Urban Finances to Facilitate Effective Urban Services: A Case Study of Bangladesh

1. Urban Finances to Facilitate Effective Urban Services: A Case Study of Bangladesh Sadiq Ahmed Policy Research Institute of Bangladesh, April 22-25

2. Table of Contents • Urbanization and Development • Urbanization Experience in Bangladesh • Urbanization Constraints • Severity of the Urban Financing Constraint • Towards an Urban Financing Strategy

3. Urbanization and Development • High- and middle-income countries are more urbanized, and their urban areas have higher economic densities, than low-income countries (Figure 1 from World Bank). • The correlation between urbanization and GDP is indicative of the productivity advantage of urban areas • Figure 1: Urbanization, Urban Economic Density and GDP: Cross-Country Correlations (2000)

4. Urbanization and Development • Bangladesh is no exception. The urban-rural output and productivity differentials are larger than the population density differential. • Population density in urban areas is twice as high as in rural areas, but urban economic density is eight times as high as rural economic density. • The average GDP per capita in urban areas is almost four times as high as in rural areas (Source: World Bank and BBS)

5. Bangladesh Path to Middle Income Status and Urbanization Figure 3: Urbanization and The Path to MIC – A 2021 Scenario Analysis • Two possible spatial economic paths to MIC status for Bangladesh (Figure 3) • Scenario A emphasizes higher-value added production in Dhaka and Chittagong. Scenario B stresses non-farm diversification outside the two main cities. (Source World Bank) • While both paths are possible, Scenario A is more risky.

6. Urbanization and Development • Private sector investment is necessary to accelerate growth. • Urban areas are attractive locations for firms because they provide better access to factor and goods markets, infrastructure, and proximity to services. • But urban centers also tend to be costly locations as agglomeration economies increase the cost of land and wages. • If urbanization is not properly managed, it can lead to traffic congestion, pollution and inefficiencies in service provision. These could choke off the growth engine.

7. Urbanization Experience in Bangladesh • Between 1961-2011, the Bangladeshi population nearly tripled in size, growing from 55 million to 150 million (Fig 4) • The urban population increased nearly twenty-fold, galloping from less than 3 million in 1961 to over 43 million in 2011 (Fig 4). • Owing to these population dynamics, the share of urban population grew from around 5% in 1961 to 30% in 2011. It is projected to reach 40% in 2021 (Fig 5).

8. Primacy of Capital City Dhaka • A major factor underlying urbanization in Bangladesh is the heavy concentration of urban population in the capital city of Dhaka (Figure 6). • Dhaka is now the18th largest metropolitan city of the world (Figure 7) (source: Worldatlas; Google)

9. Urbanization Has Been Haphazard • While the urban areas, have been the leading growth centers of Bangladesh, urbanization has been haphazard. • Much of the economic growth has concentrated in Dhaka and Chittagong putting heavy pressure on land prices that has now become a binding constraint to manufacturing sector growth. • Land prices in Dhaka have grown by almost 100% per year between 1972 and 2012, making housing unaffordable for low-to-middle income group • Transport congestion has reached nightmare proportions in Dhaka. It takes an average of 2 hours to commute to work each way within 7-8 kilometer distance. Mass transit options are virtually absent. • Weak zoning laws and poor parking enforcement adds to the chaotic city growth/layout and traffic nightmare

10. Poor Urban Services • Owing to housing scarcity, a huge slum population has grown, especially in Dhaka, where quality of life is unbearably low. Slum growth has also contributed to serious law and order problems. • Adequacy of basic services such as water and sanitation is a serious problem. For example only 35% of the population has access to tap water. • In almost all the urban centers (except Dhaka) there are no sewers and a large number of households lack connection to septic tanks. Most human excrement and waste water ends up in rivers, streams, canals and ditches, untreated. • Most urban centres face problems with the collection and disposal of solid wastes. • Noise and air pollution have reached stressful proportions. • The combination of water and air pollution contributes to serious health hazards in urban areas.

11. Poor Quality of Urban Life • The list of problems makes Bangladeshi cities very unlivable. • Mercer city livability index ranks Dhaka as the most unlivable megacity (Table 1). • Economics Intelligence Unit (EIU) city livability ranking for 2013 confirms this.

12. Urbanization Constraints • Several factors constraint urban development in Bangladesh. • Legal framework for local government institutions (LGIs) has evolved in a stop-go fashion. Some orderly shape emerged only in recent years with 5 tiers: 2 concerning urban areas and 3 concerning rural areas. The two urban LGIs are: municipalities (small towns) and city corporations (large cities). Clarity on responsibilities and financing is lacking • The demarcation of functions is unclear and overlapping. • The governance structure in theory is democratic and elections based but in practice LGIs have little autonomy and are controlled by the national government . • There is very little financial autonomy that creates much of the dependency syndrome on national government

13. Confused Overlapping Mandates • The picture of urban service delivery in Dhaka illustrates the confused and overlapping mandate problem with urban management (Figure 8). • There are as many as 9 specialized institutions and several line ministries providing urban services with little or no coordination, overlapping mandates, weak capacities and financial limitations.

14. Weak Financial Autonomy • Poor governance and weak financial autonomy are the two most fundamental constraints. • Under the Legal Framework, urban LGIs can obtain resources from a number of sources: (a) property tax; (b) rents from markets owned by LGIs; (c) fees from licenses issued to traders and non-motor vehicles; (d) fees from advertisements, cinema and entertainment; (e) sale of property/assets and (f) grants and loans from the government. • Other than property tax, all other taxes are assigned to the national government.

15. Severity of the Urban Financing Constraint • Table 2 summarizes the evolution of urban finances. The highlights are: --Government transfers account for some 54% of total urban LGI resources. --Charges and fee account for 30%. --Taxes account for only16% --There is no market borrowing.

16. Financial Autonomy of Urban LGIs: Share in total government spending • A major indicator of financial autonomy is the share of urban LGIs in total government spending. Despite some progress, urban LGIs account for only 4% of total government spending (Figure 9). • In terms of GDP, they account for less than 1 % (Figure 10). • The powerful government regulator, the Ministry of Local Government, controls and manages most urban and rural development public spending. • There is no legal framework for government transfers and as such they are not predictable because

17. Urban LGI Financial Autonomy: Weak Tax Handles • Urban LGIs account for less than 3% of total government revenues (figure 11). • This is mainly by design as almost all potent sources of revenues are controlled at the national level. • The only tax source assigned to urban LGIs is the property tax. Yet, yields are insignificant. LGIs do not have the legal authority to modify the base or the rates.

18. Fiscal decentralization: International Comparison • A review of international evidence suggests that Bangladesh is fiscally amongst the most centralized countries in the world. • Spending by all LGIs (urban and rural) account for 19-28% of total government spending in other countries as compared with only 7% in Bangladesh. • Taxes similarly are heavily centralized in Bangladesh

19. Consequences of Centralized Fiscal Framework • Low resources owing to weak fiscal decentralization contributes to poor capacities of urban LGIs to deliver services. • Inadequacy of staffing in both quantity and quality is a major bottleneck. • Political patronage and centralized decision-making on urban spending results in poor accountability of city governments • Transfers have no legal basis and are discretionary. Government control over revenues and spending essentially means that elected urban city managers belonging to opposition have little control over service delivery. • Even in cities that have managers who belong to the party in power, service delivery is constrained by inadequacy of resources. • The scope for innovative financial solutions at the local level is limited by the weakness of the property tax design and absence of public borrowing by LGIs.

20. Towards an Urban Financing Strategy • Reform of both urban governance and urban finances is critical for improving the pattern of urbanization and urban services in Bangladesh. • Strong political will of the national government is essential. There are reform champions like the Finance Minister and there is some hope that this might indeed happen. • In particular, fiscal decentralization is key to establishing accounting LGIs at both the urban and rural levels. • The strategy for urban financing needs to combine taxes, service charges, predictable transfers and responsible borrowing.

21. Tax Reforms and Fees • The first stage should focus on a major revamping of property taxes. • A properly designed property tax could yield 1.0-1.5% of GDP equivalent of tax revenues that will revolutionize urban LGI financing. This compares with a mere 0.16% of GDP yield presently. • Service fees and charges have grown significantly over time, but they still account for only 0.14% of GDP. With better service, urban LGIs should be able to increase resources from this source equivalent to about 0.5% of GDP. • Together, these could help jump-start the fiscal autonomy of urban LGIs in a substantial manner.

22. Reform of Government Transfers • Government transfers must be reformed to assign greater transparency and predictability of the transfers. The transfers will also need to match assigned responsibilities. • There should be a much better balance between spending by central ministries and LGIs based on a clearly articulated devolution of responsibilities and matching transfers that is enshrined in the legal framework • There is a considerable body of international experience that could help with the design of a proper transfer system that will work in the Bangladesh context. Basic principles include factors relating to population, poverty, endowment and performance. • A two-tier transfer system combining equity and incentives (performance ) is also possible.

23. Reform of Urban LGI Borrowings • Presently, all transfers, either grant or loans, come from the national budget. The restriction on local borrowing is understandable in the present environment of weak finances and poor capacities of urban LGIs. • Over time as urban LGIs gain experience and capacity, the Government may want to rethink its policy for their borrowings. Such borrowings could be important for delivering infrastructure. • Again, there is considerable international experience and Bangladesh can learn from those. • In general the loan financing has to be done responsibly focused on well-designed projects and in line with debt servicing capacity of the concerned LGI as well as ensuring consistency with national debt management.