Pakistan's Undocumented Entrepreneurs Dominate Shadow Economy

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

Comments

Anonymous said…
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-the-shadow-economy
Riaz Haq said…
Small is beautiful - unless you are a business that wants to grow. In which case, small is not so appealing. In Pakistan, where 90 percent of businesses are small or medium, challenges to scaling-up businesses have kept the private sector from realizing their full potential and contributing as much as they could to the economy. To help address a major constraint to the growth of small and medium enterprises (SMEs) in Pakistan, the U.S. Agency for International Development (USAID) is partnering with local banks to boost lending to SMEs. The new $60 million "U.S.-Pakistan Partnership for Access to Credit" was launched at last week's U.S.-Pakistan Business Opportunities Conference, as part of a larger bilateral government effort to boost trade and investment in Pakistan.

Finance is an important enabler of economic growth anywhere in the world. For Pakistan, which needs annual economic growth of at least 7 percent just to keep up with the number of youth expected to enter the labor market each year, this financing is important not only for the economy but for stability. Yet the private sector credit to gross domestic product (GDP) and financial depth ratios in Pakistan trail behind leading emerging economies.

In the SME segment, the volume of lending and types of financing tailored to SME needs have been very limited. A World Bank study found that only 16 percent of total credit in Pakistan went to SMEs. Moreover, about 70 percent of SME borrowing was used for working capital while only about 12 percent went toward long-term investment. Another survey shows only 11 percent of micro, small, and medium enterprises (MSMEs) in Pakistan report having access to finance, below the 15 percent international average and well below percentages reported in higher performing middle-income countries like Brazil and Turkey (30 and 48 percent respectively).

Despite these limitations, SMEs make an out-sized contribution to Pakistan's economy. The same World Bank study found that SMEs in Pakistan employ nearly 70 percent of workers in the manufacturing, services, and trade sectors and generate an estimated 35 percent of manufacturing's value addition. They also contribute over 30 percent of GDP and more than 25 percent of export earnings. Thus, alleviating a key constraint to their growth could lead to substantial increases in the number of jobs for Pakistan's large number of youth and greater income generation.

The new Partnership reflects a shared commitment to promote broad-based economic growth in Pakistan. Private sector investment was identified as an essential ingredient for growth in the Government of Pakistan's Vision 2025 strategy. The Partnership is part of a larger umbrella of U.S. support to SMEs in Pakistan to help them grow and expand into new markets. It will provide partner banks- Bank Alfalah, JS Bank, Khushhali Bank and First Microfinance Bank- with a loan portfolio guarantee through USAID's Development Credit Authority (DCA). The guarantee will lower the risk to the banks for lending in sectors they would otherwise perceive as being too risky. It will also encourage partner banks to extend longer-term loans and introduce credit products that address the needs of SMEs.

With more access to finance, small and medium businesses are poised to make even larger contributions to the Pakistan economy than they do now. The new U.S.-Pakistan Partnership for Access to Credit will make it possible for dynamic SMEs to be more than small and beautiful. After all, beauty is in the eye of the beholder and for businesses eyeing scale-up, there are few things more attractive than being able to grow.

http://www.huffingtonpost.com/borany-penh/eyeing-business-growth-in_b_6865186.html
Riaz Haq said…
Shadow Economies All over the World
New Estimates for 162 Countries from 1999 to 2007
Friedrich Schneider
Andreas Buehn
Claudio E. Montenegro


Pakistan's shadow economy estimated at 36%

Activities associated with shadow economies are facts of life around the world. Most societies
attempt to control these activities through various measures such as punishment, prosecution,
economic growth or education. To more effectively and efficiently allocate resources, it is
crucial for a country to gather information about the extent of the shadow economy, its
magnitude, who is engaged in underground activities, and the frequency of these activities.
Unfortunately, it is very difficult to get accurate information about shadow economy
activities, including the goods and labor involved, because individuals engaged in these
activities do not wish to be identified. Hence, doing research in this area can be considered a
scientific passion for “knowing the unknown.”
Although substantial literature5
exists on single aspects of the hidden or shadow economy and
comprehensive surveys have been written by Schneider and Enste (2000), and Feld and
Schneider (2009), the subject is still quite controversial as there are disagreements about the
definition of shadow economy activities, estimation procedures utilized, and the use of their
estimates in economic and policy analysis.6
Nevertheless, there are some indications that the
shadow economy has grown around the world, but little is known about the development and
the size of the shadow economies in developing Eastern European and Central Asian (mostly
former transition) countries, and high income OECD countries over the period 1999 to
2006/2007. The period was chosen as it has the most comprehensive data availability. This
study is an attempt to fill this gap by using the same estimation technique and almost the same
data sample used in Schneider and Buehn (2009) and Schneider and Enste (2000).
Therefore, the goal of this paper is twofold: (i) to undertake the challenging task of estimating
the shadow economy for 162 countries in various stages of development and located in
several regions throughout the world7
and (ii) to provide some insights about the main causes
of the shadow economy. To our knowledge, such an attempt has not been undertaken so far;
hence, we provide a unique database of the size and trends of the shadow economy in 162
countries over the period 1999 to 2006/2007. This is an improvement compared to previous
work – we used the MIMIC (Multiple Indicators Multiple Causes) estimation method for all
countries, thus creating a unique data set that allows us to compare shadow economy data.


http://www.gfintegrity.org/storage/gfip/documents/reports/world_bank_shadow_economies_all_over_the_world.pdf
Riaz Haq said…
A base year is a benchmark with reference to which national account figures such as GDP, gross domestic saving and gross capital formation are calculated.

According to the new base year, Bangladesh was an economy of Tk 34,840 billion in current prices in FY21, up 15.7 per cent from Tk 30,111 billion as per the previous base year.

https://www.thedailystar.net/business/economy/news/gdp-size-growth-down-new-base-year-takes-effect-2211826



"The size of our economy is huge, and the new base year will reflect it," he said, adding that a real scenario would allow the government to make more informed policy decisions.

Zahid Hussain, a former chief economist of the World Bank's Dhaka office, also welcomed the new base year.

He said timely revisions to data on GDP and its components determine the accuracy of national account estimates and their comparability across countries.

With the finalisation of the new series, Bangladesh will be ahead of all other Saarc countries in terms of the recency of the national account's base year.

Only the Maldives (2014) and India (2011-12) come close, while Pakistan (2005-06) and Sri Lanka (2010) are well behind.

"Improved data sources increase the coverage of economic activities as new weights for growing industries reflect their contributions to the economy more accurately," said Hussain.

The last revision was done in 2013.

The size of the agriculture, industry and services sectors has expanded as per the new base year.

The new base year uses data on about 144 crops while computing the contribution of the agriculture sector to the GDP, which was 124 crops in the previous base year.

The gross value addition by the agriculture sector rose to Tk 4,061 billion in current prices in the last fiscal year, up from Tk 3,846 billion in the old estimate, the BBS document showed.

The industrial sector saw the addition of the data on the outputs of Ashuganj Power Station Company, North-West Power Generation Company, Rural Power Company, cold storage for food preservation, Rajshahi Wasa, and the ship-breaking industry.
Riaz Haq said…
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 said…
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-point-for-pakistans-economy/

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.

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