Levelling the playing field and more

The first quarter every year is the reform talk time as the Finance Ministry engages in budgetary consultations with different stakeholders. A big elephant in the room is getting the playing field more levelled in industry and commerce. Currently, the field is too rough for the new and the unconnected to play not just against incumbents with first mover advantage but also umpires with interests in the results of the game. This may be a game changer when packaged with learning-based reforms in policy support to investments in innovation.

What level playing field means

An environment where participants compete under the same rules in dealing with each other and the government irrespective of whether they produce for domestic or foreign markets and insiders or outsiders, associate empirically with economic efficiency, innovation, and consumer welfare. Efficiency gains come from comparative advantage-based selection of production for domestic and external markets through markets where only the product quality and price matter in competition.

Rigged games are characterised by discriminatory policies applied with partiality by umpires who are also players in many instances. The most efficient do not necessarily survive, nor does the whole game collapse. It goes on even when widely perceived as rigged. Unlike in sports, quitting is rarely an option in the life of those caught on the wrong side of the livelihood game.

The role of the government is to establish nondiscriminatory rules and employ umpires who will apply them even handedly to both giants like "Messi" and "Haaland" and the many others unnoticed because they are not superstars. Without contribution from them, the team loses more often than wins. The games in the economic and political marketplace are much more complex, but generally fair umpiring goes with inclusive growth.

Symmetry in the playing field for domestic producers to produce for the domestic or foreign markets and keeping all industries open to contestability are as important in the present Bangladesh context as, for instance, the rationalisation of the import tariff regime. It is certainly important but cannot probably produce the intended results in the presence of, for instance, entry barriers in production, exports, and imports.

Markets do what they do

There is always a home turf advantage in trade as in sports. That does not prevent sports teams from playing away from home. The reason is simple. If all teams insisted on playing at home, there would be none to play against. Same applies to trade. If all countries produce for the domestic market, there can be no international trade. You don't have to be an economist to know this is a lose, lose proposition.

Import substitution is analogous to playing at home and exporting playing away from home. The two are not mutually exclusive. Every country produces for both the domestic and global market, notwithstanding several historical recalibrations of international trade relations. Level playing field is fundamentally not about whether to support domestic industries. It is about preferential treatment to some and not others by government policy.

In theory, the government can alter in good faith the incentive structure to favour either production for the home market or production for exports or both through taxation and subsidies or choose not to have either if there is no compelling evidence of market failures. History shows markets adapt to discriminatory policy preferences in ways, more too often than not, antithetical to the policy intent. The key to survival is "innovations" in relationship management to adapt to changes as the risk-reward relation changes with changes in public policy preferences. The race for survival can be virtuous or vicious depending on the quality of interaction between the market and the state in the provision of the rules for trading domestically and globally.

Governments in Bangladesh historically have attempted to do both import substitution and export promotion while discriminating between domestic market and export. History has played a predominant role in the evolution of trade policies. A major takeaway is that policy is not about "allowing" markets to direct their own investment or "let the government decide" where resources go. Governments make policy by design or default. Markets respond, including by attempting to reshape policy, "allowed" or not.

Seeing the unseen is assessing policy

Trade policy in Bangladesh has attempted to encourage production for the home market from the very inception and exports at least a decade and a half later. We have used tariff policy to restrict entry of foreign goods into the domestic market and a host of targeted subsidies and tax expenditures to encourage selling abroad. Tariffs produced revenues and export incentives increased government expenditures directly or through foregone revenues. The equation was financially not necessarily self-annihilating.

Profits from selling in the home market enjoy both the turf and the import tariff-cum-nontariff barrier advantage. Insulation of garments from the disincentive effects of these barriers through cash subsidies and duty-free imports resulted in a garment centric export base. Bangladesh saw manufacturing grow rapidly for domestic markets and exports. This is construed as evidence that the do it all with preference for the home market model has worked.

That at best is one side of Bangladesh's industrial policy coin. Large business groups benefit both from protection against imports and incentives for exports. While they are diversified, the economy has missed productivity and welfare increasing competition. Consumers pay higher prices for lower quality from the import substituting industries not particularly known for their significance as large employers either. Some have distinguished themselves as good paymasters to a relatively tiny percentage of the employed labour force in their capital-intensive outfits. Exports have done orders of magnitude better job creation, bringing women from home based work to the factories, but less well on job quality.

The World Bank's Change of Fabrics report last year documented some salient facts. Bangladesh is at the lower end of the mix between production for exports and domestic market. The exports share in GDP is well below countries at similar levels of development. The export structure is highly concentrated in terms of both products and markets. Of the top 20 export products in 2018, all but one belonged to the RMG sector. Services exports relative to GDP is only 5%. Despite being relatively well integrated into selected Global Value Chains in textiles/apparel, footwear, and transport sectors, too many new export entrants tend not to survive. The story these numbers tell is a story of missed opportunities.

Bangladesh can do better

The composition of exports matters in driving the economy. The low depth and breadth of Bangladesh's exports is attributable primarily to the perils of generalised barriers to foreign entry in domestic markets and targeted offsets to exports to make companies interested to sell abroad. High degree of protection has created an enclave for domestic industries who have become used to policy support no matter where they sell.

The national interest is to maximise the productivity of the economy. This is achieved when opportunities for reallocation of resources from one sector to the other to increase aggregate productivity are all exhausted. The existence of such opportunities implies the current allocation of resources and policy associated with it is inefficient. There is a general presumption, supported by evidence, that productivity in labour intensive exports not able to survive due to an unlevel playing field is higher because of scale economies, learning and consistency with domestic resource endowments.

This leads to the inescapable conclusion that the allocation of resources between production for home and exports is currently inefficient. Bangladesh's export intensity is well below the levels Bangladesh is capable of achieving if incentives are not distorted to favour domestic markets. There is money to be made out there by scaling down protection. But then those profiting from protection will make less money and they comprise an influential segment of the incumbents.

One survival strategy against efficient foreign competition is to appeal to nationalist sentiments. Floods of imports will cannibalise domestic industry is a narrative that resonates in rallying opposition to trade liberalisation. This narrative overlooks the growth in exports the import flood fertilises by releasing resources from inefficient uses for the domestic market.

Revenue loss is often cited as a compelling practical barrier against scaling down protection. This resonates in a country where the revenue GDP ratio is among the lowest in the world even as it is about to celebrate the 52nd year of its declaration of independence and despite high tariffs on imports or, perhaps, "because" of high tariffs on imports breeding protracted lethargy in tax reforms.

Rajan's point to ponder

Growing out of the infant industry mindset has historically proven to be highly inertial, speaking charitably. Capitalism can often be its own worst enemy when it gets used to freebies extracted from the many for the few through the state. Protectionism is one such freebie. Compensating influential exporters to mitigate the disincentive effects of such protection is a corollary. Bailing all of them out of the consequences from their own imprudent decisions follows as a derivative from both.

This points to a broader policy question, raised by Raghuram Rajan in the Indian context, worth mulling over. We elevate tariffs and subsidise industries hurt by the tariff. These incentives go towards the bigger, well-connected firms. There is an implicit benefit to scale as the government chooses the beneficiaries. If the tariffs and subsidies are removed, can the beneficiaries stand independently? If the answer is no, as many industry leaders would happily agree, are we in a permanent situation of using taxpayer money to support, what the answer by definition implies, production inefficiencies?

Levelling the playing field is a great place to start while revisiting unsustainable policies generally is imperative in the run up to finalising the FY24 budget.

Zahid Hussain is a former lead economist of The World Bank, Dhaka Office