'Stop subsidising the status quo to avoid middle-income trap'

The Prime Minister's Adviser Salman F Rahman, at a recent programme in Dhaka where the latest OECD report was unveiled, warned about the possibility of Bangladesh falling into what is known as 'the middle-income trap.' 

Noted economist Syed Akhtar Mahmood, the former Lead Private Sector Specialist in the World Bank Group, said that this rare utterance of such possibility from a high figure in the government is significant.  

In an interview with TBS, he opened up about the importance of a performance culture, FDI composition, skilled labour, innovation and private sector incentives in the right direction, to avoid such a trap.  

Bangladesh is to graduate from LDC in three years. Pointing to middle-income trap challenges that come with LDC graduation, Salman F Rahman, at an OECD study launch event, said falling into the trap will deter us from becoming a developed nation by 2041. What are your thoughts?

Salman F Rahman said 'in case' Bangladesh falls into a middle income trap, not that we 'will' fall into the trap – he is thus talking about a possibility. That itself, however, is progress. 

Some of us have been talking about this risk for around two years now.  Around the time when LDC graduation was announced, we said if our aspiration is to be an upper middle-income country in about a decade, and a developed economy in two decades (note that the government talks about a developed country, not necessarily a high-income country), then we have to recognise the many examples in the world where that a transition from middle income to higher income has not happened. 

In fact, it is more an exception than a rule that the countries which were middle income had become higher income. We have South Korea and a few other examples. But there are many more examples where countries haven't made the transition. 

I can think of Argentina which became an upper middle-income country many decades ago but has not yet transitioned to the high-income category. South Africa is another example. 

So it is very important for us to not be complacent. It is not a linear path towards upper-middle income and then a higher income country; no guarantee that this will go on a linear path. That is what the history of other countries tells us. 

Therefore, we should be concerned. We should try to find out why other countries have fallen into the middle-income trap, assess the risks of us falling in the same trap, and take actions before we are trapped. Once you are in the trap, it is very difficult to come out. So we still have time and we should take necessary actions. 

I remember that when people like Professor Mustafizur Rahman of CPD, myself and also some people in the media such as yourself talked about a middle-income  trap,  we saw a somewhat defensive reaction on the part of the government. Some senior government functionaries asserted that we do not face such a risk and we need not be concerned about it. 

That reaction by itself was not surprising because governments usually go through certain phases before they actually start recognising that there can be a problem. And after that, they have to cross one or two bridges before they publicly acknowledge this. 

They may acknowledge privately, but public acknowledgement doesn't come that easily. That is why the statement by Salman F Rahman is significant. Even to say that there is a possibility and we should be prepared, I think, is an important recognition. 

I am assuming that he made it with all seriousness and if Mr Rahman's concern is shared more widely in government, that would be reassuring because then we can assume that they will start thinking about this seriously. 

What is a middle-income trap? Why was that term coined? 

The idea is that countries like Bangladesh with low labour costs have a certain advantage when it comes to competing with other countries. 

The countries which have become quite sophisticated in their production structures based on skilled labour, South Korea for example, don't need to produce export goods based on low labour costs. They are competing in a different segment of sophisticated, maybe costly products, but they have acquired the competitive advantage by  developing a knowledge and skill base. 

The countries in the middle, which are in trap, don't have the advantage of low labour cost. At the same time, while their labour costs are high, they are not skilled and innovative enough to compete at the high end of the spectrum with countries like South Korea. 

So they lose out at both ends, to countries like Bangladesh at the low end and like South Korea at the high end. This is the trap.

Having said that, I must emphasise that we can't go on competing for long, based on low labour cost. Firstly, it is not ethical. We don't want our workers to be permanently trapped in the low skill, low income category. 

Now, as the labour cost in Bangladesh goes up, and already it is, we will have the same problem if we don't improve our skills and become an innovative economy. 

What countries like Argentina and others stuck in the trap have done is that they had lots of investment in increasing productive capacity, but unlike the South Koreans, Japanese and the developed economies, they didn't invest in innovations.

The investment in output growth is different from the investment in innovation. So that is something we should worry about. Our investments are going up, but if that investment is largely for increasing production capacity, not in productivity improvements and innovation, we may get into trouble.  

We don't have that much time to be on the right track. And being on the right track means that we have to become more competitive. Our exports will have to become more competitive. 

I think we are still in the mind-set where we are trying to extract as much duty and other privileges as possible from the developed economies. But it is unlikely that we will get these privileges for long. 

So it is high time that we started focusing on competing on the basis of higher efficiency, not through continuation of the duty privileges we currently get. 

If you get more space, maybe another three/four years beyond 2026, that is good, but we shouldn't bank on it. Our emphasis should be on how to increase our productivity. If we can increase our productivity by 10%, that is equivalent to getting a 10% concession on trade. 

The OECD study mentions our overreliance on the Ready-Made Garments (RMG) sector. Economists have long been emphasising the diversification of our export basket in general and within the RMG sector; the policymakers also admit the necessity. What is holding us back?

You are very right, there is still scope for diversification within the RMG sector. And of course there is scope for diversification beyond the RMG. One of the policy problems that we have for a long time in our policy framework is an anti-export bias. 

And this anti-export bias is operating perhaps at two or three levels. 

Firstly, there is a bias in favour of domestic production. If you have a production capacity to produce something which you can also export, your profits in the domestic market are much greater. And one of the major reasons for that is the high import duties, which are still there. It gives protection in the domestic market. 

We still have policy measures which enabled the RMG. There are other export-oriented industries that had been asking for certain facilities, but they were not getting that. This is an anti-export diversification policy. So it is not encouraging diversification of exports away from garments. 

And finally, even within garments, I think there are some policies which bias you towards producing the same four to five broad categories of products, instead of producing newer products on a big scale. 

So biases at three levels are preventing export diversification.

If we think of diversification, we can try and compete based on low labour costs, but I think we should start competing based on skilled labour, like the Vietnamese, the Malaysians and the Thais have done. So move from simple products like garments to more sophisticated products like electronics. 

I am just giving one example, but there are many other examples of sophisticated products. Now what is the good thing about sophisticated products? You obviously get a high return, fetch higher prices. But there is another big advantage. You learn much more when you produce sophisticated products like electronics than when you make garments. 

Garments are still a relatively simple product with simple operation. You do learn a lot from that too, I am not discounting it. But if you go into production of electronics, you learn a much wider range of skills and once you have done that, it becomes easier for you to go beyond electronics to some other sectors, simply because you have learnt much more than you would when you are making a simple product. 

So that is another reason why we should move towards more sophisticated products. 

But there again, the problem is incentives. I think we should always recognise that the private sector is driven by incentives and if the incentive is there to produce for the domestic market, and simple products for the export markets, then the private sector will not bother to develop the capacities to go into sophisticated products for the export market. 

The private sector usually figures a way out when they have the incentive to do something, such as making sophisticated products. If they need help to do so, they come and ask for support from the government. 

I guess in Bangladesh, the big problem is that most of the business people are used to doing certain things which they find quite profitable and continue to do that. Then, they come to the government and demand subsidies or other privileges on some excuse or the other. And the government often complies. 

So, what we have in Bangladesh is a situation where we are subsidising the maintenance of the status quo. If we do need to provide a subsidy, it should be a subsidy to trigger a change. The emerging countries subsidise change, such as finding new products or new markets, investing in productivity improvements etc. 

Also, when the governments in these countries gave support to the private sector – and industries often need support, especially the new ones - successful countries like the Koreas of the world demanded performance in return. And performance would be defined very concretely – that you have to achieve this percentage growth of exports or this percentage improvement in productivity, etc. 

And if the performance was not achieved, the privilege was often ruthlessly withdrawn and the government didn't care whether the factory actually closed down. In Bangladesh, we give privileges and all kinds of support, but we don't always demand performance in return. This is a big problem. We lack a performance culture.  

You have already mentioned innovation. The OECD report mentions only 1.2% of Bangladeshi firms invest in innovation, whereas it is as high as 30% in Vietnam. What does it imply in terms of our target to reach upper-middle-income and high-income status?

Yes, this brings us to the point of the middle-income trap. Why are these countries in the trap? Because they neglected innovation, research and development, and this is what we are seeing in Bangladesh now.

Why are we seeing this? 

Yes, sometimes private firms may have problems with innovation. That is why you need support systems and the governments have a role in creating the support systems. But I would say that the main issue here is the incentive. 

So if you can make a lot of money without being innovative, without increasing your productivity, without coming up with new products, new processes etc, then you would not be driven to be innovative and take the trouble to learn new things, which may involve some risks.  

Because why take that risk? Why take the trouble when you can already make a lot of money without doing anything. So that brings us to that question of incentive. 

Is there something in the government policy, the trade, subsidy and industrial policy, which is encouraging people to just produce what they are producing? Maybe they are just expanding their production, but not necessarily becoming more innovative. 

So let's get the incentive right first. And then the private sector will find a way to be innovative. So if they have some constraints, we can develop an innovation support system in the country. But incentives will have to be there. 

But let me also say that many of our entrepreneurs are incentivised to be innovative. However, often they face policy or regulatory barriers. 

One of my friends is in the pharmaceutical industry. He wants to export in a big way and recognises that he needs innovation for that. One way for him is to take equity stakes in foreign R&D companies. That way he can benefit from innovations done by such companies. But he is facing problems getting the permission to remit a few million dollars to obtain that equity stake. 

The regulators are focusing more on the ten or twenty million dollars that may go out now instead of thinking about the hundreds of millions of dollars that could come in the future if this entrepreneur can implement his vision.  

We have been repeatedly talking about innovation. Readers might wonder what innovation we are talking about? 

Innovation, as you know, is about doing things differently. 

So one is, you innovate new products. Second, it could be the same product, but you innovate new processes of doing the same thing. So you may continue making T-shirts, but there may be better ways of doing T-shirts.  

Let me give you a concrete example. The textile factories in Bangladesh use a tremendous amount of water in their dyeing and finishing activities, which is an environmental problem. This is also a reason why water tables are going down. But there are simple processes which can help conserve water, so you can change the way we produce the same product.  

So that is innovation – it is all about the new products, new processes, new ways to organise  businesses and also finding new markets. 

Besides innovation, Bangladesh keeps struggling with attracting FDIs as well. Vietnam is often mentioned as a competitor to Bangladesh. FDIs constitute 6% of their GDP, while  we have only 0.7%. What is Vietnam doing right?

First of all, they had a clear vision, and then they took the implementation of the vision very seriously. 

So they decided early on that they are going to be an expert-oriented economy and they were going to start with simple products like garments etc., but quickly moved on to more sophisticated products. 

They also decided that one of the major vehicles for this would be foreign investment. We must remember that like China, Vietnam also had a socialist economy and there was not a large business class. And maybe it was not completely unjustified for them to think that they will have to bring investors from outside.

Now Bangladesh has a reasonably large domestic private sector.  And of course our garments and other industries have grown based on domestic entrepreneurship. So, we may not need foreign investment for everything. 

But the challenge that we have, the challenges of diversification that we were discussing, is going into more sophisticated products and being innovative, etc. Given those challenges it is important for us to bring FDIs, just like the Vietnamese or the Malaysians did many years ago. 

So it was okay perhaps that we had developed the garment industry based largely on domestic entrepreneurship, although I feel and some others also feel that if we allowed foreign investment in garments, maybe the industry would have developed in a better way. But we certainly failed to bring foreign investment early on to move out of garments and into more sophisticated products.  

In fact, if you look at the successful countries, they all started with simple products like garments. But the transition into more sophisticated products happened within 10/15 years. For Bangladesh it is now almost 40 years since we started with garments and we haven't yet made the transition. 

Yes, there are companies like Walton and a few others; but that full-fledged transition hasn't happened and that is where FDI is very important. So that is number one. 

Number two is, when you think of export diversification, one of the ways that this happens is by entering into global value chains. So for example, instead of making a whole laptop, we can make certain parts of the laptop. There is a whole industry like that. 

So the Philippines may just make three or four  parts of a laptop, but they are making those few parts for an industry which is billions and billions of dollars in size. 

So even if you make five small parts of an industry like laptops or something like that, iPhones etc, your export earnings may actually be equal, even greater than what comes from garments now. 

But in order to do that, you need to make an entry. And that entry would be facilitated by foreign investors that are already big players in the global value chains. They know the technology and market, they have the brand, they can help us enter into the global value chain. 

Once we have made an entry, at some point maybe we can use our own brand. That is why FDI is very important to help us enter the global value chains. And that is why I often write about the composition of the FDI that's coming into the country. 

We talk about increasing the volume of FDI in Bangladesh. The government sometimes talks about how much of FDI interest has been generated, but we are not looking at the composition of FDI, i.e., what kind of foreign investor interest is coming. 

I have looked at many of the proposals that have come into the economic zones. Most of the investment is what we call 'market-seeking'. They want to exploit Bangladesh's market. That's not a surprise because Bangladesh is actually a large market. It is also a rapidly growing market. And we do need good products for the local market also. So some of that is okay. 

But I am talking about the balance. I think it is still very skewed towards the 'markets-seeking' foreign investment, not what we called efficiency-seeking, where they use Bangladesh as an efficient production base from which to export elsewhere. So the investment that is coming in may indirectly help us a bit in expert diversification, but it will not be a strong boost to export diversification. 

We need to look at what kind of investors are coming in and that brings me back to the Vietnamese story. They are very targeted. They said that this is our vision and strategy, therefore we need to target these types of investors. 

Then they went all over the world, especially where these investors are…  targeted them, asked them what they needed, and they made sure they delivered. We don't have such a targeted approach. 

What is your evaluation of the current policy regime and how can a productive sector steer the country out of the middle-income trap? 

The incentives for the private sector are defined and shaped by different types of policies such as fiscal policies (including subsidies and taxes), import tariffs, and monetary policies. 

There are all kinds of policies which affect incentives. So we need to have a hard look at these policies. What kind of incentives are they creating? Are they creating incentives to be more innovative, to be more productive, to diversify experts? This is number one. 

And related to that is the FDI policy – not the policies on paper, but the actual implementation of the policy. 

So, I think we should also be clear about the distinction between policies on paper, which sometimes are reasonably good in Bangladesh, and other times they are not, and implementation. 

There is a big gap between the policies on paper and implementation. So that is the policy side. 

Now your question about what more productive firms can do to help us avoid the middle income trap. As I said, the main characteristics of countries that are caught in the middle income trap is their failure to have invested in innovation and productivity improvements. They have invested a lot in productive capacity, but not in productivity growth and innovation. 

So the kind of firms that we are talking about, whether they are foreign firms or properly incentivized domestic firms, these are firms which will go for productivity improvements, innovation; they will want to compete not on the basis of low labour cost but on the basis of skilled labour. 

So if we have a critical mass of such companies, then that is going to be our greatest insurance against falling into the middle income trap.