BANGLADESH Photo: Tara Simpson Inclusive Growth Diagnostic June 2014 BANGLADESH Inclusive Growth Diagnostic USAID and DFID Inclusive Growth Diagnostic Team – Bangladesh Euan Davidson, DFID Anastasia de Santos, USAID Yoon Lee, USAID Nathan Martinez, USAID Caroline Smith, USAID Takele Tassew, USAID DISCLAIMER: The authors’ views expressed in this publication do not necessarily reflect the views of the United States Agency for International Development or the United States Government. i TABLE OF CONTENTS Executive Summary ........................................................................................................................ 2 Acknowledgements ......................................................................................................................... 4 1. Overview ................................................................................................................................. 5 1.1 Introduction ...................................................................................................................... 5 1.2 Methodology of Growth Diagnostics ............................................................................... 6 1.3 Organization of the Bangladesh Inclusive Growth Diagnostic ........................................ 7 2 Poverty and Economic Growth – The Bangladesh Experience ............................................... 9 2.1 Extreme Poverty ............................................................................................................... 9 2.2 Bangladesh’s Economic Growth 1970-2012.................................................................. 16 2.3 Growth Decomposition .................................................................................................. 18 2.4 Growth Accounting ........................................................................................................ 19 2.5 Private Investment .......................................................................................................... 20 2.6 Trade............................................................................................................................... 22 2.7 Labor Markets Dynamics ............................................................................................... 22 2.8 Conclusion ...................................................................................................................... 24 3 Finance................................................................................................................................... 25 3.1 Introduction .................................................................................................................... 25 3.2 Diagnostic Tests ............................................................................................................. 25 3.2.1 Test 1: If access to finance is a constraint then the real interest rate should be comparatively high. ............................................................................................................... 25 3.2.2 Test 2: If access to finance is a constraint then changes to the interest rate constraint should lead to significant movements in investment. ........................................... 28 3.2.3 Test 3: If access to finance is a constraint to growth, then agents would try to find alternative financing. ............................................................................................................. 29 3.2.4 Test 4: If access to finance is a constraint then firms or sectors less intensive in the finance constraint are expected to thrive relative to firms that are more intensive. .............. 30 3.3 Functioning of the Financial System .............................................................................. 31 3.4 Other Considerations ...................................................................................................... 34 3.5 Conclusion ...................................................................................................................... 36 4 Macroeconomic Risks ........................................................................................................... 37 4.1 The Importance of the Macroeconomic Environment ................................................... 37 4.2 Fiscal Policies and Public Debt ...................................................................................... 37 4.3 Inflation .......................................................................................................................... 39 4.4 Exchange Rate ................................................................................................................ 41 4.5 Balance of Payments ...................................................................................................... 42 4.6 Remittances .................................................................................................................... 44 4.7 Conclusion ...................................................................................................................... 45 ii 5 Microeconomic Risks ............................................................................................................ 46 5.1 Introduction .................................................................................................................... 46 5.2 Corruption ...................................................................................................................... 47 5.2.1 Test 1: Is the shadow cost of corruption high in Bangladesh? ............................... 50 5.2.2 Test 2: Do improvements in corruption correlate with investment growth? .......... 51 5.2.3 Other Considerations .............................................................................................. 53 5.3 Contract Enforcement and Property Rights ................................................................... 53 5.3.1 Test 1: Is the shadow cost of contract enforcement high in Bangladesh? .............. 54 5.3.2 Test 2: Do improvements in contract enforcement correlate with an increase in investment growth?................................................................................................................ 55 5.4 Taxation .......................................................................................................................... 56 5.5 Access to Land ............................................................................................................... 58 5.5.1 Test 1: Is the Shadow Price of Land Governance High in Bangladesh? ................ 60 5.6 Conclusion ...................................................................................................................... 61 5.7 Annex ............................................................................................................................. 63 6 Market Failures ...................................................................................................................... 64 6.1 Introduction .................................................................................................................... 64 6.2 “Self-Discovery” and Information Externalities in Bangladesh .................................... 64 6.3 Export Diversification and Coordination Externalities in Bangladesh .......................... 66 6.4 Product Space Analysis .................................................................................................. 67 6.5 Conclusion ...................................................................................................................... 72 7 Human Capital ....................................................................................................................... 74 7.1 Education ........................................................................................................................ 74 7.1.1 Participation in Education ....................................................................................... 74 7.1.2 Educational outcomes ............................................................................................. 77 7.1.3 Test 1: Shadow Price and Returns on Education .................................................... 78 7.1.4 Test 2: Movement in Education Results in a Movement in Economic Growth ..... 82 7.1.5 Test 3: Circumvention of the Education Constraint by Firms ................................ 82 7.1.6 Test 4: Constraint Intensity and Firm Performance ................................................ 84 7.1.7 Conclusion: Structural Issues in Education ............................................................ 85 7.2 Health ............................................................................................................................. 87 7.3 Annex ............................................................................................................................. 90 8 Infrastructure ......................................................................................................................... 91 8.1 Introduction .................................................................................................................... 91 8.2 Electricity ....................................................................................................................... 91 iii 8.2.1 Sector Overview...................................................................................................... 91 8.2.2 Test 1: If electricity is a binding constraint