Productivity and balance of payments: Bangladesh perspective

| Updated: July 16, 2022 20:57:35

Productivity and balance of payments: Bangladesh perspective

Productivity isn't everything, but in the long run it is almost everything.              --Paul Krugman

Balance of payments (BoP) difficulties usually develop slowly over time. They may result from developments such as a high and rising import dependency, slow but gradual loss of key export markets, declining capital inflows, rising foreign debt, unsustainable current account deficits, sustained currency overvaluation and banking sector weaknesses. But more importantly, a country encounters difficulties in its balance of payments because it is increasing productivity less rapidly than its trading partners.

Growing current account deficits are usually a precursor to balance of payments difficulties. Funding of current account deficits require capital inflows or other net currency inflows (i.e. remittances) or a drawdown in foreign currency reserves. Balance of payments difficulties can become even more acute when international reserve fall to such a low level that  they become acutely  insufficient to cope with fluctuations in imports and exports or reductions in net capital inflow. At the same time foreign loans become difficult to obtain or inaccessible which makes the situation even worse.

In fact, balance of payments difficulties can turn into a balance payments crisis. Such a situation arises when a country has a large current account deficit, but investors lose confidence and start to withdraw capital. The capital outflows cause a devaluation and inflation and further fall in confidence. This is why capital inflows are important for enabling a long term current account deficit.

A significant deficit on the current account is generally referred to as disequilibrium. It will be matched by a surplus on the financial account. Note a large surplus on the current account would also be seen as disequilibrium e.g., China, Japan. But Germany's large current account surplus is seen as an imbalance within the Eurozone. Also, a current account deficit suggests much wider disequilibrium in the economy.

Between 1980 and 2021, Bangladesh achieved a current account surplus for 14 years and a deficit for 28 years. Usually, a country recording a current account surplus indicates its dependence on exports revenue, with high savings and  weak domestic demand. On the other hand, a country recording  a current account deficit is indicative of its dependence on imports, low savings and high personal consumption rates as a percentage of disposable income.

The country with the relatively low rate of productivity growth will exhibit a persistent tendency to a deficit in its current account. Achieving a high long-run rate of growth would require for Bangladesh to reduce its balance of payment constraints through improved export performance and sustaining an import competing capacity which would lower the income elasticity of  demand for imports. While a reduction of balance of payments constraints is crucial for Bangladesh, a sustainable and inclusive process of economic growth and development also requires stimulating high productivity activities, quality employment ang higher domestic value-added.

It is clearly evident that Bangladesh has an underlying structural current account deficit problem caused by high marginal propensity to consume and declining comparative advantage as reflected in the country's deteriorating terms of trade (ToT). More than two thirds of Bangladesh's economic growth come from household consumption (69.5 per cent in 2020).

This persistently high share of household consumption restricts growth in savings and gross fixed capital formation (GFCF). In fact, a consumer led economic growth will cause a deterioration in the current account. Higher consumer spending will lead to higher spending on imports. A current account deficit may also be a reflection that saving is less than investment and investment being financed by capital inflows from abroad.

However, the current account deficit is often cyclical. During periods of high economic growth, consumers spend more on imports causing an increase in the size of the deficit, therefore even an improvement in productivity alone may be insufficient to improve the deficit if it occurs during  a period of rising consumer spending. Therefore, in such a situation Bangladesh will also need to increase its saving/income ratio.  Countries with higher savings and higher levels of investment tend to have an economy more geared towards production, exports and a lower share of income on imports.

In the long term, the current account will be influenced by the relative competitiveness of Bangladesh's export industries. As the country becomes uncompetitive, exports will decline relative to imports. This will cause a current account deficit as import expenditure exceeds export revenue.

Therefore, an improvement in productivity, in particular labour productivity in a country like Bangladesh will contribute to an increase in efficiency in production leading to a rise in output using the same amount of labour. This implies that there will be a fall in per unit cost of production, which will increase Bangladesh's international competitiveness.

It is generally agreed that there is a positive relationship between trade and productivity which implies that wider participation in international trade leads to improvements in productivity. Therefore, growth in labour productivity in Bangladesh will lead to a rise in competitiveness leading to increased demand for Bangladeshi goods, thus causing a rise in export revenue relative to import expenditure.  This will lead to a reduction in the current account deficit of Bangladesh. Furthermore, such an improvement in productivity will also result in imports being more competitive in the domestic market. Overall impact of productivity gains will lower the deficit.

The effect of trade on productivity across countries, however, depends on economic openness. Economic openness implies the degree to which trade (export + import) takes place and affects the size and growth of a national economy. Economic openness is statistically measured by using the Economic Openness Index which is calculated by taking the sum of exports and imports to be divided by GDP of the country i.e., ((X+M)/GDP)). The higher the index, the more open the economy.

According to the World Bank, Bangladesh's trade/GDP ratio was 36.7 per cent in 2019. This is lower than Sri Lanka's 51 per cent, Maldives' 150.4 per cent, and India's 37.9 per cent. What is surprising is that in a non-capitalist market economy like Vietnam, the ratio was 2004.4 per cent during the same year. On that score Bangladesh can not be considered an open economy.

Exports account for a very low share of GDP which fell to 15.32 per cent in 2019 from a peak of 20.16 percent in 2012. It further fell to 12.18 per cent in 2020. With such a low exports to GDP ratio, Bangladesh can be considered a relatively closed economy. Bangladesh indeed remains a relatively closed economy with tariff barriers that are above the already high South Asian average and twice the average of lower middle income countries-- the group Bangladesh will join in the very near future. Such an inward looking trade policy only encourages rent seeking activities. In 2020, Bangladesh accounted for 0.19 of total global exports and 0.30 of total global imports but the country now stands as the 41st largest economy in the world in terms of GDP accounting for 0.33 per cent of global GDP during the same year. This is also another indication of a fairly closed economy.

It is estimated that about 40 per cent of global trade is in intermediate inputs or more precisely global value chains (GVCs) related. Such a pattern of trade takes the trade-productivity nexus to the next level in its impact on competition. The availability of a large range of intermediate production inputs potentially lowers firms' input costs. Empirical evidence suggests that interaction of firms within global supply chains contributes to increased productivity gains. This happens in two ways-- firstly by outsourcing parts of production to international suppliers, efficiency gains are thus realised in the form of lower costs or higher quality raising productivity; and secondly, joining global production chains typically entails knowledge spill over boosting firm level productivity.

There is not enough  information available regarding Bangladesh's participation and position in global value chains. However, the readymade garments (RMG) (SITC 841-846) industry which is responsible for 81.16 per cent of total exports in 2021 has a high degree of backward GVC linkage as reflected in its import content of exports. But the industry has not been able to fully integrate into global value chains due to its very limited ability to develop forward linkages that enable exports that are further processed and re-exported by other trading partners.

Bangladesh's productivity level has largely stagnated over the last three decades, mostly due to lack of investment in capital. In fact, labour productivity in Bangladesh during this period has been half compared to that of its neighbouring country India despite some occasional spurts in productivity gains during this period. In fact, this has been widening because of India's increasing productivity gains. Overall productivity performance of Bangladesh is below par with comparable countries like India and Sri Lanka during this period.

According to the Global competitiveness Index (GCI), Bangladesh was placed a distant  105  out of 140 countries with a score 52.12  out of 100 in 2019. In fact, Bangladesh's position in 2019 declined by two positions from the previous year i.e. 2018.

Productivity in Bangladesh has been largely buttressed by the services and manufacturing sectors. Gross fixed capital formation (GFCF) is a critical determinant of economic growth through capital deepening and improved labour productivity. GCFC in Bangladesh is estimated to be about 25 per cent of GDP over last the 20 years or so.

Though disaggregate data on GFCF in Bangladesh is not available, it is likely that private dwelling accounts for a very large share of GFCF in Bangladesh. As such aggregate level of GFCF in Bangladesh does not tell the full story. Therefore, there is a need for prioritising productive investment to boost labour productivity. However, anecdotal evidence suggests that labour productivity in Bangladesh  over the last 20 years or so has been  largely determined by the level of  capital deepening in manufacturing and infrastructure investments.

Foreign direct investment (FDI) stock in Bangladesh stood at US$16.9 billion in 2019. The rate of FDI inflow was only 0.53 per cent of GDP during the same year, one of the lowest rates in Asia. Capital markets in Bangladesh are still  developing. The reasons for such low levels of FDI inflows were  likely to be influenced by a number of unfavourable indicators. Some of these indicators  include  Bangladesh's high ranking in terms of corruption perception (146 out of 180 countries),  lack of ease of doing business (168 out of 190) and innovation (116 out of 129) in 2020, and also infrastructural deficiencies.

The recent rises in food and fuel prices in the global market  have turned focus on rising inflationary pressures which will continue triggering a cost of living crisis in Bangladesh as well as on potential  negative impact on the current account. In fact, Bangladesh is now faced with rising inflation but wages remain stagnant with the result that real wages (after adjusting for inflation) are going backward to the detriment of the economy.

Also,  growth in domestic output prices of internationally traded goods and services relative to imported goods and services will further put pressures on the current account given that Bangladesh is an import dependent country not only for food and fuel but also for many inputs for manufactured and agricultural outputs. In fact, import demand for most of  these essentials is price inelastic with very limited available substitutes

Therefore, productivity growth is vital for Bangladesh's future. In this context there are clear issues that need to be addressed. They include improved educational outcomes, especially technical and vocational education; improved transport infrastructure: reform of the tax system; improved and universally accessible health care system, affordable housing, fewer regulatory restrictions to attract FDI and more open economic engagement with the rest of the world with increased participation in GVCs. 

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