The Impact of 1998 and 2008 Financial CR

BANGLADESH UNNAYAN GOBESHONA PROTISHTHAN
(BANGLADESH INSTITUTE OF DEVELOPMENT STUDIES)

E-17, AGARGAON, SHER-E-BANGLA NAGAR
DHAKA-1207, BANGLADESH
The Protishthan carries out basic research studies on the problems of development
in Bangladesh. It also provides training in socio-economic analysis and research
methodology for the professional members of its staff and for members of other
organisations concerned with development problems.
BOARD OF TRUSTEES
Chairman: The Minister for Planning, ex-officio
Trustees: A Member of the Planning Commission to be nominated by
the Chairman
The Director General of the Protishthan, ex-officio
The Chairman or a Member of the University Grants
Commission to be nominated by it
The Governor, Bangladesh Bank, ex-officio
The Secretary, Ministry of Finance, ex-officio
The Secretary, Ministry of Education, ex-officio
Two Senior Fellows of the Protishthan
Three Senior Staff Members of the Protishthan
Director General, Bangladesh Rural Development Board,
Ex-officio
One Trustee to be appointed by the President
DIRECTOR GENERAL: Mustafa K Mujeri
Manuscript in duplicate and editorial correspondence should be addressed to the

Executive Editor, The Bangladesh Development Studies, BIDS, E-17, Agargaon,
Sher-e-Bangla Nagar, Dhaka, G.P.O. Box No. 3854, Bangladesh, Fax: 880-2-
8113023,Website: www.bids.org.bd. Style Instructions for guidance in preparing
manuscript in acceptable form is appended and may also be provided upon request.
All business correspondence should be addressed to the Chief Publication
Officer at the above address.
Annual Subscriptions (Four issues per year):

Inland: Individuals: Tk.500
Institutions: Tk.600
Foreign (By Air Mail):
Individuals: US$100
Institutions: US$200
The Bangladesh Development Studies
Volume XXXIV March 2011 No. 1
Articles
1 Nor Hayati Bt Ahmad : The Impact of 1998 and 2008 Financial

Mohamad Akbar Noor Crises on Profitability of Islamic Banks
Bin Mohamad Noor
23 Monzur Hossain : Asset Price Bubble and

Farhana Rafiq Banks: The Case of Japan
39 Mohammad Amzad Hossain : Money-Income Causality in Bangladesh:

An Error Correction Approach
Notes
59 Md Abul Quasem : Conversion of Agricultural Land to

Non-agricultural Uses in Bangladesh:
Extent and Determinants
87 Mia Mahmudur Rahim : Initial Trade Policy Focus of the High

Performing Asian Economies: A Critical
Assessment
Book Review
103 M Asaduzzaman : The Bengal Delta: Ecology, State and

Social Change, 1840-1943
EDITORIAL BOARD : Mustafa K Mujeri Chairman &
Executive Editor
: Binayak Sen Associate Editor
: M Asaduzzaman Member
: Zaid Bakht Member
: Rushidan Islam Rahman Member
EDITORIAL ADVISORY BOARD: Rehman Sobhan
: Nurul Islam
: Mosharaff Hossain
CHIEF PUBLICATION OFFICER : Mohammad Meftaur Rahman
International Editorial Advisory Board

Amartya Sen Salim Rashid
Harvard University University of Illinois, Urbana-
Champaign
Keith B Griffin J B Parkinson

Professor Emeritus Professor Emeritus
University of California, Riverside Nottingham University
Nurul Islam Just Faaland

IFPRI, Washington, D.C. Chr. Michelsen Institute, Bergen
A R Khan Kaushik Basu

Professor Emeritus Chief Economic Advisor
University of California, Riverside Ministry of Finance
North Block, New Delhi
Frances Stewart S R Osmani
University of Oxford University of Ulster
Copyright BIDS, March 2011

Bangladesh Development Studies
Vol. XXXIV, March 2011, No. 1
The Impact of 1998 and 2008 Financial Crises

on Profitability of Islamic Banks
NOR HAYATI BT AHMAD *
MOHAMAD AKBAR NOOR BIN MOHAMAD NOOR **
The paper investigates the profitability of 78 Islamic banks in 25 countries

for the period of 1992-2009. The Fixed Effect Model (FEM) used to
analyse profitability shows that profit efficiency is positive and
statistically significant with operating expenses against asset, equity, high
income countries and non-performing loans against total loans.
Interestingly, the empirical results show that more profitable banks are
those that have higher operating expenses against asset, more equity
against asset and concentrated at high income countries demonstrating
close relationship between monetary factors in determining Islamic banks
profitability. The findings for 1998 Asian Financial Crisis and 2008
Global Financial Crisis are negative and imply that Islamic banks’
profitability has not been impacted during Asian and Global Financial
crises.
I. INTRODUCTION
Islamic banks today exist in all parts of the world, and are looked upon as a
viable alternative system which has many things to offer. While it was initially
developed to fulfill the needs of Muslims, Islamic banking has now gained
universal acceptance. Islamic banking is recognised as one of the fastest growing
areas in banking and finance. Since the opening of the first Islamic bank in Egypt in
1963, Islamic banking has grown rapidly all over the world. The number of Islamic
financial institutions worldwide has risen to over 300 today in more than 75
countries concentrated mainly in the Middle East and Southeast Asia (with Bahrain
and Malaysia the biggest hubs), but are also appearing in Europe and the United
States. The Islamic banking total assets worldwide are estimated to have exceed
$250 billion and are growing at an estimated pace of 15 per cent a year. Zaher and
*
Professor of Banking and Risk Management, College of Business, Universiti Utara
Malaysia.
**
Supply Chain Management Department, PETRONAS Carigali Sdn Bhd, Malaysia and
College of Business, Universiti Utara Malaysia.
2 Bangladesh Development Studies
Hassan (2001) suggested that Islamic banks are set to control some 40-50 per cent
of Muslim savings by 2009/10.
The Islamic resurgence in the late 1960s and 1970s, further intensified by the
1975 oil price boom, which introduced a huge amount of capital inflows to Islamic
countries, has initiated the call for a financial system that allows Muslim to transact
in a system that is in line with their religious beliefs. Muslims throughout the world
has only conventional financial system to fulfill their financial needs before the re-
emergence of the Islamic financial system as an alternative and comply with Islamic
principles (Sufian and Noor 2008).
Islamic financial products are aimed primarily to the investors who want to
comply with the Islamic laws (Syaria’) that govern Muslim's daily life. The Syaria’
law forbids giving or receiving riba’ 1 because earning profit from an exchange of
money against money is considered immoral and mandate that all financial
transactions to be based on real economic activity; and prohibit investment in
sectors such as tobacco, alcohol, gambling, and armaments. Despite that, Islamic
financial institutions are providing an increasingly broad range of financial services,
such as fund mobilisation, asset allocation, payment and exchange settlement
services, and risk transformation and mitigation. Despite the growing interest and
the rapid growth of the Islamic banking and finance industry, analysis of Islamic
banking at a cross-country level is still at its infancy. This could partly be due to the
unavailability of data, as most of the Islamic financial institutions, particularly in the
Asian region, are not publicly traded.
The aim of this paper is to fill a demanding gap in the literature by providing
the latest empirical evidence on the profit performance of Islamic banks in the
World during the period 1992 to 2009. The profit efficiency estimate of each
Islamic bank is computed by using the least square method of Fixed Effects Model
(FEM) to control for bank-specific effects. This paper also seeks to provide clear
empirical evidence on the impact of various explanatory variables on the World
Islamic banking profitability performance sector that touch several interesting
issues, primarily 1998 Asian Financial Crisis and 2008 Global Financial Crisis. To
1
Riba’ the English translation of which is usury is prohibited in Islam and is acknowledged
by all Muslims. The prohibition of riba’ is clearly mentioned in the Quran, the Islam's holy
book and the traditions of Prophet Muhammad (sunnah). The Quran states: "Believers! Do
not consume riba’, doubling and redoubling…" (3.130); "God has made buying and selling
lawful and riba’ unlawful… (2:274).
Ahmad & Noor: The Impact of 1998 and 2008 Financial Crises 3
list a few, the impact of total assets, deposit, inflation and country income level
towards Islamic banks profit efficiency.
Since the countries of coverage are span across 25 countries, we will also study
the profitability result based on the Islamic bank country of origin. The countries are
diversified in terms of the economic activity; we divided the classification by using
2003 Gross National Income (GNI) published by World Bank. According to 2003
GNI per capita, calculated using the World Bank Atlas method 2 , the income groups
are: low income, $765 or less; middle income, $766–$9,385; and high income,
$9,386 or more.
Based on 2003 GNI report, some high income countries may also be developing
countries. Our samples in the paper will include this particular country and study the
differences of country background into the profitability of Islamic Banks. The Gulf
Cooperation Council (GCC), for example, are classified as developing high–income
countries. This paper unfolds as follows. Section II provides an overview of the
related studies in the literature, followed by a section that outlines the method used
and choice of input and output variables for the efficiency model. Section IV reports
the empirical findings. Section V concludes and offers avenues for future research.
II. REVIEW OF THE LITERATURE

While there have been extensive literatures examining the profit efficiency
features of the contemporary banking sector, particularly the U.S. and European
banking markets, the work on Islamic banking is still in its infancy. Typically,
studies on Islamic bank efficiency have focused on theoretical issues and the
empirical work has relied mainly on the analysis of descriptive statistics rather than
rigorous statistical estimation (El-Gamal and Inanoglu 2004). However, this is
gradually changing as a number of recent studies have sought to apply various
frontier techniques to estimate the efficiency of Islamic banks. Hassan (2005)
examined the relative cost, profit, X-efficiency, and productivity of the world
Islamic Banking industry. The results also show that all five efficiency measures are
highly correlated with ROA and ROE, suggesting that these efficiency measures
can be used concurrently with the conventional accounting ratios in determining
Islamic banks’ performance.
2
Atlas conversion factor, calculating gross national income (GNI—formerly referred to as
GNP) and GNI per capita in U.S. dollars for certain operational purpose’s, the World Bank
uses the Atlas conversion factor. The purpose of the Atlas conversion factor is to reduce the
impact of exchange rate fluctuations in the cross-country comparison of national incomes.
The empirical studies on the performance of banking sectors have focused on

the Returns On Assets (ROA), Returns On Equity (ROE), and net interest margins.
It has traditionally explored the impact of bank-specific factors such as risk, market
power, size and capitalisation on bank performance. More recently, research has
focused on the impact of macroeconomic factors on bank performance.
To date, empirical researches have focused mainly on a specific country mainly
the US banking system (Angbazo 1997, DeYoung and Rice 2004, Bhuyan and
Williams 2006) and the banking systems in the western and developed countries
such as New Zealand (Ho and Tripe 2002), Australia (Williams 2003), UK
(Kosmidou et al. 2008) and Greece (Pasiouras and Kosmidou 2007). On the other
hand, fewer studies have looked at bank performance in developing economies.
Guru, Staunton and Balashanmugam (2002) examine the determinants of bank
profitability in Malaysia. They employ a sample of 17 commercial banks during the
1986–1995 periods. The profitability determinants were divided into two main
categories, namely the internal determinants (liquidity, capital adequacy and
expenses management) and the external determinants (ownership, firm size and
economic conditions). The findings revealed that efficient expenses management
was one of the most significant in explaining high bank profitability. Among the
macro indicators, high interest ratio was associated with low bank profitability and
inflation was found to have a positive effect on bank performance.
Heffernan and Fu (2008) examine the performance of different types of Chinese
banks during the period 1999–2006. The results suggest that economic value added
and the net interest margin do better than the more conventional measures of
profitability, namely Return On Average Assets (ROAA) and Return On Average
Equity (ROAE). Some macroeconomic variables and financial ratios are significant
with the expected signs. Though the type of bank is influential, bank size is not.
Neither the percentage of foreign ownership nor bank listings has a discernable
effect.
Ben Naceur and Goaied (2008) examine the impact of bank characteristics,
financial structure and macroeconomic conditions on Tunisian banks’ net-interest
margin and profitability during the period of 1980–2000. They suggest that banks
that hold a relatively high amount of capital and higher overhead expenses tend to
exhibit higher net-interest margin and profitability levels, while size is negatively
related to bank profitability. During the period under study, they find that stock
market development has positive impact on banks’ profitability. The empirical
findings suggest that private banks are relatively more profitable than their state-
owned counterparts. The results suggest that macroeconomic conditions have no

significant impact on Tunisian banks’ profitability.
Ben Naceur and Omran (2008) examine the influence of bank regulations,
concentration, financial and institutional development on Middle East and North
Africa (MENA) countries commercial banks’ margin and profitability during the
period 1989–2005. They find that bank-specific characteristics, in particular bank
capitalisation and credit risk, have positive and significant impact on banks’ net
interest margin, cost efficiency and profitability. On the other hand, macroeconomic
and financial development indicators have no significant impact on bank
performance. More recently, Sufian and Habibullah (2009) examine the
determinants of the profitability of the Chinese banking sector during the post-
reform period of 2000–2005. The empirical findings suggest that all the determinant
variables have statistically significant impact on China banks profitability.
However, the impacts are not uniform across bank types. They find that liquidity,
credit risk and capitalization have positive impacts on the State-Owned Commercial
Banks (SOCBs) profitability, while the impact of cost is negative. Similar to their
SOCB counterparts, they find that Joint Stock Commercial Banks (JSCBs) with
higher credit risk tend to be more profitable, whereas higher cost results in a lower
JSCB profitability level. During the period under study, the empirical findings
suggest that size and cost results in a lower city commercial banks (CITY)
profitability, whereas the more diversified and relatively better capitalised CITY
tend to exhibit higher profitability levels. The impact of economic growth is
positive, while growth in money supply is negatively related to the SOCB and CITY
profitability levels.
More recently Sufian (2010) suggest that overall economic freedom and
business freedom exerts positive impacts on the profitability of the Malaysian
banking sector. The positive sign of the coefficient indicates that higher (lower)
freedom on the activities that banks can undertake increases (reduces) banks’
profitability, which is consistent with the view that less regulatory control allows
banks to engage in various activities enabling banks to exploit economies of scale
and scope and generate income from non-traditional sources. Furthermore, higher
freedom on entrepreneurs to start businesses is conducive to job creation and
consequently increases banks’ profitability. He also find that freedom from
corruption has a significant positive impact on Malaysian banks’ profitability.
III. METHODOLOGY
To test the relationship between bank profitability and the bank-specific and
macroeconomic determinants described earlier, we estimate a linear regression
model in the following form:
yit = b0it + bijt Xijt + bejt Xejt + εit (1)
where i refers to an individual bank; t refers to year; yjt refers to the ROE and is
the observation of a bank i in a particular year t; Xi represents the internal factors
(determinants) of a bank; Xe represents the external factors (determinants) of a
bank; εit is a normally distributed variable disturbance term. We apply the Ordinary
Least Square (OLS) method, while the standard errors are calculated by using
White’s (1980) transformation to control for cross-section heteroskedasticity. As a
robustness checks, the empirical setting is also performed by using the least square
method of Fixed Effects Model (FEM) to control for bank-specific effects. The
opportunity to use a fixed effects rather than a random effects model has been tested
with the Hausman test. Extending equation (1) to reflect the numbers of explanatory
variables as described in Table 1, the baseline model is formulated as follows:
φjt = α + β1OE/TA + β2EQUITY/TA + β3LNTA
+ β4LOANS/TA + β5LNDEPO+ β6NPL/TL
+ β7LNGDP+ β8INFLATION + β9MARKET+
β10ΣDUMMY (AFC, GFC, MENA, ASIA, LOW, MEDIUM, HIGH)+ εj
The dependent variable is ROE;

ROE is proxy measure of bank’s profitability calculated as net income after tax
divided by total shareholders’ equity;
OE/TA is a measure of bank operating expenses against total asset;
EQUITY/ TA is a measure of bank leverage intensity measured by banks’ total
shareholders’ equity divided by total assets;
LNTA is the size of the bank’s total asset measured as the natural logarithm of
total bank assets;
LOANS/TA is a measure of bank’s loans intensity calculated as the ratio of total
loans to bank total assets;
LNDEPO is a measure of bank’s market share calculated as a natural logarithm
of total bank deposits;
NPL/TL is a measure of banks risk calculated as non performing loans divided

by total loans;
LNGDP is country gross domestic product of the country’s measured as the
natural logarithm of gross domestic product;
INFLATION is country inflation rates;
MARKET is overall stock market capitalization size of the country’s bank
operated;
DUMMY is a dummy variables which takes a value of 1 for AFC, 0 otherwise;
same apply for GFC, MENA, ASIA, LOW, MEDIUM, and HIGH where each
variable takes a value of 1, 0 otherwise.
III.1 Performance Measure

In the literature, bank profitability, typically measured by the ROA and the
ROE, is usually expressed as a function of internal and external determinants.
Internal determinants are factors that are mainly influenced by a bank’s
management decisions and policy objectives. Such profitability determinants are the
level of liquidity, provisioning policy, capital adequacy, expenses management and
bank size. On the other hand, the external determinants, both industry and
macroeconomic related, are variables that reflect the economic and legal
environments where the financial institution operates. Following Pasiouras and
Kosmidou (2007), Ben Naceur and Goaied (2008), Kosmidou (2008), and Sufian
and Habibullah (2009), among others, the dependent variable used in this study is
ROA while our study adopted ROE as our dependent variables. ROE reflects how
effectively a bank management utilising its shareholders funds in providing returns.
Since ROA tends to be lower for financial intermediaries, most banks utilise
financial leverage heavily to increase ROE to competitive levels.
III.2 Definition and the Choice of Variables

Due to entry and exit factor, the efficiency frontier is constructed by using an
unbalanced sample of Islamic banks operating in the World during the period 1992-
2009 (see Appendix 1). We collected our bank-specific variables from the financial
statements of a sample of World Islamic banks operating over the period 1992–2009
available in the Bankscope database by IBCA and sourced from individual Islamic
bank’s annual balance sheet and income statements. The BankScope database
converts the data to common international standards to facilitate comparisons and
all financial information is reported both in local currency and in US dollar. We also
convert local currency that not US dollar into US dollar for data sourced directly
from the Islamic banks. We are able to collect several internal and external
determinants as listed in Table I that stated internal as bank characteristic and
external as economic condition.
III.3 Internal Determinants

The bank characteristic variables included in the regressions are Total Loans
divided by Total Assets (LOANS/TA), Log of Total Assets (LNTA), Non
Performing Loans divided by Total Loans (NPL/TL), Log of Total Deposit
(LNDEPO), Operating Expenses divided by Total Assets (OE/TA) and book value
of stockholders’ equity as a fraction of total assets (EQUITY/ TOTAL ASSET).
Liquidity risk, arising from the possible inability of banks to accommodate
decreases in liabilities or to fund increases on the assets’ side of the balance sheet, is
considered an important determinant of bank profitability. The loans market,
especially credit to households and firms, is risky and has a greater expected return
than other bank assets, such as government securities. Thus, one would expect a
positive relationship between liquidity (LOANS/TA) and profitability (Bourke
1989). It could be the case, however, that the fewer the funds tide up in liquid
investments, the higher we might expect the profitability to be (Eichengreen and
Gibson 2001). The LNTA variable is included in the regression as a proxy of size to
capture the possible cost advantages associated with size (economies of scale). This
variable controls for cost differences and product and risk diversification according
to the size of the bank. The first factor could lead to a positive relationship between
size and bank profitability if there are significant economies of scale (Akhavein,
Berger and Humphrey 1997, Bourke 1989, Molyneux and Thornton 1992, Bikker
and Hu 2002, Goddard,Molyneox and Wilson 2004), whereas the second to a
negative one, if increased diversification leads to lower credit risk and thus lower
returns.
Other researchers, however, conclude that marginal cost savings can be
achieved by increasing the size of the banking firm, especially as markets develop
(Berger et al. 1995, Boyd and Runkle 1993). In essence, LNTA may lead to positive
effects on bank profitability if there are significant economies of scale. On the other
hand, if increased diversification leads to higher risks, the variable may exhibit
negative effects.
The ratio of Operating Expenses to Total Assets (OE/TA) is used to provide
information on the variations of bank operating costs. The variable represents total
amount of wages and salaries, as well as the costs of running branch office facilities.
For the most part, the literature argues that reduced expenses improve the efficiency
and hence raise the profitability of a financial institution, implying a negative
relationship between operating expenses ratio and profitability (Bourke 1989).

However, Molyneux and Thornton (1992) observed a positive relationship,
suggesting that high profits earned by banks may be appropriated in the form of
higher payroll expenditures paid to more productive human capital. In any case, it
should be appealing to identify the dominant effect in a developing banking
environment like Malaysia. EQUITY/TA is included in the regressions to examine
the relationship between profitability and bank capitalisation. Even though leverage
(capitalisation) has been demonstrated to be important in explaining the
performance of financial institutions, its impact on bank profitability is ambiguous.
As lower capital ratios suggest a relatively risky position, one might expect a
negative coefficient on this variable (Berger 1995). However, it could be the case that
higher levels of equity would decrease the cost of capital, leading to a positive
impact on bank profitability (Molyneux 1993). Moreover, an increase in capital may
raise expected earnings by reducing the expected costs of financial distress,
including bankruptcy (Berger 1995).
III.4 External Determinants

The economic condition variables included in the regressions are Total Loans
divided by Total Assets (LOANS/TA), Log of Total Assets (LNTA), Non
Performing Loans divided by Total Loans (NPL/TL), Log of Total Deposit
(LNDEPO), Operating Expenses divided by Total Assets (OE/TA) and book value
of stockholders’ equity as a fraction of total assets (EQUITY/ TOTAL ASSET).
Bank profitability is sensitive to macroeconomic conditions despite the trend in
the industry towards greater geographic diversification and larger use of financial
engineering techniques to manage risk associated with business cycle forecasting.,
Higher economic growth generally encourages bank to lend more and permits them
to charge higher margins, as well as improving the quality of their assets. Neely and
Wheelock (1997) use per-capita income and suggest that this variable exerts a
strong positive effect on bank earnings. Demirguc-Kunt and Huizinga (2001) and
Bikker and Hu (2002) identify possible cyclical movements in bank profitability,
i.e. the extent to which bank profits are correlated with the business cycle. Their
findings suggest that such correlation exists, although the variables used were not
direct measures of the business cycle. To measure the relationship between
economic and market conditions and bank profitability, Natural Log of Gross
Domestic Product (LNGDP) and INFL (the inflation rate) are used. Bank
performance is expected to be sensitive to macroeconomic control variables. The
impact of macroeconomic variables on bank performance has recently been
highlighted in the literature. We use the log of GDP as a control for cyclical output
effects, which we expect to have a positive influence on bank profitability. As GDP

growth slows down, in particular during recessions, credit quality tends to
deteriorate and default rate increases, thus reducing bank profitability. We also
account for macroeconomic risk by controlling for the rate of inflation (INFL). The
extent to which inflation affects bank profitability depends on whether future
movements in inflation are fully anticipated, which in turn depends on the ability of
banks to accurately forecast its future movements. An inflation rate that is fully
anticipated raises profits as banks can appropriately adjust interest rates to increase
revenues, while an unanticipated change could raise costs due to imperfect interest
rate adjustment (Perry 1992). Earlier studies by among others Bourke (1989),
Molyneux and Thornton (1992), Demirguc-Kunt and Huizinga (1999) have found a
positive relationship between inflation and bank performance.
To examine the impact of market capitalisation on bank profitability, an overall
index, MARKET has been added to the variables list. We introduce 2 variables
AFC and GFC to identify the impact of 1998 Asian Financial Crisis and 2008
Global Financial Crisis towards Islamic banks profitability. It has been entered in
regression models 2, 4 and 6 and 3, 5 and 7 respectively. To further examine the
Islamic banks origin impact on bank profitability, we introduce region index,
namely MENA and ASIA, to represent banks origin from Middle East and North
Africa (MENA) and Asian countries (ASIA) is entered in regression models 4 and 5
and 6 and 7 respectively. Finally, to test impact of country income level towards
Islamic bank profitability, we introduce LOW, MEDIUM and HIGH as variables and
been entered in regression models 8, 9 and 10 respectively.
IV. RESULTS
In this section, we will discuss the performance profitability of the World
Islamic banking sectors, measured by the Fixed Effect Model (FEM). The
regression results focusing on the relationship between bank profitability and the
explanatory variables are presented in Table 1.
IV.1 The Islamic Banks’ Profitability Performance

Based on literature, bank profitability is typically measured by return on equity
(ROE) and/ or return on asset (ROA) and usually expressed as a function of internal
and external determinants.
Internal determinants are factors that are mainly influenced by a bank’s
management decisions and policy objectives. Such profitability determinants are the
level of liquidity, provisioning policy, capital adequacy, expenses management, and
bank size. On the other hand, the external determinants, both industry and
macroeconomic related, are variables that reflect the economic and legal
environments where the financial institution operates (Sufian and Habibullah 2009).
We will select ROE as dependent variable based on several reasons. Of all
the fundamental ratios that measure profitability, one of the most important is return
on equity. It is a basic test of how effectively a company's management uses
investors' money. By measuring how much earnings a company can generate from
assets, ROE offers a gauge of profit-generating efficiency. Firms that do a good job
of milking profit from their operations typically have a competitive advantage, a
feature that normally translates into superior returns for investors. The other factor
as to why ROE has been selected is due to DuPont analysis 3 that breaks down ROE
into three distinct elements. This analysis will enable details analysis to understand
the source of superior (or inferior) return by comparison with companies in similar
industries (or between industries). DuPont analysis tells us that ROE is affected
by three things: Operating efficiency, which is measured by profit margin; Asset use
efficiency, which is measured by total asset turnover; and Financial leverage, which
is measured by the equity multiplier.
The regression results focusing on the relationship between bank profitability
and the explanatory variables are presented in Table 1. The model performs
reasonably well with most variables remaining stable across the various regressions
tested. The explanatory power of the models is reasonably high, while the F-
statistics for all models is significant at the 1% level for model 1 to model 5 and 5%
level for model 6 to model 10. The adjusted R2 is 18% for model 1 to 5 and 8% for
model 6 to 10, this is more lower compared to Kosmidou et al. (2008) at 92% and
Sufian (2010) at 75%.
The ratio of Operating Expenses to Total Assets (OE/TA) is used to provide
information on the bank operating costs against asset have. The variable represents
total amount of overhead expenses, wages and salaries, as well as the costs of
running branch office facilities inclusive utilities, stationary, etc. against bank
assets. For the most part, the literature argues that reduced expenses improve the
efficiency and hence raise the profitability of a financial institution, implying a
negative relationship between operating expenses ratio and profitability (Bourke
3
A method of performance measurement that was started by the DuPont Corporation in the
1920s. With this method, assets are measured at their gross book value rather than at net
book value in order to produce a higher return on equity (ROE). It is also known as “DuPont
identity.”
1989). The result exhibits positive relationship with bank profitability at all 10
models with 5 models is statistically significant at the 1% level. The result
justification that talent is attracted to benefit and financial returns offered by
organisation in working environment is also applicable in Islamic bankings on
justifying strong positive relationship between bank profitability with OE/TA ratio.
This is consistent with Molyneux and Thornton (1992) who observed a positive
relationship, suggesting that high profits earned by banks may be appropriated in
the form of higher payroll expenditures paid to more productive human capital.
Referring to the impact of capitalisation, it is observed from Table 1 that
EQUITY/TA exhibits positive relationship with profitability and is statistically
significant at 1% level. But when we control for GNI country income, the result is
still positive but not significant. This is consistent with previous studies (Isik and
Hassan 2003, Staikouras and Wood 2003, Sufian and Habibullah 2009) providing
support to the argument that well capitalised banks face lower costs of going
bankrupt, thus lowers their funding cost, or that they have lower needs for external
funding resulting in higher profitability. Nevertheless, strong capital structure is
essential for banks in emerging economies since it provides additional strength to
withstand financial crises and increased safety for depositors during unstable
macroeconomic conditions.
The LNTA variable is included in the regression models as a proxy of size to
capture the possible cost advantages associated with size (economies of scale). This
variable controls for cost differences and product and risk diversification according
to the size of the bank. The findings indicate that LNTA, as a proxy of bank’s size,
shows positive sign, suggesting larger banks tend to be more profitable. Concerning
the liquidity results, LOANS/TA has a negative relationship with profit efficiency
levels. There may be decreasing returns to scale through the allocation of fixed costs
(e.g. research or risk management) over a higher volume of services or from
efficiency gains from a specialised workforce, while LNDEPO reveals positive
relationship with profit efficiency. Although it is not statistically significant at the
considered levels, it is perceived that the more deposit the bank’s receive, higher
will be loan disbursement that is positively correlated with bank revenue translating
into higher profits.
For credit risk result, the impact of credit risk (NPL/TL) has a negative
relationship with bank profitability, this generally suggesting that banks with higher
credit risk exhibit lower profitability levels. The results imply that World Islamic
banks should focus more on credit risk management, which has been proven to be
problematic in the recent past. Sufian and Habibullah (2009) also find similar result
and stated that serious banking problems have arisen from the failure of financial
institutions to recognise impaired assets and create reserves for writing off these
assets. An immense help towards smoothing these anomalies would be provided by
improving the transparency of the banking sector, which in turn will assist banks to
evaluate credit risk more effectively and avoid problems associated with hazardous
exposure.
The results about the impact of macroeconomic conditions of Malaysian banks’
profitability are mixed. The empirical findings suggest that LNGDP has a positive
relationship with bank profitability when we run for model 1 to model 5. But once
we remove inflation from model 6 to model 10 because of multicollinearity
problem, it becomes negative relationship. On the other hand, INFLATION exhibits
positive sign for model 1 to model 5, for model 6 to model 10 the inflation variable
has been dropped from the regression due to multicollinearity problem with GNI
variables (LOW, MEDIUM AND HIGH). While market capitalisation represents by
MARKET exhibits positive relationship for all 10 models.
As a robustness check, a binary dummy variable AFC, which takes a value of 1
for the year 1998 where Asian Financial Crisis happened, and 0 otherwise is
included in models 2, 4 and 6 regressions. The regression result in Table 1 stated
negative relationships between AFC and bank profitability for all 3 models. The
same procedure repeated for GFC where value of 1 for the year 2008 represented
Global Financial Crisis happened, and 0 otherwise is included in models 3, 5 and 7
regressions. The GFC result is consistent with AFC that has negative relationship
with bank profitability for all 3 models.
Since the coverage of studied is from the whole world, we extend dummy
variables for identifying impact on regions where Islamic banks concentrated the
most, which takes a value of 1 for banks from the Middle East and North Africa
(MENA) region, and 0 otherwise is included in models 4 and 5 of the regression.
The results are presented Table 1, which stated negative relationship between
MENA and profitability. Then we test the same method for bank originated from
Asian, value of 1 for banks from the Asian (ASIA) region and 0 otherwise is
included in model 6 and 7 of the regression. The result exhibits negative
relationship with profitability and is statistically significant at 10% level. The result
is interesting since Asian Islamic banks are less profitable than MENA Islamic
banks.
Finally we test the impact of country income classification where the Islamic
banks operated with profitability. The three GNI country incomes classify as LOW,
MEDIUM and HIGH in the regression models 8, 9 and 10 of Table 1. Each model
starts with LOW will take value of 1 for Islamic banks originated from World Bank
GNI classification as low income country and 0 otherwise. The same procedure
applies for MEDIUM and HIGH income countries. Model 8 represents regression
with LOW income countries and the result in Table 1 stated positive relationship
with profitability. On the other hand, MEDIUM income countries in model 9 have a
negative relationship and significant at 1% level. The result implies that Islamic
banks originated from MEDIUM income countries have negative relationship with
profitability. This contradicts with basic understanding that when people have
money, banking sector will benefit from it via higher deposits, more subscribers in
financial product, etc. It may be the result of consumers in middle income countries
not engaging with banking product and facility that contribute to these negative
relationships with bank profitability. Based on Table 1, result for HIGH income
countries found positive relationship and statistically significant at 10% level. This
is interesting since MEDIUM and HIGH income countries have different results
finding between one and another. The result supports, Pareto rules of 80/20 where
20 per cent population will contribute 80 per cent of profitability; most of HIGH
income countries in the study are relatively smaller in population. We may stated
that profitability of HIGH income countries is correlated with understanding that
people or organisation will engage more with banking product that can lead towards
profitability of the Islamic banks.
The results above seem to suggest that most of the bank trait variables
continued to remain robust in the directions and significance level. Favourable
economic conditions during the period of study may have fuelled higher demand for
Islamic banking products and services, reduced default loan probabilities, and thus
resulting in profitability.
TABLE 1
RESULTS OF FIXED EFFECT MODEL ANALYSIS
Explanatory Model Model Model Model Model Model Model Model Model Model
Variables 1 2 3 4 5 6 7 8 9 10
Constant 84.8615 85.5781 52.7100 87.4972 53.8590 11.0604 14.2929 -16.5800* 0.6952 0.4958
(0.9848) (0.9384) (0.7300) (0.9547) (0.6983) (0.8386) (0.9002) (-1.7775) (0.1758) (0.0725)
Bank Characteristic
OE/TA 0.0215*** 0.0215*** 0.0213*** 0.0214*** 0.0213*** 0.0039 0.0047 0.0040 0.0040 0.0039
(12.0256) (12.0080) (11.2493) (12.0600) (11.2295) (0.3106) (0.3977) (0.3175) (0.3222) (0.3108)
EQUITY/TA 0.0043*** 0.0043*** 0.0042*** 0.0043*** 0.0042*** 0.0006 0.0008 0.0006 0.0006 0.0006
(9.5045) (9.4336) (10.2054) (9.4711) (10.1294) (0.3044) (0.4201) (0.2932) (0.2976) (0.3133)
LNTA 0.0590 0.0609 0.0601 0.0269 0.0632 1.7845 2.1160* 1.7694 1.9190 1.7726
(0.0283) (0.0291) (0.0281) (0.0127) (0.0294) (1.3176) (1.6595) (1.3910) (1.5416) (1.3730)
LOANS/TA -0.0001 -0.0001*** -0.0001 -0.0001 -0.0001 8.62 -1.3200 1.56 1.53 4.74
(-1.5693) (1.5501) (1.5965) (-1.5526) (-1.5765) (0.1865) (-0.0282) (0.3440) (0.3367) (0.1024)
LNDEPO 0.8883 0.8871 0.8855 0.8981 0.8836 1.3346 1.2356 1.4172 1.369 1.3162
(0.7843) (0.7783) (0.7962) (0.7794) (0.7892) (1.3925) (1.3834) (1.4882) (1.4607) (1.3962)
NPL/TL -21.765 -21.8186 -13.1689 -22.266 -13.2456 -0.7666 -1.3702 2.8651*** 1.6113*** -2.5617
(0.9839) (0.9688) (0.7342) (0.9824) (-0.7243) (-0.4524) (-0.6356) (2.8571) (4.0435) (-0.9632)
Economic Condition
LNGDP 0.1353 0.1353 0.1336 0.1354 0.1336 -0.0015 -0.0019 -0.0015 -0.0015 -0.0015
(0.9252) (0.9225) (0.9141) (0.9191) (0.9144) (-0.2843) (-0.3876) (-0.2816) (-0.2849) (0.2888)
INFLATION 0.0158 0.0150 0.0580 0.0129 0.0566
(0.1194) (-0.1114) (0.5703) (0.0954) (0.5500)
(Contd. Table 1)
Explanatory Model Model Model Model Model Model Model Model Model Model
Variables 1 2 3 4 5 6 7 8 9 10
MARKET 7.6300 7.6300 4.2600 7.6400 4.2500 7.63 5.0100 7.4600 7.5700 7.7200
(1.0447) (-1.0404) (0.8086) (1.0380) (0.8065) (1.3056) (1.0158) (1.2843) (1.2950) (1.3190)
AFC -0.7593 -2.0690 1.2848
(-0.1249) (-0.9884) (0.6498)
GFC -6.0962 -6.1052 -5.7177
(-0.8582) (-0.8539) (-0.9556)
MENA -0.8454 -1.2683
(-0.1394) (-0.2121)
ASIA -17.0356* -15.858*
(-1.7037) (-1.8179)
LOW 13.6031
(0.9900)
MEDIUM -29.559***
(-6.3576)
HIGH 33.2213*
(1.7371)
R2 0.4278 0.4277 0.4286 0.4279 0.4287 0.3015 0.3029 0.3010 0.3025 0.3018
Adj. R2 0.1911 0.1861 0.1873 0.1811 0.1823 0.0794 0.0812 0.0823 0.0842 0.0833
Durbin-Watson 2.9042 2.9042 2.8703
stat 2.9030 2.8704 1.8729 1.8617 1.8877 1.8848 1.8703
F-statistics 1.8075*** 1.7699*** 1.7763*** 1.7341*** 1.7397*** 1.3573** 1.3664** 1.3761** 1.3859** 1.3813**
No. of 230.00 230.00 230.00 230.00 230.00 345.00 345.00 345.00 345.00 345.00
Observations
Note: Values in parentheses are t-statistics. ***, **, and * indicate significance at 1, 5, and 10% level respectively.
V. CONCLUSIONS AND DIRECTIONS FOR FUTURE RESEARCH

By using an unbalanced bank level panel data, the present study attempts to
examine World Islamic Banks performance profitability during the period 1992-
2009. We find that the larger, more diversified, and better capitalized banks are
relatively more profitable. The empirical findings seem to support the expense
preference theory, which could be explained by the more highly qualified and
professional management that requires higher remuneration packages. On the other
hand, we find that higher credit risk has negative impact on bank profitability.
In this paper, we examine the profitability performance of the World Islamic
banks that consist of 25 countries namely Bahrain, Bangladesh, Brunei, Egypt,
Gambia, Indonesia, Iran, Iraq, Jordan, Kuwait, Malaysia, Mauritania, Pakistan,
Palestine, Saudi Arabia, Singapore, Syria, Thailand, Turkey, United Arab Emirates,
Qatar, Yemen, South Africa, Sudan and Yemen during the period of 1992-2009
with 78 Islamic banks involved. The profitability performance of individual banks is
evaluated using Fixed Income Model (FEM) against a set of bank specific variables.
The Fixed Effect Model (FEM) result that has been used for analysing
profitability proposed that profit efficiency is positively and significantly associated
with operating expenses against asset, equity, HIGH income countries and non
performing loans against total loans specifically for models 8 and 9 that positively
significant at 1 per cent level. The empirical results show that more profitable banks
are those that have higher operating expenses against asset, more equity against
asset and concentrated at high income countries. The results also suggest that
favourable economic conditions exhibit positive relationship with profit efficiency.
The impact of 1998 and 2008 financial crises have been examined in the study. The
finding for both crises is negative and non significant. It implies that world Islamic
banks’ profitability does not impacted during Asian and Global Financial crises.
Due to its limitations, the paper could be extended in a variety of ways. Firstly,
the scope of this study could be further extended to investigate other variables such
as taxation and regulation indicators. Secondly, it is suggested that further analysis
into the investigation of the Islamic banking sector efficiency to consider risk
exposure factors. Finally, investigation of changes in productivity over time as a
result of technical change or technological progress or regress by employing the
Malmquist Total Factor Productivity Index could yet be another extension to the
paper.
Despite these limitations, the findings of this study are expected to contribute
significantly to the existing knowledge on the operating performance of the World
Islamic banking industry. Nevertheless, the study has also provided further insight
to bank specific management as well as the policymakers with regard to attaining

optimal utilisation of capacities, improvement in managerial expertise etc. This may
also facilitate directions for sustainable competitiveness of World Islamic banking
operations in the future.
REFERENCES
Akhavein, J., A.N. Berger and D.B. Humphrey. 1997. “The Effects of Megamergers on
Efficiency and Prices: Evidence from a Bank Profit Function.” Review of Industrial
Organization, 12(1):95–139.
Angbazo, L. 1997. “Commercial Bank Net Interest Margins, Default Risk, Interest Rate
Risk, and Off Balance sheet Banking.” Journal of Banking and Finance, 21:55–87.
Berger, A.N. 1995. “The Relationship between Capital and Earnings in Banking.” Journal
Money, Credit and Banking, 27:432–456.
Berger, A.N. and D.B.Humphrey.1997. “Efficiency of Financial Institutions: International
Survey and Directions for Future Research.” European Journal of Operational
Research, 98 (2): 175-212.
Ben Naceur, S. and M.Goaied.2008. “The Determinants of Commercial Bank Interest
Margin and Profitability: Evidence from Tunisia.” Frontiers in Finance and
Economics. 5 (1):106–130.
Ben Naceur, S. and M.Omran.2008. “The Effects of Bank Regulations, Competition and
FinancialReforms on Mena Banks’ Profitability.” Working Paper, Economic
Research Forum,Cairo, Egypt.
Berger, A.N., A.K. Kashyap and J.M. Scalise.1995. “The Transformation of the U.S.
Banking Industry: What a Long, Strange Trip It’s Been.” Brookings Papers on
Economic Activity, 2: 55-218.
Bhuyan, R. and D.L. Williams. 2006. “Operating Performance of the US Commercial Banks
after IPOs: An Empirical Evidence.” Journal of Commercial Banking and Finance, 5
(1–2):68–95.
Bikker, J. and H. Hu. 2002. “Cyclical Patterns in Profits, Provisioning and Lending of Banks
and Procyclicality of the New Basel Capital Requirements.” BNL Quarterly Review,
221:143–175.
Bourke, P. 1989. “Concentration and Other Determinants of Bank Profitability in Europe,
North America and Australia.” Journal of Banking and Finance, 13:65–79.
Boyd, J. and D. Runkle.1993. “Size and Performance of Banking Firms: Testing the
Predictions Theory.” Journal of Monetary Economics, 31:47–67.
Demirguc-Kunt, A. and H.Huizinga.1999. “Determinants of Commercial Bank Interest
Margins and Profitability: Some International Evidence.” World Bank Economic
Review, 13:379–408.
Demirguc-Kunt, A. and H. Huizinga. 2001. “Financial Structure and Bank Profitability.” In
Demirguc-Kunt, A. and Levine, R. (eEds.), Financial Structure and Economic
Growth: A Cross Country Comparison of Banks, Markets and Development.
Cambridge, MA :MIT Press.
DeYoung, R. and T. Rice.2004. “Non-interest Income and Financial Performance at US
Commercial Banks.” Financial Review, 39(1):101–127.
Eichengreen, B. and H.D. Gibson. 2001. “Greek Banking at the Dawn of the New
Millennium.” Discussion Paper, Centre of Economic and Policy Research, London,
UK.
Goddard, J., P. Molyneux and J. Wilson. 2004. “Dynamic of Growth and Profitability in
Banking.” Journal Money, Credit and Banking, 36:1069–1090.
Guru, B.K., Staunton, J. and B. Balashanmugam.2002. “Determinants of Commercial Bank
Profitability in Malaysia.” Multimedia University Working Paper, Cyberjaya,
Malaysia.
Hassan, M.K. 2005. “The Cost, Profit and X-Efficiency of Islamic Banks.” Paper presented
at the 12th ERF Annual Conference, 19th-21st December, Egypt.
Heffernan, S. and M. Fu. 2008. “The Determinants of Bank Performance in China.” EMG
Working Paper Series.
Ho, M.T. and D. Tripe.2002. “Factors Influencing the Performance of Foreign Owned Banks
in New Zealand.” Journal International Financial Markets, Institutions and Money,
12:341–357.
Isik, I. and M.K. Hassan. 2003. “Efficiency, Ownership and Market Structure, Corporate
Control and Governance in the Turkish Banking Industry.” Journal of Business
Finance and Accounting ,30 (9-10):1363-1421.
Kosmidou, K. 2008. “The Determinants of Banks’ Profits in Greece during the Period of EU
Financial Integration.” Managerial Finance, 34 (3):146–159.
Molyneux, P. 1993. Structure and Performance in European Banking. University of Wales
Bangor, Bangor, UK. Mimeo.
Molyneux, P. and J. Thornton. 1992. “Determinants of European Bank Profitability: A
Note.” Journal Banking and Finance, 16:1173–1178.
Neely, M. and D. Wheelock.1997. “Why Does Bank Performance Vary Across States?”
Federal Reserve Bank St. Louis Review, March:27–38.
Pasiouras, F. and K.Kosmidou. 2007. “Factors Influencing the Profitability of Domestic and
Foreign Commercial Banks in the European Union.” Research in International
Business and Finance, 21:223–237.
Perry, P. 1992. “Do Banks Gain or Lose from Inflation.” Journal Retail Banking, 14 (2): 25–
40.
Staikouras, C. and G.Wood. 2003. “The Determinants of Bank Profitability in Europe.”
Paper presented at the European Applied Business Research Conference, Venice, 9-
13 June.
Sufian, F. and M.A.N.M. Noor. 2009. “The Determinants of Islamic Bank’s Efficiency
Changes: Empirical Evidence from the MENA and Asian Countries Islamic Banking
Sectors.” International Journal of Islamic and Middle Eastern Finance and
Management, 2(2):120-138
Sufian, F. and M.S. Habibullah. 2009. “Bank Specific and Macroeconomic Determinants of
Bank Profitability: Empirical Evidence from the China Banking Sector.” Frontiers of
Economics in China, 4 (2):274–291.
Sufian, F., M.S., Habibullah. 2010. “Does Economic Freedom Fosters Banks’ Performance?
Panel Evidence from Malaysia.” Journal of Contemporary Accounting & Economics,
doi: 10.1016/j.jcae.2010.09.003
Sufian, F. 2010. “Developments in the Performance of the Malaysian Banking Sector:
Opportunity Cost of Regulatory Compliance.” Int. J. Business Competition and
Growth, 1 (1):85–103.
White, H.J. 1980. “A Heteroskedasticity-consistent Covariance Matrix Estimator and a
Direct Test for Heteroskedasticity.” Econometrica, 48:817–838.
Williams, B. 2003. “Domestic and International Determinants of Bank Profits: Foreign
Banks in Australia.” Journal of Banking and Finance, 27:1185–1210.
Zaher, T.S. and M.K. Hassan. 2001. “A Comparative Literature Survey of Islamic Finance
and Banking.” Financial Markets, Institutions & Instruments ,10 (4): 155-199.
APPENDIX 1
Sl. Financial Institutions Country of Classification of countries

No. Origin
1 ABC Islamic Bank Bahrain High income country
2 Al Amin Bank
3 Al Baraka Islamic Bank
4 Arab Banking Corporation
5 Arcapita Bank B.S.C.
6 Arab Islamic Bank
7 Bahrain Islamic Bank
8 Gulf Finance House
9 Al Salam Bank
10 Shamil Bank
11 Taib Bank
12 Ithmaar Bank
13 Al Arafah Islami Bank Bangladesh Low income country
14 Shah Jalal Islami Bank
15 ICB Islamic Bank Limited
16 Islamic Bank Bangladesh
17 Islamic Development Bank of Brunei Bhd
18 Bank Islam Brunei Darussalam Berhad Brunei High income country
19 Faisal Islamic Bank
20 Arab Gambian Islamic Bank Egypt Lower middle income
21 Bank Muamalat Indonesia Gambia Low income country
22 Bank Mellat Indonesia Lower middle income
23 Bank Refah Iran Lower middle income
24 Al Bilad Islamic Bank
25 Jordan Islamic Bank
26 Arab Islamic Bank Iraq Lower middle income
27 Islamic International Arab Bank Jordan Lower middle income
28 Jordan Dubai Islamic Bank
29 Kuwait Finance House
30 Affin Islamic Bank Berhad
31 Alliance Islamic Bank Kuwait High income country
32 Bank Islam Malaysia Berhad Malaysia Upper middle income
33 Bank Islam Malaysia (L) Berhad
34 Bank Muamalat Malaysia Berhad
35 CIMB Islamic Bank Berhad
36 EONCAP Islamic Bank Berhad
37 Kuwait Finance House Malaysia
38 Hong Leong Islamic Bank
39 Maybank Islamic Berhad
40 RHB Islamic Bank Bhd
41 BAMIS-Banque Al Wava Mauritanienne
Islamique Mauritania Low income country
(Contd. Appendix Table 1)
Sl. Financial Institutions Country of Classification of countries

No. Origin
42 AlBaraka Islamic Bank B.S.C. Pakistan Low income country
43 Meezan Bank
44 Standard Chartered Modharaba
45 Bank Islami Pakistan
46 Dawood Islamic Bank
47 Dubai Islamic Bank
48 Emirates Global Islamic Bank
49 Arab Islamic Bank Palestine Low income country
50 Al Rajhi Banking Saudi Arabia Upper middle income
51 Bank AlJazira
52 EG Saudi Finance Bank
53 The Islamic Bank of Asia Singapore High income country
54 Syria International Islamic Bank Syria Lower middle income
55 Islamic Bank of Thailand Thailand Lower middle income
56 Al Baraka Turk Turkey Lower middle income
57 Kuwait Finance House
58 Ihlas Finan
59 Abu Dhabi Islamic Bank UAE High income country
60 Dubai Islamic Bank
61 Mashreq Bank
62 Emirates Islamic Bank
63 Sharjah Islamic Bank
64 Noor Islamic Bank
65 European Islamic Investment Bank Plc United High income country
Kingdom
66 Islamic Bank of Britain PLC
67 Qatar Islamic Bank Qatar High income country
68 Qatar International Islamic Bank
69 Islamic Bank of Yemen Yemen Low income country
70 Tadhamon International Islamic Bank
71 Saba Islamic Bank
72 Al Baraka South Africa South Africa Lower middle income
73 Al Baraka Sudan Sudan Low income country
74 Al Shamal Islamic Bank
75 Faisal Islamic Bank
76 Islamic Co-operative Development Bank
77 Sudanese Islamic Bank
78 Tadamon Islamic Bank
Total Countries 25
Total Banks 78
Income Groups
Low Income (55) - (Income Per Capita: $765 or less); Middle Income (52) - (Income
Per Capita: $766–9,385); High Income (40) - (Income Per Capita: $9,386 or more).
Economies are classified by GNI per capita in 2003, calculated using the World Bank
Atlas method. The groups are low income, $765 or less; lower middle income, $766–3,035;
upper middle income, $3,036–9,385; and high income, $9,386 or more.
Asset Price Bubble and Banks:

The Case of Japan
MONZUR HOSSAIN *
FARHANA RAFIQ **
This paper analyses the behaviour of the Japanese banks at the outset of
the asset price bubble in the late 1980s. The paper argues that with the
advent of financial deregulations, the declining trend of profitability
forced the banks to exhibit speculative behaviour during the asset price
bubble period (mid-1980s) to increase short term profit. This has
ultimately led to the banking crisis after the burst of the bubble in 1989.
Our empirical results support this argument. The paper also attempts to
provide a comprehensive description of a number of interrelated structural
changes in the financial system of Japan during 1977-2003 that opens up
the domain of possibility for rethinking the issues related to change in
policies. The case of Japan in the context of the rise and burst of the asset
price bubble and subsequent banking crisis could be instructive for many
countries including Bangladesh that are facing the asset price bubble
situation. Japanese experience suggests that monetary policy should
respond to asset bubbles in a cautious and moderate manner in order to
avoid economic distortions. The lessons that can be learned from the
Japanese experience are: (i) central bank’s role to burst bubbles must
depend on the degree of efficiency of the financial sector, and (ii) the
speed to burst the bubble must be based on the overall economic situation.
I. INTRODUCTION
The emergence and burst of the bubble economy in Japan in the late 1980s were
mostly characterised by the commercial banks’ aggressive behaviour, collapse of
some banks and debtor companies with a huge burden of non-performing loans
(NPL). About 180 banks were failed in the 1990s and subsequently a prolonged
*
Research Fellow, Bangladesh Institute of Development Studies.
**
Lecturer, Department of Economics, American International University, Dhaka,
Bangladesh.
stagnant period for the Japanese economy started. Naturally, the question arises:
were the banks responsible for creating the bubble that subsequently led to the
banking crisis of the 1990s? This also raises curiosity as to why the most successful
banking system of the 1960s and the 1970s has failed? Did the deregulatory
measures indicate any structural changes in the financial system that contributed to
the failure of the banks? The paper attempts to shed some insights into these
questions.
Many authors have tried to analyse the situation from various aspects (see, Aoki
and Patrick 1994, Okina et al. 2001, Hossain 2005, Aoki and Patrick 1994)
expressed concern about the structural changes that occurred in the financial system
of Japan. They argued that the asset-price bubble in the late 1980s was partially
created by the erosion of the coherence and integrity of the regulatory framework.
According to them, with diminishing opportunity for traditional lending and limited
access to bond-related services during the protracted monetary easing of the mid
1980s, banks started to increase lending to real estate companies and non-banks.
This also revealed the banks’ weak monitoring capacity in the newly emerged
market environment.
Okina et al. (2001) identified some other reasons for the emergence of the
bubble in the late 1980s and the subsequent banking crisis. These are aggressive
bank behaviour, protracted monetary easing, taxation and regulation on land, weak
mechanism to impose discipline on economic agents, self confidence of economic
agents, etc. In line with the views of Okina et al. (2001), Hossain (2005) argued that
weaknesses in the corporate governance of banks were crucial for the banking crisis
in the 1990s, rather than asset price bubble and financial deregulations.
In this paper we take the view that financial liberalisation was started in the
early 1980s without making financial institutions prepared properly for the changing
situation. As a result, financial institutions could not cope with the situation
instantly and indulged in some speculative behaviour. Of course, such behaviour
may be associated with corporate governance problem, as Hossain (2005) argued.
Therefore, analysis of banks’ profitability is important as this has led to a sharp
response from banks to the structural changes that occurred in the Japanese banking
system in the 1980s. Although the deregulatory measures were partial in nature,
these measures created problems in functioning of the banks as they were not fully
prepared for moving toward competitiveness. Thus the paper analyses the behaviour
of the financial institutions by taking their profitability issue into consideration. We
use aggregate data for the period 1977-2003 to analyse bank profitability. Since the
data resembles time-series properties, ordinary least square regression is not
appropriate. Therefore, we apply Vector Error Correction Model (VECM) to assess
Hossain & Rafiq : Asset Price Bubble and Banks 25
the long run and short run relationship between bank profitability and other
macroeconomic and monetary variables.
The paper is organised as follows. After introduction, Section II provides an
overview of the Japanese financial system. Section III highlights various aspects of
banks behaviour during the asset price bubble. Section IV describes methodology
and data and Section V discusses empirical results on bank profitability. Section VI
concludes the paper.
II. JAPANESE FINANCIAL SYSTEM: AN OVERVIEW

II.1 The Main-bank System
The Japanese financial system is predominantly bank-based. Post-war Japanese
financial system was highly regulated and banks were heavily dependent on Bank of
Japan’s (BOJ) subsidies (window guidance) and borrowings of enterprise groups.
The characteristics of Japanese model of financial system during post-war period
included high debt/equity ratios, greater reliance on bank loans than securities
markets, closer relationship between banks and borrowers, extensive corporate
cross-shareholding, greater guidance from the government in credit allocation, etc.
The system is well known as the “main bank” system. It is evident from many
research works that this “main bank” system contributed greatly to the post-war
economic growth of Japan although the varieties of functions played by the main
bank were not associated with the usual concept of commercial banking. This type
of Japanese banking system is characterised by clearly defined structural policy of
the government for stimulating and maintaining specialisation among financial
institutions. The changes were not made to achieve maximum competition in a free
market (Wallich and Wallich 1976).
There is a vast literature on how the main bank system played a very important
role in Japanese economy and financial system. The core of an enterprise group is
usually a bank that is called Main Bank. Pre-war Zaibatsu and post-war Keiretsu are
examples of such types of enterprise groups, with the big six being Mitsui,
Mitsubishi, Sumitomo, Fuyo, Sanwa and Ikkan. Group affiliation interlocks stock
shares among industrial enterprises, banks and other financial institutions. The
arrangements between main bank and group involved both financial and non-
financial aspects. The financial arrangements included the sharing of financial risk
through mutual support, preferential loans from the financial institutions and the
control of stock voting power through ownership within the group. The non-
financial arrangements included joint sale and purchase arrangements, assured
markets and sources of supply, technological affinity, combined research, and
cooperative planning. This structure of Japanese banks might be relevant to the so-
called “Industrial bank” (also available in Germany as House bank) rather than
modern commercial bank.
Unlike American and many other countries’ banks, Japanese banks were
allowed to own equity in other corporations. The shares of group member firms
owned by banks form an important link in the interlocking structure of enterprise
groups. In addition to interlocking shares, banks provide preferential loans and
board members to the group affiliated firms. A group bank serves as a screening
agent for the investment projects of the group firms and stands ready to lend funds
whenever they are needed (Hoshi, Kashyap and Scharfstein 1991). Table I
demonstrates that despite efforts to change the main banking system, each enterprise
group consisted of at least 3 banks or insurance companies in 1987. This indicates
that all the characteristics of the main banking system have not been completely
eliminated during the liberalised period.
TABLE I
ECONOMIC SIZE OF THE BIG COMPANIES (FY1987)
No. of Total Average Average Total assets Loan Board of
member Bank/In interlocking intra- (billion Yen) share1 directors
firms surance Shares group (FY1989) share2
loans (FY1989)
Mitsui 24 4 17.1 21.94 238,447 5.96 6.69

Mitsubishi 29 4 27.8 20.17 241,846 7.17 7.08
Sumitomo 20 4 24.22 24.53 153,202 6.75 6.58
Fuyo 29 4 15.61 18.20 322,798 6.03 9.38
Sanwa 44 3 16.47 18.51 377,622 7.30 8.97
Ikkan 47 5 12.49 11.18 466,250 4.44 12.44
Source: Ito (1992).
Note:1Outstanding loans lent by group financial companies/ Total outstanding loans.
2
No. of directors sent from group companies/Total outside board members.
Literature review suggests that a policy shift toward a greater emphasis on

competition was induced in the late 1960s. Amongst other measures, an effort has
been made to make banks more profit-oriented by easing the dividend restrictions
(Wallich and Wallich 1976). As a part of intensive and continuous effort to improve
the competitive structure, the Certificates of Deposits (CDs) became available in
May 1979; Gensaki 1 transactions with CDs (unregulated interest rate) became
1
The “Gensaki market” means repurchase agreement market established in 1949 by
securities houses. It became important in 1970 when FIs and large companies began to
participate.
increasingly popular, as there is no transaction tax on CDs. The Tegata 2 market,

freed from interest rate regulation, also grew in the 1980s. During this period,
restrictions on fund-raising in the securities market by firms were removed and
major firms became less dependent on bank borrowing. These deregulations were
aimed at strengthening capital market. The decade of 1980 might be termed as
undirected deregulations as like a “boat without sail.” Aoki and Patrick (1994)
termed the banking system of that time as “market-embedded main bank system”
since some elements of the main bank system remained valid. Such untargeted
liberalisation policies created many problems for the economy and the financial
sector while switching from regulated regime to a complex partially liberalised
regime.
As a compensation for reduced dependency of enterprise groups by these
regulatory frameworks, banks are allowed to expand their businesses in risk market
(security and insurance), capital market (investment banking) as well as money
market. In fact, this model follows universal banking system although economists
have no consensus on the economies of scale of universal banking (Caprio 1994).
One of the counter arguments is that commercial banking activities are less risky
than the security operations, so risky security business may affect the commercial
banking activities.
II.2 Financial Liberalisation

The structural changes in the Japanese financial system have been started from
the mid–1970s (Sujuki 1987). The main features of these deregulations were interest
rate deregulation, relaxation of regulation to raise funds in the securities and
investment market by firms, initiation of freely floating exchange rate and allowing
banks and firms to participate in the capital market, etc. to increase the ability of the
Japanese banking system to meet international competition. These deregulations
also targeted the dissolution of cross-shareholdings. 3 Many have attributed that
financial liberalisation policies were also needed to finance government budget
deficit through allowing banks to participate in the bond market. There was a sharp
increase in government budget deficits in the late 1970s and to finance the deficit,
2
The Tegata (bill discount) market is a short-term financing market for two-weeks to six-
weeks. It was spun off from the call market in 1971.
3
The Anti Monopoly Law Reform, 1977 was one-step forward in reducing cross-
shareholding. Okabe (2001) shows that cross-shareholding is gradually reducing in the
Japanese financial system.
there was a need to sell large amounts of government bonds (see Cargill and
Royama 1988).
The developments in regulatory frameworks after 1990 allowed banks to do
business in both the capital and risk market. Under these regulatory frameworks,
Japanese banks were given license to do conventional non-banking activities like
lease financing, investment and merchant banking, underwriting, insurance
business, etc. Thus, these types of regulatory frameworks allowed banks to expand
their businesses in risk market (security and insurance), capital market (investment
banking) as well as money market. This model follows universal banking-type
system rather than modern commercial banking.
Some of the deregulatory measures are noteworthy. The interest rates for large-
amount time deposits (LTDs) were deregulated in 1985, thus the share of these
deposits in the money supply had skyrocketed. The lowering of the minimum
deposit amount for money market certificates (MMCs) to 10 million yen in October
1987 made those certificates more popular among households. The Anti-Monopoly
Law Reform of 1977 specified that all financial institutions must reduce their share
holdings from 10 per cent to below 5 per cent by December 1987. 4 Although this
law was aimed at dissolution of cross-shareholdings, there was no limit on the total
number of different stocks a bank can hold. By this law, a bank’s holding of
different stocks can exceed its total capital, which might carry risk for the banking
business. Since bank’s money are the depositors short-term money, share holding in
equity of its enterprise groups sometimes may create mismatch in maturity and loan
portfolio. 5
After the collapse of the bubble, the important structural changes started by the
Financial System Reform Act, 1992 (enforced in April 1993) that has allowed banks
to conduct trust businesses either through trust bank subsidiaries or by themselves
and securities business through securities subsidiaries subject to the permission of
the Prime Minister. Later, the Financial System Reform Law of 1998 was enacted
which allows banks to conduct insurance businesses through subsidiaries from
4
By this reform the policy of 1951 again revived.
5
It is widely argued that Ministry of Finance (MOF) has been very deliberate in asserting
authority over banks, merging banks, and controlling the system. Moreover, Japanese socio-
cultural activities have been rooted in the form of “group” activities or “joint” decision;
Zaibatsu, Keiretsu, and the main bank system were a reflection of this “group” phenomenon.
With the financial deregulations, is the authoritarian role of MOF shrinking or is the “group
phenomenon” of Japanese culture getting eliminated? The interesting thing is that the
structural changes in the financial system can be explained as the two sides—industrial
banking and universal banking, of the same coin “convoy system.”
October 2000. Since March 1998, banks are allowed to establish bank-holding
companies that can own a securities subsidiary. Banks were allowed to sell
investment trusts at their counter from December 1998. This policy shift was
necessary as the bad loans consequences of the bursting bubble result in a weaker
banking system that needs further deregulations, particularly permitting banks to
engage in bond underwriting and related services more liberally.
Non-bank financial institutions (NBFIS), consumer-financing institutions,
insurance companies, etc. are mostly working as a subsidiary company of the banks.
They are heavily dependent on banks for their funding. However, the scope of
business has opened up a wide range of business possibility for the banks that
indicates a significant change in their structure compared to the structure before
1980.
III. ASSET PRICE BUBBLE (1987-89) AND BANKS’ BEHAVIOUR

With the advent of liberalisation in the 1970s and 1980s, market forces
unleashed on the hitherto regulated environment. In this market upheaval, banks lost
their big customers as they were shifted away from bank borrowing towards other
financing methods including retained profits, corporate bonds, international
financial market, etc. Due to decrease of the large firms’ dependency on banks
borrowing, banks shifted aggressively their mode of investment to the small and
medium enterprises (SMEs), NBFIs and real estate businesses.
Along with the structural changes in the Japanese financial system, the
“monetary phenomenon” made the situation more critical. In order to counter the
recession brought about by the rapid appreciation of the yen after the Plazza Accord
in 1985, the BoJ lowered discount rate five times as part of monetary easing
between 1986 and 1987. At that time, money supply was increased by more than 10
per cent. The commercial banks took this opportunity of protracted monetary easing
to lend aggressively to the SMEs and real estate market in order to increase their
short term profit. This has been possible due to lack of prudential regulations. Also,
lower tax on holding of land and higher tax on transaction of land created demand
and supply gap in the real estate sector, which contributed to rapid rise of asset
prices. With these favourable situations, banks lent aggressively to the SMEs and
contributed in creating asset price bubble and transmitting the shocks to the
economy after collapse of the bubble.
Here it might be important to note the way the bubble had burst. As part of
BoJ’s monetary tightening and government’s effort to curb land prices, the bubble
started to burst in 1990, leading to asset prices falling sharply, many debtor
companies becoming bankrupt, and creditor companies having a huge burden of

non-performing loan (accumulated direct write-offs stood around 9 per cent of GDP
in 1999; Okina et al. 2001).
Diagram 1: Transmission Channel of Shocks during Asset Price Bubble
Risky Intervention by MOF

lending Asset Price and BOJ
Bubble
Banks, its
subsidiaries in
capital market Burst of the
Failed banks bubble
NPL
Bankruptcy of
SMEs, Debtor
Companies
Fall of business investment,

personal consumption, Deflation
Output
Economic
Recession
The above diagram shows how the banks have acted as a transmission channel
for shocks to the economy during the bubble period. The new mode of investment
of banks to the SMEs made their portfolio inefficient and the actual and expected
return varied significantly. Banks failed to model capital asset pricing successfully
by considering all associated risk factors of the market. Bank management was not
efficient enough to anticipate the asset price fluctuations. As a result, banks were
burdened with huge amount of NPL due to bankruptcy of the debtor companies and
incurred huge loss as the collateral assets became uncollectible due to continuing
plunge of land/stock prices. This issue also pinpoints the moral hazard and adverse
selection due to asymmetric information in the SME market.
It is evident from the discussion that if banks were not dependent on enterprise
group and/or if they had been prepared for ongoing deregulatory measures, they
would not have had undertaken speculative behaviour and would not suffer from
moral hazard and adverse selection problems. This ultimately exhibited structural
changes to the banking system accompanied by weak regulatory measures in Japan.
The Japanese banks were under downward pressure of profit during the heyday
of the Japanese economy in the 1970s and got momentum after liberalisation started
(Figure 1). Figure 1 shows that the declining trend of profitability of Japanese banks
continued from 1970 to 1998 except a spike in 1989, at the time of bubble. The
usual question is why banks’ profitability was declining during the high economic
growth period of Japan? Were the banks ever caring about their declining trend of
profit? Following the discussion in the previous sections, undirected liberalisation
that led to frustration for the banks, along with downward pressure of profit, acted
as catalyst for banks to behave aggressively during the asset price bubble period. It
is therefore important to analyse the declining trend of profits in the backdrop of
their activities during the bubble.
Figure 1: Japanese Banks Profitability during 1964-1998
.80 20.00
.60 15.00
10.00
.40
5.00
.20
.00
.00
1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 -5.00
-.20
-10.00
-.40 -15.00
-.60 -20.00
-.80 -25.00
ROA(right scale) ROE(left scale)
Source: Authors’ estimation
There are some explanations on the declining trend of bank profitability. How
the average profit of the main bank system was declining during the regulated
period can be explained as follows. “Over-loan”, that is, borrowing from the central
bank with low discount rate and lending it to enterprises with high interest rate was
one of the main sources of profitability of banks. City banks (larger banks) have lent
more funds than they could raise through deposit mobilisation, while regional banks
had surplus of budget. So there was an imbalance of fund. Sometimes, to meet up
the enterprise groups’ excess demand for money, bank borrowed from call money
market with high interest rate and lent it to its affiliated firm with the existing
(usually lower) interest rate. This preferential loan contributed towards the declining
trend of bank profit. Thus, borrowing short and lending long created a mismatch in
the financial system as there are some maturity gap (exact data are not available)
between the deposit fund and loan portfolio. This structural weakness affected
profitability of the “main bank” system of Japan. Perhaps, banks were not much
aware about the profit because they were competing amongst themselves for market
share rather than profit (Yoshino and Sakakibara 2002), and they were backed by
the group. Lending risk analysis could be biased due to the presence of directors of
enterprise firms in banks. There is also possibility of window dressing 6 in bank’s
profit, which could overestimate the actual profit of banks.
With the pace of financial deregulation that started in the mid–1970s, capital
market became more open to large firms and large firms’ dependency on banks’
borrowing gradually declined. The scope of cross-shareholding had also shrunk. As
the banks lost their large corporate customers, they rushed to find new borrowers
and projects. This situation compelled banks to think about the profitability for their
survival and they found themselves in the surface of tough reality. Protracted
monetary easing after Plaza Accord added fuel to their efforts of increasing short
term profit.
Another factor is the Postal Saving Scheme that also contributed to the low
profitability of banks as it created distortion in the financial market by paying
higher interest rates than banks. The interest rates of the postal certificates are not
determined by the market considering the risk and return. It is also not possible for
banks to compete with postal savings by offering higher interest rates due to some
unfavourable situations of the economy, such as deflation. This is an important issue
for the financial sector of Japan as the deposit of Postal savings scheme stood at
around 30 per cent of the total bank deposits due to its favourable interest rate
(Yoshino 2000).
6
Bank sometimes manipulate their financial statements to show an inflated position of their
performance by taking favour from their own enterprise group. This unfair means is termed
as Window Dressing.
IV. DATA AND METHODOLOGY

The main objective of this paper is to analyse the profitability of Japanese banks
and examine whether the monetary phenomenon and overheated economic activity
had any influence on banks profitability. The profitability variable is represented by
two alternative measures: the ratio of profits to assets, i.e. the return on assets
(ROA) and the profits to equity ratio, i.e. the return on equity (ROE). In principle,
ROA reflects the ability of a bank’s management to generate profits from the bank’s
assets, although it may be biased due to off-balance-sheet activities. ROE indicates
the return to shareholders on their equity and equals ROA times the total assets-to-
equity ratio. The latter is often referred to as the bank’s equity multiplier, which
measures financial leverage. Banks with lower leverage (higher equity) will
generally report higher ROA, but lower ROE. Since an analysis of ROE disregards
the greater risks associated with high leverage and financial leverage is often
determined by regulation, ROA emerges as the key ratio for the evaluation of bank
profitability (IMF 2002). Both ROA and ROE are measured as running year
averages. 7
To assess the effects of various factors on bank profitability, we choose only a
few variables that are important in the light of our previous discussion. The
ROAt = α + β Bi ,t + δM t + ε i ,t
regression model is specified as follows:
(1)
where Bi,t is a vector of bank-specific variables at time t. Only total asset of
banks is considered here to represent the bank size because economies of scale can
lead bigger banks to operate with lower average costs, which could be an indicator
of profitability irrespective of other condition. The logarithm of total asset is also a
measure of bank size. Mt is a vector of time-varying macroeconomic variables, such
as GDP growth, money supply (M2+CD) and central bank discount rate. Land price
index is used as a proxy of asset price bubble. These variables are considered to
capture the effects of macroeconomic and monetary phenomenon in the profitability
of Japanese banks (Figure 2).The data are collected from the BoJ website and the
IFS of the IMF.
Since we use the aggregate data for the period 1977-2002, macroeconomic
variables are subject to time series properties. Therefore, we test the unit root
properties of the macro and monetary variables by applying the Augmented Dickey-
Fuller (ADF) test. The hypothesis of no unit root cannot be rejected at 5 per cent
7
Figure 1 presents ROA and ROE for the Japanese banking sector. The two ratios follow
similar paths, increasing over time with a spike in 1999.
level (Table II). If explanatory varoiables display unit roots, an OLS regression
cannot give precise and unbiased estimates. Therefore, we have applied the Vector
Error Correction model to assess the relationship between banks profitability and
other industry and macroeconomic variables. The results are reported in Table III.
TABLE II
RESULTS OF ADF UNIT ROOT TEST
Variable Test Statistic Test at First Remark
Difference
ROA -1.39 -6.44*** I(1)
GDP -2.51 -5.14*** I(1)
M2CD -1.93 -5.06*** I(1)
LPIND -1.12 -2.79** I(1)
ASSET -1.88 -1.70 I(2)
LASSET -3.79*** -- I(0)
Note: *** and ** indicate significance at 1 per cent and 5 per cent level respectively.
V. EMPIRICAL RESULTS
On the basis of evidence from various diagnostic and specification tests, the
final specification of the statistical model in Equation (1) was finally estimated as a
Vector Error Correction (VEC) model—up to two lags are allowed for each of the
endogenous variables in the VAR. This final specification served as the basis for
assessing the influence of domestic outputs and money supply as well as asset price
bubble on both the short and long run variation of bank profitability (represented by
the ROA) in Japan.
The estimated long-run relationship (t-ratio in parentheses) in respect of ROA
can be written as:
ROAt = -28.92 + 1.86 ASSETt-1 – 0.11 GDPt-1 + 0.23 M2CDt-1 – 0.02 LPINDt-1 (2)
(21.2) (-4.99) (13.89) (-22.74)
Estimates in Eq. (2) suggest that all the four variables, such as bank size (asset),
GDP, money supply and land price have long run association with bank
profitability. While bank asset (size) and money supply have positive impact, GDP
and land price index have negative impact. This reflects the fact that during the
heyday of the Japanese economy, banks profitability was declining due to the “main
bank” structure as is evident in Figure 1. Protracted monetary easing also
contributed positively with banks profit as banks extended loan aggressively to
different sectors. On the other hand, asset price bubble, represented by the LPIND,
is negative because of the burst of the bubble in the middle of the time series;
however, the effect is smaller than those of other variables (0.02).
Table III presents the short-run components of the VECM. Adjusted R2 and F-
statistics suggest that the variables in the VECM significantly explained short-run
changes in ROA of Japanese banks. Negative impact of past ROAs on the present
ROAs implies that banks behave desperately to increase profitability considering
long-term declining trend. Overheated economic activity represented by real GDP
growth has positive impact on the profitability. While long run relationship between
ROA and money supply has been positive, in short run, it is negative and
significant. On the other hand, land asset price has no significant impact on
profitability in the short run.
TABLE III
ESTIMATED VECTOR ERROR CORRECTION MODEL
D(ROA) D(ASSET) D(GDP) D(M2CD) D(LPIND)
D(ROA(-1)) -2.43 -0.11 -2.87 -13.89 -44.55
[-5.16] [-1.44] [-0.46] [-3.18] [-4.08]
D(ROA(-2)) -0.91 -0.06 -3.40 -11.47 -30.80
[-2.39] [-0.94] [-0.68] [-3.26] [-3.50]
D(ASSET(-1)) 1.80 0.550 -17.61 -17.28 31.22
[ 1.05] [ 1.89] [-0.78] [-1.09] [ 0.79]
D(ASSET(-2)) -1.91 0.71 37.61 41.74 158.66
[-1.03] [ 2.24] [ 1.53] [ 2.43] [ 3.70]
D(GDP(-1)) 0.12 0.007 -0.08 0.92 3.57
[ 3.59] [ 1.28] [-0.19] [ 2.83] [ 4.37]
D(GDP(-2)) 0.004 0.01 -0.26 0.94 3.31
[ 0.15] [ 2.56] [-0.67] [ 3.40] [ 4.77]
D(M2CD(-1)) -0.26 -0.01 -0.25 -2.18 -5.36
[-4.90] [-1.12] [-0.36] [-4.45] [-4.37]
D(M2CD(-2)) -0.08 -0.005 0.10 -0.71 -1.83
[-3.23] [-1.29] [ 0.32] [-3.10] [-3.19]
D(LPIND(-1)) -0.01 0.002 0.04 0.31 0.64
[-1.42] [ 1.47] [ 0.31] [ 3.03] [ 2.50
D(LPIND(-2)) -0.03 -0.006 -0.28 -0.77 -2.08
[-2.34] [-2.94] [-1.68] [-6.49] [-6.97]
C -0.001 -0.02 -1.29 -2.23 -11.19
[-0.02] [-1.41] [-1.14] [-2.79] [-5.61]
Adj. R-squared 0.69 0.85 0.19 0.69 0.88
F-statistic 5.48 12.74 1.48 5.50 16.87
Log likelihood 23.26 63.84 -35.99 -27.85 -48.91
Note: t-values are in parentheses. “D” indicates first difference.
Figure 2: Different Indicators of the Economy during 1964-1998

Growth of Money Supply and Stock Price Index (Left) and
Base Money Land Price Index (right)
30.00 40000.00 120.00
25.00 35000.00
100.00
30000.00
20.00 80.00
25000.00
15.00 20000.00 60.00
10.00 15000.00
40.00
10000.00
5.00 20.00
5000.00
.00 .00 .00
1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997
M2+CD HPM NIKK225 LPI
Call Rate and Discount Rate Growth of WPI and CPI

14.00 25
12.00
20
10.00
15
8.00
10
6.00
5
4.00
0
2.00
1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997
-5
.00
1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 -10
CR DISC WPI CPI
Growth of GDP and GNP Per cent Change of Bank Lending

25.00 25.00
20.00
20.00
15.00
15.00
10.00
BL
5.00 10.00
.00 5.00
1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997
-5.00
.00
GNP GDP 1978 1981 1984 1987 1990 1993 1996
Source: Bank of Japan.
VI. CONCLUDING REMARKS

In this paper an attempt has been made to test the hypothesis that long term
declining trend of profitability has deepened due to undirected and partial
deregulations, which later had forced banks to undertake speculative behaviour
during the bubble period. Our results suggest that while bank size and money supply
have a positive and significant association with banks’ profitability, GDP growth
has negative effect. Asset price bubble has negative effect on profitability in the
long run; however, it has no significant short-run effect. This supports the
assumption that asset price bubble has no such significant effect on bank
profitability in the short run, rather long term declining trend of profitability due to
the main banking system has had effect on banks aggressive behaviour during the
bubble period. Monetary easing at that time also added fuel to the situation. The
results also indicate that undirected financial liberalisation might have affected
banks profitability, which ultimately led to a crisis after burst of the bubble.
Thus, the two issues—partial or undirected financial deregulation and monetary
policy measures during the bubble period–were perceived to have contributed to the
speculative behaviour of the banks. As discussed in the paper, the timing and pace
of monetary policy measures to burst the bubble was not deemed as appropriate.
This has led to the prolonged banking and economic crisis in Japan in the 1990s.
The issue underscores the need for analysing the change in policies.
The case of Japan in the context of the rise and burst of the asset price bubble
and subsequent banking crisis could be instructive for many countries including
Bangladesh that are facing the asset price bubble situation. Bubbles generally arise
out of some combination of irrational exuberance, jumps forward in technology and
financial deregulation, for which the connection between monetary conditions and
the rise of bubbles cannot be denied. Japanese experience suggests that monetary
policy should respond to asset bubbles in a cautious and moderate manner in order
to avoid economic distortions. The lessons that can be learned from the Japanese
experience are: (i) central bank’s role to burst bubbles must depend on the degree of
efficiency of the financial sector; and (ii) the speed to burst the bubble must be
based on the overall economic situation.
REFERENCES
Aoki, M. and H.Patrick (eds.). 1994. The Japanese Main Bank System: Its Relevance for
Developing and Transforming Economies. Oxford: Clarendon Press.
Caprio, Gerand, Folkert Landan and Lane Timothy D. 1994. Building Sound Finance in
Emerging Market Economics. Proceeding of a conference held in Washington D.C.,
June 10-11, 1993, IMF.
Cargll, Thomas F. and Shoichi Royama. 1988. The Transition of Finance in Japan and the
U.S. Stanford CA: Hoover Press.
Caves, R. and M. Uekusa. 1976. Industrial Organization in Japan. Brookings Institution.
Hossain, Monzur. 2005. “Can Japan Avert any Future Banking Crisis?” Applied Economics
Letters (Taylor & Francis, UK), 12(7): 425-429.
Hoshi, T., A. Kashyap, and D. Scharfstein. 1991. “Corporate Structure, Liquidity and
Investment: Evidence from Japanese Industrial Groups.” Quarterly Journal of
Economics, 106 (February): 33-60.
IMF (International Monetary Fund). 2002. “Financial Soundness Indicators: Analytical
Aspects and Country Practices.” Occasional Paper 212, Washington.
Ito, T. 1992. The Japanese Economy. MIT Press.
Okabe, M. 2001. “Are Cross-shareholding of Japanese Corporations Dissolving? Evolution
and Implications.” Nissan Occasional Paper Series No. 33.
Okina, K. et al. 2001. “The Asset Price Bubble and Monetary Policy: Japan’s Experience in
the Late 1980s and the Lessons.” Monetary and Economic Studies (Special Edition),
February.
Suzuki, Y. 1987. The Japanese Financial System. Oxford: Clarendon Press.
Wallich, H. and M.Wallich. 1976. “Banking and Finance.” Chapter 4 of the book “Asia’s
New Giant- How the Japanese Economy Works”, eds. H.Patrick and H. Rosovosky.
The Brookings Institution.
Yoshino, N. 2000. “Japan’s Financial System, Asian Financial Crisis.” In Economic Issues
in Contemporary Japan: Money, Banking and Foreign Investment, by N Yoshino, M.
Kuhara, M.Lacktorin, and R.Kopp. YUHIKAKU.
Yoshino, N. and E. Sakakibara 2002. The Current State of the Japanese Economy and
Remedies. Asian Economic Papers. MIT press.
Money-Income Causality in Bangladesh: An

Error Correction Approach
MOHAMMAD AMZAD HOSSAIN *
The causal relationship between money and income remains a contentious

and lively issue in the literature. Even though the literature on this issue is
voluminous, however, for Bangladesh it is quite nascent. A few earlier
studies suffer from methodological deficiency as they did not take into
consider the time series properties of the variables. The objective of this
paper is to look on the causality between money and income in
Bangladesh. The paper differs from the earlier ones regarding data used
and econometric techniques applied. The main contribution of the paper is
to address the issue of short run dynamics of the money income
relationship within a long run relationship. The empirical results show that
money supply and income are cointegrated, implying that there is stable
long run relationship between them. The estimated error correction model
shows that there is bidirectional causality between money and income,
implying that monetary policy should be undertaken to realise the basic
macroeconomic goals of achieving higher level of output.
I. INTRODUCTION
The explanatory power of money over aggregate economic activity remains a
contentious and empirical issue in the literature. The causal nexus between money
supply and output has an important implication for the theoretical debate on whether
money matters. Besides, the conduct of monetary policy with the aim of
macroeconomic stabilisation hinges upon, among other things, whether money is
causally linked to the ultimate policy goals. However, to achieve higher output, full
employment and price level stability based on controlling the growth of money
supply crucially depends on two prerequisites: first, development of an effective
procedure for controlling the rate of growth of money stock and second, close
identification of the linkages between the desired growth rate of money and the final
*
Associate Professor, Department of Economics, Jahangirnagar University, Savar, Dhaka,
Bangladesh. This paper is based on author’s research monograph submitted to the University
Grants Commission of Bangladesh, Dhaka. The author wishes to thank the UGC for funding
the project.
objectives (Zaki 1995). Despite a large and growing body of theoretical and
empirical literature, there has not emerged any consensus regarding the overall
evidence of causality.
A good number of studies have been conducted on the money and in real
economic activity both in developed and developing countries; however, for
Bangladesh it is quite nascent. A few early studies conducted by Jones and Sattar
(1988) and Chowdhury, Dao and Wahid (1995) suffer from methodological
deficiency as they did not take into consider the time series properties of the
variables. The salient aim of this paper is to take another look at the causality
between money supply and the output growth. This paper differs from the existing
studies in the following ways. First, we use a most recent quarterly data set over the
period 1974-2008 to examine the dynamic linkage between money and income.
Second, the analysis is intended to be comprehensive in that it takes into
account of various modeling issues that arise in causality framework. It studied the
stationary properties of the considered variables in the context of Bangladesh. The
paper also applied Augmented Dicky Fuller (ADF) and Phillips-Perron (PP) tests to
examine the time series properties of money supply and income. Johansen and
Juselius test has been applied to examine the cointegration properties of the
variables.
Finally, the paper examines both short-term and long-term dynamic
relationships between the considered variables within an error-correction
framework. By and large, this paper is an improvement over the existing literature
on money supply and other variables in terms of the data used and techniques
employed.
This paper is divided into five sections. Following introduction, a survey of the
literature is presented in section II. Section III sets out the framework for the
analysis of causality, conintegration and error correction models. It also identifies
and defines the variable considered. Section IV examines and discusses the time
series properties of the variables. Finally, section V concludes the paper.
II. REVIEW OF THE LITERATURE

II.1 Theoretical Debate
There has been a long debate in the literature on the causal nexus among
money, income and prices, which dates back to 1752 following the publication of
David Hume’s “Of Money”. Hume concludes that there exists a proportional
relationship between money supply and the absolute price level. The classical
Hossain: Money-Income Causality in Bangladesh 41
school explained that changes in prices, the most important target variable in
achieving stabilisation, is basically due to changes in money supply. However,
Keynesians criticised and rejected the proportionality between money supply and
prices due to its instability in explaining the causes and remedies for the great
economic debacle like Great Depression of 1930s. The Keynesians held the view
that money does not play an active role in changing income and prices nor does it
causes instability in the economy. According to them, it is not the quantity of money
but the effective demand which is caused by autonomous spending, that constitutes
investment by business and government spending is the main source of instability.
In fact, a change in money supply is diluted by the opposite change in the velocity.
Thus the change in wages, the price level and the rate of inflation are non-monetary
phenomena and are caused by structural factors. However, they believe that change
in income causes changes in money stock via demand for money implying that the
direction of causation runs from income to money without any feedback (Froyen
2004).
The Keynesian ideas came under serious criticism by Monetarists (lead by
Milton Friedmen) in the backdrop of the presence of high inflation in different
countries after World War II due to the adoption of cheap monetary policy. The
Monetarists argue that money plays an active role and leads to the changes in
income and prices. There is unidirectional causation that runs from money to
income and prices. The argument is that for increasing expenditure (without
increase in taxes) government adopts cheap monetary policy i.e. print money which
accrues in the hands of taxpayers which leads to the persistent rise in the price level.
This argument attributes to the Monetarists contention that inflation is always and
everywhere a monetary phenomena (Blanchard, Johnson and Melino 2003). The
proponent of Monetarists is the New Classical School / Rational Expectation
School, which argues that money supply along with information asymmetries
causes the change in income and prices. While the opponent is the Real Business
Cycle School/New Classical Macro Economics, which treats money supply as
endogenous and concludes that monetary policy is irrelevant. They held the view
that neither the money supply nor the information asymmetries but the random
change in production technology (i.e. technological shock) is the dominant source
of changes in the income and price level in the economy. The Banking School also
treats money supply as an endogenous variable which depends on business
condition. That is money supply passively responds to the demand for it (Blanchard,
Johnson and Melino 2003).
The unidirectional causation from money to income and prices has challenged
in the last decades. Fischer (1962) claims the possibility of reverse causation and
concludes that there is mutual interaction between money and other macro
variables. Friedman and Schwartz (1963) also support this argument by stating that
though the influence of money to economic activity is predominant, there is also the
possibility of influences running the other way (at least in the short run). The
Banking school also supports the reverse causation between money and income,
thereby arguing for endogeneity of money supply (Froyen 2004).
The above discussion reveals that there is a linkage between money and
aggregate output in the economy. However, it is not clear whether the causality is
unidirectional or bidirectional. This debate is further intensified by the empirical
studies.
II.2 Empirical Studies

Sims (1972) has opened up the new and active area of research on the empirical
causal relationship between money and income. Based on Granger causality, Sims
developed a test of causality and applied it to the U.S. data and found the evidence
of unidirectional causality between money to income as claimed by the Monetarists.
However, this result was challenged by the succeeding studies. By applying the
Sims test in Canadian economy Barth and Bennett (1974) found bidirectional
causality between money and income. Applying Sims test to the U.K. data
Williams, Goodhart and Gowland (1976) found unidirectional causality from
income to money, which is opposite of the Sims U.S. result. However, Sims result
was supported by Brillembourg and Khan (1979) who use a longer data set.
Analysing the Canadian data Hasio (1979) found feedback between money supply
(M1) and GNP, while unidirectional causal flow from money to income, when M2
is used as measure of money. Hasio (1981) also found the same result from U.S.
money and income data. Using the data set for six industrialised countries Dyreyes,
Starleaf and Wang (1980) found bidirectional causality between money and income
in the U.S., while they found unidirectional causality from money to income in
Canada, contrary to Barth and Bennett (1974). However, they got the unidirectional
causality from income to money in the U.K., which supports the result of Williams.
Goodhart and Gowland (1976). Biswas and Saunders (1988) provide further
empirical evidence on the money-income relationship from the U.S. data which
supports Sims.
Using Singapore data Lee and Li (1983) found bidirectional causality between
income and money and unidirectional causality from money to prices. Joshi and
Joshi (1985) found bidirectional causality between money and income in India,
while for the same country Rangarajan and Arif (1990) found unidirectional
causality from money to income. Biswas and Saunders (1999) found that income
and money supply are cointegrated in India. Thus, establishing a stable relationship
between these two variables over longer time period. Upon establishment of
cointegration between money and income this study conducted error correction
estimates and found the existence of feedback between the two variables. Khan and
Siddiqui (1990) found unidirectional causality from income to money in Pakistan.
Using Geweke’s approach Kee-Giap Tan and Chee-seng (1995) found bidirectional
causality between money and income in Malaysia. This result supports Zubaidi and
Yusop (1996).
Some of the recent studies also establish the causal relationship among money,
income and price. Using time series data from 1960 to 2008 Climobi and Uche.
(2010) found that M2 appears to have a strong unidirectional causal effect on the
real output as well as on prices. The similar result has also found by Majid (2007)
for the Malaysian economy. Yadav (2009) examined the cointegration and causality
between money and income for the Indian economy. Using the data for the period
1950/51-2006/07 the study found the bidirectional causality between GNP and
money supply. Psaradakis, Morten and Mortin (2002) applied different econometric
techniques to examine the money output relationship. Using a VAR model with
time varying parameters for the U.S. data for the period 1959:1-2001:2 the paper
found that causality relationship between money and output changes over time.
II.3 The Bangladesh Perspective

As to the empirical evidence on Bangladesh, there are a few studies (Jones and
Sattar 1988, Chowdhury, Dao and Wahid 1995, Ahmed 2000) linking money,
prices, income and interest rate, but no substantial study using appropriate
econometric methodology considering the time series properties of data.
With the aid of Granger causality test based on monthly data (June 1974
through December 1985), Jones and Sattar (1988) were able to examine the causal
link between money–income and money–inflation in Bangladesh. Using several
arbitrary lag lengths they concluded that money causes prices in Bangladesh in the
short run, with a lag in general of twelve month, which disappears in the long run.
They also found the evidence of unidirectional impact of money on output, with a
lag of twenty four to thirty six months. The implication of their result is that
monetary expansion could have a significant impact on output growth, although as a
consequence the economy may experience moderate to high inflation in the short
run.
By applying multivariate vector autoregressive (VAR) model Chowdhury, Dao
and Wahid (1995) explore the relationship between money, prices, output and the
exchange rate in Bangladesh. Using quarterly data for the period 1974 to 1992 the
study concluded that the inflationary process of Bangladesh cannot be explained
solely by the “monetarist” or the “structuralist” explanation. That is, there is no
straightforward cause and effect relationship between money and inflation, while
money supply exerts a significant unidirectional impact on real output.
Ahmed (2000) attempts to investigate the issue of multivariate causality among
money, interest rate, prices and output for three South Asian countries namely,
Bangladesh, India and Pakistan in a multivariate framework using quarterly data for
the period 1967-1996 for India, 1972-1997 for Pakistan and 1974-1998 for
Bangladesh. The study concludes that monetary policy has crucial importance in
determining output in Bangladesh. This study also found that interest rate and
money as block cause output and price but output and price do not cause interest
and money in Bangladesh.
It is evident from the above studies that causal relationship between money and
income is unidirectional in Bangladesh. However, the reliability of the above result
may be undermined as they did not examine the time series properties of the data
such as stationarity and co-integration and using arbitrary lag length they conclude
whether the relationship among variables is short run or long run. This study is an
improvement over the existing studies as it examined the stationarity and co-
integration approach and applied the error correction approach to understand the
short run implication of long run relationship among considered variables.
Consequently, two issues need to be considered. The first issue is the existence of
stability of the relationship between money and income over longer period of time.
It is important to determine whether a stable relationship between monetary changes
and nominal income changes in the long run. If so, then monetary policy will have
important implications on the Bangladesh economy in the long run. The second
issue is related to the impact of monetary changes on nominal income in the short
run. The subject matter of this study is to provide short run dynamics of the money-
income relationship in Bangladesh, i.e. how do money affect nominal income in the
short run.
III. DATA AND METHODOLOGY

III.1 Data
This study is based on annual data covering 1974 to 2008 taken from the IMF,
International Financial Statistics (IFS) CD-Rom supplemented by IMF, IFS
Yearbook. Some of the early literature (Ibrahim 1999) shows that M2 is a preferable
intermediate target to stabilise the economy and M2 is found to be cointegrated with
other macrovariables and is thus superior as a long run policy variable; while Jones
and Sattar (1988) and Chowdhury, Dao and Wahid (1995) use both narrow money
(M1) and broad money (M2) to examine the causal relationships. The present study
considered broad money as monetary stock. The graphical representation of the
variables shows that there is co-movement between GDP and broad money, as
shown in Figure 1. Nominal GDP is used as a measure of aggregate economic
activity.
Figure 1: Relationship between Monetary

Aggregates and GDP
18
16
14
12
(ln value)
10
8 GDP M1 M2
6
4
2
0
89
99
75
77
79
81
83
85
87
91
93
95
97
01
03
05
07
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
20
20
III.2 The Analytical Framework

III.2.1 Granger Causality Test
We relied on the Granger Causality test due to its wide applicability to examine
the direction of causality between money and income. The basic idea of the Granger
Causality is that X causes Y if Y can be explained better by the present and lagged
values of X than by the past values of Y alone assuming that both X and Y are
stationary variables. This test assumes that the information relevant to the prediction
of the respective variables is contained solely in the time series data on these
variables (Gujrati, 2003). For illustrative purpose using a two variable system, the
Yt = α + ∑ β iYt −1 + ∑ ϕ i X t −1 + ε t
test is based on the following regression:
m n
(1)
i =1 i =1
X t = χ + ∑ φi X t −1 + ∑ μ iYt −1 + ν t
m n
(2)
i =1 i =1
where, t and νt are white noise error term and assumed to be stationary, and m
& n are the number of lags to be specified. Equation (1) postulates that current Y is
related to past values of itself as well as that of X and equation (2) proposes a
similar behaviour for X. Given the above specification, the following cases can be
distinguished:
(i) unidirectional causality from X to Y i.e. X causes Y if H0: φi = 0, i = 1,
…..n, can be rejected and (ii) does not hold;
(ii) unidirectional causality from Y to X i.e. Y causes X if H0: µi = 0, i = 1,
…..n, can be rejected and (i) does not hold;
(iii) feedback or bilateral causality is said to occur if both (i) and (ii) hold; and
(iv) independence is suggested if neither (i) nor (ii) hold.
In addition, the framework can be generalised to include more variables in the
system.
The implementation of Granger causality test needs to estimate the unrestricted
and restricted version of equations. To test whether X causes Y, the unrestricted
regression involves the estimation of equation (1) using OLS. From this regression
we obtain the unrestricted residual sum of squares (RSSur). Then, another version of
(1) that restricts the coefficient of all lagged X’s to zero is to be performed and
obtained the restricted residual sum of squares (RSSr). To test case (i) above, we
rely on the following statistic:
F = [(RSSr - RSSur)/m ] / [RSSur / (n – k)]
Which follows F distribution with m and (n – k) df. Here m is equal to the
number of lagged X terms included in the equation (1) and k is the number of
parameters estimated in the unrestricted equation. X is said to Granger cause Y if
the computed F statistics is significant at the conventional level. The same
procedure can be applied to test causality from Y to X.
The Granger causality test assumes that the disturbance term of the regression is
serially uncorrelated. However, the non-stationarity of the variables may destroy
this assumption (Serletis 1988), which makes the OLS estimation biased and
inconsistent and thus decrease the credibility of the regression result. Intuitively, a
time series is said to be stationary if its mean and variance do not systematically
vary over time. In contrast, time series is non-stationary if its mean and variance are
variant with time. Granger causality test may not be valid if non-stationarity in the
data is not handled properly. The study thus examined whether the considered time
series is stationary or not.
The number of lagged terms to be included in the causality test is an important

practical question since the direction of causality may depend critically on the
number of lagged term included. If we use too few lags we will omit potentially
valuable information contained in the more distant lagged values, the causality
result is thus distorted. On the other hand, if we use too may lags we will be
estimating more coefficient than necessary, which in turn introduces additional
estimation error into forecasts and may cause an absence of causality between them
(Feige and Pearce 1979). The study used Schwartz information criteria to make
such choice.
III.2.2 Cointegration Test and Error Correction Models
A salient feature of most economic time series is inertia or sluggishness i.e. they
have the tendency to move together. Thus we need to test for the possible
cointegration of the variables as a guide for model specification. Presence of
cointegration between two variables led to the causality in the Granger sense as
least in one direction (Miller 1998). There are two channels of causality between
cointegrated variables–the standard Granger test and the error correction
specification. Non-causality conclusion may result from failure to take the
cointegratedness into account.
The notions of cointegration provide the basis for modeling both the short run
and long run relationship simultaneously. If Yt and Xt are cointegrated, then
Granger representation theorem (Engle and Granger 1987) says that the relationship
between the two variables can be expressed as the error correction mechanism as
ΔYt = λ1Z t −1 + ∑ δ i ΔX t −i + ∑ π j ΔYt − j + u1t

follows:
k k
(3)
i =1 j =1
ΔX t = λ2 Z t −1 + ∑ τ i ΔX t −i + ∑ ζ j ΔYt − j + u 2t
k k
(4)
i =1 j =1
where, Zt = Yt – γXt , and u1t and u2t are white noise error terms. In these two
equations, the series Yt and Xt are cointegrated when at least one of the coefficients
λ1 or λ2 is not zero. This error correction model allows us to study the short run
dynamics of the long run relationship between Yt and Xt. If λ1≠ 0 and λ2 = 0, then Xt
will lead Yt in the long run. The opposite will occur if λ2≠ 0 and λ1 = 0. If both λ1≠ 0
and λ2 ≠ 0, then feedback relationship exists between Yt and Xt , which will adjust
in the long run. In addition, short run dynamics between Yt and Xt are characterised
by the coefficients i’s and ζj’s. If i’s are not all zero, movements in the Xt will
lead to Yt in the short run. If ζj’s are not all zero, movement in the Yt will cause Xt
in the short run. If γ can be obtained so that Zt can be constructed, the remaining
parameters in equations (3) and (4) can easily be estimated. Engle and Granger
(1987) propose a two-step procedure. The first step involves OLS regression of Yt
on Xt and yield a consistent estimate for γ. The next step is the OLS estimation of
equations (3) and (4) with Zt replaced by estimated Zt.
III.3 Empirical Methodology

Testing for causality and cointegration between two variables, money and
income, is done on the following steps: First the time series properties of each
variable examined by unit root tests. In this step it is tested whether money and
income are I(0), that is they are stationary. This is accomplished by applying
augmented Dickey-Fuller (ADF) test. This test is based on the following regression
ΔYt = a1 + a2 t + bYt −1 + ∑ ρ i ΔYt −i + υ t

equation with a constant and a trend of the form:
m
(5)
i =1
where, ∆Yt = Yt - Yt-1 and Y is the variable under consideration, m is the

number of lags in the dependent variable, is chosen by Schwarz criterion and υt is
the white noise error term. The null hypothesis of a unit root is that the coefficient
of Yt-1 is zero. The rejection of null hypothesis implies that the series is stationary
and no differencing in the series is necessary to induce stationary. The ADF is
widely used due to the stability of its critical values as well as its power over
different sampling experiment.
The second step involves searching for cointegration between variables. This
can be understood from the graphical representation of the two series and to see
whether they have any common stochastic trend and can be tested either by Engle-
Granger two step cointegration procedures or by Johansen-Juselius cointegration
technique. We relied on Johansen-Juselius cointegration technique. In this technique
two test statistics are used to identify the number of cointegrating vectors, namely
the trace statistic and the maximum eigenvalue test statistic. The Trace test statistic
λtrace = T ∑ ln(1 − λi )
for the null hypothesis that there are atmost r distinct cointegrating vectors is
N
(6)
i = r +1
where, λi’s are the N-r smallest squared canonical correlations between Xt-k and
ΔXt (where Xt = (M2t Incomet)/ and where all variables in Xt are assumed I(1)),
corrected for the effects of the lagged differences of the Xt process.
The maximum eigenvalue statistic for testing the null hypothesis of at most r
cointegrating vectors against the alternative hypothesis of r + 1 cointegrating
λmax = −T ln(1 − λr +1 )
vectors is given by
(7)
Johansen (1988) shows that equations (6) and (7) have non-standard
distributions under the null hypothesis and provide approximate critical values for
the statistic, generated by Monte Carlo methods.
The third step involves the estimation of error correction model as specified in
equations (3) and (4). Finally, causality and feed back relationship among time
series are tested using standard F tests.
IV. ANALYSIS OF THE RESULT
In light of the methodology presented above the time series properties of the
variables involved are examined and the empirical results are discussed in this
section. At first both money and income variables are tested for the unit roots
suggested by ADF test and Phillips-Peron test. Unit root test identifies whether the
variables are stationary or non-stationary. The test is applied to both the original
series (in logarithmic form) and to the first differences. Further, both the models
with and without trend are tried. The lag parameters are determined by Schewarz’s
criterion. The results are reported in Table I.
TABLE I
UNIT ROOT TESTS (AUGMENTED DICKEY FULLER) FOR THE PERIOD 1974 TO 2008
Series in Levels First Differences
Without Trend -2.142314 [8] -3.141494** [7]
LM2
LNGDP -1.748507 [6] -6.801368* [5]
With Trend
LM2 -1.454595 [8] -4.096095* [7]
LNGDP -0.065432 [6] -7.089567* [5]
Notes: (i) * and ** indicate significance at 1% and 5% respectively.
(ii) Figures in the parentheses represent the optimal lag length as determined by
Schwarz information criteria.
(iii) The Phillips–Perron test also gives the similar results.
The test results indicate the presence of unit roots in the original series i.e.
LM2 and LNGDP are non-stationary in their level. The results further suggest that
first differences remove these unit roots, implying that these variables are first
difference stationary i.e. I(1).
Since both variables are I(1), then it is necessary to set out cointegration tests to
determine whether there exists a stable long run relationship between money and
income in Bangladesh. We relied on the Johansen’s approach to establish the
cointegrating vectors. The result is presented in Table II.
TABLE II
JOHANSEN AND JUSELIUS TEST OF COINTEGRATION
Data Vector Lag Hypothesis Λ Trace λ Max

r <=0 20.40772** 18.63563**
LM2 , LNGDP 3
r <=1 1.772096 1.772096
Notes: i) we have experimented with a number of lags and found 3 to be the optimal lag
length. The null hypothesis states that there doesn’t exist at most r cointegrating
relationship among the variables.
ii) ** indicates significance at 5% level.
Table II reports the maximum eigen-value and trace tests of Johansen and
Juselius (1991). These are complementary versions of the same test to determine the
cointegration rank, r. Both the test suggest that nominal income and the money
supply are cointegrated. 1 This result indicates the existence of a stable long run
relationship between nominal income and money supply in Bangladesh. That is
monetary policy will have some important long run implications to changes in
nominal income on Bangladesh economy.
The cointegration between money supply and income implies long run
equilibrium relationship. However, in the short run there may be disequilibrium.
Therefore, we can treat the error term in the cointegrating relation as the equilibrium
error, which is used to tie the short run behaviour of the variables. The error-
correction mechanism first used by Sargan and later popularised by Engle and
Granger corrects for disequilibrium. Therefore, the error-correction models (ECM)
are applied to explore the direction of causality. Any ECM has an interesting
temporal causal interpretation in the Granger sense. That is when two series are seen
to be cointegrated the absence of causal relationship between them is ruled out in
the error correction framework, while such a possibility exists in the Granger test.
Therefore, we also employ Granger causality to examine the direction of bivariate
causality. The results are reported in Tables III, IV and V.
1
The visual plot of the data (as shown in Figure 1) also shows that both series share the
same stochastic trend, implying that they are cointegrated.
TABLE III
ESTIMATION OF ERROR CORRECTION MODEL
Independent Variable: LNGDP
Dependent Variable: LM2
Constant Zt-1 Δ(LM2)t-1 Δ(LM2)t-2 Δ(LM2)t-3 Δ(LNGDP)t-1 Δ(LNGDP)t-2 Δ(LNGDP)t-3
0.068535 0.070365* -0.494589 0.095438 -0.285373 -0.020475 -0.258569 0.174939

[ 6.69301] [ 2.22376] [-4.93739] [ 0.89047] [-3.32992] [-0.08821] [-0.75755] [ 0.81127]
Note: Figures in the parentheses represent t statistic.
TABLE IV
ESTIMATION OF ERROR CORRECTION MODEL
Independent Variable: LM2
Dependent Variable: LNGDP
Constant Zt-1 Δ(LM2)t-1 Δ(LM2)t-2 Δ(LM2)t-3 Δ(LNGDP)t-1 Δ(LNGDP)t-2 Δ(LNGDP)t-3
0.011319 0.050713* -0.040955 -0.044216 -0.038508 1.517708 -1.11557 0.369629

[ 3.07945] [ 4.46484] [-1.13900] [-1.14932] [-1.25180] [ 18.2155] [-9.10519] [ 4.77530]
Note: Figures in the parentheses represent t statistic.
TABLE V
DIRECTION OF CAUSALITY
Granger Causality Error Correction
F-values Causation t (err) F-values Causation
LNGDP does not 1.90620 LNGDP≠>LM2 2.22376* 19.96913* LNGDP=>LM2
cause LM2
LM2 does not 2.43743* LM2 =>LNGDP 4.46484* 114.1857* LM2 =>LNGDP
cause LNGDP
Note: *, ** and *** indicate significance at 1%, 5% and 10% respectively.
The results of Granger causality and error correction models are explored in
Tables III, IV and V. It can be seen that Granger test provides unidirectional
causality from money to nominal income, which coincides with the earlier studies
of Bangladesh, while error correction models provide bi-directional causality
between money and income in the short run. These results are in line with Lee and
Li (1983), Joshi and Joshi (1985).
It is also clear from Tables III and IV that both money supply and nominal
income, respond to a deviation from long run equilibrium. The coefficient of the
error correction term in both equations is statistically significant, implying that both
variables respond to the discrepancy from long run equilibrium (Biswas and
Sunders 1999). From Table IV, we see that the coefficient of the error correction
term is not only statistically significant but also positive. This implies that changes
in the money supply do causally affect Bangladesh’s nominal income in the short
run. Analogously, we can say that changes in nominal income also affect the money
in Bangladesh, from the information provided in Table III. By and large, the
empirical results of this study reveal that in the short run M2 supply is not truly
exogenous. From the monetary policy point of view, M2 may not be a target
variable for determining short run changes in nominal income in Bangladesh. This
may be the one reason that the monetary authorities of many developed countries
have suspended money supply as a control variable to achieve ultimate policy goals
of increasing output.
V. SUMMARY AND CONCLUSIONS

The paper applies cointegration and error-correction models to explain the
causal relationship between money supply (M2) and nominal income in
Bangladesh. The main contribution of the paper is to address the issue of both short
run and long run relationship between money and income in Bangladesh. The paper
is an improvement over the early studies in the sense of data used and
methodological point of view. The study found that nominal income and money
supply are cointegrated, indicating that there is a stable long-term relationship
between them. The implication of this result is that the monetary authority should
try to provide long run price stability or a low average rate of inflation (Biswas and
Sunders 1999). This type of monetary policy can provide stable economic
environment, which helps economic agents in their decision making (Eichenbaum
1997). Thus it can be concluded that changes in money supply will have an
important implications for changes in Bangladesh’s nominal income in the long run.
The existence of cointegration leads us to examine the short run dynamics in the
money income relationship in Bangladesh. We applied the error correction models
to make inference about the short run impact of monetary changes on nominal
income. They indicate the feedback relationship between the two, which is
consistent with some of the early studies.
REFERENCES
Abdullah, A. Zubaidi and Z.Yusop.1996. “Money, Inflation and Causality: The Case of
Malaysia (1970-92).” The Asian Economic Review , XXXVIII: 44-51.
Ahmed, M.2000. “Money-Income and Money-Price Causality in Selected SAARC
Countries: Some Econometric Exercises.” The Indian Economic Journal, 50 (1).
Barth, J. and J.Bannett.1974. “The Role of Money in the Canadian Economy: An Empirical
Test.” Canadian Journal of Economics, 30(6)
Bhanumurthy, N.R. and T. M Paul.2000. “Money Supply, Output and Price Level
Relationship in India.” The Indian Economic Journal, 47 (1)
Biswas, B. and J. P.Saunders. 1999. “Money-Income Causality: A Vector Error Correction
Analysis.” The Indian Economic Journal, 46 (1).
Blanchard, O., D. Johnson and A.Melino. 2003. Macroeconomics, 2nd edition. Prentice Hall,
Toronto.
Chowdhury, A.R., M. Q. Dao and A. N. M. Wahid. 1995. “Monetary Policy, Output and
Inflation in Bangladesh: A Dynamic Analysis.” Applied Economic Letters, 2 (3).
Climobi, P. O. and U.C. Uche 2010. “Money, Price and Output: A Causality test for
Nigeria.” American Journal of Scientific Research, 8: 78 – 87.
Dereyes, F., D. Starleaf and G.Wang. 1980. “Test of Direction of Causation between Money
and Income in Six Countries.” Southern Economic Journal, 477-487.
Edger, L. Feige and Douglas K. Pearce. 1979. “The Causal Relationship between Money
and Income: Some Caveats for Time Series Analysis.” The Review of Economics and
Statistics, 61(4).
Eichenbaum, M. 1997. “Some Thoughts on Practical Stabilization Policy.” American
Economic Review, May, pp. 236-239.
Engle, R. and C. W. J. Granger. 1987. “Cointegreation and Error Correction: Representation,
Estimation and Testing.” Econometrica, 55: 251-276.
Friedman, M. and A. J.Schwartz 1963. A Monetary History of the United States. Princeton,
N.J.
Fischer, S.1962. Rules Versus Discretion in Monetary Policy, in Friedman and Hahn eds.
Handbook in Monetary Economics, Vol.2.Amsterdam: North Holland.
Froyen, T.R.2004. Macroeconomics: Theories and Polices, 8th edition. Prentice Hall, N.J.
Gujarati, D.N., 2003. Basic Econometrics. New York:Mcgraw Hill.
Hasio, C.1979. “Autoregressive Modeling of Canadian Money and Income Data.” Journal
of American Statistical Association, 74.
Hasio, C.1981. “Autoregressive Modeling and Money Income Causality Direction.” Journal
of Monetary Economics, 7.
Hume, D. 1752. “Of Money”. Reprinted in Money and Banking (ed. A. A. Walters),
Harmondsworth: Penguin.
Johansen, S. 1988. “Statistical Analysis of Cointegrating Vectors.” Journal of Economic
Dynamics and Control, 12: 231-54.
Jones, J. D. and Z.Sattar. 1988. “Money, Inflation Output and Causality: The Bangladesh
Case, 1974 - 1985.” The Bangladesh Development Studies, 16 (1).
Joshi, K. and S.Joshi 1985. “Money Income and Causality: A Case Study for India.”
Arthavikas, 45 (1)
Khee Giap Tan and Chee-Seng Cheng.1995. “The Causal Nexus of Money, Output and
Prices in Malaysia.” Applied Economics, 27 (12}:1245 – 1251.
Khan, A. and A Siddiqui. 1990. “Money Prices and Economic Activity in Pakistan: A Test
of Causal Relation.” Pakistan Economic and Social Review, 121- 136.
Lee, S. and W. Li. 1983. “Money, Income and Prices and their Lead-lag Relationship in
Singapore.” Singapore Economic Review, 73 – 87.
Majid, A. M. Z. 2007. “Causality link between Money, Output and Prices in Malaysia: An
Empirical Reexamination.” Applied Econometrics and International Development.
7(1).
Miller, S. M.1998. “Monetary Dynamic: An Application of Cointegration and Error
Correction Modeling.” Journal of Money, Credit and Banking, 23 (2).
Psaradakis, Z., O. R. Morten and S.Martin. 2002. Markov Switching Causality and the
Money-Output Relationship (mimeo). Birkbeck College, London.
Rangarajan, C. and R.R.Arif. 1990. “Money, Output and Prices: A Macro Econometric
Model.” Economic and Political Weekly, April 21.
Serletis, A.1988. “The Empirical Relationship between Money, Prices and Income
Revisited.” Journal of Business and Economic Statistics, 6 (3).
Sims, A. C.1972. “Money, Income and Causality.” The American Economic Review, 62.
Verma, S. and S.Kumar. 1994. “Causality between Money Supply and Prices in India.” The
Indian Economic Journal, 42 (1).
Williams, W., C. Goodhart, and D.Gowland. 1976. “Money, Income and Causality: The
U.K. Experience.” American Economic Review, June: 417 – 423.
Yadav, I. S. 2009. Co-integration, Causality, Money and Income in India (mimeo).
Department of Economics, University of Hyderabad, India.
Zaki, M.Y.1995. “Forecasting the Money Multiplier and the Control of Money Supply in
Egypt.” Journal of Development Studies, 32(1).
APPENDIX A
Exploratory Analysis of the Data
The descriptive statistics for the variables are as follows:
TABLE 1
DESCRIPTIVE STATISTICS OF THE VARIABLES
LM2 LNGDP
Mean 11.79023 11.87015
Median 12.01247 11.91275
Maximum 13.88221 13.46885
Minimum 9.418971 9.597968
Std. Dev. 1.355435 1.108062
Skewness -0.280535 -0.244335
Kurtosis 1.806552 1.768452
Jarque-Bera 8.405735 8.484961
Probability 0.014953 0.014372
From the above Table it is clear that the mean and median are fairly close to each other
suggesting that these data are more or less normal. The values of the skewness are moderate
and the values of the kurtosis are below three, suggesting that the variables have a flat
distribution relative to normal. The Jarque-Bera test results suggest that we do not reject the
null hypothesis of normal distribution for at 5% level of significance.
APPENDIX B
Test of Stationarity (Autocorrelation Function (ACF) and Correlogram)
Before pursuing formal tests, we proceed with the graphical representation of
the so called “sample correlogram” based on autocorrelation function, that gives us
an initial clue about stationarity.
Autocorrelation Partial Correlation AC PAC Q-Stat Prob
.|******** .|******** 1 0.976 0.976 113.47 0.000
.|*******| .|. | 2 0.952 -0.019 222.37 0.000
.|*******| .|. | 3 0.927 -0.047 326.42 0.000
.|*******| .|. | 4 0.903 0.034 426.16 0.000
.|*******| *|. | 5 0.877 -0.073 521.02 0.000
.|*******| .|. | 6 0.851 -0.001 611.25 0.000
.|****** | .|. | 7 0.824 -0.054 696.47 0.000
.|****** | .|. | 8 0.799 0.038 777.35 0.000
.|****** | *|. | 9 0.771 -0.063 853.45 0.000
.|****** | .|. | 10 0.745 0.010 925.18 0.000
.|****** | .|. | 11 0.718 -0.026 992.42 0.000
.|***** | .|. | 12 0.693 0.019 1055.7 0.000
.|***** | .|. | 13 0.667 -0.044 1114.8 0.000
.|***** | .|. | 14 0.641 0.006 1170.0 0.000
.|***** | .|. | 15 0.615 -0.023 1221.3 0.000
.|***** | .|. | 16 0.591 0.020 1269.1 0.000
.|**** | .|. | 17 0.565 -0.054 1313.3 0.000
.|**** | .|. | 18 0.541 0.011 1354.2 0.000
.|**** | .|. | 19 0.515 -0.025 1391.7 0.000
.|**** | .|. | 20 0.493 0.020 1426.3 0.000
.|**** | *|. | 21 0.467 -0.062 1457.7 0.000
.|*** | .|. | 22 0.443 0.017 1486.3 0.000
.|*** | .|. | 23 0.418 -0.035 1512.1 0.000
.|*** | .|. | 24 0.396 0.015 1535.3 0.000
.|*** | .|. | 25 0.370 -0.055 1556.0 0.000
.|*** | .|. | 26 0.347 0.008 1574.3 0.000

.|** | .|. | 27 0.322 -0.026 1590.3 0.000
.|** | .|. | 28 0.300 0.010 1604.3 0.000
.|** | .|. | 29 0.276 -0.037 1616.3 0.000
.|** | .|. | 30 0.253 -0.007 1626.5 0.000
.|** | .|. | 31 0.230 -0.022 1635.0 0.000
.|** | .|. | 32 0.207 -0.012 1642.0 0.000
.|* | .|. | 33 0.183 -0.031 1647.5 0.000
.|* | .|. | 34 0.160 -0.020 1651.8 0.000
.|* | .|. | 35 0.136 -0.020 1655.0 0.000
.|* | .|. | 36 0.115 0.009 1657.3 0.000
Figure 4: Correlogram of LM2, 1974-I to 2008-IV.

.|*******| .|*******| 1 0.971 0.971 112.32 0.000
.|*******| .|. | 2 0.942 -0.028 218.88 0.000
.|*******| .|. | 3 0.914 0.007 320.06 0.000
.|*******| .|. | 4 0.888 0.031 416.52 0.000
.|*******| .|. | 5 0.866 0.046 509.06 0.000
.|*******| .|. | 6 0.847 0.033 598.25 0.000
.|****** | .|. | 7 0.827 0.000 684.23 0.000
.|****** | .|. | 8 0.807 -0.030 766.71 0.000
.|****** | .|. | 9 0.784 -0.035 845.40 0.000
.|****** | .|. | 10 0.761 -0.027 920.12 0.000
.|****** | .|. | 11 0.736 -0.029 990.77 0.000
.|***** | .|. | 12 0.711 -0.030 1057.3 0.000
.|***** | .|. | 13 0.685 -0.046 1119.6 0.000
.|***** | .|. | 14 0.656 -0.050 1177.4 0.000
.|***** | .|. | 15 0.628 -0.023 1230.9 0.000
.|***** | .|. | 16 0.602 0.002 1280.5 0.000
.|**** | .|. | 17 0.576 0.002 1326.4 0.000
.|**** | .|. | 18 0.552 -0.005 1368.9 0.000
.|**** | .|. | 19 0.528 -0.007 1408.3 0.000

.|**** | .|. | 20 0.504 -0.007 1444.5 0.000
.|**** | .|. | 21 0.480 -0.004 1477.7 0.000
.|*** | .|. | 22 0.457 -0.004 1508.1 0.000
.|*** | .|. | 23 0.433 -0.010 1535.7 0.000
.|*** | .|. | 24 0.410 -0.016 1560.7 0.000
.|*** | .|. | 25 0.386 -0.020 1583.1 0.000
.|*** | .|. | 26 0.362 -0.019 1603.0 0.000
.|*** | .|. | 27 0.338 -0.016 1620.6 0.000
.|** | .|. | 28 0.315 -0.015 1636.0 0.000
.|** | .|. | 29 0.291 -0.017 1649.3 0.000
.|** | .|. | 30 0.268 -0.018 1660.8 0.000
.|** | .|. | 31 0.246 -0.015 1670.5 0.000
.|** | .|. | 32 0.223 -0.013 1678.6 0.000
.|** | .|. | 33 0.201 -0.010 1685.3 0.000
.|* | .|. | 34 0.179 -0.010 1690.7 0.000
.|* | .|. | 35 0.158 -0.016 1694.9 0.000
.|* | .|. | 36 0.136 -0.021 1698.0 0.000
Figure 5: Correlogram of LNGDP, 1974-I to 2008-IV.
The correlogram up to 36 lags for both series is shown in figures 4 and 5 respectively.
From the figures we see that the autocorrelation coefficient starts at a very high value at lag
1 and declines very slowly, implying that all these time series are nonstationary. They may
be nonstationary in mean or variance or both.
Conversion of Agricultural Land to

Non-agricultural Uses in Bangladesh:
Extent and Determinants
MD ABUL QUASEM *
Bangladesh is a land scarce country where per capita cultivated land is only
12.5 decimals. It is claimed that every year about one per cent of farm land in
the country is being converted to non-agricultural uses (such high rate of
conversion will not only hamper agricultural production but will have adverse
impact on food security). The present study estimates the rate of land
conversion and consequent loss of agricultural production of the country
besides determining the factors affecting such conversion. The study is based
mainly on field survey covering 24 villages from six divisions of the country
Annual Conversion of farm land is estimated to be 0.56 per cent and the
country’s loss of rice production is also estimated to be between 0.86 and 1.16
per cent. The converted land is predominantly used for construction of houses,
followed by roads and establishment of business enterprises. The land poor
records higher rate of land conversion. The two principal determining factors
for such conversion are found to be land ownership size of a household and
the non-agricultural occupation of household heads. To arrest the existing rate
of land conversion, the surveyed households suggest for more profitable rates
of return from farming activities besides imposing special sales tax for
conversion of farm land.
I. INTRODUCTION
I.1 Background of the Study
With the growth of a country’s economy, agricultural land is usually transferred
to non-agriculture as the demand for non-farm products and services increases. This
*
The author is a former Senior Research Fellow of the Bangladesh Institute of Development
Studies (BIDS), Dhaka. He expresses his deep sense of gratitude to the anonymous referee
for his wide ranging comments on the paper. He is grateful to the Krishi Gobeshana
Foundation (GKF), Dhaka for financing the research project, “Agricultural Land Loss and
Food Security in Bangladesh: An Assessment” carried out in collaboration with the
Bangladesh Unnayan Parishad (BUP), Dhaka. His sincere gratitudes is also due to several
researchers of BIDS, GKF and BUP for their valuable suggestions while carrying out the
study.
is specially so when the country’s population and its per capita income rise.
Transfer of farm land to non-agriculture is also needed for expansion of housing
facilities in both rural and urban localities. Such transfer is also evidenced in
building infrastructures such as roads, markets, educational institutions, electricity
and industrial establishments, etc.
We are not aware of the extent of conversion of farm land for non-agricultural
uses in Bangladesh and consequent production losses in agriculture. It is generally
claimed that in Bangladesh every year over 80 thousand hectares of agricultural
land i.e. nearly one per cent a year (Planning Commission 2009) is being converted
to non-agriculture. This is definitely a matter of serious concern for the land-scarce
country like Bangladesh where per capita cultivated area is only 15 decimals. This
is too meagre an amount for the country’s food security as the productivity of land
in Bangladesh is also low. Another case study, carried out in 2004 by Directorate of
Land Records and Surveys (DLRS) of the Ministry of Land in Palas Upazilla of
Narsingdi and Sonargaon of Narayanganj district, observed a substantial decline in
the share of agricultural land to the extent of 27 per cent in Palas and 16 per cent in
Sonargaon during the period of 20 and 25 years respectively (1983-2003; 1978-
2003) i.e. more than one per cent per year. On the other hand, there has been
several-fold increase in the area under housing and permanent fallows in both these
areas.
The recently completed report on Agriculture Sample Survey of Bangladesh-
2005 by Bangladesh Bureau of Statistics (BBS) does not, however, show such high
rate of decline in cultivated land. Total cultivated land of all holdings in rural
Bangladesh amounts to 17.77 million acres in 2005 which was almost the same in
1996 i.e. before nine years (Table I). This is difficult to explain. It seems to be due
to conversion of forest and low lying fishing land as well as newly accreted char
land to crop cultivations; this needs careful investigation. It may, however, be noted
that the cultivated area per farm household has over time reduced to 1.20 acres in
2005 from 1.50 acres, recorded in 1996. This is largely due to a sharp rise in the
number of rural farm households, by 24 per cent, from 11.8 million in 1996 to 14.7
million in 2005.
The recently completed Agricultural Census-2008 finds the number of farm
households (14.40 million) almost equal to the figure of 2005 (14.47 million)
accounting for 56.74 per cent of total rural households of the country. During the 12
year period of 1996 to 2008 the number of rural families increased from 17.8
million to 25.36 million i.e. an increase by 42.5 per cent. All these new families
must have residential accommodations largely derived from the existing
Agricultural land, indicating their absolute decline over time. The Government of
Quasem: Conversion of Agricultural Land to Non-agricultural Uses 61
Bangladesh is very much aware of such conversion of agricultural land and

accordingly it has framed the National Land Use Policy-2001 keeping in view the
competitive use of land for food production, housing, urbanisation and environment
protection. The Policy has also emphasized the efficient use of land to ensure
minimum level of food security to people and suggests restrictive use of land for
housing, physical infrastructures and other constructions. For full-fledged
implementation of the Policy, the Land Act is being formulated.
In Bangladesh, the average cultivated holding is too small for sustainable
livelihood of farmers, especially of the marginal and small ones. The land
transferred to non-agriculture is derived mainly from the land poor (upto 2.49 acres)
constituting 88 per cent of total farm holdings. They are thus, becoming more
vulnerable to food insecurity. Increasing number of functionally landless and the
tenant farm households seem to have been already affected by the reduced size of
farms and land degradation due to intensive cropping.
TABLE I
CULTIVATED AREA IN THE THREE CENSUS/SURVEYS
OF BANGLADESH
(in ‘000 acres)
Census/Survey Year Cultivated Area of
All Holdings Farm Holdings
Agriculture Sample Survey-2005
Total 18,084 18,047
Rural 17,725 17,692
Agriculture Census-Rural 1996 17,771 17,749
Agriculture Census-1983/84 20,158 20,139
Source: BBS (2006).
Note: Net cultivated area is the area actually cropped during the census year regardless of
the number of crops grown and it includes the area under temporary crops, current
fallow, and permanent crops (Fruits wood trees); In other words, it is the actual area
occupying perennial and non-perennial crops and area under current fallow.
I.2 Objectives of the Study

There has hardly been any study in the area of conversion of farm land to non-
agricultural uses. The present study has been initiated with the objective of
assessing the loss of farm land to non-agriculture during the eight year period of
2001-2008 and identify the factors affecting such conversion of land and also
investigate into the current pattern of non-agricultural uses. To be more specific, the
main objectives of the study are to:
i. Estimate annual conversion of agricultural land to non-agriculture and
consequent loss of crop production during the eight year period of 2001 to
2008;
ii. Investigate into the present pattern of non-agricultural uses of the converted
land;
iii. Determine the factors affecting such conversion of agricultural land to non-
agriculture; and
iv. Suggest suitable policy measures towards protection of farm land in the
country.
I.3 The Survey Methodology and Analysis of Data

The study is based primarily on a field survey carried out in 24 villages spread
over in all six administrative divisions of the country i.e. four in each division. In
each division besides the city localities one district town and in that selected district,
one Upazilla town was selected purposively. The selected district was Laxmipur in
the Chittaging division and Sunamganj from Sylhet, Faridpur from Dhaka, Naogaon
from Rajshahi, Jhenaidah from Khulna and Pirojpur from Barisal Division. The
Upazillas selected in those districts were respectively Raipur, Jamalganj, Sadarpur,
Mohadevpur, Kaliganj and Sharup Kathi as Shown in Table II. In each of the
selected Upazillas another set of six villages in rural areas was also included in the
survey to compare the extent of land conversion in actual rural areas vis-avis urban
conditions at every level of the City, District and Upazilla, termed as Metro village,
Urban village, Peri-urban village respectively. The name of the village and their
locations may be seen in Table II .
The selection of villages for field survey at the outskirts of the cities and towns
was quite complex as we first had to capture the area potential for urban expansion
and industrialisation that existed eight years ago keeping in mind the level of land
conversion that took place during the study period of early 2001 to end 2008. To
understand the recent trend in the changes in land use, the selected villages should
have the normal access to the cities and towns leaving at present 20 to 30 per cent of
the village area under agriculture indicating that there is still scope for land
conversion to non-agriculture. It also suggests that eight years back there was no
limitation to land conversion as far as land availability was concerned. Furthermore,
the villages should not be of very much low-lying topography that was abnormally
flooded that might restrict land conversion. So, for the selection of representative
villages at the outskirt of each category of town, one needs to visit several villages
around all the selected towns and consult several groups of urban and peri-urban
dwellers to understand the previous situations. In the selection of rural villages care
was also taken to cover very similar to the one slected near the Upazilla centre.
In each of the selected villages 25 households were selected at random from the
list of resident farmers, prepared earlier by the Sub-Assistant Agricultural Officers
(SAAO) of the Department of Agricultural Extension (DAE). The enlisted farmers
were found to include predominantly the resident land owners of different sizes.
These households were interviewed following a structured questionnaire that
contains household information relating to area owned and its uses, size of the
family, occupation of the household head, amount of land converted in the last 8
years from January 2001 to December 2008, current non-agriculture uses of
converted land, loss of agriculture production, changes in the levels of food
security, causes of land conversion, etc. The household survey was conducted in
July-September 2009. It may be mentioned that in each division four villages were
selected fo which three were located at the outskirt of the city, district town and
Upazilla town and another was the rural village. In all these villages in a division
100 households were interviewed totaling to 600 in the six divisions of Bangladesh,
as shown in Table II.
TABLE II
SELECTED STUDY VILLAGES BY DIVISION IN 2008
Division Metro-Village Urban Village Peri-urban Rural Area Total
(City (District Village (Upazilla) Households
Corporation Town) (Upazila) Interviewed
(No)
Barisal Karamja Uttar Auria Sangit Kathi 100
(Barisal Namajpur (Sharup Kathi) (Sharup Kathi)
Sadar) (Pirojpur)
Khulna Lata Bisay Khali Helai Shalikha 100
(Dumuria) (Jhenaidah) (Kaliganj) (Kaliganj)
Rajshahi Dharampur Bhabani Gathi Bil- Chok 100
(Motihar) (Naogaon) Mohammadpur Harballav
(Mohadebpur) (Mohadebpur)
Dhaka Gacha Paschim- Satero Roshi Amirabad 100
(Joydebpur) Khabaspur (Sadarpur) (Sadarpur)
(Faridpur)
Sylhet Bangshi Dhar Ganipur Talia Shahapur 100
(Sylhet Sadar) (Sunamganj) (Jamalganj) (Jamalganj)
Chittagong Madhayam Atia Tali Purba Lach Debipur 100
Mohra (Taxmipur) (Raipur) (Raipur)
(Chittgong)
The analysis in the report has been made on the basis of residential status of the
households as (a) metropolitan, (b) urban i.e. district town, (c) peri-urban i.e.
upazilla town and (d) rural. In addition to residential status, survey findings have
also been examined with respect to land ownership size as functionally landless
(upto 0.5 acre), marginal (0.51 acre to 1.0 acre), small (1.01 acres to 2.5 acres),
medium (2.51 acres to 5.0 acres) and large (5.01 acres and above). The main
hypothesis of the study is that proportional share of converted agricultural land to
non-agriculture rises with the level of urbanisation while declines with the increase
in land ownership size of the household. That implies that the rates of land
conversion are higher in metro and urban villages and also among the land poor
and, hence, they are becoming more vulnerable to food insecurity.
II. SOCIO-ECONOMIC CHARACTERISTICS OF THE

SAMPLE HOUSEHOLDS
II.1 Size of the Family and Occupational Distribution
The average size of the family in the study areas was 5.1, which is little higher
than the national average of 4.85 in 2007 (BBS 2007). The largest family size was
found in large land owners’ group and the least in the case of landless households
that reflects the country’s general situation.
About the occupational distribution of the household heads in the surveyed
villages, cultivation was identified to be the highest occupation, followed by trading
and labour. Forty four per cent of the households were occupied in agriculture
against BBS findings of 47.5 per cent in 2005. The occupational distribution also
shows that the proportional share of the cultivator households expected, while that
of the traders declines from 31 per cent to 15 per cent (Table III). Such declining
trend was also noted in both the service holders’ and that transport workers’ groups.
The pattern of occupational distribution in the study areas thus is very similar to the
country’s average situation.
II.2 Land Use in the Surveyed Villages
As far as the land use is concerned, the crop land had the highest coverage of 78
per cent with marginal variation by the residential status of the localities (74 to 81
per cent). The next important land use was in the homestead area sharing 11 per
cent of total area coverage. Its average size was estimated to be 0.18 acre, very close
to the national average. The two other important land uses were recorded in orchard
and bamboo bushes and the non-crop agriculture (Table IV). Non-crop agriculture
had a larger share in metropolitan village, may be occupied by poultry and dairy
farms.
II.3 Land Ownership Distribution

The average land ownership size was 1.68 acres ranging from 1.46 acres in
metropolitan village to 1.86 acres in rural village. The largest size was recorded in
the rural area as expected.
The average land ownership size of the landless households was 0.22 acre and
in the case of large owners the size was estimated to be 8.40 acres (Table V).
The distribution of households shows that about one-third of them was
functionally landless (upto 0.5 acre), followed by small land owners (1.0 to 2.5
acres) estimated to be 26 per cent as shown in Table VI. The BBS survey 2007 on
household income and expenditures, on the other hand, found higher proportion of
the functionally landless (60 per cent) and the small land owners only 17.6 per cent.
The lower proportion of the landless in the present survey was mainly due to
exclusion of the completely landless households numbering to over 10 per cent of
total households while selecting the households from the list prepared by the
SAAOs of the DAE.
The number of large owner households was 7.0 per cent owning 35 per cent of
total land. The marginal land owners including the functionally landless households
shared 14 per cent of total owned by the interviewed households (Table VI). It may
be pointed out that the share of large owners’ land to all land was 39 per cent in
both the metro-village and the urban village, indicating more skewed distribution of
land in these villages. Any way, the overall pattern of land distribution in the
surveyed villages is very similar to the average distribution pattern of land in
Bangladesh.
TABLE III
OCCUPATIONAL DISTRIBUTION OF HOUSEHOLD HEADS BY RESIDENCE
(Per Cent)
Principal Occupation Metropolitan Urban Pre-urban Rural Total
Crop Agriculture 30.0 42.7 46.0 54.7 43.3
Non-crop Agriculture 0.7 2.0 0 1.3 1.0
Labour 12.0 4.7 12.0 10.7 `9.8
Transport 3.3 4.0 2.0 1.3 2.7
Trading 30.7 24.0 26.0 15.3 24.0
Service 14.0 10.7 8.0 5.3 9.5
House Work 0.7 3.3 1.3 3.3 2.2
Industry 0 0.7 0 0.7 0.3
Old age 4.7 3.3 3.3 6.0 4.3
Retired 4.0 4.7 1.3 1.3 2.8
Total 100.0 100.0 100.0 100.0 100.0
Source: Field Survey, BUP, 2009.
TABLE IV
LAND USE AND ITS AVERAGE OWNERSHIP SIZE BY RESIDENCE IN 2008
Land use Metropolitan Urban Peri-urban Rural All areas
% of Average % of Average % of Average % of Average % of Average
Land (acre) Land (acre) Land (acre) Land (acre) Land (acre)
Homestead and its 10.2 0.15 10.5 0.19 9.8 0.16 12.3 0.23 10.8 0.18
Adjacent Area
Crop Land 73.8 1.46 79.1 1.87 80.9 1.50 76.0 1.67 77.6 1.62
Orchard and 2.9 0.11 4.8 0.22 5.0 0.15 6.6 0.18 5.0 0.17
Bamboo Bush
Non-crop 9.0 0.31 2.7 0.12 3.3 0.11 2.9 0.11 4.3 0.16
Agricultural Land
Non-Agricultural 3.1 0.12 2.1 0.12 1.0 0.07 1.3 0.14 1.8 0.11
Establishments
Others 1.0 0.41 0.6 0.24 0.1 0.1 0.8 0.47 0.6 0.34
Total 100.0 1.46 100.0 1.78 100.0 1.62 100.0 1.86 100.0 1.68
TABLE V
AVERAGE LAND AREA OWNED AND THE FAMILY SIZE BY
LAND OWNERSHIP SIZE OF HOUSEHOLDS
Land Ownership Size Area Owned (acre) Family Size (no)
Landless 0.22 4.8
Marginal 0.47 5.1
Small 1.63 4.9
Medium 3.42 5.7
Large 8.40 6.2
All Households 1.68 5.1
Note: Landless upto 0.5 acre; Marginal 0.51 to 1.0 acres, small 1.01 acres to 2.5 acres; Medium
2.51 acres to 5.0 acres, and Large – 5.01 acres and above.
TABLE VI
DISTRIBUTION OF HOUSEHOLDS BY LAND OWNERSHIP SIZE AND RESIDENCE
(PERCENTAGE OF HOUSEHOLDS AND AREA OWNED)
Residence Landless Marginal Small (100 to Medium (250 Large (500 Total Average
(below 50 (50-99 249 decimals) to 499 decimals and Households Ownership
decimal) decimal) decimal) above) (No.) Size (acre)
Metropolitan 38.7 24.7 18.7 10.0 8.0 150 1.46
(4.9) (11.9 (20.6) (23.3) (39.3 (100)
Urban 36.7 20.0 23.3 13.3 6.7 150 1.78
(4.0) (8.1) (21.5) (27.2) (39.2) (100)
Peri-urban 28.0 25.3 26.7 12.7 7.3 150 1.62
(4.6) (12.2) (26.5) (25.8) (31.0) (100)
Rural 23.3 22.0 34.0 14.7 6.0 150 1.86
(3.3) (8.8) (30.1) (26.5) (31.3) (100)
All Households 31.7 23.0 25.7 12.7 7.0 600 1.68
(4.1) (10.1) (24.9) (25.8) (35.0) (100)
Note: Figures within brackets indicate the per cent area owned by them in each residential area.
III. AGRICULTURAL LAND CONVERTED TO NON-AGRICULTURE
III.1 Amount of Land Converted

The current survey estimated that during the eight year study period of 2001 to
2008, 46.25 acres of agricultural land was converted to non-agriculture (Table VII).
In such conversion 251 land owners i.e. 42 per cent of interviewed households were
involved. Land converters during the period were maximum in metro-village
(54 per cent) and the lowest in peri-urban and rural villages (35 per cent). Among
the divisions, Dhaka recorded the highest proportion of converters (52 per cent) in
the area and the least in Sylhet (27 per cent) as shown in Annexure Table I.
Conversion of agricultural land with respect to total land owned in the year
2001 in the surveyed villages during the study period amounts to 4.50 per cent or
0.56 per cent per year. The annual rate of conversion varies from 0.25 to 0.74 per
cent in peri-urban and urban-village respectively (Table VII). The present estimate
is lower than the previous figure of about one per cent, often quoted. The higher
rates of conversion in the current survey were noted in both urban and metro-
villages as hypothesised. This is considered to be mainly due to higher price of land
(Annexure Table II). It is also important to note that the price of homestead land is
higher by 45 per cent compared to that of farm land, recording wide variation
among the Divisions. Farm land in Sylhet is observed to be cheapest as it is
generally single cropped and people do not prefer farming. The lower conversion in
peri-urban villages might be due to stagnation in physical infrastructure building
and in the functioning of the local government-Upazilla Parishad during the period.
III.2 Conversion of Land by Division

About the annual rate of conversion of land by region, the highest rate of
conversion during the period was recorded in Dhaka division (estimated to be 1.45
per cent per year), while the lowest rate of conversion was experienced in Khulna
division, only 0.26 per cent a year (Annexure Table I). Chittagong and Sylhet
divisions had the conversion rate of 0.45 and 0.47 per cent respectively.
Average amount of land converted during the period amounts to 18.4 decimals
by the converter households and 7.7 decimals when considered all households.
Among the converters it was as high as 28.5 decimals in Dhaka Division, while the
lowest was in Barisal (7.6 decimals) as shown in Annexure Table III. According to
residential status, maximum converted area per household was recorded in both
rural and urban area (24.8 decimals each). Of all the converters the highest number
was observed in the metro-villages constituting about one-third of this total
household in this category.
III.3 Conversion of Land by Land Ownership Size

According to land ownership size the proportion of land converters generally
increases with their size, the average being 42 per cent. It increases from 30 per cent
among landless households to 35 per cent among the large landowners during 2001
to 2008, which is expected (Table VIII). But in terms of land owned by them, the
highest rate of conversion was recorded among the functionally landless households
estimated to be 23 per cent or 2.9 per cent a year and the lowest among the large
land ownership groups (1.6 per cent) or only 0.2 per cent of their land per year. In
the remaining three other groups, the rate of conversion was observed to be about
0.6 per cent per year. The highest rate of conversion among landless households
suggests that they are becoming more vulnerable to food security, especially when
their land ownership size is alarmingly low (0.22 acre).
III.4 Land Converted under Different Possessions

During the eight year study period, land was converted to non-agricultural uses
under different possession rights other than self-ownership. Some land was sold,
some acquired by the government and some was donated. The data show that the
major proportion (45 per cent) of the converted was sold while only 34 per cent was
converted under self ownership, where peri-urban village dominate covering 55 per
cent of total converted land (Table IX). Land acquired by the government had also
significant share (19 per cent), mostly observed in urban village (38 per cent). It
may be noted that conversion after sales was substantially high in rural and in
metro-village, as compared to other this categories. Such analysis by land
ownership size indicates that 63 per cent of large land owners’ converted land took
place under self-ownership, while only 17 per cent was in the case of landless
category (Table X). Conversion that occurred after sales of the land was quite high
among the medium land owners. Surprisingly, over half of the converted land of the
landless households was derived from acquired land. Such share for the large land
owners was negligible (2.1 per cent), indicating that the land poor is more adversely
affected by the acquisition of land by the state.
III.5 Share of Crop Land to Converted Land
It has been observed that of the total converted agricultural land, crop land
occupied 90 per cent where different crops were cultivated. The remaining 10 per
cent was used either in bamboo bushes and jungles or left fallow. There was some
land where unplanned orchards and trees were also grown. The share of crop land
was the highest in rural villages (95 per cent) and the lowest (85 per cent) in both
the peri-urban and metropolitan villages (Table VII). 1 Among the five land
ownership categories, the share of crop land in the converted land was the highest
(93 per cent) in small category and the lowest (85 per cent) among the marginal
land category (Table VIII). In Dhaka division, 95 per cent of the converted land was
derived from crop land, indicating that there is little scope for further urban
expansion in the division without losing valuable crop land, which is a matter of
serious concern.
III.6 Agricultural Land Converted at the National Level

According to our estimate, agricultural land is being converted at a rate of 0.56
per cent per year. On the basis of this rate of conversion and the country’s total
cultivated area of all farm households amounting to 7.19 million hectares in 1996,
conversion of land amounts to 40,452 hectares per year.
Another estimate based on annual per household conversion of land @ 0.0096
acre {(46.25 acres ÷ 600) ÷ 8} and the rural land owning households numbering to
16.01 million or {(17.828 − 1.815 or 10.18% completely landless)} in 1996 annual
converted land is estimated to be 62,478 hectares. None of these estimates is close
to the previously quoted figure of over 80,000 hectares. Furthermore if the
previously quoted figure of 80,000 hectares is taken into account, total converted
land in the country comes to 720,000 hectares during the nine year period of 1996 to
2005. But the total cultivated area in rural Bangladesh remains almost the same
(17.77 million acres) in both the years of 1996 and 2005 with marginal difference of
only 46,000 acres. We may, therefore, conclude that the previous figure of land
conversion is an over estimate.
1
Chi-square test shown that there was statistically significant difference in the rate of
conversion of land between the urban and peri-urban village.
TABLE VII
AMOUNT OF LAND CONVERTED DURING THE PERIOD OF 8 YEARS
FROM 2001 TO 2008 BY RESIDENCE
Residence Total Land Total Land Per cent Annual Per cent of
Owned in Converted Land Rate of Converted Land
2001 (acres) Converted Conversion from
(acres) in 8 Years (%) Crop Non-
Land crop
Land
Metro-village 225.11 12.24(54) 5.44 0.68 85.38 14.62
Urban Village 276.0 16.35(44) 5.92 0l.74 90.21 9.79
Peri-urban Village 240.66 4.75(35) 1.97 0.25 85.26 14.74
Rural Village 286.31 12.91(35) 4.51 0.56 95.43 4.57
All Areas 1028.0 46.25 4.50 0.56 89.88 10.12
Note: Figures within parentheses indicate the per cent of households who converted
agricultural land to non-agricultural uses in each residence category.
TABLE VIII
NUMBER OF HOUSEHLDS CONVERTED LAND AND THE AMOUNT OF LAND
CONVERTED BY LAND OWNERSHIP SIZE DURING THE
EIGHT YEAR PERIOD 2001-2008
Land Ownership Size No. of Per Cent of Per Cent of all Per Cent Share of
Households Households Households’ Area Total
Converted Converted Converted in 8 Crop Land Non-crop
Years Land
Landless 68 36 22,9 (2.86) 90.8 9.2
Marginal 48 35 4.6 (058) 82.9 17.1
Small 69 45 4.6 (0.58) 93.1 6.7
Medium 43 56 4.7 (0.59) 88.9 11.1
Large 23 55 1.6 (0.20) 89.0 11.0
All Households 251 42 4.5 (0.56) 89.9 10.1
Note: Figures in the parentheses indicate annual rate of conversion.
TABLE IX
AMOUNT OF LAND CONVERTED BY POSSESSION STATUS AND RESIDENCE
(Percentage)
Residence Self- Sold Acquired Donation Others
Ownership Occupation
Metro-village 40.36 56.45 0.65 1.96 0.57
Urban Village 30.46 29.72 38.04 1.77 -
Peri-urban Village 54.95 31.37 9.05 4.63 -
Rural Village 23.55 59.02 15.65 1.78 -
All Areas 33.66 45.15 18.92 2.12 0.15
TABLE X
AMOUNT OF LAND CONVERTED BY POSSESSION STATUS AND THE
LAND OWNERSHIP SIZE
(Percentage)
Land Ownership Size Self- Ownership Sold Acquired Donation Others
Landless 16.78 27.14 52.83 2.74 0.51
Marginal 48.83 45.20 2.13 3.84 -
Small 28.94 51.15 17.28 2.55 0.09
Medium 34.83 61.09 2.64 1.44 -
Large 63.30 34.57 2.13 - -
All Households 33.66 45.15 18.92 2.12 0.15
Source: Field survey, BUP, 2009.
IV. MAIN USES OF CONVERTED LAND AND LOSS OF

AGRICULTURAL PRODUCTION
IV.1 Non-agricultural Uses of Converted Land
Information collected indicates that more than half (55 per cent) of the
converted local was used in housing predominantly in metro villages (60 per cent),
as expected. The next two important uses were in the construction of roads and
business establishments covering 10 and 8 per cent respectively (Table XI). Non-
reported area of use was also substantial (15 per cent). The share of such land was
the largest in rural villages (25 p[er cent). Among different residential status of the
households, the second most important utilisation in peri-urban villages was road
construction covering 19 per cent of its converted land. In urban villages, next to
housing, other major uses were (a) business establishments, (b) agro-based
industries, (c) education and health institutions, and (d) road construction, each
clearing five per cent of total converted land.
It is interesting to look at the pattern of non-agricultural uses of the converted
land by their possession or ownership status. Converted land under self-ownership
was used predominantly in housing to the extent of 78 per cent for all villages taken
together but it was as high as 89 per cent in rural villages. The next important uses
were in business establishment (13 per cent) and brick fields (3 per cent), as shown
in Annexure Table IV. The principal non-agricultural use of sold out land was also
in housing (30 per cent) but over half of such land (56 per cent) remained
unreported, as the owners did not stay there and the respondents were not aware of
their current uses. Next to housing the land was occupied by mills and factories (7
per cent), concentrated in metro-villages (13 per cent). The land sold in urban
villages was largely used for office buildings and other public utilities (11 per cent),
next to housing (44 per cent). Converted land in others’ possessions e.g. acquired,
donations, etc. had the substantial use in the construction of road to the extent of 57
per cent of such category land (Annexure Table IV). The next important use was by
health and educational organisations, especially in metro villages. In peri-urban
villages, public welfare institutions had also significant share of converted land.
There were wide regional variations in the non-agricultural use of converted
land. For example, housing in Barisal covered as high as 77%; while it was only
41% in Sylhet where the requirement for new houses seemed lower. In Sylhet, the
second most important use was the construction of roads occupying 29 per cent of
land. In Dhaka, non-reported area was of claimed the largest share (31 per cent) of
land, either used or not. In Barisal, public welfare establishments covered 12 per
cent, the highest among six divisions.
Non-agricultural uses are also found different when examined by the land
ownership size of households although the housing claimed the maximum share in
all the categories. Small land owners had the highest proportion (62 per cent) in
housing while the medium owners had the lowest (42 per cent) still occupying the
maximum proportion. In the large ownership size, next to housing, the next largest
share (19 per cent) claimed by the business establishment but it had the least more
among the small land owners (Table XII). Road construction claimed 16 per cent of
the medium owners’ converted land. In the landless group, the second highest
proportional share (8.9 per cent) was occupied by health business enterprises as well
as education and health organisations.
IV.2 Previous Uses of Converted Land

As mentioned earlier, of total converted agricultural land, 90 per cent was crop
land where different crops and vegetables were grown. Collected data show that 92
per cent of crop land was under paddy and about 6 per cent was used for vegetables.
The area under vegetables was higher (27 per cent) in peri-urban villages. Among
different land ownership groups, the proportional shares of paddy land varied little,
the highest being among the large land owners (97 per cent). In the case of
vegetables, marginal land owners had the highest share (12 per cent). Before
conversion, non-crop land which was kept almost unutilised amounted to 78 per
cent, ranging between 81 and 97 per cent in metropolitan and peri-urban villages
respectively. One-tenth of the land was occupied by bamboo bushes and trees,
mostly in urban areas (23 per cent). There were some scattered plots where
vegetables were grown, accounting for only 6.0 per cent of land. The pattern of land
use as practised before conversion indicates that the conversion of land to non-
agricultural uses has adversely affected agricultural production, which is estimated
below.
IV.3 National Production Loss Based on Current Field Survey

According to the present field survey, production of different crops and
vegetables is lost due to conversion of farm land to non-agriculture. The main crops
lost were HYV paddy, local paddy and vegetables; and total annual loss of
production was reported to be Tk.22,774 per acre (Table XIII). On the basis of
annual production losses of Tk.22,774 per acre, the country’s total loss from
converted land of 40,452 hectares of 99,512 acre i.e. @ 0.56% as estimated earlier,
stands at Tk. 228 crore per year.
IV.4 Estimated National Loss of Rice Production

It may be relevant to estimate the amount of losses of rice production due to
conversion of agricultural land in Bangladesh. Annual loss of rice production has
been assessed on the basis of 5.12 acres of crop land as determined earlier. If the
converted land is double cropped by Boro (HYV) and half by Aman (HYV) and
half by local Aman considering all areas under cultivation of paddy, total amount of
annual loss of paddy from the converted land (5.12 acres) roughly amounts to 465
maunds @ 90 maunds per acre or 0.028 ton per household. Total land-owning
households in Bangladesh being 16.01 million, total loss of paddy production in the
country amounts to 0.448 million or 4.5 lakh ton, which is equivalent to 3.02 lakh
tons of rice and thus, with respect to country’s total production of 27 million metric
tons, it stands at about 1.16 per cent. Another estimate based on the proportion of
agricultural land converted amounting to 5,0995 million acres and per acre annual
loss of rice (2.24 ton/acre) reported above stands at 0.223 million tons i.e. 0.86 per
cent of the country’s annual production of rice. It would thus appear that due to
conversion of agricultural land to non-agriculture, annual loss of rice production
amounts to between 0.86 and 1.16 per cent of the country’s total rice production,
which is not a negligible amount.
TABLE XI
NON-AGRICULTURAL USES OF CONVERTED
AGRICULTURAL LAND BY RESIDENCE4
(Percentage)
Current Use Metropotitan Urban Peri-urban Rural Total
Shop/Business Enterprise 10.53 5.26 9.52 7.5 8.47
Agro-based Industries - 5.26 - - 1.13
Education & Health Organisation 3.51 5.26 2.38 - 2.82
Construction of Road 5.26 5.26 19.05 10.00 9.60
Construction of House 59.65 55.26 52.38 50.00 54.80
Mills/Factories 5.26 - - 2.5 2.67
Unutilised 1.75 - - - 0.56
Public Offices & Utilities 1.75 7.89 - 5.00 2.82
Brick Fields 1.75 2.63 2.38 - 1.69
Non Reported 10.53 13.16 14.29 25.00 15.25
All Uses 100.0 100.0 100.0 100.0 100.0
TABLE XII
NON-AGRICULTURAL USES OF CONVERTED AGRICULTURAL
LAND BY LAND OWNERSHIP SIZE
(Percentage)
Current Use Landless Marginal Small Medium Large Total
Shop/Business Enterprise 8.89 6.45 2.13 13.16 18.75 8.47
Agro-based Industries - - 2.13 - 6.25 1.13
Education & Health 8.89 3.23 - - - 2.82
Organisation
Construction Road 2.22 9.68 10.64 15.79 12.50 9.60
Construction of House 55.56 58.06 61.70 42.11 56.25 54.80
Mills/Factories - - 2.13 5.26 6.25 2.26
Unutilised 2.22 - - - - 0.56
Public Offices & Utilities 2.22 6.46 6.36 - - 2.82
Brick Fields 2.22 3.23 - 2.63 - 1.69
Non Reported 17.78 12.90 14.89 21.05 - 15.25
All Uses 100.0 100.0 100.0 100.0 100.0 100.0
TABLE XIII
ANNUAL PRODUCTION LOSS DUE TO CONVERSION OF
CROP LAND BY TYPE OF CROPS GROW
Crops Grown Total Area (acre) Total Loss of Crops Per Acre Loss (Tk)
and others (Tk)
HYV Paddy 28.88 644,137 22,304
Local Paddy 9.28 194,650 20,975
Vegetables 2.32 86,800 37,414
Bamboo Bushes, Nursery & `0.94 17,700 18,830
others
All Crops and Others 41.42 94,287 22,774
Note: Total loss of crops were estimated on the base of per acre yield of different crops on the
prevailing market prices at the time of field survey.
V. BENEFITS TO LAND CONVERTERS

Conversion of agricultural land to non-agriculture is expected to benefit the
converter households in terms of higher income and improved level of food security
despite losses in agricultural production. Such improvement is, however, dependent
on the type of non-agricultural uses of land and their efficiency of uses. This aspect
has been examined by comparing the present situations between the converter (42
per cent) and the non-converters (58 per cent) of the interviewed households.
V.1 Food Security of the Household Level

Respondents’ opinions indicate that 43 per cent of the converter households
have impressed improvement in food secure compared to 32 per cent among the
non-converters and such difference in improvement has been observed in all land
ownership groups, more so in the medium land owner group. Some households,
however, experienced reduction in food security in both the converter and the non-
converter groups though it is lower among the converters (14.3 per cent against 22.6
per cent among non-converters) as shown in Table XIV. Food security status
remains almost unchanged to the extent of 42 and 46 per cent in both these groups.
It is may be mentioned here that the food security levels increased by more than
10 per cent over time in the case of 20 per cent of the converter households
compared to only 10% among the non-converters. Proportion of households who
experienced reduction in the food security levels of above 10 per cent accounts for
10 per cent among the converter households compared to 15 per cent in the case of
non-converter households. 2
Improvement in the food security levels of the converter households over the
non-converters as reported above is not, however, reflected in the amount of
consumption of at least three food items e.g. rice, flour and pulses. Rough estimates
indicate equal levels of consumption in both these groups either in aggregate or by
land ownership size. It may be mentioned that daily per capita consumption of
cereals and pulses in the present study was estimated to be 450 gms and 20 gms
respectively by the converter households which is marginally higher than the
national average of 409 gms and 14.2 gms recorded in 2005 (BBS 2007).
V.2 Income of the Households

It is interesting to note that income of the converter households was observed to
be higher by about 50 per cent over that of the non-converters household. Such
higher income was recorded in all size ownership groups, but more so among the
marginal and the large land owners. The converters have also higher share of
income from trade and businesses (42 per cent against 36 per cent) and different
services (24 per cent against 22 per cent).
It may be pointed out that the improved level of food security among the
converter households may not be due to land conversion alone. It could be the
combined outcome of several factors such as land ownership size of the households,
their levels of education, occupational status, etc. It may, however, be mentioned
that the average size of land owned by a converter household is substantially higher
( ) over the non-converters’ owned area and (prominently observed among the land
rich). They had also higher land ownership size in 2001 (2.22 acres). The converter
households might also be more favourably located in terms of the infrastructure
development of the area. This, however, needs further investigation. Furthermore,
the average value of household assets is found to be almost equal among both the
converter and the non-converter households. Substantial differences are, however,
noticed in the case of non-housing assets i.e. in terms of agricultural equipment,
livestock, plantations, etc. It is found to be double for converter households. The
average value of such productive assets of these households is estimated to be
Tk.92,458.
2
These figures are based on perception of the respondents in the field survey.
V.3 Reasons for Changes in Food Security Levels: Respondents’ Views

Respondents among the converter households, whose food security levels
improved, opined that the increase in non-agricultural income was the principal
determinant of such improvement. This has been possible due to expansion in their
business. The other important factors were increased crop production and more
working members in a family. Among the non-converters, three major facilitating
factors as identified by them were the same as is above while the fourth one was
increased remittances from abroad.
The deterioration in the food security levels is caused by a variety of factors.
They are almost the same for both these groups–converter and non-converter
households. According to the converter households, the decline in food security was
caused by (i) the decrease in agricultural land and consequently, lower production
of crops, (ii) increase in food prices, (iii) decline in working members in a family
and (iv) increase in the number of members in a family. In the case of non-
converters, all the above mentioned causes are applicable but to them the
predominant factor was the increased food price. Overall, we may conclude that the
conversion of agricultural land by a household leads to increased non-agricultural
income and consequently higher level of food security. However, the national
concern is the attainment of minimum level of food security and also to arrest the
rate of land conversion for sustained agricultural development in the country.
TABLE XIV
CHANGES IN THE LEVELS OF FOOD SECURITY BY LAND OWNERSHIP
SIZE AND CONVERSION STATUS OF HOUSEHOLDS
(Percentage)
Land Ownership Reduced Unchanged Increased
Size Converter Non- Converter Non- Converter Non-

Converter Converter Converter
Landless 17.6 30.3 45.6 40.2 36.7 29.5
Marginal 16.7 27.8 45.8 47.8 37.5 24.4
Small 17.4 12.9 44.9 52.9 37.7 34.1
Medium 4.6 9.1 32.6 48.5 62.8 42.4
Large 8.7 15.8 34.8 31.6 56.5 52.6
All Households 14.3 22.6 42.2 45.5 43.5 31.8

VI. DETERMINANTS OF LAND CONVERSION
VI.1 Determinants of Land Conversion: Regression Results

Conversion of agricultural land to non-agriculture is dependent on a variety of
factors such as number of members in a family, income earning possibilities from
agriculture and non-agriculture uses of land besides state acquisition for
construction of roads and institutional building, etc. Regressions analyses in this
regard can provide better explanation by identifying the factors that determine the
amount of land area to be converted to non-agriculture by the households. To this
end, linear regression model is fitted taking into account several explanatory
variables for the year 2001. * The independent variables used in the model are:
i) Total land owned by household :T-LAND (decimals);
ii) Homestead land owned by a household : HOME (decimals);
iii) Proportion of non-crop land to total land owned : PNC (%)
iv) Primary occupation of the household head : P-OCCUP (agriculture=0 &
non-agriculture=1)
v) Years of schooling of the household head : (number);
vi) Per capita annual income : PCI (Tk);
vii) Household assets other than housing : Asset (Tk);
viii) Disaster losses : DISASTER (Tk);
ix) Study Area Dummy (Rural = 0);
x) Dummy for Peri-urban (PERI-UR=1);
xi) Dummy for Urban (URBAN=2);
xii) Dummy for Metro (METRO=3).
The linear regression exercise hypothesises that the area of agricultural land
converted by a household rises with the increase in its land ownership size,
homestead area and proportional share of non-crop land to total land owned.
Household heads with non-agricultural occupations and their years of schooling are
also expected to encourage land conversion as they are more exposed to non-
agricultural activities. Per capita annual income and value of non-housing assets i.e.
agricultural equipment, livestock’s, etc. are considered to have negative impact on
land conversion as they can use their land better for higher agricultural production
and more income. About the dummy variable rural village is taken to be ‘0’ i.e. with
*
Similar exercise has also been carried out for the data of 2008 and the results are found to
be quite similar.
respect. ‘0’ rural village, shift of study area to peri-urban, urban and metro city there
is increasing possibility for land conversion due to urbanisation and different other
commercial activities.
The results of linear regression exercise show that both the total land owned by
a household and the area under homestead have highly significant impact on the rate
of land conversion (Table XV). The first variable has a positive effect and in case of
10 per cent increase in total area, there would be an increase in land conversion by
3.5 per cent. An increase in homestead land by 10 per cent, would result in a decline
of land conversion by 1.4 per cent, which is contrary to our expectation. May be
their homestead area is small and therefore, little scope exists for enterprise
expansion other than housing. Positive effect of primary occupation of the
household head is also noticed at 10 per cent level of significance, suggesting that
non-agricultural occupation of the household head has positive impact on land
conversion. Disaster loss, on the other hand, has significant negative impact at 10
per cent level, indicating that the household become more conscious of retaining
crop land for food security reason due to damages occurred due to natural
calamities.
TABLE XV
DETERMINANTS OF LAND CONVERSION: RESULTS LINEAR REGRESSION
Sl. No. Dependent Variable; is Total Land Converted (Decimals)

Independent Variables Beta Sig.
i. T-LAND 0.356 0.000
ii. HOME (-) 0.139 0.003
iii. P-OCCUP 0.105 0.016
iv. Years of Schooling (No) (-) 0.006 0.894
v. PCI 0.059 0.194
vi. PNC (-) 0.077 0.087
vii. ASSET 0.012 0.775
viii. DISASTER (-) 0.079 0.056
ix. METRO (-) 0.029 0.561
x. URBAN 0.019 0.686
xi. PERI-UR (-) 0.085 0.077
Adjusted R Square 0.119 -
Source: Author’s estimate.
VI.2 Arresting Land Conversion: Respondents’ Opinions

It is wieldy recognised that conversion of land should be discouraged in
Bangladesh for ensuring food security in the country. The respondents have put
forward some suggestions for arresting the current rate of land conversion. Their
recommendations include the following (Table XVI):
(i) agriculture should be made more profitable and attractive (49 per cent);
(ii) special tax should be imposed on conversion of land (30 per cent);
(iii) area-wise ceiling may be fixed for non-agricultural uses of land (11 per
cent);
(iv) tax exemption may be offered for commercial farms and the agro-based
industries (10 per cent).
While asking the respondents’ views towards increasing profitability of

agriculture, they emphasise for raising of crop prices in the harvest seasons, ensured
timely supplies of agricultural inputs at reasonable prices, and productivity increase
of land through adoption of modern technologies and effective agricultural
extension services. These suggestions are almost equally applicable to all land
ownership groups and the residential status of the households. Also, little
differences are observed in their views when compared between land converters and
non-converters.
Open discussions with the respondents in this regard also reveal that there
should be immediate control for non-agricultural use, population growth and
introduction of special tax on converted land; and area specific ceiling may also be
imposed to restrict indiscriminate conversion of farm land. The above mentioned
suggestions lead us to conclude that to arrest the present rate of land conversion two
things are essential. These are (a) strict population control to restrict faster
expansion of housing and road construction, and (b) making agriculture more
profitable and attractive.
The government of Bangladesh is, however, aware of the existing problems and
accordingly, it is formulating strategies towards “Compact Townships” for rural
people (Planning Commission 2009). It has also emphasised the implementation of
National Land Use Policy 2001, towards restriction of unplanned housing and road
construction. In this context, proper policy formulation and adequate institutional
mechanism assume special significance.
TABLE XVI
SUGGESTIONS FOR ARRESTING CONVERSION OF
LAND BY RESIDENTIAL STATUS
(Percentage)
Residential Status Special Area-wise Tax Exemption Agriculture All
of Households Tax to be Ceiling for for Agro-based should be Responses
Imposed Non-agril. Industries made (No)
Uses Profitable
Metropolitan 31 9 7 52 26 (280)
Urban 31 10 10 49 24 (250)
Peri-urban 28 12 12 48 25 (264)
Rural 28 12 12 48 25 (264)
All Areas 30 11 10 49 100 (1058)
VII. SUMMARY AND CONCLUSIONS

The study finds that during the eight year period of 2001 to 2008 annual
conversion of agricultural land amounts to 0.56 per cent against the earlier reported
figure of about one per cent. Highest rate of conversion was noted in Dhaka division
(1.45 per cent) and the least in Khulna (0.26 per cent). In such conversion, 42 per
cent of land owner households were involved. Among the different land ownership
groups maximum rate of conversion was recorded among the functionally landless
households (2.86 per cent per year) and the least was in the large land owners
group, (0.20 per cent).
The main non-agricultural uses of converted land were identified to be housing,
road construction, business establishment and educational and health organisations
occupying 55,10,8 and 3 per cent of the converted land respectively, with little
variations among the five land ownership groups. Converted land under self-
ownership was predominantly used in housing to the extent of 78 per cent but it was
as high as 89 per cent in urban villages. The coverage by housing in the case of sold
out land was lower (30 per cent).
Based on the current estimated rate of conversion (0.56 per cent per year),
annual loss of rice production in Bangladesh amounts to 0.23 million tons or 0.86
per cent of the country’s annual rice production. Similar exercise using loss of
paddy (0.8 maund) per land owner household, total amount of loss of rice comes to
0.302 million tons or about 1.16 per cent.
Information available indicate that the conversion of land benefits the converter
households in terms of both higher household income and improved level of food
security. But the estimate of actual consumption of rice, flour and pulses was found
to be almost equal. Improvement in the food security among the converter
households was reportedly due to higher non-agricultural income, facilitated by
expansion of business.
The regression exercise carried out identifies the following factors that have
significant effects on the rate of conversion of agricultural land are:
(i) total land area owned by a household;
(ii) homestead area owned;
(iii) primary occupation of the households head; and
(iv) disaster losses incurred during the study period.
The regression coefficient shows that 10 per cent increase in total area owned
by a household leads to rise in the conversion of land by 3.5 per cent; while the
increase in homestead area by 10% reduces land conversion by 1.4 per cent.
Perhaps, the area under homestead is small and has little scope for expansion. Non-
agricultural occupation of the household heads also encourages land conversion.
The main policy suggestions to arrest the magnitude of land conversion are:
agricultural occupations need to be made more profitable and attractive compared to
non-agriculture and at the same time special tax may be imposed on the conversion
of crop land. Area specific ceiling for different non-agricultural uses may be
determined and imposed in industrialisation and urbanisation. Open discussions
with the respondents in this regard suggest strict control on population growth,
creation of more employment opportunities in rural non-farm sector and increase of
land productivity through adoption of modern technologies, to be facilitated by the
use of hybrid and high yielding seeds, uninterrupted supply of electricity to the
irrigation equipment and adequate agricultural credit at subsidised rates of interest.
In the adoption of new technologies, improved farm management practices are
required.
REFERENCES
Bangladesh Bureau of Statistics 2009: Preliminary Report on Agricultural Census – 2008.

Government of the People’s Republic of Bangladesh, Dhaka.
–––––––2007. Household Income and Expenditure Survey of Bangladesh. Government of
the People’s Republic of Bangladesh, Dhaka.
–––––––2006. Agriculture Sample Survey of Bangladesh-2005, National Volum-1.
Government of the People’s Republic of Bangladesh, Dhaka.
Government of the People’s Republic of Bangladesh, 2001. National Land Use Policy,
Bangladesh Gazette, June 2001.
Ministry of Land 2004: GIS Atlas on Land Use and Environment-Palas and Sonargaon
Upazillas Government of the People’s Republic of Bangladesh, Dhaka.
Planning Commission 2009. Steps Towards Change – National Strategy for Accelerated
Poverty Reduction II (Revised). FY 2009-11. Government of the People’s Republic
of Bangladesh, Dhaka.
ANNEXURE TABLE I
AMOUNT OF LAND CONVERTED DURING THE PERIOD OF 8 YEARS
FROM 2000 TO 2008 BY DIVISION OF THE COUNTRY
Division Total Land Total Land Per Cent Annual Per Cent of
Owned in Converted of Land Rate of Converted Land
2001 (acres) Converted Conversion from
(acres) in 8 Years (%)
Crop Non-crop
Land Land
Barisal 87.17 3.28 (43) 3.76 0.47 78.35 21.65
Khulna 190.19 3.88 (42) 2.04 0.26 82.47 17.53
Rajshahi 242.13 7.42 (44) 3.06 0.38 89.76 10.24
Dhaka 172.88 20.05 (52) 11.60 1.45 95.16 4.84
Sylhet 194.11 6.49 (27) 3.34 0.42 86.13 13.87
Chittagong 141.54 5.13 (43) 3.62 0.45 87.13 12.87
All Areas 1028.01 46.25 (251) 4.50 0.56 89.88 10.12

Note: Figures within parentheses indicate the number of the converter households.
ANNEXURE TABLE II
AVERAGE PRICE OF LAND BY TYPE OF RESIDENCE IN 2008
Residence Homestead Land Farm Land

(Flood Free High Land)
Metro-village 1,84,265 1,36,535
Urban Village 53,240 36,545
Peri-urban Village 30,690 17,402
Rural Village 15,339 10,109
All Areas 71,165 48,852

ANNEXURE TABLE III

AVERAGE AREA CONVERTED BY THE CONVERTED
HOUSEHOLDS (DECIMALS)
Division Metropolitan Urban Peri-urban Rural Village All
Village Village Village Locations
Barisal 4.2 (15) 15.4 (12) 3.0 (10) 8.3 (6) 7.6 (43)
Khulna 2.5 (14) 13.2 (9) 9.5 (10) 15.4 (9) 9.2 (42)
Rajshahi 5.1 (16) 17.2 (11) 19.9 (8) 34.8 (9) 16.8 (44)
Dhaka 41.5 (18) 73.0 (12) 11.5 (12) 24.4 (10) 38.5 (52)
Sylhet 13.7 (6) 8.5 (9) 5.5 (8) 58.5 (8) 24.0 (27)
Chittagong 18.0 (12) 14.5 (13) 3.9 (10) 7.7 (10) 11.9 (43)
All Areas 15.1 (81) 24.8 (66) 9.1 (52) 24.8 (52) 18.4 (251)
Note: Figures within parentheses indicate the number of the converter households.
ANNEXURE TABLE IV
THREE MAJOR NON-AGRICULTURAL USES OF CROP LAND BY
POSSESSION/OWNERSHIP STATUS AND THE
RESIDENCE OF HOUSEHOLDS
Residence Self-ownership Sold Acquired, Donation & Others
1st 2nd 3rd 1st 2nd 3rd 1st 2nd 3rd
Metro Housing Business Education Housing Factories Business Road Housing/ -
Village (87) (14) & Health/ (33) (13) (77) Construction Education
Factories/ (50) & Health
Brick Institutions
Fields (17)
(3)
Urban Housing Business/ Brick Housing Public - Housing/ - -
Village (67) Agr. Fields (44) Utilities Road
Industries (5) (11) Constn.
(10) (25)
Peri- Housing Business Brick Housing - - Road Edujcation -
urban (81) (15) Fields (14) Constn. & Health
Village (4) (89) Institution
(11)
Rural Housing Business Brick Housing Factories - Road - Business
Village (89) (11) Fields (27) (7) Constn. (14)
(3) (57)
All Housing Business Brick Housing Factories Business Road Education Business
Villages (78) (13) Fields (30) (7) (2) Constn. & Health (14)
(3) (57) Institution
(13)

Note: Non-reported areas excluded self-owned land amount to 1.98% of 12.28 acres, sold area
accounts for 58% of 19.98 acres; and acquired/donated shares 3% of 9.31 acres.
Figures in parentheses indicate percentage shares to uses.
Initial Trade Policy Focus of the High

Performing Asian Economies: A Critical
Assessment
MIA MAHMUDUR RAHIM *
It is generally agreed that national trade policies of Singapore, South

Korea, Taiwan and Hong Kong played an important role behind the
success of the High Performing Asian Economies (HPAEs). These
countries exercised different policies with different implementation
strategies at the initial stages of their economic success but resulted almost
the same success. Thus, on the one hand, they followed some different
ways following their specific needs and, on the other hand, maintained the
same underlying principles for their national trade policies. They were
although pragmatic in their economic policy focus, they did not adopt any
common model or blueprint policy rather their strategies were followed by
their specific strength, weakness and goals.
I. INTRODUCTION
There is a remarkable record of high and sustained economic growth from 1965
to 1990 in twenty three East Asian economies. In this area, most of the runaway
growth focuses on eight economies, sometimes collectively referred to as the “High
Performing Asian Economies” (or HPAEs). Japan, the “Four Tigers”, Hong Kong,
South South Korea, Singapore and Taiwan, and the three ‘Newly Industrialising
Economies’ (or ‘NIEs’) of Southeast Asia, Malaysia, Thailand and Indonesia
amongst twenty three economies of Asia achieved higher growth than any other
regions of the world (World Bank 1993).
The nature of HPAEs economic growth put HPAE countries together to
formulate a cluster, though their economies are remarkably diverse. Among these
countries some are the richest while some are the poorest developing countries in
the world; some are the most populous whereas some are the least; some are full of
natural resources where others are not (World Bank 1993). These countries are
also different in their infrastructural set up, environmental challenges and socio-
*
PhD Candidate, Macquaire Law School, Macquaire University, Australia.
political culture. These differences lead the background of East Asian countries’
economic success to a diverged success. Accordingly, different studies conclude
different reasons for this economic success. Though these countries at the initial
stage of their economic success exercised different policies in different ways,
nevertheless these resulted in stories of tremendous success (World Bank 1993).
With these backdrops, this paper argues that “pragmatism” was the basis of
their diverse national trade policies. For the thematic construct of this paper, neither
any particular policy nor any particular issue in policies has been discussed. Rather,
the focus of this paper is on the nature of general trade policies that contributed to
the economic success of HPAEs at its initial stages. It attempts to establish the
above mentioned central argument by monitoring four parameters of pragmatism
the HPAEs adapted: pragmatism in trade policy priority setting; pragmatism in
policy orientation; pragmatism in trade policy focus; and pragmatism in policy
implementation strategies.
II. TRADE POLICY PRIORITY SETTING

HPAEs countries did not follow the copy book policies for their economic
progress. At the same time, they did not stick to any fixed ideology based policies.
Rather they frequently moderate/alter policies which seemed to be less productive
in its application. During 1965 to 1990 these countries shifted their policy stand
frequently. Simultaneously, they were not rigid to any particular policy and focused
more on the needs rather than the policy itself.
Geographically some countries of HPAEs are very small in size. Some other
countries though bigger in size, but per capita land are no less than some other small
countries. Prior to the beginning of their success, China and South Korea depended
on food aids. But all these countries had an adaptable plus disciplined labour force
(Leipziger 1993). They concentrated on these resources and created intensive
policies for its further development and ensuring its maximum use. In the early
1970s, except Thailand and Indonesia, all other HPAEs countries successfully
increased their rate of secondary education and expenditure on educational quality
and quantity. Using imported technologies for turning educated manpower to skilled
labour force and incentives to their expatriates to endeavour rapid productivity were
a unique prioritisation of their early policy framing.
In these countries noticeable changes can be seen in the cognitive skills of
school-levels that are today comparable to, and sometimes better than those of
developed countries. Their policy further tends to set up a sustainable skilled labour
market (Leipziger 1993). Therefore, they introduced minimum wage legislation,
Rahim: Initial Trade Policy Focus of the High Performing Asian Economies 89
public sector pay policy, multinational company labour policies, labour movement
policies and laws allowing trade unionism/collective bargaining. Thus they
completed the policy cycle in this regard. Their policies for upgrading educational
quality and quantity automatically generated rapid demographic transitions that
eventually build their base for economic success. The HPAEs rapid transition from
high to low birth and death rates in comparison to Europe and North America and
the rest of the developing world is a unique example concerning this. Initially, they
were also keen in population size. At the begining of their economic growth, they
were able to have a remarkably steep decline in population growth rate compared to
some other developing countries.
Rather than following the economic success in Europe and North America, they
set their policy objectives along with their weaknesses and necessities in economic
terms. They hardly went beyond their reality of that time. South Korea was divided
and was at the horn of cold-war environment; Taiwan was compelled to assert its
economic independence; Singapore as a small city state was attempting to reach
nationhood; and Hong Kong was just a market outpost of China. In full
consideration of these gruesome national vulnerabilities these states set their
policies for economic success (Riedel 1998). While at the same period some
developing states devoted to more military power and political shift towards
communism. Differences in prioritising policy focuses result differently: in these
days, North Korea, Bolivia and Pakistan are economically far behind of HPAE
countries.
During 1980 to 1990 HPAEs started transiting from agro based production to
international trade based industrial production. At this stage of economic growth,
other than Singapore, all countries of this region were trying to develop their
technical strength concerning their agro based production. Socio-political focus
therefore changed and shifted towards the want of technical knowhow and capital
investment. As they were developing their infrastructure, they were not in a position
to finance for their economic shifting from traditional agriculture based economy
towards export oriented industrial economy. The impact of these factors on
agriculture in these countries was twofold. First, agricultural output increased and
second, agricultural share in GDP declined (World Bank 1993). Both of these
impacts are pro industrialisation. However, (at the primary stage) till the middle of
their economic success agriculture’s share in the economies of the six HPAEs with
substantial agricultural sectors (Indonesia, Japan, South Korea, Malaysia, Thailand
and Taiwan (Chinese Taipei)) rapidly declined than other developing countries as
well as increased substantially in both agricultural output and productivity.
Different policy implementation for different countries accounted for these two
concurrent but opposite phenomenon, such as: land reform policies especially in
South Korea and Taiwan; adoptions of agricultural extension services, building of
better infrastructure: roads, bridges and transportation especially in former Japanese
colonies (South Korea and Taiwan); heavy investments in rural areas: roads,
bridges, transportation, electricity, water and sanitation (e.g. Indonesia); and low
levels of direct and indirect taxation in agricultural sector. HPAE countries did not
support all their industries at the beginning; rather, their policy was focused to
support selected industries or pick “winners”. In the 1980s Malaysia abandoned
their selective industrial policies; South Korea went back from their heavy and
chemical industrial drive in 1979-1980 and likewise Singapore did not proceed
further with their high wage policy from 1985.
Let us concentrate on the situations of Japan, South Korea and Taiwan now. In
the early post war period, Japan targeted five basic industries: steel, shipbuilding,
coal, power and fertiliser. In the 1950s, after some significant opposition, it marked
automobile industry as its target, while computers became the focus of attention
during the 1960s (Rapp 1975). While industrial targeting was scaled back in the
1970s and 1980s, the Japanese government continued to promote the development
of certain sectors (such as high definition TV and advanced computer technologies)
with varying degrees of success. In the late 1960s and early 1970s, the South
Korean government aimed for infant industries, typically by supporting the creation
of large-scale enterprises that were accorded as temporary monopolies. Notable
examples include cement, fertiliser, and petroleum refining in the early 1960s; steel
and petrochemicals in the late 1960s and early 1970s; and shipbuilding, other
chemicals, capital goods, and durable consumer items in the mid-to-late 1970s.
Taiwan and Singapore were frequent in their policy priority setting and new policy
inductions. For example, Taiwan started providing preferential loans, technological
help, and management support to certain “strategic” industries since the early
1980s, no sooner it had experienced its less competitive advantage in labour-
intensive manufacturing (Yang 1993). Like some other HPAEs, Taiwan did not try
to rebuild its labor market. Singapore at the beginning of its industrlisation
concentrated on “labour-intensive” industries as it needed to provide jobs to all it’s
citizen. At this stage, Singapore successfully served MNCs requirements. But the
important issue was that it shifted towards “high wages high skills policies” very
quickly to create a strong base for future economic stability. By 1972, Singapore
raised the wages and pushed the employees to train their workers and pay them
more. When the workers were getting more monies then Singapore channeled these
extra monies to Central Provident Fund (CPF) and Housing Development Board
(HDB). In this way, the money CPF gathered was invested successfully and HDB
assured homes for every citizen. Furthermore, from 1990 Singapore shifted its
policies from “skill intensive” labour force towards “knowledge based” manpower
(Simon 2006).
III. TRADE POLICY ORIENTATION

HPAEs did not follow any general criterions for its trade policies, rather it was
selective: each country prioritised its own necessity and therefore no resemblance
can be found in its choice(s). But the pattern of their policies, that is, the pragmatic
selection of industrial sector was common to all these countries. South Korea,
during 1961 to 1971, depended on the comprehensive use of public instrument for
its industrialisation. The South Korean government mostly patronised labour
intensive manufacturing such as heavy and chemical industries. The South Korean
government gave protection and incentives to these industries; the government even
carefully monitored the total infrastructure of these industries. 1 At that time while
India and Brazil were trying to boost their economy through importing, South Korea
was subsidising its ship building, petro chemical and metal industries with a view to
be the leader in international market(s) for these products. The most remarkable
thing of South Korea’s policy was that it measured its selective industrial policy
success through export performances and stopped providing subsidies no sooner had
those industries crossed the breaking points (Leipziger 1993). In fact, their policies
were based on socialised nature of risk bearing and tight governmental control on
the financial system, which led to its success in these selected industries. However,
South Korea changed its focus from heavy and chemical industries from 1979 and
liberalised governmental support to all growing industries. At this period South
Korea also loosened its governmental control on the financial sector.
The case of Singapore can be discussed in brief at this juncture. Singapore
framed its industrial policies according to its resources and ingredients needed to
achieve its goal(s). Singapore, at its early stage, rightly pointed out that it did not
have necessary capital and technologies and therefore planned to depend on
multinational companies. From the beginning, its policies were to build up a well
structured skilled manpower. Singapore’s First Five-Year Plan focused on technical
education, schooling infrastructure and birth control. The Employment Act 1967
degrades worker’s rights to facilitate foreign direct investment (FDI) (Leipziger
1993). To support it further, the multinational companies Industrial Relations Act
1968 pioneered three year collective bargaining agreements. In 1972 National Wage
1
UNCTAD, UNCTAD bolsters analysis of the economic model underpinning threats Asian miracle,
Press Release: TAD/INF/PR/9602 16/02/96
Council was set up to keep Singapore’s skilled manpower in right track by

providing adequate wages. But from the initial period till today, Singapore has been
maintaining its standard of measuring wage limit for industrial workers according to
its productivity and standard of living (Riedel 1998). At the end of its first phase of
economic success, Singapore settled its industrial policies towards higher
technology and higher value added industries. In the 1970s, it introduced high wage
policy as a shift from traditional labour intensive industries. It is worth mentioning
here that Singapore had a remarkable policy during the first recession of 1980: in
lieu of devaluating currency it cut wages. By doing so Singapore managed to keep
high FDI flow which also ensured a competitive edge in comparison with other
developing countries of that period. They changed their industrial development
strategies in a process of “finding niches, and sezing opportunities” (Simon 2006).
But at the same time Singapore was very practical regarding the opportunities too:
before establishing a zoo they built a bird park and the rationale was that the cost of
foods for the bird park is lesser than the cost of meat for the animals in the zoo
(Simon 2006).
Let’s move the focal point to Indonesia following the same line of argument.
Akin to South Korea, Indonesia also attempted to foster its industrial policy at the
beginning of the 1980s with a view to create its own dynamic comparative
advantage. It prepared an Industrial Policy List according to which industrial entry
was directly controlled; capacity limits set; local content requirements enforced and
foreign investment being greatly discouraged. Its policy was to build its own heavy
industries utilising own resources and thereby attempted to move into ‘upstream
activities’ and to produce more market values to its goods, commodities and
multifarious services. Although it subsidised credits and provided extra trade
protection to construct steel, plastic and petro chemicals industries according to its
plans, unfortunately, failed to accomplish its purpose. Indonesia did not liberalise its
policy for foreign capital and technology and did not build up efficient institutional
support like Singapore. The Indonesian case can be compared to South Korean
situation that adopted similar kind of strategy. Nevertheless, Indonesia changed its
traditional mind set of policy grafting and took non-pragmatic strategies from 1985
onwards (Raghavan). 2 By the year 1989 it reduced public shares in industrial
sectors from 43 per cent to 23 per cent and managed to get a handsome foreign
capital investment.
“Look East Policy” was the underlying principle of Malaysian industrial policy
at the initial stage (Leipziger and Vinod 1993). Resembling South Korea, it formed
2
Raghavan C, UNCTAD to formulate East Asia lessons for Africa, www.twnside.org.sg/index.htm
a public holding company naming Heavy Industries Corporation of Malaysia aiming

to upsurge all critical industries. Malaysia welcomed foreign investment and joint
ventures from the beginning. In its policies, however, Malaysia was quite selective.
Mitshubushi, a giant Japanese automobile company conjoining with Malaysia made
an automobile brand called Proton Saga. This automobile brand depended on huge
subsidies and in the long run could not succeed (Leipziger and Vinod 1993). One of the
root cause(s) of its failure can be assumed that Malaysia failed to incorporate the
notion of international competitiveness in its policy. Another strategic loophole of
Malaysia is that it did not concentrate on making a host of managerial strength
which Singapore did (at the very outset of their economic progress). Malaysia did
not carry out the publicly managed industrial policies and turned to privatise most
of its stooping industries by 1981.
It can be recalled that HPAEs did not follow the same policy for its economic
success at its initial stage; rather, policies were tailored according to its own
necessity and strengths. 3 But HPAEs had similarities in its policy orientation
behaviour. Comparing between the success of policies of South Korea and
Singapore on the one hand and the policies of Indonesia and Malaysia on the other
hand, firstly, it becomes evident that in South Korea and Singapore industrial
policies were in compliance to the international level of efficiency but the policies
of Indonesia and Malaysia were centered around the changes of ownership and
employment patterns. Secondly, while Singapore and South Korea evaluated their
policies through the overall macroeconomic success rate, Malaysia and Indonesia
judged the policies based on the performance of selected industries. Thirdly,
without much consideration of international market and competitors, Indonesia and
Malaysia devoted entirely on their local strengths. Finally, Indonesian and
Malaysian policies for industrial development at their initial stages were based on
expectations and desires, except for their domestic strengths. But one major point is
common for all these four countries: in terms of policy strategies they were not rigid
to any particular policy and shifted or adjusted with their policy strand as and when
required.
Taiwan historically proclaimed to own the economic infrastructure during
Japanese colonialism and entrepreneur talent from the main land China. On top of
it, Taiwan was further enhanced by a huge aid from Americans. Apart from these
lucrative backdrops, Taiwan’s economic success at the preliminary stage owes debt
to its domestic policies. One positive aspect of Taiwan cannot but be applauded:
3
UNCTAD, UNCTAD bolsters analysis of the economic model underpinning threats Asian miracle, Press
Release: TAD/INF/PR/9602 16/02/96
Taiwan was successful in its land management and comparative social distribution
of national wealth before its massive drive for economic success. Its trade policies
first focused on its imported items and gradually it put greater effort in export
driven economics during 1958 to 1972. To create a favourable environment for the
foreign investors, the government of Taiwan started providing more incentives and
for doing such Taiwan was able to offset anti-export bias. At the beginning of its
export oriented economic success it concentrated in labour oriented industries but
gradually shifted towards more self-reliant strategy with large investment(s) in
industrial infrastructure and import substitution. With this policy Taiwan controlled
its public enterprises and some of these are remarkably successful. While China
Steel Corporation enjoyed the benefit of this policy, many of Taiwanese industries
failed to compete in international market(s). Taiwan again shifted its industrial
policies since it marked that with these policies Taiwan had failed to raise effective
competitiveness and a strongly consistent international market (Rao 200). In 1980 it
switched to the policies that emphasised liberalisation of trade and export
development (Leipziger and Vinod 1993). With these pragmatic changes in
Taiwanese national trade policy focus it ensured a remarkable lift on the face of its
economic success.
Hong Kong, because of its previous orientation to appropriate trade policies got
an advantage among the HPAEs. Hong Kong started far ahead than its neighbouring
developing economies. From the beginning it patronised free economic policies for
export oriented heavy industries but it supported directly the domestic entrepreneurs
to make them able to catch up heavy industries by-products. Hong Kong’s policy
was liberal, it believed in “positive nonintervention” (Leipziger and Vinod 1993)
from the beginning. Therefore, Hong Kong necessarily shifted its policies as and
when required though it was much lesser than other HPAEs.
Initially, in Thailand’s trade policies there were some attempts for building its
domestic industries but these attempts were not as compact as South Korea and
Taiwan. Considering its experiences of domestic trade policy practices during 1960
to 1970, Thailand changed its policy focus and turned to free market economic
policies. Its main interest was to build capital intensive industrial promotion from
the beginning. Eastern Seaboard was the project which can be quoted to exemplify
success as well as failure. Like other HPAEs Thailand also did not keep complying
with its failures rather shaped its policies according to the need of its economy
observing the international competitiveness of market(s). Thailand was wise in not
experimenting with its policy decisions. For example, the costlier and inefficient
parts of Eastern Seaboard project were sharply cut short (Leipziger and Vinod
1993). During the 1970s, its policies were more focused on import substitution.
With this import centric industrialisation Thailand seemed to dwindle in balancing

its payment strength. As it happens to be the cases of most HPAEs, Thailand also
turned its policies towards export development and import liberalization. By the
1980s, Thailand reduced protections to its domestic industries and created Board of
Investment with a clear mandate of promoting FDI. At the later part of initial stage
of economic progress its industrial policies were the least related with public–
financed industrialisation; rather it was pro private infrastructure development.
IV. TRADE POLICY FOCUS

In many ways, the East Asian orientation towards international trade was
different from other developing countries. Ideologically, these countries complied
with the basic concepts of free economy while maintaining considerable barriers;
they prioritised the demands arisen from necessities to their context and likewise
shifted from the basic principles of liberal economy. They were keen in attracting
international investment(s) as well as protecting their domestic production.
While Hong Kong and Singapore achieved openness by ending all restrictions
on imports and giving free rein to the export sector, Japan, South Korea and
Taiwan, in contrast, maintained significant trade barriers during their early period of
rapid growth. But the most remarkable thing is that Singapore and Hong Kong
opened their economy after a long experiment on their domestic strength. South
Korea and Taiwan pulled off most of their restriction on international trade by the
1970. Japan lowered its tariffs in successive rounds of multilateral trade
negotiations under GATT, so that they were in line with those of other OECD
countries by the early 1970s. The decline in South Korea's and Taiwan's tariff rates
was more gradual than in Japan. South Korea's nominal tariff rate averaged nearly
40 per cent in the middle of 1960, 21 per cent at the beginning of the 1980s, and
around 12 per cent at the beginning of the 1990s. The corresponding levels for
Taiwan were 35 per cent, 31 per cent and 10 per cent (Chen and Hou 1993).
Significant nontariff barriers were maintained as well, although they too were
reduced later. For example, in South Korea, 40 per cent of import items were either
prohibited or restricted in 1973. By 1981, this ratio had fallen, but to a still high 25
per cent. Further declines in the 1980s lowered the ratio to 3 per cent by 1991 (Nam
1995). In Taiwan, commodities that were subject to varying kinds of import
restrictions fell from about half of all importable in the middle of the 1960s to less
than 3 per cent by the early 1980s (Nam 1995). Moreover, these measures were
generally implemented uniformly across sectors and applied to all potential
exporters without any discrimination. Thus policymakers in these countries appear
to have been committed to increase exports generally, with less regard for the
specific commodity exported at the initial stage. The net outcome of this mix of
policies was that the effective tariff protection rates in a number of manufacturing
sectors–reflecting the incentive for firms to target domestic rather than international
markets–were “moderate” and at times negative. Thus East Asian policies tended to
favour close integration with world markets. This was ultimately reflected in their
trade and growth performance. Following this underlying principle of HPAE
countries, all East Asian exporters had fairly uniform incentives for exporting across
virtually all industries and activities, with varying degrees of import barriers and
this was an utmost necessity for them while venturing for their initial international
trade. At the initial stages, all HPAE countries considerably tried to subsidise their
domestic industries that were against the neoclassical trade policies. These were
intended to offset the incentives created by existing tariff and nontariff import
barriers to produce for protected industries in the domestic markets. 4 Malaysia, at
the beginning of its domestic industrial development, started growing palm oil with
direct assistance of its government: now the largest palm oil producer. Pohang Steel
Complex in South Korea was built by the government and still is a public property.
These direct incentives did not harm their international trades because the policies
of HPAE countries ensured that import protections were not laden with anti export
bias. Malaysian government encouraged and supported many multinationals to build
electronics producing plant and because of their active and quite non biased policies
Malaysia is now one of the biggest exporters of semiconductors. In fact, these
countries did not carry out incentive programs for long- rather gradually changed
their incentive policies in line with the international trade. For example, the explicit
export subsidy related policies in South Korea were important in offsetting trade
barriers only up to the middle of 1960 (Nam 1995).
Free entry of imports which provides inputs to the export sector appears to have
sufficed to open the import sector significantly in spite of trade barriers. As the
export sector diversified, the range of goods imported also increased, accounting for
some of the tendency towards trade liberalisation cited above. For example, in
South Korea, the number of automatically approved import items increased from
800 in the late 1960s to 5,600 in the early 1980s and nearly 10,000 in the early
1990s ( Glick and Moreno 1997). This partially reflected the impact of exemptions
for goods directed to the export sector. In addition, as the export sector boomed, so
did the volume of imported inputs. This may explain why import/GDP ratios in East
Asian economies increased to much higher levels than in Latin America, even in the
4
UNCTAD, UNCTAD bolsters analysis of the economic model underpinning threats Asian miracle,
Press Release: TAD/INF/PR/9602 16/02/96
more protected South Korean and Taiwanese economies. The main effect of trade
restrictions may have been to bias the composition of imports towards intermediate
goods rather than the final goods. However, almost all HPAE countries’ policies
regarding subsidies to their domestic industries were nearly the same in pattern and
they all shifted from this subsidy based industrialisation since they realised that
credit subsidies could not create any overall profits from international market.
V. IMPLEMENTATION STRATEGIES
Theoretically policy framing process should include all stakeholders. Every
stage of actors and beneficiaries need to be participating in this process. But in most
of the developing countries this process is not followed and, in contrast to the
theoretical policy making process, bureaucracies underplay the most significant role
in this process. It is a common phenomenon in most of the Asian countries that it
can either facilitate policy reform or prevent this process. But from the early stages
of HPAEs economic progress bureaucrats and technocrats became involved in the
makeup of the part of political mandate for reform. They were not at the driver’s
seat rather worked hand in hand with the politicians. In Singapore bureaucrats were
the part and parcel of any policy implementation. Where the “Second Industrial
Restructuring” and “The Next Lap” were political innovation, bureaucrats mostly
contributes in creation of policies for creating “Hub” culture in Singapore for this
region (Wong 2001). They were focused toward the actual data that speaks the
reality. Mr. Ngaim Tong Dow, a retire Permanent Secretary of Singaporean
government, in one of his interview mentioned that the founding Finance and
Planning Minister Dr. Goh Keng Swee was used to prepare and change his budget
policies according to related data and he never went beyond the scope of it, rather
changed his desires following the data. Like some other nations Singapore did not
planned any policy that are beyond its reach. Singapore was successful in keeping
economic policies from the political whim (Simon 2006). In Malaysia and Indonesia
technocrats were allowed substantial freedom in economic management programs.
In South Korea, President Park built a remarkable group with the technocrats and
they were entrusted in all policy level activities for implementing his vision of
South Korean development. Though these examples do not mark any finality for
economic success but this bureaucratic integration with the public policies helped
HPAEs to keep budget deficits within the limits of macroeconomic stability (even
though the actual budget deficits varied considerably). Singapore consistently
avoided fiscal deficits while Indonesia enacted a balanced budget law that generated
budget surpluses in the early 1990s. Malaysia's fiscal deficit peaked at 18 per cent
of GDP in 1982 and Thailand's public deficit averaged 5.8 per cent between 1980
and 1988. In this regard it is significant that many developing countries scores of
policies ended in dreadfully poor result though they had efficient bureaucracy and
visionary leadership(s). To implement their trade policies political leaders of these
countries rightly traced out that there should be a peaceful society and for a peaceful
society it is necessary to have an equal distribution of income among the citizen.
Industrial policy appeared to be most successful when governments tried to
“encourage” rather than “pick” individual winners to compete in world markets;
with the marketplace being the ultimate arbiter of whether continued support of an
industry was warranted. For example, even when East Asian governments did
support infant industries (World Bank 1994), it was always expected that these
industries would emerge as competitive exporters (Chang 2001). Indeed, the signal
to the South Korean government that the heavy and chemical industry drive was not
achieving its intended results signified that the new industries could not, with few
exceptions, export profitably. Thus, there were few activities within the domestic
economy for which producers could anticipate continued shelter from international
competitive pressures. In this sense, the ability to export competitively became the
‘market test’ that was used by the authorities. The expectation that firms should
eventually export provided a clear discipline for both the businessmen and
government officials.
Again, since the late 1960s the Singaporean government has been investing in
state-owned enterprises and providing incentives attracting private investors into
certain key sectors, although without an explicit effort to pick individual “winners”.
From the middle of the 1970s until the middle of 1980, Singapore also attempted to
steer production towards more skill-intensive industries by raising wages through
administrative guidance.
Through this policy implementation these countries were gradually successful
in maintaining a stable social coherence. This stability played an important role
behind the smooth functioning of the key variables of economic success at the
initial stages of HPAEs even till today. HPAEs maintained low inflation rates for
extended periods of time--a remarkable achievement, given that 1980-93 was a
difficult period for other developing economies (Western 2000). In these countries
equality of income was more than a change brought about by policy than an
inheritance. Most of the low and middle income countries were not able to achieve
similar equality of income or assets (World Bank 1993).
To sustain export drives, HPAE countries also focused on implementing a
strong culture of entrepreneurship. The traditional culture of trade had to be
changed rapidly to cope to counter the western trade partners. Singapore and South
Korea totally changed their trade management culture at the very beginning. This
positive and adaptive bent of mind in changing and restructuring policies facilitated
them to maximise their trade gains. In Singapore, state owned corporations behaved
commercially and trailed the principle of competition (Leipziger and Vinod 1993).
Other Singaporean companies tracked back the national companies. In South Korea,
these shifting activities were huge. They had to create a new set of culture for
domestic entrepreneurship. Local business firms were encouraged to follow
Japanese trading companies and local firms were compensated for this new
entrepreneurship. In this regard HPAE countries followed each other and pulled
alongside with international standard quickly. For the initial stage this shifting was
compulsory. However, this policy implementation helped these countries to build up
a stable domestic savings. This saving culture ultimately helped domestic
entrepreneurs to tie up with foreign capitals for joint ventures at the initial stage of
their economic success. In this region, public investment and the share of private
investment in public investment are higher than elsewhere in the developing world.
Nowadays domestic savings and investments in the HPAEs are significantly higher
than in other economies: they averaged about 35 per cent of GDP, compared to 15
per cent in Sub-Saharan Africa, 19 per cent in Latin-America/Caribbean and 20 per
cent in developed economies (World Bank 1993).
In the beginning all HPAE countries were more eager to accumulate further
foreign capital till their growth engine sparked. They created, rejected and shifted
their policies frequently to attract foreign investments and their sustainable use.
Other developing countries did in the same way but could not succeed to raise
domestic savings in the way HPAE countries did. Therefore, right after the spark in
their economic success, HPAE countries became capable of using their savings to
continue the progress without incurring any foreign liabilities. These countries were
committed all along in their policies and policy implementations to become players
of the global scenario. For example, in 1972, to face the sharp increase of oil prices,
like most of other countries, Singapore did not flinch. Since it does not have any
mineral oil resources, it decided that “Singaporeans would have to shallow the
medicine in one gulp since the inflation rate was well over 20 per cent (Simon
2006). Due to the rising demand in Asia and volatile situation in the Middle East,
oil prices have increased drastically in 2004-05. This has affected the national
budget of many countries. Indonesia oil subsidies amounted to 2.5 per cent of their
GDP. 5 However, Singapore was not affected in this way and never looked back
since.
5
http//news.bbc.co.uk/2/hi/Asia-pacific/4307433.stm (16.01.2008)
VI. CONCLUSION
It is evident that along with the other factors, pragmatic national trade policies
contributed a lot to the HPAE countries. The basic as well as common notions into
their national economic policies were (Lauridsen 1995):
• Proper navigation of the trade policy focus
• Flexibility into the trade policy dimension
• Coherence in related factors and policies
• Competitiveness in policy attitude.
This paper examines the nature and role of general national trade policies of the
HPAEs at their initial stages of economic success with the fundamental argument
that the policies adopted by HPAE countries were essentially pragmatic in nature.
They did not adopt any greater outward policy implementation strategy by
following any common model or blueprint; in other words, no theoretical approach
can fully be accounted for the HPAE countries economic success (Lauridsen 1995).
But each of the HPAE countries successfully maintained macroeconomic stability
through their own mastered economic policies. Pragmatic norms in trade policies
during the initial stages of HPAE countries now have an enormous appeal to a
number of newly emerging economies.
REFERENCES
Chang, H-J.2001. “Rethinking East Asian industrial Policy- Past Records and Future
Prospects.” In P. H Wong and Chee-Yuen NG (eds.), Industrial Policy, Innovation &
Economic Growth: The Experience of Japan and the Asian NIEs. Singapore:
Singapore University Press.
Chen, Tain-Jy and Chi-ming Hou. 1993. “The Political Economy of Trade Protection in the
Republic of China on Taiwan.” In Takatoshi Ito and Anne Krueger (eds.), Trade and
Protectionism. Chicago: The University of Chicago Press.
Leipziger Danny M. and Thomas Vinod.1993. Lessons of East Asia-An overview of Country
Experience. Washington D.C: World Bank.
Nam, Chong-Hyun. 1995. “The Role of Trade and Exchange Rate Policy in South Korea's
Growth.” In Takatoshi Ito and Anne Krueger (ed.), Growth Theories in Light of the
East Asian Experience. Chicago: The University of Chicago Press.
Raghavan, C. UNCTAD to formulate East Asia lessons for Africa.
www.twnside.org.sg/index.htm
Rao. Bhanoji. 200.East Asian Economies: The Miracle, a Crisis and the Future. McGraw-
Hill,Singapore, , p61
Rapp, William. 1975. “Japan's Industrial Policy.” In Isaiah Frank (ed.), The Japanese
Economy in International Perspective. Baltimore: The Johns Hopkins University
Press.
Reuven, Glick and Ramon Moreno.1997. “The East Asian miracle: growth because of
government intervention and protectionism or in spite of it?” Business Economics,
http://findarticles.com/p/articles (15/11/08)
Riedel, J. 1998. “Economic Development in East Asia: Doing What Comes Naturally?” In
Hughes, H.(ed.) Achieving Industrialization in East Asia. Cambridge:Cambridge
University Press.
Simon S.C.Tay (ed).2006. A Mandarin and the making of Public Policy :Reflections by
Ngiam Tong Dow. Singapore: NUS Press.
UNCTAD. UNCTAD bolsters analysis of the economic model underpinning threats Asian
miracle. Press Release: TAD/INF/PR/9602 16/02/96
Western Devid L. 2000. East Asia : Growth , Crisis and Recovery. World Scientific,
Singapore
Wong.P-K. 2001. “The Role of the State in Singapore’s Industrial Development.” In Wong
P. H and Chee-Yuen NG (eds.), Industrial Policy, Innovation & Economic Growth:
The Experience of Japan and the Asian NIEs, Singapore: Singapore University Press.
World Bank. 1993. The East Asian Miracle: Economic Growth and Public Policy. New
York: Oxford University Press.
––––––––1994.East Asians Trade and Investment : Regional and Global Gains from
Liberalization, Washington D.C:The World Bank
Yang, Ya-Hwei. 1993. “Government Policy and Strategic Industries in Taiwan.” In
Takatoshi Ito and Anne Krueger (eds.) Trade and Protectionism. Chicago: The
University of Chicago Press.
http//news.bbc.co.uk/2/hi/Asia-pacific/4307433.stm (16.01.2008)
Book Review
The Bengal Delta: Ecology, State and Social

Change, 1840-1943
By Iftekhar Iqbal, Palgrave Macmillan, UK, 2010, pp.268+xx
Agriculture which followed gathering and hunting, and pastoralism in the

evolution of human society was possible due to the observation that seeds of grain
or fruits falling on to the soil germinate upon natural watering by rainfall and later
provide the bounty that sustained much larger population than had been possible
before. It was also observed that not all plants grow everywhere or under all natural
conditions. That gave rise to screening of crops by season and ecological conditions.
That agriculture is determined by ecological factors has thus been known for
millennia.
Agriculture, however, had another great role to play in the history of mankind
and does so even now. Managed agriculture gave rise, for the first time, to the
abundance of food and other agricultural products over the amount necessary to
feed all and for processing for other uses. While we do not want to go into the
details of how states arose and how the peasants and the State sometime mediated
by other groups (landlords, zemindars or aristocrats), some time not were linked
with each other for appropriation of the surplus by the kings, emperors, khans and
mandarins of all sorts, the fact remains that these were the core functions of the
State to maintain its authority whether within its boundaries or trying to extending
that without. And naturally as land was the crucible upon which agriculture had
been practised, it was around land that these superstructures were built.
Dr. Iftekhar Iqbal in his book, The Bengal Delta: Ecology State and Social
Change, 1840-1943, argues that the ecology of Bengal delta determined in an
intricate manner the relationships among the British colonial State, the intermediary
groups of zemindars under permanently settled and not so settled areas in the
Bengal delta and the peasants sub-divided into various groups based on their
revenue obligations to the State or other such groups. These interactions led to
various social and economic changes during the colonial period in this part of the
world. One of the first points that the author makes is that despite ecology (he has
used ecology and environment interchangeably) being a core factor in determining

the practice of agriculture and consequently the surplus siphoned off by the State
through various revenue administrative mechanisms, there had been little analysis
of these linkages so far in the historiography of this period. The author has
discussed several issues related to his notion of ecology including the roes of
railways and water hyacinths. In my review, however, I shall concentrate only on
the first few chapters, particularly the author’s treatment of the ecology-peasant-
linkages.
I have immensely enjoyed reading the book, although it must be said that not all
my hopes have been fulfilled. These I will come to shortly. The author has tried to
bring in issues of the river system in the then Bengal, as the giver and sustainer of
life and livelihood in Bengal delta, how wastelands (fallow or forested) have been
settled and revenues determined, how railways and hyacinths interacted adversely
with these river and water flows and thus disrupted severely the “normal”
agriculture. In course of this, he has brought in a somewhat detailed discussion of
the so called the Dufferin report (officially titled, “Report on the Condition of the
Lower Classes of Population in Bengal, 1888”). This has particularly been enjoyed
because it gives a peep into the economic conditions of people in rural Bangladesh
exactly 123 years before now, although many would think the narration to be rather
much more positive than possibly it had been, in several parts of Bangladesh in
Rajshahi and Chittagong and Dhaka Divisions. Let me digress here a little Given
that we are now debating again the role of population growth and the acute scarcity
of land for cultivation and the unrelenting transfer of land from farming to non-
farming purposes as well as how well-being of the people in general still leave
much to be desired, the Dufferin report may be examined thoroughly to understand
properly the changes that have come about in the society. The particular, when I
look at the Report, I find the reporting from various districts to be of varying
content and quality, some much more explicit and detailed than others. But there is
a way perhaps to get an aggregate picture of several indicators of well-being and see
if the claims made by the collectors and settlement officers were really that much
positive. After all, do not forget the writing of Bankim Chandra Chatterjee who was
a Deputy Magistrate in several districts in Bengal, as to how statistics get
“corrected” at several levels from the Chowkidar (village police) upwards to the
Collector Sahib and thus bears little resemblance to what is on the ground. One can
not vouch that this has not happened in case of the Dufferin Report. I exhort my
economist friends to get hold of the report (one copy is available at the BIDS
library) and see the information from the present day Bangladesh be aggregated
somehow and also analysed to see if whatever ecological information are available
Asaduzzaman: Book Review 105
can be used to supplement or refute the author’s analysis. In this regard two other
reports may become important, one is the Statistical Account of Bengal by Hunter
(in 1870’s) and the other is the Plot to Plot Enumeration Survey by Ishaque in
1940’s (both are in BIDS library, the latter is also partly available on-line).
Coming back now to the basic thesis of the author, I have no problem in
principle with the notion that ecology had been the determinant of the rhythm of
agriculture, its bounties and consequently the surplus generated and distributed
during the period of 100 years under consideration. I am, however, dismayed at the
manner in which the author has treated ecology. Nowhere has he clearly explained
what ecology is to him in the particular context. He has castigated others for
equating ecology with forests without giving much thought to other agriculture
related aspects of ecology. Yet, he himself has given much effort at narrating how
the Sundarbans has been claimed for cultivation to the extent that he has chosen as
the cover of the book a drawing of a village home and surroundings in a clearing of
the Sundarbans.
The author’s discussion indicates clearly that the river system of Bengal is a
major element of the ecology. That is true. But is that all? Agro-ecology includes
the intricate intermingling of the water system (here from rivers, but what about
rainfall?), the soil characteristics again partly defined by the river system but not all
(as part is determined geologically as in the khior areas of Barind tract), the natural
vegetation, partly forests, but also others as well as the cropping patterns practised
and of course all kinds of animal, insects and microscopic life that interact with
them. Regarding health of people, he has referred to their lassitude during summer
but not thought about how a hot and humid condition can as well give rise to insects
and pest and pestilence as well and create havoc with crops. What did the peasants
do then at such times of partial or total crop failure? How did they pay the land
revenue, by under-raiyats to raiyats, raiyats to the zemindar and finally by the
zemindar to the State? The author is silent on that although he has discussed at
length the apparent tilt of the State more in favour of the peasants than the
zemindars who were created by the British under the Permanent Settlement (PS) as
the popular image goes as a group of ardent supporters of the colonial government.
Given the limitation of his own concept of ecology, the author has from time to
time mentioned it as a major factor in the agricultural system but not stated clearly
as to how the rhythm of agriculture been influenced by this physical aspect of
ecology which then leads to the surplus from output from land on which the
peasant, the State and the zemindar all make a claim. But was the surplus itself or
the revenue mechanism influenced directly and if so how by this ecology? Although
not so explicitly asked, sometime, it seems that the author has asked this question
but apart from the assertion, he has not shown any direct link.
The PS rules applied to the land under cultivation at a specific date and later on
as those lands remaining outside the purview of the Settlement at that time were
reclaimed for cultivation those still remained outside the Settlement so much so that
at points in time the land under PS was smaller in aggregate size than the not-
permanently settled land. The author gives the impression that this was the effect of
the ecology. Was it so, or was it due to the rules under the PS? Did the PS
specifically applied to certain ecological jurisdiction and not others by design? If so
what was that? It was purely for the reason that the surplus and consequently
revenue from cultivate land was far greater and sustainable than that from the so
called wasteland. The link between the provisions of the PS and the ecology was
tenuous at best.
The section titled “The reclamation process and the rise of the occupancy
raiyats” must be read by those who want to acquaint themselves with the process of
land grant after reclamation of wasteland and fixation of revenue. This is a highly
interesting section. But alas! The narration gives one little understanding of the
relationship of the reclamation and settlement process with the particular ecology
espoused by the author. For example, much has been made of the rights of the
abadkar (who actually cleared and made the land cultivable) which was as stated by
the author zealously guarded by the colonial State against the wishes of the
zemindars wanted their (abadkars) rights to be held as they (zemindars) pleased.
This is as good as claimed. But did it have to do with the ecology? Did it mean that
there was actually shortage of labour to do such clearing or reclamation of heavily
forested or dynamically unstable chars and diaras in the rivers and that unless the
rights of the abadkars who became occupancy raiyats were safeguarded they would
not be interested to do such reclamation. In that case the particular forest or river
ecology indirectly had something to do with the post-reclamation rights. But this
issue was not pursued although at one point the internal migration of labour from
economically backward regions to where wasteland abounded has been mentioned.
But this statement seems odd, the author perhaps wanted to say of migration from
land scarce to land abundant areas. and thus we have no way of understanding why
the ecology will be a major determining factor behind the reclamation process, the
rights of the abadkar or the State’s insistence of written rights.
And these issues had been followed up by the so-called political ecology of the
faraizi movement started by Haji Shariatullah and spread and strengthened further
by his son Dudu Miyan and grandson Noa Miyan. The description here lays bare
how the zemindars and indigo planters actually fleeced the peasants against which
Asaduzzaman: Book Review 107
the faraizis rose up. The story of peasants’ economic well-being described rather
uncritically earlier thus appears to be a chimera. The oppressive conditions that PS
imposed upon the Bengal peasantry has been observed in no uncertain words by
others, for example, Badruddin Umar in his Chirosthayee Bandobasto O Banglar
Krishak (Permanent Settlement and the Bengal Peasantry). But aside from this how
did these really relate to the ecology apart from what has been observed before or
that Bengal delta had been rather suitable for indigo plantation? That the agro-
ecology had been suitable for indigo plantation had nothing to do with the
oppression of the peasantry, it was the colonial exploitation, pure and simple, which
had. Blaming Nature when the man made rules decide how nature is to be used is an
unhelpful analytical method at best.
A full hundred years is under review here and certainly a lot has changed within
this period in terms of economic, social, political, technological and ecological.
True the author later brings in two aspects of change both possibly influencing the
ecology and consequently the sustained surplus generation from agriculture, viz.,
the spread of railways obstructing in many cases natural flows of water over land
and thus causing water-logging in many areas and disrupting the previous normal
ecology, and the spread of water hyacinth choking the water bodies and fields of
crops. While these two are treated separately (although I do not go into their
reviews here), Chapters 2-4 goes back and forth in time (and not even mentioning as
to what time period is being referred to leaving the reader to make his/her guess) as
if the whole period had been a static one. This I think is doing a disservice to the
analysis of social and economic history of the Bengal peasants.
The book apparently has a limited success in linking ecology to socio-legal,
economic and administrative organisation of cultivation, surplus generation and the
tensions among the various social classes and between them and the colonial State
in appropriating that surplus. Yet, this remains a good read for those who wants to
know about how the rural society was organised in certain respects during the 100
years or so prior to independence from the British. The other commendable point
here is the extensive bibliography that has been provided. Stout hearted readers may
read those and make their own conclusions, if they so desire.
M. Asaduzzaman
Research Director
Bangladesh Institute of Development Studies

The Impact of 1998 and 2008 Financial CR

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

The Impact of 1998 and 2008 Financial CR

Uploaded by

Copyright:

Available Formats

BANGLADESH UNNAYAN GOBESHONA PROTISHTHAN

(BANGLADESH INSTITUTE OF DEVELOPMENT STUDIES)

Manuscript in duplicate and editorial correspondence should be addressed to the

Annual Subscriptions (Four issues per year):

Volume XXXIV March 2011 No. 1

1 Nor Hayati Bt Ahmad : The Impact of 1998 and 2008 Financial

23 Monzur Hossain : Asset Price Bubble and

39 Mohammad Amzad Hossain : Money-Income Causality in Bangladesh:

59 Md Abul Quasem : Conversion of Agricultural Land to

87 Mia Mahmudur Rahim : Initial Trade Policy Focus of the High

103 M Asaduzzaman : The Bengal Delta: Ecology, State and

International Editorial Advisory Board

Keith B Griffin J B Parkinson

Nurul Islam Just Faaland

A R Khan Kaushik Basu

Copyright BIDS, March 2011

The Impact of 1998 and 2008 Financial Crises

The paper investigates the profitability of 78 Islamic banks in 25 countries

II. REVIEW OF THE LITERATURE

The empirical studies on the performance of banking sectors have focused on

owned counterparts. The results suggest that macroeconomic conditions have no

The dependent variable is ROE;

NPL/TL is a measure of banks risk calculated as non performing loans divided

III.1 Performance Measure

III.2 Definition and the Choice of Variables

III.3 Internal Determinants

relationship between operating expenses ratio and profitability (Bourke 1989).

III.4 External Determinants

effects, which we expect to have a positive influence on bank profitability. As GDP

IV.1 The Islamic Banks’ Profitability Performance

V. CONCLUSIONS AND DIRECTIONS FOR FUTURE RESEARCH

to bank specific management as well as the policymakers with regard to attaining

Sl. Financial Institutions Country of Classification of countries

Sl. Financial Institutions Country of Classification of countries

Asset Price Bubble and Banks:

II. JAPANESE FINANCIAL SYSTEM: AN OVERVIEW

Mitsui 24 4 17.1 21.94 238,447 5.96 6.69

Literature review suggests that a policy shift toward a greater emphasis on

increasingly popular, as there is no transaction tax on CDs. The Tegata 2 market,

II.2 Financial Liberalisation

III. ASSET PRICE BUBBLE (1987-89) AND BANKS’ BEHAVIOUR

companies becoming bankrupt, and creditor companies having a huge burden of

Diagram 1: Transmission Channel of Shocks during Asset Price Bubble

Risky Intervention by MOF

Fall of business investment,

ROA(right scale) ROE(left scale)

Source: Authors’ estimation

IV. DATA AND METHODOLOGY

Figure 2: Different Indicators of the Economy during 1964-1998

M2+CD HPM NIKK225 LPI

Call Rate and Discount Rate Growth of WPI and CPI

CR DISC WPI CPI

Growth of GDP and GNP Per cent Change of Bank Lending

Source: Bank of Japan.

VI. CONCLUDING REMARKS

Money-Income Causality in Bangladesh: An

The causal relationship between money and income remains a contentious

II. REVIEW OF THE LITERATURE

II.2 Empirical Studies

II.3 The Bangladesh Perspective

III. DATA AND METHODOLOGY

Figure 1: Relationship between Monetary

III.2 The Analytical Framework