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Journal of Policy Modeling 32 (2010) 399–417

Trade liberalization and industry performance

in Bangladesh
M. Kabir Hassan a,∗ , Ihsan Isik b,1 , Abdullah Mamun c,2
a Department of Economics and Finance, University of New Orleans, New Orleans, LA 70148, USA
b Department of Accounting and Finance, Rowan University, 201 Mullica Hill Rd., Glassboro, NJ 08028, USA
c Edwards School of Business, University of Saskatchewan, 25 Campus Drive, Saskatoon, SK S7N 5A7, Canada
Received 1 August 2009; received in revised form 1 December 2009; accepted 1 February 2010
Available online 7 March 2010

Abstract
This paper analyzes trade liberalization’s impact on Bangladesh’s manufacturing sector performance.
Using firm level input and output data and employing a nonparametric data envelopment analysis (DEA),
we calculate technical, pure technical and allocative efficiencies for a sample of 82 firms collected over
two periods of time: 1993 and 1998. Then, applying a Malmquist index method, we calculate indices
of total factor productivity change and decompose them into technological change, technical efficiency
change and scale efficiency change. Our results show that the majority of Bangladeshi manufacturing firms
experienced a positive total factor productivity growth between 1993 and 1998, averaging 29% over a
five-year period. Export-oriented firms have performed better than import-oriented firms in improving their
technical efficiency relative to the best-practice firms in their own sub-group. When these results are compared
with the official statistics on the output performance of manufacturing firms, we can conclude that trade
liberalization in the 1990s did not adversely affect the Bangladeshi manufacturing industry.
Published by Elsevier Inc. on behalf of Society for Policy Modeling

JEL classification: G21; G28; H50

Keywords: Trade liberalization; Efficiency; Productivity; DEA; Malmquist index; Bangladesh

∗ Corresponding author. Tel.: +1 504 280 6163; fax: +1 504 280 6397.
E-mail addresses: mhassan@uno.edu (M.K. Hassan), isik@rowan.edu (I. Isik),
mamun@edwards.usask.ca (A. Mamun).
1 Tel.: +1 856 256 4500; fax: +1 856 256 4439.
2 Tel.: +1 306 966 1862; fax: +1 306 966 2515.

0161-8938/$ – see front matter. Published by Elsevier Inc. on behalf of Society for Policy Modeling
doi:10.1016/j.jpolmod.2010.02.005
400 M.K. Hassan et al. / Journal of Policy Modeling 32 (2010) 399–417

1. Introduction

In Bangladesh, trade liberalization has been an important component of structural reform efforts
since mid 1980s. In early 1990s, the pace of trade liberalization has accelerated. Significant
progress has since been made in removing quantitative restrictions (QRs) and in reducing the
maximum and average tariff rates. Since the mid 1990s, however, the movement towards a lower
and uniform tariff rate has slowed due to concerns for budgetary revenues, no the balance of
payments, and, in particular, possible adverse effects of trade liberalization on import-competing
industries (World Bank Report, 1999). In this period, a number of researchers, industrialists and
government policy makers criticized Bangladesh’s trade liberalization for being too fast and for
flooding domestic markets with foreign goods in amounts that harm local industries. They also
contend that trade liberalization has, in particular, adversely affected import-competing industries,
making some of them “sick” and forcing closure of others (Khan, 1994).
The import-substitution policy in the 1980s was replaced by export-led growth policy in the
1990s. As trade liberalization allows the export sector to grow along the line of comparative
advantage, we could expect that export-oriented industries would contribute more to technical
efficiency change. The unequal infrastructure conditions of various regions of the country are also
expected to affect efficiency change in various types of industries differently. In order to evaluate
the impact of trade liberalization, it is important to quantify the impact of trade liberalization on
efficiency of manufacturing firms in Bangladesh (Rahman, 1997).
The literature on trade theory suggests that trade liberalization might improve productivity and
efficiency through increased competition and shut down of non-optimizing firms, fostering scale
efficiency, elimination of production waste, and diminishing managerial slack. Alternatively, trade
liberalization might bring about productive efficiency through international transactions, which
provide increased access to higher quality intermediate inputs. In addition, such advances in pro-
duction performance may stem from capital goods that embody improved technologies, thereby
augmenting opportunities for technology diffusion (Ozler & Yilmaz, 2002). However, as a counter
argument, Rodrik (1992) maintains that if trade liberalization causes a reduction in market shares
of domestic firms, they may lose their incentives to invest in better technologies when protection
is lifted, with negative implications about their productive performance. Moreover, sudden lib-
eral reforms can create instabilities when the underlying institutional structure contains serious
weaknesses (Beim & Calomiris, 2001). Therefore, the relationship between trade liberalization
and industry performance is subject to an empirical inquiry for fair conclusions.
A number of empirical studies that explored the impact of trade liberalization on industrial
productivity/efficiency employing macro-level methods or industry level methods have generated
mixed evidences. Roberts and Tybout (1991), Tybout (1992), Tybout and Westbrook (1995) could
not find any evidence supporting industry rationalization or scale effects following trade reforms.
Levinsohn and Petrin (2000) raise doubt on some of these results by reporting that rationalization
case is empirically most significant when industry productivity increases. They also find that the
probability for exit in response to an increase in imports is materially higher among small firms
than it is among large firms. However, findings in the available studies are generally favorable
to the hypothesis that trade liberalization leads to technical efficiency gains (Ozler & Yilmaz,
2002; Rodrik & Dani, 1995; Tybout, De Melo, & Carbo, 1991; Yulek, 1998). Yulek (1998) in his
dissertation shows that the industry efficiency improved as a result of liberal reforms launched
in Turkey. Ozler and Yilmaz (2002) report that productivity gains in Turkey were largest during
periods of rapid decline in protection rates. They also indicate that import-competing sectors
had higher productivity gains upon trade reforms. Due to the reported favorable and unfavorable
 M.K. Hassan et al. / Journal of Policy Modeling 32 (2010) 399–417 401

outcomes, it is clear that the empirical evidence is far from conclusive on the link between trade
liberalization and performance. Our paper aims to shed further light on productivity and efficiency
effects of trade reforms by drawing on Bangladeshi experience.3
In this framework, this paper analyzes trade liberalization’s impact on Bangladesh’s man-
ufacturing sector. Using firm level input and output data and employing a nonparametric data
envelopment analysis (DEA), we calculate technical (TE), pure technical (PTE) and scale (SE)
efficiencies for a sample of 82 firms collected over two periods of time: 1993 and 1998. We use
the DEA method because DEA (1) does not assume firms to be cost minimizers, thus, places
no restrictions on the functional form of the production relationship; (2) focuses on individ-
ual observations rather than on population averages, (3) concentrates on revealed best-practice
frontiers rather than on central-tendency properties of frontiers; (4) produces a single aggregate
measure of the utilization of input factors to produce desired outputs; (5) requires less data, and
(6) works well with a small sample, which is critical for our sample (Isik & Hassan, 2003; Zheng
et al., 1998). Then, applying a Malmquist index method to panel data from 1993 to 1998 for
82 manufacturing firms, we calculate indices of total factor productivity change (TFPC) for the
Bangladeshi manufacturing sector. This approach allows us to isolate contributions of techno-
logical change (TECHCH), technical efficiency change (EFFCH) and scale change (SECH) to
productivity growth (TFPCH).
This paper contributes to the trade liberalization literature in a number of ways. First, to the
best of our knowledge, this is the first study of this kind for the trade liberalization impact on
the manufacturing industry of Bangladesh. Second, it is important to assess if trade liberalization
boosts productivity and efficiency from a policy perspective. Trade liberalizations happen with
large reallocations of labor and capital, with negative consequences for some interest groups in
the local economy, making the measurement of gains from liberalization an important policy
issue for governments. Third, it uses a unique survey data set, which was commissioned and
collected by the World Bank. Fourth, we analyze productivity growth by market orientation,
production size and geographical location of firms, with significant implications in regard to
spatial, capital reallocation, competition and consolidation policies of the government. Finally,
this study will be useful for international organizations (IMF and the World Bank), domestic
policy makers and academic researchers who are interested in promoting free and fair trade
worldwide.
Our results show that majority of Bangladeshi manufacturing firms experienced a positive total
factor productivity growth between 1993 and 1998, averaging 26–29% over a five-year period.
Export-oriented firms have done better in improving their technical efficiency relative to the best-
practice (most efficient) firm(s) in their own sub-group, thus moving closer toward the maximum
potential production. This convergence between the average export firms and the best performer(s)
is expected among export-oriented firms that are normally exposed to more intensive competition
and market and production knowledge.

3 In a different context, utilizing the DEA framework, Zheng, Liu, and Bigsten (1998) investigated the differences

in technical efficiency between state (SOE), collective (COE) and township–village (TVE) enterprises in China during
1986–1990, when the country was experiencing significant economic transformation. They found that urban COEs were
less efficient than TVEs, but more efficient than SOEs in the new era, indicating ownership impact on responses to
reforms. Another DEA paper by Yang (2006) investigated the impact of state funding policies in Korea on receiving firms’
productivity and efficiency by size and operation location. Yang reports that the productivity and efficiency performance
improved for fund receiving firms and the capital locations tended to house more productive firms, indicating that the
nature of production location has important effects on firm performance.
402 M.K. Hassan et al. / Journal of Policy Modeling 32 (2010) 399–417

Import-competing firms have generally lagged behind the most efficient firms in their own
sub-group in improving their technical efficiency. This disparity basically reflects the protection
that trade barriers provide to inefficient firms as well as to efficient, more dynamic, import-
competing firms. The import-competing firms, however, show stronger positive technological
progress, on average, than export-oriented firms over the five-year period. Two factors have
contributed to their gains: the larger initial technology gap with the outside world that is nor-
mal for import-competing firms and the stimulus that a less restrictive trade policy fosters for
larger leaps in technological progress by the best-practice import-competing firms. As a result,
import-competing firms, on average, experience larger total factor productivity growth than export-
oriented firms, even though many of the former failed to close the gap with the best practice
firm(s).
Progressive reductions in trade restrictions in Bangladesh have played a role in improving
manufacturing firms’ total factor productivity growth. By inducing competition, technologi-
cal change and diffusion, and technical efficiency gains, the stimulus to trade has resulted
in increased productivity of inputs. When these results are compared with the official
statistics on the output performance of manufacturing firms, we can conclude that trade
liberalization in the 1990s did not adversely affect the Bangladesh’s manufacturing indus-
try.
This paper is divided into six sections. Following introduction in section I, Section II describes
methodology, data and sample statistics. Section III provides and analyzes estimates of technical
and scale efficiency measures in manufacturing sector. Section IV presents and discusses total
factor productivity change of manufacturing sector during 1993–1998 period. Section V concludes
the paper.

2. Methodology, data and sample statistics

2.1. Empirical design for efficiency estimations

We estimate two separate annual efficiency frontiers for the years 1993 and 1998. We believe
that the principal advantage of having panel data is the ability to observe each firm more than once
over a period of time. This is a critical issue in a continuously changing business environment
because the technology that is most efficient in one year may not be in another year (Isik &
Hassan, 2002). Furthermore, by doing so, we alleviate at least to an extent, the problems related
to the lack of random error in DEA by allowing an efficient (inefficient) firm in one year to be
inefficient (efficient) in another year, assuming that the errors due to luck or data problems are
not consistent over time.

2.2. Data, input and output

The data used in this study are obtained from two surveys taken in 1993 and 1998 by the World
Bank. The data in 1998 was collected by the Trade Reform Study Survey and contains only 10%
of the 1993 Industrial Surveys and Studies Programs. We have comparable data of 82 firms for
two periods: 1993 and 1998.
In order to determine the changes in the production efficiency of firms upon liberalization,
one first should define the production technology; what inputs firms use to generate outputs. The
input vector includes (1) labor (LABOR), (2) raw materials, (MATERIAL), and (3) physical
capital (CAPITAL). We measure the quantity of labor by the number of full-time employees
 M.K. Hassan et al. / Journal of Policy Modeling 32 (2010) 399–417 403

on the payroll and material by the purchase price of raw materials in the production process.4
Capital is calculated by summing the value of machinery, transport and premises.5 We add the
value of all industrial inputs to get the raw materials in our analysis. A similar approach is
used to aggregate labor.6 We have only one output, the dollar value of product (PRODUCT).7
We use the gross value of industrial output in current prices as a measure of output. Since we
include materials as an input in the production function estimate, this is the proper measure rather
than value-added. Besides, it is difficult to obtain reasonable deflators for capital and material
inputs.

2.3. Sample statistics for the variables and size

Table 1 displays summary statistics for one output and three inputs for 82 firms for 1993
and 1998. Panel A reports the average output and inputs for the whole sample along with their
standard deviation. Panel B details the variable statistics according to three classifications: (a)
Market Orientation; (b) Size; (c) Location. We further decompose firms into various subclasses.
For example, we divide firms in the market segmentation category into export-oriented, import-
oriented (further subdivided into import competing and import intensive) and nontradeables. We
subdivide firms according to three size classes: small, medium and large, and according to location
(Chittagong, Dhaka, and Khulna).
As we can see from Table 1, the majority of firms fall under import-oriented industries (61 out
of 82). 8 firms are in the export-oriented category and 13 are in non-tradable sector. According to
size classification, 27 firms are small, 38 firms are medium and 17 firms are large. According to
the location of the firms, the majority (45) are located in the capital city, Dhaka, 28 in Chittagong
and 9 in Khulna. We find that only export-oriented firms and import-competing firms experience
an increases in capital over the 1993–1998 period.

3. Estimates of firm technical and scale efficiency measures

Sample statistics of the measured values of the various efficiency estimates for the full sample
(Panel A), and sub-samples (Panel B) are presented in Tables 2 and 3. Because efficiency indexes
measure the relative performance of the sample firms with respect to a common frontier, it may

4 Non-productive capital and labor may produce a downward bias in total factor productivity measurement during the

trade liberalization period. Ideally, productive labor and capital should be used to estimate production frontiers. Due to
the heterogeneous nature of data, we use aggregate labor in our analysis. In calculating physical capital, we subtract the
value of non-productive capital from our analysis.
5 The capital figure for 1993 is given. Investment figures for 1994 through 1997 are also given. We calculate the 1997

capital by taking the 1993 capital value as base and depreciating this capital at 8% rate and adding depreciated investment
for 1994 through 1997. Of course, we deflate these numbers first by the GDP deflator.
6 Indices of raw materials and labor are better than simple aggregates. But, the heterogeneous nature of firm data prevents

us from performing such analysis. While we have the price of labor, we do not have the price of either raw materials or
capital, which would be useful in our analysis to compute cost and allocative efficiencies. The information we have, if
used, would result into comparing apples with oranges.
7 Data limitation prevents us from discussing the impact of capital on various efficiency measures. We have tried two

proxies for capital stock: gross domestic capital formation and capital goods import, but this did not change our results,
so we report our results without capital variable. Note that we have one value for each firm in 1993 and 1998 as a proxy
of capital. However, one could develop composite input and output indices of firms using several intermediate inputs and
producing more than on output provided one has access to homogeneous data.
 404
Table 1
Sample statistics of output and inputs: 1993–1998.
Group (observations) Output Inputs

Product Labor Raw material Capital

M.K. Hassan et al. / Journal of Policy Modeling 32 (2010) 399–417

1993 1998 1993 1998 1993 1998 1993 1998

Panel A
All (82)
Mean 41,246.8 75,163.6 251 282 28,453.4 48,267.2 15,124.1 15,256.1
Std. dev. 97,969.2 172,291.0 891.2 1407.8 66,306.3 105,327.1 35,786.2 32,173.9

Panel B
1. Market Orientation
1. A. Export (8)
Mean 96,389.8 191,796.4 293 271 73,415.8 125,486.8 35,512.1 42,095.3
Std. dev. 75,000.5 15,2615.1 414.6 257.6 63,422.4 100,173.7 39,153.3 33,318.7
1. B. Import (61)
Mean 42,111.9 74,921.1 259 319 28,285.9 48,069.7 15,573.2 14,852.8
Std. dev. 107,617.1 185,635.7 1024.5 1630.8 70,991.2 111,983.2 38,050.4 33,546.5
Import competing (47)
Mean 37,680.1 64,855.5 300 381 25,606.9 36,678.9 9645.1 9707.4
Std. dev. 101,382.0 175,752.3 1164.5 1857.0 66,440.7 81,476.1 29,593.5 26,667.7
Import intensive (14)
Mean 56,989.9 108,712.7 123 113 37,279.7 86,310.6 35,474.9 32,126.9
Std. dev. 129,514.4 219,439.7 140.7 112.9 86,759.9 179,845.8 55,043.6 47,544.6
1. C. Non-tradable (13)
Mean 3253.7 4528.1 184 112 1570.7 1674.4 469.9 632.2
Std. dev. 1752.0 2086.8 80.9 52.8 778.8 1052.5 489.5 426.9
2. Size
2. A. Small (27)

M.K. Hassan et al. / Journal of Policy Modeling 32 (2010) 399–417

Mean 2930.3 7224.9 21 22 1780.4 4436.3 1263.4 1598.7
Std. dev. 3467.2 15,097.9 9.9 17.2 2431.8 10,471.4 2449.7 3823.8
2. B. Medium (38)
Mean 22,284.3 36,941.5 134 111 16,085.8 24,243.2 9141.1 10,276.6
Std. dev. 45,939.6 70,710.4 202.0 133.6 37,101.2 47,706.8 22,006.9 19,660.9
2. C. Large (17)
Mean 144,489.3 268,504.0 878 1075 98,462.0 171,581.8 50,511.8 48,078.1
Std. dev. 170,390.9 296,062.6 1840.2 3023.2 110,875.2 173,065.1 60,115.2 52,958.3

3. City
3. A. Chittagong (28)
Mean 62,305.6 114,401.1 259 197 46,119.8 85,188.8 28,219.9 24,005.1
Std. dev. 117,328.7 198,473.4 476.3 401.7 86,805.1 149,680.6 53,762.3 46,108.8
3. B. Dhaka (45)
Mean 33,357.4 53,419.5 273 370 19,336.6 27,247.4 9108.6 10,958.1
Std. dev. 91,643.4 160,319.2 1148.1 1878.7 53,926.2 63,756.5 20,116.5 21,695.4
3. C. Khulna (9)
Mean 25,177.6 61,812.6 112 105 19,076.0 38,499.7 4458.6 9527.4
Std. dev. 46,201.5 134,143.3 44.5 64.9 37,826.7 83,603.6 7355.9 17,554.4

Source: The World Bank (1999).

405
406 M.K. Hassan et al. / Journal of Policy Modeling 32 (2010) 399–417

Table 2
Technical (managerial) efficiency measures of Bangladeshi industrial firms: 1993–1998 [estimated relative to common
frontier].
Group (observations) Efficiency measures
TE: technical efficiency PTE: pure technical efficiency SE: scale efficiency

1993 1998 1993 1998 1993 1998

Panel A
All (82) 0.766 0.628 0.832 0.731 0.921 0.859

Panel B
1. Market Orientation
1. A. Export (8) 0.777 0.783 0.864 0.859 0.899 0.912
1. B. Import (61) 0.772 0.632 0.841 0.752 0.918 0.840
Import competing (47) 0.771 0.639 0.847 0.780 0.910 0.819
Import intensive (14) 0.776 0.609 0.823 0.655 0.943 0.930
1. C. Non-tradable (13) 0.729 0.509 0.765 0.551 0.953 0.924

2. Size
2. A. Small (27) 0.807 0.584 0.887 0.747 0.910 0.782
2. B. Medium (38) 0.745 0.630 0.776 0.694 0.959 0.907
2. C. Large (17) 0.750 0.693 0.870 0.787 0.863 0.881

3. City
3. A. Chittagong (28) 0.720 0.670 0.782 0.722 0.921 0.927
3. B. Dhaka (45) 0.794 0.605 0.871 0.747 0.912 0.810
3. C. Khulna (9) 0.769 0.611 0.793 0.677 0.969 0.902

be proper to study a homogenous set of firms. To address this concern as a robustness check,
we construct separate (own-group) frontiers for each division in our sample (e.g., export versus
import orientation; small versus medium versus large firms; Dhaka versus Chittagong versus
Khulna firms). While Table 2 presents the common frontier results, Table 3 presents separate
frontier results. It is clear from the results that common frontier scores are invariably below
separate frontier scores. For example, 1993 arrays of TE, PTE and SE indexes are [77%, 83%,
86%] under common frontier (Table 2) and [83%, 89%, 88%] under separate frontiers (Table 3),
respectively. The same pattern can be verified for 1998 indexes, as well. The reason for this
outcome is that separate frontiers always lie on or below common frontiers, shortening the distance
from production location to the frontier.
From Tables 2 and 3, we also find that a downward trend in the technical, pure technical and
scale efficiency in the Bangladeshi firms occurred due to trade liberalization. The results from
Table 2 (3) suggest that overall technical efficiency falls from 76% (83%) in 1993 to 63% (69%)
in 1998. Although the frontiers are different, the level of efficiency regress appears to be the
same under both assumptions (14%). According to the separate frontier statistics, this means that
average firms could have used only 83%, and 69% of the resources actually employed in 1993,
and 1998, respectively, to produce the same level of output in these years. Stated differently, while
the average input waste in the production of firms in Bangladesh was 21% in 1993, it climbed to
 M.K. Hassan et al. / Journal of Policy Modeling 32 (2010) 399–417 407

Table 3
Technical (managerial) efficiency measures of Bangladeshi industrial firms: 1993–1998 [estimated relative to their own-
group (separate) frontiers].
Group (observations) Efficiency measures
TE: technical efficiency PTE: pure technical efficiency SE: scale efficiency

1993 1998 1993 1998 1993 1998

Panel A
All (82) 0.831 0.693 0.890 0.785 0.934 0.883

Panel B
1. Market orientation
1. A. Export (8) 0.876 0.948 0.982 0.957 0.892 0.990
1. B. Import (61) 0.812 0.654 0.870 0.768 0.932 0.851
Import competing (47) 0.806 0.661 0.870 0.797 0.926 0.829
Import intensive (14) 0.832 0.629 0.873 0.671 0.953 0.938
1. C. Non-tradable (13) 0.892 0.724 0.926 0.757 0.963 0.956

2. Size
2. A. Small (27) 0.831 0.596 0.900 0.755 0.923 0.789
2. B. Medium (38) 0.841 0.721 0.875 0.765 0.962 0.942
2. C. Large (17) 0.806 0.788 0.908 0.876 0.887 0.899

3. City
3. A. Chittagong (28) 0.813 0.768 0.865 0.803 0.940 0.956
3. B. Dhaka (45) 0.831 0.642 0.899 0.771 0.924 0.833
3.C.Khulna (9) 0.883 0.719 0.922 0.765 0.958 0.940

45% in 1998.8 This implies that there is still a substantial room for significant cost savings if the
firms utilize their productive inputs more efficiently.
Overall, average scale efficiency declined from 93% in 1993 to 88% in 1998, and pure tech-
nical efficiency declines from 89% in 1993 to 79% in 1998 (Table 3: Panel A). Comparison
of 1993 PTE and SE suggests that the major source of the technical inefficiency for firms is
pure technical inefficiency (11%), not scale inefficiency (7%). Technical inefficiencies have
much more to do with the inefficient utilization of resources (management driven) rather than
the scale of production (market driven). Common frontier results also attest the same conclu-
sions.
The results in Panel B of Tables 2 and 3 reveal that the impact of trade liberalization on technical
efficiency is not uniform across firms. If we analyze the data according to market orientation, we
find that technical, pure technical and scale efficiency improved over the 1993–1998 period for the
export-oriented firms only. For instance, separate frontier results from Table 3 demonstrate that
for export-oriented firms, technical efficiency increases from 88% in 1993 to 95% in 1998, pure

8 Technical efficiency analysis is carried out in terms of comparing all firms (groups and subgroups) to the efficient

firm in a given year. The resulting efficiency scores are comparable only to their own group scores. For example, in the
export-oriented group, the efficient firm is estimated from the export-oriented firms only, and the efficiency scores are
calculated relative to this efficient firm. We report efficiency scores calculated from a common frontier for all 82 firms
and separate frontiers classified according to their subgroups.
408 M.K. Hassan et al. / Journal of Policy Modeling 32 (2010) 399–417

technical efficiency rises from 92% in 1993 to 96% in 1998, and scale efficiency rises from 89%
in 1993 to 99% in 1998. The import-oriented firms suffer from declining efficiency. The average
technical efficiency of these firms declines from 81% in 1993 to 65% in 1998, pure technical
efficiency from 87% in 1993 to 77% in 1998, and scale efficiency from 93% in 1993 to 85% in
1998. The non-tradable sector suffers the most. The technical efficiency of this group of firms
declines from 89% in 1993 to 72% in 1998, the pure technical efficiency from 93% in 1993 to
76% in 1998 and the scale efficiency remains the same.
These results show that only the export-oriented firms gain efficiency from trade liberalization
policies of Bangladesh in the 1990s, while the import-oriented industry as well as the non-tradable
sectors loose efficiency. The export-oriented firms are more outward looking, competitive and are
more advanced with technologies to compete with the world market. Quality and cost of production
are continuously monitored so that these firms can keep their market share. This necessitates
updating their production technology. The import-competing and import-intensive firms were
heavily protected either via quota or tariff and non-tariff regulations before trade liberalization,
and thus suffered the most because they were slow to adjust.
When we divide the sample according to size, we observe that all sizes of firms invariably
incurred some efficiency loss although its degree was not uniform across different sizes. While
both small and medium firms suffer the most, the large firms suffer the least. We also see that
while small firms were the most efficient form of business in 1993, large firms were the most
efficient business type in 1998. Large firms owe their superior technical efficiency mainly to scale
improvements. Yulek (1998) also reports that larger firms were more efficient than smaller firms
in Turkey. He also states that larger firms benefited the most from liberalization mainly due to
their access to bank credit and resulting increased bank monitoring.
The organizational form (size or trade orientation) adopted by a firm sometimes may be less
important than its geographical location, if factors such as differences in the availability of natural
resources, the quality of infrastructure, the political power, the climate, and so on, significantly
differ across firms (Kyj & Isik, 2006). In order to explore the impact of location on industry
performance we divide the sample firms according to three different regions, Chittagong, Dhaka,
and Khulna. However, no clear pattern based on location of industry emerged. While firms located
in Chittagong appear to lose the least in terms of technical, pure technical and scale efficiency,
the firms located in Khulna appear to lose the most.
In summary, we find that export-oriented firms gain efficiency from 1993 to 1998. In addition,
the import-competing, import-intensive and non-tradable sector firms lose efficiency from 1993 to
1998. Although all sizes of firms lose technical efficiency, large size firms lose the least. Finally,
firms located in Chittagong lose the least amount of technical efficiency and firms located in
Khulna lose the most.
We also examine the trend in terms of scale efficiency. As Table 4 shows, while 41, 11 and 30
firms show increasing returns to scale (IRS), constant returns to scale (CRS) and decreasing returns
to scale (DRS) respectively in 1993, 50, 12 and 20 firms exhibit IRS, CRS and DRS respectively
in 1998. These results imply that main scale issue in Bangladesh is the inability to benefit from
economies of scale because of less than optimal scale. Further examination of Table 4 indicates
that scale inefficiency due to DRS is mostly associated with large size whereas scale inefficiency
due to IRS is mainly linked to small size. Accordingly, we observe that scale efficient firms that
operate where there is CRS are mostly among the medium-sized firms. Most of import-oriented
firms are suffering from less than optimal scale as well. The opposite is true for export-oriented
firms as their main issue seems to be the excess size. These results suggest that major source of
scale inefficiency in Bangladeshi firms is small size. Therefore, mergers and acquisitions between
 M.K. Hassan et al. / Journal of Policy Modeling 32 (2010) 399–417 409

Table 4
Developments in returns to scale (RTS) in Bangladeshi industrial firms during the trade liberalization era (1993–1998)a .
Firms RTS

No. of IRS: increasing returns CRS: constant returns DRS: decreasing

firms to scale to scale returns to scale
1993 1998 1993 1998 1993 1998

Panel A
All 82 41 50 11 12 30 20

Panel B
1. Market orientation
Export 8 3 2 1 2 4 4
Import 61 33 37 10 9 18 15
Import competing 47 28 30 8 7 11 10
Import intensive 14 5 7 2 2 7 5
Non-tradable 13 5 11 0 1 8 1

2. Size
Small 27 23 22 4 4 0 1
Medium 38 16 22 6 5 16 11
Large 17 2 6 1 3 14 8

3. City
Chittagong 28 9 14 3 6 16 8
Dhaka 45 29 30 7 5 9 10
Khulna 9 3 6 1 1 5 2
a The table reports the trend in the RTS of the Bangladeshi industrial firms obtained relative to common frontier for
each year; where RTS are the increases in output that result from increasing all inputs by the same percentage. There
are three possible cases: (1) constant returns to scale (CRS), which emerge when Δ% in outputs = Δ% in inputs, i.e., if
a firm doubles all its inputs, its output exactly doubles; (2) decreasing returns to scale (DRS), which happen when Δ%
in outputs <Δ% in inputs, i.e., if a firm doubles all its inputs, its output less than doubles; (3) increasing returns to scale
(IRS), which arise when Δ% in outputs >Δ% in inputs, i.e., if a firm doubles all its inputs, its output more than doubles.

small or medium firms with IRS can be encouraged to boost technical efficiency through scale
economies.

4. Total factor productivity change of manufacturing industry in Bangladesh

(1993–1998)

Recent empirical literature generally supports the view that outward orientation enhances
total factor productivity growth. Promotion of exports had been a significant source of rapid
productivity change, through greater access to best-practice technologies. In turn, non-exporting
firms could benefit from such information-related externalities. If competitive pressures in export
markets force firms to purchase new technology contained in imported inputs, then the imports of
technology rather than exports should explain TFP growth. Outward orientation influences TFP
growth in three ways: first, through a learning by exporting effect; second, through an increasing
use of imported technology; third, through an improvement of the allocative efficiency of factor
markets, due to the progressive removal of external barriers and increased competition. It is likely
that promotion of exports encourages investment both by domestic and foreign investors.
410 M.K. Hassan et al. / Journal of Policy Modeling 32 (2010) 399–417

Table 5
Trade liberalization and economic performance in Bangladesh.
Annual growth rates Before liberalization FY90 FY92 FY94 FY96 FY98 Post liberalization
1980s average 1990s average

Real GDP 4.0 7.0 5.0 3.8 5.0 5.2 5.0

Manufacturing 3.0 1.0 10.0 5.0 6.0 9.0 7.0
Agriculture 2.0 10.0 2.5 0.8 3.4 3.0 3.3
Exports (nominal US$) 7.0 37.0 25.0 4.0 8.0 12.0 16.0

Source: The World Bank (1999).

The empirical data presented in Table 5 for the 1980s and 1990s for Bangladesh clearly suggests
that market oriented policy changes, including trade liberalization, in the 1980s have contributed
to economic growth. The GDP growth rate was 4% in the 1980s, whereas it was 5% for the 1990s.
During the same time period, both the manufacturing and agriculture growth rate have increased.
Export volume has grown more than twofold during the same time period.
We now turn to an examination of the magnitude of the impact of trade liberalization on
productivity and its components (technology and efficiency) in each sub-group. Average annual
values of the Malmquist productivity index, and its constituents, for all firms and each sub-group
in the system are provided in Tables 6 and 7. While Table 6 presents the result calculated relative
to a common (pooled) frontier, Table 7 presents the efficiency change measures calculated relative
to separate (group-specific) frontiers.
One very interesting result appears from this productivity change analysis. While the total
factor productivity change is positive for all firms over 1993–1998 period, innovation seems

Table 6
Decomposition of the total factor productivity change (TFPCH) between 1993 and 1998 in Bangladeshi industrial firms
[estimated relative to common (pooled) frontier].
TFPCH TECHCH EFFCH PTECH SECH

Panel A
All (82) 1.255 1.502 0.836 0.888 0.941

Panel B
1. Market Orientation
Export (8) 1.206 1.221 0.988 1.001 0.987
Import (61) 1.230 1.463 0.841 0.906 0.928
Import competing (47) 1.275 1.486 0.858 0.937 0.916
Import intensive (14) 1.078 1.377 0.783 0.801 0.978
Non-tradable (13) 1.404 1.951 0.720 0.736 0.978

2. Size
Small (27) 1.191 1.597 0.746 0.848 0.879
Medium (38) 1.302 1.510 0.862 0.908 0.950
Large (17) 1.254 1.361 0.921 0.908 1.015

3. City
Chittagong (28) 1.401 1.489 0.941 0.931 1.010
Dhaka (45) 1.185 1.526 0.777 0.866 0.897
Khulna (9) 1.153 1.426 0.808 0.864 0.936
 M.K. Hassan et al. / Journal of Policy Modeling 32 (2010) 399–417 411

Table 7
Decomposition of the total factor productivity change (TFPCH) between 1993 and 1998 in Bangladeshi industrial firms
[estimated relative to separate (group-specific) frontier].
TFPCH TECHCH EFFCH PTECH SECH

Panel A
All (82) 1.292 1.527 0.846 0.890 0.950
Panel B
1. Market orientation
Export (8) 1.174 1.077 1.090 0.977 1.116
Import (61) 1.286 1.566 0.821 0.894 0.918
Import competing (47) 1.335 1.591 0.839 0.929 0.903
Import intensive (14) 1.119 1.472 0.760 0.776 0.979
Non-tradable (13) 1.392 1.715 0.812 0.816 0.995

2. Size
Small (27) 1.235 1.684 0.733 0.847 0.866
Medium (38) 1.343 1.548 0.868 0.886 0.979
Large (17) 1.268 1.299 0.976 0.964 1.012

3. City
Chittagong (28) 1.449 1.520 0.953 0.938 1.016
Dhaka (45) 1.217 1.555 0.783 0.871 0.899
Khulna (9) 1.174 1.421 0.826 0.834 0.991

to be more prevalent in this total productivity change. As reported in Table 7, the technolog-
ical progress (53%) for all 82 firms far outweighs the decrease in technical efficiency (15%)
and results into a total factor productivity increase of 29%. Stated differently, this suggests
that firms have become more productive induced by outward shift in production possibilities
set resulting from trade policy changes. However, at the same time, due to a lack of a proper
business environment caused by work stoppages and managerial inefficiency, the firms, using
the same input levels, are unable to produce their optimal level of output. Thus, the empiri-
cal results thus show that technological progress occurs, and efficiency declines in Bangladeshi
firms.
The results also indicate that non-tradable sector, import-competing sector registered the
highest productivity gain. The same observation was made for Turkish import-competing
firms by Ozler and Yilmaz (2002). However, the export-oriented firms experience both tech-
nological progress and efficiency increase over 1993–1998 period. Import-oriented firms
and nontradeable firms recorded technological progress and efficiency decline at the same
time. The medium-sized firms experience the largest total factor productivity growth (34%),
followed by large firms (27%) and small firms (24%). Firms located in Chittagong expe-
rience the highest TFPC (45%), followed by firms located in Dhaka (22%) and Khulna
(18%). Further decomposition of efficiency changes into pure technical and scale effi-
ciency components reveals that scale efficiency change dominates pure technical efficiency
change measures in the export-oriented firms across industry orientation, size and city
location.9

9 This shift in production frontier over a five year period may be due to (a) expansion in capital stock through (a) high

rate of investment; (b) technological progress.

412 M.K. Hassan et al. / Journal of Policy Modeling 32 (2010) 399–417

An analysis based on averages can be susceptible to extreme observations (outliers) as only a

few firms may be responsible for overall results. An analysis based on percentages (or numbers),
however, is less sensitive to such outliers. Assume that an industry is made up of only four firms K,
L, M, and N, whose productivity change scores are 0.7, 0.8, 0.9 and 1.8, respectively. These scores
indicate that while the firms K, L, and M suffered productivity loss, firm N registered an extreme
productivity growth. The results based on average would suggest that the industry experienced
5% productivity gain as the average of these four scores is 1.05. Whereas, the results based on
percentages (numbers) would correctly suggest that 75% of firms in this industry experienced a
productivity decline while only 25% recorded a productivity rise. In order to explore the impact of
possible extreme observations, we follow Isik and Hassan (2003) and Topuz and Isik (2007) and
examine the changes in the number of firms that experienced a productivity gain or loss during
the period 1993–1998.
As a robustness check, Table 8 elaborates the impact of the trade liberalization on the produc-
tivity of Bangladeshi firms by depicting the development in the number of firms, which experience
productivity gain or loss. In Panel A of Table 8, 64 out of 82 firms experience productivity growth
and 18 firms experience productivity loss over 1993–1998 period. This implies that 78% of all 82
firms examined in this paper experience productivity gain and 22% experience productivity loss.
Similarly, all 82 firms remarkably experience technological progress, and no firm faces technolog-
ical regress. Trade liberalization has positive impact on all firms by shifting their output frontier.
Out of 82 firms, 20 firms experience an efficiency increase, 59 an efficiency decrease, and 3 no effi-
ciency change. Out of 82 firms, 21 firms experience a pure efficiency increase, 53 a pure efficiency
decrease and 8 no change. Finally, 29 firms experience a scale efficiency increase, 50 experience
a decrease and 3 no change. These results are consistent with our earlier findings that while
the manufacturing industry as a whole experience productivity growth, the industry as a whole
suffers efficiency declines. This efficiency decline is caused by both pure technical efficiency
and scale efficiency decline. While the former is purely under the control of firm management,
the later is caused by trade barriers. Further liberalization is expected to reduce scale-related
inefficiency.
Further breakdown of the sample of firms confirms the general characteristics of the full sample.
Let us analyze the results with respect to productivity change, technological change and efficiency
change. While 100% of the export-oriented firms register productivity growth and technological
progress, only 63% of the firms experience efficiency improvement. In import-competing industry,
only 71% have productivity growth and 28% have efficiency improvement. Out of 13 non-tradable
firms, 92% suffer from efficiency decline. According to size category, the large firms experience
the largest productivity growth (88%), followed by medium firms (79%) and small firms (70%).
The small firms suffer the largest efficiency decline (82%), followed by medium-sized firms (71%)
and large firms (59%). Location-wise, firms located in Chittagong have the largest productivity
growth (86%), followed by firms located in Khulna (78%) and Dhaka (73%). Firms located in
Dhaka also have the largest efficiency decline (78%), followed by firms located in Khulna (67%)
and Chittagong (64%).
We report the major source of productivity loss and efficiency decrease in Bangladesh manufac-
turing industry in Table 9. These results are simple decomposition of the results reported in Table 8.
For example, of the 18 firms that experience productivity loss, the only source of productivity loss
is efficiency decline. Of the 64 firms that experience productivity growth, 89% is due to techno-
logical progress and 11% is due to efficiency increase. Of the 20 firms, which experience
efficiency increase, 65% is due to pure technical efficiency increase and 35%
is due to scale efficiency increase. Of the 59 firms, which experience efficiency
Table 8
Development in the number of Bangladeshi industrial firms with productivity gain or loss/efficiency increase or decrease during the trade liberalization era (1993–1998)a .
Firm types Indices

# firmsb Productivity change Technical change Efficiency change Pure efficiency change Scale efficiency change
(TFPCH) (TECHCH) (EFFCH) (PTECH) (SECH)
# growthb # lossb # progressb # regressb # # # no # # # no # # # no

M.K. Hassan et al. / Journal of Policy Modeling 32 (2010) 399–417

inc.b dec.b Δb inc.b dec.b Δb inc.b dec.b Δb

Panel A
All 82 64 18 82 0 20 59 3 21 53 8 29 50 3

Panel B
1. Market Or.
Export 8 8 0 8 0 4 3 1 4 3 1 5 2 1
Import 61 43 18 61 0 15 44 2 16 38 7 20 39 2
Import competing 47 37 10 47 0 14 32 1 14 27 6 15 31 1
Import intensive 14 6 8 14 0 1 12 1 2 11 1 5 8 1
Non-tradable 13 13 0 13 0 1 12 0 1 12 0 4 9 0

2. Size
Small 27 19 8 27 0 4 22 1 6 17 4 8 18 1
Medium 38 30 8 38 0 9 27 2 10 25 3 12 24 2
Large 17 15 2 17 0 7 10 0 5 11 1 9 8 0

3. City
Chittagong 28 24 4 28 0 8 18 2 7 18 3 11 15 2
Dhaka 45 33 12 45 0 9 35 1 11 29 5 16 28 1
Khulna 9 7 2 9 0 3 6 0 3 6 0 2 7 0
a The table reports the development in productivity and efficiency of the Bangladeshi firms based on the indices calculated relative to common frontier, where productivity
growth: Malmquist index (TFPCH) > 1, productivity loss: TFPCH < 1, productivity stagnation: TFPCH = 1; technical progress: TECHCH > 1, technical regress: TECHCH < 1,
technical stagnation: TECHCH = 1; efficiency, pure and scale efficiency increase: EFFCH, PTECH, and SECH > 1; efficiency, pure and scale efficiency increase: EFFCH,
PTECH, and SECH < 1, no change in efficiency, pure and scale efficiency: EFFCH, PTECH, and SECH = 0.
b Change.

413
 414
Table 9
Dominant source of productivity growth or loss/efficiency increase or decrease in bangladeshi industrial firms during the trade liberalization era (1993–1998)a .
Firms Productivity/efficiency change
Productivity growth Productivity loss Efficiency increase Efficiency decrease Efficiency
because of: because of: because of: because of: no Δ
Change # of Technical Efficiency Technical efficiency PTE SE PTE SE
firmsb progressb increaseb regressb decreaseb increaseb increaseb decreaseb decreaseb

M.K. Hassan et al. / Journal of Policy Modeling 32 (2010) 399–417

Panel A
All 82 57 7 0 18 13 7 44 15 3

Panel B
1. Market Or.
Export 8 7 1 0 0 3 1 3 0 1
Import 61 37 6 0 18 9 6 31 13 2
Import competing 47 31 6 0 10 8 6 20 12 1
Import intensive 14 6 0 0 8 1 0 11 1 1
Non-tradable 13 13 0 0 0 1 0 10 2 0

2. Size
Small 27 17 2 0 8 1 3 14 8 1
Medium 38 25 5 0 8 8 1 21 6 2
Large 17 15 0 0 2 4 3 9 1 0

3. City
Chittagong 28 21 3 0 4 6 2 15 13 2
Dhaka 45 29 4 0 12 5 4 24 11 1
Khulna 9 7 0 0 2 2 1 5 1 0
a The table presents the major sources of the developments in the productivity and efficiency of the Bangladeshi firms summarized in Table 8. For example, of the 64 firms

which experience productivity growth between 1993 and 1998 (Table 6, Panel A), 57 firms owe the growth to the progress in their technologies while 7 owe it to the increase in
their efficiencies. Definition of the sources is as follows: productivity growth because of technological progress: TFPCH > 1, and TECHCH > 1 and EFFCH; productivity growth
because of efficiency increase: TFPCH > 1, and EFFCH > 1 and TECHCH; productivity loss because of technological regress: TFPCH < 1, and TECHCH < 1 and EFFCH;
productivity loss because of efficiency decrease: TFPCH < 1, and EFFCH < 1 and TECHCH; efficiency increase because of PTE increase: EFFCH > 1, and PTECH > 1 and
SECH, efficiency increase because of SE increase: EFFCH > 1, and SECH > 1 and PTECH; efficiency decrease because of PTE decrease: EFFCH < 1 and PTECH < 1 and SECH,
efficiency decrease because of SE decrease: EFFCH < 1, and SECH < 1 and PTECH.
b Change.
 M.K. Hassan et al. / Journal of Policy Modeling 32 (2010) 399–417 415

decrease, 75% is due to decline in pure efficiency and 25% due to scale efficiency.
10

These robustness checks also reinforce that the major source of total factor productivity
improvement in the Bangladeshi manufacturing industry is technical progress (upward shift of
the production frontier by leading firms) rather than efficiency increase (movement of ineffi-
cient firms towards the production frontier). It appears that leading firms pushed the frontier
up faster than the incumbent firms could catch-up with. This result is one of the positive
outcomes of trade liberalization. It allows the export sector to invest in advanced production
techniques, worker’s training and infrastructure in order to operate in a highly competitive
environment and to succeed in global competition. The non-export sector (import-competing
and import-intensive and non-tradable) benefits from the export sector competing in the world
market. The non-export sector can replicate the management practices, improved production
and marketing techniques of the export sector. Moreover, it gains ready access to public
infrastructure (transport and communication) developed for the export sector. This positive
externality appears to increase technological growth in non-export sectors as well. While we
see the firms gain this positive externality, they are not efficient in using the input labor and
raw materials to gain the maximum level of output. We can cite reasons for this decrease in
efficiency. First, the infrastructure is less than adequate in the country. All firms must have
access to dependable power, telecommunications and other infrastructure. Second, the banking
system must be made efficient so that firms can have access to funds without undue obsta-
cles.

5. Policy measures

Human capital development and technological catch-up cause total factor productivity
change. Increases in total factor productivity change result from adjustment of labor markets
to technological changes, which itself is enhanced by skill endowment and the progressive
removal of trade barriers. Export promotion relaxes foreign exchange constraint, encour-
aging a progressive removal of external barriers and the increased import of technology.
Trade liberalization policies and greater involvement in the world market have increased
total factor productivity in Bangladesh, and this should be maintained. In order to maxi-
mize domestic growth opportunities, domestic capacity building should be encouraged, which
may not be achieved only by export promotion policies. Bangladesh can fully realize the
benefits of liberalization if it diversifies its export base, and undertakes adaptive policies in
the field of education and labor market organization to achieve allocative efficiency in the
labor market. For manufacturing industry in particular, uninterrupted energy supply should
be maintained. High anti-export bias should be phased out by lowering and streamlining tar-
iffs and tackling other behind-the-border barriers to export competitiveness. By improving
the law and order situation, Bangladesh can attract more FDI which directly helps improv-
ing performance in the export sector and aiding the efficiency of manufacturing sector in
Bangladesh.

10 Productivity growth can be achieved in spite of a substantial decline in efficiency if offsetting technical progress is

much higher. Likewise, productivity loss can occur, despite a sharp efficiency increase, if the offsetting technical regress
is much greater. In other words, for productivity loss (growth), changes in both technology and efficiency need not be
negative (positive).
416 M.K. Hassan et al. / Journal of Policy Modeling 32 (2010) 399–417

6. Conclusion

We use a nonparametric method to study the impact of efficiency changes in a sample of

82 firms in Bangladesh. Our results suggest the following conclusions. First, only firms in the
export-oriented industry experience an increase in technical, pure technical and scale efficiency.
Second, firms in non-export industry suffer a loss in technical, pure technical and scale efficiency.
Third, all firms experience positive total factor productivity change implying that trade liberal-
ization has improved overall productivity. Fourth, all firms experience technological progress
suggesting that regardless of export or import orientation or size or location, there appears
to be an outward shift of production technology. Bangladeshi firms appear to be innovating
with the changing business environment resulting from trade liberalization. Finally, all firms in
the sample suffer from declining efficiency change, which implies that firms are not utilizing
their available resources in the most efficient manner possible. In order to improve efficiency in
manufacturing, all political and non-political barriers to trade must be withdrawn. Our overall
conclusion of the impact of trade liberalization in industry is that trade liberalization has gener-
ated technological progress an industry. The impact is more pronounced on the export-oriented
industries.

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