Wednesday, 19 June, 2024

Accelerating Economic Growth

Accelerating Economic Growth

Dr. Prakash Kumar Shrestha

A higher economic growth is necessary for the prosperity of developing countries like Nepal to increase per capita income and generate employment necessary for enhancing the living standard of people. Nepal needs to accelerate economic growth to catch up with the advance countries. However, how can economic growth be accelerated? Not so easy answer, though the government always desires to have a higher economic growth as reflected in the budget statements.

Economic growth implies the rate of change of gross domestic product (GDP), which is the market value of final goods and services produced during a year by factors of production in a country. Basic factors of production include land, labour and capital. Technology and management are also necessary to integrate these factors of production to realise production. However, these factors of production are not only enough to accelerate economic growth in an economy. For a higher economic growth, domestic production of goods and services should be increased at a higher and accelerating rate.

Potential areas
Nepal has tremendous potentialities in agriculture, herbs, tourism, hydropower and, to some extent, in manufacturing industries by catching up the changes in the value chain of production in neighbouring countries. However, it has remained underdeveloped so far. Economic growth of Nepal has been very low, registering an average economic growth of 4.4 per cent in a recent decade, despite having comparatively higher economic growth of 6 to 9 per cent during 2016/17 to 2018/19. The outburst of COVID-19 in the beginning of 2020 has stalled the Nepal's higher economic growth trajectory.

To reap the available potentialities for accelerating higher economic growth, the most important thing is to have higher investment in the economy. It is the investment which increases the production capacity of the economy through capital formation. A higher level of investment provides the economy with higher volume of capital. Only with capital, productivity of labour can be increased, thereby growth of output and income. Nepal, in fact, needs higher investment of both domestic and foreign origin. But, the investment decision is very sensitive and critical decision to be made by investors, affected by many other factors and situations in the economy.

Keynesian theory of investment tells us that investment decision is based on the marginal efficiency of capital (MEC) and interest rate. Investors make investment decisions if MEC of a particular project is higher than interest rate. Interest rate is determined in the banking system, but determination of MEC, which is the expected profit from investment, depends on the several factors, which are grouped as "4Is" - infrastructure, incentives, institutions, and information, and discussed below.

To increase private investment in the economy, there should be adequate physical infrastructure like road, airport, telecommunication and electricity. Construction of physical infrastructure is mostly the role of the government since the private sector normally hesitates to invest in physical infrastructure which requires huge investment that private sector cannot afford and these physical infrastructures are public goods. Through public-private partnership, however, private investors can also be involved in construction of physical infrastructure. Without adequate infrastructure, both production of goods and services as well as people's welfare suffer.

Hence, for expediting economic growth, we need more investment in infrastructure on right places, which subsequently attracts private investment. It is pity to say that construction of infrastructure is hardly completed on time in Nepal. In addition to right and adequate infrastructure, a higher investment also requires incentives which lure the private sector to invest. Investment decision is intertemporal; benefits only come in the future from the decision made today. Obviously, investors expect reasonable level of profit in the future from the current investment. Profit rate is one of the important incentives for investors to make investment decision.

This profit rate is affected by numerous factors like market demand, government tax policies, interest rate and credit availability. Small size of domestic market and several hurdles on exporting to neighbouring countries have been providing disincentives to large investment in Nepal by lacking economies of scale. We need to overcome, hence, these hurdles through economic diplomacy for attracting investment here.

Further, government tax policies should be simple, transparent and investment-friendly. Tax compliance costs in terms of both time and money should be low as far as possible. Application of information technology and integrated approach can make tax system more tax payers friendly. Government's tax system should provide incentives to investors and it should be comparatively attractive compared to neighbouring countries. Nepal has made substantial progress in modernising tax system but still more to go to attract potential investors.

To create investment friendly environment, we should have strong and credible institutional environment. Government institutions should be credible and investors' friendly. Law and order system should be strong enough to maintain peace and security so that investors feel the safety of their investment and property. Government services should be provided effectively on time to investors so that they do not need to waste their time and money. Through the use of IT system, government services can be provided 24/7. One-window system needs to be made really effective in practical sense so that investors do not need to travel here and there to do registration and tax related matters.

Business contracts should be enforced effectively and judicial decision should be made on time in a fair manner. Effective institutions can only protect property right to encourage innovation in the economy. Nepal in fact seems to be far behind in institutional effectiveness and credibility, creating frustration to new investors, by lacking pro-activeness and coordination but having rent seeking attitudes and behaviour in almost all government offices. To increase investment, Nepal needs to make institutions more efficient, effective and investment friendly. How hard it is getting driving license is one of the examples of inefficiencies of Nepal's government offices. There are many examples of sluggishness in government institutions.

Last but not a least thing needed for promoting investment for economic growth is availability of information. Government can play the important role in generating and disseminating right information necessary for investment decisions. Existing economic potentialities, rules and regulations should be clearly disclosed through applying e-government mechanism. Such an information disclosure is much more needed for foreign investors, but potential domestic investors also need to get the information related to investment decision.
In this way, accelerating economic growth requires increase in investment. But, promoting investment further needs four more "I"s - infrastructure, incentives, institutions and information, which can make MEC of a project higher than the interest rate as Keynesian theory of investment suggests. Hence, altogether 5Is are necessary, at least, for achieving higher economic growth in the economy, among others. Hence, it can be said that a higher economic growth is not impossible as seen in South East Asian countries in the past as well as China and India in recent decades, but not so easy without amicable environment for investment.

(Dr. Shrestha is an executive director at Nepal Rastra Bank.