50 Years of Evolution of Trade Policy in Bangladesh
The country celebrates the golden jubilee of independence this year (2021), and there is indeed much to celebrate. Analysts of all shades of opinion have hailed the quality of social and economic progress achieved by the country which was, at inception, derided as a “basket case” by none other than Henry Kissinger, the US secretary of state in 1972. Bangladesh emerged in the global map with a per capita income of under USD 100, at the bottom of the income pile, in the company of such nations as Chad, Rwanda, Burundi, and Nepal. Today, having crossed the per capita income threshold of USD 2000 (USD 2270 in 2021), with a GDP of about USD 350 billion, it ranks in the top 40 economies of the world in terms of GDP.
And the growth momentum it picked up in the 1990s has not lost steam yet. The minor dip in FY2020 growth notwithstanding, over the past two decades Bangladesh has recorded the fastest and most stable rate of GDP growth among developing countries. Any economy that consistently records 6-7% GDP growth per annum for two decades has to experience significant augmentation of income per capita accompanied with substantial reduction of poverty. The economy and society also undergo momentous transformation as a consequence. That is exactly what has happened in this country of about 170 million people.
What were the key drivers of this notable transformation? Of course, there were positive political and social developments that planted the pillars of stability and inclusiveness in the transformation process. The pivotal role of Government, supported by several of the world’s most lauded NGOs, was key to the steady social and economic progress achieved through the decades. Progress in human development was acclaimed by none other than Nobel Laureate economist, Amartya Sen, who has his roots in this part of the world. A leading columnist of the New York Times, Nicholas Kristof, went so far as to suggest that President Joe Biden draw lessons from Bangladesh on how to reduce poverty in USA. Multilateral agencies like the World Bank and IMF have repeatedly acknowledged Bangladesh’s sound and prudent macroeconomic management as contributing to its sustained macroeconomic stability.
In my view, the general direction of economic policies was broadly consistent with the fundamental tenets of macroeconomic stability that laid the foundations for rapid growth and poverty reduction. To keen observers of the Bangladesh economic scene the trigger that unleashed the forces of rapid economic growth would have to be the radical change of direction in trade policy (complemented by market orientation and deregulation) during much of the 1990s decade. It is now possible to make the assessment that after first two decades of prevarication in trade policy Bangladesh was able to change course and get it right – at least partially so. In my assessment nowhere in the policy space was there such a radical change of direction as in the case of trade policy. Evidence shows that Bangladesh massively reaped the benefits of those changes in the subsequent decades prompting Arvind Subramaniam, a leading development economist, to describe Bangladesh as a “development paragon” and a “Miracle on the Meghna”. Such sobriquets have to be earned over decades of perseverance with economic and social policies while grappling with the scourge of abject poverty. In my view, switching gears in trade policy in the 1990s, from an inward-looking import-substituting policy to an outward-looking export-oriented trade policy was the game changer.
To keen observers of the Bangladesh economic scene the trigger that unleashed the forces of rapid economic growth would have to be the radical change of direction in trade policy (complemented by market orientation and deregulation) during much of the 1990s decade.
In the 1970s-decade, trade policy as an instrument of development never seems to have been on the radar. The priority agenda was the focus on addressing massive poverty and fueling economic recovery of a devastated economy, largely through domestic-oriented policies supported with donor assistance. By default, the trade policy stance was a legacy of the past – where East Pakistan was turned into a captive market for West Pakistani financial and industrial corporates via high tariffs and import controls resulting in a virtually closed inward-looking import substituting economy. Starting with zero foreign exchange reserves to pay for much needed imports, high tariffs and import controls were found to be the expedient approach to keep from falling into a balance of payments crisis. The notable industrial and trade policy innovation (indeed we can call it that) came with the special dispensation formulated for the readymade garment industry at the end of the decade. The innovation was the grant of duty-free importation of imported inputs and back-to-back LC facility to cover import costs to be paid from export proceeds. Taking advantage of this facility, Desh garments, set up by a visionary civil servant, collaborated with the Korean firm, Daewoo, to launch a 100% export-oriented enterprise to access western markets under the multi-fiber arrangement (MFA) that offered export quotas for Bangladesh. Thus was born Bangladesh’s leading manufacturing sector that would exploit Bangladesh’s comparative advantage in labor-intensive production creating millions of jobs, particularly for women. The rest is history.
There were three notable developments in the trade policy arena during the 1980s. First, there was widespread disenchantment over import substitution – that restricted imports to grow domestic industries — as a strategy of development because there was growing evidence that this approach neither generated competitive industrialization nor fueled growth. On the other hand, protectionism tended to perpetuate itself, leaving numerous inefficient firms in its wake as “infant” industries failed to become competitive and needed higher protection over time to survive. Second, departing from the import substitution regime, a new development paradigm– export-led growth – had emerged out of the tremendous export-led growth success of several East Asian economies (described by the World Bank (WB) as the East Asian Miracle) in the 1960s and 1970s. By the 1980s this new paradigm had got a firm foothold in the development discourse. Third, there was the Washington Consensus (a set of free-market economic policies that emphasized inter alia trade liberalization and was promoted by multilateral institutions such as the IMF and WB) that gained currency among development institutions and most development practitioners.
Inexplicably, these significant developments in policy sphere got little or no attention from policymakers in Bangladesh. Thus, as far as trade policy developments in Bangladesh are concerned, 1980s was a lost decade. There was little traction in mainstreaming trade policy as an instrument for development as the government took no initiative to bring trade policies into the development discourse. When trade related actions were taken at the prompting of multilateral institutions it tended to be episodic (e.g., tied to some WB loan) and limited to tariff liberalization for specific imports or sectors, without a wholistic approach towards overall extent of trade openness or measures to augment competitiveness. The only notable development was the tariff liberalization for imports of agricultural inputs that complemented the deregulation in the domestic agricultural markets – for seeds, fertilizer, machinery and implements. The general trade policy stance did little to improve the balance of payments situation, nor fueled GDP growth which was anemic throughout the decade culminating in the BOP crisis of 1990. What could be levelled as a missed opportunity was the lack of an effort to adopt the new paradigm of export-led development, a paradigm that emerged in our East Asian neighborhood and should have caught the attention of our policymakers right away, but did not. Thankfully, that changed in the subsequent decade.
The 1990s was truly the golden period of trade policy developments when you consider the whole gamut of radical changes in the trade policy regime that were launched at the start of the decade. At the close of the 1980s the economy was literally in shambles. GDP growth was anemic, foreign exchange reserves had reached rock bottom, and financing of the BOP deficit was at a dead end. The confluence of an economic and political crisis (collapse of Ershad regime and onset of democracy) paved the way for radical reforms. The economic mess left by the departing regime had to be cleared first to restore the economy’s potential for growth and poverty reduction. The WB-IMF stepped in to save the situation with structural adjustment loans and BOP support on the back of wide-ranging trade policy reforms. Much needed structural reforms were introduced that included measures for restoring internal macroeconomic stability through fiscal conservatism, market orientation and deregulation of investment, privatization of state-owned enterprises, a la Washington Consensus. Compared to the previous 20 years, the trade policy changes undertaken could be termed radical indeed and included (a) sharp reduction and rationalization of tariffs, (b) significant import liberalization through removal of bans, quantitative restrictions (QRs) and import licensing (end of license raj), (c) move from fixed to flexible exchange rates, and (d) limited convertibility of the current account. This time trade liberalization during the 1990s was deep and transformative. In 2001, a seminal World Bank study on the impact of trade liberalization on growth and poverty (David Dollar and Art Kraay, Trade, Growth and Poverty, published in The Economic Journal) listed Bangladesh among the “globalizers” of the developing world, confirming through empirical evidence that these globalizers were experiencing rapid growth in incomes and declines in poverty.
In hindsight we can argue that the WB findings signaled the dawn of a new era of trade openness that fueled rapid growth and poverty reduction in Bangladesh with the advent of the 21st century. The strategy of export-led growth built on the back of trade liberalizing policies had finally taken hold in the policy space. The liberalizing reforms of the 1990s, albeit incomplete, generated enough momentum to stimulate export-oriented manufacturing growth, job creation, and poverty reduction for the next two decades, and the momentum continues to this day. Average decadal GDP growth began rising by over one percentage point every decade, 4.8% in FY91-00, 5.9% in FY2001-10, and 7.2% in FY2011-19. The moderate poverty rate which was 57% in 1990 was nearly halved by 2010 (31.5%), and is estimated to be around 20% in 2019 – highly effective sign of inclusive growth. Like everywhere else, the onslaught of the Covid-19 pandemic has clearly disrupted the steady path of economic progress as well as poverty reduction during 2020-2021, but there are signs that a robust global output and trade recovery is underway and Bangladesh hopes to reap the benefits of that recovery through a rejuvenation of its export strategy in order to return to its pre-pandemic growth path.
Sadly, the advent of the 21st century saw the emergence of some degree of political instability during which deepening of trade policy reforms did not appear feasible. Unlike the 1990s, the first decade of the 21st century saw a slowdown in tariff reduction or other trade reforms which were episodic at best. The reform highlight of this decade was the move from flexible to floating exchange rate (managed float actually) launched by Bangladesh Bank in 2004 along with a final elimination by Ministry of Commerce of all bans/QRs on imports for protection reasons. The latter was done through a modest scheme of tariffication of the last remaining QRs on textile imports. One para-tariff, IDRC (infrastructure development surcharge) was eliminated and absorbed with custom duties (CD). But no sooner was this chapter closed, another para-tariff, regulatory duty (RD) of 3% across the board emerged in FY2010. It is fair to say that with that closed the chapter on tariff reforms. RD, which by law has to be renewed every year, has gained a life of its own and it looks unlikely to be abandoned any time soon. Meanwhile, Supplementary duties (SD), a para-tariff that was introduced under the VAT and Supplementary Duties Act of 1991, became even more pronounced as an instrument of protection as, according to PRI research, 95% of all SD impositions were intended to protect domestic industries. As confirmed by the WTO in its 2019 Trade Policy Review, tariffs and para-tariffs are now the principal instruments of trade policy in Bangladesh.
Recently, the Bangladesh economy has earned praise from analysts across the globe for its export and growth performance and is on a path to winning the war against poverty. But close to home we find an ominous tendency towards ossification that has gripped the Bangladesh tariff structure.
A closer look at the tariff developments during the two decades of the 21st century points towards a stalemate in the tariff structure, particularly during the latter part (Table 1).
Average nominal tariffs (NPR), after declining sharply in the 1990s, was ascendant for much of the past two decades. Effective tariff protection – outcome of changes in output and input tariffs – has been on the rise as input tariffs fell but output tariffs rose. That undermines incentives for exports.
Trade economists have long argued that export performance and tariff protection are not mutually exclusive. Tariffs on import substitute production are indirect subsidies that undermine support to exports and create anti-export bias. Having carved out a virtually free trade regime for the 100% export-oriented RMG sector, by ensuring world-priced inputs through the Special Bonded Warehouse System, there was too much internal resistance to the replication of this regime for the non-RMG exports. A trade economist would argue that the protectionist lobbies appeared insurmountable to create an RMG-like regime for some 1400 (HS-6-digit) non-RMG export products that Bangladesh exported in 2019. Consequently, despite evidence of potential comparative advantage, non-RMG exports got no traction, continuing to remain in the shadows of RMG exports that continues to dominate the export basket (84% of exports). The evidence is strong that these non-RMG exports which are not 100% export-oriented — in the sense that its producers cater to the domestic as well export markets — find profitability from the highly protected domestic markets relatively higher. Thus, export diversification remains stalled on the anvil of anti-export bias of the protection regime. With all its faults our claim to export success is built on the record of the readymade garment industry.
The sooner we can come out of our antiquated tariff regime and make our tariff structure reflective of a dynamic export-oriented economy the better our chance of diversifying our exports and fueling post-Covid economic recovery with a bustling diversified export-driven manufacturing sector that creates jobs and income to win the war on poverty. This is exactly the strategy laid out in the Government’s 8th Five Year Plan (FY21-25). There are promising developments in the relevant ministries for rationalization and modernization of Bangladesh’s tariff structure to bring it in tune with the dynamics of competitive global trade.
The sooner we can come out of our antiquated tariff regime and make our tariff structure reflective of a dynamic export-oriented economy the better our chance of diversifying our exports and fueling post-Covid economic recovery with a bustling diversified export-driven manufacturing sector that creates jobs and income to win the war on poverty.
After the 2020 annus horribilis, a terrible year, Bangladesh economy finds itself at a crossroad. The challenge to revive exports and grow at an average of 8% per annum over the next 3-5 years has never been more daunting as graduation from LDC status beckons – with the prospect of losing many of the International Support Measures (ISM) that gave a boost to our exports. It would be a fair assessment to suggest that Bangladesh energetically launched first generation trade reforms in the 1990s and is still reaping the benefits of those reforms in terms of export, growth and poverty impacts. But tariff reforms, one critical ingredient of trade policy, still remain largely unfinished with some ossification evident in recent times. Can the economy achieve its medium-term goals without modernizing its tariff structure? As I have argued in many fora and writings, the current tariff regime is a major stumbling block to the realization of export diversification – a priority development agenda of the Government.
As the nation addresses trade facilitation as part of second-generation trade reforms, completing the unfinished agenda of trade and tariff reforms begun in the 1990s and taking them to their natural conclusion should be a national imperative that will yield rich dividends…
As the nation addresses trade facilitation as part of second-generation trade reforms, completing the unfinished agenda of trade and tariff reforms begun in the 1990s and taking them to their natural conclusion should be a national imperative that will yield rich dividends on way to Bangladesh becoming an Upper Middle Income Country by 2031. Meanwhile, thanks to our young generation of RMG entrepreneurs and their backward linkage partners in the textiles and accessories industries, Bangladesh recently gained the epithet of “The New Asian Tiger” from the international business media (e.g. Bloomberg News), a tacit comparison to the East Asian Tiger Economies (S. Korea, Taiwan, Hong Kong, Singapore) of the 1960-70s. Imagine where Bangladesh export performance would be without the inherent anti-export bias of the high and persistent tariff protection in the non-garment manufacturing sector.
This article is a modified version of the one published in the Op Ed pages of the Daily Star on April 14, 2021.