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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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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.


*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.

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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Can’t FIRE; don’t want to HIRE

employers in troubleLike in many developing nations around the world, the process of industrialization in Nepal has been evolving with time. According to Central Bureau of Statistics, the country has about 11.7 million work force, of which 1.8 million are in the formal sector and around 3.5 million are in foreign jobs. Although, comparatively the formalized labor force covers a small chunk, an economy seeking growth cannot ignore this segment. And thus, the Labor Act, Trade Union Act, Industrial Enterprise Act, National Labor Policy were enacted, many of which were meant to protect employees and these provisions in totality can be termed Employment Protection Legislation (EPL).

As with most labor market regulations, employment protection legislation (EPL) was first introduced with the aim of enhancing workers’ welfare and improving employment conditions. It includes employees’ protection against dismissals, limitations on the use of temporary forms of employment, regulation of working hours, but in a broader sense also health and safety, protection of employees in less favorable conditions

In our case, perhaps, the existent hire and fire policy which makes it easier to hire employees but poses many restrictions on the firm’s ability to fire workers, fulfills its stated purpose, namely protecting existing jobs. But this has come at a price as it has led to many employers opting to have temporary contracts with employees and thus, less or no investment in employees’ skill development programs. Since the hire and fire policies come with added burden to the employees—legal and other transnational costs— many say this has been the reason behind the slow pace of growth. Employers, at large, shy away from hiring people on permanent basis and given the costs that come with firing employees affiliated to unions strongly backed by political parties; this has cut down incidences of hiring people.

Many employers in Nepal who have had to face permanent shut-downs and heavy financial losses have asserted that Nepal’s labor legislation is pro-workers and biased against the employers. According to them, it affects the market place dynamics and deters them from investing more in permanent employees. Perhaps, the consequences have been more dire than expected and about time we look at the laws more critically, right?

To understand more on what I actually mean, check out the following video. The second point on government regulations explains how hire and fire policies which make it difficult to fire employees have dire consequences on intended growth.

Anita Krishnan

About Anita Krishnan

Krishnan holds dual degrees--in law and sociology. Currently, she works as a Research Associate at Samriddhi, The Prosperity Foundation.

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Tapping small investments – lesson from IT

ITForeign Investment and Technology Transfer Act (FITTA) 1992 has made a provision whereby a foreign investor can invest in any sector in Nepal except arms and ammunition, tourism, cottage industries, personal service business, engineering and legal services and consultancy services. Other than these sectors, an investor can invest as much money as he/she pleases. However, the practice has been such that a foreign investor has to commit to investing at least $50,000. Not only is this practice completely against the spirit of FITTA, it also limits Nepal prospects of realizing foreign investments and the scale is substantial.

Besides being risk-free sources of investment for a host nation, Foreign Direct Investment (FDI) signifies modern technologies, advanced skill sets and lots of employment opportunities. If the business is profitable enough, foreign investors even contribute to developing infrastructure in the sites of their business operation, therefore reducing the fiscal burden of the government.

Nepal, being mired in political instability, inflexible labor laws, poor infrastructure and weak capital markets, bars itself from attracting very large FDIs. Out of tens of billions worth of FDI commitments, investments worth only around one hundred million dollars have been realized till date. If Nepal is to graduate to a Developing Nation status by 2022, we need more economic activities and smaller FDIs can play a big role in the process – IT sector is an example.

IT is one of the fastest growing sectors in Nepal and there are lots of IT companies running on foreign investments and employing hundreds of Nepalese people. One of the characteristics of this sector is that their projects (mostly developing programs) can be carried out with investments ranging anywhere between $8,000 and $12,000. These projects, if they fail to deliver as per the demands of market can be dropped altogether and new projects can be started. Quite a number of projects in this sector are thus dropped. This very fact makes investing in small clusters more preferred to large investments (like the over-$50,000 ones).
However, a move to introduce a floor on amount of permissible FDI – which stems out from the spirit of protecting domestic industries and curbing crime (as some foreigners were found to be conducting illegal activities in Nepal under the protection of a fake small-scale enterprises), has effectively barred genuine small foreign investors from investing in Nepal.

Nepal needs to muster as much foreign capital as it can attract in order to hasten the pace of economic growth. But the lack of bargaining power as a state, owing to the sorry-state of its business environment means that the prospect of realizing heavy investments is miniscule. Therefore, Nepal needs to tap these smaller but scores of investments.

One of the first things to take care of, then, would be to repeal the stipulation that requires at least $50,000 worth of commitment from foreigners to be eligible to invest in Nepal. The Act itself stipulates no such thing. It was introduced through an administrative process and thus a court decision should suffice.

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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