Current conflict Shocks and economic costs
Government expenditure has increased as a proportion of GDP because of prolonged conflict.
The conflict has resulted in the destruction and loss of life. Poverty and mass unemployment have made the individual citizens worse off. This has created frustration and divisiveness. In the long run it may redirect the production from consumer goods to those necessary for war.
Nepal is experiencing the unique problem of expenditure management because of the imbalances in resource use between current and capital expenditures. Therefore, from public expenditure perspective, additional cost can be estimated by assessing the rate of growth in internal security and defence expenditure by years. A comparison can be made in the allocation of resources in total internal security, defence, social services and economic services in terms of GDP to assess the impact of conflict on social and economic development.
Compared with 1997/98, the internal security (Police) expenditure during 2001/02 has increased two-fold. As percentage of GDP, internal security rose from 0.83% in 1997/98 to 1.43% in 2002/03. Defence expenditure grew from 0.86% to 1.39% during the same period. Interestingly, the expenditure on social and economic services that were 3.43 and 5.95 per cent of GDP came down to 2.73 and 4.13 per cent respectively during the review period. This indicates security expenses being made at the cost of social and economic services. Some efforts have been made to compare the value of output after the destruction of production factors and the potential value of these outputs before war. This can give a broad idea of how much a country has lost in output (GDP) and foreign exchange earnings. Secondly, to assess the cost in the economy, likely impact of reduced/increased development expenditure on private fixed investment, public fixed investment and public consumption can be considered. The first information is available from Kishor Sharma’s work on Economic Policies and Civil War in Nepal (2004) and second is done by ADB through simulations, in Quarterly Economic Update (2004). For lack of data, estimates are based on some underlying assumptions, the actual cost estimate should be carefully interpreted. These estimates have not considered the potentially large longer term human and economic costs either.
Sharma (2004) provides examples of declining output and per capita income by comparing the averages for seven years before war (1987/88-1994/95) and for the war period (1995/96-2001/02). The analysis reveals that GDP growth fell from 5.1% per annum in the pre-war period to 3.8% per annum in the war period. Non-agriculture GDP fell from 6.6% to 3.9% during the same period. Agricultural growth was stagnated at 3% per annum. There can be no denying that these sectors were affected also by the restriction in the movement of goods and services. These limitations had the multiplier effect in the economy. The services of hotel and manufacturing sectors were limited because of the frequent closure, low tourist arrivals and shrinking demand. Insecurity has hit joint venture industries, etc.
Theoretically government revenue falls in absolute terms as the fiscal base narrows and major sources of revenue diminish. But this has not yet happened in Nepal. However, government expenditure has increased as a proportion of GDP because of prolonged conflict. The result is budget deficit. In Nepal, foreign loan is an important source of meeting this deficit. The conflict and poor aid utilisation capacity have affected foreign aid mobilisation. The current revenue does not allow even 20 per cent counterpart funds for major loan projects. The second important issue is the cost in the economy. ADB’s latest Economic Update is important. Reduced/ increased development expenditures, and their economic implications are summarised through the medium-sized Nepal macro-econometric model. Under no-conflict scenario, it is estimated that growth will stay at 10.4% for five years beginning 2005. The conflict scenario projects a decline of development expenditure by 4.2%. This -4.2% figure is conflict level of growth as recorded during the FY 2002-04 period. Finally, the scenario under high conflict is alarming indicating 8.4% decline in development expenditure. The bottom-line is that if the conflict continues for the next five years (2005-2009) with a decline in the development spending at the current rate, the total GDP growth loss is 8.3%. Given the intensified conflict, total GDP growth loss will be 10.3%, an average loss of 2.1% points of growth per annum.
The cost of declining development spen-ding will be higher if the simulations estimate the effects of destruction of economic infrastructure, disruption of economic activities on GDP growth and impact of lower private investment. The message to the political actors and civil society is clear: find a solution to the conflict soon since it will be difficult to resist shocks and tolerate economic costs in the days to come. Prof Pyakuryal is president, Nepal Economic Association