How can Nepal Inc. be competitive ?

In mid-August 2003, Nepal's WTO negotiations were over and the Cancun ministerial meeting in September is certain to grant Nepal entry into WTO. Coming as this does in the middle of the Export Year, as 2003 is declared by the government, the news of WTO membership comes as a major achievement that the government can brag about in from of the private sector.

But, so what if Nepal receives WTO membership?

Many people are still fumbling about the answer to this question. However, it is clear to everybody that no country in the present situation can survive without becoming WTO member, and that no economy can survive the WTO order without being competitive. And a recent study commissioned under assistance from the World Bank gives some additional important insights into the issue and suggests some measures to improve the competitiveness of Nepal in the new world.

Most Liberal

Noting that the trade regime prevailing in Nepal is the second most liberal in the entire South Asia, only after that of Sri Lanka, the report entitled "Nepal Trade and Competitiveness Study" (which is though still at the draft stage) has shown that the country has indeed benefited from the trade liberalization. Per capita economic growth in 1990s, a period of fast trade liberalization, was 2.4% per annum compared to only 1% during the prior economic history of Nepal, it notes. Exports grew at an annual average rate of 15% throughout the decade of 1990s. According to a study by Binod K Karmacharya quoted in the competitiveness report, exports were the engine of economic growth during the 1991-95 period. The fall in exports by 20% in 2002 contributed negatively in the economic growth in that year.

But the report also states that though Nepal's trade to GDP ratio of 50% is high from south Asian standard, it is low when compared to similarly sized countries (that have GDP of US $ 4-6 billion) like Azerbaijan, Estonia, Gabon, Honduras and Yemen.

 Importance

Apart from its contribution to the GDP, another positive aspect about Nepal's trade is the fact that her exports are labor-intensive manufacturing and diversified agriculture, thus making trade critical for poverty reduction.  As analysis of the 1995-1996 data suggests, if the 5% average growth rate of the 1990s could be restored in the next five years, and if inequality does not worsen and consumption grows at the same rate as income, then the share of population living below the poverty line would be expected to fall below 30% by the end of FY 2007.  The report claims, simulation exercise carried out for the competitive study showed, that trade and its associated improvement in transportation can raise the income of the poor (especially the urban poor) through employment and by encouraging farmers to switch to higher-value crops. 

Weakness

As the key factors that contribute to low price competitiveness and productivity in Nepal's economy, the study has identified three weaknesses. First is the inadequate mechanisms and incentives for firms to acquire new technology. Second, is the weak infrastructure, and third an unfavorable business climate. Rigid labor legislations in the formal sector, with strict anti-dismissal rules, are blamed as preventing incentive-based wages, constraining investment in labor training, and decreasing labor productivity. The labour productivity was improved during early 1990s, but it could not be sustained during late 1990s due to the appreciation of real effective exchange rate (REER), notes the report.

Inadequate bankruptcy and foreclosure provisions raise the costs of reallocation of factors to more productive uses, leading to an economy that tolerates a broader range of inefficient firms, compared to other developing countries.  Price competitiveness is further diminished by a comparatively weak infrastructure and one of the highest charges for electricity in the region, states the report.  Transport and transaction delays lead to exceptionally high inventory costs.   An inadequate regulatory framework, unpredictable implementation, the Maoist conflict, and related uncertainty further add to costs.

Labour issue

Whenever there is a point raised for reforms in labour laws, those opposed to reforms raise the point of unemployment and underemployment. But the competitiveness study has argued that unemployment and underemployment should not be the major issues in Nepal as recent labor surveys (e.g. Nepal Labour Force Survey 1998-99) have shown low unemployment and low underemployment. The issue is low productivity, argues the report and blames it partly on labour laws. Though the labour market regulations affect only 2% of Nepal's labour force directly, the repercussions are wider, it argues. It provides disincentives to perform and discourages firms to invest in skills development.

On the contrary, these regulations also provides incentive to use more machines than labour and the report of the recent manufacturing industry census indicates that the investors have already started preferring machines to labour (see box "Manufacturing Firms in Nepal").

Informal trade

Regarding the noise that is made repeatedly about the informal trade between Nepal and India, this report shows that though the volume of such trade is almost one-third of the total formal trade between the two countries and that means the problem is serious, such trade is balanced between both sides. So the Indian claim that more goods are being smuggled into India from Nepal than that smuggled from India into Nepal seems to be wrong. Another important finding reported is that the smuggling is caused not only by tariff differential between the two countries, but also by, and perhaps more importantly, by the high transaction costs of formal trade.

Weakness of Nepali Incentives Systems

To facilitate the competitiveness of Nepali products, Nepal has three major policy measures adopted - cascading tariff, duty drawback facility and bonded warehouse facility. And this report shows that all these three systems are in fact ineffective in their objectives.

Cascading tariff

First is the cascading tariff system under which several rates or bands exist and the relative rates are intended to correspond to the stages of production or the degree of fabrication.  This usually means that the highest rates are levied on final goods, lower rates applied to intermediate goods and the lowest rates to raw materials and capital goods.  Although this approach might seem to be straightforward and sensible, it leads to serious difficulties in practice and represents a major impediment to achieving an effective policy environment conducive to rapid and efficient economic growth, notes the report.

To illustrate consequences of cascading rates, the competitiveness report notes that there are broadly three types of relationships in terms of value added in different business activities:

#   Simple assembly activities are often characterized by quite low value-added ratios (e.g., 1% or 2% are not unusual and negative value added is common);

#   Most manufacturing of consumer goods typically exhibits value-added ratios in the range of 5-30%;

#   Manufacture of intermediate goods and processing of raw materials usually have somewhat higher value added ratios, commonly 20-60%; and