By Shahid Mehmood
One of the striking features of the industrialized nations is the number of large firms that dot their economic landscape. Data released by the US Census Bureau, for example, suggests that the US has 6 million firms, with 20,000 of these employing more than 500 people. Cumulatively, these account for approximately 53 percent of the total employment in these 6 million firms. Put another way, only 0.33 percent of the total number of firms was providing employment to 53 percent of the total employed, a staggering figure even for the world’s largest economy.
We observe similar numbers in the case of other large, industrialized economies. For e-g, by end 2018, China had 34.8 million registered enterprises. Although exact statistics on employment by size of firms in China is not available, the 10 largest industries in China employ approximately 265 million workers as of 2020, which comes to 35 percent of the total number of employed people in China (775 million). Ali Baba, China’s largest e-commerce company is employing 117,600 full-time employees at present. In contrast, Pakistan’s largest online market place, Daraz, employs 89 full-time employees people for its operations in Pakistan!
In terms of numbers of registered firms, Securities and Exchange Commission of Pakistan (SECP) data indicates that by end-April 2019, there were a total of 99,291 firms registered in Pakistan. Comparison with regional peers casts a poor light given this number. Iran, which has been under international sanctions since the late 80’s, had a total of 1.6 million registered firms as of end-2018. India’s number stands at 2 million as of end-June 2020.
Why Larger Firms?
There is considerable literature on the kinds of advantages that are offered by large-sized firms, summed up in the World Bank’s recent publication regarding the need for developing countries to have large-sized firms. It is argued that:
“Economic and social progress requires a diverse ecosystem of firms that play complementary roles. Making It Big: Why Developing Countries Need More Large Firms constitutes one of the most up-to-date assessments of how large firms are created in low- and middle-income countries and their role in development. It argues that large firms advance a range of development objectives in ways that other firms do not: large firms are more likely to innovate, export, and offer training and are more likely to adopt international standards of quality, among other contributions. Their particularities are closely associated with productivity advantages and translate into improved outcomes not only for their owners but also for their workers and for smaller enterprises in their value chains”Ciani, Andrea, et. al. (2020) “Making it big: Why developing countries need more large firms“
Further, in the Executive Summary of the report, the authors argue that:
“These distinct features of large firms translate into improved outcomes not only for their owners but also for their workers and for smaller enterprises in their value chains. Workers in large firms report, on average, 22 percent higher hourly wages in household and labor surveys from 32 low- and middle-income countries—a premium that rises considerably in lower-income contexts. That is partly because large firms attract better workers. But this is not the only reason: accounting for worker characteristics and nonpecuniary benefits, the large-firm wage premium remains close to 15 percent. Besides higher wages—which are strongly associated with higher productivity—large firms more frequently offer formal jobs, secure jobs, and nonpecuniary benefits such as health insurance that are fundamental for welfare in low- and middle-income countries”.Ciani, Andrea, et. al. (2020) “Making it big: Why developing countries need more large firms“
Clearly, larger firm size impart considerable advantages ranging from higher productivity and higher R&D to secure jobs with better pay. They also spawn value chains that create further job opportunities (thus acting as an employment multiplier). From a microeconomic point of view, larger firms are usually better at covering their fixed as well as variable costs. This is something of critical importance in firms’ operations. Aside from the economic and financial aspects, they also impart ‘social value’, courtesy of their operations. Detailed explanation of this aspect is beyond the scope of this write-up, but briefly put, firms optimize upon available resources (capital, labor, knowledge, geography, etc.), and coordinate them in a manner that the end result is a product that the society wants (thus catering to the aggregate demand). In pursuing its own objective (profits), it not only creates jobs, but also supports a whole value chain through acquisitions. It follows that the larger the firm, the larger will be its production pursuits. Thus it will have a larger positive impact upon factors like jobs and support to businesses linked to its activities.
Why Can’t Pakistan Have Large Firms?
The above cited World Bank study as well as PIDE’s own webinar on the hindrances to business growth in Pakistan clarify to a large extent why Pakistan does not have large business establishments? These range from regulatory burdens, lack of policy continuity (frequent recourse to SROs, for e-g), and cultural factors (the family business culture, etc.) that prevent the expansion of business ventures. The detailed discussion of all the contributing factors is beyond the scope of this blog. However, to understand the forces that inhibit the growth of businesses, it is worthwhile to briefly discuss a few points of interest.
The way governments regulate businesses and industry can have a telling effect upon the size and operations of a firm. In a competitive environment, there are no guaranteed profits or returns. Firms have to vie with one another to capture market share. Larger market shares mean reasonable returns. For that to happen, firms have to expand their capacity to cater to market demand. Majority of firms in Pakistan employing 500 employees (or more) are in sectors that enjoy some form of government support. This inhibits the need to grow capacity beyond a certain point, and beyond the domestic market. For e.g., a large number of sugar mills employ 500 or more employees. It’s a highly protected, highly subsidized sector that has enjoyed generous government support that helps generate risk-free, guaranteed returns. And given the significant protection that it enjoys (through high tariffs), it faces little competition. Thus thus there is little need to expand beyond the domestic market.
The way markets are regulated is another critical factor. In general, there are no limits to a market’s potential for expansion. So markets where government plays the role of facilitator tend to act as an incentive for firms. This incentive is subdued when government becomes involved. Either as a direct player in the market or by regulating, the incentive to expand operations is limited.
The wheat storage market in Pakistan, for example, has huge potential. Yet there are not many private firms that venture into it since government is the dominant player. Through PASSCO, it acts a direct buyer and storage agency in the market. A similar example of obverse regulations is found in the Pakistan’s pharmaceutical sector. With a global market valued at more than USD 1 trillion, Pakistan’s market is hardly $3 billion. This is despite having an industrial structure that has the capacity to grow big. Market size is severely restricted by regulations related to pricing and lack of consistency in policies, etc.
Conclusion and Policy Recommendations
The successful founding and functioning of a firm depends upon financial factors in addition to a host of others. These include plus human capital, market conditions, technology and government policies (i.e., the regulatory framework). While financial capital may not be as severe a restraint in Pakistan, the lack of other factors is. Competitive, unhindered markets, technological prowess and government policies are lacking in terms of incentive for firm functioning and expansion.
In light of the above, there are a few policy recommendations to consider:
- Government needs to revisit its role in economic affairs, especially the questionable need for its direct intervention in various sectors through regulations. It should limit its role to that of a facilitator
- Protection afforded to select industries should be done away with. Competition is not a zero-sum game. Not only would resulting competitive pressures (internally and externally) bring an element of efficiency, but would also open new markets to Pakistani producers
- Government should do away with running businesses. Pakistan’s power sector, for example, is a potentially large market that is set to grow even further in the future but suffers from serious deficiencies due to government acting as a single buyer and running distribution companies in a bureaucratic manner
- Improve the quality of institutions that coordinate and deal with matters pertaining to firms, ranging from tax matters to legal issues. Put another way, good governance should be ensured to lessen the transaction costs of establishing and running firms.
- US Census Bureau ‘Statistics of US Businesses (SUSB) ↑
- ‘The 10 biggest industries by employment in China’, IBIS World ↑
- ‘Number of employed people in China 2008-2018’, Statista ↑
- SECP ↑
- Open Corporates ‘New Jurisdiction: Iran (1,690,000 companies)’. ↑
- The Economic Times ‘Number of registered cos reach 20.14 lakh at June end’. ↑
- ‘Making it big: Why developing countries need more large firms’, World Bank (2020) ↑
- For those interested, read Milton Friedman’s classic 1970 piece in NY Times ‘The social responsibility of the business is to increase its profits’, and the debate surrounding it. ↑
- ‘Why businesses don’t grow in Pakistan?’, PIDE Webinar, May 14, 2020 ↑
- Both the PIDE business growth webinar and the World Bank report are excellent sources of detailed discussion and understanding of this issue. ↑
- Data taken from annual reports of various sugar mills ↑
- The recently released FIA report of sugar mills confirms the above-normal profits enjoyed by this industry through subsidies and other government regulations ↑
About the author:
Shahid Mehmood is a Research Fellow at PIDE.