Wednesday, November 15, 2006

National

(Economic Development Perspective)

- P.R. Ligal, Former Vice Chairman, National Planning Commission, Nepal

1. Introduction

P.R. Ligal, Former Vice Chairman, National Planning Commission, Nepal

Nepal has under gone big challenges in the last one and half decade. The high expectation of the political party to control government and the expectation of the people for prosperity and high life style with in the shortest possible time have created instability in politics and the government resulting in to a weak and ineffective government structure and service delivery. The increase in the level of corruption led by politician at the government further destabilize the government and the poor delivery of benefit to the common mass causes disillusion among the people towards the political system and governance.

The concentration of poverty and the low social development among the mass of the people caused emergence of a movement called "Maoist Movement". The development deprived mid and far-western region gave an opportune place for breeding and consolidating the movement, which later turned in to arms conflict extended to cover almost all parts of the country later on. The conflict has taken a big toll in terms of human life. About ten thousand plus people have been killed and hundreds of thousands have been displaced from there home.

The conflict also takes a toll in terms of a lost in income due to poor economic performances caused mainly by the conflict. The destruction of infrastructures, disruption in the construction activities including manufacturing and trading activities, the bottlenecks in the free movement of goods and services as well as the disruption in the transportation system, looting of Bank deposits and household assets etc. have forced to suspend new investments and also benefiting from the investments made earlier. This has forced economy to perform under potential.

The buoyant economic performances during the early stage of policy reform failed to transcend the benefits to the common people aggravating the situation further. The problems in the political system manifested decision making at the government level and the increased security problems caused by heightened insurgency has further compounded policy implementation, when it was more needed. The result, slippage in the policy implementation delays in the necessary policy response and action taken resulting into a less than expected outcome in terms of benefit such as more employment creation and increasing income in the rural areas. All this has added conflict to strengthened and enhanced.

2. Theory and Some Empirical Findings

A region that experiences protracted conflict will also often suffer from economic underdevelopment, damaged assets, and a reduced capacity to function effectively. Armed conflict retards a country's development process, and also erodes its developmental foundation. In addition to the huge loss of lives, war leads to material losses, such as destruction of crops and roads, and extensive damage to economic and social infrastructures. Transportation and communication systems, banking, health care, education, and agriculture are often damaged or destroyed.

The economic stress caused by war lessens production capacity and limits the investment capabilities of war-torn regions. During wartime, resources are "diverted from routine maintenance of existing social and economic infrastructure" and into defense. Non-military government spending is often tightened, and there is typically a decline in investments in industrial, agricultural, and construction sectors. These industries, as well as overall trade, tend to decline. Debt often reaches very high levels.

Abundance of literature can be found in conflict, its causes and the impact on economic development. A short review on internal conflict and economic activity are summarized below. The main explanation for the channel of how internal conflict affects domestic economic activity can be found in Elbadawi’s (1999) study of civil wars and poverty. He argues that conflicts play a role in reducing investment, which will not only hurt current output but also have dire implications for future output as well because of reduced capital accumulation. In his empirical investigation, he finds that a higher incidence of civil wars leads to lower growth.

A more comprehensive approach to the effects of conflict on the economy can be found in Collier (1999), who examines the significant difference between the two types of conflict. He actually finds that civil wars are generally more damaging than international wars because they are fought entirely over the landscape of the country and so are more likely to undermine government organization. And although both lead to an immediate deterioration in the capital stock of the nation, a civil war may lead to a war overhang effect or a reduced rate of growth continuing on after the war. This differs substantively from an external conflict because there is apt to be a peace dividend or rapid growth that occurs after a war due to reduced capital stock.

Studies have found that there is a casual relationship between domestic economic activity and external and internal conflict. A reduced level of domestic economic activity tends to create incentives for increased external and internal conflict, which in turn reinforce low levels of domestic economic activity. Therefore, if the economy is affected by conflict and the incidence of conflict is affected by the domestic economy, how can we separate the effects of one on the other? One possible approach is to identify, using econometric restrictions, a separate equation for growth and a separate equation for conflict, which allows these two endogenous variables to affect one another.

Civil wars can drive away foreign direct investment, an important source of savings, as foreign investors redirect their funds to less risky and more politically stable countries. Moreover, battles and guerilla activities can destroy private and social capital while inhibiting market exchanges. The long-run and short run economic prospects of civil war–torn nations are adversely affected by such hostilities. It is unlikely that the economic consequences of civil wars will be solely confined to a nation in turmoil. There is apt to be negative spillovers to neighboring nations from disruptions to trade, heightened risk perceptions by would-be investors, severance of input supply lines, collateral damage from nearby battles, and resources spent to assist refugees. The length and accessibility of common borders are anticipated to determine the spatial transmission of negative externalities stemming from a neighbor’s internal conflict.

A better understanding of the consequences of civil wars, not only on a host country’s economic growth but also on its neighbors’ growth, is essential to improve the effectiveness of foreign assistance to developing countries. When neighborhood spillovers are substantial, this assistance may have to be augmented to counteract civil war externalities for an aid-recipient nation to stay on its path to a higher steady-state level of gross domestic product (GDP) per capita.

However, a hopeful note to lessen conflict has been sounded by Easterly. He finds that the existence of “high-quality institutions such as rule of law, bureaucratic quality, freedom from government expropriation, and freedom from government repudiation of contracts” lessens the negative effects of ethnic fractionalization on the economy. Unfortunately, the introduction of such institutions to countries where they are not currently in place may elude the imagination of even the best intentioned policy maker.

The experience in the conflict affected countries shows that these countries face severe social, economic, and political problems, both at local and national level. Conflict not only creates specific manifestations of poverty, but also affects wider structures and institutions. At the local level, in areas most directly affected by the conflict, there is likely to be:

Sri Lankan Case

 The twenty-year armed conflict in Sri Lanka for and against a LTTE spearheaded “homeland” for the Tamil population has affected every part of the Sri Lankan society, economy and polity for the last twenty years. The conflict within the Tamil militant groups; between Tamils and Muslims in the East; and between displaced people and host-communities in the western and central parts of the country has made the matter all the more worst. Similarly, driven by economic, social and nationalist issues, especially the rural youth, the Singhalese conflict erupted into violent insurrections in 1971 and 1988-89. Commonalities between the country’s two major conflicts include that they: (a) have sprung out of a perceived need for social and political change; (b) were driven largely by limited opportunities for young people in rural areas which had been strained of public and private investments compared to other parts of the country; and (c) turned hyper violent.

The conflict has taken a huge toll on the Sri Lankan economy and is estimated to have cost at least two years of GDP. Government defense expenditure accounts for some four to six percent of GDP, among the highest in the world. Public relief expenditure and the costs affiliated with damaged infrastructure are also high. In addition to direct conflict-created poverty among the population in the North and East caused by displacement and disrupted production, a slow-down in overall economic growth adversely affects attempts to reduce poverty country-wide.

Conflict is a key issue impacting on countries in the Asian, African, some European and Latin America countries. The bouts of instability and violence have threatened the basic well being of these countries besides, developmental activities that would have contributed in the transformation of socio-economic situation of its people. The recent upsurge in violence and conflict has made it clear that if sustainable development is to take root, there is a need for efforts that can foster social cohesion and build effective institutions and mechanisms to mediate conflict and manage diversity. Economic growth alone will not make these issues go away.

Recognizing that conflict undermines growth by causing social and economic disintegration and by reducing development gains, the multilateral institutions , such as, the World Bank has been providing greater attention to conflict management and social stability in its development planning and oversight.

3. Conflict and Governance Challenges

Improvements in governance have been evident in some countries, but there remain a number of governance challenges facing Asia and other conflict affected countries, prominent among these being the diversion of public resources for private ends. Much remains to be done to improve transparency and accountability in the formulation of public policy, in public-private relations, and in corresponding resource allocations.

In terms of the structures of government, there has been notable progress on decentralization and innovations in service delivery. The decentralization of both elected representation and of the public administration have recently been promoted in many Asian countries, but with mixed success. Local elections in countries such as China , India , Indonesia and Pakistan and Nepal have widened the scope for citizens to influence decision making, and increase resource allocations. Women have gained significant representation through affirmative action in local councils in these countries.

Increasing the responsibilities of local officials and elected representatives has raised questions in some contexts over the scope for elite capture and increased corruption, and almost everywhere over increased costs. Further, how far enhanced local representation translates into improved development outcomes has yet to be determined but there is some evidence of better targeted development spending on drinking water, fuel, and road construction in the Indian state of West Bengal.

Second, the capacity of governments to tax their population is an important indicator of the legitimacy and effectiveness of state institutions. The relatively low revenue/GDP ratio is a key challenge facing many Asian economies which need to raise resources for investing in infrastructure and improving social services.

Third, improved governance in the corporate sector remains challenging, especially where social and environmental impacts are concerned. Governments in turn are faced with the challenge of creating a more receptive environment for business, in respect of e.g. transparent laws and their improved implementation, and reductions of state pressure on decision-taking in crucial sectors such as banking.

Fourth, governance reform will be crucial in making markets work for the poor in the poorest regions and among the poorest people, as well as for improving the effectiveness of services and transfers made to these. This means improving the performance of public institutions at all levels and especially taking action to improve accountability and to avoid diversion of public resources.

In many countries governmental administrative machinery has been exposed to devastating situations during conflict. The destruction of administrative machinery and the paralysis of its operations are among the first targets of warring factions. The impact of conflicts on administrative machinery may be;

• Paralysis of the organizational structures of the central and local public organizations and interruption of policy processes;

Conflict-Poverty Link

Even if poverty is indeed the root cause of conflict, the effects of conflict result in more poverty. Since the effects of conflict are not merely in the short run, conflict makes poverty alleviation efforts in conflict areas challenging to begin with. A protracted conflict makes chronic poverty more costly to alleviate or eradicate especially if there are incentives for conflict to thrive. Conflict feeds into more conflict and prolongs poverty

Recognizing that conflict undermines growth by causing social and economic disintegration and by reducing development gains, the multilateral institutions , such as, the World Bank has been providing greater attention to conflict management and social stability in its development planning and oversight.

Text courtesy: Excerpts from the author's paper presented at a NEFAS Seminar held recently in Kathmandu-ed.