Towards a new regime of regional integration in South Asia

There are strong arguments for deeper regional economic integration in South Asia. It is believed to have potential for generating significant intra-regional trade and welfare gains for the countries involved. Deeper regional integration is supposed to provide countries in the region improved market access in each other’s markets, and thus help boost their exports. These will facilitate intra-regional trade and associated investment flows which will generate more trading opportunities among the countries involved since there will be tariff differentials due to the most favoured nation (MFN) vis-à-vis regional tariff regimes. These are static gains that the countries involved would be able to realise. Dynamic gains could be even greater due to the possible expansion of the scale of operation owing to easy access to the large regional market buoyed by increased investment and more efficient allocation of regional resources.

Regrettably, intra-regional trade in South Asia has hovered around 5.0 per cent for the past decade. This is significantly lower when compared to other regional arrangements such as the North American Free Trade Agreement (NAFTA), the Association of Southeast Asian Nations (ASEAN), and the European Union (EU). The current regime of regional integration in South Asia has primarily focused on the rise in intra-regional trade in goods.

“..the new regime will require clear and visible leadership from India in taking the agenda forward. Other countries in the region should not be only at the receiving end but also have to take part actively and effectively. The new regime will call for all South Asian countries to balance what effectively they can offer and what they can expect in the deeper integration process.”

However, South Asia is on the verge of a new regime of regional integration which should involve four integration processes: (i) market integration: integration in trade in goods and services; (ii) growth integration: integration in economic growth processes of the South Asian countries; (iii) investment integration: promotion of regional investment and trade nexus; and (iv) policy integration: harmonisation of economic and trade policies. A new regime on regional integration in South Asia calls for these four integration processes through responding to four fundamental questions.

On the first question “Why is there a need for a deeper regional integration in South Asia?” the answer is: there are now convincing evidences that deeper regional integration is needed for generating and sustaining economic growth in the South Asian countries, i.e. regional integration will be a critical factor in the future growth processes of these countries. This is required for larger employment creation and alleviation of poverty in a region which has the highest number and density of poor people. For the promotion of inclusive growth, regional integration will be an effective instrument.

Ensuring food security is a challenging issue, and intra-regional trade in agricultural and food products will be immensely critical. Deeper regional integration through trade and transport facilitation will increase competitiveness of these countries to better participate in the global trade. Promotion of regional supply chain will be critical in developing dynamic comparative advantages of these countries. Finally, the peace dividends, through intra-country stable political relations, will be immensely high.

On the second question “How to achieve deeper regional integration in South Asia?” the answer is: despite all shortcomings, the South Asian Free Trade Area (SAFTA) is a landmark achievement, and deeper integration has to take lessons from it. Intra-regional trade in South Asia has been low, but there are signs of huge potential. There is a need to move beyond the SAFTA; and the new regime has to put much weight on regional investment and trade nexus. Promotion of intra-regional investments and attracting extra-regional FDIs in goods and services sectors in general, and energy and infrastructural sectors in particular will be the key driver in the new regime.

On the third question “What to do?” the answer is: a comprehensive assessment is needed on achievements of the SAFTA so far. For deeper market integration in goods, full implementation of the SAFTA is needed with emphasis on further liberalisation of intra-SAARC tariffs, reduction in sensitive list, relaxing the rules of origin, and establishing effective mechanisms to deal with the NTMs/NTBs. There is a need to link intra-regional liberalisation with enhanced intra-regional investment in different services sectors. Regional and sub-regional efforts have to be promoted for different trade and transport facilitation measures, for cooperation in energy generation and transmission, and for linking energy cooperation and trade and transport facilitation with investment and growth processes of these countries. The focus should also be on promotion of regional supply chains. The new regime will call for greater integration in trade, macro, financial and industrial policies with the aim for removing different policy and structural barriers. Short-term and medium term realistic targets should be spelled out. The new regime will re-emphasise on the importance of concrete regional efforts in the diversification of the export structures of the smaller and weaker countries for them to effectively integrate with the regional economy.

On the fourth question “Who will do and what?” the answer is: the new regime will require clear and visible leadership from India in taking the agenda forward. Other countries in the region should not be only at the receiving end but also have to take part actively and effectively. The new regime will call for all South Asian countries to balance what effectively they can offer and what they can expect in the deeper integration process. Regional institutions, like SAARC Secretariat, have to be institutionally reformed and reoriented. Business associations and civil society organisations have to understand and take part in the political economy process of pursuing regional integration agenda in South Asia more than ever under the new regime.

First published at the Thinking Aloud on 1 July 2014

Published at The Financial Express on 6 July 2015


Bangladesh needs a new investment regime


Looking at the trend in the investment-GDP ratio since 1979-80, we can suggest four different investment regimes in Bangladesh. The first regime (1979-80 to 1989-90) is characterised by low level of investment-GDP ratio with an annual average of 16.5 percent. This regime generated large fluctuations in GDP growth rates and the annual average GDP growth rate was only 3.5 percent. The second regime (1990-91 to 2004-05) saw a steady rise in investment-GDP ratio with an annual average of 21 percent. This regime yielded an annual average GDP growth rate of 5 percent. The third regime (2005-06 to 2008-09) experienced a higher but virtually flat investment-GDP ratio of 26.2 percent and a resultant rise in annual average GDP growth rate to 6.2 percent. Finally, the fourth regime is the current one (2009-10 to 2013-14) with a rise in annual average investment-GDP ratio to 28.2 percent, with 6.3 percent annual average GDP growth rate.

These four investment regimes can be tagged with different economic and political environments in Bangladesh. One economic indicator is the degree of openness. During the first regime, the economy was highly protected as is manifested by a very low level of trade-GDP ratio. However, since the second regime, through different economic reform measures, the economy became more and more trade-oriented, as the trade-GDP ratio experienced a steady rise over the years since then. The third regime, however, experienced a rise in the trade-GDP ratio at the beginning and then a fall. The striking feature of the fourth regime is that, the recent years are experiencing a gradual fall in the trade-GDP ratio, which is a matter of concern. This is also linked to sluggishness in economic reforms in recent years.

On the political front, the sluggish and low level of investment during the first regime was accompanied by a military dictatorship. The second regime of the steady rise in investment was under the regime of ‘parliamentary democracies’ with high prevalence of ‘contested politics’. The third regime of stagnant investment was associated with a ‘military backed’ caretaker government with complete absence of ‘contested politics’. And finally, the fourth regime has been a regime of ‘parliamentary democracies’ with a low level of ‘contested politics’.

One very important aspect of these investment regimes is the trend in private sector participation in the economic growth process. If we look at the trend in the share of private investment in total investment, the first regime was characterised by a low and declining share of private investment. However, during the second regime, large contribution to the rise in investment came from the rise in private investment and its share in total investment. During the third investment regime, the share increased in the initial years and then fell in the later years. However, under the fourth regime, with the fact that the investment-GDP ratio has become somehow stagnant in the recent years, the share of private investment in total investment has fallen with the rise in the share of public investment, which is essentially unsustainable.

One very striking feature is that in the recent two investment regimes, the productivity of investment has fallen. One way of measuring the productivity of investment is the Incremental Capital-Output Ratio (ICOR), which is the ‘ratio of investment as percent of GDP’ to ‘GDP growth rate’. The higher the ICOR, the lower the productivity of investment. During the first regime, the annual average ICOR was as high as close to 5. However, during the second regime it came down to 4.24. The third regime saw a rise to 4.31. But, alarmingly, the fourth investment regime has an average ICOR of 4.54. This suggests that in recent years, there have been noticeable rises in the inefficiencies in the economic institutions and resultant falls in the returns to investment. This is clearly manifested by the fact that though during the third and fourth investment regimes, the annual average GDP growth rates have been little over 6 percent, the investment-GDP ratio in the fourth regime was 2 percentage points higher than that of the third regime, indicating that the economy is now needing more resources to generate the same level of GDP growth rate! This also points to the alarming fact that a mere rise in investment-GDP ratio would not ensure higher GDP growth rate in the future.

There is no denying the fact that economic diversification is very important for economic growth process to be sustainable. It is important to mention that as against the first investment regime, the second investment regime was able to generate some essential diversifications of the economy through significant expansion of some non-agricultural sectors. One such example is the growth of the export-oriented readymade garment sector. However, in the later investment regimes, there has not been much progress in further diversification of the economy in general and the export basket in particular. There remain large policy induced and supply side constraints, inhibiting further diversification of the economy.

All these suggest that there is a need for a new investment regime in Bangladesh. This new investment regime calls for some substantial policy and institutional reforms aiming at considerable rise in private investment and its efficiency.

What is needed are: (i) a new paradigm of macro, trade and investment policies aiming at economic diversification, (ii) reducing the cost of borrowing through financial sector institutional reforms, (iii) reform of the economic institutions tuned to further growth acceleration and growth maintenance, (iv) stability in the political institutions and presence of higher degree of ‘contested politics’, (v) efficient public investment in social and physical infrastructure, facilitating further private investment, (vi) attracting large FDIs, with emphasis on regional cooperation in South Asia, and (vii) improving the overall governance of the macroeconomic policy environment.

Published at the Thinking Aloud on 1 July 2015

Published at The Daily Star on 2 July 2015