Plight of small-scale manufacturing

The role of FPCCI, PBC, APTMA and other associations of large firms is currently at its peak. Proposals are being put forward to the Prime Minister and heads of economic ministries for arresting the decline in exports, reducing the impact of cheap imports on domestic industries, facilitating the ease of doing business, reducing the tax burden on the manufacturing sector and so on.
Unfortunately, the vast multitude of small units from the manufacturing and other sectors have no access to the corridors of power to voice their problems, which have virtually reached crisis proportions. They are increasingly being marginalized from playing a role in the process of development of Pakistan.
Their greater engagement is vital for achieving more inclusive growth and for promoting the process of innovation and enhancement of productivity. There is the saying, 'Small is beautiful'. In fact, in many of the East Asian tigers who achieved phenomenal export-led growth the cutting edge for increased competitiveness and diversification was small firms. For example, small firms account even now for 36 percent of South Korea's exports.
Small-scale manufacturing units constitute 42 percent of the total population of small production units in the country. There is need to understand and quantify the contribution of these small industrial units. How are these units performing currently? What is the degree of government and institutional support to the small-scale sector? What measures need to be taken on a priority basis to raise the performance of small units and increase further their contribution to the national economy?
Contrary perhaps to perceptions, small-scale manufacturing is large and spread all over the country. The Factories Act defines small enterprises as those which employ less than 10 workers. The SBP defines small units as those which employ up to 50 workers and have annual sales up to Rs 150 million. However, in India units are identified by the value of plant and machinery.
The first indicator is total employment. According to the latest Labour Force Survey of PBS of 2014-15, the number of workers employed in industrial units with less than 10 workers is as much as 5.6 million. The corresponding number in large-scale manufacturing is 3.3 million. In effect, 63 percent of the employment in the manufacturing sector is in small units.
This large share is a revelation and underscores the need for an employment promotion policy to focus also on small units. It also provides an opportunity to recognize the extraordinary skills of Pakistani crafts persons, working mostly in small units. They have demonstrated the ability to produce and sell internationally the most sophisticated products like surgical instruments, sports goods, carpets, etc. But they have unfortunately remained the most neglected component of our labor force.
The distribution of small units is concentrated largely in five industries - textiles and wearing apparel, leather, food and beverages, wood products (furniture) and fabricated metal products. The first three industries are the largest with a combined share in number of units of 64 percent.
The regional distribution of employment in small units is tilted towards Punjab, with a share approaching 66 percent. In fact, cities like Faisalabad, Gujranwala, Sialkot, Gujrat, Kasur, etc., have acquired a reputation for specializing in particular product lines. Sindh has a share of 19 percent, followed by a combined share of Khyber-Pakhtunkhwa and Balochistan of 15 percent.
A key indicator is the contribution of small units to exports. These include a wide-range of products ranging from textiles to leather and leather products, carpets, sports goods, surgical goods, cutlery, furniture, pharmaceuticals, etc. The combined export of these goods in 2016-17 is $4.8 billion. This represents a share of 27 percent in total manufactured exports. Interestingly, small units are more export oriented than large industrial units. The share of exports in value of output is almost 40 percent in the case of the former as compared to 17 percent in the latter. This highlights the strategic importance of small units in the current context.
The PBS has done a great disservice to the population of small manufacturing units by grossly understating their size and overstating their growth rate in the GDP estimates. Apparently, as of 2016-17, the share in national value added of small-scale manufacturing units is only 1.8 percent, as compared to 10.7 percent in the case of large-scale units. Further, the growth rate of the small-scale manufacturing sector is shown as over 8 percent and largely unchanged year-to-year, due primarily to lack of information. Both these magnitudes, low share and high growth, inevitably lead to a lack of interest and focus on small manufacturing units.
There was time in the 80s and the 90s when the reported contribution of small units to industrial value-added was as high as 25 percent to 30 percent. The PBS now reports the share at 14 percent. With an employment share of as much as 64 percent, the implication is that the labour productivity is less than one tenth of large units. This is highly unlikely given their relative competitiveness and success in achieving a higher share of output devoted to exports. There is a need for PBS to raise substantially the contribution of small units to manufacturing value added.
The next issue is whether small units have been able to sustain a high growth rate of over 8 percent. The answer is an unambiguous no. Employment growth from 2008-09 to 2014-15 has been under 4 percent per annum as compared to over 4 percent in the case of large manufacturing units. It is highly unlikely that labor productivity has increased by over 4 percent annually in small units in the presence of various constraints.
The clear manifestation of an incipient crisis in the small-scale sector is the precipitous decline in exports since 2012-13. Compared to the peak, either in 2012-13 or in 2013-14, the volume of exports of carpets has fallen by 50 percent, of sports goods by 31 percent, of leather products by 41 percent, of surgical goods by 5 percent and so on. Given the export orientation of small units, the level of production has consequently fallen sharply thereby drastically reducing profitability and leading in many cases to losses. The critical nature of the current situation is indicated by the sharp jump in non-performing loans to small units to over 20 percent of banks' outstanding financing.
What are the factors which have contributed to this debacle? First, small units have been hit disproportionately by power outages. According to a survey of 412 units by the Institute of Public Policy, the average number of outages faced annually by these units is over 1050. Consequently, the percentage of time lost is over 25 percent. Unfortunately, due to financial constraints, less than 35 percent of the units have been able to acquire generators. The usual response is working overtime or changing shifts, leading to higher labour costs. In effect, the percentage of output not recovered is 10 percent. On average, the total annual outage cost per unit is Rs 300,000. The outage cost per kwh approaches Rs 40. Overall, the cost nationally of load-shedding to small manufacturing units exceeds Rs 83 billion.
The second constraint is that historically the SME sector generally and the small units in manufacturing in particular have been discriminated in access to bank credit. The SBP estimates that the latter have outstanding financing which is only 2 percent of total bank credit in the country. These units also face pressures to pay bribes to functionaries of various departments. On the average, a typical unit has to pay nine taxes. This imposes high compliance costs. Further, the general lack of competitiveness, due to an overvalued exchange rate and other factors, limits their efforts to raise exports.
A comprehensive package of support needs to be put together for SMEs throughout Pakistan. This will include, first, a doubling of the share in bank credit, as proposed recently by the Governor of SBP. The central bank should facilitate this increase by introducing a Credit Guarantee Scheme for small-scale industries. This will involve SBP taking on the role of a guarantee organization for the advances which are left unpaid including interest overdue. A tax credit scheme may also be introduced for commercial banks linked to the increase annually to SMEs of advances. Second, the Provincial Small Industries Corporations may set up a special Development Fund for small units, with a 'single window' operation. The Fund may focus on providing equity type support to entrepreneurs for setting up new projects.
Third, there is need for establishment of technical support services, especially in districts with cluster of units in a particular product line. This task could be taken up by the Small and Medium Enterprises Development Authority (SMEDA), which has been somewhat moribund in recent years and needs to be activated. Also, the capacity of training facilities in skills required by small units will need to be enhanced.
Fourth, tax policy has to focus on small enterprise development. There is need for rationalization of the number of taxes to be paid. The maximum tax rate on Associations of Persons / Partnerships must be brought down from 35 to 25 percent. Simultaneously, the sales tax exemption limit ought to be doubled.
Fifth, and importantly, along with the overall steps being taken to boost exports, special incentives need to be given to small enterprises. This will include the exemption from the 1 percent export presumptive income tax, since in any cases the net profit may be less than the exemption limit of Rs 400,000. In addition, the presence and role of 'deemed exporters' should be recognized and the zero-rating of sales tax also extended to these entities.
The objective of this article was to highlight the plight of small industrial units which has largely gone unnoticed. The case for focusing on improving their performance will impact favourably on the lives of millions of workers, promote more widespread regional development and help in diversifying the export base of the country.
(The writer is Professor Emeritus and a former Federal Minister)