The State of Domestic Commerce in Pakistan Study 4 - Regulatory Issues in Domestic Commerce

THE STATE OF DOMESTIC COMMERCE IN
PAKISTAN
STUDY 4
REGULATORY ISSUES IN DOMESTIC COMMERCE
For
The Ministry of Commerce
Government of Pakistan
November 2007
By
Innovative Development Strategies (Pvt.) Ltd.
House No. 2, Street 44, F-8/1, Islamabad

Table of Contents
List of Abbreviations ............................................................................................................... i
Acknowledgments ................................................................................................................ iv
Executive Summary ............................................................................................................ 3
Section 1: Regulatory Issues in Domestic Commerce ................................................ 9
1.1. Introduction ............................................................................................................... 9
Section 2: Retail and Wholesale ................................................................................. 10
2.1 Introduction ............................................................................................................. 10
2.2 Agricultural Marketing .............................................................................................. 10
2.3 Recommendations................................................................................................... 11
2.4 Main issues in Retail Markets .................................................................................. 11
2.5 Pakistan Shops and Establishment Ordinance 1969 ............................................... 12
2.5.1 Finance ........................................................................................................ 13
2.5.2 Recommendations ....................................................................................... 14
2.5.3 Taxation ....................................................................................................... 14
2.5.5 Infrastructure ................................................................................................ 16
2.5.7 Local Road and other Local Services ........................................................... 18
2.5.9 Contract Enforcement & Repudiation ........................................................... 18
2.5.11 Law and Order ............................................................................................. 20
Section 3: Transport Sector ........................................................................................ 22
3.1 Introduction ............................................................................................................. 22
3.2 Land Transport ........................................................................................................ 23
3.2.1 Railway ........................................................................................................ 23
3.3.3 Trucking ....................................................................................................... 24
3.3.4 Recommendations: ...................................................................................... 25
3.3.5 Inter and Intra City Passenger Traffic ........................................................... 25
3.3.7 Roads .......................................................................................................... 27
3.3.9 Ports ............................................................................................................ 27
3.3 Air Transport............................................................................................................ 28
Section 4: Warehousing and Storage ......................................................................... 29
4.1 Introduction ............................................................................................................. 29
4.2. Grain Storage .......................................................................................................... 29
4.3 Cold Chain .............................................................................................................. 30
4.4 Non-perishable Items .............................................................................................. 31

Section 5: Real Estate and Construction ................................................................... 32
5.1 Introduction ............................................................................................................. 32
5.2 Cost of Doing Business ........................................................................................... 33
5.3 Main Regulatory Issues ........................................................................................... 33
5.3.1 Property Registration ................................................................................... 33
5.3.2 Taxation on Registration and Property ......................................................... 34
5.3.3 Commercialization and Other charges ......................................................... 34
5.3.4 Construction ................................................................................................. 34
5.3.5 Rental Property ............................................................................................ 34
5.4 Recommendations................................................................................................... 35
Appendix I ............................................................................................................... 36

List of Tables
Table 1: IFC Cost of Doing Business Data for Pakistan ................................................. 33

Innovative Development Strategies (Pvt) i
List of Abbreviations
ABAD Association of Builders and Developers
ADB Asian Development Bank
ADBI Asian Development Bank Institute
APCA All Pakistan Contractors Association
ATT Afghan Trade Transit
BAF Bank AlFalah
BCI Business Competitiveness Index
BOR Board of Revenue
CAA Civil Aviation Authority
CBM Cubic meter
CBR Central Board of Revenue
CDA Capital Development Authority
CIB Credit information bureau
CMR Contract for the International Carriage of Goods by Road
CPI Corruption Perceptions Index
CPIA Country Policy and Institutional Assessment
DFID Department for International Development
DHA Defense Housing authority
EDF Export Development Fund
EIU Economist Intelligence Unit
EOS Executive Opinion Survey
EPB Export Promotion Bureau
ESCAP Economic and Social Development in Asia and the Pacific
FBS Federal Bureau of Statistics
FCL Full Container Load
FDI Foreign Direct Investment
FIAS Foreign Investment Advisory Service
Ft Foot
FY Fiscal Year
GCI Global Competitiveness Index
GCR Global Competitiveness Report
GD Goods Declaration
GDP Gross Domestic Product
GoP Government of Pakistan
GOR Government Officials Residences
GRT Gross Register Tonnage
GST General Sales Tax
HBFC Housing Building Finance Corporation
HBL Habib Bank Limited
HDR Human Development Report
HFIs Housing Finance Institutions
IFC International Finance Corporation
IFS International Financial Statistics
IMF International Monetary Fund
ISAL Informal Subdivision of Agricultural Land
ISO International Standards Organization
IT Information Technology
ITU International Telecommunications Union

Survey Report on Domestic Commerce
Innovative Development Strategies (Pvt) ii
KBCA Karachi Building Control Authority
KDA Karachi Development Authority
KESC Karachi Electric Supply Corporation
KM(s) Kilometer(s)
KPT Karachi Port Trust
KSE Karachi Stock Exchange
LCL Less Than Container Load
LOA Length Overall
MCB Muslim Commercial Bank
MENA Middle East and North Africa
MOC Ministry of Commerce
MOD Ministry of Defense
MTDF Medium Term Development Framework
NBP National Bank of Pakistan
NCS National Conservation Strategy
NER Net Primary School Enrollment Rate
NHA National Highway Authority
NIE Newly industrialized economy
NIT National Institute of Transport
NLC National Logistics Cell
NTN National Tax Number
NTRC National Transportation Research Center
NTTFC National Trade and Transport Facilitation Committee
NWFP North West Frontier Province
PASSCO Pakistan Agricultural Storage and Services Corporation
PEC Pakistan Engineering Council
PHDEB Pakistan Horticulture Development and Export Board
PIAC Pakistan International Airlines Corporation
PIDE Pakistan Institute Of Development Economists
PIHS Pakistan Integrated Household Survey
PKR Pakistani Rupee
PQA Port Qasim Authority
PR Pakistan Railways
PREF Pakistan Real Estate Federation
PSDP Public Sector Development Program
R&D Research and Development
REER Real Effective Exchange Rate
REITs Real Estate Investment Trusts
RICS Royal Institute of Chartered Surveyors
SAI Social Accountability International
SBP State Bank of Pakistan
SKAA Sindh Katchi Abadis Authority
SME Small and Medium Enterprises
SPS Sanitary and Phytosanitary
SRO Statutory Regulation Order
Std Standard
TEP Total Factor Productivity
TEU Twenty-Foot Equivalent Units
TI Transparency International
TOR Terms of Reference

Innovative Development Strategies (Pvt) iii
TSDI Transport Sector Development Initiative
TTFP Trade and Transportation Facilitation Program
UK United Kingdom
UNDP United Nations Development Program
US United States
USA United States of America
USC Utility Stores Corporation
USD United States Dollars
WAPDA Water and Power Development Authority
WDI World Development Indicators
WEF World Economic Forum
WGI Worldwide Governance Indicators
WTO World Trade Organization

Innovative Development Strategies (Pvt) iv
Acknowledgment
This work has benefited from a number of focus group discussions held all over the country and feedback received at a series of seminars held at the Federal Ministry of Commerce during early 2007. The results were also disseminated at a national seminar in April 2007 in Islamabad. The study team is grateful to all the participants of these discussions as well as the 2000 respondents who gave so freely of their time.
The IDS team owes a special debt of gratitude to the officers of the Ministry of Commerce for their guidance, assistance and feedback during the course of this study. Our greatest thanks go out to Syed Asif Ali Shah, Secretary, Ministry of Commerce for nurturing these studies through all the stages.
Thanks are also due, in particular, to Mr. Naseem Qureshi and Mr. Ashraf Khan, Additional Secretaries; Mr. Abrar Hussian, Joint Secretary; Syed Irtiqa Zaidi, Consultant and Mr. Qaseem Subhani, Section Officer of the Federal Ministry of Commerce, for sparing their precious time and efforts for the studies.
The support lent to this work by Mr. Saeed Ahmad Alvi, Secretary, Department of Investment and Commerce, Government of Punjab is also gratefully acknowledged. Not only did he make a great contribution to the conceptualization of the studies, but his office helped to facilitate the workshops and field work in the Punjab for which we are eternally grateful.
The team feels a deep sense of gratitude for the Federal Minister for Commerce, Mr. Humayun Akhtar Khan, who took out considerable time from his very busy schedule to guide this work. It was his sincere and deep conviction in the value of quality research which enabled us to conduct and compile this detailed and comprehensive study on Domestic Commerce. Without his continued interest, guidance and oversight, this study would not have been possible.
This study has benefited from comments received from the following:
1. State Bank of Pakistan, Karachi.
2. Federal Board of Revenue, Government of Pakistan, Islamabad.
3. Planning and Development Division, Government of Pakistan, Islamabad.
4. Trade Development Authority, Government of Pakistan, Karachi.
5. (Management Consultants) Establishment Division, Government of Pakistan, Islamabad.
6. Finance Division, Government of Pakistan, Islamabad.
7. Pakistan Institute of Development Economics, Islamabad.
8. NTTFC, Karachi.
9. FPCCI, Karachi.
10. Planning and Development Board, Government of Punjab, Lahore.
11. Planning and Development Board, Government of NWFP, Peshawar.
12. Planning and Development Board, Government of Sindh, Karachi.
13. Planning and Development Board, Government of Balochistan, Quetta.
14. Investment and Commerce Department, Government of Punjab, Lahore.
15. Housing and Works, Government of Pakistan, Islamabad.
16. Ministry of Communications, Government of Pakistan, Islamabad.
17. Ministry of Food, Agriculture and Livestock, Government of Pakistan, Islamabad.
18. Ministry of Water and Power, Government of Pakistan, Islamabad.

v
19. Ministry of Petroleum, Government of Pakistan, Islamabad.
20. Law, Justice and H.R. Division, Government of Pakistan, Islamabad.
21. Agriculture Department, Government of Punjab, Lahore.
22. Local Government and Rural Development Division, Government of Punjab, Lahore.
23. Statistics Division, Government of Pakistan, Islamabad.

1
REGULATORY ISSUES IN DOMESTIC COMMERCE
by
DR. FAISAL BARI

Innovative Development Strategies (Pvt) 3
Executive Summary
1. Increasing globalization and the policies of liberalization, de-regulation, and privatization that successive governments in Pakistan have been pursuing over the last decade and a half have increased the need for domestic producers and service providers to be competitive with the international counter parts. This is needed not only for exporting to other countries, developed or developing, but for competitive performance in the local markets as well. With increasing globalization, this need to be competitive, both domestically and internationally, will increase manifolds. If our economy is to maintain a high growth trajectory, we need to be aware of all issues that might be creating hurdles in the way of doing business, competitively, at the international level. If our local costs, direct or indirect, are not in line with the costs in other countries, local producers will suffer, and so will the local economy. This study reviews some of the regulatory issues facing various sectors in domestic commerce and identifies the major regulatory hurdles related to each of them. While recommendations are made on major issues much more detailed work needs to be done on a host of others before an optimal course of action can be recommended. The main points from each sector are summarized below.
Agriculture Marketing
2. Pakistan clearly has a significant potential in export of fruits, vegetables, dairy products, meat and grains. These are important domestic sectors as well. But the potential has so far not been fully exploited in any of the area mentioned above. In some of these sub- sectors there are significant regulatory issues that could be crucially hampering further developments.
3. Fruit and vegetable markets, regulated by the respective provincial agricultural departments under the Market Committee Acts, pose significant hurdles to development of such markets by the private sector. Despite recent amendments, private sector is still not keen to enter this area and the small number of fruit and vegetable markets continue to impose significant distortionary costs. The Market Acts give too much regulatory authority to the government, allow it to interfere in the day to day functioning of these markets, and give it powers to control governance structures, rentals and allocation of space in the market. Under such restrictive conditions, it is not surprising that private sector has not entered the area in any significant fashion. A thorough overhaul of the Market Act, with a view to facilitating private sector entry is badly needed here.
Retail and Wholesale Markets
4. Most of the retail and wholesale businesses in our sample are not registered as businesses either under the Companies Act or under the Shop Act. Though the latter is a requirement for all shops, there is no real enforcement of the Act on small businesses. It is not the level of fees related to registration of the shop that seems to be the major hurdle in registration. It seems that a) shopkeepers either do not know of the requirement, or b) they attempt it to avoid any implications that registration might have on the taxation side.
The main regulatory issues related to wholesale and retail businesses are summarized below1:
1 A lot of these issues are common to all small and medium sized businesses, irrespective of sector or type of business.

5. Finance: Most small businesses do not have access to formal sector financial institutions. Since the bulk of Pakistani businesses fall in the category of SMEs or micro- level businesses, this lack of access to finance poses a significant problem for firm growth as well as overall growth. The main problems have to do with a) lack of reliable/contractible information on individual small firms as well as the sectors they work in, b) lack of formal registration of small businesses, c) lack of physical collateral, d) high cost, for formal sector banks, to deal with small loans, and e) high cost of collecting the required firm and sector specific information.
6. The solutions to the problem are related to a) move to balance sheet lending instead of asset based lending, b) training in balance sheet lending for bankers, c) creation of credit bureaus that keep detailed information of small firms, d) generation of reliable sector specific information, e) pooling of risk through creation of guarantee funds for initial lending.
7. Taxation: Income and sales tax levels are considered to be high. Time costs of dealing with custom clearance, compliance costs to meet all the rules and requirements are all considered to be high. There are distortionary threshold effects in our tax system and relatively high levels of corruption (or a perception of it).
8. Documentation of supply chains, widening of tax net, rationalization of tax rates, move towards self-assessment with limited interaction with tax officials, moves against corruption and lowering of compliance costs by streamlining the administrative systems needs to continue. Detailed studies need to identify threshold effects in the tax system so that they can be removed. Custom clearance processes need further improvement in terms of time required for clearance as well as for reducing discretion in setting tariff rates.
9. Infrastructure: Very few businesses were happy with the infrastructure being provided.. The main complaints relate to electricity and gas provision, road quality, and water/sewerage access and quality.
10. For electricity, the main issues are related to high tariff rates for commercial and industrial activity, load-shedding, poor quality of service, delays in getting connections, corruption, the arbitrary powers given to WAPDA, and the need to have back up (raising costs) arrangements.
11. Better planning to get to an optimal mix of hydro/thermal generation is needed for tariff adjustment. Tariffs differentials, across activity, need rationalization. NEPRA needs to be better resourced to be able to a) protect the consumers better, b) impose more discipline on WAPDA, and c) ensure a level playing for all (private and public) players. Benchmark or real competition needs to be introduced at the distribution level as well.
12. Local roads2 and infrastructure (water, solid waste management, sewerage, street- lighting, local chowkidari) are the responsibility of the local government. Better accountability mechanisms need to be introduced at the local level. For industrial estates there has been some experimentation, for infrastructure provision and management, through private-public partnerships. This needs to be generalized across all industrial estates and the same or a similar model needs to be considered for the retail and wholesale clusters and warehousing areas.
13. Contract Enforcement: Contract enforcement and repudiation issues are distorting the business environment in a variety of ways leading firms to depend on short term contracts and spot deals, forcing them into backward or forward integration, forcing them to restrict business to fewer buyers and/or suppliers, making them rely on family labour, and forcing businesses to divide rather than grow. The total cost this might be imposing on Pakistani business in terms of static costs as well as dynamic ones through distorted or restricted
2 Inter district roads and highways are treated separately under transport section.

Regulatory Issues In Domestic Commerce
growth are difficult to estimate, but our data (interviews, focus group discussions, our survey as well as previous surveys) does suggest that the costs are significant.
14. This area requires a lot more research but most solutions in the area will have to provide a better functioning, more efficient and fairer judicial system. In addition, experiments in Alternate Dispute Resolution (ADR) mechanisms and sector specific courts might also be needed.
15. Law and Order: The law and order situation in the country generally, and especially in some parts of the country (like Karachi) is quite poor and businesses complain that it imposes a significant cost on them through a) hiring guards, b) direct losses through hold-ups and so on, c) reduced business volumes due to reduced hours or reduced traffic. In some areas there are payments made related to protection money as well. A poor law and order situation can reduce future investments as well. Recommendations in this area are beyond the scope of this paper on regulatory issues.
Transport Sector
16. Losses due to a) delays and slow movement of goods, b) accidents, and c) fatalities, are costing businesses and the people of Pakistan significantly.. Roads are the main carrier of goods and passengers in Pakistan, and railways and airlines share a relatively minor part of the total traffic. Port Qasim and Karachi are the main ports of entry for international trade.
17. Railway: Railway handles about 10 percent of intercity passenger traffic and less than 5 percent of inland freight, even though given the long North-South route (Karachi to up country) it should have had a cost advantage over road transport for freight. Pakistan railways has always focused more on passenger traffic than freight. It is not run on a profit basis, continues to service non-viable routes, and offers prices that are not worked out on a profit basis. Higher management lacks performance related incentives, systems for accountability and the discipline of hard budgets. The sector does not even have an independent regulator so that Pakistan railways acts both as a monopoly in the sector and the regulator as well.
18. A sector specific regulator is needed in the area. Railways needs to be corporatized so that it has a) specific and clear objectives, b) clear incentives for management, and c) procedures for accountability. De-bundling of services and introduction of competition in the sector, by allowing the private sector to enter the area, should also be considered.
19. Trucking: There seems to be a low level self-reinforcing equilibrium in the trucking industry that needs to be broken up. High levels of competition in the sector, due to low entry barriers, are forcing freight rates to be low. But this forces competitors to cut corners on quality, leading them to a) overload, b) drive for longer hours or more recklessly, c) not buy insurance, and d) compromise on driver quality. Since competition is on prices and there do not seem to be any economies of scale, escape from this low level equilibrium seems hard. NLC, the army backed company, is different, but it is only one company and since it has the backing of the army, it actually distorts the sector even more.
20. The sector needs regulation that would break the low level equilibrium described above and force trucking companies to raise standards. This will a) erect some entry barriers, and b) raise the cost of transport, but that might be the only way of reducing costs (in terms of time delays, damages and accidents) in the long run and of developing a trucking industry in the country.
21. Passenger Traffic: Rules for inter and intra-city passenger traffic need to be worked out. Currently the sector has too many provider specific exceptions, especially in the intra- city route allocation and enforcement. There is also a need to recognize that entry has to be restricted on specific routes to ensure adequate returns for players: the transport market

cannot be perfectly competitive as the marginal cost of provision is likely to lie below the average cost of provision.
22. Some of the same issues arise in the taxi markets in cities as well. Regulations regarding entry as well as fares are needed to ensure a) a minimum quality package and b) adequate returns for providers.
23. Roads: Responsibility for highway planning, construction and maintenance lies is with the National Motorway and Highway Authority. The way the authority is set up it has little incentive to a) construct roads of high quality, and b) maintain roads optimally. There needs to be a separation between the construction/maintenance and regulatory roles and there also need to be changes in the incentive structures of the Authority to ensure a) management has incentives that are aligned with the objectives of the authority and b) optimal incentives are offered for planning for the future needs, managing construction quality and optimal maintenance.
24. Ports: Dwell time and docking costs at Pakistani ports continue to be high, as compared to other ports in the region. Longer custom clearing times, lack of processing facilities outside the docks, and lack of adequate inland transport network contribute to the longer dwell times. Rationalization of port charges should also be a high priority item on the agenda for reform.
Warehousing and Storage
25. Storage and warehousing is a very important link in supply chain management in modern economies. It is particularly important for the Pakistani economy as a) significant issues in transport and logistics imply a higher need for managing inventories, b) being an agricultural economy, the need for storing perishable items is significant. Storage of agricultural items is important for exports of course, but it is important for managing domestic prices as well. Cold-chains for non grain perishable items are generally missing from the Pakistani markets so far. Without cold chains it is impossible to export meat, dairy products and fruits and vegetables or to efficiently meet local needs.
26. Grain storage: The Government is still the major player in the procurement and storage of major food grains despite the fact that it has over the over the last decade or so, allowed the private sector to enter grain trade, export/import and storage as well. But the rules of the game are not made absolutely transparent and there have been many unexpected turnarounds that have severely affected the development of the private sector in this sector. It is difficult, under these circumstances, for the private sector to decide whether to invest in storage facilities or not and whether to enter grain trade or not. The government needs to clearly state its procurement, storage, marketing and pricing policies and think adhere to them. Without these, it is hard to see private sector role increasing in the sector.
27. Cold Chain: The creation of a cold chain involves a significant fixed and sunk investment in infrastructure related to a) buildings near hubs of output as well as near airports and ports, b) refrigeration facilities and electricity generation back-up systems and c) refrigerated trucks. If the demand for the cold chain is not well articulated, concentrated and guaranteed, it might not be feasible for a private sector entrepreneur to enter the area on his/her own and without support from the government. A government subsidy or guarantee to all the links in the cold chain might be needed to break the ice and tide the investor over the initial period.
28. Non-Perishable Items: Storage facilities for non-perishable items for retail, wholesale as well as for industry, do not seem to have any major regulatory issues, other than ones that are related to all businesses (discussed under retail and wholesale section). Most retailers do their own storage in or near their shops. The same is true of most wholesalers. If

more space is needed, businesses develop storage near their place of business, on empty lots or rented or owned property.
Real Estate and Construction
29. Construction is not only a significant contributor to the GDP, its indirect contribution to year to year growth is also significant. In addition, its current and potential contribution to employment is also large given its potentially large backward and forward linkages..
30. Real estate and construction sector have been repeatedly identified in our surveys and focus group discussions as sectors that have significant regulatory issues that need resolution. Cost of urban land, difficulty in identifying clear titles and ownership, time and cost of doing so, cost of transfer and registration, and other taxes and costs have been identified as some of the problems in the real estate area (since property regulation are a provincial subject, we use Punjab as an example of the kind of issues that are present in this market).
31. Property Registration: Pakistan does not have an efficient and transparent cadastral system for property registration. What is registered is transfer of property, and not title and so records only shows transfers. Therefore, establishing ownership is a matter of following the transfer trail, spending time and money on it, and living with a certain uncertainty regarding titles. The costs, in terms of time and lawyer fees and so on, can be substantial. Unclear records also lead to excessive and sometimes even frivolous litigation. These also limit the value of real estate as collateral.
32. Taxation on Registration and Property: One percent registration and 5 percent stamp duty on property transfer registration (on value of property) is high. Added to these are court fees, brokerage fees, search costs and so on. This encourages informal non-registered transfers and under reporting and make the property market even more opaque.
33. Commercialization and Other Charges: Commercialization fee (residential to commercial) is 20 percent of value of plot, and there are high development charges for provision of water, sewerage and road facilities.
34. Construction: Building and zoning codes vary from city to city and have a plethora of unclear and vague regulations. Some of the smaller cities do not even have codes. Some codes are out dated, for example, restriction on height of buildings. There is a great need to introduce modern building codes..
35. Rental Property: Rent restriction ordinance distorts the market for rental property. Limits on rents, excessive tenant rights and differential taxes on rental property (compared to owned property) limit development of property for rental purposes and reduces incentives for optimal maintenance. This puts upward pressure on rents on existing property. Rental property is taxed at a much higher rate than owned property setting disincentives for disclosure despite any sound economic reasoning for the differential in taxes.
36. Establishment of a transparent and efficient cadastral system for property title registration should be a high priority). Stamp duties on property related transactions and registration fees need to be rationalized. Non-registered transactions have to be banned. Most of the regulatory issues connected with the real estate sector are in the purview of the provincial and local Governments. Change of use charges and Development charges by water/sanitation authorities need to be rationalized on the basis of costs. Building and zoning codes need to be modernized and harmonized across the province. Possible environmental impacts of expansion of urban and industrial areas need greater recognition. Rental property laws need to be revised. Market distorting effects of rent control, excessive tenant rights and differential taxation (registration, stamp duty and property tax) all need to be rationalized to ensure efficiency and growth in this sector..

Section 1
Regulatory Issues in Domestic Commerce
1.1. Introduction
1. Domestic commerce can form the back bone for industrial activity in the country, and can provide the platform for our export efforts. If Pakistani businesses cannot conduct their trade and manufacturing, within the borders of the country, in an efficient and unhampered manner, it is not likely that we will be able to compete effectively in a global environment as well. In fact, smoothly functioning domestic markets and vibrant domestic commerce might be a pre-condition for good performance beyond our borders, and it might be a pre-condition for attracting high and sustained levels of investment as well.
2. Domestic commerce crucially depends on retail and wholesale, warehousing and storage, transport, and real estate markets. These have been studied in detail in the following sections that are dedicated to each of these markets. But each area offers some regulatory issues that need to be looked at as well. This section focuses on these issues exclusively and in some detail. We take each sector in turn and point out the main regulatory issues that have been identified in the area, in previous literature as well as through our data collection, and then discuss the issues in some detail to suggest some recommendations for almost all of the areas concerned. This is by no means an exhaustive list of all regulatory issues. But it does make an effort to point out all of the major issues, and it does make an effort to contextualize each issue sufficiently to motivate the recommendations made. It goes without saying that some of the issues require further study before we can get to the bottom of the issues mentioned. This is particularly true of issues surrounding the area of contract enforcement and repudiation. We hope this section will go some way in starting a debate in the area.
3. Regulation needs to be seen as an enabler and facilitator. Regulation helps the government and the society to facilitate business operations and to provide a level playing field for all. It should not be seen as a way of controlling activity or creating hurdles in the way of businesses. As such, the issue is not of over or under regulation, but of effective regulation. In some cases Pakistan has good regulatory laws and systems, but their implementation is weak. In other areas there are not enough regulations and in some there are too many. What is needed, from the government side, is a) an attempt to think of regulation as an enabler, b) to create a continuous dialogue with the business community that will allow fine tuning of regulations, and c) a constant effort to ensure effective implementation. The government has to get out of the habit of making rules for some and it has to get out of the habit of making exception as well. Markets cannot function well without optimal regulation, but regulation that is optimal and effective. This is the direction we have to move in to ensure better functioning domestic markets in all areas.

Section 2
Retail and Wholesale
2.1 Introduction
4. The importance of retail and wholesale sector in direct contribution to the GDP, the growth of GDP, and to employment in the country is already well established through the macro data available with us3. Retail alone contributes some 18 percent to the GDP and some 12-15 percent to employment. The sector has been growing at a healthy rate but is still lagging behind, in size and development, to retail and wholesale sectors in other comparator countries, so significant potential still remains in the sector. Why does the country have no large scale retail chains? Why does it have retail clusters (Azam Cloth market, Hall Road electronics market, etc.) with thousands of shops selling similar products rather than a smaller number of larger shops? Why has growth been in number of small shops rather than in size of shops or multiple shops under single ownership structures? Some of the factors have to do with regulatory issues related to the retail sector. Property rights regime in the country, contract enforcement issues, cost of introducing technology that increases the span of control of unified management structure across multiple locations, among others, are some of the issues that need to be understood from a regulatory perspective.
5. Regulatory issues related to retail and wholesale markets can be split into two areas: a) agricultural produce wholesale markets and b) other retail and wholesale markets. The fruit and vegetable wholesale markets are managed under a separate law and this needs separate consideration. For other products the distinction between wholesale and retail markets is not that clear or even important from a regulatory perspective, and their issues are similar as well – they are thus treated together.
2.2 Agricultural Marketing
6. Grain, fruit and vegetable and livestock wholesale markets are quite heavily regulated in the country across the four provinces, except if the market is in a small town. For the Punjab, grain markets are regulated by provincial food department, the fruit and vegetable wholesale markets by the provincial agricultural department, and the livestock markets by the livestock department. We have discussed grain markets in the section on storage and warehousing so we will focus on problems of fruit and vegetable wholesale markets here.
7. Fruit and vegetable wholesale market regulation comes under the agriculture department (and now the new agriculture marketing department of the province). The market regulation is enacted through the Market Committees under the Market Committee Acts. The way these Acts have been set up, no wholesale fruit and vegetable market can be set up without prior permission from the government; a market committee enjoys monopoly power
3 Details are given in the sections on retail and wholesale sectors.

in its domain and no wholesale trading can take place outside of the areas that the committee designates4, and then the Act also gives almost dominant power to the government even at the operational level.
8. The government controls the set up of the Market Committee, it controls who gets nominated to the Market Committee, it controls a major share of the revenue from markets, controls rents and other charges that can be collected, controls allocation of shops and shop space, controls expansion and other major decisions as well. Under the circumstances, it was not surprising that private sector did not participate in setting-up of fruit and vegetable wholesale markets. Government-provided facilities were inadequate, did not give enough returns to players to provide high quality infrastructure in the markets that existed - roads, storage and other facilities, cleanliness, and so on - or to plan for optimal expansion. A city as big as Lahore has only four markets for more than 7-8 million people!
9. The government of the Punjab did acknowledge the problem and set up a separate department, Agricultural Marketing department, with the explicit task of modifying laws and institutions so that private sector involvement in setting up and running wholesale markets, on a commercial and for-profit basis, could be increased. But they asked the bureaucracy to amend laws to limit the power of the bureaucracy. The result was that despite amendments, no private sector party became interested in entering the sector over the next couple of years. The amended laws still retain most of the power of the government in nominating the committee, setting rentals and most of the allocations, and micro-managing the operations and day-to-day activities of the markets. It is not a surprise that the private sector has not come into the sector despite the large potential for profits. The Market Committee Act needs a more thorough revision to reduce the role of government to just ensuring smooth functioning, protection of consumer and seller rights, and ensuring due diligence on environmental concerns.
2.3 Recommendations
 A thorough overhaul of the Market Committee Act to reduce the role of government to that of a true regulator and facilitator of commercial activity. This will mean reducing its role in determining market committee members, nominating members, determining rents and allocations, determining levies, and micro managing the day-to- day operations of markets.
2.4 Main issues in Retail Markets
10. Our sample shows that most of the retail shops are not registered and many of them do not even feel they have to register, though some felt that the cost of registering was too high – pointing to an interesting situation. By law, of course, all shops have to register under the Shop Act. But the charge for that is nominal and there is no major hassle involved in this process. There can be an issue of visits from officials and the issue of side payments (corruption), but this is usually related to the labor department and is not linked to registration under the Shop Act. Even in this case, this is not a major issue in terms of the total cost - in time and money. But this is not the same as the registration of a business as a company, etc. So the two registrations are different. It is the latter, registration of a business, that is more
4 An exception is going to be made for large scale grocery stores that are going to be coming to Pakistan soon and starting operations here. But it seems this is going to be an exception only, without a change in the larger law: an indication of how uneven the playing field can be for domestic and foreign or large players.

costly and much more time consuming, and can have implications, in terms of taxes and so on, but that is a different issue.
2.5 Pakistan Shops and Establishment Ordinance 1969
11. The majority of businesses in the retail sector especially, comprise of small shops that employ roughly 10-16 people. Such establishments do not register with the registrar of companies. Rather they register themselves with the deputy chief inspector for the area under the Pakistan shops and establishment ordinance 1969. On the other hand, companies have to register themselves with both the registrar of companies and the deputy chief inspector. There are a number of regulations that establishments have to comply with under the ordinance, however all these relate to labor conditions. Some of them are:
 Daily, weekly wage and overtime
 Overtime wages
 Time and condition of payment of wages
 Casual and sick leave
 Wages during leave or holiday period
12. There are no regulations monitoring the quality of output, or trying to prohibit non- cooperative strategic behavior that aims to reduce competition. The penalty for giving incorrect information or not complying with any of the regulations is only Rs.50 and extends to a maximum of Rs.250 for the first offence, and Rs.500 or imprisonment for 2 months for the second offence. Such low penalties will provide an incentive for employers to ignore the rules of the ordinance as it costs them more to comply with them than to default from them. Finally, the agency is not independent. The Government has the power to exempt any establishment from all or part of the provisions of the ordinance and has the power to appoint the chief and deputy chief inspectors who have the authority to enter any establishment and inspect its records, registers and documents to ensure compliance with the ordinance. Of course in the absence of any committee or agency responsible for monitoring the work of these inspectors, accountability will be an issue. Another interesting thing is that there is also a Department of Labor in Pakistan with its own labor policies and regulations, although the policies are not available on their website. Given that the Pakistan shops and establishment ordinance covers the majority of labor related aspects, what then does the Department of Labor do? Don’t the majority of roles for these two agencies overlap with each other?
13. There are apparently a few laws that have been introduced to protect consumer interests by monitoring the quality of goods produced and sold by firms, however these are very vague with no definite procedures mentioned for inspecting the goods or registering and solving consumer complaints:
 Pakistan Standard and Quality Control Authority Act 1996
 West Pakistan Pure Food Ordinance 1960
 Cantonment Pure Food Act 1960
14. In the case of the Pure Food Ordinance, the responsibility for ensuring compliance with the provisions of the ordinance rests with the local authority, without any definition given as to who this authority exactly is. For those places that come under a cantonment, it is clear who the regulating authority is (local cantonment board) and thus in these areas, there are efforts being made to ensure quality for the consumer and to act upon consumer complaints but not so in the remaining areas of Pakistan.
15. The clusters that have formed in the manufacturing and retail sectors are crucial for the growth of Pakistan. If agencies do not take the initiative to train members of the cluster

and coordinate activities96 amongst them so that they may achieve agglomeration economies of scale then the industry has to depend on individuals to take the initiative themselves as has occurred in the gems and jewellery industry of Karachi. A group of committed industry stakeholders from gems trading and mining, jewellery manufacturing, jewellery retail and wholesale, training institutions, technical service providers, raw material suppliers and other allied industries agreed to form a Strategy Working Group (SWOG) to address how the industry could reposition itself through a better strategy. The project was launched by the US Agency for International Development working in partnership with Pakistan’s Small and Medium Enterprise Development Authority. By developing linkages among stakeholders, the industry was able to increase productivity, quality and sales, something that the regulating agency should have been responsible for.
16. The major regulatory issues related to retail are discussed below5:
2.5.1 Finance
17. Most retail businesses are financed through savings and borrowings from family, relatives and friends. Very few apply for credit from the formal sector, and very few receive any assistance from the formal suppliers of credit. This is cited by many as a major obstacle to their growth. But this issue is not restricted to retailers only. It is a problem that is common to almost all small and medium sized businesses - whether in retail, manufacturing, storage and warehousing, transport, or any other sector. It has more to do with the outreach of the formal sector financial institutions.6
18. The problem can be stated briefly as follows: Formal sector institutions do not have reliable information on the sectors in which a lot of the SMEs work and they definitely do not have any reliable information on individual SMEs. It is very costly for banks to acquire reliable and contractable information on SMEs as well. SMEs are usually not registered, do not have formal paperwork, do not have credit histories, do not have physical collateral to offer (and even if they have land or buildings, we have discussed in a related section problems with real estate markets that make land a difficult asset to contract on). It makes it very difficult for formal sector credit providers to reach the SMEs. So SMEs get rationed out; they would like to have credit at going rates of interest, but formal sector institutions do not want to lend to them, and in fact they do not want to lend to them even at higher interest rates.
19. This is again an example of a low level equilibrium where the information asymmetry is such that it does not allow a higher level equilibrium to emerge. It is not that all firms are a bad credit risk; it is more that a) there is no reliable and contractable way in which banks can distinguish between the good and the bad risks, and b) there is no reliable way for the good firms or businesses to signal their quality. If we are going to address the problem, we need the institution of reliable third (independent) parties that can transmit detailed, authentic, and reliable information to the banks. It has to be detailed enough for the banks to address the issue of information asymmetry adequately before they can enter this market. It should be clear here that formal registration, of the business or shop or factory, has little or nothing to do with this. Even forming a private limited company might not give enough incentives to a firm to keep information in a manner that provides reliable information to the lenders. This is why neither the banks nor businesses feel that being registered is a sufficient condition for
5 The larger issues mentioned here are shared with manufacturing as well as others sectors of the economy.
6 There are many surveys that establish the limits on the outreach of formal sector financial institutions in Pakistan. World Bank surveys on cost of doing business, investment climate and on SMEs establish that, SMEDA studies have established that, MOIP study on industrial strategy establishes this, and LUMS SME survey as well as Bari, Cheema and Ehsan ul Haq (2006) study for ADB also establishes this very clearly.

lending to occur. Of course it might be preferred by banks that its clients be formal sector players, but this does not give sufficient and needed information to the bank.
20. It is of course in the interest of the banks as well as the potential borrowers to have such institutions, but there is a cost to setting up institutions. It might well be that where both sides might see the value of such institutions, it might not be in the interest of any one party to foot the bill for setting up such institutions. And if joint solutions from the side of clients or from the side of banks are also not easy to achieve, it might have to be the government who initially has to foot the bill, till the institution shows the value of its services and can start charging for it. It makes sense for the government to foot the bill for such institutions as it can break the low level equilibrium and create value for the entire economy. The exact form of institutions can vary, but rating agencies, agencies for creating sector specific knowledge, and credit bureaus are all needed to address the asymmetry. In addition, these institutions will need to be connected to each other too to provide a more complete information set.
21. There do not seem to be any major obstacles to the creation of such bodies. The State Bank of Pakistan has already made provisions for income based lending:, it has also extended the remit of its credit bureau to include information on borrowers of all loan size. But we have not yet seen the rise of credit bureaus with more complete information and rating agencies focusing on some sectors or on smaller firms. This might need some further encouragement from the government.
2.5.2 Recommendations
 Creation of credit bureaus that not only have information on those who have already acquired loans, but also on prospective and potential clients. SBP has a bureau that has information on existing borrowers, we need to create bureaus that have information on potential clients as well, and the field of information will need to be more than just information on loans. It will have to have information on any outstanding legal disputes, relationships with buyers and suppliers of the business, information on history of relationship with the utility providers and any other information that might be pertinent in establishing the credit worthiness of the business.
 Creation of sector specific information providers. SMEDA could play a significant role here, but the federal government needs to redefine SMEDA’s role to take on this effort in a much more concentrated manner.
2.5.3 Taxation
22. Most retailers7 have a problem with the level of income and sales tax in Pakistan. In addition, taxation structures impose significant compliance costs on businesses, and the compliance costs are higher for small and medium sized businesses, as a percentage of their sales or turnover, as compared to the larger businesses, and there are significant threshold effects as well that the current tax structure creates. These threshold effects distort incentives for registration as well as growth of enterprises, and thus create significant distortions overall as well. We will deal with these issues in turn.
23. Most retailers (and other small business owners) do not want to register their business (as a company) or do not want to get caught in the formal net as they feel that they then
7 Most manufacturers as well as service providers have similar issues with the tax authorities. We are focusing on retailers here, but the arguments made should be considered to be more general.

become a target for the tax authorities. This issue of being a target has a number of facets. A lot of retailers feel that the rate of income tax (corporate as well as personal) is too high. If they are in the net, they feel they will be under more scrutiny and will have to pay the requisite tax rate. Secondly, almost all of them feel that 15 percent sales tax is too high and is a burden on them as well as the consumers and creates hurdles in their business and its growth. Retailers also feel that since the sales tax chain is not fully documented, some of them have to bear a higher burden of taxation, for being in the formal sector, than others. This is truer of manufacturing industry than retailing, but is a general complaint. Thirdly, a number of importing retailers and wholesalers complain that the import duty and clearance process is still a major hurdle for them. The issues with Customs clearance have to do with a) the time it takes to get goods cleared, and b) the duty imposed on imports. There is still a lot of discretion, with the Customs officials, as to what duty rate to charge for a particular brand and good and this creates uncertainty for importers and it opens up the doors for corruption as well.
24. The issue of compliance cost is raised by many people, and in different ways. One Faisalabad textile manufacturer and exporter mentioned that he had absolutely no problems with the sales tax regime of the country and he thought everything was fine with him. This was unusual as almost every other person in our sample complained of tax issues. When asked how many people he had in his accounts office to deal with compliance issues related to taxation, the manufacturer said he had six people dealing with sales tax issues, another 4 dealing with customs and another 3-4 people dealing with income tax issues. This was independent of any accountants and lawyers that they hired at the time of yearly filing or in case there was a litigation to deal with. The cost of these 13-14 people, in terms of salaries and other support material was not being figured in as a cost of compliance by this manufacturer. But clearly the cost is substantial. Sales tax and income tax regimes require significant level of paperwork and interaction with the requisite departmental authorities and customs clearance is still seen as a major hurdle by exporters. The contact with authorities and the paperwork requirement also create openings for corruption and side payments as well. A number of less educated retailers and wholesalers mentioned that it was either the CBR officials or the lawyers who these retailers had hired to represent them who were making money. Since they could not understand the intricacies of the procedure they could not offer any effective checks on what the lawyers and the officials decided. The cost of compliance will be higher for smaller firms compared to larger ones, as a percentage of the sales. Even side-payments have a certain threshold size and they are not monotonic with size so that smaller firms will be paying more, again as a percentage of their turnover. It is not surprising that, given the above, most firms like to stay below radar level of the CBR and would prefer to avoid registration if they can.
25. Taxation structure still has threshold effects that discourage growth and distort business activities. Retailers are required to pay a 3 percent turnover tax if they have turnovers below a certain limit and pay 15 percent sales tax if they move beyond the point. This sets incentives for businesses to report below threshold level turnover, and in case they do go over, it creates incentives for businesses to subdivide, at least on paper, rather than cross the threshold. For example, where one of the larger confectionary makers of the country, with many shops across Pakistan, is registered as one business and pays 15 percent sales tax, his main competitors have every shop registered as a separate business and pay only 3 percent turnover tax. In effect the threshold effect is not only encouraging distorted growth, it is penalizing the person who wants to grow in a legally sound manner.
26. The issues related to local taxes have been addressed to a certain extent over the last decade. Most provinces have reduced/consolidated the number of taxes they levy and though some work still needs to be done in the area, regarding labour levies, local taxes are not a

major cause of regulatory problems for businesses now. The procedures might still be a bit time consuming, and there are still some problems of corruption in this area, but these are not a major regulatory concern any more.
 Continued focus on rationalizing the income tax structure. The introduction of self- assessment scheme has helped in lowering compliance costs and corruption costs, the process needs to continue. In addition, as the tax net broadens, the government needs to think about lowering tax rates. This will lower incentives for corruption as well as increase incentives for joining the formal sector.
 Sales tax regime requires significant work: a) the tax rate needs rationalization, b) sales tax chain needs full documentation, c) compliance procedures need to be streamlined. The zero rating of textile to get rid of a major portion of the refund game was a big positive step.
 Customs clearance process has been improved a lot over the last few years. But we need further improvements to ensure a) speedier clearance and b) less discretion for setting tariff rates, to minimize chances of corruption and time delays.
 More detailed studies of the taxation system are needed to pinpoint all threshold problems that distort incentives and could be affecting the growth of enterprises as well as entire sectors. This requires micro-studies of tax systems across sectors, but is something that the CBR can accomplish on its own. Removing these distortions need not have any tax revenue implications and so should be win-win for both businesses as well as the government.
2.5.5 Infrastructure
27. Almost all retailers have talked about the poor quality of infrastructure services offered by the state. This is again a problem that is common with all other types of businesses as well. The problems with telecommunication facilities have come down significantly in the last few years. The main problems that exist now are with a) WAPDA, b) local and national road providers, c) water, sewerage and solid waste management providers.
28. Electricity: Most businesses point out that electricity rates for commercial and industrial activity are very high, the quality of supply and other services related to electricity provision are poor, and there are high levels of corruption that they have to face in getting connections as well as in dealing with getting and paying bills.
29. Tariff rates for commercial usage of electricity are the most expensive in the country, and then come industrial rates. Domestic usage and tubewell usage rates are the lowest. But this tariff structure defies economic and developmental logic. Industrial and commercial electricity is cheaper to supply, cheaper to meter and receive money from, and contributes the most to the growth and development of the country. Keeping it more expensive raises the cost of production of firms in Pakistan, compared to other countries, and can make our industry less competitive in these times of global competition. Still the tariff structure favors domestic users. In addition, it is not even clear what the link between cost of production and provision is to the tariff rates charged to each of the groups mentioned above. WAPDA and NEPRA do not seem to have conducted any optimal tariff analyses in this regard and tariff rates seem to be based more on historical and political reasons than on any economic reasoning.
30. The quality of service of WAPDA comes under criticism as well. Electricity supplies are disrupted often, load-shedding can be frequent, unpredictable and unannounced, and repair services are patchy. This forces most manufacturers as well as wholesalers/retailers to

invest in back-up generators and sometimes even alternative systems for having full time supply. But captive power, though efficient when WAPDA is not doing its job, is nonetheless a costly and inefficient by-pass to the potential service that a national grid could provide. The cost, in terms of inefficiency, and non-productive expenditure, is borne by the society. There is a further distortion related to size here too. For the larger manufacturer or retailer/wholesaler, it is still possible to invest in a generator or back up system. The cost is a small proportion of their turnover or can be raised through bank financing. But for the smaller producer or retailer, investing in back up power can be a significant fixed and sunk cost, and could be a significant portion of its savings or working capital. But if they do not or cannot invest in back up power, they have to live with frequent disruptions to their business activity. Both options will be costly for them.
31. The arbitrary powers that have been accorded to WAPDA are costly for manufacturers and can create significant uncertainty for them. The legality of ‘detection bills’ is quite dicey. If WAPDA does send someone a detection bill, even if it is completely unwarranted, the concerned enterprise has to deposit the said amount with WAPDA before they can even start contesting the issue. The contestation can take up to months and even if the enterprise gets relief from WAPDA, the excess amount deposited is likely to be adjusted against future bills rather than being refunded. The entire process can be, again for the smaller producer, quite disruptive and costly. In one instance one of the manufacturers interviewed8 mentioned that he bought a gas turbine unit to provide him with alternative power as he was tired of the problems with WAPDA, but when he applied to WAPDA to have his industrial connection dismantled, WAPDA told him that he would have to continue to use it (and pay for it) for three years before they would let him shift to his gas based unit. This was very costly for him as he had to now sit on his unit (and the investment he had made in it) for three years before he could benefit from it.
32. The issue of arbitrary power, though not as common, is also true for other utility providers as well. The natural gas provider in Lahore requires manufacturers to pay 3 months expected bill in advance to the utility company. But there is no recourse, for a quick and fair hearing, against such steps.
 There is a need for better planning regarding our future needs for electricity. This is tied to a) setting up new hydroelectricity projects, b) getting access to more natural gas, c) having a better thermal, nuclear and hydroelectricity mix. The government has a number of initiatives in this regard, and these need to be initiated and completed on a priority basis.
 WAPDA has to be forced to rationalize its tariff structure to reflect more clearly articulated economic objectives. Commercial and industrial activity is subsidizing domestic usage and this is driving the cost of business much higher than is acceptable.
 National Electric Power Regulatory Authority (NEPRA) has to be built up technically so that it has the power as well as ability to a) provide effective checks against abuse of power by WAPDA, b) carry out analyses, regarding costs and tariffs, that can provide alternative inputs into policymaking for the government, c) offer help to WAPDA to work out better tariff structures, d) provide a more effective control for services offered by WAPDA.
 Benchmark or real competition has to be introduced between and within DISCOs, the local distribution companies, to improve the quality of services offered by them. The
8 A Faisalabad based textile manufacturer.

incentives systems of employees within DISCOs have to be aligned to ensure delivery of better services.
 NEPRA and the judicial system have to provide speedier and fairer recourse to provide relief in cases where WAPDA or DISCOs have oversteped their bounds.
2.5.7 Local Road and other Local Services
33. The state of the local roads that are off the national arteries is generally very poor. In many cases the dilapidated condition or even non-availability of farm to market roads adds significantly to the cost – both in terms of money and time – of business. It also contributes to wastage of produce. Poor road conditions in and around markets increases delivery times, causes damage to goods and to vehicles, and is a cause of accidents as well. Poor roads in and around industrial estates have been a major gripe of industrialists for a long time.
34. Local roads and other local services like provision of water, street lighting, local chowkidari, solid waste management, and sewerage systems are the responsibility of the city local government. Local governments receive a percentage of the motor vehicle registration and token fees for the purpose. But the key issue here is of incentive systems. Local governments may focus attention on better provision in areas and to constituencies from where they can get more electoral support. Industrial and commercial clients might not be high on their agenda. Local activism might be the only solution to the problem. The issue of provision in and around an industrial estate can be separated out from this. Management of local services for industrial estates can be handed over to management committees from within the industrial estate as well. There have been some interesting experiments, in this regard, under PIEDMC in the Punjab where management of Multan industrial estate, Kot Lakh Pat industrial estate in Lahore and some others have been handed over to local committees and in some cases the provision of services has improved significantly since then. This model might be worth exploring for other industrial estates as well, it might be possible to adapt it for vegetable/fruit markets as well as other wholesale and retail clusters.
 Involvement of committees of local retailers, wholesalers and industrialists, from the local cluster, might be one way of ensuring delivery of better quality local services.
2.5.9 Contract Enforcement & Repudiation
35. Issues related to contract enforcement and repudiation affect businesses in a whole variety of ways that distort current business activity as well as growth trajectories and future scenarios. In fact, the area is so important, from a regulatory point of view, that it might be important to conduct a separate study on this issue eventually. Our focus groups, interviews and data point out to a number of concerns related to the area.
36. Most retailers/wholesalers pointed out that they were competing in sectors where competitive pressures were high and there were many competitors even in vicinities where they were working. Yet, all of them also pointed out that they tended to work with a limited number of buyers and sellers, upstream and downstream, on a regular basis. The relationships they had tended to be based on repeat interactions, additions to the set happened on the basis of referral and there was hardly any place where this was based on formal contracting and document signing. Most people even pointed out that in cases of disputes, they had their own mechanisms for dispute resolution and few went to the formal sector judicial system for redress. The repeated game and reciprocal arrangement might be effective and low cost

arrangement but it can surely only be the second best as it restricts growth of these organizations, imposes significant costs of selection and development of reputations and reciprocity arrangements, and even investments in multilateral institutions of redress.
37. A large scale retailer and manufacturer of confectionery9 mentioned that he had had to integrate backwards into production of ghee because he could not find a ‘reliable’ ghee manufacturer in the country who could provide him with the quality of ghee he wanted and provide requisite quality assurances too. Since his reputation crucially depends on the quality of his ingredients, he could not take a chance on quality variance in ghee. So he had to integrate backwards into ghee manufacture, even though a) his comparative advantage is in retailing and confectionery manufacturing, and b) his growth targets are related to taking his brand name, as a retailer and manufacturer of confectionery, to many countries around the world. Lack of reliable partners and possibilities of long term contracting are forcing this manufacturer to choose a growth path that is distorting his growth and advantage and slowing down his growth in the direction he wants to move in.
38. A chain-departmental store owner10 mentioned that they also had a tailoring unit that produced men’s shalwar kameez suiting under their own brand name. This was an attempt to leverage their brand name as a quality retailer into a new area that of men’s clothing. But what was surprising was that they had set up their own tailoring shop as well and were managing it themselves. Again their comparative advantage lay in managing retail and not in managing manufacturing. But the answer was the same: they could not find reliable tailoring outfits in the city of Lahore. Hence they were also forced to integrate backwards. This is even more curious than the previous example. Where ghee was a crucial ingredient for the confectionery manufacturer, men’s shalwar kameez does not require the same sort of quality assurance, and was definitely not crucial to the retail operation of this organization. But the result was the same: they had to integrate backward where their advantage and organizational goal lay in the direction of developing the retail chain more.
39. The same story was repeated by a manufacturer of spare parts for automobiles as well. He said that if he decided to make any new part, he had to set up the entire process for himself and could not get any sub-parts, even screws and nuts, made from outside. This not only raised the setup time for any new parts for him, it also increased his R&D as well as overall cost of manufacturing as well as he had to invest into all of the relevant machinery for sub parts as well. And the reason for the same again: could not find reliable partners.
40. In all of the cases mentioned, lack of possibilities for long term sophisticated contracting, ensuring quality and delivery times, is forcing firms to integrate backwards, limit their expansion in areas where their core competence lies and restricting as well as distorting their growth.
41. On the retail and wholesale side as well, lack of possibilities of long term sophisticated contracting is leading to very limiting outcomes. There are some 15,000 wholesale and retail cloth shops in the Azam Cloth market area in Lahore. All of these shops are relatively small, all of them sell similar types of products, and all of them source their products from similar places. So their cost structures, businesses and contacts are similar as well. The question to ask is: why are there 15,000 shops and not say 500 larger ones? Why is it that every time a generation grows up, all of the brothers try to set up separate shops and do not join the father, formally, in expanding the same shop to a bigger size, under some suitable partnership or formal company arrangement. Similarly, a number of even larger retailers pointed out that the number of branches they had were restricted to the number of brothers they had: they thought they could not go into long term contracting with professional managers to create a larger chain.
9 Interview with the Chief Executive.
10 Interview with the key manager and one of the directors.

42. An importer and wholesaler11 of automobile parts pointed out that they had only 14 odd dealers in the country. These dealers were given goods on credit, had been developed over a 20 year period through a process of weeding out and now they did not add any new dealers to the lot. He said adding new dealers was too costly as one had to go through a long process of screening (inquiring about reputations from the market, finding people who could put pressure on the person if need be) and slowly building trust (starting with smaller advances and then building up from there). In the 20 year history they had faced delays and problems with payments a number of times, but had never gone to courts with that. Instead they had invested in creating informal councils of elders in all markets and it was these councils who mediated their disagreements. Even in a case where one dealer went bankrupt, it was this informal council that managed the selling of the bankrupt person’s shop and then payments to all the creditors, in proportion with loan size. Though the system worked, the owner was very aware that this was not optimal as it was holding their growth back.
43. The issues mentioned above all point to a significant cost that businesses in Pakistan are paying for not having an efficient and effective contract enforcement environment. The court system in Pakistan takes a long time to adjudicate disputes, and many people mentioned that they did not even have confidence in the court decisions anyway. So, the time and money costs of getting contract enforcement through courts are very high. As a result businesses have either developed alternatives that can deliver second best outcomes (depending on alternate dispute resolution mechanisms, mechanisms based on reciprocity or repeated interactions), or they have avoided taking on the area (subdividing businesses instead of forming partnerships) or have been forced to take on the issue themselves (backward integration or integration of activities that might not be their core activities). In each of the case mentioned, the option chosen might be the best available, but it does distort the optimal functioning of businesses, and it impacts the longer term growth prospects of the firms as well.
 It is hard to suggest recommendations for this area as it still needs further and more in-depth study. So one recommendation would be exactly that: the area of contract enforcement, as a part of the need for second generation reforms, should be accorded high priority and should be studied in a lot more detail as it seems to be imposing a significant cost on businesses in terms of carrying out day to day activities as well as planning optimally for the future.
 Many countries have started experimenting with lower cost Alternate Dispute Resolution Mechanisms, but formal sector ones. This should be looked into for commercial disputes at least.
 Some countries have also experimented with setting up specialized courts. We have done that for the area of banking. Maybe it could be tried for commercial areas as well.
2.5.11 Law and Order
44. Retailers, wholesalers, manufacturers, transporters, in fact businesses from all sectors, pointed out that the poor and deteriorating law and order situation imposed significant costs of their business operations. But the problems pointed out were different for different areas.
11 Interview with one of the owners.

45. A number of manufacturers and retailers12 from Karachi pointed out that a) they had to hire more guards for the protection of their homes as well as businesses, b) they had to have guards for their accountants who carried cash to and from banks, c) they even had to pay ‘protection’ money to groups to ensure the safety of their businesses. Despite the above, there was a significant proportion of businessmen who mentioned that their places of work or home had been robbed over the last few years, a number had had family members abducted for ransom. A number of businessmen mentioned that they had acquired immigration to Canada and some had even sent their families abroad, and some mentioned that they would not be expanding their business in Pakistan and would leave if they could sell their businesses are reasonable prices.
46. Law and order issues were not as acute in other parts of the country, but a high level of dissatisfaction did exist with the overall law and order situation. A car rental company owner mentioned that almost all of his drivers had been robbed, at least once, in various parts of the Punjab, while on duty. The incidence of mobile phone snatching has been talked about enough in the newspapers already.
47. Perceptions of law and order affect investment and growth decisions of businesses. If domestic commerce is to take off, law order situation, across the country, will have to improve substantially.
12 Based on interviews.

Section 3
Transport Sector
3.1 Introduction
48. Transport sector is a significant contributor to the GDP - 11 percent of GDP - and employment level - 6 percent - in the country.13 But the contribution of the sector could be much larger if we had a more efficient transport sector that could focus on delivering a higher quality of service. Though the estimates of inefficiency vary, even the smallest of these estimates is in a few percent of the yearly GDP of the country.14 More significantly, the indirect contributions of an efficient and high quality transport sector, in terms of lowering the costs of doing business in Pakistan, delivering goods and services on a strict time frame, ensuring on-time deliveries, especially for the export markets, could be quite significant as well. As trade barriers come down and Pakistani firms have to compete for export shares and even compete in local markets, any disadvantage that might be there, due to higher transportation costs or higher delivery times, is going to be quite costly for the country as a whole.
49. One manufacturer of engineering goods mentioned that he lost orders for exporting parts to Japan because he could not guarantee time bound deliveries. The Japanese firm wanted a strict timetable for deliveries that this Pakistani manufacturer could not live up to. He said: “I could promise when I would deliver my consignments to the port in Karachi, but I could not guarantee when they would reach Japan as I had no control over the clearance process in Karachi and every time the time it takes for clearance is different. This was not good enough for the Japanese company so they cancelled the order and instead sourced their material from a South East Asian country.”
50. An inefficient and low quality transport sector is costly in another way as well. Pakistan has one of the highest fatality rates, per head, due to accidents, in the world. The loss, to the country, in terms of lost wages, lost capital and lost future earnings, is quite significant. And this is taking the loss of life in pure economic terms only. The loss, in human terms, is of course much more and possibly immeasurable.
51. Transport sector includes air, sea and land transport, for both passengers as well as freight. Land transport includes both road as well as railway, and the inland transport market is also segmented between inter and intra city segments. Each of the above mentioned categories has its own set of regulatory issues. We will look at these separately.
13 See section on transport in this study. The figures are quoted in various World Bank and ADB studies as well.
14 These estimates are given in the section on transport issues.

3.2 Land Transport
52. For both freight and passenger traffic railway and predominantly private sector (bus and trucks) compete in the intercity market. Railways is a government owned and run monopoly, while on the road transport side, apart from NLC, a army owned entity, most of the trucking as well as bus industry is in the private sector.
3.2.1 Railway
53. Pakistan railways handles about 10 percent of inter city passenger traffic and only about 5 percent of the inland freight market. Pakistan Railways focuses primarily on passenger traffic even though there is a larger potential for profits on the freight side. But Railways is still not run on profit basis. It continues to have run routes that are financially not viable, spend resources on maintaining these, and offer prices that are not worked out on the basis of costs. In return Pakistan Railways receives subsidies from the state and also runs significant losses. But this is not the only result of the lack of focus and clarity of purpose. Due to the above objectives (or lack thereof) the incentives for Pakistan railway, to provide efficient and high quality service to passengers as well, are severely diluted. Furthermore, lack of focus on the freight business has also meant that Pakistan railway is not making profits from the area that it could have used to cross subsidize its passenger service. But this is a result of overall lack of incentivization in the entire organization.15
54. On the freight side, the share of Pakistan railways is very small. On cost estimate basis railway should have a substantial advantage over road transport for long haulage and given the North-South route in Pakistan, railways should be the optimal choice for freight transfer. But it is not. The main reason seems to be the inefficiencies in the railways system. On average it takes 8-10 days for railways to transport goods from Karachi to Peshawar, while trucks cover the same route in three days.16 Our focus group participants pointed out that nepotism and corruption in the railways meant that people with money or connections could get early deliveries but others had to wait longer and also could not predict when the goods would be delivered. They also pointed out that incidents of pilferage were also more common on Pakistan railways. For both of the above reasons some people pointed out that they preferred to use trucks for delivery of loose or smaller items and use railways for only the larger items and full container hauls.
55. The main issues with the railway system and organization have to do with a) lack of clear objectives for the organization, b) lack of high powered incentives, for the executives, to achieve clearly stated objective, and c) lack of ‘hard budgets’ and efficiency bench marks for the organization and people. But these issues are within the railway system. Some of the main problems emanate from outside. Railways is a government monopoly with almost no competition or private sector involvement. In addition, there is not even an independent sector specific regulatory authority that can impose any effective checks on the organization. So it suffers from the classic problems of non-regulated government monopolies. But the inefficiencies of Pakistan railway are affecting more than railways themselves. They are raising freight costs from what they could be and they might also be forcing excessive development and usage of trucking industry due to the distortions created by them.
15 See section on transport.
16 Interviews as well as views of focus group participants.

 Since the sector is never going to be perfectly competitive, due to large fixed costs of track, there is a need to establish an independent and empowered regulator that can enforce some quality and efficiency standards on Pakistan Railways.
 Railways needs to be corporatized so that we can a) state the specific objectives it is supposed to achieve, b) have incentive alignment for its management, and c) create reward/punishment systems for all levels, in line with objectives.
 Not all portions of the railway are necessarily a natural monopoly. For example, the track is a natural monopoly, but how many players run their trains on these tracks or how many players run their carriages on these tracks are not pre-determined. Railways, once it is corporatized, needs to introduce competition in areas that are not a monopoly.
 Debundling of services (such as in electricity now where production and distribution can be quite competitive while the national grid remains a monopoly) might be another option that railways can contemplate.
56. None of these options will work if the government does not allow the creation of an independent regulator and does not treat railways as a corporation and does not create some distance between itself and the organization.
3.3.3 Trucking
57. Although Pakistani freight rates for trucking are internationally competitive, the main problems have to do with a) low quality of service, b) time loss, c) pilferage and loss, especially in perishable items transport, due to delays, and c) lack of insurance. The trucking industry is mostly informal, predominantly organized as sole proprietorships17, and dominated by small firms. So the environment is very competitive, has few entry barriers, and is characterized by low profits. But this is where the rub is as well. The high level of competition, in an industry where marginal costs might be lower than average costs, forces firms to cut corners, overload trucks, force drivers to drive for longer hours, and/or compromise on driver quality. But if one company does it, all will and the equilibrium that results would be price competitive but will be one where only low quality players can survive. Furthermore expansion of existing players depends on the introduction of higher levels of management and technology. But this can only happen if the firms can justify the additional expense through raising prices. If the bad equilibrium exists there could be a situation where no firm is willing to take the chance. From the customer side if there is no recognition that higher quality can only come at higher price, the low quality equilibrium will not be broken. Furthermore, if there is any information asymmetry and it is hard for customers to separate higher quality players from low quality ones, separating equilibrium of higher and low quality providers cannot be established or sustained as there will always be a low quality player, posing as high quality player, who will be able to undercut the genuine high quality player in price terms and hence the high quality equilibrium will collapse18.
58. The results of the poor quality low level equilibrium show up in costs that are imposed on all players: a) higher fatality rates, b) longer delivery times, c) higher levels of
17 The fact that most of these players are not ‘registered’ as businesses in not per se against the law. Their vehicles are registered and they do not require any other registration. The fact that they might be avoiding giving income and other business taxes is not the issue we are focusing on here.
18 Those familiar with Akerlof’s ‘market for lemons’ argument will immediately see a similarity in the two arguments. This is also a case of information asymmetry leading to market collapse as in the lemons case.

damages, d) over loading leading not only to higher depreciation rates of trucks but also to damage to roads, e) old stock of trucking, f) smaller size of firms in trucking, g) low level of technology in the industry. NLC is an exception to the equilibrium given above, but since NLC is backed by the army, has special privileges compared to other players (for example NLC trucks are allowed to enter the city before 11.00 PM when private ones are not), and enjoys the benefits of an uneven playing field, it cannot be taken as an exception to the equilibrium mentioned above.
59. A higher level equilibrium would take care of a lot of issues mentioned above. But the cost of trucking will also go up as a result. But there is no reason to believe that the higher level equilibrium cannot be competitive locally leading to prices that are internationally competitive but still allow efficient players to, in equilibrium, break even while providing a higher level of services. Furthermore, it does seem that moving to a higher level equilibrium will, overall, be a Pareto improving outcome. The customers will benefit (from lower damages or insurance cover, better delivery times, and cost based pricing), as will the society (lower fatality rates, less damage to roads, lower cost of doing business), while there is no real difference in the profits for trucking companies (assuming they stay competitive). This is the main regulatory challenge in this market. But this is not a simple matter to handle. There is not a single existing regulator that has jurisdiction in the area.
60. Damages and late deliveries are tackled by the trucker and the customer directly, or if there is a dispute it can go to the regular courts. The issue of rash or poor driving is handled by the traffic police, while the issue of overloading is the jurisdiction of the highway authority. The issue of insurance is, again, currently between the trucker and the customer. To change the equilibrium we need a regulator that can set the minimum quality standard acceptable from truckers and holds them responsible for it and does not allow side bargains, between truckers and individual customers, to undermine this higher quality equilibrium.
61. At a minimum the regulator will have to ensure a) no overloading, b) proper training of drivers, c) limits on driving hours, d) and insurance cover. This might actually mean that barriers to entry into the trucking industry might have to be raised to ensure only firms that can satisfy the above criteria come in and operate in the industry in equilibrium, and, in equilibrium, make enough to cover their average costs at least.
3.3.4 Recommendations:
 Stricter enforcement of rules against overloading and on truck fitness issues
 Stricter rules for driver training, and driving conditions
 Introduction of insurance against damages
62. But the main issue here is the alignment of incentives of the regulator (or current regulators) to actually enforce the minimum standards that are set for driver training, driving conditions and against overloading.
3.3.5 Inter and Intra City Passenger Traffic
63. More than 90 percent of inter city passengers use road as a mode of transportation. Some of the regulatory issues in the area are similar to ones mentioned for the trucking industry above. We do need standards in terms of overloading, road worthiness of vehicles, speed limits, driver training and stipulations on driving conditions to ensure safety of passengers. Focus groups with transporters mentioned that two issues are a problem for them: a) the state sometimes gives preferential treatment to some companies and for some routes (Daewoo has been allowed to open a terminal in the middle of the city, while other players

have not been allowed to do this) and this nepotism leads to an uneven playing filed, and b) the state regulators, like the traffic police, route assigning agencies etc. can be quite corrupt. These issues are more pronounced for intra-city providers, but are there for intercity ones as well. It should also be borne in mind that if the average cost of provision of rides, intra city or inter city, is above the marginal cost, which it is likely to be for higher quality provision (that is when a minimum quality package has been stipulated) then some level of route exclusivity might have to be ensured for providers so that they can recover the average costs and are not forced to cut corners as they move to marginal cost provision. According to our data and focus group discussions, this becomes a larger issue in the intra city market. In some instances the government issued exclusive rights to routes to some companies but then the local authorities undermined the exclusivity by allowing mini-van drivers to plough the same route. There is a delicate balance that needs to be maintained here. Exclusivity rights cannot be allowed to establish monopolies that exploit customers in the form of very high tariffs or in the form of long waiting times. At the same time, if exclusivity is removed the equilibrium will move quickly to the low quality equilibrium discussed above. So the regulator has to stipulate a) rates, b) quality of buses, c) waiting times, and d) driving and driver quality before issuing exclusivity rights and then, most importantly, the regulator has to have the ability to check whether the provider is living up to the stipulated quality or not. The last part, dealing with checking, is one that is creating the most problems for us in the sector currently. The checking authority is corrupt and lacks the sophisticated human resource needed for effective regulation. This leads to a breakdown of the equilibrium and a move towards a lower equilibrium.
64. In most of the rest of the world the taxi markets are regulated in terms of both the fare as well as the number of taxis allowed in a city. Pakistan is an exception to this. The problem with the model we are following, of no regulation and low entry/exit barriers, is that it cannot allow a higher level equilibrium to emerge in this market. In fact, it is quite simple to show that an equilibrium, for a taxi market, cannot exist without limits on fares and number of taxis19. By not regulating the number and fare, we risk running in to a continuous disequilibrium state in which the number of taxis fluctuates over time. When the number of taxis are low in a city, higher profits force new entrants to enter the market. But as the numbers increase and competition forces fares to come down and profits decrease, at some point the excessive competition will force taxi drivers to offer rides at marginal cost. But this is not a sustainable position and it will force some taxi drivers into moving out of the business. This cycle is likely to continue over time. The Pakistani taxi/rickshaw market should exhibit this feature20. But the boom/bust model is a costly one for taxi car providers and does not bode well for the development of the industry as well.
 The passenger transport market needs regulation in terms of creating a basic minimum quality package in terms of vehicle worthiness, fare, and driver quality.
 Intra city transport requires exclusivity rights for routes as well, but the regulator has to ensure effective and efficient implementation without nepotism and corruption
 The taxi market in cities also needs regulation similar to intra city bus regulation, but with route assignment.
19 This, again, has to do with the fact that marginal cost of rides is lower than average costs and hence marginal cost pricing is not possible in this market. Break even levels have to be at average cost levels. Excessive competition can only be discouraged by limiting the fare and number of taxis.
20 A very testable hypothesis.

The State of Domestic Commerce in Pakistan Study 4 - Regulatory Issues in Domestic Commerce

The State of Domestic Commerce in Pakistan Study 4 - Regulatory Issues in Domestic Commerce

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The State of Domestic Commerce in Pakistan Study 4 - Regulatory Issues in Domestic Commerce