Emerging constraints to private investment

The analysis in Part-I suggests that the returns to good policies can be substantial.  But it also begs two questions:  First, why has the GDI (gross domestic income) response in Bangladesh has been sluggish in comparison with the dynamic Asian economies? Secondly, what does explain the stagnation of the private investment rate over the past few years?  The answers to these two questions are inter-related and can be obtained by reviewing the emerging constraints to investment.
In recent years a range of cross-country indicators of investment climate are regularly prepared on an annual cycle by specialised international agencies based on investor surveys.   These indicators provide very useful data on the emerging constraints to private investment.  While the implications of each constraint will likely vary by countries, the wealth of knowledge available from these global surveys can be productively used to inform policies.  These cross-country comparisons are especially useful to understand why some countries are able to attract more FDI (foreign direct investment) inflows than others.
The Global Competitiveness Index (GCI) prepared by the World Economic Forum has now become a fairly standard reference point for assessing the competitiveness of an economy in relation to other countries in the list.  The GCI measure is available as a composite index as well as by individual components that comprise the index.
The individual components provide fairly in-depth views about the regulatory environment faced by investors in any country as well other factors affecting competiveness including macroeconomic environment, financial services, skills, infrastructure, institutions and technology.
The trend in overall competitiveness of Bangladesh as measured by the GCI in relation to its competitors is illustrated in Figure 5.  Although the number of countries covered in the surveys between 2008 and 2014 have changed from 134 to 144 that might affect the comparability of the inter-temporal rankings, the relative cross-country rankings are not affected.  Also, the broad inter-temporal trend showing relative progress across countries remains valid.
The two main messages conveyed by Figure 5 are that: First, the competiveness of the Bangladesh economy relative to competitors remains a serious challenge. China, Indonesia, India, Vietnam and Sri Lanka are much more competitive than Bangladesh. And second, between 2008 and 2014 Bangladesh has made some progress with improving its competitiveness, but China, Indonesia, Vietnam and Sri Lanka have improved faster.  As a result, the competitiveness gap with these countries has widened.
The one exception in competitiveness performance is Pakistan. In 2008 Pakistan was well ahead of Bangladesh but it deteriorated sharply over the past six years and has now fallen much behind Bangladesh.  Competitiveness of the Indian economy has also fallen in the past six years; yet its performance remains significantly ahead of Bangladesh.
A big component of the GCI is the regulatory environment as measured by the International Finance Corporation's (IFC) cost or ease of Doing Business (DB) indicators.  The DB indicators are very helpful to measure the progress with deregulation in terms of results on the ground and not just regulations in the books and as such they reflect both the regulatory gaps and associated implementation challenges.

The DB indicators provide an overall ease of doing business index ranking as well as rankings for 10 regulatory areas that affect business decisions.  
The overall DB index for 2015 for Bangladesh and comparators based on 189 countries is indicated in Figure 6.  
Some interesting results emerge from this comparison.  First, despite past progress, the regulatory environment in Bangladesh is substantially less favourable than competitors; it is ranked at a low score of 171 as compared with the worst performing country ranking of 189 for Chad. Second, all other countries in the comparator list have a relatively better regulatory environment than Bangladesh.

And third, comparing the results of Figures 5 and 6 shows that while the regulatory environment is an important determinant of the investment climate and competitiveness of an economy, it is only one determinant. It is also important to pay attention to such other factors included in the measurement of GCI as the macroeconomic environment, labour skills, labour market, financial sector, infrastructure, technology, institutions and innovation.  Progress in these other areas can compensate for the higher transaction costs of negotiating the regulatory environment while weaknesses in these other areas can strongly offset the regulatory ease of doing business (Bangladesh versus Pakistan).
Nevertheless, the inescapable conclusion is that the overall investment climate for private sector is weak in Bangladesh by both measures (GCI and DB) and the best approach to reforming policies for improving the investment climate is to focus attention on both the regulatory environment as well as other enablers.
Drilling down the composite DB index by its 10 individual components provides substantial insights of where the main regulatory constraints bite most. The Bangladesh rankings by components are shown in Figure 7.  The three biggest constraints are getting electricity, enforcing contracts and registering property.
The ranking in these areas, especially in regard to getting electricity and enforcing contracts, puts Bangladesh at the near bottom of the global list of countries. Trading across borders, resolving insolvency and getting construction permits are also problematic and involve substantial transaction costs.   
One area where Bangladesh performs well is regarding the protection of minority investors. Bangladesh also performs relatively well in the area of starting business and paying taxes. These are encouraging aspects of the investment climate and Bangladesh can build on these to strengthen the overall investment climate.
The implications of these rankings in terms of transaction costs are illustrated in Table III.  The costs are given in terms of number of procedural requirements, the amount of time involved in meeting the regulatory requirements, and some measure of financial cost of complying with the regulation.
 In some sense the later two are more fundamental because what matters to a business are the transaction costs of complying with regulations in terms of time and money.  Ceteris paribus [all other things remaining equal], the lower the compliance cost in terms of procedures and time and money spent, the simpler and more efficient is the underlying regulatory regime.
The indicators show that the Bangladesh regulatory regime relating to contract enforcement, getting electricity and registering property is unduly complex and expensive. The high transaction costs of compliance with the regulatory regime in these three areas are a fundamental reason for the very low ease of doing business ranking and the relatively low inflow of FDI in Bangladesh.
In some sense, these three issues are a binding constraint to FDI because local investors would likely have a way to get through with their local knowledge and connections, while foreign investors will be heavily disadvantaged.    
For example, on average it takes 1442 days to enforce a contract and the financial cost of enforcement is as high as 67 per cent of the claim. As compared with this, it takes only 400 days in Vietnam and 453 days in China to enforce a contract; the financial cost is 29 per cent and 16 per cent respectively.
The performance gap between Bangladesh and the best performer is commensurately much larger: 150 days to resolve a conflict involving only 9.0 per cent of the cost of claim.  The difficulty of getting access to electricity is equally telling.  It takes 429 days to get access to electricity in Bangladesh as compared with 91 days in Indonesia, 104 days in Sri Lanka, 106 days in India, 117 days in Vietnam.
Additionally, the relative cost of getting electricity measured as percentage of per capita GDP is much higher in Bangladesh relative to comparators.  The performance gap with best practice is huge. Regarding property registration, Bangladesh takes 244 days while it is only 20 days in China, 27 days in Indonesia and 47 days in India.
The transaction costs of resolving insolvency and trading across nations are similarly high in Bangladesh in relation to the comparators.

Dr Sadiq Ahmed is Vice Chairman of the Policy Research Institute of Bangladesh (PRI).
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