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

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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

How to tackle ‘entitlement failure’ in infrastructure?

In the discourse on infrastructure and economic growth the dominant area of discussion is on the quantity and quality of infrastructure and how countries differ in these respects. While most of the countries emphasize a lot on investing in raising the quantity (and quality) of infrastructure, there is a fundamental concern whether rising supply of infrastructure ensures the access to infrastructure. This problem is manifested through the fact that due to a variety of reasons enhanced supply of infrastructure may not solve the problem of ‘entitlement failure’ in terms of effective access to infrastructure, as the people/sectors in dire need of improved infrastructure may not have the access even with an increased supply.

There appears to be a consensus among researchers and policy makers that infrastructure is a key contributing factor to economic growth. The importance of infrastructure for economic development originates from the fact that it provides both final consumption services to households and key intermediate consumption items in the production process. The deficiency of some of the most basic infrastructure services is an important dimension of poverty; and therefore, increasing level of infrastructure stock has a direct bearing on poverty reduction. Furthermore, while it is generally accepted that economic diversification is a necessary condition for a sustained and long term growth of the economy and job creation, infrastructure development is a prerequisite for economic diversification.

What is the significance of economic diversification as far as ‘inclusive growth’ is concerned?  If inclusive growth is defined as the inclusiveness in economic opportunities, economic diversification can help attain inclusive growth. However, several supply-side constraints related to weak infrastructure can restrict economic diversification. Some of these constraints are broadly ‘general’ in nature and some are critically ‘sector-specific’. Interconnection and complementarities between general and sector-specific infrastructures are key elements for increasing service efficiency, supporting the adoption of innovative technologies, promotion of economic diversification and supporting inclusive growth.

“Yet, policymakers in the developing countries are so inclined to improvement in the broad general infrastructure, i.e., enhanced supply of electricity, improvement in roads, improvement in port facilities, etc. that the developments of critical sector-specific infrastructure are largely overlooked.”

Yet, policymakers in the developing countries are so inclined to improvement in the broad general infrastructure, i.e., enhanced supply of electricity, improvement in roads, improvement in port facilities, etc. that the developments of critical sector-specific infrastructure are largely overlooked. Embarking on developing broad general infrastructure are relatively easy, whereas solving sector-specific infrastructure problems involves identifying priorities in the policy making process and addressing a number of political economic issues. Failure to deal with sector-specific infrastructure problems leads to a scenario where a large number of potential inclusive-growth enhancing sectors fail to enjoy the benefit from the improvement in broad general infrastructure, and thus end up with ‘entitlement failure’.

One such example is the leather industry in Bangladesh which accounts for around one billion US$ in exports and which has huge potentials in generating employment and growth by increasing export of higher value added products. However, this sector has not yet reached its full potential primarily due to operating constraints stemming from its production base in Hazaribagh of Dhaka city where there are minimal waste management systems and inadequate industrial layout planning. The Hazaribagh-centric tannery industry is now legally bound to relocate all the factories to a new environmentally compliant tannery estate (under construction) on the outskirts of Dhaka city. However, such relocation has been stuck for many years with unresolved decisions on cost sharing of various components of the new industrial estate. Yet, there is no denying the fact that unless this relocation is effectively done, the leather sector will continue to suffer from ‘entitlement failure’ despite significant improvements in broad general infrastructure.

“..the major critical factor behind the failure to address sector-specific infrastructure problems is the inability of the political system to deliver a political consensus around strategic plans for such sector-specific infrastructure and stable policy frameworks to support their implementation.”

Factors responsible for such entitlement failure include the lack of resources to undertake sector-specific infrastructure development, lack of reliable data to determine finance and manpower requirements of projects, lack of infrastructure development framework that adequately delineate links between general and sector specific infrastructure requirements, inadequate planning, inadequate supporting institutions, and unstable political environments. However, on top of all these, the major critical factor behind the failure to address sector-specific infrastructure problems is the inability of the political system to deliver a political consensus around strategic plans for such sector-specific infrastructure and stable policy frameworks to support their implementation.

How to deal with this entitlement failure? A major part of the sector-specific infrastructure problems needs to be solved through public investment. The priorities in the industrial and related policies need to be realigned to the country’s long term economic growth strategy in the changing world economy. There is a need for generating political capital for such realignment. However, the task of developing such infrastructure facilities cannot be left to the government alone. It is binding on policy makers to come forward with strategies and mechanisms to encourage private sector participation in such sector-specific infrastructure developments. Such mechanisms should not only provide strategies that are rarely implemented, but practical ways of turning them into tangible projects through the provision of adequate finance.

Published at the Thinking Aloud on 1 February 2016

Published at The Daily Star on 3 February 2016