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Friday March 29, 2024

Informality: A child of corruption

By Mansoor Ahmad
June 19, 2021

LAHORE: Informality is preferred by entrepreneurs because it is far cheaper than proper documentation.

The operating culture in Pakistan is such that you have to pay rent to get things done speedily no matter which way you operate.

In fact a number of informal businesses operate without paying any bribe or at the most by paying a nominal rent to operate on state property.

The vendors grease the palms of municipal officers or the police to conduct businesses on the roadside. The amount they part with is nominal compared with the rent paid at that market by the shopkeepers. These vendors sometimes buy products from the shopkeepers in the market and sell it to the consumers. Most auto-parts markets operate on this pattern.

The person coming to buy accessories or parts is lured by the vendors and the item required is provided at same or lower rate. They get cheaper rates because various shopkeepers selling similar items increase their sales through them. These road side vendors only have to pay rent to the officials. They are not confronted by tax officials. Their average sales may be higher than most shops. These and many other are small businesses that are too small to be regulated—either by choice or not.

Then there are firms that successfully avoid formality although the law requires them to document. Then again the cost of informality is lower than the formal operations. Our obsession to generate indirect taxes went too far. The sales tax regime that is applicable on all productions and services has been increased to 17.5 percent. The formal sectors have not only to pay the sales tax but also income tax. When informality could be continued at nominal rent paid to the bureaucrats there is no need to go formal. The informal manufacturers add three to four percent in their cost to compensate for the bribes they pay. Informality however can be concealed up to a limit. After companies grow they need the services of banks that are documented. These informal entities do scale up.

The larger enterprises have to succumb to documentation. They face innumerable problems. Although they enjoy economies of scale and better technology they cannot compete with similar non-documented products available in the market.

They may push their product on the strength of better quality. But they stand no chance against heavily under-invoiced similar imported products that save both import duty and sales tax. It is here that many entrepreneurs try to remain competitive by concealing production and avoiding the sales tax. They have to bribe the tax officials to look the other way. Those enterprises that fail to conceal production fade out in a year or two.

We are now entrapped in a vicious circle. Informality is on the rise among the formal operators. The FBR (Federal Board of Revenue) last fiscal announced to monitor production in cement and beverages sector through outside auditors. No report on that monitoring has been made public. One even does not know whether the measure was applied or not.

Corruption imposes a tax on productivity and competitiveness. Though the quality of regulation is on the rise in Pakistan, the regulatory environment includes many antiquated laws enforced by autonomous and government institutions at federal, provincial and local levels. Increasingly, the openness of the economy, the rapid pace of globalisation and the sophistication of firms operating in Pakistan are exposing inadequacies in the regulatory framework. Moreover high sales tax rates also breed corruption. As a result, enforcement brings arbitrary discretion on the part of government officials, causes high official and unofficial compliance costs on formal firms, and forces others to operate informally.

Further enforcement of financial contracts is untested and faces problems at the execution level. Credit bureaus are at a nascent stage of development. Development of secondary instruments and markets to increase the flow of capital from the banking sector are missing. The legal inadequacies and procedural deficiencies prevent indisputable land title and is one of the primary causes of the case backlog in the courts.

Moreover, without clear property rights, lenders will not consider land as loan collateral without an original sale deed in the bank’s possession. The resulting “dead capital” and lack of site access, hinders leveraged investment, firm level entry and efficient resource allocation.