Unit 9 Uneven development on a global scale

9.10 Application: Growth in Bangladesh and Pakistan

In this section, we compare the contrasting growth paths of Bangladesh and Pakistan, which were both part of India before partition in 1948, and became independent from each other in 1971 following the Bangladesh Liberation War. Bangladesh’s GDP per capita was much lower than Pakistan’s at independence and its economy grew very slowly initially. The growth trajectories of these two countries changed markedly from the early 1990s, when Bangladesh entered a decades-long period of much faster growth. Unlike Bangladesh, Pakistan has not achieved a sustained uptick in its growth rate.

The top two panels in Figure 9.24 differ in the story they tell about the relative levels of GDP per capita in these two countries in the most recent period. The right-hand one uses more recent (2021) comparisons of relative prices in the two economies, and provides a more accurate comparison of current levels of GDP per capita. According to the World Bank Group’s World Development Indicators data (right-hand panel), Bangladesh had higher per capita GDP than Pakistan from around 2010. This dataset, however, cannot be used to provide comparisons before 1990.

The lower panel shows that, coinciding with its more rapid rate of growth, Bangladesh’s investment share diverged from that of Pakistan from the early 1990s, rising to above 30% at the end of the period; Pakistan’s declined to below 15%.

What enabled Bangladesh to move to a high growth equilibrium and what prevented Pakistan from doing so? The case studies in the previous section emphasize that economic models can help organize the questions to ask, but detailed knowledge of the history, politics, and economics of a country is needed to make progress on the answers.

Bangladesh: Growth through trade and knowledge exchange agreements

Consistent with the growth dynamics model in Figure 9.17 in Section 9.8, Bangladesh’s rising share of investment points towards sustaining a higher growth equilibrium (through the investment rule, \(𝛼\), in the model), but as we have learned from Tanzania, that will only be the case if there is no counteracting force depressing the contribution of additional capital goods to output (\(𝛽\)). Bangladesh’s growth success rested on the establishment of a new industry in ready-made garments for export.

In contrast to President Nyerere’s strategy in Tanzania of suppressing consumption and using those resources to purchase foreign-made capital goods to produce consumer goods for the domestic market (thereby replacing imports), the approach by the government in Bangladesh was to prioritize the garment industry, and specifically export sales. But potential entrepreneurs in Bangladesh lacked:

• expertise in the manufacture of ready-made garments (organizational know-how, such as how to control quality and manage supply chains, or production line skills)
• finance to purchase the necessary machinery and equipment
• access to trade credit to buy inputs
• access to ‘bonded warehouses’, which are used to manage customs procedures for export.

They were, however, able to benefit from the earlier global Multi-Fibre Agreement (MFA) of 1974, which was designed to control imports of textiles into high-income countries from producers in South Korea, for example. The relevance of this for Bangladesh is that at the time it was not a garment exporter and therefore not a threat to clothing producers in the US, whereas South Korea faced quotas limiting its garment exports to the US. The quotas restricted the supply of imports to the US and drove up prices. This meant that for countries like Bangladesh that did not have quotas, prices of exports sold in the US would be higher than on the world market. This feature of the MFA produced so-called quota rents (additional profits), which incentivized South Koreans to consider transferring their technologies to producers in Bangladesh. Once a country became a successful exporter, quotas were imposed, but the initial quota-free period was enough to trigger the successful establishment of garment manufacturing for export in Bangladesh through joint ventures with South Korean firms.

The MFA provided the opportunity for a three-way relationship between the Bangladeshi government, South Korean companies (initially Daewoo), and Bangladeshi firms (initially Desh Garments), which launched the Bangladeshi garment industry on which the country’s shift to high growth depended. In 1983–1984, textiles accounted for less than 4% of total Bangladeshi exports. Within a decade, this share had grown to 60%, and increased to a high of 84% in 2022–2023, making it the world’s second largest exporter of textiles, behind China.

The first joint venture was agreed in 1979: the basis for the agreement was that the quota rents earned on the sales of garments to the US market by Desh would be paid to Daewoo in exchange for its supply of exporting capability to Desh. Daewoo invited Bangladeshi middle managers to South Korea to learn how to set up and operate a modern competitive exporting firm.

The Bangladeshi government backed the agreement and supplied complementary inputs, such as export finance and bonded warehouses. The key to the success of this policy package was that the government did not pay subsidies to firms. The government would have found it very difficult to monitor the use of the subsidies and there would have been many opportunities for inefficiencies and the diversion of funds away from productive investment. Instead, Bangladeshi firms received sales revenue only when they successfully exported. Part of the sales revenue (8%) was paid directly to the South Korean firms. So both Daewoo and Desh Garments had the incentive to improve efficiency to make exports of garments from Desh competitive in the US market.

According to Mushtaq Khan (featured in our ‘Economist in Action’ video), of the 150 Desh managers initially trained at Daewoo, around 130 became entrepreneurs themselves and went on to set up their own garment companies, enabling the rapid transfer of organizational knowledge and technology across the emerging manufacturing sector.

The coordination model of market failure in Section 9.6 highlights why it would have been impossible for individual entrepreneurs to enter the garment export industry. To enter the industry, a local entrepreneur would have needed to finance the acquisition of capital goods, as well as have access to the know-how, supply chains, and markets abroad. And, referring to the role of institutions in Section 9.7, the country-specific analysis highlights that there was no sudden improvement in institutional quality—rather, what mattered was the fortunate conjuncture of the MFA agreement with a Bangladeshi President, Zia, who was supportive of the export-oriented strategy. He was able to withstand pressure to subsidize powerful business interests in protected sectors of the economy where neither the stick nor the carrot of capitalist competition was present.

Through the MFA, and the first joint venture between Daewoo and Desh Garments, the success of the garment industry supported a subsequent rise in the share of investment (high \(𝛼\) in the growth dynamics model). The high growth equilibrium was also supported by an efficient use of investment (high \(𝛽\)) through the pressure of competition to secure export sales, and engagement with the South Korean firms that also provided access to a higher rate of exogenous technological progress (‘learning by doing and from others’).

The ready-made garment industry survived the imposition of MFA quotas on Bangladesh in the mid-1980s, partly by shifting into a new market segment (knitted garments), which was outside the quota regime. However, like other low-income countries, Bangladesh continued to benefit from some MFA provisions and it was remarkable how the industry thrived following the abolition of the MFA in 2004, contributing to the continuation of the country’s growth.

Based on reforms in agriculture and in education, such as mandatory primary education and a stipend programme for girls’ secondary education, growth from the early 1990s to the mid-2000s was inclusive in the sense that poverty fell. However, although growth based on the ready-made garment industry continued in the following two decades, this may be too narrow a base for future success. The implication is that Bangladesh’s growth model may not be sustainable and its GDP per capita is still low.

Pakistan: Deglobalisation and emigration

Using the lens of the growth dynamics model in Section 9.8 to interpret the failure of Pakistan to experience a sustained period of rapid growth during the three-quarters of a century since independence is relatively straightforward. Pakistan was not able to raise the share of investment (Figure 9.24 shows the data from 1980). Moreover, a policy to protect domestic producers was supported by politically connected business interests, and this resulted in weak competition in the home market and the absence of pressure on firms to compete for a share of foreign markets. The exit mechanism for failing firms was dysfunctional, with evidence of the survival of zombie (that is, loss-making) firms.

The persistent weakness of the export sector in Pakistan is reflected in the highly unusual record of a flat or falling export share of GDP during the phase of rapid globalization of the world economy over recent decades: Pakistan deglobalized while the rest of the world globalized. Bangladesh (and India) have pulled away from Pakistan in average years of schooling since 2010 (Figure 9.22). In the language of the growth dynamics model, both \(𝛼\) (capturing the investment rule) and \(𝛽\) (capturing the growth produced by a higher capital stock) have been persistently low, thereby preventing Pakistan from increasing its growth rate.

Unable to provide jobs in the capitalist sector for its rapidly growing population, Pakistan saw rising emigration. By 2019, 96% of Pakistan’s 11 million migrant workers (compared with a labour force of 69 million) were in the Gulf States responding to the demand for workers, which began after the oil price shocks of the 1970s enriched those sparsely populated countries. Remittances sent back to Pakistan were rising as a share of GDP from around 2000, while the share of exports in GDP was falling (Figure 9.25). Remittances as a source of foreign exchange came without any of the benefits for productivity of export competition. They are more similar to the effect on the economy of the flow of revenue from a natural resource discovery, which if poorly handled can produce symptoms of ‘Dutch disease’.

‘Dutch disease’ refers to the effect on the competitiveness of domestic tradables industries caused by a sudden inflow of foreign exchange into a country, which in turn leads to an appreciation of the real exchange rate.

Recalling the definition of the real exchange rate, c, from Units 5 and 7,

\[\text{real exchange rate, } c = \frac{e \ \times \ P^*}{P} \\ \text{(Increase in } c \text{ is a real depreciation)}\]

a real appreciation of home’s exchange rate (a fall in \(c\)) occurs if the nominal exchange rate appreciates (\(e\) falls) or if home’s prices rise relative to those elsewhere.

There are two channels from remittances to appreciation in Pakistan: first, through the appreciation of the nominal exchange rate as a result of the remittances in foreign currency being sold for domestic currency, raising the demand for the latter and hence producing a nominal appreciation. A sustained appreciation associated with remittances was observed for Pakistan, indicating that the central bank did not offset this through interest rate cuts or purchases of foreign exchange.

The second mechanism works through the effect of remittances on increased consumption spending in the domestic economy, which feeds into higher inflation and an appreciated real exchange rate. Both channels weaken the export sector.

A study by Jafarey et al. (2024) points to the two-way relationship between the absence of growth based on tradables in Pakistan (in contrast with manufactured goods in Bangladesh and services in India) and the expansion of remittances, which produces a self-reinforcing bias of the economy towards consumption and investment in real estate rather than investment in productive activities with the potential for strong productivity growth.¹ The share of consumption in GDP for 2014–2023 in Pakistan was 93.3%, compared with 74.5% in Bangladesh, and 70.6% in India (source: World Bank Group WDI).

In contrast to Bangladesh, where the labour force in its key export-oriented garment manufacturing industry was female-dominated, gender norms in Pakistan have changed little and the participation of women in work outside the home remains very low. Pakistan has one of the lowest female labour force participation rates in the world: 24.3% in 2024 (little changed since 1990) compared with 44.2% in Bangladesh, up from 25% in 1990.

The World Bank’s country memorandum in 2022 summarized: ‘A model of growth that is driven by consumption and government expenditure rather than by investment and exports is at the core of Pakistan’s growth challenge.’ (p. iv). The deeper causes of Pakistan’s growth problem lie with its institutional weakness. Unlike countries that were initially as poor as Pakistan but have embarked on ‘hockey stick’ growth paths, Pakistan has not found a way to build a coalition of those with power in the country who will prioritize investment in productive activities over military ambition, regional interests, and private wealth accumulation. The necessary reforms include:

• radical reform of the property rights and contract enforcement regimes to encourage investment by reducing the fear that private property will be expropriated
• greater capacity of the state to enable higher investment in education, health, infrastructure, and climate resilience without the dissipation of resources through corruption
• willingness of the elite to support the higher levels of taxation of their income, wealth, or consumption that are necessary to fund these investments
• reform of tariffs and subsidies that hinder development of tradables industries and high productivity activities
• incentives for women to work outside the home (such as addressing the problem of harassment on public transport and in the workplace).

The extent to which the economy relies on remittances may also contribute to the lack of internal political pressure for reform. Remittances raise household incomes and sustain higher consumption without the need for higher domestic productivity.