Hiccups of ‘Bangladesh Development Surprise’

20181031_091336Bangladesh’s economic growth and development performance over the past two decades have been impressive. With the poor quality of institutions, such a performance has often been termed as a ‘development surprise’ or ‘Bangladesh paradox’. But is it at all a ‘surprise’ or a ‘paradox’ – since anything beyond any reasonable explanation can appear as a paradox? Is Bangladesh’s development performance beyond any ‘reasonable’ explanation?

If we look at the quality of institutions in Bangladesh, the performance has been very poor. According to the World Governance Indicators (WGI), in 2016, out of 156 countries, Bangladesh ranked 114 in terms of ‘Voice and Accountability’, 101 for ‘Political Stability’, 138 for ‘Government Effectiveness’, 114 for ‘Regulatory Quality, 101 for ‘Rule of Law’, and 117 for ‘Control of Corruption’. Other indicators of institutional quality also portray similar pictures. For example, in the case of the World Bank’s Doing Business indicator of 2019, out of 190 countries, Bangladesh’s ranking was 176. With respect to Transparency International’s Corruption Perceptions Index of 2018, Bangladesh’s ranking was 149 out of 180 countries. In the case of the Global Competitiveness Index (GCI) of 2017-2018, Bangladesh’s ranking was 99 out of 137 countries.

Against the aforementioned poor quality of institutions, the average GDP growth rate in Bangladesh increased from 3.7 percent in the 1970s to 6.6 percent in the 2010s. Bangladesh has been able to increase the average GDP growth rate by one percentage point for each decade since the 1990s. The country cut down the poverty rate from as high as 71 percent in the 1970s to 24 percent in 2016, became the second largest exporter of readymade garments in the world, and registered some notable progress in social sectors.

How do we reconcile the above mentioned two contrasting scenarios? Difficulty in such reconciliation perhaps has led to the emergence of the ideas of ‘surprise’ or ‘paradox’. However, we can try offering some reasonable explanations to this so-called ‘surprise’ or ‘paradox’. We also argue that, without significant improvements in the quality of institutions, such ‘surprise’ will continue to lead to periodic ‘hiccups’ like the accidents in the RMG sector (several fire incidents, Rana Plaza incident of factory collapse); frequent road accidents; frequent fire incidents in the residential and commercial areas; repeated scams in the financial sector; serious environmental degradation in cities, rivers and forest areas; periodic labour unrest; uncontrolled scams in public examinations; social disintegration among youth in the forms of extremism and drugs; etc.

Now, coming back to some reasonable explanations of ‘surprise’ or ‘paradox’, if we look at the well-known institutional indicators (WGI, Doing Business, Transparency International, and GCI), all refer to the quality of formal institutions. However, in countries like Bangladesh, placed at the lower level of the development spectrum, what governs is a host of informal institutions, and the development of formal institutions is weak and fragile. There are some interesting political economy frameworks to understand the importance of informal institutions in developing countries. For example, Mushtaq Khan’s framework of ‘growth-enhancing institutions’ in contrast to ‘market-enhancing institutions’ elaborates how the role of informal institutions can be critical in developing countries. Some developing countries, especially East and Southeast Asian countries, have been successful in steering the unconventional institutions to drive growth. Another framework, proposed by Lant Pritchett, Kunal Sen and Eric Wrecker, relates to the idea of ‘deals space’. Deals (informal), in contrast to rules (formal), among the political and economic elites, are prevalent in the developing countries. Deals can be open (access is open to all) or closed (access is restricted), and also they can be ordered (deals are respected) or disordered (deals are not respected). According to this view, countries are likely to exhibit high growth when deals are open and ordered.

Informal institutions can have two distinct roles with respect to the stages of development. At the early stage of development, if countries can steer the informal institutions to the extent they are ‘growth-enhancing’ as well as the ‘deals space’ is more ordered (either open or closed), countries can manage a regime of strong growth rate and can also achieve some improvements in the social sector. However, for the transition from a lower stage of development to a higher stage, whether the country can maintain the high growth rate and achieve larger development goals, is depended on the dynamics of how the informal institutions evolve and formal institutions become stronger and functional. Not many developing countries have been able to do this. Certainly, the East Asian and most of the Southeast Asian countries are the success stories in using the informal institutions efficiently at the early stage of development as well as making some notable successes in the transition towards functional formal institutions.

In contrast to many other comparable countries of Asia and Africa at the similar stage of development, least developed countries, in particular, Bangladesh has been successful in creating some efficient pockets of ‘growth-enhancing’ informal institutions against an overall distressing picture of formal institutions. This is how the ‘Bangladesh Surprise’ story unfolds. The examples of ‘pockets of efficient informal institutions’ in Bangladesh include the well-functioning privileges and special arrangements for the RMG sector, promotion of labour exports, agricultural research and development related to food security, and microfinance.

However, the next question is how could Bangladesh create such ‘pockets of efficient informal institutions’ and make the ‘best’ use of them? The explanations include both historical and political economy perspectives. Two historical events strongly influenced the mindset of the political and economic elites in Bangladesh. First, the 1971 liberation war led to the emergence of an independent Bangladesh state which gave unprecedented, enormous and first time independent power to the burgeoning political and economic elites of the Bengali nation of this part of the world. Also, the citizens, in general, enjoyed some benefits of such power. Largely, the entrepreneurship nature of the people of this country is deeply rooted in this feeling of power. The reflection of successful entrepreneurship is seen in the cases of the RMG sector, labour migration, and microfinance. As Bangladesh is not rich in natural resources, elites found the RMG sector as a basis of generation of substantial rents. The sources of rents in the RMG sector include the Multifibre Arrangements (MFA) quota (which no longer exists) and the Generalised Systems of Preference (GSPs), different forms of subsidies, tax exemptions, a suppressed labour regime, and weak compliance. Through large scale employment generation in the RMG sector and its induced effects of poverty alleviation and female empowerment, the elites were also able to draw support from the non-elites for this sector. The second event relates to the experience of the 1974 famine, which led the elites to realize that a country like Bangladesh, with a huge population in a small piece of land, cannot afford anything like this in the future. Therefore, subsequent governments focused on the development of the agricultural sector to ensure food security. All these also helped achieve some notable progress in the social fronts.

Despite the aforementioned achievements, the fundamental question is whether Bangladesh can continue its success and achieve larger development goals with the business as usual processes. There are concerns that the weak institutional capacity of the country may work as a binding constraint as the country eyes to meet the stiff targets of the Sustainable Development Goals (SDGs) by 2030, aspires to become an upper middle-income country by 2031, and visions to become a developed country by 2041. Dividends from the existing ‘pockets of efficient informal institutions’ are on a decline, and the elites have not been able to create any new such ‘pockets’ apart from the ones mentioned above.

How is Bangladesh performing in terms of the transition from some ‘pockets of efficient informal institutions’ to well-functioning formal institutions? This can be answered by looking at how well the formal institutions are taking shape. The trends in the quality of formal institutions between 1996 and 2016, as are manifested by the movements of the World Governance Indicators, suggest that, with some fluctuations, there are deteriorations in the cases of ‘Voice and Accountability’, ‘Political Stability’ and ‘Government effectiveness’, and some trivial improvements in the cases of ‘Regulatory Quality’, ‘Rule of Law’ and ‘Control of Corruption’. As the country is plunged with a number of challenges related to slow progress in structural transformation, lack of economic diversification, high degree of informality in the labour market, slow pace of job creation, poor status of social and physical infrastructure, slow reduction in poverty, and rising inequality, such poor improvements in formal institutions will make hiccups of ‘Bangladesh development surprise’ a rule rather than an exception.

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Bangladesh’s macroeconomic challenges

imageedit_2_8238428477There are six major macroeconomic challenges for the Bangladesh economy. First, accelerating economic growth and maintaining high economic growth over the coming years will remain a big challenge. Two major drivers of economic growth in Bangladesh have been the readymade garments exports and remittances. The dividends from these drivers of growth are likely to decline in the future. There is a need to find new drivers of growth through diversification of the economy and developing productive capacities. In these contexts, stimulating private investment in diversified economic sectors and ensuring efficient public investment remain uphill tasks.

Second, containing inflation is a critical challenge. Bangladesh has been able to avoid high inflationary pressure since 2011. The overall inflation rate has remained below 7%. In recent years, the inflation rate is less than 6%. However, there are three concerns with respect to the inflation situation in Bangladesh: (i) the overall inflation rate hides the sudden as well as intermittent steep rise in food prices, especially the price of rice, which affects the poor people; (ii) as the overall inflation rate is a weighted sum of the food and non-food inflation, there are concerns that the non-food inflation in Bangladesh is underestimated due to inappropriate representation of the non-food items and their prices in the calculation of inflation rates; (iii) the overall low inflation rate at the national level may not reflect the true picture of the high inflationary pressure faced by different low-income groups as their consumption baskets and related prices are likely to be different from the national averages. Given these concerns, containing inflationary pressure for low-income people will remain a challenge for Bangladesh in the wake of further growth acceleration.

Third, the management of the exchange rate is a crucial area of concern. Though, for long, Bangladesh has been able to maintain a relatively stable exchange rate regime, the exchange rate in recent times is alleged to be over-valued. In recent years, while Bangladesh’s major competitors in the global market, such as China, Vietnam, India, and Sri Lanka, have experienced significant depreciation of their currencies against US dollar, Bangladeshi taka remained quite stable. The analysis of the real effective exchange rate in Bangladesh also shows a misaligned exchange rate regime which, together with high tariff rates on imports, leads to significant anti-export bias. In other words, the current exchange rate and trade policies are not favorable for rapid export expansion in Bangladesh. However, one important point to note here that, while the importance of the correction of anti-export bias for export promotion and diversification cannot be undermined, such correction alone cannot by itself be sufficient to trigger ‘auto’ large supply response in terms of expanding export volumes and diversifying the export basket. A number of supply-side constraints, in terms of weak infrastructure, the high cost of capital, lack of access to credit, and lack of skilled human resources can prevent local producers from expanding exports, and the lack of an enabling business environment can strangle entrepreneurship and innovation. Therefore, the policy options and support measures for exports are much more difficult and involved than the mere correction of anti-export bias.

Fourth, the surged balance-of-payment deficit in recent years remains a big concern for the stability of the macroeconomy. Over the past two years, the economy has been witnessing high growth rate in imports, while the growth rates in exports and remittances have been subdued and unstable, which has led to widening trade deficit and current account deficit. Though the current volume of foreign reserve can meet the import demand of around five months, the volume of the foreign reserve has been on a declining trend since the financial year of 2017. Given the projections of high import demand for construction and industrial raw materials in the coming days on the one hand and unstable global trading environment, thus creating uncertainties for both export and remittance growth, on the other hand, managing a stable balance-of-payment regime will remain a big challenge for the Bangladesh economy. One important lesson, Bangladesh can learn from the experiences of the successful countries from southeast Asia, is that attracting large scale foreign direct investment (FDI) can ease the pressure on balance-of-payment. Bangladesh is yet to be successful in attracting large-scale FDI. The amount of annual FDI inflow in recent years is only around 2.5 billion US$ while the country needs more than 10 billion US$ FDI annually to achieve many of its development goals. Therefore, enabling the environment for ensuring large-scale FDI remains a critical task ahead.

Fifth, while the monetary policy by the Bangladesh Bank has been, in general, able to maintain a so-called stable ‘status quo’, it has failed to generate a big push for accelerating private investment. A number of banking scams and escalation of non-performing loans show a major institutional weakness of the financial sector and pose a threat to macroeconomic stability. The high cost of credit is a reflection of the inefficient banking system which discourages inclusive financing. Therefore, the challenge of the monetary policy is more of an institutional issue rather than any narrowly-focused effort to lowering of the interest rate.

Finally, though the country has been able to maintain a stable fiscal deficit of around 5% of GDP over a long time period, in a regime of low tax-GDP ratio of around 10%, this has only been possible through keeping the vital social expenditures, like public expenditure on education, health and social protection, at very low levels. However, as the country aspires to achieve stiff development goals in the coming years, public spending on education, health and social protection has to be raised substantially. There is no denying that with such a low tax-GDP ratio many development aspirations will remain unrealized. Though the country has undertaken several reforms to improve tax collection, they have remained unsuccessful due to various institutional weaknesses and vested political patronage. The fiscal policy process thus needs a strong political commitment to simplifying tax systems, strengthening tax administration, and broadening the tax base under a wider reform agenda.

The challenging economics of climate change

imageedit_2_8238428477Global climate change has become one of the dominant discourses in the scientific and public policy arena. Studies from scientific research show that the global warming is now a real phenomenon, as there has been an unusually rapid increase in Earth’s average surface temperature over the past century primarily due to the unprecedented accumulation of carbon dioxide resulting from the burning of fossil fuels, together with emissions of other human-induced greenhouse gases. The effect of this temperature rise includes increased frequency of severe weather events (such as heat waves, hurricanes, and tornadoes), proliferated intensity of storms, and sea level rise. These changes, no doubt, pose serious threats to the welfare and existence of mankind and other living things on earth through impacting on the functioning of the ecosystem, biodiversity, and human health.

The economics of climate change refers to the study of the economic costs and benefits of climate change, and the analysis of the economic impact of actions targeting at limiting its effects. However, the economics of climate change is challenging due to the fact that there are huge uncertainties in the estimation of both the costs and benefits related to climate change. The precision of the time horizon, over which benefits and costs of climate change would accrue, is debatable. Also, there are uncertainties over thresholds for climate change impacts and the pace and form of technological innovation that can take shape in the future.

Furthermore, the effects of climate change are not uniform across countries. Different parts of the world are likely to be affected differently: countries closer to North and South poles will experience warmer temperatures and once inhospitable land will experience melting of ice. Small island nations are at risk of extinction due to rising sea levels. Low lying islands and countries are at a greater risk of flooding both from rising sea levels and increased precipitation. Countries near the equator are likely to experience unbearable heat. Some of the countries are already experiencing more frequent events of severe weather.

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The economics of climate change is further complicated by the fact that most of the developing countries can’t afford the costs of mitigation or adaptation of the aforementioned phenomenon of climate change. The 2018 Environmental Performance Index (EPI) of the Yale University ranks 180 countries on 24 performance indicators across ten issue categories covering environmental health and ecosystem vitality. These metrics provide a gauge at a national scale of how close countries are to establishing environmental policy goals. According to the EPI, most of the developing countries in the South dominate in the lower ranking. Among the bottom 10 countries in the ranking, three (Bangladesh, India and Nepal) are from South Asia. Bangladesh’s position is 179 out these 180 countries.

There are also considerable debates in the discourse of climate change with respect to the policies and actions needed to address the challenges. Two instruments are widely referred in the policy discussion. The first one is the carbon tax, which is the mandatory fee charged for the emission of a given quantity of carbon dioxide or some other greenhouse gas. The second one is carbon trading, which is buying and selling of carbon credits, abstract instruments (like money) that each represents the right to emit 1 ton of carbon dioxide or an equivalent amount of other greenhouse gases. The other policies include technology promoting programs. One more instrument, which is less explored but can be effective, is the liberalization of trade in environmental goods (EGs), which can play a crucial role in protecting the environment as well as promoting international trade in EGs. Trade has a positive effect on the environment only if environmental policy advances alongside trade liberalization. However, most of the developing countries are seriously lagging behind in conceptualizing as well as in building national capacities to implement these aforementioned instruments.

One important challenge in the economics of climate change is the political economy aspect of it. Both the global and national political economy factors are critical in addressing climate change issues. The USA President Donald Trump’s unfavorable attitude towards the warning of devastating effects from climate change, and eventually USA’s withdrawal from the Paris climate agreement has created huge uncertainties for a global partnership. At the national level, many developing countries, due to their national priorities of industrialization and lobbying power of different quarters, find it extremely difficult to contain the polluting industries. Therefore, the developing countries have uphill tasks in the future given the aforementioned challenging economics of climate change.

First published in the Thinking Aloud on 1 December 2018

Can Bangladesh continue to grow without ‘good governance’?

Selim Raihan

If we look at the growth pattern of Bangladesh from 1990, we discover two specific characteristics: first, the growth rate has been on the rise, and second, it is less volatile compared to those of many other countries (for example, India, Vietnam, Cambodia, China, Malaysia, Thailand and Ghana) which are known as ‘high growth performing countries’. Bangladesh’s growth experience has often been termed as ‘Bangladesh paradox’ given that the country has been able to perform well despite ‘weak governance’. Now, the big question is: can Bangladesh continue to grow without ‘good governance’? If we look over the last three decades, obviously, Bangladesh had been growing without the so-called ‘good governance’. Then what does this ‘good governance’ mean?

Four contemporary analytical approaches can be linked to the discussion on ‘good governance’. The new institutional economics (contemporary lead presenters are Daron Acemoglu and James Robinson), representing a variant of the neo-liberal orthodoxy, argue for specific and well-defined rules and property right systems (‘good governance’) for economic growth. There are three alternative approaches to this new institutional economics. The approach by Douglass North, Joseph Wallis and Barry Weingast argues for ‘limited access order’ in a large number of developing countries in contrast to ‘open access order’ in the advanced economies. In ‘limited access orders’, political elites divide up control of the economy, each getting some share of the rents; and since outbreaks of ‘violence’ (conflicts among the elites) reduce the rents, the elite groups have incentives to reduce conflicts among them. The approach by Mushtaq Khan stresses on ‘political settlement’, which highlights on the relative holding of the power of different groups and organizations contesting the distribution of resources, and a ‘political settlement’ emerges when the distribution of benefits supported by its institutions is consistent with the distribution of power in society. Mushtaq Khan also emphasizes on ‘growth-enhancing governance’ (un-orthodox institutional arrangements) in contrast to ‘market-enhancing governance’ (orthodox institutional arrangements, as signified by new institutional economics). Finally, the approach by Lant Pritchett, Kunal Sen and Eric Werker emphasizes on ‘deals space’, ‘rents space’ and ‘political settlements’ for growth acceleration and growth maintenance in developing countries. The rents space is characterized by private sector firms who can be rentiers (securing rent from the export of natural resources), powerbrokers (securing rent from the regulated domestic market), magicians (firms participate in competitive export markets), and workhorses (firms participate in unregulated domestic markets). Deals, in contrast to rules, among the political and economic elites, can be open (access is open to all) or closed (access is restricted); and also they can be ordered (deals are respected) or disordered (deals are not respected). The countries are likely to exhibit high growth when deals are open and ordered.

Can we explain the growth experience of Bangladesh through these four approaches? The approach by new institutional economics cannot explain the growth of Bangladesh, since Bangladesh never had the so-called ‘good governance’ but the economy continued to grow. Furthermore, all these approaches have three major problems. First, approaches of ‘limited access order’ and ‘political settlement’ emphasize more on the ‘elite agreement’ at the macro level, thus ignore the perspectives at the sectoral level. However, the ‘deals-rent space’ approach has a better holding on the sectoral level analysis. Second, all these approaches emphasize on the process of ‘elite agreement’ rather than on the outcome, which does not convincingly show how such process affects economic growth. Third and most importantly, all these approaches emphasize on ‘elite agreement’, and overlook the critical nexus between elites and non-elites within the society. Only in ‘limited access order’ approach, such nexus is shown through the ‘power of violence’ of non-elites.

Empirical research suggests that there are four major drivers of growth in Bangladesh: exports of readymade garments (RMG), remittances, growth in agriculture, and microfinance.  Now, it is clear that we cannot explain these growth drivers of Bangladesh with the usual definition of governance or politics by the aforementioned four approaches.

From a political economy perspective, in my view, there must be some substances by which these growth drivers are fueled; and I want to name these substances as ‘political capital’. The usual meaning of ‘political capital’ is a feeling of trust that politicians build among the common people through which they exert their influence in the society. But, according to my opinion, ‘political capital’ is an outcome of agreements among the political elites and support from the non-elites on such agreements over certain growth drivers in the economy. In order to source such support, elites ensure some critical benefits for non-elites. Over the last three decades, Bangladesh has been able to generate crucial stock and flow of ‘political capital’ in favor of the aforementioned growth drivers. Bangladesh is not rich in natural resources, which did not help to generate substantial rents for the political elites. Elites, thus, found the RMG sector as a source of generation of rents, and they were able to draw support from the non-elite through the creation of large-scale employment opportunities in the RMG sector. In the case of remittances, international migration of a large number of people helped alleviation of poverty, and thus gathered support from the non-elites. For the agricultural sector, this ‘political capital’ is generated from the experience of the 1974 famine, as the political elites realized that the country like Bangladesh cannot afford anything like this in the future. Therefore, subsequent governments, focused on the development of the agricultural sector to ensure food security. Finally, as microfinance, another example of elite and non-elite nexus, played important roles in generating growth and alleviating poverty in Bangladesh, there had been a construction of significant stock of ‘political capital’ around microfinance over the last three decades.

Therefore, Bangladesh can continue to grow until the ‘political capital’ provides returns over the existing drivers of growth. Given the fact that there are growing challenges for these existing drivers, political elites in Bangladesh also need to find new drivers for growth acceleration. There are two new prospective drivers, for which critical ‘political capital’ is yet to be formed. The first one relates to the comprehensive economic and trade integration with neighboring countries, and the second one is government’s initiative of setting up 100 special economic zones (SEZs) by 2030 for rapid industrialization of the country through large-scale domestic and foreign investments. It is a high time that political elites in Bangladesh come out from their comfort zone of old drivers towards the journey of building ‘political capital’ for new drivers.

Dr. Selim Raihan. Executive Director, SANEM. Email: selim.raihan@gmail.com

Transitions between growth episodes: Do institutions matter and do some institutions matter more?

Selim Raihan, Sabyasachi Kar and Kunal Sen

A large literature has examined the role of institutions in explaining economic growth. While the earlier literature has examined the role of institutions in determining long-run per capita income, a new literature examines the determinants of growth accelerations and deceleration episodes – which are large discrete changes in medium term growth rates that are common in developing countries. Some of these studies examine the onset of growth accelerations while others examine the onset of growth decelerations. However, these studies look at only the timing of the shift in the growth rate (either as an acceleration or a deceleration), and the econometric methodology they use are probit models (where the year of the break is taken as one, with other years as zero) to study the likelihood a growth break occurring in a given year, for a set of correlates. An important limitation of these studies is that they do not differentiate between the different growth episodes that a country is transitioning from or to. For example, when a country moves from a growth collapse to rapid growth, it is a different growth transition qualitatively than when it moves to an episode with slightly positive but slow growth rates.

In this paper, we investigate the role of economic and political institutions in determining the likelihood of a country transitioning from one growth episode to another. In contrast to the previous literature, in this paper, we provide a richer characterisation of the growth process where a country may move between six different types of growth episodes, ranging from growth collapses to rapid growth episodes. By doing so, we are better able to capture the episodic nature of growth and that many countries tend to switch frequently between growth collapses to slow growth episodes to rapid growth episodes.

We differentiate between six types of growth episodes – from growth collapses (where the episode specific per capita real GDP growth rate, g, is -2 per year), to negative growth (g between -2 and 0), stagnation (g between 0 and +2), stable growth (g between +2 and +4), moderate growth (g between +4 and +6), and rapid growth (g over +6). Using multinomial logit models, in the context of a panel dataset of 125 countries from 1984 to 2010, we examine the likelihood of switching from one growth episode to another growth episode. We examine the role of contract viability (as a measure of the quality of economic institutions) and the role of democracy and bureaucratic quality (as measures of political institutions) in explaining the switches that countries experience between different types of growth episodes. The data on contract viability, democracy and bureaucratic quality are derived from the ICRG database (www.prsgroup.com).

We find that though bureaucracy quality has a positive effect while switching from negative growth episode to positive growth episodes, it doesn’t matter in most of the cases while switching from lower order growth episodes to higher order growth episodes. Both contract viability and democratization can explain the switching from negative growth episode to positive growth episodes. Contract viability and democracy can also explain the movements from lower positive growth episodes to higher positive growth episodes. However, while contract viability is important for moving from stable growth episode to rapid growth episodes, democracy is not important in explaining this switch. This suggests that while better economic and political institutions matter in taking a country from growth collapses to stable growth, economic institutions matter more than the political institutions for the switching from stable growth to rapid growth.

Our results suggest that, democratic episodes do not necessarily witness transitions to rapid growth episodes from moderately positive growth episodes. However, democratic episodes do witness a transition from negative to positive growth episodes, indicating that democratization does prevent the worst type of growth episode that a country can experience. We also find that improving state capacity in the form of the quality of the bureaucracy can help in taking a country out of negative growth episodes but that higher state capacity does not increase the likelihood of rapid growth episodes. This finding suggests that previous research that has found a positive role of bureaucratic quality in fostering economic growth need to differentiate between phases of growth, and that the relationship between bureaucratic quality and economic growth may not be monotonic.

We find that the most important institutional determinant of switching to higher order growth episodes from lower ones, and in particular, to rapid growth episodes, is the nature of property rights institutions – that is, the extent to which investors trust the viability of contracts. In contrast to the previous literature on the determinants of growth accelerations, we find that not only does institutional quality matter in bringing about a growth acceleration, it is the case that the greater the quality of property rights institutions, the higher is the likelihood of a transition to a rapid growth phase.

Our findings have clear policy implications. For a country in a growth decline or collapse, it is important to stress improvements in both political and economic institutions, such as bureaucratic quality, viability of contracts and democratization to move into an episode of positive growth. However, once the country is in a stable or moderate positive growth episode, further movements into rapid growth episodes need larger emphasis on improving the quality of property rights institutions than enhanced democratization or state capacity. Economic institutions trump political institutions in bringing about rapid growth episodes, though they both matter in reversing growth collapses.

Dr. Selim Raihan (Professor, Department of Economics, Dhaka University, Bangladesh; Email: selim.raihan@gmail.com), Dr. Sabyasachi Kar (Research Fellow, Institute of Economic Growth, Delhi, India), Dr. Kunal Sen (Professor, IDPM, University of Manchester, UK)

First published at the Thinking Aloud on 1 August 2016

Published at The Financial Express on 2 August 2016

Published at ESID blog on 1 August 2016

 

 

Does institution matter for human capital development?

graph_human capital

A fundamental proposition of new growth theories is that human capital is a key driver of economic growth. Development of human capital for the people of a country encompasses not only the diffusion and assimilation of available knowledge, but also the generation of new knowledge – the source of innovation and technological change – which boosts economic growth.

It is rather a challenging task to measure a country’s stock of human capital. Popular indicators, used to measure human capital, include adult literacy rate, school enrolment rates, average years of schooling, quality of schooling etc. The Penn World Table version 8.1 provides a dataset on an index of human capital (HCI) for 134 countries over a period of 6 decades. HCI is an index of human capital per person which is related to the average years of schooling and the return to education. In 2010, United States had the highest HCI value (3.62) and Mozambique had the lowest one (1.27). In that year, among the 134 countries, 33 countries had HCI values higher than 3; 48 countries had values between 2.5 and 2.99; 28 countries had values between 2 and 2.49; and 25 countries had values less than 2. In South Asia, in 2010, the HCI values for Bangladesh, India, Nepal, Pakistan and Sri Lanka were 2.07, 1.93, 1.71, 1.99 and 3.16 respectively.

Why do some countries have higher level of human capital than others? Empirical literature have looked at different factors such as spending (both public and private) on education and health, and differences in income levels; but hardly there has been any emphasis on differences in institutional capabilities among the countries. However, quality of institution, as it affects economic growth process, can also have a bearing on the quality of human capital. Therefore, a valid question can be asked: does institution matter for human capital development? Of course there could be a bi-directional causality between human capital and quality of institution, where quality of institution could also be influenced by the level of human capital. Nevertheless, leaving aside the causality, here we are more interested to know about the association between these two.

The scatter-plot, as presented in the graph, has been generated using the data of index of human capital and index of institution for 93 countries over a period of 1984-2010 with over 2500 observations. We have constructed the index of institution using the data of six major ICRG (www.prsgroup.com) variables, namely bureaucracy quality, control of corruption, investment profile, democratic accountability, government stability, and law and order. As values of these six ICRG variables have different scales, we have rescaled them between 0 and 10. The aggregate institution index is the average of these six indicators with the range between 0 and 10, where 0 and 10 respectively indicate the lowest and highest levels of quality of institution.

The scatter-plot suggests a very strong positive association between quality of institution and level of human capital, which signifies the importance of better institution for higher level of human capital. Interestingly, if we compare Bangladesh with Malaysia, levels of both institution and human capital of Bangladesh in 1990 (1.62 and 1.52 respectively) were much lower than those of Malaysia in 1990 (6.05 and 2.31 respectively). Despite the fact that during 1990 and 2010, Bangladesh made some notable progresses in both fronts, by 2010, the levels of these two indices of Bangladesh (5.52 and 2.07 respectively) were below than what Malaysia had in 1990!

Results from a more sophisticated cross-country panel econometric regression reinforces this association. In this regression, the index of human capital has been considered as the dependent variable. We have also created two institutional indices: economic institution and political institution. The economic institution index is comprised of three ICRG indicators – bureaucracy quality, control of corruption and investment profile; whereas the political institution index consists of other three ICRG indicators – democratic accountability, government stability and law and order. Other explanatory variables include initial GDP per capita, public expenditure on education as a percentage of GDP, and under-five mortality rate. The regression results indicates that after controlling for initial GDP per capita (which has a positive significant association with human capital index), public expenditure on education has a statistically significant positive association and under-five mortality rate has a statistically significant negative association with the human capital index. The highly significant and positive coefficients of both economic and political institution indices suggest strong positive associations between these institutional variables and human capital index. The z-score regression analysis, however, refers to larger importance of political institution over economic institution in human capital development.

The aforementioned analysis points to the fact that better economic and political institutions matter for human capital development. While countries need to make critical spending for human capital development, improvement in institutional environment is unequivocally essential.

Published at the Thinking Aloud on 1 July 2016

Published at The Financial Express on 18 July 2016

Political economy of regional integration: Where do we stand in South Asia?

The aspiration for deeper regional integration is high on the political agenda of most of the leaders in South Asia. Since the early 1980s South Asian Association for Regional Cooperation (SAARC) has been working as an economic and geopolitical organization for South Asian countries with the aim of deeper regional integration and cooperation in areas of economic, trade and other common regional issues. Until now, there have been some achievements. Still, frustration prevails, as actual implementation of agreements often does not match the declared ambitions. The resulting implementation gap is most commonly attributed to the lack of political will and leadership, institutional weaknesses and capacity and resources constraints.

The dominant literature has looked primarily at the narrow economic factors influencing regional integration. However, to have a better and systematic assessment of the factors driving and constraining regional integration, it is important to explore the political economy dimensions. While policy makers and stakeholders are often aware of such political economy dimensions, they are generally discussed only informally or in ad hoc manner. A systematic discussion of the political economy factors around the regional integration agenda can generate a broader awareness among stakeholders that may ultimately lead to more realistic and effective regional policy design and processes.

From a political economy perspective, there could be three interconnected drivers for a deeper regional integration. These are economic drivers, political economy drivers and extra-regional drivers.

PE of regional integration

The economic drivers include four integration processes: market integration, investment integration, growth integration and policy integration. ‘Market integration’ emphasizes on the integration in trade in goods and services through the removal of tariff and non-tariff restrictions. ‘Growth integration’ is the integration of economic growth processes of the respective countries in a way that growth in one country benefits growth processes in other member countries. The ‘investment integration’ calls for promotion of regional investment and trade nexus. Finally, the ‘policy integration’ is the harmonization of economic and trade policies of the countries for a deeper regional integration.

However, the aforementioned four integration processes need favorable political economy (PE) drivers. The political-economy perspective considers how various players influence the national and regional decision-making context, and what impact their actions (or lack of action) have on the integration agenda. The first PE driver is the ‘primary institution’ which are the official institutions at the regional level and in respective countries entrusted to carry out the agenda of regional integration. In South Asia, the SAARC Secretariat and relevant ministries in the member countries are such institutions. The second PE driver is the ‘secondary institution’ which are private sectors, private sector associations, civil society organizations and media. Primary and secondary institutions are a combination of market and non-market actors that govern economic and political environments in the region. The third PE driver is the ‘regional public good’ which includes regional infrastructure and the status of regional trade facilitation. In South Asia, status of such ‘regional public good’ is very weak. ‘Structural factor’ is the fourth PE driver which includes historical processes and geographic factors that shape the types of political, economic and socio-cultural institutions. In South Asia, landlockedness of Nepal, Bhutan and Afghanistan, political rivalry between India and Pakistan, and huge differences in the sizes of the countries where India accounts for around 80% of the regional GDP, trade among the South Asian countries primarily through land borders are such structural factors. The final PE driver is the role of the ‘political elite’. Strong and visionary leaderships are needed from the political elites to eliminate any ‘trust deficit’, which can emerge as a result of a variety of the ‘structural factors’ mentioned above. In South Asia, such ‘trust deficit’ is often highlighted as one of the major barriers for a deeper regional integration. Also, there are concerns with regard to hesitant and inconsistent leaderships from the political elites of these countries, especially from India, in taking the regional integration agenda to a higher level.

Finally, the extra-regional drivers include a wide range of global economic and political factors that can have influence over the region. In South Asia, countries are at different levels and with different patterns of integration with the extra-regional drivers.

There are now convincing evidences that a deeper regional integration is needed for generating and sustaining economic growth and reducing poverty in South Asia. Intra-regional trade in South Asia has been low, but there are signs of huge potentials. For a deeper market integration in goods, full implementation of SAFTA is needed with emphasis on further liberalization of intra-SAARC tariffs, reduction in the sensitive list, and establishing effective mechanisms to deal with the NTMs/NTBs.

Intra-regional services trade and intra-regional investment are also low in South Asia. 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 to investment and growth processes of these countries. 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 very crucial for South Asia to integrate further. There is a continued need for a greater integration in trade, macro, financial and industrial policies in the region.

A deeper regional integration in South Asia requires clear and visible leadership from the political elites in this region, especially from India, in taking the agenda forward. The political elites have to be convinced and act accordingly to reduce the ‘trust deficit’. Regional institutions, like SAARC Secretariat, have to be institutionally reformed and reoriented with much stronger engagements from the respective ministries and relevant organizations of the member countries. Business associations, civil society organizations and media have to pursue the regional integration agenda in South Asia more pro-actively than ever.

Published at the Thinking Aloud on 1 April 2016

Published at The Daily Star on 12 April 2016