• Episode II: The subsidy that doesn’t work

    Upon general reflection, the state subsidy programs of Nepal Government to expand the affordability of certain fundamental goods & services such as basic education and health, or to improve competitiveness in agriculture sector, etc. haven’t been quite successful. In fact, the inability of the state to efficiently administer its costly subsidy programs, and the consequent compromise of value-adding investments to other sectors of the wider economy seem to be doing more harm than good. The programs have not only hindered the access and growth of targeted sectors, but also have widely distributed the massive cost of operating such programs among wider participants such as taxpayers and other economic sectors that have very little stake on administered programs. In this write-up, we will scrutinize the state subsidy in fertilizer trading to validate our claims.

    Fertilizer sector observed a deregulation of the state monopoly in fertilizer import and distribution from 1997/98 to 2007/08. While the deregulation did allow free competition against the state-owned Agriculture Inputs Company Limited (AICL), the persistence of state-subsidy in fertilizers unfairly challenged the profitability for private players. After all, the prices of the state-subsidized fertilizers were still below the cost they were procured at, thus leaving no profit potential and room for competition. So, the opportunity for enhancing competitiveness & innovation in the fertilizer trading business through free competition was refused by the state-subsidy system even though deregulation took hold. Besides, given the fact that this subsidy program cost a whooping NRs 23.19 billion in last 7 years (FY2065/66 to FY2071/72), the intensity of this burden among the taxpayers and the overall economy also appears to be phenomenal.

    In general, state subsidy in agriculture or fertilizer is basically motivated with the convention that economic prosperity in Nepal can only initiate through Agriculture development. Thus, the idea of competing & substituting cheap foods imports from India and third countries through domestic produces supported via state-subsidy programs is well subscribed to by the state. But given the assertion by Nepali Times in an article published in Jan 2016, agriculture productivity has only increased by 3.36% on an average in the last five years (from 2010 to 2015) even though the subsidies to farmers have risen by almost 500% within the same period. And this statistical figure resonates acute failure of agriculture subsidy program of the state to assist agriculture development.
    Furthermore, the purpose to externally preserve an incompetent sector by spilling other people’s hard-earned fruits of labour (via taxing) is self-defeating. After all, submitting to cheap food imports will instead generate more wealth saving that will eventually enable greater investment in areas where the market would find more economic value and comparative advantage. So, prosperity seems to be more promising in letting wealth channel in areas of actual economic potentialities with comparative advantage than attempting to rescue a sector dogmatically while denying the opportunity of cost saving.

    In countering the argument that enough food should be produced domestically to maintain food security or buffer, encouraging higher consistency in cross-border trade to assure continuous supply would be more efficient than simply employing more wealth unproductively. Given that our neighbouring food exporting countries are producing more food than their internal demands at the brink of continuous technological improvement, they will definitely carry on with the incentive to export them for economic value after all.

    However, it would be highly unrealistic to expect the state to scrap the entire agriculture subsidy program – mostly due to populist reasons. So, why not reimagine it as a voucher system that can replace direct subsidy programs as it is designed to minimize certain unwanted implications while sustaining the original purpose? Given the fact that voucher systems work on the principle of allowing grants to the ultimate consumers to purchase certain goods/services, it at least assures free competition, grants efficiency, and maintains true reflection of the market by minimizing price manipulation. After all, the vouchers distributed on a need based assessment will let demand-supply mechanism of the market determine the prices, and the private players can gain equal footing to compete with the state. (Potential for voucher systems to achieve such mentioned benefits in area of education in Nepal is well discussed in here and here.)

    The potentiality to trigger a similar mechanism also exists in sectors including agriculture & fertilizers. In fact, the Agriculture Development Strategy (2015-2034) has even envisaged the implementation of the voucher system for similar purposes. However, unless a strategical framework and working procedure is devised for its implementation, it will only be another empty promise of the Nepal government.

    Nevertheless, the voucher system and subsidies are an act of forced wealth redistribution to fund state-support programs, and therefore costs taxpayers despite their lack of direct willingness. In fact, prosperity without state support is possible and New Zealand’s case has been a great evidence for it. While the country experienced overnight scrapping off of its farm subsidies in mid 80s only to witness more farm prosperity, New Zealand has proven that economic sectors can prosper on its own if the sector is adding value to the end consumers. Therefore, state-support system as subsidy to plan development is just a half-baked logic that needs to be reconsidered from a broader perspective.

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  • The unseen cost of Public Expenditure

    It is now a commonplace in Nepal that the public services are in state of despair – the roads are dilapidated, public education & health services are well below par, the civil service is infuriating, and the State-Owned Enterprises are at a sorry state to say the least. And yet, every successive government is obsessed with collecting more and more tax from the people against their hollow over-promising claim of fixing things. This is straight unjust; and very few people have any expectations from the government. If you are any concerned at all, it only provokes you – the taxpayer – to disregard the government entirely.

    The cause of this frustration is not just the bad public service we are receiving – the public service that does not acknowledge the sacrifice of the taxpayers’ fruits labour. There actually is a larger unseen economic loss that each of us is facing. Government generally has to bear a huge administrative cost before it can deliver whatever level of services or public goods it is “supposed to”, and, this inefficiency is even more severe in case of our own government that has to spend as much as 80% of what we pay as tax in order to only fulfill its administrative (to run different administrative units that collect taxes, plan where to send that money, then channel the disbursement of that money, etc. – assuming there is nil corruption) and financing expenses. Thus, it only leaves mere 20% as residue to actually finance its promises of public welfare and services. It is a huge opportunity cost that we are all bearing with. Imagine in how many different ways you could have put the NRs. 100 (say) you pay as tax to use if only you were able to use it as per your own preferences. That NRs. 100 could have been used to serve your own needs and the needs of those others whom you’d have dispersed your wealth across in case you could choose freely where your tax money could be spent.

    But then the government has a justification to that as well. It generally uses the false claim of having generated so much employment (directly and indirectly) through public sector as a pretext to keep its clutches on the wide varieties of services and sectors it is taking charge of. Read the Yellow Book (annual performance review of the state-owned enterprises) produced by the Finance Ministry annually to see how the government often cherishes employment generation as one of the major successes through State-Owned Enterprises despite their sorry state. But in all this fanfare, very less of us realize that genuine employment would be generated anyway in letting the free choice of the taxpayers take hold. After all, Government is simply holding up Human Resources in grossly unproductive sectors that could be mobilized in other industries able to generate output that market values. So, it ultimately means that the effect of doing away with some of the unnecessary service responsibilities undertaken by the state is not plain unemployment, but it is the transition from the kind of employment generated for the sake of generating employment to the kind of employment generated for the sake of generating wealth and employment essential for economic progress. However, it is also obvious that the laid-off employees of the public sector have to get around with self-enrichment if they have to shuffle to industries outside of their former industry.

    Allowing free choice to individuals in terms of how their fruits of labour are consumed has more to offer compared to entrusting the government to fix all our problems, even more so in case of our own country. One of the possible ways to obtain this advantage of free choice would be to reconsider the role of our government, i.e. what services does the government provide to the people If the government has lesser things to do, then it only needs to collect lesser tax, and thus, lesser waste of resources in the form of administrative costs to sustain its structure. This could be a double bonus for Nepal given the government’s weak capacities – it frees up more resources to be spent on other areas, and the government can solely focus on the limited number of jobs that it has to deliver.

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  • On mature reflection

    This article was originally published by Labisha Uprety in The Kathmandu Post on October 2, 2016.

    Shree Namsaling Higher Secondary School, established in 2006BS, is a sizeable community school located in Namsaling, Ilam. It has close to 45 ropanis of land but fewer than 350 students. The place is scenic—misty and cool in the mornings.

    A colleague and I were studying a number of private and community schools in the area. The vice principal of the school was kind and welcoming, and answered all my questions patiently. The teachers were, by and large, genuinely interested in teaching the children. The school-ground, where children played happily, was big enough to take long walks on. But one look at the school’s SLC results, and everything else would seem trivial. The 10th graders in particular were performing dismally, especially in Maths, English and Science. Although I believe that SLC results are hardly the best indicator of a child’s performance, exam results are an important means to assess student progress.

    School politics

    However, what began as an assessment of exam results led to an eventual examination of the power structure between the school management committee (SMC) and the institution. Every school has an SMC, which is largely comprised of parents of those studying in the school. But there is also space for ‘donors’, which is usually used by political parties to step formally into the school. The principal of the school is also part of the SMC; so is one teacher elected from the pool of teachers.

    In a very strange turn of events, none of the community schools we visited had an active principal; all were managed by the vice-principal. One was reportedly away on informal visits, and two had mysteriously failed to turn up at the schools when the audit season came. The money that each community school gets—a sum divided under numerous headings such as salaries and scholarships—requires only the principal’s and the head of the SMC’s signature for mobilisation. It then requires no further monitoring throughout the school year and is examined by auditors at the end of the school year, again handled usually by the principal alone. The audit reports list repair and infrastructure costs. But the teachers state that even classrooms have been without doors for a long time.

    We have been more than aware that problems in public schools stem from management practices and the infiltration of politics in them. Private schools are hardly all virtuous, but they deliver better exam results and are generally not an active political breeding ground. One thing missing from community schools is the effective incentivising of the management system and teachers. This is not to say that all private schools practise this. But public schools could begin with incentivising the management system to educate children better rather than pocketing the change with every other transaction.

    Hire and fire policy

    Teachers in public schools may be better trained than those in private schools, but what good is the training when teacher absenteeism is rife? In particular, those teaching Maths, Science and English seem to continually drop out of public schools and opt for entering the bureaucracy formally, leading to dismal results in these subjects.

    A performance-based salary incentive for the contribution—in terms of time, effort and output—for both the SMC members and teachers would perhaps make for a better model, while also allowing for timely checks on monetary transactions. Though the law has provisions for school inspections, this is a rarity in rural areas, where school representatives frankly said that they had never seen a school inspector during their long service at the school.

    Community schools rank fairly low in terms of exam results, but it would be premature to conclude that they have all failed. There are many examples of how certain public schools have managed to draw students. These schools hire private teachers to fill in teaching gaps and charge students—usually only those who are directly taught by the private teachers—a small fee to pay them. The flexibility to hire and fire staff is important in an education system that should be retaining only the best teachers. Of course, this does not mean people can be fired without due reason and process; it simply means that the mechanism should be in place and practised when the need arises.

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  • Let It Die

    -This article was originally published by Akash Shrestha in Republica on September 26, 2016.

    After the 1990 political change, Nepal embarked on the path of economic liberalization. The private sector would from then on lead the economy, with the government offering growth-boosting policies and laws. In this context, between 1990 and 1996, the country grew by 5 percent a year,  hitting an all-time high of 8.2 percent in 1994. This showed that liberalization works in Nepal if we have liberal policies. So in its ninth five-year plan (1998-2002), the National Planning Commission recommended privatizing 30 state-owned enterprises (SOEs).

    But economic liberalization has not been a smooth sailing for Nepal. We have gone through a decade-long civil war, another decade-long peace-building and constitution-drafting transition and various political movements. Meanwhile, economic policy reforms took a back seat.

    Nepali Congress had led the first wave of economic policy reforms. Today, NC is the largest parliamentary party and controls the Ministry of Industries (MoI), the same ministry that was at the forefront of first wave of economic liberalization. It is therefore interesting that MoI itself is looking to revive some of these sick public enterprises (PEs) that were picked for privatization during the 1990s. The ministry, we are told, aims to revive at least three PEs within this fiscal, including the Nepal Drugs Limited (NDL).

    Some arguments in favor of reviving NDL are: It will ensure availability of quality and affordable drugs to the general public; it will save the government money that would have been spent in procuring drugs from outside; it will send a positive signal to private investors; and that it will help create jobs. Let us look at these assumptions.

    First, government running the NDL will not send a positive message to domestic and foreign investors. NDL is only one drug manufacturer in an industry that has more than 50 registered private enterprises. Most of them are making profits. So private investors are already interested in the drug industry, having spent around Rs 20 billion in it. Private drug-makers today meet half the market demand in Nepal. NDL will struggle to compete in this competitive market.

    Nor will reviving it send a more positive signal to investors. Since NDL is a state-owned enterprise, the rules that apply to private companies do not apply to NDL. NDL neither has to depend on investors for its capital, nor on consumers for its revenue. Therefore, it will put NDL at an unfair advantage.

    Second, it is not true that reviving NDL will save government billions of rupees and ensure quality drugs in the market. Yes, NDL could produce drugs that replace some foreign incumbents. But the impact will be minimal. The government distributes a total of 70 drugs (including antibiotics, medicines for diabetes, high blood pressure and heart diseases) for free, spending big money. Going by NDL’s past record, if it is to produce all these drugs, it will do so at a higher cost than the costs of the private companies. NDL has already accumulated over a billion rupees in losses and another half a billion in unfunded employee retirement liabilities. It owes another billion rupees to the government.

    nepal-drugs-limited_profit_loss

    *Source: SOE Information: Yellow Book, Ministry of Finance, 2002/03 – 2015/16
    ** Data for the year 2012/13 could not be accessed

    As is the case with most other sick public enterprises, NDL was also beset by constant political intervention and mismanagement, before it shut down. Millions of rupees have been injected into it to resume its operations (Rs 50 million four years ago being the latest injection of cash). With that track record, there is little prospect for structural reforms in the NDL. Again, with so many successful private enterprises, do we even need NDL?

    As regards quality, 37 private drug industries in Nepal have the World Health Organization’s Good Manufacturing Practice (GMP) certificates. But NDC is yet to acquire GMP certification.

    Third, of course new enterprises create jobs. But the government is not a productive agent in itself. Rather it is a redistributive agent. And, historically, the government-run state enterprises in Nepal have not been known for their job-creation capabilities. The money that is going to be injected into the NDL is going to come from the national budget, which means from taxes, grants and loans.

    In today’s context, every job that the government creates displaces the job that the private entrepreneurs could have created themselves. Government does not create new jobs, it shifts jobs from one industry to another, and puts the human resources to a less efficient use. If it is employment we are worried about, like Milton Friedman said, we could simply ban the use of machines and make everything manually. Voila! Employment all around.

    Fourth, on balance of payment, we export what is of lesser value in the domestic market and import what is of higher value in the local market. If everybody is gaining in value through this trade, should we be imposing a constraint on economic actors? Alternately, if local producers were producing high-value commodities, we would not need to import them. But in our effort to revive the NDL, we are ignoring the contribution of profit-making enterprises and putting our bet on a loss-making, inefficient enterprise. If it is so much about balance of trade, let’s export all electricity to Bihar and import fashion from there.

    Finally, the Ministry has not clarified if the old structure of the NDL will be retrained. And will it be privatized based on public-private partnership (PPP), management contracting, or cooperative model? Saying that NDL will be privatized is not enough.

    Yes, there are flaws in Nepal’s private sector, which indulge in own anti-competitive practices that have often compromised the well-being of consumers. But it is also true that Nepal as a poor country has serious administrative and fiscal deficiencies. If a government with this scale of administrative and fiscal deficiency tries to do it all, it will result in nothing but failure. The government should rather be acting as a facilitator and a monitor guaranteeing that there is a conducive policy regime, no anti-competitive practices and businesses compete to deliver affordable products.

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  • Examining insolvency in policy and practice

    This article was originally published by Labisha Uprety in The Himalyan Times on September 25, 2016.

    Insolvency is a relatively little used term in Nepal – discussions on it are fairly limited to niche circles of business and/or law. However, insolvency is one of three company exit procedures as allowed by the Nepalese legal system – the first two being cancellation of registration and voluntary liquidation of company. Being insolvent simply means that a company is unable to clear its debts and has been running under alarm-triggering losses for a substantial period of time. The Insolvency Act 2006 governs insolvency dealings in the country and allows for a number of parties to file for insolvency at the Appellate Court: the company itself, or creditors/shareholders/debenture-holders of the company. The regulatory body under which the company is registered (such as the Insurance Board for all insurance companies or the Nepal Rastra Bank for all banks and financial institutions in the country) can also file for insolvency if it has amassed substantial evidence that the company in question is unable to pay its debts. There are two options that a company can undergo once the Appellate Court accepts the case – either liquidation (which would imply selling off all assets to settle debts, and closing the company) or restructuration (modifying operations in order to rescue the business by cutting costs and selling assets or even changing ownership if needed).

    The initial process

    After a case is filed under insolvency, the court will review the evidences and host a hearing in 15 days’ time. During this time period, the company in question is allowed to offer evidence-based counter arguments as to why it should not be declared insolvent and forced to liquidate its assets. When the court decides it has found no reason to stall the insolvency procedure, it will appoint an inquiry officer to re-evaluate the company’s financial state of affairs. This investigation often lasts for a period of 90 days after which the inquiry officer will generate a report explaining whether the company could be restructured or needs to be liquidated. The Appellate Court then, based on the inquiry officer’s report, holds a meeting with the applicant on finalizing the best course of action.

    Increased length of proceedings

    Liquidation under insolvency is the last resort for any company. Naturally then, regulatory bodies or creditors of the company will not have filed for application without substantial homework. In particular, when the insolvency filer is a regulatory body – well aware of government proceedings and following due process – the inquiry official appointment, whose work can again be reviewed by the liquidator makes for redundancy. While appointment for an inquiry official is warranted in cases of body/bodies not too familiar with the due process, the decision to twice review a regulatory body’s decision (first by the inquiry official and second by the appointed manager/liquidator) could be relaxed – for it may only work to lengthen the procedure.

    A separate administration office

    Though the law states that there will be a separate provision for an Insolvency Administration Office, no such office exists even after 8 years of the Act having been passed. Currently a number of functions that the law envisages the new office to take over is being handled by the Office of the Company Registrar. This includes registering insolvency practitioners, and issuing and renewing their licenses. It also includes maintaining insolvent companies records – but the OCR is currently burdened with documentation of over 100,000 shell companies alone. These shell companies’ records are ones that OCR should be looking into in order to cancel their registration but has not been doing so for many years. If the law provisions for a separate administration for insolvency, then this would reduce one set of burden fror the OCR – allowing them perhaps to engage more resources in dealing with shell companies.

    Lack of cross-border insolvency policies

    A remarkable absence in the reigning Insolvency Act is the lack of policies for cross-border insolvency. If a parent company based on borders outside of Nepal closes, what does this mean for its branches here? There is a lack of clear policy options for this particular case, and with Nepal housing a large number of international companies’ branches – options to ease this probable concern is a necessity.

    Insolvency may be thought of as fairly uninteresting – but when a company is insolvent, it means it is sitting on resources that could be freed for other uses. Having a smoother facilitative process would allow for companies and people to use these resources better and create newer ventures and better innovation.

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  • Nepal falls behind in economic freedom

    In the Economic Freedom of the World Report 2016 Annual Report, Nepal ranks 108th out of 159 economies, with an overall score of 6.54 (in a scale of 1 to 10 where a higher value indicates a higher level of economic freedom). Nepal has dropped two places down in the global ranking compared to last year’s ranking. Previously, Nepal ranked 106th out of 157 economies with a score of 6.56.

    EFWR 2016

    Nepal scores in key components of economic freedom are:

    • Size of government: dropped to 7.89 from 8.72 in the last year’s report
    • Legal system and property rights: climbed to 4.79 from 4.33
    • Access to sound money: climbed to 6.43 from 6.42
    • Freedom to trade internationally: climbed to 6.72 from 6.47
    • Regulation of credit, labour and business: climbed to 6.87 from 6.85

    About the Economic Freedom Index

    The Economic Freedom of the World Report is world’s premier measurement of economic freedom, measuring and ranking countries in five areas: size of government, legal structure and security of property rights, access to sound money, freedom to trade internationally, and regulation of credit, labour and business. It measures the degree to which the policies and institutions of countries support economic freedom.

    The Fraser Institute produces the annual Economic Freedom of the World report in cooperation with the Economic Freedom Network, a group of independent research and educational institutes in nearly 100 nations and territories. Samriddhi Foundation is member of the Economic Freedom Network and is a co-publisher of the report in Nepal.

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