Dr. Zahid Hussain, Lead Economist, The World Bank, Bangladesh

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BOOSTING THE ECONOMY

*Dr. Zahid Hussain on fixing the economy, need for reforms in the banking sector and how to create more jobs

What according to you should be the priority of the new government when it comes to fixing the economy?
To set our priority list, it’s important to identify our objectives at first and decide how we can fulfill those with the help of existing resources and available options. I think the long-term goals-that Bangladesh has set itself, no matter who forms the next government-will not change. Nobody says that poverty reduction should not be our most important objective or priorities should not be given to achieve the sustainable development goals that we have committed to. Poverty reduction and addressing the causes behind the slowdown of poverty reduction in spite of growth is something that we should focus on in the future. One immediate reason is that inequality has increased, which is also one of the reasons why the process (of poverty reduction) has slowed down.
There has also been a decrease in job creation particularly in the manufacturing sector where more inclusive jobs were being created earlier. We need more job opportunities for the people who are uneducated and deprived. Addressing the reasons behind the jobs growth slowdown should be the immediate agenda.

Why do you think we are failing to create more jobs?
If you look at the sources of growth you get some idea about why job creation did not keep up with growth. You will find that on the demand side growth came mainly from the consumption expenditures both in private and public. On the supply side, growth came largely from domestic market-based manufacturing activities; exports did not do well enough. These manufacturing activities that serve the domestic market tend to be highly protected and are less labor intensive. This increase in manufacturing growth has actually come from increased utilization of existing capacity. That also explains why employment has not increased enough. When you utilize more the capacity that you have, there’s no need for hiring new labor as much as when the capacity itself is expanded.

If you look at the private investment to GDP ratio, you’ll see that it’s stagnant and that tells you that production capacity creation is not increasing. In various projects, Government’s investment has increased. Recorded public investment has increased. But those are not directly related to production activities. There are also questions asked about the recorded data and what is happening when it comes to public expenditure. What we record is how much we spend, but we don’t take into account whether it has been spent well enough to create public assets. Like constructing roads and bridges and so on. The bottom line is investment in factories and firms has not been taking place enough to absorb that growing labor force.

The other thing you notice from our national account’s data is that export diversification hasn’t done well enough. Exports are very over-reliant on garments. We want to reduce poverty and create good jobs. We need to address the bottlenecks to private investment and export diversification and why we don’t have an alternative to garments yet even after 20 years. Its not like we do not have knowledge about diversification and investment. It is not like we have not undertaken effort, but somehow, we are not able to complete the initiatives. Implementation is slow and even when it takes place, it is inefficient. Let’s identify a few specifics. When it comes to investment, one of the bottlenecks we have is acquisition of land. Land is difficult to find but even when you find one it is a very complicated transaction: land markets do not function well. It is not just the scarcity of land; it is also the complex dynamics of the transaction: you don’t know what you are buying. The ownership is always at risk because there are cases where there are “multiple owners” of one land. When you buy land, don’t be surprised if someone walks in after a month and sues you. This is the problem of land record management. Then there is a problem of gas connection or electricity. There is a problem of infrastructure which would connect you from the point where you want to produce to the point where you have to sell. Even when your selling destinations are local, you are still dependent on a well- functioning port for importing machinery and raw materials.

How to solve these problems? Should the lead come from our private sector?
Lack of Infrastructure and mismanagement of the existing ones are hugely affecting our local manufacturing base. Private sectors can help but the initiative must come from the public sector. One of the solutions to the problem could be working on the functioning of land market and making it better. It would require fixing land records, the legal framework and the court system. This is not going to happen in a short time. At the same time, you have to make sure that the energy supply is adequate. One initiative that we have taken correctly is the establishment of special economic zones. We have a target of 100 and we have approved over 30 of them. A few small ones have started operation under private ownership. However, we have not finished the big ones yet, the ones that would make a visible difference to the investment scenarios. We must speed up the process of implementation. We have to establish models for the investors to gain the confidence that we can deliver. Anybody can come in. You just build your factory, plug it in, and play. We have dedicated zones for garments. We have dedicated zones for certain investors. On export diversification, you have trade policy distortions. Those must be removed, even if the process is gradual.

As far as employment is concerned, all the factors above will create demand for labor, but not necessarily domestic labor. Many of the industries in the service sectors are dependent on imported labor, because domestic labor does not have the skill required to work for those industries. Creating opportunity for labor does not necessarily mean that it will benefit the domestic labor. You also have to focus on the supply side. The amount of people looking for jobs surpasses the amount of work available. There also seems to be a huge mismatch in demand and supply.

About the bureaucracy, do you think we need some reforms in that sector? Or do you think that it’s their mindset that is holding them back from delivering service efficiently?
Ideally, civil service reform is something that we have been talking about for quite sometime. We have had public administrations reform commissions several times, 12 years ago being the most recent one. Reforming civil service is something that is quite a tough nut to crack. One of the long-standing assumptions about the poor performance of the civil servants is that there is no motivation to provide service or do things, mainly because they are ill-paid. When I joined the World Bank, and when I researched on why the public expenditure is so poor, I found out that one of the reasons was the fact that the people who were given the responsibility to spend were not being paid enough themselves, leading to lack of motivation. That’s where the corruption comes from. They try to supplement their income instead of showing up to work and doing their jobs. However, in the past 4 years, we have increased wages in the public sector. There has also been an increase in subsidized loans for buying cars, apartments and educational purposes. That problem has been addressed in a big way. We have the lowest tax to GDP ratio, which means that our government is not as well off, yet we managed to double civil servants’ salaries, allowances and increased their benefits. We were ideally planning to reform them. We also had other initiatives. Three years ago, the cabinet division introduced an annual performance agreement system where every ministry sign for the coming year with the Cabinet Division. They are actually making a commitment to the prime minister on performance indicators for the forthcoming year. There have been initiatives, but they are never linked with the incentives. The solution for this could only be to reduce dependence on public administration as much as possible. Liberalization, removing unnecessary control on private market activity seems to be the more practical approach to me. Politicians can do these things, because (they) are the lawmakers. If you take things away from them (civil servants), we don’t have to depend on them for implementation. I would say that I’m in favor of liberalization.

Do you think that politicization of the state is also fueling corruption?
Yes. Most of the governments have done that. It has also been increasing. If you look for reasons why the public administration is so inefficient, so slow and so insensitive to the needs of the economy, one reason of course is politicization. If the employees are loyal to the ones who call the shots from above, their performance at work will not matter. The job will be safe regardless. They may even get promotions and prized postings at home and/or abroad. The list goes on. However, I would not say that politicization is the only reason. There is also a problem with the mindset.

What do you think about the banking sector?
This is another sector that needs immediate attention. I was talking about the binding constraints on investments; land, energy, infrastructure. However, finance is also one of them, particularly medium to long-term finance. Our banking system was in crisis in the late 80s when non-performing loans constituted over 40% of the total loans being taken and banks were heavily state owned. We undertook some very serious reforms afterwards, specifically in the 90s. We allowed private sectors to operate banks, started being open to foreign investment, and then the banking system flourished. 75% of the deposits used to come from the state-owned banks. 80-85% of the credit used to come from the state-owned banks because there was no other alternative. Now state-owned banks are at most 1/4th of the financial system. We have only done very limited privatization, but yet the dependence on state owned financial institution has declined. Conventional banking does not work for everybody, especially for small micro enterprises. With new technology coming in, we have mobile banking services; bkash has been a very successful case. It’s not like we don’t have the entrepreneurship in the financial sector, which does not respond to new opportunities, yet in the conventional banking system, we have a problem of discipline, loan recovery, adequate capital, etc. As a result, we have high interest rates. Also, access to credit is a problem for many, even for the ones having a good project. If you’ve read the headlines of today’s newspaper, you’ll se that the rate of non-performing loans is over 11%, which means that it is at a recent all-time high now. There are many accounting games that we play to keep things from the people. The ones that have been recognized in the balance sheets, that itself has become more than one trillion. This needs to be addressed, even though it is a complicated problem.

What was the reason behind all this indiscipline in the banking sector?
At the end of the day, if you look at the scenario, you would see a nexus between the regulators, the big borrowers and the owners of the banks. The government depends on banks to provide money to people they like. politically connected people, specifically. Banks depend on the government to support them, to bail them out when they lose money because of excessive risk taking. They go for quick returns, which comes with high risk. If you get caught and are on the wrong side of that game, the risk materializes. The government does not always directly give them the money, but the bankrupt institutions are the ones who sometimes help the failing banks by purchasing bonds and injecting equity capital. The money that the bankrupt institutions get comes from the government. Moreover, there is a lot of rent seeking activities that are going on even in the private banks, where these things are not supposed to happen, since private banks have to survive on their own. If they are not responding to market forces, they would go bankrupt. This is because, if they give money to do favors for the people who cannot repay, at the end of the day, the banks will have losses and the owners will suffer. Despite that, bad loans keep happening. Moreover, there are incidents, which have had a game-changing impact, because of the way they have been handled. This kind of turning points initiates a cascade of mishaps. In economics, this term is known as path dependence. Things happen, and if it’s positive, you flourish. If it’s negative, you get stuck in a vicious cycle, so you reinforce the things that had occurred. Regardless, the others get encouragement out of this, thinking that if one of them can get away with it, they too are entitled to avail the same favor. It’s kind of a bad equilibrium that we have set. A correction needs to be made from the path that we follow.

What do you think the government could do immediately to come back on the track?
I think there are two sides to the problem. One is that we have to stop the bleeding by preventing any future crisis or scams. You have macro prudential regulations. You have to make sure that there is compliance to prudential regulation. To ensure that, you need supervision and monitoring to make sure that all the banks are complying. This is what needs to be addressed; prevention needs to work to stop the bleeding.

Addressing the underlying causes of bleeding should be the second one. Banking systems have a problem everywhere; even the best ones. Even the US financial system was in crisis, but there are resolution mechanisms to solve that problem. There is a lot of debate on whether it is a working mechanism because they allowed the Lehman brothers to collapse, but not AIG. In Western countries, when they say that you may be big to fail, it means that if they fail, it will be a systemic problem, having adverse effect on the economy. In our case too, state-owned banks are not allowed to fail because they are too important and some private banks who are not doing well are not allowed to fail because they are too well connected. They get what they want regardless. We need to f9ind a way of resolving it conclusively. Not by recapitalizing the banks that always have a shortage of capital every year. We have spent more than 17 to 18 thousand crores taka just for recapitalization alone in the past decade. They need to do certain things in order to get recapitalized. India has this reform-based program. After the East-Asian crisis they implemented a lot of bank recapitalization programs. I think our policymakers have to look into it and make sure that those banks that are suffering from high non-performing loan problems or low profitability are held accountable for it. On the demand side, there are willful defaulters-big ones, known ones. Everybody knows them. They have to be brought under discipline. The same defaulters keep getting restructured and rescheduled payment of default loans. If one has a good reputation, and a good credit history, and for some reason fails to pay on time, then such accommodation is understandable since the person has proven his worth. But when a willful defaulter gets it, it shows the sheer lack of accountability existing in the system.

How can we reduce inequality?
You have to create good jobs and widen opportunities for entrepreneurship. Most of our people do not own much wealth. The only thing they have is labor. We can only help the poor by giving them jobs that are safe and pay well. You have to make sure that the rich people are paying their taxes; reducing the tendency of tax evasion and closing the loopholes in the direct taxation systems will help greatly in this regard. They have to be less dependent on indirect taxation, because they are very regressive. If they focus from indirect taxation to direct taxation, there would be a reduction in inequality because poor people would not have to pay as much tax as the rich people when it comes to taxes. We also need to protect the vulnerable. The social protection systems have to be funded and managed much better. The education system also needs to reach out to the less fortunate people to give them the capacity to reach a higher level in the labor market or even run their own business. That’s the only way we can achieve a more equitable society and prevent inequality from getting worse.

Domestic investment is very low. How do you think we can bring back the confidence of domestic investors?
You have to ensure stability on the streets. You need to have predictable policies. Even bad policies can have good results if you know how to cope with it. If you change the policies frequently, the investors will keep waiting since they will be unsure of the outcome that they will get. Then comes credibility, which comes with results. Always remember that actions speak louder than words.

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