Foreign Ownership and Firm Productivity in Bangladesh Garment Sector
Hiau Looi Kee*
May 2005
Abstract
This paper studies the productivity advantage and spillover of FDI firms in Bangladesh garment sector. This is based on a newly collected exclusive firm level data, supported by a unique custom firm level export data. Firm productivity is first estimated from a firm production function, controlling for input endogeneity, selectivity, as well as firm and year fixed effects. Results show that FDI firms are on average 20 percent more productive than domestic firms. Moreover, there are statistical evidence suggesting that productivity spillover occurs such that domestic firms may benefit from the productivity increase in FDI firms. These findings support a more open FDI policy for the Bangladesh garment sector.
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* Development Research Group – Trade, the World Bank, 1818 H ST NW (MSN MC3-303), Washington, DC 20433, USA; Tel: (202) 473 4155; Fax: (202) 522 1159; E-mail: ; I thank the World Bank, CIDA and DFID for providing research funding. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author, and do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent.
Introduction
Conventional wisdoms have it that firms with foreign equity tend to be more productive. This could be due to the firm specific tangible assets such as exclusive technology and product designs,or the intangible know-how embodied in foreign equity such as marketing, networking and sourcing. Such assets may be more readily available in big multinational corporations (MNC). As such, being part of MNCs allow the local subsidiaries with foreign equity to gain access to these assets, which in turn make them to produce more output given the same level of inputs, and thus a higher level of total factor productivity (TFP) than the solely domestic owned firms. Such hypothesis has some empirical support based on samples of Venezuela manufacturing firms studied in Aiken and Harrison (AER, 1999) and Malaysia service sector firms in Kee (forthcoming).
Unlike many developing countries such as Cambodia, Mauritius and Mongolia, where most of the garment firms are part of some larger multinational corporations in the form of foreign direction investment, less than 15 percent of Bangladesh garment firms have foreign equity. This is partly due to the industrial policies of Bangladesh in order to safe guard quota allocations of garment export to US to the domestic firms. Furthermore, foreign firms are allowed to invest in Bangladesh garment sector only if they locate the plants in the export processing zones, and are not competing with the subcontracting domestic firms supplying to the exporting firms who have quota access. Thus, almost all FDI firms export all of their products from Bangladesh.
The objective of this paper is to study the potential productivity advantage of FDI firms operating in Bangladesh. In addition, this paper aims to identify the possible channels by which local firms may benefit from the FDI firms. We focus on the productivity spillover effects, beyond the physical presence of FDI firms.
The paper first presents an overview of the garment sector, in terms of industry structure and export performance. The paper proceeds to study the firm export performance according to a unique custom export data. By dissecting the firms in terms of the markets they participated, this paper is able to assess the productivity distribution among Bangladesh garment export. The main part of the paper focuses on estimating firm productivity by modifying the state of the art technique due to Olley and Pakes (Econometrica, 1996), to control for firm and year specific biases. We relate the estimated productivity, which is the level of output not explained by the level of inputs, to the ownership structure of the firms using between firm panel regression, controlling for industry, year, location fixed effects. It is shown that firms with foreign equity are on average 20 percent more productive than otherwise identical domestic firms. The productivity advantage of FDI firms is robust to age and export destinations. In addition, we relate the productivity performance of domestic firms to that of FDI firms and show that there are indeed positive and significant productivity spillovers. For every 10 percent increase in the productivity level of FDI in the industry, productivity of domestic firms increases by 1.4 percent.
An Overview of Bangladesh Garment Sector
According to data obtained from the Bangladesh Garment Manufacturers and Exporters Association (BGMEA) Members’ Directory 2004-2005, there are more than 4,000 firms operating in Bangladesh garment sector, of which 2,800 are in Dhaka area. Almost 65% of the firms are in the woven industry, 20% in the knitting industry with the sweater industry rounds up the remaining 15%. About 13% of the woven firms also engage in the knitting industry. These are usually the larger and more productive woven firms.
Most of the garment firms in Bangladesh are locally own, with about 1% of them operating in the export processing zones (EPZs) in Dhaka and Chittagong. Finally, more than 63% of EPZ firms have some foreign ownership, from countries such as South Korea and Hong Kong. The sector as a whole employ 2.1 million workers, with 53,000 workers in the firms with foreign ownership.
Overall, firms in Dhaka are larger and more productive, relative to firms in Chittagong. In addition, firms in EPZs are the better firms than those out side of the EPZs. Finally, firms with foreign capital are the most productive of all firms:
On average, FDI firms are larger, they hire more workers given the same number of machine.
FDI firms are more capital intensive, they use less workers per machine given the same number of plant capacity. EPZ firms are also more capital intensive relative to non-EPZ firms.
Given after taking into account the numbers of product variety, FDI firms are still on average larger in capacity than domestic firms.
76% of the FDI firms are in the woven industry.
Export Performance of Garment Sector
The past few years have witnessed an expansion of Bangladesh garment export to the world market. In 1998, the total value of garment export from Bangladesh was about US$3.8 billion, it increased to US$4.2 billion in 2001 and settled at US$3.6 billion in 2003. This Information is obtained from the United Nations Comtrade Database according to the reporting of the Bangladesh government. Figure 1 presents the breakdown of the aggregate export of the Bangladesh garment sector by destinations, in 1998, 2001 and 2003. In both 1998 and 2001, the share of EU in Bangladesh garment export was about 50 percent, closely followed by the US at 45 percent, while other countries, noticeably Canada, made up the remaining 5 percent of aggregate garment export. In 2003, the importance of EU further increased to 58 percent, while the share of the US dropped to 37 percent.
Figure 1: Breakdown of Garment Export
The surprising fall in the garment export to the US could be due to transshipment or misclassification of goods. Based on US custom data from the US International Trade Commission (USITC), garment export to US from Bangladeshin fact has been steadily climbing from US$1.5 billion in 1998 to US$1.8 billion in 2003. In 2004, the value of garment export from Bangladesh further increased to US$1.9 billion, which makes Bangladesh the 10th largest garment supplier for the US market. Figure 2 presents the values of garment imports of US from 1998 to 2004 by major exporting countries. In 2004, the top ten garment exporting countries to the US market and their market shares are China (16%), Mexico (10%), Hong Kong (5.8%), Honduras (4.1%), Vietnam (3.7%), Indonesia (3.6%), India (3.4%), Dominican Republic (3.1%), Guatemala (2.9%) and Bangladesh (2.8%).
Figure 2: Breakdown of Major Garment Exporters in the US Market
We further use a firm level export data set obtained from the Textile Unit of the Export Promotion Board(EPB) of Bangladesh to analyze the export performance of the Bangladesh garment sector. This information is compiled from those firms that applied for Country of Origin Certificates in 2004. This certificate is often requested by the importing countries to verify the origins of the imported goods in order to grant trade preferences.
In this firm level data set there are 2387 garment firms exporting in 2004. The total value of garment export is US$5.7 billion, with more than 400 million dozens of garment exported. Overall 57 percent of garment export headed to the EU, 20 percent for the US and the remaining 23 percent went to the other countries such as Canada and Australia. Table 1 presents the breakdown of garment export volume by destinations.
Table 1: Garment Export by Destination, 2004Description / Quantity (dozen) / Value (US$)
EU under GSP / 319,718,411 / 3,244,562,889
Others / 32,044,542 / 1,306,109,811
USA with quota / 42,196,576 / 976,267,029
USA without quota / 19,785,482 / 159,150,271
Total / 413,745,011 / 5,686,090,000
In terms of the distribution of firms across different markets in 2004, there are 1967 firms exporting under GSP, mainly to the European market, 1039 firms exporting to the US, of which 709 export under quota allocations, and 1231 firms exporting to other countries. Figure 3 presents the distribution of firms by export destinations.
Among these firms, 46 percent only supply to one market, 34 percent supply to two markets, 14 percent to three markets, and 5 percent to all four markets. This is clearly presented in Figure 4.
Figure 3: Number of Firms in Different Markets
Figure 4: Number of Firms vs. Number of Markets
Figure 5 presents the choice of export markets of Bangladesh garment exporters according to the number of export market the firms supply. It is very clear that EU is the most popular destination, especially among firms that have only one export market. Among the 1109 firms that only supply one market, nearly 850 firms concentrate on EU which is about 76 percent. The US market appears to be toughest to break in among this group of firms, less than 8 percent only export to the US with and without quota.
For firms that supply two markets, both the EU and the others are the favorites. Together, they account for 80 percent of the markets among the 1640 firms that export to two markets. The US in quota market is popular for firms that export to more than 2 markets.
Figure 5: Market Choice by Firms with Different Markets
In addition, according to Eaton, Kortum and Kramarz (AER, 2004) who study the export performance of French firms, the number of markets a firm supplies reflects the productivity and competitiveness of the firm in the world market. The above distribution of firms implies that more than 35 percent of Bangladesh garment exporters participate in world markets widely with at least 3 export destinations, and are thus very competitive. This is quite evidence in Figure 6, when we plot the unit value of garment export (left axis) and total export value (right axis) against the number of export destinations. Firms that export to more destinations tend to have higheraverage unit values and larger in size, with the former reflects better quality and the latter indicates greater scale economies, both signalhigher productivity of the firms. The differences in unit values and total size among firms with different number of markets are statistically significant.
Figure 6: Exporting and Productivity
Preliminary Findings Based on Firm Survey
Firm level survey was conducted from the period of November 2004 to April 2005, which covers a stratified random sample of 350 firms, which is about 10% of the total population of the garment firms currently operating in Bangladesh. After cleaning up the data to exclude outliers and firms with incomplete information, there are a total of 231 firms in the unbalanced final panel data set of 1026, from 1999 to 2003. In this unbalanced panel data set, the composition of sub-industries of knitwear, sweaters and woven is 24%, 8% and 68% respectively. Among the sampled firms, 13% have positive foreign equity, while the remaining 87% are purely domestic owned. Moreover, 15% of the sampled firms are in the Dhaka and Chittagong EPZs, 63% in Dhaka and 15% in Chittagong.
Tables 2-4 and Figures 7-9 present the sample means of the key variables of the sub-industries of knitwear, sweaters and woven, by foreign versus domestic firms. It is clear that FDI firms are in general larger in sales, in exports, they purchase more material inputs, including imported materials, they hire more employees, including production workers. FDI firms also have larger capital stock and investment. All these suggest that FDI firms are larger in scale and presumably more profitable and productive. To formally study the productivity superiority of FDI firms, and the possible productivity spillover to domestic firms, we will need to first estimate firm level productivity for the firm sample. The estimated firm productivity is then relate to the ownership of the firms, and the relationship between productivity of domestic and FDI firms in the same sub-industries will be statistically examined.
Table 2: Summary for Knitwear
Figure 7: Summary for Knitwear
Table 3: Summary for Sweater Industry
Figure 8: Summary for Sweater Industry
Table 4: Summary for Woven Industry
Figure 9: Summary for Woven Industry
Estimating firm productivity
To formally study the overall productivity of firms, we need to estimate firm production function, taking into account total factor usage per unit of output. In the firm survey we asked firms to provide the annual increase in the main product price and the main material input price. The firm level price information allows us to construct firm level price indexes of output and material, which we use to deflate sales and material costs to obtain real output and material level. We estimate the following production function,
where i and t are the indexes for firm and year, respectively. In log, output, Y, is linearly related to labor, L, materials, M, and capital stock, K. Any part of Y that are not explained by the three factors of production are attributed to productivity, A, which varies by firms and years. In other words, if we regress lnY on lnL, lnM and lnK using ordinary least squares (OLS) estimation, the regression errors are the firms productivity, lnA.
However, firm’s input choices are likely to be endogenous. How many workers to hire, how many unit of fabrics to purchase, and how many new machines to set up each year depends on the productivity of the firms, which is known to the firms, but not the researchers or economists. Such input endogeneity will bias OLS estimates of labor and materials upward. In addition, if larger and older firms tend to stay in business despite low productivity, will younger and smaller firms tend to quit easier, such entry/exit decision of the firm will bias OLS estimates of capital downward.
To address input endogeneity bias and selectivity bias, we follow a 3-step nonlinear estimation methodology developed by Olley and Pakes (Econometrica, 1996). Moreover, to control for any factors that are specific to the firms, such as fraudulent accounting practice, or years, such as economic downturns, that may bias our estimates that are beyond the Olley-Pakes correction, we also include firm and year fixed effects in our regressions. We modified the three stage nonlinear estimation of the above production function due to Olley and Pakes to include firm and year fixed effects. Furthermore, even that older firms are more likely to stay in business despite temporary down turn in business, we also control for firm age in the estimation.
To control for input endogeneity, we first regress lnY on lnL, lnM, a full set of firm and year fixed effects and a 3rd order polynomial function of real investment and capital, which is used to control for the unobserved productivity. The estimated coefficients on labor and materials are consistent. Firms’ real investment, I, is obtained by deflating nominal investment from the firm survey by the GDP deflator of domestic fixed capital formation of Bangladesh in the respective years. Capital is constructed by summing real investment over the years using perpetual inventory method with an annual depreciation rate, of 10 percent:
with initial capital stock being constructed using average between firm’s first year fixed asset, F, and the infinite sum series of investment prior to the first year, assuming that the growth rate of investment of 0 and depreciation rate of 10 percent.
To obtain consistent coefficient estimate of capital, we first estimate the entry/exit decision of the firms using a Probit regression on a 3rd order polynomial function of investment, capital and age, controlling for year, region and industry fixed effects. This regression yields the propensity for a firm to stay in business. We then regress , constructed using the consistent estimates of and from the 1st step, on age, capital, and a 3rd order polynomial function of propensity of survival and . This last-stage nonlinear regression gives us consistent estimated coefficient on capital, .