Question

Read the following case study and answer the given question.

THE MACROECONOMICS OF POVERTY REDUCTION: THE CASE STUDY OF BANGLADESH

Poverty and Inequality in Bangladesh: An Overview

The long-term trends in poverty show notable progress since Independence. According to nation-wide Household Income and Expenditure Surveys, the proportion of population living below the poverty line was as high as 71 per cent in 1973/74, the earliest survey year after the country’s Independence. By the year 2000, it had come down to 40 per cent. The evidence on long-term decline in income-poverty based on national-level data is also confirmed by a number of longitudinal micro surveys and village studies comparing the situation between late seventies and late nineties.

The pace of poverty reduction has accelerated in the 1990s compared to the 1980s. Thus, the national head-count ratio dropped only marginally from 52 per cent in 1983/84 to about 50 per cent in 1991/92, but then fell relatively sharply to about 40 per cent by the year 2000. The reduction of poverty that took place in the 1990s – at the rate of about one percentage point per year – was certainly modest by the standards of East and South-East Asia in the last few decades. But at least it marked a welcome acceleration in the pace of poverty reduction compared to the near stagnation of the preceding decade. This acceleration in poverty reduction is consistent with the evidence for accelerated growth in per capita consumption expenditure (income) observed during this period.

The progress in non-income dimensions of poverty appears to have been faster than in the income dimension of poverty. The index of human poverty, which stood at 61 per cent in the early eighties, declined to 35 per cent in the late nineties. This gives a drop of 2.5 per cent per year compared with 1.45 per cent in the national head-count ratio for income-poverty over the same period.

Faster reduction in poverty in the 1990s has been accompanied by a worsening of income distribution. Thus, the Gini ratio for urban areas shot up from 0.32 in 1991/92 to 0.38 per cent in 2000, while the rural Gini increased from 0.26 to 0.30 during the same period. The main sources of increasing inequality lie in increasingly unequal distribution of non-farm income and remittance income.

The Structure and Sources of Growth

The economy of Bangladesh experienced moderately accelerated growth in 1990s compared to previous decades. In the 1980s, per capita GDP had grown slowly at the rate of about 1.6 per cent per annum. In the first half of the 1990s, growth rate accelerated to 2.4 per cent and further to 3.6 per cent in the second half of the decade. This was not an insignificant acceleration, even though by no means spectacular by the standards of the rapidly growing countries of the Asia.

The acceleration in per capita GDP growth owed itself both to higher rate of GDP growth and a lower rate of population growth, with the former playing the more important role. Thus out of the 2 percentage points acceleration in per capita income growth that was experienced from the first half of the 80s to the second half of the 90s, as much as 1.5 percentage points came from GDP growth.

In the context of the effect of macroeconomic reforms on economic growth, it is interesting to note that the outward-looking macroeconomic policy pursued by Bangladesh in the recent past did succeed in stimulating some parts of the economy (e.g. readymade garments, and fisheries) – so much so that they turned out to be the most rapidly growing activities in the 1990s. But as these activities still have a relatively low weight in the economy, they were by no means the most important sources of growth acceleration.

Analysis of the proximate sources of growth shows that industry and services contributed almost equally to the incremental growth in the 1990s, each with a share of about 41 per cent, with agriculture making a relatively small contribution of just 17 per cent. Within the broad group of industry, the manufacturing sub-sector contributed 28 per cent, out of which some 20 per cent came from large and medium industries, and the rest from small-scale industries. In agriculture, fisheries made an overwhelmingly large contribution, accounting for 15 out of the 17 per cent contribution that came from all of agriculture.

From the point of view of macroeconomic policy, a pertinent issue concerns the relative roles of tradable and non-tradable sectors in the process of growth acceleration. The report finds that at least two-thirds to three-quarters of the incremental growth in the 1990s originated from the non-tradable sectors – mainly, services, construction and small-scale industry. The increasing dominance of non-tradables in general and services in particular is also confirmed by the evidence on changing composition of labour force.

Further analysis shows that acceleration of the non-tradable sector cannot be explained by autonomous productivity improvement within the sector. A more likely explanation lies in a more robust demand stimulus originating from outside the sector, especially in view of the existence of widespread underemployment in this sector, which ought to make it particularly responsive to demand stimulus.

Evidence suggests that the demand stimulus came from three major sources – a quantum jump in crop production that occurred in the late 1980s, rapid growth in the flow of income generated by the readymade garments industry, and accelerated flow of workers’ remittance from abroad. In relative terms, crop production played by far the major role; even the combined stimulus from the other two sources was less than the stimulus that came from crop production alone. As the decade progressed, readymade garments and remittance began to assume greater importance. But even towards the end of the decade crop production remained the single most important source of enhanced demand.

The Growth-Poverty Nexus and Its Implications for a Pro-Poor Macroeconomic Policy Regime

Faster growth in the 1990s was associated with faster rate of poverty reduction compared to the 1980s. There are reasons to believe that this was more than a mere association. Since overall income inequality increased during this period – in both rural and urban areas – faster growth must have played a causal role in reducing poverty. In order to identify the precise nature of this causal relationship, it is necessary to look more closely at the growth process and the nature of the growth-poverty nexus it engendered.

It was noted earlier that non-tradable activities, especially those outside agriculture, played the leading role in bringing about accelerated growth in the 1990s. Therefore, the search for the growth-poverty nexus calls for a deeper analysis of the nature of growth in these activities. For this purpose, the report takes a close look at the rural non-farm (RNF) sector in recognition of the fact that most of the poor live in rural areas.

A sizeable proportion of rural labour force has shifted from farming to non-farm activities in the last two decades. In 1983/84, some 34 per cent of the rural labour force was engaged in non-farm activities as their principal occupation; by the year 2000 this figure stood at 39 per cent. The pace of the shift from farm to non-farm sector appears to have slowed down somewhat in the 1990s – this was especially true in the first half of the decade.

But the more important contrast, for our present purpose, lies in structure of RNF sector. The growth process of 1990s was characterised not only by faster growth of RNF sector but also a structural change in this sector that was especially favourable for poverty reduction. Although there are no systematic surveys of this sector to throw a clear light on how its structure might have changed over time, one can make some reasonable inferences by piecing together a number of different kinds of evidence for the 1980s and the 1990s.

For the 1980s, evidence suggests that the increment in landless agricultural households were absorbed almost entirely in the RNF sector. In fact, the size of this increment is large enough to account for the entire shift of labour force out of agriculture that occurred during this period. It would thus appear that the shift of labour out of agriculture could be entirely accounted for by increasing landlessness, and not by increasing number of land-owning households diversifying their sources of income towards non-farm activities. One may conclude, therefore, that this shift has taken place at the lower end of the income scale, since land ownership and income are strongly correlated. This inference is supported by the evidence from Labour Force Surveys and Household Income and Expenditure Surveys, which indicate a proliferation of low-productivity activities within the RNF sector and possibly some overcrowding in these activities.

The picture changes quite significantly in the 1990s. Labour Force Surveys show that after being more or less static in the 1980s, the proportion of self-employed workers in the RNF sector declined in the 1990s - from 66 per cent in 1990/91 to 59 per cent in 1995/96. This implies a rise in the proportion of wage-labour based enterprises. Such enterprises are likely to be somewhat larger in scale and more productive than the enterprises involving mainly self-employed workers that predominated in the 1980s. Independent evidence from Household Income and Expenditure Surveys does suggest increasing dominance of larger and more productive non-farm enterprises.

Based on these sets of evidence, the transformation that has occurred between the two decades can be summarised as follows. The 1980s were characterised by a rapid shift of labour force into the RNF sector, the predominant nature of the shift being absorption into self-employment at the lower end of the productivity scale. By contrast, the 1990s have witnessed a less rapid shift of labour force into the RNF sector, but one that has been characterised by faster growth of relatively larger-scale enterprises that are more productive and employ more wage labour. The poor rural workers have thus found an increasing opportunity to secure wage employment in the RNF sector instead of overcrowding into pettysmall-employed activities.

This transformation in the dynamics of rural labour force has important implications for the dynamics of poverty in rural Bangladesh. Analysis of the 2000 HES shows that salaried employment in RNF is much more rewarding for the poor than any other mode of employment. For example, the extreme poor working in the rural non-farm sector earned on average taka 56 per day from salaried employment as compared with taka 38 from self-employed activities. Thus the relative expansion of larger non-farm enterprises allowing for greater absorption of labour into salaried employment may have played a key role in bringing poverty down in the 1990s.

The nature of the growth-poverty nexus that operated in the 1990s can now be summarised as follows. Boosted by enhanced demand – emanating initially from the crop sector and increasingly also from the readymade garments and workers’ remittances – the non-tradable non-farm sector experienced accelerated growth in the 1990s. Faster growth enabled the non-farm enterprises to increase their scale of operation, thus tilting the structure of RNF sector more towards the relatively larger enterprises. This structural change in turn brought about a change in the nature of labour absorption in this sector, as salaried wage employment became more plentiful with the emergence of larger enterprises. Whereas in the 1980s most of the surplus labour that got absorbed in the non-farm sector found their way into low-productivity self-employment, in the 1990s the absorption occurred more into salaried employment in the relatively larger and more productive enterprises. Since salaried employment in larger scale enterprises was far more rewarding for the poor than the shift into self-employment that occurred in the 1980s, the structural change engendered by the growth process of the 1990s was especially conducive to poverty reduction.

The preceding analysis of the growth and poverty dynamics in the recent decades as well as the analysis of the impediments faced by the poor in taking advantage of economic opportunities opened up by the growth process suggest a policy package that ought to include the following elements.

First, since the lynchpin of the growth-poverty nexus was the demand-driven growth of the non-tradable sector, macroeconomic policy must do everything possible to sustain the momentum of demand expansion, without of course overheating the economy. At the very least, it should avoid unnecessary contraction of demand. Second, the incentive structure promoted by macroeconomic policies should be such as to accelerate the growth of non-tradable non-farm activities, at least over the medium term.

Third, conditions should be created that would enable the poor to find more remunerative employment in scaled up enterprises in the non-farm sector. This would in turn require the policy regime to aim at softening at least three types of constraint: (i) education and skill of workers, (ii) physical infrastructure, and (iii) access to credit.

Macroeconomic Management in the 1980s and the 1990s: An Overview

For much the 1970s, macroeconomic policy was designed in Bangladesh primarily with a view to reviving a war-ravaged economy following the War of Liberation in 1971 within an overall framework of extensive state control. A major change of direction occurred in the early 1980s with the adoption of market-oriented liberalising policy reforms known as structural adjustment. These reforms were initiated against the backdrop of serious macroeconomic imbalances. The beginning of the 1990s saw the launching of a more comprehensive programme of macroeconomic reforms, which coincided with a transition to parliamentary democracy from a semi-autocratic rule.

The reforms of the early 1990s were particularly aimed at moving towards an open economy – such as making the currency convertible on the current account, reducing import duties generally to much lower levels, and removing virtually all controls on the movements of foreign private capital. Besides, fiscal reforms were undertaken including the introduction of the value-added tax (VAT).

The launching of the wide-ranging policy reforms in the beginning of the 1990s was followed by some positive developments in the macroeconomic indicators. There was a marked improvement in the government’s budgetary position along with an equally marked increase in domestic saving rate. However, increase in saving rate was not matched by a commensurate response from private investment, at least in early 1990s. Private investment as a proportion of GDP did go up in the first half of the 1990s as compared with the late 1980s, but not by enough to match the savings effort. Things did begin to change, however, in the second half of the decade when further increase in savings effort was well-matched by increased private investment, while public investment remained more or less stable as a proportion of GDP. As a result, the overall investment rate – which was stuck between 16.5and 18 per cent during the period from 1985 to 1995 – rose to 21.5 per cent in the second half of the 1990s paving the way for superior growth performance in this decade.

All this was achieved along with remarkable success in keeping inflation under control. In the first half of the 1980s, the rate of inflation was ominously high at 13 per cent. It is only the contractionary effect of structural adjustment of that period that brought inflation down – to around 8 per cent in the second half of the decade. The 1990s saw further decline in the inflation rate – down to an average of 5.7 per cent for the decade as a whole, and this time the reduction was achieved despite relative buoyancy of the economy compared to the preceding decade.

There are, however, certain disconcerting features in the macroeconomic indicators that deserve attention. First, whenever there seems to be an upturn in investment and industrial activity levels, it comes against the balance of payments constraint leading to a depletion of foreign exchange reserve. Second, the impetus to increased savings rate may have been lost in the recent years with declining public savings. Third, while the reduction of inflation in the 1990s is a positive indicator of macroeconomic stabilisation, there is a danger that the tendency to drive down inflation to near-zero levels would unleash severe contractionary pressures that might stymie the demand-driven process of growth and poverty reduction of the kind that was observed in the 1990s.

Fiscal Policy and Public Expenditure

Over the last two decades, fiscal operations of the government had to be defined in the context of a steadily declining availability of foreign aid. The decline has been particularly rapid in the 1990s. From over 5 per cent to GDP in the second half of the 1980s, foreign financing came down to only 2.6 per cent of GDP in the second half of the 1990s.

The challenge posed by reduced availability of foreign aid has been met not by reducing expenditure, but partly by improved revenue effort and partly by increased domestic borrowing. Thus, as a proportion of GDP, total government expenditure increased slightly from 12.9 per cent to 13.6 per cent in the last two decades. This was supported by a rising revenue-GDP ratio, which went up from 6.3 per cent in the first half of the 80s to 9.6 per cent in the second half of the 90s, and increased domestic borrowing, which went up from 1 per cent to 1.9 per cent of GDP during the same period.

Of the two broad components of government expenditure – current and development – it is the current expenditure that has risen over the last two decades – from 4.6 per cent to 7.3 per cent of GDP. The increase was particularly sharp in the second half of the 1980s (which was the tenure of a semi-autocratic regime). Since then the rise has been much more restrained. The transition to a democratic regime thus seems to have resulted in increased accountability in respect of restraining the government's current expenditures.

There are signs that the restraining effect has weakened considerably in the very recent years resulting in a fresh upsurge in current expenditure. However, despite the obvious strains put on the budget by rising current expenditure, the overall budget deficit has not be allowed to get out of control. Indeed the general trend is clearly downward – from around 6.6 per cent of GDP in the early 1980s budget deficit came down to 4.4 per cent in the late 1990s.

Overall, these trends indicate that ever since the latter half of the 1980s, fiscal policy has not been used aggressively as a tool of aggregate demand management, in either direction. Fiscal policy thus played the useful role of averting a potential contraction in demand, without however leading to excess demand in the process of doing so. This helped create a reasonably stable macroeconomic environment, which allowed the real side of the economy to sustain modest growth acceleration, leading to reduced poverty, through growth-poverty nexus described above. A sharp rise in budget deficit in recent years (1999/00 - 2000/01) has raised fresh questions about the soundness of macroeconomic management. How these questions are resolved and what effect that resolution will have on aggregate demand may have important repercussions on the dynamics of growth and poverty alleviation in Bangladesh in the coming years.

The sectoral allocation pattern of development spending has undergone some significant changes in the last two decades, reflecting the changing developmental role of the government under the economic reforms. Allocations have fallen appreciably for a number of directly productive sectors – most notably, manufacturing industry, water resources, and energy, and agriculture. The reverse of this structural change in development spending is the increased proportional allocations to transport and communication, rural development and to social sectors, especially education.

The proportional allocation of education and health has continuously increased all throughout the reform period beginning from the early 1980s. Their combined share of total budgetary expenditure has gone up from 14 per cent to 23 per cent during this period. The increase has been particularly rapid for education, whose share has doubled from 8 per cent to 16 per cent, while the share of health and family planning has increased from 5 per cent to 7 per cent.

With considerable progress made in primary education in Bangladesh, the enrolment gap between rich and poor has been considerably narrowed and the gender gap has been eliminated. As a result, public expenditure on primary education is found somewhat pro-poor, in the sense that the poor receive a greater share of the benefit. The food for education programme, which was instituted to entice the parents of poor households to send their children to primary school, has a strongly poor-poor bias.

However, this pro-poor bias needs to be put into perspective. The key factor driving the pro-poor distribution of primary education is that the poor have a greater proportion of primary school age children. The rate of per-user subsidy does not actually vary much for different income groups. Furthermore, the pro-poor bias reverses strongly for secondary and tertiary levels of education.

Government's overall health expenditures are only weakly pro-poor in the sense that these expenditures were more equitably distributed compared to the distribution of household income or expenditure in the economy. However, one particular component of health spending, namely, child healthcare within the so-called essential services package (ESP) is strongly pro-poor (that is, skewed in favour of the poor).

On the whole, budgetary allocation to education, health and social safety net as ratios of GDP has increased considerably over the last two decades, and their distribution is also reasonably pro-poor. Unfortunately poor governance severely compromises the potential of social expenditures to serve the poor in the most efficient as well as equitable manner.

The main problem, however, is that in per capita terms the level of social expenditure remains very low, even by the standards of other poor countries. Part of the reason why budgetary expenditures are low in absolute terms is that the resource base is low given a low per capita income. But even as a proportion of GDP, budgetary expenditure is low in Bangladesh, even by South Asian standards. Thus, in the year 2000/01, total public expenditure was just 15 per cent of GDP in Bangladesh, as compared with 20 to 30 per cent in India, Pakistan and Sri Lanka.

Low level of expenditure is in turn explained by very low revenue effort. An analysis of the trends in tax yields suggest that the tax system is highly income-inelastic, so that the rate of growth of tax revenue tends to fall behind that of GDP unless discretionary measures are taken for enhancing the rate structure and/or expanding the tax base.

Greater effort at resource mobilisation, will, therefore, have to form cornerstone of any strategy to promote pro-poor fiscal policy. While a lot of this effort will involve improvement in institutional and administrative apparatus of tax collection, a number of macroeconomic issues are also relevant in this context and deserve some scrutiny. These are, first, the effect of external sector reforms on tax revenue; second, the size and financing of budget deficit, and third, financing of state-owned enterprises and the related issue of privatisation.

Since trade liberalisation entails a potential loss of revenue due to lowering of tariffs, a pertinent question is whether the recent failure to raise revenue efforts in Bangladesh has anything to do with her embracing of trade liberalisation. Data reveal that revenue from import duties has indeed declined as a proportion of total

value of imports. However, a great deal of tariff reforms did not lead to any effective reduction in duties, because of widespread prevalence of tariff redundancy. Moreover, any effect of reduced rates of duty was compensated partly by tariffication of quotas and partly by an upsurge in the volume of imports following trade liberalisation, both of which served to expand base of revenue collection. As a result, revenue from import duties as a proportion of GDP did not decline. In addition, introduction of VAT, on domestic and imported goods alike, enabled the government to recoup much of what was lost by way of customs duties, and it did so in an incentive-neutral manner.

As a result of these reforms, overall collection of indirect taxes did not suffer in Bangladesh following trade liberalisation. As a proportion of GDP, total revenue from indirect taxes actually increased from 4.6 per cent in late 1980s to 6.3 per cent in the second half of 1990s. Therefore, the reason for poor revenue effort lies not so much in trade liberalisation as in government’s inability to collect domestic taxes.

Inadequate success in domestic revenue mobilisation, coupled with declining foreign aid, has put enormous pressure on public finances. Given the choice between cutting down public expenditure and allowing the budget deficit to increase, the Government has on the whole opted for the latter. However, for most of the last two decades, budget deficit has generally been kept low, and so has been public debt. In very recent years, however, as foreign aid has declined even more, budget deficit grown bigger – rising from 4 per cent to about 6 per cent of GDP. This upsurge in budget deficit has rung an alarm bell in the donor community, who are advocating stringent measures to bring the deficit down.

This report argues that excessive worry on the part of donors such as the World Bank and the Asian Development Bank with current levels of deficit is unwarranted, as their arguments are based on untenable assumptions and flawed methodology. The point remains, however, that there are limits to how far budget deficit can be allowed to grow. Occasional deficit may be necessary as a counter cyclical measure, and also to break crucial bottlenecks on the supply side through judicious public investment. But it cannot be used as a regular tool for raising the trend level of public expenditure. In the long run, revenue collection must be improved, and expenditure must be prioritised. In this context, the financing of loss-making state-owned enterprises assumes special relevance. This issue is taken up next

Adapted: Osmani, S.R; Mahmud, W; Sen, B; Dagdeviren, H; and Seth, A (2003), The Macroeconomics of Poverty Reduction: The Case Study of Bangladesh, United Nations Development Programme, The Asian-Pacific Regional Programme on Macroeconomics of Poverty Reduction.

QUESTION 1

Faster reduction in poverty in the 1990s has been accompanied by a worsening of income distribution. Thus, the Gini ratio for urban areas shot up from 0.32 in 1991/92 to 0.38 per cent in 2000, while the rural Gini increased from 0.26 to 0.30 during the same period.

1.1 Explain the above statement in simple economic language to an ordinary person in Bangladesh in your own words.

1.2 With reference to the above Case Study, discuss the sources of economic growth in Bangladesh and also explain the difference between demand factors and supply factors as sources of economic growth.

QUESTION 2

2.1 Using the given case study, identify and critically evaluate the main problems being faced by Bangladesh and recommend the policies or programmes that might be used to address these challenges.

2.2 Discuss some of the main economic lessons that can be derived from the given case study by other developing countries in the world.

QUESTION 3

3.1 Given that the demand and supply for rental accommodation in United States of America is given by the following equations respectively.

Demand: Qd = 100 000 - 4P ……………………………. Equation 1

Supply: Qs = 75 000 + P…………………………………….Equation 2

Compute:

3.1.1 The equilibrium price (Pe).

3.1.2 The equilibrium quantity (Qe).

Assume that government decides that landlords are charging exorbitant rental and hence passes a ‘rent control’ law in the United States of America that prevents rents from exceeding USD2000 per unit.

3.1.3 What would be the quantities demanded and supplied at the new legislated price and what would happen in the market. (Illustrate this situation using a diagram) (10)

3.2 Economics is all about scarcity, choice and opportunity cost. Explain these concepts using a Production Possibility Curve (PPC) and also highlight the importance of this model in understanding Economics.

QUESTION 4

Economists need a deep understanding of price elasticity concepts. In that regard define and explain the various forms of price elasticity of demand and show how elasticity of demand influences the management decision making in respect of setting prices for their products and maximising revenue.

Summary

This question belongs to macroeconomics and discusses about poverty & inequality in Bangladesh.

Word count: 4800

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