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Aftermath – The Unintended Consequences of Public Policies: Book Review

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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.

About Sambriddhi Acharya

Sambriddhi is a researcher at Samriddhi Foundation.

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Economics In One Lesson by Henry Hazlitt: Book Review

Henry Hazlitt’s book “Economics in One Lesson” is a rigorous case against the ideals of government interventionism in the market economy. In this book, Hazlitt takes an angle first conceived by Frederic Bastiat, an 18th century French Economist. Bastiat famously quoted, “Government is the great fiction, through which everybody endeavours to live at the expense of everybody else”,  which was to say, the idea that government works for all is as big a lie as sun revolves around the earth. It only sounds nice in fiction and idealism. 

In reality a government while arguing for a case, totally disavows another part of the economy. For example, when a government says it will provide benefits to certain sector like agriculture, because it is “vulnerable” or “important”, what it is actually doing is taxing the productive sector and funnelling the money into a competing sector that might not be as productive. For many years, the Nepalese government has been subsidising the petroleum products through a government monopoly, but has the government ever considered where the subsidy is funded from. It is ultimately funded from the taxpayers’ money, from different sectors of an economy.

The most important argument he makes is on “Broken Window Fallacy”. The idea of “Broken Window” is that when a glass window breaks, the owner has to replace it. This circulates the money to the producer of the glass, the carpenter, the transporter and similarly around a large section of the economy, which stimulates economic activities. Hazlitt argues that this fallacy wrongly assumes that it is the breaking of the glass window that stimulates the economy through increase in circulation of money. Rather, if the glass had never been broken, the money could have been invested in an alternative sector, which would further revitalise the economy. The breaking of the window has merely diverted money into another endeavour which would have been better if avoided. In de-constructing “Broken Window Fallacy”, Hazlitt makes a strong case against Keynesian Economists-economists who follow the economic doctrine professed by John M. Keynes.

In another case, Hazlitt posits that “progressive taxation,” which is identified as all noble, also hurts the economy. When the rich in an economy are taxed higher, the amount they can save and re-invest decreases. Since they have a higher marginal propensity to save and a higher marginal propensity to invest in comparison with poorer individuals, this amount that could have been invested back in an economy is lost. As a result, it hampers the productive capacity of an economy.

The book also furthers its case against minimum wage law which is a popular political agenda, even in Nepal. He argues that “minimum wage” in idealism tries to uplift the living standard of poorer classes in society. However, in reality it actually hurts the poorer classes, because minimum wage increases the cost of production for a producer. The producer then has to lay off the workers to decrease its cost. As such what was seen as a way of helping the poor ultimately hurts them.

Hazlitt furthers criticises many policies that seem noble in political eyes but do not make economic sense. When the policies are not economically viable, no matter how much benevolent they seem, they will decrease the economic dividends a nation derives from a free functioning market. He makes an strong case against protectionism, taxation, subsidising certain industries at the expense of another, etc.

This book is an influential criticism against some of the intriguing fallacies in Political Economy. However, the book lacks somewhere in providing policy measures for certain economic challenges like depression, controlling inflation, or social challenges like distributive justice. This doesn’t necessarily undermine the value of “Economics in One Lesson.” This book does more than merely point to solutions of the economic challenges; it helps us understand the multidimensional phenomenon that “market” is. This book explains, eloquently, how any form of government intervention has counter-productive effects in a market economy, no matter the intentions. Often times, the unintended consequences outweigh the intended benefits.

For a country, where economic development has been sluggish at best, and socialist policies are taken as virtues to development rather than stumbling blocks towards free functioning of an efficient market, this book is a great read.

Sovit Subedi

About Sovit Subedi

Sovit Subedi is a research intern at Samriddhi. He graduated from University of Pune with a Bachelors Degree in Economics. His interests are in entrepreneurship, strategy and development.

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Private hydropower developers’ take on Benefit Sharing

On March 24, 2016 Samriddhi Foundation hosted an ‘Econ-ity’ discussion on the cost imposed on private developers of hydropower project due to lack of a clear benefit-sharing policy framework, at Hotel Himalaya. The parliamentarians, policy makers, bureaucrats, academicians, economists and journalists present at the event discussed over the following issues related to benefit-sharing:

 

Who is the affected and the beneficiary?
When to share the benefits?
How to share the benefits?

 

Due to lack of clear policy framework regarding Benefit Sharing, the burden of all of these issues falls on the private developers of hydropower project. These issues ideally should fall on the government’s shoulder, and clear and enforced policies should have taken care of it.

 
When it comes to issue of- how to share benefit, the existing mechanism of energy royalty being redistributed to the area where project is located, should have taken care of the problem but it is not working effectively. The mechanism has provision of distributing 38% of total royalty to the development region where the project is located and 12% of total royalty to the district but due to the weak governance the royalty amount gets lost in the system. That is why, locals demand all the services like roads, health clinics, schools from the private developers- these basic services could have been provided in the area with the re-distributed royalty.

 

One of the panelist in the Econ-ity discussion was Kumar Pandey, General Secretary of Independent Power Producers’ Association of Nepal (IPPAN). His take on the issue, especially focused on when to share benefit, was– We are private developers and thus we are guided by the profit. Benefit sharing is big and burning issue, and we agree, it should fall into our business plan. But the big question is-

Popular practice today, due to the lack of clear regulatory framework and strong governance, is we have to share the benefit with locals before any benefit from the project is realized as without sharing the benefit with locals, it is difficult to develop any project.

 

Against this background, his argument was that if there were some clear guideline on pre-benefit Benefit Sharing, it would greatly facilitate private developers. Once the construction is completed and the project goes into operation, energy royalty should then take care of the after-benefit Benefit Sharing.
Going by Pandey’s deliberation, it appears that the private developers are still willing to spend benefit-sharing with the locals but they want stable business environment . Our study also shows that private developers are willing to spend 0.5% to 2% (depending on the size of the project) of total cost of project on benefit sharing.

Dhruba Bhandari

About Dhruba Bhandari

Dhruba Bhandari is Research Fellow at Samriddhi, The Prosperity Foundation. He joined the Foundation in July 2015. He completed PhD in Development Economics from Oklahoma State University (USA) in 2013. Prior to Joining Foundation, he worked as Research Associate at Oklahoma State University.

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Regulatory challenges in hydropower development in Nepal

 

Image Source: www.proofpoint.com

Out of 40,000 MW of economically feasible hydropower potential in Nepal only about 791 MW is currently developed. The reason for underutilization of hydropower potential is that there are various challenges to developing hydropower projects in Nepal, namely- technical, financial and regulatory. Foreign Direct Investment (FDI) in hydropower sector in Nepal can be a solution to the technical and financial challenges as developed countries interested in investing in Nepal have necessary finances and have technical knowhow, but they still face regulatory challenges imposed by the government of Nepal. Regulatory challenges arise due to lack of co-ordination among ministries (industry, energy, forest, water, etc.) and political parties. A hydropower project has to deal with 7 ministries, 23 government departments and comply with the terms and conditions of thirty-six Acts. In case of FDI there is additional bureaucratic hurdles on issues related to visa, ownership of capital and exchange rates.

 
In Samriddhi’s new study “Benefit Sharing in Hydropower Projects in Nepal,” which looks into the cost imposed on private hydropower developers due to lack of clear benefit sharing regulations, we  asked private developers to list the major actors and causes that obstruct development of hydropower project in Nepal.  They responded local politics and political leaders along with co-ordination among the parties involved, lack of transmission lines and Power Purchase Agreement (PPA) as major agents and causes.  These agents and causes not only obstruct the construction and operation of projects but also hinder the projects at planning phase from coming into the fruition.

 
Tamakosi III (650 MW) project would have been the biggest FDI in Nepal with estimated cost of $1.5 Billion, but Norwegian company Statkraft decided to back out from the project. The company had been working on the project since 2007. The company cited increased bureaucratic hurdles, fragile political situation, insufficient transmission capacity and absence of necessary policies and regulatory frameworks for operationalizing power sales as causes for backing out of the project. Few years ago, the Australian Snowy Mountain Engineering Corporation (SMEC) also pulled out of the export-oriented West Seti (750 MW) hydropower project in western Nepal after battling bureaucracies for two decades.

 
While Nepal is facing power shortages and lacks sufficient funds and technical skills to build mega hydropower projects, FDI in hydropower sector will be reasonable alternative to solve the current problem. In order to attract FDI for such projects, there must be an environment of ease of doing business so that the investors can feel confident to invest in Nepal. This objective can be achieved with well thought out regulatory framework and well-coordinated bureaucracy. Careful amendments to the Industrial Enterprise Act 1992, the Foreign Investment and Technology Transfer Act 1992 and the Electricity Act 1992 can create favorable environment of  doing business and can attract FDI for mega hydropower projects in Nepal.

Dhruba Bhandari

About Dhruba Bhandari

Dhruba Bhandari is Research Fellow at Samriddhi, The Prosperity Foundation. He joined the Foundation in July 2015. He completed PhD in Development Economics from Oklahoma State University (USA) in 2013. Prior to Joining Foundation, he worked as Research Associate at Oklahoma State University.

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What do the taxes on vehicles say?

A quick look into custom duties of vehicles is enough to tell us how discouraging it is for any individual to purchase a car. For the vehicles that run on fossil fuel, the customs duties on 9 categories stand at 30% while that on the ‘Jeep, car and van’ category is almost three times that of other categories. Similar is the case with the electric vehicles. The customs on Jeep, car and van is 40% which is much higher than the 15% customs in other categories. The general belief that cars are luxury goods and should be taxed high seems the logic behind this. But, are cars luxury or high taxes have made them a luxury?  Higher taxes resulting into higher prices have made the cars less affordable to the middle and lower income class and thus only providing privilege to the rich. And, even if we regard them as luxury, are the rich only the ones who get to enjoy this luxury?

In the midst of current fuel crisis, promoting the use of the electric vehicle has become talk of the town. The customs on electric vehicles are definitely lower when compared to the vehicles that run on fuel, however, this rate seems still high for encouraging its use. If the uses of electric vehicles are really to be encouraged and promoted, the custom duty along with other taxes must be further reduced.

Ashesh Shrestha

About Ashesh Shrestha

Ashesh Shrestha is an independent researcher. He has an Economics background and is interested in Monetary economics and Public finance.

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Many Heads Creating Hurdle in Hydropower

loadsheddingNepal achieved multiparty democracy in 1990 and a series of liberal and private sector friendly policies were formulated then after. Hydropower Development Policy, 1992 and Electricity Act, 1992 also came into effect which paved the way for foreign and domestic private sector participation in generation side. Electricity Act, 1992 made a provision whereby even the private sector could acquire licenses for undertaking survey and generation purposes.

In the beginning, survey license was very cheap to acquire; for eg., NRs. 100, 150 and 200 for 1-5 MW, 5-10 MW and 10-15 MW respectively. The bureaucrats were quick to act at this. Majority of licenses were acquired by the employees working at the Ministry of Water Resource (MoWR), Water and Energy Commission Secretariat (WECS), Department of Electricity Development (DoED) and Nepal Electricity Authority (NEA), or by their relatives. What’s more, the licenses were distributed on first-come-first-serve basis without conducting sound financial and technical analysis. The license holders did not even have to construct the project, but could sell it to developers at higher prices. Thus, began the license-holding culture. These people who held licenses cited cases of landslides, local issues and others to renew their licenses time and again, without really conducting any survey. Due to this, real investors did not get a chance to construct hydropower projects. Interested parties had to buy it from these license-holders, which increased the time and cost of projects. In order to discourage pseudo license-holding, the license acquisition fee has been reviewed three times till date.

Commission for the Investigation of Abuse of Authority (CIAA) recently directed Ministry of Energy (MoE) to revoke the licenses of 10 different hydropower projects as the promoters of these projects could not complete necessary procedures such as signing Power Purchasing Agreement (PPA), making financial closure, etc. Once the license is repealed, the entire process of development of these projects starts from the beginning i.e., acquiring survey license, conducting feasibility study, finalizing Environment Impact Assessment (EIA) and so on, which costs additional time and money. Therefore, it may not be a good step to scrap licenses of projects that have already initiated pre-construction works as this will further delay the development of hydropower projects. In case of Upper Khorang Khola Hydropower Power Project, the developers could not conduct PPA in time due to delay in decision-making process of NEA. The delay in signing PPA has further delayed managing investment from financial institutions for the project. Although the license period of Kabeli “A” has matured, it has already given Letter of Intention (LoI) to contractors, issued right shares and acquired land to construct the project. A lot of initial investments made in these projects will go in vain if the licenses are nullified and the construction of projects will be further delayed. The solution to these problem lies in initiating competitive bidding process instead of issuing survey and generation licenses for construction of hydropower projects because the nation gets more benefits as it receives free energy and equity ownership along with royalty through international bidding. For example, GMR, the company that won the bid on Upper Karnali Hydroelectric project, has promised to give 12 percent free energy and 27 percent free equity. Likewise, Satluj Jal Vidyut Nigam got permission to construct Arun III after providing 21.9 percent free energy. Additionally, the public limited company of India agreed on providing 20 units of free electricity to each house of Sankhuwasabha district, where the project is located. Furthermore, the promoter of the project has agreed on issuing shares to local people. The system of providing share to the local people helps to reduce level of inequality in society to some extent as they also get return from their investments. They can further utilize that sum of money for starting other income generating works, educating children, receiving vocational training and much more.

Developing hydropower by awarding a project through international competitive bidding is the most scientific way to solve the issues related to license regime in Nepal as it creates win-win situation for all stakeholders.

Dinesh Karki

About Dinesh Karki

Dinesh Karki is an independent researcher. He has Economics degree from Xi'an Jiaotong-Liverpool University, Suzhou, China.

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