Growth, Structural Change and Inequality: An Experience of Bangladesh

Dynamic Research Journals (DRJ) Journal of Economics and Finance (DRJ-JEF) Volume 2 ~ Issue 2 (February, 2017) pp: 09-16 Growth, Structural Change and Inequality: An Experience of Bangladesh Arif Ibne Asad 1 and Dr. Stefanie Brilon 2 1 (MSc research student, Department of Economics and Institutions, Philipps Universität Marburg, Germany) 2 ( Professor of Microeconomics, Department of Economics and Institutions, Philipps Universität Marburg, Germany) Received 18 December, 2016; Accepted 21 December, 2016; Published 28 February, 2017 The author(s) 2017. Published with open access at Abstract: Growth and inequality relation is a debating issue since Kuznets (1955).In this paper we analyzed a recent issue between growth and inequality that is growth might help to reduce poverty in a nominal manner but stronger inequality still prevails when the structural transformation occurs. To analyze this issue we emphasized on the recent literature of Benabou(1996) which is treated as a significant paper discussing the recent literatures as well. In our paper we studied the case of Bangladesh by observing her GDP growth, poverty, inequality and structural change. We estimate a linear regression model of inequality and found that when structural parameter changes it reduces poverty but the inequality is worsening gradually. Finally, we recommend policy suggestion given by Benabou (1996) and investigate these policies how much attained in Bangladesh to reduce poverty as well as inequality. Keywords: Inequality, Growth, Structural Transformation, Policy Suggestions. 1. Introduction The relationship between growth and inequality has undoubtedly a debating issue among scholars since Kuznets postulated his famous curve in 1955. Although this issue is controversial, inequality in the distribution of income either increases or decreases the growth, Kuznets (1955) analysis is still recognized as the starting point of growth and inequality relation in development studies. According to Kuznets(1955), early stages of development an economy has low per capita GNP and income inequality. Income inequality tends to increase with higher growth in the process of development. But after an increase of income inequality, it tends to decrease at higher GNP growth. Kuznets argument is that during the early stages of development, the low-income economy is profoundly dependent on agriculture and other rural low-income activities. When the economy is going to be developed, there are several transformations in the economy, as Kuznets explained that: (i) Transformation of activities and employment from rural agricultural base economy to an urban industrial economy. (ii) In the industrial urban economic setup, income increases because the higher value added activities have been introduced. (iii) The income gap between rural agriculture base economy and industrially growing urban economy tends to increase. (iv) With the phase of economic expansion a rise in the share industrial and service sectors and a fall in the agricultural sector in total output. (v) Starting to employment transfer from rural to an urban economy, it helps to equalize income between the two sectors. This is the most famous inverted U-shaped curve relationship between inequality and GNP growth (Dastidar, 2004). On the other hand, the explanation of neoclassical economists likes Solow (1965), Cass (1965) and Koopmans (1965), the per capita growth rate is inversely related to the starting level of income per person in the economy. In this situation, if the structural parameters remain identical then poor countries tendency to grow faster than rich countries. There is a tendency of promoting convergence the level of per capita incomes across countries. The reason behind is that poor countries have a lower capital to labor ratios and high marginal product of capital. That is why they tend to grow at high rates (Barrow, 1991). In the present research interest of scholars, not only showing inequality and growth study but also structural transformational analysis has been added a new dimension. Sarntisart (2000) study emphasizes on the simultaneous effects in one side poverty reduction and another side in rising income inequality. The study is showing how much consistency remains in case of income inequality and structural change. The study area is Thailand. There was outstanding economic growth in Thailand due to the expansion of modern industries and 9 P a g e

other sectors till the 1990s. The expansion of agriculture is in the case of employing the largest labor force. At the same time, Thailand failed to distribute equitable economic growth. Growth had a positive impact on reducing poverty but income inequality worsened. This study analyses the changing structure of Thai economy and relevant development policies undertaken in the past four decades. Adair (2006) examines the relationship between income inequality and economic growth in Mexico. This study firstly introduces the industrial trade, production and investment patterns over the liberalization period in Mexico. These changes lead to a relative high-wage economy with industrial capital goods production and export. The study shows that annual change in manufacturing creates inequality and simultaneously brings GDP growth. It finds out that stable and negatively relationship predicted by Kuznets broke down during the period of structural reform in Mexico. The study of Ying (2014) proposes a dual growth model showing that economic growth shifts workers to the comparative advantage. It induces rural-urban structural change. The model also implies different results, i.e. average individual productivity in agriculture increases while non-agricultural sector decreases during the structural change. One of the findings of the study shows that inverse correlation between structural change and dispersion of productivity across workers. In addition, it is not necessary to follow an inverted U-shaped inequality curve in the period of structural transformation. Dastidar (2004) addresses the process of industrial transformation affect personal income distribution within developing economy. The process of structural change and overall distribution of income are interlinked. Researcher examines the hypothesis of relation between inequality and industrial transformation in developing countries. In this paper, a group of eighteen countries from Asia and Latin America has been evaluated regarding this hypothesis. Researcher finds little support on in the data set for Kuznets hypothesis of increasing inequality with industrial transformation. In this paper, I have started from Kuznets s structural transmission regarding growth and inequality relations. Then I will try to give an overview of Benabou (1996) paper. After the study of a structural issue from Benabou paper, I will try to make it related from the study of Bangladesh. The structural change of Bangladesh is an interesting issue to the researchers presently. Bangladesh is one of the developing countries where the transformation happens very fast shift to service sector. On the other hand, the majority of working force is related to agriculture. Where poverty has been becoming slower, conversely the inequality is intending to increase. The main objective of this paper is to find that does the structural transformation of Bangladesh show healthy economic behavior and its consistency with income inequality and growth? To do so first, the trends in inequality, growth and structural transformation in Bangladesh have been figured out. After that in the empirical section, I estimate an inequality regression from the data of Bangladesh in the recent period 2000-2015. For this, I use the some secondary data sources like Bangladesh Economic Review in various years and World Bank data sources. Finally, the policy recommendations suggested by Benabou (1996) have been discussed regarding reducing inequality. 2. Inequality and Growth a review of Benabou paper Economist Ronald Benabou summarized the early literature of inequality and growth. His paper Inequality and Growth (1996) has major contribution in the studies of development analysis. At first he summarized the main results of 23 early literatures which link inequality to growth and investment. Boushey and Price (2014) make commentary contribution on Benabou paper that only 13 of those could explain inequality and growth relation. Because of the remaining ten made connection between human capital attainment and growth. Ten of thirteen papers from Benabou (1996) review suggested that there are consistent, significant statistically and negative relationship between inequality and growth, two papers showed negative relationship but not implying a consistent magnitude, the remaining one found no relationship between inequality and growth (Ferreira, 1999; Rodriguez, 2000; Boushey and Price, 2014).Almost all the early studies up until 1996 found that higher the inequality associates the lower the growth. A variety of measures of inequality are used in this paper including the Gini Coefficient for income, the Gini coefficient for land ownership, the Thiel index for income, the share of income top quintiles and middle quintiles etc. (Boushey and Price, 2014).The Benabou (1996) paper is organized to present and extend the main theories regarding income distribution and growth. He also shows the relevance of these staffs. He used his analysis through two unifying models, such as: (i) The first method is a survey of the empirical literature; it integrates the more interesting issues such as political economy and imperfect capital market theories. On the other hand, it also deals with social conflict and the security of property rights and (ii) The second method is based on econometric analysis to have an investigation on whether countries are converging to the same level of inequality. The aim of Benabou (1996) paper is to identify how income distribution can affect output growth other than on reverse effects from the level of development to inequality. That is why it decently uses the instruments used in Kuznets hypothesis (1955). In the theoretical part of this paper, Benabou (1996) explained the reasons behind complete and distributional effects of asset market which begins through the balance of power in the political system. The 10 P a g e

significance of this theory is that when the income of the median voter or central middle-class people is lower, inequality is larger. So there is a common tendency to increase the pressure for redistribution. The model developed in this paper based on combined features of two papers, such as, Pearson and Tabellini(1994), and Benabou(1995). Although the mechanisms of this following paper are used in the analysis, it also formalizes the main concepts of political economy called one person one vote ideal. It analyses the role of productive public investment where growth in this model always increases simultaneously with the pro-wealth bias in the political system. The new result of this paper has some general caution whether inequality affects democracies and nondemocracies differentially. The result shows that income disparities have two more interesting impacts on redistribution and growth, such as: Firstly, it has a lesser impact on redistribution and growth only in right-wing or wealth- biased regime. And another impact on redistribution and growth is that they both have a greater contact in left wing or populist ones. Additionally, Benabou paper represents another set of theories based on the distribution of wealth and in the asset market. The distribution of wealth has macroeconomic significance as a result of imperfection in asset market. He sets up the model showing growth benefits from land reform, public schooling, or other progressive transfers and their traditional costs. The traditional mean the depressed incentives for saving or labor supply for the above expenses. Besides, the linkage between inequality and growth has been addressed in this paper. Benabou explained this relationship explicitly where he proposed a simple growth version of Prisoners dilemma. The maximum sustainable growth of the economy is negatively related to the income disparities. It is the responsibility of rich class to collectively transfer wealth to the poor. The possible strategies are land reform, a minimum wage, education subsidies or trade protection. This is the main theme which has been addressed in the present paper as policy recommendation. 3. Trends in inequality, growth and structural transformation in Bangladesh There has been marvelous economic development in Bangladesh since her independence (Helal & Hossain, 2013). The economic growth of Bangladesh has an average 5-6 % per annum over the last few years. But here the contribution and participation of labor force in GDP are the little bit distinctive. The contribution of the service sector is more than half of her GDP while the majority of people are employed in the agricultural sector. In this section, we will introduce trends of economic growth and inequality scenario of Bangladesh. After that, we will sketch the contribution of three main sectors (agriculture, industry, and service) on her GDP and the participation of labor force in these sectors. 3.1 GDP growth rate over years Bangladesh faced worse experience in growth the first two decades after her independence in 1971. The 1970s passed by devastates of war and several natural calamities like cyclones, famines, and floods. After that, the 1980s is the period of recovery and reconstructions. During this period, a slower economic growth was persisted; GDP growth was less than 4 percent in an average. On the other hand, the population grew comparatively faster, at more than 2%. But the economic condition of Bangladesh turned to be a positive starting in this period, which became stronger in the 1990s and afterward, taking Bangladesh economy to a substantially higher economic growth path (Osmani, 2015). The reasons behind the conspicuous and continued growth rate of 1990s in Bangladesh are many folds, especially slowdown of the population growth, birth of democracy and political stability, introducing the free market economic instruments, limiting state intervention and tendency to privatization, technologies, new economic policies like attempts to attract foreign direct investments (FDIs), international remittance income inflows etc. (Islam,2010). Table 1: GDP growth rate over the period Period Median GDP growth 1961-1970 4.01 1971-1980 3.00 1981-1990 3.83 1991-2000 4.70 2001-2010 5.40 2011-2015 6.46 Data source: Author s own calculation on the base of World Bank data. From the table, we can see that the GDP growth rate of Bangladesh has been increased recently at a 6.5% rate. It is obviously a good sign for the economy. Economic growth and reduction of poverty have been approaching to have the Goal of being middle-income country by 2021 (Gimenez, Jolliffe,& Sharif, 2014). 3.2 Inequality Scenario in Bangladesh Poverty line at national poverty lines shows the mean declines from the poverty lines as a percentage of the poverty line. According to the World Bank data source on poverty gap at national poverty lines (%), this gap 11 P a g e

is continuously lowering. It is a good sign for the economy of Bangladesh which can be observed from the following table. Table 2: Recent poverty gap in Bangladesh Year Poverty gap at national poverty line (%) 2000 12.8 2005 9.0 2010 6.5 Data source: World Bank The reason behind is that poverty has been reduced with the continuous process of development. In the sixth five-year plan of Bangladesh (2011) the possible contributions of the economy for poverty reduction are conspicuous. According to this report, Bangladesh has been achieved a significant reduction of poverty since 1990. A combination of factors contributes to the significant social and economic transformation. Rapid GDP growth and urbanization process are closely interlinked with the economic transformation process. While the economic transformation is the consequent of increase in labor productivity and wages, acceleration of the returns to human and physical assets, shifting the preference of production and employment from low return agricultural to non-farm sectors and expansion of export industries. On the other hand, increasing flow of foreign remittance income and growth of microfinance generate the economy forceful to work against poverty. The progress of social transformation also contributes to the reduction of poverty such as women empowerment, decreasing the number of household dependencies, increasing the number of educational attainment has contributed as well. Unfortunately, the inequality situation is not much favorable. Though the depth of poverty is reduced, the inequality is still increasing in Bangladesh. Now we will concentrate on the present inequality trend in Bangladesh. According to the report of Titumir & Rahman (2011), the Gini-coefficient at the rural level has been increased although it has a negative growth at the urban level. As only 30 percent 1 of total population live in urban areas, that is why at the national level the growth rate of Gini-coefficient has been also increased at a rate 0.16 percent. Table 3: The Gini-coefficient rural, urban and national level. Year Rural Urban National 2000 0.393 0.497 0.451 2005 0.428 0.497 0.467 2010 0.430 0.452 0.458 Growth rate 0.94-0.91 0.16 Source: Titumir& Rahman (2011) calculation on the base of Household Income and Expenditure Survey (HIES) 2005 and 2010 data for Bangladesh. The paper of Titumir& Rahman (2011) also alerts about the wide disparities. They started their argument with the concept that sustained and equitable economic growth inevitably reduces poverty. Growth might be seemed convenient on poverty reduction however growth is accompanied by rising inequalities. But current economic crisis might widen the gap between poor and rich if the economic growth has not been fairly shared. This inequality can be shown more clearly using the percentage distribution of income accruing to the household in groups (deciles) and GINI coefficient in periods 2005 and 2010. The information is given below: Table 4: Household income deciles and Gini-coefficients Household income deciles and GINI coefficient National (2005) National (2010) Total/Deciles 100.00 100.00 Lower 5% 0.77 0.78 Decil-1 2.00 2.00 Decil-2 3.26 3.22 Decil-3 4.10 4.10 Decil-4 5.00 5.00 Decil-5 5.96 6.01 Decil-6 7.17 7.32 Decil-7 8.73 9.06 Decil-8 11.06 11.50 Decil-9 15.07 15.94 Decil-10 37.64 35.85 Top 5% 26.93 24.61 Gini Coefficient 0.467 0.458 Source: Household income and expenditure survey (HIES) 2010, Bangladesh Bureau of statistics (cited in statistical year book Bangladesh 2015). 1 See UNICEF. (2010), especially in the introduction and key concepts for an insightful analysis of Bangladesh present urbanization. 12 P a g e

Although the income share slightly reduced to the top 10% households during the period 2005-2010, it is obviously indicating that not only the poor but also the middle class are suffering losses the share of income. From the lower side households income, there is nearly no change until lower 50% households and it is indicating they are living with economic difficulties. The Gini coefficient reduces a little amount in 2010 comparing to 2005. 3.3 Structural Transformation in Bangladesh There are three main sectors consisting the economy of Bangladesh, agriculture, industry and service sectors. According to the World Factbook 2015 report, the average contribution of these sectors is respectively agriculture (15.5%), industry (28.1%) and service (56.3%). So the service sector is the most prominent sector in the economy. The labor force is employed in these occupations are respectively agriculture (47%), industry (13%) and service (40%) in 2010. So economy of Bangladesh is still labor intensive in agriculture although the contribution of agriculture in GDP is not satisfactory. The service sector is growing faster and contributing the lions share in the Bangladesh economy. The demand for service sector is also continuously expanding in the recent years. To fulfill the demand of huge population this sector is expanding with a steady growth (Islam, Musa, & Das, 2012). The analysis of the following data on sector wise contribution is also clearly identifying this issue. First, we will observe the sectorwise growth of GDP and growth of the economic sector. After that, employment contribution of the three sectors will be figured out. Table 5: Sector Wise Growth of GDP (in percentage) in 2000-2010 period Sectors 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-2008- 2009-08 09 10 Agriculture 25.03 23.98 23.47 23.08 22.27 21.84 21.38 20.83 20.48 20.16 Industry 26.20 26.75 27.24 27.69 28.31 29.03 29.45 29.70 29.86 29.95 Service 48.77 49.27 49.22 49.30 49.42 49.14 49.17 49.47 49.66 49.90 Source: Bangladesh Economic Review-2010, Ministry of Finance Bangladesh (cited in Islam, Musa & Das, 2012 Paper). The growth in three major sectors can be shown from the figure 1. The agriculture sector has an upward growth rate although it is fluctuating over years. The growth in industry is also fluctuating but not as much as in the agricultural sector. Only the service sector has an increasing and stable growth. 12 10 8 6 4 2 Figure 1: Growth in three major sectors in the period 2001-2010 Recent growth in three major sectors in Bangladesh 0 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 Agriculture Industry Service Source: Bangladesh Economic Review-2010, Ministry of Finance Bangladesh (cited in Islam, Musa & Das, 2012 Paper). Figure 2 shows the employment contribution on these three sectors. The agriculture is using the large share of labor force till now with a decreasing rate. On the other hand, both the industry and the service sector have comparatively lower share than the agriculture sector but their rates are on the increase. 13 P a g e

Figure 2: Employment contribution in the major three sectors Employment Contribution (% of total employment) 70 60 50 40 30 20 10 0 1984 1985 1986 1989 1991 1996 2000 2002 2003 2005 2010 Agriculture Industry Services Source: World Development Indicators, TheWorld Bank. 4. Regression on inequality In the econometric analysis, I use the simple linear regression of inequality on the basis of the recent data from 2000-2015 in Bangladesh. The regression equation is as follows: = + 1 + 2 + 3 + 4 + Where; Inequality is the dependent variable and age dependency ratio(age), structural factor (str), Unemployment (Unp), economic growth (GDP) are the independent variables. Inequality is positively related to Age, Str and Unp. Structural factor proxies the employment share of the service sector. It shows that the increase in labor force involved in the service sector inequality increases. As a result of structural transformation, the economic advantages are distributed among a few households. On the other hand, growth and inequality has converse relationship as well. Inequality is positively related to Age, Str, Unp and negatively related to GDP, with the respective coefficients 0.211, 0.593, 0.533 and -0.386.There is insignificant positive relation between inequality and age but negative relation between growth and inequality. Table 6: The estimation of inequality regression Standardizedcoef Non-standardizedcoefficients ficients Model B Standard error Beta t Sig. (constant) 25,862 2,036 12,705,000 Age,021,024,211,881,396 Str,081,036,593 2,229,046 Unp,678,204,533 3,331,006 GDP -,247,103 -,386-2,402,033 5. Policy suggestions from Benabou to reduce inequality In this chapter we will suggest some policies recommended by Benabou. Basically we will discuss very briefly how these policies help to reduce inequality in Bangladesh. The policies are land reform, education subsidies, a minimum wage and trade protection. 5.1 Land reform and equality in Bangladesh The usefulness of land reform to reduce inequality has been well defined in the book entitled, Agrarian transition and livelihoods of the Rural Poor: agricultural land Market. The authors explain that it is undoubtedly proved that reforming land increases productivity. From the history of Bangladesh, small farms in Bangladesh are more efficient to increase agricultural poverty. The reason behind is that having more labor supply to a small farm can easily utilize every little bit of the land. It is also treated as the most sustainable way to ensure future return from it. The relative abundance of labor in Bangladesh households can easily adopt this labor intensive production technique. Small farming worthiness can be made by using the low cost of labor. 14 P a g e

If productivity does not increase, land reform will still have sufficient supports with the arguments of equity. In Bangladesh most of the people live in rural areas with a high degree of landlessness and unemployment problem. In that case land provides employment as well as social security. As we know nearly 48 % of labor force is related to agriculture, land reform is very important for substantial wealth as well as providing a basic income to the poor families. In macroeconomic sense, multiplier effect of local consumption might be proved beneficial. For example, large land holders simple accumulate their profit out of the rural areas. Small holders can accumulate their investment within the local economy. It provides more potentiality in diversifying local capital accumulation. 5.2 Education subsidies In the perspective of Bangladesh, education is treated as the key component of the government to accelerate poverty reduction. The government also increases spending on the sectors which encourage pro-poor growth and reduce poverty. Education has the topmost essence in these strategy implementation. The Bangladesh government has been concerned on educational access and completion of basic education for the poor as well as improving quality and skills of the workforce. That is why the government education spending more emphasizes on two important social safety net programs: the first one is aiming to protect disadvantages groups and the second one is to make access and participation in education where the equality in educational attainment has been given importance. There are two significant stipend programs in school level. The primary stipend program is designed for the assistance of poor students to be enlightened in rural schools. On the other hand the secondary stipend scheme is established aiming educate rural female students with no tuition fee and a small amount of stipend. But in the true sense the enrolment in primary and secondary education are relatively low in Bangladesh. On the otherhand, the enrolment rates between poor and non-poor are substantially different. Furthermore, the poor students have very little enrolment in tertiary education due to increasing education cost and lower completion rates in earlier levels of education. The government has been more priorities in public education spending at pre-tertiary level. In this case, most of the education subsidy is spent (Al-Samarrai, 2009). 5.3 A minimum wage implementation in Bangladesh There was extremely low legal minimum wage in Bangladesh before 2010. It left below the United Nations Poverty line. In 2010, a new minimum wage has been introduced, the minimum wage proposed by the government was BDT 3000 (US$38). The increasing minimum wage rate is still very low, although it prevails a good sign for the poor people. The local trade union demand was BDT 5000. The law came into effect after 2010 (Fair Wear foundation 2012). 5.4 Trade liberalization in Bangladesh Trade liberalization is one of the major policy reforms in Bangladesh. It is implemented as one of the part of overall economic reform programs. It associates the structural adjustment program in 1987. But this was not the case before. After the independence in 1971, Bangladesh followed highly restricted trade policy. High tariff and non-tariff barriers to trade and overvalued exchange rate system are used for the import substitution strategy of the government. It was undertaken for improving the balance of payment and creating a protection for the local manufacturing industries. However, a large scale liberalization of trade has been introduced in the early 1990s. Some of the objectives for this trade liberalization are: safeguard infant industry of Bangladesh, reduction of balance of payment deficits; to achieve higher economic growth and sufficiency etc. the basic tools are used now included import tariff, quantitative restrictions, foreign exchange rationing and an overvalued exchange rate (Raihan,2008). 5.5 Other policies for the reduction of inequality Obviously, there are some other policies can take part to reduce inequality in Bangladesh. Firstly, the better governance and institutions, it can be achieved by the effectiveness of fiscal policies, rent seeking behavior through discretionary access to public loans, non-repayment of this loans, insider trading, evasion of taxes, removal of corruption. Secondly the fiscal policies must ensure human capital and earning capabilities of the poor citizens. Furthermore, women empowerment and appropriate micro-finance schemes can be more beneficial for having an equitable economic distribution. According to the researchers, these possible scopes are mandatory for reducing the inequality, if there is no caring of inequality, Bangladesh will suffer in the near future. 6. Limitations of the Study The limitation of our empirical analysis is that omitted variable biases cause the endogeneity problem. There are different structural variables for example the employment contribution in the agriculture sector. The further research can be associated with consulting control variable analysis. It removes the problem of endogeneity. On the other hand, it is very difficult to manage data for the long period in Bangladesh. 15 P a g e

7. Conclusion The GDP gap between the rich and poor grows faster with the connection of the progress of average living standard. In this view, the experience of Bangladesh is identical to most other rapidly growing economies in Asia(Osmani, S. R. 2015). The structural change is obviously welcomed when it ensures equity. This is not actually the case in Bangladesh. The development programs of Bangladesh should not only be emphasized on poverty reduction but also reduction of inequality. The reduction of inequality will care the further economic progress of Bangladesh. Because of having equitable society, can have fewer economic problem. References [1]. Adair, C. (2006). Structural Change, Inequality and Growth in Mexico. The University Inequality Project Working Paper, (35). [2]. Al-Samarrai, S. (2009). Education spending and equity in Bangladesh. Breaking Down Poverty in Bangladesh. The University Press, Ltd., Dhaka. [3]. Barro, R. J. (1991). 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