Thus, according to Say, ‘supply should create its own demand’ rather than the Keynesian belief on ‘demand creating its own supply’. While economists have persistently argued on Say’s and Keynes’ belief, my aim is not so. Through this article, I would like to empirically answer two important questions: a) what is the exact nature of Nepal’s economic growth in terms of goods trade and b) what exactly should the policymakers learn in policymaking when it comes to stimulating the economy via trade. I find the latter concern to be of special significance in the context of Nepal as a lot of policy statements today are simply based on value judgments of the policymakers and hence tends to be superficial and biased without sound economic realities.
Increasing cross-border movements of goods and services has been the central feature of today’s globalizing economy. While Nepal is certainly in the catch-up process, it is one of the most open and trade-dependent country in South Asia. The trade in goods constituted 34.7 percent of the national Gross domestic product (GDP) in 2007 to that of 21.2 percent in 1990. Flipping over the data books of Asian Development Bank (ADB), the World Bank and the International Monetary Fund (IMF) concerning exports, imports and GDP figures suggest that the increase in trade volumes after 1990 led to a rapid rise in the nominal GDP. This is likely the case as a result of the trade liberalization during the 1990s. A series of market-oriented reforms like reduction of import duties and elimination of several quantitative restrictions and licensing requirements opened up the economy for a greater movement of goods across borders. But, trade remains highly concentrated on average as 50.6 percent of total trade was carried out with India, 26.1 percent with USA and around 14.4 percent with the EU. The close integration with India with trade agreement treaties on transit and preferential trading dating back to 1950 makes India the dominant trading partner of Nepal.
A closer look at the structure of merchandise trade suggest that Nepal exported 9.9 percent of all food items, 0.5 percent of agricultural raw materials and 66.7 percent of manufactured goods over the years while the same number varies to 11.7 percent, 3.5 percent and 45.6 percent respectively when it comes to imports. While the exports rely dominantly on the primary sector of the economy, the imports often include industrial and manufactured goods such as machines and the fuel to run them i.e. energy. Hence, a high reliance on the primary sector has exposed the economy to severe vulnerabilities while the terms of trade (TOT) also seems to be unfavorable.
To test the relative significance of export and import upon economic growth i.e. the growth rates of GDP, I used a causality test developed by Clive Granger, a Nobel laureate in Economics. From a layman’s point of view, a Granger causality test is a concept of causality solely based on prediction relying on past information. Based upon the results obtained from the Granger causality test (though not shown here), the nominal national GDP is being driven through exports such that an increase in exports increases the nominal GDP and vice versa. Over the same time period, the gross domestic saving has increased from 7.3 percent of the GDP in 1990 to 9.7 percent in 2007. As a result, the gross domestic capital formation as a percentage of GDP has increased from 18.4 in 1990 to 28 in 2007. But, the changes in GDP have no relation with changes in the volume of imports. This result is particularly surprising to me given the fact that the economy has faced a persistent trade deficit over the decades. The deficit has simply become larger during the period when the economy faced a decline in its production of manufactured goods even though the same period experienced an increase in the production of agricultural goods. Likewise, the results also show that an increase in exports also increases the imports in the Nepali economy. The private consumption expenditure as a percentage of GDP thus has experienced a fall with the fall in exports while it has increased during increased volumes of exports. Hence, the Nepali economy is export driven.
From a policymaking point of view, an export-driven economy requires export promoting and import-substituting trade policies. Has it been the case with Nepal? The answer is partly ‘yes’ and it would be harsh to say a complete ‘no’ because of the extensive export supportive strategies listed under the website of Export Council of Nepal (ECON). On the other hand, the answer is mostly ‘no’ because of the supply-side constraints such as poor infrastructures, lack of adequate transportation, ineffective and redundant communication facilities and energy that the production sector (supply-side) is devoid of. The policymakers in Nepal have so far failed in acknowledging that exports can only take place in place of production while the government has utterly failed in implementing the production-friendly policies. A stronger focus is needed to preserve the economy’s comparative advantage to increase exports. For example, the now ailing carpet industry which was once the mainstay of the Nepali manufacturing sector lost over half of its market due to declining demand, price controls and greater competition coupled with longer order cycles. The economy can also serve as an important transit point between the growing neighbors with opportunities for trade diversification. However, the unhealthy and unstable political development in the country has turned a lucrative opportunity to a major calamity.
The recent labor-management disputes in the form of wage bargaining have also done no good to the country’s economy. As the economy has excess capacity with significant output gap, every effort should be made to motivate the workforce. The end result would be a reduction in the unemployment rate with increased GDP. However, an increase in production should not take place at the cost of reduced productivity. Given an export-dependent economy, productivity is crucial to maintain a comparative advantage in the world economy against the global competitors. Thus, a careful use of modern technology with regular trainings and skills enhancing activities among the workforce should be the correct mode of production in our context.
Furthermore, hydropower is one sector where Nepal can enjoy indisputable comparative advantage. The enormous power potential could be exploited to meet the needs of domestic and regional energy demands. But, this requires developing new capacity to meet the domestic and export demand. One effective way could be to link with the Indian grid. On the other hand, Nepal Electricity Authority (NEA) has to be unbundled in terms of generation, transmission and distribution so as to mitigate unnecessary government intervention, improve financial performance and make the regulatory body effective. But, the development of power sector would certainly require revisiting and ramifying the Power Trade Agreement between India and Nepal.
An export-dependent economy also requires import-substituting policies. While the use of tariff barriers to prevent imports is inhumane in today’s context, the use of non-tariff barriers is still widely practiced. The use of non-tariff barriers can protect the infant industries so that they eventually turn out to be global competitors in the long run. Shielding the local industries from outside competition may cause some strains in the economy in the short run but if there is no pain, there is no gain either. But, the pain may aggravate and get irresistible in the absence of proper technological adaptation, innovation in farm practices and high literacy levels among the rural poor in a rural-centered economy.
Boosting production by eliminating the supply-side constraints should be the future of the Nepali economy. Thus, Say was right in believing that ‘supply creates its own demand’ but eventually failed in perceiving the notion of government being good, at least in our context.
Writer is an academic researcher in Energy Economics at WIK GmbH, Germany
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