The Impact of Economic Reforms on Growth: A Case Study of Bangladesh

Article excerpt

ABSTRACT

This study makes a brief assessment of the consequences of economic reforms that included a series of liberalization measures on Bangladesh's growth process by analyzing the 1974-2007 data with the help of cointegration, error correction, and Granger causality tests. The results suggest that long-run economic growth in Bangladesh is largely explained by investments in both physical and human capital, trade openness, and financial as well as capital account liberalization. While the causality runs in both ways between capital account liberalization and economic growth, it runs only in one direction from physical capital and financial liberalization to economic growth in the short-run. Interestingly, growth is not affected by trade openness in the short-run. While trade liberalization and capital account liberalization have had significant positive impacts on economic growth in the long-run, the effects of financial liberalization were found to be significantly negative. This emphasizes the need for ensuring real sector development as a prerequisite for the success of financial liberalization.

JEL Classifications: F41, F43

Keywords: Trade liberalization, financial liberalization, capital account liberalization, growth, cointegration, causality

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INTRODUCTION

Economic reforms usually entail liberalization in the areas of trade, finance, and capital. Starting from mid-1980s, Bangladesh gradually introduced various liberalization measures as part of its economic reform programs. The process was initiated by liberalizing its international trade, which consisted permitting the exporters of non-traditional items to convert some of their export earnings at higher exchange rate in the secondary market, reduction of the tarifflevel and tariffdispersion, simplification and rationalization of the tariffstructure, and deregulation of the import process as well as export incentives such as Export Performance Licensing, Export Performance Benefit Scheme, Special Bonded Warehouse Scheme, Back-to-Back L/C System, Export Credit Guarantee Scheme, Export Promotion Fund, bank loans, and "tax holiday". The financial sector reforms in Bangladesh which began during the first half of the 1990s include liberalization of interest rates, improvement of monetary policy, abolishing priority sector lending, strengthening central bank supervision, regulating banks, improving debt recovery and broadening capital market development. Capital account liberalization in Bangladesh started in 1997 (International Monetary Fund, 2000). It includes easing restrictions in capital and money market, derivatives, credit operations, direct investments, real estate transactions, personal capital movements, provisions specific to commercial banks and institutional investors.

Empirical evidence on the effects of economic liberalization on growth has been mixed. Several studies including those of Krueger (1978), Romer (1989), Dollar (1992), Ghatak et al. (1995), Sachs and Warner (1995), Gould and Ruffin (1995) and Edwards (1998) provided strong evidence of an "indirect' effect of trade liberalization on growth. A few studies, namely Wacziarg and Welch (2008), Dollar and Kraay (2004), Chang et al. (2005) and Salinas and Aksoy (2006) established a "direct' link (unidirectional causality) between export and growth. Many other studies however failed to establish any unidirectional link between export and economic growth. These include Hsiao (1987), Chow (1987), Kwan and Cotsomitis (1990), Ahmed and Kwan (1991), Ahmed and Harnhirun (1995) and Islam (1998). On the other hand, a few studies including those of Grossman and Helpman (1991), Harrison (1996), Greenaway et al. (1998), Rodríguez and Rodrik (1999), Harrison and Hanson (1999), Srinivasan (2001) and Bolaky and Freund (2004) suggest that trade liberalization may have negative impact on economic growth.

A number of studies have investigated the relationship between financial and capital account liberalization and economic growth. …