4._SME_Development_in_Pakistan_Issues_and_Remedies.pdf

SME DEVELOPMENT IN PAKISTAN:

ISSUES AND REMEDIES

[I] BACKGROUND TO SMEs AND ITS IMPORTANCE

Introduction

⎯ Today SMEs are widely regarded by experts as the panacea for many economic problems confronting the LDCs. In particular, vibrant small-scale sector—incorporating the informal firms—is expected to solve a variety of problems, including unemployment, low growth and poverty. SAARC region countries too have designed policies for the promotion of this sector, though with uneven results. Yet their faith in SMEs is ever growing. The planners now realize that since the modern production methods are generally more flexible, so manufacturing can be undertaken anywhere, and at any level through inter-firm linkages. At the same time individual country experiences in the SAARC region, and also in other parts of the world, indicate that the real catalyst for the SMEs growth is the general economic environment born of a pro-active industrial policy.

⎯ For a longtime the mainstay of Pakistan’s industrialization strategy was large scale manufacturing which recorded 8.78% growth rate during 1950-2003 as it was consistently supported by a set of macroeconomic policy measures. The small-scale sector too registered an impressive growth rate of 5.06% during 1950-2003 and that too without benefiting directly from policy support. It virtually existed in the shadow of the large scale-manufacturing sector. [Table-1 & Table-2]. A distinct feature of Pak manufacturing sector is its product diversification: textile (24.02), Chemicals (15.17%), food (13.77%), followed by others. It needs to be mentioned here that all these sectors comprise of large, medium and small firms, except in cases where economies of scale do not permit small-scale production e.g. automobiles, steel, fertilizer, heavy engineering, etc.

⎯ The government statistics show that Pakistan’s SMEs sector recorded an impressive growth of 14.7% during 1987/88 – 1996/97 when the estimated value of its output increased from Rs. 19,683 million to Rs 67,541 million.

Meanwhile, the number of Small1 and Household2 Manufacturing Industries recorded growth of 5.8% in that period. The contribution of SMEs to Pakistan’s economy, employment and poverty reduction can be seen from the fact that 90% of all private sector manufacturing units employ less than 99 workers and the SMEs employ some 78% of non-agricultural labour force. They contribute about 30% to GDP, Rs.140 billion to exports, and generate 25% of exported manufacture [GOP 2005, P293]. This data is based on the assumption that manufacturing units employing less than 100 workers are part of the SMEs.

[2] PRESENT STATUS OF SMEs: TYPES, SIZE AND

SPREAD OF ENTERPRISES

⎯ There is no single official definition of SMEs in use in different organizations of Pakistan. In particular, the world of medium enterprises is a grey area. In fact, the CMI (Census of Manufacturing Industries) data include all manufacturing units with 10 or more workers in the category of large scale manufacturing units. Since the official statistics in Pakistan do not have information on the medium enterprises, therefore it is not possible to know about their real size.

⎯ The SMEs Policy (2005) recommended adoption of a unified legal definition, which would define an SME in terms of either “employment size” or “assets (excluding land and building) [SMEDA, 2005]. It lays down separate bench marks for the small and medium enterprises [Table-3] and would hopefully clear the existing clutter in the policies of various institutions like Federal Bureau of Statistics, Small and Medium Enterprise Development Authority (SMEDA), State Bank of Pakistan, SME Bank, and Small Industries Corporations/departments of provinces. Until October 2005, there was no single criteria to serve as a basis to determine the effectiveness of SMEs policies or the government spending or the development of this sector in Pakistan because nobody knows with certainty the parameters of SMEs.

Size Distribution of Pak SMEs

⎯ Notwithstanding the infrequent surveys of SME sector in Pakistan, the number of such units, especially small, is probably much larger than is officially reported. The surveys normally cover those firms that are registered and a large number of very small firms go unrecorded because they seek to remain hidden or the enumerators are not fully motivated to include them in the data. Most of small firms in Pakistan are very small, with limited employment potential and little chance of growth; their primary concern is survival. In general, the firms with relatively more workers are smaller in number and those with smaller number of workers are in majority. Moreover, most of the firms are owner-managed, supported by family workers. The hired workers are few and found mostly in growing firms.

⎯ According to the latest Economic Census of Pakistan (2005), there were 2.96 million units in the country, of which 2.8 million (93.9%) were Establishments3 and 0.18 million (6.1%) were Household Units (including all activities of producing goods and services for sale or barter in the market).

Further, Punjab had the largest share of 65.26% in the total establishments in 2005, followed by Sindh (17.82%) NWFP (14.21%) and Balouchistan

(2.09%) [GOP 2005, P.14].

⎯ Of the total 2.96 million Establishment and Household units, about 53% were in the major industry group of Wholesale and Retail Trade and Hotels / Restaurants, followed by Community, Social and Personal Services (22.3%). Manufacturing is the third largest group with 19.72% share of the total Establishments. [Table-4]. Among the Household units, the highest share is that of Manufacturing sector (66.5%), followed by Community, Social and Personal Services (20.5%), Agriculture, Poultry Farming, Fishing etc. (8.7%), and Wholesale and Retail Trade, etc. (about 4.00%).

⎯ Manufacturing firms’ data show that, of the total 5,83,329 units in the census, 117176 were Households units (20.0%) and 466153 (80.0%) in the category of Establishments. The majority of the total manufacturing establishments (43.2%) were in Textile Wearing, Apparel and Leather industries, followed by Food, Beverages and Tobacco (20.9%), Wood and Wood Products (10.8%), Fabricated Metal Products, Machinery and Equipment (10.0%), Other Manufacturing Industries and Handicrafts (8.9%) and the remaining sectors had 11.1 % share. It is also interesting to note that in the largest industrial group of Textile Wearing, Apparel and leather, 31.5% were Households and 68.5% Establishments. The other important group of activities within the Household sector was Non-metallic Mineral Products (28.0%). Another distinct feature identified by the Census is that about 85.0% of the Household Manufacturing Establishments were located in the rural areas. [Table-5]. Further, the Textile, Apparel and Leather segment had the largest share (54.0%) among the rural area Household units. Other Manufacturing Industries and Handicrafts in the rural area Households had a share of 18.0%. In the urban areas, the largest share of the Household Establishments was that of Textile, Apparel and Leather Industries (78.7%), followed by Other Manufacturing and Handicrafts (9.3%), Wood Products including Furniture Manufacturing (3.3% and the remaining industries (8.6%). Overall, in the urban areas the share of Manufacturing Establishments (other than Households) was the largest (93.8%). Within this category, the share of Textile, Apparel and Leather was 43.0%, Fabricated Metal Products 15.8%, Food and Beverages 12.8%, Wood and Wood Products 11.6%, and the other sectors 16.8%.

Employment in SME Sector

⎯ A known feature of SME sector is its ability to create jobs. Pakistan faces the major challenge of unemployment as its labour supply continues to grow rapidly. According to the Economic Survey 2004-05, Pakistan’s labour force increased from 42.39 million to 45.23 million during 2001/02 – 2003/04 (GOP, 2005). Add a backlog of millions of unemployed workers, and one can appreciate the urgent need for promoting small-scale labour-intensive economic activities [Table-6]. On the other hand, because of limited capital availability for business, the size of modern sector is likely to remain small in the coming years. In this situation the small-scale sector is a ray of hope and is luckily growing.

⎯ The Economic Census (2005) showed that 2.96 million Households and Establishments employed 6.58 million persons. The employment pattern of the Pakistani Establishments was such that of a total of 2.96 million, 2.85 million units (96.6%) employed 1-5 persons, 0.079 million (2.67%) 6-10 persons, 26,000 (0.87%) 11-50 persons, and 1617 (0.054%) over 50 persons.

In the case of Manufacturing Establishments, 5.31 million (91.0%) had employment size of 1-5 persons, 39000 (6.62%) of 6-10 persons and over 12000 (2.05%) had 11-50 employees, and 1122 firms (0.19%) had over 50 workers.

Among the 1.56 million Establishments of Wholesale Retail, Trade, Hotel and Restaurants, 1.55 million employed 1-5 persons. Similarly, 0.625 million (or 95%) Establishments in Community, Social and Personal Services sectors were also placed in 1-5 persons group [Table-7].

⎯ Of the total 6.58 million employed in the Households and Establishments, 0.46 million (i.e. 7.0%) were females. Among the females, 15% were self-employed/proprietors and 30% were unpaid family helpers;

while the remaining 55% were paid employees. Out of total employment of

6.58 million, about 0.34 million (5.0%) were employed in Household units and among them 46% were female. [GOP 2005, P-ii and P-iii].

⎯ The informal sector (self-employment) data deserves close attention. In 2003-04, informal sector accounted for 70% of the employment in main jobs outside agriculture. The informal sector employment in the rural areas (72.90%) is even higher than that of the urban areas (67.2%) As the trend goes, formal activities are concentrated in urban areas (32.8%) compared to rural areas (27.1%) and may continue to remain so. Since the informal activities are predominantly non-agrarian, male workers are more concentrated in informal sector, both urban and rural [Table-8]. Further, informal employment is concentrated most in the Wholesale and Retail Trade (34.4%), Community and Social Services (18.7%), Construction (13.4%) and Transport (11.70%), [Table-9]. Informal sector employment show that a majority (43.7%) were self-employed, followed by employees (43.1%), then unpaid family helpers (11.7%) and finally the employers (1.5%) [Table-10].

Female Managed SMEs

⎯ Some of the urban SMEs are also female owned or managed. In a recent study of the Women Enterprises in Urban Lahore [GCU, 2004] hitherto unknown factors emerged as important variables bearing on their performance. As we move across income groups and firm sizes, the motivating factors of the business women tend to change. In the subsistence income group she acts as a wage earner.

The lower income groups operating micro and small enterprises are also wage earners but mostly produce for a middle man. The medium income groups operating micro and small firms tend to be retailers and rely on out sourcing for production; their main concern is generation of income and raising of standard of living. Like in so many other countries of Asia and Africa, Pak female-owned/managed businesses are concentrated in selected sub sectors like fashion-designing, dress-making, knitting, cane work, and food retailing. These activities are mostly home-based and thus go unrecorded in the official statistics.

Diversity of SMEs

⎯ The above details highlight the extent of diversity of SMEs in terms of size, product lines, resource base, management structure, growth requirements and so on. The medium-sized units have their distinct characteristics. They are more resourceful, with better access to market and the supply side inputs, including technology. Accordingly, the two groups of firms, medium and small, are different in terms of their product quality and growth potential. The extent of diversity of SMEs can be gauged from the fact that they operate in the manufacturing, agriculture and services sectors at different production levels despite many institutional and firm-level constraints. Besides they operate in urban and rural areas, though are concentrated more in the former. Despite their heterogeneity, SMEs are generally concentrated in selected activities such as: (i) Metal working, (ii) Furniture, (iii) Agro-based, (iv) Sports goods, (v) Fisheries,

(vi) Poultry (vii) Gems and Jewelry and (viii) Food and Catering

⎯ Even among small firms, the extent of variety in terms of production activities is very large. It cuts across all sectors, though may not be fully recorded in the official data. Put together, the SMEs make a much more complex and diverse group of enterprises existing in different sectors of Pak economy.

Depending on the type of activity, product, skill and technology required on the one hand and the level of demand on the other, a large number of SMEs operate in different sectors of the economy. However, SMEs are not found in every industry, particularly where the economies of scale act as barrier to their entry.

[Aubrey (1951)]

[3] THE REQUIREMENTS OF PAK SMEs

⎯ There can be two ways of assessing the SMEs requirements: (i) where we lump together the Small and Medium firms and record their essential needs; or (ii) disaggregate the group into two (or even more) distinct groups and pinpoint their required inputs. We prefer the second approach because it is more reliable and thus, likely to be amenable to policy measures. The first step in that direction is to know the “binding constraints” i.e. the problems of the two major groups of enterprises: (i) the SMEs; and (ii) the micro enterprises. At a more general level, every firm ⎯ small or medium ⎯ requires access to capital, better skills, product design, technology and to market. But every firm, irrespective of its size, may not have full access to these inputs for various internal and external factors which act as virtual barriers on its working. Another critical issue is that the firms’ input requirements differ in various phases of entry, survival and growth. Obviously, the nature and extent of inputs required in different phases will vary and would be industry and product specific. So there is a need to identify two separate sets of requirements of SMEs: general and group-specific and also pinpoint the phase-wise needs of each group of firms.

3.1. General Requirements

Access to Institutional Finance

⎯ Pakistan has a fairly developed financial system spread over most of the urban and rural areas of the country. There were 6974 branches of commercial banks, in December 2004. On top of these a number of specialized financial institutions working in support of SMEs: (i) the SME Bank, (established 2002);

(ii) Khushali Bank, (established 2000); (iii) The First Micro Finance Bank; and

(iv) Network Micro Finance Bank and Rozgar Micro Finance Bank (established 2001) [Table-11 and Table-12]. The three types of Micro Finance Banks have the mandate to work nation- wide, province-wide or district-wide with minimum capital of Rs. 500/=, Rs.250/= and Rs.100 million, respectively.

⎯ In addition, all commercial banks have the mandate to provide credit to SMEs and they have their special schemes in place for this purpose. Nonetheless, SMEs are generally found to be short of institutional credit. So they have to rely on their own credit for a number of activities such as upgrading of technology, increase in production, purchase of inputs and better quality materials. In many cases the SMEs rely on personal savings, including financial help of family and friends. This is particularly true of small businesses which may not even approach centers of financial credit for fear of rejection.

Access to Technology

⎯ The SME, in particular the small industries of Pakistan, are known to rely on low and obsolete technology. Associated with this is the lack of technical skills needed for producing quality products. There is a general absence of information on opportunities for technological upgradation. This drawback acts as a major barrier on road to knowledge-based modern economy. A part of the problem is linked to the inability of SMEs to acquire sophisticated equipment and R&D facilities. This is manifested in adoption of labour-intensive production methods associated with lower productivity levels and overall economic efficiency. A typical Pakistani small firm used indigenous machines of old-vintage and relies on traditional productions methods for survival. They end up producing low-quality, low-priced products and sell it accordingly. A system to correct the existing gaps in technology and skills can be laid down with the help of industrial information network for SMEs. The other and probably more important component is acquisition of new vintage technology through large-small production linkages.

Skills

⎯ The story of Pakistan’s technological resources base and its origin is fairly well known. Lahore, Sialkot, Gujranwala and Wazirabad are old centers of engineering activities. The small firms of these cities produced machine tools, diesel engines, surgical instruments, electric fans etc. even in the pre 1947 years ⎯ the time of partition of Indian subcontinent [Kibria, 1998]. With the trans-border migration of millions of people across the Punjab in 1947, many skilled Muslim workers of India arrived in Pakistan and formed the core of skills reservoir in the newly born state. Without this essential input, the old centers of SMEs and the new established clusters of textile firms in and around Lyllpur (now Faisalabad) and sports goods in Sialkot and other places would not have been established.

⎯ Like all less resourceful firms, the SMEs typically have skill deficiencies and are unable to compete with larger firms’ better-qualified manpower. Inter-firm transfers of skilled labour is a usual phenomena directly influenced by relative wage levels. In this game the larger firms have advantage over SMEs, especially in a situation of skill shortages as is occasioned in Pakistan as a result of out-migration of labour to Middle East and other countries.

⎯ It is worth nothing that, contrary to the common perception, there is a hierarchy of skills within each category e.g. (mason, plumber, electrician) as per the skill level and they are paid accordingly. As a matter of fact, an excellent worker would get a premium wage from a larger firm which a SME may not find it feasible to pay. So a smaller firm may be out competed because of limited funds despite its need for high skilled workers.

Organizational Structure/Management Level

⎯ Management skills and organizational structure are closely linked across all sizes of firms. The managerial ability influences the performance of the firms.

It has been recorded in a number of studies that the economic performance of SMEs of Pakistan is being negatively affected by the insufficient managerial skills, especially of the small firms (Aftab and Rahim, 1986). The foremost cause of low management skills of SMEs is the low educational and professional training of the business managers. In particular, SME managers are found deficient in bookkeeping, marketing, cost accounting, stock management, production scheduling and quality control. The managers are unaware of the importance of assets valuation and in some cases even adopt personalized management style, all resulting in low economic efficiencies.

Marketing

⎯ One reason Pak SMEs fail to enter export market, and in some cases even upper segments of the domestic market, is their inability to match products with the new trends in demand. Successful marketing of SMEs output is influenced by a number of factors like quality of design, finished goods, skill level, raw materials, and after-sales service. No wonder that SMEs do not manage to get a direct share in the export market. In view of their constraints, SMEs have an option of acting as linkage-partners of the large firms gradually building up their own resource base before becoming direct exporters.

3.2. Specific Requirements of Micro Enterprises

⎯ As discussed above, three types of principal constraints inhibit entry and survival of SMEs in Pakistan: (i) access to finance; (ii) access to inputs;

(iii) access to markets for the products. As the micro and small enterprises enter the growth phase, the relative importance of the constraints change. It may be noted that even a micro enterprise can manage to create a small surplus for use on its growth plans. In the case of fast growing micro firms, this constraint is even less significant. Across countries the requirements of micro-enterprises are quite similar [Liedholm and Meade, 1999]. Pakistan’s micro-enterprises also face many binding constraints in entry and growth phases.

At the entry stage these are: (i) Fixed Capital (ii) Working Capital (iii) Recovery of credit given to customers. (iv) Access to product design. (v) Access to tools, equipments raw materials: particularly for the units in small towns (vi) Access to markets: inadequate demand; more for units in small towns. (vii) Skilled labour.

(viii) Taxes. (ix) Transport and communication facilities, and (x) Government regulations. In the growth phase the constraints change and so do their importance as given below: (i) Educational level of entrepreneur; (ii) Family background:

(business traditions); (iii) Personal qualities: (attitudes, etc.) (iv) Access to institutional finance. (v) Access to new product design. (vi) Access to modern technology. (vii) Access to raw materials, equipment, tools, etc. (viii) Access to advanced skills. (ix) Access to markets. (x) Tax system and costs. (xi) Government regulations and (xii) Access to modern infrastructure and communication facilities. SME policy will have to design programmes to overcome these constraints and to spell out specific supporting measures for them.

This presupposes a proper understanding of the characteristics, requirements and growth pattern and their potential to contribute to the development goals.

[4] PROBLEMS AND CONSTRAINTS ARISING FROM THE

CURRENT POLICY ENVIRONMENT

⎯ (A) As discussed in section [3] above, the current SME policy of Pakistan does not take into explicit account the heterogeneity of the sector and, thus, consists of broad recommendations for the entire SME sector. This is the fundamental flaw in the current SME policy in Pakistan. The empirical evidence suggests the need to adopt the group-specific approach, which keeps the special needs of micro, small and medium firms in view for ensuring higher growth of firms of different sizes.

⎯ An interplay of a number factors technical and economic, finally determine the profitability and size of firms. Included among these are the following major factors with a direct bearing on why some products are preferably produced at small scale level: (1) dispersed resource processes: (2) local markets; (3) service industries; (4) separable manufacturing operations; (5) handmade projects; (6) simple assembly processes, (7) differentiated products;

and (8) small market size. Any worthwhile policy reforms initiative for the sector will have to take into explicit account the static and dynamic (long-term) requirements of SMEs with reference to (a) demand-side and (b) supply-side factors. In other words, enterprise dynamics should provide the basis for policy formulation to meet the short and long run needs of SMEs.

[Staley and Morse 1965]. Most of the known constraints of this sector relate to the “static challenges” i.e. survival in a competitive environment or in a shrinking market. These are grouped under the following majors heads: (1) rules and regulations; (2) labour laws, (3) access to institutional finance; (4) tax liability, and (5) trade restrictions.

Rules and Regulations

⎯ Businesses face a complex legal, tax and administrative environment in Pakistan, so every firm is anxious to avoid economic obligations associated with the registered status. For example, among the five major types of business structures (sole proprietorship, partnership, companies, cooperative societies and non-profit associations (trust, etc), the first is the most common in Pakistan. This form particularly suits small businesses for reasons of costs, low complexity and the ease of compliance with regulations. SMEDA (2001) survey data revealed that 72% of all SME enterprises were sole proprietors, 12% partnerships (registered), 9% partnerships (unregistered), 6% private companies and 1% (other). It is equally interesting to note that sole proprietorship was also the most favoured form of business organization for micro, small and even medium sized firms. The sole proprietorships and unregistered partnerships don’t legally require registration or prior approval from any Government department or agency. However, this type of organization doesn’t absolve them of obligation to meet labour, taxes and other regulations. But these firms enjoy tax concessions and low fixed costs because their documentations costs are very low. Similarly, micro firms (employing 1-9 persons) operate as sole proprietors with no legal obligations. In the case of partnership too the firms prefer to remain unregistered partnerships, a status which confer freedom from compliance of laws. Small firms unregistered status has a negative impact on their access to institutional finance, yet they prefer to remain in informal sector.

Labour Laws

⎯ Small enterprises operate outside the domain of the labour laws which otherwise are many and fairly complicated to operate. Provisions of Employees Old Age Benefits and Employees Social Security are just two among 76 labour laws, (Provincial and Federal) some being industry specific, in the provinces and are fairly complicated to comply with. Compliance of labour laws is prohibitive in terms of time and money. Therefore small units prefer to work in the informal sector or try to avoid registration under multiple laws, which are prohibitive for businesses. Besides, there is also lack of awareness of existing labour regulations, especially among the smaller entrepreneurs.

⎯ Even large Pakistani firms would prefer avoidance of Labour Laws. This attitude can be partly changed through proper education on the rights of owners and the benefits of enhanced labour productivity linked with labour welfare impact of laws. However, there has been little improvement in terms of entrepreneurs’ acceptance of the 100 odd existing labour laws for various reasons:

(i) laws are complicated and written in English; (ii) complexity of the laws; and

(iii) cost of compliance. To add to it are the discretionary powers of labour department, which is worsened by the lagging performance of labour courts.

[ILO, 2002].

Access to Institutional Finance

⎯ Pakistan’s Finance policy is often cited in reports as a major obstacle on the way so much so that even after Banking Reforms in the 1990s, which substantially liberalized banking operations from the regulatory reforms of the State Bank of Pakistan, the micro and small enterprises are unable to access the formal sources of credit [ILO, 2002]. It is, however, interesting to note that according to the Small and Household Manufacturing Industries data (1996-

97) almost 17000 informal firms had obtained credit from the formal credit sources. On the face of it, this data is somewhat misleading because it probably includes relatively resourceful, including medium-sized units which manage to operate without being officially registered, but have access to institutional credit.

Another, important point to note is that in Pakistan, the ratio of actual SMEs units to the registered firms (i.e. with the Businesses Associations like Federation of Chambers of Commerce and Industry) is about 1:3. So what is on record is probably different from the actual and this gives a leeway to manipulations by the resourceful businesses which otherwise may not exist on the record. The Smeda data of 2001 corroborates this information, though the sample configuration in the two sources is quite different. Smeda’s sample includes formal firms registered with government departments whereas SHMIs data relate to unregistered

(informal) firms only. However, one noteworthy observation in this case is that firms’ access to formal credit sources increases with their size. Accordingly, medium-sized firms manage to get bank credit in over 75% cases for short and long-term needs, but in the case of micro and small enterprises (MSEs) it is very low [Smeda 2001].

⎯ The biggest stumbling blocks are the State Bank of Pakistan’s (SBP) Prudential Regulations and documentation requirements, which the MSEs are just unable to meet. In the recent past, the SBP allowed Collateral-free lending of upto Rs. 100,000/= to promote micro businesses. As sole proprietors⎯without legal requirement of documentation⎯micro enterprises don’t maintain regular accounts. Accordingly they face barriers to access to bank credit, though may reap other production related benefits on account of their informal status. The Clean Lending Limited of Rs. 100,000/= as loan tenable in the case of MSEs under the State Bank’s Prudential Regulations offers some relief, though it is insufficient to meet their entire short term capital requirements.

⎯ Another component of Pakistan’s financial sector comprises the non-banking financial institutions, which also operate under SBP supervision. Most of these regulations are similar to those of the commercial banks, with same effect on the MSEs. State Bank of Pakistan regulations require the non-banking financial institutions (NBFIs) to allocate 5% of their total loans to small enterprises. If properly implemented and extended to all regions of the country, such schemes can partially meet the financial requirements of MSEs.

⎯ Government of Pakistan introduced a number of schemes in the past targeted at provision of institutional credit to the MSEs. First Women Bank’s micro credit scheme which gives small loan of Rs. 25000/= to women entrepreneurs with an excellent recovery rate of almost 100%. This scheme now covers rural areas as well. Second, Khushali Bank and Micro Finance Banks also provide micro credit to small investors in the rural areas with the objective of poverty alleviation. The initial target of the Bank was to provide Rs. 60.0 billion to small investors over 5 years period. Third, SME Bank has the mandate to provide institutional credit to the small and medium enterprises, but the subsidized credit is availed almost exclusively by the medium exporting firms and does not reach the MSEs ⎯ the sub-contractors to the medium and large firms.

The solution to this problem lay in removing the subsidy on interest rate admissible on export credit so that the benefits do not reach the unintended group of exporters. Fourth, another policy initiative of the Pakistan Export Finance Guarantee Agency is aimed at removing the requirements of collateral by the banks with upto 80% payment guarantee to exporters, including MSE, The upper limit of each transaction on which 80% guarantee is admissible is US $100,000. It is targeted at the MSE exporters and firms can have access to pre-shipment export loans. The hiccups of this system can be removed if it is administered with the collaboration of Trade and Business Associations, which have better information on the reliability and credit worthiness of borrowers, as it did in Japan in its early phase of SMEs expansion.

Export Finance Scheme

⎯ Although in operation since 1972, this scheme was improved in 1998 to make it accessible to MSEs in addition to the medium-sized firms with more resources. Consequently this facility is now also available to the small enterprises acting as sub-contractors (so called indirect exporters) for an exporter. It provides finance to the exporting firms at two levels: (i) working capital and (ii) loan equal to 41.66% of the total value of exports in the preceding year, which is provided at a low (subsidized) rate of interest. In reality, however, the small firms hardly have access to the credit of Export Finance Scheme because of either ignorance or inability to avail it for personal reasons or both. Effective measures to take the benefits of this scheme to the small firms are highly recommended.

Fiscal and Taxation System

⎯ There is sufficient evidence that local tax authorities harass small firms regarding assessment of income tax. This threatens entrepreneurs away from business and even cause revenue loss to the Government. Hence Government should involve local Small Businessmen Associations for assessment of individual firms’ tax liabilities. This will get group support for tax collection and also ensure regularity in revenue collection.

⎯ The real problem is the common practice of small businesses to avoid regular account keeping. The entire culture of small businesses is informal which seems to have seeped into the world of small enterprises. In contrast, large firms are offered concessions by government including exemption from tax payments i.e. tax holidays. Similarly, firms exporting goods produced by small units are given substantial tax rebates, but the producers do not receive any benefit for producing exportable goods. Thus there are reasons for the parent firms to avoid payment of tax liabilities as a survival strategy.

⎯ There is a general perception that Pakistan’s fiscal policy supports large firms alone to the neglect of SMEs. Some of the suggestions included in the SMEs Reform Agenda are: (i) rationalization of duties so as to make them uniform for all firms; (ii) exchange rate management system be made effective to smooth out rate changes which SMEs find unbearable; (iii) SMEs production should get a “fair share” in government purchases [Roomi, 2000].

These measures can be useful for SMEs growth.

Trade Policy and SMEs

⎯ Pak industry has an oligopolistic structure characterized by dominance of big players wielding influence on policymaking and many SMEs ⎯ with little say in economic decisions making meant for their promotion. In the realm of trade policy too, the SMEs hardly receive their due in real terms: (i) The foremost problem with trade policy is its inconsistency reflected in Statutory Regulatory Orders (SROs) relating to trade procedures. Frequent changes in SROs cause distortions in cost calculations, which are less sustainable in the case of smaller units. Second, in some cases special SROs are issued to help one firm over others; (ii) Rebates and other concessions hardly reach the small subcontractors (indirect exporters). The financial incentive included in export rebates are entirely availed by the large exporters; (iii) Direct exporters exporting 80% of or more of their output, are exempted from the hassle of filing Income Tax returns and this work is done by the Banks for them. By contrast, all vendor firms are obliged to file their tax returns and maintain books, record etc, despite being the direct contributors to the exports by the large units; (iv) Government’s export promotion schemes generally focus on the large firms. Large firms in special industrial zones enjoy waiver of customs duty and sales tax on imports of inputs depending on firm size (i.e. firms employing 100 workers or more). This automatically bars micro, small and medium firms from benefiting from this incentive package;

(v) Similarly some other incentive schemes such as No Duty No Draw back (NDND) and Manufacturing in Bond (MiB) are related to temporary imports for exports but are not designed for MSEs as they do not have the resource base required for the stipulated scale of output to enable them to avail this facility. The small firms are unable to generate the volume, which would make NDND economically and legally viable for them.

B) Constraints on Medium Enterprises

⎯ Technological constraints constitute a formidable problem for the small, but much more for the medium firms. Traditional medium firms use the low-quality production methods, resulting in poor quality of their products. These firms rely heavily on old technologies and replicate low-quality old products. Obviously they do not find a niche in the world market for those products.

⎯ Though the birth-pangs of a new medium-sized firms are also painful, in fact more because of the much higher demand for various inputs, yet unlike a small firm which is governed by the market size, a more resourceful medium firm is not dictated by the market forces and, thus, there is a scope for “conscious planning of economic activity” [Penrose 1980, P15]. Making use of its resources and modern (formal) organizational structure, a dynamic medium firm can grow as big as is dictated by the cannon of efficiency. However, these firms do not qualify for any special facility like concessional credit. Their most urgent requirement is access to new product designs and modern technology. In the light of East Asian experience of rapid industrial development, an effective official channel for technology transfer would definitely promote growth of existing medium firms as well as help in diversification into new and superior product lines.

[5] REQUIRED POLICY REFORMS FOR

STRENGTHENING SME SECTOR

⎯ The two suggested touchstones to assess the efficacy of current SME Policy in Pakistan are: (i) has this policy created the truly enabling environment for sectoral growth, and (ii) how innovative and supportive these policies are for the enterprises?

Finding Suitable Environment for Small Industry

The large size SME sector limits Governments’ and the institutions’ ability to achieve complete coverage by supporting programmes. Moreover, inconsistent economic policies create perpetual managerial problems at the firm level. Rigid bureaucratic controls and legal requirements make the environment unfavourable for business. A number of public programmes, detailed below have been launched for supporting SMEs, though their impact has been subdued so far: (i) supporting institutions and industrial estates; (ii) export processing zones; (iii) technology upgradation fund; and (iv) non-governmental support, particularly for providing funds to the small enterprises. Among these are the National Rural Support Programme (AKRSP), Punjab Rural Support Programme (PRSP), and others.

⎯ Under a revised policy (announced in 2005) the SME support initiatives are now being designed on the pattern of Japanese model, which stresses their importance and provides guidelines for structured SME development. Pakistan has designed a coherent policy for SMEs promotion through Smeda (established 1998) ⎯ an important national institution responsible for spearheading Government’s SME development efforts. It has adopted a sectoral development approach with a focus on a few priority sectors with growth potential: (i) furniture; (ii) gems and jewelry; (iii) sports goods; (iv) surgical instruments and fans; (v) marble and granites; (vi) dairy and (vii) light engineering. The current Smeda policy highlights it and is committed to the provision of six critical services needed for the SMEs of these sectors: (i) business regulations; (ii) fiscal concessions; (iii) trade rules,

(iv) labour laws; (v) incentives and (vi) support, (i.e. HRD, technology and marketing). As is well known, factors which make for success in small-scale business are to be found in the set of techno-economic conditions which bear directly on the scale of plant, and how these conditions interact with marketing, financial and managerial factors that influence the size of firms.

The ultimate success of small business will be influenced by the interacting effects of production costs, scale economies, market characteristics and location factors.

⎯ We can see why Pakistan’s small businesses operate in selected product markets of children clothing, specialized products, precision hand work such as jewelry, hand printing and metal products. These product lines sustain large number of small producers who have small initial resources. So the lesson of experience is that wherever made possible by the techno-economic factors, entry-facilitating conditions must be created for small businesses through policy measures, directed to selected product markets. Smeda’s targeted schemes for the priority sectors appears to be the correct approach under present conditions.

SMEs and Economic Efficiency

⎯ First and foremost, small firms are generally inefficient and have to be made efficient through proper policy support and guidance. Small industry needs to be made buoyant and progressive partner in development process. The best way to do so is to establish strong small-large links in production, wherever feasible. In this manner economic inefficiencies associated with small-scale as well large-scale production can be reduced through division of labour.

⎯ Complementarity of small and large industry is the primary process through which artisan firms are transformed and subsequently from a competitor to a partner with the large producers. Small-large links are of two types: forward and backward. In some cases small firms use components/parts made by large firms to make products of their own. In other, a small firm may produce a component or a part for a large manufacturer i.e.

subcontracting. This type of arrangement is quite common in Japan, Korea, China, and Taiwan. Generally, small firms are quite dependent on one or a few large customers in these countries. Such production arrangements can serve as a strong basis for ensuring survival, and even growth of small firms in Pakistan [Aftab and Rahim, 1986].

⎯ Large-Small Links may not get established automatically, they are to be developed with Government policy support.[Staley and Morse, 1965].

Emergence and growth of small industry in Pakistan owes itself to a variety of initiatives started by Government in the early 1950s and later for the promotion of industrial sector. Diffusion of industrial skills through training programmers, import licensing for import of technology, raw materials, cheap machinery, raw materials and concessional monetary and fiscal policy favoured large industry directly and small industry indirectly [Ahmed, and Amjad 1984]. As a matter of fact, the large firms of Pakistan became big centers for the small firms and facilitated growth of this sector in subsequent years.

Promotion of Entrepreneurship

⎯ Promotion of entrepreneurship through advisory services should be the major objective of SMEs policy in Pakistan. This goal can be reached through training in industrial management for ensuring efficient handling of enterprises. This strategy can be made more effective through Smeda’s supervision of various implementation programmes: (i) helping small firms to be well prepared for meeting quality standards is going to be the foremost challenge to be taken by the government agencies. This will require promotion of production channels between small and large firms to maximize the technical gains to the earlier; (ii) additionally, special incentives to those who subcontract may stimulate some large-small linkages, though it may turn out be more nominal than real development. For example, bogus firms may be set up for the purpose of realizing financial benefits on this account. Genuine and voluntary large-small linkages for manufacturing linkages are based on the principle of mutual benefits;

(iii) large firms in manufacturing, trading and services also promote small businesses in their own interest as suppliers or as industrial customers. The Ittefaq Engineering and Beco Engineering companies of Lahore are good examples of large firms investing in small firms as business partners for their long-term economic benefit. [Aftab, 1985]

Modernization and Employment

⎯ Policy measures always aim at encouraging small (i.e. traditional) firms to adopt modern product design, production methods and sales techniques for raising production, incomes and living standards. However, we have to look at the likely impact of modernization on unemployment situation as well. Selection of correct policy measures which help in replacing old with new products, especially qualitatively better and price competitive products, should end up increasing employment directly and indirectly. The SME policy need to ensure that it does not depress employment in the traditional sector. The key factor in determining the final impact of these developments would be the overall growth in the economy as in a growing economy the employment generating effects of modernization are likely to be greater than the employment reducing effects.

On the basis of the empirical evidence from many countries we can confidently say that modern small industry can contribute to more employment and income provided the major sectors of the economy grow in tandem with the overall economy, [Aftab and Rahim (1986), Berry, et al, (1991)]. The following measures are suggested for inclusion in the new SME policy.

⎯ Pakistani SMEs need to focus on: (a) development of new products;

(b) import replacements; (c) exports goods; and (d) goods with growing demand. It would be appropriate to put the scarce national resources, in particular, capital to use for the production of new products rather than duplicate lines of production that are being carried on, even with inefficiencies. Traditional products require adaptation and modifications in design and quality to meet the current demand trends. SME institutions have to play the role of catalyst in this process.

⎯ Government support for setting up a Japan’s MITI5 like organization in Pakistan would prove extremely useful as it would help in identifying and acquiring appropriate industrial technologies for SMEs. Government policy should create Dispersed Centres of Innovation and economic and social change by locating industry as far from cities as possible, preferably in the rural areas and in small towns. The deliberate decentralization of small industry is justified on the basis of excessive concentration in the cities like Faisalabad, Lahore, Sialkot, Gujranwala, Multan and Karachi.

Urban Growth Points

⎯ In view of the strong and old traditions of industrial activity in its many cities, Pakistan’s best option for promoting small-scale sector is to turn them into Urban Growth Points. The province of Punjab, NWFP and Sindh has had one such scheme or another, though in the form of Industrial Estates. Punjab has 14 such industrial estates in different cities, NWFP has 9 in different cities and Sindh 17 in various cities. These centres have been instrumental in promoting small-scale manufacturing but the results have been uneven.

⎯ What seems to be of critical importance is the correct assessment of the growth potential of such Centres. These can become real Growth Points only if there exist concrete indications of incipient industrial growth. For example, successful establishment of new industrial units or workshops and new product lines would be good indications of the potential growth of such centres. Success of Urban Growth Points would depend on a number of factors such as: (a) how well integrated are the Urban Growth Centers (UGC) with the big cities and the rural centres; (b) how much other facilities like trade, finance, equipment, maintenance facilities and repair centres, etc are available; (c) how much contribution comes from the local people in the form of leadership for the promotion of these essential services; (d) access to telecommunication facilities, power, materials and markets and (e) how responsive are the supporting services such as educational, training and research because they directly facilitate industrial growth.

Access to Institutional Finance

⎯ Along with conducive economic environment, access to institutional finance are the core and necessary conditions for the promotion of SMEs. As stated above, the institutional financing facility hardly reaches the small firms; instead it is availed by the more resourceful medium firms. This problem has its origin in the absence of a clear and functional definition of small and medium firms. Government has to clearly define the small and the medium on a permanent basis. Second, the recently established SMEs Division in the SBP should be made responsible for provision of credit to the small firms by including SMEs in the Annual Credit Plan and also apportioning a share for the small within the SME quota. Third, the SBP should monitor the distribution of credit to the SME sector so as to ensure that this facility does not go to the unintended group. Fourth, the staff of commercial banks be trained in SMEs operations with a focus on sensitizing them about the contribution of this sector to the economy. They should be trained for SME lending to meet their credit needs on cash-flow basis. Fifth, the SBP and Commercial banks should develop collateral-free products for the small firms who often fail to avail this facility for lack of “assets to serve as collateral”. Sixth, special financial institutions like SME bank, Agha Khan First Micro Finance Bank and Khushali Bank should be strengthened in terms of increased access to funds and operational effectiveness to ensure credit supply at low interest rate. Seventh, the provincial Small Industries Corporations should not be a part of the financial network for the SME sector as their performance does not justify this role. These organizations should preferably focus on advisory services for the small businesses.

Supplies of Materials

⎯ Imported and scarce raw materials are regulated items in developing countries like Pakistan. At times key materials and services produced within Pakistan may also be in short supply. Such items include cement, steel, gas, electricity, water, etc. This results in black market prices which are much higher than the official prices.