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Public Disclosure Authorized Public Disclosure Authorized Addressing Regulatory ‘Software’ Barriers to Business Growth 86243 Chandana Kularatne and Jose Lopez-Calix Public Disclosure Authorized Public Disclosure Authorized World Bank Policy Paper Series on Pakistan PK 07/12 December 2012 _______________________________________________ This paper is a product of the South Asia Poverty Reduction and Economic Management Unit (SASEP). It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Working Papers are also posted on the Web at http://econ.worldbank.org. The author may be contacted at [email protected]. Abstract This policy paper explores the relative importance of the software regulatory barriers to growth in Pakistan. Such software barriers have been identified as part of the major constraint in the “Framework for Economic Growth” of the Government of Pakistan. Indeed, adequate “software” is needed to provide an environment in which the ‘hardware’ of growth (physical infrastructure) could be expanded and made more productive. Among possible ‘software’ constraints, the findings of various international surveys allow to disentangle the relative importance of multiple possible regulatory barriers; first by identifying what is ‘in the books,’ and then by assessing what is actually experienced ‘on the ground’ by entrepreneurs. Following the ensuing prioritization of the identified barriers, this paper suggests that the new growth strategy would benefit from focused policy efforts in seven key areas, where regulatory barriers and perceived obstacles are most constraining to business development: getting electricity, paying taxes, enforcing contracts, registering property, obtaining construction permits, starting a business, trading across barriers, and having access to finance (particularly among small firms). The paper also expounds a detailed description of the provincial disaggregation of those barriers, which attempt to complement the general findings and allow for provincially-led customized solutions. The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development / World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent. Addressing Regulatory ‘Software’ Barriers to Business Growth Chandana Kularatne and Jose Lopez-Calix This paper was motivated from early conversations with Eric Manes and Shahid Javed Burki during their process of dissemination of a private sector strategy for Pakistan, and from discussions with Nadeem Ul Haque and Vaqar Ahmed during the preparation and implementation of the new Framework for Economic Growth. It has benefitted from inputs of Deepak Bhattasali. The paper is an outgrown of work extracted from Doing Business Surveys and Enterprise Surveys. Addressing Regulatory ‘Software’ Barriers to Business Growth Introduction 1. The main challenge of growth in Pakistan, according to the Framework for Economic Growth (FEG)1 is to address the ‘software’ of economic growth. In so doing, the FEG states that Pakistan has more of a software problem rather than a shortage of hardware (physical infrastructure). By software, the FEG refers to broad issues of economic governance, institutions, incentives and human resources that prevent a proper environment in which the ‘hardware’ of growth could be expanded and made more productive at every level. According to FEG, Pakistan has been implementing defective public sector projects, allocating untargeted and arbitrary incentives–subsidy and granting protection to lagging productive activities. This has adversely affected the efficiency of infrastructure development while the system of incentives and protection has stifled the development of a competitive marketplace. In response, the strategy encourages the improvement of productivity by making investment more effective and increasing competitiveness in the market; easing the entry and exit of firms; reforming tax and tariff policy and eliminating distortions; and, limiting government involvement. The strategy argues that entrepreneurship and innovation—which drive productivity and growth—could be greatly encouraged by improving the quality of regulation and, in so doing, governance; reforming and strengthening institutions; promoting market development; and, developing civil service reform. Policy incentives would imply reforming the legal and judicial framework and taxation systems, and reforming restrictive zoning laws, which have impeded the growth of domestic commerce and hampered the role of cities as generators of economic growth. 2. Besides regulatory barriers, the paper prioritizes the existence of economic distortions and poor functioning of domestic markets. Likewise claiming that the cost of doing business in Pakistan is due to excessive regulation, combined with weak institutions and inadequate market development as a constraint to business development. Whereas the current regulatory framework represses domestic commerce (retailing, warehousing, and transport), construction and city development; heavy government direct participation in agriculture, storage, transport, construction, to name a few, is also stifling investment. 3. Among such set of overarching factors that affect the business environment in Pakistan, the degree to which different regulations limit the ability of firms to increase productivity, scale and profitability is diverse and varied. It depends on whether the firm is large or small, formal or informal, the market structure and industry the firm operates in, and firm location. The ability of firms to navigate the regulatory obstacles, bottlenecks in logistics, labor and tax regulation and infrastructure hurdles (and also their impact) varies across firms. 4. Henceforth, this policy paper makes a step forward to sharpen the analysis of the FEG by disentangling the relative importance of different regulatory barriers, per the laws write-up and application itself; and assessing obstacles to market development as perceived by entrepreneurs. To do so, it (i) analyzes the business environment in Pakistan based on the Doing Business (DB) Survey 20122 and investigates how the indicators of doing business in Pakistan change with location of the firm;3 and (ii) assesses the business environment for manufacturing firms in Pakistan across firm size using the Enterprise Surveys (ES) 2007 and 1 Government of Pakistan. 2011. “Framework for Economic Growth: 2011.” Planning Commission. Islamabad. 2 World Bank. Doing Business 2012. http://www.doingbusiness.org/reports/global-reports/doing-business-2012 3 Data on location are from 2010. This caveat is made due to data availability. 1 Addressing Regulatory ‘Software’ Barriers to Business Growth 2010 conducted by the World Bank.4 While Doing Business captures data on the formal regulatory requirements faced by firms, the Enterprise Surveys provide statistics on firm perception of the business environment. By combining the information from both sources, it is possible to disentangle the importance of regulatory barriers and institutional obstacles to market development. 5. The relationship between DB indicators and economic outcomes is well documented in the economic literature. It is strongest, when looking at cross-economy correlations and across sectors within an economy to identify sectors more exposed to certain regulations, both in terms of delays or costs. And even if empirical work cannot prove causation, there is some evidence that the number of procedures and time needed to complete transactions are often longest in low income economies, and that positive changes in DB indicators are associated with higher rates of investment, firm entry and lower unemployment, and that the impact of reforms is somewhat more significant in better-governed economies.5 Evidence from Doing Business Survey on Business Regulations 6. The Doing Business indicators benchmark twelve areas of regulations across time. They are: (i) starting a business; (ii) transferring property; (iii) dealing with construction permits; (iv) accessing credit; (v) employing workers; (vi) enforcing contracts; (vii) protecting investors; (viii) trading across borders; (ix) paying taxes; (x) closing a business; (xi) getting electricity; and, (xii) resolving insolvency. The data counts the number of procedures and the time and costs of compliance, relying on inputs from a small number of professionals in each area. It is important to realize that each indicator reflects the de jure procedures and regulations that firms face and not the de facto restrictions firms experience for these different aspects of business environment. The coverage extends to 183 economies.6 7. Out of 183 economies, Pakistan is ranked 105 in the overall ease of Doing Business (DB) index for 2012. Pakistan does better than most South Asian economies except for Sri Lanka and the Maldives (Figure A1.1, Annexure A1). However, this absolute (level)