Immiserizing Bangladesh

When Jagdish Bhagwati – the outspoken free marketer – isn’t sparring with Amartya Sen on India’s future, he’s writing editorials savaging worker safety laws imposed on Bangladesh. Some may be surprised that Bhagwati, almost 80, was among the first to recognize Paul Krugman’s deep prodigy as his grad advisor – though the two are now probably rivals on regulating Bangladesh.

I’m not going to dispute the standard economic line that sweatshops and cheap labor are better for everyone involved. But Bhagwati’s pristinely hands-off approach to international working conditions leaves open room for important questions.

A theoretical dispute emerges from a 1958 paper, Immiserizing Growth: A Geometrical Note, written not by Naomi Klein but by a certain Jagdish Bhagwati. Before I detail the theory, it’s critical to note the mathematical conditions under which it’s derived are extreme but, like so many other brilliant models, helps illuminate a thematic dynamic. Bhagwati suggested that an increase in economic activity and output does not necessitate a coincident increase in standard of living:

The effect of economic expansion on international trade has been receiving increasing attention from economic theorists since the publication of Professor Hicks’ stimulating analysis of the “dollar problem”. It has, however, been insufficiently realized that, under certain circumstances, economic expansion may harm the growing country itself. Economic expansion increases output which, however, might lead to a sufficiently deterioration in the terms of trade to offset the beneficial effect of expansion and reduce the real income of the country.

As I understand, the primary conditions under which Bhagwati’s conclusion holds qualitatively stated are for countries:

  • That have market leadership on the international market.
  • Has experienced heavily export-biased growth.

Bangladeshi export of cheap garments are a forceful example of both predications. Like all other economic theories, immiserization of growth is not binary. For some increase in export-driven output, the nominal increase in income outweighs the deteriorating terms of trade and hence elevates real wages and standards of living.

However, Bhagwati here details an effect which may be framed as a countervailing tension between two abstract poles. Indeed, few of us will suggest that Bangladesh today is in a position where the marginal increase in export revenue is decreasing its real wage rate: but we may say that it is closer than most countries to reaching this threshold, and hence a fall in exports per se may not be as damaging to employment as Bhagwati has suggested in this recent column.

Another, more readily plausible, theoretical challenge emerges once we consider that it is unlikely international garment markets are perfectly competitive – at least not at the national level. (That is, the fact that within Bangladesh it might be difficult for firms to earn supernormal profits speaks little of competitiveness across borders with China or Cambodia). This is a critical assumption that Bhagwati only implicitly acknowledges. Rather, Bangladesh has both a natural and strategic comparative advantage in the garment market. The former derives from labor intensity and a previously untapped female labor market. The latter – very important here – from the specialization of international supply chains and infrastructure around a Bangladesh-dominated garment market.

To the extent that Bangladeshi firms – as a group – earn supernormal profits from this uncompetitive and scaled enterprise, the idea that slightly higher regulations will provoke disemployment is unfounded. Since such profits are ipso facto elevated from the level at which firms would keep all factors of production in their current use, it is difficult to accept that artificially, but minimally, inflated unit-labor costs will reduce output or exports.

Finally, an adaption of basic public choice theory suggests better working conditions need not fall on factory owners. Mancur Olson’s famous “dispersed costs, concentrated benefits” explains the preponderance of wasteful farm subsidies across the developed world. Let’s consider a converse of “dispersed benefits, concentrated costs”. Americans have thoroughly benefitted from extremely cheap garments resulting from similarly cheap labor. Let’s say this consumer surplus comes at the “cost” of better, basic safety in a Bangladeshi factory (I don’t like this terminology, but that aside). A regulation that increases Bangladeshi unit-labor costs represent a much higher percent of Bangladeshi incomes than the resulting fall in garment costs – accounting for rents accrued – helps the American consumer, especially accounting for the vastly higher income across the sea. That is to say, garment costs are a relatively small percent of American expenditure, and the change thereof is more irrelevant still. The elasticities of this relationship suggest incidence of basic regulation falls on interim rents and American consumer surplus, rather than employment of Bangladeshi workers, so long as the American government uniformly requires such working conditions for all countries and not just Bangladesh.

At this point we’ve established, from fairly standard theory, that a) there may not be an increase in unit labor costs, b) such a rise may not cause a fall in export-driven output, and c) such a fall may not precipitate a proportional fall of living standards. Bhagwati must believe, then, that none of the above hold true and this would be an extraordinary claim. At least the answer to the debate isn’t as clear cut as the Financial Times column suggests.

There are also practical benefits to an America requiring higher working conditions for exports from all countries. The current foreign aid model, with apologies for Jeffrey Sachs, is rife with corruption and rent-seeking behavior that is better overcome with a market proposition. This is to say that the United States can stratify various countries by bands of development and require a slightly increasing quality of working conditions – up to a reasonably sane point – by band. That means China faces more stringent restrictions to be eligible for an American export market than does Bangladesh.

Let’s say we do this instead of funding the humanitarian-industrial complex of foreign aid. That destroys a market fundamentalist argument, which is “factories will just go to China which has far higher productivity [output/hr] than Bangladesh”. Unfortunately, countries with higher productivity requirements will likely be at a farther stage of development and hence face more stringent requirements.

Rather than unfairly giving random subsidies to certain countries, the poorer countries will be allowed to develop by facing a lower protectionist standard – with fair minimums and maximums – than their richer brethren. Foreign aid works because its “effective” disposal requires no market power, hell I can remit some money to India too.

On the other hand, few countries have the market power to successfully levy international restrictions – counterintuitively, as I suggest, a more market-oriented proposal than the alternative of foreign aid. The United States is one of the few countries, especially in concert with the European Union and Australia, that commands a sufficient share of the import market to increase worker welfare through such means. Indeed it means that America must hold itself and Europe up to the highest standards so as not to provide our unions an unfair advantage, as Bhagwati worries.

This post isn’t about Bangladesh. It’s about the importance of considering alternative methods of guided development that may seem, at first approximation, paternalistic are, on second thought, fairer to international markets as a whole. Bhagwati’s own theory provides fertile ground on which to question the rather uncritical statement that any and all regulation will increase business uncertainty, curtail investment, and increase disemployment.

We should not overreact because  a building burned or fortress crashed. Rather, we must rigorously evaluate our currently flawed method of development. This, I suggest, is a golden opportunity.

  1. ‘A regulation that increases Bangladeshi unit-labor costs represent a much higher percent of Bangladeshi incomes than the resulting fall in garment costs….’

    How are garment costs falling?

    • Badly worded, I meant fall compared to the situation without said regulations.

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