Workshop on Nepal: Forging a New Beginning

Australian National University

October 5, 2008

Discussant Notes

by Swarnim Waglé

“Three Propositions to Correct Economic Incentives in Nepal,” by Hom Moorti Pant

  1. Hom-ji’s paper is an important contribution to understanding development challenges through the lens of “incentives.” This is an economist’s way of dissecting problems, and it’s qualitatively superior to what we are used to hearing on the persistent causes of Nepal’s malaise.

A sociologist might say it’s all because of the caste system, social immobility and fatalism.

A political scientist will say the system is not right; the Ranas, the Panchayat, the Democrats.

A radical Marxist might say everything is because of exploitation and imperialism; India, etc.

A Hindu fatalist may say our collective fate was pre-determined.

  1. Grand theories are interesting to listen to but ultimately unhelpful in coming up with solutions. Within development economics, they have tried different fads over the past 5 decades: 1) Foreign aid funded big dams, roads, infrastructure; 2) Investment in machines, factories; 3) Population control; 4) Education; 5) Social mobilization; 6) Policy-based lending, etc.
  1. Desired outcomes not attained because of “misalignment of incentives.” This was popularized by Bill Easterly (Elusive Quest for Growth, MIT, 2001). He quotes Steven Landsburg: “People respond to incentives; all the rest is commentary.” In other words, people do what they get paid to do. Private businesses and individuals, government bureaucrats, and even donors respond to incentives.

But these incentives may not be aligned. The development challenge is to get all the actors to do what is desirable: incentives for private firms and individuals would be to create conditions for profitable investment. For government bureaucrats, there should be incentives to not engage in rent-seeking or expropriation, but focus instead on creating quality public goods and services, etc.

  1. Hom-ji is trying to tell the story of Nepal’s under-development as one of mis-aligned or wrong incentives, especially those perpetuated by ruling politicians and bureaucrats. He argues, Nepal is poor materially (GDP per capita is under $300), and part of the reason for this is low labor productivity. Better machines and tools, proxied by higher energy use, can improve things. For better machines and tools we need investment. But investment is low. Why?
  • Social history: rulers above the law, patronage
  • Value system: fatalism
  • Geography
  • External constraints
  • Weak law and order: in particular corruption and impunity led to high costs and risks of doing business, increased uncertainty of returns; wrong learning from doing; inefficiency; distorted public expenditures.
  • Corrosive impact on politics
  • Marginalization of the poor, exclusion exacerbated
  1. Special privileges, discretionary law enforcement, opaque bureaucracy  corruption, and hence the distorted incentive system. Removing these perversions is the greatest challenge in Nepal.
  1. He is highlighting an issue that is broadly understood as the “governance” problem, or the quest to improve the quality of institutions. Different people understand it to mean different things, but there is consensus that it covers in the least:
  • Rule of law
  • Quality of the civil service
  • Freedom from repudiation of contracts
  • Freedom from govt. expropriation

7.Corruption, impunity are a sign of malfunctioning institutions. So, my suggestion to Hom-ji is to frame his issues around the rubric of “quality of institutions.” That’s what they are, and just shooting straight at the problem of incentives is less helpful.

  1. Then, Hom-ji proposes three institutional reforms to change judicial, bureaucratic, political culture.
  • Enforce rule of law
  • Maintain transparency and accountability
  • Establish credible political will
  1. Hom-ji should be more specific here. The micro- steps necessary should be spelt out. For example, what would establishing political will entail?

Holding intra-party elections at least every two years?

Making party finances completely open and independently auditable?

Introducing term limits?

Not allowing tainted leaders to come back to positions of influence?

On transparency:

Televise or make available all documents related to public contract processes?

On accountability:

Empower the CIAA with its own staff and funds so that it is truly autonomous to take action against the big culprits. For example “Sampatti Bibaran” to be probed rigorously and made legally prosecutable.

Whatever happened to the “Suryanath phenomenon” who took on Khum Bahadur, Govinda Joshi, Chiranjivi Wagle, J.P. Gupta, circa 2003? He faded with the Royal takeover and the introduction of the King’s Kangaroo Court.

One must mention here that even crooks respond to incentives: it was Khum Bahadur himself who introduced measures to strengthen the CIAA owing to intense pressure from the public and the media in the late 1990s. The incentive was to be seen doing something.

  1. Also analyze how the measures proposed should work from the point of view of incentives.

Powerful and fully autonomous CIAA – what would it do to whom?

Media programs that grill politicians – what’s in it for the them?

Public expenditure tracking, Report Cards, and other Social Accountability Measures.

  1. We are discussing all this because of our concern against under-development. And we are arguing that corruption, bad rule of law, impunity create POOR incentives for economic growth.
  1. My suggestion to Hom-ji is to talk about other kinds of incentives that also serve as POOR incentives for economic growth, such as bad economic policies.
  1. Why is this important? Maoists may be more upright and less corrupt than Congress or UML or the Royalists, but if they pursue bad economic policies, POOR incentives might be created that will retard economic growth. And from the point of view of growth, whatever the source of distortion is, both are equally bad even though, morally, the society may prefer bad policies to bad faith.
  1. Discredited economic policies could result in

High budget deficit

Excessive trade protection

Overbearing regulation and red tape

High taxes

Negative real interest (rate of interest lower than the rate of inflation)

Black market premium

Obstruction of the price mechanism; chronic shortages

  1. One potential issue of endogeneity here. Richer countries are less corrupt (odd exceptions are the likes of Portugal, or Ghana, or South Africa). We should be conscious of the fact that while corruption is causing poverty, it could be that we are corrupt because we are poor. So the paramount issue is really about sustained economic growth; all our other woes are symptoms of underdevelopment.
  1. When we analyze Nepal’s underdevelopment, we have to acknowledge other structural difficulties, including landlockedness. A few facts:

Of the 35 or so landlocked countries in the world, there are 6 in Europe that are not practically landlocked because they are well integrated into the European market. The reason landlockedness hurts is that it increases the cost of doing trade and engaging with the outside world because of distance to world markets. But in Europe that’s a non-issue. Even Switzerland has 50% of its population living in low-level cantons with access to the navigable Rhine. Exclude Botswana and Belarus, and you end up with the remaining landlocked countries that are some of the poorest..

  1. So even if corruption is eliminated, and all the incentives are aligned (i.e., bureaucrats behave responsibly, politicians become honest facilitators and investors in public goods, and private investors pursue legitimate profit-seeking ventures) Nepal’s structural constraints will still prevent it from being too rich. At 7% p.a., in 10 years we will have $600 per capita per annum, still poorer than today’s Sudan. In 20 years, we will have $1200, still poorer than today’s Sri Lanka. Even if we grow at 10% year-after-year for the next 30 years (which appears impossible) we will reach today’s income per capita levels of Russia ($4,460). Forget the pipedreams of reaching the levels of Singapore ($27,490); Australia ($32,220); UK ($37,600); USA ($43,740); Switzerland ($54,930) in our lifetime.
  1. In conclusion:
  • The paper makes a useful contribution to analyzing Nepal’s problems through the lens of incentives. This is the correct approach in my view as development is all about getting the actors respond to a desired set of aligned incentives.
  • But better to frame and situate the incentive argument around the broader agenda of improving “institutional quality” which the solutions touch on.
  • In fact, be much more specific in the measures proposed to improve the quality of institutions.
  • Paper focuses on MESO; Add the MACRO as well as MICRO facets.
  • Incentives related to politics and governance well covered. But even if the government was squeaky clean, it could follow those economic policies that will create all the wrong incentives that retard economic growth. Highlight this.
  • Finally, acknowledge that even with all the corruption uprooted, and all the right incentives in place, Nepal will still struggle. This may call for aligning our development incentives with our geographical constraints, e.g., towards services and light-weight manufacturing that render weight and distance irrelevant. But this is another topic for another day.