Explaining the ‘development surprise’

Wahiduddin Mahmud, Sadiq Ahmed and Sandeep Mahajan

BANGLADESH’S impressive record of economic growth and social development has been achieved despite apparently poor governance. Bangladesh is thus an outlier in cross-country comparisons relating governance to economic growth.¹ Recent studies show increasingly compelling evidence that good governance matters to growth, although there are many controversies surrounding these studies regarding the definition of ‘good governance’, the biases in perception of governance, the direction of causality, and the problem of isolating the effects of country-specific institutional and other factors in explaining cross-national variations. Although it is quite evident that Bangladesh’s economic performance has been negatively affected by some of the adverse governance factors, the more interesting question relates to why the country’s economy has performed in the way it has despite wide-ranging governance failures.

To understand Bangladesh’s development conundrum, one needs to deconstruct the economic growth process and focus on the main drivers behind accelerated growth. The acceleration of growth of the Bangladesh’s economy since the early 1990s has been underpinned by strong export growth, led almost entirely by the growth in readymade garment export. The garment industry has flourished in Bangladesh because of the confluence of a number of favourable factors: the early relocation of garment producers and marketing intermediaries from East Asian countries (especially the Republic of Korea) to Bangladesh to evade import quotas in the U.S. and European markets; easy transfer and spread of garment-industry-specific managerial and production skills; preferential access of Bangladesh’s garment exports in the major markets of the West; a flexible exchange rate policy and other policies adopted by the government in supporting the industry, specially by creating a set of enclave-type arrangements (for example, bounded warehouses and back-to-back letters of credit to facilitate duty-free import of fabrics); and the abundance of low-cost female labour.² Once the growth of the industry gathered momentum and it became the main exchange earner, it gained in efficiency and could exercise more clout in shaping government policies in its favour.

The uniqueness of the garment industry in Bangladesh is demonstrated by the fact that other potential exports have not fared well even when provided generous government support. For instance, besides various export-promoting schemes like the duty drawback system for imported inputs, cash incentives of up to 30% of the export value have been provided to certain export items without producing notable results. It is true that even the garment exporters complain about having to pay bribes to facilitate export formalities at the port, besides having to deal with other constraints like inadequate infrastructure. But the industry’s early foothold has helped it to withstand these constraints.

Strong export growth has contributed to GDP growth, both directly and indirectly by providing growth stimulus to other parts of the economy. There is also an indirect route through which export growth, coupled with import liberalization, has helped the growth in small-scale and informal sector activities. These later activities produce mostly nontradables or poor substitutes for imports. A real devaluation of the taka can hurt these activities by increasing the prices of imported inputs and by turning the domestic terms of trade against their products compared to tradable products. But thanks to rapid growth of export and remittances, the real exchange rate of the taka remained more or less stable at a time when there was substantial import liberalization and a marked decline in external deficits.³

Besides garment export, growth impulses have also come from workers’ remittances and from growth in agriculture and in small-scale industries and services, mostly belonging to the informal sector. The government has since the early 1980s pursued policies to encourage manpower export and attract remittances by negotiating with host countries, offering favourable exchange rates for workers’ remittances through various banking channels. Growth in agriculture has also been helped by market-oriented reforms in agricultural input markets. Moreover, because both agriculture and informal sector activities mostly remain outside the purview of the government’s regulatory functions, these are likely to be less adversely affected by poor governance as compared to the activities in the modern organized sectors of the economy.⁴

The growth of the urban centres, foremost among them Dhaka, has greatly contributed to economic growth by creating the complementarities that accompany urban growth. Dhaka, with 12 million inhabitants, has seen an eight-fold increase in its population since 1970 and is currently reckoned to be among the two fastest-growing megacities in the world.⁵ Not least because of the rapid growth of the export-oriented garment industry and the flow of remittances and the related housing construction boom, urbanization has been accompanied by job creation strong enough to accommodate over 10 million new entrants to the workforce between 1996 and 2003.⁶ Study findings show that rural-to-urban migration, instead of being mainly driven by the so-called ‘push’ factors, has been generally a means of upward economic mobility for the migrants (Khundker et al. 1994). Nevertheless, the problem of poor governance manifests here in the form of unplanned urbanization creating huge problems for the future.

In the rural areas, the non-farm sector has become more diversified, productive and dynamic, especially with the growth of the rural towns. The clusters of habitation around these rural towns have helped to promote those nonfarm activities that can cater to urban-like and income-elastic consumer demand; and these are the kinds of activities that are found to have shown more dynamism within the rural non-farm sector in terms of improved technology and higher labour productivity (Mahmud 2006). A rapid expansion of microcredit since the early 1990s is also likely to have played an important part in this process.

With the acceleration in the growth of per capita income, Bangladesh has made considerable progress in poverty reduction. During the 1990s, the national incidence of poverty declined from nearly 60% to about 50%; and a much more rapid reduction in poverty seems to have taken place in the following five-year period with the national poverty rate reduced to about 40%.⁷

More progress against poverty would have been made in the 1990s had income distribution not worsened in both rural and urban areas. In the recent period, growth acceleration in many developing countries, including in South Asia, has been accompanied by increased income inequality (Devarajan and Nabi 2006; Mahmud and Chowdhury 2008). The growth-inequality links in the case of Bangladesh seem to be, however, of a different nature. The pattern of growth in Bangladesh appear to be fairly pro-poor – with the main stimulus to economic growth coming from labour-intensive garment exports, micro- and small-scale enterprises in manufacturing and services, and remittances from migrant workers. All these sectors typically provide scope for upward economic mobility for the poor.

Even then, inequality tended to increase because the more dynamic parts of the economy happened to be the ones with relatively unequal income – such as the urban/organized sector compared to the rural/ informal sector or the dynamic part of the rural non-farm sector compared to the rural/informal sector or the dynamic part of the rural nonfarm sector compared to agriculture – and also because growth, though employment intensive, was not strong enough to pull wages up in the vast agricultural and informal intensive markets.⁸

However, the estimates for the most recent period from 2000 to 2005 suggest that the process of increasing income inequality has slowed down or even reversed. As a result, the impact of income growth on poverty reduction has been much more pronounced during this period than in the 1990s (Table 1). Real wages in agriculture and construction – the sectors dominated by informal intensive markets – have shown strong upward trends since the late 1990s, after having been stagnant for a long time.⁹ It would thus appear that Bangladesh is perhaps past the turning point of the ‘Kuznets curve’ in the income-inequality link.¹⁰

Recent analyses of poverty dynamics in Bangladesh suggest that, compared to many other developing countries, upward economic mobility in Bangladesh is less constrained by class, ethnicity or other socio-economic barriers. Access to markets with extensive rural transport networks, increasing participation of women in work outside the home, and a very rapid spread of microcredit have all contributed towards expanding the economic opportunities for the poor. Thus, everyone, even the poorest, see a chance of escaping poverty.¹¹ Such inclusiveness not only contributes to social cohesion, it also raises awareness about economic opportunities, which may explain why even poor families are increasingly sending their children to school. But it may also raise people’s expectations and lower their tolerance for governance failure.

Bangladesh’s most striking development surprise is its rapid and spectacular improvements in human development indicators, particularly since the early 1990s (Table 2). From being a laggard, Bangladesh now outperforms most Indian states and South Asia as a whole in such indicators as female school enrolment, child mortality, and contraceptive adoption rates. The achievements of Sri Lanka and the Indian state of Kerala in this respect are well-known, but the factors behind Bangladesh’s success need a closer look.

How could these achievements be made in spite of still widespread poverty, relatively low though increasing public social spending, and the poor governance of service delivery systems in Bangladesh? The improvements in the human development indicators reflect a process of social transformation that is of a much broader scale and dates back to earlier decades (Mahmud 2008). Much of this progress has resulted from an adoption of low-cost solutions like the use of oral rehydration saline (ORS) for diarrhoea treatment, leading to a decrease in child morality. More progress has come from increased awareness created by effective social mobilization campaigns such as for child immunization or contraceptives or female child enrolment. The scaling up of programmes through the spread of new ideas is helped in Bangladesh by a strong presence of nongovernmental organizations (NGOs) and also by the density of settlements and their lack of remoteness.¹² Public support in the form of many innovative interventions has also helped.

Thus far, Bangladesh has not followed the typical pathways to human development, such as the income growth-mediated path of Korea or the public spending-driven path of Sri Lanka.¹³ This is evidenced by the fact that while Bangladesh compares favourably with some of the socially progressive states of India, it lags far behind those states both in per capita income and per capita public social spending in absolute terms (Mahmud 2008).

But this also implies that further progress will require following either or both of the above pathways, as the gains from low-cost easy solutions are reaped and the amount of public spending, quality of services, and synergies with income-poverty all become important. Nevertheless, Bangladesh’s experience shows that it is possible to make rapid initial progress in social development by creating public awareness and using low-cost affordable solutions, and also that social attitudes and behavioural norms can change over a much shorter period than usually assumed in the literature of institutional economics (see, for example, North 1997).

The governance-growth nexus needs to be understood in the individual country contexts, in which institutions, historical and cultural settings, and the stage of development will matter. Most international comparisons show relatively poor perceptions of governance in Bangladesh. For example, in the most recent governance data set released by the World Bank Institute for 2005, Bangladesh’s ranking among 210 countries varies from bottom seventh to thirty-second percentile in the six indicators: 6.6 for political stability, 14.9 for regulatory quality, 19.8 for rule of law, 7.9 for control of corruption, 21.1 for government effectiveness, and 31.4 for voice and accountability. Bangladesh’s position is significantly worse than its South Asian neighbours in most indicators; only in respect of voice and accountability is it ahead of Nepal and Pakistan. The information from the surveys on Investment Climate and Doing Business carried out by the World Bank Group is also not encouraging for Bangladesh in most respects.¹⁴ Even more discouraging is Bangladesh’s very poor ranking in the economic competitiveness index prepared by the World Economic Forum.¹⁵

In some respects of governance, however, Bangladesh does well. For example, Bangladesh ranks among the top 50 per cent of the countries in terms of the ease of doing business according to the World Bank’s Doing Business survey of 2006. It actually ranks above many developing countries in terms of investor protection.¹⁶ The perception indices may also neglect many ground-level realities. Although Bangladesh scores very poorly in terms of enforcement of contracts, casual observation suggests that local business people do not regard it as any great hindrance in an environment where such enforcement can be biased to favour them and where informal methods based on business mores and customs and reputation play an important role. The corporate tax regime is relatively liberal in Bangladesh and profits are fairly high in formal sector enterprises.¹⁷

As discussed earlier, Bangladesh has in fact enjoyed governance successes in some key areas. The state has created space for the emergence of a vibrant domestic private sector. It has done this by various policy reforms aimed at maintaining macroeconomic stability, keeping fiscal deficits low so as not to crowd out bank lending to the private sector, providing access to imported inputs through import liberalization, increasing competition by reducing entry barriers, and improving the central bank’s oversight functions in respect of commercial banking. The successive democratically elected governments have been able to make fairly prudent public expenditure choices. The disaster management capacity of the government has also improved significantly over the years. The state has created space for forged partnerships with NGOs and the private sector to help deliver social services. And there has also been a certain degree of continuity in policy in spite of changes in government. Overall, the state has played a significant development role.

 

* Extracted from ‘Ecnomic Reforms, Growth, and Governance: The Political Economy Aspects of Bangladesh’s Development Surprise’, Working Paper 22 prepared for the Commission on Growth and Development by Wahiduddin Mahmud, Sadiq Ahmed and Sandeep Mahajan. Reproduced with permission.

Footnotes:

1. World Bank (2007), Volume II: Main Report, Chapter 7 and Figure 7.

2. Easterly (2002, Chapter 8) elaborately describes how, by some historical accident, the Korean firm, Daewoo, and an influential Bangladeshi bureaucrat-turned-industrialist, Noorul Quader, got together to start the process of transfer of knowledge and skills for setting up an export-oriented garment industry.

3. During the same period, the currencies of many developing countries, including India and Pakistan, underwent massive real devaluation; see Mahmud (2004, 2007).

4. There is, however, evidence that with a deterioration of law and order, small-scale and informal sector activities can be more vulnerable to illegal extortion and toll collection than larger-scale enterprise in terms of the proportionate increase in the cost of doing business; see Mahmud (2006), p. 42.

5. Lagos in Nigeria is the other.

6. World Bank (2007), Volume II: Main Report, Chapter 5. See also Acharya (2006) who explains the contrasts between Dhaka’s commercial and construction boom and the lack of it in Kolkata and Mumbai.

7. The official poverty estimates are made with reference to an ‘upper’ and a ‘lower’ poverty line. The national poverty incidence, according to the lower poverty line is estimated to have declined from 43 per cent in 1991/92 to 34 per cent in 2000 and 26 per cent in 2005.

8. See Osmani et al. (2003); Mahmud (2006).

9. World Bank (2007), Volume II: Main Report, Figure 3.7, p. 43.

10. Although the general validity of the Kuznets process has not been borne out by recent cross-country experience (see, for example, Anand and Kanbur 1993), this does not imply that it cannot be valid for specific country situations.

11. This is not to underestimate the problem of persistent or chronic poverty in Bangladesh. For empirical evidence, based on longitudinal studies, about the economic mobility of the poor, see Sen (2003) and Rahman and Hossain (1995), Chapter 7.

12. It is noteworthy that, according to the World Bank’s World Development Indicators 2005, the percentage of children with diarrhoea who were treated with oral saline was estimated at 61 per cent in Bangladesh compared to 27 per cent in India.

13. Sen, for example, distinguishes between ‘income-mediated’ and ‘support-led’ human development; see Sen (1999), Chapter 2.

14. World Bank (2007), Volume II: Main Report, Chapter 7.

15. Bangladesh ranks 98 out of 102 countries in business competitiveness according to the World Economic Forum’s Global Competitiveness Index.

16. In terms of the Investor Protection Index, Bangladesh scores 6.7 compared to the OECD average of 6.0 and the South Asian average of 5.0.

17. The World Bank’s Doing Business Survey does not take account of business profitability.

 

References"

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