The Role of the Firm
January 09, 2014
Eric Manes*
1.
Introduction
This chapter on
the Pakistani firm describes the microeconomic factors underpinning economic
growth and wealth creation, focusing on enterprise-level analysis.
Notwithstanding the key role of the firm highlighted in the chapter, data at
the firm level is difficult to obtain and even more problematic to analyze.
While the statistical issues associated with enterprise-level analysis in
Pakistan are beyond the scope of this chapter, it is important to note up front
the various limitations of the firm-level data available and the caveats
stemming from firm-level analysis.
The Census of
Establishments for 2005–07 (Pakistan Bureau of Statistics, 2007), gives a
relatively clear picture of the family of Pakistani firms: many small, locally
focused firms exhibiting varying degrees of formality and market participation,
coexisting with relatively few, large formal firms (often multi-product
conglomerates that account for the bulk of production, exports, and higher-wage
employment). Only 5 percent of a total of almost 3 million establishments
surveyed employed more than five persons at that time. In manufacturing, the
figure is similar at 91 percent of the half-million firms surveyed, with only
1,100 of these establishments reporting employment of over 50 workers.[1]
Pakistan’s
enterprise sector is seen though the duality described above: a set of firms
that operate either fully outside the formal market, institutions, and
government, or that employ a subset of informal practices and participate in
government revenue collection efforts only if necessary. Finally, there remain
those firms that are responsible for the country’s economic activity; these
firms are few but in Pakistani terms can be quite large.
Two other comprehensive surveys sponsored by the World Bank have attempted
to characterize Pakistan’s enterprise sector, and draw generalizations about
the Pakistani firm in 2002 and again in 2007. Another survey of firm-level
perceptions of the principal obstacles they faced was carried out in 2013. For
the purposes of this chapter, the World Bank’s enterprise surveys in 2002 and
2007 are the primary sources of information, along with the International
Finance Corporation’s Doing Business (DB) database. Although five years have
passed since the last survey, its conclusions are representative of the
structural relationships prior to the financial crises and political
instability that characterize this period.
2.
The Role of the
Firm in Moving the Economy Forward
Since Solow’s
seminal work on growth decomposition, the concept of productivity—the idea of
producing more with less—has been the key link between the performance of
firms, economic growth, and a country’s potential for providing improved
welfare to its population. As productivity drivers are organized at the firm
level, the firm represents a critical “private sector institution” responsible
for driving innovation, employment, and growth in the economy that Pakistan
requires if it is to move forward in the 21st century.
This critical
role played by the firm in the development process is seen through the
decomposition of the microeconomic identity that underpins the growth of income
per capita at the macroeconomic level—a key indicator of economic welfare and
one of Pakistan’s specific development goals for the near term. Specifically,
the identity in Figure 16.1 shows that income per capita is a function of
nonindependent social, demographic, and economic forces.
Figure 16.1: Microeconomic underpinnings of income growth
|
GDP per capita
|
≡
|
Labor productivity
|
x
|
Labor force participation
|
x
|
Age composition of population
|
|
GDP
|
≡
|
GDP
|
x
|
Labor force
|
x
|
Population
aged
15–64
|
|
Total
population
|
|
Labor force
|
|
Population
aged 15–64
|
|
Population
|
In the
identity, income per capita is a function of (i) labor productivity, (ii) labor
force participation, and (iii) the share of labor force share in the total
population. Further decomposing the “economic term”—labor productivity—into
changes in capital deepening (the capital–labor ratio) and gains in total factor
productivity (TFP) demonstrates the critical role of TFP in one of the key
development objectives: growth in GDP per capita.[2]
As more people
reach working age and a greater number of those begin to participate actively
in the labor force, GDP per capita will increase as long as capital deepening
persists through investment[3] and/or a
concomitant rise in TFP. Thus, in the short run, with population dynamics and
labor force participation (given certain parameters),[4]
policymakers’ central focus in growth-starved countries around the world is the
role of the firm in achieving the virtuous circles of higher TFP leading to
more investment, capital deepening, higher labor productivity, better wages,
and growing income per capita.
For Pakistan, which faces both an increase in working-age population
(the so-called “demographic bulge”) along with higher labor force participation
(in large part, female), labor productivity has grown slower than in the rest
of South Asia and particularly East Asia (Figure 16.2). Moreover, despite a
relative high during the 2000s—particularly in the boom years prior to 2009—the
lower capital intensity of growth was due to a rapid increase in labor
participation, particularly among female workers.
Figure
16.2: Labor productivity growth decomposition in selected
economies, 2001–06
Source: World Bank (2006).
Importantly,
however, while not in the same range of productivity as the East Asian
countries, growth in TFP in Pakistan was comparable to other South Asian
countries, though slightly lower than the average, owing to India’s high TFP
growth over the period (Figure 16.3). Indeed, like most countries, “factor
accumulation”—increased labor participation and investment—has been the primary
source of growth in Pakistan over the past five decades, although the country’s
growth spurts coincided with periods of higher productivity, particularly in
the 1980s and 2000s. The most recent example of TFP-led growth was 2002–06 when
it accounted for a quarter of the period’s growth rates (Figure 16.3).
Figure
16.3: Growth accounting, 1960–2005 (by year and country)
Source: World Bank
(2006).
Currently, there are real binding limits to factor-driven
growth in Pakistan, given its high labor participation rates and poor
investment climate. Thus, sustained growth in Pakistan, as elsewhere, relies on
initiating a virtuous cycle of rising firm-level growth of TFP accompanied by
investment deployment directed to productive firms. Yet, as shown consistently
throughout the world, unless the process is launched through the efficiency
signal generated by firm-level productivity growth, investment is often
misdirected to loss-making activities. Indeed, in Pakistan, the period of high
growth coincided with macro-stability, microeconomic reforms, and political
certainty.
3.
Firm-Level
Productivity and the Business Environment
Moving the economy forward, therefore, requires catalytic
forces to jump-start firm-level productivity growth in the hope of launching a
virtuous circle of efficiency improvement, productive investment, and organic
growth by private sector firms in competitive markets. An analysis of the sources
of these microeconomic foundations focuses on the collective set of amorphous
institutions: (i) factor markets, involving capital, labor, and land; (ii)
product markets, involving frictions in markets for domestic and international
goods; and (iii) the government–business interface, involving public
infrastructure, market regulation, and the provision of various public
services. In recent years, considerable attention has been given to the role of
(iv) innovation, competition, and industrial organization (entry and exit) in
firm-level productivity.
These forces are captured in a summary concept called the
business environment or investment climate, which can be growth-enhancing or,
indeed, growth-retarding. An accommodating business environment encourages
efficient operation and strengthens innovation and productivity. A poor
business environment amplifies or even creates obstacles to conducting business
activities. TFP is central to both outcomes and is influenced by a series of
factors—often considered the elements of the business environment—each with
policy playing a central role in determining whether the element facilitates or
hinders productivity. Recent research attributes 17 percent of the difference
in aggregate productivity across firms in Pakistan to differences in the
investment climate they face (see World Bank, 2009).
In gauging a
complex and dynamic business environment subject to many exogenous and
endogenous forces, it is practically impossible for one static indicator to
capture the nature of business for a country, particularly one as dynamic,
complex, and geographically diverse as Pakistan. Still, in order to set the
scene for the discussion, it is instructive to understand what the incumbent
Pakistani firm views as constraints to the business environment, and how they
are ranked over the period 2000–13. During this period, three surveys of
Pakistani enterprises were undertaken using a similar survey instrument and
covering what Pakistani firms perceived as being the most significant constraints
to the business environment. However, analyzing the various elements of the
business environment needs numerous perspectives because the forces are, in
themselves, not only difficult to observe, but also dynamic.
4.
The Business
Environment: The View of the Firm
Scaling up from a low level of equilibrium requires collective action.
In most cases, due to the well-known “free rider” problem that prevents it from
emerging on a private basis, collective action is effectively provided by the
public sector—nationally, regionally, or locally, depending on the issue and
the country. Such critical areas requiring collective action, which would allow
economy-wide efficiencies through network effects (courts, regulation,
functioning markets), may be undervalued in the face of individual inability to
cope with the deficiencies of the investment climate.
This is
particularly so when the public sector’s failure to provide public goods—such
as those requiring collective action—causes the economy to adjust to second- or
third-best solutions.[5] By
understanding the problems the private sector faces, the authorities send
critical signals to the business community that things will improve rather than
deteriorate. Such activity is a key part of an overall push to spur reform,
particularly when it is not obvious where public actions are needed first and
where public–private partnerships can play a role.
4.1.
Firms’ Perceptions
of Obstacles Around the Globe
The World Bank’s
enterprise surveys have polled firms around the world in a methodologically
consistent way to enable the best possible comparisons of opaque and diverse
areas. The surveys are conducted by the World Bank and its partners across all
geographic regions and cover small, medium, and large companies. They are administered
to a representative sample of firms in the nonagricultural, formal private
economy. The sample is consistently defined in all countries and includes the
entire manufacturing sector, the services sector, and the transport and
construction sectors. Public utilities, government services, healthcare, and
financial services are not part of the sample. The enterprise surveys collect a
wide array of qualitative and quantitative information through vis-à-vis
interviews with firm managers and owners regarding the business environment in
their countries and the productivity of their firms.
As it turns
out, global and regional firm-level perceptions differ from one another but
center around a few areas (see Figure 16.4). In South Asia, Africa, the Middle
East and North Africa, concerns about power dominate incumbent firms’
perceptions of the investment climate. In Eastern Europe and the OECD
countries, other issues matter more. Abstracting from the acute issue of power
in less developed countries, key global issues from the private sector’s
perspective involve finance, education, informality, and tax rates. Political
stability is also a concern almost everywhere, while in the more advanced
countries, formal governance institutions responsible for tax administration
and the courts are also a concern (though not as much in less mature markets).
Issues such as corruption, land, labor, and transport are notable perhaps for
the lack of concern they elicit around the world.
Figure 16.4: Firms’ perceptions of obstacles around the world
Source: World Bank, enterprise surveys (various years).
In Pakistan,
incumbent managers and entrepreneurs were interviewed three times during
2002–13 on hindrances in the investment climate (see Figure 16.5). The responses
were instructive, reflecting the economic issues of the day. Moreover, taking
the collective pulse of the business community on a regular basis allowed
policymakers to see how views had shifted during the decade, providing insights
into the dynamic forces on the ground.
Figure 16.5: Major obstacles cited by Pakistani firms
(percentage of respondent firms)
Source: World Bank (2009).
4.2.
In Pakistan: Solid
and Shifting Perceptions
The surveys’
results for the period 2002–07 show that firms responded to first-level reforms
to remove red tape and lower the cost of doing business during the first part
of the 2000s in areas where the government had devoted resources and policy
attention. The major improvements they perceived were in finance, tax
administration, anti-competitive practices, labor regulations, and customs and
trade regulations (Table 16.1). Issues that were perceived to be the top
constraints in 2002 became less important, however, in the face of rising
concerns about governance-related issues, such as political instability,
macro-management, corruption, and law and order, which had worsened
considerably.
4.3.
Energy: The South
Asia Constant
Electricity,
which represented an important area of deterioration in governance, dominated
the business community’s concerns in 2007—more than 80 percent of firms
identified it as a problem, i.e., double the proportion just five years
earlier. Clearly, compared to firms worldwide, Pakistan’s energy problem is one
of the most serious operating issues and the most obvious case of public sector
failure to provide an appropriate business environment.
Table
16.1: Major obstacles cited by firm (%)
|
Obstacle
|
2007
|
2002
|
|
Deterioration
|
|
|
|
Electricity
|
80
|
39
|
|
Corruption
|
57
|
40
|
|
Macro-instability
|
57
|
34
|
|
Political instability
|
47
|
40
|
|
Crime, theft, disorder
|
32
|
21
|
|
Improvements
|
|
|
|
Tax administration
|
23
|
47
|
|
Access to finance
|
18
|
38
|
|
Anti-competitive practices
|
14
|
21
|
|
Labor regulations
|
6
|
16
|
|
Customs regulations
|
6
|
24
|
Source: World Bank (2009).
The enterprise
surveys show that Pakistan’s problem—though severe even in 2007—was not out of
line with other South Asian countries (Table 16.2). Firms around the world
averaged seven outages per month; firms in South Asia experienced an outage at
least once a day and lost more than double the amount of sales. Although the
problem in other parts of South Asia was as severe in terms of outages, the
number of firms identifying electricity as a constraint is much lower outside
of Pakistan, and not far below the mean for the entire world.
Table
16.2: Electricity: The Achilles’ heel of the investment
climate
|
|
All
|
South Asia
|
Pakistan
|
|
No. of electrical
outages per month
|
7.3
|
33.9
|
31.7
|
|
Losses due to electrical
outages (percent of sales)
|
3.0
|
8.6
|
8.2
|
|
For those with outage
losses due to electrical outages (percent of sales)
|
5.0
|
10.1
|
9.2
|
|
Firms owning or sharing
a generator (%)
|
32.1
|
36.4
|
26.3
|
|
Share of electricity
from a generator (%)
|
6.8
|
12.3
|
5.5
|
|
For those with
generators, share of electricity from a generator (%)
|
20.8
|
27.2
|
29.3
|
|
Days to obtain an
electrical connection
|
34.1
|
44.8
|
106.3
|
|
Firms identifying
electricity as a constraint (%)
|
40.6
|
54.4
|
74.5
|
Source: World Bank enterprise surveys
(various years).
4.4.
Idiosyncratic
Issues in Pakistan
However, there
are two large differences between Pakistan and its South Asian counterparts.
The first is the time required to acquire a connection from the electrical
company. More telling, however, is Pakistan’s clear inability to cope with the
severe deficiencies of the investment climate—in this case, the provision of
electricity—as compared with its regional counterparts. Far fewer Pakistani
firms rely on electricity from their own generators; those who do—getting almost
a third of their electricity from this source—are only able to make up a small
percentage of the energy deficit (less than the world average). As is the case
for other public services, it is possible for firms to cope with the
deficiencies of the investment climate where electricity is concerned but at a
cost that many in Pakistan cannot afford.
In 2010, firms were asked to
identify “the most important obstacle” rather than a list of major obstacles”;
the results showed that the energy crisis—already a desperate concern—had
actually worsened in 2010, surpassing all other concerns as the most important
problem. In 2007, three quarters of the firms surveyed had cited electricity as
a major problem, but less than half had considered it the top problem (Table
16.3). This had changed by 2010 when two thirds of Pakistani firms considered
it the most critical problem compared to less than a third in South Asia as a
whole.
Table 16.3: Share of firms ranking obstacles as a major problem (share
of total)
|
|
Global
|
South Asia
|
Pakistan
|
|
|
2007
|
2010
|
|||
|
Electricity
|
16
|
29
|
44
|
65
|
|
Political instability
|
9
|
14
|
4
|
20
|
|
Crime, theft, and
disorder
|
6
|
6
|
8
|
3
|
|
Access to finance
|
15
|
13
|
6
|
2
|
|
Access to land
|
3
|
4
|
6
|
2
|
|
Corruption
|
7
|
6
|
19
|
2
|
|
Informal practices
|
11
|
6
|
1
|
2
|
|
Licensing and permits
|
3
|
2
|
1
|
1
|
|
Customs and trade
|
3
|
2
|
1
|
1
|
|
Inadequate education
|
6
|
2
|
2
|
1
|
|
Tax rates
|
11
|
4
|
5
|
1
|
|
Courts
|
1
|
0
|
0
|
0
|
|
Labor regulations
|
2
|
2
|
1
|
0
|
|
Tax administration
|
3
|
3
|
1
|
0
|
|
Transport
|
3
|
3
|
1
|
0
|
Source: World Bank Group, Enterprise
Note 27, J. S. Yang, (2011).
Apart from the
overwhelming predominance of the energy sector in the investment climate during
2007–10, major political concerns appeared to overshadow economic issues in the
private sector’s view. Even concerns about corruption seemed to dissipate in
the face of political events. It is important to note, however, that this does
not mean that concerns about political corruption had fallen but that
small-time business corruption of the traditional variety was being replaced by
political instability concerns. So it is not a surprise to see the concern
about corruption fall along with that of tax rates and other concerns while
electricity and political stability take the lead role as concerns regarding
the business environment.
5.
The Role of the Business
Environment: Empirical Evidence
Gauging the role
of the business environment based largely on the views of the incumbent
business community can, however, bias the overall perception in several
important ways. First, productivity gains are seen myopically and, therefore,
cost reductions are valued over other types of improvements, such as those
involving competitive pressures from increased formality and the process of
creative destruction that may follow. Second, the issues cited reflect firm-level
experience of coping with a fragmented, opaque investment climate; this may
underplay institutional issues involving rules—courts, contracts,
regulators—that incumbents have overcome but at a potential loss to innovation
and a “low-level equilibrium.”
An econometric
analysis seeking to empirically test the top constraints to productivity growth
reveals that, in Pakistan’s case, the results are consistent with firms’
perceptions of the constraints described earlier. Using data from the same
firms surveyed in 2002 and 2007, a clear set of specific variables—many of them
necessary proxies for standard investment climate issues—have important
statistical significance in explaining firm-level changes in productivity
between 2002 and 2007.
As shown in
Table 16.4, the data on Pakistani firms not only indicates a positive
correlation between productivity and employment and facets of the country’s
investment climate, it also confirms the various hypotheses derived from
firm-level perceptions. In particular, the key variables that stand out as
being associated with firm-level productivity include: (i) power outages and
the quality of power supply, (ii) the time, cost, and hassles involved in
complying with regulations, and (iii) crime and security in a negative sense.
Those variables associated with higher-productivity firms are (iv) access to
finance, (v) training and skills up and down the line, (vi) innovation, and
(vii) corporate governance. The proxy for female worker is negative due to
women being represented in lower-productivity activities.
Table 16.4: Key investment climate
variables, 2002–07
|
Infrastructure
|
Number of power outages
|
-
|
|
Low quality supplies
|
-
|
|
|
Economic governance
|
Security expenses
|
+
|
|
Crime losses
|
-
|
|
|
Manager’s time spent on red tape
|
-
|
|
|
Number of inspections
|
-
|
|
|
Informal payments for contracts
|
+
|
|
|
Illegal payments in protection
|
-
|
|
|
Finance
|
Credit line
|
+
|
|
Loans (with and without collateral)
|
+
|
|
|
Trade association
|
+
|
|
|
Labor markets and skills
|
Management training
|
+
|
|
Female workers
|
-
|
|
|
University education for staff
|
+
|
|
|
Innovation
|
+
|
|
|
Corporate governance
|
+
|
|
Source: World Bank (2009).
Statistical attempts to quantify the contribution of different
variables to firm-level outcomes demonstrate that, in 2007 at least, the
investment climate issues facing Pakistan firms did not differ significantly
across provinces (Figure 16.6). Not only were the issues
similar—infrastructure, economic governance, finance, and corporate
governance—they mattered to about the same degree across Pakistan. Governance
and infrastructure were cited as concerns in all the provinces, led by Punjab,
while the larger more globalized firms in Karachi brought into consideration
issues of innovation and competition.
On the other hand, in Khyber Pakhtunkhwa, where economic
governance and infrastructure contributed less to the investment climate,
finance and corporate governance emerged as stronger contenders. To some
extent, the different contribution of the various dimensions of the investment
climate reflects the type of firm dominant in each province. Smaller informal
firms are associated with less economic governance, less need for
infrastructure and formal finance, and usually exhibit little, if any, formal
corporate governance. These firms are lower-scale, more penalized by the
investment climate, and exhibit lower productivity than larger, more formal
firms.
Figure 16.6: Investment climate’s contribution to productivity
Source: World Bank (2009).
6.
The Transmission
of Efficiency from the Business Environment to the Firm
The empirical analysis confirms the perceptions and opinions of Pakistani
firms while providing insight into how various aspects of the investment
climate contribute to productivity and efficiency. Certainly, such information
is important to policymakers wanting to improve the investment climate in order
to strengthen the economy’s competitiveness and growth. However, for policy to
be deployed strategically—while remaining aware of all the consequences—it is
necessary to understand the various dynamic processes that take place at the
micro-, sector and economy-wide level that have the potential to affect
“aggregate” productivity.
For Pakistan,
policies geared toward improving the economy’s productivity can entail three
distinct but highly related processes: (i) lowering the “cost of doing
business” to enable the same output at a lower cost; (ii) increasing the
productivity of the enterprise sector through policies that make formality and
scale attractive to encourage firm-level growth; and (iii) increasing firm
entry and exit to enable competition, innovation, and a shift in resources from
lower-productivity firms to more competitive firms through the process of
“creative destruction.” In all three dimensions of productivity-induced growth,
the business environment has a critical role to play in enhancing or
obstructing private sector efficiency. Each of these areas forms the basis of
the analysis below and the set of policy recommendations provided at the end of
the chapter.
6.1. Lowering the Cost of Doing Business
Analyzing the cost of doing business in Pakistan involves
examining three separate dimensions: (i) the cost of complying with official
regulators; (ii) the unofficial cost of doing business as represented by the
need to (and expectation of) to provide gifts to acquire public services; and
(iii) given the amount of regulation and discretion, the difference between de
jure and de facto regulation and its important impact on the general fitness of
this activity. Given that, the firms that are most able and likely to avoid
such informal costs, and those least able to afford them, as firms that can
most easily cross the line into the state of informality.
6.1.1.
Official
Costs of Doing Business
The cost of doing business affects all
firms, but different costs affect different firms in various, often
unpredictable, ways. Formal costs relate to the rules and regulations affecting
the fees, time, and effort incurred. These “official” costs have been measured
using indices and comparisons captured by the World Bank Group’s DB project,
which collects annual data on the state of regulations for 181 countries. The
project measures regulations in eight areas and has recently expanded this to
ten (see Figure 16.7); the number of countries measured has also grown.
Figure 16.7: Pakistan’s DB ranking: From 94 in
2004 to 104 to 107 in 2012/13
Source: World Bank Doing Business database, 2013.
Pakistan has generally appeared
relatively open and favorable on scales that measure the official regulation of
firms. For much of the early 2000s, its composite index ranked highest in South
Asia after the Maldives, hovering around halfway among the 180 countries
measured. However, in recent years, what seemed on paper to be a relatively
liberal and efficient regime has deteriorated in relative terms, based on the
DB methodology, which ranks countries according to the composite DB index.
Pakistan’s ranking has since fallen steadily, dropping 13–15 places in the
world rankings since 2004. The fall is sometimes associated with the
introduction of an unfavorable business regulation or the elimination of a
favorable one, but is more often linked to limited reforms at the micro-level
while other countries have attempted to improve their own rankings.
Unfortunately,
there is little consolation that the fall in ranking stems from inertia rather
than policies harmful to the DB indicators. In the face of other reforming
competitors, a country can fall behind simply by failing to reform. In the end,
falling behind in relative terms is not costless, irrespective of how it has
occurred. An analysis of firms’ responses to regulatory issues—particularly
official regulations of the kind measured in the DB project—reveals that firm
performance is affected by variability, expectations, and perceptions of
immanent policy implementation as much as the state of official regulation. In
other words, the level of the indicator does not matter as much as firms’
intuitive expectations of future policy implementation. Thus, in Pakistan,
where regulatory streamlining is relatively recent, the inertia of the de jure
policy regime over the past few years has been viewed by businesses as anything
but benign neglect, particularly given the active reform being pursued by many
of the country’s competitors.
6.1.2.
Informal Costs of
Doing Business
Related to
reforms—or the lack thereof under the de jure policy regime—is the fact that
the de jure or official cost of doing business can be quite different from a
firm’s actual costs (in terms of time, money, and hassle). The enterprise
survey reveals that firms in Pakistan face far higher costs than just the
official costs: almost half the firms surveyed reported that they were expected
to provide public officials with gifts. This is a much higher share compared to
South Asia as a whole and twice the share of respondents for all the countries
surveyed (Figure 16.8).
Figure 16.8: Share of firms expected to provide gifts to officials
By type of official
By type of firm
Source: World Bank enterprise surveys
and World Bank (2009).
The
situation’s underlying texture provides some additional insight. The informal
costs of doing business are highest with regard to the most significant and elusive
government services globally, but particularly in South Asia. The survey’s
specific results in this area are revealing, and put into context the very high
number of days reportedly required to secure electricity and water connections.
Importantly, these areas also score globally as the most problematic from a de
jure perspective.
On the other
hand, the high level of interface between tax officials and firms seems to have
decreased significantly with the rising expectation of receiving gifts. Since required
permits and official licensing were less prevalent in daily life due to the
regulatory reforms of the early 2000s, there was no pretense of providing gifts
in exchange for access, and so gifts in these two arenas do seem as significant
today as they were some years ago. Similarly, gifts to secure government
contracts are not as needed as the daily interface requirements, as
government–business contractual relationships are fewer and more complex.
6.1.3.
De Jure vs. De
Facto Application of Regulations
The World Bank
and others have made a number of important attempts to carry out surveys,
analyze laws, and engage in advanced statistical analysis in order to reveal
the impact of the business environment on growth. Two dimensions of the
business environment are important to consider, both of which are dynamic and
complex. The first involves the de jure environment: the set of official rules
and regulations on paper that can be referred to, analyzed, and changed.
The key
distinctions between de jure and de facto regulation, as measured by the DB
project and enterprise surveys, are listed below.
-
Firms in the same
country report, de facto, wildly different times and costs associated with
completing the same transaction; de jure compliance involves a single estimate.
-
Cross-nationally,
there is very little association between the enterprise survey distributions
and DB numbers. The patterns are much more complex as the de jure environment
appears to affect only some firms, distinguishing between “favored” and
disfavored” firms.
-
In every country,
the “favored” firms report little delay in any of the three indicators while
the firms that find regulations to be an obstacle vary across countries in
terms of the extent of delay.
-
There is little
association between DB improvements and reports in the enterprise surveys;
improvements in DB are just as likely to be accompanied by deteriorations in
the enterprise surveys.
-
There are many
substantial reductions in the DB reported time but almost no instances where
this was associated with a fall in the ES reported time for compliance.
On one hand,
the World Bank’s DB project attempts to benchmark each country’s de jure
environment by continually monitoring, measuring, and ranking the composite
scores of the country’s official regulations as they translate into time, cost,
and procedures involved. On the other hand, firm-level surveys not only gauge
perceptions but also attempt to collect and benchmark qualitative and
quantitative indicators, measuring the implementation aspects of
regulations—the de facto business environment.
6.2.
Bringing a Greater
Degree of Formality into the Economy
The addition of unofficial costs to official costs amplifies the cost of
doing business; more importantly, though, it adds an added level of uncertainty
between the de jure and de facto application of laws and regulations. This
friction leads to such high, opaque, and unpredictable costs of doing business
that a large part of the economy chooses to sacrifices firm growth and
profitability by operating on some level of informality. Three dimensions of
informality exist around the world and, indeed, are strong elements of
Pakistan’s economy: (i) firms that are unreported because they maintain a small
number of employees (10–20), (ii) the avoidance of taxes and fees by firms that
remain illegally unregistered; and (iii) informal practices by formal firms,
usually in factor markets and property rights.
Almost two thirds of the firms surveyed in 2007 considered the application
of regulations to be inconsistent and unpredictable. By remaining informal and
consequently small, firms avoid the constraints imposed on them by
over-regulation. For instance, senior management in large firms spent, on
average, 13 percent of their time dealing with regulations—almost three times
what smaller firms spent (5 percent). Large firms met or were inspected by tax
officials almost seven times a year compared to three times for small firms.
Labor market regulations are also important. Only 6 percent of small firms
noted that labor market regulations affected their decision to hire and fire
permanent workers compared to over four times that share for large firms (World
Bank 2002, 2007).
The impact of
over-regulation and weak institutions in Pakistan contributes to high
compliance costs as well as to the informal costs of doing business, as
described in the previous sections.[6] The
result is a high level of cost avoidance through various means under the
heading of informal markets. Consequently, the informal sector has been
estimated to be as large as 35–40 percent of the official economy (World Bank,
2012b). Given that large firms cater to a different market from small firms,
they are relatively unaffected directly by regulatory avoidance, although some
firms, particularly in areas of design and other intellectual property, report
the unauthorized copying of designs.
A key
indicator of formality that clearly reveals Pakistan’s duality is the degree to
which firms—whether those producing technology-intensive products for export or
more traditional products for local consumption—have an incentive to adapt existing
productivity-enhancing technology that is available to any firm at a low cost
(Figure 16.9). The degree of adaptation of basic technology reflects the firm’s
degree of formality, market orientation, and indeed, incentive to compete with
others who are also adapting.
Figure
16.9: Firms’ use of technology, 2007
|
Source: World Bank enterprise surveys (various years).
Firms in
Pakistan comply with quality certification to a relatively high degree,
particularly the country’s international chemical industry and stronger
elements of the food and textile industry. However, when looking at the use of
the Internet in business as well as the degree to which financial statements
are formally audited, a much more informal picture of the Pakistan firm emerges
compared to firms in South Asia and around the world (see Figure 16.10).
Figure 16.10: Indicators of technology and formality: Groups within
Pakistan
Source: World Bank (2007).
Breaking down the country’s market structure by industry, geographic
location, size, and trade orientation, further clarifies the picture of the
Pakistani firm. As noted, the rising chemical industry in Pakistan, though
limited to a small number of large firms, is clearly the most formalized and
technologically oriented as would be expected for such high-technology firms.
The textile industry, particularly the large sector located in Sindh, is
equally formalized and technologically adapted (Figure 16.10). However, most of
the enterprise sector is not, which also emerges clearly.
6.2.1.
Nature of
Firm-Level Governance
Academics, journalists, and casual observers have written widely on the
governance aspects of the Pakistan economy and the resulting degree of “social
capital” in use in the form of informal, localized firm and market
arrangements. In some analyses, this type of enterprise sector is the result of
a “low-trust society” that forgoes arms’-length market arrangements even within
the country for more informal arrangements due to the lack of property right
protection and adherence to legal rules in conducting business.
Pakistan typically rates quite low on many governance indicators,
represented by the 2012 composite indicator, covering such areas as the rule of
law, quality of regulation, and political stability. Only Afghanistan scores
worse than Pakistan in South Asia, which itself ranks the lowest among all
regions. Without strong market governance by trusted institutions,
predictability and transparency in the business environment are likely to
suffer, keeping a large share of the economy outside the formal sector and
creating a drag on the economy’s productivity.
6.2.2.
Impact of
Firm-Level Governance
The perception that governance is an issue faced at the firm level
emerges clearly when we compare Pakistan with the rest of South Asia and the
world in terms of views on corruption, bribes, and the role of the courts in
the investment climate. Clearly, in 2007, firms in Pakistan showed more concern
about governance at the firm level and likely continue to do so today.
Importantly, while their perception and experience of corruption does not
differ much across different sizes of firms, the concern with courts rises as
the size of the firm grows, indicating the need of the more formal economy to
have a more formal governance system. Across the provinces, corruption and the
courts emerge as key concerns, apart from in KP where the concern seemed to
outstrip the experience (see Figure 16.11).
Figure 16.11: Strength of market governance (share of firms that… )
Source: World Bank enterprise surveys (various years).
The impact of a strong degree of informality in the enterprise sector is
that productivity is limited by the distribution of enterprises across the
formal/informal spectrum, given that informality in any form is typically less
efficient than a formal, market-based structure. In other words, the aggregate
productivity of the enterprise sector is based on the productivity of the
average firm, as well as the range and weighting around the average. For
high-average firms with a low level of dispersion, the aggregate will generally
be high. However, a wider dispersion will allocate resources to low- as well as
higher-productivity firms and the country aggregate will depend on how much
weight each firm is assigned.
6.2.3.
Impact on
Productivity
Figure 16.12 shows estimates of TFP broken down by aggregate and average
productivity for eleven countries where data was available. The statistical
relationship between the investment climate variables and productivity is
positive, but is due mostly to the allocative term rather than average firm
productivity. Pakistan’s mean productivity—that is, the part of productivity
affected by the investment climate—is comparable with that of Mexico and South
Africa, lower than that of Chile and Brazil, and higher than that of other
countries in the region (Indonesia, Turkey, and the Philippines). This
underscores the investment climate’s positive impact.
However, in Pakistan, the investment climate’s contribution to aggregate
productivity is made prominent by the fact that it has a negligible and
marginal impact on average productivity. This market characteristic is observed
strongly in Brazil and Pakistan and to a lesser extent in India and Bangladesh.
On the other hand, countries like Chile, Mexico, and South Africa derive their
high levels of aggregate productivity growth from business conditions that
raise the average productivity of the representative firm. The residual
term—called “allocative efficiency”—represents the variance of the productivity
across firms (size of term) and whether the weighting is associated with
higher- or lower-productivity firms (the sign of the term). Countries like
Brazil, India, Bangladesh, and at the highest level, Pakistan, have a high
variance in productivity across different enterprises. The variance is positive
in these cases because larger firms with higher weights have higher
productivity.
Figure
16.12: Productivity (mean) breakdown across countries
Source: World Bank (2009).
From the perspective of overall efficiency and competitiveness, the
high variance of firm-level productivity embodied in the allocative efficiency
term may reflect market frictions that enable low-productivity/low-market share
firms to exist without exiting. A large allocation term not only supports the
hypothesis of duality in the economy where formal and (relatively)
high-productivity firms coexist with smaller, informal, low-productivity firms.
A positive allocation term indicates that top-ranking firms are using most of
the resources in terms of average productivity. However, the coexistence of a
high efficiency term and a low average productivity term shows that
low-productivity firms dominate in terms of numbers but not market share.
Traditionally, aggregate productivity in a dual economy is depressed because
too many resources are allocated to low-productivity production in the informal
sector.
6.2.4.
Role of Friction
in the Economy and Firms’ Ability to Cope
Friction may
arise from a variety of factors, including the adjustment costs of entry and
exit, difficulties in contract enforcement, lack of property rights
enforcement, poor retail systems, competition issues, market structure, and
technological factors. These sources of friction are part of the investment
climate for doing business and affect the efficiency of the average firm in a
given country, but they can also help explain the existence and role of a large
allocative efficiency term. When trying to explain a pattern statistically, the
most important findings confirm the hypothesis described above:
-
Variables that
relate to firms’ degree of formality and the ability of formal firms to cope
with business problems are highly significant in terms of explaining
productivity patters.
-
In infrastructure,
these factors include ownership of a generator, transport, and security, and
the number of days of inventory. Location in an industrial estate is also
significant, representing productivity gains from agglomeration economies.
-
There is also a
strong association between productivity and variables representing the formal
nature of firms. Economic governance variables include (i) handling disputes
through courts, (ii) reporting sales to the tax authorities, (iii) dispersed
ownership concentration, and (iv) access to checking/savings accounts and
working capital through private banks.
-
Innovation and
skill variables are also significantly associated with productivity
differences, including process innovation, new equipment, foreign direct
investment, and training.
In terms of
infrastructure and economic governance, the evidence shows that firms with a
larger market share seem to cope better with the negative elements of the
business climate. In particular, the highly negative association with average
productivity is muted since the effect is concentrated on firms with a small
market share. For instance, ownership of a generator is slightly related to
improved productivity but the impact is amplified for aggregate productivity
because ownership of generators is concentrated among firms with a large market
share. Similarly, the positive association with a firm that has a large amount of
inventory, uses the courts, and pays for security is also amplified at the
aggregate level through the allocative effect.
In the case of
variables reflecting the degree of formality, the allocative efficiency effect
is small, implying that the positive association with formality applies to all
firms. Two variables are significant in this regard. First, under economic
governance, reporting sales to the tax authorities contributes substantially to
both aggregate and average productivity. Second, a firm’s access to its own
bank account is correlated with increased productivity at the average firm
level. There is a small allocative efficiency term here, implying that having a
bank account is positively associated with having a large market share. On the
other hand, there is a strong negative association with concentrated ownership;
unlike the other two variables, however, it is associated with a smaller market
share, muting the aggregate impact.
The results strongly indicate
that productivity-enhancing variables, i.e., finance, innovation, and labor
skills, are associated with firms that have a larger market share. In the case
of finance, the negative impact of prepayment for purchases and working capital
financed by internal funds is concentrated on firms with a small market share.
The positive correlation between productivity and working capital financed
through private banks is associated with firms that have a larger market share.
For innovation and labor skills, the positive association with productivity—especially
for new processes and equipment—is concentrated on firms with a larger market
share. The effect is stronger for the training variable because a small degree
of association with average productivity is amplified at the aggregate level.
6.2.5.
Differences Across
Provinces
Differences in
the relationship between investment climate variables and productivity are
relatively robust across provinces and firm size, but with some small
differences that are worth noting (Figure 16.13). Specifically, infrastructure
accounts for the highest share of productivity differences in all the provinces
with a somewhat lower impact in Balochistan. Conversely, economic governance
contributes more to productivity in Balochistan than in the other provinces. In
KP, unlike the other provinces, economic governance, finance, and corporate
governance contribute relatively equally to productivity, with finance and
corporate governance accounting for a larger share than in the other provinces.
Innovation contributes to productivity the most in Sindh and the least in
Punjab.
Figure
16.13: Productivity (mean) breakdown across provinces
Source: World Bank (2009).
6.3.
The Impact of the
Investment Climate on Various Types of Firms: Results from the O&P
Decomposition 2002–07
The range of
specific investment climate variables that are significantly associated with
productivity differences, highlight the wide range of ways in which the
investment climate affects economic growth. Some variables—infrastructure,
economic governance, and finance—remain robust and significant over time. For
example, the negative impact of power outages, crime losses, payments to
receive government contracts, and the positive impact of access to formal
finance are consistently significant. On the other hand, issues relating to
government–business interface—for example, the number of inspections or the
time taken to comply with regulations—fall in significance.
The effect of
individual investment climate variables is associated with aggregate productivity
through average productivity and the allocation of resources. Specifically, 14
percent of the effect that investment climate variables have on aggregate
productivity is due to average productivity; the remaining 86 percent is due to
the allocation effect. The key significant variables and their share in total
average and aggregate productivity are as follows:
-
Number of power
outages (infrastructure). The share in average productivity is -13.3 percent
and the share in allocative efficiency is 6.7 percent. Hence, the negative
effect on productivity is biased toward low-market-share firms.
-
Days of inventory
of main intermediate material (infrastructure). The share in average
productivity is 14 percent, while the allocation effect (9 percent) amplifies
the average, indicating the positive effect concentrated in high-market-share
firms.
-
Sales reported for
tax purposes (economic governance). This variable accounts for 12.8 percent of
aggregate productivity and 12.3 percent of the average productivity effect.
-
Working capital
financed by internal funds (finance). Out of a total share of -6.6 percent in
aggregate productivity, -8.3 percent is accounted for by average productivity,
indicating that the effect is muted and concentrated among firms with a low
share of sales.
-
Working capital
financed by private banks (finance). This variable is positively associated,
accounting for 11.3 percent of productivity. The allocation effect accounts for
almost the entire effect (9.6 percent) indicating that the positive effect is
concentrated among firms with a high market share.
-
Dummy for process
innovation (innovation and competition). Its share in aggregate productivity is
15.7 percent but, like finance, this arises through allocative efficiency (13.1
percent) since the average effect accounts for one sixth of the overall
contribution.
-
Dummy for training
(labor markets and skills). Of its total share of 12.4 percent in aggregate
productivity, 11 percent is due to allocation and 1.4 percent due to the average.
-
Largest
shareholders (corporate governance). The aggregate effect is -8.1 percent,
decreasing from -16.2 percent (average) by a positive allocative efficiency of
8.1 percent.
6.4.
Encouraging
Innovation, Structural Change, and the Process of “Creative Destruction”
Perhaps the most
traditional and possibly most important dimension of productivity growth comes
from the process of “creative destruction” where competitive pressure forces
firms to constantly discover and implement new technologies to produce new
products or old products in new ways. In this way, all firms are not equal in
terms of productivity growth. Schumpeter considered it the “essential fact
about capitalism”; the body of work since then has analyzed firm-level data and
confirmed the importance of both direct and indirect productivity effects of
firm entry and exit over time (Bartelsman, Haltiwanger, & Scarpetta, 2004).
Firms differ not only in their managerial ability, location, organization,
and know-how, but also in their ability to advance in a contestable market by
adapting to new knowledge where other firms have not. Recent evidence supports
the hypothesis showing that new and relatively more productive establishments
displace older and relatively less productive ones. However, the empirical
evidence also gives insights into how the process of creative destruction
works, and shows that there are reinforcing indirect effects. First, the
invention or application of superior technology by a new entrant may encourage
incumbent firms to improve their own technology (Bartelsman et al., 2004). Second,
the creation or deepening of the contestability of markets through creative
destruction also serves to raise productivity through competitive pressure.
There are also
impediments to the positive outcomes of creative destruction. Even in markets
without friction, the advantages that firms have with which to advance while
others fall behind may first show up in the form of profitability and only
later, as productivity. New firms are not necessarily more productive as
learning needs to take place and the empirical evidence supports this. If
learning does not take place, then new entrants exit quickly and only
productive ones survive. Empirically, the high level of deaths in the early
years of firm life supports this argument.
6.4.1.
Absence of Dynamic
Structural Change
This discussion
is important in Pakistan’s context as the earlier sections explaining the wide
variance in productivity demonstrate that large gains can accompany creative
destruction. However, equally importantly for countries such as Pakistan, there
are impediments to the process of creative destruction. As described earlier,
the lack of strong institutional governance allows laws and regulations to be
implemented in ways that favor firms in an unpredictable and opaque manner.
Creative destruction thus occurs for reasons other than efficiency or not
operating at all.
High-technology
exports constituted less than 2 percent in 2008—a share that remains broadly
unchanged over the last 25 years (Figure 16.14). This is extremely low for a
country that has good educational and research institutions, and a large
population. For example, Vietnam’s share of high-technology exports rose from
0.7 percent to 3.8 percent of the total in the same period, whereas India’s
increased from 2.8 percent to 6.2 percent. Moreover, while the majority of
Pakistan’s exports (around 54 percent) were classified as low-technology
products even in 1985 (Lall, 2000), this share has increased further over time,
reaching close to 80 percent in 2006.
Figure 16.14: Technological content of Pakistan’s exports
Source: World Bank (2012a).
Generally the
consensus is that Pakistan’s economy has shown limited, if any, transformation
over the past 20 years. One common aggregate export basket demonstrates that
the country remains a low-technology exporter with very little movement in its
share of exports, which could be an outcome of creative destruction. This low
level of technology content is also reflected in the very low level of
technology exhibited by firms operating in Pakistan.
Two other
dimensions of Pakistan’s export dynamics support the low level of structural
change in the economy over time. First, compared to other countries, and
relating changes in export sophistication to changes in income per capita,
Pakistan demonstrates far less structural change than countries thought to be
going through such dynamics, e.g., China, India, and Vietnam. Second, when
examining Pakistani exports, we see that not only is there a high degree of
concentration of exports in only a few firms, this has not changed much over
time. In 2002, 1 percent of firms accounted for 40 percent of exports and 5
percent accounted for 71 percent. In 2010, exporters became more concentrated
among the top 1 percent, and the top five accounted for 76 percent—a trend
opposite to that of other dynamic economies in the world, which are geared
toward more participation in international trade, not less (see Figure 16.15).
Figure
16.15: Export sophistication and concentration, 2003–10
Export sophistication:
Product space
Export concentration: Firm
space
Source: World Bank (2012a).
6.4.2.
Some Low Degree of
Discovery and Diversification
The dynamic
dimensions of Pakistan’s economy showed some promising signs during the early
part of the 2000s. By 2007, there was evidence of structural change but growth
in the technological content of exports remained miniscule. Unlike the limited
data on firm entry and exit (births and deaths) in the domestic market, there
is more firm data available for products bought and sold on international
markets. Therefore, granular levels of entry and exit can be examined for
export products and exporting firms as a proxy for creative destruction at the
economy-wide level (Figure 16.16).
Figure 16.16: Export product discovery and death
Source: World Bank (2012a).
First, when
looking at the product level, there is strong evidence of product discovery by
exporters at low levels. Each point represents a product in a particular
market. When mapping new products in new markets in 2008 and old products in
1998 (which no longer existed in 2008), it is clear that births well exceed
deaths at the product level. The results are consistent with a low but positive
degree of creative destruction.
Second,
important patterns emerge when examining firm-level data on trade. Export entry
and exit is lower in Pakistan than in its peer countries but new entrants have
consistently offset the losses of exiting firms. This result, consistent with
the finding at the product level, confirms some positive degree of churning at
the firm level. Pakistani firms are quite dynamic along this margin, as seen by
the significant entries and exits over the years from 2002 to 2010. According
to the trade data, each year, anywhere between 16 and 37 percent of firms exit
as another 19 to 37 percent enter (Figure 16.17).
Figure 16.17: Export entry and exit rates
Source: World Bank (2012a).
Third, at
first sight, there seems to be significant destruction and creation of
exporters in the data; entry and exit rates are in fact lower than in other
lower middle-income countries. Moreover, the net effect on the number of
exporters seems to be marginal. This suggests that the number of exporters is
not expanding any significantly over time. Firm export growth due to the entry
of new firms into the export market during 2002–10 was, on average, 1–2 percent
higher than the loss in growth due to firms that stopped exporting.
Finally,
dynamism fell significantly after 2004. This emerges clearly if we decompose
export growth by intensity and firm, country, sector, and product-extensive
margins (Figure 16.18). Fewer firms have entered and exited the export market
since 2004 and incumbent exporters have become more conservative in terms of
export markets, sectors, and product experimentation. In short, over the second
half of the last decade, entries and exits by new firms as well as existing firms
in new countries, sectors, and products, all fell consistently.
Figure
16.18: The dynamics of exports: Firms, markets, sectors, and
products, 2002–10
Source: World Bank (2012a).
The declining
entry and exit at the firm, sector, and product level provides a strong
indication of the decrease in the dynamism of exports in Pakistan over this
period. This fall in some of the dynamic aspects of exports in the early part
of the decade may have been a rational response to the deteriorating business
environment, which, in turn, can be traced to (i) macroeconomic, political,
policy or other form of instability experienced by the Pakistani firm, and (ii)
a policy framework that offered declining incentives to enter, compete, and
innovate.
6.4.3.
Evidence of
Reform-Based Productivity
An analysis of
the World Bank’s enterprise surveys of 2002 and 2007 to identify limited
evidence of creative destruction confirms that aggregate productivity in
Pakistan’s manufacturing sector increased over this period.[7] The
observed increase in productivity was due mainly to the allocation becoming
more biased toward larger-market-share firms and only marginally due to a rise
in the term measuring average productivity. This indicates that there was
indeed a process of reallocation, but of market shares toward
higher-productivity firms, i.e., the larger, more traditional firms (as
indicated by their export concentration). The lower-productivity firms lost
market share but not while they remained in the market and increased the
“average firm” productivity term.
The increase
in aggregate productivity is observed for both the datasets and is confirmed by
extracting a nonrepresentative panel sample of 400 firms that were surveyed
twice. The increase was due to a rise in firm-level productivity as well as
economy-wide productivity gains resulting from market shares going to firms
with higher levels of productivity. The change in the productivity distribution
over 2002–07 indicates a slightly smaller concentration of low-productivity
firms in 2007 than in 2002.
This
observation is shown as kernel density graphs for the two sample periods where
the average productivity distribution of firms moving to higher-productivity
areas supports a dynamic analysis of rising firm-level productivity (Figure 16.19).
The results clearly show the high concentration of low-productivity firms,
which characterizes Pakistan’s enterprise sector. This underscores the results
described above, which imply low average productivity and a wide range of
productivity differences among coexisting firms. This migration of firms toward
the more productive areas of the frequency distribution is consistent with the
hypothesis that the period was characterized by policymaking that induced
creative destruction, productivity increase, and improved competitiveness.
Figure
16.19: Kernel density for productivity, FY2002 and FY2007
Source: World Bank (2009).
7.
The Role of Public
Policy
The investment
climate plays a critical and determining role in supporting two driving forces
of Pakistan’s development strategy: (i) an increase in competitiveness and
firm-level efficiency, and (ii) the creation of high-quality jobs to provide
employment to a large proportion of the working-age population. In both cases,
the investment climate plays a critical role through complex transmission
mechanisms.
As described
in detail, the business environment has a direct and indirect effect on both
these objectives through various transmission channels—each of which contain
policy options to help foster the effectiveness of the transmission. As the
chapter has described, the investment climate affects firms’ employment and
efficiency either negatively or positively by: (i) affecting the cost of doing
business, both official and unofficial; (ii) creating incentive for
participation or not in the formal economy; and (iii) proactively fostering the
process of entry and exit so that creative destruction leads to inclusive
growth. All three transmission mechanisms are highly susceptible to the policy
frameworks established by governments, regulatory authorities, and judiciaries
at various levels of jurisdiction.
Pakistan’s
policy and institutional landscape has been shifting since independence, and
continues to do so. The most recent seismic shift was the 18th Amendment to the
Constitution, which seeks to complete the process of establishing a federation
of provinces. Therefore, as the predominant center of executive power shifts
from the military to the federal and on to the provincial level, while the
judiciary becomes more active and regulators continue to play an independent
role, the business environment remains an irrelevant set of rules, a work in
progress, a noisy annoyance, or a rent-seeking opportunity depending on the
individual businessperson’s perspective.
7.1.
Options in a
Public–Private Dialog Framework
Given the
continuously shifting sands of Pakistan’s business environment, it is critical
that the public sector remains in close contact with the views of the business
sector. Naturally, information gathered regularly can be informative in
adjusting and calibrating the focus and priority of critical aspects of the
public sector’s effort. More important, however, is an ongoing public–private
dialogue. This can be done in various ways, for example (i) through
dissemination and discussion around surveys such as those analyzed here; (ii)
through public–private task forces established for a short period of time, such
as that established by the Planning Commission in 2010; or (iii) through the
more permanent participation of the private sector on various committees and
councils.
In any of its
incarnations, the results of maintaining close contact with the Pakistani
business community will serve not only to collect input on the most important
deficiencies of the business environment, but also to monitor the progress on
implementing reforms, and even helping to organize the private sector for
collective activities. Such engagement is not only informative but also
empowering for the private sector, which will ultimately be making the
investment and employment decisions. Indeed, public sector dialog with the
business community represents a key aspect of the former’s effort to provide
the catalytic force needed to spur a productivity-virtuous circle.
7.2.
Addressing the
Cost of Doing Business
Reviewing the regulations facing the firm in a structured and
comparative way is a necessary first step to gauge where the country, region,
or locality stands in terms of a regulatory framework for business. In its de
jure form, the regulatory framework is often measured by benchmarking
indicators, such as those created by the World Bank’s DB project.
The importance of a DB-type review is threefold: (i) it can be deployed
at various levels of jurisdiction and cover the various institutions
establishing the rules of the game; (ii) it compares like indicators against
those of other countries to help judge the severity of the problem; and (iii)
it takes the first step in documenting the time-and-costs requirement based on
legal and regulatory rules. The second step is usually a regulatory review of
some sort that tries to (i) establish the rationale for a regulation, (ii)
eliminate those that are redundant, and (iii) improve those where necessary by
looking at front-line implementation issues.
More elusive
is the effort to address the unofficial costs of doing business. The evidence
shows, however, that some reforms are clearly without controversy in terms of
reducing the unofficial costs of doing business. The first and most obvious
measure is to minimize steps, procedures, and agencies, while ensuring that the
bodies in charge of governance are empowered and accountable. Independence,
checks and balances, and third-party verification are all ways that authorities
around the world use to minimize the probability of prohibitively large costs
imposed through unofficial means. Finally, involving and mobilizing the public,
civil society, and other interested bodies through public awareness campaigns,
can help change the narrative around the role of bribes and gifts for public
officials, which is often part of the enabling environment.
7.3.
Improving the
Incentive for Formality
The issue of
informality in transitional countries is difficult to understand and is opaque
in its causes and effects. Additionally, it is not clear whether it yields a
net loss to society or has a role in the way economies operate. Certainly, to
the degree that regulations impose such high costs that firms find it
profitable to remain informal to avoid them, it may be obvious that the
official costs are too high. It may be the case that many of the basic business
costs, such as for taxes, labor, and safety, are just too high. To the extent
that the informal costs are unpredictable, opaque, and applied inconsistently,
firms will avoid engagement.
On the other
side of the equation, where the attraction of a formal structure—finance,
contracts, land, etc.—is not enough to cause firms to register, pay takes, and
play by the rules, then it would be beneficial for society if these “pulls” for
informal firms be made available even through a pilot, micro-, or social
capital approach. The saying is appropriate that, if the system is not working
for the average firm, then the average firm will find it difficult to work for
the system. In other words, without the benefits of being formal, available,
accessible, and applicable, firms will have no reason to participate in the
formal economy.
7.4.
Encouraging and
Enabling the Process of Entry and Exit
A key dimension
of fostering “good” creative destruction is that the governance of the system
should be strong, transparent, and accountable. It is only through such
legitimacy bestowed on the system that the process of creative destruction can
be viewed by society as stable, beneficial, and worth the costs of structural
adjustment. However, it is also the primary and perhaps the only way that an
economy can upgrade its production over time so that growth is driven by
private sector innovation, investment, and indeed, failure, in a risk-taking
environment.
Specifically,
the role of institutional governance is critical to an organic and productive
process of entry and exit. Entry has to be governed by rules and procedures,
and most importantly, have access to land, labor, markets, and services. The
legal framework must be such that risk-based finance can be deployed based on
clear and solid estimations of risk and uncertainty. At the same time, exit
should be quick, decentralized to a creditor-based approach that allows for
restructuring as well as liquidation, and is done in such a way that it fosters
rather than hinders entrepreneurship. This means that entrepreneurs with ideas
that did not work should not be penalized so much that they are unwilling to try
again with another idea.
Finally, the
principal driver behind the innovation and productivity growth that emerges
from a holistic process of creative destruction is the competition generated
with a level playing field in contestable markets. As competition is not a
natural element of an economic landscape, the policy framework behind the
business environment often needs to attend to both explicit as well as implicit
competition dimensions. On the implicit side, the framework would include, for
example, open markets for all firms who meet the basic criteria, a high
propensity to import, and a welcoming attitude toward foreign direct
investment. As a second step, an explicit framework would include a competition
law and an enforcement agency ready and willing to take concerted efforts to
address private competition breaches as well as discuss and lobby against
public sector ones.
8.
Conclusions
This chapter has
provided evidence from firm-level surveys that, in the grand scheme of poverty
reduction and the growth of shared prosperity, the firm plays perhaps the most
critical institutional role in a country’s development goals. Total factor
productivity, which determines the business sector’s competitiveness and
wellbeing, occurs at the firm level where the inputs of labor and finance are
added to land and premises in order to make the output and sale such that the
value of outputs is greater than the value of inputs.
In
Pakistan—where the firm means so many things depending on one’s experience,
perspective, and interest—in its simple form, the country appears similar to
many others with a dual economy: a large set of very small firms usually
operating at some level of informality and coexisting with a small set of
seemingly large firms, which, due to their export-oriented nature, large
following, and traditional position in society would find it difficult to
officially acknowledge the idea of operating informally. In Pakistan’s case,
however, the distribution of firms is skewed very much toward the smaller end.
At the same
time, it is clear that large firms in Pakistan are not faring as poorly as
expected, given their ability to cope with the investment climate’s
deficiencies unlike the large number of small informal firms that end up facing
highly local markets. Overall, this configuration of productivity growth is
beneficial to overall aggregate productivity, but to the extent that
nonproductive or less productive smaller firms fail to exit, it will constrain
existing opportunities for raising taxes and increasing productivity through
new firms.
The way to the
heart of Pakistan’s development is, therefore, through the firm. The central
focus of policymaking should be to foster the three transmission mechanisms of
productivity enhancement at the firm level. In addition, by reaching out to the
private sector from time to time, a productive public–private dialog should be
initiated, which may create the spark to kick-start a virtuous circle of growth
in Pakistan.
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[1] In the census, out of a total of 580,000 manufacturing establishments,
43 percent were associated with the textile and leather industry, 20 percent
were food- and beverages-related firms, and 11 percent were engaged in
machinery, equipment, and basic metals where higher value-added and
intra-industry linkages are evident.
[2] The economic literature attributes differences in
output per worker between rich and poor countries to TFP. See Caselli (2005),
Hall and Jones (1999), and Klenow and Rodríguez-Clare (1997).
[3] As the labor force increase, labor productivity
decreases due to the declining marginal productivity of labor, requiring more
capital investment to maintain the same level of labor productivity.
[4] In the medium term, labor force participation can be
related to economic factors as people enter or leave based on the probability
of finding work.
[5] For example, firms
in Sialkot have substituted private collective action for public services in
the form of collective infrastructure, including an airport and a dry dock.
[6] Approximately 75 percent of firms state that it is
common to have to make an informal payment or gift to get things done.
[7] Caution should be used when interpreting productivity
purely as efficiency. There is a debate in the field on whether productivity is
better viewed as firm-level revenue generation power; this consists of using
factors more efficiently (i.e., technical efficiency) resulting from
firm-specific investments in technology, competition, labor, and skills on one
hand, coupled with firm-specific market power that allows a firm’s own prices
to be raised in relation to the sector deflators being used. In this analysis,
such as distinction is not possible, so the term “productivity” is used to
cover both instances.
Labels: Pakistan, Pakistan Economy, Pakistan: Moving the Economy Forward, Publications
posted by S A J Shirazi @ 1/09/2014 12:00:00 AM,
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