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 2.5.4 Recommendations ....................................................................................... 16 2.5.5 Infrastructure ................................................................................................ 16 2.5.6 Recommendations ....................................................................................... 17 2.5.7 Local Road and other Local Services ........................................................... 18 2.5.8 Recommendations ....................................................................................... 18 2.5.9 Contract Enforcement & Repudiation ........................................................... 18 2.5.10 Recommendations ....................................................................................... 20 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 3.2.2 Recommendations ....................................................................................... 24 3.3.3 Trucking ....................................................................................................... 24 3.3.4 Recommendations: ...................................................................................... 25 3.3.5 Inter and Intra City Passenger Traffic ........................................................... 25 3.3.6 Recommendations ....................................................................................... 26 3.3.7 Roads .......................................................................................................... 27 3.3.8 Recommendations ....................................................................................... 27 3.3.9 Ports ............................................................................................................ 27 3.3.10 Recommendations ....................................................................................... 28

3.3 Air Transport............................................................................................................ 28 Section 4: Warehousing and Storage ......................................................................... 29 4.1 Introduction ............................................................................................................. 29 4.2. Grain Storage .......................................................................................................... 29 4.2.1 Recommendations ....................................................................................... 30 4.3 Cold Chain .............................................................................................................. 30 4.3.1 Recommendations ....................................................................................... 31 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

http://en.wikipedia.org/wiki/Gross_Register_Tonnage

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.



65. In principle the regulation required in the passenger market is not difficult to work

out. The main difficulty here has to do with fair, efficient and transparent implementation -

and this something that our governments, at all levels, have not found to be easy.

3.3.7 Roads

66. The National Motorway and Highway Authority is responsible for planning,

constructing and maintaining all the highways, while local roads come under the authority of

local governments. For our purposes the issue of highways is more important to consider. It

has already been stated that a significant proportion of our roads are not in a good enough

condition, imposing time and accident costs on passengers as well as cargo carriers and also

imposing a higher depreciation cost on vehicles. On the other hand lack of implementation of

regulations on dash driving as well as overloading also cause a higher rate of damage to roads

and a faster erosion rate.

67. The main regulatory problems in the area are clear enough to delineate. The way the

National Motorway and Highway Authority is set up it has little incentive to a) construct

roads that are of high quality, and b) maintain roads at a high quality level. Though NHA is

responsible for managing the initial construction, incentives to ensure quality a low and there

does not seem to be any mechanism for ensuring accountability and punishment if standards

are compromised. Once the road has been commissioned NHA has no incentive to impose

regulations against overloading and other activities that can damage the road as its incentives

are not based on optimal maintenance of roads. Its incentives are actually structured in a way

that it is better for the authority to let the road deteriorate to a sufficient degree and then go

for major repairs (the opportunities for corruption and nepotism are higher in major repairs

than in minor ones). Public censure against poor roads is not an effective means of creating

incentives for optimal maintenance. Optimal maintenance incentives will have to link

reward/punishment for the authority and its executives with outcomes of maintenance.

68. The basic issue with the incentive structure seems to be that the NHA has been given

the power to a) plan for future needs, b) manage the construction process, c) act as a

regulatory authority for managing the construction, and d) manage maintenance as well. So it

is in fact acting as both an executing agency as well as a regulator. These function set up

different incentive structures for the authority that work, in some cases, against each other.

As an executing agency the opportunities for corruption in the making of roads can be

significant, but then how can NHA, as a regulator, be effective in curbing this corruption.

Similarly, if it has no incentives for optimal maintenance, but has incentives to encourage

major repair contracts, how can it manage optimal maintenance and also act as an effective

regulator in this regard. For a better managed highway system the incentive confounding

elaborated upon above needs to be resolved.


Separation of the regulatory function of the highway authority from the executing

one.

Alignment of incentives for maintenance with the incentives of the executives of the

authority

3.3.9 Ports

69. The dwell time at Pakistani ports are 3 to 4 times dwell times in other more efficient

ports. Port entry costs are also very high here (See section on Transport). Though Pakistani



ports function at profits, this might not be a good idea as it does raise the cost of doing

business for local firms. The real criteria for port efficiency should be on the basis of dwell

times and cost comparisons with other ports in the region and around the world. On these

criteria we do not do too well.

70. The main issues underlying the longer dwell times seem to be:

Custom clearance, despite recent improvements, still takes longer than it should, and

still allows for a degree of corruption to occur

Paperwork required for clearance of goods also takes longer

Too much time is allowed for free storage

It should be possible to do some of the processing that is currently done at the port to

be done outside of port so that more space is available within the port and a higher

turnover can be ensured

Limited rail and transport services force customers to keep goods at the port for

longer. In this regard the longer free storage time makes sense, but it does impose a

cost on all

Fumigation takes longer

Uncollected or unclaimed cargo lies in the port for too long before it is auctioned

The inefficiencies related to labour relations or training or dock workers also slows

down operations.


Port charges need to be rationalized. The port should be viewed as a service provider

and not a profit maker. Its business should be efficiency and the requisite regulator

has to ensure that the monopoly power of the port as well as the private parties

providing the port operations is not exploited.

Customs processing, the paperwork requirements, fumigation and other processing

requirements will need additional and continuous vigilance. Where ever requirements

can be rationalized, competition from private sector be introduced and transparency

be introduced, it should be done.

Labour relations have to be better managed to ensure least disruption and labour

training has to be optimally invested in. Again the regulator will have to ensure that

the incentives of the port authorities are well aligned for this purpose.

3.3 Air Transport

71. A very small fraction of freight and passengers are transported by air in Pakistan.

Land transport, for most of the routes, is less costly and more efficient. So we are not going

to deal with the regulatory issues of air transport except for saying that some of the issues that

we face in the railways area, of dealing with a government owned monopoly and trying to

make it more efficient, are also present in air transport: despite the fact that other carriers

have been allowed in, PIA still holds a dominant position and enjoys the benefits of

favourable treatment from the government. Development of air transport will have to be

linked with the creation of an independent and fair regulator who can make the playing field

more leveled for all players.

29

Section 4

Warehousing and Storage

4.1 Introduction

72. Storage and warehousing form a very important part of the supply chain of a modern

economy. This is true of modern manufacturing and service provision concerns. With

significant issues related to transport and logistics still unresolved, having optimal levels of

inventory and using inventory drawdown and buildups as a way of smoothing manufacturing

as well as wholesale and retail process is an important way of dealing with cost of business

issues. But it is especially true of economies heavily dependent on agricultural produce for

local market functioning as well as for most of its export earnings. Storage of agricultural

grains is seen as a key way of maintaining prices of important items like wheat, rice and

sugar, and storage of cotton is important for both domestic textiles as well as direct and

indirect exports. Similarly storage of seasonal fruits and vegetables is essential if the country

wants to enter processing of such items for paste and juice for domestic and external markets.

But this, like storage of meat, meat products, and dairy products, requires a cold chain.

73. Storage and warehousing sector has traditionally been ignored in Pakistan. For most

of our history government used to be the almost monopoly buyer for grains and so almost all

large scale storage of grain used to be in the public sector. The government allowed the

private sector to enter grain markets a few years ago, but most of the storage continues to be

with the public sector still. Fruit and vegetable storage, though in the private sector, was

mostly restricted to storage for only short periods needed to transport goods from the farms

and orchards to factories and wholesale and retail markets. Storage for industrial, consumer

and non-perishable items has mostly been done by individual factories, wholesalers and

retailers.

74. The main regulatory issues related to the area are discussed below:

4.2. Grain Storage

75. Traditionally, government was the major buyer of major grains in the country. Apart

from being responsible for managing stores it also managed the export and import needs of

these grains. But over the last decade, as a part of the structural adjustment packages and the

need to redefine the role of the government in these markets, some private sector

participation in grain buying, storage, and export and import has been allowed. But this

participation is still at a small scale.

76. More importantly, conversations with private sector players in the area suggests that it

is the unclear and vacillating policies of the government of Pakistan and the provinces that is

making private investment in the area difficult.21

Private sector will enter the grain storage

21 Interview with the owners of some of the leading agricultural marketing firms in Pakistan.



and warehousing area in the hope that it will be able to benefit from higher market prices

later. But if the government a) decides to enter and exit the market unpredictably, and b)

allows or disallows imports/exports unpredictably, the private sector will be faced with a high

level of uncertainty, and will not be willing to invest in the area. If domestic prices are slated

to be higher later, private sector would like to store and benefit from the increase expected in

prices. But if the government allows imports, when prices start to increase, investors are

going to take a loss or not make the level of expected profits. If investors fear government

action, they will not invest in the area in the first place. Similarly, if prices abroad are higher,

but the government slaps a ban on exports, the expected profits will not materialize and

foresight will lead to lower investments than needed. In the last few years we have seen

examples of all of the above. In some years government has exceeded the announced targets

of procurement for wheat, in others they have not picked up enough, in some years rising

domestic prices have made government import grains in a hurry, in others government has

continued bans on international trade for longer than optimal. It is thus no surprise that

private sector investment in grain storage has not taken off yet.

77. The government storage facilities suffer from the usual problems that one would

expect. Most studies point out that the loss percentage is high in government storage, and

then there are also issue of quality losses due to infestation, mould and dampness and theft as

well. (Section on Storage). Here the problem is one of incentives again. The government

departments, PASSCO as well as the provincial departments of food, do not have high

powered reward and punishment systems of accountability for its employees based on

performance and outcomes.


The government role in procurement, storage, distribution, export and import, and

price maintenance has to be clearly stated and then the government has to stick to the

role.

It is not being argued that everything be left to the private sector. This area, in most

countries, has government involvement. But the important issue is predictability.

Government action has to be predictable to allow the private sector narrower bounds

on uncertainty when contemplating long term investment dealing with setting up

storage facilities.

Government storage facilities need to be run on corporatized and business oriented

basis, with strong performance and outcome based incentives.

4.3 Cold Chain

78. Perishable items, especially fruits and vegetables, require a cold storage chain to extend

their life beyond a few days after picking. The cold chain has to include, for some goods, even

refrigerated trucks as well. But even when these are not needed, a cold chain might need to have

facilities near main centers from where the fruit and/or vegetable is collected, facilities near

factories where processing needs to take place, and facilities near dry and sea ports as well. The

entire cold chain is therefore an expensive proposition and would need a fairly high level of bulk

and business activity to make sense of the large fixed investment. So far, in Pakistan, even though

we have centers from where large amounts of certain fruits could be collected (citrus in central

Punjab, apples in the North, mangoes in the South of Punjab and some parts of Sindh), there are

no large scale exports of fruits directly or even facilities for processing these fruits and vegetables

into paste and/or juice. So where there are stand alone cold storage facilities available here and

there, there are no integrated cold chains at a large scale and there is no demand (separate from



desire) for these as yet as well. But clearly we are stuck in a sub-optimal equilibrium. If one looks

at international prices for citrus fruit, juice as well as paste, or prices for tomato and tomato paste,

the differentials between local and international prices point out the high level of returns that are

possible in these areas. But despite that, there have not been any significant investments in the

area so far. This points to possible larger market failures in the sector. It is possible that the fixed

costs of the cold chain might not be justifiable through one project, but common use of resources

initially and then subsequent individuated investments might be the way to go. In such cases it is

possible that no single private party might come forward and take the risk of incurring high initial

fixed and sunk costs, taking the risk of large losses in the bargain. The government might have a

role here in subsidizing the initial investment or underwriting the initial risks.


The government might have to underwrite the initial investments in the creation of cold

storage chain, in conjunction with private sector parties willing to invest in fruit and

vegetable grading, packaging, and processing facilities. The government of Punjab has

already taken some steps in this direction through the creation of a company, Punjab

Agricultural Marketing Company (PAMCO), as a public-private sector initiative. This

company has been given the task of developing the cold storage chain as well as

facilitating the development of processing of fruits and vegetables, especially for export

purposes. Similar initiatives might be needed in other provinces as well.

4.4 Non-perishable Items

79. Storage facilities for retail and wholesale do not seem to have any major regulatory issues

attached to them. Most people interviewed for our research seemed to suggest that they had

adequate facilities for their purposes and those needing more space could use space available in

industrial estates or near their facilities. There do not seem to be any major regulatory hurdles in

the development of further space as well. The problems people mentioned, related to conditions

of roads, access to electricity and difficulty with electricity connections and so on are more

general problems that we will deal with when we are dealing with regulatory issues facing retail,

wholesale and manufacturing in general.


Section 5

Real Estate and Construction

5.1 Introduction

80. Well functioning real estate markets are important for reducing and streamlining the

cost of doing business for firms in manufacturing, retail, transport as well as construction.

Real estate costs form a significant part of the fixed costs of doing business in Pakistan.

Additionally, well functioning real estate markets that guarantee titles and lower search costs

for ensuring titles also allow firms to use real estate as collateral for accessing funds from

banks and other lenders. Since the formal sector financial market depends heavily on physical

collateral for advancing funds, secure land titles could allow firms, especially small and

medium sized firms as they have limited assets, to acquire funds from commercial formal

sector providers.

81. Construction sector has the potential to not only be a significant contributor to the

overall GDP of the country, but to be a large contributor in the year to year growth of GDP as

well. It is also a labour intensive industry so that the potential for creating gainful

employment through construction activity is also significant. Well functioning real estate

markets are a very important ingredient for allowing construction industry to take off.

Pakistan faces significant shortages in availability of housing units (more than 5 million)

alone, and if commercial spaces are added to it, the shortages are much more severe. Needed

reforms in these two sectors could have a significant impact on construction activity for all

commercial sectors, development of housing market and on development of cities.

82. Problems with the two sectors have been repeatedly identified by participants in our

survey, focus groups, and seminars as posing significant constraints on growth and they have

also been identified in previous literature in the same vein. At a Lahore seminar on Domestic

Commerce, the Managing Director of Makro Cash and Carry, a company that is just entering the

market in Pakistan and has the potential for changing the chain-store market in the country

completely, said that they had major difficulties in identifying property (time and search cost),

getting clear titles (time cost as well as cost of lawyer fees) and then getting it transferred (too

long a process, and with significant costs as well) to the company, and the entire process raised

both time and money costs significantly. He also added that urban land was very expensive and

made a lot of commercial activity non-viable. Participants in our Peshawar seminar (focus group)

complained that rents for commercial property were too high, there were not enough markets and

market space around, and height and other restrictions in construction created significant

distortions for them. Previous manufacturing sector surveys have also identified lack of space,

cost of transfers and managing property, and price of rents as problems.



5.2 Cost of Doing Business

83. The IFC data-base on cost of doing business, maintained for more than 175 countries,

points out that in terms of ease of registering property Pakistan was ranked 68th (higher ranks are

better) in the comity of nations in 2006, down from 57 in 2005, and in terms of ease of enforcing

contracts Pakistan was ranked 163rd

in both 2005 and 2006. The importance of contract

enforcement data, for the real estate market, should be clear from the following: one survey

estimates that more than 80 percent of all civil litigation in Pakistan is related to land disputes.

84. According to the IFC database, it takes 6 procedures and 50 days to get property

registration in Pakistan, and the cost of registration is about 4.4 percent of the property value.

This compares reasonably with the region but not too well with the OECD country benchmarks.

In terms of getting contract enforcement, it takes 55 procedures and 880 days, and the cost of

getting enforcement comes to about 22.6 percent of value of debt. These, again, do not compare

very well with OECD benchmarks.

Table 1: IFC Cost of Doing Business Data for Pakistan

Pakistan Region OECD

Registering Property

Procedures (number) 6 5.8 4.7

Time (days) 50 118.6 31.8

Cost (%age of property value) 4.4 5.3 4.3

Enforcing Contracts

Procedures (number) 55 38.7 22.2

Time (days) 880 968.9 351

Cost (%age of debt) 22.6 26.4 11.2 Source: World Bank/IFC Cost of Doing Business Database website

5.3 Main Regulatory Issues

85. Apart from foreclosure laws, most of the regulatory issues pertaining to real estate and

construction markets are related to the provincial and local levels. Taking the example of Punjab,

we bring out, in some detail, the regulatory issues that need to be worked on in order to ensure

better functioning, less distorted and more enabling real estate and construction sectors. We do

not focus on contract enforcement issues that pertain to judicial matters as these are beyond the

purview of this section. Instead, we suggest regulatory solutions that would restrict, though not

eliminate, the need for recourse to the judiciary.

5.3.1 Property Registration

86. Pakistan does not have an efficient and transparent cadastral system for property

registration. What is registered is the transfer of property and not the title (ownership right). So

establishing title is a process of following up on previous transfers to establish current rights.

There is a ‘search-certificate’ that can be issued by the sub-registrar’s office saying that the title is

good, but this falls well short of a government guarantee of title. Thus the cost of ensuring

property title, in terms of finding previous transfers, getting the search certificate, issuing notices

in papers and paying for lawyers and other mediators, and possession, can be substantial. Even

after due caution, the risk of costly litigation remains. This distorts the outcomes from the real

estate markets in a number of ways. Getting property, for housing as well as commercial activity

is costly and tedious and fraught with risks (making it a poor saving instrument). Clear titles

command significant premiums in real estate markets (explains the value of DHA plots) and can

slow down expansion of cities and hence raise prices of existing plots. Unclear records lead to

excessive and often frivolous litigation, and they limit the use of real estate as collateral for loans



too. Land records are inaccurate complex and opaque. This encourages corruption as well as

fraud, and it also leads to excessive litigation.

5.3.2 Taxation on Registration and Property

87. There is a one percent registration fee and 5 percent (on value of property) provincial

stamp duty on property transfer registration. Other fees, in the form of court fees, brokerage fees,

search costs etc. are in addition to this. High levels of taxes on registration encourage informal

titling and non-registered transactions. These can be on the basis of power of attorney based

transactions as well as benami transactions. But these transactions, though they may be cheaper

for the transacting parties, create significant distortions in the market by making it more opaque

and non-transparent. Property tax rates have been revised downwards a number of times in the

last few years. These might not form as big a constraint now as they used too up to a few years

ago.

5.3.3 Commercialization and Other charges

88. Commercialization fee for change of use of property (from residential to commercial) is

20 percent of the value of the plot. In addition, there are very high development charges by water

and sanitation authorities as well. These charges apply to areas that have been declared as

commercial areas already.

5.3.4 Construction

89. Building and zoning codes regarding heights of buildings, plot to covered area ratio, rules

for space utilization, etc. remain the responsibility of local governments, but there is a multiplicity

of agencies involved here with multiple rules and procedures. For example, in Lahore building

codes are imposed by LDA, Cantonment Board as well as the Tehsil Municipal Authority

(TMA). There is no rationalization of the codes across these bodies, and there is no

rationalization of codes across cities as well. In some of the smaller cities clear building codes do

not exist, in other cases, some of the provision of the codes are archaic and need change. For

example, till a few years ago LDA imposed a 300 feet limit on height of buildings in Lahore. For

a main commercial hub like Lahore, with urban property at a premium the restriction did not

make sense. The stated reason for the limit was LDA’s fears about fires, and the ability of

contractors to arrange for delivery of infrastructure in tall structures. Though private insurance

requirements could have taken care of these issues. LDA has now removed some of these

restrictions. Though building codes are a local issue, TMAs might not have the capacity to build

their own codes and so the provincial governments can halp TMAs build modern building codes

and develop their capacity to ensure implementation. This will also facilitate standardization of

codes across the province at least. There is as yet no realization of possible environmental

impacts of construction and expansion of urban areas into rural areas. These need explicit

recognition so that the impacts can be planned for.

5.3.5 Rental Property

90. Rent restriction ordinance continues to distort incentives for the development of property

for rental purposes. The issues here have to do with a) limits on rents, b) excessive tenant rights,

and c) differential taxation on rental property. Limits on rents and how much rents can go up by

reduce incentives for construction of property for rental purposes as well as incentives for

maintaining rented property. Tenant eviction procedures are costly and lengthy, and strong tenant



rights again weaken incentives for owners to develop property for rental purposes. High rate of

stamp duty and registration fee (3 percent and 1 percent of value of contract) also discourage

registration of rental contracts. Property tax on rented property is still almost 10 times that on

owner occupied property. This differential also discourages property rentals. Since there does not

seem to be any sound economic reason for the differential, closing the gap between these to rates

could lower the distortion in rental markets significantly.

5.4 Recommendations

Establishment of a transparent and efficient cadastral system for property title registration

should be a high priority (Provincial responsibility).

Stamp duties on property related transactions and registration fees need to be rationalized

(Provincial responsibility).

Non-registered transactions have to be banned (Provincial responsibility).

Change of use charges need rationalization.

Development charges by water/sanitation authorities need rationalization 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

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)

have to be rationalized.



Appendix I Regulatory System in America

91. The department of Commerce in America is responsible for regulations on commerce and

foreign trade. Focusing only on Commerce, there are 6 agencies within the department:

1. National Institute of Standards and Technology NIST (setting quality standards)

2. Bureau of industry and security (all matter related to defense)

3. Bureau of economic analysis (contains survey data)

4. National oceanic and atmospheric administration

5. Technical administration

6. Minority business development agency.

92. The objective of each agency is clearly defined and does not overlap with that of any

other agency. In particular, the NIST has outlined in detail, the procedures for setting standards

in the industry. For example, a committee is established that includes members of producers,

consumers, manufacturers and possibly other state or Federal agencies. This ensures that the

interest and concerns of every party that is affected by these regulations is taken into account.

How new standards are set, old standards that are no longer appropriate are removed and how

quality is monitored by inspectors is all specified in detail. Technical administration is

responsible for training individuals to increase productivity and to discover improved methods of

technology through research and development.

93. Regarding information on registration and licensing authorities in America, every state

has its own rules and policies. I was able to obtain this information for Colorado state. The

interesting aspect of this is that although all businesses need to be licensed, there are certain

businesses for which obtaining a license requires certain qualifications. The department of

Regulatory Agencies contains separate divisions for banking, real estate, financial services, civil

rights, securities and registrations. Within the division for registrations, there are 30 licensing

boards that represent different professions (barbers, land surveyors, midwives, plumbers,

engineers etc). Each board in turn explains the licensing requirements and has registration forms

available online. For professions such as barbers, there is a need to pass an examination so as to

qualify for the license unless the individual is trained abroad.

94. The advantage of this network of divisions and boards is that it creates an organized

system. Interested individuals are aware of which board of which division they have to apply to

if they want to obtain a license and are aware of the procedures. Also, each board has a

complaint office allowing efficient and fast processing of customer complaints. The need for

obtaining a license is not a barrier to entry because the licenses are issued quickly and in some

businesses, with minimal requirements. This helps to ensure that markets are contestable as it is

the threat of potential entrants that ensures good quality and standards by the incumbent firms.

Regulation in America and UK

95. In the US, the transport sector is dealt with individually and separately from any other

sector unlike in Pakistan. There is a secretary of Transport who monitors the Department of

Transport. The Department itself comprises of 9 agencies namely:

1. Federal Aviation Administration

2. Federal Highway Administration

3. Federal Motor carrier safety Administration

4. Federal Railroad Aministration

5. Federal Transit Administration



6. Maritime Administration

7. Pipeline Hazardous materials Administration

8. Surface Transport board (registers interstate surface transport)

9. St. Lawrence Seaway Development Corporation.

96. The Federal Transit Administration is responsible for planning, building and operating

transit systems with cost, convenience and accessibility in mind. It covers all forms of transport

such as rail vehicles, buses, commuter ferryboats, trolleys, subways and people movers. The

administration also maintains a national transit library a repository of reports, documents and data

generated by professionals. It is designed to facilitate document sharing amongst individuals

interested in transit and transit related topics.

97. Similarly, each department has its own set of regulations and policies relating to a specific

aspect of the transport industry.

98. The UK has a similar well-defined organization structure responsible for regulating the

transport sector. The Department of Transport board contains members from the rail group,

aviation group, delivery and security group, roads regional and local transport group and the

driver vehicle and operator group. This ensures that all sectors of the transport industry are

properly represented in the board to allow for effective decision making. The department itself

comprises of 6 agencies namely:

1. Driving Standard Agency

2. Driver Vehicle Licensing Agency.

3. Vehicle certificate Agency

4. Vehicle and operator services Agency

5. Highways Agency

6. Maritime Agency

99. As for the US, each agency has its own set of regulations and policies and a well-defined

set of objectives that does not coincide with any other agency.