4/19/2013

TERM PAPER

IN SEARCH OF EFFICIENCY WITHIN EQUITY: THROUGH THE EYES OF BANGLADESH

PUBLIC ECONOMICS

Submitted to: Dr. Mohammed Farashuddin Submitted by: Sharjil Muktafi Haque ID: 2012-3-88-003 The top 1% have the best houses, the best educations, the best doctors, and the best lifestyles, but there is one thing that money doesnt seem to have bought: an understanding that their fate is bound up with how the other 99 % live. Throughout history, this is something that the top 1 percent eventually do learn. Too late. Joseph Stiglitz This paper discusses current scenario of Bangladesh economy in terms efficiency and equity. It focuses primarily on taxation, government expenditure and mechanisms for redistribution of income in order to harness long-run Efficiency with Equity.

IN SEARCH OF EFFICIENCY WITHIN EQUITY: THROUGH THE EYES OF BANGLADESH OVERVIEW IS EFFICIENCY AND EQUITY MUTUALLY EXCLUSIVE?
Efficiency and equity has long been at the heart of many debates between noted economists throughout the ages. Major disagreements centered around the notion that one cannot complement the other and how much to reduce efficiency to obtain equity. The other point of disagreement is how much weight to assign to an increase in equality and a corresponding decrease in efficiency. The point which has often been ignored is that it is not necessary that that efficiency and equity be mutually exclusive. Government expenditure on education for instance raises quality, hence efficiency of labor or human resources. At the same time because employees have better skills due to education, they can earn a better living than if they were uneducated. Achieving efficiency with equity requires a series of Pareto Improvements. Only through continuous Pareto improvements, can an economy reach a Pareto optimal point where no one can be made better off without someone being made worse off.

BANGLADESH: HAS IT OBTAINED GROWTH WITH EQUITY?

Bangladesh economy has shown strong resilience and achieved consistent economic growth riding on the pillars of export, remittance and agriculture. Bangladesh economy has been growing at a consistent GDP growth rate of more than 6% for last 10 years. This growth trajectory has been achieved regardless of bureaucratic problems, corruption, natural calamity and political instability. But while this impressive growth rate does give plenty of reasons to smile, one must stop to determine, is the entire population, from the richest to the poorest, feeling the benefits of a more efficient economy? Is the distribution of income equitable? In short, has the nation achieved efficiency with equity?

CURRENT SCENARIO IN BANGLADESH: POVERTY REDUCTION & INCOME INEQUALITY

INDICATOR GDP Per Capita (USD) Human Development Index Poverty Head Count Ratio Labor Participation Rate (%) Income Share held by highest 20% Income Share held by lowest 10% 1990 286 0.32 60 74 38.6 3.8 1995 323 0.35 53 73 37.3 3.8 2000 364 0.4 50 72.0 42.6 3.9 2005 429 0.45 41 71 41 4 2010 675 0.51 33 71 41 4

Source: The World Bank

Bangladesh achieved good progress in poverty reduction over the past decade. Poverty reduction gathered good momentum 2001-2010 compared with the previous decade. The number of people under the poverty line declined by 15 million compared with 2.3 million in the previous decade. Bangladeshs rate of poverty reduction has been almost twice as fast as that of many other major economies: between 1999 and 2008, the poverty headcount rate in India and the rest of the developing world, excluding China, declined by an estimated 0.9 percentage points per year. Growth of labor income and lower dependency ratio were the main drivers of poverty reduction. During the first part of the 2001-2010 decade, the increase in wages in the non-farm sector was the most important factor contributing to poverty reduction. At the same time, three key poverty reducing shifts also took place: workers moved away from agriculture towards manufacturing and services; many workers gave up daily and self-employed work for salaried jobs; and the average level of education of the workforce increased. During the second half of the decade most of the poverty reduction occurred in the farm sector, in particular through a significant rise in labor income, which interestingly was not associated with higher education or with changes in occupation. The rise in labor incomes was accompanied by a decline in the earnings penalty associated with living outside of Dhaka, which also contributed to reducing poverty. Apart from increase in labor income, changes in the demographic composition of the population, in particular lower dependency ratios due to an increase in the adult population and a decline in the fertility rate, also helped reduce poverty over this period.

TAXATION & GOVERNMENT EXPENDITURE

Redistribution of income comes primarily through fiscal instruments namely taxation and government expenditure. The underlying assumption is that the government takes money from the rich and re-allocates it to the poor. However, proper reallocation will also depend on the type of taxation used in an economy. While both regressive and proportionate taxation systems hurt the poor more than the rich, a progressive taxation is most effective in redistribution of income. By transferring wealth from one individual to another, we make one individual better off while the other one becomes worse off. In this manner, after redistribution of wealth, if we let the forces of competition freely play themselves out, we will obtain a Pareto efficient allocation of resources. However, leaving allocation to market forces may compromise equality, which is where the government must come in. The re-allocation comes in the form of development expenditure, cash transfer, subsidy etc. Development expenditure is perhaps the most important tool in the governments arsenal in bringing equitable distribution of income.

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IN SEARCH OF EFFICIENCY WITHIN EQUITY: THROUGH THE EYES OF BANGLADESH SCENARIO OF FISCAL POLICIES AND BUDGET IN BANGLADESH
Size of the budget for the current fiscal year in Bangladesh is roughly 1,917 billion, out of which the biggest component is tax revenue BDT 1,122 billion.

Budget Allocation
19% 5% 6% 7% 13% 12% 12% 7% 8% 12% 18% 12%

Revenue Sources
3% 2% 7%

59%

Public Administration Miscellaneous Expenditure Agriculture Transportation & communication Energy & Power sector

Interest Education & Information Technology Local Gov. & Rural Development Social security & welfare Others Tax Revenue (NBR) Non-tax Revenue Foreign Grants Domestic Financing Foreign Loan Tax Revenue (Non-revenue)

Source: Ministry of Finance

Size of the ADP is generally increased by 10%-15% in each budget. However, the increase was more than average historical trends in the current year as the government eyes the next national polls. Development expenditure, up by 33% from the previous budget, has been set at BDT 601 billion, of which BDT 550 billion is for Annual Development Program (ADP). To meet an increased expenditure, more focus has been given on income tax, supplementary duty and non-bank borrowing in the next fiscal year's budget. However, it is also important to note that generally implementation rate of the ADP is not 100% and has hovered between 80%90% in the last 5 years. Furthermore, increasing ADP implementation solely for the purpose of winning national elections will neither bring efficiency nor any equity to the economy as proper infrastructural development is required at a commendable and steady pace every year if indeed the lower-income group is to feel the effects of better infrastructural facilities.

CURRENT INEFFICIENCY WITHIN THE SYSTEM

Shortfall in tax collection: the revenue board collected BDT 72,118 crore in July-March against the target of BDT 76,918 crores in the July-March period. (Source: Bangladesh Bank - Selected Indicators) ADP implementation rate of only 54% in the first 9 months, implying slow progress of development expenditure which is required for equitable distribution of income. Bureaucratic inefficiency due to lack of organizational incentives, personnel restrictions, procurement restrictions and budgeting restrictions: Corruption and influence of political parties giving rise to principle agent problems have also resulted in bureaucratic inefficiency.

The role of the government in redistributing income cannot be over-emphasized when discussing inefficiency, inequality and possible mitigations. It plays the single most vital role and determining how much revenue to collect, at what tax rates to collect, and how best to spend it to reduce poverty. Otherwise, while the nation will continue to achieve growth, this prosperity will be felt the most by the rich, and much less by the poor.

WHAT STEPS CAN BE TAKEN TO ACHIEVE THE ULTIMATE OBJECTIVE EFFICIENCY WITHIN EQUITY?
Further development of agricultural sector Utilization of advanced technology
Agricultural output, constituting 18% of GDP, has posted constant growth against odds faced at home. In the last 10 years, this sector has grown at an average of about of 4.5%. In fact, agricultural solidity has acted as a safeguard against other challenges as the country has achieved food production stability. This year Bangladesh had favorable rainfall during planting. Along with that, the central bank has taken several initiatives to provide low cost financing to support sustainable growth. Since countrys

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IN SEARCH OF EFFICIENCY WITHIN EQUITY: THROUGH THE EYES OF BANGLADESH

agricultural production is using relatively older technology, there is still room from growth despite gradual shrinkage in cultivable land. With gradual transfer of technologies and improved seeds, the country can slowly but surely reach agricultural self sufficiency and efficiency. This will in turn increase employment, reduce income disparity and provide sustainable earning source for the entire labor force engaged in this sector.
BD AGRICULTURAL EFFICIENCY 68 64 60 56 52 2000 2003 2006 2009 Cultivable Land (% of Total Land) Food Production Index 130 110 90 70 50

Food Production Index

Cultivable Land (% of Land Area)

Source: The World Bank, Trading-Economics

Higher access and allocation in government spending in education

Regional economies such as Srilanka, India and Vietnam spend about 5% of their GDP in the education sector while the figure is only 2.3% for Bangladesh. Naturally, this is reflected in the literacy rates. Country Srilanka Vietnam India Bangladesh Literacy rate 94% 90% 74% 59%
Source: The World Bank

Allocation for education in annual budgetary programs has to be made higher so that the number of primary and secondary school education becomes much larger than present. Bangladesh also suffers from a shortage of quality teachers in primary schools. Furthermore, university education has to be made affordable for the lower income group. This is one of the most vital aspects of achieving equity with efficiency. Only if the lower income group can have access to public/private university education can they break out of the poverty line and rise to the life of at least a lower middle class if not more. To achieve this, the government has to allocate amounts much larger amounts of funds for scholarships for students who need financial aid for education.

Conditional Cash transfer

While, cash transfers are not always the best solution for income redistribution since they do not always obtain the desired results another option for the government is conditional cash transfer. Conditional cash transfer programs aim to reduce poverty by making welfare programs conditional upon the receivers' actions. The government only transfers the money to persons who meet certain criteria. This has historically been used in Bangladesh before as well. In 1994, a Conditional cash transfer program was established which was titled Female Secondary School Assistance Project. The program provided tution and stipend for female students conditional only upon school attendance and girls remaining unmarried. Similar moves by the government can help raise equity as well as efficiency since education or other similar development assistance will also raise the recipients productivity level as well.

Remittance usage in infrastructural projects like Padma Bridge

Bangladesh currently ranks eighth in the list of highest remittance earner in the world. This years remittance inflow is pro jected to be around USD 14.5 by World Bank, Bangladesh Bank and other leading financial institutions. Rather than letting the remittance pile up our foreign exchange reserve, part of the remittance can be used in an Equity Formation Solution, meaning part of the remittance can be used to buy equity holding in construction works such as Padma Bridge and the equity holder can reap a share of the toll that the users will pay once it is constructed. In this way, this resource (remittance) can be used efficiently to bring equity by allowing better infrastructural support to all both the rich and poor.

More effective implementation of ADP

The Annual Development Program takes up more than 90% of the countrys development budget. Naturally, implementation of this program largely determines the countrys infrastructural development. Historically Bangladesh has not fully utilized ADP allocation and hovers around 85%. However, full allocation of ADP is a must if the company has to improve efficiency through higher investments which require infrastructural support as well as equity, since public works or projects such as Padma

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IN SEARCH OF EFFICIENCY WITHIN EQUITY: THROUGH THE EYES OF BANGLADESH

Bridge, or a possible Mawa Bridge will be shared by both the rich and the poor. But the poor, are the ones who will have a higher marginal utility of consumption of public goods.

Mechanism for effective usage of excess Foreign Exchange Reserve in Bangladesh

Foreign exchange reserve at present in Bangladesh is projected to go to USD 14.5 billion at the end of the current fiscal year, driven largely by consistent remittance. At, present we have more than the necessary level of foreign exchange reserve. This fund can be diverted for infrastructural development work such as creation of Padma Bridge. However, there is no mechanism at present which permits the government to take money directly from the foreign exchange reserve. Development of such as mechanism is vital because using our own reserves to fund development is much more feasible than taking costly loans from external lenders such as World Bank or Asian Development Bank.

Efficiency in banking system in maintaining homogenous lending rate

Efficiency and equity also requires regular or occasional access to credit for investment or expansion purposes. The banking system of Bangladesh has often shown erratic lending rates. For instance, the foreign commercial banks lend at much higher interest rates than the private commercial banks. This disparity has to be wiped out to ensure that all creditworthy borrowers can avail any amount of credit at an affordable rate if and when necessary.

Controlling inflation the invisible tax

Inflation generally hurts the poor much more than the rich. The central bank has to carefully monitor money supply in the economy, ensure that money does not get channeled into unproductive sectors to ensure that inflation is within controllable and tolerable levels. Otherwise, despite bringing desirable fiscal reforms, the lower income group will still feel the effect of less real income due to high inflation.

Expansion of Credit programs for Sharecroppers

The central bank has taken up a commendable credit program for share croppers in which over BDT 7 billion has been disbursed to over 5.5 lakh sharecroppers. An independent survey study by a group of experts on this special credit project for the sharecroppers was conducted in 2011. The study, which interviewed 400 sharecroppers from 7 divisions of the country, shows that 80 percent sharecroppers cultivated high valued paddy and harvested 2.0-2.4 metric ton per acre, which is almost twice the former 1.0-1.2 metric ton per acre. The findings of the study also confirm that 95 percent sharecroppers repaid the loan in time and 90 percent sharecroppers find themselves in a relatively better financial condition than they might had without this loan facility. This program is a clear indicator that equity can go hand in hand with efficiency and that such programs need to not only be maintained but also increased in frequency and has to reach a greater number of people to further raise equity and efficiency.

Mechanisms for improving tax collection

The National Board of revenue is on its way to missing its tax collection target for the current fiscal year. According to the first nine months data, shortfall in tax collection is about 6.5%. Shortages in tax collection mean that government expenditure may have to be revised or be financed through debt. Thus it is essential that tax collection be improved. Several initiatives can be taken such as expansion of tax net, prevention of tax evasion through strict monitoring by the National Board of Revenue. Only through proper tax collection will the government have the scope to redistribute the income through public works and projects.

Reduction of Political instability:

Political stability has long hurt Bangladeshs growth. The country as a whole has to ensure that disputes between political leaders and all the unwanted baggage that comes with political turmoil be independent of economic growth. Reduction in the number of strikes in a country such as Bangladesh is a must if the country has to achieve a higher GDP growth trajectory. Strikes hurt the poor even more. For instance the farmers generally get lower price for the rice crops during such times. Reduction of political instability thus is a must for enhancing equity and efficiency in Bangladesh .

For now, the government must focus on larger budgets with focus on development expenditure. Strict monitoring to ensure targeted levels of revenue collection is a must, along with high implementation rates of ADP. Only through these mechanisms, will money be taken from the rich and be allocated to the poor. The government of Bangladesh, like all other nations, must focus on ensuring that infrastructural development gets highest priority in its agenda along with the other steps mentioned above. Only then, can Bangladesh truly end its search for efficiency with equity and smile at the prosperity shares by the entire nation of 16 crore people.

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