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  • 3. Table of Contents  List of Tables ............................................................................................................................................... vii List of Figures ............................................................................................................................................... ix List of Boxes ................................................................................................................................................ xii Acronyms and Abbreviations ......................................................................................................................xiii Acknowledgements  .................................................................................................................................... xv  .Executive Summary .....................................................................................................................................  vi  x1  Introduction .......................................................................................................................................... 2  1.1  Raison d’être for an Industrial Policy  ........................................................................................... 4  . 1.1.1  Brief Historical Review .......................................................................................................... 5  1.1.2  Towards an Industrial Policy ................................................................................................. 7  1.2  Methodology and Structure ........................................................................................................ 10 2  Industrial Sector of Pakistan: Structure, Performance & Problems ................................................... 12  2.1  Structure & Performance of the Industrial Sector in Pakistan ................................................... 12  2.1.1  Growth Trends .................................................................................................................... 13  2.1.2  Structural Rigidity & Inadequate Transformation  .............................................................. 16  . 2.1.3  Productivity ......................................................................................................................... 21  2.1.4  Export Performance ............................................................................................................ 25  2.1.5  Summary Analysis ............................................................................................................... 32  2.2  Investment Trends in Pakistan .................................................................................................... 33  2.2.1  Aggregate Investment Trends ............................................................................................. 34  2.2.2  Regional Comparison and Pakistan’s Investment Gap ....................................................... 35  2.2.3  Widening Resource Gap between Investment & Domestic Savings  .................................. 37  . 2.2.4  Actual & Potential Total Private Investment & Domestic Savings ...................................... 38  2.2.5  Sectoral Composition of Investment .................................................................................. 40  2.2.6  Foreign Direct Investment .................................................................................................. 42  2.2.7  Sector‐wise Decomposition of FDI ...................................................................................... 44  2.3  Constraints to Investment & Manufacturing Growth in Pakistan .............................................. 46    iii 
  • 4. 2.3.1  Macroeconomic Instability & its Impact on Investment & manufacturing ........................ 47  2.3.2  Infrastructural Constraints on Industrial Growth ............................................................... 59  2.3.3  Factor Markets Constraints on Investment & Manufacturing ............................................ 74  2.3.4  Standards, Regulation & Governance Constraints .............................................................. 96  Competitiveness & Industry Stagnation ........................................................................................... 109 3  Competitiveness of Key Industrial Sectors of Pakistan ..................................................................... 125  3.1  Primary Industrial Sector .......................................................................................................... 126  3.1.1  Chemical Industry ............................................................................................................. 126  3.1.2  Steel Industry .................................................................................................................... 133  3.1.3  Fertilizer Industry .............................................................................................................. 137  3.2  Value Added Knowledge Based Industrial Sectors ................................................................... 141  3.2.1  Auto & Farm Machinery Industry ..................................................................................... 141  3.2.2  Electronics Industry ........................................................................................................... 144  3.2.3  Pharmaceutical Industry ................................................................................................... 151  3.3  Value Added Skill & Engineering Based Sectors ....................................................................... 159  3.3.1  The SME Sector ................................................................................................................. 159  3.3.2  Fan Sector ......................................................................................................................... 161  3.3.3  Cutlery, Utensils & Hunting Equipment Sector ................................................................. 169  3.3.4  Horticulture Processing Sector ......................................................................................... 177  3.3.5  Surgical Instruments Sector .............................................................................................. 181  3.3.6  Sports Goods Sector .......................................................................................................... 186  3.3.7  Ceramics Sector  ................................................................................................................ 191  . 3.3.8  Furniture Sector ................................................................................................................ 195  3.3.9  Leather Sector ................................................................................................................... 202  3.3.10  Gems & Jewellery Sector .................................................................................................. 207  3.3.11  Marble & Granite Sector ................................................................................................... 211  3.3.12  Light Engineering Sector ................................................................................................... 219  3.3.13  Fisheries Sector ................................................................................................................. 230 4  Spatial Concentration of Economic Activity ...................................................................................... 232  4.1  Introduction .............................................................................................................................. 232  4.2  New Economic Geography and Development .......................................................................... 234    iv 
  • 5. 4.3  Mapping Measures of Regional and Spatial Inequality ............................................................ 237  4.3.1  Regional Spatial Distribution of Population and Density .................................................. 237  4.3.2  Measuring Regional Poverty and Income Inequality ........................................................ 243  4.3.3  Spatial Disparities in Social Infrastructure ........................................................................ 253  4.3.4  Market Access and Spatial Inequality in Road Infrastructure ........................................... 260  4.3.5  Agglomeration of Manufacturing Industries in Pakistan .................................................. 265  4.3.6  Localization versus Urbanization Externalities ................................................................. 274 5  Poverty Impacts of Public Investments and Causes of Industry Agglomerations  ............................ 278  . 5.1  Introduction .............................................................................................................................. 278  5.2  Are Regional Infrastructure Disparities Influencing Incidence of Poverty? .............................. 278  5.2.1  Background ....................................................................................................................... 278  5.2.2  The causes of poverty in Pakistan ..................................................................................... 279  5.2.3  Methodology and data  ..................................................................................................... 281  . 5.2.4  The basic regressions ........................................................................................................ 283  5.2.5  The effect of spatial inequality in social infrastructure on rural poverty ......................... 285  5.2.6  Spatial inequality in road infrastructure and rural poverty .............................................. 288  5.2.7  Does high inequality cause high poverty in Pakistan? ...................................................... 290  5.2.8  Method of Analysis ........................................................................................................... 293  5.2.9  Social infrastructure and poverty: How inequality affects poverty? ................................ 294  5.2.10  Road infrastructure and poverty: Does inequality matter? .............................................. 296  5.3  What Factors Cause Agglomeration of Manufacturing Industries?  ......................................... 298  . 5.3.1  Background ....................................................................................................................... 298  5.3.2  Explaining agglomeration  ................................................................................................. 299  . 5.4  Nature of Scale Economies and Patterns of Industry Agglomeration ...................................... 303  5.4.1  Background ....................................................................................................................... 303  5.4.2  Empirical specification ...................................................................................................... 303  5.4.3  Empirical results ................................................................................................................ 304  5.5  Compendium of Policy Notes  ................................................................................................... 307  . 5.5.1  Policy for pro poor infrastructure investment .................................................................. 307  5.5.2  Location policy for industrial development ...................................................................... 309  5.5.3  Agglomeration economies, scale externalities and growth of firms ................................ 311    v 
  • 6. References ................................................................................................................................................ 312    vi 
  • 7. List of Tables   Chapter 2Table 2‐1: Distribution of workforce by formal/informal sectors and by gender in Pakistan, 1999‐2008 (%) ............................................................................................................................................................... 18 Table 2‐2: Average Product Shares in the Manufacturing Sector of Pakistan, 1970‐90 (percent) ............. 19 Table 2‐3: Growth Accounting in Pakistan by Decades, 1961‐2005 (percent) ........................................... 22 Table 2‐4: Growth Accounting in Asia, 1961‐2005 (percent) ..................................................................... 22 Table 2‐5: Annual Labor Productivity Growth, 1990‐2006 (percent) ......................................................... 24 Table 2‐6: Country Export Shares Relative to Total World Exports, 1970‐2008 (percent) ......................... 25 Table 2‐7: Revealed Comparative Advantage and PRODY in Textiles, 2008/09 ......................................... 26 Table 2‐8: Technological Level of Pakistani and World Exports, 1998‐2008 (percent) .............................. 30 Table 2‐9: Comparisons of Savings and Investments, 1994‐2009 (% of GDP) ............................................ 38 Table 2‐10: Inward FDI Performance Index, 2003‐08 ................................................................................. 43 Table 2‐11: Regional Comparison of FDI, 1990‐2000 ................................................................................. 43 Table 2‐12: Harbison‐Myer Skills Indicators ............................................................................................... 76 Table 2‐13: Data on Enforcing Contracts .................................................................................................. 102 Table 2‐14: individual Tax, Corporate Tax and Tax Revenue Comparisons, 2007‐2009 (% of GDP) ........ 105 Table 2‐15: Pakistan’s Global Competitiveness Index Ratings, 2003‐2010 .............................................. 111 Table 2‐16: Malmquist Index of Sector Means, 1998‐2007 ...................................................................... 113 Table 3‐1: Demand for Petrochemical Products ....................................................................................... 129 Table 3‐2: Import of Basic Chemicals in Pakistan (Million US$) ............................................................... 129 Table 3‐3: Foreign Direct Investment in the Electronics Industry, 2002‐2009  (US$ Million) .................. 147 Table 3‐4: Fan Industry Characteristics ..................................................................................................... 162 Table 3‐5: Cutlery and Steel Ornaments Industry Characteristics ............................................................ 169 Table 3‐6: Surgical Industry Characteristics .............................................................................................. 182 Table 3‐7: Sports Goods Industry Characteristics ..................................................................................... 187 Table 3‐8: Pakistan Ceramics Industry ...................................................................................................... 192 Table 3‐9: Leather Industry Characteristics .............................................................................................. 203 Table 3‐10: Marble and Granite Reserves in Pakistan .............................................................................. 212 Table 4‐1: Population Density by Area...................................................................................................... 238 Table 4‐2: List of poverty studies and their methods ...................................... Error! Bookmark not defined. Table 4‐3: Poverty estimates for the 1990s reported by previous studies .................................................... 244 Table 4‐4: Inflation-adjusted poverty lines per adult equivalent per day used for poverty estimates .......... 245 Table 4‐5: Regional poverty in Pakistan, 1990-91 to 2005-06 .................................................................... 246 Table 4‐6: Changes in Gini inequality in Pakistan and urban and rural areas .......................................... 250 Table 4‐7: Changes in Gini inequality by provinces .................................................................................. 252    vii 
  • 8. Table 4‐8: District level variables used in principal component analysis ....... Error! Bookmark not defined. Table 4‐9: Principal component rotated factor loadings ............................... Error! Bookmark not defined. Table 4‐10: Most and least developed districts based on rankings from principal component post‐primary school system and hospital index  ............................................................................................... 255  .Table 4‐11: Change in concentration by Gini index in Punajab ..................... Error! Bookmark not defined. Table 4‐12: Agglomeration of 3‐digit manufacturing industries in Pakistan, 2005‐06 ............................. 270 Table 4‐13: Geographic concentration of 3‐digit industries in Punjab, 1995‐96 – 2005‐06  .................... 273  .Table 4‐14: Mean values of industrial concentration measures overtime ............................................... 274 Table 4‐15: Localisation versus urbanization externalities in Punjab, 1995‐96 to 2005‐06 ..................... 276 Table 5‐1: Incidence of poverty by household characteristics, 2005‐06 .................................................. 280 Table 5‐2: Distribution of Rural Sample by Household Survey ................................................................. 282 Table 5‐3: Definition of variables used in the Probit Regressions ................. Error! Bookmark not defined. Table 5‐4: Effects of household and individual characteristics on rural poverty in Pakistan, basic results .................................................................................................................................................................. 284 Table 5‐5: Marginal effects of the impact of education and health infrastructure on rural poverty ....... 287 Table 5‐6: Summary Statistics of Punjab’s Data ............................................ Error! Bookmark not defined. Table 5‐7: Post‐primary school system and poverty under different inequality regimes ........................ 295 Table 5‐8: Road density and poverty under different inequality and polarization regimes  .................... 297  .Table 5‐9: Descriptive statistics for agglomeration regression ................................................................ 300 Table 5‐10: Pearson’s correlation ............................................................................................................. 301 Table 5‐11: OLS specification for agglomeration regression .................................................................... 302 Table 5‐12; Scale Externalities and Productivity in Manufacturing Industries in Punjab, 1995‐96 – 2005‐06 .............................................................................................................................................................. 305    viii 
  • 9. List of Figures   Chapter 2Figure 2‐1: Association between Manufacturing Value Added (MVA) Growth & GDP .............................. 13Figure 2‐2: Historic GDP growth Rate in Pakistan, 1954‐2006 (percent) ................................................... 14Figure 2‐3: GDP Growth Rate in Pakistan, 2001‐09 (percent) .................................................................... 15Figure 2‐4: Sectoral growth rates in Pakistan, 2001–09 (percent) ............................................................. 15Figure 2‐5: Annualized Growth Rates of Key Sectors in Pakistan for 10 Year Periods, 1970‐2009 (percent) .................................................................................................................................................................... 15Figure 2‐6: Sectoral Shares in GDP of Pakistan, 1970‐2009 (percent) ........................................................ 16Figure 2‐7: Shifts in Sectoral Shares in GDP of Pakistan, 2000‐09 (percent) .............................................. 17Figure 2‐8: Employment Shares by Sector in Pakistan, 1980‐2009 (percent) ............................................ 18Figure 2‐9: Performance of the Large Scale and Small Scale Manufacturing Sector in Pakistan, 1950‐2010 (%) ............................................................................................................................................................... 20Figure 2‐10: Manufacturing Value Added in US$ (Billions), 2001 & 2007 .................................................. 21Figure 2‐11: Total Factor Productivity by Firm Size & Firm Age, 2001‐2006 (log values) ........................... 23Figure 2‐12: Sectoral Value Added/Worker in Pakistan, 1981‐2002 (Rs at contact prices of 1999‐2000) . 23Figure 2‐13: Output per Worker Growth in Pakistan, 1980‐2006 (percent) .............................................. 24Figure 2‐14: Output per Worker in Asian Economies, 1990‐2004 (assuming 1990 as base of 100) .......... 25Figure 2‐15: Competitiveness and Performance of Pakistan’s Exports, 2000‐2007 (percent) ................... 28Figure 2‐16: Product Concentration Index, 1974‐2008 .............................................................................. 28Figure 2‐17: Market Diversification Index, 1971‐2008 ............................................................................... 29Figure 2‐18: Elasticity of Pakistan’s Exports to GDP of Industrial Countries, 1985‐2007 (percent) ........... 31Figure 2‐19: Total, Private and Public Gross Fixed Capital Formulation (GFCF) in Pakistan, 1980‐2009 (% of GDP) ........................................................................................................................................................ 34Figure 2‐20: Aggregate Investment Gap of Pakistan Relative to other Countries, 1980‐2008 (percent)  .. 36 .Figure 2‐21: Long Run Indexed Real/Potential Investment Decline in Trend Rate of Private Investment, 1980‐2009 ................................................................................................................................................... 39Figure 2‐22: Growth Rate in Real Private GFCF & Total GFCF, 2000‐2010 (%) ........................................... 40Figure 2‐23: Share of Manufacturing Investment in Total Fixed Investment, 2000‐10 (percent) .............. 42Figure 2‐24: FDI Investment as % of Gross Fixed Capital Formation, 1990‐2009 (percent) ....................... 44Figure 2‐25: Sectoral Decomposition of FDI, 2004 and 2008 9percent)  .................................................... 45 .Figure 2‐26: Real GDP and Investment Growth in Pakistan, 1991‐2009 (percent) .................................... 49Figure 2‐27: Exports, Net Factor income from Abroad and Imports, 1990-2008 (percents of GNI) .......... 52Figure 2‐28: Inflation and Investment in Pakistan, 2001‐2010 (% p.a.)  ..................................................... 55 .Figure 2‐29: Electricity Demand and Supply, 2003 – 10 (MW) ................................................................... 60Figure 2‐30: Provision of Training to Workers ............................................................................................ 81Figure 3‐1: Petrochemical Value Chain ..................................................................................................... 128Figure 3‐2: Demand and Supply Gap of Steel in Pakistan ......................................................................... 133   ix 
  • 10. Figure 3‐3: Pakistan’s Fertilizer (N.P.K) Plant Capacity & Demand (000’ tons in nutrients) ..................... 137Figure 3‐4: Pakistan’s Fertilizer Import ..................................................................................................... 138Figure 3‐5: Comparison of Pakistan’s NPK Ratio with other Countries .................................................... 139Figure 3‐6: Pakistan’s Gas Demand and Supply Balance .......................................................................... 139Figure 3‐7: Motorization Levels per 1000 persons ................................................................................... 142Figure 3‐8: Broad Comparison of Pakistan and Indian Pharmaceutical Value Chain ............................... 154Figure 3‐9: Pakistan’s Fan Exports, 2004‐2009 (US$) ............................................................................... 163Figure 3‐10: Typical Value Chain of Fan .................................................................................................... 164Figure 3‐11: Capacity Utilization over typical 12 Month Period ............................................................... 165Figure 3‐12: Average Export Price of Fans US$ ......................................................................................... 166Figure 3‐13: Pakistan’s Cutlery and Steel Ornaments Sector Exports (US$) ............................................ 171Figure 3‐14: Value Chain for a 12 Inch Dagger ......................................................................................... 173Figure 3‐15: Average Export Price of Steel Used in Making Cutlery and Ornaments, US$/Kg ................. 175Figure 3‐16: Product Split of World Exports & Pakistan Exports, 2005‐09 (US$ Million) ......................... 183Figure 3‐17: Exports of Pakistan’s Surgical Instruments Sector, 2005‐09 (US$)  ...................................... 183 .Figure 3‐18: Value Chain Breakdown of a 5.5 Inch Forceps ..................................................................... 184Figure 3‐19: Pakistani Exports of Sports Goods, 2003‐2009 (US$ Billion) ................................................ 187Figure 3‐20: Comparison of World and Pakistan’s Sporting Goods Product Split .................................... 188Figure 3‐21: Typical Value of Hand‐Stitched Export Quality Training Soccer Ball .................................... 189Figure 3‐22: Ceramics Exports for Pakistan, 2005‐2009 (US$) ................................................................. 193Figure 3‐23: Furniture Export of Pakistan, 2005‐2009 (US$) .................................................................... 197Figure 3‐24: Pakistan Export Price Comparison, 2005‐2009 (US$/Kg of Wood) ...................................... 198Figure 3‐25: Key Challenges in Pakistan’s Furniture Value Chain ............................................................. 199Figure 3‐26: Comparison of Pakistan and World Product Split ................................................................ 204Figure 3‐27: Marble & Granite Exports of Pakistan, 2005‐2009 (US$ Million) ......................................... 212Figure 3‐28: Value Chain of Marble and Granite Industry ........................................................................ 214Figure 3‐29: Traditional Quarrying Method .............................................................................................. 217Figure 3‐30: Advanced Method of Quarrying ........................................................................................... 218Figure 3‐31: Value Chain for Radiator Production .................................................................................... 225Figure 4‐1: Post‐primary school system and current population, 2005‐06 .............................................. 240Figure 4‐2: Hospital size and current population, 2005‐06 ...................................................................... 241Figure 4‐3: Value of large‐scale manufacturing production and population growth ............................... 242Figure 4‐4: Regional Poverty headcount in Pakistan, 1990-91 to 2005-06 ................................................. 247Figure 4‐5: Poverty headcount in urban Pakistan, 1990-91 to 2005-06...................................................... 248Figure 4‐6: Poverty headcount in rural Pakistan, 1990-91 to 2005-06 ....................................................... 248Figure 4‐7: Changes in inequality in Pakistan and by regions ................................................................... 251Figure 4‐8: Changes in inequality in the four provinces ............................................................................ 253Figure 4‐9: Location of districts by education and hospital index  ............................................................. 257 .Figure 4‐10: Industry clusters and development ranking of districts, 2005-06 ........................................... 258Figure 4‐11: Resource based clusters and development ranking of districts, 2005-06 ................................ 259Figure 4‐12: Spatial inequality in road density in Punjab, 2005‐06 .......................................................... 262   x 
  • 11. Figure 4‐13: Relative road density of the districts of Punjab with Lahore district, 1992‐93 vs. 2005‐06   263 .Figure 4‐14: Spatial inequality in road density in Khyber Pakhtunkhwa, 2005‐06 ................................... 264Figure 4‐15: Relative road density of the districts of KP with Peshawar district, 1993-94 vs. 2005-06 ....... 265Figure 4‐16: District level employment shares in Pakistan’s manufacturing sector .................................... 267Figure 4‐17: Distribution of 3-digit Ellison-Glaeser index ......................................................................... 271Figure 5‐1: Distribution of inequality and per capita income .................................................................... 291Figure 5‐2: Distribution of Poverty and Per Capita Income ...................................................................... 292Figure 5‐3: The effect of inequality on poverty in Pakistan, 1990-91 to 2005-06 ....................................... 293   xi 
  • 12. List of Boxes   Chapter 2Box 2-1: Inward Investment Incentives Regime in Pakistan ..................................................................... 45Box 2-2: Energy in Comparison with China and India ............................................................................. 63Box 2-3: The Case of Gawadar ................................................................................................................... 72Box 2-4: Cartelization & Case Studies .................................................................................................... 109Chapter 3Box 3-1: The Steel Industry of China ....................................................................................................... 125Box 3-2: The Automobile Market of Malaysia ......................................................................................... 132Box 3-3: Electronic Industry in China ..................................................................................................... 139Box 3-4: Singapore Electronics Industry .................................................................................................. 141Box 3-5: New Drug Filings of Some Successful Indian Pharmaceutical Companies.............................. 144Box 3-6: Past Government Intervention in the Furniture Sector ........................................................... 189Box 3-7: Depiction of Suha Bazar of Lahore............................................................................................ 196Box 3-8: Italian Marble Industry ............................................................................................................... 203   xii 
  • 13. Acronyms and Abbreviations   ADR Alternative Dispute ResolutionAPI Active Pharmaceutical IngredientsBOP Balance of PaymentsCRO Clinical Research OrganisationDAP Diammonium PhosphateDFID Department for International DevelopmentEDB Engineering Development BoardEPZ Export Processing ZonesEOBI Employee Old-Age BenefitFDI Foreign Direct InvestmentFPCCI Federation of Pakistan Chambers of Commerce and IndustryGDP Gross Domestic ProductGMP Good Manufacturing PracticesIAG Industry Advisory GroupIDB Industrial Development BoardIPR Intellectual Property RightsITP International Trade PriceKIBOR Karachi Interbank Offer RateMMF Man Made FibreNAVTEC National Vocational & Technical Education CommissionNEQS National Environmental Quality StandardsNPO National Productivity OrganisationOEM Original Equipment ManufacturerPEFMA Pakistan Electric Fan Manufacturers AssociationPEPCO Pakistan Electric Power CompanyPHADC Pakistan Hunting Arms Development CompanyPIB Pakistan Investment BondPLDC Pakistan Leather Development CouncilPPP Public Private PartnershipPSDC Pakistan Stone Development CompanyPSM Pakistan Steel MillPSQCA Pakistan Standards & Quality Compliance authorityPSI Pre-shipment InspectionsR&D Research & DevelopmentRFID Radio Frequency IdentificationSECP Securities & Exchange Commission of PakistanSEZ Special Economic ZonesSME Small & Medium EnterprisesSMEDA Small & Medium Enterprise AuthoritySG SafeguardsSPS Sanitary & PhytosanitaryTBS Tariff Based SystemTBT Technical Barriers to TradeTDAP Trade Development Authority of PakistanTEVTA Technical Education & Vocational Training AuthorityTVET Technical & Vocational Education TrainingUNEP United Nation Environment Programme xiii  
  • 14. WAPDA Water & Power Development AuthorityWHO World Health OrganisationWTO World Trade Organisation xiv  
  • 15.  Acknowledgements This study has been completed with the support of several individuals, departments andorganizations. The project would not have been possible without the facilitation and overallguidance provided by Prof. Ijaz Nabi (Dean, LUMS). We would like to thank Ms. Shaista Sohail,Joint Secretary, Ministry of Industries and Production for providing us invaluable information andsupport throughout the project. We would also like to thank officers from EngineeringDevelopment Board, Small & Medium Development Enterprise (SMEDA), Technical andVocational Training Authority, and Chambers of Commerce & Industry across the country fortheir useful ideas on industrialisation and its issues in Pakistan. We owe a debt of gratitude toProfessor Ha Joon Chang (University of Cambridge), Professor Alice Amsden (MassachusettsInstitute of Technology) and Dr. Faheem ul Islam (LUMS) for their insightful comments and ideasin deriving the policy proposals. We thank the members of the staff of the World Bank forproviding the funding and over all support for the project. We would like to acknowledge theresearch support provided by Kiran Javaid and Abubakar Memon and the editorial input receivedfrom Shahbano Ijaz and Nadia Mukhtar. Finally we would like to thank the numerousrepresentatives of the private sector, especially the members of the Task Force who took time outfrom their busy schedules to discuss in detail the problems of Industry and the possible solutions. Prof. Abid A. BurkiProf. Kamal A. MunirDr. Mushtaq A. KhanM. Usman Khan, CFA IMCAdeel FaheemAyesha KhalidDr. Syed Turab Hussain (Focal Person) xv  
  • 16. Executive Summary  Introduction: The third tier of analysis takes a more telescopic view of the industrial sector The Industrial Policy report constitutes a where the focus is on the spatial aspects ofcomprehensive analysis of Pakistan’s industrialization - economic geography,manufacturing sector aimed at deriving covering issues such as inter and intrapolicy recommendations for Industrial provincial inequalities in infrastructuralgrowth and development. The report isstructured to provide a three tiered analysis provision and its resultant impact onof Pakistan’s industry. income inequality, poverty and industrial The first tier is a macro level analysis of cluster formation. The analysis in thisindustrial structure and performance which section uses the Census of Manufacturinghelps identify the major constraints Industries (CMI) disaggregated data set andhampering structural change in the rigorous econometric and statisticalcountry. The policy recommendations techniques to come up with both indexesderived from this section are the broader or measuring industrial concentration and thehorizontal interventions required for factors which significantly affect clusterindustrial development spanning a wide formation or the lack of it.sphere of economic activity in the country. Industrial Sector of Pakistan: The second tier of analysis presents Structure, Performance &detailed look at the manufacturing sector Problemsthrough a firm/sector level analysis. Themain obstacles in increasing firm The first tier - macro level analysiscompetitiveness and sectoral growth are analyses the structure/performance of theinvestigated through both a value chain industrial sector using various macro and industry specific indicators across time andand a stakeholder analysis. This in comparison to other countries. Themethodological approach helps divulge the primary focus in this section is onnecessary vertical or sector level policy macroeconomic management andinterventions. There are a total of twenty performance with respect to industrialfour sectors covered in this analysis ranging sector growth. The section highlights thefrom important ancillary industries, fact that although over the last four decades Pakistan has experienced over five percentknowledge based industries to the major average GDP growth rate, these episodes ofsmall and medium scale export based high growth rates were mostly consumptionindustrial sectors. driven leading to frequent ‘boom’ and ‘bust cycles. The fact that industry has not been xvi  
  • 17. the main engine of Pakistan’s growth has countries such as Korea and Taiwan, theled to on average a low and variable growth secular fall in investment is shown to be therate. key factor behind an overall sluggish growth The macro analysis also reveals that the in GDP.structural change in Pakistan has beenskewed towards a shift from agriculture to Following the discussion on industrialservices with manufacturing growth performance and investment trends, theremaining fairly stagnant. It shows that broader impediments resulting in thePakistan’s manufacturing sector is largely systemic stagnation of industrial growthconcentrated in a few industrial products and investments are highlighted in thiswith relatively less value addition compared section. Constraints related to factorto countries within the region. With a markets, infrastructure provision, lack ofnarrow manufacturing base and a macroeconomic stability, regulatoryconcentration in low technology and low environment, and security/negativevalue-added products whose share in the perception of Pakistan, are brought to theworld market is decreasing, the prospects of forefront. This is done by using theindustrial growth remain uncertain. repository of existing evidence on the abovePakistan’s economy was built around textile mentioned constraints such as the cost ofand its current base is still concentrated in doing business data collected by Worldtextiles. Cotton textile production is the Bank and other similar studies. Themost important of Pakistans industries, analysis is used to inform policy which byaccounting for about 19 percent of large- removing cross-cutting bottlenecks wouldscale industrial employment and about 60 facilitate the overarching growth of thepercent of total exports. industrial sector. These essentially are the horizontal policy interventions required to After reviewing the characteristics and stimulate overall manufacturing growth.performance of the manufacturing sector Some of these interventions arethe report looks at the over time trend of summarized below.investment in the country relative toregional economies. Investment in large In terms of macroeconomic stability thescale manufacturing sector is shown to be need for enhancing the fiscal space –volatile with a significant recent decline as a through expansion of the tax base – isconsequence of both periodic stressed. The importance of prudent fiscalmacroeconomic instability and an and monetary policy is underscored albeitinvestment climate which has been with a recommendation to lower thepersistently poor. As increased investment nominal interest rate which has been aor capital accumulation is a necessary major factor in stifling investment andcondition for growth, substantiated by the manufacturing growth recently. Emphasis isexperience of the newly industrialized also put on the need to coordinate trade xvii  
  • 18. policy with industrial policy. Effective use computerized clearance system. Finally, theof Non-Tariff Barriers NTBs and creation importance of Gawadar as a potential ventof a Science Park is also suggested as for future growth is emphasized withmechanisms to protect and facilitate the suggestions to harness this potentialgrowth of value added industry in the through the help of China.country. To promote the growth of existing and Specific policy recommendations are resource based industries policies are putgiven to resolve the energy crisis – which by forward to create industrial estates andfar has proven to be the most binding agro-processing zones at the identified ‘hotconstraint to industrial growth and spots’ of economic activity. Thedevelopment over the past couple of years. intervention of the government is specificEffective management of load shedding, to technology up-gradation, branding,peak load pricing and the need for improving quality standards such as phyto-preferential treatment of the industrial sanitary measures and facilitating access tosector over both consumer and commercial international markets. Provision of hardsector is stressed. Captive power generation and soft infrastructure and commonin industrial estates and special economic effluent treatment plants in the industrialzones is also recommended. It is suggested zones is also put forward.that the long term energy mix should shift The issues in factor markets, labor, landtowards more efficient/cost effective and credit, are also dealt with andsources, such as wind, hydel and solar appropriate polices are derived to tackleenergy. The need for the development of some of these. Various mechanisms arelocalized machinery for hydel, thermal and suggested to improve Labor skills andcoal based power plants is also pointed out. training. For example, specific programs After highlighting the issues and problems such as a Skill Development Fund and awith the country’s logistical infrastructure Skill based wage subsidy scheme arethere are specific recommendations given proposed to provide incentives toto upgrade it. For example, major businesses to invest in worker training. Inrestructuring of the railways and new terms of credit markets, the rationing ofinvestments in freight services are small businesses is shown to be one of thesuggested. To reduce transportation and major constraints to their growth. Policiestrucking costs the building of Logistical such as credit guarantee schemes andParks near industrial estates is promotion of venture capital funds arerecommended. The importance of an discussed as possible mechanisms toAutomated Customs Clearance system is address the credit market failures arisinghighlighted in Ports and it is suggested to from asymmetry in information. In case ofmaintain and improve the existing land markets, the need for achieving xviii  
  • 19. security of property rights by expediting the government interventions to knowledgecomputerization of land records is based and technology intensive sectorsunderscored. falling under the ambit of WTO rules and regulations. There is a detailed discussion onstrengthening governance to stimulate Competitiveness of Key Industrialinvestment and manufacturing growth in Sectors of Pakistanthe country. It is noted that businessesspend too much time and money dealing The second section of the industrialwith bureaucratic red tape and meeting the policy report is a micro level analysis as it“informal” costs of relations with the state. focuses on the issues of selected firms andAlso, uncertainty about the security sectors within the country. This sectionsituation acts as a deterrent to outside comprises analyses of both large and smallinvestors from seeking business manufacturing sectors. In both cases, thepartnerships in Pakistan. The judicial competitiveness of each sector is assessedsystem works slowly and the sanctity of and policy options are proposed to enhancecontracts and of land rights can be opaque. it. This is done by conducting in depthPolicy proposals addressing these consultative sessions with sectorgovernance issues are also put forward. representatives, analyzing all existing literature on sector’s in Pakistan and for Finally, a strategic recommendation given some sectors through a simple value-chainin this section is the creation of a full scale analysis supplemented by a broaderScience Park to promote knowledge based industry assessment that contextualizedindustries in the country The Science Park value-addition achieved in a particularwill have formal operational links with chain. This methodology helps identifyuniversities and research centers. It will those factors which inhibit value additionhave the necessary infrastructure to and result in relegation of firms to thefacilitate R&D, manufacturing, marketing lower rungs of the global value chain. Theand branding – covering thus the entire reasons behind the lack of value additionproduct cycle. The Park would not only and competitiveness is identified withprovide incubators for scientific particular emphasis on factor conditions,innovations it will also be the production demand conditions, domestic rivalry,center for cutting edge products. This related industries and the role of theinitiative would attract professionals, government. This broader analysis providesbusinessmen and scientists which would to insights that became the basis for verticalan extent reverse brain drain facilitating the policy interventions that are both strategictechnological up-gradation of industry. The and emergent.Science Park would also allow governmentpolicy coordination and targeted xix  
  • 20. We are able to cover all major large scale improve governance structure of the Steelsectors, key SME export sectors and light Mill and triple its capacity over the next fiveengineering sectors. This coverage includes years and make investments to enable theprimary/ancillary industry such as Steel, Steel Mill to manufacture high grade steel.Chemical and Fertilizer. We include We also propose that government shouldknowledge based sectors such as Auto, use the existing iron ore deposits ofElectronics and Pharmaceutical including Pakistan to its full benefit.Bio-Chemical. And finally, we look at In this section we also analyze few of theeighteen small and medium scale enterprise sun-rise sectors. The selection of the sun-sectors some of which are critical for export rise sectors is based on where we believeand some feed in directly into the local gaps exist in the global value chain andmarkets. The sectors in this category among there is room for Pakistan to augment itsothers include, Surgical Instruments, Sports strategic comparative advantage toGoods, Fans, Cutlery, Agro-food, Leather, competitive advantage. We argue that suchFurniture, Marble and Granite, Gems & opportunities mainly exist in knowledgeJewllery and Light Engineering Sector. based industries such as Auto, Electronics We argue that the inclusion of primary and Pharmaceuticals. While analyzing thesectors is necessary as almost all the value auto sector we find that the past policiesadded industry depends for their inputs on were heavily influenced by MNCs and thethese sectors. For example, leather tanning interests of the local industry were highlyrequires the use of 101 chemicals, out of compromised. We present evidence that inwhich around 98 are currently being periods the deletion policy was followed,imported. This not only adds more to the significant growth of local industrycosts but also results in shortages. Similarly, resulted, however, since the introduction ofthe pharmaceutical sector is entirely Trade Related Intellectual Property Rightsdependent on imported chemicals. We (TRIPs) there has been no indigenization orrecommend that if Pakistan is to move growth of the local auto industry. Themore towards value addition then licensing regimes of internationalgovernment will have to invest in building collaborators especially in the tractorthe chemical industry in the country. One industry are prohibitive. They limit thesuch recommendation is to set up a Naphta permission of sales, especially in valuecracking facility. Moreover, steel is an input added export markets. We recommendinto almost all the value added industries. ways by which government can promoteIt is surprising to see that even with a large outward FDI and assist the tractorlocal demand for steel the Steel Mill of manufacturers, for example, to acquirePakistan is running in significant deficits. international brands. The deletion programWe recommend to the government to xx  
  • 21. is also strongly supported, in fact, deletion knowledge intensive industries weshould occur at a much higher pace. recommend that the government should establish Science Parks and provide At this point in time, no country can attractive fiscal incentives to attractafford not to develop competencies in investment into the bio-technologyelectronics. Electronics pervade almost all industry.industries and competitiveness in anyindustry requires knowledge of electronics Finally, in the economic activities of mostboth at the level of product and process. developing regions, small and mediumMoreover, with increasing affluence a large enterprises (SMEs) play a major role anddemand has developed for electronic items Pakistan in this case is no exception. Itssuch as Televisions, Computers, Washing economy is dominated by SMEs, whichmachines, Air conditioners etc. Similarly, produce most of its output and employwith the Tata Nano, India has most of its workforce.1 Specifically, SMEsdemonstrated that producing competitive constitute 90 percent of the economicautomobiles is not the sole preserve of rich, establishments and contribute 30 percentdeveloped nations. Developing countries of GDP and 25 percent of export earnings,are just as capable of producing products and employ 78 percent of the non-that will appeal to the global segment agricultural labour force. Hence, we havewhich cannot yet afford automobiles but broadly looked at around eighteen criticalwill settle for slightly lower quality. SME sectors in Pakistan. However, realizing the domestic constraints Our findings reveal that most of theseand limitations we recommend that sectors face similar issues and impedingPakistan should only focus on product factors to growth. One of the major issuesmanufacturing and not component faced is the inadequate availability ofmanufacturing. For this, product design appropriate human resource and skills. Theand development institutes will have to be existing government entities such asestablished with strong linkages in national TEVTA and NAVTEC are providing classand international engineering universities. based skills that are not necessarily alleviating the problems faced by the Similarly, Pharmaceutical, in fact Bio- industry. During our field visits we foundChemical is a sector with great future that almost all industrial units in Sialkotpotential. Both India and China are fast Small Industrial Estate had vacancies fordeveloping capabilities to improve their only skilled workers.market shares in the bio-chemical industry.                                                             Pakistan cannot afford not to develop this 1 The data for all Pakistan indicate that SMEsindustry as there is going to be enhanced account for about 90 percent of all enterprises,demand both locally and in international employ 80 percent of the non-agricultural labor force, and account for approximately 40 percent ofmarkets. For development of such the GDP xxi  
  • 22. Another major impediment is low levels design that takes place is a result of reverseof productivity, resulting from both engineering done at the initiative of theinadequate up-gradation of technology and factory owner. Government has fundedpoor production and floor management some common facility and producttechniques. Due to high levels of illiteracy development centers, however, theirand lack of training, most of the capacity to deliver to the needs of specificentrepreneurs’ struggle with basic costing sectors is fairly limited. Therefore, wetechniques and lean production recommend specific type of linkages thatmanagement methods. The floor designs need to be created between SME sectorsare suboptimal resulting is high wastages of and research and development centers. Welabor time and inputs and makes it also indicate priority sectors whereimpossible to capture the actual costs of government needs to immediately establishproduction. Similarly, in most industries, design and research centers.such as leather, sports, surgical, fans, cutlery Finally, another issue facing the sectors isthe technology being used is outdated. lack of branding and marketing. PakistaniWhen combined with low scale of products are increasingly fetching lowerproduction all this results in significant price in international markets. Moreover, itinefficiencies and loss of productivity. is also becoming exceeding difficult forHardly, any of the SME sectors employ Pakistani product to find access into newerprofessional management or formal systems international markets. Given the lack ofof record keeping. We recommend that the innovation, most of the industry acts as an Original Equipment Manufacturers OEMNational Productivity Organization of hence branding has always been limited. InPakistan should play a lead role in addition, marketing has been a consistentlybenchmarking the SME industrial sectors weak area limiting the growth potential ofand assist them in lean management tools firms. Finally, all of the above factors haveso as to extract the maximum results from made it extremely difficult for the sectors toexisting capacities. meet international quality standards and compliance requirements. The Almost all the SME sectors that were international standards on quality, healthconsidered face issues with innovation and & safety and environment are becomingdeveloping original designs and products. increasingly stricter. With their current characteristics Pakistani products are beingThis is indicative of the lack of refused access to many markets based oncollaboration and link between sectors and non compliance to these standards. It isuniversity engineering departments and imperative that the government not onlyproduct development centers. In fact there provides the hard infrastructure such asis hardly any evidence of formal linkages laboratories and testing centers but alsobetween research & development centers builds the capacity of Pakistan Standards Quality Compliance Authority (PSQCA) toand industry. Any innovation or product enforce domestic quality standards. This xxii  
  • 23. will ensure mandatory compliance to some between the leading and the laggingminimum standards which will then build districts is increasing with the passage ofcapacity of the sectors to meet similar time, which should worry policy makersstandards in international markets. who are interested in bringing about spatial equality.Spatial Concentration of EconomicActivity Poverty Impacts of Public The most striking feature of economic Investments and Causes of Industryactivity in Pakistan is the geographic Agglomerationsconcentration (clustering) and location offactors of production in few cities, The econometric evidence shows thatincluding unequal spatial distribution of poverty coexists with illiteracy of householdincome, poverty, education, health and heads and lack of household assetphysical infrastructure, among others. The ownership. Therefore, the governmentconcentration of economic activity in few emphasis on human capital accumulationmetropolitan areas symbolizes the and social and physical infrastructurecoexistence of development and development as tools for poverty reductionunderdevelopment within and between makes sense. Policies that seek universalregions. We examine the economic access to education by increasing thegeography of Pakistan by exploring regional quantity and quality of schools and collegesand spatial inequality and document seem to have a strong power to reducevarious mapping measures to highlight poverty. While current attention tospatial distribution of population, regional investment in social infrastructure is clearlypoverty and income inequality, spatial appropriate, policy inattention to spatialdisparities in social infrastructure, road inequality in income is very costly,infrastructure, and agglomeration of especially in more deprived districts. Ourmanufacturing industries. We employ empirical analysis of the evolution ofdifferent measures of concentration to gain poverty on the basis of high quality districtinsight into spatial inequality (in poverty, level data on post-primary education andincomes, road infrastructure and industrial hospital infrastructure index indicates thatconcentration) as a function of different increased public sector investments onpush and pull factors that explain education and health infrastructure lead toconcentration versus dispersion of a sharp decline in poverty in all but highlyeconomic activities. unequal districts where these investments Our results suggest that investment in are not associated with a decline in poverty.social infrastructure and physical Policies that encourage investment in socialinfrastructure is highly concentrated in infrastructure by also promoting moremetropolitan cities, big cities and their spatial equality in the distribution ofsurrounding districts while districts located income may yield higher returns.away from these urban demand centers are The econometric results further show alagging behind. While we have evidence of strong negative association between roadconvergence in the leading districts, the gap density and poverty incidence. The xxiii  
  • 24. magnitude of fall in poverty due to road from 1995-96 to 2000-01, but it drasticallydensity is even higher than the effect of fell by about 33% in the next five years.investment on post-primary school system Exploring the causes of agglomeration, weand hospitals. We also find that the long find that district population, road density,run effects of road density on poverty are and the pool of technically trained workersfar greater than the short run effects. We all help promote agglomeration ofconclude that income equality matters as manufacturing industries. Thefar as public investment on infrastructural determinants of industry agglomerationprojects is concerned. The long run poverty guide us on the causes of dense economicalleviation potential of investment on roads activity across spatial units, and thealmost doubles when we move from high difficulties faced in attractingincome inequality districts to low income manufacturing activities in remote districts.inequality districts. Therefore, we reiterate However, a range of policy instrumentsthat pubic policies that seek more regional have already been tried in Pakistan, e.g., taxequality in incomes are far more desirable holidays, building infrastructure infor pro poor growth policies. industrial estates, free trade zones, export This study has also examined the nature processing zones, etc. There is no evidenceof geographic concentration of on their systematic success or failure. We,manufacturing industries in Pakistan by therefore, advise that more empiricalusing the Ellison and Glaeser research need to be conducted to evaluateconcentration index. While there is little the effectiveness of past policies todoubt that increasing returns to scale conclude under what circumstances theseassociated with agglomeration externalities programs and policies are likely to succeed.do exist at a wider scale in Pakistan, it is Exploring the relative strengths ofmuch more difficult to identify factors that localization versus urbanization economiescause industry agglomeration. We have also our results suggest that localizationexplored how geographic concentration of economies (within-industry externalities)manufacturing industries emerges from the are much more important thandynamic process overtime and what is the urbanization economies (inter-industrynature of agglomeration economies. Our spillovers), which implies that industry-findings show that agglomeration of specific subsidies and infrastructuralmanufacturing industries is widespread in investments are likely to yield much higherPakistan where only 27% of the industries pay offs. However, productivity growth inare not agglomerated, 35% are highly the manufacturing sector as a whole isagglomerated and 38% are moderately almost stagnant since 1995-96. Therefore,agglomerated. However, industry policies aimed at rebuilding the industrialconcentration remained roughly constant sector of Pakistan by adopting coherent xxiv  
  • 25. strategies are long overdue to which weturn to in the next chapter titled principalrecommendations. xxv  
  • 26. i  
  • 27. 1 Introduction The process of structural change has been a central feature in the economic growth anddevelopment of both the Western Economies and the Newly Industrialized Countries of the East.As an economy develops the share of agriculture in GDP inevitably declines while that ofmanufactures and services increases. In other words, structural change is a gradual shift from lowproductivity to high productivity activities. Along with this observable structural transformationthere is a large body of empirical literature which suggests that there is a “U” shaped relationshipbetween a country’s income level and its degree of product specialization or sectoral concentration[see, Klinger and Lederman (2004)]. At low income levels specialization is high and is primarilydetermined by resource based comparative advantage. As the country becomes richer themanufacturing base diversifies with firms producing and exporting a wider range of relatively moresophisticated products. However, at higher levels of income, the process reverses; specializationagain increases but in high value added and technologically advanced products. Thereforeincreased product diversification is an intermediate stage in the process of structuraltransformation and economic development of a country.In the context of the Pakistan economy this structural transformation has been skewed in favourof the services sector. Since the 1970s the growth in services has outstripped that in agricultureand industry resulting in its current 50% share in GDP. Agriculture and industry over the pastdecade have contributed around 25% each to GDP with the share of agriculture declining overtime and that of industry remaining fairly stagnant. In fact, between 2008-09, in the wake of bothinternal security issues and the increasingly binding energy constraint, output in themanufacturing sector contracted by 3.3 percent with large-scale manufacturing registering asubstantial decrease in output of 7.7 percent [GoP (2009a)]. Notwithstanding the recentcontraction of overall industrial productivity and output, the industrial structure of the countryhas not experienced any significant change in the course of the past thirty years. Themanufacturing base remains rigidly narrow leading to a lack of product and export diversificationwhich has been a major impediment to sustained economic growth and development of thecountry. 2  
  • 28. The short term revival and the long term growth of Pakistan’s economy thus hinges on both theperformance and the structural transformation of its industry. As mentioned above, in the pastyear and a half the country has seen a dramatic retardation of economic activity characterized inparticular by a stagnating manufacturing sector. The current energy crisis has further eroded thecompetitiveness of manufacturing resulting in a tremendous loss of income, employment andexport revenues. Given the fact that the potential of growth and development of a country isinextricably linked to the extent of investment and industrialization the continued dismalperformance in industrial growth in Pakistan does not augur well for the future. Therefore it isimperative to develop an industrial policy which is implementable and has the ingredients toprovide the much needed impetus to industrial growth and diversification. While focusing on therevival and restructuring of the industry the strategy would have to be guided by the over archingobjective of achieving efficient, sustainable and equitable development.Pakistan today has the highest population growth rate2 in the South Asian region with hordes ofunskilled entrants into the labour force every year. These adverse demographics pose a seriouschallenge to effective policy making. If the industrial base of the country does not expand toabsorb this surplus labour, the bourgeoning unemployment in both urban and rural areas is likelyto have serious socio-economic and political ramifications.3 On the other hand, a growingpopulation has the potential to become a significant economic asset, if adequate policies are inplace to facilitate the development of a large, healthy and skilled labor force. Therefore a centralmotivation and aim of the industrial policy should be to generate widespread employment andraise income levels across the country, with the longer term aspiration of achieving convergence inliving standards in rural and urban areas. This would subsequently reduce the incidence of povertyand lessen the widening inter and intra regional income inequality. An industrial policy, whichemphasizes domestic as well as international linkages, promotes and facilitates entrepreneurialactivity, focuses on the development of small and medium scale industries, and provides an                                                            2 1.8% in 2007-08, [see GoP (2009a)].3 The manufacturing sector in 2007 -08 absorbed only 13% of the country’s labour force compared to 11.5% in 1999,a meager 1.5% point increase over the course of almost a decade, [GoP (2009a)]. 3  
  • 29. impetus to services, trade, transport and other ancillary sectors, can achieve the objective ofinclusive and broad based growth.The formulation of the industrial policy is in accordance with the overall growth and developmentpriorities of the Government of Pakistan (GOP) as broadly identified by the “9-point” Plan putforward by the Planning Commission (PC) and the Prime Minister’s Economic Advisory Council(EAC) [GOP(2009a)]. In fact most of the priority areas highlighted by the Plan where ‘deep, broad-ranging, and sustained’ policy intervention is required are in sync with the objectives of theindustrial policy being proposed here. For example, Industrial Competitiveness, Human CapitalDevelopment, Energy, Capital Markets, Public-Private Partnership for Infrastructure andInstitutional/Administrative reform are some of the relevant areas which would be dealt with inconsiderable detail in the industrial policy report.The outcome of the industrial policy project is in the form this comprehensive report. Thisparticular report, constitutes the analysis on the basis of which the industrial policy has beenderived. Moreover, this report also provides a rigorous and detailed analysis of the spatial aspectsof industrialization from which specific policy briefs are drawn addressing issues of disparities ininfrastructural provision, regional inequalities and factors influencing spatial distribution andconcentration of industries. Therefore this report provides the analysis and evidence for thepolicies that have been developed for industrialization in Pakistan presented as summary form inearlier chapter titled “Principal Recommendations”.1.1 Raison d’être for an Industrial Policy In order to articulate the rationale of government intervention and hence outline the broaderprinciples on which an industrial policy is to be based it is important to contextualize thisdiscussion in a historical perspective. Therefore the following section gives a brief synopsis of thecompeting ideas on industrial policy in the twentieth century. 4  
  • 30. 1.1.1Brief Historical Review In the course of the economic development of the West and the Newly Industrialized Countries(NICs) of Asia, there is no example of a country following a completely laissez faire policy withregard to industrial development. The nature and the extent of involvement and intervention ofthe state varied across countries, with each having its particular recipe for industrial development,but in none of these was industrialization achieved through the unfettered workings of the market.The relative success of the Asian Tigers and more recently of China and India in sustaining highgrowth rates has been on the back of an activist industrial policy. The extent of state interventionin these economies ranged from a variety of input subsidies; tax exemptions; tariff protection todirect public sector investments in large scale projects e.g., steel manufacturing plant in Korea andJapan.The post 1945 Structuralist conception of development considered capital accumulation orindustrialization as the engine of economic growth and development. For the Stucturalists aninterventionist industrial policy in conjunction with trade protectionism was imperative for thetransformation of an economy from primary low value added production to high value addedmanufacturing, i.e., Import Substitution Industrialization.4 The logic of state intervention wasbased on the prevalence of economies of scale (agglomeration economies) in manufactures and theinherent coordination failure present in an under developed economy. In the absence ofcomplimentary investments (backward and forward linkages) and the lack of necessary industrialinfrastructure the costs of entry for a pioneering firm into a sector were considered exorbitant i.e.,coordination failure. Given these structural constraints, industrial development or breaking awayfrom resource and factor based comparative advantage was viewed as next to impossible in a freetrade environment, giving credence to the infant industry argument for protection and the bigpush model of large scale state planning and intervention for industrial development.5                                                            4 Hans Singer (1950) and Raul Prebisch (1950) showed a secular decline in terms of trade of poor countries. Thisfinding served as one of the critical arguments for structural change.5 Within the economics profession the proponents of a development strategy led by the state were many such asRagnar Nurkse (1953), Arthur Lewis (1955), Paul Baran (1957), Rosentein-Rodan (1943). In fact with the exception ofa few like Albert Hirschman, who viewed development as a more spontaneous –chaotic process, the consensus wastowards state led development strategy. 5  
  • 31. State intervention in its various manifestations was not always successful in achieving efficientindustrialization and sustained economic growth. The experience of Latin America stands in sharpcontrast to that of East Asia. Although both regions pursued an activist industrial and trade policy,the outcomes achieved were significantly different. In countries like Korea and Taiwan protectionin the form of subsidies and tariffs was afforded to firms with a clear state objective of achievingeconomies of scale in production through explicit export requirements, forced mergers andinvestment licensing [Chang (2003)]. Latin America on the other hand did not have such a clearfocus in terms of achieving economies of scale or creating incentives for firms to be outwardoriented. In fact in most countries the industrial policy was essentially inward looking, focusingmore on achieving domestic self sufficiency in manufactures rather then creating future exportvents. The outward oriented industrial policy of the East Asian countries gave an opportunity tothe domestic firms to target regional and international markets allowing economies of scale andefficiency in production. The inward orientation of Latin America, and, the shift of resources fromthe larger agricultural sector, limited and stifled the source of demand for the nascentmanufacturing sector retarding its growth, efficiency and competitiveness, e.g., the Argentinean carindustry [see, Bruton (1998)].Notwithstanding some notable exceptions, such as the aircraft, steel and shoe industry of Brazil,generally the industrial transformation of Latin America was not as successful as in East Asia.According to Rodrik (2004), “the difference between East Asia and Latin America is not thatindustrial transformation has been state driven in one and market driven in the other. It is thatindustrial policy has not been as concerted and coherent in Latin America as it has been in EastAsia, with the consequence that the transformation has been less deeply rooted in the former thanit is in the latter.”The 1980s brought a major shift in development thinking. The debt crisis and the ensuing macroeconomic instability which ravaged Latin America for more than a decade was blamed on the‘villainous’ policies of state intervention and trade protection pursued by the region [Taylor(1996)]. The fact that East Asia remained unscathed from the vagaries of the debt crisis gavesupport to the Neo-Liberal view which was cantered on the concept of market supremacy and trade 6  
  • 32. liberalization. Export led growth was highlighted as the main factor behind the successfultransformation of East Asia while its activist industrial policy and initial years of trade protectionwere essentially overlooked. The alternative put forward was articulated by what came to be knownas the Washington Consensus. Under the neo-liberal development paradigm the role of the statein industrial development was limited to correcting market failure and to the provision of publicgoods. The rampant rent seeking, corruption and inefficiency of the governments in developingcountries brought further scepticism on the effectiveness of the role of the state in industrial andeconomic development. Although, market failure or externalities gave a theoretical justification ofstate intervention, economists and policy makers of the mainstream became more circumspect ofgovernment intervention stressing the greater propensity and prevalence of government failure asopposed to market failure in developing countries.1.1.2Towards an Industrial Policy As is evident from the above historical overview of industrial policy demarcating the domain ofstate intervention in an economy has been the source of continued controversy and debate.However, there is an emerging consensus between the heterodox and the mainstream economistson the broader role of Industrial Policy. The importance of structural transformation is realized byall, the differences which remain are on how much or to what extent can a country deviate from itscomparative advantage. The notion of comparative advantage in neo-classical trade theory isessentially static; it does not allow the possibility of industrial transformation given current pricesand factor endowments present in an economy. As stated earlier the central objective of industrialpolicy is to diversify the industrial base and move into higher value added activity. While themainstream economists stress on a ‘step by step’ – gradual transition towards higher value addedproduction in conformity with available technology and factor resources, the heterodox stress theimportance of defying comparative advantage by taking ‘leaps’ in certain areas which areconsidered strategic [see, Lin and Chang (2009)].Given that the fundamental principle of an industrial policy is to facilitate the process of structuraltransformation a possible bridge between the two perspectives on Industrial Policy could be tofocus intervention to facilitate both ‘new activity’ into the industrial sector and also help existing 7  
  • 33. firms upgrade their products and production methods. In other words the policies shouldconsolidate and strengthen existing comparative advantage and at the same time harness potentialor dynamic comparative advantage resulting in a diversified and internationally competitivemanufacturing and export base.The ‘new activity’ entrepreneurs are those who either introduce a new product in the domesticmarket or develop a more efficient production technology for an existing product. In fact theformation of a potential industrial cluster is to a great extent dependent on the incentive structurespresent for the first entrant or the pioneer firm in a new industry. Although the ability of the stateto ‘pick winners’ is in any case limited on account of imperfect information on future returns onnew investment opportunities, however, through strategic policy intervention the state can increasethe probability of a new entrant becoming a ‘winner’[see, Hausmann and Rodrik (2003)]. Suchstrategic intervention can lead to the formation of an economically viable and vibrant cluster. Thepolicies which facilitate the emergence of new clusters, especially in economically depressed areas,would result in a more equitable and inclusive growth – a broader objective of the industrialpolicy.The facilitation a state can provide the entrepreneur is by addressing both coordination andmarket failures which would otherwise impede the germination and growth of the new product orproduction technique. Coordination failures might arise due to spatial impediments such as theabsence of necessary infrastructure (road network, electricity etc.) or the non-existence of criticalcomplimentary investments in the area. Therefore the costs of entry for a pioneer firm wouldgenerally be far more than that of later entrants. In fact these costs would tend to decline with anincrease in the number of firms in the cluster – agglomeration economies.6 Also, greatercompetition through entry of firms in the future would reduce the profits of the pioneer or ‘newactivity’ firm, impeding incentives to ‘enter’ in the first instance and hence jeopardizing the                                                            6 An investment by a firm creates positive externalities (benefits) for other firms. Therefore while there are diminishingreturns to investment at the level of the firm there exists increasing returns at the level of the industry (cluster). Asindividual firms do no take into account the positive externality of their investment decisions they tend to underinvest. Hence private investment is socially sub-optimal – thus creating the rationale for government intervention. 8  
  • 34. formation of a potential cluster. This problem might also require a competition policy which couldensure a certain degree of profits for the pioneering firm so as not to inhibit entry incentives.Similarly, a market failure hindering a new activity or investment could be in the credit market,either because of a lack of collateral or asymmetry in information due to the absence of a credithistory. In either of the two cases (coordination and market failure) the state can intervenethrough the provision of necessary infrastructure and by devising mechanisms such as a venturecapital fund which would enhance the prospects of a new entrant or an innovator to qualify forfinancing. Furthermore, industrial policy can be employed to gradually alter the existing factorresources and thus comparative advantages. For example, investments in education and vocationaltraining would increase the endowment of skilled labour. This would not only help existing firmsmove up the value chain but also encourage new investments which are skilled labour intensive.The key lesson derived from East Asia is that industrial policy is not a ‘one off’ but a process wherefirms and the government learn about the major impediments as well as opportunities and ‘engagein strategic coordination’. Therefore the broader method or approach towards formulatingindustrial policy should be through the continued interaction between the private sector and thegovernment. This engagement should be effectively institutionalized so that it can form the basis ofa dynamic, flexible and evolving process of industrial policy making. The crucial point about thispublic-private engagement is a balanced position which is somewhere between bureaucratic ad hoc-ism and complete embeddedness of the private sector in industrial policy and planning. While theformer extreme (ad hoc-ism) would increase the likelihood of inappropriate policy formulation thelatter (complete embeddedness) would spawn a state patronized inefficient industrial sector [see,Rodrik (2004)].An important constraint in industrial policy making which is relevant today is the more restrictive‘policy space’ available to countries. Leaving aside the debate on the effectiveness of trade policy,developing countries under the WTO world trading system cannot readily use trade policy as aninstrument for industrial development as was done by most industrialized countries in the past.For example, export subsidies, local content requirements and quantitative restrictions on importsare all illegal under the WTO. Moreover, the WTO’s TRIPS Agreement ensures that there is no 9  
  • 35. reverse engineering and copying of goods which has rendered technology transfer through learningand imitating difficult. The positive aspect of WTO is the institutional mechanism which allowsdeveloping countries to negotiate for increased ‘policy space’. The failure of recent rounds ofnegotiations which attempted to extend multilateral disciplines to national competition andinvestment policies is evidence of developing countries effectively protecting their policy space[Rodrik (2004)].Finally, given the tight fiscal constraints facing most developing countries the extent and ability ofstate intervention through either public sector investments or subsidy provision is severely limited.In many instances these limitations are part of the conditionalities imposed by multi lateralagencies. Prudent macroeconomic policy and an increase in domestic public revenue generationwould facilitate a more proactive role of the government in industrial policy. In the absence offiscal space, the feasibility issue of industrial policy is of paramount importance and it underscoresthe need for strategizing and prioritizing government intervention.1.2 Methodology and Structure The particular methodology adopted in this report is to devise specific programs and policyinterventions from a three tiered analysis of the industrial sector. The first tier is a macro levelinvestigation of industrial performance which is supplemented by a second tier firm-level analysisof competitiveness. The third tier is a detailed study on the spatial aspects of industrialization orindustrial cluster formation. Therefore, the report has been divided into three sections inaccordance with the employed methodology.The first section covers the first tier of analysis that is macro level analysis of Pakistan’smanufacturing sector. This section gives detailed description and analysis of structure andperformance of Pakistan’s industrial sector and investment trends in the country. It also highlightsmajor impediments to both investments and increased productivity and product diversity withinthe manufacturing sector. These constraints range from macroeconomic instability, energyshortage, infrastructure bottlenecks, factor market imperfections to governance and security issues. 10  
  • 36. The analysis in this section is based on the repository of existing evidence on the above mentionedconstraints such as the cost of doing business data collated by World Bank and other similarstudies. From the description and analysis of the major constraints hampering industrialisation wederive the broader policy prescriptions or horizontal interventions. These policies are essentiallyaimed at creating the necessary conditions for industrialisation in the country.In section two of the report the first tier macro level analysis is supplemented by a second tiermicro level analysis of firm/sectoral competitiveness. This is to help identify both specificproblems affecting the competitiveness of a particular industry and issues that cut across all sectorsunder study. The analysis covers both large and small manufacturing sectors. In both cases, thecompetitiveness of each sector is assessed and policy options proposed to enhance it. This has beendone by conducting in depth consultative sessions with sector representatives, analysing all existingliterature on sector’s in Pakistan and for some sectors through a simple value-chain analysissupplemented by a broader industry assessment that contextualized value-addition achieved in aparticular chain. The outcome of this analysis is both general as well as specific policy programswhich corroborate and enrich the policies outlined in the macro level analysis.The third part of the report – tier three- takes a ‘bird’s eye view’ of industry by focusing on thespatial aspects of industrialization. The analysis in this part provides a compendium of policy notesbased on an in depth investigation of the formation of industrial clusters and their spatialdistribution. The mapping measures reveal the main determinants of cluster formation andidentify the determinants of existing clusters. This analysis has helped in identifying the degree towhich cluster formation is dependent on ‘historical accidents’, government policy or regionaleconomic characteristics or comparative advantages. This section has also looked at the impact ofdisparate infrastructural provision on regional poverty and income inequality. Hence the criticalnexus between public policy and inter and intra regional inequality has been drawn through theanalysis of industrial cluster formation. Hence the three tiered approach in this report has resultedin a set of policy programs which are not only consistent but are founded on a rigorous andcomprehensive analysis of the industrial sector of Pakistan. 11  
  • 37. 2 Industrial Sector of Pakistan: Structure, Performance & Problems Pakistan’s economy faces a critical period. The growth rate of the country’s population is thefastest in the region while the growth of its Gross Domestic Product (GDP) has slowedsubstantially in the past couple of years. This declining economic performance received anothermajor setback at the hands of the destruction caused by floods in August 2010. Moreover,excessive inflation, energy and food shortage, rising insecurity about life & property and alarminglevels of mistrust and cynicism in citizens towards the state is rapidly weakening the state structureand threatens the stability of the country. If these trends continue, the country will be faced withdiminishing expectations, a demoralized citizenry, and large numbers of unemployed youthsfuelling extremism not only within Pakistan but outside as well. These trends must be reversed.A key element for reversing this economic degradation in Pakistan is to achieve rapidindustrialization. Only this can bring the much needed economy-wide structural change forsustained economic growth and productive job creation to absorb the country’s enormous younglabour force. However, the required industrialization will not happen on its own. TheGovernment of Pakistan will have to take bold steps to create the confidence in the private sectorto rebuild the industrial base of the country.In this section of the report we present an account of the historic performance and structuralchange of the industrial sector in Pakistan, the investment trends and their link toindustrialization and the current depth of cross-cutting problems and issues faced by the industry.Finally, based on this economy wide diagnostic of the industrial sector, in this section we alsopresent ‘horizontal’ policy prescriptions and programmes to be adopted by the Government ofPakistan, to enable industrial growth in the country.2.1 Structure & Performance of the Industrial Sector in Pakistan The main ingredient in the growth and development experience of the West and the NewlyIndustrialized Countries (NIC) of the East was the rapid capital accumulation, or growth, in themanufacturing sector. The increasing significance of industry and a rapid rise in the proportion ofmanufacturing output traded internationally has been a central feature of these economies. The 12  
  • 38. high positive correlation between manufacturing value added and GDP growth across countries isevident from Figure 2-1 below.7 In the developed countries, in tandem with rising per capitaincome, there has been a gradual movement of resources from manufacturing towards the servicessector, in particular financial services. However, in Pakistan, over the past three decades thecontribution to GDP of the manufacturing sector has been stagnant. The structural change inrecent years has been skewed primarily towards the services sector. Industry, particularlymanufacturing has hardly shown any dynamism in contributing to GDP growth and employmentin the country. This section reviews the performance of the industrial sector in detail, highlightingits characteristic and the reasons behind its lack of competitiveness.Figure 2‐1: Association between Manufacturing Value Added (MVA) Growth & GDP GrowthSource: UNIDO Database2.1.1Growth Trends The average annual GDP growth rate in South Asian countries, in the 1990s, ranged between 4%in Pakistan to about 5.5% in India [World Bank (2010b)]. The growth rates, other than that ofPakistan, were considerably higher than the respective countries’ historical rates. The growth ratein Pakistan was fairly volatile in the initial decades (50s-60s) with a noticeable sharp increase in thelate 50s as a consequence of large scale industrialization in Ayub’s time followed by short periodsof negative growth as a result of the two wars with India. The growth performance showed relative                                                            7 This is a scatter plot for 131 developing countries for the period 2000 -2005 to show the relationship between growthin manufacturing value added (MVA) and the growth in gross domestic product (GDP). The scatter points representindividual countries. The regression line shows that the higher the growth in manufacturing, the more rapid is theGDP growth. 13  
  • 39. stability in the 1970s with a spike in the early 1980s reaching as high as 9%. However in the1990s, GDP growth exhibited a declining trend particularly in the years 1993 and 1997 (see Figure2-2). The growth started to recuperate after the nuclear explosions in 1998 but then againdecreased considerably in 2001. From 2001-2006 the growth rates of almost all South Asiancountries including Pakistan rose. The growth in Bangladesh increased by about one percentagepoint whereas the growth in India jumped by 2%. Pakistan too overcame its poor growthperformance of the 1990’s. The surge in remittances and foreign aid during this period led to apredominantly consumption fueled boom resulting in a growth rate of over 7% in 2006[Government of Pakistan (2007b)]Figure 2‐2: Historic GDP growth Rate in Pakistan, 1954‐2006 (percent)Source: IMF, 2008However, in the past two years due to a number of factors, Pakistan experienced a dramaticretardation in economic activity. The growth rate fell from 4% in 2008 to 2% in the fiscal year2009 (see Figure 2-3 below). During the same time period the growth rates of other countries inSouth Asia also fell, owing to global recession, but not to such low levels as that of Pakistan. Forexample, India’s GDP growth rate fell to 6.7% in 2008 but has risen since then to 7.2% in 2009.Similarly Bangladesh has maintained its growth rates at an average of 6.2% [Asian DevelopmentBank (2010)]. 14  
  • 40. Figure 2‐3: GDP Growth Rate in Pakistan, 2001‐09 (percent) 10.0 8.0 6.0 4.0 2.0 0.0 2001 2002 2003 2004 2005 2006 2007 2008 2009Source: Federal Bureau of StatisticsThe collapse of Pakistan’s growth in 2008, after the high growth in the period 2002-2007, is atestament to the fact that without addressing the structural weaknesses of the economy, GDPgrowth cannot be sustained on the back of capital inflows and consumption spending alone. Withthe exception of 2003-04 the declining manufacturing production and exports during the periodof rapid growth was indicative of the balance of payments crisis that Pakistan faced in 2008. In2008-09, output in the manufacturing sector shrank by 3.3% in face of both the increasinglybinding energy constraint and internal security issues [Asian Development Bank (2010)]. Theperformance of the three key sectors over the last ten years and over longer periods is depicted inFigure 2-4 and 2-5 below.Figure 2‐4: Sectoral growth rates in Pakistan, 2001–09 (percent) Source: Government of Pakistan (2009a)  15  
  • 41. Figure 2‐5: Annualized Growth Rates of Key Sectors in Pakistan for 10 Year Periods, 1970‐2009 (percent)  9  8  7  6  5  4  3  2  1  ‐ 1970s 1980s 1990s 2000‐09 Total Agriculture Industry ServicesSource: Government of Pakistan (2009a) and Bureau of Statistics data on GDP2.1.2Structural Rigidity & Inadequate Transformation As mentioned before, structural change has been a fundamental characteristic in the growth anddevelopment of western economies and the NIC’s. Structural change entails a gradual shift fromlow productivity to high productivity activities. As an economy develops, the agriculture share inGDP declines whereas that of manufactures and services increases. In addition, empirical evidencesuggests a ‘U’ shape relationship between a country’s income level and its degree of productspecialization [Klinger and Daniel (2004), and Cadot, O. et al. (2007)]. Specialization is high at lowlevels of income per capita but as the country becomes richer it tends to diversify and produce andexport a wider range of relatively more sophisticated goods. However, as income level furtherincreases, specialization increases again but now in technologically advanced and high value addedgoods. This implies that increased product diversification is a middle stage in the process ofstructural change and essential for sustained growth of a country.Figure 2‐6: Sectoral Shares in GDP of Pakistan, 1970‐2009 (percent)   60  50  40 30  20 10  0 1970s 1980s 1990s 2000‐09  Agriculture Industry ServicesSource: Government of Pakistan (2004a) and (2009a), and Bureau of Statistics data on GDP. 16  
  • 42. In the case of Pakistan (see Figure 2-6 above), the structural change has been tilted towards theservices sector. Pakistan, from being a largely agrarian economy in terms of contribution to GDP,has become a dominantly services led economy accounting for more than 50% of the GDP.Manufacturing share, on the other hand, has grown more slowly. Both agriculture and industryhave about 25% share in the GDP with the share of agriculture falling and the share of industryremaining fairly constant over time8. This means that structural transformation in Pakistan hasbeen from agriculture to services, circumventing to a large extent the manufacturing sector.Figure 2‐7: Shifts in Sectoral Shares in GDP of Pakistan, 2000‐09 (percent)  100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Services Sector Industrial Sector Agriculture  Source: Government of Pakistan (2004a) and (2009a), and Bureau of Statistics data on GDP.Even though the services sector has become the main growth driver in Pakistan, its potentialcontribution to employment is limited as compared to the industrial sector. Therefore, theagriculture sector continues to provide employment to a significant proportion of the country’slabor force. The share of employment in Pakistan’s agriculture sector has declined over time but itstill employs more than 40% of the labor force (Figure 2-8). This shows that a major part of thelabor force is stuck in the low productivity sector. The service sector employs above 30% of thelabor force while the industrial sector employs only 20%. Given the deteriorating performance ofthe manufacturing sector in the past years, most of the workers move from the agricultural sector                                                            8 http://www.statpak.gov.pk/depts/fbs/statistics/national_accounts/table13.pdf 17  
  • 43. to the services sector implying that the sector with highest value addition has the lowest share interms of employment. This is a matter of concern since movement of labor from low productivitysectors (agriculture) to relatively high productivity sectors (such as manufacturing) generates thesurplus that spurs growth. Even during the recent economic growth spurts in Pakistan, non-agricultural formal sectors, particularly manufacturing failed to generate employment. In fact, bothmale and female worker share in formal non-agriculture employment fell between 1999-2000 and2007-08 as shown in Table 2-1.Figure 2‐8: Employment Shares by Sector in Pakistan, 1980‐2009 (percent)            Source: Government of Pakistan (2004a) and (2009a), and Bureau of Statistics data on GDPTable 2‐1: Distribution of workforce by formal/informal sectors and by gender in Pakistan, 1999‐2008 (%) Male Female 1999-2000 2007-08 1999-2000 2007-08Agriculture 44.3 36.87 72.93 74.98Non-agriculture 55.56 63.12 27.14 25.07Formal 19.01 17.15 9.29 6.86Informal 36.55 45.97 17.79 18.22Source: Government of Pakistan (2003) and (2008)Felipe (2007) provides a comparison of Pakistan with other Asian countries, which shows thatPakistan, along with India and Philippines, are the only exceptions where industry has not beenthe main engine of growth. Whereas the share of the manufacturing sector in GDP in countrieslike Malaysia, Indonesia and Thailand has increased considerably over the past three decades, thisshare has remained stagnant in the case of Pakistan. In 2007, the manufacturing output share was 18  
  • 44. only 19% of GDP in Pakistan compared to the Peoples Republic of China (35%), the Republic ofKorea (24.7%), Indonesia (28%), and Malaysia (29.8%) [Asian Development Bank (2008)].This lack of structural transformation in Pakistan is indicative of the manufacturing sector’sunsatisfactory growth performance. The manufacturing sector grew by an average 10.61% duringthe period 1998-2007[Raheman, A., et al (2008)].The growth rate in the manufacturing sectordeteriorated from 14.0% in 2004 to 8.2% in 2007 and further to 5.4% in 2008 [AsianDevelopment Bank (2008)]. This decline in growth can be attributed to the fact that this sectorcontinues to be heavily concentrated in low value added consumer products such as food,beverages and textile, as depicted in Table 2-2 below. The industrial sector in Pakistan has failed tomove into more sophisticated products such as capital goods and continues to be dominated byresource based and low technology activities. The lack of production of capital goods and anabsence of upstream ancillary industries such as chemicals and engineering limits the growthpotential of the industry.Moreover, the manufacturing sector is stuck in production of items that are losing share in theworld market. For example, in 2008, the share of textiles, garments and footwear in Pakistan’sexports was more than 60% whereas the share of these items in world exports was merely 5.8%[United Nations Commodity Trade Statistics Database]. The manufacturing sector, due to the lackof innovation or improving competitiveness, is reliant on outdated production techniques and alabor force with low technical skills.Table 2‐2: Average Product Shares in the Manufacturing Sector of Pakistan, 1970‐90 (percent)  Product 1970s 1980s 1990sFood & Beverage 30.45 30.94 22.89Textiles 27.78 18.14 25.06Apparel, leather & textile 2.04 2.37 2.80Industrial Chemicals 11.20 14.29 15.50Petroleum & Coal 5.27 6.01 3.26Rubber & Plastic 1.80 1.80 1.42Metals & Non-metals 9.1 14.2 13.2Nonelectrical Machinery 1.84 2.14 2.09Electrical Machinery 3.31 3.26 5.43Transport Equipment 2.99 2.89 3.05Source: Felipe (2007) 19  
  • 45. Breaking down the analysis of manufacturing performance into large and small scale, it is apparentthat the growth of small scale industries has remained almost constant since 2000 as shown inFigure 2-9 below. The growth of large scale industries on the other hand has been quite volatile.Large scale manufacturing saw a rapid increase in growth rate of (from around 4% in 2002 to 20%in 2004-05) which was followed by a sudden retardation of growth. In 2007-08, the increase ininflation, a bourgeoning fiscal and trade deficit and an outflow of capital forced Pakistan to resortto the IMF program in 2008. The overall economic instability, the hike in interest rates on accountof the macro stabilization program coupled with the deteriorating security situation and powercrisis contracted the growth of large scale manufacturing significantly.Figure 2‐9: Performance of the Large Scale and Small Scale Manufacturing Sector in Pakistan, 1950‐2010 (%)     25 20 15 10 5 0 1950s 1960s 1970s 1980s 1990s 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 ‐5 ‐10 Large Scale Small & HH Linear (Large Scale)Source: Government of Pakistan (2007b) and (2010a)The following figure is a comparison of manufacturing value added across different countries.During the period 1968 and 2001, MVA in Thailand, Malaysia and Korea increased by a factor of14, 27 and 40 respectively [World Bank (2010b)]. In Pakistan, however, manufacturing valueadded in the same period increased merely by a factor of 7 [World Bank (2010b)]. Even in morerecent years i.e., 2001-2007, there has not been any marked increase in the manufacturing valueadded in Pakistan as illustrated in the figure 2-10 below. 20  
  • 46. Figure 2‐10: Manufacturing Value Added in US$ (Billions), 2001 & 2007Source: World Bank (2010b)2.1.3Productivity The competitiveness of an economy is closely associated with the productivity of its industry,particularly at the firm level. Strong growth in productivity is essential for maintaining export sharein an increasingly competitive world market. Pakistan, however, faces difficulty competing with itscompetitors owing to either lower factor productivity or higher worker wages. Pakistan has aboutthe same factor productivity as Bangladesh but its wages are almost 50% higher [The InternationalMonetary Fund (2010a)]. On the other hand, wages in Pakistan are similar to China and India butfactor productivity is much lower.The contribution of factor productivity in the growth process of Pakistan has been trivial. Duringthe period 1960-2005, about 80% of the GDP growth rate in Pakistan was explained by capitalaccumulation and labor expansion whereas total factor productivity (TFP) contributed theremaining 20% of the overall growth (Table 2-3). However, the contribution of TFP in GDPgrowth has fluctuated considerably during this period. TFP explained almost 38% of GDP growthrate in the 1980s but this fell to merely 18% in the 1990s (Table 2-3). TFP growth then recoveredto some extent during 2001-2005 and contributed to 22% of the GDP growth rate [TheInternational Monetary Fund (2010a)]. Moreover, during the 1990s, total factor productivitygrowth in the manufacturing sector was 2.4% [Chaudhry (2009)]. And over the period 1998-2007, 21  
  • 47. total factor productivity in the overall manufacturing sector, increased only by 0.9% [Raheman, A.et al (2008)]. This implies that the growth of the manufacturing sector has been mainly driven bygrowth in inputs i.e., labor and capital and the contribution of total factor productivity has beenfairly low.Table 2‐3: Growth Accounting in Pakistan by Decades, 1961‐2005 (percent) GDP Growth Capital Labor Total Factor Productivity1961-1970 6.97 4.48 1.63 0.861971-1980 4.58 1.80 2.30 0.481881-1990 6.09 1.90 1.90 2.301991-2000 3.86 1.45 1.71 0.712001-2005 4.55 1.58 1.92 1.04Source: World Bank (2006)Even though labour expansion is an important source of growth, it does not explain the variationin growth across countries. Despite almost similar labor expansion in Pakistan, India, Bangladesh,and East Asia over the period 1961-2005, the countries experienced different growth rates (Table2-4). This means that the difference in growth across countries can be attributed to capitalaccumulation and productivity improvements. Available evidence [World Bank (2006)] shows thatfor the period 2001-2006, the growth differential between East Asia and South Asia can beexplained mainly by total factor productivity.Table 2‐4: Growth Accounting in Asia, 1961‐2005 (percent) GDP Growth Capital Labour Total Factor ProductivityPakistan 5.28 2.31 1.89 1.08India 4.57 1.77 1.50 1.30Bangladesh 3.38 1.16 1.64 0.57East Asia & Pacific 6.46 3.15 1.74 1.71Source: World Bank (2006)Looking at inter firm productivity differentials, the following figure depicts that larger firms havea higher total factor productivity relative to medium and small sized firms suggesting the greateraccessibility and use of more efficient production techniques. 22  
  • 48. Figure 2‐11: Total Factor Productivity by Firm Size & Firm Age, 2001‐2006 (log values) 2.5 Aggregate productivity Average productivity Efficiency term 2.0 1.5 1.0 0.5 0.0 Small Medium Large Young Old (<25 employees)  (>=25 & <100 (>=100 (<5 years) (>=5 years) employees) employees)  Source: World Bank (2009b) Labor Productivity  In Pakistan, overall labor productivity calculated as total value added (GDP) divided by the totalnumber of workers, increased between 1981 and 2002.9 However, there is significant variation inlabor productivity over the period across the three sectors as evident from Figure 2-12 below.Figure 2‐12: Sectoral Value Added/Worker in Pakistan, 1981‐2002 (Rs at contact prices of 1999‐2000) Source: Bjornestad, Liv (2008)In Pakistan, worker productivity in industry was higher than for services in the 1980’s and the1990’s but has fallen recently. Worker productivity in agriculture, which was robust in the past, felldrastically in 2000-06 (Figure 2-13).                                                            9 This only provides an approximate measure as it does not take into account any differences in the number of hoursworked in the two periods 23  
  • 49. Figure 2‐13: Output per Worker Growth in Pakistan, 1980‐2006 (percent)Source: World Bank (2010b)During the period 1990-2006, overall labor productivity in Pakistan grew by only 1.29%, whichwas quite low compared to labor productivity growth in other developing countries such as India,Bangladesh, Indonesia, Malaysia and Thailand (Table 2-5).Table 2‐5: Annual Labor Productivity Growth, 1990‐2006 (percent)  Overall ManufacturingPakistan 1.29 2.08India 3.38 -1.1Bangladesh 2.92 4.05Indonesia 2.99 3.09Korea 3.93 8.76Sri Lanka 2.84 1.74Malaysia 2.69 5.11China 9.07 1.97Thailand 3.61 2.6Source: Asian Productivity Organization (2009)Relative to other countries in the Asian region, marginal improvements in labor productivity overtime have reduced Pakistans competitiveness to a great extent. Figure 2-14 sourced from the ILOshows that based on output per worker, Pakistan has fallen considerably behind many otherregional economies over the past two decades, despite a relatively similar starting point. 24  
  • 50. Figure 2‐14: Output per Worker in Asian Economies, 1990‐2004 (assuming 1990 as base of 100)Source: The Conference Board and Groningen Growth and Development Centre, Total Economy Database, January2006 2.1.4Export Performance A major change in the global economy has been the relentless increase in the proportion ofinternationally traded manufacturing products. The exports of manufactures have been growingrapidly and many developing countries are gaining a global market share.Table 2‐6: Country Export Shares Relative to Total World Exports, 1970‐2008 (percent)  1974 1980 1990 2000 2008Pakistan 0.14 0.15 0.18 0.15 0.15India 0.56 0.43 0.57 0.70 1.32Malaysia 0.55 0.74 0.94 1.61 1.43Thailand 0.32 0.37 0.74 1.13 1.25Source: United Nations Commodity Trade Statistics DatabaseDespite such overwhelming manufacturing success in developing countries, many countriesincluding Pakistan have still not been able to establish a vibrant industrial sector. During theperiod 1990-2008, exports of India, Malaysia and Thailand as a share of world exports increasedon average by 185% but Pakistan’s share declined by 17% over the same period (see Table 2-6). 25  
  • 51. Moreover, Pakistan exports a narrow range of manufactured products that are essentially low valueadded. To illustrate the lack of competitiveness in the industrial sector in Pakistan, two measuresof competitiveness for textile products, which comprises of a significant proportion of totalexports, are shown in the table below. The first measure, PRODY10, is an index that associates acertain income level to each product. A high value of PRODY means that the product is producedby high income countries; the implication is that higher values of PRODY imply moresophisticated products. The second measure is revealed comparative advantage11, where a valuegreater than unity implies that the country has a comparative advantage in that product. Thevalues of these two measures shown in the table 2-7 below indicate that despite being a majorproducer of raw cotton, Pakistan does not show a comparative advantage in those products of theTable 2‐7: Revealed Comparative Advantage and PRODY in Textiles, 2008/09 Product PRODY ($) Revealed Comparative Advantage (RCA) Raw Cotton 2,036 5.89 Cotton Yarn 5,631 86.5 Cotton Fabrics 4,541 114.98 Men & Boys Readymade garments 6,777 13.18 Women & Girls Readymade garments 5.16 5.16 Clothing Accessories Knit Wear 9,419 22.51Articles of Felt (Technical Textile) 22,486 0.1 Bonded Fibre Fabric 31,250 0.18Source: UN Commodity Trade Statistics, and Asian Development Bank                                                            10 To construct PRODY, the methodology in Hausmann et al. (2005) and data from the UN Commodity TradeStatistics Database (COMTRADE) at the 5-Digit level were used. PRODY is constructed as the weighted average of theper capita GDPs of the countries exporting a specific product, and thus represents the income (and productivity) levelassociated with that product. The weights are the revealed comparative advantage of each country in each product(normalized to one). If most high-income countries have revealed comparative advantage in the export of a product,PRODY would be high.11 To construct RCA, the methodology in Balassa (1965) and data from COMTRADE were used. The RCA isconstructed by finding the ratio of the share of product A in Pakistan’s total exports to the share of product A in totalworld exports. If RCA is greater than 1, then it implies that the country has a comparative advantage in that product. 26  
  • 52. textile sector that fetch higher prices. The low values of PRODY suggest that Pakistan’s exports areconcentrated in those cotton products (raw cotton, cotton yarn, and cotton fabrics) that areproduced by low-income countries. Apparently Pakistan’s strong comparative advantage in theseproducts is mainly due to policies of the government that backed low value-added elements.Government policy has not yet fostered the industry to move into more sophisticated products,such as articles of felt and bonded fibre. The low value added and narrow range of exports istherefore a direct consequence of a stagnant manufacturing base [Department for InternationalDevelopment (2010)].Pakistan’s export positioning in the world markets is also not very encouraging. In the figurebelow, the vertical axis measures the worldwide growth in the export of product x, as a share oftotal world exports, while, the horizontal axis measures the growth in the export of product x for acountry as a share of total world export of product x. If the country’s product is in the right handupper quadrant (competitive quadrant), it means that the product is internationally competitive.Hence, the more products a country has in the ‘competitive quadrant’ the stronger is itsinternational competitiveness [World Bank (2010b)].As evident from the figure 2-15 below, Pakistan has a minute proportion of its exports in thecompetitive quadrant, i.e., chemicals at 2.6%. Manufactures exports are dominated by textileswhose world demand is falling. This clearly illustrates lack of product diversification. Incomparison, Indian manufactured exports are beginning to be more diversified the exports ofIndia and quite a few products namely pharmaceuticals, chemicals, iron and steel and automotiveparts are located in the ‘competitive quadrant’ [World Bank (2010b)].More so, the product concentration index of Pakistan’s export has historically remained above0.4012 as depicted in figure 2-16 below. This index reached its highest value for Pakistan in the year                                                            12 2 1/ 2 The product concentration level is measured using the index, Gt = ( ∑ Wit ) , where k is the number of products kthat account for more than 90% of Pakistan’s exports and Wi is the share of commodity i in total export earnings. Theindex can take a value between 0 and 1; the closer it is to 1, the greater the degree of concentration.  27  
  • 53. 1997 after which it has shown a declining trend, and is now at an all time low value of 0.43[Ahmad, H et al. (2010)]. This clearly illustrates the need for focusing on product diversification.Figure 2‐15: Competitiveness and Performance of Pakistan’s Exports, 2000‐2007 (percent)   Positioning of  Indias Major  Manufactured  Exports in  Positioning of Pakistans  Major Manufactured  Exports in  2007 2007 10.0 10.0 Pharmaceutical Annual growth of product’s share in world’s total exports in 2000‐2007 Annual growth of product’s share in world’s total exports in 2000‐2007 s, 3.1% 8.0 8.0 Iron and steel,  Pharmaceuticals 6.0 5.7% , 0.6% 6.0 4.0 4.0 Chemicals,  2.0 11.4% Automotive  2.0 Chemicals, 2.6% products, 2.4% 0.0 0.0 ‐5% 0% 5% 10% 15% 20% ‐20% ‐10% 0% 10% 20% 30% 40% 50% ‐2.0 ‐2.0 Telecommunicat Clothing, 21.4% Machinery and  ions equipment,  transport  0.4% ‐4.0 ‐4.0 equipment,  Office and  Textiles, 6.6% Machinery and  4.5% Clothing, 6.7% telecom  ‐6.0 transport  Textiles, 41.4% equipment,  equipment,  ‐6.0 0.5% 11.6% ‐8.0 ‐8.0 Annual growth of Country’s share in Product’s global exports in  Annual growth of Country’s share in Product’s global exports in  2000‐2007 2000‐2007Source: World Bank (2010b)Figure 2‐16: Product Concentration Index, 1974‐2008Source: Ahmad, H et al. (2010) 28  
  • 54. Pakistan’s exports are quite concentrated geographically, with the Hirschman concentration indexestimated at 0.2513 in 2008 (Figure 2-17 below). This shows that Pakistan is doing fairly well interms of a diversified market for exports. This is also evident from the fact that 90% of thecountry’s exports were going to 45 countries in 2008.Figure 2‐17: Market Diversification Index, 1971‐2008Source: Ahmad, H et al. (2010)The underlying reason for South Asia’s inability to achieve dynamic competitive is the failure toclimb up the technology ladder in production. This has been shown by Sanjaya Lall (2003) in hisanalysis of evolving technological intensity in East and South Asian economies. He groups exportsin four technology categories: resource based exports (industrial raw materials), low technologyembodying exports, and medium and high technology embodying exports. The technologicalchange is assessed for the period 1981-2000 for Pakistan, India, China, Malaysia and Thailand.The increase in the share of medium and particularly high technology exports has been remarkablein China, Malaysia and Thailand. On the contrary, Pakistan increased its share only in lowtechnology exports with almost no change in the share of medium and high technology exports.Over the past two decades, the share of low technology manufactured products increased from54% to 76% of total exports where as that of medium technology products increased from 7.8% to                                                            13 The Hirschman index measures the geographical concentration of exports i.e. it shows the degree to which acountry’s exports are dispersed across different destinations. The Index can take a value between 0 and 1; higher valuesindicate that exports are concentrated in fewer markets. A value of 1 indicates that all exports go to a singledestination. Hence high concentration levels can be interpreted as an indication of vulnerability to economic changesin a small number of export markets. 29  
  • 55. 8.4%. However, high technology products remained an insignificant 0.6% of total exports[Government of Pakistan (2010b)]. This shows that the technological sophistication inmanufacturing in Pakistan continues to be low resulting in the country’s exports being dominatedby low technology manufactures.In order to improve export competitiveness, a country must upgrade technologies in all activities,build new capabilities, and find new markets [Lall and Weiss (2004)]. Unfortunately, Pakistan hasnot been able to move up the technology ladder, i.e., from low to medium and from medium tohigh technology exports. Felipe (2007) calculates EXPY for Pakistan, which is a proxy for acountry’s level of export sophistication or an indicator of its competiveness. The results show thatPakistan’s index in 2004 (4628) is almost the same as that in 1986 (4,664), which is about thesame that Indonesia, Malaysia, Philippines, and Thailand had in the late 1970s, and well below thelevels of China and India in the 1980s. This indicates lack of export sophistication in Pakistan,which can be attributed to slow technology adoption and up gradation.To date, Pakistan has not been able to upgrade its export structure and exports continue to bedominated by low-technology manufactures whose share is declining in the world market. In fact,in 2008, when the share of medium and high technology products in world exports was 57.6%,these products accounted for merely 9.5% of Pakistan’s exports (see Table 2-8).Table 2‐8: Technological Level of Pakistani and World Exports, 1998‐2008 (percent) Pakistan Exports World Exports* Growth Share Share Growth ShareSector 1998-2008 1998-2000 2006-2008 1998-2008 2008Total 9.6 10.1Primary 10.1 12.3 12.7 11.2 11.4Resource-based 23.9 3.5 10.9 10.5 14.8Low-technology 8.2 74.7 66.7 9.2 16.2Medium technology 8.7 8.6 8.1 10.1 35.5High technology 17.5 0.8 1.4 9.3 22.1*Exclusive of oil exportsSource: United Nations Commodity Trade Statistics DatabaseMore so, the performance of medium technology exports has not been encouraging with theirgrowth rate being below both the world growth rate of this category and Pakistan’s total export’s 30  
  • 56. growth rate. The growth of high technology exports, on the contrary, has been remarkable at17.5% per year; however, the share of high technology products in total exports is negligible tomake any significant impact. Moreover, the share of high technology exports of manufacturedgoods in Pakistan is abysmally low in comparison to other countries.The fact that Pakistan has been unable to upgrade technology in export products is also illustratedby the figure 2-18 below. The figure shows the elasticity of Pakistan’s export with respect to theGDP of industrial countries14 since 1985. This elasticity is a proxy for the non-price competitive(i.e. the quality attribute) of Pakistan’s exports [Felipe and Lim (2008)]. As evident from the figure,this elasticity is low, taking an average value of 0.87 for the period 1985-2007. This highlights theneed for upgrading the export package of Pakistan.Figure 2‐18: Elasticity of Pakistan’s Exports to GDP of Industrial Countries, 1985‐2007 (percent)Source: Felipe and Lim, 2008                                                             14 This shows by what percentage Pakistan’s exports change when the GDP of these countries increases by onepercentage point. 31  
  • 57. 2.1.5Summary Analysis Starting from a dominantly agricultural economy, the structural transformation of Pakistanrequired an increasing share of the industrial and manufacturing sector in the GDP, which wouldhave accelerated growth by creating more employment opportunities and higher value of exports.However, the structural transformation in Pakistan has been from agriculture to servicescircumventing the manufacturing sector to a large extent. The current growth pattern in Pakistan,with more than 50% of the growth coming from the services sector, is not sustainable as theservices sector cannot continue to grow without growth and development in the industrial andmanufacturing sector since the demand for services largely comes from these sectors.The East Asian experience shows that the export sector has the potential to serve as a growthengine of an economy. But for that it is essential for the country to move up the technology ladderi.e. from low to medium and from medium to high technology exports. This, however, has notbeen the case for Pakistan. The performance of the manufacturing sector in Pakistan, particularlyin terms of positioning of manufactured exports in the world market has not been veryencouraging. This is because Pakistan continues to produce low value added and less technologyintensive goods, whose shares are decreasing in the world market. The stagnant growth of themanufacturing sector along with a narrow base of manufactured goods and lack of productdiversification has been an obstacle to sustained economic growth and generation of employmentin the country. Pakistan has the highest population growth rate in South Asian with hordes ofentrants in the labor force every year. If the industrial base of the country does not expand toaccommodate this surplus labor, the mounting unemployment may lead to grave socio-economicand political consequences.Thus, for sustained economic growth and employment creation in Pakistan, it is vital to accelerategrowth and development of the industrial sector with particular emphasis on boosting exportcompetitiveness. Pakistan has had a relatively stable export composition over the years with onlytwo sectors, textiles and rice, accounting for more than half of total exports. Furthermore, theshare of about 40% of Pakistan’s export goods particularly textile items, in the world market, is 32  
  • 58. declining. This shows that the Pakistan’s export basket mainly comprises of products that are notaligned with global trends. Thus, in order to enhance export competitiveness, there is an urgentneed to diversify manufacturing export base and to shift focus from low to medium and high valuemanufacturing. Moreover, the range of markets to which Pakistan exports is relatively small. So,efforts must be made to target world markets such as Russia, United Arab Emirates and SaudiArabia in which Pakistan is currently an underachiever so that the country can realize the growthpotential offered by these dynamic world markets.The revival of the Pakistan economy hinges on the performance of its industry. Even though,increases in total factor productivity at the firm level are essential for sustained growth, factorproductivity in the manufacturing sector, increased only by 0.9% during 1998-2007 [Raheman, A.et al. (2008)]. Thus, it is important for Pakistan’s manufacturing sector to increase total factorproductivity, which can be done by improving both technical efficiency and technological progress.Improvement in technical efficiency requires quality enhancement of inputs like labor and capital.In order to bring about technological progress, efforts should be made to increase the research anddevelopment activities in the manufacturing sector.2.2 Investment Trends in Pakistan There is a vast body of empirical literature which confirms that investment in capital goods is anecessary condition for economic growth [Levine and Renelt (1992); Durlauf and Quah (1999)]. Theeconomic miracle of Korea, Taiwan and lately that of China was based on sustained high rates ofcapital accumulation which transformed the economic structure of these countries fromagriculture to industry in a relatively short period of time. High rate of investment not onlystimulated domestic economic activity and increased employment and income in these countriesbut also allowed them to export value added manufactured goods to the world [Rodrik (1995)].Although GDP growth in Pakistan over the last three decades is comparable with other developingcountries, investment in the manufacturing sector has been sluggish. Consequentially the share ofmanufacturing in total GDP over the same period has been stagnant in Pakistan and there hasbeen a gradual erosion of the country’s export competitiveness. There are various factors whichexplain low investment in Pakistan ranging from macroeconomic instability, imperfections in 33  
  • 59. factor markets to infrastructural constraints which have reduced the perceived return to the privateinvestor. The factors behind low investment would be discussed in detail in the next section. Herewe focus on describing the key trends and patterns in public and private fixed investment inPakistan.2.2.1Aggregate Investment Trends Total fixed investment as a percentage of GDP in Pakistan has remained within the range of 15%to 20% in the last three decades. Between the years 2003 to 2006 the share of investment rosefrom 15% to more than 20%  (see Figure 2.19), due to improvement in the macroeconomicenvironment. However, in the last three years, the investment trend reversed and investment’sshare in GDP decreased substantially. The worsening internal security situation and increasedmacroeconomic instability brought about a sharp fall in private investment pulling down the shareof total investment in GDP by almost four to five percentage points (see Figure 2-19). Figure 2‐19: Total, Private and Public Gross Fixed Capital Formulation (GFCF) in Pakistan, 1980‐2009 (% of GDP) Note: Total GFCG includes private sector, public sector and general government.Source: GoP (various years)Decomposing total investment into private and public investment, in the early 1980s the fall inpublic investment was more than compensated by an increase in private investment, resulting inrising overall investment rates in the 1980s. Public investment declined from 9.2% of GDP in 80sto below 5% in 2000s. On the other hand private investment increased from 7.8% of GDP in the1980s to 12.7% of GDP in 2000s (see Figure 2.19). 34  
  • 60. The fall in public investment came as a result of economic reforms introduced in the late 1980swhich were aimed at achieving fiscal consolidation.15 Given the large and increasing debt servicingburden and chronic fiscal deficits, it was public investment and development expenditures whichbore the brunt of these expenditure reductions. As is apparent in the figure below, the fall inpublic investment coincided with a significant increase in private investment. Financial reformswhich entailed greater autonomy to the State Bank and privatization of commercial banks gave animpetus to the private sector. The role of the government in the economy was further reducedthrough privatization of large public sector entities leading to the share of the private sectorincreasing to 84% of GDP [ADB (2008)].It has to be noted that the relationship between private and public sector investment to a largeextent depends on the nature of public investment and does not have to be necessarily negative.Recent literature has discussed the crowding-in phenomena (as opposed to the standard crowdingout effect) by analyzing public and private investment in Pakistan. Public investments ininfrastructure and utilities (roads, transports, ports, energy, gas, water and sewerage) enhanceinvestments from the private sector whereas poor infrastructure increases uncertainty, distortsinvestment returns and increases the cost of doing business. In the next subsection of this report,we discuss the various binding constraints impeding investments in Pakistan.2.2.2Regional Comparison and Pakistan’s Investment Gap In order to allow a comparative analysis of Pakistan with the rest of the region, we compute thedecade wise investment gap: difference between the rate of growth of investment in Pakistan andother developing countries within and outside the region for each decade. On average Pakistan’sinvestment gap in the 1980s was narrower than the investment gap in the 1990s and 2000s. Figure2-20 below shows that in 1980s investment in Pakistan grew on average 1.73 % less thanBangladesh’s investment. Investment during this period was marginally below India (-0.27) andSouth Asia (-0.15) but was 0.81% more than the low middle income countries. The relatively lower                                                            15 As a result of fiscal and external deficits Pakistan sought help in the late 1980s from the World Bank and IMF onan emergency basis for the revival of economy. The Structural Adjustment Program (SAP) was introduced to addressthe twin deficits through reductions in expenditures and increases in tax revenue along with conditions pertaining tothe restructuring of the economy through liberalization, privatization and deregulation. 35  
  • 61. investment gap in 1980s can be attributed to both, the revival of the private sector throughdenationalization and the large amount of economic aid given to the country in this period.The investment gap was the widest in the 1990s primarily as a consequence of political andeconomic instability in the country. However, during the years 2000-08, there was a marginalimprovement in Pakistan’s negative investment gap relative to the gap of 1990s. This narrowing ofthe gap was due to the increase in investment share as percentage of GDP from 17.4 in 2000 to22.40 in 2008.16Figure 2‐20: Aggregate Investment Gap of Pakistan Relative to other Countries, 1980‐2008 (percent)Source: Authors’ calculations using World Development Indicators for various years.In order to explain the sustained negative investment gap of Pakistan we now analyze thedisaggregated trends in investment across the region. The negative investment gap of Pakistancompared to its regional competitors is explained by consistently low public as well as privateinvestment over the past three decades.There is a systematic fall in public sector investment in the South Asian region post 1985-86. Thismight be attributed to reduction in the size of government or reduced investment by the publicsector in the wake of liberalization reforms adopted across the region. However, the depth of thereform seems to have been much more in Pakistan as is evident by the fall in Public investmentover this period which is substantially more than in both India and Bangladesh. The privateinvestment trend in Pakistan also remained sluggish compared to the sharp increase in private                                                            16 GoP (2009). 36  
  • 62. investment in both India and Bangladesh. During the 1990s, Pakistan’s private investmentremained approximately close to 10% of GDP whereas private investment of both in India andBangladesh remained above 10% of GDP and followed an increasing trend  (see Table 2.19). Thereasons for Pakistan’s relatively stagnant private investment in the 1990s thus range from politicalinstability, to poor infrastructure coupled with deeper economic reforms in particular tradeliberalization (e.g. reducing trade barriers and duties) which exposed a vulnerable manufacturingsector to greater international competition.The short spurt in private investment in Pakistan post 2002 was not enough to bridge the regionalgap. Both public and private investments as percentage of GDP were less than India andBangladesh’s investment from 2002 to 2008. Public investment remained stagnant at 10% of GDPwhile private investment growth could not be sustained due to worsening macroeconomicinstability, high nominal interest rate, and low economic growth.2.2.3Widening Resource Gap between Investment & Domestic Savings Pakistan’s share of manufacturing in GDP pales in comparison to the Newly Industrialized Asiancountries (Malaysia, South Korea, and Indonesia) which started industrialization in the same timeperiod (1960s) as Pakistan.17 The share of investment and saving as percentage of GDP were above30% during 1965-90 in East Asian economies in sharp contrast to the low investment savingtrends, approximately 13-14% of GDP in South Asia. Pakistan has had persistently low levels ofsavings and investment compared to other countries with similar levels of income (Table 2-9below). Savings in the economy have been constrained by both high fiscal deficits (reduced publicsavings) and an inflationary environment (increased consumption expenditures).The low level of saving compared to investment has widened the resource gap in Pakistan. Theresource gap went up by 3.2% in 2008 due to the increase in the investment rate in that year andnarrowed down to 5.4% in 2009 due to a reduction in investment as a percentage of GDP. Lowinvestments in the economy slow down economic growth whereas low savings exert pressure on                                                            17 Investment Climate Report (2007) 37  
  • 63. external accounts to finance domestic investments. The large and widening resource gap alsoincreases the external debt and debt servicing burden which can potentially lead tomacroeconomic instability.Table 2‐9: Comparisons of Savings and Investments, 1994‐2009 (% of GDP) 1994-2001 Average 2007 2008 2009World Saving 22.1 23.7 23.8 21.4 Investment 22.4 23.3 23.4 21.5 Resource Gap -0.3 0.4 0.4 -0.1Developing Saving 24.1 33.0 33.5 31.1Economies Investment 24.8 28.8 29.3 29.2 Resource Gap -0.7 4.2 4.2 1.9Developing Saving 32.7 44.7 44.7 43.6Asia Investment 32.4 37.9 39.1 39.5 Resource Gap 0.3 6.8 5.6 4.1Pakistan Saving 15.4 17.8 13.3 14.3 Investment 19.0 22.9 21.6 19.7 Resource Gap -3.6 -5.1 -8.3 -5.4Source: SBP (2008) and ADB (2010)2.2.4Actual & Potential Total Private Investment & Domestic Savings Major structural, governance, and economic reforms18 were introduced in early 2000s to improvebusiness environment and foster macroeconomic stability (ADB, 2008). In spite of these reformsthe investment response from the private sector was unimpressive. The contribution of privatefixed investment to total GDP showed only a 5% increase in the last ten years (from 10% of GDPin 1999 to 15% in 2008). In the last two years, the share of private investment in total GDP hasfallen from 15% in 2008 to 11% in 2010 [ADB (2008)].As noted earlier, the private investment growth rate has been uneven and sluggish in the last threedecades. In figure 2-21 below the potential indexed investment line shows the trajectory that                                                            18 Implementation of the Privatization Act 2000, creation of the Ministry of Privatization and investment, Board ofinvestments (BOI), and Insurance Act 2001 were important steps in this direction. A new legal structure wasintroduced to strengthen the financial system which includes introduction of recovery laws, legal structure for non-bank financial institutions, monetary and fiscal board for better coordination between monetary and fiscal policies,and the Fiscal Responsibility and Debt Limitation Act 2005 primarily aimed at reducing fiscal deficits. 38  
  • 64. Pakistan would have followed post 1980s if Pakistan had maintained an annual 9% investmentgrowth rate. On comparing the post-1980s potential private investment trajectory with actualprivate investment growth, private investment grew less than the potential growth rate except fortwo short time periods 1988-94 and 2004-07. In the last two years, the private investment growthrate shows increasing deviation from the potential investment trajectory (see Figure 2.21).Figure 2‐21: Long Run Indexed Real/Potential Investment Decline in Trend Rate of Private Investment, 1980‐2009Source: GoP (various years)On average private investment grew 5.1% in the 1980s, 8.8% in 1990s, and 18% in 2000s. Eventhough private investment showed impressive growth during 2000s, there were sharp fluctuationsin the annual growth rate of private investment (Figure 2-22 below). The volatility in privateinvestment reflects the uncertainty in the economic environment exemplified by poormacroeconomic management and low demand for produced goods. The uneven growth rate inprivate investment also matches the economic growth patterns achieved during the same timeperiod (see Figures 2.22 and 2.2). 39  
  • 65. Figure 2‐22: Growth Rate in Real Private GFCF & Total GFCF, 2000‐2010 (%) 25.00 20.00 15.00 10.00 5.00 0.00 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 -5.00 -10.00 -15.00 Total GFCF Private GFCFSource: GoP (various years) 2.2.5Sectoral Composition of Investment Empirical evidence shows that the social and economic returns of manufacturing investment arehigher compared to investment in other areas. Investment in the manufacturing sector results invalue addition, employment generation and expansion of the productive capacity of the economy.In the context of Pakistan there is a dearth of empirical evidence on economic growth anddifferential and average returns of investment in manufacturing sector versus non-manufacturingsectors. Wang (2009) analyses the impact of foreign direct investment on GDP growth in Asianeconomies and finds higher growth effects for economies receiving FDI in manufacturing sectors.The sectoral shift of investment from industrial sector to services sector (finance, transports andcommunications) has serious implications on the long term growth prospects of the economy. Thespurt in economic growth experienced in early 2000s was fueled by growth in services divertingresources from the manufacturing sector. The share of industrial (large scale manufacturing,mining and quarrying, construction and electricity) investment in total investment has beendeclining since 2003 whereas the share of transport and communication investment rose duringthe same time period. The share of industrial investment in total investment has declined from38% to 20% from 2000-10. On the other hand the share of transport and communication went 40  
  • 66. up from 12% to 24% of total investment19. Although, the recent decline in total investment ismatched with falling shares of both industrial investment and transport and communicationinvestment. Interestingly, the share of small scale manufacturing industries has increased slightly overthe same time period and flattened at 5% of total investment20.Within the industrial sector, the manufacturing sector commands the highest investment share intotal industrial investment. In the last 10 years, the share of manufacturing investment has slowlyincreased from 63% in 2000 to 75% in 201021. On average the increase in the share ofmanufacturing in total industrial investment has been approximately 1% in the last 10 years. Thechange in annual share of manufacturing investment is unimpressive compared to the sizeablecontribution of manufacturing sector to the GDP growth rate. The declining manufacturing share,which decreased from 30% in GDP growth in 2001 to 23% in 2010, is a direct consequence of theslow fixed capital formation in the manufacturing sector.The share of total manufacturing investment in total investment has declined from 23% in 2001to below 15% in 201022. Within manufacturing investment, the share of large scale investment hassubstantially decreased in the last 2 years in contrast to a slight increase registered by the smallscale manufacturing industries. The share of large scale industry was around 20% in 2000 whichhas dramatically declined below 10% in 2010 (see Figure 2-23)  23. The downward trend in largescale manufacturing investment reflects both an increase in the cost of doing business in Pakistanand the worsening macroeconomic and security environment.                                                            19  Authors calculation using various Economic surveys.20 ibid 21  ibid 22  ibid 23  ibid  41  
  • 67. Figure 2‐23: Share of Manufacturing Investment in Total Fixed Investment, 2000‐10 (percent) 25.00 20.00 15.00 10.00 5.00 0.00 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Share Large scal Share Small scaleSource: GoP (various years) 2.2.6Foreign Direct Investment Foreign Direct Investment (FDI) is a package of capital, transfer of technology and managerialskills from developed countries to developing countries. The literature identifies strong linkagesbetween economic growth and FDI in recipient countries. The growth benefits largely hinge uponthe flow of FDI in specific sectors. The concentration of FDI in the manufacturing sector bringsmore benefits than in non-manufacturing sectors of the economy [Wang (2009)].Pakistan experienced phenomenal growth in FDI inflow in the last four years (2006-09). Duringthis time period, the country received $17.8 billion in the form of FDI which grew six times (from$0.4 billion in 2001 to $2.4 billion in 2009) [SBP (2008-09)]. FDI reached a peak of $5.6 billion in2007 and stayed high for another one year in 2008. On comparing Pakistan’s FDI performancewith other countries using IND (inward FDI performance index), Pakistan performed better thaneven China in attracting FDI in 2005-07 controlling for the size of the economy.24 Pakistan clearlyoutperformed in the last five years in receiving FDI compared to its regional competitors (see Table2-10).                                                            24 The index ranks countries on the basis of relative share of FDI compared to world FDI and the size of the economyof recipient country compared to world economy. If the value of index is more than one it means the country isreceiving proportionally more FDI than the relative size of its economy. 42  
  • 68. Table 2‐10: Inward FDI Performance Index, 2003‐08Countries 2003-05 2004-06 2005-07 2006-08Bangladesh 0.46 0.48 0.4 0.33Nepal 0.05 -0.01 0.00 0.00India 0.45 0.62 0.63 0.71Pakistan 0.75 1.03 1.12 1.06Sri Lanka 0.66 0.61 0.54 0.57China 2.02 1.32 0.99 1.08Source: SBP (2009)However over the long term Pakistan’s ability and performance in attracting FDI in comparison toits regional competitors in South Asia has been below par. South Asia as a region claimed onaverage less than 1% of the total world FDI in the last decade with a small proportion going toPakistan. Table 2-11 below reveals the long term trend of FDI in Pakistan in the last two decades.Pakistan had attracted on average $0.5 billion FDI annually (about 20% of the total FDI inflow inSouth Asia) during the 1990-00 time period whereas India received almost two thirds of total FDIto the region in the same period.Since 2001, South Asia’s share in total FDI is following an upward trend, but the share of Pakistanin the regional FDI exhibits cyclicality. The share of Pakistan’s FDI declined from 9.4% in 2001 to5.6% in 2009 of total FDI in the region. However, India managed to keep a high share which wasabove 80 percent of total regional FDI to the region in 2009.Table 2‐11: Regional Comparison of FDI, 1990‐2000 Inward FDI Flows (US $ Billions) Pakistan China India South Asia Asia and Developing World Oceania Economies1990-00 (annual 0.5 30.1 1.7 2.6 76.7 130.7 495.4averages)2001 0.4 46.9 3.4 4.1 108.7 217.8 825.92002 0.8 52.5 3.4 4.5 92.0 155.5 716.12003 0.5 53.5 4.3 5.3 101.4 166.3 632.62004 1.0 60.6 5.3 7.0 147.6 233.2 648.12005 2.2 72.4 7.6 12.1 210.6 316.4 958.72006 4.3 72.7 20.3 27.8 284.4 434.4 1459.12007 5.6 83.5 25.0 33.9 338.2 564.9 2100.02008 5.4 108.3 40.4 49.7 374.6 630.0 1770.92009 2.4 95.0 34.6 41.4 303.2 478.3 1114.2Sources: UNTAD (various country fact sheets) available at http://www.unctad.org 43  
  • 69. In line with the above data, FDI as percentage of gross fixed capital formation (GFCF) has beenquite volatile in Pakistan since 2001. The share of FDI as percentage of GFCF increased frombelow 5% to close to 25% in 2007 (see Figure 2.24) due to heavy inflow of FDI (see Figure 2-24).This share has shown a secular decline since 2008 as a result of the international liquidityconstraints. In comparison with other countries it is apparent that the FDI as percentage of GFCFis not as volatile as in Pakistan. The FDI as percentage of GFCF has followed a gradual upwardtrend in India and South Asia since 2005. However, recently there has been a decline in the FDIas percentage of GFCF due to international liquidity constraints.Figure 2‐24: FDI Investment as % of Gross Fixed Capital Formation, 1990‐2009 (percent)  30.0 25.0 20.0 15.0 10.0 5.0 0.0 1990- 2001 2002 2003 2004 2005 2006 2007 2008 2009 00 Pakistan China India South Asia Developing EconomiesSource: UNCTAD (various years) 2.2.7Sector­wise Decomposition of FDI Optimal sectoral composition of FDI is immensely important in terms of realizing the real gainsfrom technological spillover effects, managerial skills transformation and economies of scale. Thegrowth premium of FDI in the manufacturing sector is higher than the nonmanufacturing sector.The FDI sectoral composition for Pakistan has been skewed away from the manufacturing sector.Pakistan mostly received FDI in the last two decades in the oil and gas sector, power, financial, andtelecommunication sectors. In 1990, the concentration of FDI was in the power sector followingthe government’s policy of allowing foreign IPPs (independent power producers) to enter themarket. In the late 1990s, the focus and share of FDI shifted towards areas like financial servicesand telecommunication. 44  
  • 70. The recent phenomenal growth in the inflow of FDI in Pakistan also confirms the above findingsthat Pakistan’s manufacturing sectors receives a low and insignificant amount of FDI. The Figure2-25 below provides sectoral comparison of FDI for two years 2004 and 2008. Financial business,telecommunication, and oil & gas are the main recipients of FDI in Pakistan whereas themanufacturing sector claims less than one fifth of total FDI received in 2008. The share of themanufacturing sector’s FDI has further declined in 2008 compared to 2004. The low share of themanufacturing sector in FDI reinforces the existing state of low technology accumulated over thetime period.Figure 2‐25: Sectoral Decomposition of FDI, 2004 and 2008 9percent)  100% 80% 60% 40% 20% 0%  2004 2008 Manufacturing Oil and Gas Telecommunications Financial Business Other ServicesSource: SBP (2008) In order to ensure competitiveness and to improve the returns of investment in manufacturingsector, the Government of Pakistan has introduced various incentives for foreign investors. For thelast two decades, Pakistan has introduced incentives like allowance of 100% foreign equity, lowimport/custom duties and tax relief for manufacturing investments supported by liberalization,deregulation and privatization reforms and opening of all major sectors for FDI (See Box 2-1). Themain objective of these reforms is to ensure a business friendly environment by unleashing controlover market forces and offering a more competitive environment. For example, the initiation of aone window option for the foreign investors and avoidance of double taxation are key steps to benoted here. 45  
  • 71. Box 2‐1: Inward Investment Incentives Regime in Pakistan  The incentives include: 1. All economic sectors open to Foreign Direct Investment 2. Foreign investment fully protected 3. Equal treatment to local and foreign investors. 4. 100 % foreign equity on repatriable basis allowed 5. No Government sanction required. 6. Attractive tax / tariff incentives package. 7. Remittance of Royalty, Technical and Franchise Fee, Capital, Profits, Dividends allowed 8. Zero rated sales tax on import of plant, machinery and equipment 9. Initial Depreciation Allowance at the rate of 50% is permissible on an “eligible depreciable asset” placed into service in Pakistan for the first time in a tax year. 10. Amortization of pre-commencement expenses allowed at the rate of 20% annually. 11. Amortization of intangible assets allowed over a period of ten years. 12. Rationalization and lowering of corporate tax rates 13. Full repatriation of capital, capital gains, dividends and profits allowed. 14. No restriction on payment of royalty and/or technical service fees for the manufacturing sector. 15. Agreements on Avoidance of Double Taxation with 52 countries 16. Bilateral Agreements on promotion and protection of investment with 46 countries. Source: Pakistan Board of Investment2.3 Constraints to Investment & Manufacturing Growth in Pakistan In this section the major constraints hampering Pakistan’s investment and manufacturingperformance are highlighted in order to derive broader industrial policy interventions. Asdiscussed in the previous section the main ingredient behind economic growth is increased capitalaccumulation/investments and higher productivity and diversity within the manufacturing sector.An understanding of the major obstacles impeding investments and manufacturing growth istherefore imperative in the formulation of an industrial policy which is centered on the objectiveof achieving sustained growth and wide spread employment. There is rich literature oncomparative analysis of developing countries explaining their disparate historical growthperformances. These studies show that the institutional, policy and regulatory environment of aneconomy effect the investment and production decisions of firms thus playing a critical role inexplaining the cross country variations in aggregate growth performance [Dao, 2008; Dollar,David, Mary and Mengistae (2005)]. The empirical evidence supports the fact that firms performbetter in developing countries which have a stable macroeconomic and political environment, are 46  
  • 72. relatively less bureaucratic, have efficient financial and regulatory institutions and are supported bywell functioning factor markets.Pakistan’s economic performance is marred by an array of constraints hindering the growthpotential of the economy and more specifically, that of the manufacturing sector. These includesupply side problems of the factor markets, macroeconomic instability in the country and issuespertaining to the economic and business environment (infrastructure, regulatory andadministrative, crime and insecurity). This section will begin with an analysis of the impact ofmacro instability on investment and manufacturing growth. This would be followed by problemsin factor markets and of physical infrastructure which inhibit both investments and manufacturingsector growth. Finally, the regulatory and security environment would be discussed in the contextof investment and manufacturing performance. 2.3.1Macroeconomic Instability & its Impact on Investment & manufacturing There is an integral link between investment and growth in the manufacturing sector and themacroeconomic environment of a country encapsulated by the GDP growth rate. Increase ininvestment leads to growth which in turn acts as a positive stimulus to investments. This bidirectional causality between growth and investments has been empirically verified for bothdeveloped and developing economies. Macroeconomic variables such as inflation, interest ratesand exchange rate also impact investment and manufacturing performance and in turn can beaffected by the investment rate. An unstable macroeconomic environment characterized by highrates of inflation, large fiscal deficits, increasing external debt, and volatile exchange rate is in mostinstances accompanied by a fall in both investments and manufacturing growth causing an overalldecline in GDP growth. For investors, macro instability and uncertainty about future economicoutcomes, such as demand conditions and expected relative prices, act as a large cost potentiallydelaying or reducing current investments. On the other hand a stable macroeconomicenvironment enhances investment rate, allows efficient allocation of resources and raises the levelof productivity and growth of the manufacturing sector. Therefore the management of keymacroeconomic policy instruments, that is, fiscal policy, monetary policy, debt management, andexchange rate policy can significantly influence factors determining investment level and growth. 47  
  • 73. Macroeconomic stability is gauged through level and consistency in fiscal deficits, external debt,inflation rate, and extent of exchange rate volatility. These important factors determine degree ofrisk in the business environment. For example, to raise more revenue in response to poor fiscalmanagement, the governments in developing countries tend to monetize the debt or levy inflationtaxes which cause a hike in overall prices and thus negatively impact investment andmanufacturing. Volatility in exchange rate distorts relative price levels in the economy whereaspoor debt management may create a possibility of credit rationing from international financialinstitutions. There is a large body of literature on developing countries which offers empiricalevidences on gains in economic growth and investments associated with macroeconomic stability[Bleaney, 1996; World Bank, 1993; Fischer, 1993; and World Bank, 2004]. On average,developing countries experience 0.15% decrease in GDP growth and 0.35% in investment ratiofor a 1% increase in fiscal deficit [Bleaney, (1996)].The East Asian economic miracle brought about by a phenomenal increase in investments andexports would not have been possible had it not been for the relatively sound macroeconomicenvironment in these countries25 over a time period of 30 years (from 1965 to 1990).26 The fiscaldeficit during these 30 years remained at a manageable level across these countries. The inflationrate hovered around 9 percent compared to 18 percent in low and middle income countries. Dueto sustained low inflation, the real interest rate remained stable in the same time period. As aresult, investment on average remained 20 percent of GDP from 1965 to 1990 with a highcomposition of private investment. These developments translated into a long period of sustainedhigh economic growth transforming the East Asian Economies.Macroeconomic stability has been a key challenge for the policy makers in Pakistan for the lastfour decades dominating the economic management agenda of successive governments. Onaverage Pakistan has had relatively higher GDP growth rates compared to other developingcountries in the last four decades. In early 1970s and 1980s Pakistan experienced GDP growthrates reaching almost 7% in 1970s and 9% in 1980s. However, growth rates flattened in 1990s and                                                            25 Hong Kong, the Republic of Korea, Singapore, Taiwan, China; and the three newly industrializing economies ofSoutheast Asia, Indonesia, Malaysia, and Thailand.26 World Bank (1993).  48  
  • 74. remained below 5%. The growth rates during 2001-10 remained slightly above 5% [GoP (2009-10)]. The performance of other macroeconomic variables such as inflation rate, fiscal deficit,exchange rate, and balance of payments were less resilient as compared to the GDP growth rates inthe same time period. Figure 2-26 shows the strong positive correlation between investments andGDP growth in the country. The downward trend of GDP growth post 2005 is in tandem with thefall in investment rates.Since the initiation of macroeconomic reforms in 1999, Pakistan experienced a mixed trend in itsmacroeconomic variables. A relatively stable macroeconomic environment was experienced duringthe period 2001- 2007. Fiscal deficit showed a downward trend since 1998 and declined from7.7% of GDP in 1998 to 2.4% in 2004. On average, fiscal deficit remained close to 4% in thisperiod. In addition, current account deficit reduced to 0.7% of GDP in 2001 from 4.1% in199827.Figure 2‐26: Real GDP and Investment Growth in Pakistan, 1991‐2009 (percent)  40.00 35.00 30.00 25.00 20.00 15.00 10.00 5.00 0.00 1991  1992 1993 1995  1994 1996 1997 19981999 2001 2000 2002 2004 2003 2005 2006 2008  2007 2009 -5.00 -10.00 investment growth rates GDP growth ratesSource: GoP (various years)In fact, in 2003 the current account deficit turned into surplus due to the double digit growth rateexperienced in exports which reached to 19.1%. Stable exchange rate, falling interest rate andsingle digit inflation boosted investment rate to an unprecedented level of 22% of GDP in 2007.However, macroeconomic instability revisited Pakistan after five years in 2008. The currentaccount deficit was as high as 8.8% in 2008 due to increase in oil import bill. Fiscal deficitincreased to the level of 7.6% in 2008, 5.2% in 2009, and is believed to remain above 5% in the                                                            27  Authors’ calculations using various issues of economic surveys.   49  
  • 75. years to come due to future debt repayment28. Since 2008, inflation and interest rates have goneup signalling deterioration in the macroeconomic environment. The level of inflation reached apeak of 20% in 2009 and 13% in 2010. In response to high inflation and as part of themacroeconomic reform agenda, the State Bank resorted to a contractionary monetary policyresulting in a significant increase in the interest rate. The worsening economic and securityconditions in the country caused an outflow of short term capital which consequently led to thedepreciation of the currency. The rupee exchange rate touched an historic low of Rs 85 per dollar(22 percent depreciation) in the last 3 years. Resultantly, the investment to GDP ratio alsofollowed a downward trend in the same time period. Figure 2-27 below shows the dramatic fall ininvestment growth around the year 2007-08, which coincides with the increase in the interest ratesfrom single to double digits.Figure 2‐27: Investment and Interest Rates, 2001‐2009 (percent) 45.00 40.00 35.00 30.00 25.00 20.00 15.00 10.00 5.00 0.00 2001 2002 2003 2004 2005 2006 2007 2008 2009 6 months T-bills lending rate investment growth rate Private investment growth ratesSource: GoP (2010a)Therefore the growth experience of Pakistan can be characterized as having spates of high growthfollowed by periods of low growth rates. In recent years these ‘boom’ and ‘bust’ cycles have beenbrought about mainly by changes in consumption demand triggered by short term capital flows,aid and a surge in remittances. The main reason behind a lack of sustained GDP growth is theinstability in investment rates and the resultant sluggish growth in the manufacturing sector whichin turn has impeded the structural transformation of the economy. The failure in fiscal                                                            28  ibid  50  
  • 76. management, both in terms of revenue generation and allocation and size of expenditure, has beenthe root cause of the country’s macroeconomic problems. The Twin deficits – Fiscal and Trade Pakistan’s macroeconomic instability is largely explained by its persistent failure in containing thefiscal deficit within 4-5% of GDP.29 The chronic high fiscal deficit resulted in increased borrowingfrom both internal and external sources to cover the resource gap.Since 2004, the internal gap (Government consumption and tax revenue gap) have coincided withthe external gap (export and net factor income i.e. remittances) (see Figures 2-28 and 2-29). Therewas a large capital inflow into Pakistan in the form of remittances and aid post 9/11 which led toan appreciation of the nominal and the real exchange rate. This appreciation reduced thecompetitiveness of our exports (the Dutch Disease effect) and increased import demandsignificantly leading to a widening current account deficit. In order to bridge the trade and fiscalgap, the economy has to rely on external sources of financing. Delays or non-availability of externalfinance jeopardize the macroeconomic stability of Pakistan in the long term exerting pressure onforeign reserves, exacerbating inflation and interest rates, and deteriorating currency stability.                                                            29 The large fiscal deficit of the 1970s is attributed to the expansionary fiscal policy as a result of nationalization policyfollowed by Bhutto’s regime. Large increase in interest payments over the debt accumulated in the 1970s worsened thefiscal deficit in subsequent periods, 1980s and 1990s. The fiscal deficit grew approximately 7% until 1990s. The highfiscal deficit in 1990s is also attributed to the failure of economic management in terms of reducing expenditure andincreasing revenues along with implementing key structural reforms in the economy. During this period the deficit wasmostly financed by extensive controls on financial markets, relatively strong monetary growth and external borrowing.The deficit peaked at almost 9% of GDP in 1990-91. It was, however, subsequently managed down to 5.5% by 1994-95. After the adoption of macroeconomic stability program in 1999, fiscal deficit dipped down to the level of 5%during 2000-09  51  
  • 77. Figure 2‐28: Tax Effort and Government Expenditure Gap, 1990‐2008 (percent) Source: Felipe and Lim (2008).Figure 2‐27: Exports, Net Factor income from Abroad and Imports, 1990-2008 (percents of GNI)Source: Felipe and Lim (2008).Recently, the external account has further deteriorated after showing some recovery signs in early2000s. With the slowdown of international economic growth and surge in international oil prices,the current account surplus went into a deficit in 2005. In the last two years as a result of anincreased import bill due to the sharp depreciation of the exchange rate accompanied with sluggishdomestic manufacturing growth and a resultant fall in exports, the current account deficitmounted to 8.4% of total GDP [Felipe and Lim (2008)].Since external capital inflows are quite unpredictable, external imbalance depletes foreign reserve,exerts pressure on inflation and results in exchange rate volatility. In 2007, Pakistan’s foreignreserves declined by 27% due to current account deficits and net outflows from portfolio 52  
  • 78. investment. In 2008-09, the foreign exchange reserves accumulated ($12 billion) on receivinginflows from IMF as part of macroeconomic stabilization program and other agencies. In thecurrent year, 2010, Pakistan’s foreign reserve further strengthened ($15 billion) due to lowercurrent account deficit and increase in remittances [GoP (2009-10)]. Effect of Budgetary Rigidity and Reduced Fiscal Space on Investments  The inability of the government to finance its fiscal deficits through increased domestic taxrevenue has led to a severe restriction in fiscal space over time. The accumulated debt over theyears and interest payments on the principle require a large portion of the budgetary allocationlimiting the share for development expenditures. According to 2010 budget estimates, almost 79and 21 percent of total expenditure is spent on current and development expenditures,respectively. Key components of current expenditures like debt servicing, subsidies and defenseexpenditure explain its rigid structure. Interest payments alone, account for 27% of totalexpenditure.Due to the rigid structure of current expenditures, it is development expenditure which ends upbeing curtailed to reduce the fiscal deficit for e.g., cuts in spending on physical infrastructure,despite its significance in enhancing both the quality and quantity of private investments. Thequality of investment is also affected by low development expenditure on health and education.Low spending on education and vocational training leads to a poorly trained or worse, unskilledlabour force (discussed in the next section), trapping the manufacturing sector in a ‘bad’equilibrium of low value-added and low technological intensive products.The mode of budget deficit financing in developing countries can further add to macroeconomicinstability [Fischer and Easterly (1990); Easterly and Schmidt-Hebbel (1993)]. Low tax revenue toGDP ratios leave few options for the Government to finance the deficit, except borrowing fromexternal sources, domestic banks, and from the State Bank of Pakistan. Financing throughdomestic banks raises the interest rate and leaves less credit for private sector investment –crowding out effect. Following a downward trend till 2005, interest rates rose sharply(contractionary monetary policy) in response to high inflation, causing a significant fall ininvestment. 53  
  • 79. With little improvement in the repayment capacity, debt continued to accumulate at an alarmingrate. Serving to reinforce each other, the volumes of both the fiscal deficit and debt soaredcontinuously. The bulging domestic debt profile was the result of “excessive governmentexpenditures, stagnant tax revenues, high returns on government securities and inappropriatesequencing of fiscal reforms” [State Bank of Pakistan, (2001)]. On the other hand, unwieldycurrent account deficits, sluggish export revenues and declining worker remittances caused a rise inthe debt burden of the country.During 2000- 2001, the debt situation was dire. After 9/11 and the war on terror, huge amountsof debt were either written off or rescheduled in return for Pakistan’s support. In addition, thequota for Pakistani exports to the US and the European Union was increased as a premium forbeing a part of the coalition in the war against terrorism. As a result of foreign aid and foreigninvestment inflows, there was a substantial increase in remittances as well, all of which helped thecountry with its debt situation. In 2006, the debt to GDP ratio improved further and fell below60% for the first time in two decades. However this improvement was not long-lived as Pakistan’sdebt position deteriorated sharply in fiscal year 2008, reflecting the country’s large fiscal andcurrent account deficit. Monetization, Inflation and Investments Structural issues in the budget imply that financing budget deficits through printing moneyincreases inflation in the economy. In other words, fiscal imbalance and expansionary monetarypolicy have a strong linkage with inflation. From 1991 to 1995, inflation rates ranged between9.3% and 12.9% as a direct result of monetary expansion and low growth rates. Money growthrates had climbed up to a level of 12.6% in 1990 and had stayed in the range of 16% to 18%,except when they reached an exceptionally high rate of 30% in 199230. Pakistan had experiencedsustained inflation, ranging from 10% to 13% till 1998. The persistence of double-digit inflationalong with high fiscal deficits has been one of the biggest issues for the Pakistani economy, as bothwere major causes of the macroeconomic imbalances of the 90s. There has been general agreementthat excessive growth in money supply, adjustment in government–administered prices, imported                                                            30  Authors calculation using various issues of Economic Surveys  54  
  • 80. inflation (pass through of exchange rate adjustment), escalations in indirect taxes, and inflationaryexpectations are the major factors responsible for the persistence of double-digit inflation duringmost of the 1990s. Both food and non-food inflation were at play, averaging 11.6% and 10.3%respectively during the eight years of the1990s31.Figure 2‐28: Inflation and Investment in Pakistan, 2001‐2010 (% p.a.) 40 35 30 25 20 15 10 5 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Grow th WPI Grow th GDPD Investment grow th ratesSource: GoP (2010a)During 2000-2003, inflation decelerated to less than double figures. However this did not last longas inflation rose again in fiscal year 2005-2006. This rise was mostly on account of a sharpeconomic recovery that raised income levels and hence domestic demand, coupled with thecontinued impact of mounting oil and commodity prices internationally. Sharp increases ininternational prices of food and energy in 2008 again led to a noticeable spike in inflation rate (asmeasured by the Wholesale Price Index and GDP deflator). The accompanying decline ininvestment during this period created a situation of stagflation in the economy [see Figure 2-30].As part of the fiscal reforms tied to the ‘Fund’ conditionalities and in a bid to curtail subsidies forfiscal consolidation, the Government is obligated to transfer the hike in oil and utilities prices toconsumers (elaborated in detail in the energy section). Passing on higher prices to consumers and                                                            31 ibid  55  
  • 81. industries leaves economic managers with even fewer options for reducing the cost of doingbusiness and improving the competitiveness of the economy. Policy Recommendations Fiscal Policy The government faces an immediate need to reduce the bourgeoning budget deficit and increaseits limited fiscal space. For that, the Federal Bureau of Revenue (FBR) has to substantially increaseits revenues by widening the tax base. The tax to GDP ratio of the country is around 9 percentwhich is one of the lowest in the world. The tax base has to expand to include sectors which areout of the tax net, such as agriculture. Currently, the manufacturing sector bears most of the taxburden.Moreover, instead of levying more taxes or increasing tax rates, FBR has to improve its taxcollection system. Viable incentives need to be provided to tax officials to minimise rent-seekingand increase tax collection. At the same time, appropriate incentives have to be generated toincorporate the large informal economy existing in manufacturing, services and retail.On the expenditure side, there has to be a significant reduction in wasteful current expenditureand a slash in defense spending (without compromising the security of the country). A reallocationof resources towards development expenditure, in particular health, education, energy and physicalinfrastructure, is required to stimulate investment in the economy and increase the vitality andproductivity of the manufacturing sector. The Ministry of Industries is an important stakeholderwhen it comes to budgetary allocation decisions. It should play its role as an industryrepresentative in making a case for increased spending in areas which directly or indirectly benefitindustry. However, given the tight availability of fiscal space, the ability of the state to invest inlarge-scale infrastructure development projects is impaired. Also, any new or greater spendingallocation carries with it a huge opportunity cost. The government would therefore need tocarefully prioritize its development spending on the basis of maximum social and economic rate ofreturns. 56  
  • 82. Moreover, an increase in domestic revenue generation and the resultant reduction in fiscal deficitwould reduce the debt burden, both domestic and international, on the economy, creating greaterfiscal space in the future. A reduction in international borrowing from multi-lateral agencies thatimpose conditionalities in the form of prescribed policy rules and restrictions would also buy thegovernment greater policy autonomy or ‘policy space’. Monetary Policy In times of macro-instability characterized by high unemployment and inflation, the central bankor monetary authority normally resorts to a contractionary monetary policy to curb demand-pullinflation in the economy. However, the resultant higher interest rates raise the cost of capital,negatively affecting investment in the economy and causing stagflation. As investment in themanufacturing sector also contracts due to the higher cost of borrowing, industrial growth tends toslow down during such macroeconomic reforms. The first-best policy prescription is therefore toavoid any such macro imbalance or instability which would then call for contractionary measures.Developing countries in general and Pakistan in particular, have more often than not financedfiscal deficits by printing money (monetisation) or borrowing commercially. While both methodsof financing are inflationary, the latter also results in crowding out of private investment.Therefore using expansionary monetary policy to finance fiscal deficits is not a viable policyoption. Trade and Industrial Policy under WTO Pakistan has, over the past two decades, significantly liberalized its trade regime, both on accountof its membership of the WTO and the Structural Adjustment Programs of the World Bank andthe IMF. Liberalization has entailed a conversion of quota restraints to tariff barriers withsubsequent reductions in tariff rates and elimination of export subsidies. Therefore liberalizationreform to some extent makes government usage of trade policy [as an instrument of industrialpolicy] a thing of the past. International trade rules and multilateral agency conditionalities havean impact on the policy space available to governments. The term ‘policy space’ has been defined 57  
  • 83. as ‘the scope for domestic policies, especially in the area of trade, investment and industrialdevelopment which might be framed by international disciplines, commitments and global marketconsideration’ [ODI, (2007)]. The major international commitments as outlined in the DohaRound of WTO talks are in six areas: tariffs, agricultural policy, services, TRIPs (Trade RelatedIntellectual Property Rights), investment and Aid for Trade.As far as tariffs are concerned, ‘bound’ tariffs on commodities as negotiated with the WTO arenormally much higher than ‘applied’ tariffs. This allows considerable policy space to countries toincrease tariffs as part of an industrial strategy to give temporary protection to a strategic sector. Inthe case of Pakistan, for example, the bound tariff rate on average is almost 100%, while theapplied tariff is around 15%. This low applied tariff is not due to the WTO rules, but because ofliberalization reforms included in the IMF and World Bank Structural Adjustment and MacroStabilization programs. It should be noted that bilateral and multilateral trading agreements mayalso result in tariff reductions.Flexibility under international rules allows government to use tariffs (between applied and boundrates) for temporary protection of industries. Peak (higher than average) and escalating (low oninputs and high on finished products) tariffs can be used to protect strategic or ‘sunrise’industries/sectors that can potentially exhibit economies of scale or are value-added industries.However such protection has to be conditioned on clearly- defined objectives and targets, such asexport performance and product quality improvement. Otherwise, a policy of arbitraryunconditional protection would either breed inefficiency in production (eventually lowering thequality of the protected product) or just give another lease of life to ‘sunset’ or declining sectors.The use of subsidies such as export subsidies or subsidies on domestic inputs (to discourage use ofimported intermediate goods) is prohibited under the WTO Agreement on Subsidies andCountervailing Measures (SCM). The subsidies which are classified as non-actionable and hencepermitted under SCM fall under the category of Research & Development and EnvironmentInitiatives for disadvantaged regions. This category can be effectively employed to upgrade thetechnology of production and quality standards within an industry. 58  
  • 84. Other available import-substituting policy instruments are anti-dumping duties and safeguardmeasures, which are invoked on the premise of fairness in competition. Availing these measuresrequires diligence and capacity on the part of the import-competing sector under threat as well aseffective pursual of the case by the Ministry of Commerce and Industries at the WTO.The most controversial of the WTO rules deal with TRIPs, which introduces regulations onpatents and copyrights. The main implication of this is the imposition of costs on countries whichare net importers of technology, i.e., developing countries. Such rules would limit the diffusion oftechnology through reverse engineering and copying. The upside of TRIPs for developingcountries is Article 66.2, which requires developed countries to incentivize enterprises andinstitutions in their territories to promote and encourage technology transfer to developingcountries members of the WTO. Although the TRIPs agreement also allows developing countriesto subsidize R&D and then protect the innovation through property rights, very few developingcountries can be classified as innovators, thereby restricting the benefit of TRIPs to the leaders intechnology.2.3.2Infrastructural Constraints on Industrial Growth Energy  The acute energy shortage of the past two years is the most important constraint adversely affectingthe industrial sector today. The government of Pakistan has been unsuccessful in meeting thegrowing demand of energy and has failed in maintaining a consistent supply of this vital input tothe industrial sector. The energy crises of Pakistan manifested in the unreliability of power supplyand frequent load-shedding places a huge burden on the manufacturing sector. Moreover, theexisting power subsidy structure charges a higher tariff from the manufacturing sector in order tosubsidize power for commercial, agricultural and domestic consumption. The shortage in supplyand periodic upward revisions in the power tariff structure has substantially increased the costs ofproduction of industry, eroding its profit margins and international competitiveness. Theunscheduled and persistent outages affect the production processes of a large number of industrialunits, with electricity-intensive sectors bearing most of the burden, for e.g., those producing 59  
  • 85. textiles, basic metals, leather products, rubber and plastic products, paper and paper products, etc.The gravity of the situation is evident from data gathered by the Investment Climate Surveys(2006) which suggest that the number of firms that consider electricity to be a major constraint hasrisen by 50% between 2002 and 2006. Since the problem is now worse than it was in 2006, thenumber of affected firms is bound to be greater (See Figure 2-31).The main reason behind this problem was the inability of successive governments to increaseenergy supply in accordance with the projections of demand in the country. The demand forelectricity has been rising steeply over the years, with consumer demand rising sharply in thecurrent decade. In fact, the share of domestic consumer demand in total consumption hasincreased from 23% in 1980-81 to 46% in 2007-08 [Institute of Public Policy (2009)]. Moreover,electricity demand is outstripping supply by a significant margin, as is evident from Figure 2-31,and by 2010, demand is expected to exceed supply by approximately 5,500 MW. The governmentwas, however, unable to anticipate the rising demand and therefore adequate measures were notmade in time. Proof of the government’s complacency on the energy issue is found in thedeclining proportion of public sector expenditure on the power sector from 28% in the 1980s toless than 3% in 2000s [Institute of Public Policy (2009)].Figure 2‐29: Electricity Demand and Supply, 2003 – 10 (MW)Source: Private Power Infrastructure Board: http://www.ppib.gov.pkAd hoc government policymaking regarding privatization and delays in tariff reforms did not allowIPPs to make appropriate investments in improvement and upgradation of technology which couldhave absorbed some of the excess demand in electricity. Circular debt was one of the consequences 60  
  • 86. of such government indifference. The government failed to make timely payment to powerproducers who were unable to pay the oil and gas companies supplying them with the inputs,resulting in decreased production. The consequence of these deferred payments was theaccumulation of PKR370 billion in debt [Institute of Public Policy (2009)]. Thereforemismanagement in the power sector and lack of appropriate and timely policy intervention fuelledthe problem. Other proximate causes include downturn in the economy owing to the war onterror, fluctuating oil prices, and collection losses due to the dilapidated transmission anddistribution systems.A study conducted in 2008 by the Institute of Public Policy (IPP), Beacon House University,estimated costs of outages to industry by surveying a sample of 65 industrial units. The survey wasconducted in four main industrial centers of Pakistan and included both continuous and batch-making industries. The estimated cost of load- shedding for firms with self-generation facility wasfound to PKR74 billion, and for firms without self-generation, PKR83 billion. Therefore the totalcost to the industrial sector was estimated to be PKR157 billion, which was 9 percent of the totalindustrial value added and constituted a 7 percent loss in production. The resultant employmentloss was estimated at 300,000 workers [Institute of Public Policy (2009)].Slowdown in the manufacturing sector results in reduced economic activity in sectors such aswholesale and retail trade, transport and communications, banking and insurance etc. As a changein industrial value added has a multiplier effect on the rest of the economy, the IPP report alsoextrapolated the national cost of load-shedding with the aid of an estimated short run multiplierusing their estimated industry costs. The total cost of industrial load-shedding to the economy wasestimated at PKR210 billion, which comes to around 2 percent of GDP. The estimated loss ofexports was found to be PKR75 billion [Institute of Public Policy (2009)].From an international standpoint, given that Pakistan has the greatest number of firms sufferingfrom maximum hours of power interruptions; it should come as no surprise that it comes secondonly to Bangladesh in terms of losses to firms due to such interruptions. According to the WorldBanks Enterprise Survey 2008 (Pakistan country Profile 2007), in Pakistan the loss to firms due topower outages is approximately 10 percent of sales. This is slightly lower than the South Asian 61  
  • 87. average of 11 percent but much higher in comparison to that of low income countries which isaround 7 percent. Nationally, we observe that the situation was much worse in 2007 than it was in2002, and that amongst the provinces, Sindh suffered the most. Based on size, small-sized firmswere the largest victims of the energy problem.Installing generators to supply electr icity when there is an outage, is however, not a very feasiblealternative since the cost per unit of electricity is significantly higher if using generators. It mustalso be noted that only around 6 percent of domestic energy production occurs using generators,suggesting that the problem of power outages is still more or less unresolved. Inefficient Distribution and Management System In 2006, the rundown condition of the transmission and distribution system cost Pakistan anestimated PKR4.3 billion for each percentage point line loss. According to the WorldDevelopment Indicators, following India, these losses are greatest in Pakistan. This situation,though still fairly serious, is an improvement over 1998-99, when these losses amounted to 31%.32Another indicator of the inefficiency of power production is the delay in getting an electricityconnection. The waiting period for a new connection in Pakistan is up to 92 days. This is morethan three times that in India and about 50% higher than that in Bangladesh [World Bank,(2009b)]. Moreover, the waiting time for a new connection in Pakistan has deteriorated drasticallyfrom 2002, when it was about 32 days. On a national level, the situation has actually worsened in3 out of 4 provinces from 2002 to 2007, with delays in NWFP now almost 3 times more than in2002. As for different sized industries, medium-sized firms suffer the most with a delay of around140 days.The loss to firms as a result of delays in installing a connection is compounded by the informalpayments (rents) made in order to get a connection. According to World Bank (2009b), informal                                                            32 http://socyberty.com/issues/energy-crunch-in-pakistan-cause-effect-solution  62  
  • 88. payments are highest in Pakistan if compared internationally. This implies a high level ofcorruption another important constraint to be discussed later.Power therefore remains an important issue that needs to be addressed by the government, since itnot only has direct costs for the industrial sector, but also a multiplier effect in the economy as itslows down the activity in other sectors such as transportation, banking and wholesale and retailtrade. Thus it is now essential to prepare a strategy for the development of the energy sector inPakistan, with focus on increasing electricity generation, improving the quality of electricitydistribution, and finding alternatives to depleting national gas resources. 63  
  • 89. Box 2‐2: Energy in Comparison with China and India Energy is a vital ingredient for driving and sustaining the engine of growth in any country. This is precisely why rapidly growing and industrializing economies like China and India have paid special attention to energy production. According to a report by the United Nations, Global Trends in Green Energy (2009), "Manufacturing leadership is shifting from Europe to Asia, as countries like China, India and South Korea continue to increase their commitments to renewable energy.” In China, coal production is the main energy source, providing 70-75% of energy presently. In 2007, the amount of coal produced was equivalent to 2.37 billion tons, making China the second largest energy user in the world. However, China intends to improve its energy mix by increasing the shares of alternative energy and nuclear energy by 15% and 5%, respectively. India is reported as the fifth largest wind and solar-water heating energy producer by the Global Trends in Green Energy report (2009). The shares in the energy mix of the country in 2009 were: coal 60%, hydropower 20%, oil and gas 11%, alternative 6% and nuclear 3%. Like China, India also plans to increase the share of alternative and nuclear energy in its energy mix. The goal set by National Action Plan on Climate Change (NAPCC) is to meet 10% of country energy needs through renewable sources by 2015. As for solar power, the target set by the National Solar Mission is 20GW by 2022. In order to meet these targets, the government is offering generation-based incentives for the solar power industry. Moreover, in collaboration with some advanced countries, India aims to set up power stations that are powered by coal and have zero emissions in the long-run. The country also currently has around a million solar systems operating in rural areas. Pakistan also has a huge reservoir of renewable energy sources that are yet to be exploited. If proper attention is paid to these energy sources, Pakistan would be able to overcome an energy deficit that is estimated to rise to 64% by 2030. During the year 2005-2006, the government commenced many projects on renewable energy including the development of wind and solar energy so that these could generate at least 5% of power by 2030. The government has also devised a strategy to expand the generation capacity of nuclear power to 8800mw by 2030. For this purpose, Pakistan Atomic Energy Commission (PAEC) plans to set up multiple units on the same site. As for manufacturing nuclear fuel, the PAEC intends to institute a Pakistan Nuclear Power Fuel Complex (PNPFC). However, a well thought out approach and vigorous efforts are essential to make the aforementioned projects meet their desired objectives. 64  
  • 90. Policy Recommendations Securing Supply An analysis of the energy mix of Pakistan reveals that out of the 5 most commonly used sources ofenergy [namely oil, nuclear, natural gas, hydroelectric and coal], Pakistan uses natural gas (50%)and oil (30%) the most, in contrast to the rest of South Asia, high-income countries and the worldat large, which rely on coal. Although coal is abundant in Pakistan, it is of poor quality in mostcases. The energy mix in Pakistan needs to be altered so as to allow extensive power productionthrough low cost means which would make industry more competitive.In order to bridge the growing energy deficit, investments in the power sector are imperative.Expanding power generation capacity in the country would entail upgrading existing generationfacilities and investing in both thermal and hydel plants.In the medium- to long-run, we strongly propose a shift in energy mix. This may be attained bydeveloping localized, cheaper machinery for hydel, thermal and coal-based power plants. For thispurpose, the interaction of manufacturers and power producers, including WAPDA needs to befacilitated to develop machinery best suited to Pakistan’s needs.In special economic zones, science parks and industrial estates, captive power generation should beallowed. At the same time, steps should be taken to facilitate the local development of windturbines and solar energy technology. For this purpose, pilot research projects should be initiatedbringing together universities, industry, foreign and local experts and relevant governmentdepartments.The following is a description of the merits and demerits of the various sources of powergeneration. 65  
  • 91. Hydel or HydropowerWhile the generation of electricity using hydropower saves fuel, greater investments are required inhydropower than in thermal generation. Hydropower plants are also located away from areaswhere demand for energy is high, raising transmission costs for hydropower. But keeping theseconstraints in mind, estimates suggest that hydropower is more attractive as its maintenance costsare lower and that it is more efficient when fuel prices rise and discount rates decrease [(Ministryof Industries (2005)]. The hydel projects which are in the pipeline should be completed as soon aspossible. These are Neelum-Jhelum (969MW), Tarbela 4th Extension (960MW), Suki Kinari(840MW), Munda Dam (700MW), Khan Dubar (130MW), Allai (126 MW), and Jinnah Hydro(96MW) [Institute of Public Policy (2009)].CoalCoal is an under-utilized resource and generates only 5 percent of Pakistan’s energy needs and 1percent of electricity needs. In comparison, India uses coal to meet 54% and 47% of its energyand electricity needs respectively [Ministry of Industries (2005)]. In addition, coal can also be usedfor gasification, fuel and chemical extraction, briquetting and in the processing industry.Substitution of coal for gas has taken place in the cement industry, but coal is mostly imported.Thus in the long-run there needs to be a development of coal fields (in Thar for example), andsetting up of power plants. This sort of exploration and development is a provincial matter andprovincial governments will need to be on board if coal is to become an alternative energy source.Oil and GasIt is estimated that at prices of PKR11000 per ton for oil and PKR172 per MCF for gas, thesubstitution of gas for oil will reduce the fuel component of electricity generation by PKR0.52 perkWh to PKR2.37 per kWh. This amounts to a reduction of 18% in fuel cost and 13% fall fromthe average electricity tariff of PKR4.09 in 2003 (WAPDA, 2003). Furthermore the World Bank(2003) estimates annual savings of 130,000 tons of fuel as a 300MW plant is converted from oil togas. Yet caution is advised, as conversion to gas carries the risk of depleting resources in the nextfive years unless new reserves are found [Ministry of Industries (2005)] 66  
  • 92. Achieving Efficiency in Distribution A comprehensive program that focuses on reducing technical losses and improves the reliability ofthe distribution system is required. Distribution companies should be provided adequate resourcesto upgrade their overloaded transmission and distribution systems. It is estimated that the requiredinvestment could potentially be recovered in less than three years through savings in transmissionand distribution losses [Institute of Public Policy (2009)].The circular debt problem needs to be resolved in the short-run. The payments to IPPs (thermal)should be conditioned on the utilisation of at least 75 percent of their capacity. Sector-wide energyaudits should be conducted, starting with heavy load industries. Based on the recommendations ofthe audit, incentives should be provided to the industry to shift toward more energy-efficientproduction methods and technology. Improvement in the Load Management System (LMS) The schedule of outages should be in accordance to the needs of various industries. Those sectorsor clusters which are heavily reliant on electricity and incur large losses due to unscheduled powerinterruption should be given priority and should be provided continuous electricity for thescheduled period.As long as power shortfalls remain, the load needs to be managed carefully. Areas with a heavypresence of industry, both large-scale and SMEs, should be given the status of industrial corridors.These corridors could be given separate feeders, where load- shedding would only occur whenabsolutely necessary33. This needs to be arranged after consultation with PEPCO, so that thepresent suboptimal matching of grid stations and 11kv feeders can also be addressed. Load-shedding schedules for such units need to be announced at least two months in advance and load-shedding days should be clustered for both electricity and gas. No such priority should be given toindustry that is based in residential areas.                                                            33 This point is also addressed in the section on industrial estates and other special economic zones. 67  
  • 93. Pricing Policies If subsidies are essential, they must be up-front budget allocations rather than cross-subsidization.In 2003, fertilizer producers and household consumers were paid a subsidy of PKR 14 billion andPKR 9 billion respectively [Ministry of Industries (2005)]. These were cross subsidies that resultedin a higher price for industrial consumers. Cross-subsidies increase the cost of energy for industryother than fertilizer, and results in supply shortages due to over- consumption in the householdsector. Energy pricing should be rationalised according to usage; however priority should be givento industry in determining the extent of sector-specific electricity subsidies. In industrial corridors,peak-load pricing schedules should be announced.Finally, the industrial sector should be consulted and informed about any changes in pricing policywell in advance so that these are factored into their costs of production. Post-dated billing ofindustry electricity consumption should be avoided. Transportation An efficient and well-integrated transport system is integral to the growth and development ofindustry as it reduces the cost of production and increases the competitiveness of firms. InPakistan, however, transport systems suffer from insufficient investments, poor management andneglect of essential maintenance. The low reliability and high costs of the transport sector hinderPakistan’s economic growth by reducing the productivity of its industry and the competitiveness ofits exports. The cost of inefficiencies in the country’s transport system has been estimated at about4-6 percent of GDP [The International Monetary Fund (2010a)]. Roads Road transport caters for 90% of Pakistan’s passenger traffic and 96% of its freight. The roadnetwork in Pakistan not only lacks quality, but also suffers from under-maintenance. In fact, 70% 68  
  • 94. of the 7086km national road network is of poor to fair quality [Energy and Infrastructure SectorUnit South Asia Region (2002)]Despite the significance of the road transport system, it has received insufficient investmentparticularly from the private sector. Even though public sector investments have been made in theroad sector led by the National Highway Authority (NHA), the capacity increase has not beensufficient to match the increase in traffic flows. For this purpose, NHA devised a policy frameworkin 1999, along with incentives to attract private sector investment for national highway projects.But the efforts have been in vain. This is because out of the two projects granted to the privatesector by NHA, one contract was cancelled whereas the other project developer was unable to raisethe finances needed for the project [Asian Development Bank (2008)].Moreover, due to the poor condition of roads, Pakistan has a record of over 70 fatalities permillion of population per year [Energy and Infrastructure Sector Unit South Asia Region (2002)].This is estimated to cost USD1 billion to the economy [Energy and Infrastructure Sector UnitSouth Asia Region (2002)]. The major entities responsible in this regard are the Ministry ofIndustries and Production, Ministry of Commerce, Ministry of Railways and the provincialgovernments.Finally, trucking, a much-used form of transport, has not been developed as a formal activity. Theowners of these sole proprietorships and partnerships have little incentive to register themselves asdoing so does not promise a growth to business; it is an additional regulatory burden. Furtherproblems include the age (20 years on average) and condition of trucks, overloading of trucks andhigh costs for less-than-container-load shipment [World Bank (2006)].Thus in order for the road sector to be able to aid sustained GDP growth, an in-depth analysis ofthe road transport network should be conducted and followed up by a carefully planned andimplemented strategy for the expansion and upgradation of the road network. Road linkages connectingmarkets and industry must be developed for efficient logistics. 69  
  • 95. Railways Pakistan Railways is a non-profitable and technically insolvent public sector unit. Over the pastthirty years there has been a continued diversion of resources towards the expansion of the roadnetwork at the cost of the railways. During this period, as a consequence of lack of resources,railway share of inland passenger traffic declined from 41% to 10%, and in freight traffic, from73% to a meager 7% [World Bank (2007)]. There has hardly been any private sector activity inthis sector and plans to privatize railways have not been implemented. There has been no changein the Railways Act since 1980. Although the Act allows the private sector to participate in railtravel, it assigns the Government the role of both competitor and regulator [Asian DevelopmentBank (2008)]. Thus the Act needs to be revised to create effective Public-Private Partnerships(PPPs) in the railway sector [Asian Development Bank (2005)]. A business plan has been developedfor 2005-2011 that stresses private sector participation in the railways sector in order to enhance itsefficiency and competitiveness. However, this plan needs to be implemented speedily andeffectively [Asian Development Bank (2008)]. Ports The total dry cargo handled at Pakistan ports in 2003-4 was 25.2 million tons which represents agrowth of over 8 percent from the 1999-2000 [Ministry of Industries (2005)]. The two main ports,Karachi and Port Qasim, handle 56% and 44% of dry cargo respectively, and 18 tons of liquidcargo. The main problem facing ports is congestion at the terminals. Facilities have not expandedsufficiently to handle the increased traffic that resulted from trade liberalization. The majorinefficiencies associated with ports include the following [Ministry of Industries (2005)].Custom clearance is cumbersome due to time-consuming manual systems, particularly the amountof paperwork and high number of physical interactions. Also, the period of free storage at 7-9 daysis longer than international norms. Cargo is often uncollected for long periods and has to beauctioned. 70  
  • 96. There are limited rail services for quick transportation of cargo. This is because Pakistan Railwayshas difficulty in organizing a competitive freight service owing to the priority it gives to passengers.Moreover, the freight forwarder role is not institutionalized and leads to high freight prices.Shipping agents representing foreign carriers quote higher prices to Pakistani exporters, withoutintermediation by a freight forwarder that can negotiate bulk rates for trade.The Dock Labour Board at Karachi port is another drag on the competiveness of exports. Theoverstaffing and unnecessary labour regulations at the Karachi Port Trust raise the cost of serviceto users [Competitive Support Fund (2007)].Thus, the working of ports must be improved if Pakistan is to become more competitive ininternational trade. Policy Recommendations: Roads Revamping of the reporting structures of the National Highway Authority (NHA) andstrengthening of audits and monitoring can help in improving road quality. As poor quality ofroads does not negatively affect the revenues earned by the NHA, the incentives for roadmaintenance have to be revamped. One way could be to bring in private contractors to maintainroads under contracts that allow returns to cover costs and yield a reasonable profit.A roads commission is needed to develop an overall strategy for roads. It would include in itspurview connecting roads to major industrial estates, railways and border points as well asconnectivity with Balochistan and tribal areas. Major stakeholders such as the Ministry ofIndustries and Production, Ministry of Commerce, Ministry of Railways and provincialgovernments must participate in decision making.Truckers get away with low quality haulage services due to a lack of regulation. The market offerslow barriers to entry and trucks can be financed at low interest rates. This causes cut-throatcompetition and a downward pressure on fares, often below operating costs. Overloading and poormaintenance of trucks affects both road quality and transport service. To correct this market 71  
  • 97. failure, truckers need to register and the government must impose quality standards and encouragebranding, so that with premium attached to brands, fares will increase. In case of overloading, themagnitude of the fine should nullify the incentive to overload.In partnership with the private sector, logistical parks of international standard need to be setupnear industrial areas, agricultural hubs, and ports. For this purpose, land needs to be provided,and government should invite local/foreign investors to develop facilities for storage, loading-unloading facilities, and rest areas. Dry ports should be established within or adjacent to theselogistical parks34. Vehicle quality testing stations and a Radio Frequency Identification (RFID)based tracking facility should be established within the logistical parks. The government shouldalso ensure the creation of cold storage facilities near agricultural hubs and expedite the creation ofcold chains from agro-based clusters to Karachi. Ports Many of the inefficiencies of ports have to do with delays at the port, high charges, labourproblems and restrictive practices in on-shore cargo handling. This results from the port authoritybeing run as a government monopoly. The government needs to transition to the role of settingstandards and monitoring compliance, leaving daily port operations to the private sector. This willpromote competition and result in efficiencies such as lower service tariffs from competitiveoperators. Privatized container terminals show that significant efficiency gains can be achieved[Ministry of Industries (2005)].Port entry and maritime service charges need to be reduced. Privatization needs to be extendedbeyond container terminals to operations such as the engineering department workshop and shorehandling. Preparing regular statistical reports for port traffic and shipping, waiting time andfinancial indictors can help to benchmark port efficiency and take informed decisions.Pakistan Automated Customs Clearance System should be maintained and the software issuesneed to be resolved immediately.                                                            34  Logistical parks provide trucking space, short residences, hotels, recreation etc.  72  
  • 98. The government needs to facilitate private sector investment in a bulk-handling port facility. Thiscould be done through public-private partnerships by following the ‘landlord concept’ employedsuccessfully in the Karachi Port Terminal. The government should facilitate the establishment ofsilos at the Karachi port for the storage of commodities such as coal and cement.Box 2‐3: The Case of Gawadar  Gawadar is located in Baluchistan and its strategic location needs to be exploited. It is east of Iran, south of Afghanistan, and boasts a sea port almost at the mouth of the Strait of Hormuz. Gawadar is an essential node in the Iran-Pakistan-India pipeline, which could cross from Iranian to Pakistani Balochistan. At the same time, Gawadar is of enormous strategic importance to China, Afghanistan, Iran and Central Asia. However, the development and usage of the Gawadar Port has stalled as a consequence of a myriad of issues ranging from lack of infrastructure investment by the government, prohibitively high cost of transportation, security issues, absence of any significant industry in Baluchistan, and foreign interests which feel threatened by its development. Accordingly, the following policy recommendations are offered: 1. Scrap the deal with PSA and seek assistance from China in developing the port. 2. Urgently complete roadworks linking Gawadar to up-country. Currently, transporters have to go through Sukkur. 3. Incentivize China and/or UAE to build oil refineries near the port. 4. Seek Chinese assistance in building a rail link between Gawadar and northern parts of the country. Railways Railways According to the World Bank (2004), Pakistan Railways has the assets and potential to do muchbetter, especially with regards to freight. Pakistan Railways will need to address its structuraldeficiencies that span institutional weaknesses and suppression of private sector participation.The financial weaknesses stems from an ad-hoc and unsustainable budget process that is a mixtureof deficit financing and capital injections. There is no long-term budget strategy. The government’smonopoly discourages private capital since they are not subject to accountability and marketdiscipline. 73  
  • 99. The business plan for 2005-2011 that stresses private sector participation in the railways sector inorder to enhance its efficiency and competitiveness, also needs to be implemented. Newinvestment is required in the Railway Freight Service and new tracks need to be laid in order tosupport transportation within the country. An increase in the share of national railway in nationalfreight from the current 4% to 22% by 2030 as proposed in Vision 2030 [GoP Document] alsoneeds to be realized.2.3.3Factor Markets Constraints on Investment & Manufacturing Labour Market, Skills and Human Capital Development The main problems in the labour market in Pakistan that inhibit competition are the lack ofdemand for educated and skilled human labour, and a legal regulatory framework that does notsupport market flexibility. More so, weaknesses in labour legislations for minimum wage, socialbenefits, employment contracts and layoff regulations remain unaddressed. The out-of-dateregulations concerning maximum hours, labour taxes and temporary contracts cause real wages tostray from productive levels causing inefficiencies and eroding the competitiveness of firms.In comparison with export-oriented East Asian firms (in China and Thailand), the employmentconditions are much more rigid in South Asian firms including Pakistan. Moreover, Pakistan’shighly inflexible labor market particularly with respect to hiring and firing is manifested in its lowrank of 136 on the doing business indicators for employing workers [World Bank (2009b)]. Thehiring conditions in Pakistan are strict owing to laws governing minimum wage and temporarycontracts. Social security payments associated with hiring a worker are about 12% of the salarywhich is comparatively higher than in the South Asian region. Firing conditions are relativelyeasier; however, an employer still has to pay the equivalent of 90 weeks of salary to dismiss aworker, which is again high compared to that in the region [Asian Development Bank (2008)].Such rigidities in the labour market have a negative impact on foreign direct investment [AsianDevelopment Bank (2008)]. Moreover, the need for more flexible arrangement in the labour 74  
  • 100. market arises as firms are now well-integrated in global markets, trading systems and value chains,which makes them susceptible to international macro or industry-specific shocks. And producerscan best respond to these shocks if the manufacturing process and input and output markets areflexible.The high levels of compliance cost issues and enforcement requirements lead to reliance ontemporary and informal markets. This is why labour demand in Pakistan is dominated by a largeinformal sector and participation in the formal sector is very small. The informal sector isdominated by a relatively less educated and unskilled workforce. Moreover, it operates with lowtechnology and little institutional support from the government.The educational foundation of the work force is weak. In fact, enrollment trends show that halfthe numbers employed in firms have less than three years of education. In Pakistan, 51% of theworking population has no proper schooling and on average had 3.88 years of schooling in 2000.Bangladesh stands at 50.1% and 2.58 years, with Sri Lanka in much better condition at 14%without schooling and an average of 6.87 years of schooling (Barro-Lee Indicators from Barro andLee (2000)). Moreover, small firms usually have less educated employees than medium and largeindustries in Pakistan [World Bank (2009b)].Absence or weakness of skills in the labor force greatly hampers the productivity andcompetitiveness of firms in Pakistan. Workers have few opportunities to acquire skills asgovernment agencies responsible for skill enhancement function poorly. Employers, on the otherhand, do not have incentive to invest in the training of workers owing to the fear of losing them tocompetitors. As a result, firms are stuck with workers operating at low levels of productivity.Hence, labour market factors such as issues in labor laws, hiring and firing difficulty, and lack ofskilled labor force result in sub-optimal outcomes that constrain production, growth andcompetitiveness of firms. Thus, there is a dire need to reform the labor market, particularly toincrease flexibility in hiring and firing and to lower the costs of compliance. Moreover, in order forPakistan to be competitive in the international market, human resources must be developedthrough focusing on education and vocational and technical training. 75  
  • 101. Human Capital and Skills Upgrading worker skills is a key to stimulating investment by dynamic firms and for improvingworkers’ incomes and enhancing the competiveness of firms. To be competitive in today’sintegrated world requires an increasing supply of skilled manpower to complement rapidlychanging technologies. Moreover, countries with a broad base of skilled human labor are morelikely to enhance productivity and become internationally competitive as is evident from the caseof South Korea, Singapore and Taiwan.A poor skill base is one of the main factors contributing to the low technological intensity ofmanufactured items in Pakistan. A study by the World Bank (2004) shows that 70% of firmsidentify the supply of skilled labour as an important impediment to business operations inPakistan. The Harbison-Myer skills indicator is a classic skill index based on school anduniversity enrollment. The index places Pakistan below all South Asian countries other thanBangladesh and Nepal. Moreover, this ranking has fallen from 69 to 77 during the period 1985-1998 ( See Table 2-12).Table 2‐12: Harbison‐Myer Skills IndicatorsCountry 1985 (Country Ranking) 1998 (Country Ranking)South Korea 26.8 (6) 36.1 (10)Taiwan 22.5 (21) 27.8 (23)Singapore 14.8 (37) 23.1 (29)Thailand 10.8 (48) 15.6 (45)Malaysia 9.2 (51) 11.1 (55)Sri Lanka 10.1 (58) 9.1 (53)China 9.8 (59) 5.2 (67)India 7.2 (60) 8.1 (69)Nepal 6.4 (71) 5.4 (66)Bangladesh 4.0 (72) 4.3 (76)Pakistan 4.4(69) 4.2(77)Source: Ministry of Industry (2005) 76  
  • 102. Moreover, labour productivity growth rates for Pakistan’s industrial sector remained at 1.48percent from 1992 to 2001 which is far less than other South Asian countries such as Bangladeshand India that stand at 1.52 and 5.05 percent respectively [Japan International CooperationAgency (2006)].Since the inadequacy of skills is a major constraint to the growth and competitiveness of manysectors in Pakistan (particularly those that manufacture exported goods), it is vital to expand theskilled labour base. Basic Education Education augments the productivity of a worker by enhancing cognitive skills. Literature showsthat returns to education increase with the level of education. According to Kingdon andSoderbom (2007), returns to education monotonically increase with education so that an extrayear of education is progressively more valuable when attained at successively higher levels ofeducation. Haque (1977) also finds positive and higher returns to education at higher levels ofeducation. According to a study conducted by PIDE on the returns to education in Pakistan, eachyear of additional schooling results in a 7 percent increase in returns for wage earners [Nasir andNazli (1998)]. In Balochistan, rewards are higher for tertiary education whereas in Punjab they arehigher for secondary education [Jamal et al. (2003), Shabbir and Khan (1991)] find different inter-provincial returns to schooling by using data on male wage earners. At the national level, thereturns to schooling are 9.1% whereas for Punjab and Baluchistan returns stand at 9.9% and 4.4%respectively. According to Nasir and Nazli (2000), gender, regional, provincial, skilled/unskilled,public/private dimensions have significant impact on earnings. Graduates of private schools earn31 percent higher than public schools counterparts. More so, workers with literacy and numeracyskills receive wages that are roughly 15% higher than workers without these skills [Ministry ofIndustries (2005)].Despite the higher returns associated with education, an average Pakistani worker receives abouthalf the average years of schooling that is received in East Asia and around 80% of the years ofschooling provided to workers in other South Asian countries [Barro and Lee (2000)]. In fact, 77  
  • 103. Pakistan ranks last in both primary and secondary education enrollmentin South Asia. Secondary schools in Pakistan serve only two fifths of the population (PIHS, 2001-02). In 2002, even though net enrollment improved slightly at both the secondary andmatriculation level, it declined for primary education. According to official statistics, grossenrollment in 2005-06 was close to 90%, however there is a sizeable drop as we move from theprimary level to the secondary level [See Figure 2-32]. However, according to the World Bank(2009), only 42% of children in Pakistan are enrolled in primary school and of those only two-fifths make a transition to secondary school, with secondary school enrollment standing at16%. Enrollment at matriculation then is only 9 percent. Basic Education Education augments the productivity of a worker by enhancing cognitive skills. Literature showsthat returns to education increase with the level of education. According to Kingdon andSoderbom (2007), returns to education monotonically increase with education so that an extrayear of education is progressively more valuable when attained at successively higher levels ofeducation. Haque (1977) also finds positive and higher returns to education at higher levels ofeducation. According to a study conducted by PIDE on the returns to education in Pakistan, eachyear of additional schooling results in a 7 percent increase in returns for wage earners (Nasir andNazli, 1998). In Balochistan, rewards are higher for tertiary education whereas in Punjab they arehigher for secondary education [Jamal et al. ,(2003). Shabbir and Khan (1991)] find different inter-provincial returns to schooling by using data on male wage earners. At the national level, thereturns to schooling are 9.1% whereas for Punjab and Baluchistan returns stand at 9.9% and 4.4%respectively. According to Nasir and Nazli (2000), gender, regional, provincial, skilled/unskilled,public/private dimensions have significant impact on earnings. Graduates of private schools earn31 percent higher than public schools counterparts. More so, workers with literacy and numeracyskills receive wages that are roughly 15% higher than workers without these skills [Ministry ofIndustries, (2005)].Despite the higher returns associated with education, an average Pakistani worker receives abouthalf the average years of schooling that is received in East Asia and around 80% of the years of 78  
  • 104. schooling provided to workers in other South Asian countries [Barro and Lee, (2000)]. In fact,Pakistan ranks last in both primary and secondary education enrollmentin South Asia. Secondary schools in Pakistan serve only two fifths of the population (PIHS, 2001-02). In 2002, even though net enrollment improved slightly at both the secondary andmatriculation level, it declined for primary education. According to official statistics, grossenrollment in 2005-06 was close to 90%, however there is a sizeable drop as we move from theprimary level to the secondary level [See Figure 2-32]. However, according to the World Bank(2009), only 42% of children in Pakistan are enrolled in primary school and of those only two-fifths make a transition to secondary school, with secondary school enrollment standing at16%. Enrollment at matriculation then is only 9 percent.Figure 2‐32: Gross Enrolment Trends in Pakistan, 2001‐2006 (percent)Source: PIHS (2001-02 and 2005-2006)In the year 2003-2004, around 77% of the workers employed in the manufacturing sector hadeducation level below matriculation [Government of Pakistan (2004b)]. Across firm sizes, smallscale industry employs the least educated in terms of number of years of schooling followed bylarge scale industry. Interestingly, medium sized industries employ workers with relatively greaternumber of years in school (see Figure 2-33). This highlights the need for expanding the educatedworkforce for raising the productivity of firm in the manufacturing sector and hence to make theminternationally competitive. 79  
  • 105. Figure 2‐33: Average Education Attainment of Workers in Pakistan    100% 13+ yrs 80%  7-12 yrs 4-6 yrs 60%  0-3 yrs 40%  20%  0%  Small Medium Large Avg. mfg. Avg. serviceSource: PIHS (2001-02 and 2005-2006) Vocational Training There are considerable benefits from investment in training, such as improvement in worker skills,increase in entrepreneurial activity, facilitation of workers in adapting to technological change andincrease in the rate of movement of workers into more productive sectors [Middleton et al.(1993)].Formal training institutes have been set up in Pakistan with the purpose of broadening the skilledlabor base. Such training institutes have the capacity to train over 200,000 workers, which is about1.2 percent of the 17 million population that drops out from basic education [Ministry ofIndustries (2005)]. However, there is regional disparity in the number of technical education andvocational training institutes across provinces; Punjab has 287, Sindh has 156, NWFP with 55 andBaluchistan only 14 [Japan International Cooperation Agency (2006)].The technical and vocational education and training (TVET) systems in Pakistan remain supply-driven and lacking a national direction. This leads to a shortage of skilled manpower that decreasestotal factor productivity of the manufacturing sector. In order to become competitive in the globalmarket, it is necessary to reform the TVET system, in particular, change it from a supply-drivensystem to one that is connected to market demand. The National Vocational and TechnicalEducation Commission, established in 2005, intends to transforms the existing supply-driven 80  
  • 106. TVET system to a demand-driven one. The Commission also aims to assist provincial governmentsin development of skills, create Public Private Partnership (PPP’s) so that the private sector canclearly indicate the type of skills they are seeking and coordinate national sectoral training policies[The International Monetary Fund (2010a)]. There are also a number of private-public initiatives.They include the Pak-Swiss Training Centre and the Textiles Institute of Pakistan.According to World Bank (2000), the only significant variable that increases labour productivity istraining programs. Moreover, Nasir and Hina (2000) identify the return to training in Pakistan asranging from 2.5 to 4 percent. Nonetheless, most firms in Pakistan do not consider inadequateskill level to be an obstacle in growth even though evidence shows that technical education andtraining increase worker earnings. Due to this belief, very few Pakistani firms provide formal ortechnical training to their employees as compared to other countries. And in manufacturingsector, on average, barely 5 percent firms provide technical training (see Figure 2.34).Figure 2‐30: Provision of Training to Workers International comparison Type of firm South Africa  Avg. Philippines  service Brazil  temp workers  Avg. mfg. regular workers Egypt  Sri Lanka  Large Turkey India Medium Chile  Bangladesh Small Pakistan  0%  10%  20%  30%  40%  50% 60% 70% 0% 10% 20% 30%  40%Source: World Bank (2009b 81  
  • 107. Moreover, training is subject to market failures. The costs of training an employee are sunk costs.Because workers often leave their jobs for better ones, employees under-invest in training. To addto this, a large proportion of Pakistani labour is hired on an informal contractual basis. Thisfurther lessens the likelihood of firms recovering their training costs.Since technical training by enhancing skills of workers can make a potent contribution toindustrial productivity, there is utmost need of addressing the structural weakness in the technicaland vocational education and training systems. Policy Recommendations: Increased Provision of Primary and Secondary Education across the country Basic education is the right of every individual; therefore it is the obligation of the government toensure universal provision of quality education at the primary and secondary level. The first broadpolicy intervention required by the government is to increase the allocation of budgetary resourcestowards primary and secondary education, with the long term aim of achieving universal literacy inthe country. Along with provision of basic education, the quality of education needs to improvesignificantly through improvement and updating of curricula, teacher training programs,regulation of educational and teaching standards in private schools (especially in smaller townsand rural areas where these proliferate) and standardization of education across both private andpublic schools.The disparities across and within provinces in terms of both enrollment and literacy rates have tobe addressed through increased provision of functioning primary and secondary schools by thegovernment in areas which have a higher incidence of illiteracy. 82  
  • 108. Upgrading Vocational Training and Skills Many vocational training institutes have been established, yet their delivery mechanism and policygoals need to be revised. The general strategy in the last few years has been to encourage privatesector partnership through government grants. The requirements of the workplace can usually bebest determined by the employers themselves. In Pakistan employers play a negligible role ininfluencing what is taught in TVET institutes.In 2009, the National Vocational and Technical Education Commission (NAVTEC) wasestablished to overcome the lack of standardization, skill gaps, non-availability of proper curricula,poor quality of instructional staff, inadequate accreditation, poor infrastructure and low privatesector technical education and vocational training capacity. NAVTEC is a regulatory bodyresponsible for long-term planning in this particular field. It will also be responsible for settingstandards for formulating the syllabus, accreditation, certification and trade testing, etc.In 2009, NAVTEC gave PKR2000 per month to each trainee during its training course35.Presently, 1522 technical institutes with an enrollment of 314,188 are operating in the country,providing technical skills to the labour force. The goal is to produce one million skilled laborersper year [National Vocational and Technical Education Commission (2009)].In order to develop a skilled labour force along modern lines, the Labour and Manpower Divisionhas established five Skill Development Councils (SDCs) in Islamabad, Karachi, Lahore, Peshawarand Quetta. The SDCs assess the training needs of their geographical areas, prioritize them on thebasis of market demand and facilitate training of workers through training providers in the publicand private sector. These Councils have met the diversified training needs of the industrial andcommercial sectors and have so far trained 46,674 workers [Mumtaz, K. et al (2010)].In 2006, TEVTA made changes in its loan policy so as to provide loans to its training institutesthat could only be used on books, equipment and student transport and not on real estate or bank                                                            35 http://www.molm.gov.pk/ -> Labor and Manpower Division -> Information and Services -> The steps taken by theGovernment to curtail unemployment in the country 83  
  • 109. deposits. In June 2010, the government moved to make TEVTA functional and proposed to giveseed money of PKR15 million, with the rest of the amount to be generated from TEVTA’s ownresources36.The 2009-2013 NAVTEC Skills Strategy is the first attempt at a formal policy direction for TEVTactivities. The vision is “Skills for Employability, Skills for All.” The strategy aims at a shift fromtime-bound, curriculum-based training to flexible, competency- based training as well as a shiftfrom supply-led training to demand-driven skills development by promoting the role of industry inboth the design and delivery of TVET. The main objectives are to provide relevant skill, improvingaccess, equity and employability while assuring quality [National Vocational and TechnicalEducation Commission (2009)].The reform agenda includes establishing industry specific Centres of Excellence, increasing therole of the private sector, reforming the apprenticeship system, encouraging entrepreneurship,making training delivery flexible, integrating informal economy workers, enhancing workermobility, providing career guidance and placement services, registering and accrediting institutesand reforming the management of training institutes. These initiates when launched at the sectorlevel will trigger industrial competitiveness.The action plan of the government to achieve these objectives is to strengthen institutionallinkages with industry, as training is designed around skills and knowledge that are not necessarilyrelevant to the market. To link the industry and government, it is proposed that sector specificIndustry Advisory Groups (IAG) be established. Each IAG will be represented by members oflarge, medium and small industry, including all sub-industries that fall within the category,international employers, and employees. Their responsibilities will be to carryout periodic sectorsurveys, identify skill needs in their sectors, indicate new and emerging areas and occupations and                                                            36 http://archives.dawn.com/archives/79036 84  
  • 110. determine and update competency standards for workers. IAGs will be established gradually overtime, with the aim to establish two each year until all major sectors are represented.Under the National Skills Strategy, the government proposes to promote and facilitate theestablishment of sector-specific training institutes and Centres of Excellence. These institutes areto be located in proximity to relevant industry in order for them to benefit from new technologies,and to facilitate industry placement of trainees and trainers and also to enhance information flowsbetween the training institute and industry. Where possible, NAVTEC will help Pakistani Centresof Excellence establish partnerships and links with reputed industry-specific training facilitiesabroad.Training by firms is usually workplace-based and therefore, practical and relevant to industry needsbut it does not lead to any nationally recognized certification. Therefore, though workers gainskills, their skills are not formally recognized beyond the boundaries of the firm. The hope is thatleading firms may consider sponsoring a training unit within a public sector institute, wheretrainees can be trained specifically on their machines and according to their requirements andstandards. Such a model may also be useful for clusters of industries which do not have their owntraining establishments and have difficulty financing training individually.The following are two specific programs which can be piloted by the government to incentivize thefirms to train unskilled workers.Skills Development FundUpgrading worker skills requires more than just vocational and technical training. Worker trainingthat is led by firms themselves has an impact on firm-level productivity like in several East Asianand Latin American economies. The problem is that there is a market failure, that firms incurcosts while training. These sunk costs cannot be retrieved when workers leave their jobs. Thusfirms tend to under-invest in training employees.The under-investment effect is magnified when there is imperfect information about both theproductivity value of training and the skill requirements associated with the use of new 85  
  • 111. technologies. To encourage firms to invest in upgrading worker skills, there should be the creationof a Skills Development Fund financed though a payroll levy grant system (Figure 2-35). A smallcompulsory levy of about 1% payroll outlay is imposed on firms, and is matched by thegovernment. Firms are issued vouchers against the contribution they make to training institutes inexchange for the required training. The training institutes cash their vouchers with the SkillsDevelopment Fund.Figure 2‐34: Payroll Grant System  Source: Ministry of Industries, 2005.Implementing such a system will require extensive consultation with the private sector in order toensure ownership and decrease private sector perception of an increased tax burden.Such initiates have been successful in Malaysia and South Africa. Two successful training centersin Pakistan include the Pak-Swiss Training Centre (PSTC) and the Textile Institute of Pakistan(TIP). The PSTC provides training in Precision Mechanics and Instrument technology and itsmandate is extended to the private sector. TIP was established under public funding as a private 86  
  • 112. not-for-profit institution to meet the acute shortage of qualified textile professionals. Its boardcomprises mostly private sector professionals.Skill based Wage Subsidy SchemeIn a skill based wage subsidy the government would pay a certain proportion of the stipulatedminimum wage of an unskilled worker (see Figure 2-36). For example, the firms could pay sixtypercent of the minimum wage to the worker, whereas the remaining forty percent would be thegovernment’s contribution payable through the training institute directly to the worker. The sizeFigure 2‐35: Skill Based wage Subsidy Scheme  Continuous Government feedback & 40% of monitoring Wage Bill Factory registers Factory Fresh Workers at Sector Training Employ Fresh the Institute Institute Workers to Train ‘on the Job’ (4 days 40% of Provide class room a week) based training (2 60% of Wage Bill days a week) Wage Bill Workerof the subsidy would be in accordance to the skill premium. This subsidy would be tied to both,on the job training received by the worker, and, classroom based instruction at the local trainingcenter. To claim the subsidy the firm or employer would have to register the worker at the trainingcenter. With the subsidy in place the employer would have an incentive to employ, register andtrain the worker. The training would be on the job and hence would be relevant to the technologyand skill set required for the specific job. Higher education – University‐ Industry Linkages    There is need for an effective linkage between industry and academia. Industry needs to be thedriver of higher education in engineering and science. Engineering and science degrees need to be 87  
  • 113. developed around industry needs. Following are some proposals to effectively enhance theuniversity-industry linkage: 1. Science and engineering universities need to introduce new courses and degrees in view of local industry needs. 2. With collaboration from industry, state-of-the-art laboratories should be established in universities to meet the R&D needs of business. 3. Government should sanction USD10 million for joint research projects involving universities and industry, based around actual industry problems. Capital Market  Capital markets help mobilize savings and raise investment funds in excess of the loans banks arewilling to provide to firms. Moreover, they help mitigate risk by spreading it across a large numberof share owners.The major sources of credit in Pakistan are banks and trust funds at 67% of assets [JapanInternational Cooperation Agency (2006)]. The Central Directorate of National Savings comessecond at 22%. Seven percent is provided by non-bank financial institutions like developmentfunds, investment banks, leasing, Modarba companies, trust funds, venture capital etc. Theremaining 4% comes for insurance [Japan International Cooperation Agency (2006)].A detailed breakdown of lending categories in Pakistan shows that the fastest growth in credit is inthe personal loan category. As evident from Figure 2-37 below, banks seem to have devoted muchof their resources in expanding the personal loans portfolio rather than lending to privateenterprises and industry. 88  
  • 114.  Figure 2‐36: growth in lending by Borrower Category in Pakistan, 2001‐2007 (base Year 2001)Source: World Bank (2010b)The financial market in Pakistan is shallow as firms rely on retained earnings to finance theirworking capital and investment needs (see Figure 2-37 below). Trade credit and banks plays asmaller role in working capital financing; Pakistan’s firms rely more on internal funds. The patternof funding using retained earnings is robust; ranging from 88% in NWFP to 78% in Sindh [WorldBank (2009b)].Credit rationing in the formal credit market is a major constraint faced primarily by small- andmedium-sized firms (see Figure 2.38) that constitute a significant portion of the industry. A studyconducted by the Lahore University of Management Sciences (LUMS) in 2006 also highlightedthat access to finance is the most critical impediment to the growth of the SME sector. A surveyfound that 57% of new investment by SMEs and 67% of their working capital comes fromretained earnings, whereas according to studies conducted by international organizations, banksprovide only 7–8% of the total funding requirement of SMEs [The International Monetary Fund(2010a)]. This is due to constraints on both the demand and supply side. On the supply side theseare: weak and poorly enforced creditor rights, high unit costs of SME lending, and the reputationof SMEs as riskier borrowers in the financial system. On the demand side the constraints consist ofloan disbursement procedures, high interest rates and collateral requirements that raise the cost ofaccess to credit [Bari, Cheema and Haq (2005)]. As a result of these financial constraints it is 89  
  • 115. difficult for micro enterprises and SMEs to grow in size and scale. The resultant diseconomies ofscale and inaccessibility to efficient technology of production are the main factors behind their lowproductivity, which inhibits their growth potential.Figure 2‐37: Access to Finance by Firm SizeBy applying for loans/lines of credit By result of loan applications 2.0 No. of times applied No. of times rejected Large 1.6 1.2 Medium 0.8   Small 0.4 0.0 0.0 0.1 0.2 0.3 Small Medium LargeSource: World Bank (2009b) Information asymmetries and the fear of adverse selection are factors that restrict commercial banklending to SMEs. This is because the information that SMEs can provide to banks in the form offinancial accounts, business plans, feasibility studies, etc. often lack detail and rigor. This problemis aggravated by the low level of education of small entrepreneurs. In a sample surveyed by Pasha,35 percent were either illiterate or educated to below the matriculation level and unable toadequately articulate their case [Department for International Development (2010)].In order to mitigate the problem of asymmetric information and adverse selection, banks haveadopted precautionary measures such as requiring that financing be collateralized, with collateraloften exceeding 100 percent of the loan. In Pasha’s sample, the average value of the collateral washigher, the smaller the business. This, however, leads to other issues as SMEs generally do nothave many assets that can be collateralized; for example, over 40 percent of the SMEs in Pasha’s 90  
  • 116. survey admitted to not receiving a bank loan because they lacked the necessary collateral.Moreover, it is difficult for banks to take possession of the collateral though legal procedures giventhe slow working of Pakistan’s judicial system. The World Bank team for the 2005 report was toldby banks that the average period for taking custody of the collateral, in instances when they wereable to do so, could be 4–5 years or more after default had been declared, and the time and costsof pursuing the process of obtaining possession kept mounting.Box 2‐1: The Banking Revolution?In January, 2011, at an inaugural ceremony, the former Governor of the State Bank of Pakistan stated that“Branchless banking is the future of the country’s financial sector as it opens up opportunities forbringing unbanked segments of society into the financial system”.Branchless banking—carrying out banking services (cash deposits/withdrawals, utility bill payment,funds transfer etc) using cellular phones—has been gaining attention as it is viewed as an effectivemedium of increasing financial inclusivity through its extensive reach and lower cost of services delivery[Ivatury and Mas (2008); Lyman, Ivatury and Staschen (2006)]. The case of Pakistan is very interesting.With an estimated 12% [Honohan (2007)] banked or having access to financial services but with acellular mobile teledensity of more than 60%37, it presents a unique case with immense potential; so muchso that Auerswald, Bayrasli and Shroff (2010) see it as a key driver of competition in the financialservices industry and recognize it as one of the four key areas that could enable the economy of Pakistanin becoming more entrepreneurial.Currently, branchless banking in Pakistan is in its embryonic stages. There are only two Branchlessbanking license holders: Easy Paisa, which is a joint venture between Telenor and Tameer MicrofinanceBank, was launched in 2009 while UBL Omni by United Bank Limited followed. Both provide similarservices including but not limited to mobile account, money transfers, scheduled bill payments and cashservices. For both the most basic of services can be availed upon providing a copy of originalComputerised National Identity Card (CNIC).In a study conducted by the Boston Consultancy Group for Telenor in 2011, it was indicated that forPakistan a supportive and more flexible regulatory framework would be needed to make branchlessbanking hassle free for its clients and the service providers. Their estimates forecast a potential decreaseof up to 20% in the level of financial exclusion, increase of 3% in GDP and the creation of 1 million newjobs by 2020, through mobile financial services. Whether these forecasts are too ambitious remains to beseen.                                                              37 Figures available at: http://www.pta.gov.pk/index.php?option=com_content&view=article&id=269&Itemid=599(Accessed on 08 Aug, 2011) 91  
  • 117. Moreover, most commercial banks regard SMEs as riskier than large firms due to many reasons.Firstly, SMEs face a more uncertain competitive environment compared to larger companies; theyexperience more variable rates of return and higher rates of failure. Secondly, SMEs are lessequipped in terms of both human and capital resources to withstand economic adversities,particularly unanticipated economic shocks. Thirdly, their inadequate accounting systems and lackof financial controls undermine the accessibility and reliability of information on profitability andrepayment capacity. Finally, SMEs in Pakistan operate in a somewhat ambiguous environmentregarding governance, which reduces the security of transactions. Thus there is a greater risk thatbanks will not get paid, or that assets such as property will not be properly registered.In view of all these difficulties, banks frequently refuse to lend at all or severely restrict the size oftheir loans to SMEs. It is, therefore, not surprising that 86 percent of the SMEs surveyed by Pashahad not acquired a bank loan. Moreover, in the total private sector credit disbursement ofPKR1,669.738 billion in FY2007, the share of the SME sector was a shocking 1.7% [AsianDevelopment Bank (2008)]. Policy Recommendations: The State Bank of Pakistan, under its Financial Inclusion Program (FIP), recently launched twoprograms to enhance the flow of credit to small and rural enterprises. The Financial InclusionProgram was launched in 2009 in collaboration with UK’s Department for InternationalDevelopment (DFID) in order to promote inclusive economic growth through the provision ofsustainable financial services to the poor, small entrepreneurs, women and marginalizedcommunities. The government should help in disseminating information about this particularscheme through the various business/industry associations representing SMEs around the country.                                                            38 State Bank of Pakistan. (2007). SBP Annual Report 2006-07, Vol I. Karachi  92  
  • 118. The first program launched under FIP is the Credit Guarantee Scheme (CGS) for Small and RuralEnterprises in which the SBP will share 60% of the losses from short-term and medium-term loans(up to a maximum of PKR5 million per loan) extended by banks to SMEs. Each loan will have atenure of up to three years and will have an interest rate equivalent to the 3-month Karachi InterBank Offer Rate (KIBOR) rate plus 300 basis points (bps). The initial capital for this scheme is tobe provided by DFID39.The main problem with the CGS scheme is ‘moral hazard’ on the part of both the borrower andthe lender. As the loss to the borrower from defaulting is mitigated by the guarantee given by theState Bank, the incentive of paying back the loan is reduced. On the other hand the lendingcommercial bank does not have the incentive to rigorously scrutinise borrowers and vigorouslyfollow up on the credit disbursed because of the loan repayment guarantee provided by the StateBank.The second program is the Refinance Scheme for SMEs in NWFP, FATA, Gilgit and Baluchistan,with the stated purpose of increasing the supply of credit to SMEs. The interest rates for thisprogram will be floating based on a formula linked to the rates on 6-month Treasury Bills andPakistan Investment Bonds (PIBs).The procedural requirements such as excessive documentation of loan application by commercialbanks are perceived as a major hurdle by SMEs. The government (MOI) should advocate the StateBank to facilitate the development of a uniform simplified and efficient procedure for loandisbursement to small and micro level enterprises. This will substantially reduce transaction costsfor SMEs and increase their incentive to apply for loans.Information asymmetry is the principle factor behind lack of access of SMEs to credit, so it isimperative to have a Credit Rating Agency specialising in the SME sector. The State Bank hassuccessfully launched the Pakistan Credit Rating Agency, however it does not cover the SME                                                            39 http://www.sbp.org.pk/press/2010/CreditSchemes-19-Mar-10.pdf 93  
  • 119. sector. An agency similar in scope but targeted towards the SME sector should be supported by thegovernmentThe government should recommend to the State Bank to promote Venture Capital Funds inPakistan in order to stimulate small-scale entrepreneurship in the country and also rectify creditmarket failures present in the formal commercial banking system. Venture Capital Funds do notonly provide capital but also support nascent enterprises and entrepreneurs with technical andmanagerial support. Such support is crucial for the success and survival of a new business.The State Bank along with the Ministry of Industries should provide information on investmentopportunities in the country and facilitate investment by expatriate Pakistani’s both directly andthrough such Venture Capital funds.Invoice-based financing, where the borrower gives accepted invoices (or receivables) of its businesscustomers or downstream buyers, as collateral to the commercial bank should be promoted by theState Bank as an alternative to collateral based lending.  Land Market Land represents a principal asset for manufacturing firms. In Pakistan, however, inefficient andarchaic land registration procedures and transfer laws have an adverse effect on investment andgrowth in the manufacturing sector.According to Ellis and Dowell (2009), present land markets in the province of Punjab for example,are fairly dysfunctional. They highlight a list of problems faced in the land and housing market.The list includes: excessive public ownership, inadequate infrastructure services, weak propertyrights, pervasive public and private sector rent-seeking, counter-productive urban planning policiesand regulations, costly construction regulations, limited financing for property developmentand acquisition, rent controls and inadequate property tax based revenue-generating mechanisms.Land acquisition is a cumbersome process that results in delays and high costs. Moreover, it isextremely costly to impose penalties if a party fails to abide by the contract. Also, difficult 94  
  • 120. regulations relating to property registration encourage formal titles to remain in place and do notfacilitate land being put to best productive use. In other words, high costs give incentive toentrepreneurs to undervalue their property or evade registration altogether. According to theDoing Business in 2005, data of the World Bank, it takes 49 days to register property and the costof this is 4.2% of the property.Numerous studies have pointed out the deficiencies owing to which land property rights are notclearly defined in Pakistan. These include multiple agencies involved in land registration andtransfer, complex record keeping, and sale transactions without valid conveyance documents.These factors, by effectively removing land from the pool of acceptable collateral in many cases,retard finance access to firms. As the World Bank study (2009) pointed out “without clearproperty rights, lenders will not consider collateral as loan security without an original sale deed inthe banks possession. The resulting ‘dead capital’ [i.e., capital that cannot be used for investment,collateral, or in some other productive purpose] . . . hinders leveraged investment, firm level entry,and efficient resource allocation.” Also, banks prefer using land titles as collateral as they cannotbe moved or hidden [World Bank (2009b)]. Therefore the establishment of secure property rightscan provide incentives for asset owners to actively invest in their property and can increase theeffectiveness of land being used as collateral. Policy Recommendations: The current land registration laws present certain elements that make the acquisition processlengthy and often require high informal costs. In addition to the formal land registration and landtenure system, there are strong and widely used informal land transfer systems, such as oralcommitments, collateral assurances, powers of attorneys etc., that operate outside the formal landregistrations. The existence of these parallel systems is said to have created serious complicationsby providing shelters to land mafias, registration fee evaders, and public sector rent seekers. 95  
  • 121. An even more critical issue in terms of land availability is the "title of record" dimension of landparcels. Under current legislation, the records of rights in land primarily reflect a fiscalresponsibility. The person mentioned in the records is liable for land revenue or property tax; thathe is also the rightful owner is only incidental. The land registration documents only havepersuasive, not conclusive, evidentiary value.In light of the problems stated above, the following steps should be taken immediately: 1. Reform of the Land Registration Act is imperative in order to provide security of titles. 2. There is an immediate need to computerize land records. Therefore the provinces should complete computerization of all land records as soon as possible. 3. There is an immediate need to computerize document land records. Therefore the Provinces should complete computerization of all land records as soon as possible.The provinces are on board with these recommendations, in fact some reform work has alreadystarted in Punjab and Sindh.2.3.4Standards, Regulation & Governance Constraints International Standards and Quality Compliance The use of standards and technical regulations to measure quality has become an inevitable needfor international trading. The use of standards contributes to technological progress by promotingquality and increasing competition. Under the WTO, countries are allowed to decide on nationalstandards in a way that their enforcement does not discriminate between domestic and importedgoods. Compliance implies upgrading production methodologies to international standards andsatisfying conformity assessment procedures.Institutions for quality control and standardization have existed in one form or the other inPakistan since 1950. For example, the Standards Institution (PSI) was established in 1951 under 96  
  • 122. the Ministry of Industries, with the objective of formulating national standards. A TestingLaboratory (CTL) was also established in 1951 under the Ministry of Industries to undertake thetesting of industrial raw material. However, it was in the 1980s that the need for a certified qualitymanagement system became apparent in Pakistan. Thus the ISO-9000 Quality ManagementSystem was introduced and was a good confidence-building measure.A number of other certification agencies entered the country in the late 1990s. Around 10,000firms are now certified. The Export Promotion Bureau and Ministry of Science and Technologyjoined hands with the Pakistan Institute of Quality Control (PIQC) to work towards bettercertification and international quality control. However, there are concerns regarding itseffectiveness [Shah and Shariff (2010)]. Since 2000 onwards, sector-specific Quality ManagementStandards like TS-16949, ISO – 22000, AS9100B, etc. have been implemented.However, the pace of development of quality in the government itself is presently not very strong.Very few original standards in line with the needs of the local industry were developed and agreater part of the productive sector is not acquainted with these standards. For this purpose, anational accreditation body- the Pakistan National Accreditation Council (PNAC)- was formed tobe responsible for qualifying and approving the certification bodies, consultants and trainers.PNAC is a signatory with International Laboratory Accreditation Cooperation (ILCA) and AsiaPacific Laboratory Accreditation Cooperation. Along with the Pakistan Standard and QualityControl Authority (PSQCA) and the Pakistan Council for Scientific and Industrial Research(PCSIR), the PNAC deals with issues of technical barriers to trade (TBT).PCSIR, established in 1953, provides ISO 9000 certificates. PCSIR labs offer testing for exportersbut the facilities are inadequate for exporter needs. Over the years the PCSIR research budget hasalso shrunk, and no significant research is being conducted [Ministry of Industries (2005)]. PCSIRalso lacks a focus on industry and rarely attracts contractual work from the private sector, whichcould potentially improve PCSIR’s financial problems. In Pakistan compliance with qualitystandards is highest in the exporting sector. With textile leading the manufacturing sector with90% of the imports, it is the most aware and compliant domestically [Ministry of Industries(2005)]. However, it falls short in international standards of working conditions, child labour, and 97  
  • 123. environmental standards. There is also a limited ability for measurement, standards, testing andquality. Services in Pakistan that can ensure these are also costly and difficult to access.The private sector has found alternatives by developing in-house techniques by approaching privatetesting institutions or going abroad to higher quality testing initiations. Furthermore investment intesting and accreditation to avoid TBTs is substantial and prevents the exporting sector expansion.There is a need to expand the current network of labs and testing facilities. Public researchinstitutes with testing and certification potential should focus more on developing state of the arttesting and accreditation, rather than engaging in commercial research. The other issue of standardization is that of environmental protection. Health costs for Pakistandue to water pollution in 2003 were estimated between US$1.7 billion and US$4.7 billion[Ministry of Industries (2005)]. Specific industries such as leather, textile, paper and board, sugarand polyester cause more pollution. This is an area of concern since cotton and leather togetheraccount for 70% of total exports from the country [Government of Pakistan (2004a)].Laws in place fall under the Environmental Protection Act 1997, which establishes federal andprovincial Environmental Protection Agencies. The act makes pollution control a priority andfocuses on industrial waste water discharges and air and car emissions. However, regulationrelating to effluents in water bodies have not been enforced [Ministry of Industries (2005)]. Thereare other laws dealing with industrial pollution under the Act but they are qualitative and so havelimited potential for implementation. Governance and Corruption One measure of good governance is the consistent and predictable interpretation of rules by thegovernment officials. However, this area is considered to be a problem in Pakistan as only 46% offirms believes that rules and regulations are consistently applied by the officials [see Figure 2-39]which is worse than that in comparator countries which average at about 60% of firms. Nationally,this perception is weakest in Baluchistan. Similarly small firms are more disillusioned with theinterpretation of rules. 98  
  • 124. Figure 2‐38: Comparison of Consistent and Predictable Interpretation of Rules By firms size and province By international comparison Balochistan  Brazil Pakistan Sindh  Philippines Punjab  Turkey NWFP  S. Africa Small  India Sri Lanka Medium  Chile Large  Average 0 20 40 60 80  100 0 20 40 60 80 100 Source: World Bank (2009b)Corruption has been seen as another major impediment to private sector activity in Pakistan.Bribe incidence in Pakistan has increased from 40% in 2002 to 48% in 2007 [World Bank(2009b)]. According to the Doing Business Indicators (2009), around 57% of the firms consider itto be a severe problem in Pakistan and this percentage is second only to Brazil and Bangladesh (60-70 %) while all the other comparator countries rank better on this indicator. More so, large firmsare more susceptible to corruption, where the percentage rises to 78% [World Bank (2009b)]. Crime and Security The poor law and order condition is another impediment to industrial activity in Pakistan. Theproblem is impacting industry at two levels. The security concerns have created a poor perceptionof Pakistan in international markets and the buyers in these markets have become stronglyskeptical about Pakistan’s ability to supply consistently. This has resulted in loss of several large 99  
  • 125. orders where buyers have refused to work with Pakistani companies. Secondly, the domestic crimesituation and ineffectual role of the ‘thana’ impedes the activity of the private sector40. Theprivate sector is insecure about life, property and assets. The failure of the police to inhibit crimehas resulted in private sector reducing their economic activity in the country. Based on an earlierWorld Bank Survey, the percentage of firms considering law and order to be a major problemincreased from 22% in 2002 to 35% in 2007. Smuggling & under invoicing The Afghan Transit Trade Agreement is a serious issue for industry. A range of goods which areofficially imported for the Afghan market make their way into Pakistan through well-establishedand strong smuggling networks operating on both sides of the Afghan-Pakistan border. Prices ofthese smuggled items in the local market are much lower than those of local manufactures,resulting in an erosion of local market shares and loss in revenue41. One way to control smugglingis to increase the transaction cost of smuggling and reduce the wedge between importable prices oflegal and smuggled goods.The same issue is being faced by significant amount of under-invoicing of imported goods. Theimporters normally import products at very low prices to avoid paying high amounts of duty. Thisevasion of duty leads to lower costs of acquiring the goods and hence it becomes extremely difficultfor the local industry to compete with these imported products. In some cases the manufacturersin the local industry are able to convince the government to set a fixed ‘international trade price’(ITP), however, in most cases the import lobby is able to influence the determination of ITPs intheir favor. For example, the team working on this report was told by a local tyre manufacturerthat the ITPs on some types of radial car tyres was set at a value lower than the material cost of                                                            40  Firms due to the general prevalence of crime devote large resources to security expenses, even though not all of themsuffer such losses. 50% of firms allocate resources to security, while only 10% actually experience incidence of crime.Such needless expenditure on security is detrimental as it results in inefficient allocation of resources which otherwisecould have been put to more productive use. Therefore, the environment needs to be made more secure so that firmswill not devote large sums of money towards security and instead increase their productivity and competitiveness. 41  Field interviews conducted by team under the current project.  100  
  • 126. manufacturing the tyre. Such inadequate governance and corruption is damaging the industrialactivity of the country.  Regulatory Constraints Functioning of Courts  A well functioning court system is essential for creating an environment conducive to investmentand business transactions. In many developing countries, a common impediment in doingbusiness is the absence of efficient courts. Consequently, 80% of people opt for informalinstitutions in order to seek justice [Wojkowska (2006)].Even in Pakistan, the functioning of courts is a significant problem for over one third of the firms[World Bank (2009b)]. In fact, according to the World Bank’s Enterprise Surveys, firms inPakistan identified courts as one of the top ten constraints to investment, as important as politicalinstability and access to finance in 200742. At the provincial level, almost 66% firms in Sindh findthe functioning of courts to be more of a problem. Sindh is followed by Baluchistan, NWFP andthen Punjab. With these poor perceptions about courts, many firms avoid using the judicial systemto settle disputes. World Bank studies [The International Monetary Fund (2010a)] cite a backlog ofmore than 100, 000 cases in the High Courts of Sindh and Punjab, and estimate that when thesecases were taken up by the courts, it took an average of 46 steps. A significant proportion of suchcases took more than 5–7 years to be decided, whereas appeals and implementation of thejudgment took even longer. This could be a reason why the use of a third party to settle disputeshas risen by 70% [World Bank (2009b)].Hence, formal adjudication systems are often unable to settle disputes in a timely and cost-effectivemanner in Pakistan that can act as a severe disincentive to investment particularly foreign                                                            42 World Bank. Enterprise Surveys. Pakistan Country Profile. Available at http://www.enterprisesurveys.org  101  
  • 127. investment. Moreover such slow and costly judicial procedures create unpredictability, a low trustenvironment, resulting in market segmentation and wasteful litigation.In June 2009, the National Judicial Policy came into effect in Pakistan to tackle the shortcomingsin the judicial system. The policy, in particular, aimed to ensure an independent judiciary, clearthe backlog of cases, reduce the time period for disposal of cases and exterminate corruption.However, since the policy is at its inception stage it is too early to measure its effectiveness acrossthe nation [World Bank (2010a)].Contract Enforcement An efficient and effective legal system, particularly enforcement of contracts, is vital forfunctioning of a market economy. This is because lack of procedures for effective contractenforcement restricts contestability, restrains corporatization, increases project risk, reducestechnology transfers and may hamper the development of the financial system [Department forInternational Development (2010)]. As Hobbes puts it in 1651 “He that performeth first has noassurance that the other will perform after, because the bonds of words are too weak to bridlemen’s ambitions, avarice, anger, and other passions without the fear of some coercive power.”Table 2-13 illustrates the ease of enforcing contracts in Pakistan in comparison with that in SouthAsia. This is determined by tracking the time, cost, and number of procedures involved from themoment a plaintiff files the lawsuit until actual payment. In Pakistan, it takes on average 1261 daysand 47 procedural steps to enforce a contract at a cost of 29.7% of the claim value (see Table 2-13).This performance is longer and more costly than in the South Asia region, where it takes onaverage 1052.9 days and 43.5 procedural steps to enforce a contract at a cost of 27.2% of the claimvalue.Table 2‐13: Data on Enforcing ContractsIndicator Pakistan South AsiaProcedures (number) 47 43.5 102  
  • 128. Time (days) 1261 1,052.9Cost (% of Claim) 29.7 27.2Source: World Bank (2010a)Moreover, a survey conducted by the World Bank in 2009 showed that the time and cost ofenforcing contracts greatly varied across cities in Pakistan. The time needed to enforce a contract ison average about 1300 days. In Faisalabad it takes the least amount time (730 days) to enforce acontract, whereas in Peshawar it takes 2190 days. And in Punjab, for seven major cities, it took1116 days on average to enforce a contract at an average cost of 31.9% of the value of the claim.43The costs comprise court, attorney, expert and enforcement fees. Again the costs vary across citiesin Pakistan. They are cheapest in Sukkur (20.6% of the claim value) and most expensive in Lahore(42.8% of the value of the claim) [World Bank (2010a)].It is evident from recent research that, among comparable economies, a country’s effectiveenforcement of contracts is a vital determinant of its comparative advantage in the world market.This means that countries that are able to enforce contracts properly tend to produce and exportmore sophisticated products compared to those with poor contract enforcement [Nunn (2007)].Hence an effective contract enforcement regime is required for Pakistani firms to becomeinternationally competitive. Moreover, it is crucial to develop an efficient contract enforcementmechanism to reduce the cost of doing business in Pakistan. Reforms are in progress to improveenforcement of contracts, which include setting up of judicial tribunals to speedily resolvecustoms, labor, tax and banking disputes [Asian Development Bank (2008)]. However, thesereforms must be pursued with commitment over the long-term to lead to expected results.                                                            43 According to a study of the World Bank in 2008 of the cost of doing business in India, using Ludhiana as thetypical city for the Indian Punjab, it took 862 days on average to enforce a contract at a cost of 20% of the value of thedebt.  103  
  • 129. System of Taxation  Pakistan’s tax system is one of the major hindrances towards growth in the manufacturing sector.According to The Investment Climate Report by the World Bank, in 2009, 40% firms in Pakistanstated taxes as being a barrier in doing business; even though this number decreased from 47% in2002. Over all, taxes increase the cost of doing business, take away the incentive to invest in themanufacturing sector, and create obstacles for local producers to face competitive internationalmarkets, all of which are hindrances towards growth of the manufacturing sector [World Bank(2009b)]. Procedures Pakistani manufacturers have to go through a cumbersome and difficult procedure to pay a largenumber of taxes to many agencies. According to World Bank (2008), Pakistani manufacturers haveto pay taxes to 47 agencies which, on average, takes about 560 hours annually. It is for this reasonthat Pakistan ranks 143 out of 183 countries in the ease in paying taxes indicator, where Chinaranks 140th and Malaysia ranks 24th; Maldives ranks the first in the paying taxes indicator whereit takes less than an hour to pay yearly tax. The time taken for Pakistani manufacturers in payingtaxes is nearly double the global and South Asian average, which are 286 and 285 hoursrespectively. It takes a lot of time for producers to understand the complicated procedure that goesthrough adjustments every now and then [World Bank (2010a)].Between 1990 and 2007, 75 changes had been made to the Sales Tax Act by the Federal Bureau ofRevenue; this shifting set of rules and complicated tax-paying procedures increase compliance costsand undermine the trust of the tax payers. It had been announced that corporate tax rate would befurther lowed to 30% by 2007, which has not come to pass as the corporate tax rate still remains at35%; such discrepancies also weaken the taxpayer’s trust in the government [World Bank (2010a)].  104  
  • 130. Due to the tax rates and complicated tax collection system, tax evasion has become quitesignificant leading to low tax-to-GDP ratio as compared to other countries in South Asia [see Table14]. In 2007, in a country of 156.7 million, only 2.3 million tax payers were registered [WorldBank (2010a)]; of course the reasons stated above cannot be completely blamed for these statistics,though it is up to the tax administrative system to correct this. Until recently corruption within thefederal bureau of revenue was a major problem in tax collection which was curbed to some extentby increasing employee wages, but more needs to be done to avoid tax evasion and to solveproblems in tax administrating agencies.Tax Structures Where the number of taxes and collection procedures are a problem, so are the average tax rates.Recent studies by the World Bank show that, in Pakistan, the corporate income tax rates onprivate companies have dropped from over 55% in the 1990s to a uniform 35%, apart from anadjusted smaller rate for small companies. However, even this decrease in tax rate is not enough.Table 2-14 shows Pakistan’s Individual and Corporate tax rates since 2007 compared to those ofother South and East Asian Countries. In addition to the already high tax rates, the introductionof the Value Added Tax (VAT) or its variant form of GST will further burden manufacturers.VAT, which was to replace the Sales Tax in July 2010, is defined as a multi-stage tax which will belevied on the value-added items at each stage of chain of supply of goods and services. This tax willcause pessimism among producers, making them hesitant about growth in their production.Table 2‐14: individual Tax, Corporate Tax and Tax Revenue Comparisons, 2007‐2009 (% of GDP)Country Year Individual tax rate (%) Corporate tax rate (%) Tax Revenue (% of GDP) 2007 20 35 9.8Pakistan 2008 20 35 9.8 2009 20 35 10.9* 2007 30 33.99 12.4India 2008 30 33.99 12.9 2009 30 33.99 -- 2007 45 33 --China 2008 45 25 -- 2009 45 25 -- 2007 -- 30 8.0 105  
  • 131. Bangladesh 2008 -- 30 8.8 2009 -- 27.7 -- 2007 35 35 14.22Sri Lanka 2008 35 35 -- 2009 35 35 -- 2007 28 27 --Malaysia 2008 28 26 -- 2009 27 25 -- 2007 20 20 13.9Singapore 2008 20 18 14.6 2009 20 18 -- 2007 35 27.5 16.6Korea, Rep 2008 35 27.5 -- 2009 35 24.2 --Source: GoP (2010a). Pakistans tax base is also a major concern as the tax burden is unevenly distributed amongtaxpayers; this needs attention if manufacturing is to grow. The income-tax ordinance of 2001contains 70 pages of exemptions which shelter many activities from taxes and a majority of theweight of taxes falls on the manufacturing sector. According to the recent Economic survey,industry contributed 63% of the collected taxes in 2009-10 whereas agriculture and servicescontributed only 1% and 26% respectively. Even within the 63% total tax collected from theindustrial sector, most is collected from a few large-scale manufacturers. The threshold forcorporate income tax for small companies is very low which would motivate firms to remain small.Also, this discriminatory treatment with taxes creates bias, causing investors to invest in selectedinstruments and sectors.It is rightly argued that the trade of manufactured goods contributes to the growth of themanufacturing sector; for this reason policies should be implemented to make trading amongmanufacturers an easy process. Pakistan has recently taken steps to integrate itself in the globaleconomy. By reforming its tariff system it has become one of the more open economies in SouthAsia. However, there is room for further improvement as there are specific tariffs which, likediscriminatory taxes, exempt certain sectors, leading to misallocation of resources. There is also theissue of complex tariff and tax structures for importers and exporters, both of whom have to pay amultitude of taxes; some of these are: import duties, import surcharge, export duties, income taxon imports and export development surcharge. Again, paying this many taxes after going through 106  
  • 132. complicated procedures disincentivizes manufacturers to import raw materials or to export theirgoods. As local goods are not exported, local producers do not face competition in internationalmarkets lowering growth in the manufacturing sector.Efforts have been made to decrease the compliance cost of taxes as specific tax reforms have beenundertaken in order to improve tax filing and payment. Three large and medium taxpayer units(LTUs) and thirteen Regional Tax Offices (RTOs) have been set up in major cities to educate andfacilitate taxpayers; a universal Self-Assessment Scheme has been introduced to limit interactionsbetween taxpayers and tax officials; institutional reforms have been made in the FBR so it canfunction more practically while an internal audit and internal affairs department has also been setup. Frequent surveys are being undertaken for feedback from taxpayers. These efforts have had apositive impact on tax collection, leading to a decrease in the number of firms that consideredtaxes a major obstacle. However more reforms need to be made in order to make tax collectionsmoother and less of an obstacle in the way of growth for manufacturing firms in Pakistan.Policy Recommendations:  The following are some proposed solutions in this regard: 1. The government should increase controls at the Karachi port and Afghan border to curb smuggling 2. Efforts should be made for tariff harmonization between Afghanistan and Pakistan. A bilateral agreement could be made to adjust tariffs on both sides, with the objective of minimizing tariff differentials to reduce the premium on smuggling. 3. Afghan custom clearance should be conducted at Karachi 4. The Letter of Credit for the import of these products should only be issued in Afghanistan. It should be noted that this has already been implemented. 5. The government should negotiate some degree of quantity control on products meant for Afghanistan, based on the market size or demand estimates in Afghanistan. 6. Rationalization of the sales tax regime in Pakistan would also help in reducing the premium on smuggled goods that are manufactured domestically; e.g. tyres. 107  
  • 133. 7. Another serious issue concerns under-invoicing. To tackle this problem, the government should: o Use International Trade Price (ITPs) lists to reduce the incidence of under- invoicing. 8. Costs of Doing Business: Costs of doing business affect both domestic and foreign investment in the country. These costs relate to bureaucratic inefficiency or red tape, endemic corruption, complicated systems of taxation and business registry to weak contract enforcement systems stemming from dysfunctional provincial judicial systems. We propose the following: o All labour-related issues to be handled at a single window. o All labour-related tax dues (EOBI, WWF, Social Security, etc.) to be lumped as a single payment. o An online system for registration of new businesses should be developed. o All unnecessary procedures of starting a business, such as the requirement to establish a company seal, should be abolished. o Refunds of duty drawbacks and sales tax should be completed in one month. o Businesses should be allowed to keep their three month security deposit with Sui Gas in National Saving Certificates. o Contract enforcement needs to be improved through the following measures: I. Setting up of specialized courts or commercial divisions in existing courts II. Design and implement case management systems in courts. III. Introduce a maximum time limit of three months on all commercial cases. IV. Strengthen the Alternative Dispute Resolution (ADR) System. Encourage and support provinces to replicate the ADR system piloted in Karachi.  108  
  • 134. Competitiveness & Industry Stagnation A competitive economy experiences high economic growth providing more opportunities forindustrial investment and expansion. Competitiveness is a function of the physical, institutionaland environmental factors of an economy which collectively shape the business environment facedby manufacturers [State of Competition in Pakistan, (2009)]. These factors not only determinefuture prospects but also explain past performance of the manufacturing sector of an economy.After closely examining the growth manufacturing sector, we conclude that Pakistan hasunderperformed in providing a growth-conducive environment to its manufacturers.The industrial sector of Pakistan has been rather stagnant and uncompetitive for the past fourdecades. As the graph below shows (Figure 2-40), value-added in industry (as % of GDP) has beenranging between 21% and 27% since 1970. From 1994 to 2003 it was stagnant at about 23%, afterwhich it rose to 27% and has been at that level to date. Pakistan’s value-added has been the lowestamongst comparators, as can be seen in the graph below. Even low income countries add morevalue Pakistan. And while world value-added has also been falling since the 1970s, it started from asubstantial 38% and is still above that of Pakistan. The most important trend to notice is that ofthe lower middle-income economies, in which, according to the World Bank (YEAR), Pakistan isalso included. The average value-added in lower middle-income countries is significantly higherthan that of Pakistan, with a large gap of 14% [see Figure 2.39]. Figure 2‐39: Industry Value Added, 1970 – 2008 (% of GDP) 109  
  • 135. Source: World Bank (2010c). Pakistan and Global Competitiveness The stagnant growth of Pakistan’s manufacturing sector is also in line with its deterioratingranking of competitiveness as measured by the Global Competitiveness Index (GCI) on theparameter of intensity of local competition. Pakistan ranked 83 out of 122 countries in 2008, andwent further down the list of competitive economies to 101 out of 134 countries in 2010. For thelast two consecutive years, Pakistan’s ranking is unchanged at its ranking of 101 [see Table 2-15].The GCI ranking of Pakistan is not very impressive and depicts a dismal picture of localcompetition in the industrial sector. On comparison with its regional competitors, Pakistan isabove Bangladesh, but far below India’s ranking. India outperforms Pakistan across all twelvepillars44 on which the GCI based its ranking. Though Bangladesh is ranked at the 106th positionon GCI, its macroeconomic stability is better than Pakistan. However, on almost all twelve pillars,Pakistan’s performance is better than 42 other countries having similar income per capita in 2010.Pakistan is scaled among other regional competitors like India and Bangladesh as a factor-driven                                                            44 Competitiveness is defined by 12 pillars (institutions, infrastructure, macroeconomic stability, health and primaryeducation, higher education and training, goods market efficiency, labor market efficiency, financial marketsophistication, technological readiness, market size, business sophistication, and innovation) and divided into threecategories (basic requirement, efficiency enhancers & innovation and sophistication) 110  
  • 136. economy; an economy in an earlier stage of development which lacks sophistication andinnovation [Competitiveness Support Fund (2010)].Table 2‐15: Pakistan’s Global Competitiveness Index Ratings, 2003‐2010 2003 2004 2005 2006 2007 2008 2009 2010Rank 73 91 94 91 83 92 101 101Out of 101 104 117 125 122 131 134 133Hard score (out of 3.4 3.17 3.51 3.66 3.82 3.77 3.65 3.67)percentile 27.72 12.50 19.66 27.20 31.97 29.77 24.63 24.06Source: Various Global Competitiveness Reports2.3.4.5 Assessment of Competition in Pakistan’s Manufacturing Industry  Competition and competitiveness are two sides of the same coin. Competition plays a vital role ineconomic development and growth through productivity and efficiency improvement (Carlin etal., 2004). Firms growing in competitive markets charge low prices, practice allocative efficiency,develop new products, innovate in distribution and production, and adapt new technology. Forexample a country-level finding by Sakakibara and Porter (2001) show that export competitivenessin Japan is attributed to domestic competition and not to collusion or government intervention.Competition or domestic rivalry measured by instability in market shares, has a strong and positiverelationship with trade performance in terms of enhancing export shares in world trade. Stabilityof market share of firms in a particular industry marks an overt cooperation among firms. Inaddition, unstable market shares signify competition among firms. These results are robust forindustries involved in research and development in technology-intensive products.A substantial portion of the industrial sector of Pakistan has been characterized by low levels ofcompetition ever since its inception in 1947. From being concentrated in the hands of a fewfamilies to nationalization, the economy finally embarked on the path of market-oriented private-sector-led growth in the late 1980s and 1990s. This privatization was aided by a favourable worldeconomy and led to an increase in economic activity, bringing growth rates to around 7.5 percentin 2005. However, operation of most of the basic utilities still remained in the hands of the public 111  
  • 137. sector. Even in the private sector, large-scale manufacturers continued to enjoy the attention thatthe government bestowed on them.Another important development over the years was the transition from having no small-scalesector, to an indifference towards its existence in 1970s and 1980s and then to a conscious attemptto promote SMEs in late 1990s, allowing the emergence of a nontrivial small-scale manufacturingsector in the industry (Zaidi, 2005). Although the size of an SME does not allow for scaleadvantages, it benefits from the higher level of competition in the market which allow marketforces to dictate outcomes. However, the bias is still towards large-scale manufacturing withpolicies such as preferential access to credit.Even though high concentration ratios in some industries can lead to productivity advantages dueto economies of scale, power is concentrated in a few players resulting in oligopolistic behaviour.While such anti-competitive practices are mostly carried out without government knowledge, thereare instances when they actually occur with government acquiescence. At times price-setting alongwith other defensive measures have been a form of political patronage carried out in the name ofprotecting industry. Such cartelization behavior leads to barriers to entry and exit, dampening thespirit of competition and therefore decreasing the incentive to innovate. This lowers productivityand makes it difficult for the industry to be internationally competitive.The empirical evidence on low total factor productivity (TFP) of Pakistan’s large-scalemanufacturing sector supports the outcome of low competition mentioned above. Raheman et al.(2008) analysed most of the large-scale manufacturing industries in terms of total factorproductivity, which was decomposed into technical efficiency change and technical change(technological adoption). During the time period 1998-2007, the overall TFP growth rate wasmerely 0.9 percent. This comprised a positive technical efficiency change of 1.2 percent but anegative technical change that reduced the overall TFP growth rate to 0.9 percent. Out of theeleven industries in question, seven have a technical change index of less than 1 (see Table 2-16). 112  
  • 138. Table 2‐16: Malmquist Index of Sector Means, 1998‐2007 No. Industry TFP Change TE Change Tech Change PE Change SE Change1 Automobile Assembler 1.013 1.000 1.013 1.000 1.0002 Automobile Parts & 1.002 1.011 0.992 1.000 1.011 Accessories3 Cement 1.023 1.030 0.993 1.027 1.0024 Chemical 1.016 1.026 0.991 1.026 1.0015 Engineering 1.007 1.014 0.994 1.006 1.0086 Oil & Gas Exploration 1.020 1.000 1.020 1.000 1.000 Refinery7 Oil & Gas Marketing 1.038 1.016 1.024 1.000 1.0168 Pharmaceutical 1.005 1.000 1.005 1.000 1.0009 Textile Composite 0.993 1.012 0.984 1.013 0.99910 Textile Spinning 0.998 1.017 0.984 1.015 1.00211 Textile Weaving 0.988 1.007 0.982 1.000 1.007Mean All Industries 1.009 1.012 0.998 1.008 1.004 Source: Rehman et al., 200845.Large-scale manufacturing industries are dominated by a few large players who prefer not to investin new technology and R&D due to lack of pressure from market competition. The industrialsector stagnates as TFP growth rates are low. There is a dearth of empirical evidence on large-scalePakistani manufacturing firms for analyzing industries on the basis of productivity growth anddegree of competition. However, the Competition Commission of Pakistan offers evidences ofanti-competitive behaviour found in key industries like sugar, cement, automobile, and fertilizer(see box 2-4).Box 2‐4:  Cartelization & Case Studies Thus there is a good case for intervention in Pakistan’s manufacturing sector, which consists of many industries that are dominated by large firms that have been accused of collusive behaviour. The Cement Industry One such example is of the cement industry. The sudden price hike of cement in February-March 2007 came after prices rose from July 2005 to April 2006. And while price declined till January 2007, it shot up by PKR50 per bag in the following month. Low product differentiation and high market concentration may give rise to collusive behaviour among cements manufacturers. Figure 1 below shows that 54% of the market is shared by three                                                            45 Rehman, A., Afza, T., Qayyum, A. & Bodla, M. A. (2008). Estimating Total Factor Productivity and itsComponents: Evidence from Major Manufacturing Industries of Pakistan. Pakistan Development Review, 47 (4). 113  
  • 139. manufacturers. Figure1: Capacity Based Market Shares Source: CCP internal research, based on data for the year 2006-07, CCP 2008. It may also be argued that seasonality could be a reason for the price hike. Other factors could include higher demand arising from the construction of mega-structures ( like Gawadar port), a real-estate boom and earthquake reconstruction, yet the rise was still too much, too sudden and too unwarranted. Therefore, the Association of Builders and Developers (ABAD) which buys around 30 percent of cement asked the government to look into the matter, accusing the industry of cartelization. ABAD’s involvement meant that the situation was serious, as bulk consumers like the government and ABAD can not only influence production, but are also protected against sudden price hikes by their contracts. It was small consumers in the end who were hardest hit. In addition, unfair business practices like absence of expiration dates allowed dealers to create artificial shortages to raise prices. In this regard, the Competition Commission of Pakistan (CCP) found a discrepancy and proof of collusive behavior: while the All Pakistan Cement Manufacturers Association (APCMA) claimed that cement could not be stored for more than 10 days, the committee found that it could be stored for around 60 days. This meant that while the manufacturers could cause a temporary shortage, it would not last for long. The CCP’s endeavors were further supported by a company which had left the APCMA and provided proof (by supplying minutes of an APCMA meeting) that manufacturers were allotted supply/production targets, which falls outside the jurisdiction of the APCMA (CCP, 2008). The Sugar Industry The sugar industry has also been very concentrated in Pakistan. Historical political patronage, aided by a licensing system, has made it a rent-seeking industry par excellence. While sugar prices had shown a gradual increase till 2007- 08, it was the major sugar crisis in late 2009 and early 2010 that proved harmful for consumers. The government intervened and fixed the price of sugar atPKR40/kg while raiding hidden sugar stocks. This ill-considered policy intervention led to the creation of black markets where sugar was sold at PKR60/kg, allowing traders to make windfall gains. The price did eventually fall to PKR52/kg once the price limit was lifted. The massive sugar shortage depicts an abuse of free market forces. According to the CCP report, the information obtained from the Pakistan Sugar Mills Association (PSMA) clearly shows that its role was not limited to being a representative of the sugar producers-it also allowed cartelization under its auspices. Not only did it intervene in terms of deciding output and prices, but it also worked with the Trade Corporation of Pakistan to decide on the level of imports to be allowed inro the country (CCP, 2010a). 114  
  • 140. Fertilizer Industry The fertilizer industry was founded in the 1960s when two plants were set up, one of which – National Fertilizer Corporation – was a public enterprise and the other Esso Pakistan Fertilizer (now Engro) was in the private sector , resulting in a duopoly market structure. Even after another player, Dawood Hercules Chemicals Limited, started urea production in 1971, the sector remained largely protected with fixed prices, subsidies, and quotas. The public sector continued to enjoy dominance until complete privatization in 2002. However, even after privatization, the level of concentration was high with Fauji Fertilizer (FFC) and Engro having a majority of the market share. As depicted in Figure 1.XX, the industry is dominated by 6 to 7 players, with FFC and Engro enjoying around 43 % of market power in 2010. This has given the main players substantive power in terms of setting prices. The level of competition has fallen substantially and barriers to entry and exit have emerged. Figure II: Market Power of Participating Firms Collusive behavior was observed in early 2009, when a case of tie-in sales of urea with DAP, (an expensive fertilizer) which had been in effect for quite some time, was brought to the attention of the CCP. The subsequent investigation done by the CCP revealed that the firms were forcing dealers to buy DAP with urea and had cut off the dealership of those who refused. The farmer class was hardest hit, as these policies were inevitably passed onto them by the dealers. The farmers were placed in a difficult position as they could not always afford to buy expensive fertilizer when they wanted to purchase just urea (CCP, 2010b). Source: NFDC data.Anti-competitive behaviour in large-scale manufacturing industries hurts allocative efficiency andproductivity in the economy. Few dominant players in large-scale manufacturing industries protectthemselves from competition and resort to unfair trading practices such as controlling prices, andrestrict trading practices through collusive behaviour. To raise the productivity of themanufacturing sector, competition is inevitable. A dynamic manufacturing sector that can activelycontribute to national and international markets is not viable unless competition constraints areremoved. 115  
  • 141. 2.3.5Other Horizontal Issues & Interventions Knowledge­based Industries through a Full­Scale Science Park The industry in Pakistan is suffering due to an extreme shortage of research and development andinnovation. Although the investment regime of Pakistan is one of the most liberal in the region, ithas failed to attract knowledge based industry investments even from non-resident Pakistanis.In light of this a cornerstone of the proposed industrial policy is the establishment of a sciencepark in Pakistan. The proposed science park will have formal operational links with one or moreuniversities, research centers, or other institutions of higher education. It will be designed toencourage the formation and growth of knowledge- based industries. It will have all theinfrastructure required to attract professionals, consultants and managers and will houseorganizations ranging from R&D to manufacturing, marketing and branding. In short, theobjectives of the establishment of a science & technology park in Pakistan are the promotion oftechnology commercialization, transfer and diffusion by fostering links between Industry anduniversities, R&D labs, and promoting the formation and growth of knowledge-based companies.A science park fulfils several purposes that are critical to the success of the 2010 industrial policy.Most importantly, it enjoys the status of an R&D establishment, which means it sidesteps the sameWTO regulations that prohibit any subsidies to local organizations. Local organizations can beencouraged to indigenize through collective government sponsored R&D and build brands withina science park.Second, a science park captures the entire product cycle, rather than just focusing onmanufacturing. It provides incubators for scientific innovations as well as a production center forcutting-edge products. Universities will be playing a very strong role in the emergence of theproposed science park and will be required to supply trained human resource and a knowledgebase for industrial innovation. 116  
  • 142. Third, a science park provides economies of scale and scope with respect to commoninfrastructure facilities (such as transport, power, information and communication technologyconnectivity, office and production space, and waste treatment) and technical services (such asrecruitment, training, mentoring, financing, networking, and legal and IPR consulting).Finally, through delegation of powers to the science park level, various ministries and governmentbodies can achieve coordination, a goal that otherwise remains difficult to achieve.The aim is to create an environment where knowledge-based industries can thrive and the requiredprofessionals can reside with their families. The total area for the park will be about 200 hectares.The project will be executed in 3 phases. Phase 1 will include the survey of different sites inPakistan for the park and the selection of the most suitable site including a detailed feasibilitystudy. The 2nd phase will include building the infrastructure as well as building and recruitingpark clients. The last phase will include facilitating the investment environment for the clients andbuilding bridges between different universities of Pakistan, R&D institutes and park clients.Policy Recommendations:  The government of Pakistan should incentivize the investment environment in the science parkthrough the following measures: • Absorb initial startup costs for the science park • Provide infrastructure of the park including amenities • Establish venture capital funding for start-ups • Provide five year tax holiday • Ensure industrial laws and regulations simplification • Ensure delegation of power from several other government agencies to park administration for ‘one stop operation’ • Pass special commerce and tax laws for science park operation • Ensure cooperation programs among universities, research institutes and park clients • Provide transparent, competitive R&D grants 117  
  • 143. Development of Industrial Estates, Special Economic Zones, Export Promotion Zones Industrial zoning and infrastructure is significantly deficient in Pakistan. The Industrial estateswere developed several year ago and lack modern attire and facilities that are required by modernage industries. Even in places where the government has established new estates/zones the privatesector has resisted moving to these states either due to poor planning or due to exorbitant landprices. When designing most of these estates the economic opportunity cost is hardy consideredand in some cases prime agriculture land has been reserved for ill-organized industrial activity. Wehave considered Special Economic Zone and location choice in much more detail in the sectionon spatial aspects; however, we have presented some policy guidelines to address other issues: Policy Recommendations:  The following is proposed in this respect: 1. To promote the growth of existing and resource-based industries the government should create industrial estate and agro processing zones at the identified ‘hot spots’ of economic activity. This mapping is provided in Chapter 5 of the report. This should be done while preserving agricultural lands and observing municipal zoning laws. 2. The government should develop these estates through the provision of necessary soft and hard infrastructure and world class logistic facilities. 3. The government should facilitate estates and zones in: • Accessing appropriate technology. • Obtaining information about modern methods of production. • Improving quality standards such as phyto-sanitary measures for agriculture processing. • Product branding and up gradation. • Accessing international markets. • This should be done by creating linkages with universities, research centres available locally and internationally, and by creation of centres of excellence. 118  
  • 144. • Captive power generation should be permitted at the estate level. • Effluent Treatment Plants and Solid Waste dumping sites should be established in all industrial estates. Incentives such as tax break should be provided for local construction/fabrication of effluent treatment plants. • With falling duties, the attraction of EPZs (where imports are duty free) has fallen dramatically. EPZ such as the one in Gujranwala should be turned into an industrial zone. • The government should rationalize its existing portfolio of industrial estates. The failed estates or SEZs (e.g., Gadoon) need to be liquidated and lessons learned from their failures. Sukkur Small Industrial Estate should be developed. • Business incubators for SMEs should be set up to reduce costs for business start-ups. Assisting Sick Industrial Units In any business not all firms survive due to a variety of reasons however in relatively efficientmarkets the productive capacity of failed firms is acquired by others. In Pakistan due to difficultiesin liquidation of businesses a huge amount of productive capacity lies dormant at any point intime. The government should institute a more transparent and efficient procedure/system to helpdistressed firms get out of business quickly and at least cost.Policy Recommendations:  • Recommend changes to the bankruptcy laws to make it easier for businesses to acquire distressed firms. The transition and exchange of hands in business will be made swifter under these legal revisions. • Also fully support the Corporate Rehabilitation ACT being developed by SECP and ensure that the ACT covers the possibility of providing technical support in reviving the sick industry. Implementing Cleaner Production Programs  119  
  • 145. Growth of the industrial sector cannot be visualized without strengthening cleaner productionprograms in the country. As defined by the United Nations Environment Program (UNEP),cleaner production is “the continuous application of an integrated environmental strategy toprocesses, products and services to increase efficiency and reduce risks to humans and theenvironment.” The implementation of cleaner production programs is an integral part of thepolicies that aim at increased competitiveness and increased efficiency of firms because they helpfirms save energy, conserve water, control pollution, ensure safety of machines and equipment,improve health and safety of workers, improve environmental conditions and the image of thefirm at the local and international levels.Policy Recommendations:  • Encourage and promote investment in local manufacturing of cleaner production equipment along with other emerging environmental technologies. However, in the interim period the Ministry should advocate policies that ensure low prices for imported cleaner production equipment. • Pilot projects that help demonstrate costs and benefits of private investment in cleaner production technologies, e.g., CO2 recovery, should be initiated as part of awareness raising campaigns. Similarly, awareness raising seminars and training programs should also be used to harness full benefits of cleaner production programs. • A policy for cleaner production needs to be devised that offers tax incentives and tax rebates to compliant firms and to firms who want to establish Effluent Treatment Plants. These incentives should also apply to those who get ISO 14001 certifications. • Offer tax incentives to encourage private sector to set up quality testing and certification laboratory facilities in all sectors, especially those relating to textiles, sugar, leather and pulp and paper sectors. • Allocate funds for next ten years to set up well designed landfill sites for disposal of hazardous and non-hazardous industrial solid waste and installation of Hi-tech incinerators. 120  
  • 146. • The existing National Environmental Quality Standards (NEQS) were developed in isolation without consulting all the stakeholders. That is the reason why these Standards are non-productive and hard to implement in their present form. There is a need to revise the NEQS in consultation with all the stakeholders. The new NEQS should be industry/sector specific and should be based on the ground realities. Trade and Economic Linkage with India Despite the potential for massive gains from greater economic integration between India and Pakistan,46a hostile political environment has hamstrung the formation of closer economic ties between the twocountries leading to the lack of success of the South Asia Free Trade Area (SAFTA). Pakistan accountsfor less than 0.5% of India’s trade and India accounts for less than 1% of Pakistan’s trade (Khan, 2011).At the time of partition 70 percent of Pakistan’s exports were to India and 63 percent of India’s exportswere to Pakistan. Empirical studies done on the potential impact of trade with India clearly show thatthere are net aggregate gains from trade to both countries. The potential benefits of greater economiccooperation between Pakistan-India are large and range from efficiency gains as a consequence of tradecreation, access of Pakistani industry/businesses to the bourgeoning Indian market, transfer of technology,meeting of energy shortfalls across the two countries to movement of human and capital resources. Inempirical studies which use the gravity model approach the expected increase in bilateral trade betweenIndia and Pakistan ranges from as little as 0.5 times greater (Rahman et al., 2006) to 10 times greater(Hirantha, 2004). Interestingly, a study by Baroncelli (2007) finds that if regional animosities relent, astaggering increase in trade of 400% can be realized (Khan, 2011). In a recent study Khan (2011) attempts to determine the potential for trade between India and Pakistan.Based on the gravity model estimates, this paper constructs actual-to-potential trade (APT) ratiosfollowing Egger (2002) and Batra (2004). The lowest APT ratios of the two countries were for their tradewith one another. The ratio for India’s exports to Pakistan was 0.02 while the ratio of Pakistan’s exports                                                            46 Kemal et. al (2002), State Bank of Pakistan (2006), Panagayria (2007), Naqvi and Schuler (2007).  121  
  • 147. to India was 0.01 for the period 1976-2005. These statistics were 0.05 and 0.02 for the period 1996-2005.Inversely, the potential-to-actual trade is 20 times greater than recorded trade or it can expand from thecurrent $2.1 billion to nearly $42 billion provided that mean relations estimated by the PIIE gravity modelhold (Khan, 2011).As mentioned before, the major gain for Pakistani industry and businesses from increased trade with Indiawould be through access to its large and growing market. This would allow firms in Pakistan to enjoyeconomies of scale and strengthen their competitive advantage generating both income and employmentdomestically. Moreover, there would be positive trade creation effects as India could supply Pakistan withpotentially cheaper inputs which are currently imported at a relatively higher cost. Also, given the factthat the two countries have similar factor endowments and technologies, the scope of intra industry tradeis substantial. Trade in energy is another area where there can be major gains to both countries. Thebenefit to Pakistan from both royalty and a share in the supply of Iranian gas routed through Pakistanwould relieve the binding energy constraint which has crippled Pakistan’s manufacturing. Finally, in thelonger term, movement of labor and capital across borders posits major gains across both countries.The following are some short-term and medium-term strategies which have to be adopted by bothcountries to harness this potential for trade. Short-term measures basically make good on the proposalsdiscussed and agreed upon at the Musharraf-Singh 2005 meeting such as easing visa restrictions,eliminating the requirement that ships touch a third-country port before bringing in imports, openingadditional bus routes and border crossings among others. Medium-term measures include removal ofconstraints from FDI and services trade, lowering tariffs on chief Pakistani exports by India, allowingtransit trade from India by Pakistan, energy and information technology (IT) trade among others. Inconclusion, short-term and long-term measures that exploit the potential for trade can create vestedinterests that support more far-reaching liberalization policies and also foster a harmonious environmentin which the political problems that have bedeviled India-Pakistan relations can find repose.  122  
  • 148. Engaging Pakistani Diaspora The Ministry of Overseas Pakistanis, Government of Pakistan, estimates that close to 6 million47Pakistanis are settled abroad, mostly in the Gulf region, United States and Europe. Though theremittances received from these regions, over the past few years, have been on the constant rise, theseexpatriates present an opportunity the gains from which have not been fully realized.As highlighted by Newland (2004), remittances are not the only channel through which expatriates cancontribute. Market development (outsourcing of production), technology transfers, philanthropy, tourismand other intangible flows of knowledge and cultural influences are some of the other means. By sharingknowledge and networks, the diaspora is able to enhance the social capital available in the country oforigin enabling it to take advantage of ‘brain gain’.One of the key ways in which the economy of Pakistan could be helped by this brain gain is through thepromotion of entrepreneurship [Auerswald, Bayrasli and Shroff (2010)]. Two examples of such initiativesare: the partnership between Lahore University of Management Sciences (LUMS) and Organization ofPakistani Entrepreneurs (OPEN) and The Indus Entrepreneurs (TIE). With appropriate governmentintervention for the promotion of such initiatives, linkages between local and foreign Pakistanientrepreneurs could be strengthened at a larger scale, fostering greater economic growth and povertyreduction through ventures in high impact industries.Looking at some of the countries in this region, such as India and China, it is not difficult to realize thatmuch needs to be done. Both countries have actively sought to galvanize the potential of their respectivediaspora through preferential policies, availability of special instruments to the expatriates and promotionof ventures undertaken [Singhvi (2001); OECD (2002)]. On the flip side, India, which is closer to home,                                                            47 Figures available at: http://www.moops.gov.pk (Accessed on 08 Aug, 2011) 123  
  • 149. has achieved success with its diaspora initiatives in little over a decade—not a significantly long period oftime. For Pakistan, this means that there still might be time to catch up with the rest. 124  
  • 150. 3 Competitiveness of Key Industrial Sectors of Pakistan A key component of the 2010 industrial policy comprises increasing the global competitiveness ofvarious significant sectors in the country. The sectors are selected on various bases, includingwhether the sector provides an input that is critical to downstream industries, enjoys significantdomestic demand, and has potential to become internationally competitive to boost exports. Inthis report we present brief analyses of the challenges facing such sectors along with strategicrecommendations. We should note at the outset that in this task we were helped by various studiesthat have already been completed by organizations ranging from SMEDA to the EDB. Similarly,agencies such as JICA and the World Bank had completed studies that proved to be useful.A sectoral approach adds greater specificity to policy recommendations. In the past, theGovernment of Pakistan has generally relied on blanket policy interventions. Blanket policyinterventions, while useful in defining the broader contours of industrialization, more often thannot, tend to inadequately address the sector specific tradeoffs. For example, whenever, APTMA isable to convince the government to devalue the Rupee, it creates negative externalities for thepharmaceutical sector which is dependent on imported raw material. Analyzing various sectorsalerts us not only to the sector-specific challenges but also to potential conflicts between them.In formulating sector level policies, four considerations were foremost in our minds. First, weaimed for dynamic comparative advantage, or competitive advantage, rather than staticcomparative advantage. In other words, we are of the view that Pakistan should not keepsupporting only industries where it has a resource advantage (e.g., textiles) but also broaden itssupport to span sectors where it can develop a competitive advantage based on capabilities. Inindustries with resource-advantages, value-addition must be the goal. Second, Pakistan must investin ramping up for industries where it is likely to grab global market share. These are industrieswhere either production has become too costly for more developed nations, or industries wherethe knowledge gap is not prohibitively large (e.g., industries where knowledge, technology orcomponents are no longer proprietary). Pakistan will have to quickly move into the sectors where 125  
  • 151. gaps are appearing in global value chains. Third, Pakistan should ensure that local enterprises areable to exploit all potential local demand, in particular focusing on industries where large demandexists domestically.48 Finally, in order to boost export competitiveness, a key strategy should be‘outward foreign direct investment’. This will involve plugging value chain gaps (e.g., absence ofR&D or branding knowledge) by buying assets abroad.Below, we provide descriptions of three primary sectors (steel, chemical and fertilizer), followed bythose of several downstream sectors.3.1 Primary Industrial Sector This section of the report covers three of the primary industrial sectors of Pakistan; Steel,Chemicals and Fertilizers. These sectors are important not only in terms employment and revenuegeneration, but also as significant contributors in supporting the competitiveness of the valueadded Industry. All value added industry, be it textile, leather, engineering or food processing isdependent on inputs produced by these industrial sectors. If Pakistan has to improve its industrialcompetitiveness it will have to significantly upgrade and strengthen these primary/ancillaryindustries.3.1.1Chemical Industry In recent years, the global chemical industry has become one of the fastest-growing manufacturingsectors despite soaring crude oil prices and stricter international environmental protectionstandards. It is now well established that because of forward and backward linkages, polymerconsumption has a significant multiplier effect on GDP growth. Moreover, the chemical industry                                                            48  It is now established that securing the domestic market gives local firms the platform from where exportcompetitive products can be launched. Furthermore, research has shown that “ ‘national’ ownership to secure thehome market (defined by majority stock ownership and directorships) has become more critical over time for fivereasons: Without national enterprise, the illegality of local content regulations under WTO law is binding, outwardforeign direct investment is implausible, out-sourcing for developed countries is untenable, establishing brand namesis impossible, and reversing brain drain of the top national talent is less likely.”  126  
  • 152. is considered to be a major driver for innovation, and, developments within it have strong positiveeffects across industries such as auto, rubber, textiles, consumer products, agriculture, petroleumrefining, pulp and paper, health services, construction and metals. In India for instance, thechemical industry has been a leading driver behind economic growth.A key by-product of oil refineries is Naphtha, which when cracked further, produces ethylene,butadiene, propylene, benzene, toluene, paraxylene etc. for a number of downstream industriessuch as Textiles, Paints, Plastics, Pharmaceuticals, Agriculture, Packaging and others (see Figure 3-1). Pakistan has no facility to produce basic olefins like Ethylene, Propylene, Butadiene, Styrene aswell as aromatics like Benzene, Toluene and Xylene due to absence of Naphtha cracking facility.This has resulted in limited growth of chemical and petrochemical industry in the country.At present, the petrochemical industry of Pakistan is mainly downstream and includes productionof polyvinyl chloride (based on imported Ethylene), synthetic fibres (based on imported MEG),Purified Terephthalic Acid (based on imported Paraxylene), aromatics and carbon black. Currentdemand of the Petrochemical based Products is around 2.0 million tons/year [BOI, (2010)] (Table3-1). For manufacturing of these products, a large quantity of basic raw material is imported e.g.,Pakistan spent around $1 billion on import of these polymers in 2009 (Table 3-2) [BOI, (2010)].Similarly, the chemical industry is not fulfilling domestic requirements, as a result every year alarge amount of foreign exchange is also spent on the import of different chemicals. This hascaused a burgeoning chemical import bill of approximately US$ 4 billion49 which isapproximately 12 percent of total imports. Given the high demand for inputs/raw material by thedomestic downstream industry there is a vast potential to manufacture petrochemicals within thecountry.                                                            49 Federal Bureau of Statistics (2008-09) 127  
  • 153. Figure 3‐1: Petrochemical Value Chain Source: : ‘Pakistan Petrochemical Market”, Lotte Pakistan, 2008: 16 128  
  • 154. Table 3‐1: Demand for Petrochemical ProductsProducts Quantity Metric TonsPolypropylene 15,000Polyethylene 200,000Polyvinyl chloride 90,000Polystyrene 30,000Monoethylene glycol 400,000Synthetic fibres 730,000Pure terephthalic acid 400,000Total 2,000,000Source: BOI, (2010)Table 3‐2: Import of Basic Chemicals in Pakistan (Million US$)Product HS Code Import value (Million US $)Polymers of ethylene, in primary forms 3901 383Polymers of propylene, other olefins in 3902 317primary formsPolymers of styrene, in primary forms 3903 27Polymers of vinyl chloride, other halogenated 3904 20olefinsStyrene 290250 36Ethylene glycol (ethane diol) 290531 162PTA 291736 47Total 992Source: UN Commodity Trade Statistics DatabaseIt is evident that the lack of integration in Petrochemical industry of Pakistan is hampering thegrowth of downstream chemical industry. For the establishment of a fully integrated industry, it isimperative to set up a naphtha cracker plant in the country which is the missing link in the valuechain. Pakistan has a crude oil refining capacity of 12.81 Million Tons/Annum50 and there arefurther refining projects in the pipe line which will increase this capacity in the near future.Refineries produce around 900,000 Tons/Annum51 of Naphtha which is being exported at anominal price because of absence of Naphtha cracking facility in the country. Thus, a large-scalenaphtha cracker in Pakistan is the need of the hour. There have been many studies conducted                                                            50 Ministry of Petroleum and Natural Resources51 Pakistan Energy Yearbook 2008 129  
  • 155. recently which have stressed the need for establishing such a facility.52 With this building block inplace a large number of chemicals can be produced which include plastics, synthetic rubbers,fertilizers, explosives, solvents, dyes and pharmaceuticals. The estimated cost of this project is US $1.5 Billion53. However, it is imperative to mention that such a facility and investment should bemade by the private sector. The role of the government should be that of a facilitator. Governmentmay invest in developing more detailed feasibilities and taking stock of national resources andfurther use this information to attract private sector interest. During the period of this study theresearch team met with three of the largest chemical units in the country and all showedsignificant interest in making investment in this arena if suitable and consistent policy support wasprovided.Keeping in view the importance of a naphtha cracker for the development of the chemical industryand subsequently for spurring growth in other sectors, it is imperative to revive the hydrocrackerproject through public-private partnership. There needs to be an expeditious decision on this asthe costs of installing a hydrocracker plant/complex have risen substantially. In 1992, its cost was$350 million54, whereas the current international estimates of constructing the project are around$ 1.5 Billion. India and Singapore are some examples where the government has played an activerole in the establishment of cracker plants. In India majority of cracker projects are either stateowned or in public-private partnership. The largest naphtha cracker in India is established by stateowned Indian oil which started production in March 2010.Similarly, Petrochemical Corporation of Singapore (Pte) Ltd, a joint venture between theGovernment of Singapore, The Development Bank of Singapore Limited and the Japan-SingaporePetrochemicals Company Limited (JSPC), established a $2 Billion petrochemical complex aftersetting up the country’s first cracker plant in 1984.                                                            52 Second Quarterly Report 08 (SBP); BOI; Technology Based Industrial Vision and Strategy for Socio-economicdevelopment (PIDE)53 Oil & Gas Pakistan; BOI; p-2054 http://www.dawn.com/wps/wcm/connect/dawn-content-library/dawn/in-paper-magazine/economic-and-business/the-elusive-hydrocracker-project 130  
  • 156. Investments in naphtha cracker worldwide are dependent on local availability of feedstock anddownstream demand55. China and India are the demand centers therefore more investments havebeen made in naphtha crackers. Opportunity also exists for Pakistan where naphtha feedstock isavailable and demand for chemical products is reasonable (import of ethylene polymers rangebetween 200,000 tons to 300,000 tons per annum during 2005-200956 which is expected to growfurther). Policy Recommendations: The chemical industry must be developed in order to steer the composition of industrial outputtoward more capital-intensive and technology-intensive sectors and engineering heavy productswith the aim of upgrading our export profile and reducing our reliance on costly imports. Webelieve that significant inter-industry externalities will be generated by focusing on the chemicalsector.  • Begin groundwork for the establishment of a petrochemical complex in Hub. This complex should include a refinery, a naphtha cracking facility, and facilities for manufacturing of certain petrochemicals for which demand has been ascertained. Hub is a suitable location because Byco (formerly Bosicor) refinery is already located in the area and another refinery project is proposed at that location. After expansion Byco will be the largest refinery in the country while National Refinery and Pakistan Refinery are located nearby in Karachi which produce more than 60%57 of Naphtha in the country. This will provide easy access to Naphtha and reduce transportation costs. This will have to be a public-private partnership given the magnitude of investment involved with significant investments to be made by the private sector. The textile industry will be a major beneficiary of this initiative. Despite extensive BMR, the industry appears to have shifted down the value chain in the past few years, with many value-added units closing down. Also, while the world has moved to MMF-based textiles, Pakistan has remained hugely dependent on cotton-based textiles. The establishment of a Naphtha cracking facility should greatly boost the downstream                                                            55 Chemicals in the Middle East 2020, McKinsey & Company, 2008, pp.556 UN Commodity Trade statistics57 Lotte Pakistan 131  
  • 157. development of MMF based textiles, technical textiles, and facilitate the processing sector which is hugely dependent on imported chemicals. • In order to proceed with the above initiatives, we recommend that the chemical industry be brought under the purview of MoIP rather than the Ministry of Textiles, where it is currently housed. 132  
  • 158. 3.1.2Steel Industry Steel is a critical ingredient for most intermediate and final products in an industrial economy,and it is difficult if not impossible for Pakistan’s industry to become competitive without a reliablebase for steel production. Pakistan has an abundance of iron ore deposits (with the largest oneslocated near Kalabagh (an estimated 300 million tons), Dilband (200 million tons) and Chiniot(100 million tons). Unfortunately, despite this availability, local steel production has not kept pacewith increasing demand (see Figure 3-2), and Pakistan has become increasingly reliant on steelimports, that limits the expansion in the value added industry..Figure 3‐2: Demand and Supply Gap of Steel in PakistanSource: ‘National Steel Policy’, Engineering Development Board, Pakistan, (2010: 13)It is clear from the figure above that the gap between demand & supply of steel is increasingdramatically. The present gap of 1.4 million tons is projected to increase to more than 3.6 milliontons by the year 2015.Pakistan’s total installed manufacturing capacity of steel is estimated to be around 4 million tonswith capacity utilization averaging around 80%. The following are the major players in theindustry: 133  
  • 159. • Pakistan Steel Mills (the country’s only integrated steel plant) • Steel melters (re-melting imported & locally generated scrap) • Steel re-rollers (using local manufacturing & imported & ship-demolition rollable materials) • Ship demolition industry Box 3‐1: The Steel Industry of ChinaIn 1949, steel in China recorded a production of a meagre 158 thousand tons. However, by 1996, the Chinese steelindustry had forged its way to the number one place in the world in terms of production with over 100 million tons.This breakthrough was achieved with prudent industrial policy of China towards its steel sector. Back in 1960s,China adopted a series of standardized designs in the steel industry and set up billet mills, rod mills, cross-typesection mills, seamless pipe mills and high plate mills. Furthermore, with the development and spread of continuouscasting techniques, the steel industry underwent a thorough up-gradation in the 1980s.After achieving dominance in terms of quantity, the industry is now focusing on improving the quality of itsproducts in order to supply a high percentage of the needs of its most demanding customers, such as automobilesand electrical appliances. This is particularly true of steel sheets which have to be imported in order to satisfy thedemands of a number of industries. In order to achieve this, a vigorous program has been set in motion to invest inequipment that will improve steel quality. This includes continuous-casting equipment and improved rolling &finishing equipment. The hot-strip mill has become a focal point, with five new units starting production in the2000s.Source: Hogan (1999) and industry reportsWith an installed capacity of 1.1 million tons, Pakistan steel is the country’s only integrated steelplant employing blast furnace and converter technology with total dependence on imported oreand coking coal. Their product mix include continuous cast slabs & billets, rolled billets, hot-rolled flat products, thin strip, pig iron and hard coke.In the steel melting sub-sector, there are about 110 units with an installed capacity of 2.0 milliontons. Most of these units are run in the informal sector and their product range includescontinuous cast billets, thin ingots, and a non-standard product called ‘runners’. On the otherhand, the installed capacity in the steel re-rolling sub-sector is in the vicinity of 3.2 million tons.Their product mix includes rebars for the housing & construction sector and a wide range ofstructural steel sections for industrial and other applications.Until a few years back, the ship demolition sub-sector was a supply source of close to a million tonsof re-rollable & re-meltable scrap besides forged steel shafts, non-ferrous scrap and serviceable 134  
  • 160. engineering goods. However, due to a sharp increase in the international market for demolitionvessels, the output of this source has declined to a negligible 0.2 million tons (NationalManagement Consultants, 2007) .All sub-sectors of Pakistan’s steel industry suffer glaring weaknesses, some of which are: • General fragmentation leading to conflict of interests within the industry sub-sectors; resultantly leaving little room for the government’s fiscal measures to induce capacity enhancement. • Aging of equipment installed at Pakistan Steel Mills resulting in a breakdown frequency much above internationally acceptable levels; lack of preventive maintenance and the inability of the Pakistan Steel to carry out major capacity enhancement during the 25 years of its operating life. • Old and obsolete technology being used by the steel re-rollers with an industry-average rolling capacity of plants less than 2 tons/hour. The same problem of obsolete facilities is faced by the ship demolition industry.Since Pakistan Steel Mills is the sole source of supply for more than 450 medium capacity andsmall capacity foundries in the country, therefore, it is extremely important to revive PSM. TheGovernment of Pakistan has been under serious pressure to privatize the steel mill as it iscontinually running in a deficit. The amount of money that the government had to pour into thesteel mill to keep it running exceeded Rs 25 Billion in 2009-10. However, we feel that privatizationis not the solution to this problem. Privatization will only result in asset stripping and loss of anasset for which the government in future may not have enough recourse to re-establish. The steelmill should stay in control of the public sector, however, governance and transparency in itsoperations should be achieved. A possible way of addressing the problem of steel mill managementis to contract it out to a professional steel management company using a transparent internationaltender for public private partnership. The management should be negotiated against strict targetsand the remunerations should be tied to the performance against these targets. 135  
  • 161. The private sector in the steel industry is mainly clustered in Lahore, Gujranwala and morerecently in Peshawar and Noshera. The Steel Melters Association of Pakistan claims that around80% of the countries steel producing furnaces are located in Lahore and Gujranwala (EDB Report,2010: 20). The major impediment to the private sector is the limited availability of power. Steelproduction’s major input is electricity and given the current shortage the industry is extremelyhandicapped.In the backdrop of the above, Pakistan’s policy on steel is to decrease reliance on imports anddevelop and expand the indigenous steel industry. Policy Recommendations: Based on the importance of steel as a basic industry, foreign currency constraints, employmentconsiderations and the ability of the steel industry to insulate Pakistani economy from worldeconomic cycles, we recommend the following: • Triple the capacity of the PSM over the next 5 years to make it economically viable. The government will take steps to attract investment into enhancing PSM’s capacity to 3 million tones. • Incentivize further steel production with a goal of producing 8 million tones of steel indigenously by 2015 by establishing an industrial park. This park will be given priority in terms of power, gas and financing. The park will also contain facilities for foreign experts, whose visits will be sponsored by the government. • Invest in the enhancement of existing knowledge resources. For this a steel and metallurgy institute will be set up in conjunction with the PSM, universities and downstream industries. • Re-evaluate the impact on overall industry and the basis on which FATA was allowed tax exemptions on running steel furnaces. 136  
  • 162.  3.1.3Fertilizer Industry Agriculture is one of the major economic sectors of Pakistan contributing around 22% of GDP.Fertilizer industry is one of the key suppliers of raw material to the agriculture sector. Investmentsin improved fertilizer technology have made a vital contribution to the economy by helpingfarmers improve crop yield and productivity over the last few years. With population predicted togrow by 19 % by 2025, the country’s need for enhanced food production will be critical.Combined with a predicted decrease in arable land up to 25% per capita, the crop yield per acremust rise.As it is, in 2008 imports of Urea and DAP reached approx Rs 82 bn. As depicted in Figure-I, after2018 if not before, the demand supply gap will begin to widen. If further capacity is not added andPakistan continues to import fertilizer, the burden due to current import subsidy will be immense.Figure 3-3 shows the Pakistan’s fertilizer import - DAP has the highest share in imports as there isonly one plant producing DAP in the country.Figure 3‐3: Pakistan’s Fertilizer (N.P.K) Plant Capacity & Demand (000’ tons in nutrients) Increase in Capacity bySource: ‘Development of a National Fertilizer Strategy for Pakistan’, Arthur D. Little, 2009: 15 137  
  • 163. Figure 3‐4: Pakistan’s Fertilizer ImportSource: ‘National Fertilizer Strategy, Pakistan’, Arthur D. Little, 2009: 45In addition, a recent study conducted by Arthur D Little consultants has identified Pakistan’sNPK mix (Figure 3-4) as one of the reason for below average crop yield compared to othercountries and suggested a mix of NPK- (Nitrogen, Phosphorus, Potassium) ratio of 65:17:17.Keeping in view the demand and to stop ongoing imports of fertilizers in the future, an additional1,000 - 1,500 tons of urea and 1,000 - 1,500 tons of DAP are needed annually until 2025 tobalance the NP ratio. Potassium fertilizer (K) is to be imported because of a lack of any accessiblepotassium footprint in the country.Another critical issue facing the industry is availability of natural gas. For nitrogen based ureafertilizer the primary input/raw material is natural gas. Government of Pakistan is the majorstakeholder in the gas utility companies providing gas to the fertilizer plants. Fertilizer sectorconsume 16% of total gas supply of the country out of which 80% is used as feedstock. However,natural gas demand has far exceeded the available supply. Figure 3-5 shows that indigenous gasreserves and planned projects in pipelines, which if materialized could give energy security for ashorter period. However there still will be a supply gap post 2015. This situation calls for betterresource management to sustain the growth of the industry.There is a dire need for both government and the fertilizer companies to thrash out an alternatesolution to work around limited gas availability without (1) substantially cutting domestic ureaproduction and hence raising reliance on imports and (2) weakening contribution margin for urea 138  
  • 164. players. A two pronged strategy is recommended where on one side focus should be on managingthe existing resources efficiently and on the other hand efforts should be made to increase the gassupply (new explorations and long term contracts with neighbouring countries).Figure 3‐5: Comparison of Pakistan’s NPK Ratio with other CountriesSource: ‘Development of a National Fertilizer Strategy for Pakistan’, Arthur D. Little, 2009: 80 Figure 3‐6: Pakistan’s Gas Demand and Supply BalanceSource: ‘National Fertilizer Strategy, Pakistan’, Arthur D. Little, 2009: 63To better utilize the existing resources, it is advisable to link the subsidy on gas with efficientutilization of gas. This will force the manufacturers to improve energy efficiency in their plants byupgrading these to reduce gas consumption. Fertilizer plants should also be encouraged to investin alternative feedstock for energy production (water, solar, coal, fuel oil, bio fuel) which canreduce the burden on gas reserves. 139  
  • 165. Similarly, efforts should be made to use alternative feedstock and reduce the consumption ofNatural Gas. Energy sector which is so far the largest consumer of gas needs to switch toalternatives like hydro, nuclear, solar and coal based technologies. Demand in transport sector isgrowing at fastest pace and efforts should be made to use alternate bio fuels (bio diesel, bioethanol). Only the fertilizer sector is completely depending on Natural Gas because it is by originthe key building block to produce Ammonia. Alternative feedstock (naphtha, fuel oil) are limitedin Pakistan and while coal is expensive (because of quality of Pakistan’s coal reserves) and lessefficient than Natural Gas58. With expected future increase in gas prices further studies should becarried out to assess the possibility of using coal based plants. As China is the only country whichhas coal based ammonia plants, their assistance could be sought to develop alternate feedstockstrategy for the fertilizer sector. Policy Recommendations: Being the backbone of agricultural productivity, the role of fertilizers will always remain crucialand owing to its strategic importance, we recommend the following: • Incentivize industry to add further capacity of Urea and DAP in line with the suggestions of ADL. This will correct the current NPK mix. • Conduct energy audits of fertilizer manufacturing plants to assess their energy efficiency, and vary their gas subsidy based on their efficiency. • Incentivize fertilizer plants to invest in alternate modes of energy production. • Explore the feasibility of coal as alternate feedstock. • Keeping in view the rising energy demand and supply gap, efforts in further explorations of reserves needs to be expedited                                                            58  ‘National Fertilizer Strategy, Pakistan’, Arthur D. Little, 2009: 80  140  
  • 166. 3.2 Value Added Knowledge Based Industrial Sectors  3.2.1 Auto & Farm Machinery Industry The auto market is one of the largest segments in world trade. The annual size of automotiveexport trade in the world has grown to a massive level of over US$ 600 billion, which accounts forabout 10 per cent of the world export [‘The automobile market of Pakistan’, UNESCAP, (2005:1)]. Changing models, improving fuel efficiency, cutting costs and enhancing user comfort withoutcompromising quality are the most important challenges of the auto industry in a fast globalizingworld. Hence there is a need for exploring the industrial complementarities in the South Asiaregion for better quality, favorable costs, fuel efficiency and attractive designs. The automobilemarket of Malaysia is a case in point (see Box 3-2).Automobile sector is one of the fastest growing sectors in Pakistan. It contributes towards thenation’s economy in the form of technology transfer, employment, investment and much more.Automobile sector contributed over PKR23 billion to the national exchequer in the year 2003-04(www.pama.org.pk).Box 3‐2: The Automobile Market of MalaysiaIn late 1970s, the Malaysian automobile market had 11 assemblers of automobiles. The volume of importedCompletely Knocked Down (CKD) units increased rapidly during this period due to government protection oflocal assembly. However, the excessive number of makes and models produced by the 11 assemblers for the smalllocal market made it difficult for local part makers to achieve economies of scale, reflected in high prices and lowlocal content., (averaging only 8% in 1979). The local content was largely limited to tires, batteries, paints, filters,seat-belts and glass items. There was official dissatisfaction with the slow growth of and limited local participationin the industry, encouraging the idea of a state-led development of a ‘national car.’ The first national car company,Perusahaan Otomobil Nasional (Proton), was then launched in 1985 as a joint venture with Mitsubishi. Withstrong support and protection from the state, Proton has managed to dominate the passenger car market byoffering the most economical price. By 1995, it managed to capture 77% of the domestic market and alsoexported its cars to 28 countries, accounting for 23% of total sales. Afterwards, the government initiated a 2ndnational car project named Perodua, to produce smaller passenger cars for the local market. Perodua also receivedpreferential treatment from the government and its Kancil model became the 2nd best selling car in Malaysia. Thegovernment has also encouraged other automotive projects due to which the Malaysian auto industry consisted offinal assembly, parts and components producers, supporting industries (input suppliers of parts and componentproducers), repair services, franchised distributors and financial agencies.Source: Jomo Sundaram (2007) 141  
  • 167. It is estimated that 32% of Pakistan’s 170 million population is urbanized with over 60% of thepopulation aged between 15-35 years. Additionally, Pakistan has one of the lowest motorizationlevels (8 vehicles per 1000 persons) in Asia compared to India (11), Indonesia (21), Sri Lanka (25),and Malaysia (641) [BMA Capital report, (2009)]. These factors indicate that the domestic marketfor automobiles is large and has the potential to grow tremendously in the future.Figure 3‐7: Motorization Levels per 1000 personsSource: United Nations World Statistics pocketbook and Statistical yearbook, BMA ResearchThe supplier industry is driven by the level of subcontracting provided by the assemblers and bythe auto replacement market. According to the Pakistan Association of Automotive Parts &Accessories Manufacturers (PAAPAM, 1995), the supplier industry consists of about 1900 firms.These firms fall into two quite distinct segments, one supplying to the replacement and the otherto the OEM market, i.e., to assemblers. About 75% of the firms supply to the replacement market.These firms are small with an average of 4 employees, belong to the informal sector, and supplygenerally low-quality products. The remaining 25% of firms supply components to the major 142  
  • 168. assemblers. These Original Equipment Manufacturer (OEM) suppliers are relatively large (averageof 100 employees) and were mostly developed by Pakistan Automobile Corporation (PACO)through technical assistance and other support.Until 2006 a deletion program was followed in the Auto industry. Due to some structural reasonsas well as poor governance leading to smuggling and under-invoicing, the deletion program couldnot be as successful as one would have hoped. Indeed, by many accounts after many years, with afew exceptions, major OEMs have achieved less than 40% local content. This too is incomponents that are inherently difficult to import (e.g., seats, batteries, tyres etc). Moreover,transfer pricing where it occurs, acts as a disincentive to produce locally. Where the auto industryhas localized, it has yielded highly favourable results generating almost 200,000 jobs and anextensive vendor industry. Several parts are now produced competitively within the country, andin some areas we are ideally poised to even export. However, a few barriers continue to preventthis industry from growing further. Policy Recommendations: The automobile industry is essential for promoting related industries, enhancing utilization oflocally-made components, encouraging the upgrading of technology, engineering and technicalskills, therefore we recommend the following: • Strictly enforce the Tariff–based System (TBS) which is officially in use, but effectively in abeyance. This is absolutely crucial. In the absence of effective monitoring, the progress of local auto industry will be severely impeded. • Revise the indices that are still quoted for parts deletion. These are not based on international prices and are misleading. New indices need to be based on international prices of respective components, and the TBS needs to be brought in line with these. • Transfer pricing severely impedes the development of a local market, and benefits parent companies of OEMs. While Pakistan officially has an ‘arm’s length’ rule in effect, it is very weak. Application of the arm’s length principle by FBR needs to be considerably strengthened. 143  
  • 169. • Granting of Pakistan-specific licenses for assembly restrict the export potential of OEMs in parts of the industry where high levels of deletion have been achieved. The government needs to take remedial steps to eliminate this constraint. In this regard, priority will be given to three sectors: two-wheelers, three-wheelers and tractors. These are the sectors where most deletion or indigenization has been achieved, and these are poised for international growth. Starting with these sectors, the government will a) complete deletion fully, b) facilitate the acquisition of foreign brands and c) facilitate the establishment of joint ventures where such restrictions are not in force. • Establishment of Clusters: Three different clusters should be organized within the Auto and Farm Machinery sectors. Two automobile clusters should be located in Lahore (Sheikhupura Road, near Motorway) and Karachi (near Port Qasim). These will cater to cars, motor cycles and three wheelers. Furthermore, a Tractor and Farm machinery cluster should be located in Daska (near Gujranwala). • In order to facilitate deletion, and develop local parts based on global standards, an Auto Design Institute will be established in conjunction with NED University. All OEMs will be required to collectively sponsor this Institute, and transfer technology through this initiative to vendors. The government should sponsor foreign consultants to come and stay at the Institute for the next two years, within which the Institute should complete full localization. • Indigenization and development of local industry has suffered in the past whenever fully made up cars (whether as cabs or otherwise) have been imported. This practice should not be allowed in the future.3.2.2Electronics Industry Electronics is one of the largest manufacturing sectors in the global economy. It is considered asone of the world’s fastest growing industries with market size of $ 1659 billion in 2008, which iscomparable to automobile approx $ 2500 billion59. The industry in search of low cost destinations                                                            59 World Electronics Industries 2008-13, ’, Decision Etudes Conceal, 2009 144  
  • 170. offers huge potential to developing countries. Singapore, Malaysia, Thailand, Taiwan andPhilippines are some of the examples where electronics is the largest export industry.Developments in this industry have an impact on other sectors in the economy such asautomobiles, telecommunication, engineering etc.Electronics industry in Pakistan is still in infancy and unfortunately never became a major revenuegenerating industry despite the huge potential of electronics industry for developing economies.The industry largely focused on activities confined to assembly operations based on importedComplete Knocked Down (CKD) or Semi Knocked Down (SKD) kits and materials. Nevertheless,industry assembles a variety of products ranging from power supplies, inverters, converters toconsumer electronics (TV, Cassette Recorders and DVDs), telecommunication equipment to moresophisticated manufacturing operations like Printed Circuit Board (PCB) and wafer fabrication.Most companies are involved in consumer electronics while there are few companies involved insophisticated production/assembly but using imported components or sub-assemblies. Therefore,contract manufacturing by domestic firms under the patronage of foreign firms (OEMs) did notincrease the technological know-how.The electronic sector in Pakistan could not develop to the desired level due to a host of issueswhich are mainly because of the absence of a long term vision for the development of this vitalsector. Unlike Malaysia, Korea, China and India where the electronics industry attracted focusedgovernment attention which provided various incentives and an enabling environment for makingprofitable investments. Foreign investors found these countries attractive to establish JointVentures, Technical collaboration and set up facilities to produce cost effective products. Critical Issues Following are major issues that have impeded development and growth of this sector: Poorly Articulated Value Chain   145  
  • 171. As stated earlier, assembler imports majority of components. There is no deletion policy adoptedin electronics industry as the case in automobile which hinders the transfer of technology. Thissituation indicates that even large multinational companies assembling TV sets are as a matter offact engaged in import business, as they are actually selling the imported parts just after givingthem the shape of an assembled product.In past Pakistan has an indigenization/deletion programme for different products of theengineering industry which was formulated in 1987 to promote the engineering base of thecountry. It aimed at facilitating the exploitation of available resources; the transfer of technologyand linkages between large, medium and small-scale industries. The programme encompassed theengineering, electrical goods and automobiles industries. Under this programme tariff exemptionswere linked with local content requirements. This deletion programme for electronics industry wasabandoned in 2001 following the World Trade Organization (WTO) Agreement on Trade-RelatedInvestment Measures (TRIMs) which came into force in 199560.Later, Government introduced Emerging Electronic Products Assembly Scheme (EEPAS) in Tradepolicy of 2001 which was very much focused on assembling. Under EEPAS indigenization is notnecessary. To facilitate investors, CKD kits @ 5% Customs Duty are allowed for various items andthe determination of local manufacturing status is not required. These include television sets,cellular mobile phones, VCD & DVD players, cassettes player, electronic calculators, radio,microwave ovens and CLI apparatus. Lack of Technological Know How  Pakistani electronics manufacturing firms are dislocated from the main international sources oftechnology and research & development. It is because industry is confined to the assembling ofimported components. It operates in relative isolation from the world centres of science andinnovation and is behind in engineering and technical skills. Universities in Pakistan are not                                                            60 Trade policy review’, WTO, 2006: 99 146  
  • 172. technologically advanced and other educational and technical /vocational institutions are poorlyequipped. Low Foreign Direct Investment  The most effective way of enhancing competitiveness is collaboration with foreign companies.Table 19 below compares the foreign direct investment in Pakistan’s electronics industry withPhilippines which eyes $1 billion investment in 2010. It shows that Pakistan has very low level ofFDI in electronics.Table 3‐3: Foreign Direct Investment in the Electronics Industry, 2002‐2009  (US$ Million)Country 2002 2003 2004 2005 2006 2007 2008 2009Pakistan 26.4 17.6 17 16.5 21 22 51.9 39.9*Philippines 270 230 443 776 732 1400 400 484.1*Till AprilSource: Economic Survey of Pakistan, ‘Electronics Industry’, SEIPI p.10The low level of foreign investment indicates that the industry does not have significant foreignsupport which is the most effective tool to improve quality and strengthen competitiveness amidincreasing competition with imported goods and rapid expansion of markets. This in turn mayhinder favorable development of the industry in future. This situation can be contrasted withPhilippines where electronics the largest export industry. Leading component manufacturers andOEMs have established their plants with billions of dollars of investment.However, foreign collaboration must move beyond the assembly stage. In other words, forward andbackward linkages needs to be created and sector needs to transform from consumer to theprovider of inputs. Foreign investment direction should be directed by the government andforeign investors should be facilitated to go into joint ventures with local firms. The only way thatPakistan can establish an innovative technological base is by diffusing imported technologies todomestic firms. Therefore, the government should import foreign technologies only in the form of 147  
  • 173. technology licensing, technology transfer agreements with foreign firms, capital goods imports andreverse engineering. Box 3‐3: Electronic Industry in ChinaChina started from focusing on developing R & D institutes and training centres in early 1950s. By 1959, 25 Chinesenational universities were teaching classes in electronics fields, including radio technology, vacuum electronics,semiconductor technology etc. it started developing this industry initially for military application with soviet assistancebut later shifted to other areas. Its impressive performance in this industry over the years is mainly attributed tolaunching large projects of national importance aimed at solving the common problems being faced. This includes‘Golden series’ projects which include a nationwide public economic information processing network (Golden BridgeProject), an electronic monetary and modern payment system (Golden Card Project), a foreign trade informationsources network (Golden Customs Project), an electronic taxation system (Golden Taxation Project), the industrialproduction and circulation information network (Golden Enterprises Project), an education and research network(Golden Intellectual Project), an agricultural management and service network (Golden Agriculture Project), and anational economic micro-policymaking support system (Golden Policy Project). In addition, long-range nationalplanning encompassing the electronics industry includes a semiconductor project called the 909 semiconductormanufacturing projects, the air traffic control system project, and the Three Gorges Dam project.China has been luring outside investment with incentives like subsidized loans, tax exemptions, and a 50 percentdiscount on land. FDI has focused on attracting high-tech industry; upgrading foreign-invested enterprises beyondsimple processing and assembling; and inviting foreign purchasing, venturing, or investing in state-owned enterprises.China’s policies for encouraging foreign trade include the following: • The government has designated 5 SEZs, 14 open coastal cities empowered to exercise the same policies as the SEZs, and a series of zones along the Chinese coast connecting the SEZs and open cities to form a coastal opening belt; these offer attractive incentives for foreign investment and trade. • A government-sponsored export network includes several hundred factories nationwide, producing a range of products; participants receive guaranteed supplies of electrical power, raw materials, tax reductions on inputs, and attractive purchase prices. • Special investment funds are made available by Ministry of Foreign Trade & Economic Co-operation (MOFTEC) for the technological upgrading of selected enterprises. • Preferential treatment is given to Sino-foreign joint ventures if they are categorized as either export-oriented or technologically advanced projects; for example, enterprises that export 70 percent or more in value of their products may reduce their income tax liability by half at the end of the tax reduction or exemption period. • Local enterprises are exempted from import duties on raw materials provided by overseas suppliers to meet export contracts or for use in manufacturing exports. • The People’s Bank of China (PBOC) offers trade credits in domestic currency to exporting enterprises (most of them foreign trade corporations (FTCs)) to finance exports. • PBOC offers export seller’s credits to Chinese enterprises selling electronic and machinery equipment in the international market. • Credits (in foreign currency) are extended to buyers of complete sets of Chinese-made machinery and electronic equipment valued at a minimum of US$1M per transactionSource: Pecht (2006) 148  
  • 174. Trade through Illegal Channels and Under Invoicing Local industry is able to meet the 75% of the domestic demand. Rest is imported to fill the gap.Current import duties on luxury consumer goods encourage people to invest in illegal activitiessuch as smuggling through the Afghan transit trade (ATT) and under invoicing of importedproducts to cut duties. The local market prefers the latest product and buys from smugglers ortheir comrades.61 For example, one industry executive told during the interview that their latestLCD is available in the local market which they have yet to launch. This not only affects theindustry but also a loss of revenue for Government. Similarly, under invoicing is one of the issueswhich also need to be dealt with. Strategic Direction Pakistan has lagged behind in the development of its electronics industry; therefore, a coherentstrategy is needed to be put in place to develop this sector with a view to increasing the country’sgrowth potential as well as achieving self-sufficiency by reducing dependence on foreign sources ofproducts, materials, components and equipment. China, Singapore and other Asian countries areexamples to learn where countries without strong local capabilities have become major exporters ofelectronics products in international markets. They paid attention to integrated productionsystems, starting by performing relatively simple assembly. Many countries have managed toupgrade their role by moving into greater local content, design and development, regionalmarketing and so on. China and Singapore is worth mentioning for advanced electronics, withimpressive design capabilities and growing local linkages (Box 3-3 and 3-4). The strategy adopted bySingapore was based on FDI and the country followed a strict focused criteria. If Pakistan adoptsthe same strategy FDI will definitely add to resources and capital formation. This will transferproduction technology, skills, innovative capacity and international marketing network.                                                            61 ‘National Electronic Policy’ Engineering Development Board, p.20. 149  
  • 175. Given our infrastructure, however, we believe that it would be very difficult for us to go directlyinto manufacturing of components. It would be more prudent for Pakistan to develop capabilitiesin system design instead. This is the model India has followed. System design involves innovationin architecture and function. Using mostly off-the shelf components, entrepreneurs innovate tocreate new designs. In due course of time, manufacturing of Printed Circuit Boards and othercomponents follows.Box 3‐4: Singapore Electronics Industry The Singapores semiconductor industry has grown from humble beginnings as an assembly- and test- subcontracting supplier to a fully integrated, cutting-edge technology wafer fabrication hub. It was because Singapore Government focused on learning, technological acquisition, rapid movement up the industrial ladder, and the skills of its working population. On the other hand, their government provided capital, tax concessions, infrastructure, education and skills training, and a stable and friendly business environment. Following are the salient features of Singapore’s strategy employed over the years: • Economic Development Board (EDB), a governmental body that had more autonomy than normal government ministries established in 1961, acted as a one stop shop for developing the new industries in Singapore. • EDB was governed by its own Board of Directors. It has freedom to develop its own salary structure and promotional grades and procedures, conduct commercial affairs etc, without being bound by governmental rules and regulations. • Reduced the tax rate for approved industries to 4 percent. The incentive could be enjoyed for up to 15 years. • Taxes were also reduced on royalties, license fees and R&D costs payable to overseas enterprises. • Export incentives were also given by way of duty-free inputs as well as enhanced tax allowances for market development expenditures overseas. • The Government also sought to encourage the establishment of even larger firms by exempting firms with fixed assets in excess of S$150 million from income tax for up to 15 years. • After 1970, Initial emphasis to develop low-tech, labor-intensive industries was changed to high- tech industries. • To facilitate the transformation, EDB initiated overseas industrial training schemes, joint Government-industry training centres and provided local industrial training grants for developing necessary skills. • To attract Multi National Companies (MNCs) they provided substantial cuts in taxes and fees to reduce the cost of production. MNCs in electronics industry in 1970s and early 1980s were a major thrust for Singapore. • Since 1991, Singapore’s strategy revolved around industrial clusters. Ten areas are singled out for special attention by the Board. These are: electronics, chemicals, life sciences, engineering, education, healthcare, logistics, communications and media, headquarters and promising local enterprises. Source: Tan (1999) 150  
  • 176. Policy Recommendations: The competitive advantage of our electronics industry must be shifted from low wage labormanufacturing organized by multinationals to low cost, rapid ramp-up, high volume andincreasingly automated manufacturing activities. In order to achieve this, we propose thefollowing: • New courses in systems design must be initiated across engineering universities around the country. These course need to be designed jointly by faculty and industry experts. • In order to kick start this process, the government should initiate a series of workshops open to related entrepreneurs, faculty and business people. Foreign experts should be invited to conduct these hands-on design workshops. • The government should also identify other mechanisms to transfer design skills to Pakistan. • Where there is demand of a particular electronics item, e.g., energy savers, the government should first look to local parties. If a part can be manufactured at home, local vendors should be preferred. • As a matter of priority, the government should facilitate anyone who wishes to initiate manufacturing of Printed Circuit Boards in the country. • EME College should be given a grant to establish an internationally accredited design, testing and certification institute.3.2.3Pharmaceutical Industry  The size of the local pharmaceutical market is around US$1.5 billion. The local manufacturescomprise 60% of this share and the multinationals account for the remaining. Over the recentyears, the local industry has experienced impressive growth (double digit) as compared tomultinationals in the local market. Industry sources report that the potential in this market is 151  
  • 177. huge62. The market size can easily exceed US$2.3 billion by 201262 in Pakistan as incomes increaseand the health expenditure as percentage of GDP increases (currently 1% - US$7/8 per capitaspending). The industry is currently struggling due to lack of chemical industry in the country,poor governance, lack of compliance with standards and electricity shortages. In addition, theindustry also complains that strict regulatory control on prices of about 900 active ingredientscreates distortion in the market and impedes effective supply to end consumers.Another area where the local industry has raised concerns is that the government policy forpharmaceutical sector by design has always been pro-multinationals (MNCs). The policy allowsMNCs to act as price leaders in the market. As most of the MNCs are driving their profits out oftransfer pricing, they set drug prices at unreasonably low prices. This creates a disincentive for thelocal industry to compete.In comparison, India has always had a strong protectionist policy for its pharmaceutical industry.During the protection period the Indian industry rode high on the bases of large local demand.The Indian industry gained significant momentum and size over the protection period. Thedifference in scale is evident with Pakistan having only 400 manufacturers and India having25,000 units. The market share dispersion is also extremely different in India as compared toPakistan. In Pakistan the MNCs are the largest and there is a significant difference in size of anMNC and the largest local industry, on the other hand in India, whereas, the MNC are part of thetop 10 the shares/size are almost equal to the local companies. Under the protection period theIndian plants were able to invest significantly in production capacity and using the strong supportof their ancillary industry such as chemical was able to emerge as a global leader in thepharmaceutical industry.The Indian industry felt threatened to the introduction of the TRIPs agreement as until that timethe industry was only producing drugs through reverse engineering. But with new patent lawsunder the TRIPs which protected not just the process but also the product made posed newchallenges for the industry. However, with government support and strong management in theIndian pharmaceutical industry the challenge was seen as an opportunity. The pharmaceutical                                                            62 Pakistan Pharmaceutical Manufacturers’ Association (PPMA) 152  
  • 178. industry for the first time post TRIPs realized the gains to me made through research anddevelopment. The industry started to invest heavily in new drug formulations and started applyingfor patents. Box 3-5 below presents the recent developments of some of the pharmaceuticalcompanies in India. Indian ratified the TRIPs agreement in 2005, and in a little less than 5 yearsthe Indian industry has emerged a leader in original drug formulations as well. This policy ofenhanced expenditure on research and development aided by the policy of outward FDI hasresulted in Indian companies acquiring several pharmaceutical companies around the globe. Thisstrategy has helped India emerge even stronger post TRIPs agreement.Box 3‐5: New Drug Filings of Some Successful Indian Pharmaceutical Companies 1. Ranbaxy Laboratories is one of the most successful companies and have filed six Abbreviated New Drug Applications (ANDAs) in 2008 showing extreme focus on research and development. It also has the largest basket of products for the US market with 141 approved drugs and another 98 applications waiting in pending. The company has also filed 271 Drug Master Files (DMFs) comprising 48 Active Pharmaceutical Ingredients (APIs). The company has also managed to secure patents on 12 of the total 185 patents it has applied for. 2. Dr. Reddy’s has so far filed in 122 cumulative ANDAs and have already received 13 final approvals for the USA and 4 from Canada. In addition 7 approvals are tentatively granted by the US. Moreover, Dr. Reddy’s has the largest APIs pipeline in the Indian pharmaceutical industry and has filed 23 DMFs only in 2008. In total they have filed for 281 DMFs, out of which 127 are in the US. 3. Aurobinda filed the highest number of ANDA’s and DMFs from India in 2007-2008 (47 were filed and 17 were approved). It has approval on 67 ANDAs from the US FDA and has also filed in a total of 318 patents. Globally the company has 1017 DMF filings. Source: Company websitesThe Pharmaceutical industry is also suffering due to lack of compliance with the quality andstandards requirements of international markets. Majority of the plants/units in Pakistan do notconform to the minimum quality standards, certified production processes, health & safetymeasures and quarantine issues. This has been a result of inadequate investment, lack of awarenessand the local industry doing business for ‘life style management’ and not processing themanagerial capabilities of building corporations. India, on the other hand, has over 800 WHOcertified units; Pakistan has yet to come up with one. Another important compliance requirementis the enforcement of ‘Good Management Practises’ (GMP). GMP compliance is a necessaryrequirement of the US FDA. Several local companies whereas, have managed to get GMP 153  
  • 179. compliance certificates but implementation of requirements are not adhered to (i.e.) compliance isonly limited to process and not to functional implementation.The local pharmaceutical industry in Pakistan is still predominantly small scale. The reason is thatthe local industry is mostly financed by equity and none of the bigger groups in Pakistan haveventured into this industry due to the lack of technical knowhow. Pharmaceutical industry innormally classified as a knowledge based industry and Pakistan generally lacks in availability oftrained human resource required by such an industry. Moreover, the other industrial sectors, suchas textiles, offer too high an incentive in terms of handouts and subsidies that the opportunity costfor entrepreneurs entering into pharmaceutical is too high.Other areas of advantage for India include; (i) lower minimum wage (Indian Rs 3,600 as comparedto Pakistan where the wage is Rs. 7,000); (ii) Energy cost to industry is Indian Rs 2.5/unit in India,in comparison the average cost of electricity in Pakistan from the grid is on average Rs 12/unit andthrough diesel generators is around Rs 24-25/unit. India has consistent energy for industry,whereas, industry here is working half its shift on self generated energy. Such cost implicationsimply lower profits and hence lower investments. Moreover, as discussed above, there is hardly anyinnovation in Pakistan even at the stage of raw material. Whereas, India has developed indigenoustechnologies, and the industry there is working on innovating low cost formulas. Smallmanufacturers normally concentrate on ‘low cost drugs’, whereas the bigger players are makingmore sophisticated drugs. Figure 3.-8 below compares the broad contours of a typicalpharmaceutical value chain in Pakistan and India.Figure 3‐8: Broad Comparison of Pakistan and Indian Pharmaceutical Value Chain APIs – raw Formulation/ Batch manufacturing, Pharmacies, hospitals, material 154  packing & distribution exports and patients 
  • 180. 1. Pakistan: 95% imported APIs. At the Packing & Pakistan has developed India: 5% imported API – formulation distribution no strong local network to sell remaining are produced in India. stage no major major difference pharmaceutical products difference exists between India through sales agents. 2. Exchange rate devaluations hurt between Indian and Pakistan However, on the export Pakistan industry significantly, no and Pakistan – side the branding and such adverse impact on Indian Indian industry quality compliance issues industry. however, has all stay a significant weakness. the required 3. Most of the API’s produced by certifications. India are certified and hence they Another area are able to export. Little incentive in where Indian’s Pakistan to make APIs due to lack are adding value of quality control and certifications is indigenous and manufacturing APIs require pharmaceutical economies of scale so exports are a must as local market not so big.The next generation success in the pharmaceutical industry is likely to come in the Bio-technologyindustry. This is one of the sun rise industries where a lot of growth is expected to happen.Moreover, Bio-technology industry for a country is also important from a strategic point of view.Given this importance of the Bio-Technology industry India has recently announced acomprehensive ‘Bio-Tech’ policy aimed at attracting investment in the sector, training humanresource and providing support for the requisite hard and soft infrastructure. In addition, theIndian policy provides several fiscal benefits such as tax breaks, research and development grants tobusinesses venturing into the Biotechnology industry. On the other hand, Pakistan has not evenstarted the thought process on establishing a Bio-technology industry. The stakeholder analysisconducted for this report revealed that current there is only one company in the entirepharmaceutical sector of Pakistan that has moved into bio-tech. In their experience, thegovernment’s current policy stance has been more restrictive rather than attractive towards bio-technology industry. It is necessary for the Pakistan’s policy makers to introduce significantincentives to motivate investors to invest in this critically important sector of the future.Other factors that are hampering the growth of the local pharmaceutical include the following: • Inadequate branding: The branding should focus on product differentiation and the quality of the drug. 155  
  • 181. • Regulatory barriers: The list of Active Pharmaceutical Ingredients (APIs) that can be imported keeps on changing at short intervals based on the interests of the MNC lobbies. • Weak enforcement: Inadequacy of enforcement of counterfeit drugs is also retarding local investment. • Capacity & behaviour of health inspectors: The health officers do not possess the requisite skills and knowledge of the pharmaceutical industry to conduct health and safety inspections. Inspectors normally, use petty excuses as a way of rent seeking. Furthermore, the industry feels that under the 18th amendment the transferral on inspection to provincial inspectors will be disastrous as it will increase the ‘informal’ cost of doing business significantly. • Inconsistency in import duty: The import duty on pharmaceutical raw materials (not manufactured locally) was to be fixed at 5 percent (as proposed in the Federal Budget for 2005/06). However, a number of items are still assessed at 10-15 percent as the budget policies have not been fully implemented. • Exemption from Sales tax: The sales tax on local purchases of packing material such as cartons, leaflets, bottles, ampoules, labels, corrugated boxes, aluminium foil, rigid PVC, gelatine capsules, and other such items is a heavy burden. This tax is inconsistent with the governments policies to keep the prices of pharmaceutical products affordable for patients. In keeping with such policies, the imports of pharmaceutical raw materials, and the local purchases of such materials, are exempted from sales tax; the pharmaceutical industry argues that it would be logical to extend the same treatment to the packaging for pharmaceutical products. • Income Tax: The advanced income tax on import letters of credit has been increased to 3 percent from 1 percent in previous years. This has made a significant increase to the cost of production, because the refunds of this tax (if and when made by the tax authorities) take at least two to three years. • Environmental Degradation: Another area which the federal and the provincial authorities should promptly deal with, is the environmental degradation created around pharmaceutical manufacturing plants by other industries. Such pollution often creates 156  
  • 182. health hazards and therefore impacts with particular severity on the pharmaceutical industry. It also gives purchasing missions from overseas the impression of dirty and unsafe conditions, and thereby affects the chances for increasing exports. Policy Recommendations: It is important to pursue a particular policy on the pharmaceutical sector in order to correctmarket failures (since social benefits exceed private ones), fostering innovation and promotingcompetition. Therefore, we recommend the following: • Prices should not be regulated for drugs whose markets are competitive or monopolistically competitive. Price regulation should only be there in the case of a monopoly or collusive oligopolistic behaviour. • Allow duty free imports of all APIs (active pharmaceuticals ingredients) and machinery for both domestic and export markets – However, this benefit should be lifted as the domestic industry picks up and protection should be provided for WHO pre-qualified APIs manufactured locally. • All locally purchased items like packaging material, etc. should be exempted from sales tax. • The government should share mark-up cost on loans and allow investment adjustment against future taxes for putting up international standard manufacturing facilities targeting the pharmaceutical markets of the US, UK, Australia, Japan and also those in developing countries. • Provide incentives such as tax breaks for carrying out R&D on molecules and all ancillary activities like setting up CROs (Contract / Clinical Research Organisations) subject to meeting certain targets. • Incentives , such as the carryover of net operating loss (NOL) for purposes of tax deduction, should be provided for new start-ups in Bio-technology. Other such incentive is to make it attractive for such high technology industry to locate themselves in science parks proposed earlier in the report. • The government should provide tax breaks for setting-up internationally certified bioequivalence / bioavailability labs, local manufacturing / fabrication of machines and other hardware. 157  
  • 183. • Allow long-term subcontracting with drug manufacturers as opposed to 2 years as per the current rules. • Ensure internationally acceptable manufacturing quality standards / (Current Good Manufacturing Practises) CGMP compliance in both the local and multinational manufacturing companies in the country • Ensure continuous power supply to the pharmaceutical manufacturing to ensure international (Good Manufacturing Practises) GMP compliance of maintaining the required levels of temperature control. This will not only ensure high quality of the locally produced medicines but will also make the industry competitive internationally. • The government should introduce technical courses relevant to the pharmaceutical industry in universities or other institutions. Representatives of the industry contended that, for example, it was next to impossible to find trained mechanics to deal with the electronics that are in almost all the machinery used by manufacturing units. 158  
  • 184. 3.3 Value Added Skill & Engineering Based Sectors The industrial sectors considered in this section fall in the category of SME business. At the outsetwe have provided policy prescriptions for the SME sector as a whole. The Sector specific policiesthat follow are designed in line with these general policies. 3.3.1The SME Sector According to the most recent study conducted on SMEDA [SME Policy (2006)], Pakistan’s premieragency for supporting small and medium sized enterprises: “Pakistan’s economy is dominated bySMEs with more than 90% of enterprises belonging to this category. The SME sector is sufferingfrom many constraints including lack of access to finance63, limited access to markets, lack ofinfrastructure, hostile business environment, corruption and red tape, weak management and lackof access to skilled labour. Also, many of the government policies are devised from the perspectiveof large firms and not SMEs. The implementation of SME policies in Pakistan is fragmented andlimited and needs to be more effective in light of the SME sector’s importance and contribution”. Policy Recommendations: Clusters of SMEs can also meet the requirements of the new competitive global marketplace veryefficiently and effectively. Therefore, we can no longer treat SMEs as unproductive and marginal,but these have to be characterized as key elements of industrial development and growth.Therefore, we recommend the following: • A cabinet committee for SMEs should be established to fast track decisions on SME policy matters. • Exemption limit for excise duty should be raised from Rs. 5 million to Rs. 10 million.                                                            63  Small and Micro enterprises are often rationed out of the credit market due to information asymmetries such asopaque knowledge of firms and sectors on the part of commercial banks. Information asymmetry results in relativelyhigh collateral requirements for SMEs which along with the degree of documentation required for loan applicationdeter them from resorting to the formal sector credit market – commercial banks. Lack of credit availability thusseverely impedes the growth potential of small scale and micro enterprises. Data suggests that over 90 percent of smallenterprises finance their business and working capital requirements through retained earnings.  159  
  • 185. • A capital subsidy for investment in technology should be provided. • Incubation centres should set up in sunrise industries. Some of the sunrise industries include: o Bio-technology o Information Technology o Electronics and telecommunication equipment o Non-conventional energy sources • Establishment of testing and certification facilities should be financed. • A vendor development programme should be initiated under which ‘buyer – seller meets’ exhibitions are organised at regular intervals and at dispersed locations. • A fresh census of small scale industries should be conducted with special focus on gathering information on the incidence of sickness of industries and its causes. • Skill development initiatives specific to SMEs should be initiated. Schemes covering the areas highlighted below should be developed: • Training should be provided in quality management systems • Training support for entrepreneurial and managerial development of SMEs • Training and benchmarking for designing lean manufacturing techniques • SMEDA should be institutionally restructured to enable it to design sectoral programs for the SMEs that involve tailor-made investment projects in various sectors. The new organization structure should also enable SMEDA to interact with the government (federal and provincial) and its entities for developing favourable policy environment for SMEs. SMEDA’s new organization structure should also allow it to network domestically and globally to bring the maximum benefits for the SMEs of Pakistan. • Adequate human resource with greater financial flexibility should be made available to run the revised organisations structure. • The joint equity participation fund should be revitalised and should be allowed to provide loans up to 25% of the project value with a maximum cap of Rs. 10 million. The mark up charged on these loans should be 5%. 160  
  • 186. 3.3.2Fan Sector Global fan trade is classified on the basis of energy consumption. Fans consuming less than 125watts of energy are generally referred to as domestic fans and fans consuming over 125 watts areclassified as industrial fans. Fan industry in Pakistan is mainly dominated by production ofdomestic fans. Hence, by its very design is missing on the opportunity offered by the high valueadded and the growing value added market of industrial fans.Pakistan’s fan industry is mainly clustered in four major cities namely, Gujrat, Gujranwala, Lahoreand Karachi. However, 98% of the countries production is centred at Gujrat and Gujranwala.The sector comprises over 450 SMEs, of which 300 are based in Gujrat and the rest inGujranwala. The industry produces on average 8 million fans a year with an estimated value of Rs17 billion. Out of the total production, approximately 30% fans consist of pedestals, 7% bracketsand the remaining 63% are ceiling fans64. The industry belongs to the light engineering industrycategory, and is one of the industries that existed at the time of independence.The sector, whereas, has shown high levels of growth in the recent years suffer from low levels ofproductivity, inadequate technology upgrade and shortage of skilled staff. Moreover, most of thecompanies operate under locally created brands with only a couple moving to internationalbranding of their products. Even the local branding is sharply fragmented with 4/5 largecompanies representing over 60% of the local market share. The industry also requires testing andcertifications of their products mainly conducted or required for electrical safety. Certificationsare normally required for export markets, whereas, general performance and safety testing areconducted regardless of the market. As a result of the field exercise we have identified that thosefirms which have large local market demand are better at innovation and new designs as comparedto those firms which are solely focused on export markets. The reason for this being that localmarket provides enough stability for companies to invest in research and development. Moreover,                                                            64 ‘Pakistan Light Engineering Sector’, Board of Investment, 2009: 18 161  
  • 187. the companies supplying in the local market are better connected to their end consumers andhence are able to incorporate customer feedback in a more diligent manner. Additionally, it wasalso found that current export markets are not necessarily offering higher margins as compared tolocal markets.The table 3-4 below presents the main characteristics of the industry:Table 3‐4: Fan Industry CharacteristicsCharacteristic ValueNumber of units 450Total Installed Capacity 9.5 – 10 Million FansCurrent Production 8 Million FansContribution to National Exports 0.20%Contribution to GDP 0.27%Sector Employment 25-30,000Capital Labor Ratio 6 workers/Million (Rs)Total Estimated Investment Rs 5.0 BillionSource: CMI Data, PEFMA interviews and ‘Pakistan Light Engineering Sector’, BOI, 2009: 20Out of the 450 companies only 5-6 companies can be categorized as large scale integratedmanufacturing units. These units have in house capacities to conduct most of the productionprocesses and are also characterized with higher levels of investment and more modern technology.Tier 2 companies are numbered somewhere between 40-50 and have medium sized units and inhouse capacities to conduct major portion of the production process, however, lacks in investmentand modern technology. The remainder can be categorized as Tier 3 companies with smalloperations, high degree of outsourcing and outdated machinery. The average age of the machineryemployed is between 5-10 years. Sales are also fairly concentrated with five large firms in Gujratand three in Gujranwala, accounting for 40% of total industry sales.The fan sector contributes in multiple ways to the national economy (Table 20). It offers pro-pooremployment creation opportunities, income generation, foreign exchange and social developmentby strengthening cluster development in and around Gujrat and Gujranwala. It offers directemployment to around 25-30,000 people. However, employment is seasonal as most factoriesoperate for only five to six months during the year. This scale of employment is far below itspotential as the industry currently faces a seasonal demand. The sector has recently picked up in 162  
  • 188. exports as well. Figure 3-9 below shows that foreign exchange earnings of the sector are consistentlyon the rise. For the most recent year (2009) the exports crossed US$32 Million. This has increasedPakistan’s share in world fan exports to over 1%. The sector contributes 0.2% to Pakistan’s totalexports. The sector has experienced double figure export growth over the last five years and hencehas continued to contribute more and more to national economy.Figure 3‐9: Pakistan’s Fan Exports, 2004‐2009 (US$) 35.0 32.0 30.0 27.5 25.0 23.4 20.0 18.4 15.5 15.0 12.6 10.0 5.0 0.0 2004 2005 2006 2007 2008 2009 Pakistan Exports Mean ExportsSource: UN Commodity Trade Statistics3.3.2.1  Value Chain Analysis Value Chain analysis tool is employed to explain the specific issues faced by the producers of thefan industry. Where data is available analogies with reference to the global value chains are alsomade to identify critical weaknesses. The analysis points out that there are several supply sideconstraints as well as weaknesses in value addition. It must be emphasized that the value chainpresented below represents what is typical for the industry. It is possible that some larger firms maybe slightly better placed and some small ones slightly adversely placed than the representationpresented below. However, the numbers provided below have been verified by industryrepresentatives.The overall structure of the value chain (Figure 3-10) suggests that industry typically adds 23% invalue addition of around Rs 450 per fan. The vendors are also adding almost same amount ofvalue addition, however the importers take the major bulk of the value addition. 163  
  • 189.     Figure 3‐10: Typical Value Chain of Fan  Component Cost (Rs)  Raw Material 1453  Casting 50 Major cost in this component is electricity  Assembly 67 charges. Overheads 186  Marketing 20  Selling Price : Rs.2100       Vendors &   Raw Casting          Assembly    Overheads     Marketing      Importers Material Suppliers 81.8%   2.8%  3.8% 10.5% 1.1 %   50% of the materials are imported.  95% of the costs are for electricity consumption. Value Chain analysis has revealed the following issues facing the industry: Low levels of productivity The industry composition suggests that it is dominated by small firms and as such does not benefitfrom economies of scale. This is a critical reason why the fan industry in Pakistan is not able tocompete on costs with is international competitors. The average capacity of a typical firm is around200-300 Fans/day which is extremely low as compared to Chinese counterparts where firmsaverage productivity is 45-50,000 Fans/day.Another reason for low levels of productivity is capacity utilization. The numbers in the table 20above indicate that the capacity utilization for the industry is over 80%. This number however ismisleading as the industry currently operates seasonally. Figure 3-11 below suggests that industry 164  
  • 190. only operates to full production capacity in the first five months of the year. From July onwardsthe operations fall to a quarter of the total installed capacity. This seasonal production is not onlyan impediment to investment but is also draining out the skilled workers from the industry. Theworkers have little incentives to train for an industry that only provides employment for 5 monthsduring the year. The seasonality is affecting the productivity and deterioration of skills in theindustry.Figure 3‐11: Capacity Utilization over typical 12 Month Period 100 90 80 70 60 50 40 30 20 10 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov DecSource: Board of Investment, Pakistan (2009: 23)Lack of technological advancement is another reason for low productivity. Older technology isbeing used as compared to its counterparts. For example, currently lathe machines are used forbody turning, if technology is upgraded to CNC machines the productivity will increase by at least4 times. Similarly, shifting drilling technology to multiple drilling will increase production 3 times.For pedestal fans currently majority of the industries use manual coiling techniques, moving toautomatic coil inserters will increase productivity by 5 times. Similarly, over 90% of the firms areusing spray paint technology with wet paint. This technique has a high wastage ratio. Around 40%of the paint is wasted and furthermore, this technique is environmentally hazardous also [PEFMAinterviews]. The industry needs to move to more efficient techniques, such as electrostatic powdercoating paint. This technology is not expensive and provides much better results in terms ofquality and avoids wastage. The change in technology will not increase productivity but will alsoincrease quality and performance of the product. When considering global value chains, China’sproduction processes are much more efficient and highly productive. In addition to technological 165  
  • 191. gaps, productivity is also affected by weak production process flow management. The assembly linein factories need to be rationalized so that the existing set ups achieve better technology. Difficulty in getting adequately trained manpower  As discussed above seasonality of demand is an impediment to skilled manpower. Fan industryoffers employment opportunities for 5-6 months which does not attract workers at first place.Secondly, there are also inadequate training facilities for the industry. This is an impediment toachieving better technology i.e. low level of skills is impeding investment into modern machinery. Lack of R&D and design innovation  Value chain analysis shows that average value addition in the industry is around 25-30%. This lowvalue addition is due to high content of input and low price fetched by the product in the market.The VCA above reflect that the average price of a Pakistani fan (ceiling) is around US$2565. Thisnumber goes down to US$2066 if we take the overall average export price. In comparison, fansfrom countries such as Finland, France, Brazil etc are fetching much higher export prices. Figure 3-12 below provides a comparison of per fan export price of various countries.Figure 3‐12: Average Export Price of Fans US$ France 76 Finland 122 Netherlands 45 50 Brazil 17 Thailand 31 Italy 16 30 Germany 16 Spain 16 USA 11 20 India China 0 10 20 30 40 50 60 70 80 90 100 110 120 130 PakistanSource: UN Commodity Trade Statistics Database                                                            65 Based on interviews with industry66 UN Commodity Trade Statistics Database  166  
  • 192. This difference in price is mainly due to better designs, better quality, marketing and branding.Some of the high value added ceiling fans sell for around US$500-600 in the US retail market.This analysis presents an opportunity and a threat. The industry should not only focus onproducing and exporting more fans, in fact, it should focus more on value addition and makingbetter design and innovative fans that fetch higher prices. Given the nature of the industry valueaddition seems only possible if Pakistan begins to make fans for high income markets.VCA also reveals that over 80% of the cost represents material and parts required to produce fan.Out of this 50% of the materials are normally imported. Therefore, compared with internationalcompetitors such as China the local industry is at a disadvantage due to lack of research anddevelopment in materials. China has been able to diversify its production of materials required forfan manufacturing moving into PVC, composites of metals etc. Pakistan on the other hand is stillrelying on pure materials which are not cost effective.There is also lack of training institutes and research and development centres. The industry hasaccess to Fan Development Institute, however, the capacity of this institute to do meaningfulresearch and product development is fairly limited. The institute currently works as a servicecentre, provides basic testing and certification facilities in partnership with Intertek. The institutecompares unfavourably to the research and training facilities that are available in countries whichcompete with Pakistan in International markets. Inconsistent Quality and Certification The industry generally feels that improving quality and standards is extremely important. The Fansstandards are normally two types; performance and safety. There are no defined quality or safetystandards for Fans in Pakistan. This practice has led to inefficiencies in the system. First, lack ofquality and standards result in customary production techniques and a variety of different partbeing used by the industry. Quality is difficult to maintain when there are non-standard partsbeing employed. Therefore, lack of standards at local level results in unreliable quality in domesticmarket. 167  
  • 193. Furthermore, moving to higher value product in export markets requires complying with certainquality standards and attaining certifications. Currently testing facilities are inadequate for thispurpose. Policy Recommendations:  The light engineering sector is playing an important role in employment generation and povertyalleviation through endogenous technology. It consists of small and medium-sized lightengineering industries, like the fan cluster, which have been producing import-substitutionproducts. Our recommendations are the following: • Create awareness and facilitate common branding and consortium-building of companies to benefit from scale economies. National Productivity Organization (NPO) will support the cluster actors to develop standardized parts and move towards common production and sourcing. • Strongly advocate to State Bank to ensure effective implementation of initiatives provided for SME financing at reduced mark ups. • Strongly advocate with State Bank and commercial banks to ensure availability and utilization of long term project financing and technology up gradation. Share mark up costs for technology upgradation. • Provide funding to Fan Development Institute to upgrade machinery at the common facility centre. • Establish training facility by supporting TEVTA and FDI under PPP arrangements to provide labor training on modern machines. • Establish a centre of fan engineering and designing at the University of Gujrat. • Work with Pakistan Electric Fan Manufacturing Association (PEFMA) to develop domestic standards for fan manufacturing. The standards will be enforced and monitored by PSQCA. • Share costs to meet compliance with international requirements such as CE Marking, UL Marking, etc. • The government should facilitate joint ventures with foreign companies and ensure technology transfer. 168  
  • 194. 3.3.3Cutlery, Utensils & Hunting Equipment Sector The cutlery and hunting equipment industry is mainly clustered in and around Wazirabad withsome production also taking place in Gujranwala, Sialkot and Dir. 95% of the countriesproduction is centred at Wazirabad. The sector comprises over 400 SMEs, of which 250 areinvolved in cutlery manufacturing, whilst the remaining is involved in production of huntingknives, swords etc. The industry produces on average 4.3 million different types of products withthe value estimated at over Rs 6 billion. Global trade in cutlery is classified as; kitchenware cutlery(HS Code: 8215, 821591, 821510, 821520) and non-kitchenware cutlery (HS Code: 8208, 8211,8212 and 8214) where non-kitchenware includes swords and hunting equipment. Cutlery industryin Pakistan is involved in both kitchenware and swords and hunting equipments.The industry belongs to the light engineering industry category, and is one of the industries thathave existed prior to independence. This is one sector where Pakistan over the years has developedcapabilities to penetrate high value / high income markets such as Germany, USA, France,Belgium etc. The average export price of goods made in Wazirabad is around $25-27/Kg (Steel),which is much higher than the Chinese products which on average fetch (US$3-5 (Compositematerial)). However, the price is lower than some of the more sophisticated producers such asGermany and Switzerland.The sector, whereas, have achieved reasonable export growth in the recent years have suffered fromintense competition from China especially in the cutlery sector. The major impediments of thesector include low levels of productivity, inadequate technology upgrade and shortage of skilledstaff. Moreover, most of the companies operate without any brands with only a couple moving tobranding of their products. Furthermore, the industry in the years to come will face highercompliance requirements, especially the cutlery manufacturers, who would be required to meetstandards on use of ‘food grade materials’. Currently not much compliance or testing requirementexists and only a few companies adhere to ISO standards.Table 3‐5: Cutlery and Steel Ornaments Industry Characteristics 169  
  • 195. Characteristic ValueNumber of units 400Total Installed Capacity 7.5 – 8.0 Million piecesCurrent Production 4.3-4.5 Million piecesContribution to National Exports 0.25%Contribution to GDP 0.11%Sector Employment 10-15,000Capital Labor Ratio 6 workers/Million (Rs)Source: ‘Pakistan light engineering sector’, BOI , 2009: 28, and Industry interviewsOut of the 400 companies only 10-15 companies can be categorized as large sized manufacturingunits within the sector (relative basis). These units have in house capacities to conduct most of theproduction processes and are also characterized with higher levels of investment and more moderntechnology. Tier 2 companies are numbered somewhere between 40-50 and have medium sizedunits and in house capacities to conduct major portion of the production process, however, lacksin investment and modern technology. The remainder can be categorized as Tier 3 companies withsmall operations, high degree of outsourcing and outdated machinery. The average age of themachinery employed is between 10-15 years.The above composition suggests that the industry is dominated by small firms and as such doesnot benefit from economies of scale. This is a critical reason why the cutlery industry in Pakistanhas not been able to compete on costs with is international competitors – and China has been ableto easily replace Pakistani products in traditional markets. The average capacity of a typical firm isaround 50-60 Cutlery/day and 25-30 swords, hunting equipment/day which is extremely low ascompared to Chinese counterparts where firms average productivity is in thousands per day.Nevertheless, the sector contributes in multiple ways to the national economy. It offers pro-pooremployment creation opportunities, income generation, foreign exchange and social developmentby strengthening cluster development in and around Wazirabad. It offers direct employment toaround 10-15,000 people. This scale of employment is far below its potential as the industrycurrently faces a stiff competition from China. Unhelpful government policies and energy criseshave resulted in closure of over 300 units in last few years. Figure 3-13 below shows that foreignexchange earnings of the sector are consistently on the rise. For the most recent year (2009) the 170  
  • 196. exports were almost at US$50 Million. This has increased Pakistan’s share in world exports to over0.4%. The sector contributes 0.25% to Pakistan’s total exports.The export data suggests that Pakistan has been able to develop capabilities to supply in majority ofproducts categories, however, the scale and share of markets remained small or insignificant. Thispresents with both an opportunity and a threat. It is an opportunity as the market is large enoughto allow Pakistani exporters to expand their shares and increase export earnings. It is a threatbecause, if Pakistan does not upgrade its production and improve efficiency, it may lose even theexisting market shares to new entrants such as Viet Nam.Figure 3‐13: Pakistan’s Cutlery and Steel Ornaments Sector Exports (US$) 52.00  50.00  48.00  46.00  44.00  42.00  40.00  38.00  2005 2006 2007 2008 2009Source: UN Commodity Trade Statistics3.3.3.1 Value Chain Analysis Value Chain analysis tool is employed to explain the specific issues faced by the producers of theindustry. Where data is available analogies with reference to the global value chains are also madeto identify critical weaknesses. The analysis points out that there are several supply side constraintsas well as weaknesses in value addition. It must be emphasized that the value chain presentedbelow represents what is typical for the industry. It is possible that some larger firms may be slightly 171  
  • 197. better placed and some small ones slightly adversely placed than the representation presentedbelow. The numbers provided below have been verified by industry representatives.The overall structure of the value chain (Fig 62) suggests that industry typically adds 43% of ex-factory sale price in value addition in the tune of around Rs 145 per dagger. The vendors are alsoadding around 15% in basic raw materials; however the importers take the major bulk of the valueaddition. Uncompetitive Cost Structure The value chain analysis of daggers using imported steel (Figure 62) depicts that over 60% of thecosts represents the material and parts required to produce the dagger knife. Out of this 70% ofthe cost is for the steel used. Although the local steel is low in cost but mostly it do not meet thequality standards required by foreign buyers. Product finish is poor for local steel. It is mainly usedby cutlery manufacturers selling in local markets. However, local steel do not qualify as ‘foodgrade’ steel and cannot be used for export market cutlery. Availability of steel is an issue. Thestocks and prices are quite variable resulting in pricing problems for the industry. Damascus steelis one of the success stories of the sector. Damascus steel is the highest quality steel for huntingknives, swords and similar equipment. The sector has developed capacity to produce its ownDamascus steel. Some of the larger units have developed the capability to produce high qualityDamascus steel and are able to enter global market at much favourable terms.In comparison, China which is the leader in global trade of cutlery and similar products has acompetitive advantage due to availability of alternative low cost materials. For instance, the averageexport price of Chinese cutlery per Kg is US$3.5, whereas of Pakistan is US$ 20. The maindifference is that Chinese have captured a major market share by competing on low costs and highturnovers. Their strong research and development capacity in alternative materials have given thema clear advantage in the market.Other issues concerning cost structure are use of imported machinery and high electricity charges.Almost 95 % of Chinese manufacture use local machinery in the production process. They areable to purchase machinery at a fraction of the cost of European machinery. Firms in Pakistan 172  
  • 198. have to rely on imported machines which are quite expensive. Hence, lack of support fromengineering industry leads to a significant competitive disadvantage. Similarly, electricity is themajor input in all of the production processes. Therefore, shortage of electricity and highelectricity charges are critical impediment to competitiveness. Manufacturers use diesel fuelledgenerators for continuing the production which is expensive and cost of electricity for a typicalmanufacturer comes to around US$ 0.20/Kwh as compared to US$0.11/Kwh for a Chinese  manufacturer. Overall Value Addition & Productivity Value chain analysis shows that average value addition in the industry is around 43%. Valueaddition could be increased with reducing the input costs as discussed above and fetching the highprices in the market. Input costs also affected with level of productivity. The industry as a wholesuffers from productivity issue. This has resulted both due to inadequate investment in technologyand also a lack of availability of skilled labor. Most of the processes employ less productivetechnology. Comparison with the Chinese value chain reveals that:Figure 3‐14: Value Chain for a 12 Inch Dagger  Component Cost (Rs)  Raw Material 175 Cutting Hardening & Grinding 28    25% of the material used is Handle Making 50 wasted at cutting.  Overheads 05 Cleaning Polishing & Packaging 32  FOB Sale Price : Rs.340          Material   Raw Cutting      Handle    Overheads      Cleaning      Importers Hardening &  Material Polishing & Suppliers Grinding Making 1.8% 61 4%     81 % of the material used is steel Major cost in this component is which is expensive and have high electricity charges degree of price volatility. 173  
  • 199. • Pakistani firms use one piece die press for cutting, in comparison the Chinese and other competitors such as Germany, France etc. use 12 piece heavy die press. Hence, their process is 12 times more productive. • Pakistani firms use hand hammering for straightening purpose, the Chinese counterparts use automatic straightening machine. The hand hammering technique can process up to 250 pcs/day and in comparison the automatic machine straightening process 5,000 pcs in an 8 hour shift. • Similarly, grinding is done using an open grinder in Pakistan, in comparison, Chinese use belt grinders. The local practice can only process 100-125 pcs/day as compared to belt grinding that can process around 600 pcs/day. • Finishing of the products is the weakest area in the local value chain. Some of the firms have shifted to automatic cleaning machines which have improved the quality of the cleaning and also the speed. However, generally the sector relies on manual labor doing the cleaning work. This process is slow and also has some environmentally hazardous effects. Similarly, the polishing process is manual as compared to Chinese firms which use vibrator machines. With current practices one worker is able to polish a maximum of 100 pcs/day and in comparison vibrator machine technology can process 1000 pcs/day. • On the other hand, in terms of price Pakistan operates much favorably to China (Figure 3- 15). This suggests that Pakistan is not directly competing with China, due to China’s focus on low value high turnover products. Pakistan needs to capitalize on more sophisticated producers such as Switzerland, Germany, Japan, France etc. All these countries have higher costs of production than Pakistan, especially labor costs. Pakistan can compete with these countries more fruitfully rather than trying to compete with China. Pakistan will not be required to invest significantly in scale, instead, investments can be made: in sophisticated technologies, improving quality and finishing and marketing and branding. Weak branding and marketing is one of the main reasons for low value addition. Almost all the firms supply unbranded products to international buyers, who sell these products under their brands and are able to add more value. 174  
  • 200. Figure 3‐15: Average Export Price of Steel Used in Making Cutlery and Ornaments, US$/Kg  4 China 14 Brazil 12 Belgium 21 Pakistan 30 Spain 30 35 France 44 Japan 83 Germany Switzerland 0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90Source: UN Commodity Trade Statistics3. Difficulty in getting trained manpower Pakistan is far behind in technology and modern production processes. As discussed above thislack of technology results in inadequate productivity and higher costs of production. Theimpediment to achieving better technology is not only lack of capital but also lack of knowledgeand appropriate skills to use modern technologies. The level of skills is impeding investment intomodern machinery. It is because there is no specific training facility for the industry. Another issueis the lower wages in the sector as compared to others which does not attract the workers. Lack of R&D and Design Innovation  According to general competitiveness framework the sophistication of local customers is anintegral reason why companies are forced to innovate and then succeed abroad. In this aspect thesword and hunting equipment industry is 100% export focused, whereas cutlery industry generates85% of its sales in the local market. However, the segment of the local market which is catered bythe cutlery segment is highly price conscious. The consumers in the local markets are not willing topay high price and are always looking for low price products. This is a critical reason why theindustry has not been able to jump up the value curve even with massive domestic demand. 175  
  • 201. This structure of the local demand has led to little product development. The industry continuesto produce (with some exceptions) traditional cutlery using low cost and below standard materialand hence is unable to compete in the international markets.The industry seems to be doing reasonable well in the export market which mainly comprisehunting knives, swords and daggers. Pakistani products normally fetch higher prices as comparedto majority of other countries. There is significant demand for high end products in the marketand if the industry can enhance its productivity without compromising on quality then it will beable to gain a greater level of market share.There is also lack of training institutes and research and development centers to spur innovation.Although industry has access to Cutlery Institute, however, the capacity of this institute to domeaningful research and product development is fairly limited. The institute comparesunfavorably to the research and training facilities that are available in countries which competewith Pakistan.The government realizing the potential of this sector has already established a nationalrepresentative body namely the Pakistan Hunting Arms Development Company (PHADC). Policy Recommendations: The interventions in the cutlery sector are directed at the cluster level. This lowers transactioncosts and helps generate relationships between enterprises which improve their efficiency throughthe development of cooperation and maximize the potential of the cluster through thedevelopment of mutual learning. Specific recommendations are: • Continue to support the initiatives of the PHADC and ensure that the initiatives carried out by PHADC are balanced in regional representation. • Regularly monitor the performance of the PHADC against established targets and goals to ensure that the company delivers to the needs of the sector. • Finance joint projects between University of Gujrat and Pakistan Cutlery Association to work on research and development of newer metals required for the industry. • Advocate with provincial government to ensure that TEVTA’s service centre in Wazirabad also offers skill training specifically for the cutlery and swords industry. 176  
  • 202. • Share mark up costs of technology upgradation conditional on companies meeting set export requirements. • Provide support to PSQCA to work with the sector associations to develop a set of core standards, especially relating to the use of materials and their quality. • Advocate with State Bank and commercial banks to ensure availability and utilization of long term financing. • Advocate with TEVTA Punjab to fully operationalize their cutlery common facility centre. • Engage Pakistan International Freight Forwarders Association (PIFFA) to run export training programmes in Wazirabad and work with the sector association to run training programmes on business processes, business English, etc.3.3.4Horticulture Processing Sector Pakistan is endowed with a diverse range of fruits and vegetables. Citrus, mango and dates fromPunjab, mango and dates from Sindh, cherries, strawberries, peaches, plums and apricots from theKhyber Pakhtunkhwa, and, dates, apricots, peaches and plums from Balochistan, have a largedomestic market in addition to a growing export market. The country produces around 2.2 milliontones of citrus, 1.7 million tones of mango, 0.7 million tones of dates and around 0.6 milliontones of apricots, peaches and plums (Pakistan Horticulture Development and Export Board,2008). Even with this extensive availability of natural resource, the value added horticultureindustry has not grown accordingly.One critical reason for this lack of growth has been coarse market links between the growers/fruitmarketers and industry. Due to product seasonality the price of the fruit varies significantly and sodoes the quality. Owing to the risk of non- availability of raw fruit (fresh or frozen), the valueaddition industry feels hampered in making large investments. In addition, even after severalefforts made by the government and the private sector, quality and compliance infrastructure isstill inadequate. Furthermore, a significant amount of fruit in Balochistan, Sindh and KP is goingto waste due to adverse conditions with processing plants lying idle and capital stock depleting.Another major area that has restricted the development of horticulture value added industry is theinability of the growing sector to meet the international quality and SPS standards. The health and 177  
  • 203. safety standards for food products have become extremely strict in international markets andrequire certain protocols and procedures to be met to qualify for market access. Developingcountries such as Pakistan has faced several export restriction due to non-compliance with suchrequirements. The small size of farms makes it even more difficult to expand the certification andgood practices knowledge compliance. PHDEC has been working in creating awareness on GobalGood Agricultural Practices (GAP) and other similar Sanitary & Phytosanitary (SPS) requirementsimpacting the potential of the horticulture sector. United Nations Industrial DevelopmentOrganization (UNIDO) has also been very active in supporting Pakistan to achieve compliancewith international quality and SPS requirements. The EU Trade Related Technical Assistance(TRTA) II programme managed by UNIDO is closely looking at the citrus and mango regions ofPakistan in terms of building trade capacity and develop value addition opportunities.Until such time Pakistan is able to grow fruits that satisfies most of the protocols required byinternational standards it will be difficult to attract significant investment in the value addedindustry. This is because that even with a population of over 170 million there is still a minimaldemand for products such as dried exotic fruits, canned fruit, packaged juices etc. The little localdemand that exists is entirely captured by either imported products or products sold by the MNCs.To build demand locally the industry will have to initially rely on export markets. However, if thefruit is unable to satisfy the compliance requirements it will be impossible for products made outof these fruits to meet the quality and certification requirements. Hence, the efforts to improvegrower capacity to meet requirements need to be strengthened.Another issue that has restricted local investment in the value added horticulture industry is thelack of implementation of local quality and standards. The value added horticulture industry, forexample, the juice industry suffers extremely from counterfeit products and smuggling from India.It is impossible for local fruit juice makers that are complying with all the standards laid down bythe PSQCA to compete with counterfeit juice manufacturers that do not comply with anystandards. As the high income markets are captured by imported products or MNCs such asNestle, the local manufacturers have to compete in low income markets. As price is the maincriteria in these markets, the counterfeit producers are driving out the genuine producers. 178  
  • 204. Additionally, a lot of low price/poor quality juice is being smuggled from India into the country.Some of this is being sold in original packaging while some is brought in bulk quantity orconcentrate form and repackaged in Pakistan. In presence of such elements it will be difficult toattract new investors into the value addition industry.Finally, horticulture is a critical pro-poor sector and ties in well with the agenda of achievingbalanced development/growth. As shown in the later part of this report, development in all fourprovinces of Pakistan has been sharply asymmetric. The areas where industry has developed havebecome the epicentre of government’s focus and tended to receive proportionally high amount ofgovernment spending. Most of the underdeveloped areas are those where little or no industrialactivity has emerged. However, these underdeveloped areas are rich in natural resources andhorticulture production is the main activity in most of these under developed areas. As part of thecluster mapping exercise conducted for this report we have identified several ‘hot spots67’throughout Pakistan. The hot spots identified in the underdeveloped areas comprise mainly fruitand vegetable plantations.Furthermore, at the time of writing this report Pakistan was faced with severe floods. The severityof destruction caused by these floods has mostly hit the already underdeveloped areas, furtherdestroying the minimal infrastructure that existed. In recognition of this fact, it is reasonable toassume that government spending is likely to increase in these flood affected areas. Given most ofthe flood affected areas are also the least developed it makes evident sense for the government tostructure its expenditure in such a way that redevelopment work also encourages private sectorinvestment and industrialization in these areas. One such policy measure could be to provide fiscalincentives to set up horticulture value added industry in these regions. The raw material for suchindustry already exists in these regions and hence if government channels its redevelopmentexpenditure in such a way to build industry friendly infrastructure connecting the hot spots, thenprivate sector can be lured in to set up industry and produce employment. However, this will                                                            67 Areas where some form of clustering has emerged 179  
  • 205. require certain measures including compliance requirements and strong fiscal incentives to attractprivate sector incentives. Policy Recommendations: Fresh vegetables and fruits are a good example of a non-traditional agricultural export crop, andthey illustrate the potential for agricultural diversification and production of high-value crops. Ourrecommendations are: • Keep on supporting PHDEC to improve awareness on quality and compliance (establish PAKGAP Standards) and up-gradation of cool chain infrastructure and also to advocate with the provincial governments to strengthen their strategic support to upgrade the horticulture sector in meeting quality, compliance and certification requirements. The provincial government departments responsible for markets are to be requested to further facilitate linkage between the value-added sector and fresh fruit markets. • Incentivise local manufacturing of juicing and pulping equipment by providing technical information and support from research centres such as Ayub Research Institute, Faisalabad. • Strengthen PSQCA’s enforcement capacity to ban / fine all illegal / counterfeit juice suppliers in the market. • Provide special time bound incentives to initiate a support plan to restart business activity in flood and war stricken areas. Special horticulture processing and value added zones should be developed in interior Sindh, Balochistan, KP and Southern Punjab. Land should be provided on attractive terms. The zones should be declared exempt from all taxes and duties; however a target employment for each zone must be set to qualify for this exemption. • Develop seven clusters in the agro-sector including dairy cluster in Sahiwal, Pak Pattan and Okara; Citrus cluster in Sargodha; Mango cluster in Multan and Mirpur Khas; exotic fruit cluster in Swat; dates cluster in Sukkur/Khairpur and exotic fruit and apricot drying cluster in Gilgit. 180  
  • 206. 3.3.5Surgical Instruments Sector In the early twentieth century, clusters of surgical instrument production were found in Sheffield(UK), Nogent-sur-Marne (France), and Solingen and Tuttlingen (Germany). With the exception ofTuttlingen, none of these locations survived as significant centres for surgical instrumentmanufacturing. Instead, a number of new actors, such as Pakistan, Malaysia, Poland and Hungary,emerged as important producers of traditional surgical instruments. Pakistan has seen consistentexport success in the surgical instrument sector for several years now.The cluster consisting mainly of small and medium enterprises (SMEs), has its main markets in theUnited States and Western Europe. Over 99% of Pakistan’s production is generated from Sialkot.The industry produces on average over 150 million pieces a year with an estimated value of aroundRs 22 billion. Out of the total production, approximately over 95% is exported68. The industrybelongs to the light engineering industry category, and is one that has specialized in skill and stableexport market share.For the purpose of trade; four broad categories can be defined where Pakistan is supplying in theexport markets. The categories include; (i) HS Code 9018 – Instruments for medical, surgical anddental; (ii) HS Code 9021 – Orthopaedic appliances; (iii) HS Code 9022 – Equipment using X-rays, alpha, beta, gamma rays. The exports of Pakistan predominantly fall in the category 9018.Pakistani exports make up only a small fraction of world trade in surgical and medical deviceindustry, which amounts to over $113 billion (just for above 4 HS Codes). This is one sector wherePakistan has developed special capabilities to penetrate high income markets such as Germany,USA, France, Belgium etc. The average export price of goods made in Sialkot is around $1.5-2.5(Note: some products sell for much higher prices – the price quoted is the average trade price fordisposable products), which is much higher than what Chinese products fetch (US$0.35 – indisposable products). However, the price is lower than some of the more sophisticated producerssuch as Germany and France.                                                            68 Authors’ Field Interviews 181  
  • 207. Table 3‐6: Surgical Industry CharacteristicsCharacteristic ValueNumber of units Over 2300Total installed capacity 225 – 250 million piecesCurrent production 150 million piecesContribution to national exports 1.21%Contribution to GDP 0.41%Sector Employment 100,000 – 150,000Capital labor ratio 10 workers / million (Rs.)Total estimated investment Rs 12 billionSource: BOI reports, CMI data and PEFMA interviewsThe sector comprises over 2300 companies, of which around 30 can be considered large and theremainder can be split as 150 units of medium sized and remaining as small. Besides small andmedium units, a few units are large and have a 90% integrated system. Most of the larger andmedium sized firms are exporting, however, the smaller/vendor units usually supply to commercialexporters/traders. The main raw material used in the production is ‘steel’. Around 60% of thissteel is manufactured locally and the remaining 40% is mostly imported from Germany.The categories of firms can be divided in to three tiers. The tier 1 firms are the ones that aretechnically advanced and have exports over Rs.100 Million. These are technically advanced firmswith lot of mechanization. These are also the firms which have shifted some of their productionout of the disposable instruments and moved into more sophisticated products such variousmedical devices. Tier 2 and Tier 3 firms are predominantly involved in making basic surgicalcomponents.Figure 3-16 below compare the product split of world trade in surgical instruments (this is HSCode 9018) with that of Pakistan. It is quite clear the device and apparatus component of thetrade is growing over time relative to basic disposable instruments. In addition, the disposableinstruments are fetching lower prices over time, whereas the medical device industry has beenclimbing up the value curve. Pakistan has only grown slightly in basic instruments and theindustry’s capacity to supply more sophisticated equipments is fairly low. 182  
  • 208. Figure 3‐16: Product Split of World Exports & Pakistan Exports, 2005‐09 (US$ Million) World ($ Bn) Pakistan ($ Mn) 60 120.00 High Value  High Value  50 100.00 Apparatus,  Apparatus,  Syringes &  Syringes &  Needles Needles 40 80.00 Dental  Dental  Instruments 30 Instruments 60.00 20 40.00 Basic Surgical  Basic  Instruments 10 20.00 Surgical  Instruments 0 0.00 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009Source: UN Commodity Trade Statistics Figure 3‐17: Exports of Pakistan’s Surgical Instruments Sector, 2005‐09 (US$) 300.0 250.0 200.0 150.0 100.0 50.0 0.0 2005 2006 2007 2008 2009Source: UN Commodity Trade Statistics3.3.5.1 Value Chain Analysis The overall structure of the value chain suggests that industry typically adds 80% of ex-factory saleprice in value addition in the tune of around Rs 160 per forceps. The retailers in the foreignmarkets are adding the maximum value which is around 3 times more than the producer. Themean reason for this is branding and direct contact with the end user and market. 183  
  • 209. Figure 3‐18: Value Chain Breakdown of a 5.5 Inch Forceps In these three processes high degree of outsourcing to Material = Rs 42 vendor industry exists. Large firms outsource between Forging & Shaping = Rs 5.5 15-25%, while medium to small firms outsource up to Milling & Machining = Rs 7 Rough grinding & tampering = 70% of this work to vendors. Rs 18 Final grinding, fitting & polishing = Rs 22 Overheads & Packing = Rs Availability of Raw Material The value chain analysis above depicts that over 35% of the costs represents the material and otherinputs required to manufacture a forceps. A major portion of this cost is the steel used. Twodifferent types of steel are currently being used. Locally manufactured which costs Rs. 110/Kg andimported steel which costs Rs. 250/Kg. The above analysis refers to imported steel forceps.Although the local steel is low in cost it mostly does not meet the quality standards that arerequired by foreign buyers. The finish of the product is poor if local steel is used and rusting is acommon issue due to non-uniform tampering. Some industry has raised concern about the qualityof the local steel as not conforming to ‘health’ grade steel.Moreover, the availability of steel is also an issue. The stocks and prices are quite variable resultingin pricing problems for the industry. Large firms normally import large quantities whereas thesmall ones have to rely on supply from the vendor industry. Especially in the case of reusableinstruments which are made entirely from imported stainless steel, the firms have to import steelfrom Japan, France and Germany. In most of the cases, the lead time is two to three months,which results in the firms not being able to fulfil their orders and eventually the customers turningaway from them. Due to this huge lead time, the price of raw material varies substantially and the 184  
  • 210. Sialkot firms are not able to quote any specific prices for a long period, due to which the firms arenot able to successfully do their costing. Difficulty in Getting Adequately Trained Manpower There is currently no formal training and research centre in Sialkot which caters to the trainingneeds of the industry. As the statistics show, the industry is currently involved in the manufactureof conventional surgical instruments which are made out of locally made steel; most of theprocesses are out sourced, and are performed by vendors sitting in the small sweat-shops located inand around the city of Sialkot. These shops mostly employ informally trained workforce or newjob seekers who work as apprentices. The industry is not ready to move into high-tech, highervalue surgical goods because of the absence of technical and research centres in Sialkot. Limited Diversification of Products One of the major weaknesses of the Sialkot industry is the limited diversification of products.Almost all of the manufacturer’s are competing in the same product line, which makes the supplyexcessively greater than the demand and reduces the profit margins significantly. Inconsistent Quality Producer Image Currently there are no set of rules and regulations governing the standards of the industry. Thereis no watch dog that can monitor the negative activities in the industry. Moreover, the overallimage of the Sialkot surgical instruments industry is that of a low cost producer. The clusterproduces a variety of standard instruments, relying heavily on labor intensive techniques. Policy Recommendations:  The surgical industry of Sialkot suggests that sector-specialized clusters of small and medium sizedproducers can be well positioned to respond to rapidly changing, demand-driven, global marketsor the new competitive landscape. Since the international success of Sialkot’s surgical instrumentproducers owes much to gains obtained from clustering, we recommend the following: • Establish a Surgical training school in Sialkot. This will train workers not only in the basic skills but will create an educated workforce which understands the nature of the product. This is imperative given the fact that as quality standards and compliance regimes get tougher worldwide the workforce will have to understand the requirements of these standards. 185  
  • 211. • Upgrade / Establish laboratory in Sialkot to provide surgical instrument specific testing and conformity assessment certifications. Under new WHO regulations the industry will soon have to make a change in their polishing and cleaning techniques. The industry will have to shift from chemical to water based cleaning and polishing systems. This shift will increase costs and also change the testing and certification requirements. A laboratory is required that can test for sterilization, chemical presence, etc. The government working with the sector will either upgrade the Surgical Association Laboratory or will extend more support to the laboratory being established by the Punjab Government. • Facilitate via foreign offices for local companies to acquire international brands. • Support development of steel industry which is the primary input into surgical industry. • Establish an excellence centre for instrument design and innovation in medical device industry. • The government itself is one of the largest procurers of surgical equipment for public hospital. The procurement rules should be made more transparent so it becomes fairer to local manufacturers and also the payment methods should be such that rent seeking and any unnecessary delay is minimized. • Launch a sector competitiveness project executed by NPO.3.3.6Sports Goods Sector In most segments of the global sports goods market, industrial producers face a supply sidestructure which is typically a ‘fringed’ global oligopoly; global because a handful of bigTransnational Corporations (including Nike, Adidas, Reebok etc.) covers a major share of theworld market for each sports good; and ‘fringed’ because, in each developed country, a number ofcompeting small and medium-sized enterprises take over the remaining ‘fringe’ or margin of thelocal domestic market left by the big firms. The global sports goods industry is expected to grow by$8-9 billion in the next 3 years and is expected to reach total sales volume of about $78.6 billion by2013. The total global market of sports goods is segmented in different categories. The maincategories include Golf (22.40%), Fitness/Athletics (12.60%), Fishing (9.50%), Racquets (4.30%),and others (51.10%). 186  
  • 212. Currently, the total exports from Pakistan amount to $600 million a year which are less than 1%of the total world market share. Out of the total world market, Asia comprises $22 billion annualmarket of sports goods. However, exports from Pakistan to Asia are minimal and hardly register onthe radar screen.Table 3‐7: Sports Goods Industry CharacteristicsCharacteristic ValueNumber of units Over 10,360Contribution to national exports 3%Contribution to GDP 0.51%Sector Employment 300,000 – 350,000Skilled to unskilled ratio 2:30Capital labor ratio 12 workers / million (Rs.)Total estimated investment Rs 34 billionSource: BOI reports, CMI data and PEFMA interviewsThe sports goods being manufactured for export from Sialkot include tennis balls, rackets, hockeysticks, polo sticks, cricket bats & balls, footballs, badminton rackets and other associated products.Pakistan exports more than half of its total exports in sporting goods to the US, the UK andGermany. Figure 3-19 below shows that the exports of sporting goods from Pakistan havestagnated and declined to a low of US$0.26 billion in 2009 from a high of US$0.34 billion in2006 (www.trademap.org). The firms that were surveyed reported that not only they were unable toattract new buyers but were also finding it exceedingly difficult to maintain their existing clientele.Figure 3‐19: Pakistani Exports of Sports Goods, 2003‐2009 (US$ Billion)Source: TRADEMAP 187  
  • 213. Figure 3-20 below compare the product diversity in Pakistan’s sport’s goods industry with Worldmarket. The product mix of Pakistan is not in line with the trend of word market demand. Thispattern may explain why the exports from the sector has been declining in the recent years.Figure 3‐20: Comparison of World and Pakistan’s Sporting Goods Product SplitSource: TRADEMAP 2008 data 188  
  • 214. Value Chain Analysis For illustrative purposes we have considered a representative value chain of an export quality handstitched soccer ball. As shown in Figure 3-21 the overall value added is between 15-20%. We weretold that this number was much higher a few years back, however, the increased cost of localinputs and stiff competition from China has caused a hard squeeze on this number. Below wehave presented issues identified along the value chain.Figure 3‐21: Typical Value of Hand‐Stitched Export Quality Training Soccer Ball Raw Material = Rs 202 Assembly process & overheads = Rs 172 Marketing = Rs 5 Factory margin = Rs 30 Importers margin = Rs 4813.3.6.2 Issues Diversification of Market Pakistan’s export of sporting goods to the US, the UK and Germany covers more than half ofPakistan’s total export of sporting goods. Diversification of geographical export markets is badlyneeded. France for example is Europe’s largest market for sporting goods. Variability in Demand The production of footballs follows a roller coaster ride due to several reasons. The prime reasonfor this fluctuation in output is due to the hike in demand for soccer balls for the FIFA world cup,which is held after every 4 years. Similarly, the manufacturers face a sudden surge in demand six tonine months before UEFA Euro cup. Immediately after these major tournaments themanufacturers face a sudden dip in demand. This variability in demand has a severe impact on themanufacturing systems of sports goods firms. The impact of variation propagates from onemanufacturing stage to the next with increasingly adverse effects on production planning andcontrol activities. 189  
  • 215. Fierce Competition in the International Market Pakistan is now facing serious challenges from India, China, Taiwan, and South Korea ininternational sports goods markets. India and China have an advantage of cheap labor and rawmaterial while countries like Taiwan, Japan and South Korea are experts in mechanization and useof modern equipment. So Pakistan once the uncrowned king of sports industry is now facingserious competition from Asian competitors. A few years back Pakistan was the leader in theexports of sports gloves. Now China has surpassed Pakistan and the gap is growing with eachpassing year. Chinese sports industry is growing at a rate of 8% every year. It holds 50% share inthe sports market of cricket, hockey and baseball, while Pakistan and India merely have a share of8% and 6%. Similarly our industry is lagging in composite (graphite) based sports goods. Sialkotused to be the hub of wooden (mulberry) hockey sticks but with the shifting of world demandtowards composites; the local industry failed to cope up with the pace of the world which resultedin the reduction of our share in the international market. Issue of Child Labor The soccer ball industry of Pakistan, principally concentrated in the city of Sialkot, has been underscrutiny in recent years for employing child workers. Many reports describe children stitchingsoccer balls in small rural workshops or in homes. The widespread coverage of children stitchingsoccer balls galvanized consumers, labor and religious groups and government officials to call for astop to this practice. In June 1996, the U. S. Secretary of Labor and members of Congress helpedlaunch the Foul Ball campaign to ensure that soccer balls used by American children are stitchedby adults and not children.The public attention led U. S. importers to enter into an agreement with Pakistani manufacturers,the ILO and UNICEF to stop using child labor. More recently, public attention has focused onthe use of child labor in Indias soccer ball industry, leading to negotiations between Indian soccerball manufacturers, exporters, NGOs and international organizations to develop a code of conductprohibiting child labor. This code of conduct has in the meantime been implemented by severalkey Sialkot producers who became world class and are now major suppliers to the world’s biggest 190  
  • 216. brands: Nike, Adidas, Puma. In addition, smaller, individual companies have taken steps to assureconsumers that their products are not made by children. They have done so by revising theirproduction process or creating child labor labels. Some U. S. importers, including Reebok andBaden Sports, have begun to label their soccer balls as produced without child labor. Policy Recommendations: Since a collective capacity to compete, adapt and innovate has emerged in the sports goodsindustry, therefore, we recommend the following: • Continue to support the ongoing competitiveness initiative being managed by SMEDA and agree to fund the initiatives that will be identified as a result of this exercise. • Establish a sports good sector company with broad base representation of the private sector. This company will implement the sector competitiveness strategy developed with support from SMEDA. • Operationalize the Sports Industries Development Centre being established in Sialkot. • Support development of a material bank in partnership with the private sector to facilitate development of newer products. • Facilitate establishment of strong linkages of the sector with NED Karachi, Gujrat University and Loughborough University to work on product and design development. • Advocate with the provincial government to complete its Sports Goods testing laboratory project on a priority basis. • Provide targeted tax benefits for companies diversifying into more competitive products such as golf equipment. The credits will be conditional development and exports of these products.3.3.7Ceramics Sector Ceramics industry can be divided into ceramic tiles, Tableware, Refractory, Sanitary ware andElectric Insulators. The ceramics industry in Pakistan consists of both organized and unorganizedsegments. The production of insulators and tiles is entirely concentrated in the organized sector,and are fully documented. However, Sanitary ware, Tableware and refractory are primarily in theunorganized sector. The industry has made significant progress over the last few years. The 191  
  • 217. industry has been able to penetrate export markets and also supply to an increasing local demand.Table 3-8 shows the ceramic industry structure in Pakistan. Industry is mainly located inGujranwala, Gujrat, Lahore, Karachi, and Peshawar. Figure 3-22 shows recent exports of ceramicproducts from Pakistan which are consistently on decline. More than 60% of the exportscomprised of bathroom, kitchen and other sanitary fixtures (HS Code 6910) and bulk of it goes toUAE, Saudi Arabia and Afghanistan. US, UK, Germany and France are the leading importer inthis category but Pakistan’s exports to these countries are negligible. This shows that the currentexports are not even a fraction of the total potential offered by the sector. Ceramics and sanitaryware is a growing industry and as the incomes, tastes and preferences of the world consumerschange it offers diverse opportunities. As the sector has a significant demand it can be classified asan important growth sector for Pakistan, given, Pakistan’s share in world market is still very weak.Table 3‐8: Pakistan Ceramics Industry Tiles Insulators Sanitary ware Tableware RefractoriesStatus Highly Highly Organized+ Organized+ Un-Organized Organized Organized Un-Org Un-OrgNo. of Units 7 1 63 150 20Total 2,435 465 6,000 7,500 207EmploymentTechnology Capital Capital Labor Intensive Labor Labor IntensiveLevel Intensive Intensive IntensiveAutomation Highly Auto, Semi & Low Automation Automated LowLevel Automated Manual AutomationSource: SMEDA Report, 2007: 4 192  
  • 218. Figure 3‐22: Ceramics Exports for Pakistan, 2005‐2009 (US$)Source: UN Commodity Trade StatisticsThe critical issue faced by the industry at the moment is the unannounced electricity loadshedding which severely impacts productivity and costs. The ceramics industry runs on acontinuous production process where most of the cost is incurred at the starting phase of theprocess when the kiln is being heated. Once the kiln has reached its optimal temperature thevariable cost falls significantly. In most countries the costs are controlled by not switching of kilnsover several decades. However, given the uncertain nature of electricity supply this is not possiblefor manufacturers in Pakistan. The costs of production as a result of this frequent switching onand off of the kilns (sometime 3 to 4 times a day) increase the electricity usage and cost to such anextent that Pakistan’s industry is unable to compete internationally.Another issue faced by the industry is lack of design and product development capacity. The basictechnology of making ceramics and bath room fitting and accessories is exactly the same aroundthe world. What differs is the design and product innovation capacity. The colour scheming anddesigning and size of tiles can add more than 150% to the total value added. Similarly, consumerswould pay exorbitant prices for high fashion bathroom fittings and accessories. It is extremelysimple to make intelligent bathroom/wash room accessories by adding low cost electronic gadgetsand sensors made in China. Several Indian companies have recently launched a whole range of 193  
  • 219. electronically controlled bath room fittings and accessories. Simply adding these low costelectronic parts significantly increase the value of the products. However, to do this the sector willrequire strong linkage with the electronics industry and also with academia working in the field ofelectronics and product design. For this purpose the government did facilitate the establishmentof a product development centre for ceramics industry, however, the project was converted into ina marble factory by TUSDEC. The reason provided was to make the facility commercially viableservice centre and to generate revenue for TUSDEC. This action may help in justifying a highexpense government created company, however, fails to achieve the purpose of assisting anindustry where significant value addition potential exists. This lack of vision, element ofcorruption and poor governance has on several occasions illuminated the effectiveness ofextremely important initiatives.The sector also lacks availability of skilled workers and formal training facilities. There are noformal schools that offer training to workers of the industry at all levels. The industry is unable tofind basic skills, managerial skills, technical skills and design skills. The sector has no linkage withdesign schools such as National College of Arts (NCA), Pakistan School of Fashion Design and theIndus Valley. The students of these colleges must by default attend 6-8 months on factoryinternship programme in the sector. This will not only help the industry improve its designcapacity but also contribute in training our youth closer to the ground realities of the country andto come up with original creative work in line with the needs of the local industry.Finally, as with most of the other SME sector, this sector is also constrained by branding andmarketing. The small size of the enterprises makes it impossible for businesses to spend money onbranding or marketing their product. The packaging quality is poor and often the products aredamaged during transport. There are no display centres at places where foreign buyers/touristshave easy access. Policy Recommendations: The objective of the interventions directed at the ceramics industry is to improve its competenceand technology among the ceramics firms in order to help them become more innovative. 194  
  • 220. • Ensure that the Ceramics Industry be provided continuous electricity for 10 months during the year in lieu of complete shut down for two months • Ensure that the ceramics centre established in Gujranwala focuses on product design and development and offers training courses specifically for the ceramics sector. • Engage SMEDA to assist in creation of networks in the cluster and facilitate these networks to acquire international brands that are currently up for sale due to rising costs in the west and continued economic down turn. This outward FDI should be facilitated by the government to assist the sector develop its international branding. • Facilitate HEC, TEVTA, NAVTEC and the sector association to work with NCA, PIFD and Indus Valley to assist them in revising their courses to allow for 8 month to a yearlong internship on the factory floor to understand the designing requirements and limitations. The factories should also contribute partially to run this programme on a sustainable level; their contribution can be in the form of providing material, space and machinery to student to work on. • Support Identification of international buyer clusters of ceramics and facilitate international market access through TDAP.3.3.8Furniture Sector Furniture sector of Pakistan has historically grown on the basis of large local demand.Traditionally, it has been a resource and labor intensive industry which included both local craft-based firms and large volume producers. It was only recently that Pakistan entered into thefurniture export market. However, this entry has occurred on competitive terms as countries suchas China, Indonesia, Vietnam, Malaysia, and Brazil have also over time expanded their furnitureindustry replacing market shares of USA and EU firms. Top exporting countries in the world offurniture trade include China, Italy, Germany, Canada, and USA, respectively69. Major importingcountries are USA, U.K, Germany, France, and Canada.                                                            69 UN Commtrade statistics 2005-2009  195  
  • 221. Pakistan’s furniture industry has a long history of craftsmanship supported with strong forest base.Pakistan has 2.3 million of hectares of wood forest, supplying Sheesham wood to around 82% ofentire furniture industry of Pakistan. Sheesham is well known for its durability and quality andnormally fetches a higher price both in the local and international markets. The main woodreserves are the State owned forests in Khyber Pakhtunkhwa, Northern areas and Azad JammuKashmir (AJK). The local furniture industry also has to rely on import, especially furnitureaccessories, wood tops, plywood, roundwood, veneer and packaging materials).The sector predominantly comprises MSMEs70 with about 6,000 firms or productive units inPakistan employing 80,000 workers71. The cities of Karachi, Lahore, Peshawar, Gujrat and Chiniotare considered as the main clusters of furniture manufacturing in Pakistan with majority ofmanufacturing units concentrated in Chiniot and Karachi. Industries in Karachi and Lahore arepredominantly focusing on adding value to furniture produced in other clusters.The industry’s performance has been impacted by low managerial and technological capabilities,inconsistent quality and insufficient production capacity to meet growing domestic andinternational demand and product diversity. Most of its current production volume is gearedtowards the domestic market, competing directly with low-priced imports which have beenaggressively capturing Pakistan’s domestic market share. Especially in low cost office furnitureChinese and Southeast Asian firms have replaced local manufacturers significantly.On the positive side the furniture industry of Pakistan in endowed with several favorableenvironment and conditions with regards to craftsmanship, geographical location, low labor costand a young entrepreneurial base. However, unprecedented increases in input prices, stiffcompetition from Asian exporters like China, India, Vietnam and Malaysia are serious challengesfaced by the industry. High utility costs, improper wood seasoning, substandard finishing andpacking, poor designs & quality, lack of R & D, low level of quality control, inefficient productioncapacity & technological practices/methods, access to international markets, and not meetingworld standards and requirements are the problems plaguing the Pakistani furniture industry                                                            70 Micro, Small, and Medium Enterprises 71  ‘The furniture sector in Pakistan’, European Union TRTA program, 2007  196  
  • 222. The performance of the sector in terms of export has been much below expected potential. Overthe last five years the exports have averaged at just a minimal US$10 million as compared to thetotal world market of $50 billion. The growth in exports over this five year period has also beenlargely negative (see Figure 3-23). The major export markets of Pakistan include; UAE (16%), USA912%0, UK (11%) and Afghanistan (10%)72.Figure 3‐23: Furniture Export of Pakistan, 2005‐2009 (US$)Source: UN Commodity Trade StatisticsOn the other hand the domestic furniture market has expanded at much a rapid pace, growing ataround 25% per annum a year reaching over $160 million in value [European Union TRTAreport, (2007: 25)]. It is expected that the local demand will reach $1 billion by 201573. Thisgrowth potential offers significant opportunity to develop the industry on home grown demandand build capabilities that will ensure heightened competitiveness in international markets.                                                                  72 UN Commtrade statistics 2005-200973 IFCA estimates (Dec. 2006), SMEDA Furniture Strategy (2007) 197  
  • 223. Figure 3‐24: Pakistan Export Price Comparison, 2005‐2009 (US$/Kg of Wood)Source: UN Commodity Trade Statistics3.3.8.1 Value Chain Issues Figure 3-25 provides a snapshot of the furniture value chain and highlights the challenges which arecurrently impeding the performance of the industry. Shortage of Sheesham and Other Wood Resources  Although Pakistan possess some of the best quality wood varieties (e.g. Sheesham, Deodar, and Walnut),this 2.3 Million hectares of wood is not managed well. There are claims of widespread exports ofunprocessed logs and sawn timber to the Gulf countries. The waste happens from sawing to poor storingpractice of final products, which can reach 50% on average based on the value chain analysis providedbelow. Another issue is quick depletion of natural resources. Estimates indicate that around 1.23 to 2.4million cubic feet of Sheesham wood is cut annually [Furniture Strategy paper, SMEDA (2007 :p.9)]. At such anaccelerated pace of deforestation, replenishing of resources will not be possible. 198  
  • 224. Figure 3‐25: Key Challenges in Pakistan’s Furniture Value Chain Domestic International Market Hypermarket Mail order Dept Franchise Chain Retail DIY Stores housee Stores Stores Stores Stores Consumer Consumer Bedroom Kitchen Other furniture Channel Channel Large retailers Buying Groups Non-Specialized Distribution Bedroom Kitchen Other furniture Specialized Distribution Non-Specialized Distribution Domestic Importers/ Distributor Selling agents W e ak m a na ge ria l c a pa c ity a t firm a n d c lus te r le v e l manufacturers Wholesalers (National & International) Ina de qua te ha n dlin g of w ood / la c k of s k ille d la bor Buying agents Transport Poor market knowledge Flooring, Joinery, Furniture and parts - firms Manufacturing Intermediate & final Reconstituted panel Products plants key inputs are imported Inputs Local and imports: Woodworking items, seating/upholstery items, glass, marble, metal, plastic (structural design), finishers, measuring, jig fixture Timber/board Sawmills, veneer, plywood Imported sawn wood (USA, (4.2 million sheets (8x4) particleboard / year) Europe, Malaysia) Log bidding and auction Wood Supply, Domestic Roundwood (Kiln Drying is Missing) International market PRoduction Other, i.e. deodar, poplar, Domestic & international Sheesham (82%) mulberry (18%) Key sector challenges Raw material instability Sources: Peter Rayner (2006), ITC report (2007), SWOG analysis (2007)Source: Furniture Strategy paper, SMEDA 20073. Value‐Chain Productivity  In addition to the raw material replenishment gaps wood is also wasted due to lack of properhandling and processing techniques. The quality of the wood is compromised due to improperwood drying techniques. According to analysis above wood waste can reach up to 50% across thevalue-chain.Inconsistent quality and waste problems are result of widespread use of informal wood dryingpractices (e.g. sun drying). Currently, less than 10% of Pakistan’s wood production is kiln-dried,resulting not only in waste, but quality problems that are basic requirements for export markets. 199  
  • 225. Kiln drying eliminates moisture (to about 8-10%), bugs, and other impurities. In order to addressthis problem the Government of Pakistan has initiated pilot projects to provide appropriate wooddrying kilns Chinyot.Moreover, lack of proper cutting techniques, handling of wood and scarcity of inputs or specializedsuppliers (e.g. glue and dyes) affects the final product in both cost and quality. Basic professionalwoodcraft techniques, such as cabinet making skills rather than using nails are widely lacking.Moreover, adequate quality and finishing procedures are lacking, and modern packaging isvirtually non-existent in most factories. Such techniques and resources are essential to modernizePakistan’s firms across the value-chain to make it competitive. Volume and Price Strategy The sector has historically employed a volume rather than value based production strategy. Theindustry has always focused on way and means to increases the number of unit sold rather squeezemore value out of existing production. This strategy will have to be revised as the quantity of localwood available is declining. The industry is increasingly becoming dependent on imported woodsand accessories. This dependence is a big factor contributing to cost hikes and rendering industryuncompetitive in international markets. The industry will have to change its focus to a value basedstrategy and compete on the basis of quality, design and product variety using more of made upmaterials. Changing Consumer Preferences Another issue faced by the furniture industry in Pakistan is its inability to innovate. Pakistan’sfurniture historically was valued both in local and international markets due to the use ofextremely good quality of wood. However, the market demands and trends have changed andconsumers both in the local and international markets prefer furniture that is cotemporary, easy tomove and economical to replace as fashions and designs change. The demand of furniture whichused to be tied down to the quality of wood and endurance has now shifted to economical, trendy 200  
  • 226. and light looking well designed furniture. IKEA which is one of the biggest furniture retailers inthe world work on a simple model based on reasonable cost, high fashion decor and easy toreplace furniture. The Pakistan industry will have to shift gears to stay competitive and flexibleenough to rapidly changing demands of consumers.Box 3‐6: Past Government Intervention in the Furniture SectorIn order to address the issues being faced by Pakistan’s Furniture sector, United States Agency for InternationalDevelopment (USAID) as part of Strategic Development and Competitiveness Project formed a strategic workinggroup (SWOG) of committed industry stakeholders in 2006. SWOG has become a recognized private sector ledplatform on which all the key players in the value chain, including the public sector have come together. SWOG hasdeveloped a vision shared and agreed by the private sector and the Government of Pakistan:In the short-term, it is focused on ensuring 100% usage of kiln dried solid wood for manufacturing. This is a criticalbasic processing requirement both to gain domestic market share from imports, as well as an international standard toexport. Another complementary goal is to ensure credible supply of sustainable timber immediately and throughoutthe next 10 years. In the long-term, the industry’s vision is to become a globally competitive and sustainable furnitureindustry with improved productivity throughout the value-chain and increased export levels.To accomplish the above directions, while addressing the key sector challenges, SWOG identified followinginitiatives).Pakistan’s Furniture Sector Challenges and Proposed Initiatives Challenge Proposed Initiative Benefits Sustainable forestry system Replenishment of sheesham and other wood Wood and component bank resources Shortage of Sheesham Reconsider use of sheesham in Stable prices and reliability of inputs and other Wood public buildings Greater availability of supply for value added Chain of custody reforestration products Improved supply by curbing illegal trade Establish 250solar kilns across Ensure availability of quality raw material Pakistan World class technical capabilities, including Value Chain Common Facility Training and design, CAD and manufacturing techniques Productivity Manufacturing centres Furniture accreditation for greater export Furniture Testing Labs competitiveness Marketing (exhibitions, show Informed industry and market choices for rooms) and industry/market timely strategic actions information capturing Weak coordination Establish a sector development Critical capacity requirement to coordinate mechanisms company (Furniture Pakistan) actions proposed by SWOGIn order to coordinate the activities and implement devised strategies a sector development company FurniturePakistan has been established in 2007. It is focused to be a lead organization in developing the Pakistan furnitureindustry into a world leader in manufacturing and trading of furniture products. It is a focal platform for sustainedpublic-private sector dialogue and interaction. Till 2010, Furniture Pakistan has implemented some initiatives andwith these targeted interventions, Pakistani firms have regained some share of the growing domestic market by curbingthe current growth rate of imports. However, exports have not picked up and are consistently declining.Source: SMEDA Strategy on Furniture    201  
  • 227. Policy Recommendations:  It will be difficult to compete against the Asian furniture giants from the small workshop culturethat Pakistani industry is pursuing. In order to strengthen the industry, we recommend thefollowing: • Keep supporting the ‘Furniture Pakistan’ initiative and provide funding for implementation of strategic actions developed by the furniture sector. • On priority basis ensure provision of solar kilns for wood drying in Karachi, Chiniot, Peshawar, Lahore and Gujrat. • Ensure early completion of common facility centres for product development and training facilities in Karachi, Chiniot and Peshawar. • Allow duty free import of low cost woods and alternative material for furniture manufacturing. • Develop capacity within universities and research centres to work on development of alternative to wood materials that can be used for furniture making. This type of material is required for trendy yet economical furniture. IKEA is an example which is a leading furniture retailer in the world. Pakistan will have to build capacity to move toward low cost materials but high value added design and contemporary furniture. • Support establishment and implementation of domestic quality standards for furniture.3.3.9Leather Sector The size of the leather industry, on a global level, stands at $100 billion. A significant portion ofthis number is shared by the developing countries (around 50% belongs to China, Italy and India),while developed markets of US & Europe are major consumers of leather products. The globalindustry is largely ‘buyer-driven’ with producing countries manufacturing in line withspecifications, designs, fashion guidelines, quality and social standards and technical adviceprovided by the buyer countries. China and Italy are the leading producers and exporters ofleather products / leather with exports worth US$25 billion and US$19 billion respectively. AfterChina and Italy, there is a fairly large drop in the export market shares, with Brazil and India 202  
  • 228. taking the 3rd and the 4th positions. Pakistan’s trade size of US$1.2 billion is close to the formaltrade data for Turkey, Vietnam and Indonesia and Argentina74.The Pakistan Leather Industry has a significant place in the world leather industry built upprimarily on the basis of a large raw material supply, which supports a strong tanning industry, aconsiderable garment business and growing footwear, bag and glove components. However thesector has failed to achieve its potential as t the latest figures show exports are under US$ 1 billionmark. The Pakistan leather industry has been unable to keep up with the changing demands ofthis extensively ‘buyer-led’ industry. This has caused the overall industry to fall short competingwith the competitors who have moved ahead of them in terms of quality, productivity,completeness of the value chain, as well as a favorable domestic enabling environment.Table 3‐9: Leather Industry CharacteristicsCharacteristic ValueNumber of units 675 tanneriesCurrent Production 30 million m2Contribution to National Exports 6.5%Contribution to GDP 5%Sector Employment 0.5 millionSource: BOI Reports, CMI Data and PEFMA interviewsPakistans leather industry represents 6.5% of Pakistan’s total export base. During 2007-08, theproduction of leather was about 30 million m275 and export of leather and leather productsamounted to US$ 1.25 billion. This number has however fallen below the US$ 1 billion marksince then. About 90% of the leather and value addition goods and products are exported infinished form (Pakistan Tannery Association). The industry is predominantly clustered in andaround the cities of Karachi, Sialkot, Lahore, Kasur, Charsadda and Bannu with a much smallercluster in Multan. There are about 675 tanneries in the formal sector,76 which are concentrated ina few clusters, of which, Kasur (275), Sialkot (250) and Karachi (150) are the most important.                                                            74 Turkey’s informal trade data brings it to over US$3bn.75 Leather Sector Strategy, SMEDA 200976 Leather Sector Strategy, SMEDA 2009 203  
  • 229. The history of the modern leather industry in Pakistan dates back to the beginning of the 20thcentury, when hand-made leather was produced in Kasur by using flour and vegetables77. Rawhides and skins were exported to many countries around the world. The trend from cottagevegetable tanning to wet blue was initiated in the early ‘60s and the industry started production offinished leather in the early ‘70s. Production of leather products, such as garments and footwear,started in the mid ‘70s. The product profile of the leather sector export is dominated by thegarments sub-sector with the largest share of 43%, the finished raw leather sub-sector (finished andun-finished) at 34%, the gloves sub-sector at 13%, footwear at 9% and other leather productsincluding saddles, belts, bags and other clothing accessories at 1%.Figure 3‐26: Comparison of Pakistan and World Product SplitSource: TDAP, PLGMEA, PGMEAThe figures above re-iterate the anomaly that the Pakistan leather sector is divergent from theglobal market trend as Pakistan’s two smallest sub-sectors are the world’s largest, namely footwearand other goods. The comparison above again suggests that there is considerable room forPakistan’s leather sector to grow in footwear and other products. Developing capacities in thesetwo products can assist the sector climb a rapid growth trajectory.More generally, Pakistan’s leather sector consists of the following key subsectors: • Tanning and finishing                                                            77 The Sialkot leather cluster believes leather making in what is today Pakistan may date back 2,000 or more years.   204  
  • 230. • Footwear and some of its components • Garments • Gloves • Saddlery • BagsThe industry structure is predominantly small to medium size proprietorships / family runbusinesses (nearly 80%78). The production centres are predominantly located in Karachi, Sialkot,Lahore and its surroundings, Kasur, and to a much lesser extent in Charsadda and Bannu. Issue in Value Chain