Pakistan's Shadow Entrepreneurs

[Riaz Haq]

Pakistan has 109 informal entrepreneurs for every formally documented entrepreneur, ranking the country 4th in the world for the size of its shadow economy, according to a study published by Professor Erkko Autio and Dr. Kun Fu of the Business School of London's Imperial College.

Pakistan's 109 shadow entrepreneurs for every officially registered one rank it 4th behind Indonesia's 131, India's 127 and the Philippines' 126. Egypt ranks 5th with 103 shadow entrepreneurs.

The U.S. appears at number 32 on the list with 2.37 unregistered businesses for each registered one, while the UK exhibits the lowest rate of shadow entrepreneurship among the 68 countries surveyed, with a ratio of only one shadow economy entrepreneur to nearly 30 legally registered businesses.

Shadow entrepreneurs are individuals who manage a business that sells legitimate goods and services but they do not register it. This means that they do not pay taxes, operating in a shadow economy where business activities are performed outside the reach of government authorities.

The shadow economy results in loss of tax revenue, unfair competition to registered businesses and also poor productivity - factors which hinder economic development. As these businesses are not registered it takes them beyond the reach of the law and makes shadow economy entrepreneurs vulnerable to corrupt government officials.

In a study of 68 countries, Professor Erkko Autio and Dr Kun Fu from Imperial College Business School estimated that business activities conducted by informal entrepreneurs can make up more than 80 per cent of the total economic activity in developing countries. Types of businesses include unlicensed taxicab services, roadside food stalls and small landscaping operations.

 A 2011 World Bank report titled "More and Better Jobs in South Asia" showed that 63% of Pakistan's workforce is self-employed, including 13% high-end self-employed. Salaried and daily wage earners make up only 37% of the workforce.

M. Ali Kemal and Ahmed Waqar Qasim, economists at Pakistan Institute of Development Economics (PIDE), have published their research on their estimates of the size of Pakistan's shadow economy.

They have explored several published different approaches for sizing Pakistan's underground economy and settled on a combination of  PSLM (Pakistan Social and Living Standards Measurement) consumption data  and mis-invoicing of exports and imports to conclude that the country's "informal economy was 91% of the formal economy in 2007-08".

While Pakistan's public finances remain shaky, it appears that the country's economy is in fact healthier than what the official figures show. It also seems that the national debt is less of a problem given the debt-to-GDP ratio of just 30% when informal economy is fully comprehended. Even a small but serious effort to collect more taxes can make a big dent in budget deficits. My hope is that increasing share of the informal economy will become documented with the rising use of technology. Bringing a small slice of it in the tax net will make a significant positive difference for public finances in the coming years.

Related Links:

Haq's Musings

Pakistan's Underground Economy

Job Creation in Pakistan

IBA Report on Entrepreneurship in Pakistan

Pakistan's Economy Ranks Among World's 25 Largest

Tax Evasion in Pakistan Fosters Foreign Aid Dependence

[Riaz Haq]

Why Do Entrepreneurs Operate in the Shadow Economy?

What is the “rule of law” and why does it matter for entrepreneurs? In this video, Democracy that Delivers for Entrepreneurs keynote speaker Hernando de Soto explains how the legal and institutional structures that entrepreneurs and business people in the developed world take for granted are sorely lacking in many developing countries. As a result, those who want to start a business are often forced to operate in the shadows — lacking formal registrations, licenses, and any protection for their property.

De Soto’s organization, the Institute for Liberty and Democracy (ILD), estimated that up to five billion people may be completely shut out of the legal system. The results can be catastrophic and even world-changing.

When Tunisian fruit peddler Mohamed Bouazazi had his cart, scale, and inventory confiscated by a police inspector in 2011, he was so despondent that he set himself on fire — igniting the Arab Spring that brought down several governments around the region.

Bouazizi’s name has now gone down in history, but he was not alone. ILD has found dozens of informal entrepreneurs around the Middle East and North Africa who immolated themselves for similar reasons. In a much less dramatic fashion, these kinds of institutional barriers to entrepreneurship stifle economic growth and opportunity around the world on a daily basis.

http://www.cipe.org/blog/2013/03/25/why-do-entrepreneurs-operate-in...

[Riaz Haq]

THE size of Pakistan’s informal economy is estimated to be as much as 56 per cent of the country’s GDP (as of 2019). This means that it’s worth around $180 billion a year, and that is a massive amount by any yardstick. by Dr. Lalarukh Ejaz, Assistant Professor, IBA Karachi

https://www.dawn.com/news/1610606

The country’s large black economy is inextricably linked to the levels and quality of governance exercised by the state. In the course of fieldwork for my doctoral research for the University of Southampton, I found that many Pakistani women who were setting out starting their own businesses did so in the informal sector. The reasons they gave usually related to their experience of dealing with the bureaucracy and government machinery in Pakistan which they found to be dominated by red tape and tedious and complicated procedures.

This is precisely what drives many people who want to engage in economic activity towards the undocumented economy. The headache of having to deal with a large bureaucracy, of complying with complicated and long registration procedures, of getting approvals and licences from various government agencies and departments make it difficult for most people to operate within a documented framework.

A large black economy is an indication of misgovernance and indicates a failure of the government to ensure that all businesses and entrepreneurial ventures are included in the formal sector. This failure in turn leads to reduced tax revenue collection since all entities outside of the formal economy do not pay any tax to the government.

Given that the size of the black and informal economy is estimated at over half of the country’s GDP, bringing it under the documented net would bring hundreds of billions in tax revenue. Those funds would then be spent on social sector development projects and help the FBR meet its annual revenue collection targets.

The solution is to increase the size of the formal economy and this can be done by making transparent and efficient those institutions tasked with registering and regulating businesses. Instead of harassing businesses and entrepreneurs, agencies like the FBR should act as facilitators and make it easier for new ventures to be registered and come under the documentation net. This would in turn be good for the FBR because achieving the tax collection target would be easier than if they were in the black economy.

Government requirements for new businesses are linked to the general level of governance. A state whose primary aim is to improve the lives of its citizens will prioritise good governance over all other things and will formulate and implement policies that enable this. In fact, such a state will also be able to realise that having such priorities ends up helping it as well, not least because a happy populace is a more economically productive populace.

Unfortunately, in a country like Pakistan, so far, this has not been the case. A multitude of licences and permissions are required from a wide variety of federal, provincial and local government departments to operate a business or a store. Having to comply with all of these requires not only a lot of time on the part of the entrepreneur but also funds for greasing the cogs of the bureaucratic machinery that regulates businesses and commercial enterprises in Pakistan.

The result of this is that a significantly growing number of entrepreneurs, and especially those that happen to be female, are increasingly veering towards the informal sector. This is both good and bad — good because it enables economic activity to take place, and jobs to be created, away from the unwanted glare of government inspectors and officialdom, and bad because the incomes generated from such activity don’t end up getting counted in the national GDP and nor are taxes paid on it.

[Riaz Haq]

According to Pakistan’s Economic Survey 2020-21, approximately3.25 million SMEs account for nearly 90 percent of all the businesses operating in Pakistan. This sector holds approximately 40 percent and 25 percent of the country’s annual GDP and exports respectively. However, one of the major hindrances in the financial inclusion of the SMEs sector in Pakistan is that approximaely 97 percent of SMEs are undocumented and operating under individual ownership as an informal sector.

https://www.pakistantoday.com.pk/2022/03/23/green-smes-a-turning-po...

The SMEs sector of Pakistan needs to undergo a green transformation to achieve environmentally, socially and economically sustainable development in the future. Based upon the economic importance of this sector, the development of eco-friendly or Green SMEs is pertinent for realizing the vision of a ‘Clean and Green Pakistan’. Due to their small and flexible nature, SMEs are more suited to pioneer green innovations and contribute to green growth, especially in local and emerging markets that may be neglected by large corporations. Integrating the element of environmental sustainability in the SMEs sector can synergize this important economic sector with SBP’s Green Banking initiatives. The SBP can launch low-interest green financing schemes, under the umbrella of Green Banking, for environmentally friendly SMEs such as renewable energy production, smart-metering, building retrofitting, green supply chain activities, eco-friendly channel financing and waste recycling.

Pakistan’s SME sector can undergo green transformation under the circular economic model through green financing, re-manufacturing, repair, maintenance, recycling and eco-design businesses. Green financing can also be provided for the development of sustainable agricultural value chain activities such as the establishment of Electronic Warehouses for the storage of various commodities as collateral through which an Electronic Warehouse Receipt (EWR) system can be implemented across the SME sector. SBP can launch a low-interest financing scheme for the development of EWR and Green Warehouses to ensure economic and environmental sustainability in SMEs connected with the supply chain industry. This can play an important role in overcoming the shortage of safe storage facilities for various businesses through effective public-private partnerships.

The effective adoption of environmentally friendly business operations by the SME sector of Pakistan depends upon green capacity building within the SME sector and among the concerned stakeholders. This can be achieved by inculcating green management knowledge among students across all educational levels. The SBP can provide stakeholder training and also awareness sessions at the university level to ensure green education and the creation of green awareness. The Green SME sector can play the role of an important cog in the attainment of the United Nations–Sustainable Development Goals (UN-SDGs) 2030. An increase in employment and production of the country’s SMEs sector will lead to an increase in employment and production in the rest of the economy.
Existing SBP’s financing schemes for SMEs, such as the SME Asaan Finance (SAAF) scheme, the Kamyab Jawan programme, the Kamyab Pakistan Programme and the Housing and Construction Finance schemes can be transformed into green finance programmes. Recently, Prime Minister Imran Khan, launched interest-free financing, worth Rs 407 billion, for youth, women and farmers and the construction of low-cost houses and starting a business. If this initiative is targeted towards eco-friendly startups or Green SMEs, it can result in the robust growth of Pakistan’s green industries and environmental sustainability.

Green financing can also be extended towards the Small & Medium-sized construction industry and allied businesses under the Naya Pakistan Housing Scheme like the financing of zig-zag brick manufacturers, green cement manufacturers, green warehouses and eco-friendly logistics companies.

[Riaz Haq]

Pakistan Economic Survey 2021-22

Chapter 5: Money and Credit


https://www.finance.gov.pk/survey/chapter_22/PES05-MONEY&CREDIT...


Currency in Circulation (CiC)
During the period 01stJuly-29th April, FY2022 CiC witnessed an expansion of Rs 991.7
billion (growth of 14.4 percent) as compared to expansion of Rs 673.0 billion (growth of
11.0 percent) during same period last year. Currency-to-M2 ratio reached 30.7 as on
29thApril, 2022 against 30.2 percent during same period last year. Significant growth in
CiC has been observed particularly in the month of April, 2022 on account of cash
demand during Ramzan and Eid Festive.

[Riaz Haq]

Although Pakistani startups posted a 36% decline in third quarter (July-September) of calendar year 2022 compared to the previous quarter, the financial technology (fintech) showed rising graph during the same period.

https://www.nation.com.pk/10-Nov-2022/unbanked-population-helping-p...

According to the data of Invest2Innovate (i2i), a startups consultancy firm, six out of the 14 deals that took place in Q3 2022 were fintech startups, compared to two deals of e-commerce startups. Fintech startups raised $38 million which is 58% of total funding ($65 million) in Q3 2022, compared to e-commerce startups that raised 19% of total funding. The i2i data shows that in Q3 2022, fintech raised 37.1% higher than what it raised in Q2 2022 ($27.7 million). Similarly, in Q2 2022, the total investment of fintech was 63% higher compared to what it raised in Q1 2022 ($17 million).

Sumbal Qureshi, a fintech consultant, told WealthPK that political situation has an impact on the economic situation of the country due to which a lot of foreign fintech companies have held back their initiatives. This situation is also a challenge for local fintech firms. The unusual growth is just because the existing fintechs and more established companies are trying to survive at the moment. They are trying to overcome the situation by continuing to invest in the fintech sector.

Imran Jattala, a well-known IT expert, told WealthPK that 5% of the world’s unbanked population lives in Pakistan. About 18,000 people are crossing the age of 18 every day in Pakistan, and unbanked population and those under 18 use fintech for their financial affairs. So fintech and digital banking is going to thrive despite a decrease in startup funding.

According to data of Pakistan Telecommunication Authority (PTA), over the years, branchless/mobile banking has shown tremendous growth based on the telco-banks-fintech nexus, contributing significantly to financial inclusion. The m-banking network has expanded to over 534,460 m-banking agents and 74.6 million m-wallet accounts. This network enabled more than 2.2 billion annual transactions worth over Rs8 trillion in 2021. Despite these developments, cash still dominates economic activities and there is scant use of electronic payments, especially by micro and small retailers. Cash is the predominant payment method in Pakistan as it is considered ‘safe’ by the majority of retailers and suppliers. Many wages and salaries are also paid through cash.

The importance and usage of electronic banking and alternative delivery channels has increased during the post-Covid-19 period. Realising this, the State Bank of Pakistan further incentivised the use of digital financial channels by instructing banks to waive all inter-bank and intra-bank charges on digital transactions. This resulted in a substantial annual increase of 206% in inter-bank transfers and 122% in intra-bank transfers through internet banking. For mobile banking, the impact was even higher, with a three-fold increase in mobile banking inter-bank transfers from Rs765 billion in FY 2020 to Rs2.346 trillion in FY 2021.