Nepal’s Growth Strategy For Catching Up With India And China – Analysis

By Hari Bansh Jha

Abstract

Nepal lies on the southern slopes of the Himalayas between two of the world’s fastest growing economies – India in the south and China in the north. India has been maintaining a sustainable economic growth rate of 9 percent, whereas China’s economic growth rate is still higher. With a growth rate of merely 3.4 percent, Nepal so far missed the chance to align its own development with the economic dynamic of its giant neighbours. This is all the more surprising because Nepal offers many possibilities for closer economic integration with the huge Indian and Chinese markets on its footstep, such as a big potential to produce hydropower, favourable laws regarding investment including FDI, diverse ecological belts suitable for different agricultural activities, an attractive tourism sector, and not least its very location as a prospective transit economy between India and China. But up to now, Nepal has been plagued by weak governance, inadequate infrastructure, power shortage, labour militancy, an expanding trade deficit, and a poor tourism policy. The core problem of Nepal’s development perspective is an institutional bottleneck. With a politically weak government and a politically divided society, the speed of economic development will remain below its potential. To overcome this bottleneck and to initiate a catching up process with India and China, a politically committed government should encourage private trade and capital flows especially with India and China, and otherwise focus on macroeconomic stability and the provision of public goods, such as the development of infrastructural facilities and higher investment in health and education services.

1.0 Background

Until recently, South Asia was largely known among the international community as the region of internal and external strife and home to the world’s largest number of poor with low per capita income and poor social indicators. But in nearly two decades, the scenario in the region has changed significantly. During this period, there has been a substantial increase in the per capita income in this region in terms of dollar, decline in poverty and improvement in human development indicators. In fact, South Asia’s rate of economic growth remained 6 per cent between 1998 and 2008, which is now projected to grow at 7.9 per cent in 2013.[ii] The entire region has emerged as one of world’s leading economies. It is second only to East Asian and the Pacific economies in terms of growth and even the gap is closing.

India with growth rate of GDP of 8.6 per cent in 2010 has taken the lead in South Asia, yet some other countries in the region are not far behind. In 2010, Sri Lanka’s growth rate of GDP was 7.6 per cent); while the growth rate of GDP was 5.8 per cent in Bangladesh and 4.1 per cent in Pakistan. [iii] Even tiny countries like Bhutan and Maldives have quite higher rate of economic growth. Virtually, Nepal with annual rate of economic growth of 3.5 per cent (2010) is the only country left behind, which symbolize the “Island of Poverty.”[iv]

Inhabited by nearly 30 million people, Nepal missed the bus of economic growth of South Asia. The country is predominantly agricultural. Over 80 per cent of the population are directly or indirectly involved in agricultural activities. Today the country ranks in the bottom 10 per cent of the countries in the world although in its direct neighborhood both India and China have achieved remarkable rates of economic growth.

In 2010, the per capita GDP in Nepal was $557 against the per capita GDP of $ 1,380 in India and the per capita GDP of $ 4,382 in China. [v] People falling below the international poverty measures of $ 1.25 per day constitute 55 per cent of the total population of the country. But the Central Bureau of Statistics in Nepal presents that only 25 per cent of the population are below the poverty line. The Nepalese planners feel that the poverty level in Nepal has declined because almost half of the country’s households have members working abroad. [vi]

Productivity in all important sectors is low. There has been un-utilization or under-utilization of resources and the available infrastructure is weak. The supply of essentials like electricity and petroleum products including kerosene oil is erratic. The carpet and garment industry together account for about 70 per cent of Nepal’s overall exports, but even they are severely affected mainly due to the labour problems. There is a huge deficit in balance of trade and it is growing each year.

Moreover, Nepal is plagued by poor governance. During the time of transition from monarchy to the republican set up in 2008, a government slogan promised the making of a ‘New Nepal.’ But thereafter very little effort was made to translate the vision into reality and people’s hopes have been largely belied.

Nepal has neither adequate domestic savings nor Foreign Direct Investment (FDI) to achieve higher rates of economic growth. A country needs to have at least 30 to 40 per cent savings of its national income to achieve higher rates of economic growth, but Nepal’s Gross Domestic Savings was as low as 9.4 per cent in 2006 against the investment rate of 24 per cent. [vii] So nearly 70 per cent of the development expenditure is met by foreign aid, but even aid utilization is poor. Against this backdrop, the present study was conducted during the three months [viii] at the GIGA Institute of Asian Studies, Hamburg, Germany to derive at policy recommendations to inform the Nepalese government, planners and policy makers as to how the country could ‘catch up’ with its fast growing neighbours – India and China – under the given constraints.

2.0 What is catching up?

Quite often, the per capita income of the poorer economies has a tendency to grow faster than the per capita income of the richer economies. In fact, the prospects for achieving higher rates of economic growth are higher in the poorer countries than in the richer ones. This is due to the fact that the diminishing returns in terms of capital are not as strong in the poorer developing countries as in the capital rich countries. Furthermore, the poorer countries have an additional advantage of replicating production methods, technologies and institutions of the richer countries.

In the initial stage of growth, there could be a difference in the techniques of production between the leading rich nations and the following poor nations, but ultimately the labour and other costs give the follower nations a better opportunity to catch-up. Such a catch-up approach continues until there is something that the follower nations learn from the leading nations, and this tendency to catch up ceases once the discrepancy between the leading and follower nations ceases to exist.

The advantages of a latecomer country in the growth sector are well explained in the flying-geese model as developed by Kaname Akamatsu in 1930s. According to this model, the latecomer economy might industrialize and develop by adopting strategies like product development, diversification and upgradation of industries from consumer goods to capital goods and take advantage of relocation of industries from advanced countries. [ix] But for all this there should be a facilitating state and market economy with a human face ready to extend all necessary support to those industries which have comparative advantage over similar industries in developed countries.

It, thus, appears that simply being poor is not in itself a guarantee to catch-up higher economic growth. In order to catch-up economic growth of comparatively advanced economies, it is necessary to have access to capital to promote catch-up, which quite often is a problem in the poorer countries. With this regard, Moses Abramovitz suggests that the poorer countries need to develop social capabilities like the ability to absorb new technology, attracting capital and participation in global markets. [x]

In fact, there is certain similarity between the approach of Kaname Akamatsu and Moses Abramovitz about the prospects of catching up for the latecomer countries. There is a focus in their models on such aspects as facilitating state, market economy and social capabilities as pre-conditions for the latecomer to catch up economic growth rate of the developed countries.

3.0 Factors Governing Catching up Approach

The catching-up approach demands structural changes in the economy. For this, it is necessary to create an enabling environment for harnessing both the natural and human resources. Some of the factors that are pre-requisite for catching up are as follows:

Political Commitment by Leaders and Effective Government

Higher growth rate do not come automatically. It is rather the fruit of commitment made possible by the political leaders in the government through a rigorous process of long planning. Therefore, the role of the government is of utmost importance in growth strategy. A government is not merely a policy maker, but more so a service provider, investor, employer and arbitrator. It is far easier to catch-up growth of the rich countries when there is stable, honest and effective government. Such a government plays an important role in maintaining price stability and fiscal responsibility, which is highly important to the growth of private investors. Besides, such a government opens the door for industrial growth by pumping huge public investments in infrastructure, education and health. Significantly, the effectiveness of the government largely depends on factors like the pool of talents it has, the incentives it gives and the service delivery in different fields. Well trained civil servants are an asset; while poorly motivated and ill-prepared civil servants are costly and rather liabilities of a nation.[xi]

Growth Identification and Facilitation

In order to catch up the rate of economic growth of the lead nation, the politically committed government needs to identify the strong industries within the country with a high record of success in production and trade. It needs to provide these industries with the needed support to enable them to improve their quality and make production at a competitive rate to export to the market of the lead country. [xii] If needed, the government could also invite FDI in sectors in which there are no domestic industries. Research and development activities are promoted to give way to innovations.

Economic Integration through Physical Connectivity

Physical connectivity is most crucial in the catching up process. It is important not only for the mobility of the people and social integration, but also for the integration of the market and economy of the poor countries with the developed countries. In the absence of world-class infrastructure and railroads, it is not possible to take advantage of multi-modal transport system. Investments in infrastructural sectors such as in roads, rails, airports and more significantly power breed private investment. On the other hand, the telecommunications helps raise productivity for its role in disseminating price information to farmers and other producers. It brings out transparency and ensures delivery of government services in financial and trade related services. So the follower nations make huge investment for the development of some of these infrastructural facilities. It is through the investment rather than consumption that an economy ensures the trade-off between present and future standards of living.

Use of Surplus Labour

Labour is key to different factors of production. In many poorer countries, there is surplus labour, which is a great asset to them. Proper utilization of the labour force in development activities increases the income and wealth of the country.

Technology Transfer

Catching up is impossible without the knowledge of the world economy. Technological know-how adds to the efficiency of the labour towards the utilization of land and capital. In the market economy, the government heirs foreign experts to gain knowledge in certain sectors in case such knowledge does not exist in the country. Foreign education is also treated as a channel of knowledge transfer.

Human Capital

Human capital denotes the skills of labour force. It represents the productive capacity of individuals. It creates the ability and efficiency to transform raw materials and capital into goods and services. It helps to improve labour productivity, facilitate technological innovations and bring higher returns to capital. Its role is also important in poverty reduction.

Most importantly, human capital and the skills learnt are the outcome of educational attainment. Education helps the growth of a person’s labour productivity and earnings. It is well known that there is a positive relationship between the years of education and per capita GDP. [xiii]

Therefore, in the initial stage the government of the follower nation takes pro-active role and make investment in promotional areas. Priority is accorded to the growth of education focusing on vocational education and skill development programmes. A minimum investment of 7 to 8 per cent of the GDP in education, health and training is required to ensure catching up with the lead countries.

Investment in human capital such as in health, schooling and skill development creates opportunities for the attainment of sustained high growth for a long period of time. An analysis of data of 146 countries between 1950 and 2010 shows that there is a wide gap in the human capital accumulation between industrialized and developing countries. At the global level, the average number of years of schooling is 8 years, while it is almost 11 years in the industrialized countries and just 6 years in South Asia and sub-Saharan Africa. [xiv] There is a wider gap in the years of schooling between the industrialized and developing countries. Estimates are that it will take nearly 3 decades for South Asia and almost a quarter century for sub-Saharan Africa to catch up the average years of schooling of industrialized countries. Even Central Asian and East European countries will take nearly a decade to come to the level of industrialized countries.

4.0 Successful Experiences in Catching up

In several parts of the world, the poorer countries converged with the developed countries in line with the catch-up theory. During the 16th and 17th century, Britain targeted the industrial development of the Netherlands when its per capita GDP was nearly 70 per cent of Netherlands. In the late 19th century, Germany, France and USA targeted the British industries when their per capita income was between 60 per cent to 75 per cent of the per capita GDP of Britain. During the period of Meiji restoration, Japan targeted the industries of Prussia when its per capita GDP was about 40 per cent of that of that country.

In the 20th century, countries like Germany, France and Japan which heavily suffered in the wake of the Second World War managed to regain themselves in the post-war (1945-1960) period.[xv] Japan targeted the industries of USA in 1960s when its per capita GDP was nearly 40 per cent of the per capita GDP of USA.

Later, Mauritius targeted Hong Kong’s industries in the 1970s when its per capita income was only half (50 per cent) of the per capita GDP in Hong Kong. Ireland targeted the information industries of the USA in 1980s when its per capita income was only around 45 per cent of the per capita income of the USA. Similarly, Costa Rica targeted the memory chip assembly and testing related industries of Taiwan when its per capita GDP was 40 per cent of the per capita GDP of Taiwan.[xvi]

Moreover, the modernization of the Japanese industries in 1960s and 1970s paved way for the growth of the East Asian tigers like Hong Kong, Singapore, South Korea, Malaysia and Taiwan. Later, China stole the show from the industrial upgradation by the East Asian Tigers in 1980s. The establishment of Special Economic Zones (SEZs) by China during this period was of great help in attracting FDI and in kick starting an economy.

Many SEZs were established in Guangdong, Fujian and Shanghai coastal areas of China following Deng Xiaopeng’s decision to open up the economy in 1978. This was also the time when Taiwan and Hong Kong were looking for the prospect of transforming their industries from low-tech to high-tech and from manufacturing to the services sector. So once they found that the SEZs were opened up in China, they dismantled their low-cost industries and transferred them to the SEZs. Countries like Taiwan and Hong Kong accounted for nearly 70 per cent of FDI in China between 1978 and 1992. Significant flow of FDI from outside this zone took place only after 1995.[xvii] The industries thus set up in SEZs began to produce and export goods to the traditional market of US, West Europe and South-East Asia. In fact, this worked as kick start for China’s drive for modernization.

In their catching up process, countries like China, Brazil and India have attained the level of growth which Japan had in 1960s or the East Asian Tigers had it in 1980s. Both in India and China, public sector reforms played key role in pushing the growth rate higher as given below:

5.0 Public Sector Reforms in India and China

Understanding the pre-eminent role of public sector, China began to introduce public sector reforms programs in 1978 whereas India initiated public sector reforms programs almost 13 years later in 1991. The pre-reform economic system in China was a copy of centrally planned economy of the Soviet Union, albeit with some modifications. In fact, China introduced public sector reforms in a gradualist manner as many people believed that the reforms in public sector would help the country to achieve higher rate of economic growth.

In course of implementing public sector reforms, China introduced competitive environment for business by changing centrally planned economy into market economy. It adopted open door policy as long-term economic policy of the country. Accordingly, the laws and regulations of the land were framed in a way that it could attract foreign investment. As per the new provisions made, the land could be leased to the investors for 15 years and if needed even up to 75 years. Foreign trade was decentralized and the value added tax system was introduced. Some of these measures soon helped China to achieve higher rate of economic growth, though it was at the cost of suppressing peoples’ consumption.

On the other hand, the Indian model of economic growth was based on the approach of mixed economic system, which inherited ethos from both the capitalist and socialist system. The rate of economic growth in this model of economic growth was very low, which was often called ‘Hindu rate of economic growth’ – a derogatory term to express lower rate of economic growth.

Eventually, the lower rate of economic growth pushed India to a severe crisis in balance of payments in 1991. This further led to severe liquidity crisis. As a result, the foreign exchange reserves in the country plummeted to such an extent that the government had no option left but to resort to such harsh measures as selling its stock of gold to obtain foreign exchange, using special facilities at IMF and receiving emergency bilateral assistance from Japan and Germany. [xviii]

In order to face the severe economic crisis, the government of India introduced public sector reforms effectively and efficiently in 1991. Simultaneously, such reforms were introduced in industrial policy, trade policy, exchange rate policy, foreign investment policy, taxation policy, etc. Most importantly, under the industrial policy reforms, the licensing system was abolished for most of the industries. The limit to investment in large Indian/foreign companies was abolished. Private sector was allowed to operate in all kinds of industries other than those related to strategic and defense units. Also, access to foreign technology was increased. Similarly, under the tax reforms, a number of measures were adopted not only to broaden the tax base, but also to simplify the tax laws, rules, procedures and forms. The structure of custom duties was also simplified. And in the financial sector, sweeping reforms were made in banking, insurance and capital market.

Unlike in China, the public sector reforms in India were due to the compulsion of economic crisis. But such measures paid dividend soon. The GDP growth rate that had dipped to as low as 0.9 percent in 1991-92 in India shot up remarkably to 5.1 percent in 1992-93 and 6.2 percent in 1995-96. [xix]

Before the introduction of public sector reforms, both Indian and Chinese economies were largely state controlled and isolated from world economy. Their rate of economic growth was very low. However, in the process of integrating with the world economy, both India and China tried to liberalize and modernize their economies. All possible efforts were made to lower trade barriers, create congenial environment to attract foreign investment and ensure deregulation of industries. With the liberalization of the domestic economies, the banks were also liberalized.

Once the state control mechanism was replaced by integration of the respective economies with the world economy, both India and China began to make miracles by achieving higher rate of economic growth. In both of these countries, the public sector reforms promoted accountability, effectiveness and efficiency in service delivery and ensured transparency in order to achieve higher rate of economic growth.

Gradually, understanding the role of the private sector, efforts were made by India to create friendly environment for private sector investment and for this infrastructure facilities were built. In China, too, the government had developed various infrastructural facilities including of course roads, electricity to attract Foreign Direct Investment (FDI). Political stability backed by good governance system also facilitated the growth of domestic and foreign investment. Thus, the public sector reform was not competitive but complimentary to the development of private sector investment and/or FDI in Indian and Chinese economic growth model.

Statistics show that currently the rate of economic growth in India in 2011 is 8.8 percent while in China the GDP growth is recorded a little higher as 9.7 percent. Economic miracle in India and China established a fact that higher economic growth is possible not only in comparatively closed society such as China, but also in democratic and a more open regime like India. With this regard, the Indian diplomat Ronen Sen rightly said, “Today what we have done is proven that democracy and development, federal democracy and development, with devolution, are inseparable.”

Economic reforms in India some 20 years ago in 1991 have not only transformed India but it has done so even globally. India is now a potential economic superpower. It is likely that India could catch up China in terms of economic growth by 2020. One of the potential advantages of India over China is the demographic shift in favour of young and able working population, which will possibly lead India to reach higher growth trajectory. [xx]

If the Asian economic history is made the base, it appears that ultimately India will overtake China for the sole reason that sustained development depends on entrepreneurship, a strong private sector, rule of law and political openness. India is ahead of China in possessing some of these blocks needed in economic growth. Michael Schuman in his article “Will one Economic Model Prevail?” finds that the Chinese economy looks lovely from the outside, but it is rotten at the core.[xxi] On the other hand, the Indian growth engine might occasionally look smeared, but it is powerful. India’s growth is balanced because of strong domestic demand drives. This gives protection to the economy from external shocks, which is largely lacking in China as it is over dependent on investment and exports. China could balance itself if it is able to become more Indian. [xxii]

6.0 Nepal’s Prospects for Catching-up

Being a latecomer in the race for economic growth is really a challenge to Nepal. But it also provides an opportunity to use the country’s cheap surplus labour, which is highly important in the catching up process. Encouragingly, the latecomer Nepal provides certain grounds to catch up, which are given below:

Existence of Support services

Nepal is having a growing middle class and educated population. Roads and communication facilities have been developed in various parts of the country. Almost half of the country’s total households receive remittances. Each year there is inflow of remittance worth nearly US $ 3 billion in the country. This has increased the purchasing power of the people. Besides, the banking services and macro-economic management are well developed. [xxiii]

Potential Energy Sector

More than 6,000 rivers exist in Nepal with a combined run-off of about 200 billion cubic meters. All the river systems in the country finally end in the Ganges. Together, they contribute to over 40 per cent of the water of this river.[xxiv] They have the potential to generate 83 thousand MW of hydropower, but so far only 600 MW are harnessed. But given the fact that both India and China have competent manpower and resources to develop hydropower and that India is a big market for the export of power, Nepal has big prospect for the harnessing the water of rivers for power production on a large scale, which is a short cut method to transfer quick growth to Nepal.

Foreign direct investments (FDI) and Special Economic Zone (SEZ)

As China benefited from the development of SEZs in its coastal regions, Nepal could also benefit from SEZs if they are established at suitable locations in the country. All necessary tax incentives could be provided to the industries in SEZs for a fixed period of time, apart from providing them such facilities as credits for investment and foreign exchange for their expansion and growth.

The flat land of Terai region of Nepal is best suited for developing SEZs because of the proximity factor in trade with the bordering Indian states. Of India’s population of 1.21 billion, more than 361 million people live in Nepal’s bordering states of Sikkim, West Bengal, Bihar, Uttar Pradesh and Uttarakhand in India. By developing SEZs in this region, Nepal could easily export goods right across the border in the neighbouring bordering states with which there is similarity in tastes, preferences and purchasing power.[xxv]

Another opportunity is that the Inland Container Depot (ICD) at Birgunj (Nepal) in Terai is already linked to Raxaul (India) through the Indian broad-gauge railway line. Several facilities have been provided at the dry port to allow Nepal’s import and export of goods with India and third countries. Besides, other ICDs are also in operation in this region at Biratnagar and Bhairahawa. Those dry ports have significantly reduced time in the transportation of goods, transport costs, pilferage and demurrage at the port of Kolkata in India. [xxvi]

Nepal has also formulated all necessary laws to attract FDI. The country provides opportunities to foreign investors to make investment and take due profit. The climatic factor and ecological base of the country provides further opportunities to investment in hydropower, tourism and different other sectors. The signing of the Bilateral Investment Promotion and Protection Agreement (BIPAA) with India in October 2011 is a positive attempt towards attracting investment from India and other countries in such areas as hydropower, fast-track road, railways, tourism, education, health, agriculture and other infrastructural projects during the “Investment Year 2012-13″ and even afterwards. Nepal could enter into similar agreements with China to take advantage of its huge surplus of foreign exchange reserves for investment in this country. [xxvii]

Unique Landscape for Agriculture

Nepal is a unique country for having all the three regions – the plains (Terai), hills and the mountains. Therefore, many of the plants or crops grown in any part of the world could be produced in this land. This provides breeding ground to the domestic and foreign investors to make investment in agricultural sector and benefit from it. In fact, Dabur Nepal, a multinational company, has already been reaping dividends from investment in the herbal sector.

Prospective Tourism

Nepal has comparative advantage over both its neighbours, India and China, regarding tourism. Within so close proximity of nearly 85 kilometres to 150 kilometres of width and nearly 1,000 kilometres of length, Nepal is endowed with diverse landscapes which range from the sea level up to the world’s highest peak of Mt. Everest. Of the world’s 10 tallest mountains including the highest Mt. Everest, 8 mountains are situated in Nepal. There are over 240 peaks lying over 20,000 feet from above the sea level.[xxviii] Besides, the rivers, thick forests, flora and fauna, and above all the most hospitable people of Nepal provide unique attractions to tourists from all over the world.

Nepal is well known for its rich cultural heritage. Some of the cultural heritage sites in Kathmandu, Bhaktapur, Patan and Lumbini are world famous.

Being the birth place of Goddess Sita, Janakpur is the attraction for the Hindus from all over the world. Many of the Hindus visit Pashupatinath and Muktinath temples for its religious importance. Similarly, Lumbini the birth place of Lord Buddha provide the same attraction to the Buddhists from all over the world as Mecca provides to the Muslims and Jerusalem to the Christians.

Nepal provides a clean environment and certain level of infrastructure to the tourists in line with the concept of eco-tourism. Trekking routes in the mountain areas are well known. Shelter houses of moderate standard exist for the tourists in several rural and remote regions, which provide basic services at affordable prices. Standard hotels are available in the cities. Many of the tourist centers in the country are connected to roads and air service. For some of these reasons, Nepal is also called ‘Shangri-La’ i.e. heaven on earth. Quite often Nepal’s tourism package is linked to India, which is an added advantage to the tourists.

Potential Transit Economy

Each of India and China has comparative advantage over the other in the trade sector. Against India’s comparative advantage in IT software, China does have comparative advantage in IT hardware. While India does have comparative advantage in auto components, pharmaceuticals, chemicals and machine tools, China possesses strengths in areas like electronics, toy making and machinery. [xxix] Therefore, the volume of trade between the two countries has increased phenomenally to $70 billion in 2011.[xxx]

Since China is India’s largest trade partner, Nepal has a great potentiality to take advantage of the geographical proximity and emerge as transit country between the two. Nepal could help India and China to develop trilateral infrastructural facilities like roadways, railways and airways. If some of these facilities are developed, both India and China might benefit from the transit routes through Nepal as this would reduce the cost on transportation of goods and services. On the other hand, Nepal could emerge as an attractive centre for investment as it would have the opportunity to tap the vast markets of India and China.

Open Border and Prospects of Free Trade

All through the ages, Nepal and India have maintained an open border system for the movement of people of one country into the other. This provides further opportunity to the two countries to move one step forward towards establishing a new order in which there could be free flow of goods and services from one country to the other. Nepal is likely to benefit from this new arrangement as it might give way to economic integration with India in the same way as the European Union has benefited through the integration of the European economies. This move might encourage Nepal to catch up the level of economic growth of India in a shortest period of time.

In the past, Nepal had missed the opportunity of catching up the rate of economic growth of India mainly for its failure to integrate its economy with India in infrastructure development, skill development and in matters related to the knowledge economy. It is encouraging that the Indian Prime Minister Manmohan Singh has advocated partnerships with neighbours in South Asia, including Nepal, through the development of greater connectivity in transport, road, rail, waterway, communication, transit routes and commercial links in order to give way to mutual dependencies for the mutual benefit. [xxxi]

The vision for free trade and economic integration between Nepal and India is governed by the Factor price Equalization Theory. This entails that the relative prices for two identical factors of production in the same market happen to be equal to each other on account of competition. Such factors which receive the lower price before the integration of two economies tend to become more expensive after the integration of the economies. On the other hand, the factor that receives a higher price before the integration of two economies becomes cheaper. Therefore, it would be in Nepal’s interest to accelerate the rate of its economic growth and reap the advantage of Factor Price Equalization theory by integrating its economy with the economy of India.[xxxii] Free trade arrangements between Nepal and China, however, is a remote possibility given the fact that the mainland is very far off. On the other hand, free trade arrangements with India might even allure Chinese and other investors to make investment in Nepal to tap the vast Indian market.

Ground for Relocation of Industries

Given the fact that the labour costs in Nepal are comparatively cheap and that there is a big Indian market right across the border, the country provides a good ground to those Indian and Chinese industries which want to relocate to other regions in their effort to upgrade themselves. For this, the country needs to establish SEZs and by doing so it could primarily target China where the cost of production in the industrial sector is growing fast. All such resources as land, labor, water, power and pollution compliance are getting expensive. The country has gradually been losing its stronghold and is becoming less competitive in the production of footwear, toys and many other labor intensive products. Mainly due to the cost factor apparel related industries are getting relocated to country like Bangladesh. Vietnam has been able to develop footwear industries almost in the same way as Poland has been developing its furniture industries. The establishment of SEZs could provide opportunities for those industries in the neighbourhood which want to

7.0 Bottlenecks in Catching Up

Despite the fact some of the prospects for Nepal to catch up the economic growth rate of India and China, there are some bottlenecks as presented below:

Continuation of Lower Intensity of Conflict

Nepal was heavily affected by a civil war that lasted between 1996 and 2006. During the time of conflict, more than 16,000 people were killed and a number of infrastructural facilities were destroyed. Though the conflict somewhat subsided after the Comprehensive Peace Agreement was signed in November 2006 between the Government of Nepal and the UCPN-M, [xxxiii] political stability is yet to return to this strife-torn nation. The Maoist rebel forces continue to stay in different cantonments and satellite camps in various parts of the country. On November 1, 2011, Nepal’s major political parties, including the Unified Communist Party of Nepal – Maoists (UCPN-M), Nepali Congress, Communist Party of Nepal – Unified Marxist Leninist (CPN-UML) and Samyukta Madhesi Morcha signed a seven point agreement with regard to the integration and rehabilitation of People’s Liberation Army of UCPN-M. Yet the agreement is opposed by a major group within the UCPN-M and its implementation is in limbo. As yet, the rebel forces who unlawfully captured the private property of individual owners have not been returned to them.

Governance Deficit

The law and order situation in Nepal is still fragile, despite the fact that civilian rule was established following the Constituent Assembly elections in 2008. People find it difficult to move freely in certain parts of the country, particularly in the Terai region and eastern hills due to the presence of armed groups. The country is still plagued by bandhs, strikes and donation drives by certain unscrupulous elements. Rule of law and justice does not prevail. The government and the law makers are more interested in the power game rather than in the game of improving the governance system of the country.

Inadequate Infrastructure

Ever since the beginning of the Plan era in Nepal in 1956, several infrastructural facilities, including roads and airports have been developed. But still a lot needs to be done to develop connectivity through roads, rails and airports within the country and also with the neighboring countries. Because of the lack of roads, Nepal imports apples from China and India but to its dismay much of its own apple grown in Mustang and other mountain districts get rotten or are sold at very low price. Moreover, the telecommunications and internet facilities are still confined to the urban centers and the quality of services is often questionable.

Lack of Consistency

On an average, a government does not last even for a year in Nepal. Sometimes the government is lead by one political party, while at the other time it is led by other party. The change in government shakes the entire bureaucratic structure. So there is a lack of consistency in decision as well as in policy making. Even if certain decisions are made at the political level, there are hurdles in the implementation at the bureaucratic level.

No Seriousness about Transit Economy

No doubt the rising volume of trade and economic intercourse between India and China provides reasonable justification to develop Nepal as a transit country. Yet there is no serious dialogue among the stakeholders on this issue. India and China have border problems. They have a feeling of distrust between them. Each of the countries has security concerns, but Nepal’s choice in addressing security concerns of its neighbours is very limited.

Power Shortage

Nepal has a history of 100 years of hydro-power production. Yet the country produces far less than 1 per cent of its total hydropower potential. Most of the industries and economic activities in the country are affected either due to the inadequate supply or lack of power. As per the Water Resources Strategy 2002, Nepal was expected to harness up to 25,000 MW of power within two decades. But given the performance in this sector, it is not possible to harness even a quarter of the target.

Insecurity to Investment and Labour Militancy

Labour militancy unleashed by certain radical forces has affected most of the industries in the country. Some of the multinational companies run under FDI like Dabur Nepal or Surya Nepal have also been targeted. Even at a time of power crisis, some of the hydropower projects under construction are frequently targeted by certain unscrupulous elements. This has increased the security concerns of the investors in Nepal.

Neglect of Surplus Labour

No significant effort has ever been made to use to surplus labor in the country in productive activities. So more than 3 million youth have migrated to countries other than India in pursuit of employment.[xxxiv] Each day almost 1,300 youth are leaving the country for employment in overseas countries.[xxxv] The government record shows that the people who are seeking foreign employment has grown by 40 per cent in the recent years despite the growing recessionary trend in different parts of the world. Estimates are that 3 to 3.5 million people have migrated to India for job.

Expanding Trade Deficit

Expanding the trade deficit with India and China is a challenge. In 2009-10, India’s share in Nepal’s exports formed 66 per cent against its imports of 58 per cent from this country. Nepal’s deficit in balance of trade with India nearly doubled to Rs. 317 billion between 2008 and 2010. [xxxvi] Similarly, Nepal’s imports from China are six times the country’s total exports to this country. Virtually, this problem is due to the poor supply position of Nepal.

Poor Tourism Policy

There is a lack of proper tourism policy in Nepal. Hippy tourism does not auger well for the economy. Not much attention is given to develop museums and also for the promotion of cultural heritage. Money earned through the tourism business is not spent so much on its growth. Moreover, not much has been done to train tourist guides through training, building adequate hotel infrastructure and creating due public awareness in the society. Unfortunately, the quality of services as expected to be provided to the tourists in certain areas is far from satisfactory. There are reports that the services provided by the personnel at the security, immigration and transport points at Nepal’s Tribhuvan International Airport are mostly offending to the tourists. Quite often, the security checks are arbitrary, toilets and other areas are not well maintained. In addition, the government employees including the immigration officials and the transporters are rude and their only intention is to fleece passengers rather than providing them due service.[xxxvii] Many tourists have reported misbehavior of certain groups of people such as the local transporters in Annapurna trekking routes in Mustang and other such tourist hubs.[xxxviii]

8.0 Some Lessons in Growth Strategy

But there the question arises if Nepal should blindly follow the strategies that should help it to take to the same level of economic growth as achieved by India and China or there is any lesson as well that Nepal could perhaps learn from the higher economic growth rate of these countries. Of the several factors that led to higher economic growth rate of India and China, the most crucial factors were the role of facilitating state, market economy and social capabilities developed by in India and China almost in tune with the catching up models of Kaname Akamatsu and Moses Abramovitz. But in course of economic growth there were certain deficits in both the countries, which a latecomer country like Nepal need to avoid. In the Indian model of growth, the distribution aspect is weak. The poor do benefit from economic growth, but they do not benefit in the same ratio as the rich benefit. China on the other hand benefited by suppressing the wage rates of the labourers and even by grabbing the land of the farmers for industrialization and development activities. But now there is a growing discontent in this country against some of these highhanded measures.

9.0 A Way Forward

Since Nepal is endowed with natural resources, including land, water, minerals and above all the people and it has climatic advantage over its neighbours, there is no reason why the Nepalese cannot have the same standard of living, if not better, as compared to their southern and northern neighbours. But for this, Nepal’s annual rate of economic growth would have to be substantially increased from 3.5 per cent at present to at least 13 to 14 per cent in the long-term. Given the political will, there is no reason why Nepal cannot achieve higher rate of economic growth like its neighbors like India and China. In fact, the opportunities for catching up are more in Nepal than what it was available to countries like Japan or even the East Asian Tigers. Against this background, Nepal could consider some of the following points in its catching up process:

The political leaders should be committed to improve governance system of the country to catch up high rate of economic growth of India and China.

High investment needs to be made for the production of hydro-power, apart from the construction of high quality roads, rails, air, telecommunications and internet to develop connectivity within the country and also with India and/or China.

Human capital should be improved through education and health; while technology transfer needs to be ensured for the inflow of know-how in every sector of the economy, including in agriculture, industry, trade or service sectors.

Nepal should try to opt for a free trade arrangement with India with a view to integrating its economy with India to take advantage of economy of scale, dissemination of information, technology and knowledge spillovers, free trade and higher foreign direct investments.

All needed support should be given to potential industries, particularly hydropower and tourism to target the market in India and China as per the spirit of growth identification and facilitation framework.

Nepal should kick start its economy by inviting those labour-intensive industries from India and China to its SEZs which are in the process of going hi-tech, converting themselves from manufacturing to service sector and seeking ways and means to shift elsewhere.

Nepal will have to maintain consistency in decision and policy making and provide fast clearance towards the implementation of decisions.

Security needs to be given to the investment made and also to the employees of FDI firms.

Distribution of resources should go side by side the national economic growth and the state should ensure justice in the matter of fixing wage rates of the workers and give due compensation to the farmers while taking their land for industrial and development activities as per the democratic norms.

References

Abramovitz, Moses, “Catching Up, Forging Ahead, and Falling Behind,” The Journal of Economic History, Vol. 46, No. 2, June., 1986.

Asian Development Bank. 2011. Asian Development Outlook 2011 – South South Links. Mandaluyong City.

Bajpai, Nirupam and Jian, Tianlun, “Reform Strategies of China and India: Suggestions for Future Actions,” in http://www.cid.harvard.edu/hiid/564.pdf

Chaturvedy, Rajeev Ranjan and Malone, David M., “India and Its South Asian Neighbours” in ISAS Working Paper No. 100-Date: November 26, 2009.

Commission on Growth and Development. 2008.The Growth Report: Strategies for Sustained Growth and Inclusive Development. Washington, DC: The World Bank.

Dhungel, Kamal Raj, “BIPPA and Nepal Move in the positive direction” in The Himalayan Times on November 10, 2011.

Editorial, “The state of our state” in the Himalayan Times, November 10, 2011.

Holslag, Jonathan. 2010. China and India: Prospects for Peace. New York: Columbia University Press.

Hari Bansh Jha, The Economics of Peace: A Nepalese Perspective” in ORF Occasional paper #29, December 2011. New Delhi: Observer Research Foundation.

Jha, Hari Bansh. 2010. The Economy of Terai Region of Nepal: Prospects for its Sustainable Development. Kathmandu: Centre for Economic and Technical Studies.

Jha, Hari Bansh Jha. 2010. A Rapid Situation Assessment on Agriculture and Migration in Nepal. (Unpublished Report). Kathmandu: Centre for Economic and Technical Studies.

Lin, Justin Yifu “The New Structural Economics and A Rethinking of Development Economics and Policy,” powerpoint presentation in Hamburg on September 7, 2011 in econ.worldbank.org/WBSITE/EXTERNAL/EXTDEC/0,,contentMDK:20273940~menuPK:477175~pagePK:64165401~piPK:64165026~theSitePK:469372,00.html

Pyakuryal, Bishwambher, “Nepal’s Binding Constraints to Growth,” Bankok: UN/ESCAP, 30 September 2009 in http://www.unescap.org/pdd/SeminarSeries/Pyakuryal_NepalConstraints_30sept09.pdf

Schuman, Michael, “Will One Economic Model Prevail? The Case for India: Free to Succeed,” Time, November 21, 2011.

Shrestha, Ramesh, “Half of Nepali Households have members working abroad: Survey” The Kathmandu Post, June 28, 2011 in http://www.ekantipur.com/the-kathmandu-post/2011/06/28/money/half-of-nepali-households-have-member-working-abroad-survey/223411.html

Son, Hyun H. “Human Capital Development” in ADB Economics Working Paper Series, No. 225, October 2010.

“South Asia Water – unquenchable thirst” in The Economist, November 22nd-December 2nd 2011.

“PM Manmohan Singh to China’s Wen Jiabao: Back off on South China Sea,” Times of India, November 19, 2011 in http://timesofindia.indiatimes.com/india/PM-Manmohan-Singh-to-Chinas-Wen-Jiabao-Back-off-on-South-China-Sea/articleshow/10786454.cms

Raman, B., “Economic Catching up with China,”South Asia Analysis Group, November 18, 2006 in http://www.southasiaanalysis.org/per cent5Cpapers21per cent5Cpaper2029.html

Thapa, Manish, “The Role of Civil Society, Government, and Political Parties in Peacebuilding” in The New Dynamics of Conflict in Nepal. (Ed. Bishnu P. Poudel and Hari Bansh Jha). 2009. Kathmandu: The National Advisory Council-South Asian Affairs, The Centre for Economic and Technical Studies in cooperation with Friedrich-Ebert-Stiftung.

The Himalayan Times, March 17, 2011.

http://en.wikipedia.org/wiki/Nepal

http://en.wikipedia.org/wiki/List_of_countries_by_GDP_%28nominal%29_per_capita

http://www.cid.harvard.edu/hiid/564.pdf

http://www.theodora.com/wfbcurrent/nepal/nepal_economy.html

http://www.grips.ac.jp/module/prsp/FGeese.htm

http://www.nepembassy.org.uk/fullnews.php?filename= 2011 0326

http://www.nepalnews.com/archive/2011/nov/nov11/news 16.ppp

(Jha is Professor of Economics and Executive Director of Centre for Economic and Technical Studies in Nepal.)

i Jha completed this research work while he was Visiting Scholar at Institute of Asian Studies, Institute of Global and Area Studies (GIGA), Hamburg, Germany from 12 September to 11 December 2011.

ii World Bank, “SL to lead South Asia growth with India” in Daily News, June 11, 2011 in http://www.dailynews.lk/2011/06/11/news01.asp

iii Asian Development Bank. 2011. Asian Development Outlook 2011 – South South Links. Mandaluyong City: p. xix.

iv http://www.theodora.com/wfbcurrent/nepal/nepal_economy.html

v http://en.wikipedia.org/wiki/List_of_countries_by_GDP_%28nominal%29_per_capita

vi Ramesh Shrestha, “Half of Nepali Households have members working abroad: Survey” The Kathmandu Post in http://www.ekantipur.com/the-kathmandu-post/2011/06/28/money/half-of-nepali-households-have-member-working-abroad-survey/223411.html

vii Bishwambher Pyakuryal, “Nepal’s Binding Constraints to Growth,” Bankok: UN/ESCAP, 30 September 2009 in http://www.unescap.org/pdd/SeminarSeries/Pyakuryal_NepalConstraints_30sept09.pdf

viii Fom September 15, 2011 onwards.

ix http://www.grips.ac.jp/module/prsp/FGeese.htm

x Moses Abramovitz, “Catching Up, Forging Ahead, and Falling Behind,” The Journal of Economic History, Vol. 46, No. 2, June., 1986, p. 390.

xi Commission on Growth and Development. 2008. The Growth Report: Strategies for Sustained Growth and Inclusive Development. Washington, DC: The World Bank:., pp.66-67.

xii Justin Yifu Lin, “The New Structural Economics and A Rethinking of Development Economics and Policy,” September 7, 2011 in econ.worldbank.org/WBSITE/EXTERNAL/EXTDEC/0,,contentMDK:20273940~menuPK:477175~pagePK:64165401~piPK:64165026~theSitePK:469372,00.html

xiii Hyun H. Son “Human Capital Development” in ADB Economics Working Paper Series, No. 225, October 2010, p. 2-8.

xiv Ibid, p. 20.

xv http://en.wikipedia.org/wiki/Convergence_(economics)

xvi Justin Yifu Lin, no. 12.

xvii B. Raman, “Economic Catching up with China,” South Asia Analysis Group, November 18, 2006 in http://www.southasiaanalysis.org/per cent5Cpapers21per cent5Cpaper2029.html

xviii http://www.cid.harvard.edu/hiid/564.pdf

xix Nirupam Bajpai and Tianlun Jian, “Reform Strategies of China and India: Suggestions for Future Actions,” in http://www.cid.harvard.edu/hiid/564.pdf

xx “India could catch up with China’s economic growth by 2020” in http://www.pravasitoday.com/india-could-catch-up-with-chinas-economic-growth-by-2020

xxi Michael Schuman, “Will One Economic Model Prevail? The Case for India: Free to Succeed,” Time, November 21, 2011, pp. 40-41.

xxii Ibid.

xxiii http://www.nepembassy.org.uk/fullnews.php?filename= 2011 0326

xxiv “South Asia Water – unquenchable thirst” in The Economist, November 22nd-December 2nd 2011.

xxv Hari Bansh Jha. 2010. The Economy of Terai Region of Nepal: Prospects for its Sustainable Development. Kathmandu: Centre for Economic and Technical Studies. pp.98-99.

xxvi Ibid., pp.100-101.

xxvii Kamal Raj Dhungel, “BIPPA and Nepal Move in the positive direction” in The Himalayan Times on November 10, 2011.

xxviii http://en.wikipedia.org/wiki/Nepal

xxix Jonathan Holslag. 2010. China and India: Prospects for Peace. New York: Columbia University Press: pp. 65-66.

xxx “PM Manmohan Singh to China’s Wen Jiabao: Back off on South China Sea,” Times of India, November 19, 2011 in http://timesofindia.indiatimes.com/india/PM-Manmohan-Singh-to-Chinas-Wen-Jiabao-Back-off-on-South-China-Sea/articleshow/10786454.cms

xxxi Rajeev Ranjan Chaturvedy and David M. Malone, “India and Its South Asian Neighbours” in ISAS Working Paper No. 100-Date: November 26, 2009, p. 2.

xxxii Jha, 2010, no. 25, pp. 97-98.

xxxiii Manish Thapa, “The Role of Civil Society, Government, and Political Parties in Peacebuilding” in The New Dynamics of Conflict in Nepal. (Ed. Bishnu P. Poudel and Hari Bansh Jha). 2009. Kathmandu: The National Advisory Council-South Asian Affairs, The Centre for Economic and Technical Studies in cooperation with Friedrich-Ebert-Stiftung, p. 33.

xxxiv Hari Bansh Jha. 2010. A Rapid Situation Assessment on Agriculture and Migration in Nepal. (Unpublished Report). Kathmandu: Centre for Economic and Technical Studies. p. 13.

xxxv Hari Bansh Jha, The Economics of Peace: A Nepalese Perspective” in ORF Occasional paper #29, December 2011. New Delhi: Observer Research Foundation. p. 14.

xxxvi The Himalayan Times, March 17, 2011.

xxxvii Editorial, “The state of our state” in the Himalayan Times, November 10, 2011.

xxxviii http://www.nepalnews.com/archive/2011/nov/nov11/news 16.ppp