Third Draft

Understanding Reform: The Case of Bangladesh

A. K. M. Atiqur Rahman
Manzur Alam Tipu

DRAFT REPORT PREPARED FOR GLOBAL DEVELOMENT NETWORK (GDN) ON

THE REFORM EXPERIENCE OF BANGLADESH UNDER THE ‘UNDERSTANDING
REFORM’ PROJECT

Institute of Development, Environmental, and Strategic Studies (IDESS)

North South University
12 Kemal Ataturk Avenue, Banani, Dhaka 1213, Bangladesh
Ph: 988 5611-20 ext. 157 email: ides@nsu.agni.com
Fax: 880-2-882-3030
I. Introduction:

When Bangladesh started its journey as a newly independent state in the early 1970’s it
was one of the poorest countries of the world. In 1972 the per capita income of Bangladesh was
a meager 190 USD (at 1995 constant dollar). Henry Kissinger, the then Secretary of State of the
US termed Bangladesh as a bottomless basket for aid programs. The prospect for achieving
economic progress with Bangladesh’s extremely adverse conditions that included frequent natural
disasters, extremely high population density, very little human or physical capital and natural
resources, and poor governance appeared bleak. In one of the earliest book on Bangladesh’s
economy by international authors Faaland and Parkinson (1976) termed Bangladesh as ‘a test
case for development’ with the intended meaning that if economic development were possible in
Bangladesh it should be possible everywhere else on the planet. After three decades of struggle
with adverse circumstances and experimentation with socialism in the initial few years and
subsequently with varieties of reforms Bangladesh today presents a case of being a success in a
number of social and economic fronts while frustration remain about not nearing the enormous
potential she has for attaining growth and elimination of poverty in a short period of time.

While many of the low income countries of the world achieved little or no growth during
the 80’s and the 90’s decades Bangladesh experienced per capita GDP growth of more than 2.5%
or more per annum. Per capita income, since independence, has risen more than three-fold, and
income poverty has been reduced by almost half. Some improvements in the human
development indicators, such as the 100% primary school enrollment with 1:1 ratio of boys to
girls; children immunization coverage, reduction in population growth rate, and reduction in
infant mortality exceed the rates progress of most developing countries (Temple, 2003). In
addition to these concrete progress measured by various development indices, Bangladesh’s
achievement in the hosting the largest NGO network of the world with various innovations in
development interventions, its success in apparel exports and its innovation of caretaker form of
government to ensure fair elections have also given good reasons to feel optimistic about the
future of the country.

Despite these successes, Bangladesh remains one of the poorest countries in the world
with a per capita income of around 400 US dollars. Still more than half of its population living on
less than one dollar a day income, 60% of children suffering from malnutrition and a large
portion of the population is exposed to drinking arsenic contaminated water. Bangladesh has
been ranked as the most corruption infested country for the last four years successively in terms
of the Corruption Perception Index (CPI) published by the Transparency International. Extremely
confrontational politics often degenerating into general strikes with street fighting resulting
massive disruptions to economic activities often raises doubts about sustainability of the progress
Bangladesh has achieved. Indeed, no discussion about Bangladesh’s economic development or
reforms fail to place the issue of governance at the center. Reforming institutions of governance
for establishing rule of law and the capacity for building institutions for delivering good
governance remains the focus of future reform efforts.

Bangladesh is one of the first 35 countries which adopted Bretton Woods institution
sponsored Structural Adjustment Program (SAP). It started with World Bank structural and
sectoral adjustment loans (SALs and SECLs) in 1980. IMF introduced three-year structural
adjustment facility (SAF) in 1986 in Bangladesh that had been followed by extended structural
adjustment facilities (ESAF) in the early 1990s. Since then funding from IMF and the World Bank
has been provided under the umbrella of SAP. All reform programs received extensive donor
assistance with a focus of building a better market economy with special attention to preventing
human disasters. While the reform programs were being implemented with varying pace and
varying emphasis at different points of time, the polity had also been becoming increasingly more
open and democratic, with encouragement from the donor countries. The aim of the paper, in
accordance with the Understanding Reforms Project (URP), is to address three fundamental
questions centering the reform experience in Bangladesh: why, what kind and how well? The
first question leads us to explain why or what factors led Bangladesh to begin the journey on the
path of market oriented reforms. The second question leads us to explain what factors account
for some of the observed successes and failures of the steps taken towards establishing a more
market oriented and a more open economy. The third question leads us to evaluate the
outcomes and to draw implications for future reform efforts.

1.2 Methodology and Hypothesis

The methodology adopted by the URP is unique at least for studying the Bangladesh’s
reform experience. Previous studies on Bangladesh’s reform experience have given ample
description of the reform inputs and outcomes. In one study politico-economic setting of the
country has also been described in addition to presenting some discussion and analysis of the
reform programs and economic and social performance (Ahmed 2003). Our attempt at viewing
the whole reform program as a game of strategic interactions between stakeholders within the
context of initial conditions and settings of the polity will hopefully provide a fresh perspective on
the ways through which context matters in the past and future reform efforts in Bangladesh.

While several studies looked at particular parts of the reform process such as impact of
trade liberalization on firm efficiency (World Bank, 1999) and productivity impact of agricultural
input usage (Ahmed, 2000), this study looks at reform in a holistic approach. Although we shall
discuss reforms under different sectors, e.g., agricultural reform, (international) trade
liberalization and privatization, under separate headings the focus is on the of steps that, taken
together, impacted on the creation of a more market oriented environment in the country. The
narrative will particularly focus on the institutional and the politico-economic analysis of the
reform experience.

The following set of hypotheses will guide the research:

1. Disastrous failure of the state controlled economic management and unavailability of

domestic resources at the disposal of autocratic rulers makes them easy compliers of
donor demands for democratic as well as market oriented reforms.

2. In the absence sufficient state capacity the donors have to take the driver’s seat in the
reform process.

3. A state with weak institutions of governance can nevertheless derive significant economic
benefits from acts of simple deregulation and liberalization.

4. When a program of divestiture is carried out to gain political legitimacy without

considering efficiency reasons, undesirable results can ensue due to wrong sequencing.

5. A government of a clientilist system may achieve decent macroeconomic performance

when foreign aided projects are significant means of distributing clientilist favors and
governments internalizes the understanding that foreign is contingent upon
macroeconomic balance.

6. A clientilist system contributes towards in weakening general governance by formal rules

but it may be able to issue bold executive orders in favor or against markets.
 7. However, a clientilist system may leave room for paternalistic kind of government and
NGO interventions for poverty alleviation.

8. A clientilist system without apparent lack of capacity institution building is sustained by

an electorate that do not voice a demand for formal rules for government but inclined to
make arbitrary demands.

The paper is divided in three chapters. The first chapter consisting of three sections
narrates the historical background, i.e., the politico-economic and institutional context of
economic reforms in Bangladesh. Chapter two is about the implementation stage of the reforms
and thus geared to answering the question: what kind of reform? In this chapter we narrate the
inputs, outcomes and effects of agricultural reform, trade liberalization, privatization of SOEs
followed by discussion of reform measures in the financial sector and in the fiscal and monetary
management. In chapter three we present our assessment of the impact of the reform process
(i.e., how well) in the economy as a whole and devote a separate section on analysisng the
institutions of governance and draw implications for second generation reforms. At the end of
the chapter brief concluding remarks are made.
 Chapter II

The Background and Context of Reforms

This chapter is divided into three sections. Section I gives an account of the historical
background of the country’s economy and polity. Section II describes how the country started its
experimentation with socialist economic policies after its birth as an independent country soon to
be reversed following a devastating economic crisis. In section III we discuss changes in the
polity and the emergence of a parliamentary form of government with elections held under a
innovative system of non-partisan caretaker government.

2.1 Historical Background

Although Bengal enjoyed prosperity in ancient times, hunger and famine became
common to Bengal since the merchants of East India Company took over the ruling powers in
Bengal in the middle of the eighteenth century. Contrasting the “want, famine, and mortality” in
Bengal, that was prosperous in the past, and the increasing prosperity in North America Adam
Smith wrote: “the difference between the genius of the British constitution which protects and
governs North America, and that of the mercantile company which oppresses and domineers in
the East Indies, cannot perhaps be better illustrated than by the different state of those
countries.”1 During the East India rule and the direct British rule, although Calcutta prospered,
East Bengal, later to become East Pakistan and then Bangladesh, was to remain mired in poverty.
In April 1947, the year the British left India, Bengal’s last British Governor, Sir Frederick Burrows,
predicted that East Bengal was condemned to turn into ‘the greatest rural slum in history’.2

In a book written for introducing Bangladesh to the outside world James Novak (1995)
states that the most significant event of Bangladesh’s history that had left the most indelible
impression in the psyche of Bangladesh, is the Great Bengal Famine of 1943, when millions of
people died of hunger and starvation and related diseases. He states that the leaders of
Bangladesh could never forget the humiliation of human dignity when people fought with street
dogs for food on the streets of Calcutta. Later we shall we shall see that an event of devastating
famine played a crucial role in starting the reform process and the threat of food shortage was
always in the back of the mind of the government leaders who negotiated reform package with
the donors since the devastating famine of 1974.

When Pakistan was created from British India in 1947, people of East Pakistan nurtured a
hope that their prosperity, lost centuries ago, would return soon. Pakistan government followed
private sector led strategy of industrialization through import substitution for achieving rapid
development. This strategy had built in bias in favor of industrial and urban development against
agriculture and rural development. Although East Pakistan had the larger share of votes, the
political and economic power was concentrated in favor of West Pakistanis due to greater
presence in the military and the civil bureaucracy, better educational attainment, and also prior
presence of an industrial entrepreneur class. Although jute, the largest export earner of
Pakistan, was grown in East Pakistan, jute mills and jute export was controlled by the west
Pakistanis. Industrial development and urbanization in East Pakistan was low to begin with, and
the gap between West and East Pakistan became far bigger due to unequal pace development in
the two wings of the country. Even the industries that were set up in the East Pakistan were

1
Smith, (1776), pp. 72-73.
2
Quoted in Lapierre and Collins (2002), p. 136.
mostly controlled by West Paksitani entrepreneurs. The unequal development, even though
private sector led, engendered by the import substituting industrialization strategy that involved a
great deal of state support and sponsorship created a deep sense of disparity among the East
Pakistani citizens. People developed widespread dislike not only for West Pakistanis but also
against the rich and the capitalists in general. The appeal of Awami League (AL), calling for
regional autonomy and increased independence of economic management, received widespread
support among the Bengali masses. Although Awami League (AL), led by Sheikh Mujibur
Rahman, was essentially a middle class party in nature, it incorporated many of the socialist
ideals of the European Fabian socialism of the 1940’s.

When Bangladesh achieved its independence from West Pakistani rule, through a bloody
liberation war, there was a widespread support for nationalization of industries including banking,
insurance and foreign trade3. Although the new government suffered from an acute shortage of
people experienced in general administration, the government took over the job of running
industrial and major commercial enterprises. For a country that would have been dependent on
international assistance even under normal circumstances (i.e., with private sector management
of the economy), the assumption of economic management of all major business activities by an
inexperienced government manned by scantly educated officials and led by politicians with no
knowledge of statecraft was destine to lead the country to a major crisis immediately after its
birth.

2.2 The Crisis and the Beginning of Reforms

When Bangladesh was created there was very few bureaucrats with the experience at
the highest level of administration. There were not enough people with the requisite educational
background and experience to fill the vacant posts even in general administration. There was
almost none in the government with the managerial expertise for running industrial or
commercial enterprises. Still an ideologically driven young group of economists led the
government to impose stifling government control on the economy by creating several
government corporations and agencies to run the economy.

Since well-educated bureaucrats were short in supply, factory managers and officials
responsible of vital economic functions were recruited from political cadres who had little
educations had little experience other than in the field of politics. Many of the managers of the
state owned enterprises (SOEs) got themselves involved in outright theft and looting. People
with political power or with connections with the highest levels of government got busy in rent
seeking and smuggling. With little taxes and other revenue flowing to the exchequer
government resorted to inflationary deficit financing to conduct its operations. The domestic
economic crisis assumed critical magnitude with adverse movements the international economic
situation; namely increases in the price of Bangladesh’s main imports, i.e., oil and food, and
downward movements in the price of Bangladesh’s main export, jute. Unable to finance the
import of desperately needed food, while the US insisted on the cancellation of jute export to
Cuba as a precondition for the delivery of food aid from the US, the new government became
witness to a severe famine in 1974.

It is interesting to note that while people became disillusioned with the promises made
by Awami League (AL), the ruling party, and its economic planners there was no mass agitation
by the hungry people. While the imposition of socialist planning on Bangladesh’s subsistence

3
Major sectors that were left to the private management were agriculture, construction, and
internal trade. None of these sectors were also free from widespread intervention of the
inefficient government machinery.
economy was responsible for most of economic miseries, the most vocal protests against the
Awami League (AL) regime’s mismanagement came from students and political parties calling for
even more hard-line and purer form (i.e., free from the corruption) of socialist rule. Mujib (the
Prime Minister of the country at that time) responded to the protests by imposing one party rule
and ban on all newspapers except four government-owned national dailies. Those calling for
purer forms of socialism faced arrests and other forms of repression while the silent majority
most of whom were too poor and too illiterate to either to understand the difference between
socialism and free markets, or even articulate their dissatisfaction. A very small minority of
people who opposed socialist policies refrained from expressing their views for fear of
persecution by both the government as well the opposition who were even more militant
proponents of socialism.

A small group of young military officers capitalized on the widespread dissatisfaction at

the mismanagement of the economy and the autocratic rule who were themselves frustrated due
to increasing marginalization of the well armed but ill-paid armed forces. A couple of coups and
counter coups in 1975 resulted in the installation of General Ziaur Rahman, who imposed martial
law in the country.

The task before the government after the removal of Mujib was to ensure enough food
availability. Since the country was suffering from chronic food deficit, the most important task
before the rulers was to ensure the supply of adequate food from international donors. While
Mujib government was reluctant to engage with the western countries because of its socialist
leanings, the immediate job of its successor was to mend relations with the US as quickly as
possible. The positive reception of the overthrow of Mujib by the military shown by the public
who once idolized Mujib as the father of the nation, convinced all subsequent governments, both
popularly elected and non-elected, that continuance of political power required support from the
military as well as the international donors.

The reversal of statist doctrinaire approach to economy ended and a slow process of
economic reforms began with the installation of Gen Ziaur Rahman government. However, more
important than the policy reversals was to restore order in the government machinery. Since the
base of power of Zia was the military, he had to end the policy of marginalizing the military and
bring it at the center of power while at the same time ensure that no one from the armed forces
threaten his own political authority. Zia also had to start the process of legitimizing his power by
organizing popular elections and contest in it by forming his own political party. Bans on political
parties and newspapers previously imposed by Mujib was withdrawn. While Mujib regime relied
on its own political cadre while marginalizing both military and the civil bureaucracy, and
condemning all persons connected with Pakistani rule, Zia tried to consolidate his rule by seeking
advice from experienced civil bureaucrats earned their experience in connection with the former
Pakistani government. He formed his own political party by combining former Pakistan Muslim
League leaders and also leftist politicians of pro-China orientation. Only people left out from his
party were AL leaders and pro-Moscow leftist political leaders. Economic policy advice was
sought from civil bureaucrats, donors and other local economists leaving out the architects of the
Mujib’s socialist program. As a result of these policies and good agricultural harvest the economy
re-gained stability and the Gross Domestic Output reached the 1969 levels i.e., the highest level
of output achieved prior to the independence of Bangladesh.

Why the political party that brought independence with overwhelming and dedicated
support of the general masses became autocratic while a military general who rose to power
without any election comes to restore multiparty democracy is seems odd and deserves
explanation. AL, led by Mujib although was successful in organizing an emotion charged political
movement against the Pakistani regime, demonstrated very poor capacity to govern4. When the
economy faced serious crisis, instead of reforming economic policies and accommodating
opposing viewpoints Mujib saw the solution to the problem of mounting discontent in shutting
down all channels of expressing dissatisfaction. This is partly due to the predominance of
socialist ideas among the small group of educated elite and the students. Most of the people
who were not socialists and believed in private sector led development did not have any strong
voice and formed a part of the silent minority among the well-educated population. Mujib did not
hear the voice of any pro-market force in the political arena. He saw that it was the more hard
line communists who voiced strong opposition to his rule, so he used their own tools to defeat
them. General Ziaur Rahman did not possess enough knowledge or educational background to
grow a conviction for democracy or market, but he was a pragmatist. He saw that in order to
retain political power he would have to maintain good relationship with the donors and
administer the country by drawing from small crop of experienced and efficient political leaders
and bureaucrats available, without worrying about whether they had supported the former
Pakistani government or not. General Zia first had to change his title of Chief Martial Law
Administrator (CMLA) to President of the Republic because donors countries felt somewhat
uneasy to honor a person as a head of state with a military title. Subsequently, it was again
donor preference for dealing with someone elected through a formal elections that led Zia to
arrange a referendum and then a popular election which he was certain to win.

2.3 Political Reforms

While the main difficulty faced by the former socialist block countries is the need to build
market supporting institutions from scratch, the difficulty faced by Bangladesh has been to build
and consolidate institutions of self government. AL, the populist party that led the fight for
independence from Pakistan demonstrated little capacity to appreciate the significance of the
major institutions governance. By starting as a democratic party it quickly destroyed democracy
by establishing one party rule. It impaired the institution of civil bureaucracy by distributing its
jobs to political cadres and it damaged free markets by nationalization of all industries and major
trades. After a devastating famine and a brutal coup, the succeeding governments had to start a
process of restoration of all those institutions. Although military intervention received widespread
support, because it restored law and order and food availability, the donors clearly felt the need
for re-establishment of a democratic form of government.

General Zia had little doubt that with reasonable food prices, thanks to generous aid
from donor countries, and a more disciplined governance compared to AL rule he already
enjoyed popular support. Zia formed a new political party, Bangladesh Nationalist Party (BNP),
lifted all restrictions on democratic political activities and held elections in which he was certain to
win massive popular mandate. Support for Zia was not due to any economic program or for any
sort of political reform. Ordinary people did not care whether factories were de-nationalized or
whether multiparty democracy was re-instituted, assurance of aid flow, the flow of food aid in
particular, was the critical determinant of the durability of government.

Another critical job faced by the new government was re-establishment of authority of
the state through a credible institution. During the brief AL rule the credibility of the civil
bureaucracy led by civil politicians was severely damaged. Although Mujib hated the military
because of his sufferings in the hands of the Pakistani military, he did not possess the capacity to
realize the importance of restoring the civil bureaucracy into an effective and credible governing

4
See the comment of Mr. S. A. Mahmood, the president of Dhaka Chamber of Commerce in
1986, quoted in Humphrey (1992), p. 36 and footnote #60.
institution. The military emerged as a relatively more honest and disciplined institution for
delivering basic governance and established the confidence among the people that it can govern.

When General Ershad took power, after Zia’s overthrow in a coup in 19815, he also had
democratize himself by offering general elections in 1983 which he was elected by massive votes
again by ensuring that he could keep famine at bay and thus in total control of the situation.
Therefore one can see the instrumental role played by the donors in instituting multiparty
democracy in Bangladesh, a role made so effective due to the well-recognized vulnerability of
Bangladesh’s economic situation. Had Bangladesh possessed rich natural resource deposits and
far lesser population, perhaps the governments could afford, like some of the governments of
countries in the African continent, to be more authoritarian by ignoring the international
community by delaying democratization and perhaps they could also afford to delay the
implementation of donor prescribed reforms.

Democracy (in the sense that governments attain legitimacy by getting elected by
popular vote) in Bangladesh, has achieved certain degree of consolidations in Bangladesh due to
two reasons in addition to donor preference for giving aid to countries with democratically
elected governments6. The first of these two reasons is the high level of interest that general
masses take in the election ritual; perhaps because this is one occasion when otherwise
powerless people feel that they count for something. Second reason is a unique Bangladeshi
institutional innovation, which is the practice of holding national elections under a non-partisan
caretaker government. The creation of this institution, under which all three national elections
since 1991 has been held, has ensured free and fair elections ensuring legitimacy of the elected
governments.

The emergence of the institution of caretaker government is reflects both negative as

well as positive aspects of the polity. On the one hand it reflects that the credibility of the
existing government institutions is low. While India’s election commission has been performing
the job of conducting elections in a vastly spread out country with little doubts about its
impartiality and efficiency, Bangladesh had to make changes in the constitution to recognize the
vulnerability of the civil administration to partisan pressure7. Similar problems of credibility also
afflict the judiciary underlying the uphill battle Bangladesh faces in establishing institutions of
good governance.

One the other hand it reflects that people are innovative enough to be able to create
institutions that can address the failure of the existing institutions. Very importantly it shows that
the politicians of the country are capable to create a set of laws and submitting to those laws for
resolving conflict. However there are reasons to believe that it was an isolated and an
exceptional instance of institutional innovation. So far both political parties have hailed the

5
Ershad came to power by a bloodless coup in 1982 by removing democratically elected Sattar,
who led the government for few months after the assassination of Zia.
6
It is widely believed that the reason the military in Bangladesh today refrains from taking over
the political power, despite the ability to do so, is the clear message that the donors, US in
particular, that the international aid and other concessions might be significantly reduced for a
military government. Although Pakistani military can still take the risk due to the country’s
strategic importance and greater domestic resource base, Bangladesh is to poor to impart that
kind of confidence to its Generals.
7
After a series of widely reported rigging of elections held under the BNP government ((1991-
1996) AL led highly disruptive agitation movement with the contention that it is not possible to
hold fair elections under a partisan government. It resulted in a constitutional amendment
making the provision of a non-partisan caretaker government, for a three month term headed by
a former chief justice, to hold elections at the end of each political government’s five-year term.
caretaker government system when they won the elections held under it and questioned its
integrity and called for its reform when they lost.

With a credible system of holding free and fair elections Bangladesh’s has established
democratic form of government but its polity remains clientilist that privileges rent seeking and
corruption. The poverty and illiteracy of the population and lack of a tradition for formal rules of
governance that translates into lack of capacity or demand for building institutions for delivering
good governance. Thus the early history of the people explains the roots of the clientilist system
and its resilience, understanding of which is would be the key to understanding reforms in its
deep level.

The clientilist polity of Bangladesh with little capacity for building institution and
propensity for undermining formal rules in favor of exercising discretionary authority in all affairs
of governance nevertheless is capable of producing few good outcomes. Majority of these so-
called reforms were accomplished by executive orders majority of which originated from series of
meetings held between donors and high officials of the government.
 Chapter III

Inputs, Outcome and Effects and Political Economy of Reforms

in Major Sectors

The initial thrust of reforms in Bangladesh came as response to mitigate chronic food
shortage and extreme mismanagement of the state controlled sectors of the economy. As
mentioned earlier, after the state managed economy collapsed and aid was desperately needed
for the survival of an extremely vulnerable population, the new leaders installed by a military
coup was never had any socialist predilection and were desperately looking for any alternate way
out. The main concerns of the aid agencies was primarily humanitarian and there was no grand
design for creating a market economy at that point of time.

The first goal of reforms in the agricultural sector was to bring Bangladesh out of the
constant threat of famine. Reforms in agricultural sector, with donor assistance, with the goal of
attaining food self sufficiency was embraced by the government whole heartedly. Privatization
involving divestiture of state owned enterprises also started early. Reforms in all other sectors
received attention in the 80’s with greater comprehensiveness in the 90’s under the Structural
Adjustment package.

Section 2.1 discusses agricultural reforms, section 2.2 discusses trade liberalization,
section 2.3 discusses privatization, section 2.4 discusses financial reforms, and section 2.5
discusses reforms in fiscal and monetary management. Reform measures under these separate
headings constitute parts of an overall process of market oriented reforms.

2.1 Reforms in the Agricultural Sector

In the early 70’s almost entire input distribution system in agriculture and a significant
part of food grain distribution was under government control. A parastatal with the name of
Bangladesh Agricultural Development Corporation (BADC) was in charge of purchasing and re-
selling all major agricultural inputs including chemical fertilizer, pesticides and irrigation
equipment with the complete exclusion of the private sector. Public Food Distribution System
(PFDS), originally set up in 1943 during the Great Bengal Famine and expanded rapidly
afterwards, was geared to price stabilization, farm price support, providing food to the poor as
well as certain priority groups. Both the input distribution and the public food grain distribution
system (PFDS) tolled a heavy amount of fiscal pressure because of huge subsidy associated with
these.

2.1.1 Agricultural Reform Inputs and Outputs

Reform process in agriculture started in the mid 1970s, although major reforms in this
sector has been implemented in 1980s and 1990s. Major inputs in the agricultural reform in
Bangladesh have been the following:

• Gradual reduction in subsidy in agricultural input

• Gradual reduction in the role of BADC in supplying, managing, and marketing agricultural
inputs and equipment
 • Reduction and/or abolition of licensing requirement for private trading of agricultural
inputs and equipment
• Reduction of the role of the government in the output market and limit its role in
providing safety nets and price stabilization
• Extension of trade liberalization policy in both input and output market of agriculture,
i.e., opening up of agricultural input imports and import of food grain to private sector in
the 90’s.

Outcome of the reform in agriculture was very positive. First, budgetary pressure has
declined due to reduction and elimination of subsidy that was evident even the early 1980s.
Subsidy in fertilizer reduced from 48 per cent in 1979 to 23 percent in 1982 (Osmani and
Quasem, 1990). The impact of subsidy reduction on fertilizer prices was partially offset by the
price reduction effect arising from increased competition among the traders in the liberalized
private sector. Gradual privatization of fertilizer distribution had generally ensured timely supply
of fertilizer to the farmers and a better spatial integration of fertilizer market.

Reform outcome is more pronounced in case of irrigation equipment. With the

withdrawal of import restrictions and removal of standardization restrictions, there had been
substantial reduction in initial investment cost of irrigation equipment. Econometric analysis by
Ahmed (2000) showed that the adoption of seed-fertilizer-irrigation based HYV is driven by
expansion of irrigation, while wider spread availability of fertilizer at reasonable price played
supporting role.

Liberalization of import of food grains resulted in expansion in food import by private

importers and reduction in import of food by the government. While up to 1992, both
commercial import of food and food import under food aid were made directly by the
government, by the end of 1990s entire commercial import of food was made by the private
importers. Private import of food helped the goal of achieving food price stabilization despite
limited role of PFDS after the reform.

2.1.2 Political Economy of Agricultural Reform

Reforms in agriculture have resulted in a most remarkable feat, which is bringing

Bangladesh out of the shadow of famine. This is an area of reform where reforms consisted of
some easy de-regulating steps resulting in win-win outcomes. The sequencing of de-regulations
was the key, which was planned carefully by the donor agencies with full cooperation from the
government. Attainment of food self–sufficiency which was the government objective was also
helped by donor assistance in flood embankment, irrigation, research and extension projects.

There are several reasons behind this achievement. First, the political will. The reason
for the political will has been explained before: it was clear to every government that a necessary
condition for retaining political power in Bangladesh was ensuring adequate food supply.
Achieving food self-sufficiency was in every government’s priority target. Governments knew
that increasing food production required construction of embankments, adoption of HYV and
widespread use of modern inputs such as mechanical irrigation, chemical fertilizers and
pesticides. Government knew that subsidizing these inputs was too costly but didn’t know how
to come out of the subsidy program without disrupting production. Donor assistance was critical
in this regard since they not only provided funds for expensive constructions such as flood
protection embankments but also showed the government how to use the market to achieve its
goals through right sequencing. Bangladesh followed the sequence of privatizing agriculture
market starting from retail trade towards wholesale and apex trade that is consistent with the
sequencing strategy as suggested by Mackinon (1993).8

Reforms were gradual because the extreme poverty of the peasants ruled out any big
bang approach. Since there were no big farming lobby and almost all farmers were essentially
poor none had any entrenched interest in the previous policies. Only group of losers was the
high officials of BADC who saw their power curtailed. Since the government at the top level was
convinced, with arguments and aid conditionality, these high officials of BADC could not put up
very effective resistance.

The sequencing of agricultural reform was such that gains of reform were almost
immediately visible for peasants. Since greater competition among private traders could offset
the effect of withdrawal of subsidy on input prices there were no losers, hence government did
not have to worry about creating extra safety nets. On the public food distribution side, the
withdrawal was very slow and the raising of food prices under public distribution advanced in
parallel with the increase of people’s purchasing power. Hence the urban population hardly
noticed the discontinuation of government subsidy through PFDS.

The distributional impact of market oriented agricultural reforms were not significant
because most peasant farmers were subsistence farmers. For centuries they were familiar with
flood and drought and even starvation. Liberalization of agricultural inputs made modern inputs
cheaper9 and thus reduced their vulnerability to vagaries of nature. While subsistence farmers
were better off with more production, liberalization of trade created employment as well as
business opportunities hitherto non-existent. Hence it was a win-win deal for all.

Liberalized market for agriculture input was functioning pretty well until mid 1994 before
falling into a crisis in early 1995. Prices of fertilizer skyrocketed in peak season due to a shortage
artificially created by government appointed dealers of fertilizer10. The crisis sparked a riot
causing the death of some 17 people when police opened fire on peasants demonstrating for
fertilizer. In our view this crisis reflected the absence of appropriate institutions (e.g., anti-trust
laws and competition authority to enforce fair play in the market) to support free market
operations. Biggest traders in Bangladesh often get together and create artificial crisis of some
inelastic consumer commodities to reap windfall profits. It is often alleged that some of these
businessmen who engage in such activities also maintain good contacts with highest levels of
governments. When crisis of other commodities such as sugar and cooking oil occur, people
suffer and government popularity decline but crisis in these commodities never sparked a riot.
Fertilizer crisis sparked a riot because it is a life and death issue for many peasant farmers and
no government can ignore the life death matters of the predominant occupational group of the
population. Government responded to the crisis in its habitual ad hoc manner by increasing
surveillance and telling all the dealers that dealership would be cancelled if there is any more of
such crisis. All successive governments of Bangladesh demonstrate from this kind of ad-hocism
and excessive reliance on executive orders reflecting a lack of capacity for institution building for
long term solutions. We have discussed the origin of such low capacity in section on historical
background and this issue will be further discussed in chapter three.

8
For more on the actual sequencing and the role of government and donors see Ahmed, R. et al
(2000).
9
Even though studies suggest that quoted price before and after reforms remained same,
competition among private traders made the availability easier and that is why the use of modern
inputs increased substantially after market liberalization.
10
It should be noted that although fertilizer trade is fully privatized, production of main fertilizer
is carried out in government owned factories. Only government-appointed dealers can buy
fertilizers from government owned factories.
2.2 Trade and External Sector Reform

Like most of the other developing countries, Bangladesh used to maintain a very
protective trade policy. Import substituting strategy with high tariff and non-tariff protection
along with overvalued fixed foreign exchange regime gave rise to over capitalization and creation
of excess capacity (Ahmed, 1978). Government responded to current account deficit and
deteriorating terms of trade with extensive quantitative restrictions (QR’s) and high levels of
customs tariff. Bangladesh faced considerable difficulty to pay for her imports with a narrow
export base forcing it to seek IFI assistance quite often.

2.2.1 Inputs and Pace of Trade and External Sector Reforms

Bangladesh took her first tentative steps toward liberalization, under the directive of IMF,
through devaluation of the currency by a staggering 58% (1975) and later by a further 10%
(1979). During the mid 1980s import liberalization process was initiated under he the Import
Program Credit (IPC) of the World Bank. Although the government officials and local economists
were against the conditionalities imposed by IFIs, government faced with balance of payment
crisis could not refrain from taking conditional loans from IFIs.

The prescription for trade liberalization from donors was only very grudgingly accepted
as a condition for receiving aid by the government under balance of payment crisis. Government
bureaucracy was extremely slow to implement the trade liberalizing prescriptions.
Implementation of the trade policy reform was accelerated in the early 1990s perhaps reflecting
the combination of influences of the fresh attitude of a newly elected government, waves of
change in the world especially of the liberalization moves in neighboring India in 1991 and also
closer monitoring and supervision by the IFIs.

Top customs duty (CD) rate came down from 350 per cent to 35 per cent. Tariff slabs
has been reduced from 24 to 17. Average CD, numbers of slabs, dispersion in tariff all marked
sharp decline. A moderately flexible exchange rate policy was adopted since mid 1979 with the
exchange rate being pegged with a basket of currencies of the main trading partners. In 1994,
the government accepted the obligations embodied in IMF article VIII, making the Taka
convertible for current account transactions. Exchange rate had been adjusted periodically based
on changes in Bangladesh Bank’s Real Effective Exchange Rate (REER) along with considerations
of foreign exchange reserve situation, inter-bank market exchange rate, unofficial exchange rate,
and overall macroeconomic situation. Government’s management of the exchange rate had
become so flexible since 1994 that when Bangladesh adopted a fully floating exchange rate
regime on May 2003, the exchange rate remained largely stable around the old government
determined rates.

Some have criticized that that Bangladesh’s trade liberalization proceeded too fast.
However, a cross country comparison, as documented in a World Bank study (World Bank, 1999)
shows that the pace of liberalization was not that fast as many of the comparable countries
proceeded even at a faster rate. Although the pace of reform was not as fast as alleged by the
critics, it is also true that trade liberalization in the 1990s has been quite fast compared to
liberalization and reforms in other sectors in Bangladesh.

2.2.2 Outcome and Political Economy of Trade Liberalization

Like the reforms in agriculture policy trade policy reform was largely an IFI assisted
program with an almost win-win outcome. The challenge for the IFIs was that the planning and
finance ministry officials could not understand how balance of trade could improve when imports
are made easier. There was also reluctance of many government employees in the tax and
customs department who saw their carefully planted patterns of graft dangerously threatened.
Protests came from the political parties in the opposition11, as they voiced the populist argument
that such import liberalization would turn this country to a market of foreign commodities eroding
self-reliance. Same sort of populist criticism also came from left leaning economists, intellectuals,
and some civil society think tanks. Businessmen and Chambers were also critical of trade
liberalization policy as they feared of growing competition in the industry and reducing the rents
that emanated from trade restrictions.

However, as the finance minister himself got convinced through numerous meetings with
IFI officials, the lower level officials could not drag their feet longer. The material of the Finance
Minister’s speech outlining liberalizing moves triggered countrywide general strike by the
opposition. Later on the businessmen and the chambers realized that their fear of trade
liberalization was unfounded. Most of the chamber leaders who were engaged in international
trade found that with trade liberalization their businesses grew many-fold. The growth in their
business resulted from increase in consumer's purchasing power due to fall in the price of
imported goods. Many new traders got involved with import businesses as cost of imports
significantly went down.

One of the biggest losers were in the whole trade liberalization process were inefficient
SOEs that were operating behind high tariff walls. However some private entrepreneurs were
quick and efficient enough to set up more efficient factories in businesses, such as textile
manufacturing where SOEs dominated, that were capable of competing under a liberalized
environment. The biggest growth under the liberalized environment was experienced by the
textile exporters who experienced nearly 13% growth throughout the decade of 90’s. However
even before the larger liberalization of the 90’s, textile units were already enjoying special
privileges, such as duty drawback scheme and special bonded warehouse facilities, that
tantamount to operations under a complete free trade environment12. Liberalization in the other
sectors of the economy helped the growth of textile exports in an indirect way.

After the implementation of major waves of trade liberalization in the first half of 1990s,
the position of a group of critics started to change. As the finance minister saw that the dire
warnings from his officials about serious the fall of revenue after liberalization did not materialize
while the balance of payments situation improved, he felt more confident about IFI
recommendations in favor of liberalization. The quick falsification of about the dire consequences
of trade policy reform especially on the balance of payment forced most of the intellectual
defenders of protectionism to limit themselves to criticizing the pace and sequencing of trade
liberalization. These intellectuals used some of the negatively affected manufacturing enterprises
in the public as well as the private sector in support of their argument against the pace of
liberalization. Most of their criticism emanate from the extra-ordinary importance they attach to
the word ‘industrialization’ which to them is synonymous with development perhaps reflecting the

11
In Bangladesh virtually there is no deep difference in terms of stated economic policies among
the two main political parties. Since the major trade liberalizing push came during the regime of
Bangladesh Nationalist Party (BNP), the opposition party Awami League started saying things
that they thought would arouse negative sentiments against the ruling party. If BNP had been in
the opposition they would have opposed trade liberalization voicing the same arguments.
12
One of the significant factor for the growth of textile exports in Bangladesh was the special
GSP and the quota system practiced by the developed countries. Without GSP and quota it is
doubtful that trade liberalization alone could help Bangladesh make its presence felt in the
international market.
emphasis placed in the textbooks of development economics of the 40’s and 50’s decade
(Bhattacharya and Titumir 2001).

The key to success of trade policy reform was that it was very easy to implement
because it hardly made any demand for increased administrative capacity. Since Bangladeshi
businessmen had far greater exposure to trading business than manufacturing entrepreneurship
they had little trouble availing themselves of the opportunities made available by the increased
openness. There was no powerful lobby or a industrial entrepreneurial class with entrenched
interest in protectionism because most Bangladeshis are either peasants or traders with
manufacturing output contributing to less than 15% of GDP. Businessmen could easily take
advantage of greater opportunities for trading, encouraged by eased up trade restrictions. The
manufacturing units that operated under trade restrictions were mostly owned by government,
where worker jobs were not immediate threatened because of their status as government
employees enjoying job security. These SOEs were shut down at a much later stage and workers
were offered generous golden handshake with financial support from the IFIs.

2.3 Privatization of SOEs

2.3.1 Background and the Sequence of Privatization

After the political change in 1975, the government dropped its commitment to socialism
and emphasized upon the role of private entrepreneurship. The Government under Ziaur Rahman
wanted to hand over the nationalized SOEs in jute sector to their original owners and 247
enterprises were privatized under this effort during 1979-80. However, the process stopped as
the Bangladesh Jute Mills Corporation (BJMC) turned in profit that year13.

The most dramatic and sweeping privatization attempts were carried out between 1982-
86, during the first half of the General Ershad’s rule. Enterprises that were brought under direct
ownership of the GOB from Bangladeshi owners were released for sale to private buyers, and
thus the process of denationalization started in this period. Within months after the
announcement of a “New Industrial Policy” the military regime of General Ershad started
transferring the ownership of 222 industrial firms along with few hundred commercial enterprises
from the public sector to private sector. By 1986 the share of the public sector in the total
industrial-sector assets fell from 85 percent to roughly 40 percent. Before the massive
transformation of the Eastern European Countries, Chile and Bangladesh had been declared
“champion performer in the world of privatization or divestiture” (Berg, 86)14. Since then the
privatization has proceeded at lot slower pace. In the 90’s Bangladesh ranked the of slowest
among the countries in South Asia in the area of privatization.

Through a process of privatization, denationalization and disinvestment and privatization

the number of public sector enterprises has come down from their peak of 416 in 1976/77 to 146
in 1990/91, and to 116 in 1999/00. Share of public sector in the total asset of the industrial and
financial sector also declined. While about 90% of industrial asset were owned by the public
sector during the early 70s, only about one third of the industrial asset is currently owned by the
government. Despite donor proddings

13
Proponents of retaining SOEs used this profit earning instance to argue that enterprises under
the state management is also capable of being efficient. The profits of BJMC was due to a
temporary surge in demand in the world market rather than any sustained improvement in
efficiency.
14
The only other country that had undertaken such dramatic and far-reaching privatization effort in the
decade of the 80’s was Chile (see Humphrey, p. 92).
2.3.2 Political Economy of Privatization

The most important reason behind the dramatic privatization program of Bangladesh is
probably explained by a negative reason, the disastrous failure of the public sector. Public sector
failed immediately after take over not only because of the classic incentive problem but also
because there was acute shortage of managerial expertise or experience. The economic crisis
resulting from severe mismanagement of the state-controlled economy made it clear to almost
everyone, except some economists and left-wing political parties that private sector has to be
brought back to take the leading role in the economy.

A deep sense of injustice and betrayal also created a powerful force comprising of the
former Bengali owners who were dispossessed by the nationalization drive. As the state
controlled economy got into deeper and deeper crisis, this group also started a concerted
campaign to further discredit the state controlled economy and bringing back the private sector
dominance. When General Ershad, after coming to power in 1982, was looking for some allies
from the elite section of the society to back his military regime the dispossessed industry owners
were a natural choice. The most sweeping phase of the denationalization program carried out
during the 1982-86 period could be interpreted as a drive for gaining legitimacy, by General
Ershad who came to power by a military coup, through correcting a perceived act of injustice to
the former owners of industrial enterprises.

Among all the reform programs in different sector of Bangladesh, the privatization
program was most internally driven. It was driven by failure of SOEs and by the need to gain
political legitimacy rather than any conviction, in the political leadership or in the academia,
about the efficacy of the private sector. Although the donors always maintained that a market
economy with private sector dominance was better than a state controlled economy, during the
80’s they were directly involved with the reform of the sector corporations, the controlling units
of the SOEs15. From 90’s donors encouraged privatization through intellectual arguments and
providing funds for golden handshake but there was no serious pressure from the donors for
embarking on privatization in the industrial sector.

The staunchest opponents of the privatization program always came from the employees
of the SOEs. The left wing political parties and few academicians were diehard critics of the
privatization program. The academic arena was clearly dominated by economists and other
intellectuals who were in favor of greater state control of the economy. Whenever the ruling
political party came forward with a privatization move, the potential losers would always go to
the opposition party for ready political support.

Although almost most people agreed that state control was not taking the economy
forward and there had been a good number of supporters of privatization program, there were
few, if any, passionate supporters of privatization program. The most vocal academics were
passionate antagonists of the privatization initiative and always saw privatization as a conspiracy
of the world capitalists represented by the World Bank and the IMF. The workers opposed
privatization for fear of losing job in an economy, with more than one third of the labor force
facing unemployment or underemployment, where every single job in the modern formal sector
was deemed too precious. Bureaucrats were fearful of losing control and thereby a more limited
scope for graft. Although business chambers in general showed support for privatization in
public, privately many of them were also fearful of facing competition. The vast majority of the
population living in rural areas were passive about the whole privatization issue. The

15
In the agricultural sector, however, donors got directly involved in the liberalization and
privatization measures with a great deal of success, as discussed above.
government itself was not confident about its capacity to implement a successful privatization
program. Therefore, except for a brief period, none of the governments showed a non-
vacillating commitment toward privatization program.

2.3.3 Outcome and Effects of Privatization

Just as the nationalization drive was not well planned privatization was also not very well
planned and was not carefully sequenced. Apart from gaining political legitimacy in the case of
General Ershad, for all successive post-Mujib governments privatization meant getting rid of the
loss making enterprises through divestiture. After divestiture government thought its job was
finished and never considered what kind of institutional support and private sector supporting
environment it must create for the efficient functioning of the economy. For instance, although
government privatized jute mills, the privatized mills were required to pay government mandated
wages and purchase raw jute at government mandated procurement price. When the private
sector went for financing to the state controlled financial sector it found that government owned
enterprises were to receive loans on a priority basis and their loan applications were disqualified
for reasons for which government was more responsible. While there were various
administrative support for the SOE’s the private sector were to negotiate through an inefficient
and corrupt bureaucracy. When the private sector jute mills tried to win foreign buyers through
aggressive price-cutting over the price offered by Bangladesh Jute Mills Corporation (BJMC), they
were accused of shortchanging ‘greater national interest’.

Due lack of capacity of the government for handling16 post privatization situation divested
enterprises found themselves in various troubles. Since government had almost monopoly
control over financial institutions and officials of those institutions were either inefficient or
corrupt, privatized enterprises saw that that the easiest way for them to survive was to become
active players in the game of rent seeking and corruption. Defaulted loans started accumulating
in development financial institutions (DFI) as well as nationalized commercial banks (NCB) at
higher rate after privatization.

Several studies were conducted by both supporters (e.g., Dowlah, 1997) and critics of
privatization (e.g., Sobhan and Ahsan 1984) and all of them focused on the profit and loss
situation of the divested enterprises themselves ignoring the question of larger economy wide
efficiency gains. For example, when an enterprise was found closed after divestiture it was
necessarily assumed by both groups as indicating a negative result for privatization, forgetting
the all important questions whether the whole economy gained or lost in terms of allocative
efficiency17.

In general the studies carried out on the post-privatization performance of the divested
enterprises reveal the following: some privatized enterprises show improved profits or reduced
losses while some others show the opposite, some privatized enterprises also show improved
capital and labor productivity (Rahman, 2000) and introduction of new goods while others show
increased loan default, closure and even complete disappearance (Sen, 1997; Akram, 1998).
Almost all studies found that employment declined in the divested enterprises and it affected
mainly white-collar workers reflecting the class bias of clientilism under government
control(Bhaskar and Khan, 1995)18. There is also little dispute that a good number of divested

16
As discussed above government could not provide them a level playing field with SOEs and
with each other.
17
See Tipu (2002) for a more detailed analysis of this point.
18
Bhashkar and Khan (1995) interprets the loss of white collar jobs as evidence of clientilism of
government towards the section of society that supplies white collar workers, since it is the
relatively better off section of the society that is more well connected with the government.
enterprises defaulted on loans borrowed from the government owned financial institutions. While
the debt default problem has been interpreted by some as a proof that government shouldn’t
have embarked on privatization (Akram, 1998), some have interpreted as a consequence of an
inefficient government’s excessive control of the financial sector (Humphrey, 1992; Tipu, 2002).

The debt default crisis shows that there has been a problem of sequencing. Debt default
crisis could have been avoided had financial sector could have been reformed into an efficient
sector prior to embarking on massive divestiture. However, building an efficient financial sector
calls for greater financial management capacity in the central bank and other public regulatory
institutions. On the other hand divesture and deregulation only calls for one firm executive
order. As will be discussed below Bangladesh has shown greater success in the areas requiring
executive orders but continues to struggle with institution building and even maintaining the
integrity of good institutions derived from the past.

Even though the divested enterprises show mixed performance, it can probably be
argued that the impressive rate of growth that Bangladesh has achieved in the last two decades
has been led by the private sector. Although all divested enterprises did not benefit directly from
privatization, the private sector friendly environment signaled by the privatization program
appear to have convinced the private sector to undertake investment and productive activities
with energy and enthusiasm. Despite the poor planning and poor implementation of the
privatization program by an inefficient bureaucracy, the relatively strong performance of the
private sector and the economy as whole, although below its potential, appear as a surprise to
many observers. (Humphrey, 1992).

2.4 Financial Sector Reform

Bangladesh inherited an undeveloped and un-diversified financial system, with the pre-
dominance of commercial banks that were nationalized with the Presidential Order of 1972. Till
1982, all the financial institutions were kept under the ownership as well as regulatory control of
the government. Financial repression was the norm in the early days. Interest rates were
heavily regulated and credits were mostly directed towards ‘so-called’ priority sectors and the
public enterprises with little concern for risk and profitability. Bank branches increased mainly to
satisfy demands for employment for the educated youth. A huge proportion of the asset profiles
of the financial institutions became overdue. All these had been reflected through decline in the
profitability of the nationalized commercial banks (NCBs). Rapid expansion of credit created
inflationary pressure, although the overall private investment was not stimulated.

With the policy change of the government regarding the role of private sector after the
political change in 1975, IMF took a strong role in monitoring the supply of money by establishing
its office inside the Bangladesh Bank (BB), i.e., the central bank premises.

In 1989, first steps towards deregulation of interests rates were taken. In 1992, under the
structural adjustment package, the interest rate bands were removed from all but three of the
lending sectors and banks were allowed to fix lending interest rate on their own judgment.
However the practice of regulating interest rates for some priority sectors remain intact.

Since the private sector was growing and NCB’s could hardly keep pace, the pressure for
allowing local private banks to finance increasing activities of the growing private sector built up.
The government decided to allow the operation of local private banks and to denationalize two
out of six NCBs in 1982. Number of private commercial banks (including 2 denationalized
commercial banks) stood at 40 by the year 2000. A good number of leasing, insurance and also
merchant banks also sprang up taking advantage of the deregulated environment.
 A major reason for proliferation of private sector banks is a guarantee of huge profits in
an undiversified and a protected financial market. No domestically owned bank has ever been
closed down even after piling up bad loans. On the other hand the central bank never lets any
bank go without cash for fear of bank run. BB’s capacity to monitor and verify the financial
activities of commercial banks, despite pouring of good quantity of donor funding on financial
management, remains weak. Reliance on executive orders and the practice of ad hoc measures
is endemic in all public institutions and therefore any improvements in the loan default scenario is
likely to be temporary. The interest rate dispersion, i.e., the gap between lending and deposit
rates, in Bangladesh is very high and this high dispersion has so far resisted all reform attempts
to minimize the default risk of lending.

While a majority of the domestically owned private commercial banks are widely reported
to be engaged in insider lending and various other irregular practices causing the amount of
infected portfolio to swell, the foreign commercial banks have been the best performers in terms
of conceding least quantity of defaulted loans. One of the reasons for the success of the foreign
banks has been their prudent management and greater respect for laws and official regulations.
Foreign banks have also played the role of supplying the best quality human resources at the top
management levels of the local banks and other local business organizations. On the contrary
local banks are not only able to utilize their knowledge of weaknesses of the government
institutions and use various informal relationships to their advantage. For promoting better
financial discipline an impartial government determined to achieve quick market oriented reforms
could let the foreign banks expand their operations while restricting the operations of those local
banks that are not performing well. However for a politically elected government letting
politically connected people to open new banks and continue operations gets a higher priority
than bearing the short term political costs of letting foreigners earn the easy profits.

Liberalization of capital markets resulted in a surge in the inflow of foreign equity funds
in the early and mid 90s. The inflow of foreign funds gave rise to a speculative bubble in 1996
that burst within few months. The burst of the speculative bubble brought forward reports of
severe mismanagement and manipulation in the stock market. Despite widespread reports of
illegal collusion, cheating and fraud by the stockbrokers not a single person could be convicted
resulting in loss of confidence in the capital market. It is a common knowledge almost all
auditing firms can be paid to sign any amount of false accounting information. Donors have
financed technical assistance projects for improving the institutional capacity for capital market
regulations that has clearly not been enough to bring back credibility of the capital market
operations.

2.5 Fiscal and Monetary Management Reform

In the initial years, the government had to rely on deficit financing because the new
government demonstrated little awareness of fiscal or monetary discipline. Naturally there was
excessive growth in domestic money supply that fueled inflation. With little capacity and
awareness in the government about needs of fiscal and monetary discipline IMF had to play a
strong role when the government asked for a bailout.

Since those inflationary years of the 70’s (i.e., 19.3% during 72-80 period), the
macroeconomic area of the became an area of strength of the government, lauded by the World
Bank and other external observers. Why a government with no substantial improvement in
administrative capacities or significant reforms in institutions goes on to be applauded as one of
the best performers in the area of macroeconomic management (Temple, 2004) appears to be a
puzzle. A plausible reason appears to be the disastrous failure of the first post-independence
government impressed all subsequent governments to be sensitive to the IFI demands. Since it
is relatively easier for IMF to monitor and negotiate monetary growth with a government with a
very centralized and powerful executive branch, macroeconomic management has emerged as an
area of strength for Bangladesh economy19.

The most significant achievement in the fiscal area under the structural adjustment
program was the introduction of trade neutral value added tax (VAT). VAT has been the major
instrument through which government could offset the loss of revenue from trade liberalization.
We have shown above that the people who vocally opposed trade liberalization moves were
defeated by the failure of their prediction of dire consequences in government revenue earnings
and balance of payments consequences. Therefore credit must be given to this aspect of the
‘packaging’ or ‘clustering’ of the structural adjustment package.

It should be noted that Bangladesh has one of the world’s lowest tax GDP ratios. Donors
have provided a good deal of technical assistance in enhancing government capacities for
improving tax collection. Government eagerness to improve its revenue collection is increasing
since foreign aid is declining over the years while government expenditure is growing.
Corruption in the tax administration, lack of capacity for efficient design of tax policy, the general
tendency among the top politician to the lowest individual for evading rules are difficult for
donors to solve. Reforms in the tax administration, (thanks to IFI conditionality as parts of
structural adjustment package and PGRF) as well as improvements in per capita incomes have
resulted in a very slow but continuous improvement of tax-GDP ratio over the years. This area
can improve further with an overall improvement in the capacity of the civil bureaucracy. Overall
improvement in the governance institutions of governance would be essential for ensuring that
the pressure for generating more revenue does not result in imposition of excessive burdens on
the honest individuals and the politically weak groups. Weak governance along with a pressure
for earning more revenues result in a tendency to spare those individuals who can bribe the tax
men or can use informal connections with the political or administrative high-ups.

Besides good macroeconomic management (i.e., low deficits, sustainable debts and low
inflation) analysts have praised the composition and targeting of the public expenditure (Temple,
2004; Ahmed, 2004). Public expenditure has been termed pro-poor even with lot of systemic
inefficiencies. The pro-poor bias of the budget is perhaps a combination of a humanitarian focus
of international donors and a democratic polity with clientilist tendencies. Natural disasters and
poverty of Bangladesh has received a great deal of international attention and hence poverty
focused projects have received greater donor funding. It is rational for government agencies and
NGO’s to focus on those projects that are likely to draw maximum donor funding. Moreover, as
Sen and other economists (Quibria, 2004) as pointed out that democracy and a free press is the
most potent weapon for fighting famine and other worst form of human sufferings, Bangladesh
democratic polity and free press has had positive influence for a pro-poor bias of public
expenditure. This bias is not contradictory to clientilist government since with a pro-poor focus
government can award the procurement contract to favorite individuals and groups while
satisfying the donor concerns at the same time.

19
In addition to IMF monitoring, a sustained fall in the velocity of money, which is yet to be
explained, has also been responsible for the low rates of inflation with a increasing growth rate of
money supply in recent years.
 Table 2.5.1: Some Facts on of Fiscal Sector Performance
FY81-90 FY91 FY92FY93 FY94FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02
Tax GDP ratio (%) 5.4 6.2 6.5 7.3 7.1 7.9 7.3 7.9 7.7 7.4 6.8 7.8 7.8
Direct tax as % of tax Revenue 6.6 7.0 6.5 6.7 6.7 6.4 7.0 6.4 6.7 7.4 7.2 6.4
VAT as a % of tax revenue -- -- 21.6 27.7 28.1 29.5 30.6 31.5 31.3 30.27 31.6 31.5 31.7
Growth of revenue 14.1 15.4 21.7 16.2 11.0 15.7 9.2 10.5 9.5 4.9 8.4 13.2 14.5
Growth of Current Expenditure 17.7 8.5 8.1 7.7 7.5 12.6 14.7 6.1 15.7 15.6 10.0 12.0 9.8

Social Sector Expenses as a %

of total public Expenditure 18.53 20.4 22.2 23.5 25.9 24.7 25.4 24.7 23.9 23.7 23.8 23.9

Share of Domestic Finance in

ADP (%) 25.0 26.2 35.8 43.0 42.3 48.9 45.3 41.5 49.5 52.4 48.7
Growth in M2 (%) 21.6 12.1 14.1 10.6 15.4 16.1 8.3 10.8 10.2 12.8 18.6 16.6 13.1

Table 2.5.1 presents some measures of fiscal performance in the 90’s under two
democratically elected regimes (i.e., the 91-96 period was ruled by BNP while the 96-01 period
was ruled by AL. It is evident that tax-GDP ratio has increased in the 1990s. Share of public
expense on social sector has increased over time. While growth of public revenue was lower
than the growth of current expenditure throughout 80’s, revenue growth rates started exceeding
growth of current expenditure. Dependence on the foreign aid also has been substantially
reduced as evidenced by increased shared of internal financing of Annual Development Plan
(ADP).

Although in terms of manifesto and explicit pronouncements there seems to be almost no

difference between the two major political parties, BNP and Awami League, the fiscal picture
reveals interesting difference between the two parties. Donor advice and conditionalities were
more readily accepted by the BNP government and the fiscal balance did mark an improvement
during the BNP regime (1991-1996) and again (2001-present). AL has demonstrated more
confidence on its own group of left leaning intellectuals with a preference for bigger government
and less respect for donor prescriptions. AL tried to satisfy its supporters with more recruitment
in government jobs and dishing out more purchase contracts to its favored group of businessmen
(or commission agents) often disregarding financial balance situation and ignoring warnings from
the donor agencies. Although BNP has shown identical tendencies20 but it has demonstrated less
confidence on the left leaning intellectuals and has been more willing to listen to donor advice.
By succumbing to extreme clientilist pressures within the inner circle of power Awami League
went on spending hard cash on expensive defense items such as Mig-29 and frigates with no
apparent disregarding the donor warnings. Disregard for donor warnings resulted in reduced
flow of foreign aid leading to precariously low levels of foreign currency reserves at the end of
Awami League’s tenure. BNP government’s assurance to satisfy donor conditionalities and
demonstration improved fiscal performance have resulted in greater inflow of foreign aid
bolstering foreign exchange reserves in the recent years. This kind of reluctance of grass roots
based political parties to implement donor prescriptions and the relatively more faithful
implementation by the ones with military and autocratic roots while none really understands and
owns these packages could explain why military governments were favored by some intellectuals
in the past.

20
All political parties that have been in power have demonstrated very similar clientilist
tendencies. The predominant mode of distributing clientilist favor has been family ties and
relationship established through informal and illegal financial transactions (i.e., bribes and
campaign contributions).
 The importance of planning by the IFI about appropriate packaging and clustering of
reform programs is hard to overemphasize, especially because the capacity to understand the
objective of reforms and adjust it to the local circumstances is scarce among the administrative
personnel responsible for implementation of reform programs. While we have mentioned the
packaging of VAT with reduction in import tariffs as an instance of right clustering there is at least
one instance of inappropriate packaging of reform measures. Recently under Poverty Reduction
and Growth Facility (PRGF) program, IMF asked the government of Bangladesh to set up an
independent debt management office. One of the authors of this report was asked to write a paper
on debt management strategy for the ministry of finance as a consultant. It was found that
currently the BB, the central bank, automatically monetizes the debts incurred by the government.
There is no plan in the horizon that government would either give any independence to the central
bank or put any limit on automatic debt monetization. Under these circumstances, it is difficult to
see the productivity of the aid money that is spent on creating a separate debt management office
with several officers and staff, with practically nothing to do. There was no one within the
government to question the use of setting up such an office, since aid money enables the
government greater discretion at least in the short run.
 Chapter III

Aggregate Economic Performance and the Issues for

Institutional Reforms

In this chapter we first discuss the aggregate performance of the economy in relations to
the reforms in the areas discussed above. Next we discuss the institutional context of the
structural reform and implications for second generation reforms. We then discuss the This
chapter is divided in two sections. Section 3.1 narrates the aggregate economic performance
and section 3.2 presents summary and conclusions of the paper.

3.1 Reforms and Aggregate Economic Performance

While explaining the history of economic growth in Bangladesh, Mujerie and Sen (2002)
classified the growth dynamics in four phases (Box 3.1.1). According to their scheme, ensuing
macroeconomic crisis in the 1980s led to the compulsion for undertaking a range of stabilization
program at the end of 1980s. Implementation of these programs resulted in a new phase of
development during the period of 1989-93 that may be termed as “formation of favorable initial
conditions” in terms of improved macroeconomic fundamentals and also improvements in
educational attainments. The subsequent period exhibited much improved performance both in
terms of higher economic growth and faster pace of social development. Mujerie and Sen’s
approach is based on simple judgment about observed growth rates that nevertheless seems to
be a convenient periodization for organizing the observed growth experience.

Box 3.1.1: Periodizaion of Growth in Bangladesh

• Up to 1981/82: Period of reconstruction and recovery amidst political turbulence21
• 1982/82-1988/89: Period of slow economic growth with growing macroeconomic
instability
• 1989/90-1992/93: Period of crisis driven economic reforms and formation of favorable
“initial conditions” (i.e., macro stability)
• 1993/94-1999/00: period of higher economic growth and faster social development
especially in the rural areas

Source: Mujeri and Sen (2002)

Table A2 in the appendix shows that current account balance, gross budget deficit, and
inflation all came down to a low level by the early 1990s. Real exchange rate also came close to
unity during this period (Rahman and Basher, 2001). Thus, the country achieved notable
macroeconomic balance during the early 1990s. The country also had notable achievements in
social indicators of development (appendix table A1) by this period. The period was followed by a
higher rate of growth, although the growth rate did not reach very high levels.

We attempted to find a structural break on the trend growth path of GDP and
investment. According to our estimates, FY 1992 appears as the structural break point in the

21
Starting from mid 70’s till the establishment of the institution of caretaker government in 1991,
the threat of a cycle of military coups and counter coup always haunted the political scene.
trend growth path of GDP, and FY 1994 appeared is the break point for trend growth path of
industrial GDP. Structural break in the trend growth path of investment appeared at 1990 (table
A4)22. Thus, it seems that macroeconomic stabilization and trade liberalization created a pre
condition for achieving higher economic growth. Slow progress in educational attainment and
improvements in other social indicators and perhaps unaccounted transmission23 of higher Indian
growth and liberalization around the same period could also play an important role in fostering
growth rate in the subsequent period after stabilization.

Table 3.1.1: Test of Structural Break in the Trend Growth Path of Macro Variables
Break point in the F-statistics Period
trend growth path considered
GDP 1992 112.75 1982-2001
Industrial GDP 1994 20.17 1982-2001
Investment 1990 36.56 1982-2000

Inflation rate could be a comprehensive indicator of macroeconomic stability in a least

developed country like Bangladesh. We estimate a simple model of inflation incorporating both
structural and monetarist factors. The model includes growth in M2/GDP ratio and the food gap
as a percentage of total consumption as the regressor.24 Estimated regression results is reported
in table 3.1.2. Both the variables appear statistically significant. It is important to note here is
that the inflation rate in the 1990s is lower than that of earlier periods by about 2.5% even after
controlling for the usual determinants of inflation. The negative coefficient of the dummy
variable substantiate further that the reform measures of the 90’s has successfully contributed in
bringing price level stability.

Table 3.1.2: Inflation in Bangladesh

Dependent Variable: Inflation measured by GDP deflator
Model 1 Model 2
Intercept -0.053 2.86
(-0.05) (2.09)
Growth in (M2/GDP) 0.334 0.239
(6.07) (4.08)
Food-gap as a % of its 0.239 0.186
requirement (3.79) (3.22)
Dummy for the period -2.479
after 1990 (-2.73)
Adjusted R-Square 0.70 0.78
Durbin-Watson 1.74 2.38
Source: Authors estimate with data from different sources

While stabilization had been important for growth, donor conditionality and IFI
monitoring appears to be the strongest influence against unsustainable pattern of public
spending and the resultant macroeconomic imbalance. Successive governments, especially those
with military roots (e.g. BNP, and Ershad’s Jatiya Party) have, so far been more effectively

22
We tried to find out the structural break in the trend growth path for the period FY 1982 to FY 2002 by
conducting an F test considering all possible years for structural break. F statistic attaints is highest value
when 1992 was used as the break point.
23
In addition to formal trade Bangladesh has significant informal trade with India which is
estimated to be several times the volume of formal trade (Rahman and Rahman, 2001).
24
In Bangladesh expenditure on food counts a lions share of household budget and increase in food price
have strong affect on price index. Hence, food gap is used as a determinant of inflation in our regression
model.
constrained by the IFI’s to from rapid fiscal monetary expansion. As the influence of donors
decline due to decline in the volume of aid and improvement in governments confidence in
domestic resources, there is little institutional safeguard or political reason to hold the
governments from engaging in unsustainable public spending. So far the donors have been very
influential because governments had to restrain spending as a condition for obtaining balance of
payment support, in future if donor influence decline, improvement in the quality of political
leadership would likely be the most important factor for maintaining fiscal discipline.

Some positive features associated with the economic growth in the 90’s deserve
attention. First, increase in growth rate in the 1990s was associated with both capital growth
and growth in total factor productivity (Rahman 2003b)25. Second, investment rate increased in
the 1990s even after controlling for its determinants (Rahman 2003a)26. Third, as we have just
mentioned, inflation rate was lower even after controlling for its determinants. At the same time,
the period was associated with faster pace of development in some social indicators.

Hardcore poverty started to improve the 1990s. Absolute poverty started to decline from
the mid-90s. Disaggregated picture of poverty over rural and urban areas shows some
interesting patterns. Hardcore poverty started to decline in the rural areas since 1990s.
However, incidence of urban poverty virtually remained unchanged. Percentage of people below
the absolute poverty line in the urban areas has slightly increased over 1990s. This mixed
picture of poverty reduction despite an increase in growth is clearly consistent with the picture of
income distribution. In the early 1990s inequality (as measured by Gini-coefficient) had
increased. Thus, the period of reform coincides with increase in urban poverty, which implies
that a good number of people who are marginalized in the rural areas migrated to urban areas in
search of work.

Table 3.1.3: Incidence of Poverty and Inequality

1985-86 1988-89 1991-92 1995-96 2000
Percentage of people National 26.86 28.36 28.00 25.06 19.98
below hardcore Rural 26.31 28.64 28.27 24.62 18.72
poverty line* Urban 30.67 26.38 26.25 27.27 25.02
Percentage of people National 55.65 47.75 47.52 47.53 44.33
below absolute Rural 54.65 47.77 47.64 47.11 42.28
poverty line* Urban 62.55 47.63 46.70 49.67 52.50
Percentage of income National 2.81 2.64 2.58 2.24 2.40
earned by the poorest Rural 2.92 2.74 2.67 2.56 2.77
decile Urban 2.84 2.76 2.64 1.92 1.99
Gini co-efficient National 0.379 0.379 0.388 0.432 0.417
Rural 0.360 0.368 0.364 0.384 0.366
Urban 0.370 0.381 0.398 0.444 0.452
*Direct calorie intake method. Poverty lines for absolute and hardcore poverty in 1985-86 were estimated
based on 2200 and 1800 kcals respectively. Poverty lines in the subsequent years are based on 2122 and
1805 kcals respectively.
Source: Household Expenditure Survey, different issues.

Although growth rate accelerated in the 1990s, growth was has been lower than the
potential. During the early 1990s the IFIs opined that Bangladesh could be an emerging tiger in
South Asia. Empirical evidence have not supported such optimism. Trend growth rate increased
from 3.6% during FY 1981-91 to only 4.9% during FY 1991-02 as compared to the target rates
of 6-7 per cent. Although growth in manufacturing and the industrial sector was impressive in

25
See appendix table
26
See appendix table
the early 1990s, overall trend growth rate in the period FY 1991-02 could not reach the target
rates because of the lower growth of the manufacturing sector in the later years.

Sustainability of the recent growth performance remains questionable (Rahman, 2003)

for the following reasons. First, the process of industrial growth has been discontinuous as it fell
in the second half of 1990s. While GDP growth was propelled by manufacturing growth with a
stagnant agriculture during the first half of the 1990s, the growth in the second half of the 1990s
is accounted for by the impressive growth in agriculture with stagnant manufacturing. Lack of
stable pattern of growth in manufacturing lowers the confidence in the future sustainability of the
aggregate growth rate. Second, savings, investment, and private investment as percentage of
GDP have stagnated in the recent years despite after a noticeable growth in the early to mid
1990s. Third, growth accounting exercise shows that TFP growth (Table A9) decelerated in the
second half of 1990s, implying a declining of dynamism in the economy. Fourth, apparel sector
that accounts for about 25% of manufacturing value addition, 33% of manufacturing
employment, 20% of annual investment (Bhatacharya and Rahman, 2000), and has a strong
linkage effect on other economic activities will face a serious uncertainty after 2004 with
complete phasing out of MFA. Any deceleration of this sector will seriously affect employment,
investment, export and the growth of the manufacturing sector as well as of GDP.

Investment must be stimulated for accelerating growth. A recent survey by Bangladesh

Enterprise Institute (BEI) and the World Bank shows that investment climate is very poor
compared to other countries in Asia because of poor quality infrastructure, poor governance,
corruption, excessive intervention by bureaucracy, high cost of financing, economic policy
uncertainty, and lack of adequate skilled manpower (World Bank and Bangladesh Enterprise
Institute, 2003). Bank lending rates remains high reflecting high default-risk premium.

Figure 3.1.1

Savings and Investm enr as % of GDP

25
20 SAV
15
INV
10
5 PRIVINV
0
19 81

19 84

19 87

19 90

19 93

19 96

20 99

2
-0
-

-
-

-
80

83

86

89

92

95

98

01
19
 Figure 3.1.2

Annual Grow th Rate of Investment at constant price

25
20
15
INV
10
PRIVINV
5
0
-5
19 2

19 5

19 8

19 1

19 4

19 7

20 0

3
-8

-8

-8

-9

-9

-9

-0

-0
81

84

87

90

93

96

99

02
19

3.2 Issues for Reforming Institutions of Governance

There is a widespread consensus that Bangladesh has a great potential to achieve far
greater successes in economic and social fronts but reaching its potential is contingent on
ensuring good governance. It appears as surprising to many that in terms of social indicators
Bangladesh has surpassed India, although in terms of good governance Bangladesh lags far
behind.

The major institutions of governance of Bangladesh was inherited from Pakistan which
inherited those institutions from the British colonial administration27. The positive about
inheriting these institutions was that these institutions are suitable for supporting a very efficient
governance with a market based economy. Unlike many other TCs where these institutions had
to be built from scratch, Bangladesh could use these organizations with little modifications.
However the trouble with these institutions was that these were built a very astute group of
statesmen with a very clear purpose of holding the people of colonized under the rule of the
mother country not for serving the people of the colony. It has been noted by historians that
when the British left India, the leaders of both Pakistan and India scrambled to fill the positions
left vacant rather than embarking on the job the job of re-orienting the those institutions to serve
the needs of the free countries.

The colonial government ruled the country with a civil bureaucracy manned by extremely
well-educated well-trained and knowledgeable and well-paid officers with lot of powers vested on
them. During the colonial days native youth who received modern education dreamed to obtain
a lower level job within the civil administration. National politicians who were elected to office as
ministers under the British rule longed for some authority to distribute these lucrative jobs to the
steadily increasing number of educated youth who did not find jobs due to a stagnant economy
under the British rule. After the independence of India and Pakistan, while in India the civil
bureaucracy maintained its grip on the administrative affairs of the country, in Pakistan the

27
The civil bureaucracy, the military, the judiciary, can be cites as being the most important
institutions of governance left by the British colonial government. The legislative branch of
government is built in the model of British Parliamentary democracy
military overtook the leadership due to better pay and training, thanks to generous aid from the
US for the Pakistan military during Johnson administration. After the independence of
Bangladesh, the leadership demonstrated little understanding or regard for maintaining the
quality of this very important institution. In addition to the lack of respect for among the
leadership of the new country for the rules and laws governing those institutions there was
severe scarcity of quality personnel to fill the gap. While jobs were given to political cadres in
these institutions the nominal salary was hardly adjusted with the spiraling inflation. While the
private sector adjusted prices and salaries with changes in the general price levels public sector
salaries got depleted in real terms. As a result subsequent generations of educated youth no
longer considered public sector job as their best possible option, their first option became
migration to foreign countries or obtaining an opportunity in the private sector. Although many
other countries face similar problem, Bangladesh’s civil service has become almost dysfunctional
giving rise to a long tradition of corruption and rent seeking as the most practiced business by
anyone possessing some of power in the government. The erosion of capacity and integrity of
the civil service serves imparts further legitimacy to the clientilist politicians for using
discretionary directives as the predominant mode of governance.

While the governments have used the institution of civil bureaucracy as a tool for
clientilism and weakened it considerably, the military has remained relatively well organized and
less corrupt. A major reason for the military to maintain it integrity was that the recruitment in
the military always remained strictly professional and even during military rule chain of command
was not broken and discretionary powers were enjoyed only at the top level. The military also
maintained relatively better salary and benefits. During the elections under the caretaker
government the military has performed a highly appreciable role of being a neutral law
enforcement agency. When minor elections are held under a partisan government candidates
who are not favored by the ruling party invariably calls for military presence since the home
ministry administered police force has never been able to act without being influenced and
corrupted. Reformation of governance in Bangladesh could well use the organization of the
military of as a model for re-organizing various organizations of civilian wings of the government.
The current ruling government has achieved considerable success in improving the deterioration
of law and order situation by constituting a new police force titled RAB (for Rapid Action
Batallion) by using the organization of the military as its model28.

Although democracy in the sense of electing the heads of government has been
established, the expectation of the common masses suits a clientilist system. The identity of the
main leaders, (i.e., being the daughter and widowed wife of two previously slain leaders) and
their main political capital, (i.e., public sympathy for being slain while at top of government),
reflect the utility of exploitation of popular sentiments and irrelevance of profound debates about
policies for winning elections. The general masses expect the leadership of the state to be kind
and benevolent monarch who distributes clientilist favors. There is little understanding of the
issues of rule of law and constitutional limit on the government even among a good proportion of
the educated population. As a consequence, all government authorities are consolidated in the
hands of the person of the prime minister and her family members or whoever can claim close
personal ties with the prime minister or her/his family.

The election potential of a member of the parliament is dependent upon how much
clientilist favors one can promise to the influential constituents. An aspirant for the elected
offices has to buy votes by giving paying money either directly to the poor constituents or to

28
However, the scope of using the organization of the military may be rather limited
while more attention need to be focused on creating the demand for autonomous institutions
where heads of the government could be held accountable.
individuals with influence who can guarantee a certain number of votes. When he gets elected
he must be compensated by ensuring some rents for himself. He has to arrange procurement
contract for the businessmen who contributes toward his campaign. He has to promise jobs in
the public sector or in the private sector by using his personal influence. This pressure leads
government to expand public sector jobs which are low paying but secured and vested with a lot
of discretionary authority. These low paid workers in the public sector with legal and illegal
discretionary authority in turn engage in activities to create rents for themselves. Political
workers who are engaged in extortions and other rent seeking activities usually enjoy benign
neglect from the poorly paid and often corrupt police department. This process is a result of lack
of demand for formal rules from the poor and illiterate electorate.

The pressure on the political government for distributing clientilist favors is also major
reason why governments, have generally been slow to give up control over state owned
enterprises. We have seen that after being ‘a champion performer in the area of divestiture’ in
the early 80’s Bangladesh has become the slowest country in the South Asia region in the area of
divestiture and privatization. As the opportunities for distributing public sector jobs are shrinking
and private sector activities are expanding, political governments must ensure that they have
enough discretionary authority for harassing or favoring the private sector so that clientilist favor
can be distributed through the private sector. Once a private sector enterprise becomes big
enough through carefully cultivating good relationship inside the government agencies and
bureaus who apply government laws and policies ‘selectively’, a symbiotic relationship grows
between governments and the particular enterprise. A symbiotic relationship between the
government and the enterprise with all the right contacts ensures that the particular business will
find it extremely easy to start operation in any new area. This established enterprise in turn will
honor any request for political contributions of various kinds including employment of a relative
or a political cadre from well placed politicians or government officials. This symbiotic
relationship between established enterprises and government explains why all established
businesses in Bangladesh operate in numerous lines of businesses while ordinary people and
foreign investors find it extremely difficult to start a new business without customized29 help from
government or one that have already established the right connections. These ‘group of
companies’ not only have easy access to credit from government owned banks30 with leniency
shown in the even of default, customized interpretation and application of laws in their favor and
against their competitors. The abuse and the selective use of laws create resentment among the
population against all laws and regulations and authority in general that are cleverly manipulated
by parties in opposition for organizing disruptive political protests termed ‘hartal’.

In a poor country like Bangladesh, the subtle mechanism through which rule of law and
justice translate into long term growth for the whole society has proven to be too subtle general
population, officials, politicians and the civil society. The direct interventionist method through
government and NGOs have received lot more attention and support. The greater social
appreciation and understanding of the interventionist measure could explain why Bangladesh
governments as well as the NGO efforts in Bangladesh could achieve relatively better success in
their interventionist programs. However, an alternative explanation for success in interventionist
programs in health, sanitation and education for the poor could also be an outcome of the need
to maintain the stability of a clientilist system. In this system an equilibrium could result from
deliberately keeping weak bureaucracy while keeping an easy exit for the competent individuals
to seek employment abroad, weak legal and justice system for facilitating the use of private

29
It means that one cannot surf the government offices without some special efforts. Automatic
mechanism that treats all individuals equally is non-existent.
30
Often they have their own banks and government’s discretionary authority ensures that private
banks will honor requests from government high ups.
sector as instruments of clientilism at the same time safeguarding the legitimacy by improving
welfare of the poor through interventionist programs.

The fact that Bangladesh’s macroeconomic management has earned praise appear to run
counter to the clientilist nature of the polity. It seems that extreme poverty of the population
that has kept the level of material aspirations quite low may explain this apparent contradiction.
Very little money is required to buy votes of the poor people during elections, and expenditure of
relatively little resources on the locally influential individuals have so far proven enough.
However as the poverty situation improves and people’s expectation level increases over time,
macroeconomic balance would be difficult to maintain. However the absence of
institutionalization of excessive spending leaves scope for institutionalization of rules for
responsible spending. However like every other aspect of good governance achievement of this
goal is also contingent on the improvement in institution building of the general polity.

3.2 Concluding Remarks

The liberalization moves in agriculture along with donor assistance helped Bangladesh to
come out of the shadow of famine and achieve food self-sufficiency. The massive
denationalization of the early 80s, never carefully planned and as a result wrongly sequenced,
nevertheless resulted in giving unmistakable signal to the private sector to release its energies.
The trade liberalization moves that was carefully packaged by the IFI’s along with several fiscal
reform measures resulted in very positive outcomes. Although outcomes of these reforms have
been impressive, the reforms have been termed as easier ones(Ahmed, 2004) and insufficient to
put the country on a path of sustainable high quality growth that is within its potential.

One of the major questions to be addressed by the URP project is whether good policies
create good institutions. In Bangladesh, the problem seems to of institutionalization of any
policy, either good or bad. It has been easier to produce good actions, and sometimes quite
bold, from the government because not even bad policies are institutionalized. Huge
discretionary power in the hands of the government explains why IFI’s often become so
successful in actions requiring bold executive orders but continues to fail in ensuring continuity
and implementation of rules and policies written on paper. Donors have voiced, often with the
medium of donor funded civil society organizations, the demand for autonomous institutions
where government heads could be held accountable. While the institution democratic elections
have taken hold easily, institutions for holding elected government accountable are, at present,
either non-existent or ineffective.

Even without improvements in capacity for institution making and success in the second
generation of reforms, we may nevertheless observe continuation of the current level of growth
of GDP around 5%-6% in the future due to catch up effect, improvements in education and
infrastructure, and increasing globalization and growth spillover from neighboring countries.
Poverty reduction and human development may still continue via interventionist measures.
Capacity to build institutions for delivering good governance would be necessary for the country
reach its growth potential but more importantly for creating the confidence that the growth
process is just. One can hope that the understanding the importance of the need for such
reforms will permeate in the society without requiring another crisis.
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 Appendix:

Table A1: Indicators of Human Development

1980 1990 2000*
Poverty headcount rate (percent), upper poverty 58.8 49.8
line
Life expectancy at birth (years) 56.9 56.0 60.6
Gross primary enrolment Ratio (percent) 61.0 72.0 97.5
Gross secondary enrolment Ratio (percent) 18.0 19.0 42.0
Adult illiteracy rate (percent) 71.0 65.0 55.0
Fertility rate (birth per woman) 5.0 4.3 3.0
Infant mortality rate (per 1000 live births) 101.4 94.0 66.3
Crude birth rate (per 1000 people) 33.4 32.8 19.9
Crude death rate (per 1000 people) 10.2 11.3 4.8
Source: World Bank, * some data are for 1999

TABLE A3: TRENDS IN MACROECONOMIC BALANCES: FY86-FY02

(PERCENTAGE OF GDP AT CURRENT MARKET PRICE)

FY86-90 FY91 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02
Saving-Investment
Investment 15.6 16.9 17.3 17.9 18.4 19.1 20.0 20.7 21.6 22.2 23.0 23.1 23.2
Of which: Public 6.6 7.0 6.5 6.7 6.7 6.4 7.0 6.4 6.7 7.4 7.2 6.4
Private 10.3 10.3 11.5 11.8 12.4 13.6 13.7 15.3 15.5 15.6 15.8 16.8
Gross National Savings 16.9 19.7 19.3 18.2 18.8 19.3 20.2 21.6 21.8 22.3 23.1 22.4 23.4
Gross Domestic Savings 11.9 14.6 13.9 12.5 13.1 13.3 14.9 15.9 17.4 17.7 17.9 18.0 18.2
Fiscal Balance
Total Revenue 6.5 7.6 8.3 9.1 9.2 9.8 9.2 9.6 9.5 9.0 9.0 9.6 10.2
Total Expenditure 12.1 13.6 13.0 13.0 15.0 14.4 13.9 13.3 12.9 13.6 14.5 14.8 14.9
Overall Budget Deficit:
of which -5.6 -6.0 -4.7 -3.8 -5.8 -4.6 -4.7 -3.7 -3.4 -4.6 -6.1 -5.1 -4.7
Net Domestic Financing 0.6 1.9 1.2 1.8 0.7 1.8 1.5 1.6 1.9 2.8 2.8 2.6
Balance of Payments
Trade Deficit -7.2 -5.7 -4.9 -5.3 -4.9 -6.2 -7.3 -6.5 -5.4 -5.9 -5.6 -6.1 -5.4
Current Account Balance -2.8 -3.9 -0.4 -0.8 -0.3 -1.8 -2.3 -1.3 -0.6 -0.9 0.0 -2.2 0.5
Inflation rate (based on CPI) 7.8 6.4 3.6 3.0 5.3 8.5 4.1 1.7 7.0 8.9 3.9 1.7 2.4
Source: Bangladesh Bank, BBS, IFS Yearbook
 Table A4: Growth Accounting
1981-91 1991-96 1996-01
Growth % Contribution Growth % Contribution to Growth % Contribution
to GDP Growth GDP Growth to GDP Growth
GDP 0.0361 0.0454 0.0535
Capital 0.0394 53.5% 0.0498 53.7% 0.0687 62.8%
Worker 0.0252 35.6% 0.0170 19.1% 0.0154 14.7%
TFP 0.0039 10.9% 0.0124 27.2% 0.0120 22.5%
Source: Authors own calculation. Labor share is estimated as 0.51 based on data on
employment and wages in different labor force survey. Capital data is taken from Rahman and
Rahman (2002).

Table A2: Export Performance of Bangladesh

YEAR TOTAL EXPORT OF Annual Growth Average

BANGLADESH Rate Growth Rate
(IN MILLION US$)
1983-84 811.00
1984-85 934.43 15.22% 17.09%
1985-86 819.21 -12.33%
1986-87 1076.61 31.42%
1987-88 1231.20 14.36%
1988-89 1291.56 4.90%
1989-90 1923.70 48.94%
1990-91 1717.55 -10.72% 13.65%
1991-92 1993.90 16.09%
1992-93 2382.89 19.51%
1993-94 2533.90 6.34%
1994-95 3472.56 37.04%
1995-96 3882.42 11.80% 10.73%
1996-97 4418.28 13.80%
1997-98 5161.20 16.81%
1998-99 5312.86 2.94%
1999-00 5752.20 8.27%
2000-01 6467.30 12.43%
2001-02 5986.09 -7.44%
Source: Export Promotion Bureau, Bangladesh