Originally posted in Dhaka Tribune on 15 December 2021
Prof Mustafizur Rahman, distinguished fellow at the Centre for Policy Dialogue (CPD), discusses how Bangladesh can avoid the middle income trap, on the 50th anniversary of the country’s independence
Bangladesh made the middle-income transition, from lower income country (LIC) to lower middle-income country (LMIC) status, in 2015 when the country crossed the World Bank threshold of GNI per capita of US$ 1025 (according to World Bank’s Atlas Method). At present (2021) the thresholds, which is a moving average, are as follows: LIC (less than $1045.0); LMIC ($1046-4095); UMIC ($4096-12695); HIC (greater than $12696). There is no denying that middle income graduation is a recognition of Bangladesh’s impressive track record in terms of consistent rise in the average per capita income over the past years. The middle income graduation will also hopefully generate dividends in the form of branding of the country, as also standing in terms of credit rating which in turn is expected to generate positive externalities through enhanced FDI and inward resource flows.
However, middle income graduation would mean that Bangladesh has now made a transition from beneficiary of grant and highly concessional loans to a blend country. Blend countries are eligible for a combination of concessional and non-concessional loans. In view of this, Bangladesh is no more exclusively eligible, for example, for the World Bank’s soft term loan facility, the loan provided through the World Bank’s IDA window, for which the terms are relatively flexible with an interest rate of about 0.75% per annum, maturity period of 30-40 years and grace period of 10 years. The interest rates for the newly negotiated loans, be it extended by the World Bank or other multilateral or bilateral development partners such as India and China are already going up. In a few years Bangladesh will be graduating to a non-blend country. This transition will be accelerated particularly also in view of the recent rebasing and reestimation of the country’s national accounts (whereby per capita GNI has increased from less than $2300 to $2554). Loans following this transition will be mostly non-concessional, and with more conditionalities and stringent terms.
It will be pertinent to note here that till now Bangladesh’s external sector debt and debt service payments (as percentage of foreign exchange earnings) have been quite impressive and manageable. As of now this is relatively low, equivalent to about 3% of the earnings from export of goods and services. Bangladesh’s total outstanding public sector foreign debt currently stands at $52.8 billion, which is about 14.9% of the GDP. The corresponding figure was 11.9% in FY2015 ($23.9 billion). This is a distinctive departure from many developing countries at similar levels of development. Nonetheless, in view of middle income graduation, debt servicing liability of Bangladesh is expected to go up significantly as was pointed out earlier. In the backdrop of Bangladesh’s growing developmental needs, including the rising demand for putting in place the required infrastructure and in connection with SDG implementation, the amount of borrowings will likely go up considerably over the coming years. Indeed, this amount is already on a notable rise. In FY 2021-22, the amount of gross aid is projected to be more than $10.3 billion, which is much higher compared to the $3.0 billion in FY2015 and $2.2 billion in 2010. Even compared to the actual aid figure of preceding FY2021 ($7.2 billion) the projected figure for FY2021-22 is about 43.0% higher. Thus, there is no doubt that with the rising interest rate and increasing foreign loans, the debt-servicing liabilities will also go up along with the outstanding public debt. From this perspective, one can not overemphasise the need to ensure good value for the aid money spent to ensure robust economic, financial and social returns on investment.
From the above vantage point, identifying the key drivers of sustainable middle income journey is of heightened importance for Bangladesh. Global experience bears out many instances of countries which, having made the transition from low income status, got stuck in a trap of slow economic GDP growth and slow growth of per capita income. To recall, the term “middle income trap” was first coined by Indernit Gill and Homi Kharas in 2007 for countries which escaped poverty but were yet to achieve prosperity. Many countries had fallen into the lower middle income trap having made the transition from LIC to LMIC, and upper middle income trap following the transition from LMIC to UMIC. Median number of years various countries have taken to graduate from LMIC to UMIC was 15 years and the median number of years countries took to advance from UMIC to HIC was 23 years. One can thus well appreciate how challenging it will be for Bangladesh to attain its developmental ambition as articulated in the Vision 2041 which puts the target of UMIC status by 2031 and developed country status by 2041.
In going forward Bangladesh will need to learn from cross-country experiences of middle income journey and why so many countries have fallen into the dreaded middle income trap and what needs to be done if Bangladesh is to avoid this.
Evidence suggests that consistently high economic growth rate is crucial to avoiding the middle income trap. This is evidenced by the experience of South Korea which was able to make two successful transitions from LMIC to UMIC and from UMIC to HIC over a relatively short period of time. On the contrary, Malaysia and Philippines have been stuck in the MIT for prolonged periods (28 years in UMIC and 34 years in LMIC respectively) because of the failure to generate high GDP and per capita income growth on a sustainable basis.
A survey of relevant literature shows that many economies, which at one point in time experienced rapid growth thanks to low-wage and low-skills based competitiveness, were not able to sustain the momentum when they transitioned to middle income status. Rising wages, when not accompanied by rise in productivity, led to loss of competitive edge. For Bangladesh the challenges will be compounded by significant preference erosion emanating from the LDC graduation in 2026. Higher investment in compliance assurance, both labour and environment, will put further pressure on the balance sheet of enterprises. Indeed, the aspiration of sustainable LDC graduation and sustainable middle income graduation should be seen as mutually reinforcing and synergistic.
It is pertinent to recall here that South Korea was able to increase its total factor productivity significantly and persistently in the course of its middle income journey. Labour productivity and physical capital and human capital endowment posted a consistent strengthening in this period. Experience shows that countries which made successful middle income journeys were able to stimulate domestic investment and attract a higher amount of FDI, these were able to build a broad-based supply-side capacity and diversified export and market base. These countries were able to sustain a competitive edge by moving from factor-driven competitiveness to technology and productivity driven competitiveness. East Asian economies such as South Korea pursued an active export-oriented strategy by putting in place strategic trade and industrial policies, underpinned by a blending of skilled labour and technology and providing targeted support to entrepreneurs and enterprises. Investment in education, R&D and training was raised significantly. These countries developed regional value chains and established production networks by deepening regional cooperation and integration. To be true, South Korea and Taiwan pursued different strategies, the first giving emphasis on development of large industries and the latter on SMEs.
Rising inequality is also a hallmark of many of the countries experiencing the MIT. Literature shows that increasing inequality is not only not fair from a distributive justice perspective, but also could slow down future development. A fair and inclusive development process makes the middle income journey stronger.
Global experiences show that realising Bangladesh’s vision to transit from LIC to UMIC and subsequently to HIC, will hinge on building broad-based coalitions around a number of key drivers: (a) inclusive politics and the democratisation of political parties; (b) effective devolution of power; (c) promotion of reforms geared towards good governance and accountable, transparent administration; (d) greater space for civil society and citizens’ voices; (e) an empowered working class and enforceable trade union rights; (f) women’s empowerment; (g) greater mobilisation of domestic resources; (h) a productive private sector; (i) effective public-private partnerships; (j) development of skills and productive forces to cater to the needs of building supply-side capacities, moving up the value chain, by building production networks and through higher investment in technological upgrading and imparting of the skills required for the ‘new economy’ as against the ‘traditional economy’; and (k) strengthened regional and global integration of the economy.
Hopefully, policymakers will draw necessary lessons from global experiences informing the middle income journey so that Bangladesh is able to attain its ambition of transitioning to an inclusive and developed country by 2041 as articulated in the Bangladesh Vision 2041.
Professor Mustafizur Rahman, distinguished fellow, Centre for Policy Dialogue (CPD), Dhaka, Bangladesh