The simplified version of this article was published in The Kathmandu Post on 26th August, 2016
The preliminary Economic Survey Report for FY2015/16 yet again makes the same old assertion regarding the economic performance of Nepal by exhibiting the underperforming state of capital expenditure that has been hampering the real economic growth of the country since multiple years. It is of no surprise that yearly Gross Fixed Capital Formation (i.e., an indicator of Investment expenditure) is again below the required criteria warranted for the Nepalese Economy that is characterized with considerable Capital/Infrastructure deficit and strong potentiality of Marginal Productivity of added Capital (MPK). As I mentioned, it is reasonably legitimate to recognize strong potentiality of MPK of Nepal on technical grounds as it is categorized as a low-income country with Gross Capital formation way below the steady/optimum level of Capital (refer Fig 1 to know steady level of capital).
Statistically speaking, the Gross Fixed Capital Formation (GFCF) for FY 2015/2016 in basis to preliminary Economic survey conducted by Ministry of Finance (MoF) was NRS 562,458 Million, which only makes up to about 25% of the GDP for the FY2015/16 (MoF, 2016). However, in midst of this statistical figure, Sapkota (2016) draws the minimum threshold for GCFC (% of GDP) of about 30% in order to boost required real economic growth of the country that can uplift per-capital income and generate further employment based on Investment Expenditure. On this regard, the negative disparity between the required Gross capital formation and acquired Gross Capital formation in terms of %GDP is numerically observed, whereas the felt observation of this deficit is highly relevant as every layman can relate the lack of adequate infrastructure as major barrier to national progress.
And only to bolster this argument regarding the state of Capital formation deficiency in the Nepalese Economy, we can always refer the graphical comparison of GCFC (% of GDP) of Nepal with the average of low-income countries in last 8 years that is being developed by retrieving data from World Bank’s database and Economic Survey Report 2016. Since the countries belonging to the low-income category (inclusive of Nepal) share the common resolution (i.e., more Investment expenditure) to fuel growth, the comparison is relevant to recognize relative performance of Gross Capital Formation in Nepal.
As it can be observed from the provided comparative graphical representation, the GFCF (% of GDP) of Nepal fell below the average of its kind in last couple years even though it appears to be in the trend of reconvergence. Whatsoever, the GCFC (% of GDP) of Nepal is considerably below the minimum threshold of 30% recommended for the nation’s real economic growth by Sapkota (2016).
If dug down deeper regarding the component of the Gross Fixed Capital Formation of the Nepalese economy, it is surprising to discover wide inequality in the volume contribution of Private Fixed Capital investment and Government/Public Fixed Capital investment throughout the timeline. This figure stays put even though the planned expenditure commitment of the Government is ballooning (The FY 2016/17 budget crosses NRs 1000 Billion) in midst of huge required role of Government to fund Infrastructure development. While the ratio of Private Contribution on GFCF to Government Contribution was about 3.23 times in FY2015/16 as per the Economic Survey 2016, the wide difference in contribution of the two parties through the period of 8 years is exhibited in comparative contribution graph developed below.
In observing the stark difference in contribution towards Gross Fixed Capital Formation by two parties throughout the timeline, it would be reasonable to conclude the underperforming role of Government in inhibiting the growth of GFCF/GDP ratio while the leading role of Private party even in midst of not so friendly regulatory environment exhibits strong enthusiasm. The persistent low absorption rate of the Government budget hovering at about 75% as per Sapkota (2016) due to lagging delivery capacity of the performing stakeholders appears to be relatable to observed underperformance from Government side. On the flip side, the minuscule role of Government in economic affairs might seem reasonable to allow the Free Market system take hold. But, given the huge output gap in merit and social sectors (as Public Infrastructure, Health and Education sector) in our underdeveloped economy that cannot be fulfilled by Private party due to lack of excludability and rivalry features of the sectors, Government is sought to be primarily and emergently responsible to close this output gap (Singh, 2015). And therefore, the demand for larger role of the government/ Public party in Capital formation is legitimate. Besides to it, Sapkota (2016) also recommends jacking up of the Public Fixed Capital Investment (% of GDP) to 10% (presently at 5.9% as per Economic Survey Report) further bolsters the argument for needed higher Public role in Capital formation.
Theoretical Consideration connecting Gross Fixed Capital Formation (GCFC) to National Income (Y) growth:
The pattern of statistical data definitely recognizes the Government/public sector as culpable in observed underperformance of Capital Expenditure/Gross Fixed Capital Formation. And as certain level of GFCF is recommended to achieve real economic growth in this paper, there of course is theoretical model to support the causative relationship.
Theoretically, the Solow Growth Model (i.e., an important aspect of classical economics) acknowledges the relationship of National Income per worker (y) with Stock of capital per worker (k) to be y = √k. While holding other ingredient of production (importantly labour (l)) constant, Solow Model, with support from Cobb-Douglas production function has come to this causative relationship that remains valid regardless of the size of the economy based on labour (l) size. Moreover, while this positive causative relationship between some form of National Income/GDP (Y) and Capital stock (K) remains valid, the function is only valid unless an economy reaches the state of steady/Optimum level of capital. Essentially, an economy reaches a steady/optimum level of capital when further addition in-Investment expenditure for capital formation is cancelled by equal unit of accumulated depreciation causing null change in Capital stock/formation (i.e., ∆k = 0). Obviously, the Nepalese economy from every lens is way below steady level of capital, thus it leaves considerable leeway for Capital formation and National Income/GDP growth before it reached steady/optimum level of capital.
given figure recognizes the steady of level of capital at k* at which the economy remains at equilibrium. The goal of every rational economy (including the Nepalese economy) is to reach the steady level of capital (Golden level of Consumption). On a rough guess, Nepalese Economy possibly lies closer to “0” than “k*” at the moment. And, the resolution to it higher Gross Fixed Capital Formation coupled with higher GGCF (% of GDP).
References:
Ministry of Finance (2016). Economic Survey Report 2016. Government of Nepal.
Singh, S.K. Dr, (2015). Public Finance in Theory & Practice. 9th Ed. S.Chand Publishers.
Sapkota, C. (23 May 2016). Why capital spending is chronically low and what can be done about it. The Kathmandu Post.
World Bank (2016). Gross Fixed Capital Formation (% of GDP). World Bank Group.
Theoretical Foundation:
Mankiw, N. (2010). Macroeconomics (7th ed.). New York, NY: Worth.
Analytical Perspective on Economics