Too much of a good thing?
THE flow of remittance has increasingly become an important source of our foreign exchange earnings. Mr. Halimur Rahman (DS, Feb 6) has highlighted the importance of remittance from NRB. Remittance was around 2% of GDP in 2001, and rose rapidly to 8.8% in 2007. This is a staggering increase in a short period of time, and exceeds the amount of foreign currencies received through foreign aid.
This is a very encouraging development, and policy-makers should consider seriously some of the measures to raise the flow of remittance further, as suggested by Mr. Rahman. However, we need to keep in mind that too much of a good thing can be harmful.
Remittance and foreign aid both are sources of foreign currencies. They help us fill the resource gap -- the gap between our domestic savings and investment needs, and the gap between export earnings and payments for much-needed imports. Therefore, research findings on the effectiveness of foreign aid should apply equally to remittance.
Since the seminal work of Prof. Anisur Rahman in the late 1960s doubting the effectiveness of foreign aid, researchers are still debating the issue. Readers can read the former World Bank economist William Easterly's recent provocative monograph "White Man's Burden." Another interesting read is Oxford Economist Paul Collier's "The Bottom Billion."
Besides generating scope for corruption, there are several reasons why foreign aid can be less effective. As Prof. Anisur Rahman showed, instead of adding to the pool of available savings, foreign aid can encourage consumption (especially government expenditure) and hence reduce domestic savings. In that case, there is no net gain in the total available funds for investment. Then there are leakages through mismanagement, lack of coordination, the choice of wrong projects, the inappropriate anti-growth policy environment, and so on.
Recent research on the effectiveness of foreign aid has introduced the idea of diminishing returns. That is, there is an optimal level of foreign aid and beyond that level, the effectiveness of foreign aid declines.
Following this strand of research, some researchers even go further to claim that too much foreign aid can be harmful, especially if it comes at a rapid rate. They use a concept, called "Dutch Disease" or "Gregory Effect."
Nearly three decades ago, Bob Gregory of the Australian National University worked out the implications of the boom in mineral exports (especially coal) since 1964-65 that lasted until the early 1970s. He showed that the growth of a new export sector led to real appreciation, which had adverse effects on both import-competing and (non-boom) export sectors. This became famously known as the "Gregory Effect."
A similar phenomenon occurred in the Netherlands after the discovery of natural gas in the North Sea in the late 1970s, hence the name "Dutch Disease."
How can foreign aid or remittance give rise to Dutch Disease or the Gregory effect?
There are basically two channels for this to happen. First, aid and remittance come in foreign currencies, but that needs to be converted into taka for domestic use. So when aid and remittance flows rise, demand for taka also rises, so the value (price) of taka goes up -- our currency becomes stronger. You can look at it from another angle: with increased flows of aid and remittance, the supply of foreign currencies rises and hence their price in taka falls -- foreign currencies become cheaper.
This may be good for imports and for people who want to take overseas trips, but it is not good for our exporters.
If the Bangladesh Bank wants to prevent this by supplying more taka to meet the increased demand for converting foreign currencies, there will be inflationary pressure. This also hurts exports and encourages imports.
The second channel works as people who receive remittance (and the government who receives aid) begin spending. People spend on non-tradable products, such as real estate. So the demand for non-tradable products and hence their prices rise; investment and other resources move from the tradable sectors (such as industry and agriculture) to the non-tradable sectors.
People also spend on tradable products, like ready-made garments. This reduces the availability of tradable products for exports. The combined effect of reduced investment in tradables and increased domestic consumption of them is that exports cannot offset imports.
Thus, a sudden surge in remittance or aid can lead to a balance of payments crisis, and deindustrialisation. This can be very serious, particularly for a country like Bangladesh whose export sector is very narrow and needs diversification.
Is the "Gregory Effect" or "Dutch Disease" a fait-accompli? Perhaps not in a country like Bangladesh, which has a huge potential and a large pool of unemployed labour. But we still have limited capital and skilled manpower. Therefore there can still be resource switching from the tradable sector to the non-tradable sector, and consequently Dutch Disease occurs.
However, there is now a growing body of research that shows that governments can prevent this. The government needs to invest in productivity-enhancing infrastructure, education, skill upgrading, and research and development, and create an environment for remittances to be used in productive investment.
While the current focus is on measures to encourage more remittance flows, the government at the same time needs to develop policies to encourage remittance receivers to invest in agriculture, rural and agro-based small-scale industries.
The government can also ease the restrictions on allowable consumer durables that Bangladeshis working abroad can bring with them. This will lessen the pressure on the domestic supply of such items (either imported or locally produced). That is, instead of bringing money and spending here, they should be allowed to bring goods in order to prevent an additional burden on the balance of payments. This will be like commodity aid that transfers resources directly to the recipient country.
The scheme can be extended to encourage NRBs to set up import business for raw-materials and equipments for rural and agro-based industries. In sum, what is needed is a well-coordinated policy framework for enhancing remittance flows and the productive utilisation of them.
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