$4.4 Billion and How To Proceed

By: Bikal Dhungel 

  

  

Following a 7.8 magnitude earthquake that cost the lives of over 8000 Nepalese, people all over the world donated generously to help Nepal. The total loss in monetary terms is expected to be around $7 billion, one third of Nepal's nominal gross domestic product (GDP). The government held a donor conference in Kathmandu where high ranking officials from national governments and international organizations participated and pledged a fantastic $4.4 billion both as grants and loans. However, the Nepalese government still needs to assess how they can feasibly spend that amount in an effective way to make the most out of it. $4.4 billion is a gigantic amount, more than four times the regular official development assistance (ODA) Nepal receives in a typical year. It is slightly less than the total remittance flow of $5.5 billion that entered the nation through formal channels last year. $4.4 billion divided among the population will give a mere $1700 per person, twice the nominal per capita income. Amount of this size will not generate large outcome but if spent intelligently, the multiplier effect will be huge and is enough to transform the nation. $4.4 billion will be accompanied by another $5.5 billion remittance flow this year and Nepal's own development budget.   

  

The most important question now is how we can spend the money in such a way that we are independent from international support in the future? Example of Haiti shows that mismanaging fund would lead to another disaster that can turn to be worse than the earthquake itself. This disaster can also lead to violence when political parties and groups fight for their share of aid ignoring the overall welfare of the nation, a reason why donor countries prefer to spend aid through INGOs and NGOs instead of giving to recipient government. But there are also examples where international support has been used intelligently to rebuild nations from where Nepal can take lessons.   

  

14th August 1945, the official date of the end of World War II. Two atomic bombs were dropped on the Japanese cities of Hiroshima and Nagasaki. Germany had already surrendered and the biggest war in human history cost the lives of over 70 million people worldwide where more than 50 million were civilians. The losses of properties and the cost to rebuild were immeasurable. Europe was left devastated. Yet, in another decade they again brought the continent in pre-war level and major  

European economies were experiencing economic booms. How did that happen? Taking the example of  

Germany, the country that was hit hardest in terms of material loss, there is much to learn. When Germany surrendered, the victors of World War II, the USA, UK, France and Soviet Union kept their presence in German states and were concerned about its future. They had to make sure that Germany does not start another war like both World War I and II. How to monitor that country to ensure world peace had been a major concern. The USA understood that politically and economically unstable Germany would threaten peace more than an economically powerful Germany integrated to the world economy. Same argument was valid for Europe and Japan. The US foreign minister brought the plan to rebuild European states destroyed by World War II with the name 'Marshall-Plan'. $13 billion was released from which Germany received $1.4 billion, about 2% of its gross domestic product of the year 1945. That amount was tiny in comparison to the support Nepal got this time, which is about 20% of the GDP. How Germany used that amount is remarkable. It cleared the ashes of World War II, rebuilt the critical infrastructures necessary to kick-start growth and after five years, the German economy reached the beginning of the phase called „ Economic Miracle „. From 1949 to 1973, Germany grew at an average of 6.5% per year. The total wealth more than tripled during that period. The economic policy of Finance minister Ludwig Erhard who later became the Chancellor was massive capital accumulation that strengthened production which led to rural to urban migration that in-turn boosted productivity.  

Industrial production grew and Germany immediately became the leading exporter of the world. The German government had to import labour from abroad to work in booming industries. Heavy investment was made in educational sector with more priority on technical education and training schemes, institutions were created that were necessary to create rule of the game of economy, financial institutions grew which worked under a close cooperation with the state, the central bank called 'Deutsche Bundesbank' was formed whose main goal was to maintain currency stability. Other reforms like the progressive tax system, social security system and health care reform was made which helped to grow the economy further and made Germany a stable and robust country. The most important factor was the will of the people to contribute to build their nation and their hard work guided by genuine principles of government which was growth and development oriented. The Germans didn't work for themselves, they worked for their children. They built the country for their children and grandchildren. The history of economic development shows that one generation should always sacrifice their hard work for future generation. It was the case in South Korea, Singapore and elsewhere. It takes a generation to build a nation. What Nepal can learn from Germany is, in order to do something, there should be a strong will, a strong sense of sacrifice. Until we only think about ourselves, it will not contribute to growth and development. Short-sightedness will not generate growth. We need to think about our children and should be ready to sacrifice our effort for their prosperity.  

   

Nepal today resembles with Germany in a sense that Germany also didn't have a constitution. The German constitution is a random collection of paragraphs that were added and removed and again added, neglected and again brought to life time and again in the last 60 years. There was never such thing like constitution assembly. They also didn't need a constitution. They needed development and development needs a genuine development policy. Constitution alone without a feasible development policy will not bring change. Without a robust economic development, neither democracy nor peace will sustain. Where there is poverty, there will be violence, there will be war. The Germans understood this and decided to focus on development first and constitution later. However, a basic political foundation is also vital to development. If Germany were unstable, with various social and economic problems, they would not have achieved development. Here the question arises why political stability and supporting institutions are necessary for development. The history of the United Kingdom gives an answer of this question. Why industrialization started in England and not in Japan, South Africa, Spain or Russia has been a question researchers took long time to reach a consensus and that it is the political foundations that supported industrialization in England. Daron Acemoglu and James Robinson mention in their book  

‘Why Nations Fail’ that prior to seventeenth century, European states were full of aristocrats that resembled the political structure of typical under-developed countries like Nepal. Prosperity was limited to few, landlords had full control over their peasants, slavery was usual, wealth was concentrated on aristocrats and most importantly, there were heavy restrictions on economic activities. Consequently, broad majority of people suffered from poverty and deprivation. However, England managed to breakthrough from the system. The revolution of 1688 gave birth to economic and political institutions that were successful in providing incentives for business, trade and innovation. The property rights law was brought which guaranteed fruits to creative minds whose inventions was saved from being copied by free riders. Monopolies were reduced giving rise to competitors. Roads, canals and infra-structures supporting economic activities were built. Educational institutions were built to provide high quality of education in that time. These foundations created a way for industrial revolution which later spread to other parts of Europe as well. The short history of 17th century England teaches 21st century Nepal that without creating or reforming institutions that pave the way for technological advances, growth will not follow. Institutions that ensure wealth redistribution for social security and education must be present. Also institutions that ensure a rule of the game in terms of finance and trade are pivotal. On the other hand, in the presence of extractive institutions, authorities and governments to enrich the few will postpone development. Acemoglu and Robinson give example of Eastern Europe and Russia during the time of industrialization. These nations managed to disrupt economic activities which put the ruling aristocrats in power whereas the majority suffered, a story that is valid in Nepal of 21st century.  

   

  

  

From 17th century England and 20th century Germany, Nepal should learn that building a robust political foundation and then feasible economic policy is eminent to welfare growth. Making the existing institutions powerful and creating ones that are necessary in the field of finance, education, health and others is vital. Infra-structures should be built in areas that are critical to growth. Critical bottlenecks of development should be determined and they should be removed. In education sector, best practices from the world adapted to local conditions should be integrated to the curriculum. To summarize, Nepal should focus on following points: maintain political stability, create an environment for domestic and foreign investment, create institutions, reform education policy, work on the efficiency of public sector, guarantee property rights, reduce credit constraints for the poor and for small scale entrepreneurs, support the entrepreneurs, closely co-operate with the private sector, make technological learning in all fields a priority and minimize market distortions.   

$4.4 billion will surely be not enough to reform everything but it is enough to initiate the change. These were the policies that countries with rapid growth had in common. These were the foundations upon which double digit growth was achieved. Germany was able to initiate these changes with only a cash injection of 2% of its GDP, Nepal is getting much bigger share. Same thing is also true for South Korea, Taiwan or Botswana. So, if there is a strong will, Nepal can become another Asian Tiger in the coming decades.   

   

  

  

  

  

Aid, Inflation and Entrepreneurship

By; Bikal Dhungel 

Global official development assistance (ODA) is not without criticism. In the last 5 decades, over one trillion dollar has been given as aid. Still, many countries especially in sub-Saharan Africa are poorer than 40 years ago. Per capita income did not rise there.  Based on this figures, the backlash on aid has been rampant recently. People are grouped into three categories. First, those who support aid unconditionally (like Jeffrey Sachs), second, who thinks aid should be conditional (Esther Duflo ) and third, who think aid does not work at all (Dambisa Moyo, William Easterly). All three groups have robust data and well-grounded reasoning. Whatsoever, the initial reason for development aid, (to foster development) could not be realised. Otherwise over 1 billion people living below $1.25 a day would not be a reality today. However, it does not necessarily mean that aid has completely failed. As Esther Duflo puts it, ‘Aid might have helped to avoid even bigger disaster’.

The portion of poor people worldwide has decreased but this decrease mainly took place in South East Asia, especially in China. In least developed countries, the situation has not changed much. Despite huge amount of aid, development failed. The figure below shows aid as a percentage of government expenditure. From the figure it can be concluded that countries receiving highest amount of aid are in Africa and three in Asia, which includes a war torn Afghanistan, Cambodia and Nepal.

Source: World Bank, 2012

Also in the past these countries have been receiving a high amount of aid per capita. So, what was the role of aid in these countries? Has aid been fruitful at all?

There is no single answer to these questions. There are many unique factors that caused under-development. Some of the countries mentioned above are landlocked. Landlocked countries are in comparison poorer than countries that have access to the see. They also trade less especially due to the high cost of trading. A recent survey has showed that the cost of shipping good is 19% of the total price in Africa whereas it is less than 5% in the US. Why I mentioned trade is because trade is about trading goods and services. To trade, it is necessary to produce these goods and services. Producing goods and services means creating employment and that will eventually contribute to development. This is where the role of aid comes. First, what happens when aid is pumped into a country that produces less and trades less? A recent case study in Mogadishu, Somalia showed that the influx of aid has caused massive price hikes for basic goods that the most vulnerable were unable to afford it. With increased aid and remittance inflow but with a constant supply of goods, price normally goes up. When aid and remittance doesn’t go hand in hand with increased supply of goods and services, the money will be lost in inflation. So, even a well-intentioned support can worsen the situation further. A similar pattern is visible in Nepal. The high inflow of remittances has caused the price level to go up. From the year 2000 to 2013, inflation averaged 6.8% whereas GDP grew only by 4.1% in average. At the same time manufacturing and agricultural yield shrank but import sky-rocketed. Hence, it will be correct to conclude that remittance and aid has increased our foreign dependency but caused our manufacturing sector to vanish. This phenomenon is also called ‘The Dutch Disease’. Moreover, it also caused a price hike in non-tradable goods like real-state and housing. Such development puts Nepal in a vulnerable situation especially when the remittance and aid flow is disturbed by economic crisis.

The National Living Standard Survey 2010/11 shows that almost 80% of remittance is used for consumption and less than 5% is used for income generation. As mentioned above, once remittance flow reduces, it is likely that more people will be pushed below poverty line due to the lack of saving and income source. So, putting aside some remittance for investment is a form of insurance for rainy days. Moreover, the government has a role to play to avoid any inflationary tendency so that the remittances are not simply lost in price rise. Some countries including Nepal have introduced the instrument called remittance bond but it has failed to generate any positive result in Nepalese case. In terms of Aid, how they are spent is not known. The government spending process is in-transparent.  Still, like remittance, more inflow without accompanied by more production, there will be no long term gain.

Hence, main focus should be on entrepreneurship. If aid and remittance are invested, they create jobs and will help the people to sustain even without them in the future. Simply giving more and more aid both in the form of cash and goods is harmful in the long run. The famous story of mosquito nets clarifies this.

Malaria is one of the largest causes of death worldwide. According to the World Health Organisation, in 2013 alone, almost one million people died due to Malaria. But Malaria can be easily prevented, for example by vaccination or by using mosquito nets. So, an aid organisation decided to distribute mosquito nets for free in some rural area. Before the distribution, there was an entrepreneur who produced mosquito nets. She had 20 employees who could support ten family members each by their job. Now the aid organisation has distributed mosquito nets for free in the whole area and the local net producer was out of business. 20 employees and their family members lost their income source. In the short term it was still good for the general public because they all got free mosquito nets. After few years, the nets become old and cannot be used anymore. So, again the aid organisation should come and give them free nets. If they cannot do it anymore due to whatever reason, prevalence of malaria will again rise. Had they built the capacity of local net producer, the supply of nets in the absence of aid had continued but now the local net producer has gone out of business and the donor agency cannot give aid anymore. So, everybody is worse off.  The vicious circle of aid goes on like this. Aid should be given again and again.

How aid can be used in order to boost sustainable economic growth depends on how the receiving government chooses to use it. In the aftermath of World War II, the famous Marshall Plan was initiated with a total of $14 billion to rebuild Europe. The amount was used to build critical infra-structures that were vital for growth. Within five years, Europe built a robust economy and the period of ‘Economic Miracle’ started in Germany. The only difference between the Marshall Plan and Development Aid today is, Marshall Fund was perceived as a ‘one time’ support whereas recipients of Development Aid get it in yearly basis without having used it efficiently in the previous year. Marshall Fund was spent responsibly with targeted investments whereas Development Aid mostly vanishes within the recipient government and bureaucracy.

The lesson to take is simple: when the donors teach how to fish and actively support in the process until the capacity is built, no aid is required in the future. In contrast, if aid is given for the sake of giving, first it can cause inflation putting the vulnerable in even more risk and second it should continue further as it kicks small scale entrepreneurs out of business, like the story of mosquito nets.