International

Adding More Fruits to the Basket

HOW IMPORTANT IS EXPORT DIVERSIFICATION?

Export earnings are the largest source of foreign exchange in Bangladesh and a critical driver of the economic growth. In Fiscal Year (FY) 2016, earnings from total exports amounted to $34 billion which is approximately 16% of the GDP of Bangladesh. If we take a look at the export basket of the country, we can perceive that over 96% of all exported goods are manufactured products. By examining the top five manufactured goods, it is observed that Bangladesh’s export basket is predominantly dependent on the RMG industry – contributing to 82% of total exports in FY 16. A high reliance on RMG makes the industry and hence, the economy, extremely vulnerable to external shocks. Moreover, domestic shortfalls and competition from rival countries also pose a serious threat to the growth and sustainability of the industry.

Figure: 1 ; Source: EPB

Many may think that low minimum wages in the RMG industry provide a competitive edge against other countries; however, it is vital to remember that the country has low productivity growth in the sector and low wages alone are not adequate to maintain the sustainability of the RMG sector. To reduce the dependency of the economy on the RMG sector, the process of ‘export diversification’ can help. This occurs when new products are introduced, or the share of other products are increased in the export basket. Export diversification can also be geographical – where products are exported to new emerging markets, hence increasing the overall export earnings of the country.
The RMG industry in Bangladesh has had tremendous growth since the 1980s as shown in Figure 1; with an export of a meager $0.7 million in FY 1980, the country has managed to increase it to $28 billion by the end of FY 2016. The industry employs 4 million workers out of which 80% are women. Currently, the Bangladeshi RMG sector has a comparative advantage in two areas, namely, high capacity and low wages. Bangladesh’s apparel industry has a total of 5,600 factories, putting it ahead of countries like Indonesia (2,450 factories), Vietnam (2,000 factories) and Cambodia (260 factories) in terms of capacity.

“TO REDUCE THE DEPENDENCY OF THE ECONOMY ON THE RMG SECTOR, THE PROCESS OF ‘EXPORT DIVERSIFICATION’ CAN HELP. THIS OCCURS WHEN NEW PRODUCTS ARE INTRODUCED, OR THE SHARE OF OTHER PRODUCTS ARE INCREASED IN THE EXPORT BASKET.”

The other factor – low wages, may not be a sustainable competitive aspect of the country’s RMG industry. The minimum wage in the industry increased in 2013 by 77% – from Tk. 3,000 ($37.5) to Tk. 5,300 ($66) a month. Although the minimum wage in Bangladesh remains lower than India, Pakistan, Indonesia, and Vietnam, the rise in wages lead to a change in the comparative advantage the country has against its competitors. Similarly, in the face of a wage hike, countries with relatively lower wages will pose as more of a threat for the domestic RMG industry. For instance, some nations in Africa such as Ethiopia has minimum wages which are as low as $23 a month. Moreover, African countries enjoy the benefit of zero duty to the United States under the African Growth and Opportunity Act whereas Bangladesh has to pay a tax of 15.6%. In 2013, Africa’s apparel export to the US was a fifth of that of Bangladesh’s so it may not be a surprise if Africa takes full advantage of their zero duty opportunity and surpasses Bangladesh’s position in apparel export to the US.

Figure: 2 Source: McKinsey Report

Higher productivity in the RMG industry can help to negate the effects of rising wages. However, productivity has increased slightly in the country’s RMG industry and needs urgent attention. Figure 2 shows the productivity of the Bangladeshi RMG industry and its competitors, compared to the productivity of China. India operates at a productivity that is 92% of that of China’s, and Bangladesh runs at 77%. This is lower than Pakistan by 10% points. Standard economic theory reveals that wages should be dependent on the productivity of labor, however, in Bangladesh, wage increases mainly took place after being pressurized by workers and the international community following tragic events such as the Rana Plaza collapse. A McKinsey report in 2011 advises that it is crucial for the industry to improve productivity not only to lessen the effects of rising wages but also to close the productivity gap that exists between Bangladesh and its competitors. This is vital in upholding the competitiveness of the industry against a spike in wages.

Figure 3: Export Diversification on the way Traditional Markets

Export diversification can help in this regard. New products can be introduced to the export basket, and the export of existing products can be increased as well. The example of leather and engineering industries can be taken; we can see that these industries have exhibited double digit annual average growth rates of 27% and 11%, respectively. An important thing to point out is that the protection system that currently exists in Bangladesh makes it easier to cater to the domestic market rather than exporting. An anti-export bias is present which allows suppliers to make more profit by selling their products locally rather than exporting. The RMG industry has been able to overcome this problem with the help of several methods such as back-to-back L/C for import finance and bonded warehouse system for inputs that are imported free of duty.

TOP 5 MANUFACTURED EXPORT GOODS IN BANGLADESH, FY16

Source: Export Promotion Bureau

Geographical diversification of exports can take place where products are shipped to new international markets. In the case of RMG exports, we can see that in FY 2009, 93% of Bangladeshi RMG exports went to the traditional markets – i.e. USA, EU and Canada. However, we can note that this pattern is changing as the proportion of RMG exports are increasing to the emerging economies. RMG exports in emerging economies have increased from 7% in FY 2009 to 15% in FY 2014. This is depicted in Figure 3. Cash incentives by the government have played a prominent role in encouraging geographical diversification of markets in the RMG industry. Cash incentives of 5%, 4%, and 2% were given in FY 2010, FY 2011 and FY 2012 for exporting to new destinations.

“A MCKINSEY REPORT IN 2011 ADVISES THAT IT IS CRUCIAL FOR THE INDUSTRY TO IMPROVE PRODUCTIVITY NOT ONLY TO LESSEN THE EFFECTS OF RISING WAGES BUT ALSO TO CLOSE THE PRODUCTIVITY GAP THAT EXISTS BETWEEN BANGLADESH AND ITS COMPETITORS.”

Some experts believe that the economy’s heavy dependency on the RMG industry may make it vulnerable to international shocks; however, shocks such as global financial crises are likely to have minimum effect on Bangladeshi RMG exports. To put this in context, let us take the case of the USA, which is Bangladesh’s largest export partner. The share of Bangladesh in USA’s total imports was about 0.2% in 2016, which depicts the vast size of the world market that Bangladesh can take the opportunity to sell its products to. However, international financial crises may reduce export earnings in the short-run as Bangladesh is a price-taker in the global market and such crises create pressure for reduction of the price of output. This can result in a decrease in export earnings, despite the total volume of garment export remaining unchanged. A developing country like Bangladesh will be affected by a fall in export earnings even in the short-run as economic growth of the country is largely dependent on exports. In such cases, diversification of markets can significantly help. The brunt of financial crises in the US or EU will be relatively less in the emerging markets than in those countries. Thus export earnings from emerging economies may not decline for Bangladesh.

PHOTO PROVIDED BY DBL

Bangladesh has the potential to engage in manufacturing labor-intensive products as it has a high endowment of labor. However, it is essential to address problems such as lack of infrastructure and energy, land acquisition; political stability is crucial as it gives a signal to international buyers of an uninterrupted flow of production and hence, reliability. As exports are one of the main drivers of growth, it is crucial to promote it and increase foreign earnings. Export diversification, both in terms of products and markets can help significantly in increasing overall exports and hence aid the country towards achieving high economic growth.

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