Article on Alternative perspective on Economic Development

The Kathmandu Post (Jan 23, 2011)

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No invisible hands here

Kalpana Khanal, Prakash Kumar Shrestha

KATHMANDU, JAN 22 -
Nepal is now at a historical juncture of exploring a new path for economic development and peace building. In addition to the political agenda, economic issues should get space to shape the path of long-awaited and elusive economic development in Nepal.

Even after more than three decades of state-led development efforts and more than two decades of market-based economic policies, Nepal is still at the bottom of the development ladder with widespread poverty and unemployment. The economic liberalisation process initiated from the mid-1980s pushed the country into a decade-long internal armed conflict in 1996, resulting in a fragile political system. With the initiation of the peace process in 2006 and the declaration of a republic in 2008, Nepal is now recuperating from the shock of internal conflict, and in search of not only a new political system, but also a new way of attaining economic development.

Nepal initiated state-led development in 1956. However, after facing a balance of payments (BOP) deficit for three consecutive years in the first half of the 1980s, Nepal adopted an economic liberalisation process by implementing Structural Adjustment Programme in the mid-1980s. Then it pursued the International Monetary Fund and the World Bank’s prescription based on the Washington Consensus. Economic liberalisation policies embraced include privatisation of state-owned enterprises, market-determined price system, trade liberalisation, financial sector liberalisation and fiscal consolidation.

Consequently, Nepal has become one of the most liberalised countries in South Asia. On the contrary, economic performance has been dismal with low economic growth and denigrated living standards. It can be claimed that the economic liberalisation process has eroded the industrialisation base and ignited deindustrialisation of the Nepali economy. While Nepali markets have been flooded with imported goods, the capacity to compete in the exports market has not been strengthened.

Despite the implementation of three structural adjustment programmes and one Poverty Reduction and Growth Facility (PRGF) programme, Nepal still ranks 193rd in the world, with a per capita GDP of US $470. To the surprise of many market proponents, in the middle of implementation of the economic liberalisation process, Nepal plunged into the internal armed conflict in 1996 fuelled by an army of the deprived and unemployed. Neo-liberalisation policies mainly focused on macroeconomic stability, bypassing employment generation and poverty alleviation under the false belief of a trickle down effect.

Nepal was at par with East Asian economies like South Korea, Malaysia, Singapore and Thailand in the 1960s. The development gap widened in subsequent years, thus falsifying

the notion of neo-classical convergence proposition. Nepal still faces problems of limited productive land base, a landlocked location, dismal industrialisation, a weak export base, low per capita GDP growth, and a slow transition from a subsistence agricultural economy. The share of agriculture in GDP is still 35 percent and provides employment for two-thirds of the population, but not enough food to feed the whole country.

More importantly, Nepal is one of the lowest per capita consumers of commercial energy—a very critical indicator of industrial and urban development. Nepal has been passing through unprecedented energy crises for the last few years, facing power outages of up to 12 hours every day. As a consequence of this and prolonged political transition, investment has been low resulting in stagnant economic growth. This has also compelled a massive exodus of youth for foreign employment. It is hard to imagine that industrialisation will bring economic growth and development amidst the acute energy crisis. This situation is partly the result of neo-liberal policies of more than the past two decades that minimised the role of government in infrastructure building with hopes that a market-led economy will work through invisible hands to bring market equilibrium.

The developmental experiment in Nepal, and many studies done elsewhere, confirm that market-based development strategies alone do not work in countries like Nepal. On the same note, Chang and Grabel (2004) have suggested three reasons why the Washington Consensus is not desirable. First, the economic policies associated with the neo-liberal agenda have failed to achieve their chief goals and the cost of this failure has done serious harm to the developing world. Second, historical and current evidence supports multiple routes to development. In reality, most of the policies used by successful countries run counter to the policies advocated by neo-liberal economists today. Third, in the face of such evidence, some of those most closely associated with the Washington Consensus (and with neo-liberal policies) have recently attempted to modify their positions.

In this context, it is now necessary to recognise Karl Polanyi’s view that institutions, governance and distribution matter. In the preliminary stage of development, the government should be instrumental in bringing the economy onto a path of development. The state can fail in many dimensions, but as Polanyi (1944) emphasised, it is the central economic actor.

We should ignore the ‘one size fits all’ notion of economic liberalisation policy. In reality, the appropriateness of any particular policy depends on specific national conditions, such as resource endowments, the scarcity of foreign exchange, proximity to key markets, social and political conditions, and so on. Therefore it has to be a genuine task of emerging economists, politicians and policy makers to come up with alternative ideas and to promote feasible alternative policies that already exist in order to enhance rapid economic development that is equitable, stable and sustainable. The poor living in developing countries like Nepal deserve concrete development strategies that can guarantee decent jobs and provide basic infrastructure in the 21st century, not only piles of glossy reports that describe their plight with colourful pictures.



Khanal is a PhD student at the University of Missouri, Kansas City and Shrestha is a PhD student at the New School for Social Research, New York City)



kalpana khanal Prakash Kumar Shrestha

Article on Controlling Inflation

Breaking the bank

PRAKASH KUMAR SHRESTHA

Published on January 17, 2010

Recently, people have shown concern over the relatively high inflation in Nepal. After having low inflation averaging 3.6 percent from 2000 to 2005, inflation began to rise and reached levels as high as 13.2 percent in the fiscal year 2008/09, before sliding down to 10.5 percent in 2009/10. Recent data published by Nepal Rastra Bank (NRB) showed that as of mid-November 2010, annual inflation was 8.4 percent. In the news media, NRB has been blamed for not controlling inflation (see TKP Dec. 06, 2010, Fighting Inflation).

The NRB Act 2002 has clearly entrusted the NRB with the job of maintaining price stability and balance of payments (BOP) consolidation (external sector stability) through monetary policy, being fully influenced by the neo-classical notion of inflation determination. The belief that monetary policy can determine inflation is based on the Quantity theory of money. This is a closed-economy theory where money supply is proportionally related to price level if the economy is in full employment.

Another theory, the monetary approach to balance of payments in an open economy, shows the relation between money supply and balance of payments (BOP). In fact, both relations work when money is used solely for transaction purposes—where any finance motive is completely ignored. In other words, such a direct relationship only exists, for instance, when a helicopter drops a bounty of money in a place with no existing financial institutions. Though it may be common for people to blame the NRB after looking at the NRB Act 2002, a closer look at the determinants of inflation in countries like Nepal reveals that these notions of neo-classical inflation determination do not work. Criticism of the NRB is not enough to contain inflation.

In 2009, an expansion of monetary aggregates seems to have been accompanied by higher inflation, but a long-run relationship between the two is not strong in Nepal. Many empirical studies in Nepal have shown a weak relationship between money supply and price levels. Rather, inflation in Nepal is impacted primarily by inflation development in India on account of geographical proximity and the pegged exchange rate regime.

Despite the fact that inflation distorts price signals and leads to resource misallocations, Friedman’s hypothesis that inflation is always a monetary phenomenon may not be true—supply and cost play an equally important role in determining economic inflation. According to the heterodoxy school of thought, inflation does not necessarily have a monetary origin. In this context, post-Keynesians prefer to utilise income policy to control inflation taking into consideration cost-push inflation and the wage-price spiral.

The Nepali economy is at a historical crossroads—passing through a prolonged political transition it currently lacks an investment-friendly environment. Once we look at the disruptions to continuous supply caused by a series of strikes and blockades, low production, the energy crisis and so on, it is not strange to see high inflation in Nepal. Luckily, we haven’t experienced hyperinflation as has been observed in Latin American countries. The highest inflation recorded in Nepal was 21.2 percent in 1991/92 as the economic liberalisation process gained momentum. Given the structure of our economy—low industrialisation and rain-fed agriculture production—containing inflation to less than five percent is hard enough.

How can monetary policy bring down inflation? Following the neo-classical principle, one could argue for increasing interest rates or sucking up liquidity to lower the growth of money supply in the economy. Since last year, interest rates have already risen substantially and pleading for a further

rise in interest rates to combat inflation would be a disaster for the economy. Some productive areas like hydropower construction have already

faced growing production costs due to rising interest rates, with increasing challenges in obtaining credit. It seems this may protract the period of dark-ages in Nepal.

Moreover, sucking up liquidity to tighten the monetary policy will further aggravate the liquidity crunch, which the banking system has been facing for over a year. If the interest rate continues to grow, it may lead to a financial crisis through loan defaults and insolvency. Arguing for a tight monetary policy rests on the false belief that no economic agent ever defaults. As the land prices slide and transactions slow with rising interest rates, borrowers will certainly begin to default on their loan payments, sending a ripple effect across the financial sector.

One cannot deny that an attempt to lower inflation by raising interest rates may itself have an inflationary and redistributive effect. Rising interest rates may promote inflation, especially when firms are highly indebted, by increasing the cost of production. A tight monetary policy will increase the income received by the financial sector at the expense of the indebted sector.

In this situation, monetary policy alone is not enough to curb inflation. But it can be controlled to some extent by ensuring the smooth supply of goods and by strengthening agricultural production, which requires effective law and order and a strong government support system. However, such an effective governance system is not likely in the near future. Since people have a disinterest in agricultural activities, monetary policy does not seem to control impending further inflation, which is going to be emanating from globally rising food prices. Having lower inflation in Nepal will remain an illusion. Any improvements will require a joint effort from all stakeholders.

Shrestha is a PhD student at The New School for Social Research, New York