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

THE STATE OF DOMESTIC COMMERCE IN
PAKISTAN

STUDY 4
REGULATORY ISSUES IN DOMESTIC
COMMERCE

For
The Ministry of Commerce
Government of Pakistan
November 2007

By
Innovative Development Strategies (Pvt.) Ltd.
House No. 2, Street 44, F-8/1, Islamabad

Table of Contents

List of Abbreviations ............................................................................................................... i
Acknowledgments ................................................................................................................ iv

Executive Summary ............................................................................................................ 3

Section 1: Regulatory Issues in Domestic Commerce ................................................ 9
1.1. Introduction ............................................................................................................... 9

Section 2: Retail and Wholesale ................................................................................. 10
2.1 Introduction ............................................................................................................. 10
2.2 Agricultural Marketing .............................................................................................. 10
2.3 Recommendations................................................................................................... 11
2.4 Main issues in Retail Markets .................................................................................. 11
2.5 Pakistan Shops and Establishment Ordinance 1969 ............................................... 12
2.5.1 Finance ........................................................................................................ 13
2.5.2 Recommendations ....................................................................................... 14
2.5.3 Taxation ....................................................................................................... 14
2.5.5 Infrastructure ................................................................................................ 16
2.5.7 Local Road and other Local Services ........................................................... 18
2.5.9 Contract Enforcement & Repudiation ........................................................... 18
2.5.11 Law and Order ............................................................................................. 20

Section 3: Transport Sector ........................................................................................ 22
3.1 Introduction ............................................................................................................. 22
3.2 Land Transport ........................................................................................................ 23
3.2.1 Railway ........................................................................................................ 23
3.3.3 Trucking ....................................................................................................... 24
3.3.4 Recommendations: ...................................................................................... 25
3.3.5 Inter and Intra City Passenger Traffic ........................................................... 25
3.3.7 Roads .......................................................................................................... 27
3.3.9 Ports ............................................................................................................ 27
3.3 Air Transport............................................................................................................ 28

Section 4: Warehousing and Storage ......................................................................... 29
4.1 Introduction ............................................................................................................. 29
4.2. Grain Storage .......................................................................................................... 29
4.3 Cold Chain .............................................................................................................. 30
4.4 Non-perishable Items .............................................................................................. 31
Section 5: Real Estate and Construction ................................................................... 32
5.1 Introduction ............................................................................................................. 32
5.2 Cost of Doing Business ........................................................................................... 33
5.3 Main Regulatory Issues ........................................................................................... 33
5.3.1 Property Registration ................................................................................... 33
5.3.2 Taxation on Registration and Property ......................................................... 34
5.3.3 Commercialization and Other charges ......................................................... 34
5.3.4 Construction ................................................................................................. 34
5.3.5 Rental Property ............................................................................................ 34
5.4 Recommendations................................................................................................... 35

Appendix I ............................................................................................................... 36

List of Tables

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

Innovative Development Strategies (Pvt) i
List of Abbreviations

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

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

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


Innovative Development Strategies (Pvt) iv
Acknowledgment

This work has benefited from a number of focus group discussions held all over the country
and feedback received at a series of seminars held at the Federal Ministry of Commerce
during early 2007. The results were also disseminated at a national seminar in April 2007 in
Islamabad. The study team is grateful to all the participants of these discussions as well as the
2000 respondents who gave so freely of their time.

The IDS team owes a special debt of gratitude to the officers of the Ministry of Commerce
for their guidance, assistance and feedback during the course of this study. Our greatest
thanks go out to Syed Asif Ali Shah, Secretary, Ministry of Commerce for nurturing these
studies through all the stages.

Thanks are also due, in particular, to Mr. Naseem Qureshi and Mr. Ashraf Khan, Additional
Secretaries; Mr. Abrar Hussian, Joint Secretary; Syed Irtiqa Zaidi, Consultant and Mr.
Qaseem Subhani, Section Officer of the Federal Ministry of Commerce, for sparing their
precious time and efforts for the studies.

The support lent to this work by Mr. Saeed Ahmad Alvi, Secretary, Department of
Investment and Commerce, Government of Punjab is also gratefully acknowledged. Not only
did he make a great contribution to the conceptualization of the studies, but his office helped
to facilitate the workshops and field work in the Punjab for which we are eternally grateful.

The team feels a deep sense of gratitude for the Federal Minister for Commerce, Mr.
Humayun Akhtar Khan, who took out considerable time from his very busy schedule to guide
this work. It was his sincere and deep conviction in the value of quality research which
enabled us to conduct and compile this detailed and comprehensive study on Domestic
Commerce. Without his continued interest, guidance and oversight, this study would not have
been possible.

This study has benefited from comments received from the following:
1. State Bank of Pakistan, Karachi.
2. Federal Board of Revenue, Government of Pakistan, Islamabad.
3. Planning and Development Division, Government of Pakistan, Islamabad.
4. Trade Development Authority, Government of Pakistan, Karachi.
5. (Management Consultants) Establishment Division, Government of Pakistan,
Islamabad.
6. Finance Division, Government of Pakistan, Islamabad.
7. Pakistan Institute of Development Economics, Islamabad.
8. NTTFC, Karachi.
9. FPCCI, Karachi.
10. Planning and Development Board, Government of Punjab, Lahore.
11. Planning and Development Board, Government of NWFP, Peshawar.
12. Planning and Development Board, Government of Sindh, Karachi.
13. Planning and Development Board, Government of Balochistan, Quetta.
14. Investment and Commerce Department, Government of Punjab, Lahore.
15. Housing and Works, Government of Pakistan, Islamabad.
16. Ministry of Communications, Government of Pakistan, Islamabad.
17. Ministry of Food, Agriculture and Livestock, Government of Pakistan, Islamabad.
18. Ministry of Water and Power, Government of Pakistan, Islamabad.

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

1
REGULATORY ISSUES IN DOMESTIC
COMMERCE

by

DR. FAISAL BARI

Innovative Development Strategies (Pvt) 3
Executive Summary

1. Increasing globalization and the policies of liberalization, de-regulation, and
privatization that successive governments in Pakistan have been pursuing over the last decade
and a half have increased the need for domestic producers and service providers to be
competitive with the international counter parts. This is needed not only for exporting to
other countries, developed or developing, but for competitive performance in the local
markets as well. With increasing globalization, this need to be competitive, both domestically
and internationally, will increase manifolds. If our economy is to maintain a high growth
trajectory, we need to be aware of all issues that might be creating hurdles in the way of
doing business, competitively, at the international level. If our local costs, direct or indirect,
are not in line with the costs in other countries, local producers will suffer, and so will the
local economy. This study reviews some of the regulatory issues facing various sectors in
domestic commerce and identifies the major regulatory hurdles related to each of them.
While recommendations are made on major issues much more detailed work needs to be done
on a host of others before an optimal course of action can be recommended. The main points
from each sector are summarized below.

Agriculture Marketing

2. Pakistan clearly has a significant potential in export of fruits, vegetables, dairy
products, meat and grains. These are important domestic sectors as well. But the potential has
so far not been fully exploited in any of the area mentioned above. In some of these sub-
sectors there are significant regulatory issues that could be crucially hampering further
developments.
3. Fruit and vegetable markets, regulated by the respective provincial agricultural
departments under the Market Committee Acts, pose significant hurdles to development of
such markets by the private sector. Despite recent amendments, private sector is still not keen
to enter this area and the small number of fruit and vegetable markets continue to impose
significant distortionary costs. The Market Acts give too much regulatory authority to the
government, allow it to interfere in the day to day functioning of these markets, and give it
powers to control governance structures, rentals and allocation of space in the market. Under
such restrictive conditions, it is not surprising that private sector has not entered the area in
any significant fashion. A thorough overhaul of the Market Act, with a view to facilitating
private sector entry is badly needed here.

Retail and Wholesale Markets

4. Most of the retail and wholesale businesses in our sample are not registered as
businesses either under the Companies Act or under the Shop Act. Though the latter is a
requirement for all shops, there is no real enforcement of the Act on small businesses. It is
not the level of fees related to registration of the shop that seems to be the major hurdle in
registration. It seems that a) shopkeepers either do not know of the requirement, or b) they
attempt it to avoid any implications that registration might have on the taxation side.

The main regulatory issues related to wholesale and retail businesses are summarized below
1
:

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 roads
2
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 us
3
. 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
designates
4
, 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? Dont 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 Pakistans 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 below
5
:

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 SMEDAs role to take on this
effort in a much more concentrated manner.

2.5.3 Taxation

22. Most retailers
7
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
interviewed
8
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 confectionery
9
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 owner
10
mentioned that they also had a tailoring unit that
produced mens 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 mens 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, mens 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 wholesaler
11
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 persons 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 retailers
12
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 proprietorships
17
, 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 collapse
18
.
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 Akerlofs 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
taxis
19
. 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 feature
20
. 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 68
th
(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 163
rd
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-registrars 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 LDAs 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.

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