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February 2015 Economy and Policy

Published on: 2015-03-08 00:00:00     2383 times read    0  Comments
 
With remittances, an economy can spend more than it produces, import more than it exports or invest more than it saves, and this might even be more relevant for small economies. 
 
--By Prof Dr Kamal Raj Dhungel
 
An important agenda of discussion in the world today is the remittances of workers. It plays a vital role in the economic development of any country especially that of the developing nations. With remittances, an economy can spend more than it produces, import more than it exports or invest more than it saves, and this might even be more relevant for small economies. 
 
The monetary flow has been increasing over the years. World Bank estimates that official remittances inflow in developing countries in 2005 was US$ 167 billion, which jumped by 140 percent and reached to US$ 401 billion in 2012.   Since 1990, openness has been followed by deindustrialization and migration in Nepal. Deindustrialization weakens domestic economy.  Jobs are massively cutting down and so is the output of the economy as it has not been able to create additional jobs to put additional people into work. 
 
Obviously unemployment has been rising. Deindustrialization limits the ability to create new employment opportunities that could solve the burning problem of unemployment. It necessitates sending people where their labour is demanded. Migration to foreign land is becoming the major alternative to address the problem of unemployment and pro migration policies are being formulated. These policies have fostered the migration of Nepali on a scale of above 1500 a day to foreign countries in search of employment opportunities. No matter how much they earn, a major portion of their earning goes in supporting the livelihood of their family back at home. For many developing countries, the remittances sent by their citizens constitute a larger source of foreign exchange than international trade, aid, or foreign investment. It seems true for Nepal. 
 
Total income from remittance was four times greater than earning from exports, 81 times greater than FDI, eight times greater than the earning from tourism and nine times greater than grants in 2009. Tourism is a promising sector in Nepal. Income from tourism seems to fluctuate, indicating fluctuation in the employment opportunities. Export and tourism earning were 11 and five percent respectively of the GDP in 2009. This indicates that the progress of domestic sector that earn foreign exchange is not as encouraging as remittance. This, of course, has a significant impact on Nepal’s economy.
 
Nepal receives a significant amount of remittance every year. In 2012 it accounted for US$ 4793 million. This gradually shifted the base of the economy from mere subsistence farming to remittance. It definitely increases the household income and thereby increases the purchasing power of the mass of people in general and poor people at the bottom of the economic hierarchy. Remittance fuels their propensity of migrant families to consume more, and thereby increase the demand of goods. These households consume more than what they would have without remittance. It increases the demand of goods and services. As deindustrialization limits the ability to produce goods domestically, it forces the national economy to depend on imports to meet the increased demand. This has been increased the volume of imports over the years. 
 
Trend of remittance and import
Both remittance and import have been increasing over the years. During 2000-2012, the inflow of remittance increased alarmingly at an annual growth rate of 35%. In 2000 remittance was 2.03 percent of the GDP while in 2012 it was 24.96 percent. This increased the consumption as nearly 80%  of remittance was spent on consumption. Increase in consumption obviously increases the demand for goods and services that can be fulfilled either through imports or by  expanding domestic production. In lack of the latter, Nepal’s import has been increasing at the rate of 16.4 percent during the past decade. It has become the backbone for delivering goods and services. However, annual growth rate of exports during the period remained 4.7 percent. Such trend has created huge deficit in trade balance. 
 
In 2003, import was 25.4 percent of the GDP but with an annual growth rate of 2.6% it jumped to 32.9 percent in 2012. However during the same period there was negative growth in exports. It witnessed at a negative growth rate of 7.2 percent during the period with 10 percent ratio to the GDP in 2003 and just 4.5 percent in 2012. The trade deficit starting with 15.3 percent in 2003 reached 28.4 percent in 2012 with a 6.4 percent annual growth rate. Declining rate of export and the increasing rate of import produces trade imbalance thereby making the balance of payment unfavourable.  The above facts prove that import and remittance move in the same direction. The co-movement of these variables is given in figure 1, which shows that both of these variables have non-stationary increasing tendency.
 
Marginal propensity to import
Marginal propensity to import (MPM) states that the amount of import rise or fall associated with the rise or fall in the inflow of remittance. MPM is thus the change in import induced by the change in remittance. The MPM is the increase in imports that is caused by a certain increase in income. This concept expresses the idea that as income of economic agents (firms and households) increases, so does their demand for consumption of goods imported from abroad. Since this relation also holds true for the whole economy, at the aggregate level the marginal propensity to import can be calculated as the ratio between the increase in total imports of an economy and the increase in its output. In mathematically formalized economic models, the marginal propensity to import is equal to the partial derivative with respect to output in an import function. If imports are assumed to be a linear function of output, the marginal propensity to import is equal to the slope of the resulting straight line. This writer has estimated marginal propensity to import. From empirical analysis it appears that the import and remittance variables are positively correlated over the time period of 1974 to 2012. The marginal propensity to import during that time period is found 0.48. It indicates that a 1 percent change in remittance will change the import by 0.48 percent. It indicates that additional increase in remittance by say rupees 100 in Nepali economy will increase the import by 48 rupees. The implication is that nearly 50 percent of the remittance that Nepali youths are supposed to have sent home from abroad countries has been spent in importing goods. 
 
Conclusion
Analysis of import function particularly reveals that the marginal propensity to import is found around 0.5. It implies that half of the additional amount of remittance received by Nepali economy from foreign countries would be spent on importing goods. Nepal should reduce import dependency to mobilize remittance in productive sectors that can help to boost economic growth. Its domestic production level needs to be increased through establishment of import substitution industry. At the same time it requires to attract much more remittance. Both policies are vital for achieving desired growth in country’s GDP.
 
The author is Professor of Economics at the Tribhuvan University.
 

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