FRONTIER FIRMS AND JOB CREATION in Bangladesh Rami Galal Marc Schiffbauer Alice Rossignol Gharam Dexter © 2025 The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved. This work is a product of The World Bank. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy, completeness, or currency of the data included in this work and does not assume responsibility for any errors, omissions, or discrepancies in the information, or liability with respect to the use of or failure to use the information, methods, processes, or conclusions set forth. 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COntents ​Contents ​ CKNOWLEDGMENTS ����������������������������������������������������������������������������������������������������������������������������������������� 1 A FIGURES AND TABLES ����������������������������������������������������������������������������������������������������������������������������������������� 2 ACRONYMS AND ABBREVIATIONS ������������������������������������������������������������������������������������������������������������������������ 5 ​EXECUTIVE SUMMARY ���������������������������������������������������������������������������������������������������������������������������������������� 6 1 ​ . ECONOMIC GROWTH, PRODUCTIVITY, AND JOB CREATION���������������������������������������������������������������������������������� 12 ​ 1.1 Economic growth and job creation ������������������������������������������������������������������������������������������������������������������������������������ 12 ​ 1.2 Structural transformation and job creation ����������������������������������������������������������������������������������������������������������������������� 16 ​2. FRONTIER FIRMS ����������������������������������������������������������������������������������������������������������������������������������������� 23 2.1 Definition and characteristics of frontier firms ������������������������������������������������������������������������������������������������������������������ 23 2.2 Frontier firms and job creation ������������������������������������������������������������������������������������������������������������������������������������������ 28 ​3. THE BUSINESS ENVIRONMENT������������������������������������������������������������������������������������������������������������������������ 32 3.1 Quality of the business environment���������������������������������������������������������������������������������������������������������������������������������� 32 3.2 Preferential lane for frontier firms ������������������������������������������������������������������������������������������������������������������������������������� 38 3.3 Administrative weaknesses ����������������������������������������������������������������������������������������������������������������������������������������������� 40 ​ . SELECTIVE INTERVENTIONS ��������������������������������������������������������������������������������������������������������������������������� 44 4 ​ 4.1 Frontier firms and selective interventions �������������������������������������������������������������������������������������������������������������������������� 44 ​ 4.2 Benefits and costs of selective interventions ��������������������������������������������������������������������������������������������������������������������� 49 ​ 4.3 Assessment of industrial policy in Bangladesh ������������������������������������������������������������������������������������������������������������������ 53 5 ​ . POLICY RECOMMENDATIONS ������������������������������������������������������������������������������������������������������������������������� 58 ​ 5.1 Business environment �������������������������������������������������������������������������������������������������������������������������������������������������������� 58 5.2 Industrial policy ����������������������������������������������������������������������������������������������������������������������������������������������������������������� 60 5.3 State capacity �������������������������������������������������������������������������������������������������������������������������������������������������������������������� 63 ​REFERENCES ��������������������������������������������������������������������������������������������������������������������������������������������������� 65 ​APPENDIX: World Bank Enterprise Surveys Data ����������������������������������������������������������������������������������������������� 71 Frontier Firms and Job Creation in Bangladesh ACKNOWLEDGMENTS Acknowledgments This report was prepared by a team led by Rami Galal (Economist, World Bank). The core team members were Marc Schiffbauer (Lead Economist, World Bank), Alice Rossignol (Young Professional, World Bank), and Gharam Dexter (Private Sector Specialist, World Bank). The report benefited from valuable input from Md Abir Hasan (Consultant, World Bank), Mihaly Fazekas (Scientific Director, Government Transparency Institute), Aly Talibab (Researcher, Government Transparency Institute), Eduardo Sandoval (Consultant, World Bank), and the research assistance of Mauricio Latorre (Consultant, World Bank), Bente Jessen- Thiesen (Consultant, World Bank), and Asif Qurishi (Analyst, World Bank). It drew on various data sets, primarily the World Bank Enterprise Surveys (2013 and 2022) and the Survey of Manufacturing Industries (2019). Part of the analysis used the World Bank’s Investment Climate Assessment (ICA) 2.0 framework. The report was carried out under the guidance and support of Gabi Afram (Practice Manager, World Bank) and Mathew Verghis (Regional Director, World Bank). The team is grateful for the insightful and constructive comments of the following peer reviewers: Gaurav Nayyar (Lead Economist, World Bank), Silvia Muzi (Senior Economist, World Bank), Michael Engman (Lead Economist, World Bank), and Suhail Kassim (Senior Operations Officer, World Bank). We are also thankful for additional comments received from Mohamed Ihsan Ajwad (Senior Economist, World Bank), and Souleymane Coulibaly (Lead Country Economist, World Bank). The team would also like to acknowledge the instructive conversations with various individuals within and outside the World Bank. Within the World Bank, we benefited from the insights of Hosna Ferdous Sumi (Senior Private Sector Specialist, World Bank), Siddharth Sharma (Lead Economist, World Bank), Bernard Haven (Senior Country Economist, World Bank), Ayago Wambile (Senior Economist, World Bank), Angela Prigozhina (Senior Economist, World Bank), Tatsiana Kliatskova (Senior Financial Sector Economist, World Bank), Nagaraju Duthaluri (Lead Procurement Specialist, World Bank), and Nishat Noman (Procurement Specialist, World Bank). From outside the World Bank, we benefited from the input of Selim Raihan (Professor, University of Dhaka), Ahsan Mansur (Director, Policy Research Institute), Debapriya Bhattacharya (Distinguished Fellow, Center for Policy Dialogue), Masrur Reaz (Chairman, Policy Exchange Bangladesh), Bazlul Haque Khondker (Director, Policy Research Institute), Mohammad Belal Hossain Chowdhury (Director General, Duty Exemption and Drawback Office, government of Bangladesh), Tanvir Ahmed (NBR, government of Bangladesh), and representatives of the private sector, including Runner Group, Symphony Mobile, and the Federation of Bangladesh Chambers of Commerce & Industries. Frontier Firms and Job Creation in Bangladesh 1 FIGURES and TABLES Figures and tables Figure 1.1 Bangladesh’s growth track record has been impressive from 2000 through 2018 ·············································································· 13 Figure 1.2 Poverty plummeted between 1995 and 2021 ················································································································································· 13 Figure 1.3 Job creation did not matched economic growth between 2018 and 2024 ···························································································· 13 Figure 1.4 The employment elasticity of growth lagged aspirational peers between 2000 and 2024 ······························································ 13 Figure 1.5 The working-age population is growing faster than new employment opportunities, 2013–22 ··················································· 14 Figure 1.6 Unemployment is rising, especially for youth ages 15 through 24, 2012–22 ························································································· 14 Figure 1.7 Labor’s contribution to growth declined between 2000 and 2017 ·········································································································· 15 Figure 1.8 The share of income accruing to the bottom 80 percent of earners is decreasing ·············································································· 15 Figure 1.9 Bangladesh has a low job quality measure ······················································································································································ 15 Figure 1.10 Bangladesh had the lowest output per worker among its peers ·············································································································· 16 Figure 1.11 Growth in value added is moderate despite its low base ···························································································································· 16 Figure 1.12 Firms in Bangladesh are the least productive among their peers in the South Asia region ······························································ 16 Figure 1.13 Sectoral employment shares, 2010–19 ····························································································································································· 17 Figure 1.14 Labor productivity by sector, 2010–19 ······························································································································································ 17 Figure 1.15 Actual and modeled value added per worker ················································································································································· 17 Figure 1.16 Most productivity growth stems from within-sector improvements rather than cross-sector reallocation of factors of production ·················································································································· 18 Figure 1.17 More-productive manufacturing firms in Bangladesh do not employ more workers ········································································ 18 Figure 1.18 The top 10 percent most productive firms produce 35 times more sales per worker than the bottom 10 percent in services ······································································································································································ 19 Figure 1.19 Few higher-productivity firms coexist with many low-productivity firms, especially in services ··················································· 19 Figure 1.20 Bangladesh has fewer young firms compared with peers ·························································································································· 19 Figure 1.21 Firms in Bangladesh are older than those in peer countries ······················································································································· 19 Figure 1.22 Bangladesh has the fewestregistered firms relative to market size compared with peer countries, 2018 ··································· 20 Figure 1.23 Bangladesh is tied with India for the lowest business density among peers, 2018 ············································································· 20 Figure 1.24 Firms in Bangladesh lag behind their peers in investing in new, more-productive technologies and processes ······················ 21 Figure 1.25 Firms’ investments have declined since 2013 ················································································································································· 21 Figure 1.26 FDI is scarce among Bangladeshi firms ····························································································································································· 21 Figure 1.27 The majority of greenfield investments are directed toward the utility sector ···················································································· 21 Figure 2.1 A small group of firms in Bangladesh is significantly more productive than the rest ········································································· 24 Figure 2.2 Frontier firms are substantially more productive than non-frontier firms ····························································································· 24 Figure 2.3 Frontier firms have outperformed their competitors in recent years, 2019–22 ···················································································· 25 Figure 2.4 Frontier firms innovate more ··············································································································································································· 25 Figure 2.5 Total sales: frontier versus non-frontier firms, 2013 ······································································································································ 25 Figure 2.6 Total sales: frontier versus non-frontier firms, 2022 ······································································································································ 25 Frontier Firms and Job Creation in Bangladesh 2 FIGURES and TABLES Figure 2.7 The garments sector grew from representing less than one-quarter of frontier firms’ sales in 2013 ············································ 26 Figure 2.8 . . . to almost two-thirds of fronter firms’ sales in 2022 ································································································································· 26 Figure 2.9 The garments sector constituted about one-half of non-frontier firms’ sales in 2013… ··································································· 26 Figure 2.10 . . . and continued to make up roughly one-half of non-frontier firms’ sales in 2022 ·········································································· 26 Figure 2.11 Frontier firms dominated exports in 2022 ······················································································································································· 27 Figure 2.12 The overall number of exporting firms has declined since 2013 ··············································································································· 27 Figure 2.13 Share of total employment: frontier firms versus other firms, 2013 ········································································································· 28 Figure 2.14 Share of total employment: frontier firms versus other firms, 2022 ········································································································· 28 Figure 2.15 Frontier firms’ employment by sector, 2013 ···················································································································································· 28 Figure 2.16 Frontier firms’ employment by sector, 2022 ···················································································································································· 28 Figure 2.17 Non-frontier firms’ employment by sector, 2013 ··········································································································································· 29 Figure 2.18 Non-frontier firms’ employment by sector, 2022 ··········································································································································· 29 Figure 2.19 Most manufacturing jobs are in younger non-frontier firms ····················································································································· 29 Figure 2.20 The capital intensity in the garments sector is lower than among the rest of manufacturing ························································ 30 Figure 2.21 Among frontier firms in garments, capital intensity is higher and has grown at a pace similar to the rest of manufacturing ················································································································································································ 30 Figure 2.22 Frontier firms pay higher wages and employ more skilled workers ········································································································· 30 Figure 3.1 Bangladesh’s score in the Doing Business index is the lowest compared with all peers ···································································· 33 Figure 3.2 The gap has widened between Bangladesh’s Doing Business score and regional and income-group peers’ scores ··············· 33 Figure 3.3 Firms’ time dealing with regulators and waiting for regulatory services exceeds those in peer countries ·································· 34 Figure 3.4 Bangladeshi firms report high incidence of corrupt practices in regulatory services ········································································· 34 Figure 3.5 The value of gifts expected in Bangladesh for securing government contracts is relatively high ·················································· 35 Figure 3.6 Start-up costs for a business are high, especially for younger firms ········································································································· 35 Figure 3.7 Twice as many Bangladeshi firms experience power outages compared with firms in peer countries ········································· 36 Figure 3.8 Manufacturers with higher losses from power outages are less productive ························································································· 36 Figure 3.9 Manufacturers with higher losses from power outages are less likely to invest ··················································································· 36 Figure 3.10 Frontier firms spend less time dealing with business regulations compared with non-frontier firms ··········································· 37 Figure 3.11 Regulatory services are faster and more consistently implemented for garments firm s··································································· 37 Figure 3.12 Frontier firms endure fewer and shorter electricity cuts compared with non-frontier firms ···························································· 38 Figure 3.13 Frontier firms face fewer losses from power outages compared with non-frontier firms ································································· 38 Figure 3.14 Incidence of noncompetitive procurement for transport, utilities, and construction projects ························································ 38 Figure 3.15 Three-quarters of frontier firms are LLCs and PLCs ······································································································································· 39 Figure 3.16 Most non-frontier firms are sole proprietorships or partnerships ············································································································ 39 Figure 3.17 A higher share of frontier firms have either a line of credit or loan from a financial institution ······················································· 40 Figure 3.18 Bangladesh has a low score of regulatory quality ········································································································································· 40 Figure 3.19 Firms in Bangladesh face longer waiting times and high variation in the implementation of regulatory services ··················· 41 Figure 3.20 Bangladesh scores particularly low in government effectiveness compared with peers ·································································· 41 Figure 3.21 Bangladesh’s rule of law score is significantly lower than most peers’ scores ······················································································· 41 Figure 4.1 RMG manufacturers and exporters enjoy the lowest corporate tax rates ······························································································ 45 Figure 4.2 Exports enjoy the lowest lending caps ····························································································································································· 46 Frontier Firms and Job Creation in Bangladesh 3 FIGURES and TABLES Figure 4.3 Frontier RMG firms rely substantially on imports ·········································································································································· 47 Figure 4.4 RMG firms are concentrated in EPZs . . . ···························································································································································· 48 Figure 4.5 . . . compared with the share of RMG firms outside EPZs ····························································································································· 48 Figure 4.6 Firms in EPZs generate 10 times more revenue than firms outside such zones ···················································································· 48 Figure 4.7 The REER was stable until 2011, appreciating thereafter ····························································································································· 49 Figure 4.8 Annual export growth declined following appreciation of the REER, but less so for the RMG sector ··········································· 49 Figure 4.9 The value of RMG exports and Bangladesh’s share of the global market have soared since 1993 ·················································· 50 Figure 4.10 The number of RMG factories and workers has multiplied since 1993 ···································································································· 50 Figure 4.11 The link between RMG exports and employment growth has deteriorated ························································································· 51 Figure 4.12 The RMG sector’s number of employees relative to exports has declined precipitously ··································································· 51 Figure 4.13 Bangladesh has the lowest tax to GDP ratio among peers ························································································································· 52 Figure 4.14 Corporate tax incentives constituted the bulk of direct tax expenditures in 2021 ·············································································· 52 Figure 4.15 Import duties on final goods are much higher than on intermediate inputs ························································································ 53 Figure 4.16 Bangladesh’s exports were concentrated in textiles in 2021 ······················································································································ 53 Table 4.1 Sectoral affiliation of bonded warehouses is dominated by RMG and related industries ································································· 47 Frontier Firms and Job Creation in Bangladesh 4 Acronyms and abbreviations Acronyms and Abbreviations Acronym Definition BAB Bangladesh Association of Banks BCA Banking Company Act of 1991 BKMEA Bangladesh Knitwear Manufacturers and Exporters Association BGMEA Bangladesh Garment Manufacturers and Exporters Association BW bonded warehouses EDF Export Development Fund EPZ export processing zone FBCCI Federation of Bangladesh Chambers of Commerce and Industry FDI foreign direct investment FOB Free on Board (price) GDP gross domestic product ICA 2.0 Investment Climate Assessments 2.0 ILO International Labour Organization LDC least developed country LEED Leadership in Energy and Environmental Design LLC limited liability company LMEs large and medium enterprises MFA Multi-Fiber Agreement MNE multinational enterprise NBR National Board of Revenue NPL nonperforming loan OECD Organisation for Economic Co-operation and Development PLC public limited company REER real effective exchange rate RJSC Registrar of Joint Stock Companies and Firms RMG ready-made garments SMEs small and medium enterprises SMI Survey of Manufacturing Industries SRO statutory regulatory order TFP total factor productivity TIN tax identification number Tk Bangladeshi taka UN Comtrade United Nations Commodity Trade Statistics Database UNCTAD United Nations Trade and Development US$ United States dollar VA value added VAT value added tax WBES World Bank Enterprise Survey WDI World Development Indicators WEO World Economic Outlook WGI Worldwide Governance Indicators Frontier Firms and Job Creation in Bangladesh 5 Executive Summary Executive Summary Bangladesh has made notable developmental progress over the past two decades. Economic growth has been among the top 10 percent globally, and poverty has been reduced by 80 percent over the same period. Exports also saw a dramatic jump from US$6.5 billion in 2000 to US$57.5 billion in 2023. The private sector has played a critical role in this success, spurred by public policy that allowed the ready-made garments (RMG) sector to reach new heights. Bangladesh’s impending graduation from the United Nations’ least developed country (LDC) category in 2026 is a testament to these successes. The question is whether the country is now poised to continue this remarkable performance in the future under the current policy regime, especially in light of some disagreeable changes in the external environment and the emergence of new challenges at home. This report focuses on one of these challenges—namely, that of creating sufficient productive jobs through the private sector for a rapidly growing labor force. The shortfall in job creation is well documented. A World Bank jobs diagnostic report (Farole et al. 2017) and another more recent report on jobs and resilience (World Bank 2024) pointed out that, although Bangladesh’s economic growth over the previous decades was significantly fueled by labor, this trend had markedly decelerated in recent years. From 2013 through 2022, the working-age population grew annually by 1.5 percent, significantly outpacing the 0.2 percent growth in employment. The situation is even more challenging for young people, who face additional hurdles in transitioning from education to employment, often with inadequate market-relevant skills. The 2024 Quota Reform Movement, which ignited a series of protests by students that turned deadly and ultimately led to the ouster of the regime, underscores the urgency of addressing the problem of job creation. What makes meeting the job creation challenge more acute is that the current structure of the economy is not likely to generate the quantity and quality of jobs that Bangladesh needs. Although economic growth over the past two decades has been impressive, the pace of job creation has not matched this achievement. The responsiveness of job growth to gross domestic product (GDP) growth has lagged peers, and measures of the quality of jobs fell short of what was expected given the level of the country’s GDP. The pattern of structural transformation shows that jobs have not been created in the most productive segments of the economy, with productivity growth in services remaining stagnant since 2016. Numerically, labor productivity in Bangladesh systematically lagged peers, with firms about 66 percent less productive than their neighbors in South Asia. Within firms, productivity-enhancing investments in capital and new technologies have been scarce. Similarly, foreign direct investment, a crucial conduit for new and more productive technologies, was meager. Frontier Firms and Job Creation in Bangladesh 6 Executive Summary As for the private sector, it can be divided between frontier firms that demand high-skilled workers and non-frontier firms that host most jobs but have limited prospects of output and productivity growth. Frontier firms are defined in this report as the top 10 percent of all firms in terms of their level of productivity. They have been the drivers of Bangladesh’s economic performance over the past 10 years, making up three-quarters of all formal firms’ revenues in the country. Frontier firms are on average about 11 times as productive as other firms, produce 70 percent of the country’s exports, and are concentrated in the garments sector and tend to operate in export-processing zones. They also exist less extensively in other services and manufacturing. Consistent with their higher labor productivity, frontier firms pay higher wages, employ more skilled workers, and are more capital intensive than non-frontier firms. The problem is that they employ only 15 percent of all formal workers, whereas non-frontier firms that host the vast majority of Bangladesh’s labor force operate well below the productivity frontier, rely on more basic production technologies, and offer lower-skill, lower-paying jobs. Much of the conventional wisdom to promote competitiveness and job creation in Bangladesh amid its LDC graduation is arguably not likely to resolve the job creation challenge. It is often recommended that Bangladesh would be well advised to spur exports through diversification and climb up the global value chain ladder through investments in digital and automation technologies while matching those with high- skilled workers (for example, Berg et al. 2021; Gu, Nayyar, and Sharma 2021). These suggestions are desirable in their own right and can indeed be justified on the grounds of maximizing the benefits to Bangladesh from globalization, but they are likely to be more beneficial to frontier firms and high-skill workers because they rely on capital-intensive technologies, which are in short supply for most firms. Added to this, skill-biased technological change and globalization tend more broadly to favor frontier firms over non-frontier ones (Acemoglu and Restrepo 2019; Diao et al. 2021). Accordingly, the next wave of transformation to attain inclusive growth in Bangladesh is not likely to come merely from advancing the interests of the leading firms but also from empowering all firms. This is the main argument of this report. What Bangladesh needs to do to address the job creation challenge is to ensure that all firms—frontier and non-frontier—have the opportunity to grow and to be more productive. How to do so is arguably the most important developmental question facing Bangladesh today. To provide some insights into the answer, this report assesses the performance of frontier and non-frontier firms and identifies their characteristics, explores the features of the business environment that merit reforms, identifies the shortcomings of the prevailing pattern of selective government interventions, and offers a set of policy recommendations for the next wave of transformation. The report distinguishes itself from previous studies in several ways. First, it puts forward a new perspective on how to create productive jobs in Bangladesh, not only by relying on frontier firms but also by empowering non-frontier ones. Second, besides updating the features of the business environment in Bangladesh and documenting the divergent experiences of frontier and non-frontier firms, it offers a fresh analysis of the pattern of selective government interventions and its underlying causes. Third, the report goes beyond assessing various policy instruments and delves into issues related to the capacity of the state in Frontier Firms and Job Creation in Bangladesh 7 Executive Summary designing and implementing them, along with some discussion of the political dynamics of the relationship between the state and frontier firms. Finally, the report puts together a policy reform agenda that has the potential of supporting the government of Bangladesh in its effort to meet the challenge of creating decent and productive jobs through the private sector. One of the report’s most important messages is that the past strategy of combining export promotion for frontier firms and import substitution for the rest of the firms has run its course. On the plus side, there is little doubt that export promotion policies have resulted in a resounding success of the RMG sector and that this has contributed to Bangladesh’s impressive developmental track record. However, there are growing concerns that overreliance on RMGs is not in the best interests of Bangladesh going forward. The positive impact of the sector on creating jobs is diminishing: the sector’s number of employees relative to the value of its exports is just half what it was 10 years ago. Its share of female employment has also dropped from 90 percent in the 1980s to 50 percent today, and women’s retirement age in the sector currently stands at just 35 years. The fiscal cost of supporting RMG exporters is also sizable. Corporate tax exemptions, which include favorable rates to RMGs, amounted to 2.4 percent of GDP in 2021. Combined with a host of other tax exemptions and limited coverage of taxpayers, Bangladesh’s ratio of tax revenues to GDP is one of the lowest in its region. Furthermore, with over 80 percent of Bangladesh’s exports entering preferential markets, the impending LDC graduation is forecast to result in a 7 percent to 14 percent reduction in exports. Meanwhile, the nonexporting sectors continue to operate within an import substitution strategy, which accords them heavy protection and restrained competiton. As a result, these firms tend to be less productive, and therefore are able to offer only lower-paying jobs. Going forward, a new strategy and a new set of policies are much needed. Starting with the business environment, the reform agenda should aim at making it more friendly to both non-frontier and frontier firms. Currently, there are several shortcomings that frontier and non-frontier firms must endure. However, by virtue of their capabilities and resources, and the room for discretion in the implementation of regulations, frontier firms seem to be able to navigate better through the complex regulatory environment. Based on the evidence provided in this report, it takes non-frontier firms a longer time to secure regulatory services compared with their frontier counterparts. Frontier firms also enjoy better public services, such as fewer and shorter power outages, leading to lower revenue losses than non-frontier firms. These disparities can be reduced by simplifying the regulations themselves, reducing the room for discretion in their implementation, and strengthening the government’s capacity to enforce the rules. Similarly, it is time for the government to evaluate and rationalize its pattern of selective interventions. Currently, frontier firms benefit from lower corporate tax rates, an array of ad hoc discretionary tax exemptions, along with access to preferential credit, lending caps, and numerous interest rate subsidy programs primarily targeting RMG exporters. At the same time, the trade regime heavily favors RMG exporters by enabling them to enjoy duty-free imports while according other sectors protection from competition from imports by maintaining high tariffs. The combined effects of both features are to encourage a few exporting firms in the frontier segment of the economy and to make sales in the domestic market more profitable for the others. Frontier Firms and Job Creation in Bangladesh 8 Executive Summary This pattern of selective intervention, born from clientilistic state–business relations, is not consistent with sustainable and inclusive development, nor does it enhance the capacity of the economy to create decent and productive jobs. To convert the proposed strategy into action, the report advocates a set of concrete policy and institutional reforms under the headings of the business environment, industrial policy, and state capacity. The key recommendations are summarized below. Reforming the business environment entails the following measures: 1. Reducing transaction costs for firm entry, operation, and exit is essential for improving the business environment. In Bangladesh, facilitating the entry of new firms requires simplifying the registration procedures (for example, to establish a limited liability company) and consolidating licensing processes, introducing a provisional licensing system and developing sector-specific guidelines for permits, and exempting newly established firms from mandatory annual audit fees in their first years of operation unless they surpass a certain revenue threshold. Based on consultations with stakeholders, the cost of starting a business in Bangladesh amounts to approximately US$ 10,000. This significant expense poses a challenge, particularly for new companies. The total includes RJSC registration, obtaining a trade license, and annual audit fees, regardless of the size of firm revenues. Reducing operational costs requires streamlining regulatory procedures and developing a centralized online platform for all applications, combined with strict processing timelines, robust anti-corruption measures, and providing regular training on ethical standards for officials. Finally, reducing transaction costs for the exit of firms requires clear bankruptcy regulations, simplified legal procedures to ensure smooth business discontinuation or transformation, more efficient allocation of resources, and protection of the interests of all relevant stakeholders. 2. Addressing glaring bottlenecks in public services, particularly in the area of energy provision, can be done by investing in binding bottlenecks in energy infrastructure, upgrading the national grid, and expanding access to alternative energy sources to ensure a stable power supply and reduce reliance on costly generators. It would also be desirable to enforce competitive procurement practices in awarding public contracts in transport, utilities, and construction, which would improve the efficient provision and quality of these utilities. 3. Promoting consistency in the implementation of regulations across all firms, frontier and non- frontier, which involves streamlining the rules themselves and empowering regulatory officials through capacity-building programs. Increasing transparency through digitizing administrative processes and conducting regular performance audits can also reduce opportunities for corruption and ensure equal treatment across firms, sectors, and regions. Frontier Firms and Job Creation in Bangladesh 9 Executive Summary Reorienting industrial policy involves the following measures: 4. Adopting a more effective industrial policy by embracing a strategic, data-driven approach to diversification in support of economic growth and job creation at the levels of sectors and main products. This process should begin with evaluating existing selective interventions (such as the Export Development Fund and the duty drawback systems), followed by designing new policies that support activities with high growth and job creation potential. The evaluation can be guided by whether existing policies have clear performance metrics (such as those used in the RMG sector), include specific sunset clauses, and target activities (such as experimental ventures and innovation) rather than sectors. 5. Aligning broad policies with export promotion and competitiveness, which would critically require maintaining a competitive exchange rate regime to make exports more attractive than selling in the domestic markets. Similarly, reducing the import-substitution bias by making tariffs more neutral would work in the same direction (through implementation of the National Tariff Policy of 2023). Finally, diversification of exports can be enhanced further by improving market access (for example, by signing new FTAs), providing assistance for compliance with newly introduced international standards, and working toward building better trade logistics. 6. Encouraging innovation over lobbying, which could be done by providing support to horizontal industrial policies such as education, training, and research and development activities. It could also be pursued by supporting the adoption of new technologies and establishing business incubators and innovation hubs. In all cases, it is important to limit lobbying influence and rent-seeking behavior, especially in relation to frontier firms. 7. Dedicating special attention to designing an appropriate industrial policy for services, given its increasing role in job creation and economic growth. This would entail a new strategy targeting the removal of the constraints faced by firms across information technology, financial services, tourism, health care, and small and medium enterprises more broadly. It could further involve some measures of support, provided that they are well designed. 8. Shifting away from a top-down approach to a collaborative and adaptive strategy in the design of industrial policy to ensure the responsiveness and effectiveness of the new policies. It is important, though, that the outcome of such a dialogue serves the public interest—and not that of the few. Strengthening institutional capacity through the following measures: 9. Strengthening the capacity of key state institutions and establishing a clear definition of their roles to improve Bangladesh’s business environment and its industrial policy regime. For example, it would be desirable to reform the National Board of Revenue by separating tax policy development from tax Frontier Firms and Job Creation in Bangladesh 10 Executive Summary collection so as to enhance its efficiency and reduce internal conflicts of interest. As another example, enhancing the independence of Bangladesh Bank by minimizing political interference would enable it to practice more effective oversight of the banking sector, creating a stable financial environment that supports sustainable economic growth. Finally, the modernization of land administration by updating land records and reducing discretionary decisions by officials is essential to improving transparency and efficiency. 10. Adapting to new circumstances and capitalizing on opportunities. Given that reform is an ongoing and dynamic process, it is important that government institutions continuously monitor any new developments and make the necessary adjustments to respond to these changes and take advantage of any emerging opportunities. This requires strengthening monitoring and evaluation (M&E) systems. The remainder of the report is structured as follows: Chapter 1 assesses the capacity of the economy of and the private sector to generate adequate jobs for a rapidly growing labor force in Bangladesh. Chapter 2 explores these same questions, with a focus on frontier firms. Chapter 3 explores the extent to which the business environment, both de jure and de facto, is friendly across firms and sectors. Chapter 4 evaluates the merits of government interventions, through such instruments as subsidies, taxes, and preferential regulatory rules, with a view to identifying where reforms may be needed. Chapter 5 provides a set of mutually enforcing policy recommendations. Frontier Firms and Job Creation in Bangladesh 11 1. Economic growth, productivity, and job creation 1. Economic growth, productivity, and job creation With a particular focus on economic growth and structural transformation, this chapter assesses the ability of the economy of Bangladesh to generate good and productive jobs relative to the needs of the country. It first looks at the trend and pattern of economic growth in recent years in relation to the rate of job creation. It then delves into issues of productivity and structural transformation, given their critical role in contributing to the creation of decent and productive jobs. 1.1 Economic growth and job creation Bangladesh has made notable developmental progress. Numerically, economic growth has consistently surpassed the global average and remained largely above the threshold of the 90th percentile for most of the past couple of decades (figure 1.1). Alongside this growth, and since the mid-1990s, poverty was reduced from over 30 percent of the population living under the US$2.15 per day poverty line to just 5 percent in 2022 (figure 1.2). The private sector has increasingly played a critical role in this success, particularly firms engaged in ready-made garments (RMG) exports. Bangladesh’s impending graduation from the United Nations’ least developed country category in 2026 is a testament to these successes. Frontier Firms and Job Creation in Bangladesh 12 1. Economic growth, productivity, and job creation Figure 1.1 Figure 1.2 Bangladesh’s growth track record has been impressive from Poverty plummeted between 1995–2022 2000 through 2018 8 80 Poverty headcount ratio (% of population) 7 70 6 60 5 50 GDP Growth (%) 4 40 3 30 2 20 1 10 0 0 2001 2002 2016 2017 2018 2019 2000 2003 2004 2005 2006 2007 2008 2010 2011 2012 2013 2014 2015 2009 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Bangladesh Global average Global 90th percentile $3.65 a day (2017 PPP) $2.15 a day (2017 PPP) Source: World Economic Outlook Database. Source: World Bank calculations based on World Development Indicators Database. Note: PPP = purchasing power parity. However, this impressive track record has not been matched by equal success in job creation. In recent years, real gross domestic product (GDP) growth averaged 6.4 percent between 2018 and 2024, but, as shown in figure 1.3, job growth fell below what was expected given the country’s level of economic growth. Additionally, while Bangladesh’s employment elasticity of growth, which measures the responsiveness of job creation to economic growth, was higher than that of some neighboring countries, it was much lower than regional peers such as Indonesia, the Philippines, and Viet Nam (figure 1.4). Although these measures are not without limitations, they suggest that economic growth has not translated effectively into job creation. Figure 1.3 Figure 1.4 Job creation has not matched economic growth The employment elasticity of growth lagged aspirational peers between 2018 and 2024 between 2000 and 2024 5 Viet Nam 0.49 Job growth, average 2018-24 (%) 4 Philippines 0.48 Indonesia 0.46 3 Türkiye 0.32 2 Bangladesh 0.28 Bangladesh India 0.24 1 Nepal 0.19 Sri Lanka 0.14 0 4 -2 0 2 4 6 8 0 0.1 0.2 0.3 0.4 0.5 0.6 1 GDP growth, average 2018-24 (%) Elasticity Source: ILO 2012 and World Economic Outlook. Source: World Bank calculations based on World Economic Outlook and ILOSTAT. Note: GDP = gross domestic product. Black line is a linear prediction of job growth on GDP growth. Frontier Firms and Job Creation in Bangladesh 13 1. Economic growth, productivity, and job creation The working-age population in Bangladesh has grown faster than employment growth, particularly among young people, exacerbating the unemployment rates. From 2013 through 2022, the working-age population grew annually by 1.5 percent, significantly outpacing the 0.2 percent growth in employment (figure 1.5). This disparity led to a 2 percent yearly rise in unemployment, reaching 5.5 percent in 2022. The situation is even more challenging for young people. Although the population of ages 15 through 24 remained relatively stable between 2013 and 2022, its share in employment shrank by an average of 3.4 percent per year, increasing their unemployment rate from 10 percent to 16 percent (figure 1.6). Figure 1.5 Figure 1.6 The working-age population is growing faster than Unemployment is rising, new employment opportunities, 2013–22 especially for youth ages 15 through 24, 2013–22 18 Working-age population, Population 1.5 16 ages 15–64 14 Employment 0.2 Rate of unemployment (%) 12 Unemployment 2.0 10 8 Population 0.0 6 ages 15–24 Youth, Employment 3.4 4 2 Unemployment 5.6 0 4.0 3.0 2.0 1.0 0 1.0 2.0 3.0 4.0 5.0 6.0 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 Average annual growth rate 2013-22 (%) Unemployment, 15–64 Unemployment, 15–24 Source: ILOSTAT. Source: ILOSTAT. The reduction in the contribution of labor to GDP growth signals that lower-skilled workers might not have been benefiting from growth. Between 2000–05 and 2012–17, capital’s contribution to GDP relative to labor increased, indicating a shift toward a more capital-intensive economy. For workers, capital deepening can be advantageous if it leads to wage and employment growth. However, it might also mean that workers are not benefiting enough from the gains in productivity—for example, if routine tasks are substituted by information technology—negatively impacting lower-skilled labor the most (Autor and Dorn 2013; Goos, Manning, and Salomons 2014). In Bangladesh, the reduction in labor’s share for the lowest 80 percent of the income distribution (figures 1.7 and 1.8) is consistent with this prediction. This trend can have broader adverse economic effects as well because declining labor shares can negatively influence key macroeconomic variables such as household consumption, private investment, net exports, and government consumption (ILO 2012). Frontier Firms and Job Creation in Bangladesh 14 1. Economic growth, productivity, and job creation Figure 1.7 Figure 1.8 Labor’s contribution to growth declined The share of income accruing to the bottom 80 percent between 2000 and 2017 of earners is decreasing 100 50 5 90 16 45 4 30 33 Share of real GDP growth (%) 80 40 3 Share of total income (%) Income share grwoth (%) 70 30 35 2 60 18 30 17 1 50 25 0 40 20 1 30 15 54 52 49 20 10 2 10 5 3 0 0 4 20002005 20062011 20122017 Bottom 40% Middle 40% Top 20% Capital stock Labor Total factor productivity Share Growth (RHS) Source: World Bank calculations based on World Development Indicators Database. Source: ILOSTAT. Note: RHS = Right-hand side. Available measures of job quality also suggest that Bangladesh is underperforming relative to its GDP. Generally, a good-quality job is one that provides sufficient earnings to raise living standards, offers adequate benefits, ensures job security and safety, and fosters job satisfaction. Taking this multitude of factors into consideration, one study covering 40 countries (Hovhannisyan et al. 2022) found that job quality in Bangladesh was lower than expected, given its GDP per capita, and that its rank was below peers such as Sri Lanka (figure 1.9). Figure 1.9 Bangladesh has a low job quality measure 30 25 GDP per capita (US$, thousands) 20 15 Sri Lanka 10 5 Bangladesh 0 1 1.5 2 2.5 3 3.5 4 JQM for wage employees Source: Hovhannisyan et al. 2022. Note: JQM = job quality measure. Frontier Firms and Job Creation in Bangladesh 15 1. Economic growth, productivity, and job creation 1.2 Structural transformation and job creation Two factors have contributed to labor’s declining share in GDP growth in Bangladesh, namely, low labor productivity and limited structural transformation. For the former, available evidence indicates that labor productivity in Bangladesh was the lowest among its peers during the period 2010 through 2019 (figures 1.10 and 1.11). The average output per worker in Bangladesh in 2019 was just 72 percent of that of workers in India, one-half those in Indonesia, one-third of those in Sri Lanka, and only one-fifth of those in China. Despite some improvement over time, labor productivity remained relatively low compared with those peers. It’s important to note that labor productivity is only a partial measure because it excludes the contributions of capital and efficiency improvements. Nonetheless, it is still suggestive of the variations in performance. Figure 1.10 Figure 1.11 Bangladesh had the lowest output per worker among its peers Growth in value added is moderate despite its low base Bangladesh 8 7 China China Growth in value added per worker, 6 Viet Nam India Philippines 2019, three-year average 5 Indonesia 4 India Nigeria Bangladesh Sri Lanka 3 Pakistan Türkiye 2 Indonesia Philippines 1 Pakistan Sri Lanka 0 Türkiye 0 5 10 15 20 25 30 35 1 Viet Nam 2 0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 Nigeria 3 Value added per worker (2015 US$) Overall value added per worker, 2019 2010 2019 Source: World Bank calculations based on World Development Indicators Database. Source: World Bank calculations based on World Development Indicators Database. Note: Value added per worker is defined as the ratio between the total value added Note: Value added per worker is defined as the ratio between the total value added generated by an economy and the total number of workers employed in the economy. generated by an economy and the total number of workers employed in the economy. Figure 1.12 Firms in Bangladesh are the least productive among their peers in the South Asia region The shortfall in productivity is equally present in manufacturing and services. Firms in manufacturing and services in Bangladesh were Manufacturing -.65 on average about 66 percent less productive than their peers in other South Asian countries (figure -.66 1.12). This is a worrisome indicator from the Services perspectives of growth and the creation of decent and productive jobs. 0 Log of sales per worker Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Note: For this figure, the peers of the South Asia region are firms in Afghanistan, Bhutan, India, Nepal, and Pakistan. Regression of log sales per worker on dummy for manufacturing and services firms in Bangladesh after controlling for sector, location, firm size, and firm age. Frontier Firms and Job Creation in Bangladesh 16 1. Economic growth, productivity, and job creation With respect to structural transformation, the evidence shows that job creation has not occurred in the most productive segments of the economy. Services have become the largest employer in Bangladesh, with the share of the working-age population employed in the sector increasing from 35 percent to 41 percent between 2010 and 2019 (figure 1.13). This trend was balanced by a decline in the share of workers in agriculture, where employment declined from 47 percent to 38 percent over the same period. Although services are significantly more productive than agriculture, the drawback of this trend is that labor productivity growth in services has been stagnant since 2016 (figure 1.14). In the meantime, while industry has experienced a steady rise in productivity, making it 14 percent more productive than services, employment in the sector has remained low and relatively stable between 2010 and 2019. These trends inhibit overall productivity growth in the economy. In fact, had productivity growth in services matched that of manufacturing, aggregate labor productivity in the economy would have been 20 percent higher in 2020 (figure 1.15). Figure 1.13 Figure 1.14 Sectoral employment shares, 2010–19 Labor productivity by sector, 2010–19 50 6 Sectoral employments shares (percent) 45 5 40 Labor productivity 35 4 30 25 3 20 2 15 10 1 5 0 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Agriculture Industry Services Agriculture Industry Services Overall Source: World Development Indicators Database. Source: World Development Indicators Database. Note: Labor productivity is defined as the ratio between the total value added Note: Labor productivity is defined as the ratio between the total value added generated by a sector and the total number of workers employed in the sector. generated by a sector and the total number of workers employed in the sector. Figure 1.15 The sluggish pattern of structural transformation Actual and modeled value added per worker is consistent with the finding that most 5.0 productivity growth has been driven by within- 4.5 sector and within-firm gains, rather than cross- Value added per worker sectoral reallocation. Figure 1.16 presents the 4.0 results of an aggregate productivity decomposition 3.5 of the economy, which indicates that most 3.0 productivity growth has been driven by within- sector productivity gains. Static reallocation—the 2.5 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 shifting of resources across activities of similar Actual Sector shares fixed productivity levels—accounts for about half Source: World Bank calculations based on World Development Indicators Database. as much. Demographic change and dynamic Note: Value added per worker generated by a sector and the total number of workers employed in the sector. In the figure, the hypothetical level of value added per worker reallocation (that is, resources shifting from lower- is reported if the labor shares of manufacturing and services sectors would have remained at the same level as in 2010. to higher-productivity activities, have played a lesser Frontier Firms and Job Creation in Bangladesh 17 1. Economic growth, productivity, and job creation role. Figure 1.17 presents a more in-depth look into the drivers of aggregate labor productivity growth in manufacturing. Overall manufacturing productivity is driven almost entirely by improvements within firms—not from labor reallocating from less- to more-productive ones. In other words, more-productive manufacturing firms are not employing more workers in Bangladesh, possibly reflecting restrictions and inefficiencies that are distorting the domestic markets. Figure 1.16 Figure 1.17 Most productivity growth stems from within-sector More-productive manufacturing firms in Bangladesh do not improvements rather than cross-sector reallocation of factors employ more workers of production 12 Demographic change 10 Participation rate 8 Employment rate 6 Dynamic reallocation 4 Static reallocation 2 Wtihin-sector productivity 0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 Sources of productivity growth Allocative efficiency Within-firm productivity Source: World Bank calculations based on World Development Indicators Database. Source: Bangladesh Bureau of Statistics, “Survey of Manufacturing Industries (SMI)-2019,” Data covers 2000–17. July 2020, based on 9,000 firms. Note: Using the Shapley method, per capita output growth is decomposed into four Note: Labor productivity is decomposed following Olley and Pakes (1995). Allocative components: productivity growth, employment growth, labor force growth, and efficiency measures to what extent more-productive firms employ more workers. change in working-age population. Sector and firm productivity differentials have been widening over time. The 10 percent most productive firms in manufacturing are 14 times as productive as the bottom 10 percent (figure 1.18). Although this productivity differential is sizable, it is substantially larger among firms in services, where the top 10 percent most productive firms produce 35 times more sales per worker than the bottom 10 percent. In both sectors, there is a small group of highly productive firms, while most firms are substantially less productive, as illustrated by the skewed productivity distributions (figure 1.19). In services, an even larger number of firms has lower productivity levels. One of the implications of the falling gap between agriculture and low-productivity service activities is a weakening of incentives for less-skilled workers to move away from agriculture. Frontier Firms and Job Creation in Bangladesh 18 1. Economic growth, productivity, and job creation Figure 1.18 Figure 1.19 The top 10 percent most productive firms produce 35 times Few higher-productivity firms coexist more sales per worker than the bottom 10 percent in services with many low-productivity firms, especially in services 0.6 14 Manufacturing 5 0.4 Density 35 0.2 Services 9 0 0 5 10 15 20 25 30 35 40 6 8 10 12 14 Distribution of sales per worker (US$ 2009, logged) Productivity 90–10 percentile Productivity 80–20 percentile Manufacturing Services Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Note: Distribution of log sales per worker among manufacturing and services firms. Note: Distribution of log sales per worker among manufacturing and services firms. The limited presence of new and young firms signals a lack of dynamism in the private sector, along with limited opportunities for job creation. New and young firms are often important sources of job creation and are more likely to adopt innovative technologies and business practices, which can directly enhance the productivity of their workers. Bangladesh has few such firms to drive productive job creation. Just 21 percent of all formal firms in Bangladesh have started operations since 2012 (figure 1.20). This share of young firms is only half of that among Viet Nam’s private sector, where 40 percent of firms started operating after 2012. Firms in Bangladesh tend to be much older than those in peer countries (figure 1.21) and exhibit signs of stagnation. Figure 1.20 Figure 1.21 Bangladesh has fewer young firms compared with peers Firms in Bangladesh are older than those in peer countries 45 25 40 Share of young firms (10years or less) 40 36 20 35 30 29 Firm age (years) 15 25 21 20 10 15 10 5 5 0 0 Bangladesh 2022 India 2022 South Asia Viet Nam 2023 ia e sh ia es am ina a d ye e si an od In d pin rki Ch tN la d ail mb on Tü ili p Vie Th In d ng Ca Ph Ba Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Note: South Asia is the average for this region in the past 10 years. Young firms are those that started operating in the past 10 years. Frontier Firms and Job Creation in Bangladesh 19 1. Economic growth, productivity, and job creation Bangladesh’s low rate of new firm entrants in the formal private sector indicates the presence of barriers to entry, which inhibit efficient resource allocation and productive job creation. Although Bangladesh registered about 4,500 new limited liability companies (LLCs) in 2018, that was the lowest rate of newly registered LLCs per 1,000 working-age people (ages 15 through 64) among peer countries (figure 1.22).1 The low investments in new firms have resulted in a low business density: only 1.5 LLCs exist for 1,000 working- age people, which is one of the lowest rates among peer countries (figure 1.23). In the Philippines and Thailand, for example, 10.7 and 5.5 LLCs exist per 1,000 working-age people, respectively. The low share of young firms and low number of formal firms limit the opportunities for well-paid jobs in Bangladesh and point to significant barriers to entry. Figure 1.22 Figure 1.23 Bangladesh has the fewest registered firms relative to market Bangladesh is tied with India for the lowest business density size compared with peer countries, 2018 among peers, 2018 10 70 8.7 62.3 9 New companies per 1,000 adults 60 Companies per 1,000 adults 8 7 50 6 40 5 4 30 3 20 16.8 2 1.6 1.5 1.4 10.7 1 0.7 10 5.5 5.4 0.3 0.3 0.1 0.04 0 1.5 1.3 0 ** am ye d ia a es* ia e sh e si an ** ye d es* ia e sh ia od In d rki ina an tN pin la d od In d ail on rki ina mb Tü pin la d Ch ail Vie Th mb In d ng ili p Tü Ch Ca Th ng ili p Ba Ca Ph Ba Ph Source: World Bank Entrepreneurship Database 2018, Source: World Bank Entrepreneurship Database 2018, https://www.worldbank.org/en/programs/entrepreneurship. https://www.worldbank.org/en/programs/entrepreneurship. Note: The total (new) business density is defined as the total (new) number of private Note: The total (new) business density is defined as the total (new) number of private limited liability registered firms per 1,000 working-age people (those ages 15–64). limited liability registered firms per 1,000 working-age people (those ages 15–64). * The Philippines is reported in the Eurostat list of offshore financial centers. * The Philippines is reported in the Eurostat list of offshore financial centers. ** For China, only the data for Beijing and Shanghai were included. ** For China, only the data for Beijing and Shanghai were included. Productivity growth and job creation within firms could have been stronger if firms invested and innovated more than they did. At the firm level, the creation of productive jobs hinges on investments in capital and new technologies, which are limited among Bangladeshi firms because of restricted access to finance, the existence of complex regulatory requirements, and a lack of awareness about the benefits of technological upgrades (Gu, Nayyar, and Sharma 2021).2 Compared with their peers, only 3 percent of firms in Bangladesh license a technology from a foreign company, whereas the share is about 10 percent of firms in Indonesia, the Philippines, and Viet Nam (figure 1.24). This implies a forgone opportunity for domestic firms to upgrade the quality of their investment through technology transfer from foreign-owned companies. Moreover, firms’ investments have declined over time, as shown in figure 1.25, which plots the distribution of Bangladeshi firms’ investments in physical capital in 2013 and 2022. Notably, the decline in investment was more pronounced among the bottom half of firms that have invested in physical capital. 1 2018 is the latest year with available data for Bangladesh; the rate was comparably low in earlier years. 2 World Bank (forthcoming) provides a sector-focused analysis of impediments to greater private investment. Frontier Firms and Job Creation in Bangladesh 20 1. Economic growth, productivity, and job creation Figure 1.24 Firms in Bangladesh lag behind their peers in South Asia in investing in new, more-productive technologies and processes 70 60 50 Percent 40 30 20 10 0 Share of firms using technology Share of firms having their own website Share of firms that introduced Share of firms that spend on R&D licensed from foreign companies* a process innovation Bangladesh Cambodia India Philippines Viet Nam China Indonesia Thailand Türkiye Source: World Bank Enterprise Survey 2022 or latest available year for peer countries. Note: R&D = research and development. Foreign direct investment (FDI), a crucial Figure 1.25 conduit for introducing new and more productive Firms’ investments have declined since 2013 technologies, is also scant in Bangladesh. FDI in 0.2 Bangladesh has hovered around 1 percent of GDP, 0.15 which is substantially lower than the average share of Density, weighted FDI to GDP among lower-middle-income countries 0.1 and peers in the South Asia region (figure 1.26). Over the past decade, the utility sector has attracted 0.05 the majority of greenfield FDI in Bangladesh. In 0 0 5 10 15 contrast, very little FDI went to market services, such Volume of investments (US$ 2009, logged) as finance or business services, both of which have 2013 2022 a higher potential for raising productivity among Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Note: The figure shows the density of firms’ investments in 2013 and 2022. domestic firms (figure 1.27). Figure 1.26 Figure 1.27 FDI is scarce among Bangladeshi firms The majority of greenfield investments are directed toward the utility sector 5.0 18,554 4.5 Greenfield FDI (US$, millions) 4.0 Share of FDI in GDP (%) 3.5 3.0 2.5 2.0 1.5 3,933 1.0 2,584 2,237 0.5 1,093 1,106 0 21 0 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 201014 201519 202023 Agriculture Construction Manufacturing Market services Bangladesh LMIC South Asia Mining and quarrying Nonmarket services Utilities Source: World Bank, based on the UNCTAD FDI markets database, https://unctadstat. Source: World Bank, based on the UNCTAD FDI markets database, https://unctadstat. unctad.org/datacentre/dataviewer/US.FdiFlowsStock. unctad.org/datacentre/dataviewer/US.FdiFlowsStock. Note: FDI = foreign direct investment; LMIC = lower-middle-income countries. Note: FDI = foreign direct investment. Frontier Firms and Job Creation in Bangladesh 21 1. Economic growth, productivity, and job creation The low level of FDI in Bangladesh limits also the scope for links and productivity or job spillovers to domestic firms and suppliers. FDI has been found to spur significant productivity spillovers to domestic firms, especially among domestic (non-frontier) manufacturing or services firms supplying products or services to multinational enterprises (MNEs) operating in the country, which have been found to be significantly more productive than local firms. The scant FDI stock in Bangladesh, however, limits the scope for such productivity spillovers to domestic suppliers. Moreover, most FDI in Bangladesh is in the utilities sector (figure 1.27), where firms have fewer links with domestic suppliers, further limiting the scope for spillovers to domestic firms. In contrast, manufacturing or services sectors where large spillovers have been found in other countries have seen modest FDI. Such productivity spillovers or trickling down may also arise from frontier firms sourcing inputs from domestic suppliers (not operating at the domestic productivity frontier). There is, however, little evidence in existing research for such spillovers apart from those by MNEs, making this a crucial area for future research. However, the sizable productivity gaps between domestic frontier and non-frontier firms indicate that these links remain limited and that productivity growth has not, by and large, trickled down to many non-frontier firms. Taken together, the findings so far suggest that Bangladesh’s economy is not poised to generate the quantity and quality of jobs required to meet its needs. The rate of job growth in response to GDP growth lags that of peer countries, and job quality measures do not align with the nation’s GDP level. Structural transformation patterns indicate that job creation has not occurred in the most productive sectors and that productivity growth has been driven more by improvements within firms rather than from reallocation of resources across firms and sectors. But even then, compared with peer countries, within-firm productivity growth in Bangladesh is low because the average investments by firms into productivity-enhancing capital and new technologies are relatively meagre. These features suggest that the economy at large is not likely to generate sufficient jobs in the future. The question discussed next is whether this assertion applies to frontier firms as well. Frontier Firms and Job Creation in Bangladesh 22 2. Frontier firms 2. Frontier firms Despite the low productivity of Bangladeshi firms on average, some of those firms enjoy world-class status. This group of firms, which are defined here as frontier firms based on their superior productivity performance, tend to possess the organizational and operational capabilities to be at the forefront. This chapter delves into their definition and characteristics and assesses whether they hold the potential for creating the productive jobs that Bangladesh needs. 2.1 Definition and characteristics of frontier firms Which firms are considered frontier firms? Frontier firms are defined in this report as the most productive 10 percent of all formal firms. This demarcation follows the approach taken in similar studies (Andrews et al. 2015). The main data source underpinning the analysis is the World Bank’s Enterprise Surveys (WBES) conducted in 2013 and 2022, complemented by the Survey of Manufacturing Industries (SMI) conducted in 2019. The primary measure of productivity used in this report is total factor productivity (TFP), complemented by labor productivity where data were not available. Specifically, although the WBES provide information on the revenues and labor inputs of all firms, they lack full information for about one-half of the firms in the sample with respect to physical capital stock. To cover this limitation, frontier firms are defined here as the 10 percent most productive firms in terms of TFP, augmented by the subset of firms for which no TFP measures were possible but which are among the top 10 percent in terms of labor productivity. Following this definition, frontier firms accounted for 13 percent of all firms in the sample in 2022.3 Notably, frontier firms are defined at the economywide level, and not within individual sectors, which mitigate concerns about potential small sample issues within sectors when identifying frontier firms. The presence of only one or two frontier firms in certain sectors, such as automobiles or smartphone manufacturing, aligns with findings from consultations. A description of WBES data uses for analysis in this and other chapters is provided in the appendix. 3 As a robustness check, we tested alternative definitions of frontier firms—using the top 5 percent and 15 percent of firms as well as labor productivity and TFP alone—and found that the differences between frontier and non-frontier groups remained significant across all definitions. Frontier Firms and Job Creation in Bangladesh 23 2. Frontier firms Frontier firms are about substantially more productive than the average non-frontier firm. Their TFP is 11 times higher than non-frontier firms. As for labor productivity, each worker in a frontier firm generates on average 5.5 times more output than a worker in a non-frontier firm (figure 2.2). These are significant disparities, reflecting a variety of differences in their characteristics. Figure 2.1 Figure 2.2 A small group of firms in Bangladesh is significantly more Frontier firms are substantially more productive than productive than the rest non-frontier firms 0.4 Size (ln. Employment) 0.091 N = 967 0.3 Age (ln.) 0.051 N = 959 Density 0.2 2.4 Labor productivity (ln.) N = 967 0.1 1.7 TFPR (ln.) N = 480 0 10 12 14 16 18 20 0 Value added per worker (US$ 2009) Coefficients on: Frontier firm = 1 Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Note: TFPR = total factor productivity revenue. Labor productivity distribution among all 990 World Bank Enterprise Survey firms. Since the dependent variable is the log of productivity, the coefficient’s effect on actual productivity (rather than its log) is obtained by exponentiating the coefficient. This results in values of 10.02 and 4.47 for labor productivity and total factor productivity, respectively, indicating the corresponding multiplicative changes in productivity. Frontier firms innovate more and have outperformed their competitors in recent years, expanding the productivity gap. Frontier firms grew faster than non-frontier firms between 2019 and 2022. Their sales growth was 13 percent higher over those three years than that of non-frontier firms of comparable size and age and operating within the same state and sector (figure 2.3). Consistently, they also had 11 percent higher labor productivity growth and were 14 percent more likely to invest in fixed assets. Frontier firms invest more in innovation, spend more on research and development, and are more likely to have a website or license foreign technology (figure 2.4). The higher levels of investments in innovation and the hiring of skilled labor are consistent with the findings that manufacturing productivity in Bangladesh is driven by greater efficiency improvements within firms rather than by the allocative efficiency of markets. Frontier Firms and Job Creation in Bangladesh 24 2. Frontier firms Figure 2.3 Figure 2.4 Frontier firms have outperformed their competitors Frontier firms innovate more in recent years, 2019–22 Real annual Introduced new 0.00036 sales growth (%) 13 product or service = 1 N = 911 N = 956 Introduced new/significantly 0.012 improved process = 1 Annual 3.3 N = 951 employment growth (%) Spent on R&D = 1 0.069 N = 946 N = 951 Annual labor Use technology from 11 a foreign company = 1 0.027 productivity growth (%) N = 524 N = 907 Has international 0.12 quality certification = 1 N = 956 14 Buying fixed assets (%) Has its own website = 1 0.19 N = 946 N = 956 0 0 Coefficients on: Frontier firm = 1 Coefficients on: Frontier firm = 1 Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Note: Results are based on regressions of different firm performance variables on a Note: Results are based on regressions of different firm performance variables on a dummy for the most productive frontier firms, controlling for firms’ size, age, location, dummy for the most productive frontier firms, controlling for firms’ size, age, location, and economic sector. and economic sector. Frontier firms account for an increasingly large share of total revenues among formal firms in Bangladesh. The frontier sector made up three-quarters of all revenues of formal firms in Bangladesh in 2022, up from 41 percent in 2013 (figures 2.5 and 2.6). This represents an 80 percent increase in the share of these firms in the total sales of all firms in the formal sector. Figure 2.5 Figure 2.6 Total sales: frontier versus non-frontier firms, 2013 Total sales: frontier versus non-frontier firms, 2022 Non-frontier 26% Frontier 41% Non-frontier Frontier 59% 74% Source: World Bank Enterprise Survey 2013, https://www.enterprisesurveys.org. Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. The ready-made garments (RMG) sector has become increasingly dominant in the group of frontier firms. In 2022, the garments sector alone made up almost one-half of all revenues of formal firms in Bangladesh and 61 percent of the revenue of the frontier segment. This represents a fivefold increase between 2013 and 2022 and has outweighed the chemicals and pharmaceuticals sector, which was the predominant frontier sector in 2013. Other sectors within the frontier firms in 2022 were other services, including personal and business services, representing 15 percent of total revenues. The remaining sectors of food production, retail, textiles, and other manufacturing each contributed less than 10 percent in 2022. Frontier Firms and Job Creation in Bangladesh 25 2. Frontier firms Figure 2.7 Figure 2.8 The garments sector grew from representing less than . . . to almost two-thirds of frontier firms’ sales in 2022 one-quarter of frontier firms’ sales in 2013 . . . Leather Other Services Food Retail Food 2% 2% 4% 1% 3% Retail Other Manufactur Textiles 1% 8% 1% Motor Vehicles & 2% Furniture 0% Other Garments Manufacturing 8% Other Services 5% 15% Garments Chemicals and Non-frontier 45% Pharmaceuticals 60% 17% Non-Frontier 26% Source: World Bank Enterprise Survey 2013, https://www.enterprisesurveys.org. Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. The RMG sector is also heavily present in the non-frontier segment, signaling a significant productivity divide within the sector. The RMG sector made up about one-half of the non-frontier segment in terms of revenue in both 2013 and 2022 (figures 2.9 and 2.10). The strong presence of RMG in both the frontier and non- frontier is consistent with the polarization within the sector as described in a report by Berg and others (2021) as follows: “Bangladesh’s advanced manufacturers are characterized by a high degree of entrepreneurship and strategic management; these firms have made investments in productivity improvement, digitization, automation, and sustainability, and they operate according to international best practices. In contrast, the small operators that make up the majority of the market typically focus on CMT [typically less automated cut, make, and trim mode of operation].” It is also in line with the findings of an ADB (2016) report according to which over 90 percent of the employment in the RMG sector was informal despite its overall export orientation. Figure 2.9 Figure 2.10 The garments sector constituted about one-half of . . . and continued to make up roughly one-half of non-frontier non-frontier firms’ sales in 2013 . . . firms’ sales in 2022 Furniture Other Services Retail Other Services Leather Products 1% 1% Textiles 1% 1% 2% Retail Food 3% 1% Food 0% Other 2% Motor Vehicles Manufacturing Hotels Other 0% 3% 0% Chemicals & Manufactur Garments Pharm. 15% Frontier 17% 3% 40% Frontier Garments 74% 36% Source: World Bank Enterprise Survey 2013, https://www.enterprisesurveys.org. Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Frontier Firms and Job Creation in Bangladesh 26 2. Frontier firms Frontier firms make up most of Bangladesh’s exports. In 2022, frontier firms made up 69 percent of Bangladesh’s exports, up from 37 percent 10 years earlier (figure 2.11). Over the same period, the number of exporting firms in total has halved from 25 percent to 13 percent (figure 2.12). Taken together, these trends show an increased concentration of total export revenues among a narrow segment within the group of frontier firms and suggest that an increasing share of firms are either unable or unwilling to export. Figure 2.11 Figure 2.12 Frontier firms dominated exports in 2022 The overall number of exporting firms has declined since 2013 80 100 69 90 87 88 70 83 63 80 75 78 Share of firms exporting (%) Share of total exports (%) 60 70 50 61 60 40 37 50 31 39 30 40 30 25 22 20 20 17 13 12 10 10 0 0 Not exporting Exporting Not exporting Exporting 2013 2022 2013 2022 Non-frontier Frontier All firms Non-frontier Frontier Source: World Bank Enterprise Survey 2013 and 2022, https://www.enterprisesurveys.org. Source: World Bank Enterprise Survey 2013 and 2022, https://www.enterprisesurveys.org. Note: Exports include both direct and indirect exports. Note: Exports include both direct and indirect exports. Frontier Firms and Job Creation in Bangladesh 27 2. Frontier firms 2.2 Frontier firms and job creation The problem is that while frontier firms generate three-quarters of Bangladesh’s sales, they account for only 15 percent of all formal employment (figure 2.14). The gap between revenues and jobs is even starker in the RMG sector. RMG frontier firms generate almost half of Bangladesh’s total revenues but only one out of 12 formal private sector jobs, which means that empowering other firms and activities is critical from the point of view of creating more and better-paid jobs (figure 2.16). Figure 2.13 Figure 2.14 Share of total employment: frontier firms versus other firms, Share of total employment: frontier firms versus other firms, 2013 2022 Frontier 5% Frontier 15% Non-frontier Non-frontier 95% 85% Source: World Bank Enterprise Surveys 2013, 2022, https://www.enterprisesurveys.org. Source: World Bank Enterprise Surveys 2013, 2022, https://www.enterprisesurveys.org. Note: Employment is the number of permanent, full-time employees. Note: Employment is the number of permanent, full-time employees. Figure 2.15 Figure 2.16 Frontier firms’ employment by sector, 2013 Frontier firms’ employment by sector, 2022 Food Chemicals Other Food 1% 0% Furniture Manufacturing 1% Other 2% Textiles 0% 1% Manufacturing 1% Motor Vehicles & Other Services Retail 0% 3% 0% Leather Retail Garments 1% 0% 8% Other Services Garments 0% 2% Non-frontier Non-frontier 95% 85% Source: World Bank Enterprise Surveys 2013, 2022, https://www.enterprisesurveys.org. Source: World Bank Enterprise Surveys 2013, 2022, https://www.enterprisesurveys.org. Note: Employment is the number of permanent, full-time employees. Note: Employment is the number of permanent, full-time employees. Frontier Firms and Job Creation in Bangladesh 28 2. Frontier firms Among non-frontier firms, employment grew in services and declined in manufacturing. Between 2013 and 2022, the share of employment in services tripled, from 5 percent to 15 percent (figures 2.17 and 2.18). The RMG sector remained the dominant employer in the non-frontier segment, but its share declined from 58 percent in 2013 to 53 percent in 2022. Meanwhile, the share of other manufacturing firms declined more sharply, from 26 percent to 8 percent over the same period. One manufacturing sector that saw a notable jump in employment growth was textiles (the fabric from which garments are made), rising from almost zero to 9 percent. Figure 2.17 Figure 2.18 Non-frontier firms’ employment by sector, 2013 Non-frontier firms’ employment by sector, 2022 Food Furniture Food Hotels Other Services 2% 1% Leather Products 3% 1% 3% 1% Other Services Chemicals & Retail 5% Pharm. 0% Retail 4% 6% Motor Vehicles Frontier 0% Other 5% Manufacturing 8% Other Garments Textiles Garments Manufactur 58% 9% 53% 26% Frontier 15% Source: World Bank Enterprise Surveys 2013, 2022, https://www.enterprisesurveys.org. Source: World Bank Enterprise Surveys 2013, 2022, https://www.enterprisesurveys.org. Note: Employment is the number of permanent, full-time employees. Note: Employment is the number of permanent, full-time employees. Within manufacturing, most jobs are created in Figure 2.19 younger non-frontier firms that started operating in Most manufacturing jobs are in younger non-frontier firms the past 20 years. Formal private sector employment 400,000 in the manufacturing sector is concentrated in younger manufacturing firms that do not operate at 300,000 the productivity frontier (figure 2.19). Removing the constraints facing these firms and any prospective 200,000 entrants and enabling them to grow and become 100,000 more productive is thus key to facilitate the creation of more productive jobs in the country. 0 0-4 5-9 10-14 15-20 20+ Frontier Non-Frontier Source: Bangladesh Bureau of Statistics, “Survey of Manufacturing Industries (SMI)-2019,” July 2020. Note: Total number of manufacturing employees by age group. Frontier Firms and Job Creation in Bangladesh 29 2. Frontier firms Figure 2.20 The capital intensity in the garments sector is lower than Frontier firms have become much more capital- among the rest of manufacturing intensive over time, meaning that a much higher 1,400,000 amount of capital is needed to create a job. Figure 1,200,000 2.20 shows the evolution of firms’ capital-to-worker 1,000,000 ratio between 2013 and 2022 among frontier and 800,000 non-frontier manufacturing firms. The capital 600,000 intensity among garments firms grew by 70 percent 400,000 between 2013 and 2022; the capital intensity in the 200,000 0 rest of the manufacturing sector increased even 2013 2022 more—by 166 percent in the same period. In both Garments Rest of Manufacturing cases, the substantial increase in the capital–labor Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Note: Capital is proxied by the replacement value of machinery, vehicles, and ratio has been driven by frontier firms. Notably, equipment. Employment is the number of permanent, full-time employees. while frontier firms in garments show the most Figure 2.21 substantial increase in capital intensity between Among frontier firms in garments, capital intensity is higher 2013 and 2022, the capital–labor ratio among non- and has grown at a pace similar to the rest of manufacturing frontier garments firms scarcely changed during 3,000,000 that period (figure 2.21). In other words, the labor intensity in frontier firms is substantially lower than 2,000,000 that of their non-frontier counterparts, and the gap has widened since 2013. Although increasing capital 1,000,000 intensity raises labor productivity, it also implies that a significantly higher amount of capital is necessary 0 2013 2022 for each job created in frontier firms. Also, although Garments - Frontier Garments - Non-Frontier Rest of Manufacturing - Frontier Rest of Manufacturing - Non-Frontier the increased use of imported inputs might explain Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. part of the rise in capital intensity in the RMG sector, Note: Capital is proxied by the replacement value of machinery, vehicles, and equipment. Employment is the number of permanent, full-time employees. the urgent need to create quality jobs elsewhere, Figure 2.22 particularly outside the frontier that accounts for Frontier firms pay higher wages and employ more skilled most imported inputs, remains valid. workers Wages (ln.) 0.42 Consistent with their higher labor productivity, N = 947 frontier firms pay higher wages and employ more Share of skilled in all prod. workers (%) 5.4 skilled workers. Frontier firms pay 42 percent higher N = 499 wages than non-frontier firms that have a similar Investment 0.6 in equipment (ln.) firm size and age and operate in the same state and N = 151 Investment in land 3.2 sector (Figure 2.22). The higher wages also reflect and buildings (ln.) N = 53 their higher share of skilled production workers (5.4 Capital / Labor (ln.) 0.93 percent more on average) than that of non-frontier N = 500 0 firms. Coefficients on: Frontier firm = 1 Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Note: Results are based on regressions of different firm characteristics on a dummy for the most productive frontier firms, controlling for firms’ size, age, location, and economic sector. Frontier Firms and Job Creation in Bangladesh 30 2. Frontier firms Overall, economic growth in Bangladesh has been driven by a small group of very productive firms over the past 10 years, but there are too few of them. Frontier firms are about 11 times as productive on average as other firms. They are concentrated in the garments sector and generate most of Bangladesh’s exports. Consistent with their higher labor productivity, frontier firms pay higher wages and employ more skilled workers than non-frontier firms. Although frontier firms account for most revenues in the formal private sector, they employ only one in seven workers. Within the RMG sector, labor intensity relative to revenue is even lower. Meanwhile, most jobs are being created in non-frontier services firms. In other words, frontier firms are creating productive, well-paid jobs, but given their capital intensity and reliance on high skills, they are unlikely to create sufficient productive and decent jobs to absorb a large segment of job seekers. Frontier Firms and Job Creation in Bangladesh 31 3. The business environment 3. The business environment What would it take for non-frontier firms in Bangladesh to grow faster and create more and better jobs? This chapter investigates whether the business environment in Bangladesh could be blamed, at least in part, for its sluggish performance, either because of the complexity of the rules and deficiency in their implementation or because frontier firms can in fact overcome these hurdles more easily. The assessment is carried out under three topics: the quality of the business environment in Bangladesh compared with peers and over time, the possible preferential lane for frontier firms, and, finally, the underlying reasons for the weaknesses in the design and implementation of rules. 3.1 Quality of the business environment The business environment, a critical enabler of firms’ capacity to operate productively and create jobs, is particularly challenging in Bangladesh compared with that of its peers. For firms entering the market, clear, transparent, and accessible regulations facilitate the establishment of new businesses. While in operation, firms rely on the provision of basic and modern infrastructure, access to finance, and a host of regulations governing payments, dispute settlement, and permits, among other factors. If firms need to exit, the availability of easy-to-handle bankruptcy procedures would enable them to redeploy their assets at a minimal cost to themselves, relevant stakeholders, and the economy at large. Against this backdrop, figure 3.1 demonstrates that Bangladesh, according to the most recent data from the Doing Business 2020 index, is 50 percent below the score of the frontier economies. In comparison to regional neighbors, such as India, Sri Lanka, and Pakistan, the lag is 18 percent, 29 percent, and 30 percent, respectively. Frontier Firms and Job Creation in Bangladesh 32 3. The business environment Figure 3.1 Bangladesh’s score in the Doing Business index is the lowest compared with all peers e sh es ia a am a pin d e si t an od la d nk an i ye a er i tN on l i li p mb i na La pa k is ng ia ail rk Ni g In d In d V ie Ne Ph Sr i Ba Ch Th Pa Ca Tü 0 5 10 8 10 Gap from top performer (%) 12 15 20 18 20 20 25 30 27 28 29 30 35 34 40 38 45 50 48 Source: Doing Business Indicators (archived database), World Bank, https://archive.doingbusiness.org/en/doingbusiness. Bangladesh’s overall score on the Doing Business index has not shown signs of improvement over time. Between 2014 and 2020, Bangladesh’s score remained largely stable (figure 3.2). However, the gap between Bangladesh and the South Asian average widened significantly, doubling from 7 points in 2014 to 15 points in 2020. Similarly, the gap between Bangladesh and the lower-middle-income average increased from 9 points to 13 points. Figure 3.2 The gap has widened between Bangladesh’s Doing Business score and regional and income-group peers’ scores 70 60 59 58 55 56 57 52 54 53 54 53 51 53 51 52 50 44 44 45 Doing Business score 41 42 43 41 40 30 20 10 0 2014 2015 2016 2017 2018 2019 2020 Bangladesh South Asia Lower-middle-income countries Source: Doing Business Indicators (archived database), World Bank, https://archive.doingbusiness.org/en/doingbusiness. Frontier Firms and Job Creation in Bangladesh 33 3. The business environment Business regulations in Bangladesh are time consuming and cumbersome. The number of days to obtain licenses and the amount of time required by senior management for compliance is relatively high compared with that for regional peers (figure 3.3). For instance, obtaining construction permits or import licenses takes on average 49 days, almost double that in India. Moreover, the ability of firms to access public procurement contracts, operating licenses, import licenses, or construction permits depends on their willingness and ability to provide gifts in exchange for those regulatory services. Specifically, 72 percent of firms reported that they were expected to provide a gift in exchange for obtaining an import license, which is twice as high as the share of firms in India (figure 3.4). Bangladeshi firms also more frequently report being expected to provide gifts in exchange for access to operating licenses and construction permits. Public procurement contracts are not always awarded competitively, and the value of expected gifts in exchange for contracts are reported to amount to 2 percent of the contract value, one of the highest shares among peer countries (figure 3.5). Figure 3.3 Firms’ time dealing with regulators and waiting for regulatory services exceeds those in peer countries 60 50 49 49 40 28 Percent 30 20 13 10 0 Senior management time spent Days to obtain an operating license Days to obtain Days to obtain an import license dealing with the requirements of a construction-related permit government regulation (%) Bangladesh Cambodia India Philippines Viet Nam China Indonesia Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Note: Only peer countries with data available are listed. Figure 3.4 Bangladeshi firms report high incidence of corrupt practices in regulatory services 80 70 60 Share of firms (%) 50 40 30 20 10 0 Firms expected to give gifts Firms expected to give gifts Firms expected to give gifts Firms expected to give gifts in meetings with tax officials to get an operating license to get an import license to get a construction permit Bangladesh India Philippines Viet Nam China Indonesia Thailand Source: World Bank Enterprise Survey 2022 or latest available year for peer countries, https://www.enterprisesurveys.org. Note: Only peer countries with data available are listed. Frontier Firms and Job Creation in Bangladesh 34 3. The business environment Figure 3.5 The value of gifts expected in Bangladesh for securing Starting a business in Bangladesh also imposes government contracts is relatively high significant costs on firms. The main legislation governing firms includes the Rules of Business of Bangladesh 1996 (revised in 2009) and the Companies Act XVIII China of 1994 (amended in 2020 by Act No. 7). These laws India cover limited liability companies (LLCs), unlimited liability companies, and sole proprietorships. Philippines All business activities require a trade license, Thailand which is governed by the Local Government (City 0 0.5 1 1.5 2 2.5 Corporation) Act 2009 and Municipal Taxation Value of gift expected to secure a government contract Rules; the trade license is categorized as a general (% of contract value) trade license, commercial trade license (for retail Source: World Bank Enterprise Survey 2022 or latest available year for peer countries, suppliers), or manufacturing trade license. In https://www.enterprisesurveys.org. Note: Only peer countries with data available are listed. addition to that requirement, companies may also need environmental and sector-specific permits. Figure 3.6 On the basis of consultations with stakeholders, the Start-up costs for a business are high, especially for younger firms cost of starting a business in Bangladesh amounts to .8 approximately US$10,000. This significant expense poses a challenge, particularly for new companies. .6 The total includes registration with the Registrar of Joint Stock Companies and Firms, obtaining a trade .4 license, and paying annual audit fees, regardless of the size of firm revenues. For more than 50 percent .2 of the firms under six years old, these costs exceed 10 percent of their annual revenues (figure 3.6). 0 10% of firm's annual revenues 25 50 Annual revenues (Tk, million) Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Note: Young firms are those firms that started less than six years ago. Poor electricity services undermine productivity, investment, and competition. Power outages are frequent and costly for firms operating in Bangladesh relative to peers (figure 3.7). These outages lead to direct revenue losses for firms and inhibit their ability to make productivity-enhancing investments (figures 3.8 and 3.9). To mitigate the cost of power losses, many firms opt to acquire costly generators. This in turn constitutes an additional barrier to entry and substantially higher operating costs for existing firms, especially younger or less productive firms. Given that most generators run on gas, the recent spike in gas prices have further exacerbated the operating costs of generators and raised barriers to entry. Frontier Firms and Job Creation in Bangladesh 35 3. The business environment Figure 3.7 Twice as many Bangladeshi firms experience power outages compared with firms in peer countries 100 90 89 80 70 71 60 Percent 50 40 30 26 20 9 10 0 Share of firms experiencing Number of electrical outages If there were outages, average losses Days to obtain an electrical electrical outages (%) in a typical month due to electrical outages (% of annual sales) connection (upon application) Bangladesh Cambodia India Philippines Viet Nam China Indonesia Source: World Bank Enterprise Survey 2022 or latest available for peer country, https://www.enterprisesurveys.org. Figure 3.8 Figure 3.9 Manufacturers with higher losses from power outages are less Manufacturers with higher losses from power outages are less productive likely to invest Experienced electrical outages Experienced electrical outages Losses due to Losses due to power outages (% sales) power outages (% sales) 3 2 1 0 1 0.5 0 Coefficient in regressions on: sales per worker (US$ 2009, logged) Coefficient in regressions on: buying fixed assets Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Note: The figure shows the result of a regression of sales per worker on a dummy for Note: The figure shows the result of a regression of firms’ capital investments on a firms experiencing power outages and the share of losses due to power outages in dummy for firms experiencing power outages and the share of losses due to power total sales after controlling for sector, location, firm size, and firm age. The information outages in total sales after controlling for sector, location, firm size, and firm age. The is available only for manufacturing firms. information is available only for manufacturing firms. 3.2 Preferential lane for frontier firms Although the adverse business environment poses considerable challenges for the average firm, frontier firms reportedly experience more favorable treatment. To demonstrate the differences in the experiences of frontier and non-frontier firms, figure 3.10 plots the wait times for a host of regulatory services, including the time to obtain an electrical connection, water connection, construction permit, Frontier Firms and Job Creation in Bangladesh 36 3. The business environment Figure 3.10 Frontier firms spend less time dealing with business regulations operation license, import license, and clear imports compared with non-frontier firms and exports through customs. The figure shows the range from the 25th to the 75th percentile of firms, with a vertical line demarcating the median. The Frontier full range of wait times is shown in the whiskers. The results show that non-frontier firms experience higher median wait times, with a distribution skewed on the side of longer wait times. Non-frontier The provision of regulatory services is even more 0 10 20 30 differentiated when comparing wait times within Estimated wait time in days and across sectors. On average, garments firms Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. experience wait times for regulatory services that are Note: Results are based on regressions of different policy variables on a dummy for the most productive frontier firms, controlling for firms’ size, age, location, and economic about half as long as those faced by firms in other sector. Observations per group: frontier 26, non-frontier 111; 29 outliers (7 in frontier: 40–210 days, 21 in non-frontier: 40–730 days). manufacturing and service sectors (figure 3.11). Within the garments industry, wait times are also Figure 3.11 more consistent across firms compared with other Regulatory services are faster and more consistently implemented for garments firms manufacturing and especially services firms, where some firms face wait times of up to two years. Overall, Garments these findings suggest that regulatory uncertainty is relatively high, especially outside of the garments sector, where firms tend to be less productive and Other manufacturing non-frontier. Senior managers in frontier firms spend less time Services dealing with regulators than those in non-frontier firms. Being a frontier firm is associated with a 5 0 50 100 150 Estimated wait time in days percentage point decrease in senior management time spent in dealing with government regulations, Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Note: Coefficient of variation (variance divided by the mean) measures the variation compared with non-frontier firms operating in the in the implementation of the following regulations across firms in Bangladesh: time taken to obtain an electrical connection, water connection, clearing exports through same sector and state and having a similar firm size customs, clearing imports through customs, obtaining a construction permit, obtaining an operating license, and obtaining an import license. Observations per and age. Frontier firms also receive fewer inspections sector: garments 54, other manufacturing 76, services 29. Seven outliers in other manufacturing and services: 180–730 days. by tax officials than non-frontier firms. Frontier firms face fewer losses from electrical power outages than non-frontier firms. The number of electrical outages is slightly less for frontier than for non-frontier firms, but the duration is over 20 percent shorter for frontier firms (figure 3.12). As a result, frontier firms have a 1.5 percentage point lower sales loss caused by power outages than non-frontier firms do (figure 3.13). This provides a strong motivation for firms to seek more reliable electricity services. In an interview, one large manufacturer in Bangladesh explained that they had provided their land at no cost to a private electricity producer next to their factory in exchange for Frontier Firms and Job Creation in Bangladesh 37 3. The business environment potential preferential access to the generated electricity, exemplifying how in one instance, large, incumbent firms find ways to cope with the poor overall provision of electricity services. Figure 3.12 Figure 3.13 Frontier firms endure fewer and shorter electricity cuts Frontier firms face fewer losses from power outages compared compared with non-frontier firms with non-frontier firms 35 40 Experienced electrical outages = 1 -.0023 30 35 N = 959 30 25 Number of electrical outages in a typical month -2.4 25 Frequency 20 N = 954 Hours 20 15 Losses due to 15 power outages (% sales) -1.5 N = 959 10 10 Electricity To 5 5 Operations is an obstacle = 1 -.079 N = 954 0 0 Non-frontier Frontier 0 Number of electrical outages in a typical month Average monthly duration (RHS) Coefficients on: Frontier firm = 1 Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Note: Results are based on regressions of different policy variables on a dummy for the most productive frontier firms, controlling for firms’ size, age, location, and economic sector. Figure 3.14 The higher quality of public services enjoyed by Incidence of noncompetitive procurement for transport, frontier firms is supported by more-competitive utilities, and construction projects public procurement processes. A comparative 33 analysis of procurement practices for transport, 32.2% Average single bidding rate in TUC (%) 32 utilities, and construction projects in locations where frontier firms operate reveals a striking disparity— 31 that is, public procurement procedures for these 30 29.3% 29.1% infrastructure services are more competitive and 29 28.7% transparent. This results in a markedly lower 28 prevalence of single-bid procurement processes— 27 when municipalities and economic activities relying 26 Above average TUC inputs Below average TUC inputs on these services have a higher share of frontier Frontier Non-frontier firms (figure 3.14). Consequently, frontier firms tend to benefit from better-maintained infrastructure, Source: Survey of Manufacturing Industries, 2019. Note: TUC = transport, utilities, and construction. Frontier = above average share of more reliable utilities, and expedited construction sales by frontier firms. Number of observations: 64 frontier above average, 47 frontier below average; 10 non-frontier above average, 17 non-frontier below average. projects, thus reinforcing their advantage over non- frontier firms. Frontier Firms and Job Creation in Bangladesh 38 3. The business environment Finally, in terms of legal status, frontier firms tend to be LLCs and publicly listed companies (PLCs), which entails considerable advantages over non-frontier firms, which are typically sole proprietorships or partnerships (figures 3.15 and 3.16). LLC status means that firms are distinct legal entities, protecting owners’ personal assets from business liabilities, which encourages investment and risk taking. Unlike sole proprietorships, LLCs can also benefit from corporate tax advantages and other incentives, which can be reinvested into the business to fuel growth. Additionally, LLCs can more easily attract investors and secure financing because they provide a more structured and reliable business framework. Unlike partnerships, LLCs do not impose joint liability on their members, allowing for clearer management and decision-making processes. This structure fosters a more stable environment that is conducive to scaling operations, expanding markets, and enhancing overall productivity. Figure 3.15 Figure 3.16 Three-quarters of frontier firms are LLCs and PLCs Most non-frontier firms are sole proprietorships or partner- ships Limited partnership Limited partnership Publicly listed 2% 0% company LLC 1% 6% Partnership Publicly listed 14% Partnership company 23% 23% Sole proprietorship 16% Sole proprietorship LLC 70% 45% Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Note: LLC = limited liability company; PLC = publicly listed company. Note: LLC = limited liability company. However, owing to the complex procedures for establishing an LLC, many firms opt for alternative registration statuses. Other business structures offer simpler registration processes but pose considerable disadvantages for firm operation and growth. Sole proprietorships, single-owner businesses open to any Bangladeshi citizen over the age of 18, are easier to establish than LLCs. Setting up a sole proprietorship involves obtaining clearance for a business name, securing a trade license, acquiring a tax identification number, and opening a bank account. However, sole proprietorships are not distinct legal entities, so the owner is fully liable for business operations and income. They cannot benefit from corporate tax advantages and face expansion difficulties because of capital limitations tied to personal finances and business profits. Partnerships, regulated by the Partnership Act of 1932, allow individuals to share business profits and pool resources. Unlike companies, partnerships do not require directors, secretaries, or shareholders, giving partners greater control and full ownership. However, partners bear unlimited liability. Among the frontier segment, 45 percent of revenues accrue to LLCs and 23 percent to PLCs. This is a very different distribution than with non-frontier firms, where the total share of revenues is dominated by sole proprietorships and partnerships. Frontier Firms and Job Creation in Bangladesh 39 3. The business environment Figure 3.17 Finally, frontier firms also enjoy greater access to A higher share of frontier firms have either a line of credit or a credit. Only 29 percent of non-frontier firms report loan from a financial institution having a bank loan or a line of credit with a financial 45 42 Share of firms with a line of credit or loan (%) institution compared with 42 percent of frontier firms 40 (figure 3.17). Part of this disparity is due to legitimate 35 29 30 differences in credit-worthiness, but it also owes to 25 a greater availability of dedicated concessional credit 20 available to frontier firms, as will be discussed in 15 section 4.1. 10 5 0 Frontier Non-frontier Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. 3.3 Administrative weaknesses Why do frontier firms experience a more favorable business environment than non-frontier firms? The answer likely has to do with three interlinked and mutually reinforcing features of the business environment: the complexity of the regulations themselves, the room they create for discretion by officials in implementation, and weak state institutional capacity to design and enforce the regulations. These drawbacks enable frontier firms that are better resourced and connected to have an edge over non-frontier firms. First, on the rules themselves, the Worldwide Figure 3.18 Governance Indicators (WGI) offer a telling Bangladesh has a low score of regulatory quality snapshot of the overall quality of regulations in 70 Bangladesh (figure 3.18). Compared with peers, 60 59 58 54 Bangladesh scores at the 18th percentile of all 51 Regulatory quality score 50 43 countries on their score for regulatory quality, which 40 36 37 is based on the perception of the government’s 30 25 ability to design sound policies and regulations that 20 18 promote private sector development. 10 0 Second, the long wait times and variations in e sh ia es am i na a d iye ia e si an od In d pin rk Ch tN la d ai l on mb Tü accessing regulatory services suggest a high degree i li p V ie Th In d ng Ca Ph Ba of discretion. The regulatory services included in Source: Worldwide Governance Indicators, World Bank, https://www.worldbank.org/en/ publication/worldwide-governance-indicators. this matrix are for firms’ wait times for obtaining an electrical connection, water connection, clearing imports and exports through customs, Frontier Firms and Job Creation in Bangladesh 40 3. The business environment Figure 3.19 Firms in Bangladesh face longer waiting times and high and obtaining a construction permit, operating variation in the implementation of regulatory services license, and import license. The average wait times 1.5 Viet Nam 2023 Philippines 2015 for all firms in Bangladesh for securing different Coefficient of variation for regulatory services Türkiye 2019 Indonesia 2023 services is 35 days, which is the longest among peer countries.4 In addition, there are substantial Bangladesh 2022 Thailand 2016 variations in the implementation of regulations. The China 2012 1 India 2022 coefficient of variation in wait times for different regulatory services is higher than the average for peer countries (figure 3.19).5 These variations in Cambodia 2023 policy implementation persist, even among firms 0 0 10 20 30 40 operating in the same sector. Average time in days Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Note: Coefficient of variation (variance divided by the mean) measures the variation in the implementation of the following regulations across firms in Bangladesh: time taken to obtain an electrical connection or a water connection; time taken to clear exports through customs or to clear imports through customs; and time taken to obtain a construction permit, an operating license, or an import license. Third, the WGIs also show that state administrative capacity to design and enforce the rules in Bangladesh is not on par with peers. This conclusion is based on the WGI’s measure of government effectiveness, which aims to capture the quality of civil service, its independence from political pressure, and the credibility of government commitment to policies. The data show that Bangladesh does not fare well compared with peer countries (figure 3.20). A similar conclusion holds with respect to measures of the rule of law, which includes perceptions of confidence in contract enforcement (figure 3.21). Figure 3.20 Figure 3.21 Bangladesh scores particularly low in government Bangladesh’s rule of law score is significantly lower than most effectiveness compared with peers peers’ scores 80 60 55 55 68 53 66 Government effectiveness score 70 63 48 50 45 59 58 60 56 Rule of law score 40 37 50 44 33 30 40 37 30 21 30 23 20 20 10 10 0 0 e sh ia es am i na a d i ye e sh ia es am i na a d i ye ia ia e si e si an an od od In d In d pin pin rk rk Ch Ch tN tN la d la d ai l ai l on on mb mb Tü Tü i li p i li p V ie V ie Th Th In d In d ng ng Ca Ca Ph Ph Ba Ba Source: Worldwide Governance Indicators, World Bank, https://www.worldbank.org/en/ Source: Worldwide Governance Indicators, World Bank, https://www.worldbank.org/en/ publication/worldwide-governance-indicators. publication/worldwide-governance-indicators. 4 Comparing average waiting times across countries should be viewed with some caution for some regulatory services. Receiving or renewing an operating license may be associated with mandatory complementary registrations or inspections (safety or health inspections) in some countries but not others. However, comparing the dispersion of waiting times across countries does not suffer from this bias because the coefficient of variation corrects for such differences in levels across each country. 5 The coefficient of variation, which is defined as the ratio of the standard deviation to the mean, is a normalized measure of dispersion of a probability distribution. It is independent of measurement units and can be used for non-negative values. Frontier Firms and Job Creation in Bangladesh 41 3. The business environment The complexity, room for discretion, and weak institutional capacity can be illustrated by three concrete examples: land administration, the National Board of Revenue (NBR), and the banking sector. In the first case, land administration and management is highly fragmented, plagued with inefficiencies, and ill equipped to effectively resolve disputes. The administrative structure governing land involves multiple layers and a lack of coordination among the Ministry of Land, the Ministry of Law, and various subunits such as the Settlement Office, Assistant Commission, Sub-Registry Office, and Survey Tribunal. Moreover, land records have not been systematically digitized, and many regulations remain unchanged since British colonial rule. Although these issues pose considerable challenges to all firms, comprehensive studies into the land management system in Bangladesh by Raihan and others (2024) and Ferdousi, Islam, and Raihan (2024) found that politically connected landowners and investors are better able to secure recognition of their land rights, often through illicit practices. The dual mandate of the NBR, which is responsible for both tax policy and tax collection, creates a significant institutional weakness that affects the business environment. The NBR predominantly focuses on tax collection, dedicating minimal resources to tax policy analysis, which leads to poorly informed fiscal decisions (Ahmed 2024c). This lack of separation between policy making and implementation means that tax changes are frequently introduced without due analysis of their impacts on revenue or resource allocation. Added to all of this is that tax administration in Bangladesh tends to lack sufficient autonomy, with the NBR functioning as other government departments and staffed by civil servants who primarily rely on policing and threats to enforce tax collection. The third case comes from the institutional arrangements governing the central bank and the banking sector. The central bank, Bangladesh Bank, lacks independence, both formally and informally, which undermines its ability to regulate the banking sector effectively (Hassan et al. 2024). It is de facto subservient to satisfying the needs of the Ministry of Finance. Despite being empowered by the Banking Company Act of 1991 to regulate the banking sector autonomously, the establishment of the Ministry of Finance’s own banking division has severely marginalized the central bank’s role. This lack of autonomy is exacerbated by the government’s frequent overreach, appointing civil service members to key central bank positions despite clear legal prohibitions. Consequently, critical policy decisions, such as those related to monetary policy and the management of nonperforming loans may be politicized or handled outside of the central bank. The dual authority system, in which state-owned banks are governed by the Banking Division of the Ministry of Finance and private banks are governed by the central bank, creates a fragmented regulatory environment and allows for influence from bodies such as the Bangladesh Association of Banks. The pattern that emerges from the analysis in this chapter is that the business environment in Bangladesh is not as friendly as that of neighboring countries and that frontier firms are better equipped to deal with its shortcomings. By virtue of their relatively superior capabilities and better connections, frontier firms can leverage their edge to maneuver through the ad hoc regulatory landscape more adeptly than their less sophisticated counterparts can. This advantage may also enable them to Frontier Firms and Job Creation in Bangladesh 42 3. The business environment benefit from regulatory gaps and inconsistencies, further entrenching their position versus competitors. The underlying political economy factors governing state–business relations will be discussed briefly in the following chapter on selective interventions. Frontier Firms and Job Creation in Bangladesh 43 4. Selective interventions 4. Selective interventions This chapter examines whether selective government interventions in Bangladesh favor frontier firms- which create fewer jobs-over the rest of the private sector, evaluates the overall impact of these policies on the economy, and assesses the design and implementation of these policies. Unlike the business environment, which affects the entire private sector, selective interventions target specific sectors, activities, or a few large firms, under the premise that the economic benefits from these interventions outweigh their costs. The instruments of interventions are numerous, possibly including preferential taxation and trade policies and a variety of explicit or implicit subsidies (for example, in relation to credit, land, infrastructure, regulatory rules, and even promotional activities abroad or at home). The problem is that the track record of such policies in developing countries is mixed at best, yet governments around the world, including that of Bangladesh, use them extensively. To explore the merits of these policies in the case of Bangladesh from the perspective of productive job creation, the rest of the chapter is organized under three sections: selective interventions and frontier firms, the costs and benefits of selective interventions, and an assessment of industrial policy in Bangladesh against good practices. 4.1 Frontier firms and selective interventions From the previous chapters, it is evident that frontier firms tend to exist mostly in the garments industry, particularly the segment of the sector engaged in exports. In some basic sense, it is then expected that this segment of the garments sector is the one receiving most of the preferential treatment. The question is whether that is borne by the evidence. To make that judgment, this section examines a number of instruments of government support programs, including tax incentives, concessional finance, labor regulations, and trade policies and facilitation. On taxation, it is evident from figure 4.1 that the corporate taxation regime offers preferential rates to frontier-dominated activities. Whereas the standard corporate tax rate is 27.5 percent, the garments and textile manufacturers pay between 12 percent and 15 percent. It is true that the rates for the mobile phone Frontier Firms and Job Creation in Bangladesh 44 4. Selective interventions services, tobacco, and banks are higher, ranging from 37.5 percent to 45 percent, but even then, the rates for the favored sectors are about half the standard rates. Figure 4.1 RMG manufacturers and exporters enjoy the lowest corporate tax rates 5 10 15 20 25 30 35 40 45 50 Standard corporate tax rate 27.5 Publicly listed companies 20 Listed banks 37.5 Sole proprietorships 22.5 Unlisted banks 40 Merchant banks 37.5 Tobacco manufacturers 45 Listed mobile phone operators 40 Unlisted mobile phone operators 45 RMG manufacturers and exporters 12 Export-oriented companies 12 Textile industries 15 Jute goods exporters 10 Source: NBR, Orbitax, KPMG. Note: RMG = ready-made garments. Discretionary tax exemptions granted through statutory regulatory orders (SROs) are used as another avenue for concessions that tend to benefit better connected firms. Tax laws and regulations are frequently adjusted in the annual budget cycle to introduce new measures or to grant exemptions, particularly in areas such as customs duties and value added taxes. These changes, communicated through SROs, are not typically based on a rigorous analysis of their impact on economic performance or fiscal revenue and resource allocation. Rather, a review of 926 customs duty–related SROs issued between fiscal 2015 and fiscal 2019 by Ahmed (2024c) concluded that exemptions are often granted in response to political lobbying by well-connected beneficiary groups. Such lobbying is also not done in secret. In fact, the National Board of Revenue (NBR) regularly meets with industry associations such as the Federation of Bangladesh Chambers of Commerce and Industries (FBCCI) for consultations on tax policy. Moreover, although SROs are typically granted at the sectoral level, there are no guarantees that they accrue to all firms in that sector. Lengthy administrative procedures, as well as extensive documentation requirements and site visits, can prevent some firms in a given sector from attaining these benefits, especially among new firms and small and medium enterprises (SMEs). Frontier firms also enjoy preferential access to credit. Although microfinance institutions and informal financial institutions are prevalent in Bangladesh, the dominant source of external financing for firms is carried out through formal commercial banks, which fall under the supervision of Bangladesh Bank. Bangladesh Bank has long used interest rate caps with lower rates for exporters than for other producers. Frontier Firms and Job Creation in Bangladesh 45 4. Selective interventions In 2004, Bangladesh Bank imposed a 7 percent interest rate cap for exporters, compared with a 13 percent interest rate cap introduced in 2009 on housing loans, working capital to large and medium enterprises (LMEs), term loans to LMEs, and agriculture. The average lending rates for different sectors is shown in figure 4.2, which clearly indicates that exporters have consistently enjoyed access to credit at the lowest interest rates offered by banks (Miyauchi 2017). Figure 4.2 Exports enjoy the lowest lending caps 18 16 14 12 Lending cap rate (%) 10 8 6 4 2 0 Large and medium industry SMEs Export Large and medium industry SMEs SCBs PCBs 2014 2018 2021 2024 Source: Lending rates database, Bangladesh Bank, https://www.bb.org.bd/en/index.php/financialactivity/interestlending. Note: PCBs = Public commercial bank; SCBs = Scheduled commercial bank; SMEs = small and medium enterprises. In addition to lending caps, numerous interest rate subsidy programs have primarily targeted ready- made garments (RMG) exporters. The Export Development Fund (EDF), established in 1989, provides concessional financing to exporters to facilitate the acquisition of raw materials, machinery, and other production inputs. The EDF amounted to US$9.29 billion in fiscal 2021, up from US$6.18 billion in fiscal 2020, with a total of 56 banks deploying EDF refinancing facilities to 1,380 borrowers as of the end of June 2021. Similarly, the government’s COVID-19 stimulus package included significant subsidized loans for the RMG sector, such as a Tk 50 billion allocation for factory worker wages at a highly subsidized interest rate of 2 percent, and a Tk 300 billion working capital loan facility at a 9 percent interest rate, with half of the interest covered by a government subsidy (Raihan 2020). Other subsidized interest rate programs to exporters have included the Export Facilitation Pre-finance Fund and pre- and postshipment credit refinance programs, among others (Raihan and Razzaque 2007). In terms of the trade regime, frontier exporting firms benefit from duty-free imports. Frontier garments exporters rely substantially on imported inputs, as shown in figure 4.3, where the mean value of imports for frontier RMG firms dominates the distribution. As such, they have been the primary beneficiaries of these duty-free import programs. The Bonded Warehouse program, introduced in 1997, has primarily Frontier Firms and Job Creation in Bangladesh 46 4. Selective interventions served the RMG sector, enabling firms to store imported raw materials/inputs and packaging without payment of customs duties, provided that at least 70 percent of the goods manufactured from these inputs are then exported (O’Shea 2015). Despite the announcements of an expansion of bonded warehouses to other industrial sectors, change has yet to occur. A summary of bonded warehouse facilities as of 2024 is provided in table 4.1. From a list of 7,789 bonded warehouses from the NBR, over 90 percent are affiliated with RMG and related packaging and accessories. Similarly, the back-to-back letters of credit, which permitted firms to import raw materials based on their export orders, enabled RMG exporters to overcome the burdens of complex customs duties and claims. For eligible exporters not availing bonded warehouse or duty drawback facilities, the government provides a cash incentive set at 15 percent to 25 percent of the Free on Board export value. Export incentives have amounted to between 1.2 percent and 2 percent of total expenditure in annual budgets of the government between 2019 and 2024. Figure 4.3 Table 4.1 Frontier RMG firms rely substantially on imports Sectoral affiliation of bonded warehouses is dominated by RMG and related industries Sectoral affiliation Number % of total 16 RMG 5,413 83 Mean value of imported inputs (Tk, billions) 14 13.8 Packaging 476 7 12 Oil and gas 220 3 10 Plastics 190 3 8 Leather/Footwear/Bags 130 2 Agriculture/Agribusiness 33 1 6 Metal 30 0 4 Bikes 12 0 2 1.5 Electric 9 0 0.2 0.1 0 Cars 6 0 RMG Rest of manufacturing RMG Rest of manufacturing Total 6,519 100 Frontier Non-frontier Source: World Bank Enterprise Survey 2022, https://www.enterprisesurveys.org. Source: NBR 2023. Note: RMG = ready-made garments. Note: RMG = ready-made garments. Based on staff calculations from a total log of 7,789 bonded warehouses. Exporters also enjoy a variety of benefits by opting to operate in export processing zones (EPZs). The benefits include tax holidays, duty-free imports, and exemptions from value added taxes and other duties. The World Bank carried out a survey in 2019–20 that was representative of firms in and outside EPZs at the district level in Bangladesh. The RMG sector accounted for 84 percent of the revenue of firms in EPZs (figure 4.4) compared with 57 percent outside EPZs (figure 4.5), suggesting that firms inside EPZs are disproportionately those from the frontier segment compared with those outside EPZs in the same districts. Moreover, firms in EPZs are much larger than firms outside EPZs, generating on average over 10 times more revenue (figure 4.6). Frontier Firms and Job Creation in Bangladesh 47 4. Selective interventions Figure 4.4 Figure 4.5 RMG firms are concentrated in EPZs . . .  . . . compared with the share of RMG firms outside EPZs Food Other Food Chemicals 0% 1% 2% Other Plastics and 0% Plastics and 0% rubber Leather rubber 0% 4% 12% Chemicals 39% Garments Garments and textiles and textiles 57% 84% Leather 1% Source: World Bank Economic Zones Survey 2020. Source: World Bank Economic Zones Survey 2020. Note: EPZs = export processing zones. Note: EPZs = export processing zones. Figure 4.6 Although an overvalued exchange rate is costly Firms in EPZs generate 10 times more revenue than firms outside such zones to exporters, the RMG sector has been at least 700 partially compensated for the consequent loss 583 in competitiveness. Historically, exporters in 600 Total firm revenues (Tk, billions) Bangladesh benefited from a more flexible exchange 500 rate regime. Figure 4.7 illustrates the long-term 400 trend in the real effective exchange rate (REER), 300 showing a stable downward trend until fiscal 2011, 200 when the REER was 5 percent lower than in fiscal 100 1990 (Ahmed 2024a; Ahmed 2024b). Over this 49 0 period, export growth reached an annual average Within EPZs Outside EPZs of 17.3 percent (figure 4.8). However, after fiscal Source: World Bank Economic Zones Survey 2020. 2011, the REER began to appreciate as a result of the Note: EPZs = export processing zones. Bangladesh Bank’s policy of maintaining a relatively stable nominal exchange rate despite a widening inflation differential between Bangladesh and its trading partners. Consequently, the REER appreciated from 94.4 in fiscal 2011 to 165.2 in fiscal 2020, a substantial 75 percent increase in the real value of the Bangladeshi taka (Tk). Despite some corrections between fiscal 2020 and fiscal 2023, the REER in fiscal 2023 remained 57 percent higher than in fiscal 2011. As a major importer of raw materials, the RMG sector has been supportive of maintaining a stable nominal exchange rate (Hussain 2020), especially because other selective interventions have compensated for the overvaluation (Raihan 2024; Sattar and Shareef 2019). The upshot is that, although the sharp appreciation had a significant adverse impact on overall export performance, the impact on non-RMG exports was more severe than on RMG exports. Frontier Firms and Job Creation in Bangladesh 48 4. Selective interventions Figure 4.7 Figure 4.8 The REER was stable until 2011, appreciating thereafter Annual export growth declined following appreciation of the REER, but less so for the RMG sector 180 20 Real effective exchange rate (FY1990=100) 160 18 17.3 140 16 Growth rate of exports (%) 14 13.8 120 12 100 10 80 8.5 8.0 8 7.7 60 6 4.6 40 4 20 2 0 0 FY 19902011 FY 20112023 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 22 20 20 20 20 20 20 19 20 20 19 19 19 19 20 20 20 20 FY FY FY FY FY FY FY FY FY FY FY FY FY FY FY FY FY RMG Non-RMG Total Source: Bangladesh Bank. Source: Bangladesh Bank. Note: REER = real effective exchange rate. Note: REER = real effective exchange rate; RMG = ready-made garments. There are also signs that frontier business owners receive preferential treatment in labor disputes. According to Hassan and others (2022), the state consistently favors the interests of business owners over those of trade unions and workers in both formal and informal dispute settings. The experience of the 2023 minimum wage protests largely back this view. Worker representatives proposed a minimum wage of Tk 20,393, whereas factory owners suggested Tk 10,400 (Star Business Report 2023a). Eventually, the government accepted a compromised wage of Tk 12,500, effectively siding with the factory owners over the labor unions (Star Business Report 2023b). This section has reviewed a wide range of selective interventions, and the conclusion is that these interventions were mostly in favor of exporters, especially those in the RMG sector. Non-frontier firms did not benefit as much from such interventions. The questions are whether the preferential treatments extended to frontier firms have paid off and whether their benefits have outweighed the costs to the economy. These questions are addressed next. 4.2 Benefits and costs of selective interventions The assessment of the merits of selective interventions takes sizing up their benefits and costs to the economy—and not just those to their immediate beneficiaries. In the case of Bangladesh, as well as in other countries, providing partial accounts of the benefits without worrying about the costs is not enough. However, the difficulty is that a full assessment requires a general equilibrium model, which is too demanding in terms of data requirements. The alternative route is to attempt to identify the main items of the costs and benefits, while evaluating the process of designing and implementing interventions from the perspective Frontier Firms and Job Creation in Bangladesh 49 4. Selective interventions of best practices. Although this approach does not provide a full account of the developmental impact of selective interventions, it makes it possible to describe how Bangladesh may do better in the future in redesigning its industrial policy. On the side of the benefits, there is little doubt about the success of the RMG sector in Bangladesh. The apparel sector, which began more than 40 years ago, generated US$31.5 million in earnings in fiscal 1983–84, accounting for just 3.8 percent of total export earnings. Today, it is the largest foreign currency earner in the country, contributing 84 percent of the US$55.5 billion from merchandise sales in fiscal, 2022–23. The share of Bangladeshi textiles in global exports has risen from 0.5 percent to nearly 4 percent (figure 4.9), contributing between 13 percent and 16 percent of gross domestic product (GDP) over the past decade. Between 1994 and 2020, the number of RMG factories increased from 1,537 to 4,621 (figure 4.10). During the same period, employment in the sector grew from 800,000 to 4 million, out of a total workforce of 69 million. Job creation has been inclusive, with many workers being women, as well as those from poorer households and districts and with lower levels of education (Kabeer and Mahmud 2004; Matsuura and Teng 2020). Figure 4.9 Figure 4.10 The value of RMG exports and Bangladesh’s share of the global The number of RMG factories and workers has multiplied since market have soared since 1993 1993 40 4 7,000 4.5 Number of workers in the garment sector (millions) RMG export values (US$, billions) 35 3.5 6,000 3.5 Number of garment factories 30 3 3 RMG global share (%) 5,000 25 2.5 2.5 4,000 20 2 2 3,000 15 1.5 1.5 2,000 10 1 1 5 0.5 1,000 0.5 0 0 0 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 RMG exports Global market share RMG factories RMG workers Source: BGMEA. Source: United Nations Commodity Trade Statistics Database (UN Comtrade), https:// Note: RMG = ready-made garments. comtradeplus.un.org. Note: RMG = ready-made garments. Competition in the global markets has also contributed positively to the process of learning by doing, the adoption of modern technology, and the upgrading of product quality. The RMG sector’s exposure to international standards and requirements has necessitated continuous improvements in production processes and product standards. This exposure led to the adoption of advanced technologies and best practices within the sector, with over 200 factories acquiring Leadership in Energy and Environmental Design certification. The growth of the RMG sector has also stimulated the development of ancillary industries, such as textiles and packaging. Frontier Firms and Job Creation in Bangladesh 50 4. Selective interventions Against these positive effects, selective interventions have been costly in a variety of ways. On the issue of job creation by the RMG sector, figure 4.11 shows Bangladesh’s RMG exports and employment over the period 1993–2019. It shows that while exports have continued to rise consistently over time, the number of workers has plateaued since 2012. In fact, the sector’s number of employees relative to exports has been declining for decades (figure 4.12).6 The pattern of female employment has also changed. The share of female employees, which was originally between 80 percent and 90 percent in the early 1990s, has since declined to about 50 percent today (Kabeer and Mahmud 2004; Matsuura and Teng 2020). Moreover, the expected retirement age for women is just 35 years. Figure 4.11 Figure 4.12 The link between RMG exports and employment growth has The RMG sector’s number of employees relative to exports has deteriorated declined precipitously 40 400 5.5 RMG workers per million US$ exports RMG export values (US$, billions) 35 350 30 4.5 300 Millions employees 25 250 3.5 20 200 15 2.5 150 10 100 1.5 5 50 0 0.5 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 RMG exports RMG sector workers Source: BGMEA. Source: BGMEA. Note: RMG = ready-made garments. Note: RMG = ready-made garments. The forthcoming graduation from least developed country (LDC) status poses risks to the sustainability of Bangladesh’s heavy reliance on preferential access for RMG exports. According to a vulnerability profile analysis conducted by the United Nations Conference on Trade and Development (2022), Bangladesh has effectively utilized preferential access programs, which, as of 2018, allowed over 80 percent of its exports to enter preferential markets—a significantly higher rate than other LDCs. This success is underscored by the increase in apparel exports to the European Union under the Everything But Arms program, which resulted in a doubling of related revenues between 2011 and 2018. The loss of preferential access, coupled with the need to comply with stricter rules of origin, can significantly impact Bangladesh’s exports.7 Estimates suggest that losing LDC-specific preferential market access could lead to a reduction in the range of 7 percent to 14 percent in baseline exports. The majority of this decrease is expected to affect textile and clothing exports to developed markets, where tariff changes would be more disadvantageous (Rahman and Bari 2018; WTO and EIF 2020). 6 The employment figures presented here are based on comprehensive data from the BGMEA. However, alternative estimates, such as those from Haque and Bari (2020), suggest that employment in the RMG sector increased to 4.2 million by 2022. Despite these variations, the trend of declining employment relative to RMG export growth remains consistent. 7 For further reading on the impact of LDC graduation on Bangladesh, see OECD and UNCTAD (2023) and UNCTAD (2023). Frontier Firms and Job Creation in Bangladesh 51 4. Selective interventions The extensive use of tax incentives has also contributed to Bangladesh’s exceptionally low rate of tax revenue generation. Tax revenue relative to GDP in Bangladesh stands at just 8 percent of GDP, which is much lower than all comparator countries (figure 4.13). An analysis by the NBR, published in 2024, of the 2020–21 budget cycle on tax expenditures (government revenue losses from tax exemptions, deductions, or preferential tax rates) provides a telling story in which corporate tax incentives constitute the majority of direct tax expenditures. Direct tax revenues (corporate and personal taxes) make up one-third of NBR’s total revenues. Direct tax expenditures are concentrated on the corporate side and amount to 2.4 percent of GDP (figure 4.14). The extensive use of tax incentives benefiting the RMG sector has led many to conclude that the RMG sector stands outside of the tax net (Mansur 2020; Raihan 2024). Figure 4.13 Figure 4.14 Bangladesh has the lowest tax to GDP ratio among peers Corporate tax incentives constituted the bulk of direct tax expenditures in 2021 20 80 4.0 18 18 70 68 3.5 15 Share of total direct taxes (%) 16 14 60 3.0 13 Tax-to-GDP ratio 14 Share of GDP (%) 12 12 50 2.5 10 10 11 10 40 2.4 2.0 8 32 8 30 1.5 6 20 1.0 4 1.2 2 10 0.5 0 0 0.0 Corporate income tax expenditure Personal income tax expenditure e sh a a es n l ye ia co m le pa e si nk uta As - in idd pin rki Ne e la d La on uth Bh Tü r-m i li p Sr i In d ng So Ph we Ba As a share of total direct taxes As a share of GDP (RHS) Lo Source: World Development Indicators Database. Source: NBR 2023. Note: RHS = Right-hand side. The strong support for the export growth of the RMG sector was combined with trade protection for other sectors, both of which may have hampered diversification and deepened the productivity divide between frontier and non-frontier firms. Figure 4.15 shows that the average tariffs on outputs have been rising, while the average tariffs on imports have been declining since 2009. This pattern of protection creates a significant anti-export bias that impedes the growth of non-RMG exports and hinders export diversification (Kathuria and Malouche 2016; Sattar and Ahmed 2012; Sattar 2020; Sattar 2021; Sattar 2023). It acts as an indirect subsidy for import-substituting industries and a tax on exporting industries by making selling in domestic markets more profitable than exporting. It further diverts resources toward production for the domestic market and away from production for exports. This is probably what happened, for instance, with respect to industries such as ceramics, plastics, tableware, kitchenware, footwear, lamps, and biscuits, which enjoyed the benefits of tariffs ranging between 85.6 percent and 113 percent. The upshot is that although there may well be export potential in a number of non-RMG sectors, this potential has not been realized, rendering Bangladesh’s export basket to be dominated by the RMG sector (figure 4.16). Frontier Firms and Job Creation in Bangladesh 52 4. Selective interventions Figure 4.15 Figure 4.16 Import duties on final goods are much higher than those on Bangladesh’s exports were concentrated in textiles in 2021 intermediate inputs 60 Vehicles Machinery Chemicals 1% 1% 1% Metals 50 Agriculture 0% 3% Other Average tariff rate (%) 40 1% Services 12% 30 20 10 Textiles 81% 0 2000 2004 2006 2009 2008 2005 2003 2007 2002 2001 2020 2010 2016 2014 2018 2015 2012 2013 2019 2017 2011 Output tariffs Input tariffs Source: National Board of Revenue Tariff Database and the Policy Research Institute, Source: United Nations Commodity Trade Statistics Database (UN Comtrade), https:// https://policyinsightsonline.com/2021/05/why-bangladesh-urgently-needs-a- comtradeplus.un.org. coherent-national-tariff-policy/. 4.3 Assessment of industrial policy in Bangladesh This section evaluates the selective interventions in Bangladesh against the main features of best practices. The main question posed here is whether different industrial policy instruments were designed and implemented to generate the best results for Bangladesh in terms of diversification and productivity improvement through a process of learning by doing, thereby boosting economic growth and enhancing job creation. If not, it is time to take corrective action, as will be discussed in the next chapter. Before going forward, though, it is important to note that industrial policy inherently involves experimentation and that not all interventions will yield positive results. However, there is always room for the adoption of mechanisms that prevent the entrenchment of failures and support the seizing of emerging opportunities. By their very nature, industrial policies are supposed to facilitate the discovery of new areas of comparative advantage. Hausmann and Rodrik (2003) and Rodrik (2004) emphasize the importance of addressing information externalities associated with identifying new cost structures for emerging activities, which often impede entrepreneurial diversification in low-income countries such as Bangladesh. This discovery process typically involves experimental ventures into new products and the adaptation of foreign technologies to local contexts. By supporting these activities, Bangladesh, as well as other countries, could expand beyond their current specialization and explore new domains where a new comparative advantage could be established. When a pioneering entrepreneur makes a breakthrough, it often sparks imitation, leading to a more diversified and resilient economic structure. Bangladesh’s industrial policy does not seem to fully follow this perspective. Frontier Firms and Job Creation in Bangladesh 53 4. Selective interventions A hallmark of successful industrial policy is the establishment of a clear target against which the government can extend its favorable treatment to those who meet it. The target can be exports, job creation, or any desirable objective. According to this rule, Bangladesh seems to have succeeded partially. As discussed above, several forms of interventions were extended to boost exports, and the RMG sector took advantage of these interventions to the extent that Bangladesh became the second largest exporter of RMG in the world after China. However, the interventions did not benefit other sectors to the same extent. On the contrary, the government simultaneously adopted a trade regime and exchange rate policy that tended to favor production for domestic markets. The implementation of these policies was not associated with clear targets, nor were they applied uniformly. The endgame of both policies is a duality in the economy, in which frontier exporting firms in the RMG sector took advantage of the policies and tended to be relatively more efficient than their domestic counterparts as a result of competition in the global market, alongside other firms that face little competitive pressure to mitigate their inefficiencies. It is also worth noting that the RMG sector benefited from an opportunity that was not available to other sectors, namely, the Multi-Fiber Agreement (MFA). In 1973, the United States established the MFA to protect its own garments and textile industries, instituting bilaterally negotiated quotas for the garment and textile exports of developing countries to the United States. However, not all countries were subject to these quotas; Bangladesh, for instance, was exempt because it lacked a garments industry at the time (Goto 1989). The quota system effectively increased the prices of imported garment products in the United States, allowing countries not under quotas to export at prices above the competitive rate. The MFA’s quotas on exports from more competitive nations enabled less competitive, or follower, countries such as Bangladesh, to sell at higher prices once the leading exporters reached their quota limits, thereby enhancing the follower countries’ competitiveness for the duration of the quotas. Moreover, the MFA incentivized leading textile exporters, such as the Republic of Korea manufacturers, to look for new production locations, including Bangladesh, to evade the quotas. By shifting some production to countries such as Bangladesh, Korea could maintain more of its textile industry. Taking advantage of the external opportunity presented by the MFA was the backing of the RMG industry at the highest political office in the country. Bangladesh president Ziaur Rahman facilitated the first collaboration between Bangladeshi textile manufacturer Desh Garments and the Korean multinational Daewoo in 1979. He also supported key policy instruments such as back-to-back letters of credit and EPZs.8 Technology transfer was facilitated because Daewoo covered the cost of training a significant number of Bangladeshi supervisors and managers in setting up a plant, managing quality control, and minimizing raw material wastage, while Desh Garments provided the necessary land and machinery in Bangladesh. The quota-induced price differential reduced the competitiveness gap, allowing Bangladesh to catch up. This collaboration led to such success that by 1985, the Bangladesh garments industry had achieved substantial growth, prompting U.S. president Ronald Reagan to negotiate quotas for Bangladesh under the MFA (Rashid 2006). By the late 1980s, 115 of the initial 130 managers trained at Daewoo factories had established their own garments firms (Rhee 1990). These enterprises continued to thrive even after the removal of the quotas. The price differential, though significant, was not so large as to make Bangladeshi firms immediately profitable Frontier Firms and Job Creation in Bangladesh 54 4. Selective interventions without effort. Instead, it ensured that private investors would succeed only through genuine capability development. If the price differential had been enough for instant profitability without the need for learning, the initial boom might have been immediate, but these enterprises would likely have collapsed once the quota advantages disappeared with the gradual phase-out of the MFA. The partial boost provided by the quota rent was sufficient to encourage private investment while also ensuring that success required genuine capacity building at an early stage (Khan 2013). Another feature of best practice in industrial policy concerns the announcement of a sunset clause at the outset to prevent the allocation of resources to unproductive activities or those no longer needing support, which is a feature that has been notably absent in Bangladesh. Sunset clauses stipulate that government support will be phased out after a predetermined period. This approach encourages beneficiaries to strive for establishing competitiveness and allows for the reallocation of financial and human resources to more promising ventures. In the case of Bangladesh, the RMG sector has enjoyed prolonged government support through different types of instruments. The absence of a sunset clause generally encourages rent- seeking behavior, develops dependence on the state for support, and deprives the economy from resources that could be allocated to support a new set of activities. The absence of a sunset clause has also been a feature of the tariff regime, which remained largely unchanged for prolonged periods of time (Sattar 2020; Sattar 2021). Currently, the weighted tariff rate on all products in Bangladesh is 10.9 percent, which is almost double the average for the South Asian region and 2.5 times the average for lower- and middle-income countries. Protection is the sum of a high customs duty, compounded with additional para-tariffs in the form of supplementary and regulatory duties. The lack of a clear time frame for how long protections will last or when they will be scaled down reduces the incentives for entrepreneurs to improve efficiency, lower costs, or become more competitive in international markets. Moreover, for other sectors with export potential, such as agro-food processing, footwear and leather products, and electronics, tariff protections make domestic sales more profitable than exports. This status quo is deeply entrenched. As noted in an earlier World Bank report (2022), trade reforms would be supported by outsiders (potential exporters) but opposed by insiders (current exporters, largely the RMG sector) who benefit greatly from the current trade regime. The report noted that “groups that benefit directly from the existing economic arrangements will resist reforms (and even those not benefitting may favor the status-quo rather than risking disorder),” indicating that preferential access has created a roadblock to potential future reforms. Although industrial policies that focus on activities rather than specific sectors can yield broader economic benefits, Bangladesh’s policies have been predominantly RMG-centric. Even though successful industrial policies in East Asia were not entirely sector neutral, their most effective support was tied to performance targets and were largely generic in nature. In contrast, Bangladesh’s industrial policies have traditionally favored the RMG sector, overshadowing other potential growth areas. This bias has significantly benefited the RMG industry but has created imbalances, because other sectors, despite being identified as priority or thrust areas in national industrial policies, have not received comparable support. Where they were the Frontier Firms and Job Creation in Bangladesh 55 4. Selective interventions target of support (for example, the agro-food processing and non-RMG exports), the beneficiaries faced challenges in accessing the subsidies or incentives because of bureaucratic hurdles and complex procedures. Many firms have also criticized the duty drawback system for being bureaucratic, cumbersome, and time consuming (Raihan et al. 2017). Although the government established the Export Development Fund (EDF) to provide preshipment financing for raw material imports and other forms of support to exporters of new and nontraditional items, many non-RMG sectors have struggled to benefit from this program. Stringent rules and regulations are significant barriers that prevent many nontraditional, export-oriented industries from accessing government stimulus packages aimed at export promotion, diversification, and growth (Rahman 2015). There are also allegations that the EDF disproportionately benefits large companies. The shortfalls in Bangladesh’s industrial policy practices are further compounded by the nature of the relationship between the state and large businesses. The current economic and political climate in Bangladesh is often described as “crony capitalism.” Mahmood (2023) identifies three stages of crony capitalism in general: Initially, the state privileges key firms to develop essential industries or infrastructure, which can positively impact development as long as the firms remain efficient. However, this can devolve into a scenario where privileges become necessary for firms to maintain competitiveness, leading to widespread demands for these benefits. Over time, these privileges become normalized, making firms increasingly dependent and less competitive without them. In the final stage, crony firms become predatory, expanding aggressively through acquisitions or exerting undue influence on policy making to preserve their advantages. In Bangladesh, Mahmood concludes that the garments sector exemplifies this progression, having secured significant privileges and playing a dominant role in policy making. Raihan (2024) crucially notes that “the ‘state capture’ by the RMG lobbies is manifested in the form of ensuring special privileges for them, and a high presence of RMG businesses among members of parliament.” By associating with powerful industry lobbies, such as the Bangladesh Garment Manufacturers and Exporters Association (BGMEA), Bangladesh Knitwear Manufacturers and Exporters Association (BKMEA), and the Federation of Bangladesh Chambers of Commerce and Industry (FBCCI), firms are connected to the government via the deals the association participates in. The close ties between the business elite and policy makers are evident in Bangladesh’s political landscape. Following the January 2024 elections and before the dissolution of parliament in August, the nongovernmental organization Shushashoner Jonno Nagorik reported that, excluding the 50 women- reserved seats allocated postelection, nearly 67 percent of lawmakers were businessmen (Dhaka Tribune 2024). The garments sector alone contributed 18 parliamentarians, representing 6 percent of parliament (Zaman 2024). Business interests were also prominent in the national cabinet, where 16 out of 37 ministers were businesspeople, holding significant positions in ministries such as local government, foreign affairs, commerce, planning, and power (Khan and Apu 2024), as well as special advisory roles to the prime minister. A similar pattern was also visible in local political positions, where mayors are often former heads of major industry associations. Besides the possible influence of all these actors in the design of policies, they may also have an influence on their implementation. In the case of tax policy, the NBR regularly meets with industry associations such as the FBCCI for consultations on tax revisions. The government has also delegated Frontier Firms and Job Creation in Bangladesh 56 4. Selective interventions considerable independent powers to BGMEA and BKMEA in the enforcement of bonded warehouses and issuance of customs certificates. Ample evidence highlights the benefits of political connections for connected firms in Bangladesh. Muttakin (2012) studied 155 family and nonfamily firms, finding that political connections significantly enhance the performance of family firms, particularly those with ties to ministers or parliamentarians. These connections provide substantial advantages, including preferential access to government subsidies, contracts, and financing opportunities, often without associated costs for family firms. In contrast, politically connected directors in nonfamily firms tend to negatively affect performance. This disparity underscores the importance of political connections for family firms in Bangladesh, a conclusion reaffirmed by Muttakin and others (2015). Mahmud, Ahmed, and Mahajan (2008) corroborate these findings, noting how politically connected businesses leverage their influence for preferential access, which poses significant political risks for the government in enforcing tax compliance. The lack of legal safeguards against conflicts of interest between parliament and businesses allows businesspeople to promote laws that benefit their interests, fostering an environment of crony capitalism. Equally important, firms excluded from these entities are largely cut off from the possibility of influencing policies. In one interview, the CEO of a manufacturing company quipped that you are not in business until you are a member of the FBCCI. Meanwhile, a representative of the FBCCI noted that, for years, they have not been accepting new members without an express request from high levels of government. This dynamic constitutes an almost insurmountable entry barrier to new or outsider firms. Raihan (2024) notes that for firms unconnected to the government, “bypassing the BGMEA and maintaining bilateral interfaces with the state’s regulatory authority, in relation to duty-free import processes, would be prohibitively costly, in terms of the informal transaction costs that would be incurred and the excessive amount of time the process would entail.” The result is that new firms are unable to influence the pattern of selective intervention in such a way as to support experimentation in new and potentially promising activities. In summary, the current strategy of combining export promotion for frontier firms with import substitution for others seems to have reached its limits. Frontier firms, especially RMG exporters, have been the main beneficiaries of industrial policy, significantly contributing to Bangladesh’s development and achieving global competitiveness. However, the declining potency of frontier firms for job creation, the costs of foregone government revenues, expected export losses from LDC graduation, and lack of diversification are reasons for action. To foster growth in other sectors and identify new sources of economic transformation, the approach to industrial policy must evolve. The next chapter will attempt to provide recommendations on how to achieve it, although the political barriers to reform are not to be ignored. Frontier Firms and Job Creation in Bangladesh 57 5. Policy recommendations 5. Policy recommendations Bangladesh has reached the limits of a development strategy that combines import substitution for non-frontier firms and export promotion for frontier ones. Historically, this approach yielded notable economic growth and a significant jump in exports. However, it is becoming increasingly evident that it can no longer achieve these objectives in the future, let alone meet the challenge of creating the productive jobs the country needs. Past successes were driven by a narrow group of highly productive frontier firms, mostly in the ready-made garments (RMG) sector, leaving most of the remaining firms behind. By comparison, non-frontier firms operated behind walls of protection and did not benefit from the competitive pressure of exposure to global markets, thereby remaining less efficient and offering lower-skilled and lower-paying jobs. Going forward, a significant shift in policy orientation is necessary, akin to the transformative changes made earlier. The purpose of this shift in policy orientation is to empower non-frontier firms, without compromising on the success of frontier firms, by integrating them both domestically and globally. Doing so would enhance the possibility that Bangladesh moves successfully into its next phase of sustaining high economic growth and creating decent and productive jobs. On the basis of the findings of this report, the main features of the new policy regime can be grouped under three headings and distilled into 10 key policy actions. The policy reform package is intended to unleash the capacity of all firms and enable them to boost economic growth and meet the challenge of creating decent and productive jobs. 5.1 Business environment 1. Reduce transaction costs for firm entry, operation, and exit. Facilitating the entry of new firms requires lowering the burdensome registration procedures and costs, particularly for establishing a limited liability company. It would also require simplifying and reducing the costs of registration and possibly consolidating the process for obtaining licenses into a single application Frontier Firms and Job Creation in Bangladesh 58 5. Policy recommendations to minimize bureaucratic overlap and the time required for approval. Furthermore, offering a provisional licensing system could allow firms to commence operations while their applications are being processed, with strict compliance checks within a specified period of time. For sectoral and environmental permits, developing sector-specific guidelines that streamline the approval process will ensure clarity and reduce redundancy. A fast-track approval mechanism for low-risk businesses and start-ups could be introduced to expedite their entry into the market. Regarding audit fee reforms, newly established firms could be exempted from mandatory annual audit fees for the first three years of operation unless they surpass a specified revenue threshold. To lower the transaction costs for firms’ operation, it is essential to streamline regulatory procedures and simplify the process of securing operating and trading licenses, as well as procuring public contracts. Developing an integrated, centralized online platform for all permit and license applications would provide clear guidelines and requirements. Establishing a strict time ceiling for processing the applications will ensure greater efficiency and accountability of public servants. Combining these measures with transparency and accountability through robust anti-corruption measures would also be beneficial. This could include mandatory disclosure of all interactions between firms and regulatory officials—monitored by an independent anti-corruption body—and implementing a public tracking system where applicants can monitor the status of their applications in real time. Additionally, promoting competitive practices in public procurement by enforcing strict anti-corruption regulations and ensuring that the tendering process is transparent and fair would reduce the expectation of gifts in exchange for contracts. Providing regular training for government officials on ethical practices and the importance of transparency can further support these measures. Reducing the transaction costs for a firm’s exit requires providing clear mechanisms for bankruptcy, market exit strategies, and redeployment of assets, allowing for the smooth discontinuation or transformation of businesses. Establishing clear and efficient bankruptcy regulations will help firms navigate the exit process without undue delay or excessive costs. Simplifying legal procedures and reducing bureaucratic hurdles associated with bankruptcy filings will enable firms to exit the market more smoothly. Additionally, developing comprehensive market exit strategies, including guidelines for winding down operations and liquidating assets, will further support businesses in their transition, as well as ensure that the interests of creditors, employees, and other stakeholders are adequately protected. Collectively, all these measures will enhance allocative efficiency within the economy, especially considering the evidence presented in the report that indicates most of the productivity gains come from improvements within firms—not from the reallocation of resources across sectors. 2. Address bottlenecks in public services. To mitigate the adverse impact of inadequate provision of public services on firm entry and operation, it is important to identify bottlenecks and address the most critical among them. In this regard, it seems essential to ensure a stable power supply by investing in energy infrastructure. Doing so will reduce reliance on Frontier Firms and Job Creation in Bangladesh 59 5. Policy recommendations costly generators, which currently poses a significant financial burden on new firms and those with limited resources. Upgrading the national grid and expanding access to alternative energy sources could also help lower operational costs and encourage investment by firms. Addressing uncompetitive practices in public procurement would help reduce the poor quality of public transport, utilities, and construction. This would include enforcing strict regulations to minimize single-bid processes and encouraging broader participation from a diverse pool of bidders. Establishing transparent and rigorous evaluation criteria will help ensure that contracts are awarded based on merit and value rather than favoritism or corruption. Additionally, providing training and capacity-building programs for procurement officials will help reinforce best practices and ethical standards in the procurement process. 3. Promote consistency in the implementation of regulations. To promote consistency in the implementation of regulations across firms, sectors, and regions, the starting point is to streamline the rules themselves along the lines suggested earlier. In addition, it would be useful to offer capacity-building programs to officials in charge of implementing these rules. The purpose of these programs is to ensure that the rules are implemented uniformly, thereby enhancing the credibility and predictability of regulatory institutions. Addressing corruption head on is also critical to achieving consistent regulatory implementation. This can be done by eliminating rent-seeking opportunities and increasing transparency through digitalization of administrative processes. For instance, automating such services as tax collection and land management reduces direct contact between the public and civil servants, thereby minimizing opportunities for bribery. Simplifying laws and making regulatory processes more transparent will also curtail the power of officials to demand bribes. Regular, independent performance audits of regulatory bodies should be conducted, and the results published to ensure accountability and adherence to established procedures, further supporting the goal of consistent and fair regulatory enforcement across all sectors. 5.2 Industrial policy 4. Adopt a more effective industrial policy. To enhance the effectiveness of industrial policy, the starting point should be to evaluate existing selective interventions and then design new policies that support activities according to their potential contribution to economic growth and job creation. In both instances, an important yardstick is whether policy interventions Frontier Firms and Job Creation in Bangladesh 60 5. Policy recommendations are tied to a clear target. Historically, the RMG sector has benefited from meeting export targets, but other sectors lacked similar benchmarks. Instituting clear benchmarks for other sectors, be it employment generation or the adoption of new technology, could contribute to greater diversification, higher productivity, or even a cleaner environment. Such realignment could enhance the accountability of the recipients of policy favors and avoid the declaration of bureaucratic claims of success. By aligning industrial policy with clear performance metrics, Bangladesh can prevent the entrenchment of ineffective practices and ensure that all sectors are given a fair chance to contribute to the country’s economic development. Incorporating sunset clauses into industrial policies is another crucial step toward preventing the prolonged misallocation of resources to unproductive activities or to those no longer in need of support. The current industrial policy has benefited the RMG sector from sustained government backing, while other sectors have benefited from prolonged tariff protections that discourage efficiency and innovation. By establishing predetermined time frames for phasing out support, sunset clauses can encourage firms to be competitive and allow for the reallocation of resources to more promising ventures. This approach can help diversify the industrial base, enabling sectors such as agro-food processing and electronics to emerge as significant contributors to the economy, thereby reducing the current overreliance on the RMG sector. A shift in focus from sector-specific to activity-based industrial policies can also yield broader economic benefits. Although Bangladesh’s policies have predominantly favored the RMG industry, other potential growth areas have been neglected. To rectify this imbalance, industrial policies should support activities that have the potential of promoting diversification, productivity, innovation, and/or productive job creation. For instance, simplifying the duty drawback system and making it more accessible to non-RMG sectors can promote export diversification. Additionally, ensuring that the support mechanisms offered by the Export Development Fund are available to all eligible firms, not just specific sectors or large companies, can help smaller firms overcome financial constraints and contribute to export growth. Promoting the discovery of new areas of comparative advantage is essential for fostering long-term diversification and economic growth. Unlike the RMG sector, which benefited from favorable treatment and the Multi-Fiber Agreement, other sectors have struggled to identify and capitalize on new opportunities. The new industrial policy should support experimental ventures into new products and technologies, providing the necessary infrastructure and financial backing to explore these areas. This can involve setting up innovation hubs and providing grants for research and development in emerging industries. By facilitating the adaptation of foreign technologies and supporting pioneering entrepreneurs, Bangladesh can expand its industrial base and establish new areas of comparative advantage, driving economic diversification and resilience. 5. Align broader incentives with export promotion. Empowering firms and encouraging exports would require broad changes to incentives, the most important of which is a more competitive exchange rate regime. The effect of such a regime is that it would make it Frontier Firms and Job Creation in Bangladesh 61 5. Policy recommendations more attractive for firms to export than to produce for the domestic markets. In the process of switching destinations, firms will strive to be more efficient to be able to compete, capitalizing on the most abundant resource in Bangladesh, namely, labor. Similarly, enhancing the competitiveness of Bangladesh’s economy would require reducing the import- substitution bias of the trade regime. In this regard, a revision of the trade regime comes to the top of the list, the purpose of which would be to reduce the profits from selling in domestic markets rather than exporting. This recommendation is consistent with the views of the National Tariff Policy (2023), which calls for the liberalization of trade and rationalization of tariffs to strengthen competitiveness of domestic industries, expand and diversify exports, promote investment, and create employment. Moreover, Bangladesh would benefit from additional efforts to support export diversification. The efforts could include improving market access abroad through the engagement in new free trade agreements, extending special support to exporting firms in their attempt to comply with safety and environmental regulations of major trading partners, which will improve trade logistics through deregulation and investments in ports and transport networks, attract export-oriented foreign direct investment by lowering the cost of doing business, and address skills gaps through investment in education and training. 6. Encourage innovation over lobbying. Encouraging innovation over lobbying for regulatory advantages is also vital for fostering a competitive environment. Providing tax incentives and grants for firms that invest in research and development or adopt new technologies can shift the focus from seeking preferential treatment to engaging in innovative activities. Implementing strict regulations to limit the influence of lobbying on regulatory processes will help ensure fairer competition. By creating an environment that rewards innovation and discourages reliance on regulatory maneuvering, Bangladesh can cultivate a more dynamic and equitable business landscape. 7. Expand industrial policy beyond manufacturing. To broaden the scope of industrial policy, the benefits of selective interventions should be more accessible not only to large firms but also to small and medium enterprises (SMEs) and service sector firms as well, given their potential for job creation. Developing a comprehensive strategy for services is essential and should target key bottlenecks in areas such as information technology, financial services, tourism, and health care. By tapping into the potential of these activities, Bangladesh can drive innovation, enhance service delivery, and create new employment opportunities that manufacturing alone cannot achieve. To support this shift, it is important to build a supportive ecosystem that includes business incubators, innovation hubs, and sector-specific training programs. These initiatives can provide the necessary Frontier Firms and Job Creation in Bangladesh 62 5. Policy recommendations infrastructure and skill development to foster growth in the service sectors. Additionally, policies should be designed to facilitate easier access to financing for service-based SMEs, helping them scale up their operations and contribute more significantly to the economy. 8. Shift policy design from a top-down approach to a collaborative and adaptive strategy. The approach to industrial policy must evolve away from traditional top-down mechanisms to more collaborative and adaptive strategies. A more effective approach involves a partnership model in which public agencies provide a range of tailored public services in exchange for firms committing to specific employment and quality targets. This reiterative interaction allows for the development of policies that are responsive to the needs of the business community. By fostering continuous dialogue and feedback loops between the government and the private sector, this model can help identify successful initiatives and discontinue those that are ineffective. Such an adaptive framework not only mitigates the risk of poor resource allocation but also enhances the ability of public agencies to learn from real-world outcomes and adjust policies accordingly. The precondition for this process to work is that policy design stays ultimately with policy makers and that the target of these policies should be the interest of the economy at large, and not groups of special interests. 5.3 State capacity 9. Strengthen the capacity of the state to design and implement policies. To improve the business environment and the state’s ability to better design and implement effective industrial policy, Bangladesh would need to strengthen the institutional capacity of the entities in charge of these tasks. In addition to capacity building, the institutional reforms should aim at establishing clear roles and responsibilities between and within different institutions so as to prevent conflicts of interest and improve effectiveness. By ensuring that these institutions operate independently and transparently, Bangladesh can create a more equitable business environment that supports the growth and development of non-frontier firms and fosters inclusive economic growth. Three concrete examples are provided. First, reforming the National Board of Revenue (NBR) to separate tax policy development from tax collection would enhance efficiency and reduce conflicts of interest. Transforming the NBR into an independent agency focused solely on tax collection, with clear objectives and better incentives for personnel, ensures that tax policies are developed based on thorough analysis and implemented fairly. This reduces opportunities for exploitation and corruption. Frontier Firms and Job Creation in Bangladesh 63 5. Policy recommendations Second, enhancing the independence of the Bangladesh Bank by minimizing political interference would enable more effective oversight of the banking sector and ensure that regulatory actions are impartial and based on sound economic principles. Strengthening the central bank’s autonomy will help create a stable financial environment that supports sustainable economic growth and development. Third, modernizing land administration would reduce fragmentation and streamline processes. Updating land records and reducing opportunities for discretionary decisions by officials will make it easier for non- frontier firms to secure land and obtain necessary documentation. Improving the transparency and efficiency of land management will reduce barriers to business expansion and investment. 10. Monitor, evaluate, and adapt as needed. Finally, it is important to recognize that reform is an ongoing and never-ending process. The adoption of the reforms proposed in this chapter may be good enough for now, but circumstances change, and new opportunities arise over time. It is therefore essential that government institutions keep an eye on such developments and be able to adjust according to these changes. A final overall note is in order. None of the proposed measures alone will achieve the desired outcomes, nor will the proposed reforms take place without political champions at the highest level. Adopting the reforms collectively, even in a phased manner, holds the promise of bringing about a positive qualitative change in the business environment and the pattern of government interventions to all firms in Bangladesh. It also promises to put Bangladesh on the road to fulfilling the aspirations of its people for prosperity and for decent and productive employment. However, these reforms require a political commitment and determination to fulfill their promise. At this juncture of its history, Bangladesh is poised to take actions for the benefit of its people. Frontier Firms and Job Creation in Bangladesh 64 References References Acemoglu, Daron, and Pascual Restrepo. 2019. “Automation and New Tasks: How Technology Displaces and Reinstates Labor.” Journal of Economic Perspectives 33 (2): 3–30. 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The surveys provide sampling weights for each country–year episode and are representative of the formal private sector economy. The weighted estimations are thus representative of the formal private sector at the country–year level. The sampling considers the following industries (International Standard Industrial Classification codes): all manufacturing sectors (group D); construction (group F); services (groups G and H); and transport, storage, and communications (group I). In particular, the sample size ensures a minimum precision of 7.5 percent for the 90 percent confidence interval for estimates of (a) the population proportion and (b) the mean of log sales of these industries. A second level of stratification is firm size, defined as small (5–19 employees), medium (20–99 employees), and large (100 or more employees). The targeted firms are establishments with at least five full-time employees with a minimum of eight working hours (or a complete work shift) per day. The restriction in firm size is designed to limit the surveys to the formal economy; thus, firms that are not registered with the registrar or tax authority are excluded. An establishment is defined as a single physical business location and may be part of a firm. However, establishments are required to make their own financial decisions, have their own managerial oversight, and maintain their books separate from the parent firm. Moreover, targeted establishments are located in major metropolitan areas of a country. The sampling methodology is the same in all countries. The questionnaire is administered during face-to-face interviews with owners, managing directors, accountants, or other relevant staff. The interviewers as well as all other survey staff are thoroughly trained, and World Bank experts supervise the training. The interviewers must pass an exam at the end of the training to qualify for the work. The World Bank assures the strict confidentiality of the survey information. Any missing data or inconsistencies are checked by the interviewer and a field supervisor immediately after the interview and after cleaning of the data. Neither the name of the respondent nor the name of the firm is used in any document based on the survey. The high degree of confidentiality is necessary to avoid biased declarations of respondents, who are informed of these conditions at the outset of the interview. The World Bank ensures a wide publicity of the survey’s launch (for example, via newspaper advertisements), and it contacts local agencies to gain the support of the local business communities. These actions create Frontier Firms and Job Creation in Bangladesh 71 Appendix value for potential reform recommendations that result from the survey and thereby improve a firm’s incentives to respond to the questionnaire. Pilot surveys and field experience indicate that a core enterprise survey can be completed in approximately 45 minutes. The shorter completion timeframe contributes to the quality of the responses. Despite these carefully designed survey characteristics, nonresponses could compromise the random nature of the sample if the rationales for nonresponses vary systematically with the respondents’ innovation activity. Thus, the WBES include additional fieldwork reports that examine the reasons for nonresponses in each country, industry, and class of firm size. This report relies on the most recent enterprise survey for Bangladesh from 2022. The survey includes 998 firms and, as with all WBES data, is stratified at the sector and firm size level. The survey for Bangladesh contains sampling weights that have been applied in the analysis to report statistics that are representative for Bangladesh. In the report, the analysis that relies on the enterprise survey applies the Investment Climate Assessment (ICA) 2.0 methodology to assess the performance of firms, along with firm characteristics and policy variables affecting firm performance. Comparisons across firms are restricted to firms operating in the same sector and location, and, where adequate, to firms with a similar size and age. Frontier Firms and Job Creation in Bangladesh 72