factors leading to illicit financial outflows are bribery, kickbacks and the proceeds of corruption in MENA and developing Europe . However, trade mispricing is the main channel for such flows out of Asia and the Western Hemisphere. Trade mispricing (to avoid duties or taxes) accounted for 53.9 percent of cumulative illicit flows from developing countries over the period 2000-2008.

Illicit outflows from Africa increased by 22.3 percent, Middle East and North Africa (MENA) by 19.6 percent, developing Europe by 17.4 percent, Asia by 6.2 percent, and Western Hemisphere by 4.4 percent.

Asia accounted for 44.9 percent of total illicit flows from the developing world followed by Middle East and North Africa (18.6 percent), developing Europe (16.7 percent), Western Hemisphere (15.3 percent), and Africa (4.5 percent).

Illicit outflows from China was US$291.8 billion in 2009, the highest of any other country. Between 2000 and 2009, cumulative illicit financial outflows from China was US$2.74 trillion.

The report states that increasing transparency in the global financial system is critical to reducing the outflow of illicit money from developing countries. It recommends the following to control illicit financial flows:

  • curtail trade mispricing
  • require country-by-country reporting of sales, profits and taxes paid by multinational corporations
  • require confirmation of beneficial ownership in all banking and securities accounts
  • require automatic cross-border exchange of tax information on personal and business accounts
  • harmonize predicate offenses under anti-money laundering laws across all Financial Action Task Force cooperating countries

Here is how South Asian countries (and China) stand on illicit financial outflows ranking:

Country rankings by largest average non-normalized (High-End) IFFs estimates
Rank (out of 157 countries) Country Average of 2000-2009, USD million
1 China 273700.15
15 India 12842.98
58 Bangladesh 1628.07
62 Pakistan 1449.46
83 Nepal 604.01
98 Sri Lanka 299.01
111 Afghanistan  171.49
115 Maldives 134.50
139 Bhutan 31.24

Tuesday, December 13, 2011

Pros and cons of privatization

Here is an interesting piece on privatization and sale of assets by John Quiggin, who is a professor of economics at the University of Queensland and author of Zombie Economics.

The balance between the public and private sector is always changing, so privatization is not of itself good or bad. The only general answer to the question of whether to sell public assets is: “It depends.” Before looking at the central arguments that determine the desirability of privatization in any given case, it is useful to consider the policy in its historical context.

With the emergence of sovereign debt problems as a central policy concern, however, privatization is back on the agenda. Selling assets seems to be an easy way for governments to raise cash. Meanwhile, economic arguments about the costs and benefits of private and public ownership remain unresolved, and have been further complicated by the challenges to economic theory posed by the financial crisis.

While there are many arguments for and against privatization in particular cases, in general the most common argument for privatization is that it provides hard-pressed governments with a source of ready cash. But this argument is not as clearcut as it might seem. Selling an asset yields an immediate financial benefit, but it requires governments to forgo the earnings or services the asset would otherwise have generated.

The obvious question is whether the proceeds from selling an asset are more or less than the value of the earnings forgone. In principle, this is a straightforward question. We can look at the amount of interest saved if the proceeds from the sale were used to repay public debt and compare those savings to the earnings that would be generated under continued public ownership. Alternatively, but equivalently, we can convert a projected stream of future earnings into a present value, discounted at the rate of interest on public debt. If the proceeds from the sale exceed the present value of forgone earnings, privatization has improved the government’s fiscal position.

There are two factors that will determine the outcome of an exercise of this kind:

First is the operational efficiency of the firm under private and public ownership. In general, a firm operating in a competitive market will do better under private ownership. However, if the market requires extensive regulation—to deal with monopoly or externality problems—the advantages of private ownership are diminished and may disappear.

Second is the relative cost of capital, taking appropriate account of risk. In general, even after allowing for default risk, governments can borrow more cheaply than private firms. This cost saving may or may not outweigh the operational efficiency gains usually associated with private ownership.

Still, it remains relatively rare to see privatization subjected to this simple empirical test. I have analyzed a number of Australian and British privatizations of the 1980s and 1990s and found that very few of them increased public sector net worth (Quiggin, 1995; 2010). The privatizations undertaken by the Thatcher government, widely applauded at the time, were among the worst in terms of their effects on the net worth of the public sector. Most notable was the sale of 50 percent of British Telecom for a mere ₤3.7 billion, at a time when its pretax earnings were about ₤2.5 billion a year.

So, when is sale of public assets desirable?

First, like all large organizations, governments have changing goals and objectives. Assets that were useful in one context may be superfluous in another. For example, as the U.S. military has become smaller and more professional, the need for army bases has declined, and some have been closed and sold. Rational asset management makes sense regardless of views about privatization and public ownership.

Second, some enterprises are unprofitable under public ownership, perhaps because of political constraints on such matters as hiring and firing, but can be sold to private investors who are not subject to these constraints. In cases of this kind, there is a clear fiscal benefit. However, it is important to consider whether the constraints in question are inherent in public ownership and whether the question of structural reform can be separated from that of private or public ownership.

Finally, if a government is in such dire straits that it can no longer borrow at the prevailing low rates for high-quality public debt, often it makes sense to sell income-earning assets. The interest saved is more than the earnings forgone. In cases of this kind, privatization may take place at fire-sale prices—not an optimal outcome. A preferable alternative is for international lenders such as the IMF to provide liquidity while efficient adjustments (including asset sales where these pass the benefit-cost test) are undertaken.

The verdict

In general, however, the idea that governments can improve their financial position to any significant degree by selling assets is an illusion arising from a focus on accounting numbers rather than economic realities. The economic argument for privatization is that it will lead to more socially efficient provision of goods and services, more competitive markets, and greater responsiveness to consumer needs and preferences. The strength of this argument, and of counterarguments based on market failure, varies from case to case.

The strongest case for privatization arises in the wake of rescues like that of General Motors in the United States and, several decades earlier, of Rolls-Royce in the United Kingdom. Firms like these, operating in competitive markets and with no particular need for regulation, never belonged in the public sector. In the ordinary course of events, faced with severe financial difficulties, they would have gone out of business. However, given their iconic status, governments were willing to risk public money to keep them going. In both these cases, the rescue was successful and the firms were returned to private ownership.

[…] In summary, privatization is valid and important as a policy tool for managing public sector assets effectively, but must be matched by a willingness to undertake new public investment where it is necessary. As a policy program, the idea of large-scale privatization has had some important successes, but has reached its limits in many cases. Selling income-generating assets is rarely helpful as a way of reducing net debt. The central focus should always be on achieving the right balance between the public and private sectors.

Monday, December 12, 2011

Why Do Voters Dismantle Checks and Balances?

Voters often dismantle constitutional checks and balances on the executive. If such checks and balances limit presidential abuses of power and rents, why do voters support their removal? We argue that by reducing politician rents, checks and balances also make it cheaper to bribe or influence politicians through non-electoral means. In weakly-institutionalized polities where such non-electoral influences, particularly by the better organized elite, are a major concern, voters may prefer a political system without checks and balances as a way of insulating politicians from these influences. When they do so, they are effectively accepting a certain amount of politician (presidential) rents in return for redistribution. We show that checks and balances are less likely to emerge when (equilibrium) politician rents are low; when the elite are better organized and are more likely to be able to influence or bribe politicians; and when inequality and potential taxes are high (which makes redistribution more valuable to the majority). We show that the main intuition, that checks and balances, by making politicians “cheaper to bribe,” are potentially costly to the majority, is valid under different ways of modeling the form of checks and balances.

Read the full paper by Acemoglu, Robinson and Torvik (2011).

Friday, December 9, 2011

Top ten exports and imports of India and China

India’s top two export items are petroleum, coal products and manufacturers. China’s top two export items are electronic equipment and machinery and equipment. Meanwhile, India’s top two import items are oil and metals. China’s top import items are machinery and equipment, and electronic equipment. In terms of export value, China is way ahead of India. Also, most of Chinese exports are relatively high value added goods, but that of India are primary commodities. Textile and wearing apparel are top fourth and fifth exports of China. The value of electronic and machinery exports of China is 3.6 times higher than the value of textiles and wearing apparel exports. Few years ago, textiles and wearing apparel were the top export times. Seems like China fast moving to export of higher value added items.

India China
Top ten exports to world, 2010 USD bn Top ten exports to world, 2010 USD bn
Petroleum, coal products 37.15 Electronic equipment 427.80
Manufactures n.e.c. 32.63 Machinery and equipment n.e.c 329.62
Chemical, rubber, plastic pro 26.97 Chemical, rubber, plastic pro 125.76
Textiles 15.49 Textiles 112.06
Machinery and equipment n.e.c 13.72 Wearing apparel 98.62
Ferrous metals 10.71 Manufactures n.e.c. 58.00
Wearing apparel 9.23 Transport equipment n.e.c. 56.06
Metals n.e.c. 8.60 Leather products 54.83
Minerals n.e.c. 8.35 Metal products 54.50
Motor vehicles and parts 8.05 Wood products 45.19
Top ten imports from world, 2010   Top ten imports from world, 2010  
Oil 65.51 Machinery and equipment n.e.c 273.94
Metals n.e.c. 33.99 Electronic equipment 197.66
Chemical, rubber, plastic pro 31.15 Chemical, rubber, plastic pro 175.43
Machinery and equipment n.e.c 29.65 Oil 135.30
Manufactures n.e.c. 15.67 Minerals n.e.c. 114.81
Electronic equipment 14.72 Metals n.e.c. 68.45
Minerals n.e.c. 12.91 Motor vehicles and parts 54.56
Ferrous metals 9.46 Ferrous metals 28.09
Petroleum, coal products 7.93 Petroleum, coal products 27.60
Coal 7.23 Oil seeds 26.54

Here is a previous blog post on Nepal’s top export to and imports from India and China.The data is sourced from UNCOMTRADE database using WITS. It is at 2-digit level (GTAP nomenclature).

Wednesday, December 7, 2011

Challenges to railways connection in South Asia

Following the two-day Inter-governmental Committee (IGC) meeting of commerce secretaries of Nepal and India, India has agreed to waive off additional customs duty on 162 Nepali export items.It had imposed an additional customs duty on 331 Nepali exportable items in 2006. It waived off the duty on 169 items in 2008, but continued to impose duty on 162 items. The waiver will come into effect from Mach 2012. It is good news to Nepalese exports exporting goods (such as metal products, steel, iron alloy, copper sheet, yarn, textile and cotton, tea, ginger) to India.

The two sides also agreed to hold a meeting to review the Railway Service Agreement (RSA). Nepal has been pushing for the revision of RSA to pave the way for linking cargo train services between Birgunj dry port and Bangladesh via Rohanpur-Shinghabad route, and Visakhapatnum port in India. It appears that both sides are positive to operationalize Rohanpur-Shinghabad railway line and Visakhapatnam ports at the earliest. Meanwhile, at the 17th SAARC Summit in Addu, the Maldives, the attending heads of state decided to finalize a Regional Railways Agreement and complete the preparatory work on an Indian Ocean Cargo and Passenger Ferry Service by the end of this year. The declaration also decided on early demonstration run of a Bangladesh-India-Nepal container train.

Establishing railways link between nations is not an easy task because each time a train passes through a country it is under different jurisdiction, and the operating cost and hence pricing could be different in the connected countries. There has to be transnational railways policy coherence to run such arrangements smoothly and successfully. And, ensuring this coherence is more of political stint than anything else. It would require political will to let the transnational railways system run by an independent body that can fix prices and operate under set guidelines under different jurisdictions.

Below are three fundamental points outlined by Paul Collier in a discussion related to transnational railways initiative in Africa. It is relevant to the proposed railways connection in South Asia (and between Nepal and India).

Railways are a primary example of a network industry. The key feature of a network industry is that its operations are so interconnected that it is more efficient to run it as a single entity. This presents an unavoidable role for public policy: how to manage a monopoly provider in the public interest.

They are a classic example of high fixed costs relative to operating costs. In the parlance of economics, the marginal cost—the cost of producing one more unit—is well below the average cost. For social efficiency, prices should be set around the marginal cost, but for an activity to be commercially viable prices must at least equal the average cost. This tension in pricing calls for a political solution: typically either a subsidy from the government or cross-subsidization from users who are not very price sensitive to those who depend on cheap rail service.

The mainland continent of Africa is split into so many countries that inevitably rail lines need to be international, especially because many of the countries that would benefit most are landlocked. Yet a transnational network investment is potentially at risk from each national polity. Indeed, each time rolling stock crosses borders a valuable asset moves into a new jurisdiction.

Because African governments have yet to tackle these three political challenges, the African rail network remains inadequate.

Tuesday, December 6, 2011

Spurring growth in Nepal during crisis

Here is the PowerPoint presentation I used during a guest lecture at Department of Conflict, Peace and Development Studies, Tribhuvan University, Kathmandu, Nepal.

Spurring Growth During Crisis_2011-12-05