Bangladesh and the Corruption Function

By Nicole Woods

Bangladesh is one of the poorest nations in the world. With purchasing power parity, its GDP in 2000 was $203 billion and its rate of growth was 5.3%. Although this growth rate inspires optimism, analysts determined that it will not be enough to improve conditions in Bangladesh. A double-digit unemployment rate is one reason for this deduction. Many factors impede development in Bangladesh's economy. Economists reason, for example, that Bangladesh is slow to utilize energy resources such as natural gas, which prevents rapid economic expansion. Moreover, annual floods damage property and reduce produce harvests, increasing the need for government programs. Most importantly, corruption removes expenditures from GDP to an underground economy.(CIA)

The government responds to these obstacles by increasing government spending on recovery programs. This action was critical to Bangladesh's recuperation following severe floods in 1998. Minimal tax revenues, however, cannot completely fund these projects, which typically fail due to poor management, and the government runs a deficit.(USDOS, p4) In addition, the principle cause of government debt in Bangladesh is corruption. Bangladesh is one of the most corrupt countries in the world, and the World Bank estimates that 2-3% of GDP growth is lost to corruption each year. Per capita income could double if the government restrained corruption.(Transparent International Bangladesh, p2) Tax evasion and corruption of government officials reduce tax revenues, and government projects fail as bureaucrats become wealthy.(Susan Rose-Ackerman, p9) The reduction of funds increases the government debt.

To illustrate, the equation for fiscal deficit (D=G-Yt) with government corruption is D=G-[Yt-Cr]. Corruption (Cr) reduces tax revenues (Yt), and the subtotal is the amount of useful funds. The deficit (D) is the amount of funds subtracted from government spending (G). This equation is the corruption function, a mathematical demonstration of how corruption effects the economy. The effects of corruption on aggregate expenditures are observable from the equation, as is the relation between Bangladesh's rate of growth and its capacity if corruption did not exist.

To continue, government deficit crowds-out investment spending because it utilizes most of the avaiable credit. Investment spending is a very weak variable of Bangladesh's economy. If businesses cannot obtain credit in order to expand, then investment spending remains low, as do wages and employment.(USDOS, p4) Bangladesh's rate of unemployment in 1996 was 35.2%.(CIA) This high rate reduces wages because of the principle of supply and demand in the labor market. Then, the cost-push theory of inflation dictates that companies maintain low prices on merchandise because they do not need to finance high wages. The Bank of Bangladesh takes advantage of this low-inflation opportunity to lower the discount rate, which increases the money supply and the amount of credit available to businesses for investment spending.(USDOS, p4) According to the monetary theory of inflation, increasing the money supply also increases the rate of inflation. These two contraditory inflation trends in Bangladesh created a 5.8% rate of inflation based on 2000 consumer prices.(CIA) This inflation rate might be lower and more stable if the BOB did not need to accommodate profuse government spending.

Another method to encourage investment spending is to attract foreign investment and trade. The Bank of Bangladesh occasionally has devalued the takka, maintaining an exchange rate that is semi-flexible in relation to the exchange and inflation rates of Bangladesh's trading partners.(USDOS, p4) As of January 2001, the exchange rate was 54DT to the US dollar.(CIA) Devaluation improves the balance of trade by encouraging other countries to purchase Bangladeshi exports. Bangladesh also attempts to reduce foreign competition and to generate more revenue for its generous government spending through high tariffs. Almost 60% of its revenue derives from import taxes, tariffs, and duties. As a founding member of the WTO, however, Bangladesh is obligated to follow guidelines regarding its trading policies, and therefore is currently in the process of reducing these tariffs. Foreign investment spending, however, has not improved adequately. The crowding-out effect, for one reason, occasionally prevents investment until the next increase in the money supply. Corruption especially deters foreign investors, who are concerned about profit margins and rapid development.(USDOS, pp6-7) In essence, Bangladesh must stop corruption in order for there to be a significant increase in foreign investment.

Suggestions for improvements in the Bangladeshi economy are two-fold: government reforms to reduce corruption and a more vigorous trade policy to improve the inflow of capital. Academics who study corruption recommend that the government terminate corrupted programs completely rather than attempt to weed out corrupted branches. This measure often takes the form of privatizing, where the government relinquishes control to a private company. Some programs are vital, however, and the government must simplify them and reduce as much bureaucracy as possible. This action will remove the middlemen who are the principle receivers of corrupt payments. Lastly, the government can legalize some of the corrupt payments, which will enable it to regulate the prices. Legalizing will also transform the money from underground to lawful expenditures, and can then increase the GDP.(Rose-Ackerman, p39)

Modifications to trade policies are more diverse. Initially, removing corruption should reduce the crowding-out effect and attract more investment. At this stage, Bangladesh shold be weary of export-processing zones, which are either internationalized or tax-exempt properties used for manufacturing or assembling merchandise using the local labor force at a minimal wage. Thse zones exploit the environment, increase illness, and lead to unmonitored growth surrounding the zones. Instead, Bangladesh should encourage a reversal of the brain-drain trend, which has caused the country to export most of its educated and elite labor force. In order to reverse this tendency, the government can offer benefits to nationals overseas who are considering investing in their home country. For example, Bangladesh might offer lower tariffs or lower taxes on investments made by Bangladeshis abroad. The possibilities depend on the government's capabilities and its legislation regarding foreign investment.

To conclude, the corruption function describes the effect of corruption on the government deficit and, therefore, on the national economy. The increased debt crowds-out investment spending, increasing the rate of unemployment but also enabling the Bank of Bangladesh to lower the discount rate in order to increase the money supply for investment spending. Yet low profits, crowding-out, and corruption reduce foreign investment. It is imperative that the government dedicate itself to reducing corruption in order for the economy to develop competitively.



Central Intellegence Agency, World Factbook 2001, available online at

Rose-Ackerman, Susan, Corruption and Government: Causes, Consequences, and Reform, Cambridge University Press, 1999.

Transparency International Bangladesh, Fact-finding report on the Bureau of Anti-Corruption, December 2001, available online at

US Department of State, 1999 Country Reports on Economic Policy and Trade Practices, Bureau of Economic and Business Affairs, March 2000, available online at