In terms of purchasing power parity, Bangladesh still has a long way to go

Although Bangladesh's consistent economic growth over the past two decades led most around the world to laud it as a role model for development, to most Bangladeshi citizens, the ultimate confirmation came in 2021 with the country eclipsing its regional rival India in terms of per capita GDP. According to World Bank estimates, the per capita GDP for Bangladesh was $1,961.64 compared to only $1,927.7 for India in 2020.

Even veteran economists rejoiced as the doubts and questions got submerged in the exuberance of celebration. Unfortunately, as it often happens, the much-needed nuance regarding these estimates also got lost amid all the noise.

Thankfully, in a recent seminar organised by the Bangladesh Institute of Development Studies, Dr Syed Mainul Ahsan, Professor Emeritus at Concordia University, addressed some of those issues and added some rigour to the discourse surrounding per capita income. 

Syed Mainul Ahsan. Illustration: TBS

In his presentation, he outlined the limitations of the typical methods of calculating per capita GDP and claimed that Bangladesh still lagged behind India in terms of purchasing power parity (PPP). The PPP is a method that compares the relative price of a standard consumer basket across countries to calculate the exchange rates relative to that of the United States and more accurately reflects the standards of living across countries. 

The Business Standard spoke to him to delve deeper into these issues and understand what his findings mean for the economy. 

In your presentation you mentioned that Bangladesh still lags behind India in per capita GDP in terms of purchasing power parity (PPP). Would you elaborate on this?

World Bank estimates from 2020 suggested that based on per capita GDP (at current USD), Bangladesh had eclipsed India in FY2020-21. But these measurements fail to reflect ground reality as they fail to address the differential exchange rates across countries as well as currency manipulations. 

For better understanding, according to the same source, the per capita income at constant local currency (with 2015 as the base year) for Bangladesh was 90 percent of India in 2020. However, Bangladesh's per capita income dropped to 67 percent of India when 2010 was used as the base year instead. 

In terms of purchasing power, Bangladesh's per capita GDP was only 78 percent of India's. That is, in terms of purchasing power parity, Bangladesh still has a long way to go to eclipse India. 

Why are we prioritising the PPP approach over typical measures of per capita GDP? What are the limitations of the mainstream approach?

At the end of the day, the goal of per capita GDP is to measure the standard of living in an economy. In doing so, as Amartya Sen recommends, it is more important to take into consideration the distribution of income instead of the average per capita income level. 

The typical per capita GDP calculation method is merely an average and can be affected by severely skewed income distribution. That is, the per capita income level may be high although most of the income remains concentrated in the hands of a few. 

Illustration: TBS

Moreover, per capita GDP is measured by dividing the per capita GDP in local currency by the exchange rate. However, the market exchange rates across countries can be affected by a number of factors such as changes in net exports, foreign direct investment, factor income as well as portfolio investments.

The market exchange rate's exposure to all of these factors makes it a rather unreliable covariate for measuring per capita GDP. 

GDP by purchasing power parity, on the other hand, compares the relative price of a standard basket of goods across countries to derive the implicit exchange rate and is not affected by the other factors in the market. That is why this approach gives an estimate which is a much better approximation of reality. 

Would you explain the differences in different measurements of per capita GDP for the basic understanding of our readers? 

GDP at constant local currency adjusts for domestic inflation which the current USD method does not account for. That is why this method is preferred for calculating the growth of real GDP. 

Later this estimate is divided by the exchange rate for the base year to report GDP at constant USD. For instance, currently, the World Bank uses 2015 as the base year to calculate GDP at constant costs. But there are limitations to this method as the real equivalent exchange rate may wildly vary within five years – the interval at which the base year is changed. 

More precisely, the circumstances that give rise to this exchange rate in 2022 may be wildly different from that in 2015. For instance, the Indian currency was overvalued in the 2000s, but it turned out to be somewhat undervalued in 2015. Similar fluctuations were reported for Japan. Most economists had no idea that the market exchange rate could fluctuate so much. 

GDP by purchasing power parity, on the other hand, compares the relative price of comparable consumer baskets. They consider the United States as the benchmark economy and the exchange rate in this method is measured by finding the cost of a particular basket that costs $1 in the US. For instance, a standard basket that costs $1 in the US costs approximately Tk33 in Bangladesh and 22 rupees in India. 

Unfortunately, conditions to produce such a basket of goods and the circumstances under which they are consumed also vary across countries. That is why PPP is not used as a universal method for comparison across countries. But when it comes to comparing per capita GDP across countries with similar consumer baskets like India and Bangladesh, PPP is the most ideal tool. 

You mentioned that there was an 'exuberance' in both the Bangladeshi and Indian media regarding Bangladesh eclipsing India in per capita income. Why do you believe that the media has foregone the nuance in this case? 

The media likes catchy headlines. If the media reported that Bangladesh eclipsed India in per capita GDP but lags in purchasing power parity, it adds no value to them. The readers buy newspapers or click on the news based on catchy headlines. 

It also depends on public awareness. If the limitations of per capita GDP measurement such as its failure to incorporate inflation and address exchange rate fluctuations were common knowledge, the media would not have to forego the nuances involved.

Why do countries keep using per capita GDP given the limitations you mentioned? 

Unfortunately, incorporating so many dimensions in the measure of per capita income is rather cumbersome. Various indexes focus on the inequality aspects like the Multidimensional Poverty Index or the Human Development Index. 

However, in most cases, the data on these indicators such as the multidimensional poverty index is unavailable or unreliable for most countries. But when it comes to comparison across countries, we are interested in a more uniform, simpler method of estimation. 

For its simplicity of calculation, per capita GDP at the current USD appears to be very attractive for global comparison. 

The Committee for Development Planning (CDP) uses per capita GNI (also an average measure of national income) as a criterion to recommend countries for LDC graduation. Given the limitations you mentioned, how can we be sure that the graduating countries will survive preference erosion?

One limitation of the PPP approach is that it requires the content and price of the standard consumer basket to be updated at regular intervals. While such adjustments are possible for countries like India with reputed national datasets, for most countries, such adjustments are irregular at best. 

That is why the CDP uses the average per capita GNI as one of the criteria for LDC graduation. In their defence, the GNI is a much better indicator than per capita GDP as it included factor income from abroad such as remittance. 

The World Bank suggests that per capita GNI is more closely related to economic development than per capita GDP. GNI only focuses on the income of the nationals of a country while excluding income made by foreign nationals who in most cases simply remit their earnings abroad and have little contribution to the domestic economy. 

What policies should Bangladesh take to really improve in per capita GDP in terms of PPP? 

For starters, the real growth rate must be increased. To do so, I would recommend macroeconomic stability and inflation management. Just look at Sri Lanka. Long-term macroeconomic mismanagement, particularly in terms of trade, has left its economy in shambles. 

Although the trade management in Bangladesh appears to be well-managed, we must remain vigilant against trade misinvoicing.

Another important issue that must be addressed is human capital development. Bangladesh has a history of inflating academic grades as well as passing rates. This practice is not particularly conducive to human capital development. For instance, we lag behind India, China, South Korea and even Vietnam in most indexes pertaining to human capital. 

Thirdly, Bangladesh needs to foster a hospitable environment for technological innovation. While Bangladesh performed well in exports, it is heavily reliant on the RMG, pharmaceutical and leather industries. 

For instance, about 20 percent of all exports from Vietnam are technological exports while the rate is somewhere around 1 percent for Bangladesh. So, to attain growth effects on income, Bangladesh must improve its manufacturing prowess, especially by employing technology and innovation.