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The Economics of Minimum Wage

(This article was first published in the HImalayan Times on the 22nd of July, 2018.)

Sometimes, the most noble of intentions might yet produce severe unintended and negative consequences. Nepal’s minimum wage law comes ominouslyclose to achieving this feat.

We, as a country, are setting out on a mission to achieve unprecedented levels of growth and create new economic opportunities. We need all the international and domestic investments we can secure in order to trigger that growth. Our policies, institutions and hard infrastructures will greatly determine how successful we become towards that end. But the minimum wage law seems to be incompatible with investment targets; it also appears to have overlooked domestic labour scene.

Scaring away investors

From foreign investment perspective, the new minimum wage (Rs. 13,450) which is a 38% growth from previous minimum wage makes Nepalese labour the most expensive in the region. Merge that with Nepal’s dismal performance in other global competitiveness indices like the Doing Business Index or Corruption Perception Index or Economic Freedom Index (just some among many), any prospective investor could quickly put off thoughts of bringing investments here. It already takes months to acquire a business visa to Nepal. According to the Doing Business Report, it takes 339 hours just to pay federal taxes and three years to enforce contracts.

No investor will research all small initiatives regarding foreign investment promotion in a new host country before making investment decision. They will look at these indicators and work out what country offers them the highest prospect of return. Towards that end, such dismal performance plus minimum wages that have grown 400% in the last decade while labour productivity has failed to keep pace will not help.

An ignorance of domestic reality

Cost of labour is an important factor from a domestic investment perspective as well. Formalisation of labour and organic wage growths are other couple of important aspects of labour.

If we look back at the last couple of years of Nepal’s economy, construction industry has grown at one of the fastest rates. Demand of construction workers is therefore high. Consequently, the wages of construction workers have skyrocketed. Today, one can hardly find a mason who will work for below Rs. 1500 a day. This is way above the government-set daily minimum wage. This simple example goes to show that if we create opportunities for investments to flourish and industries to grow, the government does not have to intervene and set workers’ wages in order to guarantee a decent income to them.

But then again, there is a great number of workers in the service and agro industry who have not seen their wages grow at similar rates. This might beg a question as to what we do about them. But even here, we have to be weary of the fact that a great many of these workers (who make the least income) in these sectors are informal workers in the first place. Therefore, a raise in minimum wage does not really enhance their economic positions. In fact, that brings us to another greater risk – the risk of lay-offs.

Risk of lay-off is real

Once again, for an investor (domestic or foreign) labour poroductivity matters. If the labour productivity increases in a similar rate as wages, then s/he can churn out greater profits from her/his business and everybody is happy. But when labour productivity does not increase at the same rate (which is what is happening in Nepal), then it is only a matter of time before the investor starts thinking of laying off workers and getting the same job done through fewer workers. Of course, s/he could offer some raise to those workers who are more productive and can take in some extra load. Such a raise will have come at the cost of the worker that is laid off. In the end, the law that was supposed to help the worker got her/him out of the job.

Minimum wage should not disincentivise

When we argue that minimum wage should cover at least the basic needs of an individual, we should be careful that a minimum wage does not put an individual in a position that s/he no longer needs to worry about being more productive or enhancing her/his economic position further. At best, it should be a support position while s/he starts out as an economic actor. It should be a position that everyone wants to grow out of. In that sense, it should incentivize an individual to be more productive, and not the stagnate.

Looking back at our minimum wage policy and the growth of minimum wages over the years, this will be another very important factor to look into two years from now when we sit to revise it again; if we continue to live with this policy until then, that is.

Akash Shrestha

About Akash Shrestha

Akash Shrestha is Coordinator of the Research Department at Samriddhi, The Prosperity Foundation where his focus areas are petroleum trade and public enterprises. He also writes newspaper articles, blogs and radio capsules, based on the findings of the studies conducted by The Foundation.

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Economic Policies in Emerging Markets

Samriddhi, The Prosperity Foundation organized a Nepal Leaders’ Circle meet on the topic “Economic Policies in Emerging Markets.” Rt. Hon. Hugo Swire, MP, MInister of State, Foreign and Commonwealth Office, UK was the speaker for the event. While Nepal is looking to graduate into the status of Developing Country by the year 2022, this program sought to bring out valuable inputs from the participants on how Nepal can benefit from the global trends of cross-border investments by setting the right kind of policy environment that offers profitable prospects to the investors.

Attendees discussing Economic Policies for Nepal

Attendees discussing Economic Policies for Nepal

The event was organized at Hotel Himalaya, Kupondole on the 3rd of June, 2014. The meeting was attended by senior bureaucrats, experts, business community leaders, economists, editors & columnists and foreign investors. The following is a summary of the entire session:

Rt. Hon. Hugo Swire

Rt. Hon. Hugo Swire commenced the session by talking about why, despite all natural, geographical and human endowments, Nepal has not been able to transform itself into one of the major players in the global economy. He acknowledged how Nepal has been a land of peace in the past and reinstated the same peace in the present, albeit having gone through a period of insurgency in the last decade. He then went on to iterating how Nepal cannot afford to be complacent in being a least developed country in the pretext of the same old civil war and waste its resources like hydropower and tourism, and killing the entrepreneurial spirit in the people in the meantime. He expressed how Nepal needs to acknowledge the need of FDI to uplift itself from the Least Developed Country status. There seems to have been discussions over whether Nepal intends to be under aid and assistance all the time, or change it and shift its focus towards bringing in investments. However, not much action has been done in this regard. Similarly, constitution drafting has taken too long a time already. While Nepal is spending much of its time debating and discussing its political and economic agendas, Nepal has utterly failed to reap the benefits of it resources; the opportunities they provide for attaining Nepal’s economic transformation.

The speaker then went on to justifying his statements by giving examples from international experiences. In India, BJP overthrew the ten-year reign of Congress and UPA by selling hopes of economic reforms. Narendra Modi’s Gujarat reforms were the building blocks of BJP coming to power. In China, despite the communist roots, they have liberalized their economy because they realize that they have to allow economic freedom to the people to protect their own political dominance. Currently, they are planning building hundreds of newer cities. Similarly, in the UK itself, they have acknowledged the fact that in order to keep the pace with globalization and international investments, they have to become more and more inward investment friendly. They need to revamp their infrastructures like the airports, the energy sector and more. For this they need capital investments and they are turning to more international investments in these regards.

The speaker concluded his opening remarks by reiterating how there is no alternative to being open to foreign investments to boost the Nepalese economy. The private steers the market while the public sector caters to the needs of the most vulnerable groups in the society. But he also mentioned that foreigners will not come in just by debating in favor of Foreign Investments (FIs). Investors are mobile these days. They create job opportunities and contribute to economic growth; but in the mean time they look for certain pre-conditions before making investments abroad. Some of such necessary pre-conditions that Nepal needs to be guarantee the foreign investors, as highlighted by Rt. Hon. Hugo Swire were,

  • Clarity in economic polices
  • Certainty in terms of being free of risks that a host country can impose; like nationalization, change in rules of engagement in a retrospective manner
  • Accountability in government
  • Transparency
  • Predictability in the markets
  • Rule of law
  • Fair tax environment

General Discussion

After the speaker concluded his deliberation, the floor was set open for interaction among the participants. Some of the key issues discussed during the interaction session are:

  • A functioning government is a must for allowing the private sector to grow. Government should encourage private sector. When there is wealth creation, that is which can then be redistributed by the government by delivering public services. But if the government hamstrings the private sector, it is not beneficial for any group.
  • Capitalism is being redefined globally. After the 2007/08 economic recession, capitalism has had a bad reputation. The key issue is to get the right balance between regulation and promotion of private sector.
  • The domestic market of Nepal is being over-protected in the fear of its resources being exploited by foreigners and Nepal being converted into a dumping-ground. But the reality is that with foreign investments, the economic sectors of Nepal will be modernized, made more productive and will create more job opportunities. Then Nepal will in fact be able to supply its goods and services to the international market.
  • Nepal needs to send out signals to the rest of the world that it is welcoming FDI. International giants already have lots of places to go to. So Nepal should go to other countries and promote its own market. The foreigners need to be convinced that there is a demand and substantial market for foreign products in Nepal. For example, Oxford University could be lured by selling the prospects of great market by selling the idea of Nepal’s geographical proximity with India and China, both of which are going out for higher studies.
  • Nepal has a minimum threshold on the amount of permissible FDI. Then there is corruption, which in turn creates unpredictability for investors. Things like these discourage investors. Peru, Chile, Brazil, they are all going to London, promoting their markets and negotiating terms of doing business in their respective countries.
  • In the UK, government tries to make sure that the taxpayers’ money is used wisely and optimally. If there is something that the private sector can do better than the government can, the government pulls out.
  • The presence of donor agencies like USAID, DFID, Gtz and many more have turned Neal into a welfare state itself. There seems to be no shame in asking for aids and assistance when seeking the same to support the people who need help, but the idea of FDI is suddenly perceived as a threat to national sovereignty. This needs to change. No country will colonize Nepal. Nepal should open up its markets.
  • Nepal faces severe challenges in terms of having high numbers of rural population and low human capital. But this is not a unique problem in the world. Mongolia a faced similar challenge. But they have found a way around it by using there mineral resources. In Nepal, there is high potential of hydropower generation. This should be tapped in.
  • Political parties need to come together for a economic transformation of Nepal.

Hon. Minendra Rijal, Minister of Information and Communication, GoN

After general discussions Minister of Information and Communication, Hon. Minendra Rijal delivered concluding remarks to formally end the session. Some of the highlights of his deliberation were:

  • Competition is the pre-requisite for economic growth. He used the example of NTC and NCell, one 92% government owned company while the other, an over 80% foreign investment have been competing with each other, delivering better and cheaper services to the consumers than in the days when NTC had a monopoly in the telecommunication sector of Nepal. NTC is even looking for foreign strategic partner and a process of divesting 30% of government ownership has already begun. These activities, he believes, will serve the Nepalese consumers even better in the days to come.
  • Investment Board of Nepal (IBN) is working with foreign investors in the hydropower sector of Nepal.
  • Nepal Telecom, Nepal Army Welfare Fund, Pension Fund and others have huge pools of unused funds. Nepal still needs to work on creating an investment-friendly climate for these domestic institutions. These funds can then be mobilized as investments.
  • Overall, government should realize that there might be times when certain sectors need to be protected from foreign investors, but Nepal should never protect inefficiency.

Akash Shrestha

About Akash Shrestha

Akash Shrestha is Coordinator of the Research Department at Samriddhi, The Prosperity Foundation where his focus areas are petroleum trade and public enterprises. He also writes newspaper articles, blogs and radio capsules, based on the findings of the studies conducted by The Foundation.

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