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Why is Bangladesh Outperforming Kenya? A Comparative Study of Growth and its Causes since the 1960s

Working papers

This paper compares and contrasts the growth performances of Bangladesh and Kenya over the period 1960-2000. It seeks to establish the reasons why Kenya's initially rapid growth in per capita income began to falter in the 1980s, and turned negative in the 1990s, and why that of Bangladesh has recently risen consistently, after a period of decline in the 1970s. It also seeks, by comparing developments in these two countries of similar per capita income, poverty and social indicators, to throw light of more general interest on growth processes in low-income developing countries. It asks, in particular, how and why the economic performances of two countries with similar reputations for corruption have diverged. Main conclusions

The paper draws the conclusion that no simple explanations suffice to explain the divergences in the two countries' performance. Political and institutional factors have impinged on production incentives both directly, by shaping the perceptions and expectations of investors and producers, and indirectly via their influence on the conduct of those facets of economic policy to which producers and investors are most responsive.

In the 1960s and 1970s Kenya's rate of GDP growth was close to 7% p.a., significantly faster than the average of a little over 2% p.a. achieved in the same period by Bangladesh. In the 1980s and 1990s the order was reversed, with Bangladesh's economy growing at nearly 4.5% and Kenya's at only 3% p.a. Over the most recent decade the difference widened as Kenya's growth rate sank to 2% p.a. In terms of per capita income Kenya was poorer than Bangladesh in the 1960s, then overtook it in the 1970s, but is now some $60 poorer.

Bangladesh's mediocre performance in the 1960s and 1970s can be ascribed in large part to the political circumstances first of its subordinate position as the East Wing of Pakistan and then of the turbulence that accompanied and followed its struggle for independence. Its subsequent and unexpected economic revival and expansion reflected the benefits from the point of view of enterprise development of relative economic and political stability and predictability, restraint in public expenditure, progressive (if tardy) economic liberalisation and trade and exchange policies that maintained external competitiveness. Bangladesh made significant (if still inadequate) progress in human capital development at low cost. These conditions facilitated the accumulation of indigenous private sector capital in the very successful export-oriented garment industry, and the implementation of a 'Green Revolution' in rice production. They enabled Bangladesh to survive the decline of the world market for its former staple exports, jute and jute textiles, and to redeploy its resources in line with its comparative advantage. Producers' incentives were sufficiently strong for them to overcome the well documented deficiencies of the business environment; namely, extensive corruption, an inefficient bureaucracy, power shortages and poor infrastructure.

Kenya's overall commendable growth record in the first two decades of independence is associated with simultaneous progress on several fronts. In agriculture production of maize for the home market increased with the wide adoption of hybrids, export-oriented production of coffee and tea expanded and horticulture began. Manufacturing grew with foreign investment for import substitution, taking advantage of the markets in the neighbouring East African Community countries. Tourism emerged as a major foreign-exchange earner. And there was a major expansion in public services, requiring large continuing fiscal outlays. With external financial support, Kenya weathered the storm of the oil crises and other terms-of-trade shocks of the 1970s without loss of momentum.

Kenya's growth momentum faltered in the 1980s and was lost in the 1990s as the result of a combination of factors which tarnished the country's image as a location for business expansion and as a growing force in commodity exports. These factors included inept macroeconomic management, episodes of inflationary instability, mounting public debt, the botched implementation of (extensive) economic liberalisation and institutional reforms, the effects of physical insecurity on tourism, worsening corruption at all levels and the extension of cronyism in the formal private sector. Import competition, following liberalisation in the 1990s, contributed to the decline of manufacturing industries formerly established behind protective barriers. Agricultural marketing liberalisation was followed by faltering maize and coffee production as producer incentives weakened. The disorderly macroeconomic adjustment of the 1990s - accompanied by falling public expenditure, declining real wages and worsening services - was made more painful because some external financiers withheld their support.

Methodology

The method of enquiry adopted in the paper is eclectic. Taking its cue from the empirical literature on the causes of growth, the paper makes pair-wise comparisons covering a range of possible influences on growth performance - sectoral, macroeconomic, fiscal, external, institutional and geographical. Econometric methods are used to help identify significant factors and turning points. Factors common to both countries are not explored in depth.

Comparative performance

Salient points of economic difference and similarity have been:

# Savings, investment and public expenditure. Bangladesh's domestic savings were very low for many years, and have only risen towards 20% of GDP in the later 1990s. Public expenditure as a share of GDP has been uncharacteristically low for a low income country. Investment has risen above 15% of GDP only since 1990. Some two-thirds of it, however, have been in the private sector. In Kenya, rates of saving and investment have been high by the standard of low-income countries, though both have fallen sharply in the 1990s. The share of public expenditure in GDP has been exceptionally high for a low income country. Some 40% of investment expenditure has been in the public sector.

# Trade. In both countries the share of exports in GDP declined in the 1960s. The decline persisted until the late 1980s in Kenya. Kenya lost world market share for its coffee exports, but was able to increase its presence in export markets for tea and horticultural products. Bangladesh's export decline was reversed in the 1970s, in spite of the shrinking market for jute and jute products. In the 1990s there was rapid real export growth, notably through the expansion of exports of garments.

Both countries have liberalised their trade and exchange policies. Both accepted IMF Article VIII (current account convertibility) obligations in 1994. Bangladesh remains more protectionist and restrictive on payments. However, the legacy of its pre-independence association with Pakistan left Bangladesh with a specialisation in export-oriented activity - the manufacture of textile products - for which it had comparative advantage. In Kenya, regional free trade, initially with the East African Community and now with COMESA, encouraged diversification into manufacturing where it has no international competitiveness. Under the influence of exports of manufactures, Bangladesh's economy has become steadily more open to trade since the mid-1970s. Kenya's economy, in contrast, experienced a declining trend in its trade/GDP ratio from the 1960s which lasted until the late 1980s.

# External financing. Bangladesh's resource gap shrank from 10% of GDP circa 1980 to 5% of GDP in 2000. It has been financed by an inflow of remittances which increased steadily to some 4% of GDP by 2000, and by concessional financing from donors, which has recently diminished from 6-8% to around 2% of GDP. Bangladesh's external debt is very largely concessional.

Kenya's resource gap has also at times been very large - close to 10% of GDP in the period 1978-81 - and was still in excess of 5% of GDP in the late 1990s. Remittance inflows were insignificant until 1995, since when they have amounted to almost 5% of GDP. Kenya borrowed heavily on non-concessional (as well as concessional) terms to finance its public expenditure in the 1970s and 1980s, raising its debt-service/export ratio to a peak of nearly 40%, and precipitating payments difficulties. Inflows of aid and other sources of external finance have been volatile, leading to large swings in foreign-exchange reserves.

# Human resources. Bangladesh has a population more than four times the size of Kenya's, but it has a lower dependency ratio as population growth has been slower. Population growth rates have fallen decisively in both countries to less than 2% p.a. Enrolments in education and rates of child mortality have improved in both countries, but Bangladesh's indicators, formerly worse than Kenya's, are now superior, following rapid recent improvement. In Kenya life expectancy began to decline in the 1990s, but the labour force remains better educated than in Bangladesh, thanks to an earlier lead in school enrolments. Labour force skills - measured by the average number of years of schooling of the working-age population - have increased in both countries by 6.25% p.a.

Causal factors

The most prominent factors explaining the divergent patterns of GDP growth and international competitiveness have been:

# Factor accumulation. The accumulation of physical and human capital has played a significant part in promoting growth in both countries, but not consistently so throughout the period. In Bangladesh physical capital accumulation (or the absence of it) significantly explains the pace of growth at all times, but human capital accumulation contributed detectably and unambiguously only prior to 1980. In Kenya physical - but not human - capital accumulation affected the rate of growth over the whole period, and particularly in the first half; in more recent years both physical and human capital played a significant role but one which was weakened by the adverse effects of shocks and instability on growth.

Empirical evidence indicates that investment in physical capital has risen when domestic savings have been higher. In Bangladesh, inward remittances have also raised investment. In Kenya, investment has been lower at times of high interest rates and falling terms of trade.

# Total factor productivity growth also varied between sub-periods: it was high in Kenya before 1980, and positive in Bangladesh after 1980, but at other times it was nil or negative. Marginal returns to factors were positive at times, but negative at others. In other words, there were forces at work, other than factor accumulation, affecting growth outcomes.

# Macroeconomic policies and management. Although both countries have pursued similar structural adjustment policies of hesitant domestic market liberalisation, more thoroughgoing liberalisation of trade and payments and real exchange-rate depreciation, differences in macroeconomic and fiscal management have been profound. From the late 1970s to the mid-1990s Bangladesh followed policies of low public expenditure, low taxation and minimal domestic borrowing. Inflation fell in the 1980s and has remained low in the 1990s. Interest rates remained steady and fairly low.

Kenya's macroeconomic management has been more erratic. Public expenditure, taxation and employment have been high. The large public payroll raised formal sector wage levels. There has been continuous domestic financing of the fiscal deficit, at times on a very large scale, causing prolonged episodes of relatively high inflation (over 15%) and high and variable nominal interest rates.

Econometric evidence indicates the positive contribution of price stability to growth in both countries - and the negative effect of inflation.

# Exports. Fitted growth equations show that export expansion has contributed to economic growth in Bangladesh throughout the period. In Kenya it had no significant effect on aggregate growth during the early period of fast growth, when the real export/GDP ratio was falling, and has only exerted a weak influence on growth during the more recent period of inferior performance.

# Institutional and governance factors. Both countries are now once again multi-party democracies, having experienced periods of authoritarian rule. Kenya has been politically more stable and less prone to acts of violence than Bangladesh.

The quality of public institutions has declined over the years in Kenya, and confidence in them has fallen as corrupt practice has become more pervasive. In Bangladesh institutional effectiveness has never been high, but in some respects there has been strengthening. Corrupt practice has become institutionalised and predictable. Respected civil society organisations have complemented the action of public services. Surveys of local business opinion rate governance less negatively in Bangladesh than they do in Kenya.

# Competition. Cronyism and rent-seeking have characterised government-business relations in Kenya. This has raised entry barriers, diminished competition in business life and impaired international competitiveness. In Bangladesh, indigenous private enterprises have been predominantly small- or medium-scale. They have grown quickly in number - as in the ready-made garment sector - and have behaved competitively. This has increased the flexibility of the economy, and its ability to respond positively to external and internal income-earning opportunities.

# Labour and transport costs. Labour costs in manufacturing have been lower in Bangladesh than in Kenya. In Kenya, formal sector wage rates and labour costs in US$ terms rose in the 1970s and 1980s due to growing public-service employment, but then declined in the 1990s. There was no equivalent increase in Bangladesh. International sea freight transport costs have, until the late 1990s, been markedly higher in Kenya than Bangladesh. Inland road haulage rates remain higher, because haulage is more cartelised, in Kenya than in Bangladesh.

# Agriculture. Bangladesh's long stagnant farm sector experienced accelerating growth starting in the later 1980s, due in large part to the widespread and successful implementation of Green Revolution technology, accompanied by the liberalisation of prices, input supply and marketing. Kenyan farmers raised maize yields in the 1970s and 1980s by adopting hybrid varieties, but have had no successor productivity-enhancing technology. Poorly designed and implemented marketing reforms contributed to falling maize and coffee output in the 1990s. Tea and horticultural exports, however, have continued to expand.

Implications

The paper, while noting that context specificity precludes firm prescriptions, draws some policy implications from the two countries' experiences. These include the importance of (a) patience and consistency in policy choice and implementation: maintaining stable and predictable macroeconomic and enterprise-related policies long enough for investor confidence to build and to overcome negative presumptions; (b) prioritising and fostering those institutions which support competition and competitive market conditions; and (c) tackling the logistical and fiscal impediments and distortions which prevent countries playing to their comparative advantage in trade.

John Roberts and Sonja Fagernas