Risks Factors and Opportunities for Ensuring Effectiveness, Sustainability and Achieving Synergies with Development Strategy.
Summary The proposed Reconstruction Opportunity Zone (ROZ) bill in Senate and the House are in line with economic-political relationship that self reliance of countries only comes from economic growth, not from pure dependence on foreign aid that can only provide temporary help from eminent economic collapse. Hence it presents a step forward in our thinking. However, any well policy prescription towards Pakistan has to take into account risk factors, and mitigate against them to achieve effectiveness and sustainability. Without mitigating these risks, the ROZs have capacity to back fire. Instead of showcasing potential economic-integration to move make society progress, they can serve as glaring examples of globalization’s capitalistic selfish greed that exploits people and increases social deprivation, thereby marginalizing and alienating the very people the ROZs is supposed to win over. To discover risk factors we started by asking a simple question, "What can make ROZs failure, and how can we guard against it"? It is such questions that were asked of prominent Pakistani economists, industrialists and financiers, social entrepreneurs, presidents of micro-finance bank and SME bank, as well as members of Federation Chamber of Commerce and CIPE Pakistan. In our recommendations, we chose not to focus on security concerns that are obvious and were brought up by majority of people interviewed, but instead we focus on salient features that are most likely to be overlooked until it is too late. Our recommendation is that proposed ROZs legislation be modified to mitigate significant risks that exist and better ensure broad economic impact to the poor and to achieve stated goals. China has shown that special economic zones can account for over 10% of the country's GDP and serve as engine for rapid economic growth and employment. However, for each successful story are survivor biased, and does not count the hundreds of failed efforts to create on economic zones. Accordingly, we have to be humbly very cognizant that no matter what policies America tries to implement with good intention, systematic corruption in the process can erode the resources, reducing effectiveness of aid that was supposed to benefit the poor. The more narrowly targeted the prescription, there more there is potential for abuse to divert its use completely. Furthermore, the precise micro-legislation will result in inefficient market product selection and mix instead of legislating the general process of maximum economic impact and leaving optimal market discovery to entrepreneurs. Focusing on fundamental economic principals and using the ROZ to create complete cycles of human capital investment, entrepreneurship and value creation is only way to ensure long term success of the country. ROZs have to be considered as part of a holistic development strategy considering its impact on neighboring communities, and should not be considered in isolation. For example, creating a ROZ in an area without basic drinking water, health care and high incidence of militant violence ignores basic needs of survival and safety before economics. First risk factor is that ROZs does not actually make people resilient to radicalization, and in fact further provides economic base for the militancy. The stated goal of ROZs is to provide gainful employment means that can provide alternatives to militancy. ROZs does present a opportunity to change of hearts and minds of people. However, social mindset change is not an automatically driven from economic self-interest. For mindset change to happen, what is first needed is buy-in of a vision that can counter radical ideology. A vision of communities who can achieve lives of dignity through self-empowered problem solving, whose talent and resourcefulness is proudly showcased to the world through economic inter-dependence. Nurturing a sense of local ownership and pride in the resulting products is going to be the key to driving change. This vision can be accomplished by integrating leadership, problem solving and decision making skills to all who are employed in the ROZs. Accordingly, sustainable change has to start from cultivating primary demand for self-motivated improvement, through capacity building, adult education, vocational skill, management, team-building and leadership training for all workers. These trainings would empower them organize, to diagnosing, framing and solve problems that affect their own teams, common problems of ROZs, as well problems of their surrounding communities. Such distribution of leadership skills down to the line level is the only way to organically evolve local values to embrace and take ownership of change instead of rejecting change when faced with the anxiety of loss cultural identity. Second risk factor is that success of ROZs will transfer wealth to rich industrialists, and have only marginal impact on welfare of the tribal areas laborers. The business environment is biased in favor of large oligopolies that bribe themselves into powerful relationship with the state, extracting concessions, illegal subsidies, pay little or no taxes and acquire international market presence. We propose tilting the game slightly in favor of small and medium sized enterprise to create a broader diffusion of resulting economic prosperity. ROZ can become an international market access platform that sources materials from micro-finance businesses in the region, and provides the critical missing link for providing global market access to micro-finance entrepreneurs. If such value chains are created it can have much deeper impact on regional economy that impact the poor, instead of value being accumulated by already wealthy Pakistani industrialists. Accordingly, the proposed legislative restrictions of 35% of sum of costs of production of ROZs should be eased when its materials are sourced from micro-finance funded social enterprises operating in the region. One way would be to keep the overall 35% level, but count the cost of materials from regional micro-finance enterprise toward the number and reduce ROZ specific required fraction to 10-15% range. Accordingly, ROZs would leverage natural synergies with USAID funded Micro-Finance Institutions that can provide the vetting, reporting and monitoring of broader social impact. Third risk factor, the ROZs are unlikely to receive enough financial capital to overcome the hurdle to achieve sustainability from American and Pakistani investment unless other international friends of Pakistan and their respective self-interests and potential markets are taken into account. We have to take into account business and economic model forecast of ROZ to get a sense of what a successful and sustainable. An estimate of total investment required to have significant impact on employment in tribal areas and also make ROZ sustainable is about $5-10 billion. This estimate assumes that ROZs are confined to vicinities of areas of existing clusters of economic activity in tribal belt. However, this estimate swells to $10-20 billion if ROZ objectives include stimulating economic activity where it is currently low. These minimum required investment is large because ROZs are unlikely to be sustainable without capital investment in human capital, production technology and supporting infrastructure of roads, energy, water that should be part of complementary public sector programs. Their chances of being sustainable decreases the further they are located away from existing natural existing clusters of economic activity. Creating and making an Special Economic Zones sustainable requires significant investment and rigorous planning and execution. Saudi Arabia hired McKinsey consulting to perform a $26 million comprehensive global study of SEZs to create their own $50 billion business plan. As part of this plan, Saudi Arabia and a number of oil producing desert neighbours are considering outsourcing their agricultural farming and agro-product production to countries like Pakistan. Accordingly, if ROZs facilitate agriculture based businesses they have much higher chances of attracting direct investment from Saudi Arabia because it will further their own objectives and reduce their risk of investment in Pakistan. Furthermore, Pakistan has only a 1.5% penetration in European textile market versus 13% of the USA market. Thus convincing Europeans to also ease tarif restrictions can have very significant impact on sustainability of ROZs and will further attract more private capital. To the extent that ROZs facilitate global economic integration they can create a multiplier effect on Pakistan's economy that is not just dependent on American consumers ability purchase goods and recoup the return on investment. Forth risk factor is that the ROZs are located in remote location and fail, they will not only waste private investment, but also scarce public investment. The Govt of Pakistan could wind up spending its precious limited resources on building infrastructure for ROZs in remote locations that will ultimately be of little use, and would have taken away from infrastructure needed to boost broad economic trade between existing centers of economic activity. Accordingly, the process to selecting the ROZ sites have to be clearly laid out in transparent manner and requires further analysis. Fifth risk factor is ROZs specific reporting requirements and constant action required form Govt of Pakistan are likely to distract from fundamental structural reforms that are needed to improve business efficiency, intellectual property laws, reduce subsidies to private entities, fight corruption in tax and customs departments. These reforms will require simultaneous international diplomatic efforts to build political will for Pakistani government reforms must be sustained, that when combined with appropriate aid can deliver real change in accountability, corruption and justice for poor in tribal areas with incrementally integrate tribal areas into Pakistan. Thus, there is risk that ROZs may increase short-term employment at the cost of taking resources away from much needed reforms that are vital for long-range economic sustainability of the Pakistan. Sixth risk factor is that if that business partners anticipate the expected changes of failures of ROZs, they will not invest in local human capital in sites deemed to fail, and thus guaranteeing the unsustainable of the effort. Instead the entrepreneurs will act in their economic interest by extracting subsidies from the local government to participate in high risk ROZs, making little themselves effort to invest and build local human capital and instead preferring to hire already skilled tribal workers who currently work in major cities to relocate back and work locally. Businesses already get tax breaks from depreciation in the first five years of operations. It will take at least 2-3 years of investment to build up the local human capital to a globally competitive level. Thus, if ROZs legislation is based on medium 5 year term and also has significant clauses that could cause it to lapse at any particular year, this introduces significant uncontrollable risks that reduces the expected return on human capital investment. To mitigate this risk, the ROZ has to guaranteed life longer than 10 years there must be subsidized provision for education and vocational training facilities and links with local universities that can reduce barriers to investment in local human capital. Over all each of the risk factor high lighted can be addressed as part of a comprehensive development strategy. However, we have to not loose sight of fundamental reforms needed to create long term sustainability of Pakistan. Also, promoting ROZs miss out on a larger question, of why the rest of Pakistan should pay be higher total tariffs to America than is paid by France that has almost ten times the export to USA. Senate Bill Questions The Senate bill has a condition that Pakistan must show continued progress towards protecting private property rights. However, in tribal areas of Pakistan, especially FATA citizens do not even have basic private property rights. The land is collectively owned by the tribes. Thus progressive progress is not realistic. Fundamental constitutional reforms to extend Pakistan's constitution to the people of FATA and provide them access to democratic political participation. ROZ Industries Favoring specific industries in ROZ like Textile should not be done. Textiles account for 55% of Pakistan's exports in 2009. The industry has potential to provide temporary boost to economy with reduced American tariffs that are at par with what other countries pay that export in to America. However, textile is not necessarily the long-term engine of economic growth of Pakistan. According to Pakistan textile industry association, 90 percent of Pakistan's textile industry is losing money losses and facing closure. More than two months of production has been lost due to power cuts and gas shortages. China tops the US textile market with a share of 36 per cent followed by Bangladesh 21 per cent, India 18 per cent, Morocco 19 per cent and Pakistan 13 per cent. Even with proposed ROZ or broad tariff cuts, unless energy production is sustained, the Pakistan textile industry will loose market share in the US due to lost production time. However, in the European market, China tops again with a share of 29 per cent, Vietnam 28 per cent, India 19 per cent and Pakistan only 1.5 per cent. This is because Pakistan has been effectively locked out of European markets due to very high tariffs. This presents a significant opportunity, for USA to show leadership and work with European partners to join hands in opening trade access to Pakistan.' There is significant room for Pakistan to make much more headway into European markets. This is because the Pakistani textile industry is very inefficient and takes 75% more production time compared to regional competitors and are over staffed by up to 57% according to Werner International, management consultants to the world textile, apparel & fashion industry. Further, government subsidy driven, and cumulatively pays less tax then the sum of the three largest American corporations operating in Pakistan which have a very small fraction of the gross revenue. Furthermore, there industry extracts further illegal subsidies from the government to enrich the owners. If ROZs focus to much of the attention on textiles, it risks simply accumulate wealth to the existing wealthy industrialists. The historical major employment industries in Pakistan is agriculture, agro-products and textile. However, the industry of growth will continue human capital intensive higher value driven industries such as telecommunications, IT and services. The country has one of the cheapest high quality design printing press in the world, but account for negligible global market share and thus great potential for expansion. The manufacturing base is ideal for light weight manufacturing of items with relatively low electricity usage due to energy constraints of the country. Pakistan also can take advantage of global Indian brand boom, and stands to gain from intersection of traditional South Asian motifs fused with modernity in fields from fashion to natural organics products that include everything from natural herbal medicines, to foods, to cosmetics. However, to expand in areas of organics, broader USAID initiatives would need to be paired that wean farmers off the carcinogenic pesticides currently in used in Pakistan and provide them with training and capital to move towards organic produce. Integrated Development Strategy For the ROZs to be most effective, the economic development effort has to be integrated with USAID effort to provide human development services for the communities around ROZs. The sustainable development plan for the region, that includes providing basic education, health care, water, housing and civic leadership training to the communities surrounding the ROZs. Broad based employment Focus the ROZ to provide opportunities for growth of small to mid-sized entrepreneurs who can create jobs. They are much more competitive and can provide broader growth engine for the economy. One of the fundamental problems in Pakistan is that smaller entrepreneurs are crowded out of larger markets by cartel of industrialists who get to the top through government subsidies and contracts, and then prevent others from fairly competing against them. Pakistan Business Competitive and Customs Corruption We propose investment of Pakistani independent institutions that can monitor and report on competitiveness of businesses in the ROZ. Furthermore, such institution should set up a public bullet-in board of business competitiveness issues that face the businesses in the ROZ that anyone should be able to lodge a complaint through. These bullet-in service should be addressed with escalating chain of command from with in the Govt of Pakistan for timely resolution of the complaints. For example, one of the notoriously most corrupt departments is the Pakistan Customs. ROZ are going to need to import a whole slew of items into the country, some of which could be parts or middle stage materials on which value added work is then going to be done. The corruption in Customs force businesses to pay heavy import tax, which makes value added impossible to compete in global markets. Furthermore, industrialists bribe customs officials to obtain the export order lists of their competitors. Then reach out directly to the foreign client and undercut the price. The resulting price war erodes the profitability of the entire industry, and results in a spiral down in which everyone looses. However, it is almost naive to suggest that customs corruption can be tackled as part of ROZ package. Corruption needs to be part of systematic strategy of Pakistan government reform that builds political will through systematic international pressure coupled with appropriate aid to fund independent accountability bodies within Pakistan. That is only way to ensure long run run sustainability of the Pakistan. Women employment and entrepreneurship ROZ should have special provisions for women entrepreneurs and employment opportunities while taking into account local traditions. Lack of economic opportunity for women is one of the fundamental reasons why investment in education and health of girls is not made. Thus, it creates a cycle of early child mortality and lifelong deprivation. This behavior is codified through rationalization of customs. However, creation of new economic opportunity shifts the household economic decisions of relative investment in girls health and education. Logistics and transportation infrastructure One of the fundamentally lacking piece of infrastructure in Pakistan is regional distribution warehouses that are linked via major road arteries across economic clusters of Pakistan. This investment in transport links need to precede the launch of ROZs. Furthermore, lack of cold storage and food processing technologies puts a severe limit on the capabilities of the agriculture sector. Investment in these facilities will not only allow value add growth of agriculture sector, but also add to the food security of the country. Combined this infrastructure increase the ease of doing business across Pakistan, and will enable new dynamic supply chains to be form for Just-in-Time manufacturing with low working inventory requirements. ROZ Land Creating ROZs will require significant amount of land. Where is that going to come from? If we leave it to usual tactic of the Pakistan Government, the land is going to be acquired through exercise power of Eminent Domain. This basically means that the very poorest people are going to get kicked out of their houses, their properties razed to the ground, and they will be rendered homeless in effort of trying to provide them jobs. America has to make sure that the land acquisition process itself is just and equitable and does not create more local resentment towards America and capitalism. Location of ROZs The closer ROZs to existing clusters of economic activity, the higher the chances that they will be self-sustainable and profitable in the long-run even if US subsidies are removed. This is a very important consideration. ROZs cannot be located on totally remote areas where there is very little skills to start with, and they cannot be globally competitive. Thus a trade off needs to be made with skills availability and serving people who need employment the most. The solution is to create networks of medium sized ROZs near clusters of existing medium economic centers villages and cities, and linked via roads and rail to major cities around them, and network of smaller seed ROZs in more remote areas that can then be expanded if they are successful. This will enable goods to flow among ROZs and to/from other cities to create supply chains. This physical link should be accompanied by free flow of information link between ROZs so they can form dynamic supply chains and obtain market information. This can serve as basis of a modern networked economy. Furthermore, the more remotely located ROZs are , the harder it will be to attract the highly skilled talent to train, manage and operate them. Thus these ROZs have to provide housing facilities for attracting highly skilled workers from the urban area of Pakistan to reside in tribal areas. Human Capital only way to survive globalization Pakistan exists next to China and India, two of the worlds most rapidly growing economies. Furthermore, in 2007 Pakistan became only the second country to sign a Free Trade Agreement with China. The only way any Pakistan manufacturing industries can survive is if it goes through intense boot-camp on how to compete in global economy. The adult literacy rate in the region is 17%, thus vast majority of the laborers are low skilled. Adult literacy and capacity development have to be integral part of the ROZ strategy. Self-guided as well as tutor mediated training institutes should be available in the ROZs for all employees, similar to Small Business Administration resources available to entrepreneurs in the USA. To accomplish investment in human capital, basic knowledge and training should be made Open Source via video and test driven skills assessment and goal driven learning paths. These should be made available using video mediated distance learning technologies suitable for disconnected developing world. College and University Partnerships Provision of basic adult education and vocational training for the working population of the ROZ would allow workers who are illiterate to increase their capacity over time. For higher education concepts, we need to create active partnership with local vocational colleges and universities for vocational, engineering and management training. The management training on Total Quality Management, manufacturing to specifications, as well as international marketing is needed to understand how to create products catered to changing global demand. Such conceptual tools are absolutely critical for loosely coupled groups of smaller companies to create Just-in-Time dynamic supply chains to operate together to create higher valued complex products and adjust to changing global economy. The partnerships with local colleges and universities should provide with internship opportunities for students, as well as have the professors perform research on ROZ and their firms and ways to improve them. Natural Resource Dependence ROZs need scarce energy and clean water resources, and their eco-foot print is very important consideration for welfare of the poor and voiceless local people who are going to be trampled in the process of industrialization. Care has to be taken that introduction of ROZ does not extract precious water and energy, and thus actually increase the deprivation of the poor in the locality of the ROZs. If the poor are deprived of water that is diverted for industrial use, it will increase infant mortality in the region. Where possible, the ROZ should be coupled with self-reliant industrial energy power plants, and if water is scales industrial water sourcing should be coupled with solutions of water for the neighboring communities. Venture Social Capital The ROZs infrastructure should be leveraged to provide incubator services as well as scaling capital for local Entrepreneurs as well as Social Entrepreneurs who have business plans that can have social impact across areas of social-economic development in Pakistan. These social include everything from local grown solutions to increase shelf-life of produce to technology for remotely monitoring of maternal health to reduce fact maternal and mortality. These should also leverage links to engineering and other research departments at the local universities for students to have business plan competition for socially impacting and development ideas.
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