Tuesday, May 28, 2013

Nepal fixes minimum wage at Rs 8000 per month, the highest in South Asia

Following tripartite negotiations involving representatives from the government, trade unions and employers, minimum wage in the formal sector has been increased to Rs 8,000 per month, up from the revised Rs 6,200 in 2011. It includes Rs 5,100 as salary and Rs 2,900 as dearness allowance. Previously, the basic salary was Rs 3,550 and the dearness allowance was 2,650.

Basic monthly salary is up by 43.7%, dearness allowance by 9.4%and daily wage by 37.7%. Overall, minimum monthly wages is up by 29 percent. Inflation was 9.6% in FY2011, 8.3% in FY2012 and is estimated to be above 10% in FY2013.

With the new revised wage rate, Nepal will continue to have the highest minimum wage in South Asia. Here is a more detailed look at comparative minimum wage in South Asia.

Now, the challenge is to boost productivity accordingly. Else, Nepal will continue to see the erosion of competitive edge, loosing the already shrinking markets abroad. The cost of production is already high compared to regional competitors. For instance, the cost of production of 60-knot carpet hovers around $80 per square meter in Nepal, but the production cost of the same variety hovers around $45 per square meter in India. It is mainly due to the compulsion to run diesel generators because of lack of adequate supply of electricity, high labor cost, high cost of raw materials, skills gap, strikes, lack of R&D within the private sector, etc. Realistically, some of these supply-side constrains and structural bottlenecks is hard to overcome in the short term. But, some hiccups like skills enhancement, strikes, and labor cost (which is potentially settled for the next two years) can be addressed in the short term itself.

The Minimum Wage Determination Committee has recommended the revised minimum wage to the government for its final approval. As per the Labour Act 1992, workers’ minimum salary is reviewed every two years. According to some estimate, formal sector constitute around 300,000 workers only.

Friday, May 24, 2013

Credit constraints faced by youths and structural transformation

Blattman et al. worked with the Ugandan government and World Bank to randomize large, relatively unconditional cash transfer program in Uganda (Youth Opportunities Program of the Northern Uganda Social Action Fund), and followed nearly 2500 people two and four years afterwards. They found that credit constraints are holding back youths. Excerpts from Blattman’s blog and paper below: 
  • Most start new skilled trades like metalworking or tailoring.
  • Labor supply (employment hours) increases 17%. Those new hours are spent in high-return activities, and so earnings rise nearly 50%, especially women’s.
  • Earnings rise nearly 50%, especially women’s.
  • The people who do the best are those who had the least capital and credit to begin with.
  • Credit constraints seem to be less binding on men, since men in the control group start to catch up over time. Female controls do not, partly because they have worse access to starting capital. With the grant they take off, further even than men. Without it, they stagnate, even more so than men.
  • Despite huge economic effects, there is little impact on cohesion, aggression, and collective action (peaceful or violent). So, public spending on the grounds of social stability cannot be fully justified. But the impacts on poverty and structural change alone probably justify big public investment.

Wednesday, May 22, 2013

China’s and India’s dominance on saving and investment in 2030

The latest Global Development Horizons, published by the World Bank, report titled ‘Capital for the Future: Saving and Investment in an Interdependent World’ projects developing countries’ share in global investment to triple by 2030 to three-fifths, from one-fifth in 2000. It states that improvements in institutional factors will co-evolve with ongoing regional and global integration of developing countries’ financial markets, rendering developing countries much more significant sources, destinations, and potentially also intermediaries, of global capital flows.

By 2030, half the global stock of capital, totaling $158 trillion (in 2010 dollars), will reside in the developing world, compared to less than one-third today. Also, the report estimates the developing world’s infrastructure financing needs at $14.6 trillion between now and 2030.

China and India will be the largest investors among developing countries, with the two countries combined representing 38 percent of the global gross investment in 2030, and they will account for almost half of all global manufacturing investment.

The report notes that productivity catch-up, increasing integration into global markets, sound macroeconomic policies, and improved education and health are helping speed growth and create massive investment opportunities, which, in turn, are spurring a shift in global economic weight to developing countries. It finds that:
  1. Developing countries’ employment in services will account for more than 60 percent of their total employment by 2030 and they will account for more than 50 percent of global trade.
  2. This shift will occur alongside demographic changes that will increase demand for infrastructural services. Indeed, the report estimates the developing world’s infrastructure financing needs at $14.6 trillion between now and 2030.

South Asia: Saving and investment 
  • One of the highest saving and highest investing regions until 2030.
  • In a scenario of more rapid economic growth and financial market development, high investment rates will be sustained while saving falls significantly, implying large current account deficits.
  • By about 2035 is likely to have the highest ratio of working- to nonworking-age people of any region in the world.
  • The region’s share of total investment in manufacturing expected to nearly double, and investment in the service sector to increase by more than 8 percentage points, to over two-thirds of total investment.
Policy implications
  • National policy makers seeking to support investment activity in their economies should concentrate their efforts on establishing a favorable investment climate.
  • Financing for infrastructural projects will pose a major challenge. To meet their future infrastructure financing needs, policy makers in developing countries will need to leverage private sector financing through public-private partnerships as well as tap structured financing from global capital markets.
  • Governments will have to sustainably manage public finances with an eye toward the forthcoming demographic changes.
  • Demographic shifts due to changes in household structure will increase the importance of financial markets in providing for income support during old age.
  • Policy makers in developing countries have a central role to play in boosting private saving through policies to raise educational attainment, especially for the poor.
  • Policy makers will need to prepare for a greater role of capital markets in international financial intermediation and promote the development of domestic capital markets.

Friday, May 17, 2013

Links of Interest (2013-05-17)

Both participants and non-participants have gained as the economy has grown; however, the rates of poverty reduction have been higher for participants.The paper's econometric estimates show significant welfare gains resulting from microcredit participation, especially for women. They also show that the accrued benefits of borrowing outweigh accumulated debt. As a result, households' net worth has increased, and both poverty and the debt-asset ratio have declined.

There is now evidence that, for example, lending by state-owned banks has helped in mitigating the impact of the crisis on aggregate credit. But evidence also points to negative longer-term effects of direct interventions on resource allocation and quality of intermediation. This suggests a need to rebalance the state's roles from direct to less direct involvement, as the crisis subsides. The state does have very important roles, especially in providing well-defined regulations and enforcing them, ensuring healthy competition, and strengthening financial infrastructure. One of the crisis lessons is the importance of getting the basics right first: countries with complex but poorly enforced regulations suffered more during the global crisis. Evidence also suggests that instead of restricting competition, the state needs to encourage contestability through healthy entry of well-capitalized institutions and timely exit of insolvent ones

The impact of a negative rainfall shock on optimal import tariffs is generally ambiguous, depending on the weight placed by the domestic policy maker on tariff revenue, profits and the consumer surplus. The more weight placed on domestic profits, the more likely it is that the policy maker will respond to a rainfall shortage by reducing import tariffs. These findings are robust to alternative assumptions about market structure and the timing of the game. Using detailed panel data on applied tariffs and rainfall for 70 nations, the authors find robust evidence that rainfall shortages generally induce policy makers to set lower tariffs on agricultural imports.

A political process is modeled whereby a promise of low fuel prices is used in democracies to attract voters, and in autocracies to mobilize support among key groups. Subsidies to fuels are viewed as either easier to observe, easier to commit to, easier to deliver, or better targeted at core groups, than other public goods or favors offered by rulers. Easier commitment and delivery than for regular public goods can explain the high prevalence of such policies in autocracies, and also in young democracies where the capacity to commit to or deliver complex public goods is not yet fully developed.

Growth and structural transformation

Structural transformation refers to the reallocation of economic activity across the broad sectors agriculture, manufacturing and services. This review article synthesizes and evaluates recent advances in the research on structural transformation. We begin by presenting the stylized facts of structural transformation across time and space. We then develop a multi–sector extension of the one–sector growth model that encompasses the main existing theories of structural transformation. We argue that this multi–sector model serves as a natural benchmark to study structural transformation and that it is able to account for many salient features of structural transformation. We also argue that this multi–sector model delivers new and sharper insights for understanding economic development, regional income convergence, aggregate productivity trends, hours worked, business cycles, and wage inequality. We conclude by suggesting several directions for future research on structural transformation.

Monday, May 13, 2013

Does microfinance impact development outcomes?

Not necessarily.

According to a new paper, based on randomized evaluation in 104 slums in Hyderabad, by Duflo et al. (2013), microfinance did not lead to “changes in any of the development outcomes that are often believed to be affected by microfinance, including health, education, and women’s empowerment.”

Major findings of the study (extracted from the abstract of the paper):
  • Fifteen to 18 months after Spandana began lending in treated areas, households were 8.8 percentage points more likely to have a microcredit loan.
  • They were no more likely to start any new business, although they were more likely to start several at once, and they invested more in their existing businesses.
  • There was no effect on average monthly expenditure per capita. Expenditure on durable goods increased in treated areas, while expenditures on “temptation goods” declined.
  • Three to four years after the initial expansion (after many of the control slums had started getting credit from Spandana and other MFIs ), the probability of borrowing from an MFI in treatment and comparison slums was the same, but on average households in treatment slums had been borrowing for longer and in larger amounts.
  • Consumption was still no different in treatment areas, and the average business was still no more profitable, although we find an increase in profits at the top end.
  • We found no changes in any of the development outcomes that are often believed to be affected by microfinance, including health, education, and women’s empowerment.

Read the full paper here.

Wednesday, May 8, 2013

Exports and cost of production in Nepal and India

Here is an interesting article about how the rising cost of production and the resulting loss of overseas markets are shifting carpet production from low-end to high-end lately.

Excerpts from the article:

Hurt by rise in production cost of carpets and tough competition in the market, Nepali carpet producers and exporters have shifted focus on high-end carpets on which competition is relatively low.
Nepali exporters are facing tough time retaining their market in overseas countries due to flooding of cheaper low-quality carpets there.
“We are gradually losing our markets for normal carpets. To stay in the business and beat our competitors, we are gradually switching to production and export of high-quality carpet,” Anup Bahadur Malla, president of Nepal Carpet Exporters´ Association, told Republica.
Lengthy economic slowdown in European countries and high competition in US has dragged down the demand for Nepali carpets as customers there prefer cheaper carpets supplied by other countries.
“That is why we are putting focus on high-end carpets on which we have comparative advantage,” said Malla. He further added that share of high-end carpets on total carpet exports has increased to around 50 percent from less than 20 percent recorded a couple of years ago.
Nepali entrepreneurs are producing and exporting 100-knot carpets which are made from a mixture of natural fiber and wool.

Cost of production

Excerpt related to the cost of production in Nepal and India.

Cost of production of 60-knot carpet hovers around $80 per square meter. Production cost of the same variety hovers around $45 per square meter in India, according to the exporters.

It is not that Nepal’s production (export sophistication) is shifting up the value chain due to product innovation and high productivity. The incongruous shift in production to high-end carpets is due to the compulsion arising from the inability to compete in even low-end production— an odd phenomenon given that Nepal still has one of the lowest per capita GDP in Asia and is largely an agriculture-based economy [but high consumption is fueled by increasing remittance inflows, which fund burgeoning imports]. Traditionally, with this sort of income level, comparative advantage should be on the production of low value added goods and services due to cheap labor costs, and as innovation kicks in and income rises, production shifts to high value added goods and services. It is essentially a structural transformation from low value added production, low productivity sectors (usually comparative advantage based) to high value added, high productivity sectors (both comparative as well as competitive advantage based). Also, increasingly high productivity in agriculture sector usually provides a foundation for high growth in industrial sector.

Unfortunately, this is not happening. Due to low growth and the dearth of job opportunities, thanks to protracted political uncertainty and half-hearted policy initiatives on this front, a large number of youths are going abroad for jobs, consequently creating a shortage of workers in almost all sectors. As an upshot of this, share of remittances backed, consumption driven services sector is growing at a rapid pace (about 50% of GDP) while industry sector is squeezing (about 15% of GDP, which is almost equal to the share of retail and wholesale trade).

Some might argue that its like in India where services sector is also huge and growing relative to agriculture and industry. However, in Nepal’s case, the rising share of services sector in GDP is not coming from high value added production (ITC, BOPs, innovation, etc.), but from low value added production, which too is dependent on remittances for growth (exogenous factor). Hence, the whole process is not ‘organic’ but kind of distorted (and without much multiplier effect).

A course correction is needed, which will require boosting productive capacity of the economy (supply-side stuff driven by both public and private investments) and the proper management of increasing remittance inflows so that more of it is spent on capital formation and less on consumption (currently stands at 2.4% and 78.9%, respectively).

Anyway, going back to the faltering exports, below are some of the reasons, mostly arising from rise in production costs (more here):
  • Political instability and strikes, and its impact on production costs
  • Lack of electricity (also see this, this and this)
  • Poor industrial relations, plus highest minimum wage in South Asia but low productivity
  • Lack of innovation and R&D by private sector, and reliance on concessions for survival
  • Policy inconsistency and policy implementation paralysis
  • High inflation, which increases nominal cost of production
  • High cost of inputs (arising from globally high prices and lately the depreciation of Nepali rupee against third currencies)
With this background, the solutions to break this cycle are no-brainer!

Sunday, May 5, 2013

Remittances revisited: Bilateral remittance inflows to Nepal

A lot has already been written about remittances in Nepal. Below I present two charts showing bilateral remittance inflows in 2011 and the total monthly inflows to Nepal over the years. All data sourced from the World Bank’s database and this latest brief.

In 2011, Nepal received an estimated US$4.22 billion in remittance from 30 countries. The top five destinations were Qatar (US$1.69 billion), India (US$1.39 billion), the US (US$276 million), the UK (US$192 million), and Thailand (US$112 million). Remittance inflows in 2011 was about 22% of GDP, making Nepal the six highest remittance receiver (as a share of GDP).

The table below shows the latest estimates of remittance inflows for 2012 (previous estimate here). It is in an increasing trend. Total remittance inflows in 2012 is estimated at US$4.95 billion.

Migrant remittance (US$ million)
Year Inflows Outflows
2008 2727.1 5.3
2009 2985.6 12.3
2010 3468.9 32.4
2011 4216.9 39.2
2012e 4953.3

Nepal's economy is largely dependent on remittances and migration for growth (services sector), consumption, imports, poverty reduction, jobs, and overall macroeconomic stability.

Remittances have been crucial in supporting services sector growth, which then affects overall economic growth. The expansion of services sector to over 50% of GDP is partly attributed to the rise in consumption demand backed by remittances. Its impact is quite visible in sectors such as real estate and housing, financial intermediation, retail and wholesale trade, transportation and communication, hotels and restaurants, and education. Similarly, it has ensured external sector stability by pushing current account and balance of payments in surplus despite ballooning trade deficit. Had it not been for remittances, Nepal would not have been able to afford such a high level of imports (around 25% of GDP). Foreign exchange reserves contribution by remittances is about 63% (24% of GDP). Gross national savings are also high (35% of GDP).

Meanwhile, it has supported revenue mobilization, with about 70% of tax revenue coming from customs duty and consumption tax (consumption fueled imports supported by higher purchasing power due to high remittances).

At the household level, the decline in poverty and inequality (Gini coefficient based on consumption) is largely attributed to increasing remittances, which 56% of households received in 2011. Household consumption is primarily financed by remittances (about 79% of remittance is used for consumption purpose). Similarly, the extra boost to income from remittances has enabled households to send children to private schools and afford better healthcare services.

At the institutional level, it has fostered policy complacency as policy makers do not have to do much to balance the macroeconomy or reduce poverty as it is automatically done by remittances. Unfortunately, it is leading to a ‘vicious policy cycle’—high inflow of remittances is exerting low pressure to improve policy weaknesses, which then is leading to inadequate investment climate reforms and low private investment. It leads to subdued growth rate with limited job opportunities, forcing more migration and more inflow of remittances.

The biggest risk to Nepal’s economy is to sustain this process. Given the lackluster policy attention devoted to this issue, it is unlikely that the policymakers will do anything substantial to address the issues in the near future. Nepal needs to channel remittances to productive usages, especially to finance long term development needs such as infrastructure, urban development and municipal services. The main challenge for the government, private sector, and development partners is to find out a way to decrease remittance income going to consumption and channel it to productive usages. As of now, only 2.4% of remittance income of a household is used for capital formation.

Thursday, May 2, 2013

India’s existing economic institutions could not cope with strong growth: Raghuram Rajan

Raghuram Rajan, the chief economic adviser to India’s Ministry of Finance, argues that economic growth slowed down in India due to two reasons:
  • As India’s existing economic institutions could not cope with strong growth, its political checks and balances started kicking in to prevent further damage.
  • Investment slowdown began as political opposition to unbridled development emerged. The resulting supply constraints exacerbated inflation.

He prescribes the following solutions:
  1. India must improve supply, which means shifting from consumption to investment.
    • By creating new, transparent institutions and processes, which would limit adverse political reaction.
  2. Over the medium term, axe the thicket of unwieldy regulations.
    • One example of a new institution is the Cabinet Committee on Investment, which has been created to facilitate the completion of large projects. By bringing together the key ministers, the committee has coordinated and accelerated decision-making, and has already approved tens of billions of dollars in spending in its first few meetings.
  3. India needs less consumption and higher savings.
    • The government has tightened its own budget and spent less, especially on distortionary subsidies.
    • Households also need stronger incentives to increase financial savings.
      • New fixed-income instruments, such as inflation-indexed bonds.
      • Lower inflation.
      • Lower government spending and tight monetary policy are contributing to greater price stability.