Nepal has few resources but numerous economic and political problems. Hence, trying to solve all the problems using limited stock of resources might not produce the best synergistic effect. For instance, the spray-gun approach tried in the past did not produce growth rate as expected by the policymakers. A smarter strategy would have been to devote a proportionally high amount of resources in relaxing the binding constraints, which could have led to a large positive effect on growth rate.
The main issue here is to identify the most binding constraints on economic activity and to design a set of policies that, once targeted on these constraints at any given point of time, would produce the biggest bang for the reform buck. This would not only help construct a hierarchy of the strongest constraints, but also identify the most binding one so that economic policies designed to relax it would produce a favorable change in growth rate. Following this line of policy-oriented approach, a growth diagnostics of the Nepali economy (done by this author in collaboration with Prof. Sinan Koont, Dickinson College, PA) shows that bad infrastructure is the most binding constraint on economic activity.
That being said, it does not mean that other constraints like human resources, macroeconomic stability (financial, monetary and fiscal), microeconomic risks (property rights, corruption and taxes), coordination failures and information externalities (self-discovery) in the market, low savings, and poor intermediation are of no importance. What it really means is that these constraints are not as strong as bad infrastructure is, if our objective is to bring the largest change in growth rate in the short term, i.e. improvement in the supply of infrastructure (relaxing the binding constraint) would produce the largest positive change than relaxation of other constraints.
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The poor quality of existing infrastructure and a virtual absence of linkages between production and manufacturing sites in the hilly and mountainous regions has not only stymied structural transformation and impeded a shift to new productive activities, it is also leading to a skewed spatial distribution of agents (firms and labor) and assets in the economy. The major firms are clustered in and around few cores like Kathmandu, Pokhara and Tarai—the same places which have relatively low transportation costs and high potential for economies of scale. The road density in Tarai (24.99) is two and 17 times higher than in hilly and mountainous regions respectively.
In terms of infrastructure quality, Nepal ranks 132 out of 134 countries considered in the Global Competitiveness Report 2008-2009 and its infrastructure quality is worse than the average score for the factor-driven economies (determined by institutions, infrastructure, macroeconomic stability and health and primary education). Research studies show that a deterioration of infrastructure from the median to the 75th percentile raises transportation costs by 12 percentage points and reduces trade volume by 28 percentage points. The availability and quality of infrastructure affects the agricultural sector as well. A study done in 2004 by the Ministry of Industry, Commerce and Supplies showed that if transportation time is reduced by 50 percent, then it would result in higher income through increased use of fertilizers and market access.
There is undersupply of roads infrastructure, the most important one in terms of stimulating economy in a short period and connecting produces, retailers and consumers. The supply of roads infrastructure is so low (and market price so high) that communities themselves are teaming up to construct garbled roads. Only 56.88 percent of the total roads network is paved. Note that, Nepal has one of the lowest total roads network (17280 km) when compared to countries with similar income per capita. For instance, Burkina Faso, a landlocked country in Africa with similar income per capita, has longer roads network and higher road density than Nepal. It is not surprising that Nepal has the highest transportation costs (trade-weighted) in South Asia. The transportation costs for textile and clothing industry is more than three times the cost prevailing in India, six times than in Bangladesh, and 34 times than in Sri Lanka. This is the same industry which is rapidly losing its market share chiefly due to loss of price and quality competitiveness after the end of MFA in 2005, labor dispute, and energy crisis. Its performance has a strong bearing on exports revenue and GDP growth rate.
Among other modes of infrastructure, the decades old rail service is dysfunctional and the quality of airports is terrible. Out of 133 countries considered in Travel & Tourism Competitiveness Report 2009, Nepal ranks 114. There is approximately 500MW of wedge between demand for and supply of electricity and electricity consumption (69.5 KWh per capita) is the lowest in South Asia. Worse, the electricity tariff rate in Nepal ($0.093 per KWh) is almost double the rates prevailing in India and Bangladesh. Furthermore, telephone subscriber rate in Nepal is also the lowest in South Asia.
If the objective is to generate high growth rate in a short period of time, then the policymakers must put more emphasis on those constraints whose relaxation would produce the largest effect on growth rate. In recent years, bad infrastructure has been the most binding constraint on economic activity. Policymakers should focus policies on and devote more resources to relax this constraint in order to kick-start the process of generating a high growth rate in a short period of time.
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