• Cost of Unspent Capital Budget

    A unique trend has emerged in Nepal over the last ten years or so whereby the success of a Finance Minister is measured by the amount of revenue generated by the state during his/her term rather than the soundness and impact of his/her policies. And interestingly, Nepal government has been able to generate higher and higher revenues with every passing year. But has the increased revenue been able to deliver real growth, or greater achievements in development indicators for Nepal? Not quite! And this is where another attribute of Nepal government comes into the scene—greater revenue collection but consistently low capital spending.

    * Source: Financial Comptroller General Office & Nepal Rastra Bank

    Fiscal year Percentage Capital Expenditure (CE) budget in total budget Actual capital expenditure (% of allocated budget for CE) 9-month spending (% of allocated CE Budget)
    2016/17

    30

    23.75

    2015/16

    26

    56.30

    15.5

    2014/15

    18.9

    76.09

    17.5

    2013/14

    16.45

    78.37

    26.9

    2012/13

    16.33

    82.56

    * Source: Ministry of Finance & Nepal Rastra Bank

    As can be seen above, the Government of Nepal (GoN) has been boosting revenue collection every year. Likewise, provision for capital expenditure—which is seen as the backbone of economic development—has also been growing. These ever-increasing revenue targets (and actual collection beyond the targets) are not necessarily problems in themselves; however, the fact that government consistently fails to employ these resources to development activities is definitely one.

    With reference to this year’s data, only 31 percent of the total capital expenditure has been injected in the economy as we approach the end of tenth month of this fiscal year. Weaker spending capability pushes the deadline of the governmental projects and also increases the cost of the projects. The mega-projects like Pokhara Int’l Airport, Postal “Hulaki” highway, Melamchi drinking water project, ‘Madhya Pahadi Lokmarg’ and other national priority projects have been affected by weaker spending ability. Piles of billions of rupees worth of unspent capital expenditure prove that government is achieving its targets only in papers. And these sorts of failures only create bottlenecks for greater economic growth.

    A question then arises—why does the government collect larger revenue every year despite being unable to utilize it fully? One possible reason is that politicians can easily promise growing revenues towards new welfare programs. Welfare programs are useful tools to become more popular among voters, and these programs can be implemented in quick span of time unlike infrastructure development.  In 2016/17, the GoN doubled allowances for old age, disable, single woman and endangered communities programmes. While there is no questioning intended benefits of these programs for genuine beneficiaries, it is also equally true that these are tools of vote-bank securing at the cost of other development activities that could create greater wealth in the economy. What is ominous about these programmes is that these are irreversible, for any politician who wishes to undo these programs will be committing a political suicide—they will become unpopular among voters. And obviously, these expenses need to increase over time.

    On the other hand, every penny unspent by the government compromises the ability of economy to flourish. The frozen budget which is collected from taxpayers, if had not been collected in the first place, those funds would still be in the hands of private individuals. These private individuals could have consumed, invested or even saved this money at financial institutions. For entrepreneurs and credit seekers, this would mean greater availability of funds. All these could contribute towards wealth creation inside the economy. This is the alternative way by which the economy could have grown—leading to more new entrepreneurs, more jobs in the economy, and higher production of goods and services by the private sector. Unfortunately, some of these possibilities have been largely compromised in our country.

    Therefore, what could be better for the economy is that every year, as our budget-making process begins, the government factor these other things that get compromised as the government looks to grow bigger (and create new welfare programs). There is a private sector in the economy, and every time the government grows, it shrinks the space for private sector as well. If the government is inefficient at utilising resources, then it should re-think exercising control over greater resources every year.

     

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  • Uncategorized

    Aftermath – The Unintended Consequences of Public Policies: Book Review

    Public policies can give rise to unintended consequences. It is needless to say that government forms policies with good intentions – usually to eliminate existing social or economic issues and to bring socially desirable changes within the country. However, when government adopts a certain policy with the shortsighted vision of positive impact it may generate without any regards to possible ramifications such a policy could have on a long term, the policy ultimately perpetuates and aggravates the very problem it was trying to mitigate in the first place.

    This book—Aftermath— raises the question of efficacy of public policies by looking into several instances when they failed to carry out their fundamental function – enhancing social well-being. From minimum wage law to alcohol prohibition, Thomas E. Hall delves into inevitable repercussions the United States faced and is still facing due to hasty implementations of several policies by the government.

    In a free market, wage rate is determined by the worker’s marginal productivity. There is a voluntary agreement between the employer and the employee regarding the amount the employee gets paid. However, when the government intervenes in this consensual relationship between the employer and the employee, by setting a minimum wage rate that mandates the employer to pay no less than the stipulated amount to the employee, adverse consequences can arise. According to Hall, minimum wage law, passed with the objective of giving every employee – mainly unskilled and teenage workers – enough wage to sustain a basic standard of living, has been proved to be counterproductive. When employers are forced to pay the employees more than what they originally used to pay or when the law is binding, they either lay off workers to reduce the cost or replace them with someone more skilled. This leaves unskilled and teenage workers bereft of employment. Hall further rebukes this law for encouraging discrimination by employers on the basis of race, sex, or physical appearance when selecting a potential candidate for a job, as evidenced by employment rate of white teenagers exceeding – by a large amount – that of black teenagers in the 1950s (minimum wage rate was increased from $0.75 to $1.00 per hour in 1956).

    Hall talks at length about how minimum wage law increases cost for firms, which in turn induces these firms to layoff workers in order to maintain their profit margin. Nevertheless, he neglects to address the cost incurred by taxpayers for the public assistance programs implemented to financially support citizens earning below cost of living. The author’s assessment would have been more convincing if he had provided an analysis on how much the public would have to contribute in tax in the absence of minimum wage law (for such assistance programs) and if this cost to the public is higher/lower than the social cost of implementing minimum wage law.

    The author also examines the effectiveness of cigarette tax. Revenue generation along with discouraging cigarette consumption was the primary purpose of cigarette taxation when it was first implemented in Iowa in the 1920s. However, what policymakers failed to take in account while pushing this agenda was the possible outbreak of illegal activities it could entail. Hall explains how the tax incentivizes people to engage in smuggling to make substantial profit by exploiting large price disparity in different countries. This leads to the rise in organized crimes and criminal groups resorting to violence to monopolize the profit generating trade of cigarettes. Furthermore, he illustrates how the government incurs revenue loss if the tax is increased beyond a certain threshold. He argues that the government will only increase tax to the point up to which there is positive revenue growth even after factoring for the people who give up smoking as a result of increased cost of smoking. Hall concludes that excessive tax on cigarettes leads to intensified smuggling along with diminished revenue.

    In retrospect, inefficiency of these public policies is clear to the government as well as the public. Hall reasons that despite the evident social and economic costs they engender, large share of public and well defined interest groups support these policies making it difficult for the government to repeal them – middle and lower income groups are proponents of progressive income tax; labor unions are convinced minimum wage makes poor better off; and non-smokers want cigarette consumption to decline.

    I personally gained profound insights from this book on the history of several public policies – how they came into existence – and how they have affected well-being of the country over the years. Aftermath is definitely a constructive read for those who have ever wondered why public policy matters spark controversies; it will make the readers critically reassess government’s role in the market and whether government intervention is always justified on the grounds of “enhanced social welfare” within the country.

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  • Remittance: Where is the money going?

    It is hardly news for us that Nepal is one of the largest recipients of remittance (relative to the Gross Domestic Product); inbound remittance is equivalent to 30% of Nepal’s GDP, and continues to grow by the year. Yet, not much of this money is being channeled to productive activities, and that, many argue is a worrisome event for Nepal. But why could that be happening? According to one of the recent updates published in national daily, much of this money is spent on loan repayment, daily consumption, education and health, and some bit is being saved. A closer look at these headings clearly reflects Nepal’s ground realities, and offers cues to why not much is going into productive sector.

    25% on loan repayment
    The primary reason behind so many young people migrating to foreign lands is a search for economic opportunities—opportunities that are not available for most of them in Nepal. This migration, however, does not come free of cost. Since most of these economic migrants come from poor families that also do not have much savings in the first place, they acquire loans in hundreds of thousands to get themselves into these foreign lands. Obviously then, the first priority for them is to repay their loans so that they can secure greater disposable transfers for their families as soon as they can.

    24% on daily consumption
    Around 25 percent of Nepalese are living below the poverty line. For most of these people, it is daily battle—meeting their basic needs. Therefore, when the level of income increases, a large portion of the disposable income is spent on daily consumption. People cannot be expected to make huge proportions of saving and invest it while they do not even have a decent arrangement regarding their basic needs of food, clothing and shelter. And that is what we see so many poor Nepalese people doing with growing remittances. When disposable income increases, it’s a basic human behavior to uplift living standard for better and healthy life.

    10% on education and health
    While a large portion of Nepal’s budget is spent on health and education sector, access of people to quality health and education services are not satisfactory to say the least. The number of free public schools is high but large numbers of students are now slowly moving to privately-run schools for quality education. This is a manifestation of the fact that parents believe that quality education is a pre-condition for their children’s secure future, and that they perceive private schools as better educators.
    Similarly, public health services are not accessible to all. That is not to mean that private health services are, however, the same services that the government has committed to offer to the people for free are non-existent in a lot of places, and people have to spend a substantial chunk of their income on accessing these facilities.
    Combined, these expenses reflect the inefficiency of state institutions, and poor quality of whatever little services are available to the people.

    28% on savings
    The above-three major headings and some others (including trade, cultural and religious activities, etc.) account for 72% of remittances, leaving behind only 28% for savings. This is the amount that could actually go to productive sectors in the form of investments. And that is where the catch is, for Nepal. If nothing else changes, most of this money will go into purchasing land and gold as these assets guarantee a certain amount of return (which substantially greater than investing in other economic sectors in Nepal). However, if the goal is to have this money channeled to productive sectors, then Nepal will have to rethink its policies such that there are respectable returns to be earned from the productive sectors as well. And this will come through building a conducive environment for doing business, meaning stable and market-friendly policies that allow people to start their businesses with ease, protect their private properties, guarantee contract enforcement, allow for easy exit from the market, and ensure rule of law.

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  • Automatic Route – A Prerequisite for FDI Inflows

    Nepal Investment Summit, 2017 raised the aspirations of many investors and business opportunists as it unlocked various possible alternatives to promote investment-friendly policies and practices. Among the many commitments, political stability to attract foreign investors, huge FDIs from various nations including China and USA, and the assurance of Minister of Industry to promote friendly regulatory framework for doing business in Nepal were the major outcomes of the Summit. Parallelly, the MoI had also been working on reforming the Foreign Investment Act, and the provision of granting permission to some investors via “automatic route” seemed to be a good complementary move; there were also some genuine arguments about why it was limited to only some, and why not all.

    However, a recent move by the MoI to remove the provision of automatic route from the draft of Foreign Investment and Technology Transfer Bill (FITTB) countervails these commitments. The removal of this policy requires foreign investors to enter Nepal through a long and cumbersome process—submit multiple documents to the regulator (Department of Industries, Investment Promotion Board, or the Nepal Investment Board, depending on the scale of investment), and additional documents to Nepal Rastra Bank (NRB). This approval system for Foreign Direct Investment has been one of the biggest tailbacks for investors to make actual investments in Nepal.

    Nepal does not need such a complex approval process. What Nepal actually needs is simple Acts and regulations to attract as many investors as possible in order to meet saving-investment gap, technology and skill gap and generate ample employment opportunities. The many goals of the GoN – completion of national pride projects, building of satellite cities, infrastructure development projects, energy development projects and an aim of achieving double digit industrial growth rate – cannot be fulfilled with limited domestic investments. Foreign direct investment is an irrefutable factor for the economic development of Nepal and thus, we cannot afford to offset our potential investors.

    Nepal already ranks in the 109th position in the World Bank’s Index of ease of Starting a Business. Moreover, Nepal is the only country in South Asia to have a two-layer approval system and extensive paper-works to bring in foreign investments – a major comparative disadvantage which makes Nepal less attractive to the foreign investors. Foreign investors are likely to explore more favorable alternative investment destinations within the markets of South Asia rather than investing in Nepal. Nepal already lags behind in numerous ways than other neighboring countries. In such scenario, a policy change that enables easy entry of FDI in Nepal could be a competitive factor among its South Asian counterparts.

    Automatic route could indeed be a defining factor for economic transformation of Nepal through which foreign investors could bring in investments without government approval, reducing the lengthy and cumbersome processes. Nepal, in this matter should comprehend India’s reform. After the adaptation of automatic route for FDI, India was able to attract $44.20 billion in 2015, a rise by 28%. The FDI contribution in GDP of India during that period was 14-15%.

    It is apparent that Foreign Direct Investment is crucial for the economic growth of Nepal. Automatic route could be seen as the most rational step for the government to take in order to attract these FDIs for executing all its committed plans. However, the removal of this principal provision by the MoI is unconceivable.

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  • Four Reasons Why the NEA Should Not Procure LED Bulbs

    The Government of Nepal’s decision to purchase 200 million units of energy efficient LED bulbs has created a big controversy. While the decision in itself has been projected as being in the national interest, the NEA has been facing suspicions of corruption for having bypassed the public procurement law, and having resorted to the special power of the cabinet for buying light bulbs.

    Granted that the NEA is acting in the national interest and there is no corruption involved, there are still other reasons to why the procurement of LED bulbs by the NEA is wrong.

    1. Going beyond the NEA’s mandate
    Nepal Electricity Act, 2041 states that the primary objective of NEA is to supply the power by generating, transmitting and distributing electricity efficiently and reliably, making it accessible to everyone. That is to say that NEA is tasked with only generation, and management of supply of electricity to make it affordable and accessible to all Nepalese. Therefore, procurement of LED bulbs falls beyond the mandate of the NEA as it is clearly not indispensable for either the generation, or the transmission and distribution of electricity.

    2. The flaw in the proposed financing model
    To finance the procurement, the Government of Nepal is granting a loan of Rs. 2.08 billion which the NEA seeks to repay by selling the bulbs through its distribution centers. In a country where 25.2% of the population lives below the poverty line, it is not pragmatic to expect people to spend money in purchasing energy efficient bulbs in the name of contributing to national interest. In this scenario, the government is likely to provide subsidies to make it affordable to the poor, reducing the retail price (which may even be below the cost price). As soon as that happens, the NEA will face similar fate as the NOC where the dysfunctional subsidy policy rendered it unable to even attain break-even, making it impossible to pay the loans.

    3. Crowding out private investment
    The NEA, as it is a public enterprise, enjoys few privileges that private enterprises do not. It neither has to depend on investors for capital, not on consumers for profit. With the unlimited government backing, it can afford to procure goods at economic cost and sell them in the market at social costs, even if it makes loss after loss. This disrupts the playing field for private enterprises for they cannot compete with state-backed competitors. This will eventually crowd out private investments.

    4. Policy insecurity; lack of predictability
    The most important factor affecting investment decisions of private investors is predictability, which is a function of policy stability. The fact that the state-owned enterprises can, at any moment, use the special powers of the government to curb the law of the land makes it further challenging for private investors. In this case, Honorable Minister of Energy, Mr. Janardan Sharma has cited the provision in the public procurement law that allows direct procurement with an international inter-government organization but he has conveniently left out the condition of the provision being applied only in the case of pre- existing supplier of the said goods or services. These kind of malpractices also set negative precedents that can be borrowed by other sectors of the economy as well, which has the potential of making it impossible for private investors to operate in any sector in Nepal.

    The Alternative Solution
    The rationale given for the purchase of the bulbs by Honorable Minister of Energy, Mr. Janardan Sharma and the MD of NEA, Mr. Kulman Ghising, is its potential to reduce the national electricity consumption by up to 200 MW. Nepal has adopted a liberal economic policy and there are private enterprises that are offering the same service as the NEA is attempting to. If the goal is to lessen the peak demand, then the government could very well relax some of the taxes that apply to these products, making these energy-efficient bulbs affordable to most, if not all, consumers of the grid electricity.

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  • Maximum Tuition Fee Limit Regulation That Backfires

    In advocating for equal access to quality education in Kathmandu valley, Ministry of Education (MoE) has recently devised the regulation to set maximum limit on the tuition fees of private and boarding schools based on official categorization of the schools and the grade standards they conduct. While the maximum tuition fees limit per student studying at 9th and 10th standard for grade-A school is set at NRs 3,600, the tuition fee limit is set varying for other schools belonging to different category for the grade standards they conduct.

    Given that the appeal for this price/tuition fee control is justifiable in order to make sure that quality education as a fundamental need of the society is affordable to all income holders, the side-effect of such restrain regulation that distort the balancing mechanism of the market is unfathomable and historically observed. Simply take the cliché case of maximum rent price regulation practiced in different cities of the world that brought the entire tenancy housing market into dire straits. New York City stays as a classic example whereby setting maximum rent price below the usual market price at tenancy housing market not only disturbed the incentive to supply enough apartment to meet the growing demand for it, but it also resulted to degradation of housing quality as house-owners could not afford to upgrade and maintain the housing standard while depending on below feasibility rent revenue. Alas, it led the city to only offer the fiasco of inadequate-barely livable residential housing thanks to rent price control legislation.

    Importantly, it is necessary to recognize that the disastrous unintended consequence of rent price control has less if any to do with the unique characteristics of the housing industry of a particular city, but more if not all to do with distortion of the governing market fundamental (i.e., price) that allows the supplier of a particular commodity to supply it in a particular quantity and in quality as demanded by the market.  Similarly, in implicating the distortion of same market fundamental or price in the private education market in Kathmandu, the exact same horrendous consequences are likely to be observed.

    At first and foremost, when private schools are forced to depend on limited tuition fees set by the maximum limit regulation, they are also forced to invest limitedly on infrastructure maintenance, upgrade, and in adopting innovative education practice in order to break-even. And, if the legislation prescribed tuition fees or the revenue is below what the market would offer, investment on increasing the education related infrastructure and the quality of the education will also be below the pace of what price liberalized private school market would have offered. And henceforth, the quality of the private education system is more likely to be compromised.

    Likewise, the ability to charge below-feasibility maximum tuition fees as per the regulation shall also discourage new investment in private schools enough to meet the demand growth of private education possibly triggered by the guardians who are encouraged to transfer their children from public schools. A research from Samriddhi Foundation clearly states that cost structure and initial investment outlay for opening schools with infrastructure required for meeting Grade-C category cannot be feasibly fulfilled by the maximum tuition fee limit set for them. Therefore, a rational investor willing to make profit will not have incentive to establish schools of such category in order to meet the growing demand of private school education. Given the widening gap in supply and demand of private school education as the consequence of this regulation, the motive of this very regulation to make private school education affordable to normal people can instead backfire. With virtually no growth in number of private schools in compared to demand for it, the supply-shortage will rather create an underground economy whereby people with better connections and willing to pay more money off the table are more likely to get their children admitted at private schools while the marginal ones are left out.

    This directive on setting maximum limit of tuition fees can be a costly constraint on growth of private educational institutes of Nepal. The directive meant for ensuring quality education to all at affordable prices, in itself can be a major factor hindering the growth of educational sectors. There are numerous reforms required in Nepal regarding its quality of education. In current scenario, the government must instead focus on improving the quality of public schools and not on decreasing competitiveness among private schools affecting its quality and lowering the possibility of low income household children to get a quality education.

     

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