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Hilal English

Unlocking the Growth Potential of Small-scale and Household Manufacturing Industries in Pakistan

May 2022

With Pakistan paving newer avenues for industries to thrive, flourish and benefit its economy, SHMIs are also being provided opportunities to grow.


Since independence, Pakistan has mainly pursued the path of import substitution industrialization to absorb surplus labor and bring about a balanced regional growth. Despite the rapid growth of GDP, employment opportunities have remained inadequate to absorb the rapidly increasing labor force. The use of inward-looking policies to incentivize large-scale industries resulted in the allocation of resources towards capital-intensive activities, that in turn generated fewer employment opportunities. 


SHMIs/SMIs have been vital in the growth of Pakistan’s economy. They represent an appropriate alternative to promote sustainable growth, create employment, develop rural and remote regions, ensure optimum utilization of unexploited resources, attain self-reliance, and improve the standard of living of the people.


Until the 1970s, no explicit policy framework existed for small and medium-sized industries (SMIs). Policymakers thought that, perhaps, these industries do not have any dynamism. Consequently, these industries, especially those based in industrial clusters, were developed in a haphazard manner with exclusive effort of the private sector. The nationalization of mostly large-scale industries in the early 1970s provided an unintentional growth impetus for small-household manufacturing industries (SHMIs). With these developments, SHMIs came on the radar of policymakers. 
SHMIs/SMIs have been vital in the growth of Pakistan’s economy. They represent an appropriate alternative to promote sustainable growth, create employment, develop rural and remote regions, ensure optimum utilization of unexploited resources, attain self-reliance, and improve the standard of living of the people.
One of the important features of urban-based SHMIs is their capability of operating autonomously on the strength of sub-contractual relationships and production-based networking with large- and medium-sized firms. Some of them are innovative and produce innovative parts for larger firms. Thus, they make an important contribution in enhancing competitiveness through their indigenous outsourcing cooperation and play a critical role in the progression of technological innovation.
In the rural areas, SHMIs produce goods by mostly using locally available raw materials to meet the demand of the rural population. They provide nonfarm employment to people and thus control rural-urban migration.
Dynamic SHMIs serve as a platform to upgrade the quality of the workforce, improve business management skills and diffuse technological know-how throughout the economy. These enterprises help mobilize domestic resources towards productive use that otherwise may have remained unutilized. These enterprises not only serve the domestic low-income consumers, but also produce a wide variety of quality ‘cultural’ goods that have a high demand in the international markets. 
SHMIs working in industrial clusters draw on the economies of scale benefits by purchasing inputs from cluster-based specialized suppliers, labor market pooling and knowledge spillovers. Consequently, these characteristics of clusters enable inter-firm division of labor to produce quality intermediate inputs and final goods for both domestic and international markets.
Against the positive aspects of the SHMIs, many of them face a higher average cost due to their small size. While some of these units survive on the strength of their efficiency in the use of resources and linkage with larger firms; others survive, despite being inefficient, merely by paying lower wages to workers, evading taxes and circumventing state regulations. Similarly, some fail due to low employability of modern technology and proficient workers, inaccessibility to markets, discriminative policies and regulations, etc. New firms, at times, fail due to inexperience, lack of finance, and management skills. This situation calls for governmental support to alleviate SHMIs’ problems to harness their full potential.
An Overview of SHMIs
In 2015 (the latest year for which data on SHMIs is available in Pakistan) there were 1.24 million units of SHMIs, with 15.7% located in rural areas and 84.3% in urban areas, respectively. Out of the total SHMIs, 63.4% were household units and 36.6% were small units. Provincial details can be noted from Table 1. 



Overall, the manufacturing sector contributes 12.8% in the GDP and 16.1% in the labor force, while SHMIs’ contribution to the GDP is 2.12%. Within the manufacturing sector, SHMIs contribute 12% in its GDP. Despite their numerical dominance, however, SHMIs account for a small proportion in the GDP. There is no separate data available for SHMIs but reportedly, SMIs’ contribution in the total exports is 40%. 
Between 1996-97 and 2015-16, the annual growth of household units was 10.92%, while small units increased by 1.58%. Within the household manufacturing industries, 95% are operated by individual owners whereas 4.6% are operated under partnership. A similar trend is observed for small units.


Global experience gives a loud and clear message that firms grow when they become more productive and not simply because they are large. Firms that are more creative and productive graduate to large-size and, in the process, obtain access to resources and market information, which enables them to become even more productive.


About 2.7 million workers were engaged in SHMIs. Out of this, 56% were working in household units and 44% were engaged in small units. SHMIs experienced a 5.2% growth in employment between 1996-97 and 2015-16. Employment by gender shows that there were 28% males compared to 72% female employees working in household units. In contrast, 96% males compared to 4% females were engaged in small manufacturing units. Overall, 21.6% of the total workers employed are paid employees, and the remaining are unpaid family workers and self- employed. More paid workers (42.84%) are working in small units than (4.63%) in household units.
Potential Industries/Businesses
Some of the industries and businesses that present vast potential to new entrants to set up their own companies include: jewelry, prefabricated buildings, furniture, grain milling, bakery products, textile products, prepared meals, wood products, stone products, clothing and apparel, etc. Besides, upcoming businesses for startups include: real estate business, e-commerce, content-writing, YouTube channel, fitness clubs, graphic-designing, mental health education center, e-learning sites, travel consulting, software development company, online book publishing, selling insurance, marketing automobile parts, tourism agency, starting a restaurant chain, furniture business and selling, event management services, poultry farming, agriculture business, service stations, stationery store, book selling, talent acquisition agency, custom t-shirt, mugs printing company, toys, paper bags, photography, and beauty parlors, etc.


SHMIs can increase their output size manyfolds if they are developed by alleviating the abovementioned problems. Earlier policy actions announced by the GoP, if implemented in letter and spirit, can assist in unlocking the latent potential of SHMIs.


Characteristics of SHMI
SHMIs are comprised of those industries that manufacture, produce and render services with the help of small machines and less labor. These industries make a one-time investment in machinery, plants, and equipment. These industries are generally labor-intensive and hence play an important role in the creation of employment. SHMIs’ main characteristics are:
▪  Ownership and Management. They are usually under single ownership, while a few have partnership. The owners are actively involved in the day-to-day business activities.
Flexibility. They are more adaptable to the changing business environment and are more flexible as compared to larger firms.
Limited Reach. They have a restricted zone of operations and marketing and mostly meet local or regional demand.
Resource Utilization. They use local resources like talent, raw materials (agricultural and mineral), and labor. With the mobilization and utilization of local resources, primary industries are promoted.
Labor Intensity. They are a major source of employment. Because of the limited availability of technology, they tend to use more labor for their production activities, thus creating more jobs.
Links with Larger Firms. About a quarter of SHMIs reportedly do sub-contractual work for larger firms. Sub-contracting arrangements involve sharing of equipment and designs between firms. Such production networking eases the capital and resource constraints of SHMIs, which makes them less susceptible to uncertainty and thus help in improving competitiveness. 
SHMIs’ Problems
Current low contributions of SHMIs in the GDP is due to many problems they face that include:
Finance. A major problem faced by SHMIs is the inadequacy of capital to operate and develop. This is mainly because they do not have financial literacy, and carry insufficient creditworthiness and collateral. SHMIs mostly operate in semi-urban and rural areas which makes it difficult to access financial institutions for finance. The majority thus rely on personal finances, credit from informal lenders, loans from friends and relatives. Household enterprises hardly receive any funding from the financial institutions.
Human Resources. The artisans usually learn their skills and production methods from their elders. The provision of formal technical advice and training is limited. Due to shortage of funds, SHMIs are not able to employ skilled labor. They cannot pay high wages to attract skilled workers, and hence employ low skilled workers. This causes low labor productivity which affects their competitiveness. A single person often manages all the operations, who is overburdened and often lacks basic managerial skills needed to operate any unit.
Entrepreneurship. A major constraint limiting the diversification process is the lack of entrepreneurship. SHMIs lack business champions who can identify niche products for niche markets. Entrepreneurship development requires SHMIs’ links with larger, especially, foreign, firms.
Market Accessibility. The intermediaries exploit SHMIs by paying a low price for their products and making delayed payments. In some cases, goods are sold to wholesalers at cost price which discourages SHMIs; consequently, they reduce the quality and quantity they produce. 
Raw Materials. SHMIs purchase raw materials in small lots; they lack bargaining power in the market. The storage facility is another issue that refrains them from holding inventories of raw materials to control the seasonal ups and downs in their supplies.
Discriminative Policies and Regulations. A major hurdle faced by SHMIs is the distinction between ‘industrial’ and ‘commercial’ importers with respect to tariff rates. SHMIs, being relatively small users of imported raw materials and inputs, have to obtain their supplies from commercial importers and bear the burden of higher tariff rates and intermediaries’ charges. In effect, such measures place SHMIs at a cost disadvantage relative to larger firms. Besides, export rebates and export refinance meant to encourage non-traditional exports benefit only larger firms.
Other Obstacles. These include lack of business planning, lack of information on accounting, managerial and marketing practices, adoption of standardized processes and procedures, limited access to new technology and information-communication technology, and red tapism, etc.
Existing SHMI Policies
To harness the growth potential, the Small and Medium Enterprises Development Authority (SMEDA) has taken various initiatives. These initiatives are for SMIs and not exclusively for SHMIs. SMEDA provides business development services, infrastructure development through establishing common facility centers, industry support for productivity enhancement and energy efficiency as well as human capital development through training programs. A comprehensive program includes online clinic and webinars, training sessions, helpdesks and virtual meetings with key stakeholders. SMEDA has also launched a one-window operation to create a hassle-free business environment. 
The Government of Pakistan (GoP) has also established a Microfinance Bank to meet the financial needs of SHMIs. Moreover, most commercial banks in the country have specialized departments for small firms. Besides, the GoP has established the ‘Small Industries Corporation’ in all provinces, aiming to establish industrial estates; provision of marketing facilities; setting up of technical service centers; establishing handicraft development centers and carpet centers; provision of investment counseling and guidance to newcomers and provision of loans to small firms on easy installments.
The GoP has also recently unveiled a new SME Policy 2021-25, that is aimed at providing facilitation in registration, streamlining of taxes, access to credit and provision of land, while dividing SMEs into three sectors: low risk (including services sector, transport, and wholesale, etc.); medium risk (including light engineering, leather, auto parts, cutlery, and sports goods, etc.); and high risk (dealing in explosives, fire equipment, boilers, and chemicals, etc.). Under the policy, a No Objection Certificate (NOC) is not required for start-ups and expansion to low-risk businesses. The medium-risk firms will be provided NOC within 30 days, and if the certificate is not issued within 30 days, it is deemed that the NOC has been issued. 
Overall, the latest policy aims at providing facilities and incentives to SMEs. Key initiatives on SMEs include access to credit, lowered tax regime, and regulatory simplifications. The GoP has decided to establish an SME fund and restructure SMEDA to make it a more private sector driven entity.
This policy further intends to address issues hindering the development of SMEs such as unnecessary inspection that adds to the cost-of-doing business. To eliminate harassment and bribes by the inspectors, a self-declaration by firms on regulatory compliance and an e-inspection portal to monitor and self-verification of on-site inspections visits have been introduced.
The new policy also offers tax incentives to SMEs by reducing the turnover tax rate from 1.25% to 0.25% for enterprises having an annual turnover below Rs. 100 million, while the tax rate has been fixed at 0.5% for units with a turnover between Rs. 100 million and Rs. 250 million.
Additionally, the ‘Asaan Finance Scheme’ was launched to ensure access of capital to the industries. Loans up to Rs. 10 million with lower markup rates of 9% will be provided without any collateral for setting up new businesses. In addition, Rs. 23.5 billion is allocated to cover 60% of the financial loss borne by SMEs.
Under this policy, 4,200 acres have been allocated to develop 19,500 plots, along with dedicated industrial infrastructure. Market access regulations are being revised to allow greater SME participation in the public sector procurement of goods and services. 
This policy specifically focuses on supporting women entrepreneurship by attaining greater access to finance, awareness, and training. Women-led enterprises have been given a 25% rebate in tax.
Unlocking the Growth Potential of SHMIs 
Global experience gives a loud and clear message that firms grow when they become more productive and not simply because they are large. Firms that are more creative and productive graduate to large-size and, in the process, obtain access to resources and market information, which enables them to become even more productive. One implication of this experience is that public policies should target productivity rather than size and support reforms that make it possible for market mechanisms to remove low productivity firms while facilitating the entry or growth of high productivity firms. In this regard, it is imperative to keep entry and exit costs low to benefit from productivity gains. 
SHMIs can increase their output size manyfolds if they are developed by alleviating the abovementioned problems. Earlier policy actions announced by the GoP, if implemented in letter and spirit, can assist in unlocking the latent potential of SHMIs. I extend this list by putting forward some pertinent policy recommendations: 
• Support SHMIs through explicit policy measures especially those who use domestic raw materials. Policy measures in this context should include, among others, credit availability with soft conditions to meet fixed and variable capital costs, fiscal incentives to award progress, provision of cost effective and efficient hard and soft infrastructures, etc.
• SHMIs producing quality products for export market should be ensured the needed capital, appropriate skills and technology, market information, and export refinance.
• Eliminate discrimination against SHMIs in trade and industrial policies.  
• Promote industrial clusters with the provision of infrastructure facilities for smaller units. 
• Stimulate formation of industrial networks by promoting outsourcing cooperation among domestic and foreign (especially Chinese) firms to get access to technology, value chain and branding. 
• Establish a one-stop shop exclusively for SHMIs to access government services, links to financial institutions, legal services, marketplaces for business opportunities and fulfill government requirements such as payment of taxes. 
• Capacity building through establishment of centers for innovation and quality improvement that should assist SHMIs with product design, improvement of production methods, efficient use of multipurpose equipment, and facilitate the process of product testing and certification for product standardization.


The writer is a Professor of Economics at the School of Social Sciences and Humanities at NUST, Islamabad. 
E-mail: [email protected]
 

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