Tuesday, August 30, 2011
Economics of Federalism.
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The following opinion piece was published in Republica on August 30, 2011. I wrote it in collaboration with Mr Nanda Kaji Budhathoki, a fellow Economist at IIDS. The direct Republica link is here.
In recent years, we have seen unprecedented changes in our political and social landscapes. We overthrew the monarchy, and became the only country in world history to elect the Maoists by a majority. Overthrowing the monarchy was only a matter of time as the discontent with the monarchial system had been brewing ever since the first democracy in 2007 B.S. However, the overthrowing of the two hundred year old monarchial system has thrown us headfirst into previously unchartered waters of “federalism”. The problem is, we as people still do not agree on what it means, how it should be set up, and what direction it should be headed towards.
Under a federal system, power is divided between the central and the state governments. The idea for this division of power arises from the understanding that the center and states have separate functions. Therefore, they must have separate powers, including the economic power of spending and taxing. In addition, longstanding practices of caste and ethnic discrimination, greater power privileges in the hands of the social upper castes, centralization of authority in the capital city, uneven development and persistence of mass poverty in remote geographical regions are some of the key reasons why the demand for federalism in Nepal has gathered momentum in the last few years.
Mass internal migration occurred during the years of the Maoist insurgency where people moved from rural and insurgency affected areas to urban centers. Also, centralization of all economic and political powers has resulted in the Kathmandu valley becoming an urban giant that gets difficult to manage and control each passing year. Our largest city receives disproportionately large share of public and private investments, as well as incentives for investments when compared to the country’s second largest or other large cities. In development economics, this is called the first city bias, and it is a massive hindrance to the development of the rest of the country.
Kathmandu district alone generates 42 percent of the total revenue in Nepal. Top 12 revenue generating districts in Nepal generate 94 percent of total revenue. The remaining 63 districts generate only 6 percent of total national revenue. These numbers clearly suggest that something is terribly wrong in Nepal in terms of distribution of economic powers. The Eastern, Central and a few parts of Western regions are economic powerhouses whereas the Mid-western and Far-western regions languish in poverty and zero opportunities.
All the opportunities in Nepal, today, seem to be concentrated only in the Kathmandu valley and a handful of other urban centers. Given this, the discontent among the Nepalese populace for the central government is understandable. Most see this as a failure of the central government system. Therefore, a federal structure is more preferable.
The manifesto of the three major political parties—Nepali Congress, UML and Maoist—show that they, pretty much, agree on how the powers should be divided, and how jurisdictions should be assigned. Also, there is a consensus that foreign policy, currency, national security, international trade, monetary policy, central bank, large hydropower projects, mega projects, railways, airways, national highways, customs duty and other issues of national interest should be controlled by the central government. Issues like water, land, forest resources, education and health should be under the control of provincial or state governments.
However, discussions on the economics of federalism have been lacking in Nepal today. We do not seem to be seriously analyzing the economic ramifications of a federal republic structure. We have to ensure that the federalism that we design preserves the market structure while providing more incentives for economic growth and development, and not less. Economically, state governments under a federal structure have to work frugally and on the margin due to their inability to print money and borrow limitlessly. So, the federal structure that we create should help and augment the capability of the states to govern and run themselves without engaging in free-riding.
Jurisdiction over the environment and welfare responsibilities should be federal responsibilities. Ramifications of water and air pollution from one state could be borne by another. Therefore, assigning environmental responsibilities to the states is probably a bad idea. Similarly, if the states are given the welfare responsibility, some states will lure the rich and wealthy with unfair practices like lower taxes. As a result, poorer states will not be able to fulfill their welfare obligations like education and healthcare.
Also, the decentralization theorem of federalism suggests that if consumption of public goods depends on geography, states are more efficient in providing such goods. Since much of public service delivery in Nepal is adversely affected by our rough geographical terrain, devolving the delivery of public goods to the state level is better.
While designing the federal structure, more focus should be given to disadvantaged areas in the Mid-western and Far-western regions. These areas lack developmental infrastructures and opportunities. So, creating a federal structure and asking these areas to run themselves via their own revenue generation is undesirable and dishonest. The imbalance between states in these regions and rest of the country should be corrected through intergovernmental transfer from the central to state governments.
The concept of such transfers, as well as from richer to poorer state governments, is common among federal nations. In the United States, taxpayers in New York and Connecticut help out those in Louisiana and Alabama. Similarly, in China, taxpayers in Shanghai help out those in the poorer western and central provinces. So, in principle, taxpayers in Kathmandu and Morang have an obligation to help out those in Dolpa and Rukum until these regions experience economic growth sufficient enough to make them self-sustaining. The magnitude and duration of such transfers will start decreasing as these states start growing economically.
Federalism discussions in Nepal have been hijacked by political parties and their interests. Each party has brought its own bias and greed into the table while proposing the design of the new federal states. What we need today is to rise above the petty politics of it all. The new federal states should be designed such that they are politically stable, socially harmonious, and, above all, economically sustainable.
The following opinion piece was published in Republica on August 30, 2011. I wrote it in collaboration with Mr Nanda Kaji Budhathoki, a fellow Economist at IIDS. The direct Republica link is here.
In recent years, we have seen unprecedented changes in our political and social landscapes. We overthrew the monarchy, and became the only country in world history to elect the Maoists by a majority. Overthrowing the monarchy was only a matter of time as the discontent with the monarchial system had been brewing ever since the first democracy in 2007 B.S. However, the overthrowing of the two hundred year old monarchial system has thrown us headfirst into previously unchartered waters of “federalism”. The problem is, we as people still do not agree on what it means, how it should be set up, and what direction it should be headed towards.
Under a federal system, power is divided between the central and the state governments. The idea for this division of power arises from the understanding that the center and states have separate functions. Therefore, they must have separate powers, including the economic power of spending and taxing. In addition, longstanding practices of caste and ethnic discrimination, greater power privileges in the hands of the social upper castes, centralization of authority in the capital city, uneven development and persistence of mass poverty in remote geographical regions are some of the key reasons why the demand for federalism in Nepal has gathered momentum in the last few years.
Mass internal migration occurred during the years of the Maoist insurgency where people moved from rural and insurgency affected areas to urban centers. Also, centralization of all economic and political powers has resulted in the Kathmandu valley becoming an urban giant that gets difficult to manage and control each passing year. Our largest city receives disproportionately large share of public and private investments, as well as incentives for investments when compared to the country’s second largest or other large cities. In development economics, this is called the first city bias, and it is a massive hindrance to the development of the rest of the country.
Kathmandu district alone generates 42 percent of the total revenue in Nepal. Top 12 revenue generating districts in Nepal generate 94 percent of total revenue. The remaining 63 districts generate only 6 percent of total national revenue. These numbers clearly suggest that something is terribly wrong in Nepal in terms of distribution of economic powers. The Eastern, Central and a few parts of Western regions are economic powerhouses whereas the Mid-western and Far-western regions languish in poverty and zero opportunities.
All the opportunities in Nepal, today, seem to be concentrated only in the Kathmandu valley and a handful of other urban centers. Given this, the discontent among the Nepalese populace for the central government is understandable. Most see this as a failure of the central government system. Therefore, a federal structure is more preferable.
The manifesto of the three major political parties—Nepali Congress, UML and Maoist—show that they, pretty much, agree on how the powers should be divided, and how jurisdictions should be assigned. Also, there is a consensus that foreign policy, currency, national security, international trade, monetary policy, central bank, large hydropower projects, mega projects, railways, airways, national highways, customs duty and other issues of national interest should be controlled by the central government. Issues like water, land, forest resources, education and health should be under the control of provincial or state governments.
However, discussions on the economics of federalism have been lacking in Nepal today. We do not seem to be seriously analyzing the economic ramifications of a federal republic structure. We have to ensure that the federalism that we design preserves the market structure while providing more incentives for economic growth and development, and not less. Economically, state governments under a federal structure have to work frugally and on the margin due to their inability to print money and borrow limitlessly. So, the federal structure that we create should help and augment the capability of the states to govern and run themselves without engaging in free-riding.
Jurisdiction over the environment and welfare responsibilities should be federal responsibilities. Ramifications of water and air pollution from one state could be borne by another. Therefore, assigning environmental responsibilities to the states is probably a bad idea. Similarly, if the states are given the welfare responsibility, some states will lure the rich and wealthy with unfair practices like lower taxes. As a result, poorer states will not be able to fulfill their welfare obligations like education and healthcare.
Also, the decentralization theorem of federalism suggests that if consumption of public goods depends on geography, states are more efficient in providing such goods. Since much of public service delivery in Nepal is adversely affected by our rough geographical terrain, devolving the delivery of public goods to the state level is better.
While designing the federal structure, more focus should be given to disadvantaged areas in the Mid-western and Far-western regions. These areas lack developmental infrastructures and opportunities. So, creating a federal structure and asking these areas to run themselves via their own revenue generation is undesirable and dishonest. The imbalance between states in these regions and rest of the country should be corrected through intergovernmental transfer from the central to state governments.
The concept of such transfers, as well as from richer to poorer state governments, is common among federal nations. In the United States, taxpayers in New York and Connecticut help out those in Louisiana and Alabama. Similarly, in China, taxpayers in Shanghai help out those in the poorer western and central provinces. So, in principle, taxpayers in Kathmandu and Morang have an obligation to help out those in Dolpa and Rukum until these regions experience economic growth sufficient enough to make them self-sustaining. The magnitude and duration of such transfers will start decreasing as these states start growing economically.
Federalism discussions in Nepal have been hijacked by political parties and their interests. Each party has brought its own bias and greed into the table while proposing the design of the new federal states. What we need today is to rise above the petty politics of it all. The new federal states should be designed such that they are politically stable, socially harmonious, and, above all, economically sustainable.
Labels: economics, federalism
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