Impact of Trade Liberalization of Bangladesh Essay

Introduction: There exists a wide range of theoretical and empirical literature on the relationship between foreign trade and economic growth in both developed and developing countries. The early literature focused mostly on the role of export in economic growth. The spectacular success of the outward oriented policies in the East Asian countries provided a basis for the adoption of such polices in developing countries like Bangladesh. Accordingly, the literature tried to support or reject the logic of universal application of export led growth policy in developing countries. The dynamic linkages between export and import or import and income did not receive much attention in this literature. But experience shows that in many countries export is highly dependent on import of capital goods and intermediate inputs as well as raw materials giving a case of bivariate causality between trade (export-import) and economic growth. The relationship between foreign trade and economic growth has long been discussed by different school of thought. The theoretical standpoints can be summarized in terms of technological know how, market expansion, resource allocation, ease of balance of payments, employment generation and income creation. (Hossain & Salim 2009). Karl Marx focuses on the role of exchange in economic growth. In his opinion, the expansion of production needs a growing market which will promote production continuously (Chen 2009). The classical school treats the foreign trade as a means of optimal distribution of resources and increasing productivity that stimulate economic growth. In similar vein is Alfred Marshall and his other neoclassical followers and they dictum that trade enhances growth because of the benefits of comparative advantage, full capacity utilization, greater economies of scale and increasing rate of investment and technological change (Krueger, 1978; Kavoussi, 1984). This school identifies five different ways in which foreign trade affects macroeconomics performance of a country: the revenue effect, capital accumulation effect, substitution effect, income distribution effect and the effect of the weighted elements. All these effects together imply that trade strengthens economic growth over time as an economy develops (Chen, 2009). The structuralist school led by Sir William Arthur Lewis (1915-1991) holds that in the dual economy model if the modern industrial sector produces export goods and the traditional agricultural sector produces import substitutes, then foreign trade would expand the market and lead to increase in production. The new growth theories which consider increasing returns to capital put more focus on trade as an argument of growth. According to these theories, international trade leads to technological diffusion that affects the medium and long term output growth of the developing countries by improving productivity. The new trade school (led by Paul Krugman) emphasizes the role of trade in economic growth through economies of scale and improving the optimal allocation of resources. It is claimed that international trade enables countries to specialize in goods and services by stimulating competition and promoting technological change based on â€Å"comparative and competitive advantage†. As a result, consumers would be able to consume more products of better quality at cheaper prices and therefore human welfare would be increased (Gupta at al. , 1997, World Bank, 2002). Economic growth is mainly depend on physical and human capital, technological progress, high rate of savings, macroeconomic stability, capital mobility, trade liberalization and so on. Trade plays important role on economic growth. There is a growing volume of empirical literature on the relationship between foreign trade and economic growth. In the 1970s and 1980s a number of studies examined the relationship between export and growth. Many such studies (see for example, Balassa, 1978; Feder, 1983; Heller & Porter, 1978; Kavoussi, 1984; Michaely, 1977; Ram, 1985; Tyler, 1981) supported the view that export growth promoted overall economic growth. Thus, there is a general question arises in mind: What are the impacts trade liberalization (from inwardness to the outward orientation) on economic growth? What are the dynamics and causality among export, imports and income? Bangladesh is striving hard to boost up its exports in order to meet the import payments, foreign debts, internal expenditure, maximize domestic welfare and also to reduce the country’s dependence on foreign aid grants. Therefore, since independence Bangladesh has experienced different policy regimes to enhance its foreign exchange earnings and rapid economic growth. Bangladesh has pursued a proactive policy of trade liberalization, characterized by removal of Quantitative Restrictions (QR), rationalization of tariff rates, a flexible exchange rate policy and active incentive structure for promoting the export sector and enhancing export sector performance. The objective of this paper is to examine the trade policy (from Inwardness to Openness), structural changes and performance of foreign trade and also examine the causality among export, imports and growth in Bangladesh. After analyzing these issues, some policy suggestions have been put forward to boost up the foreign trade sector so as to enhance foreign exchange earnings. 2. An Overview of Foreign Trade Polices of Bangladesh: From Inwardness to Openness/Trade Liberalization: In the current era of globalization, trade liberalization emerges as one of the most effective policy concerns for governments all over the world, especially for developing countries. Trade liberalization is believed to enhance economic growth and development through specialization and technological advances. In the post-war period, in line with the mainstream thinking, many developing countries adopted in inward-looking strategy of development. This strategy, particularly when it went beyond the easy first stage, led to distorted incentive and misallocation of resources. It favored import-substitution (advocates replacing imports with domestic production) at the cost of export. It also involved undue governmental intervention in the working of the market. Because of the widespread â€Å"government failure† to ensure adequate growth, and because of the successful example of export-led growth in South-East Asia, pendulum began to shift to trade liberalization and greater openness since the late 1970s and early 1980s. According to the World Development Report 1987, an outward-oriented strategy is defined as one in which the incentive structure is neutral between import-substitution and export production. Thus, an export-led growth strategy does not require a favored treatment for exports in the form of subsidies or other incentives; only a eutral policy regime which does not discriminate between domestic and export production. In a nutshell, the main requirements of this strategy would be moderate tariffs (preferable a uniform rate of tariff), dismantling of quantitative restrictions such as import licensing or quotas, a market-oriented exchange rate regime (as overvalued exchange rate would discriminate against exports and favor imports) and market-friendly laws and rules rather than discretionary controls. After independence in 1971, Bangladesh like her neighbors in South Asia pursued an inward-looking import-substitution strategy of growth. This was mainly characterized by the nationalization of all heavy industries and financial institutions. Import substitution policy (a trade and economic policy that advocates replacing imports with domestic production. It is based on the premise that a country should attempt to reduce its foreign dependency through the local production of industrialized products) was the basic premise of such state intruded and controlled development strategy where the role of the private sector was shriveled. The result of such a strategy was so painful that Bangladesh faced balance of payments (BOP) disequilibrium, foreign exchange shortage, and relatively low growth rate of national income and micro inefficiencies like inefficient import competing enterprises producing low quality products. Furthermore, the debt crisis in the early 1980 provided an important argument for trade reform. Consequently, since 1982 on being advised by the developed countries, along with the General Agreement on Tariffs and Trade (GATT), International Monetary Fund (IMF) and World Bank (WB), Bangladesh has started to shift its trade strategy to a strong outward looking one as part of market oriented economic reforms (structural adjustment packages) particularly after the year of 1985.