Friday, November 14, 2014

Historical path and growth forecast: Regression to the mean

Lant Pritchett and Lawrence Summers argue that growth forecasters should taken into account the potential of a slowdown in China and India, especially their growth averaging towards the mean based on both internal (institutions) and external conditions (commodity prices, climate change, geopolitics, etc).

Excerpts from the paper:

Regression to the mean is the single most robust finding of the growth literature, and the typical degrees of regression to the mean imply substantial slowdowns in China and India. relative even to the currently more cautious and less bullish forecasts.

India and, even more so, China are experiencing historically unprecedented episodes of growth. China’s super-rapid growth has already lasted three times longer than a typical episode and is the longest ever recorded. The ends of episodes tend to see full regression to the mean, abruptly.

It is impossible to argue that either China or India has the quality institutions that have been associated with the steady dynamic of growth in the currently high productivity countries. The risks of sudden stops are much higher with weak institutions and organizations for policy implementation. China and India have very different modalities of this risk, but both have tricky paths to continued prosperity.

We suggest several implications of these conclusions. First, there will be a strong tendency to assume that, if growth slows substantially in China or India, it will represent an important policy failure. This is not right. Regression to the mean in a decade or so is the rule, not the exception. What would require much more explanation would be continued rapid growth, which would be very much outside the general run of experience. Second, those making global projections should allow a very wide confidence interval with respect to growth for countries whose current growth rates are far from the mean. Given the sensitivity of commodity demands in particular to growth rates in Asia, this suggests substantial uncertainty about the medium-term path of commodity prices. In the same way, forecasts of global energy use and climate change impacts should also recognize the possibility of discontinuities in Asia. Third, much geopolitical analysis has focused on the implications of a rising China, and certainly Chinese international relations theorists have extensively studied past rising powers. Contingency planning should also embrace scenarios in which Chinese growth slows dramatically, presumably bringing with it a range of domestic and international political implications.

Saturday, November 8, 2014

Minimum wage and productivity in Nepal and South Asia (plus China)

Here is an update on the minimum wage and labor productivity in South Asia (plus China). In 2012, in a series of blog posts (here and here— also, here and here), I indicated that the minimum wage in manufacturing sector in Nepal is the highest in South Asia. The latest updated data (sourced from DB2015) shows India’ and Pakistan’s minimum wages above Nepal’s.

At US$95 per month in 2014, the minimum wage in Nepal was the third highest in South Asia. The minimum wage in India and Pakistan was $142 per month and $110 per month, respectively. In 2012, Nepal had the highest minimum wage in South Asia. Minimum wage in Nepal has drastically increased from $32.3 in 2007— a 194% growth over 2007-2014.

Relative to Nepal’s level (=100 in the chart below), minimum wages in China, India, and Pakistan are higher. Sri Lanka had higher minimum wage than Nepal in 2013.

However, productivity has not kept pace with the increase in minimum wage. Compared to 2007, labor productivity (measured by the ratio of minimum wage to value added per worker – not a perfect indicator, but its okay for indicative purpose!) in Nepal decreased by 18%. In fact, India and Pakistan also saw a decline in labor productivity over the same period. Sri Lanka and China saw increase in labor productivity. The ratio of minimum wage to value added per worker in 2007 was 0.8, which increased to 0.9 in 2014 (a higher value indicates lower labor productivity). Note that value added per worker is also affected by quantity and quality of other inputs, particularly raw materials and physical and social infrastructures (electricity, transport, educated workforce, healthcare, etc). The average value added per worker is the ratio of an economy’s GNI per capita to the working-age population as a percentage of the total population.

Nepal’s labor productivity is the lowest in South Asia. The chart below shows South Asia’s (plus China’s) labor productivity relative to Nepal’s in 2013 and 2014. All of them have better productivity than Nepal’s. India’s and Nepal’s labor productivity seems to be converging lately. This opens up an opportunity to relocate manufacturing firms to Nepal as wages are lower here and productivity is pretty much similar. IF the other inputs listed above are reasonably supplied in Nepal (plus reasonable degree of political stability), there is no reason to doubt that an increasing number of firms may opt to base their manufacturing plants here.

Lower (competitive) wages and higher labor productivity attract domestic and foreign investment, which help to boost jobs creation and economic growth. Nepal’s formal sector labor market suffers from a high degree of unionism (often politically motivated and at times violent), which has resulted in the closure of many domestic as well as multinational firms. Overall, manufacturing sector has been weakening over the past several years. Its share of GDP declined to an estimated 5.6% in FY2014 from 8.2% of GDP in FY2002. The average growth rate has been a mere 3.2% in the last five years. Here is a related blog post on this issue.

Wednesday, October 29, 2014

Doing Business 2015: Nepal ranked second in South Asia (globally, 108 out of 189 economies)

In its latest Doing Business 2015: Going Beyond Efficiency, the WBG has ranked Singapore as the top economy in terms of ease of doing business. The other top ranked economies are New Zealand, Hong Kong SAR (China), Denmark, the Republic of Korea, Norway, the United States, the United Kingdom, Finland, and Australia.

The report ranks economies based on performance in ten indicators: starting a business, dealing with construction permits, getting electricity, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts, and resolving insolvency. This data for this year’s report covered regulations measured up to 01 June, 2014.

Tajikistan was the global top improver in 2014. The other economies that have made the most progress in several areas of regulation last year were Benin, Togo, CĂ´te d’Ivoire, Senegal, Trinidad and Tobago, the Democratic Republic of Congo, Azerbaijan, Ireland and the United Arab Emirates.

Doing Business in South Asia

In South Asia, Sri Lanka made the most progress and was ranked 99 out of 189 economies, followed by Nepal (108), the Maldives (116), Bhutan (125), Pakistan (128), India (142), Bangladesh (173) and Afghanistan (183).

The regional average (rank) is 134 in DB2015.

Rankings could go up or down depending on progress in business regulatory environment, progress by other economies (based on data revisions and methodology) and addition of new economies in the ranking (last year Libya, Myanmar, San Marino, and South Sudan were added).

This year 7 changes were made: (i) DB ranking is based on distance to frontier scores; (ii) data of 2 cities were taken into consideration for economies with over 100 million population; (iii) methodology was revised for getting credit indicator; (iv) protecting investors indicator was changed to protecting minority investors and its scope expanded; (v) resolving insolvency indicator has been expanded; (vi) calculation of the distance to frontier score for paying taxes indictor was changed; and (vii) employing workers indicator was changed to labor market regulations and scope for this expanded. These tend to affect the overall score and hence the rankings. So, this year’s ranking is comparable to last year’s only (DB 2014 ranking was revised based on DB 2015 methodology). However, the scores for these indicators and sub-indicators may still be safely compared to DBs of previous years.

Next year’s DB 2016 will cover quality measures as well (on top of the regulatory measures covered right now), including the quality of building regulations, the reliability of electricity supply, the quality of land administration system, the postfiling process of paying taxes, and the quality of judicial administration system.

Nepal in DB 2015

In terms of ease of doing business, Nepal ranked 108 out of 189 economies. In DB 2014, Nepal ranked 109 out of 189 economies. Between DB2014 and DB2015, Nepal initiated one reform in starting a business, which led to improvement in its ranking in that category by 35 notches. Specifically, Nepal made dealing with construction permits easier by implementing a new electronic building permit system. This pushed up Nepal’s ranking in dealing with construction permits indicator to 91 from 126 in DB 2014. In registering property indicator as well, Nepal’s ranking improved by 2 positions (up from 29 in DB 2014 to 27 in DB 2015). The ranking in all other indicators has gone down.

Doing Business 2015: NEPAL
DB rank 2015 108 out of 189 economies
DB rank 2014 109 out of 189 economies
Indicator ranking
Topics DB 2015 Rank DB 2014 Rank Change in Rank
Starting a Business 104 97 -7
Dealing with Construction Permits 91 126 35
Getting Electricity 85 78 -7
Registering Property 27 29 2
Getting Credit 116 111 -5
Protecting Minority Investors 71 70 -1
Paying Taxes 126 120 -6
Trading Across Borders 171 169 -2
Enforcing Contracts 134 134 No change
Resolving Insolvency 82 78 -4

In South Asia region, Nepal has the best ranking (globally 27) in registering property. It requires 3 procedures, 5 days and 4.8% of property value to register a property in Nepal. The regional average is 6.4 procedures, 99.5 days, and 7.2% of property value.

Registering Property
Indicator Nepal South Asia OECD
Procedures (number) 3 6.4 4.7
Time (days) 5 99.5 24
Cost (% of property value) 4.8 7.2 4.2

In trading across borders indicator, Nepal has the lowest rank in the region.

Trading Across Borders
Indicator Nepal South Asia OECD
Documents to export (number) 11 8 4
Time to export (days) 40 33.4 10.5
Cost to export (US$ per container) 2,545 1,923 1,080
Cost to export (deflated US$ per container) 2,545 1,923 1,080
Documents to import (number) 11 9 4
Time to import (days) 39 34.4 9.6
Cost to import (US$ per container) 2,650 2,118 1,100
Cost to import (deflated US$ per container) 2,650 2,118 1,100

The reform measures initiated by Nepal since 2010 are as follows:

  • DB 2015: Nepal made dealing with construction permits easier by implementing a new electronic building permit system.
  • DB 2014: Nepal made starting a business easier by reducing the administrative processing time at the company registrar and by establishing a data link between agencies involved in the incorporation process.
  • DB 2012: Nepal improved oversight and monitoring in the court, speeding up the process for filing claims.
  • DB 2010: Nepal made transferring property easier by reducing the registration fee. Nepal improved access to credit information by starting to distribute historical data.

Distance to frontier

The report also provides scores for ‘distance to frontier’, which benchmarks economies to the frontier in regulatory practice. In other words, it measures the absolute distance to “the best performance achieved by any economy on each Doing Business indicator since 2005 or the third year in which data for the indicator were collected. The measure is normalized to range between 0 and 100, with 100 representing the frontier.”

When compared across years, the distance to frontier measure shows how much the regulatory environment for local entrepreneurs in each economy has changed over time in absolute terms, while the ease of doing business ranking can show only relative change. DB 2015 ranking is based on distance to frontier score.

An economy’s distance to frontier is indicated on a scale from 0 to 100, where 0 represents the lowest performance and 100 the frontier. For example, a score of 60 in DB 2014 means that an economy was 40 percentage points away from the frontier constructed from the best performances across all economies and across time. A higher score in DB 2015 (say 70) indicates an improvement.

Compared to DB 2014, in DB 2015, in Nepal, there was improvement in starting a business, dealing with construction permits, getting electricity, registering property, and trading across borders. There was no change in all other indictors.

Distance to Frontier (% points)
Topics DB 2015 DB 2014 Change in DTF
Starting a Business 83.01 82.71 up 0.30
Dealing with Construction Permits 71.83 64.87 up 6.96
Getting Electricity 76.07 75.67 up 0.40
Registering Property 83.08 83.03 up 0.05
Getting Credit 35 35 No change
Protecting Minority Investors 56.67 56.67 No change
Paying Taxes 66.52 66.52 No change
Trading Across Borders 36.08 36.07 up 0.01
Enforcing Contracts 49.65 49.65 No change
Resolving Insolvency 45.41 45.41 No change

Finally, Kaushik Basu reflects on being a consumer of DB (as Chief Economic Adviser to the Indian government) and producer of DB (as Senior VP and Chief Economist at the WB):

What I suspected when I was a user of Doing Business, and now know, is that a significant number of the top 30 economies in the ease of doing business ranking come from a tradition where government has had quite a prominent presence in the economy, including through the laying out of rules to regulate different dimensions of the activities of the private sector. However, all these economies have an excellent performance on the Doing Business indicators and in other international data sets capturing various dimensions of competitiveness. The top-performing economies in the ease of doing business ranking are therefore not those with no regulation but those in which governments have managed to create rules that facilitate interactions in the marketplace without needlessly hindering the development of the private sector. Ultimately, Doing Business is about smart regulations that only a well-functioning state can provide. The secret of success is to have the essential rules and regulations in place—but more importantly to have a good system of clearing decisions quickly and predictably, so that small and ordinary businesses do not feel harassed.

[...] Another common criticism is implicit in the question, If economy x is growing fast, why does it not rank high on the ease of doing business? First, if the ease of doing business ranking were constructed in such a way that it had a very high correlation with GDP or GDP growth, there would be little reason to have a new ranking. We would be able to get our result from looking at GDP or GDP growth tables. Second, this question is often rooted in the common mistake, already noted, of treating the ease of doing business ranking as an all-encompassing measure of an economy’s goodness. It is not. An economy can do poorly on Doing Business indicators but do well in macroeconomic policy or social welfare interventions. In the end, Doing Business measures a slender segment of the complex organism that any modern economy is. It attempts to capture a segment that is representative of other general features of the economy (and effort will be made to improve on this), but the fact remains that an economy can undo the goodness or badness of its performance on Doing Business indicators through other policies.

[...]A poor score should alert a government that it ought to examine its regulatory structure. On the basis of this it may decide to change some regulatory features and policies in ways that may not even directly affect its ease of doing business ranking but nevertheless improve the economy’s performance. If this happens, and there is some evidence that it does, the Doing Business report would be serving its purpose.

Monday, October 27, 2014

Structural transformation and fundamentals: Where does Nepal stand?

Here is an interesting presentation by Prof. Dani Rodrik, who explores new growth strategies in the context of the increasing value added and employment shares of services sector. The main idea is that manufacturing activities still are more important than services sector activities in terms of sustained rise in income per capita, productivity and employment. Links to the new growth strategies presentation by other economists and practitioners here.

The combo (and modified) chart above depicts the nature of structural transformation, investment in fundamentals, and the resulting nature of growth rate in Nepal. While the ‘Asian Tigers’ had high investment in fundamentals and a rapid structural transformation, Nepal is seeing moderate investments in economic fundamentals and a very slow (meaningful) structural transformation, leading to a low growth trap. The challenge for Nepalese policymakers is to transition the economy from (3) to (4) in a generation’s time!

According to Rodrik, rapid structural transformation together with high investment in fundamentals results in rapid and sustained growth.

Fundamentals include:

  • Reasonably stable fiscal and monetary policies [At least indicator wise, Nepal has done reasonably well as revenue is increasing, budget deficit is below 2.2% of GDP and has ended up with surplus some times, public debt is below 30% of GDP, forex reserves are sufficient to cover almost 9 months of imports, current account and balance of payments are mostly in surplus, etc. Unfortunately, these have been possible not due to domestic economic activities, but due to low public expenditure absorption capacity and large remittance inflows]
  • Reasonably business-friendly policies [Nepal’s ranking in Doing Business and other cross-country comparable assessments has been improving. Investors complain more about lack of electricity rather than corruption and labor issues.]
  • Steady investment in human capital and institutions (important for sustaining growth post middle-income level) [As a share of budget, Nepal spends the most in education and spending in health is also one of the highest in the region. However, the expenditure efficiency is a different story.]

[So ‘investment in fundamentals’ is not too bad. But these have not emerged out of domestic economic activities. The relatively sound indicators are due to exogenous factors.]

Structural transformation includes:

  • Labor-absorbing as well as incrementally higher productivity activities (shift from agriculture to industrial activities as well as employment shares).
  • Later on productivity services activities, which would normally require skilled workforce (may create a symbiotic relationship between this and manufacturing, which would use the innovation from the latter to enhance productivity).
  • Unorthodox policies may also work: Export subsidization, protection of home markers, exchange rate management, value addition rules, SEZs)
  • A generally generous global context in terms of technology transfer, market access

[Here, Nepal has ended up with an unusual structural transformation. Most of the GDP growth is coming from non-tradable sectors such as construction, retail and wholesale trade and real estate and housing. The demand for the services sector activities are in turn driven by public expenditure and remittances (see the rise in services sector value added while a premature deindustrialization in the chart below). Tradable sectors such as manufacturing and high-value agriculture activities are not prominent. Worse, more and more workers are shifting to informal activities in services sector until they find jobs overseas. Addressing this will be one of the major economic challenges for the Constituent Assembly II, if the country wants to realize its goal of graduating from LDC status by 2022.]

Note: The first three charts agriculture, industry and services sectors valued added (% of GDP) to the log of per capita GDP of China, India, Nepal, Bangladesh, Japan and South Korea over 1960-2012. The last chart shows the evolution of sectoral value added with respect to log of per capita GDP. It shows that the decline of agriculture sector is accompanied by the increase of services sector while the industrial sector is already declining.

A meaningful structural transformation to sustain a high and sustainable growth in the post-LDC graduation era would require beforehand a strong industrial sector and high value added agriculture and services sector activities, with an employment centric strategy to absorb the surplus labor. To promote higher productivity, high value-added production and high income generation, the agriculture sector requires adequate and appropriate commercialization, provision of necessary infrastructure and technology to link with the industrial sector, and promotion of agribusiness activities such as agro-processing, storage, and warehousing, among others. Similarly, for high productivity and value added services sector activities (alternatively, it also means that fewer folks with high skills can be employed), there needs to be strong backward and forward linkages with the industrial sector along with the narrowing of skills gap required in the market, increase in R&D investment to promote innovation, and investment in education and health sectors to boost the capacity of the economy to sustain progress and prosperity. This would partly position and help sustain the industrial sector as an engine of inclusive growth.

Sunday, October 19, 2014

Nepal’s industrialization and global value chain

Here is an abstract from a recent ADB economics working paper by Yurendra Basnett and Posh Raj Pandey:

The world’s trade landscape is being shaped by global value chains, which present new opportunities as well as challenges to developing countries. While large developing countries are leveraging the benefits of global value chains, smaller economies have been less successful. In this paper we examine the constraints faced by Nepal, a land-locked least developed country, in participating in global value chains. We find that weak and ineffective industrial policy has led to de-industrialization, which in turn has reduced productive capacity. The high cost of transport and energy, inadequate provision of public goods and low levels of investment reduce the country’s ability to participate in global value chains. As a land-locked country, Nepal is dependent on regional neighbors for access to global markets. Shallow regional integration, the prevalence of non-tariff barriers, and inefficient transit trade further disadvantage Nepal.

Tuesday, October 14, 2014

Manufacturing-led growth is still more powerful than services-led growth in low-income countries

Dani Rodrik is skeptical that “a services-led model can deliver rapid growth and good jobs in the way that manufacturing once did”. Excerpts from a recent article on why productivity gains in services sector activities are self-limiting and mostly lower than in manufacturing sector. It has to do with the nature of services activities, which are mostly low value added, low productivity and non-tradable type in low-income countries.

Two things make services different from manufacturing. First, while some segments of services are tradable and are becoming more important in global commerce, these typically are highly skill-intensive sectors that employ comparatively few ordinary workers.
Banking, finance, insurance, and other business services, along with information and communications technology (ICT), are all high-productivity activities that pay high wages. They could act as growth escalators in economies where the work force is adequately trained. But developing economies typically have predominantly low-skilled labor forces. In such economies, tradable services cannot absorb more than a fraction of the labor supply.
That is why, for all of its success, the ICT sector in India has not been a primary driver of economic growth. By contrast, traditional manufacturing could offer a large number of jobs to workers straight off the farm, at productivity levels three to four times that in agriculture.
In today’s developing countries, the bulk of excess labor is absorbed in non-tradable services operating at very low levels of productivity, in activities such as retail trade and housework. In principle, many of these activities could benefit from better technologies, improved organization, and greater formalization. But here the second difference between services and manufacturing comes into play.
Partial productivity gains in non-tradable activities are ultimately self-limiting, because individual service activities cannot expand without turning their terms of trade against themselves – pushing down their own prices (and profitability). In manufacturing, small developing countries could thrive on the basis of a few export successes and diversify sequentially through time – t-shirts now, followed by the assembly of televisions and microwave ovens, and on up the chain of skill and value.
By contrast, in services, where market size is limited by domestic demand, continued success requires complementary and simultaneous gains in productivity in the rest of the economy. Focusing on a few sectors yields no quick winning opportunities. Growth therefore must rely on the much slower accumulation of economy-wide capabilities in the form of human capital and institutions.

2014 Noble Prize in Economic Sciences for Jean Tirole

The 2014 Noble Prize in Economic Sciences is awarded to French economist Jean Tirole of UniversitĂ© Toulouse 1 Capitole “for his analysis of market power and regulation”.

Here is the Nobel committee’s brief on his work and here is the detailed explanation. His main theoretical contributions is related to the understanding and regulation of industries with a few powerful firms (oligopoly), which influence prices, volume and quality. His research has helped governments to design regulations "so that large and mighty firms will act in society's best interest" and that there is a need to ensure that different industries may require different regulations. Other important issues that has Triole’s contributions in microeconomics are market failures, oligopoly, asymmetric information, game theory, competition regulation and industrial organization, procurement theory and optimal contracts. More on the depth and breadth of his work is outlined here and here.

Excerpts from the Nobel committee's brief:

Price caps can provide dominant firms with strong motives to reduce costs – a good thing for society – but may also permit excessive profits – a bad thing for society. Cooperation on price setting within a market is usually harmful, but cooperation regarding patent pools can benefit everyone involved. The merger of a firm and its supplier may lead to more rapid innovation, but it may also distort competition.
To arrive at these results, a new theory was needed for oligopoly markets, because not even extensive privatization creates enough space for more than a small number of firms. There was also a need for a new theory of regulation in situations of assymetric information, because regulators often have poor knowledge of firms’ conditions.
Tirole’s research would come to build upon new scientific methods, particularly in game theory and contract theory. There were great hopes that these methods would contribute to practical policy. Game theory would aid the systematic study of how firms react to different conditions and to each other’s behavior. The next step would be to propose appropriate regulation based on the new theory of incentive contracts between parties with different information. However, even though many people could see the research questions, they were difficult to solve.
Jean Tirole’s research contributions are characterised by thorough studies, respect for the peculiarities of different markets, and the skilful use of new analytical methods in economics. He has penetrated deep into the most central issues of oligopolies and assymetric information, but he has also managed to bring together his own and other’s results into a coherent framework for teaching, practical application, and continued research. Tirole’s emphasis on normative theories of regulation and competition policy has given his contributions great practical significance.