Development Paradox

Bijendra Man Shakya | 25 October 2021
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Nepal reduced poverty with open economy and trade but lagged in maintaining growth.

The International Day for the Eradication of Poverty was observed on October 17th in Nepal and all over the world amidst reversing decades of progress in the fight against extreme poverty due to the global pandemic. According to the World Bank, the recent crisis will push around 71 to 100 million people into poverty. That means the increased number of poor, mainly from South Asia and Sub-Saharan Africa, will add to 1.3 billion people already living under abject and persistent poverty or $1.90 a day.

The world poverty headcount ratio, which was about 36 percent in the early 1990s, when the International Day for the Eradication of Poverty began, had reduced to less than 10 percent in current times. An initiative to cut global poverty at this scale was supported by, among others, the sustained growth in developing countries which unilaterally liberalised their economies at a greater pace since the last four decades. Worth mentioning is the achievement made by our two giant neighbours China and India in reducing the poverty levels as they transformed from closed to opened economies.

Nepal performed satisfactorily as well in this regard. The poverty ratio in the country declined from about 40 percent until the late 1980s to around 25 percent in 2010 and approximately to 17 percent in 2019. Liberalisation of the economy in the early 1990s propelled the growth with the highest ever average increase of 5 percent between 1986 and 1996. It prompted the specialisation of labour-intensive products exploiting low-skilled labours for exports, and encouraged the import of inputs at the most competitive costs. Surprisingly, services trade and inflow of remittances also thrived in the face of increased import trade.

With one in four households depending on remittances in 1996, and by 2011, almost half of the country’s household income depended on remittances. Not only did more families receive remittances, but the figures reflected an exponential growth over two decades. From its contribution of 2 percent to the GDP in 2000, it increased to 22 percent in 2010 and 30 percent in recent years, making Nepal one of the highest recipients of remittances in the world based on its contribution to GDP. The phenomenal rise in remittances helped combat poverty and improved the livelihood of the rural poor.

Nepal’s post-liberalisation case had casually exemplified the proposition based on the correlation between trade openness, growth, and poverty reduction advocated by proponents of free trade and the economy. This ideology was explained earlier by classical economists like Adam Smith and David Ricardo. Influenced by the industrial revolution, classical thought believed that countries gained from trade without restrictions. It allows efficient allocation of domestic resources and induces specialisation among countries leading to a mutually beneficial trade.

Empirical studies had shown that many countries in South and South-east Asia and Eastern and Central Europe that had undergone the policy reform and trade openness during the 1990s had experienced miracle growth. The growth rate in such countries was far superior compared to the gain experienced by countries that believed in import substitution for economic welfare during 1960-1970.

Despite compelling evidence of a connection between trade, growth, and welfare, it was condemned later by several economists as the speed of globalisation took place. Opponents blamed globalisation, mainly for rising inequality and wage disparity between and within countries. This issue has drawn an acrimonious debate over globalisation and inequality among affluent economies. But it mattered less to impoverished countries like Nepal because the basis of their problem lies not on inequality but on maintaining sustained growth to continue with combating poverty. Paradoxically, Nepal had irregular and modest growth but brisk poverty reduction, which, according to the World Bank, contradicts many countries that experienced rapid growth but modest poverty reduction.

Then, what is responsible for the growth laggard in Nepal? It is the policy flaws that matters the most. Nepal's trade liberalisation policy was a necessary condition but not a sufficient one for trade openness boosting growth leading to sustained poverty alleviation. Its effect depends on other complementary policies that the country follows for the “trickle-down” effect with increased openness and growth.

But policymakers boosted labour export and remittances inflow as an end rather than considering it as a means to growth. As a result, a large scale migration depleted the stock of the workforce at home, weakening manufacturing and agriculture sectors evenly. The contribution of agriculture and manufacturing sectors have reduced to less than 30 percent and 10 percent respectively in the face of an increased share of services to three-fourths of GDP. The balance between job creation at home and labour export has been overlooked just as failing to strike a balance in manufacturing and services. Labour outmigration led to an increased inflow of remittances boosting household expenditure and quickly generating government revenues. As a setback, it not only discouraged creating productive employment at home but also contributed to the steady loss of competitiveness through appreciation of the real exchange rate.

The large scale migration and increased inflow of remittances had somehow relieved pressure on the government to be accountable and deliver services. It solved the problem of unemployment, enabled greater consumption, and generated revenue from tariffs and taxes. Thus, the cycle of low growth and poverty incidence continued despite the programmes to alleviate poverty are in place in the country.

For these economic maladies and mismatches, one blames a prolonged political transition, frequent changes in government, natural disasters, including the devastating earthquakes in 2015, in addition to the country’s irregular topography. But, the root cause is the existing development model, which overly depends on remittances disregarding other sectors of the economy. Against this background, Nepal needs a balance between the manufacturing and services sectors for growth. It should address the compensation mechanisms to recover the loss from trade openness to address the poverty incidence. In addition, there is a need for easier access to anti-poverty programmes as growth may be slow to reach the rural areas home to a majority of poor and isolated from the centres of economic activity. That means a development model without balanced regional development will remain as ineffective as the current development endeavour.

Bijendra Man Shakya is an associate professor of economics at Tribhuvan University.

This article was originally published on The Kathmandu Post.
Views in this article are author’s own and do not necessarily reflect CGS policy.