ISLAMABAD, Nov 1: State-owned power sector entities in Pakistan have failed to stop high levels of line theft and their politically negotiated power tariffs are significantly distorting the growth potential of small and medium enterprises (SMEs), says the Asian Development Bank.
A latest study of the ADB on “SME development in Pakistan”, a copy of which was also made available to Dawn, is also of the view that poor infrastructure, particularly in the power sector, increases the cost of growth for firms of all sizes.
“Poor power provision entails high costs, poor quality of service, lack of reliability and corruption in obtaining supplies. This reflects the failure of state-owned utility providers to deliver,” the study noted.
The cost of firms’ growth in Pakistan, it said, was increasing significantly because of high compliance costs of fiscal and non-fiscal regulations. High compliance costs arise because these regulations involve a direct contact between officials and firms; grant excessive discretion to officials; tend to entail complex non-transparent rules; and give rise to a significant corruption burden.
“The cost of corruption for firms is exacerbated by excessive delays in dispute resolution,” the study said, adding that high compliance costs were also the result of proliferating regulations and regulatory agencies.
The cascading nature of the tariff structure raises the cost of firm-level growth. An important new finding of this study is that regulatory costs are heavily biased against SMEs that have entered their expansion phase; this sets a strong incentive for firms to remain small.
Low levels of skill, training and education among workers and management raise the cost of firm growth. “This is a consequence of the poor quality of education and training offered in Pakistan,” the study said. An important factor explaining this is the regulatory structure of education. Given the poor quality of public sector education, regulatory checks enforced by the public sector are ill-designed and ineffectively enforced upon public and private institutions. This allows the entry and existence of low-quality providers that allow the average standard of education to fall to the lowest common denominator.
Furthermore, the human capital constraint is exacerbated by the lack of investment in training by firms, in particular, by SMEs. Their inability to appropriate the returns on investment and enforce contracts deters SMEs from investing in managerial and worker training.
Market transaction costs and inefficient contract repudiation are constraining the growth and risk-taking ability of firms in Pakistan. An outcome of high market transaction costs is weak linkages with high-quality intermediate goods and raw material suppliers. “This is a consequence of poor trust networks and an inefficient judicial system enforcing contracts”.
In particular, high market transaction costs and inefficient formal contract enforcement inhibit the development of SME clusters and subcontracting networks, imposing high inventory costs and, perhaps, forcing SMEs into sub optimal diversification.
“This is an important insight which suggests that designing the right regulatory framework within which to execute and enforce contracts is as important for the SME growth as the traditional emphasis on reducing state control and regulation,” the study added.
It concludes with a set of broad, strategic recommendations on stimulating the growth of SMEs in Pakistan. The study provides detailed recommendations concerning SME-specific binding constraints, including financial sector constraints, judicial constraints, and fiscal and regulatory constraints. It also recommends measures to overcome constraints that are generic across firms’ size, that is, infrastructure and human resource constraints.
“The findings suggest that lowering these constraints would have a significant positive impact on the growth of SMEs in Pakistan,” the study added.