Pakistan in the Apparel Global Value Chain January 2019 Prepared by Stacey Frederick and Jack Daly Duke Global Value Chains Center, Duke University This research was prepared by the Duke University Global Value Chains Center on behalf and under the guidance of the World Bank. The report is based on both primary and secondary information sources. In addition to interviews with firms operating in the sector and supporting institutions, the report draws on secondary research and information sources. The project report is available at www.gvcc.duke.edu. Acknowledgements The Duke University Global Value Chains Center would like to thank all the interviewees, who gave generously of their time and expertise. It would specifically like to recognize the contributions of the Sustainable Development Policy Institute (SDPI) and Mahrukh Kayani for their extensive support during our field research in Pakistan. The Duke University Global Value Chains Center undertakes client-sponsored research that addresses economic and social development issues for governments, foundations and international organizations. We do this principally by utilizing the global value chain (GVC) framework, created by Founding Director Gary Gereffi, and supplemented by other analytical tools. As a university-based research center, we address clients’ real-world questions with transparency and rigor. www.gvcc.duke.edu Duke Global Value Chains Center, Duke University © January 2019 2 Pakistan in the Apparel Global Value Chain 1. Introduction............................................................................................................................................................... 6 2. The Global Apparel Industry ................................................................................................................................. 8 2.1. The Apparel Global Value Chain .............................................................................................................. 10 2.2. Global Trade in the Apparel GVC ........................................................................................................... 15 2.2.1. Global Supply ....................................................................................................................................... 15 2.2.2. Global Demand.................................................................................................................................... 17 2.3. Lead Firms and Governance ...................................................................................................................... 18 2.4. Human Capital ............................................................................................................................................... 20 2.5. Standards ........................................................................................................................................................ 22 3. Pakistan and the Apparel Global Value Chain ................................................................................................. 23 3.1. The Development of the Apparel Industry in Pakistan ....................................................................... 27 3.2. Pakistan’s Current Participation in the Apparel GVC ......................................................................... 27 3.2.1. Firm Profile ........................................................................................................................................... 28 3.2.2. Backward Linkages .............................................................................................................................. 30 3.2.3. Product Profile..................................................................................................................................... 32 3.2.4. End Markets.......................................................................................................................................... 34 3.3. Governance and Industry Organization .................................................................................................. 35 3.3.1. Lead Firms ............................................................................................................................................ 36 3.3.2. Institutional Context .......................................................................................................................... 37 3.4. Upgrading in Pakistan’s Apparel GVC ..................................................................................................... 41 3.5. Human Capital ............................................................................................................................................... 43 3.5.1. Wages .................................................................................................................................................... 43 3.5.2. Female Participation ........................................................................................................................... 44 3.5.3. Skilled workers .................................................................................................................................... 45 3.5.4. Education and Training ...................................................................................................................... 45 3.6. Advantages and Constraints ...................................................................................................................... 46 3.6.1. Advantages ............................................................................................................................................ 46 3.6.2. Constraints ........................................................................................................................................... 48 4. Lessons for Pakistan’s Upgrading in Apparel GVC from Global Experiences ......................................... 52 4.1. Case Studies................................................................................................................................................... 54 4.1.1. Vietnam ................................................................................................................................................. 55 4.1.2. Sri Lanka ................................................................................................................................................ 58 4.2. Key Lessons for Pakistan ............................................................................................................................ 63 5. Proposed Upgrading Trajectories for Pakistan Apparel GVC..................................................................... 63 6. Appendix .................................................................................................................................................................. 66 7. References ............................................................................................................................................................... 70 3 List of Tables Table 1: World Apparel Exports by Product Categories, 2006-16 ..................................................................... 14 Table 2: Top 10 Apparel Exporters by Year and Value, 2008-16 ........................................................................ 16 Table 3: Job Profiles in the Apparel GVC .................................................................................................................. 21 Table 4: Pakistan’s Textile and Apparel Exports, 2009-16 .................................................................................... 24 Table 5: Pakistan’s Apparel Exports by Product Category, 2006-16 .................................................................. 25 Table 6: FDI Inflows to Pakistani Textile and Apparel Industry, 2007-16.......................................................... 26 Table 7: Profile of Pakistani Businesses Exporting Apparel, 2016-17 Fiscal Year ............................................ 29 Table 8: Apparel Companies in Pakistan with >$100m in Exports, 2016-17 .................................................... 30 Table 9: Top 10 Inputs Imported by T&A Exporters, 2014/15-16/17 ................................................................ 31 Table 10: Pakistan’s Fabric, Yarn and Fiber Imports, 2006-16 .............................................................................. 32 Table 11: Pakistani Tier I Apparel Suppliers of Major Global Buyers ................................................................. 36 Table 12: Textile & Apparel Specific Supporting Stakeholders in Pakistan ........................................................ 38 Table 13: SWOT of Pakistan’s Apparel Industry ..................................................................................................... 46 Table 14: Top 10 Global Trousers Exporters, 2016 ............................................................................................... 47 Table 15: Hours to Process Import Container Through Customs ..................................................................... 49 Table 16: Foreign vs. National Ownership in Apparel Factories, 2017-18 ........................................................ 50 Table 17: European Lead Firms Sourcing from Pakistan’s EPZs and SEZs ........................................................ 51 Table 18: Selected Upgrading Trajectories in the Apparel GVC ......................................................................... 53 Table 19: Vietnam FDI, Total and T&C, 2000-11 .................................................................................................... 57 Table 20: Sri Lanka’s Apparel Exports to the World.............................................................................................. 60 Table 21: Import Tariffs for Inputs in Asian Apparel Industries ........................................................................... 63 Table A-1: Worldwide Cotton Production and Exports, 2014-1766 Table A-2: Top 10 Apparel Importers by Year and Value, 2008-16 ................................................................... 66 Table A-3: Apparel Lead Firm Types and Examples ................................................................................................ 67 Table A-4: Selected Apparel-Related Private Labor Standards and Organizations.......................................... 68 List of Figures Figure 1: Pakistan’s Apparel Exports, 2002-16 ........................................................................................................... 6 Figure 2: The Apparel Global Value Chain ................................................................................................................ 11 Figure 3: Share of Apparel Exports by Material, 2005-2016 ................................................................................. 15 Figure 4: Top Global Apparel Exporters by CAGR, 2010-2016 .......................................................................... 17 Figure 5: Fastest Growing Apparel Import Markets, 2010-2016 ......................................................................... 18 Figure 6: Pakistan in the Apparel GVC ....................................................................................................................... 28 Figure 7: Share of Total Export Value for Leading Apparel Products, Pakistan ............................................... 33 Figure 8: Pakistan’s Top Apparel Export Destinations, Final Products, 2008-2016 ........................................ 35 Figure 9: Unit Value of Trouser Exports, South and Southeast Asia, 2005, 2012, 2016 ................................ 42 Figure 10: Vietnam, Sri Lanka and Pakistan Apparel Exports, 2002-16 .............................................................. 54 Figure 11: Vietnam in the Apparel GVC .................................................................................................................... 56 Figure 12: Sri Lanka in the Apparel GVC ................................................................................................................... 59 List of Boxes Box 1: Social Compliance in Apparel GVC ................................................................................................................. 9 Box 2: Raw Materials in the Apparel GVC ................................................................................................................ 12 Box 3: Automation in Apparel GVC ........................................................................................................................... 13 4 Acronyms APTMA the All Pakistan Textile Mill Association CAD Computer Aided Design CAGR Compounded Annual Growth Rates CCC Clean Clothes Campaign CMT Cut, Make & Trim providers DTRE Duty and Tax Remission DLTL Drawback of Local Taxes and Levies EDB Engineering Development Board EPZ Export Processing Zone FDI Foreign Direct Investment FOB Free on board GE4DE Gender Equality for Decent Employment GENPROM United Nations Development Programme’s Gender Promotion in the Garment sector through Skills Development GSP General System of Preferences GVC Global Value Chains GVCC Global Value Chains Center ILO International Labour Organization MFA Multi-Fibre Agreement MMF Man Made Fibres NTC National Tariff Commission OBM Original Brand Manufacturers ODM Original Design Manufacturers OEM Original Equipment Manufacturers PBOI Pakistan Board of Investments PRGMEA Pakistan Readymade Garment Manufacturer & Exporter Association PTEA Pakistan Textile Exporters Association RSP Retail Selling Price SEZ Special Economic Zone SMEDA Small and Medium Enterprise Development Authority TVET Technical and Vocational Education and Training T&A Textiles & Apparel WRAP Worldwide Responsible Accredited Production 5 1. Introduction Pakistan’s apparel industry is inexorably linked with its history in textiles. Long one of the world’s leading cotton producers, Pakistan has used local access to the natural fiber as well as the related yarn and fabric materials to integrate into the apparel Global Value Chain (GVC) in certain product categories. Overall, Pakistan’s apparel exports stood at US$5.7 billion in 2016, an increase of nearly 200% compared to 2002, when they were US$1.9 billion (see Figure 1). From 2010 to 2016, the country’s annual growth rate of exports was 7.5%, which helped it gain market share to become the world’s eighth largest apparel exporter, ninth if one aggregates all 15 countries in the European Union. Although those data points suggest a broad-based increase, it is important to note that growth has been narrowly concentrated. Three product categories—trousers, knit shirts and sweaters/sweatshirts—accounted for 66-71% of apparel’s export values from 2006 to 2016. Of those, only one had dramatic expansion: trousers. With its cluster of denim manufacturers, Pakistan’s exports in the product category grew by an average of 11.6% in the period from 2006 to 2016, lifting the country to the position of the world’s sixth-largest exporter with 4% market share. Figure 1: Pakistan’s Apparel Exports, 2002-16 6 Export value (US$, billions) 5 4 3 2 1 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Total Apparel Exports Top Three Product Categories (trousers, sweaters/sweatshirts, knit shirts) Source: UN Comtrade, 2002-2016b, 2002-2016c. The sector has had difficulty making much headway in other products. At a time when China’s position as the unquestioned apparel heavyweight is receding to a degree, there has been some worldwide reshuffling in recent years. However, it has been countries such as Vietnam, Cambodia and Bangladesh—and not Pakistan—that have had the most success growing their exports across product and material categories. Critical attributes that have allowed businesses in those markets to integrate into the supply chains of leading firms include quality, lead time and compliance to social and environmental standards in addition to the baseline metric of price. 6 Pakistan’s potential upgrading in the GVC has been constrained by multiple factors. Upstream, there are supply chain gaps in critical inputs. Synthetic fibers and important components that are not available in the local market are subject to tariffs and taxes that increase costs. This even includes cotton, where production has stagnated in recent years and the fibers that are generated are of low quality. Downstream, underdeveloped energy infrastructure and challenging security considerations have hampered apparel producers. Lead times are not necessarily a major limitation with the existing product mix, but they limit the potential for industry expansion because of the potential for delays associated with imported inputs. Meanwhile, industry institutions are fragmented and fail to take a holistic look at the sector. Cognizant of these and other macro issues, global buyers have largely shunned investing in Pakistan, with incoming FDI into the apparel industry below levels seen in regional competitors. Vietnam and Sri Lanka can both serve as potential models as Pakistani stakeholders consider how best to propel the industry forward. Vietnam, as highlighted, has been notable for its expansive gains, allowing it to become the world’s fourth largest apparel exporter. Sri Lanka’s export profile is more concentrated, but the country punches above its weight class by concentrating on a narrow range of export products. Both countries have attracted foreign investment, using industrial parks and all- inclusive investment measures to attract global buyers. Pakistan’s strengths in the apparel sector revolve around its integrated industry with high domestic ownership located in a country with a long history of producing cotton and relatively competitive labor prices. This affords multiple plausible paths for generating increasing returns in the form of higher exports and employment prospects. The burgeoning retail market in Asia might pose additional opportunity. In terms of greatest likelihood of success, solidifying its position in existing niches is likely to gain the most immediate traction. However, it will be critical for all Pakistani stakeholders across the value chain to convene and agree on a shared strategic vision. Pakistan’s apparel industry has been examined by many organizations in recent years, with its workforce and labor regulation being regular subjects of research interest. This report centers its analysis on the country’s firms, using the GVC framework to evaluate their interaction with global industry forces. After assessing the current industry, the goal was to identify future upgrading trajectories. Research was supported by both qualitative and quantitative efforts. Field research was conducted in September 2018, with Duke GVCC researchers interviewing 25 in Lahore, Faisalabad and Karachi. Interviews were supported by firm-level data based on Pakistan Custom’s Authority data provided by the World Bank as well as the UN Comtrade database. The report is structured as follows: It first provides an overview of the apparel GVC to present a clear understanding of the scope of the industry, how markets are structured and how changing distribution of demand and supply destinations and lead firm organization alter structural dynamics in the chain. It then analyzes the domestic industry within Pakistan, first detailing the country’s position in the chain by looking at its firm profile, backward linkages, product profile and end markets. The internal organization of the industry is then outlined as well as recent examples of upgrading and the factors that influence the labor environment. After assessing the country’s advantages and constraints, it pivots to Vietnam and Sri Lanka’s experiences. The report then concludes by outlining potential upgrading strategies to enhance the country’s competitiveness. 7 2. The Global Apparel Industry Key Points • China is world’s leading source of apparel products, accounting for 34% of the value of global exports in 2016. Its market share has declined some in recent years as the country has focused on higher-value activities. • Countries such as Vietnam, Cambodia and Bangladesh have increased overall market share by integrating into supply chains of lead firms in significant volume. New sourcing locations are evaluated by range of variables, including price, quality, lead time and compliance to social and environmental standards. • Lead firms in the value chain are Original Brand Manufacturers (OBMs) that control marketing & sales activities. Other categories of businesses include Cut, Make & Trim providers (CMTs) that are responsible for cutting, sewing and adding trim to produce garments; Original Equipment Manufacturers (OEMs) that perform CMT activities but also source raw materials; and Original Design Manufacturers (ODMs) that design and develop while overseeing the production process. The apparel industry has often played a catalytic role in economic development. With low barriers to entry in terms of capital, technology and labor skills, many countries have targeted the sector as a means for providing significant employment opportunities and export revenue. The benefits associated with the industry ensure the competitive environment is fierce. For markets to upgrade within the chain, domestic apparel manufacturers must find a way to embed themselves within well- established international networks of production and distribution, notably organized by South Korean, Taiwanese, and Chinese or Hong Kong first-tier suppliers and US and European buyers. The depth and breadth of these networks is highlighted by the size of international trade in the industry. In 2016, the world value of apparel trade was approximately US$377 billion.1 Although there has been some fluctuation in the value of global exports in recent years, the industry’s growth rate for the six years between 2010 and 2016 was 2.3%. Since the economic crisis, apparel exporters have become even more focused on Asia, but with less emphasis on China. China’s share of apparel trade peaked in 2010 at 43% before falling in more recent years. Instead, growth between 2008 and 2016 has been driven by Southeast and South Asian suppliers. These characteristics provide a broad snapshot of the industry. Building on these, the considerations that have helped shaped the global industry in recent years include the following: 1. China remains the world’s largest apparel producer and exporter. China’s share of global apparel exports increased from 26% to 43% in the period from 2002 to 2010 before falling to 34% in 2016. Even with that decline, the value of its total apparel exports was 126% higher than the second leading exporter, the EU-152. The country has wide-ranging capabilities across diverse categories of products and materials. In recent years, the country’s exports 1 For this report, apparel products are those covered by the 61 and 62 HS codes. 2 The European Union-15 (EU-15) includes Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden and the United Kingdom. 8 have shifted toward product categories with higher unit values, including coats, dresses and skirts and within product categories (knit shirts). China’s top exports in 2015 by product category were sweaters/sweatshirts (16%), trousers (15%) and coats (12%). In terms of world market share, China accounts for the highest percentage of bras (51%), coats (49%), accessories (46%), miscellaneous apparel (45%), and baby apparel (44%). 2. New sourcing destinations are increasingly evaluated based on factors beyond price, with quality, lead time and compliance to social standards the most important considerations. While China is likely to remain the dominant sourcing destination for the foreseeable future, there are indications the Chinese industry might be entering a period of transition. Industry surveys suggest large-scale buyers are looking to diversify their supply chain as a hedge against China’s increasing labor costs, currency appreciation and policy focus on higher value-added industries. Although this isn’t reflected in trade data to a significant degree, it nonetheless provides opportunities for other countries in the sector. Nations like Cambodia, Vietnam, Bangladesh and Pakistan have taken advantage to varying extents.3 As new markets enter the chain, local businesses must understand the governance landscape. Lead firms in the apparel GVC concentrate on the highest value-adding activities (branding and retail) while setting minimum standards and sourcing criteria for suppliers. Whereas price is important, buyers do not necessarily buy from the supplier that offers the lowest price. Instead, other key factors include quality, lead time and reliability in delivery, access to inputs, full package services as well as compliance to social and, to a lesser extent, environmental standards. Box 1 below introduces social standards while the Standards subsection offers more detail. The Lead Firms and Governance subsection also examines these features of the chain in further detail. Box 1: Social Compliance in Apparel GVC Social compliance has increased in importance in buyers’ sourcing decisions as a response to a variety of factors. Corporate social responsibility (CSR) campaigns by NGOs and compliance-conscious consumers have played a role, often spurred through concern about working conditions or well- publicized disasters in apparel factories. Labor and environmental compliance are important due to the labor intensity of the apparel industry and the environmental impact of the textile industry (energy use and wastewater are two examples). Lead firms have introduced initiatives to align with these efforts or increasing requirements for sustainability reporting. For example, Levi’s, the jeans manufacturer, has prioritized reducing greenhouse gas emissions in its supply chain. Other buyers have developed codes of conduct and monitoring and auditing systems to ensure “brand security.” Compliance with buyers’ labor and environmental standards generally does not provide suppliers or countries with a competitive advantage since it has become a minimum criterion for entering and remaining in supply chains. Poor compliance and bad occurrences do not only affect individual firms but can affect the image of the whole country. Source: Frederick, 2016. 3 The China-Pakistan Economic Corridor is one such example; the partnership between the two countries could yield initial investments of US$2.7 billion in Pakistan’s textile & apparel (T&A) industries (Pakistan Today, 2018). For more information, please see the section on Pakistan. 9 3. The retail sector in Asia offers growth opportunities. The largest and the fastest- growing consumer market for apparel is in Asian countries, including Australia, China, Japan, Korea, and Russia. In 2015, Asia-Pacific accounted for roughly a third of global apparel retail sales, up from 23% a decade before. The region also had the highest compound annual growth rate (7.6%), compared to the world average of 2.9%. The retail sector in Asia presents opportunities for growth in the higher value-added service and knowledge-intensive activities. As of yet, these markets do not have powerful domestic brands and global brands have yet to fully tap these markets. Asian firms may be particularly suited for entering the market due to advantages in cultural affinity, sizing, advertising channels, language and preferred retail formats. 4. The global apparel industry is still influenced by tariffs, especially in regions such as South Asia. Although the Multi-Fibre Agreement (MFA) quota regime that characterized the apparel industry for decades no longer exists, there are still prominent barriers to trade. Tariffs are the most significant, with developed nations regularly applying charges of 10-13% depending on the product. While broader trade agreements sometimes eliminate or reduce these levies, textile and apparel products are often subject to restrictions.4 There are also important regional variances. South Asia continues to be one of the least integrated regions in terms of intraregional trade as a share of total trade, with intraregional trade accounting for close 5% compared with 50% in East Asia and 22% in the Sub-Saharan Africa (Kathuria, 2018). Its most important trade agreement is the South Asian Free Trade Agreement (SAFTA), but there is little progress in its implementation given political tensions, particularly between India and Pakistan. Despite some growth in textile trade from India to Bangladesh and, to a lesser extent, Sri Lanka, one cannot speak of a regional value chain. 2.1. The Apparel Global Value Chain As in many other sectors, the apparel industry is organized in GVCs where production of components and assembly into final products is carried out via intra-firm networks on a global scale. The apparel supply (or value) chain can be broken up into five stages: 1) design; 2) pre-production logistics; 3) apparel production; 4) distribution; and 5) marketing & sales. While apparel is intertwined with the textile industry, this report focuses primarily on apparel, devoting only limited space to textile production and raw materials.5 Figure 2 below depicts the main stages and actors. The subsections that follow provide additional detail on each segment. The Governance and Industry Organization section then outlines the main categories of firms. 4 To cite one example: 27 developed countries have provided tariff preferences to over 100 beneficiary countries through the General System of Preferences (GSP). However, tariffs for apparel products are only marginally reduced in the standard EU and USA GSP schemes. Within the GSP, some countries have negotiated preferential access for lower-income countries such as the Everything but Arms and the GSP+ initiatives by the EU, and the Africa Growth and Opportunity Act AGOA by the USA. Preferential market access in these agreements is governed by relatively restrictive rules of origins that typically require the use of yarn and fabric produced in a granting or signatory country, which has had a crucial impact on outcomes. 5 Textile components are also used in products such as home textiles (linens, curtains and rugs/carpets are examples) and industrial-use products such as filters, seat belts or building materials. Non-apparel end uses are considered a separate GVC and are thus not included in this report. 10 Figure 2: The Apparel Global Value Chain Source: Authors. Note: Raw materials & inputs feed into textile components that are then used to generate apparel products. Since this report focuses on the apparel GVC, the raw materials & inputs as well as components segments are considered separate supporting activities. Design: This stage includes actors that offer aesthetic design services and product development for outputs and components throughout the value chain. Design and style activities are used to attract attention, improve product performance, cut production costs and give the product a strong competitive advantage in the target market (Fernandez-Stark et al., 2011). Designers can be divided into two categories: 1) creative design, which has traditionally involved human designers sketching and generating fashion ideas that are featured in shows; and 2) technical design, which involved translating those ideas into garments.6 As this is their core competency, firms operating in the high-end segment of the market retain design functions in-house, while consumer brands and retailers, which follow the design tendencies set by the high-end market segment, are more open to outsourcing design to other companies. Pre-Production Logistics: Critical pre-production activities in the apparel GVC include the sourcing of materials such as fabrics, yarn, trim and accessories. The inputs must align with the design needs and product characteristics associated with the final product. Factors that are prioritized include price, quality, reliability and lead times. Fabrics are the most expensive input into apparel production. It can be divided into two key categories: knit and woven. Trade is evenly split between knitted and woven apparel (50% and 50% 6 Computer-Aided Design (CAD) is a growing component of the design segment of the chain, with software programs generating ideas for customers based on previous tastes. Box 7 on Red Collar Group in China provides some detail on the development of these companies. 11 in 2016). Knitted, however, is growing at a faster rate than woven—in 1992, knits were only 40% of the world export market while woven apparel was 60%. Woven garments have higher unit values than knitted (US$9.8 per unit compared to US$4.3 in 2015). Each differ considerably in terms of yarn and machinery requirements as well as labor skill and capital investment. Woven fabrics require considerably higher investment than knit production. Knit-textile producers are more often vertically integrated with apparel production, while woven fabric producers are independent. Knit fabrics are used for t-shirts, dresses, sweaters, underwear and swimwear amongst others, while woven fabrics are used for dress shirts, pants, jeans, and home furnishing such as bed linens and curtains. The quality of textiles is directly related to the final product’s quality. However, in contrast to apparel production, textile production is more capital-, skill-, and scale-intensive, which is a challenge for the establishment of backward linkages. A certain minimum size of the apparel industry, locally or regionally, is a requirement for local or foreign investment into backward linkages, particularly in the woven segment (Staritz & Frederick, 2014). Box 2: Raw Materials in the Apparel GVC The four largest categories of inputs in the apparel GVC include natural fibers, synthetic fibers, apparel trim and accessories (buttons, zippers, hangers, tags and other small accessories), and capital equipment and machinery parts. Natural and synthetic fibers are produced from raw materials such as cotton, wool, silk, flax and chemicals. There are also categories of non-essential inputs such as packaging and broad services applicable to a range of industries, such as transportation, logistics, catering, information technology (IT), construction, cleaning, security, human resources, and training. Cotton is the most significant natural fiber. In developed countries, the production model is typically medium- to large-scale commercial operations with mechanized harvesting, while in developing countries, production tends to be dominated by small-scale producers who harvest the cotton by hand (Cotton Council International, 2014). With its potential to employ large numbers of lower- skilled workers, governments often provide subsidies to support production in many locations. Worldwide, the leading producers are India, China, the United States, Pakistan, Brazil, Turkey and Australia (USDA FAS, 2018). Major exporters include the US, Australia, Brazil and India, while Bangladesh, Vietnam, China and Turkey top the leading importers. The US, Egypt, India and China are the leading sources of higher-quality cotton (Fernandez-Stark et al., 2016). Table A-1 presents the countries that figure most prominent in global production and export. Source: Frederick, 2016. Apparel Production: Apparel production includes cutting, sewing and finishing activities. Manufacturers cut and sew woven or knitted fabric or knit apparel directly from high quality yarn.7 A large portion of the work is labor-intensive, has low fixed costs and requires simple technology. These characteristics have encouraged the move to low-cost locations, mainly in developing countries. In contrast, textile (yarn and fabric) production is more capital and scale intensive, demanding higher worker skills; as a result, it has partly remained in developed countries or shifted towards middle- income nations. 7 A common description of businesses engaged in basic cutting, sewing and finishing activities is Cut, Make & Trim (CMT). Full package refers to firms that perform CMT services and also perform sourcing, logistics and other services. See Governance section for additional details. 12 Box 3: Automation in Apparel GVC Although recent advances in automation in the apparel industry have prompted speculation the sector could be vulnerable to disruptive change, the nuances of the apparel industry highlight the complexity of the issue.8 Automating a production process typically occurs because: (1) it is expensive to hire people to do the job; (2) the product has the potential to be contaminated if handled; or (3) the task is repetitive with minimal changes. Apparel, particularly the sewing segment, does not meet these requirements. There has historically been a pool of low-cost labor from a global perspective, contamination is not an issue, and whereas the task is repetitive, it changes often. Apparel fabrics are also soft and flexible, making it difficult for a robot to handle. For these reasons, Crystal Group—one of the largest clothing manufacturers in the world—has expanded production in Bangladesh and Vietnam, with its CEO specifically stating that robots could not compete with humans. Source: Frederick, 2015; Bain, 2018. Distribution: The next stage of the value chain captures the business-to-business relationships that move garments to customers. The distribution segment of the value chain can also be considered post-production logistics or apparel sourcing. The key factors apparel buyers consider when selecting a supplier are similar to the factors that apparel producers themselves evaluate with textile inputs: cost, quality, lead time and reliability as well as social and environmental compliance. The distribution segment of the chain is best evaluated based on product categories. Products can be divided into three primary ways: gender, product or materials. The main features of each are as follows: • Gender: Womenswear makes up the largest share of the global apparel market as measured by Retail Selling Price (RSP). It is followed by menswear (roughly 30% share), childrenswear (11%), apparel accessories (5%) and hosiery (4%). Men’s apparel is generally considered to me more “commodity-like” and basic in terms of construction and sizing, with styles changing less dramatically. Women’s apparel is more fashion-oriented, with frequent style changes. Product’s often have more detail and design features than menswear. As such, finding womenswear suppliers can be more difficult because manufacturers need to have the logistics capabilities to produce and supply products with shorter lead times and production and design-related skills and machinery required to make the more detailed styles. • Product: The global apparel industry can be divided into 14 product subsectors: trousers; sweaters and sweatshirts; knit shirts; coats, woven shirts; dresses and shirts; underwear and 8 The first robotic, automated production line could be operational by the end of 2018 with larger-scale implementation further ahead (Stacey & Nicolaou, 2017). Softwear Automation produces a clothes-making robot called “Sewbot,” The system was being installed in a facility in the United States with the expectation of producing 1.2 million T-shirts per year at a price that is competitive with manufacturing and shipping the same material in low-wage locations (Peters, 2017). Such developments led one report concluded that the broader textiles, clothing and footwear industry faced higher automation risks than workers in automotive and auto parts; electronics and electrical parts; textile, clothing and footwear; business process outsourcing and retail value chain (Chang et al., 2016). ASEAN nations could be in particularly precarious situation, according to the analysis, with as many 88 percent of Cambodian, 86% of Vietnamese and 64% of Indonesian wage workers facing possible replacement. 13 pajamas; suits and formal wear; miscellaneous apparel; accessories; athletic apparel; hosiery & socks; bras; and baby apparel. Trousers have historically been the largest export category, with a 20% share of the world market in 2016. Sweaters and sweatshirts were the second largest at 13%. Dresses/skirts, coats and miscellaneous apparel are all important growth areas for global markets, with growth rates of more than 5% in the period from 2006 to 2016. Table 1 below provides a list of the export values of each product category. Table 1: World Apparel Exports by Product Categories, 2006-16 World CAGR Value ($, Billions) Product Category Share (%) (%) 2006 2010 2014 2016 2016 2006-16 Total 292 327 402 377 2.6 Trousers 60 62 78 76 20% 2.5 Sweaters/Sweatshirts 44 47 55 50 13% 1.2 Knit Shirts 39 44 52 49 13% 2.3 Coats 21 26 37 35 9% 5.1 Woven Shirts 22 24 31 29 8% 2.7 Dresses/Skirts 16 23 29 27 7% 5.2 Underwear/Pajamas 17 18 21 20 5% 1.5 Suits/Formalwear 20 17 20 17 5% -1.3 Misc. Apparel 9 12 16 15 4% 5.4 Athletic 10 11 14 14 4% 3.2 Accessories 10 13 15 13 4% 3.2 Bras 8 9 11 11 3% 2.9 Hosiery/Socks 7 10 12 11 3% 4.1 Baby 8 9 10 10 3% 2.1 Trousers, Sweaters, Knit Shirts 142 153 185 174 46% 2.1 Coats and Dresses/Skirts 38 50 66 62 16% 5.1 Source: (UN Comtrade, 2002-2016b, 2002-2016c). Note: The product categories are ordered by value of international trade. Blue shades equal CAGRs > 3%. Red shades equal CAGRs < 1%. • Materials: The two main materials are cotton and man-made fibers (MMF), with the two categories representing 43% and 35% of world apparel exports in 2016. Wool and silk comprise relatively small market shares (5% and 1%, respectively), while the remaining 17% are from other textile materials or the material is not disclosed (UN Comtrade, 2002-2016c). It is worth noting that MMF has increased its share dramatically in recent years at the expense of cotton—in 2005, cotton materials accounted for 51% of worldwide apparel exports compared with 26% for MMF. Figure 3 below depicts the share of global apparel exports by material in selected years from 2005 to 2016 and provides a sense of MMF’s growing market share. Cotton’s shrinking share of material exports is partially attributable to the unit value associated with each of the main categories. Apparel made from silk and wool have the highest average unit values (US$25 and US$15 per item in 2015). However, of the main materials, apparel made from MMF has higher unit values compared to cotton: US$7.3 per unit compared with US$5.2 in 2015. 14 Figure 3: Share of Apparel Exports by Material, 2005-2016 100% 7% 8% 8% 90% 16% 14% 14% Material Share of Apparel Exports 80% 70% 26% 28% 60% 35% 50% 40% 30% 51% 50% 20% 43% 10% 0% 2005 2010 2016 Cotton MMF Other Textile Materials (Other, Wool, Silk) N/A (Unspecified) Source: UN Comtrade, 2002-2016b. Marketing & Sales: This segment of the chain includes all activities associated with pricing, distributing and selling the physical apparel product, including marketing and branding. The companies that participate in these activities are often the lead firms in the chain. Once these companies receive the apparel product, they do not frequently make physical alternations. Apparel is marketed and sold to consumers (via retail channels), institutions or the government. This stage of the chain accounts for the highest value addition in the chain. 2.2. Global Trade in the Apparel GVC Global trade in the apparel industry has been characterized by Chinese supply and European and American demand for some time. In recent years, there has been some indication the overall dynamics are evolving; with labor costs in China increasing and the country focused on higher value industries such as electronics, locations such as Cambodia, Vietnam and Bangladesh have increased their export presence. The following section analyzes global supply and demand. Unless otherwise stated, the source for all trade data is the UN Comtrade database. 2.2.1. Global Supply China is a behemoth in the apparel GVC. The country has accounted for at least 30% of global exports since 2006 and has regularly outpaced the world’s second leading apparel exporter (the EU-15) by at least 100% during that span. Its export portfolio is diverse with capabilities spread throughout product categories, material, construction type and gender. In terms of world market share, China accounts for the highest percentage of bras (51%), coats (49%), accessories (46%), miscellaneous apparel (45%), 15 and baby apparel (44%). Its top two exports by product category are sweaters/sweatshirts and trousers, although that has shifted in more recent years to categories with overall higher unit values such as coats and dresses or skirts. Table 2 lists the world’s top apparel exporters by year and value.9 Table 2: Top 10 Apparel Exporters by Year and Value, 2008-16 Value (US$, billions) World Share Partner 2008 2010 2012 2014 2016 2008 2010 2012 2014 2016 TOTAL 343 330 365 402 377 China 134 142 149 141 130 39% 43% 41% 38% 34% EU-15 60 52 54 63 58 18% 16% 15% 16% 15% Bangladesh 14 17 23 29 33 4% 5% 6% 7% 9% Vietnam 10 11 16 22 25 3% 3% 4% 5% 7% Turkey 16 15 17 19 17 5% 5% 5% 5% 5% India 11 13 13 16 15 4% 4% 4% 4% 4% Cambodia — 4 6 9 10 — 1% 2% 2% 3% Indonesia 8 8 10 10 10 2% 2% 3% 3% 3% Pakistan — 4 — 5 5 — 1% — 1% 2% Sri Lanka — 4 5 5 5 — 1% 1% 1% 1% Morocco 5 — — — — 1% — — — — Mexico 5 4 5 — — 1% 1% 1% — — Hong Kong 6 — — — — 2% — — — — Top 5 269 269 296 330 309 78% 82% 81% 82% 82% Top 10 236 239 258 284 263 69% 72% 71% 71% 70% Source: UN Comtrade (2002-2016b). Note: HS02, 61+62 codes. Exports are based on import data. ( —) indicates a country was not in Top 10 in given year. Pakistan, as an example, was not in top 10 in 2008 and 2012. There are indications China’s apparel industry might be facing headwinds. Growth has largely stagnated in the value of the country’s apparel exports—it exported US$142 billion worth in 2008 for a 43% share of the global market; in 2016, the total was US$130 billion for a 34% share. Moreover, the country’s increasing labor costs and policy focus on higher value-added industries has led lead firms to evaluate other countries. Since the global economic crisis, apparel buyers stated their intent to decrease the share of apparel sourced from China as a response to increasing costs, (Frederick, 2016; McKinsey & Company, 2013). Countries in South and Southeast Asia have proven the largest growth markets as China enters a period of transition. Cambodia (16%), Vietnam (15%), Bangladesh (12%) and Pakistan (7.5%) posted the highest Compounded Annual Growth Rates (CAGRs) for the value of their exports in the six- year period from 2010 to 2016 (see Figure 4 below). As a result of this and more recent expansion, Cambodia was the world’s seventh largest exporter by value in 2016, Vietnam was the fourth, Bangladesh the third and Pakistan the ninth. 9 The highest unit value cannot necessarily be interpreted as having the highest value addition or the highest margins. Calculations on individual margins vary significantly by company and are complicated by individual firm strategies—some companies will take a loss on certain products in order to maintain relationships with buyers. Multi-country, firm-level datasets would be required to draw conclusions about most profitable products. 16 Figure 4: Top Global Apparel Exporters by CAGR, 2010-2016 18 16.1 16 15.0 CAGR (%): 2010-2016 14 12.0 12 10 7.5 8 6 4.2 4.2 4 2.4 2.3 2.0 1.7 2 -1.4 0 -2 Source: UN Comtrade (2002-2016b). 2.2.2. Global Demand Geographic end markets for apparel can be analyzed using both retail and trade data. The retail data supplements trade date because several growing apparel markets are omitted in trade data because this excludes non-traded apparel—apparel produced domestically for the domestic market—and countries with limited trade data availability. In 2014, the value of the global apparel retail market was approximately US$1.38 trillion and the total value of apparel imports was US$402 billion (Frederick, 2018a). Highlighting some of the discrepancies between trade and retail data, Asia-Pacific was the largest retail market in 2014, accounting for 34% of sales for a value of US$474 billion. By contrast, it generated less than 20% of the global import market. With respect to import data, the largest and the fastest growing import markets include South Korea, UAE, Australia, China, Poland, Saudi Arabia and Mexico (UN Comtrade, 2002-2016b). Figure 5 below presents the fastest growing apparel import markets, while Table A-2 in the Appendix lists the largest global importers in the period from 2008 to 2016. There is a high degree of consistency each year, with the EU-15, US and Japan consistently ranking as the top three markets followed by Hong Kong and Canada. Although the US and the EU-15 remain the largest importers, emerging and regional markets are gaining in importance and represent equally important opportunities for apparel manufacturers. Diversifying end markets not only increases growth prospects—especially since mature markets such as (the United States and the EU-15) are experiencing a slowdown in demand—but it also reduces risks and dependency on certain markets and buyers (Frederick, 2016). 17 Figure 5: Fastest Growing Apparel Import Markets, 2010-2016 20.0 China, 17.7 15.0 CAGR % (2010-2016) Korea, 12.1 Saudi Arabia, 8.4 10.0 Mexico, 8.6 Czechia, 7.4 Poland, 8.2 Chile, 6.3 UAE, 6.6 5.0 Australia, 4.9 Singapore, 3.4 0.0 0 1 2 3 4 5 6 7 8 9 Import Value, 2016 ($US, billions) Source: UN Comtrade (2002-2016b). Apparel is represented by HS02 (61+62); countries shown are non-top five importers with had imports greater than US$2 billion in 2016 and a change in export value greater than the world average between 2010 and 2016. 2.3. Lead Firms and Governance The categories of firms that participate in the apparel GVC can be roughly distinguished based on the activities they perform. The four primary distinctions were first introduced in the apparel GVC diagram (Figure 1). They are as follows: 1. Cut, Make & Trim (CMT): A marginal supplier that typically generates low-cost outputs in high volume. The manufacturer only cuts the fabric, sews it together and adds final trim (zippers, buttons) and is not responsible for sourcing fabrics. 2. Original Equipment Manufacturer (OEM):10 The apparel manufacturer is responsible for all production activities, including the CMT activities as well as finishing. The firm must have upstream logistics capabilities, including procuring (sourcing and financing) the raw materials, piece goods, and trim needed for production. 3. Original Design Manufacturer (ODM): The apparel supplier is involved in the design and/or product development process, including the approval of samples and the selection, purchase and production of required materials. The apparel supplier is also responsible for coordinating the production and logistics activities. 4. Original Brand Manufacturer (OBM): The apparel supplier is responsible for branding and marketing of the final products. 10 Full package or Free on board (FOB), which is an international trade term, are also used to describe this category in which the manufacturer is responsible for financing and coordinating shipment of the product to the buyer. 18 Lead firms are set apart because of their purchasing power and control over the activities that generate the most profitable returns. The share of the retail selling price attributable to manufacturing an apparel item is typically less than 30%, of which raw material costs make up the largest share. Costs associated with intangible activities including product development, design, marketing, branding and management contribute the other 60-75% (Hester, 2013; Newbury, 2013). The lead firm sets the price to develop a final product and thus determines the final product margin, the difference between the cost of manufacturing, and the price it will pay to purchase or manufacture the product. These activities primarily take place at the headquarters of global retailers and brands in the United States and Western Europe.11 There are two key sets of business-to-business relationships in the apparel value chain. The first is the division between lead firms and the first-tier supplier (often OEMs). The second is between the first-tier supplier and branch locations or subcontractors and input suppliers (CMTs in the above categories). These relationships are important for production-related decisions. First-tier suppliers are responsible for coordinating the supply chain and thus make decisions on which factories are included in the chain. Lead firms may or may not have a relationship with these factories or suppliers farther upstream. There are recent trends associated with governance and power in the apparel GVC that are worth accentuating. These include the following: 1. There has been some consolidation as buyers are increasingly purchasing from larger, more capable first-tier suppliers (OEMs and ODMs). Lead firms prefer fewer suppliers because identifying and maintaining relationships with many vendors adds unnecessary time and transaction costs for buyers whose core competencies are in the higher-value activities related to marketing and branding. With these companies increasingly focused on sourcing from larger and more capable vendors, the smaller firms focused on assembly face challenges in forming direct relationships with global buyers. It should be noted that this does not necessarily mean there are fewer apparel manufacturers overall—smaller firms still play a role as subcontractors to first-tier suppliers and as producers for domestic markets. However, there are clear indications of supply chain consolidation, which forces companies in emerging markets that are attempting to enter and upgrade within the chain to consider variables that are outlined below. 2. Firm-specific factors beyond price are critical in the supplier selection process, with two characteristics gaining in importance. Traditional metrics such as price and quality are baseline considerations that all suppliers must demonstrate to be competitive. There are also a range of secondary characteristics that buyers use to evaluate potential suppliers. Two specific factors have increased in importance in recent years: full-package capabilities and lead time. Full-package capability describes non-manufacturing capabilities or value-adding services. With lead firms concentrating on core competencies and reducing the complexities of their supply chains, the expectation is that suppliers can handle more responsibilities. Buyer surveys show 11 While lead firms are most often the OBMs, there are four different types: 1) mixed retailers/mass merchants; 2) specialty retailers; 3) brand marketers; and 4) brand manufacturers. These lead firms are responsible for selling different types of brands, including national brands, private labels, exclusive labels, and licensed brands (Frederick, 2015). Table A-3 in the Appendix provides further descriptions and examples of each category of lead firm. 19 the most important services include input or material sourcing and financing and product development (Frederick, 2016). These require more diverse skill sets, including customer service, technology training and supply chain management (Frederick, 2015). The emphasis on lead time is related to the shift to lean retailing and just-in-time delivery, where buyers reduce the inventory risks associated with supplying apparel to fast-changing, volatile markets by replenishing items on their shelves in very short cycles and minimizing inventories (Frederick, 2015). Buyers are reconfiguring their sourcing strategies by working with fewer vendors and forming more strategic relationships, sourcing products closer to home and adapting new software and planning technology to streamline the process. 3. Although firm-specific considerations are critical, country and industry characteristics also play significant role in chain relationships. Industry and country- level variables are generally of less importance compared to firm-specific factors in the supplier selection process. There are, however, areas where the local environment is a prominent consideration. At an industry level, while lead time and full-package capability have become important criteria for suppliers, linkages with local or regional textile suppliers is critical. Fabric production needs to be competitive in terms of price, quality, delivery time and variety. In this context, the possibility to import inputs duty-free is crucial given the large variety of fabrics (Frederick, 2016). There are also country-level considerations that can impinge growth in the apparel GVC. The most important supporting features are transportation and power infrastructure, political stability, security environment and overall costs associated with trade. Historical relationships and established well-known capabilities within a country or region are important factors for chain entry or upgrading; concerns over any of the supporting features can be disqualifying, especially for markets that have very limited functional capabilities (Staritz & Frederick, 2014). Pakistan is an example of a country where political turbulence has damaged the apparel industry. Because of concerns over security and political stability, executives from foreign companies rarely visit the country, making it difficult for exporters to access new markets (Shaikh, 2015). 2.4. Human Capital The fact apparel production is labor intensive ensures the industry supports a high number of workers. Worldwide, estimates suggest that close to 14 million people work in the sector, placing the industry among the global leaders in terms of overall employment (UNIDO, 1963-2014). If textiles and apparel are combined, the industry is easily one of the top employment generators, accounting for 11-13% of global manufacturing employment, with combined employment of at least 26.7 million in the formal sector.12 Most workers are concentrated in production-related segments; they are often female and earn minimum wages. There is also a strong youth component to the industry, especially at the assembly stage. In 2012, the average age of the textile workers was about 26 years in Cambodia and 30 years 12 It should be stressed there are inconsistencies in estimates on the workforce of the global industry owing to what activities and products are included. Additionally, including informal workers in developing countries would dramatically increase the size of the global workforce. Some have gone as high as 75 million (Stotz & Kane, 2015). 20 in Vietnam, while that of non-textile and apparel workers was 35 years and 38.5 years, respectively (Kotikula et al., 2015). While the required formal education and skill level is low at the assembly stage, it rises rapidly as countries upgrade into higher-value stages; workers with more advanced skills are needed to support new service functions, such as logistics, finance, design and marketing. Table 3 below provides an overview of the most important job profiles in the apparel GVC. It is organized by value chain segment. Table 3: Job Profiles in the Apparel GVC Skills/ Position Job Description Typical Education Skill Level Experience Design Assistant Training in aesthetics of product development, some BA/BS, Apparel Experience; Fashion market and consumer knowledge, and technical skills Design Computer Skills Designer required to translate ideas into samples Senior Creative talent within the industry that can develop new BS/MS, Apparel Experience; Designer design lines for production. Design Computer Skills Product BS/MS, Business or Product life cycle management (PLM) Development Apparel Apparel Production Layering/laying fabric on cutting table: Ensure materials Fabric None — are straight, smooth and tension free. Inspect for faults Spreading/ Cut fabric by hand. High school Technical training Cutting Pieces are cut via a computer-controlled machine. Technical education Sewing Speed and Operate sewing machines to join, reinforce, decorate, or No formal education Machine accuracy skills; perform related sewing operations required Operators OTJ experience Hand Sewers/ Sew, join, reinforce, or finish, usually with needle and No formal education Required Embroidery thread required experience Activities may involve final sewing/attaching Finishing None buttons/zippers/fusing, dyeing, ironing/pressing, etc. Supervisory roles; assure work flows along the line; HS diploma/ Line Leaders Management skills workers often start as operators and progress technical education Oversee pace of the work and ensure stoppages are Technical education/ Communication/ Supervisors minimized, monitor production levels, train, etc. BS Planning Export Plans and coordinates all activities related to international Communication BS, Business Manager shipment of goods Logistics Marketing & Sales Marketing Responsible for market research, marketing/advertising, Marketing skills BS/MS, Business Analyst networking and positioning brands in the market. and experience Industrial Arrange shop floor; lean production, Six Sigma BS, Engineering Engineers Office and Book keeping, human resources, payroll, accounting, BS Computer skills Administrative customer service; ERP. Responsible for financial management, supply chain Corporate Experience; optimization, quality control, strategy and business BS/MS, Business Management General business development. Low Low-Medium Medium Medium – High High Skill Level No formal Literacy and Technical Technical education University degree education; numeracy skills education/certification /undergraduate degree and higher experience Source: Adapted from Fernandez-Stark et al., 2011. 21 2.5. Standards At the same time that lead firms influence much of the contours and shape of the apparel GVC, private standards administered by outside parties play an important governance role in monitoring workplace conditions of apparel factories. These multi-stakeholder initiatives are composed of lead firms, NGOs, unions, government agencies and in some cases large MNC suppliers. Table A-4 in the Appendix below lists majors private labor standards associated with the global industry; the largest and most prominent include the Fair Labor Association Workplace, the Fair Wear Foundation, ILO/IFC Better Work Programs, the Clean Clothes Campaign (CCC) and the Worldwide Responsible Accredited Production (WRAP). These initiatives have both their strengths and weaknesses. A significant one is that they primarily target the supply chains of the largest global lead firms, which only account for a relatively small share of the global apparel manufacturing. An additional problem is the sheer number of initiatives—Table A-4 in the Appendix only includes a sample of the most prominent. Having multiple programs with similar requirements creates confusion and complexity and results in higher compliance costs, which ultimately increases fragmentation rather than promoting harmonization. While the standards often succeed at identifying compliance issues in factories, they do not necessarily represent a means to address power asymmetry in the chain. The actual requirements to comply with the codes and standards are often low; in many cases, they do not address one of the primary concerns of workers regarding “living” wages. Furthermore, the definition of “living wages” is not universal nor is it legally binding. Estimates have been created as part of the Asian Floor Wage, but they are not part of an internationally agreed upon convention or standard. Some mention living wages, but due to inability to clearly define a living wage, they provide no means of enforcement. There are also enforcement issues with respect to other issues such as minimum wages and child labor. Buyers all mandate that national minimum wages are paid in suppliers’ factories, but labor unions contest that these wages fall far below acceptable levels. Factory owners can also circumvent minimum wages by hiring employees under different titles (such as an apprentice) or as temporary employees that are not mandated under national minimum wage policies. As far as child labor, most third-party standards have adopted ILO conventions prohibiting children younger than 15 from working as part of their programs. While it is not a prominent issue at first- tier factories and suppliers, it is observed in the informal sector in developing countries. Textiles in countries such as India has been highlighted as a sector and location where the issue is rampant (Theuws & Overeem, 2014). 22 3. Pakistan and the Apparel Global Value Chain Key Points • Pakistan’s strong recent growth rate in apparel exports (6.3% from 2006-16) is somewhat deceptive. Its position in the GVC is concentrated in a small handful of products. Trousers is the largest export category, accounting for 50% of the value of the country’s exports in 2016. The product’s recent growth has been robust (11.6%). But expansion in other categories has been subdued. • Pakistan’s cotton base and integrated supply chain offer both strengths and weaknesses. It provides benefits with doubling down on existing products, such as trousers and denim. But it is a liability for product diversification, which is an important consideration as global buyers move toward sourcing from vendors and countries with broader product availability to reduce complexity and costs. • In order to move forward, the industry should prioritize securing cost-competitive access to critical inputs (either by supporting cotton production and/or by simplifying tariff regime), attracting higher levels of FDI and enhancing the institutional environment. Energy infrastructure is also a key impediment. Pakistan’s foothold in the apparel GVC can trace its roots to the country’s history of cotton production. Long one of the world’s top-five sources for the raw material, a small group of local companies have taken advantage of the access to selected inputs to move from textiles to apparel and integrate into the supply chains of leading firms. With production clusters in Karachi, Lahore and Faisalabad, Pakistan was the eighth largest apparel exporter in 2016, accounting for close to 2% of worldwide share with heavy representation in certain product categories. The sector’s importance to Pakistan’s overall economy can be detected through multiple metrics. The combined Textiles & Apparel (T&A) industries generated a minimum of US$10.3 billion in exports each year between 2009 and 2016 (see Table 4).13 Throughout that period, the industry accounted for between 53-61% of the value of the country’s total exports, with the 2016-17 financial year representing a recent historical apex (61%) (GoP MoF, 2018). If one focuses more narrowly on apparel, Pakistan had US$5.7 billion in exports in 2016. Annualized growth was 6.3% in the period from 2006 to 2016 and 2.3% in the period from 2011 to 2016. With US$2.9 billion in value, the country’s largest export product category is in trousers, where it ranks as the world’s sixth-leading supplier. All told, the T&A sectors directly employed roughly 2.5 million people. 13 While this report concentrates on the apparel GVC, there are times when segregating the apparel from textiles is not possible. In instances where data or other sources aggregate, this report uses the term “T&A industry.” 23 Table 4: Pakistan’s Textile and Apparel Exports, 2009-16 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 T&A exports 10,338 13,887 12,470 13,156 13,856 13,589 12,553 12,531 Cotton & cotton textiles 9,755 13,147 11,803 12,628 13,348 13,139 12,168 12,248 Synthetic 446 608 546 406 383 331 288 204 Wool & woolen 137 132 121 122 125 119 98 79 T&A share of total 54 56 53 54 55 57 60 61 exports (%) Source: (GoP MoF, 2018). Source’s source: Ministry of Textiles. Note: US$ millions. Despite the significant economic activity, the industry still trails competitors in upgrading metrics. It has been hobbled by many features, from limited product diversity to onerous tariff regimes to infrastructure constraints to regulatory shortcomings. Although the competitive undercurrents that have shaped the global industry since the expiration of the MFA have influenced Pakistan, they have not been felt in the same way as in countries such as the Vietnam, Sri Lanka and Cambodia, where the growth of the sector has often been driven by foreign investment. The characteristics associated with the industry that are worth accentuating include the following: • Recent growth has been concentrated narrowly in certain product categories. The annualized growth rate of Pakistan’s apparel exports is somewhat deceptive, suggesting a broad-based increase that is, in fact, far more concentrated. Driven by CAGRs of 11.6% from 2016-16, trousers are Pakistan’s largest export product, accounting for 50% of the value of all apparel exports in 2016. That figure represents a 19% increase in share since 2006 (see Table 5). There are certainly other categories where exports are expanding, but they generally are in products where Pakistan has only a negligible share of global trade. The country’s second and third largest categories (sweaters/sweatshirts and knit shirts) have largely been stagnant. Trousers are far more promising—Pakistan is the world’s sixth leading exporter and has the third best unit value in the global top 10. 24 Table 5: Pakistan’s Apparel Exports by Product Category, 2006-16 Export Value Share of Pakistan’s CAGR (%) Product Category (US$, billions) Total Apparel Exports 2006 2010 2014 2016 2006 2010 2014 2016 2006-16 Total 3.1 3.7 5.4 5.7 — — — — 6.3 Trousers 1.0 1.4 2.5 2.9 31% 39% 46% 50% 11.6 Sweaters/Sweatshirts 0.5 0.4 0.6 0.6 16% 11% 11% 11% 2.4 Knit Shirts 0.6 0.6 0.6 0.6 19% 17% 11% 10% -0.3 Hosiery & Socks 0.2 0.3 0.4 0.4 7% 8% 7% 6% 5.4 Accessories 0.2 0.3 0.3 0.3 5% 7% 6% 5% 6.5 Coats 0.2 0.2 0.2 0.2 5% 5% 4% 4% 4.3 Underwear 0.2 0.2 0.2 0.2 6% 5% 4% 3% -0.2 Athletic 0.1 0.1 0.2 0.2 3% 4% 4% 3% 5.0 Suits/Formalwear 0.1 0.1 0.1 0.1 3% 2% 2% 3% 6.3 Miscellaneous 0.0 0.0 0.1 0.1 1% 1% 1% 1% 10.5 Baby 0.0 0.0 0.1 0.1 1% 1% 1% 1% 9.8 Dresses/Skirts 0.0 0.1 0.0 0.0 1% 1% 1% 1% 0.0 Woven Shirts 0.0 0.0 0.1 0.0 2% 1% 1% 1% -0.9 Bras 0.0 0.0 0.0 0.0 0% 0% 0% 0% 18.1 Top Three 2.0 2.4 3.7 4.1 66% 66% 68% 71% 7.1 Source: UN Comtrade (2002-2016c). Note: Blue shades equal CAGRs > 5%. Red shades equal CAGRs < 1%. • The EU-15 has ascended to the position as Pakistan’s top export market. As recently as 2008, the US was Pakistan’s largest export market; in that year, 45% of total export value of Pakistan’s apparel exports went there compared with 42% to the EU-15. The situation has shifted in recent years. In 2016, the EU-15 received 54% of the value of Pakistan’s apparel exports while the US accounted for 24%. The importance of the European market is likely to continue with Europe granting Pakistan preferential access as a trading partner as part of the GSP+ program. • The apparel sector has undergone only limited economic upgrading, with 8-10 large companies generating close to one-third of the export revenue. Most of the companies active in Pakistan’s sector moved into apparel only recently after beginning as textile companies. The delayed nature of this integration has resulted in relatively modest product diversity and limited economic upgrading, with the increase in trouser exports and unit values being a prominent exception. By and large, Pakistan’s outputs are predominantly men’s wear (knit and woven) that is made from cotton fabrics. The value chain is as much as a local one as a global one, with companies active in one geographic area, possessing little in the way of international operations and largely serving the domestic market. There are few OBMs active in the market and only scattered examples of ODMs; most companies are OEMs or second-tier CMTs. There are, of course, exceptions. Eight companies had more than US$100 million in exports during the 2016/17 financial year, accounting for 31% of the value of Pakistan’s total apparel exports. Nishat Mills, Sapphire Group and US Apparel & Denim are among the country’s most prominent exporters; almost all these firms are integrated while some produce both apparel and home textiles. Most focus almost exclusively on the export market. At the other end of the spectrum, close to 90% of the roughly 5,000 businesses that export apparel products earn less than US$1 million annually from international trade. 25 • FDI into the T&A sectors has been minimal. Like the larger economy, Foreign Direct Investment (FDI) has played a minimal role in Pakistan’s apparel sector. The textile sector has been more attractive, receiving moderate amounts of inflows in the early 2000s, although that interest has waned in more recent years. Overall, the total size of FDI in the apparel sector has been estimated to be less than 2% (Frederick, 2016). Table 6 below charts FDI inflow into the T&A industries from 2007-17. The apex came in 2011-12, when the sector received 3.6% of all the country’s investments.14 Table 6: FDI Inflows to Pakistani Textile and Apparel Industry, 2007-16 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Textile & Apparel (US$, million) 30.1 36.9 27.8 25.3 29.8 10 -0.2 43.9 20 15.5 Total FDI (US$, million) 5,409 3,719 2,150 1,634 820 1,456 1,698 987 2,305 2,746 T&A share of total 0.6% 1.0% 1.3% 1.5% 3.6% 0.7% 0% 4.4% 0.9% 0.6% Source: Pakistan BOI (2018). Note: Each year represents financial years, beginning in July and ending in June of the following year. • Although female participation has increased, labor in the sector still suffers from male overrepresentation. There are also shortages of trained workers. Both the T&A industries in Pakistan have traditionally been characterized by limited social upgrading. The textile sector employs as much as 40% of the industrial labor force, yet there is also a significant shortage of trained labor, forcing companies to invest resources on internal training (CNV Internationaal, 2017; GoP MoF, 2018). 15 A central characteristic of the workforce is that it has traditionally been skewed heavily toward men, with cultural stereotypes against factory work, the lack of public transportation and insufficient child care all playing key roles in the low female participation rates (Huynh, 2017; Munir et al., 2018). Although male workers still hold approximately two-thirds of all T&A jobs (Huynh, 2017), there has been some evolution in recent years. Significantly, the average annual growth for women in the industry has been 10% over the last four years compared with 4.3% for men. The following portion of the report analyzes Pakistan’s participation in the apparel GVC and examines how it is attempting to spur growth. Its goal is to provide a foundation for the potential upgrading trajectories and recommendations that follow in subsequent sections. Its organization is as follows: first, the country’s history and development in the apparel industry and its current participation in the GVC is examined before the organization of the industry is outlined as well as key firms and important institutions. After assessing upgrading steps that have been taken by stakeholders, there is then discussion of the country’s human capital before the section concludes with advantages and constraints that will shape future participation in the apparel GVC. Qualitative and quantitative data presented in this section is based on field research conducted in Pakistan in September of 2018. Duke GVCC spoke with 25 stakeholders active in the apparel GVC 14 The government has made attempts to attract more investments to Pakistan’s broader economy. The China- Pakistan Economic Corridor (CPEC) is perhaps the most prominent example. Published details indicate the project is first focused on infrastructure, although the textile sector has also been linked to Chinese interest, with yarns and cloth being a target, although there could be some spillover into apparel (Husain, 2017). 15 The annual requirement for trained individuals in the textile sector is estimated to be 135,000 people; the annual supply is closer to 10,000 (CNV Internationaal, 2017). 26 during three separate week-long trips to Islamabad, Faisalabad, Lahore and Karachi. Individual citations are included when supplemental material was used to support the analysis. 3.1. The Development of the Apparel Industry in Pakistan Pakistan’s long history in textile production has provided a foundation for its apparel industry. With Punjab serving as the primary production region, cotton accounts for 14% of the country’s total cropped area and is the leading agricultural output during the rainy season from May until December (Batool & Saeed, 2017). In addition to the local supply, the domestic industry received boosts from the government in the 1950s and 1960s through various government initiatives that attempted to increase exports in the sector. Programs such as the Export Bonus Scheme and the creation of the Pakistan Industrial Credit and Investment Corporation as well as the Investment Development Bank of Pakistan all prioritized moving agricultural workers from traditional industries to the textile sector (McCartney, 2014).16 As a result of the government-assisted efforts and the country’s natural resources, Pakistan’s exports were heavily dominated by cotton-based textiles. In 1979, textile exports accounted for US$991 million and included predominately raw cotton, yarn and fabrics; apparel exports, meanwhile, amounted to only US$79 million (Staritz & Frederick, 2012). Throughout the 1980s and 1990s, the growth of the country’s textile capabilities provided some support for the expansion in apparel exports, especially those that were dependent on domestically sourced cotton yarns and fabrics. By comparison, apparel products based on MMFs have historically only accounted for a small share of production and export (Khan, 2003). The reliance on cotton speaks to a central feature of the industry: it has been slow in moving into apparel production. Although there has been an overall increase in the exports for both textiles and apparel, the performance of the two sectors has been uneven, with textiles dominating for many stretches.17 By and large, Pakistan continues to produce low-value cotton yarn and cloth and intermediate products for the world market. 3.2. Pakistan’s Current Participation in the Apparel GVC Pakistan has an established foothold in the apparel GVC, solidifying its place in the last 15 years as an exporter of a handful of outputs. The country uses one of its larger advantages—its expansive base of cotton production—to provide global markets with both intermediate (yarn and fabric) and final products. Led mostly by domestic companies that have not accessed FDI to significant degrees, Pakistan’s downstream apparel products are mostly concentrated in three categories: trousers, knit shirts and sweaters/sweatshirts. The US initially served as the country’s largest market, although access to European market has increased since the implementation of the GSP+. 16 The Export Bonus Scheme offered incentives for increasing manufacturing exports; while the development banks offered capital for investments (McCartney, 2014). 17 Textile exports grew rapidly during the first half of the 1990s but stagnated in the second half and in the early 2000s before surging in 2003 and 2004 in light of increased exports to the EU and the US (Nordas, 2004). Pakistani textile exports increased their share in the world market from 2.8% in 1995 to 3.1% in 2004. Apparel exports grew more steadily from US$530 million in 1991 to US$2.6 billion in 2004, but the country’s global share remained between 0.8-1.1% of total exports. 27 Figure 6: Pakistan in the Apparel GVC Source: Authors. Note: The product categories in the Distribution segment of the value chain are ordered by approximate size of global market. Trousers, shirts (woven & knit) and sweaters/sweatshirts are the apparel products that have the largest worldwide trade. Figure 6 above offers a visual representation of Pakistan’s level of activity in the apparel GVC. Where possible, it has layered in export data available through UN Comtrade.18 Boxes depicted in green are where the country has the highest shares of the global market; trousers and hosiery/socks are the two final product categories where Pakistan exceeds 3% of exports, although the country does have 3-4% global market share in both yarn and fabric (woven fabric). Sweaters/sweatshirts, knit shirts and accessories are areas where Pakistan holds 1-3% global market share.19 White boxes signify areas where Pakistan has little to no export activity. Red circles then indicate gaps in the chain. The section that follows analyzes Pakistan’s position in the apparel GVC from four perspectives: firms, backward linkages, products and end markets. 3.2.1. Firm Profile Pakistan’s apparel industry is characterized by a small handful of large companies that generate much of the country’s exports and then thousands of smaller, local firms that access foreign markets in moderate to minimal volumes. Production is concentrated in or around the major cities of Karachi, Lahore, Faisalabad as well as Multan, Gujranwala, and Sialkot. The entire population of companies that 18 Shadings and comparisons involving the services performed in the apparel GVC (design, marketing, etc.) are not included because of the lack of available data. 19 It should be noted that Pakistan accounted for 1.2% market share in athletic apparel products in 2016; however, that category is not included in the GVC diagram because of its small market size. 28 exported apparel products during the 2016/17 fiscal year included 4,954 businesses (Pakistan Customs Authority, 2018). These firms generated US$4.7 billion in export revenue under the 61 and 62 HS codes.20 Table 7: Profile of Pakistani Businesses Exporting Apparel, 2016-17 Fiscal Year Number of Export Top Product Number # of HS Top Markets Threshold Firms Value Categories of codes (Share) (Share) (Share) (Share) Markets 1. 620322 (59%) 1. United States (31%) US$1.5B Over US$100m 8 (0.2%) 2. 611595 (12%) 76 2. Germany (11%) 70 (31%) 3. 610910 (6%) 3. UK (10%) 1. 620322 (26%) 1. United States (28%) US$1.6B US$10-100m 64 (1.3%) 2. 620342 (13%) 135 2. UK (16%) 86 (34%) 3. 610590 (8%) 3. Spain (14%) 1. 620322 (8%) 1. United States (33%) US$1.2B US$1-10m 401 (8%) 2. 610590 (8%) 178 2. UK (14%) 133 (25%) 3. 620342 (6%) 3. Germany (11%) 1. 611610 (7%) 1. United States (26%) Less than US$0.5B 4,481 (90%) 2. 610590 (7%) 203 2. UK (18%) 164 US$1m (10%) 3. 620349 (5%) 3. Germany (9%) 1. 620322 (30%) 1. United States (30%) TOTAL 4,954 US$4.7B (—) 2. 611590 (6%) 207 2. UK (14%) 175 3. 620342 (6%) 3. Germany (10%) Source: Authors based on Pakistan Customs Authority database. HS codes: 620322 = men's or boys' trousers or related products; 611595 = panty hose, tights, stockings, socks and other hosiery; 610910 = cotton T-shirts; 620342 & 620349 = recreational performance outerwear; 610590 = men's or boys' shirts, knitted or crocheted (other textile material): 611610 = gloves. While the total number of businesses and the average exports suggest an industry that is heavily oriented toward SMEs, the sector is best described as bifurcated. At the top, roughly 10% of businesses account for 90% of exports. In the 2016/17 financial year, that point of delineation was US$1 million in export sales—473 of Pakistan’s apparel exporters eclipsed this threshold while 4,481 did not. Table 7 above provides a summary of the general profile of businesses exporting apparel products. It divides companies into four categories based on the value of exports. Although it is not unusual that a handful of firms account for the majority of exports in a country, it is notable that Pakistan’s upper echelon includes many of the country’s largest companies across the entire economy. Eight topped US$100 million in apparel exports during the 2016/17 financial year. These companies represented 0.2% of the entire population of apparel exporters but generated 31% of the exports, reinforcing the top-heavy nature of the industry.21 All are integrated from fabric to apparel, and many have at least some internal yarn spinning capacity. Only one company exports textiles in significant volume. All concentrate on export markets nearly exclusively. The largest exporters often concentrate in a narrower range of products. The 620322 HS code (men’s or boys’ trousers or related products) was especially popular for companies that generated over US$10 million in apparel exports in 2016/17—59% of the exports for the over US$100 million firms 20 The totals described in this subsection differ slightly from the figures outlined in the “Product Profile” subsection for two reasons: 1) They capture the 2016/17 fiscal year instead of the 2016 calendar year; and 2) the firm-level data is based on Pakistan’s exports whereas the trade data reflects Pakistani imports reported by trading partners. 21 This likely understates the concentration at the top. Consolidated data was not available for parent companies that aggregates individual locations or subsidiaries. If it were, the share would be much higher. 29 fell into this category while 26% of the exports for the US$10-100 million businesses did the same. In fact, six of the largest eight exporters appeared to specialize on individual products, with one HS code that accounted for at least 84% of exports during that financial year. While the US was still the largest market for many firms that generated more than US$100 million, there is geographic diversity, with few concentrating on any one market (see Table 8 below). The most common import for businesses in this grouping include labels, cotton and narrow woven fabrics; however, the overall import footprint for these firms is light (only US$77 million across the 50-65 HS codes for the 2016/17 financial year) (Pakistan Customs Authority, 2018). Instead, most of these inputs are available on the local market or generated internally by the companies. Table 8: Apparel Companies in Pakistan with >$100m in Exports, 2016-17 Exports Apparel Largest HS Largest Market Largest Import* Firm (US$, Share of Code (Share) (Share) (Share of Total) millions) Exports^ Firm #1 217 100% 620322 (97%) United States (28%) Synthetic sewing thread (24%) Firm #2 211 95% 611595 (84%) United States (28%) Labels (44%) Firm #3 209 84% 620322 (99%) Spain (22%) Labels (28%) Firm #4 195 97% 610510 (26%) United States (67%) Narrow woven fabrics (37%) Narrow woven fabrics of Firm #5 186 100% 611090 (23%) United States (24%) other materials (35%) Firm #6 180 83% 620322 (99%) United States (43%) Cotton (81%) Firm #7 154 67% 620322 (99%) United States (48%) Labels (38%) Firm #8 123 100% 620322 (99%) Spain (36%) Labels (38%) Source: Authors based on Pakistan Customs Authority data. ^ = is compared only against the firm’s textile exports and not economic activities that fall outside T&A GVC. * = The firm database only had imports for textile and apparel (HS codes 50-65). A three-year period (2014-17) is used to smooth potential supply chain fluctuations. HS codes: 620322 = men's or boys' cotton suits, ensembles, suit-type jackets, blazers, trousers, etc.; 611595 = panty hose, tights, stockings, socks and other hosiery; 610510 = men's or boys' shirts, knitted or crocheted (cotton). Smaller businesses export similar products in significant volumes, although not to the same narrow degree as the larger firms. There were 401 companies that exported between US$1-10 million worth of apparel during the 2016/17 fiscal year (8% of the total population). Their product distribution was more evenly distributed, with the largest five outputs all having between 5-8% shares of the total market. In terms of sheer volume, the majority of businesses exporting apparel are SMEs generating less than US$1 million in sales. In total, more than 90% of the firm population (4,481 of 4,954 total firms) falls into this category. These companies export products in at least 203 HS codes, with gloves, mittens and mitts, coated or covered with plastics or rubber (HS code 611610) being the most popular (7% share). While men’s or boys’ cotton suits, jackets and pants is the largest product HS code for Pakistan’s largest exporters, it is only the fourth leading output for the country’s smaller companies. 3.2.2. Backward Linkages Cotton is the most significant import for companies active in Pakistan’s apparel value chain, despite the fact the country is one of the world’s largest five producers. Three of the largest 10 product categories for imports for firms that specialize in T&A exports from 2014-17 are different cotton varieties or classifications. Together, these three categories account for close to 20% of all imports, 30 with the 5201.0090 HS code (an “other” category that captures cotton products) being the largest. Other prominent categories include artificial fibers, chemical compounds and capital equipment. Table 9 below lists the top imports from the 2014/15 financial year through 2016/17. The largest 10 accounted for 43% of all imports from T&A firms located in Pakistan. Table 9: Top 10 Inputs Imported by T&A Exporters, 2014/15-16/17 Share of HS Code Product Import Value (%) 5201.0090 Cotton, not carded or combed (other category) 14.5 3926.9099 Plastic materials (other category for elastic bands and others) 5.1 5504.1000 Artificial staple fibers (of viscose rayon) 5.1 3902.1000 Polypropylene 3.0 5503.2010 Synthetic staple fibers (of polyesters) 2.8 2905.3100 Ethylene glycol (Ethanediol) 2.8 8446.3000 Weaving machines (for fabrics with width larger than 30 cm) 2.7 5201.0060 Cotton (length exceeding 28.5 mm but not 31 mm) 2.7 5402.3300 Textured yarn of polyesters 2.6 5201.0050 Cotton (length exceeding 24.5 mm but not 28.5 mm) 2.1 — Total 43.4 Source: Pakistan Customs Authority (2018). The inflow of significant volumes of cotton could be considered something of a surprise considering Pakistan’s position as a leading cotton producer. The country’s total production volume has fluctuated between 7-10.6 million bales since 2008, placing the country in the top five in the world (USDA FAS (2018). Yet output has plummeted in recent years, dropping nearly 34% in 2015/16 before a moderate increase in 2016/17. Quality is also low, which can be tied to a number of factors, including a pricing system that rewards weight, antiquated production and picking technologies as well as a familiarity with low-grade, small staple cotton (Batool & Saeed, 2017). The result is that local apparel producers pursue imports to access higher quality raw materials to blend for textile production that eventually results in apparel (Field Research, 2018).22 With the local production at least serving as a backstop, cotton is not the most significant gap in the chain. Instead, the largest demand is for MMFs that are not widely produced in the domestic market (or synthetic fibers, as depicted in the apparel GVC diagrams). If one concentrates more narrowly on the fabric, yarn and fiber inputs that are used to create garments, roughly 64% of Pakistan’s aggregated material imports in 2016 were for MMF. In total, Pakistan imported roughly US$1.55 billion in MMF materials in 2016. Approximately 82% of the country’s US$600 million worth of fabric imports was for MMFs compared with 7% silk and 6% cotton (see Table 10). Most came from China, a share that has increased rapidly in recent years, from 59% in 2006 to 86% in 2016. For yarn, 84% of Pakistan’s imports are for MMFs in 2016 as opposed to 13% for cotton. China is the largest source, accounting for 61% of the US$750 million of Pakistan’s yarn imports in 2016. The only category where there is relative balance between cotton and MMF imports is in the unfinished fiber segment, which includes raw cotton and reinforces 22 The bottom line is that Pakistan is the third-largest cotton consuming nation in the world and the sixth biggest importer (Batool & Saeed, 2017). It is a net cotton importer. 31 the dynamics described above. Pakistan imported US$1.06 billion worth of unfinished fiber in 2016; 55% was cotton material while 41% was MMF. Table 10: Pakistan’s Fabric, Yarn and Fiber Imports, 2006-16 Import Value (US$, billions) Share Material 2006 2009 2012 2016 2006 2009 2012 2016 Fabric (Knit, Woven) Total 0.15 0.07 0.22 0.60 — — — — MMF 0.11 0.05 0.10 0.49 75% 63% 45% 82% Silk 0.00 0.00 0.02 0.04 2% 6% 8% 7% Cotton 0.02 0.01 0.08 0.04 16% 15% 37% 6% Other (wool, 0.01 0.01 0.01 0.02 7% 16% 6% 4% vegetable fiber, etc.) Yarn (Filament, Staple, Unprocessed) Total 0.26 0.36 0.61 0.75 — — — — MMF 0.24 0.32 0.55 0.63 90% 89% 90% 84% Cotton 0.01 0.01 0.04 0.10 4% 2% 7% 13% Silk 0.01 0.02 0.01 0.01 4% 6% 2% 1% Wool 0.00 0.01 0.01 0.01 1% 2% 1% 1% Silk or Vegetable 0.00 0.00 0.00 0.01 1% 1% 0% 1% Fiber Fiber (Unfinished; Unfinished or Waste; Waste) Total 0.71 0.87 1.04 1.06 — — — — Cotton* 0.40 0.48 0.57 0.58 56% 56% 54% 55% MMF 0.25 0.32 0.42 0.43 35% 37% 40% 41% Silk or Vegetable 0.05 0.06 0.05 0.04 7% 7% 5% 3% Fiber Wool 0.01 0.01 0.00 0.01 2% 1% 0% 0% Silk 0.01 0.01 0.00 0.00 1% 1% 0% 0% Source: UN Comtrade (2002-2016a). Note * = category captures raw or slightly processed cotton. 3.2.3. Product Profile Although it has not enjoyed the dramatic, double-digit growth of regional peers (see Figure 4 in global section), Pakistan’s apparel exports have steadily increased in recent years. The country ranked as the world’s eighth leading apparel exporter in 2016 with US$5.7 billion in trade, ninth if one considers the EU-15 as an aggregated bloc.23 Its annual growth rate in the period from 2010 to 2016 was 7.5%, which is the fourth highest among the leading 10 exporters, trailing only Cambodia, Vietnam and Bangladesh. Pakistan’s exports are concentrated in three product categories: trousers, knit shirts and sweaters. Together, the trio accounted for 66-71% of the country’s exports in the period from 2006 to 2016. Much of the increase has been driven by trousers, which had an annual growth rate of 11.6% during that same span. The growth rates for the other two exports—knit shirts and sweaters—have been more moderate. Figure 7 below charts trousers’ overall increase in export share as measured by 23 The totals described in this subsection differ slightly from the figures outlined in the “Firm Profile” subsection for at least two reasons: 1) They capture the 2016/17 fiscal year instead of the 2016 calendar year; and 2) the firm- level data is based on Pakistan’s exports whereas the trade data reflects Pakistani imports reported by trading partners. Exchange rate fluctuations may also play a role. 32 value; Table 5 that was introduced earlier has individual data points. Of the country’s second-tier apparel products, hosiery & socks and accessories are two categories where annual growth exceeded 5% in the period from 2006 to 2016 and total export value was at least US$300 million. Figure 7: Share of Total Export Value for Leading Apparel Products, Pakistan 60% Export Share (Based on Value) 50% 40% 30% 20% 10% 0% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Trousers Knit Shirts Sweaters/sweatshirts All other products Source: Authors based on UN Comtrade (2002-2016). Trousers’ growth comes at a time when Pakistan’s jeans manufacturers have enjoyed some success, with denim being identified as a growth opportunity (Mangi, 2018). The value of the country’s exports places it sixth individually in the world, trailing China, Bangladesh, Vietnam, Turkey and Cambodia.24 Pakistan captures a higher unit value for its pants than its regional peers, trailing only the EU-15 and Turkey for highest unit value among the world’s 10 largest trouser exporters. The “Upgrading in Pakistan’s Apparel GVC” examines this trend in further detail, while Table 14 in the Advantages subsection lists the leading trouser exporters. Consistent with its profile as a major cotton producer, Pakistani apparel exports skews heavily toward the material. Cotton’s share of total apparel exports has been between 82-87% in the decade from 2006 to 2016. MMF exports have comprised 6-9% of the country’s total during the same period. In terms of fabric construction, woven products have become Pakistan’s most common, overtaking knitted outputs in 2012 and increasing market share from 41% in 2006 to 53% in 2016. Knitted products still accounted for 47% of Pakistan’s apparel exports in 2016. This trend distinguishes Pakistan from the global industry, where knitted products have grown at a faster rate than woven.25 24 The EU-15 combined had US$9.2 billion of trouser exports in 2016. However, no individual country ranked ahead of Pakistan—Italy was the EU’s leader with US$2.2 billion in trouser exports. 25 At the same time that it imports fabric, yarn and fiber in significant quantities, Pakistan also regularly exports textile components. In 2015, importers from around the world reported US$2.5 billion in imports of fabric from Pakistan, 98% of which was woven fabric, and US$1.8 billion in yarn (98% staple), for a combined total of US$4.4 33 3.2.4. End Markets Pakistan’s apparel products are largely exported to one of two destinations: the EU-15 and the US. One of the more prominent developments in the Pakistan apparel industry in recent years is its increased access to European markets. The US had been Pakistan’s top trading partner throughout the early 2000s before the EU-15 took over that position in 2009. EU’s ascension has continued in the years since—the 15 countries that comprise the EU-15 received 54% of Pakistan’s apparel exports compared to 24% for the US. Growth markets include Poland (exports were up 27% on an annual basis in the years between 2012 and 2016) and China (up 39% annually in the same span), although these markets still receive small percentages of final products. Figure 8 below charts the EU-15’s and the Rest of World’s recent gains as well as the US’s decline.26 One reason that Pakistan’s exports to the EU-15 have surged in recent years is the country’s participation in the GSP+ program since 2014. As part of the initiative, the EU provides preferential market access to developing countries in exchange for that country committing to improve both human capital and labor rights. Although Pakistani exports to the EU have been on an upward trajectory for some time, the growth rate has increased in more recent years. At the same time, exports to the US have declined significantly because of political and security considerations. The US State Department has regularly issued travel advisories against visiting the country since the September 11th terrorist attacks, and the relationship between the two countries has been strained at various points since Osama Bin Laden was killed in Abbottabad in 2011. With the travel restrictions, Pakistani suppliers must travel to the US or nearby countries (Bangladesh, Sri Lanka, the UAE) to meet global buyers or work via intermediaries. The limited access hinders opportunities to engage in product development and design with US buyers and facilitate economic upgrading. billion. Both are primarily cotton-based (87%). The main fabric importer is Bangladesh (19%) and China (68%) for yarn (UN Comtrade, 2002-2016a). The country ranked seventh in global yarn exports and eighth in fabric. 26 In terms of products and fabric construction, there is only minor variance in terms of destination. The most important products in both the US and EU-15 markets are trousers and sweaters and sweatshirts. In terms of fabric construction, there have been recent changes in the composition of exports to the US compared to the EU- 15 countries, with knit exports to the US declining in importance. 34 Figure 8: Pakistan’s Top Apparel Export Destinations, Final Products, 2008-2016 60 Share (%) of Pakistan's Apparel Exports 50 40 30 20 10 0 2008 2012 2016 EU-15 US Rest of World Source: Authors based on UN Comtrade (2002-2016). 3.3. Governance and Industry Organization A defining characteristic of Pakistan’s apparel industry is that it is mostly oriented toward the domestic market, notwithstanding the largest 8-10 companies, which sell almost exclusively to foreign buyers. With limited amounts of FDI and thousands of SMEs that struggle to export to foreign countries in significant volume, there are only limited connections to the global industry. Using the distinctions outlined earlier in the report, there are no OBMs and only scattered examples of ODMs. The majority are either OEMs or second-tier CMT manufacturers. The companies that have managed to integrate into the supply chain of global buyers generally owe their success to longstanding textile production. The largest firms often were established in the second half of the 20th century and used the country’s cotton base as a foundation for entering the industry as yarn manufacturers. With access to cotton inputs as well as country-level supporting features that did not serve as debilitating constraints—Pakistan’s labor costs were not exorbitant, human capital was reasonably skilled and the port of Karachi served as an effective point of distribution—a small handful of businesses earned high returns by performing low-value, CMT-like activities. While subsequent economic upgrading has mostly occurred on a delayed basis, the leading firms have managed to diversify to a degree, with the largest performing ODM activities. There are exceptions to this general narrative. Some companies that started in apparel production have consolidated their position through strategic integration, both backward into textiles and forward into finishing activities. Critically, the firms that followed this path progression made investments in human capital that allowed for the development of higher-value activities such as washing and finishing that have allowed a small number of firms to distinguish themselves for regional competitors and attract the attention of prominent OBMs (Field Research, 2018). 35 3.3.1. Lead Firms Major buyers such as Target, the Gap, Levi’s, C&A and others have supply chains that extend into Pakistan. These global lead firms typically purchase garments from a small network of Tier 1 suppliers that are located throughout the country. There are 5-10 Pakistani companies that sell to more than one large global buyer while 25-30 more that have assimilated into the supply chain of at least one lead firm (see Table 11). There are still other businesses that either aggregate purchases across many smaller suppliers (intermediaries/agents) or others that have niche product categories and interact more directly with specialty buyers. Three of the largest intermediaries/sourcing agents for the apparel industry in Pakistan are Matrix Sourcing, Li & Fung and Texlynx. Table 11: Pakistani Tier I Apparel Suppliers of Major Global Buyers Pakistani Global Workers in Year Segment/Products Location Suppliers Buyers Pakistan Est. C&A, New Weaving, dyeing, Lahore, Nishat Mills Look, Target, 1000-5000 1951 finishing, woven apparel Faisalabad Levi’s, Gap Yarn, Fabric, Knitwear, Sapphire Group — Lahore 25,000 1970 Woven apparel Gap; C&A; Artistic Fabric & Denim New Look; Karachi 5000-10,000 — Garment manufacturing/yarn Target; VF US Apparel & Tesco, Levi’s, 18,250 (1,650 Textile (US Denim fabric; Jeans Lahore 1975 C&A denim) Denim) Kabirwala Mahmood Group — Yarn, woven 12,500 1935 Multan Gul Ahmed M&S, Target Yarn, stitching Karachi 10,000+ 1953 Textile Mills H&M; Tesco; Lahore, Interloop Limited Levi's; Target; Hosiery 15,000 1992 Faisalabad C&A Masood Textile Yarn, knit fabric, Levi’s, Target Faisalabad 22,000 1984 Mills (MTM) knitwear Knit fabric, Knit cotton Klash Private Ltd. Europe Faisalabad 10,000 2002 tops Comfort 7,500 (5,500 H&M Yarn, Dyeing, Knitwear Lahore 1987 Knitwear apparel) Source: Authors based on company websites, LinkedIn profiles. The largest of these firms generally have established histories as textile producers, with any backward or forward integration most often occurring in the recent past. Nishat Mills, for example, is one of the larger T&A companies in the country. It began in 1951 as a textile manufacturer in Lahore before supplementing with apparel manufacturing in 2007. Smaller numbers of businesses were more proactive in diversifying their product portfolio earlier in their existence. Artistic Denim is an example of an exception to the larger trend of specialization in textiles. The denim producer began manufacturing jeans decades ago, which has allowed it to build expertise that has been identified as a key factor in the company’s growth trajectory (Mangi, 2018). 36 There are many large denim manufacturers that have supported Pakistan’s strong trouser exports. Levi’s—a leading global brand of jeans—purchases from at least 10 Pakistani suppliers in Karachi, Lahore and Faisalabad: Akhtar Textile Industries, Akhtar Textiles, Combined Fabrics, Cotton Web Limited, Crescent Bahuman, Dynamic Sportswear, Firhaj Footwear, Interloop Limited, Masood Textile Mills, Nishat Mills and US Apparel & Textiles (Levi, 2018). 3.3.2. Institutional Context There are number of domestic institutions that have helped give Pakistan’s T&A industries its shape. Some of these are broad-based organizations that interact with multiple stakeholders across the broader economy. Examples of these groups include the Ministry of Commerce, Ministry of Industry and Production, the Small and Medium Enterprise Development Authority (SMEDA), the National Tariff Commission (NTC), the Engineering Development Board (EDB). There are also export promotion agencies such as the Pakistan Export Processing Zones Authority and the Trade Development Authority of Pakistan. Labor issues are then handled by the Ministry of Human Resource Development and the provincial labor secretaries. There are then industry-specific actors. Owing to its historical importance of cotton, many of these organizations have a textile focus. At the government level, the most prominent is the Ministry of Textile Industry, which coordinates programs and strategies for the entire sector. It is supported by active industry associations, including the Pakistan Readymade Garment Manufacturer & Exporter Association (PRGMEA), the All Pakistan Textile Mill Association (APTMA) and the Pakistan Textile Exporters Association (PTEA). Table 12 below provides a summary of the key stakeholders. As the government agency charged with formulating textile policy, the Ministry of Textile Industry plays a significant in shaping strategy. Its most recent policy document is the Textiles Policy 2014-19 document, which was released in 2016 and replaces the 2009-14 version. The latest edition outlined 15 goals, many of which have quantifiable targets, including doubling textiles exports from US$13 billion to US$26 billion, facilitating new investments of US$5 billion in machinery and technology, boosting the composition of non-cotton materials in fibers from 14% to 30%; and improving the non- cotton mix in garments from 28% to 45% (MOTI, 2015). To support the broader strategy, the Ministry of Textiles pledged a variety of budgetary support mechanisms through 2019. These include the reduction of local taxes, access to easy finance, a sales tax refund regime, duty-free imports on machinery, and funding for vocational training. Additionally, the document proposed policy interventions to address the following issues or challenges: 1) tariff rationalization; 2) product diversification; 3) funding support for technology upgrades; 4) SME development; 5) establishment of product development centers; 6) OHS audits and trainings;27 7) Joint Ventures, mergers or relocation of international manufacturers; 8) strengthening textile firms; 9) electricity and gas; and 10) awareness and information dissemination. 27 As part of this effort, the government proposed conducting analysis on energy usage and distributing information about best practices related to conserving energy. 37 Table 12: Textile & Apparel Specific Supporting Stakeholders in Pakistan Name Classification Established Description All Pakistan Textile Mills Industry Largest trade association, representing textile 1957 Association (APTMA) Association spinning, weaving, and composite mills All Pakistan Textile Industry Processing of textile products in Dyeing, Processing Mills Association 1990 Association Bleaching and Printing. 372 members (APTPMA) Faisalabad Karachi Cotton Association Industry 1933 Cotton association for the whole of Pakistan. (KCA) Association Ministry of Textile Industry Government Formulates programs and strategies to bolster 1973 (MOTI) Agency the competitiveness of textile sector Pakistan Cotton Ginners Industry Industry association for cotton ginners, 1958 Association Association representing more than 1,200 members Pakistan Hosiery Industry Manufacturers Association 1960 Represents hosiery and knitwear industry Association (PHMA) Pakistan Readymade Garments, Manufacturers & Industry Provides assistance to manufacturers and 1981 Exporters Association Association exporters to promote trade environment (PRGMEA) Pakistan Textile Exporters Industry Advocates for textile exporters and 1985 Association (PTEA) Association communicates with government Source: Authors. While the Textiles Policy 2014-19 document provides some strategic guidance to the sector, there are three regulatory areas that influence Pakistan’s participation in the apparel GVC to significant degrees: labor; tax & tariff; and trade & investment. Each is outlined below. Labor Policies An important component of the labor environment in Pakistan is the 18th Amendment to the Constitution. Passed in April 2010, it pushed labor as well as 46 other subjects to provincial governments. The result is a patchwork of laws across the country that lack consistency with little harmonization (CNV Internationaal, 2017). The International Labour Organization (ILO) and other NGOs have attempted to provide regulatory foundations to support workplace gains across the whole country, but there is often minimal implementation at the local, provincial or national levels. The implications for the apparel sector have been pronounced. The most prominent labor issues involve the right to form unions and the ability to earn a minimum wage, although there are also considerations for child workers, workplace safety and limiting excessively long work days. Each is examined below. • Freedom of Association: Unions do not have a strong presence in the T&A industries. This is primarily the result of non-regulatory considerations, although it should be noted that the right to strike is not considered a fundamental right (CNV Internationaal, 2017). Moreover, labor laws do not apply to Pakistan’s Export Processing Zones (EPZs), where workers are not allowed to unionize (Richardson et al., 2017). Estimates indicate that 30-40% of all SEZ employees in Pakistan are female textile workers (CNV Internationaal, 2017). • Minimum wages: The governments of Punjab and Sindh provinces set basic wage laws that govern most T&A workers. After variance between regions prevailed in previous years, all 38 provinces have set the minimum wage for unskilled work to PKR 14,000 (roughly US$115) per month (Wage Indicator, 2018). • Workplace safety: While there are basic protections enshrined into national law, prominent incidents have highlighted their inadequacy.28 Both the Punjab and Sindh provinces have initiated processes to improve occupational health and safety, although there are hurdles—including an untrained and largely illiterate workforce—preventing progress. • Use of child labor: Child labor is prohibited through Article 11 of the constitution. However, the informal sector is characterized by the employment of children as young as 10, with many working in various segments of the textiles chain (CNV Internationaal, 2017). Tax and Import Tariff Policies There are many components of the tariff and tax regime for apparel exporters. Three of the more prominent are the Duty Drawback of Taxes (DDT), the Drawback of Local Taxes and Levies (DLTL) and the Duty and Tax Remission (DTRE).29 Key features of each are as follows: • DDT: Pakistan’s Economic Coordination Committee approved a 50% refund on duties, taxes and fees collected on the importation of textile inputs that are then used for export. Additional drawbacks are possible if companies increase exports by at least 10% or trade with non-traditional markets in Africa, Latin America and the Commonwealth of Independent States (Fibre2Fashion, 2017). Originally offered as a benefit to companies for the 2017 fiscal year, the government extended the benefit in 2018. • DLTL: The DLTL provides textile exporters with refunds for local taxes and levies. Refunds are on values of their enhanced exports on an incremental basis if increased beyond 10% over previous year’s exports. The rates vary by stage of the supply chain, with home textiles receiving 6%, apparel earning 7% and components between 3-4% (MOTI, 2015; Observer., 2017). • DTRE: The DTRE allows businesses to import inputs duty free provided they re-export them (i.e., if a firm needed to import synthetic fibers or yarn, the same entity would need to export the product). However, only direct exports receive the benefit, thereby encouraging firms to integrate vertically to be eligible for the program. The average tariff on cotton imports from Most Favored Nations (MFNs) is 3.8%, with individual rates ranging from 1-10% (WTO, 2015).30 These rates are subject to fluctuations. In 2017, for instance, the government imposed a 4% tariff and 5% sales tax on imported cotton while excluding local cotton from the tax (USDA, 2018). The government then eliminated the tariff and taxes in 2018 to reduce 28 One example is a 2012 fire at a textile complex in Karachi that killed nearly 300 workers. Windows were barred at the site and many of the exits locked (ur-Rehman et al., 2012). 29 There are other policies designed to offer benefits to exporters, including manufacturing bonds. In the interest of brevity, this report focused on the schemes directly cited during field research. The government announced a plan in 2018 to offer security bonds for tax refunds; however, T&A exporters have expressed concerns about the proposal (The Express Tribune, 2018). 30 For comparison, Pakistan’s average (MFN) tariff on textiles and textile articles is 18.7%, with the individual range between 1-25% (WTO, 2015). 39 costs on manufacturers.31 The cost and complexity of importing synthetic fibers is also an issue that inhibits product diversification in Pakistan (Kumar et al., 2016). Tariffs on imports of MMF are higher than cotton; the range, depending on the product is 5-16% (Pakistan Federal Board of Revenue). Due to the nature of the DTRE program, if a firm needed to import synthetic fibers or yarn, the same entity would need to export the product. However, given that most companies are structured as independent units— fabric and cut/sew are separate entities—the woven fabric would have to be exported to get the drawback unless the fabric manufacturer and the apparel producer are the same entity. Trade and Investment Policies Pakistan’s Board of Investments (PBOI) helps coordinate strategies related to FDI while also managing the country’s SEZs. The organization released two strategy documents in 2013 to help shape the country’s approach to foreign investors: the 2013 Investment Policy and the FDI Strategy 2013-17. Both identified the textile industry as a priority sector; neither includes apparel. One component of the 2013 Investment Policy was the Special Economic Zones Act 2012, which allowed for the creation of processing zones in the country. The benefits for businesses located within the 50-acre minimum tracts included: 1) duty-free import of capital goods; 2) income tax exemptions; 3) infrastructure support; 4) allowances for captive power generation; 5) one-window facilities operated by the BOI for administrative and compliance requirements; 6) dry port facilities; and 7) security considerations (Pakistan BOI, 2013). The SEZ regime provides similar services as the country’s Export Processing Zones (EPZs), which are managed by the Export Processing Zone Authority, which is also housed under the Pakistani government. EPZs were first established in Pakistan in 1980, and there are eight spread throughout the country. Economic benefits include competitive lease rates on buildings as well as tariff and tax reductions for inputs and exemptions from foreign currency exchange repatriation regulations (EPZA, 2018). A critical difference between EPZs and SEZs is that EPZs are more oriented toward foreign trade. Businesses in EPZs must export 80% of products, while companies in SEZs can sell in higher volume to the domestic market (Richardson et al., 2017). Another difference is the Export Processing Zone Authority provides more active management of EPZs while private companies or public-private initiatives often govern SEZs (Richardson et al., 2017). Finally, the award of GSP+ status is one of the more significant recent developments as far as trade. GSP+ status allows more than 76% of Pakistan’s T&A exports to enter the EU-15 without duties or quotas (EC, 2018b). To receive GSP+ benefits, products must have undergone double transformation. For apparel, this means the yarn, fabric and final garment must all originate from a beneficiary country. Pakistan is also a beneficiary of preferential market access under GSP to Canada, Japan, New Zealand, Norway, Russia, Switzerland, and Turkey, and it also has signed bilateral Free-Trade Agreements (FTAs) with countries such as Indonesia, Malaysia, Sri Lanka, Iran and Mauritius. 31 Non-tariff barriers are also a constraint, with the government sometimes raising phytosanitary concerns on imported cotton that arrives on vehicles instead of through the port in Karachi (USDA, 2018). 40 3.4. Upgrading in Pakistan’s Apparel GVC With its historical roots in cotton and textile production, Pakistan has been primarily active in supporting activities of the apparel GVC. There has been some recent industry evolution, with most of the country’s largest exporters adding apparel capacity at different points in the last 10-15 years. However, the delayed nature of the economic upgrading has led to relatively modest product diversity and limited activity in value-generating activities. The upgrading that can be detected is somewhat limited and has often worked in tandem with each other.32 For example, process upgrades in the form of reduced lead times to important destinations along with investments in human capital have allowed for product upgrades in the form of increasing amounts of woven products with more sophisticated washes and finishes. Combined, these factors have allowed the country to access markets that pay high price premiums while also diversifying to new markets (end market upgrading). As highlighted in the “Firm Profile” and “Lead Firms” subsections, the industry is top-heavy. It is notable that the largest companies generally focus on one product, suggesting a sophistication with specialization and scale economies that serves as an advantage. It is these companies that have been most proactive about making progress to improve competitiveness in other respects. The apparel industry’s most tangible gains include the following: Process upgrading: Although it is difficult to quantify gains associated with improvements to Pakistan’s production processes, officials from many of Pakistan’s leading companies repeatedly highlighted gains in lead times as being critical factors that have allowed some to sell into the supply chains of lead firms such as Levi’s and H&M.33 The exact lead times vary depending on the product and market; however, most businesses reported reductions from 4-6 months to 2-3 months to as little as 35 days to ship products from Karachi to the EU, depending on the buyer (Field Research, 2018). Some firms have also invested in human capital, recruiting textile engineers and other skilled labor from production hubs in Turkey and elsewhere to develop capacity within Pakistan to generate garments with sophisticated washes and finishes. Product upgrading: Pakistan has made some moves into higher-value products in apparel production. Pakistan has a strong presence in denim manufacturing, with at least 10 companies active in Levi’s supply chain. Many started selling to the jeans’ manufacturer in the last 10 years, with some crediting improvements to their wash and finishing processes described above. During that time, Pakistan’s unit value for exports of trousers has climbed to the third highest among the leading 10 global exporters. This has been driven by the country’s increasing exports to the EU-15―the share of overall trouser exports to the EU-15 jumped from 55% in 2012 to 61% in 2016, and the unit value of Pakistan’s EU-15 trouser exports is higher than its global average (US$9.5 vs. US$8.9). Overall, the unit value of the country’s trouser exports increased 48% in the period from 2005 to 2016, giving Pakistan the highest unit value of trousers of anywhere in South and Southeast Asia. Figure 9 below charts the unit value of trouser exports for regional peers. 32 This section considers only apparel upgrades. There are other examples if one includes textiles. The widespread addition of spinning capacity for textile production is one. A common progression for integration involves adding spinning capabilities followed by weaving, knitting and finishing. 33 Surveys based on the perceptions of buyers have placed Pakistan with India for having the worst performance on lead times and reliability of eight Asian nations: China, Vietnam, Sri Lanka, Indonesia, Cambodia, Bangladesh, India and Pakistan (Frederick, 2016). 41 Pakistan’s overall shift toward more woven products can also be considered a product upgrade. Woven’s share of Pakistan’s apparel exports increased from 41% in 2006 to 53% in 2016. This is notable for two reasons: 1) the unit prices associated with woven garments were US$9.8 per unit in 2015 compared with US$4.3 for knitted; and 2) the global industry has moved more toward knitted products. Figure 9: Unit Value of Trouser Exports, South and Southeast Asia, 2005, 2012, 2016 10 25 9 8 20 Unit Value of Exports (BARS) Export Value (DOTS) 7 (US$, billions) (value/items) 6 15 5 4 10 3 2 5 1 0 0 Unit Value of Exports 2005 Unit Value of Exports 2012 Unit Value of Exports 2016 Export Value (US$, billions) 2005 Export Value (US$, billions) 2012 Export Value (US$, billions) 2016 Source: Authors based on UN Comtrade (2002-2016). Note: Bars illustrate unit value of exports while dots indicate the total value of trousers for a given year (US$, billions). As with all UN Comtrade data presented in this report, unit values were calculated using mirror data from importers. Unit value was calculated by dividing the export value into the number of units sold. End market upgrading (diversification): Most of the apparel from Pakistan is still bound for two large markets: the US and the EU-15. However, there has been diversification in export destinations, with markets outside those locations receiving increasing share. The “Firm Profile” subsection highlighted how apparel companies export to 175 total markets. The aggregated share of Pakistani exports going to countries outside the EU-15 bloc and the US increased from 12% in 2008 to 22% in 2016. The individual percentages are ultimately small, but the growth rates are strong—exports to Poland were up 27% on an annual basis in the years between 2012 and 2016 while China increased 39% annually in the same span. Industry specialization or intersectoral upgrading: In addition to apparel, Pakistan is also a top exporter of home textiles and textile components (yarn and fabric), which are industries that have substantial overlap with the apparel GVC and make use of local cotton production. Pakistan exported US$777 million of bathroom and kitchen linens in 2016 and US$773 million of cotton bed linen (WITS, 42 2018), which would place both items in the top three of product categories if they were considered apparel exports. Moreover, both rank in the top six in analysis of export potential for the country’s outputs, with Southeast Asia being targeted as potential growth markets. 3.5. Human Capital The sizes of apparel workforces are difficult to ascertain. The overlap and inconsistencies in definitions associated with the T&A sectors is one reason for the challenge. Another is the high number of informal workers in developing countries. With respect to Pakistan, recent estimates have suggested there are as many as 2.2 million apparel workers and 4.2 in the greater T&A sectors (Huynh, 2017). However, the authors believe these estimates include home textiles in addition to footwear, neither of which are the focus of this study. Interviews conducted for this report suggest there are 700,000- 1 million workers in Pakistan’s apparel industry and that the T&A industries employ 2.5 million (Field Research, 2018). Regardless of the size, there are three features associated with Pakistan’s apparel workforce that are worth accentuating: 1) its low wages when compared with larger markets such as China, India, Indonesia and others (but not Bangladesh and Cambodia);34 2) its relatively low percentage of female workers; and 3) its shortage of skilled and literate workers in some areas. The first two characteristics are reinforced both through regional analysis as well as discussions with local stakeholders. The third factor—the skills gaps—can be best detected through country-level analysis. The following subsections explore each issue in further detail. Many data sources aggregate both T&A in their surveys; this subsection distinguishes between the two when possible and uses the T&A distinction when it is not. 3.5.1. Wages The average monthly wage for Pakistani workers across all industries during the 2014/15 financial year was PKR 14,971, which was roughly the equivalent of US$145 at that time (PBS, 2015).35 Financing, insurance, real estate and business services had the highest monthly salaries (PKR 36,659 or US$360) while agriculture, forestry, hunting and fishing had the lowest (PKR 7,804 or US$76). As was detailed in the Labor Policy subsection, provincial governments are responsible for setting minimum wage guidelines—the current minimum wage is PKR14,000 across all provinces. Most apparel workers in Pakistan are still paid on a piece-rate basis for each basis of apparel generated (AASR, 2015). There is a wide range of salaries. Interviews with company officials associated with this project indicated that many paid their factory employees roughly US$200 per month (Field Research, 2018). A survey of workers in the Punjab province indicated that the highest paying positions include dyeing managers (average monthly salaries are from PKR180,000-300,000 or US$1,717-2,862), production planning (PKR65,000-90,000), cutting masters (PKR50,000-120,000), washing masters 34 It is possible to make a comparison of apparel wages in Asian countries through different sources (see Huynh, 2017; van Klaveren, 2016; van Klaveren & Tijdens, 2018). One can estimate that Pakistan’s apparel wages were higher than Bangladesh’s and comparable to Cambodia’s, while being significantly lower than India, Indonesia and China. However, none of the data points were from within the last three years, and they do not include supplementary features such as pensions and healthcare. Furthermore, the authors’ estimates of Pakistani apparel workers’ wages (US$200 per month) was higher than external sources. 35 The last Labor Force Survey published by the Pakistan Bureau of Statistics was after the 2014/15 financial year. 43 (PKR 45,000-100,000), weaving masters (PKR45,000-70,000), knitting masters (PKR40,000-70,000) and industrial engineers (PKR30,000-85,000) (AASR, 2015). Knitting helpers and assistants, stitching helpers, bundle makers, and applique thread cutters are all at the other end of the spectrum, with all paying either minimum wage or just below. 3.5.2. Female Participation The T&A is slightly more inclusive of female workers than Pakistan’s entire economy. Of the 57.4 million total workers active in the country’s labor force in 2014/15, 44.1 million were males (nearly 77%) compared with 13.4 million females (PBS, 2015). The share of females in the garment, textile and footwear sectors was 35% (Huynh, 2017). There have been recent increases in the female share, yet Pakistan still trails all its regional peers except for India (24%). Myanmar (95%), Vietnam (79%), Sri Lanka (76%) and China (66%) all have demonstratively higher women participation rates in apparel than Pakistan (van Klaveren & Tijdens, 2018). Individual estimates highlight the low numbers of female workers across Pakistan’s apparel GVC. In Punjab, a survey of garment manufacturers reported that the departments with the highest shares of female employees were Human Resources & administration (17%), finishing (16%), stitching (16%), product development (12%) and embroidery (11%) (AASR, 2015). The least popular divisions for females were logistics (1%), weaving (2%), production planning (2%), dyeing (2%), knitting (3%) and research & development (3%). The high percentage of male workers has historical roots in many factors, including cultural norms about women’s suitability for factory work, perceived security and safety issues, the lack of public transportation and insufficient child care all playing key roles (Huynh, 2017; Munir et al., 2018). Under the old system, males were paid for each unit produced and had independence to work at different locations and determine their own schedule (Munir et al., 2018). With the phaseout of the MFA, Pakistan had to compete with countries in the region that had lower wage rates. That presaged the development of a more structured, salaried system that appealed less to the experienced males and provided increased opportunities for women, who proved to be less resistant to change. Supporting programs initiated by internal and external stakeholders also played critical roles in increasing access for women (Munir et al., 2018). Among the more prominent are the United Nations Development Programme’s Gender Promotion in the Garment sector through Skills Development (GENPROM) and the ILO’s Gender Equality for Decent Employment (GE4DE). These changes and programs have led to quantifiable participation gains. The average annual growth rate for women’s employment (10%) exceeded men’s (4.3%) from 2010/11 to 2014/15 (Huynh, 2017). In textiles, the average annual growth rate for women’s employment was nearly 23%. Yet despite these increases, women’s pay remains well below men’s, with a pay gap of as much as 64% (Richardson et al., 2017). Research into the issue has found that 93% of women apparel workers earn less-than- minimum-wage salaries (Richardson et al., 2017).36 36 It is worth pointing out that women work at smaller businesses to much higher degrees than men. Roughly 69% of men worked at businesses of five or less employees compared to nearly 100% of women (Huynh, 2017). 44 3.5.3. Skilled workers A sizeable percentage of Pakistan lacks basic foundational education skills. The literacy rate of the population above 10 years old is 61%: 72% for males and 50% for females (PBS, 2015). The majority of the literate population attended formal schools but did not complete 10 years. Roughly 6% of the literate population completed high school while 5% finished high school and earned a formal degree.37 The workforce in the apparel industry is not without its strengths. While wages are higher than low- cost competitors such as Bangladesh, they are lower than many markets, including China, India and others (van Klaveren, 2016). Some companies have invested in human capital in areas such as washing and finishing, and surveys have indicated that at least 25% of the workforce is highly skilled in a number of areas, including stitching, design, production planning, dyeing and merchandising (Field Research, 2018; AASR, 2015). However, companies also report significant volumes of average or poorly skilled workers (AASR, 2015). The specific gaps often depend on the geographic regions; however, an underlying feature is that training systems are underdeveloped (Field Research, 2018). Only 32% of businesses in Punjab had a formal system to train their employees, while 52% believe it is a waste of resources (AASR, 2015). While there is an established Technical and Vocational Education and Training (TVET) system, there are only limited amounts of spots available for the close to 1 million new labor market entrants each year (Sandhu, 2018). Moreover, only 2.5% of TVET students receive formal, on-the-job training through the program (Sandhu, 2018). 3.5.4. Education and Training Pakistan offers T&A-specific education and training at all levels—technical/vocational, industry-specific institutes and four-year universities offering B.S., M.S. and PhD programs. This is relatively unique and is often a key bottleneck for countries wishing to upgrade by increasing skills. • Universities: There are two main universities that provide textile and apparel-specific degree programs: National Textile University and the Textile Institute of Pakistan. These institutions offer bachelor’s and master’s degrees in classes that focus on T&A subjects. • Industry-Specific Training Institutes: The Ministry of Commerce/Ministry of Textiles and the industry association for the different stages of the supply chain in Pakistan have set up a series of technical training institutions in the country. Operational funding is provided by the relevant industry association (via membership dues) with some support from the national or provincial government for consumables. Institutes also receive funding from international NGOs for specific programs or machinery. These relationships are facilitated by the Ministry of Textiles. The main programs include the Pakistan Readymade Garments Technical Training Institutes (located in Lahore and Karachi) and the Pakistan Knitwear Training Institute (located in Lahore). 37 The Labor Force Survey uses a category labelled “intermediate” to describe students who completed 12 or 13 years of education while “degree and above” includes students who finished 14 or more years of education. 45 • Technical and Vocational Programs: TVET has textile courses. Of the 339,624 graduates from 2009-2018, approximately 7% (23,629) were from textile or apparel-related programs (not including tailoring). Programs with the most graduates are dressmaking, machine embroidery, fashion designing, hand embroidery and stitching operator. Some of the constraints with the program were outlined above, with as little as 2.5% of the program’s graduates receiving formal on-the-job trainings (Sandhu, 2018). 3.6. Advantages and Constraints There are strengths and opportunities associated with the sector, with the country’s expansive cotton production, its growing exports in certain product categories and its access to the European market being three of the more prominent. The high rate of domestic ownership also offers potential for future upgrading. Balanced against the reasons for optimism are a number of challenges, both related directly to the industry as well as the country as a whole. Table 13 summarizes both the strengths and weaknesses. The most prominent advantages and constraints are then outlined in the section that follows. The potential upgrading section expounds on possible opportunities. Table 13: SWOT of Pakistan’s Apparel Industry Strengths Weaknesses • Status as leading cotton producer has • Cotton production is declining, and the quality is strengthened backward linkages to allow for low presence in trousers • Gaps in the supply chain have limited product • Low labor costs distinguish country from some diversity and upgrading regional peers • Concerns with lead times • GSP+ access to EU-15 markets • The supporting environment is fragmented • High rates of domestic ownership provide • Limited amounts of FDI leave parts of domestic familiarity with downstream activities sector disconnected from global industry • Supporting environment provides industry with • Skills deficiencies continue to undermine sector’s institutional foundation potential • China-Pakistan Economic Corridor (CPEC) • Complicated and inefficient trade and investment project could improve infrastructure regimes • Infrastructure and safety remain leading concerns Opportunities Threats • Increased specialization in trousers and denim • Climate change • Diversification of apparel products or move into • Terrorism and political instability related outputs (medical textiles) • ODM and OBM for select products • Boosting share of women workers Source: Authors. 3.6.1. Advantages Many of Pakistan’s advantages in the apparel industry can be traced to its historical position as a cotton and textile producer. Enhanced access to European markets, cost-competitive labor and high percentages of domestic ownership are also important considerations. The follow subsection expounds on Pakistan’s strengths in further detail. 1. Status as leading cotton producer has strengthened backward linkages to allow for presence in trousers. Although its output has been stagnant for the better part of 20 46 years, Pakistan still ranks in the top five globally in terms of annual cotton production. Access to the material has provided textile manufacturers with a critical input and facilitated the country becoming a top-10 exporter of yarn and fabrics. The backward linkages have also allowed Pakistan to carve out a niche in certain product categories where the country’s limited supply of MMF materials does not act as a roadblock. Trousers are the most compelling example. If Pakistan is going to have a strong presence in one category, trousers are an advantageous one. Globally, they are the leading apparel export product. In 2014, 69% of all trouser imports around the world were cotton, 23% were MMF, 6% was other material and 2% were wool. That profile has suited Pakistan well. At a time when it has expanded its capacity for denim production, Pakistan ranked as the sixth largest individual trouser exporter in 2016 (seventh if the EU-15 is considered as one bloc), and the value of its exports are the third highest among the leaders. Table 14 below lists the world’s top 10 trouser exporters in 2016 and includes each market’s unit value. Table 14: Top 10 Global Trousers Exporters, 2016 Value Volume Shares (%) Unit Partner (US$, billions) (items, billions) Value Volume Value World 76.3 10.5 — — 7.3 China 19.8 3.3 26% 32% 6.0 Bangladesh 11.1 1.8 15% 17% 6.3 EU-15 9.2 0.8 12% 7% 12.1 Vietnam 5.6 0.9 7% 8% 6.6 Turkey 4.3 0.4 6% 4% 11.0 Cambodia 3.1 0.5 4% 4% 6.8 Pakistan 2.9 0.3 4% 3% 8.9 Indonesia 2.3 0.4 3% 4% 5.3 India 1.8 0.3 2% 3% 6.1 Mexico 1.8 0.2 2% 2% 8.7 Source: (UN Comtrade, 2002-2016c). Exports based on world imports from all countries. 2. Low labor costs distinguish country from some regional peers. While there are exceptions (Bangladesh is a prominent one), Pakistan’s wage rates are lower than many regional competitors (van Klaveren, 2016), especially large economies such as China, India and Indonesia. The relatively cheap labor provides Pakistan with advantages, especially since it can distinguish itself from lower-cost competitors such as Bangladesh with an integrated supply chain as well as capacity to produce export products with sophistication, including finishes on denim and trouser outputs. 3. GSP+ access to EU-15 markets. The EU-15 reaffirmed Pakistan’s GSP+ status in 2018, providing the country with preferential access to its markets. Under the scheme, 76% of Pakistani T&A exports—including trousers—qualify for duty-free access with as much as 80% receiving preferential rates. As highlighted through the report, the EU-15 has become Pakistan’s largest market for apparel products. All told, T&A products account for roughly 80% of all Pakistani exports to the EU-15 markets (EC, 2018a). 4. High rates of domestic ownership and vertical integration. Pakistan’s low levels of FDI offer both advantages and disadvantages. On the positive side, it affords a familiarity with 47 downstream activities such as marketing and distribution. Whereas branch plants of foreign owned companies usually only engage in assembly, Pakistan’s largest exporters are vertically integrated. They also tend to focus on one product, which suggests a sophistication with specialization and scale economies that serves as an advantage. The potential of moving into design and brand development is higher than Southeast Asian competitors such as Vietnam and Cambodia, which represents a significant opportunity since markets outside the US and EU do not have established sourcing relationships with East and Southeast Asian firms (Kumar et al., 2016). 5. Supporting environment provides industry with institutional foundation. Pakistan has numerous institutions and organizations specific to the T&A industry. One of the most prominent is the Ministry of Textiles, which sets policies and strategies for the entire sector. There are also a range of industry associations for each stage of the chain as well as an assortment of educational institutions. While each of these groups of stakeholders have shortcomings (see Weaknesses), their presence and engagement provides a foundation that often serves as a key impediment when these groups do not exist. 6. China-Pakistan Economic Corridor (CPEC) project could improve infrastructure. China and Pakistan’s ambitious CPEC project is slated to improve infrastructure throughout Pakistan, especially in areas that have textile capabilities. Improved roads and electricity facilities are potential benefits, and Chinese officials are reportedly interested in investing in Pakistani yarn and cloth production (Husain, 2017). 3.6.2. Constraints Despite the country’s strengths, Pakistan faces multiple challenges in the apparel industry. Some are sector-specific while others impair the country’s larger economy. Most have been entrenched for a long period of time. The most pronounced are explored in the subsection below, with the weaknesses that are unique to the apparel sector presented first before the discussion moves toward weaknesses that inhibit the competitiveness of Pakistan’s broader economy. 1. Cotton production is declining, and the quality is low. Despite its status as one of the world’s largest cotton producers, the country’s overall production level has been stagnant for some time, notwithstanding a dramatic plunge in 2015.38 Beyond the productivity challenges, contamination associated with the cotton is a concern. A number of reasons for the inferior output have been observed, including a pricing system that favors weight over quality, poor seeds and antiquated picking techniques (Batool & Saeed, 2017). Additionally, the government has supported other crops such as sugarcane to a higher degree in recent years, thereby depriving farmers of extension services while also distorting economic returns associated with agricultural activities (Field Research, 2018; (Batool & Saeed, 2017). Aggregated, these factors have pushed exporters to import cotton to meet internal demand, using the higher quality raw materials from other countries to blend for textile production that serves as an input for apparel. Although some of the sourcing from abroad is a means of accessing longer staple varieties that are unavailable domestically, the underdeveloped linkages between upstream 38 The drop was the result of a variety of challenges, some of which characterized the global industry and others that were more localized (pests, floods, human capital constraints and sub-standard inputs) (USDA, 2018). 48 and downstream actors serves as a constraint. 2. Gaps in the supply chain have limited product diversity and upgrading. Three product categories—trousers, knit shirts and sweaters/sweatshirts—accounted for 71% of Pakistan’s exports in 2016. In order to achieve greater product diversity, domestic companies need increased access to a variety of inputs. Apparel companies import cotton, dyes & chemicals, accessories & trim, and elastic in significant volume. The local supply chain also does not generate polyester and other MMFs in bulk. Without access to the MMF materials, apparel exports have largely concentrated on cotton outputs, thereby running against the grain in the global industry. MMF’s share of global apparel exports increased from 26% in 2005 to 35% in 2016; MMF apparel was only 9% of Pakistan’s exports in 2016. Clothing made from MMF has higher unit values compared to cotton: US$7.3 per unit compared with US$5.2 in 2015. 3. Concerns with lead times. The global section emphasized how lead times often determine whether businesses can integrate into the supply chains of lead firms. Previous studies have grouped Pakistan with South Asia’s least competitive countries in terms of lead times and reliability, primarily due to import logistics (Lopez-Acevedo & Robertson, 2016) (see Table 15 below). It should be stressed there is anecdotal evidence Pakistan’s industry has made improvements in this area, reducing it down from 4-6 months to as little as 35 days (Field Research, 2018). Furthermore, interviews with stakeholders indicated that current lead times do not appear to act as a major constraint for apparel manufacturers based on the country’s existing product mix, which does not rely on imported MMF materials to a significant degree. Although lead times associated with existing paradigm might not be disqualifying for firms supplying global buyers, if Pakistan looked to diversify its exports, they would likely emerge as a prominent issue. Delays associated with the country’s complicated tariff regime could be expected to add time to shipments. Pakistan’s apparel production centers are also more inland than competitors and not clustered in EPZs or SEZs. These features, combined with the country’s undistinguished road infrastructure, would be likely to act as a roadblock. Table 15: Hours to Process Import Container Through Customs Sri Lanka China Vietnam Pakistan Bangladesh India 130 158 170 294 327 350 Source: Lopez-Acevedo and Robertson (2016). 4. The supporting environment is fragmented. There are at least eight prominent industry associations with ties to Pakistan’s apparel industry, with each stage of the broader T&A value chain having its own body. While the Ministry of Textiles is the organization that should provide a holistic direction for the industry, that does not appear to be its focus, instead providing resources to each stage but not an overall direction (Field Research, 2018). With the sheer number of conflicting voices, there is not a body that provides unified direction for the entire chain. 5. Limited amounts of FDI leave parts of domestic sector disconnected from global industry. Although there are benefits associated with the limited amount of foreign ownership, there are also costs. Pakistan ranks among the lowest recipients of FDI in the apparel industry, which deprives it of access to new markets and inputs that could facilitate 49 product diversification. Moreover, the limited FDI deprives Pakistani firms of the ability to distinguish themselves in existing markets such as the US, which is potentially debilitating in light of the global trend toward supply chain consolidation. There are other possible benefits of FDI, including access to modern technology and skilled labor that may help local businesses refine internal processes. Table 16 presents a regional comparison on FDI, organized by countries that have the highest local ownership. Pakistan has the third highest share of national ownership (93%), trailing only Turkey and India. On the other end of the spectrum, Cambodia has the highest share of FDI (97%). Table 16: Foreign vs. National Ownership in Apparel Factories, 2017-18 Country National Foreign Joint Venture Total Factories Turkey 99% 1% 0% 695 India 95% 5% 0% 1,001 Pakistan 93% 5% 2% 134 South Korea 88% 11% 1% 177 Bangladesh 79% 20% 1% 579 China 79% 20% 1% 3,387 Sri Lanka 78% 17% 5% 202 Mexico 77% 21% 2% 211 Thailand 63% 34% 3% 111 Indonesia 54% 45% 1% 280 Vietnam 46% 54% 0% 628 Myanmar 14% 85% 1% 106 Cambodia 3% 97% 0% 263 Total 78% 21% 1% 8,110 Source: van Klaveren and Tijdens (2018). Note: Based on a database of apparel factories for 24 lead firms that included 8,110 production sites in 25 countries. While only countries with at least 100 factories were included in this table, the total line includes all locations. 6. Skills deficiencies continue to undermine sector’s potential. The high numbers of low-skilled workers have been widely identified as a constraint to growth in Pakistan’s apparel industry. The specific skills gaps often depend on geographic regions; however, an overarching characteristic is that businesses do not invest in formal training systems while government- run programs do not respond to industry needs or are not effectively implemented (Field Research, 2018; Nabi & Hamid, 2013). Key impediments include lack of coordination between the private sector and educational institutions on curriculum design and job placement, outdated training equipment and unqualified teachers (AASR, 2015). The issues exist throughout the chain, with shortages of candidates who could fill management positions at larger firms or provide leadership at SMEs for logistical and administrative challenges associated with complying with export regulations. 7. Complicated and inefficient regimes for trade, investment, taxes and tariffs. A reason for Pakistan’s low levels of FDI is its high tariffs and complicated tax regime, which has been widely identified as an impediment to growth and integration into manufacturing and agricultural GVCs (WTO, 2015a). While many of the challenges are systemic and not unique to apparel, the industry has been impaired by the assortment of taxes, duties and tariffs on a wide range of goods. Technically, SEZ and EPZs programs do exist, although most apparel 50 companies that export from Pakistan are located in neither.39 Table 17 below lists the factories located in Pakistan that have integrated into the supply chains of selected lead firms; it is instructive how few are located in SEZs or EPZs. Almost all stakeholders interviewed described the administration for these initiatives as weak or complicated (Field Research, 2018). Table 17: European Lead Firms Sourcing from Pakistan’s EPZs and SEZs Company Headquarters Suppliers Operations in Pakistan’s EPZs and SEZs 29 manufacturing factories (1 in EPZ); 10 processing factories (1 H&M Sweden EPZ) Inditex Spain No information Marks & Spencer United Kingdom 3 factories (0 in EPZ or SEZ) C&A Belgium & Germany 23 factories (1 in EPZ) Espirit Germany 17 factories (0 in EPZ or SEZ) Source: Richardson et al., 2017; Authors. The country’s tariff and tax programs are instead more important for apparel exporters; however, schemes such as the DDT, DLTL and DTRE are fraught with pitfalls, from complicated administrative requirements to delayed payments of refunds for tariffs on imports and other expenses (Field Research, 2018). The implications are expansive. The cost and complexity of importing synthetic fibers limits product diversification, and with the DDT and DTRE programs only providing rebates for direct exports, many businesses are discouraged from selling to local markets. Furthermore, with the complicated nature of the tariff regime and limited use of SEZs and EPZs, there is little incentive for foreign companies to establish operations in Pakistan. 8. Infrastructure and safety remain leading concerns. There are multiple challenges that industry stakeholders face that are beyond their control. Pakistan’s infrastructure has long been a concern, with its comprehensive network or roads, ports, railways, airports and electricity ranking 110th out of 137 countries (WEF, 2017). Energy infrastructure ranked 115th in the same surveys, and officials from the country’s leading apparel exporters almost universally list it as their top challenge (Field Research, 2018). With the 18th Amendment’s provisions that provinces have first right to energy resources, there is sometimes geographic discrepancies to the energy challenges.40 However, as a general rule, electricity prices threaten Pakistan’s competitive position. Estimates suggest that Pakistan’s knitwear manufacturers pay PKR 13 per unit for electricity compared to PKR 8-9 in Sri Lanka, India and Bangladesh, while uncertainties about its availability during production lead some buyers to view local suppliers as unreliable (Sandhu, 2018; Shaikh, 2015). Security is another example. The Global section of the report highlighted how political considerations can limit buyers’ willingness to meet and engage with stakeholders from risk- prone markets. Pakistan’s reputation and the corresponding travel advisories that have been instituted by the US government and others limit networking opportunities for Pakistan 39 The first EPZ established is located in Karachi and focuses on textiles with 18 garment and clothing factories; it had exports of US$358 million in 2014-15 (Richardson et al., 2017). 40 In 2012, for instance, businesses in Punjab suffered daily outages of 8-12 hours, which raised costs for companies that could afford to buy generators while slashing production for smaller firms that could not (Shaikh, 2015). 51 exporters. With the challenges, domestic companies must work through intermediaries or fly to nearby locations to meet with global buyers or new clients. 4. Lessons for Pakistan’s Upgrading in Apparel GVC from Global Experiences There are two pathways for upward growth in the apparel GVC. A country can pursue both simultaneously; however, the policies and skillsets needed to achieve these two paths are quite different. Table 18 below provides a summary of the individual economic upgrading trajectories. The first pathway is focused on expanding exports, particularly in volume and higher-value goods. It most often includes both product and process upgrading, which describes the following: • Product upgrading: The production of more complex products, which requires increasing the capabilities of the firm. As countries gain experience, they can move from low-cost commodities to higher value-added fashion goods that warrant higher returns as labor rates increase (e.g., progressing from basic to complex products). • Process upgrading: This reduces cost and improves flexibility by improving production methods; it requires capital investment and better worker skills to operate new machinery and/or information and logistics technology. A subcomponent of this strategy includes supply chain upgrading, which describes increasing backward linkages into textiles. The second path is towards functional upgrading into related service industries associated with apparel, including sourcing, supply chain management, design, product development, marketing and branding. The four main stages of functional upgrading in the apparel GVC are as follows: 1. Entry into the chain via Assembly/CMT: This is the most basic stage of the apparel industry. As outlined in the global section, CMT manufacturers are responsible for cutting, sewing, supplying trim, and/or shipping the ready-made garment. The buyer purchases the fabric and supplies it to the manufacturer, along with detailed manufacturing specifications. The contract manufacturer has a variety of customers and does business on an order-by- order basis. Work is frequently carried out in EPZs or similar geographic areas that offer tariff reductions for export production to the buyer’s country. 2. OEM/Full Package/FOB: The apparel manufacturer takes responsibility for all production activities, including the CMT activities, as well as finishing and distribution. The firm must have upstream logistics capabilities, including procuring and financing the necessary raw materials, piece goods, and trim needed for production. In some cases, the buyer specifies a set of textile firms from which the garment manufacturer must purchase materials; in other cases, the firm is responsible for establishing its own network of suppliers. The firm is also often responsible for downstream logistics, including packaging for delivery to the retail outlet and shipping the final product to the buyer at an agreed selling price. 3. ODM/Full Package with Design: This business model includes design in addition to manufacturing. A garment supplier that does full package with design carries out all steps involved in the production of a finished garment, including design, fabric purchasing, cutting, sewing, trimming, packaging, and distribution. Typically, the supplier will organize and 52 coordinate the design of the product; approval of samples; selection, purchasing and production of materials; completion of production; and, in some cases, delivery of the finished product to the final customer. Full package with design arrangements is common for private- label retail brands. 4. OBM: This is a business model that incorporates branding of products, in addition to or in lieu of design and manufacturing. Many firms in developing countries enter OBM with brand development for products sold on their domestic or neighboring country markets. While the progression from OEM to ODM to OBM is not altogether common, there are prominent examples, including countries such as Turkey. Table 18: Selected Upgrading Trajectories in the Apparel GVC Upgrading Description Trajectories • Assembly (CMT): The focus of the supplier is on production alone; suppliers assemble inputs, following buyers’ specification CHAIN ENTRY • Inputs—such as textiles, accessories, and packaging—may be imported due to (Assembly/CMT) limited availability and quality concerns over local inputs • Product focus may be relatively narrow • Increase unit value by producing more complex products, which requires PRODUCT increasing the capabilities of the firm UPGRADING • Countries must move from low-cost commodities to higher value-added fashion goods that warrant higher returns as labor rates increase • Machinery: improving productivity through new capital investments PROCESS • Information and Logistics Technology: improving the way the firm carries out these UPGRADING activities, which benefits both the firm and the chain because it reduces the total time, cost and increases the flexibility of the supply chain process SUPPLY CHAIN • Increasing forward and backward integration in production stages UPGRADING END MARKET • Diversifying or expanding sales to new geographic locations or types of buyers UPGRADING CHAIN/ INTERSECTORAL • Using the skills and knowledge acquired in apparel to move into another GVC. UPGRADING FUNCTIONAL • Firm takes on a broader range of tangible, manufacturing-related functions, such as UPGRADING sourcing inputs and inbound logistics, as well as production. (Full package/ • The supplier may also take on outbound distribution activities related to delivering OEM) the final product to the buyer’s preferred destination. • Supplier carries out part of the pre-production processes, such as design or FUNCTIONAL product development UPGRADING • Design may be in collaboration with the buyer, or the buyer may attach its brand (Full package/ to a product designed by the supplier ODM) • In many cases, ODM firms work with designers from the lead firms to develop new products • Supplier acquires post-production capabilities and is able to fully develop products FUNCTIONAL under its brand. There are two options: UPGRADING (1) Supplier maintains a relationship with the buyer and develops brand collaboratively. (Product Brand/ (2) Supplier establishes its own distribution channels by establishing a new market channel OBM) that is typically more profitable and allows the firm to expand skills. 53 Source: Authors; based on Frederick and Staritz (2012) 4.1. Case Studies In analyzing different prospective paths for upgrading in the Pakistan apparel industry, it is useful to look more in depth at specific examples from countries that have success in the apparel GVCs with different strategies. Two cases were selected for further examination: • Vietnam is an example of a country that has realized its potential in the apparel GVC. The country’s labor force is roughly comparable to Pakistan’s (57.4 billion for both; 1.3 million in apparel for Vietnam; 700,000-1 million in apparel for Pakistan), yet it has ascended to the position of the world’s fourth leading source of apparel with US$24.9 billion in exports in 2016 (see Figure 10). Its upgrading trajectory is most closely aligned with the first path described above (product and process upgrading). FDI has played a critical role, and export activity is broad based across all product categories. Designated industrial or export zones have played an important role in Vietnam’s apparel development. • Sri Lanka is an example of a country that outperforms some of its baseline metrics. The country’s apparel workforce and its overall GDP are both dramatically lower than Pakistan.41 Yet the country’s apparel exports are roughly on par with each other (US$5.1 billion in 2016 for Sri Lanka vs. US$5.7 billion for Pakistan). Moreover, Sri Lanka has used strategic JVs to build out its capacity in certain product niches as well as assist in the cultivating its design and branding capabilities (functional upgrading). Given Pakistan’s light footprint in the broader apparel industry, it might be an approach to replicate. Figure 10: Vietnam, Sri Lanka and Pakistan Apparel Exports, 2002-16 40 35 30 Apparel Exports (US$, billions) 25 20 15 10 5 0 2002 2004 2006 2008 2010 2011 2012 2014 2015 2016 Vietnam Pakistan Sri Lanka 41 Sri Lanka’s apparel workforce is 300,000 and its GDP was US$87 billion in 2017 compared to Pakistan’s US$305 billion (Sri Lanka EDB, 2016; World Bank database). 54 Source: Authors based on UN Comtrade (2002-2016). 4.1.1. Vietnam The apparel sector played a key role in Vietnam’s export-led development strategy. Other labor- intensive manufacturing industries such as footwear and electronics also became important export sectors during the 1990s, but apparel always played a catalytic role. Exports have then increased at rapid rates in the 2000s. Import data from Vietnam’s trading partners show an increase from less than US$6 billion in 2006 to US$24.9 billion in 2016, an annualized growth rate of 15.4%. That jump has allowed Vietnam to climb to the position of world’s fourth largest apparel exporter in 2016 while its share of global exports increased from 2% to 6.6% in the same period. Overall, apparel has accounted for between 12-14% of Vietnam’s total exports during that time. The sector is also significant employment generator. Official statistics from Vietnam’s General Statistics Office (GSO) report T&A employment of 1.58 million in 2015, with 85 percent of the total in apparel. Unofficial industry estimates typically state employment levels of 2 million or more workers (AFTEX, 2010; Better Work Vietnam, 2011; Saheed, 2012). Collectively the industries accounted for 25% of manufacturing employment in 2015 (GSO Vietnam, 2014b). A notable feature of Vietnam’s growth is that it has been comprehensive across product categories. Vietnam’s CAGR between 2005 and 2015 was greater than the world average in every area. Its share is the highest for coats (11% in 2015), but there are six other areas where it has at least 6% share. Figure 11 below presents Vietnam’s participation in the apparel GVC. 55 Figure 11: Vietnam in the Apparel GVC Source: Authors. Overall, Vietnam is not necessarily the most cost competitive country, but it is the closest country to matching China in terms of overall capabilities. China and Vietnam both perform better than expected when analyzing the unit values of exports alone. Vietnam’s rank by unit value varies across product categories, but it delivers in all other areas important to global buyers when choosing a sourcing partner as the first or second-ranked country. China and Vietnam’s ability to deliver in all non-cost related factors important to buyers is a key reason they have been able to continue export growth despite higher unit values (Frederick, 2016). Upgrading and Importance of FDI in Vietnam’s Apparel Industry Vietnam’s upgrading in the apparel GVC has mostly followed the path of increasing exports and backward linkages into textile production. Between 2005 and 2013, Vietnam’s average unit value for items increased from US$5.7 per item to US$5.9. The three subsectors in which Vietnam holds the most significant share of world exports are also those in which the country has unit values above the global average (coats, miscellaneous apparel and athletic wear). A critical feature of Vietnam’s apparel industry is the high volume of inflowing FDI. There are three types of firms in the country: state-owned enterprises (SOEs); domestically-owned private firms; and foreign-owned firms (including 100% foreign ownership and joint ventures). SOEs can be entirely funded with national or local capital, or joint stock companies (JSC) with over 50% state capital. Private domestic firms may operate as JSCs or private limited companies or collectives. 56 FDI in Vietnam’s T&A industry was approximately US$4.4 billion from 2000 to 2011, accounting for around 9% of total FDI during that time (see Table 19 below). While domestic private firms historically have accounted for the largest numbers of companies, FDI enterprises generate most exports. Firm- level apparel export data by apparel firms in 2015 indicates that two-thirds of exports were by foreign- owned firms. Table 19: Vietnam FDI, Total and T&C, 2000-11 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2000-11 FDI Total* 1.3 1.3 1.4 1.4 1.6 1.9 2.4 6.9 9.6 7.6 8.0 7.5 51.1 T&A FDI 111 236 406 386 201 426 617 689 530 185 169 450 4,408 T&A FDI 40 74 149 121 71 109 127 148 111 63 72 80 1,165 Projects T&A 9% 18% 29% 27% 13% 22% 26% 10% 6% 2% 2% 6% 9% Share Average 2.8 3.2 2.7 3.2 2.8 3.9 4.9 4.7 4.8 2.9 2.4 5.6 3.7 Value Sources: Frederick (2017). * = US$, billions. All other currencies in US$ millions. Ownership is dominated by South Korean and Taiwanese firms, with Hong Kong and Japanese businesses also active to a lesser extent. Foreign firms have entered JVs with SOEs and later increasingly set up 100% foreign-owned subsidiaries, which are focused almost exclusively on exports (Huy et al., 2001; Schaumburg-Muller, 2009). Other notable characteristics of FDI firms are its high rate of women employees (67% in 2011 for foreign-owned, compared to 31 and 37 percent for state and non-state) and higher pay than non-state domestic enterprises but less than state-owned (GSO Vietnam, 2014a). Foreign-owned firms are MNCs that operate in “closed” networks, with raw materials imported from global supply networks and sales coordinated from headquarter locations abroad. Nearly all export- oriented domestic firms are partially-owned by the Vietnam Textile and Garment Group (Vinatex), the former SOE that is now only partially owned by the government. Vinatex has approximately 120 companies in which it either (a) owns entirely, (b) holds partial ownership through JSC arrangements (c) is a partial owner through JVs agreements. Supportive Policies for FDI Vietnam has used different strategies to encourage investments. Vinatex played a key role, with its arrangements attracting foreign companies. The Ministry of Planning and Investment (MPI) is the government agency that coordinates specific policies related to FDI, including manufacturing zones that fall under three broad categories: Industrial Zones (IZs); Economic Zones (EZs); and EPZs. IZs and EPZs play an especially important role in attracting investments in Vietnam. Foreign capital is encouraged to locate in these areas through infrastructure and services such as electricity, water and communications. There are specific benefits associated with each. Industrial zones are designated geographic areas where the manufacture of products occurs. Projects located in the zone receive tax benefits such as 10% corporate income tax rates compared to 20% for other businesses as well exemptions and reductions for 4-9 years (Dezan Shira & Associates, 2013). EPZs are IZs that generate export products. They also receive tax incentives and benefits such as reduced land prices and reduced regulatory oversight. Critically, businesses in EPZs are exempted from tariffs on imports of inputs 57 provided they are re-exported as apparel products within 90-120 days. They also do not pay export taxes. Both IZs and SEZs have been used as an industry policy tool to promote inter-enterprise linkages. Several IZs have been planned to create industrial clusters such as T&A industry in Binh Duong and T&A IZs in Hung Yen. The project in Binh Duong featured a US$760 million investment by a Taiwanese company for textile dyeing and chemical fiber facilities (VIR, 2016). Other investments associated with the project included US$274 million yarn facilities. Whereas EPZ/IZs policies provide exporters with tariff and tax exemptions, Vietnam’s trade agreements offer preferential access to many markets. Vietnam has enjoyed duty-free market access to Japan since 2009 through the Vietnam-Japan EPA. For the EU market, Vietnam had GSP status, which traditionally reduced tariffs on exports from Vietnam export to the EU to 9.6% on average. In the wake of the US withdrawal from the Trans-Pacific Partnership,42 Vietnam’s government has agreed with the EU on the EU-Vietnam Free Trade Agreement (EVFTA). When it is finalized, tariffs on apparel exports to the EU will be reduced to zero (Fibre2Fashion, 2018). 4.1.2. Sri Lanka The export-oriented apparel sector has been the main source of growth of exports and formal employment for the last three decades in Sri Lanka. The industry contributes about 40% of total industrial production and directly employs around 300,000 people (Sri Lanka Export Development Board, 2016), which accounts for around 14% of the industrial labor force and 21% of the manufacturing labor force. Indirectly, more than 1.2 million people are dependent on the sector. Sri Lanka’s apparel exports were US$5.1 billion in 2016. The annual growth rate for the period from 2006 to 2016 eclipsed the global average (3.3% for Sri Lanka vs. 2.3% for the world). But while Vietnam is an example of a country that has increased its capabilities across almost all product categories and materials, Sri Lanka is more like Pakistan in that focuses on specific niches (see Figure 12 below). 42 Vietnam’s apparel exports to the US—its most important export market—face MFN tariffs. 58 Figure 12: Sri Lanka in the Apparel GVC Source: Authors. Intimate apparel (bras) and underwear/pajamas are the most prominent examples. Sri Lanka’s exports in the bras HS category rose from US$200 million in 2006 to US$600 million in 2016, an overall increase of 200% that helped push the country’s global share in the category from 2.9% to 6%. Underwear and pajamas—a related product category that features similar materials and companies active in the supply chains—followed a similar trajectory, jumping from US$531 million in 2006 to US$925 million in 2016. Sri Lanka now controls almost 5% of global export market share in that product category. Otherwise, the country has a relatively light market share in other goods, with accessories (2.5%) and baby apparel having the largest presence (2.2%). These are all the HS codes where Sri Lanka’s growth has concentrated in the most recent decade where trade data is available. Process upgrading is something of a prerequisite to be competitive in intimate apparel. The production of bras and swimwear, in particular, are complicated and demand a certain level of skill from suppliers. As a result, there is a degree of stability in the relationship between lead firms and their key suppliers, and the global competition is less cost sensitive. Outputs in these categories have also facilitated a degree of end market diversification. While the US and the EU-15 still receive 78% of Sri Lanka’s apparel exports, the share going to other countries increasing from 6% in 2006 to 22% in 2016. China, Russia and Australia have had the largest growth. Table 20 below provides a synopsis of the critical background data associated with Sri Lanka’s apparel industry. 59 Table 20: Sri Lanka’s Apparel Exports to the World Share of Apparel Value (US$, Billions) Change Exports 2006- 2006 2008 2010 2012 2014 2016 2006 2012 2016 16 Trousers 1.0 1.1 1.0 1.1 1.2 1.1 26% 25% 21% 13% Underwear, Pajamas 0.5 0.6 0.6 0.7 0.9 0.9 14% 15% 18% 74% Intimate Apparel (Bras) 0.2 0.3 0.4 0.5 0.6 0.6 7% 10% 13% 169% Knit Shirts 0.5 0.6 0.5 0.5 0.6 0.6 12% 11% 11% 23% Woven Shirts 0.3 0.3 0.3 0.3 0.4 0.4 7% 7% 7% 33% Accessories 0.1 0.2 0.2 0.3 0.3 0.3 4% 6% 7% 129% Sweaters 0.3 0.4 0.3 0.3 0.3 0.3 9% 6% 6% -3% Dresses & Skirts 0.2 0.3 0.3 0.3 0.3 0.3 6% 7% 5% 16% Baby 0.1 0.1 0.1 0.2 0.2 0.2 3% 4% 4% 97% Athletic 0.1 0.1 0.1 0.1 0.2 0.2 3% 3% 3% 62% Misc. Apparel 0.1 0.0 0.0 0.1 0.1 0.1 1% 1% 2% 92% Coats 0.2 0.1 0.1 0.1 0.1 0.1 4% 2% 2% -47% Suits/Formalwear 0.1 0.1 0.05 0.05 0.04 0.04 2% 1% 1% -48% Hosiery & Socks 0.03 0.04 0.03 0.03 0.03 0.02 1% 1% 0.4% -33% Total 3.7 4.3 4.0 4.5 5.4 5.1 39% By Fabric Knit (HS61) 1.7 2.2 2.1 2.4 3.0 3.0 47% 53% 59% 73% Woven (HS62) 2.0 2.1 1.9 2.2 2.3 2.1 53% 47% 41% 8% Top Five Export Destinations USA 1.8 1.6 1.2 1.6 1.9 2.1 48% 35% 40% 15% EU-15 1.7 2.3 2.2 2.1 2.3 2.0 46% 46% 38% 14% Russia 0.01 0.03 0.04 0.10 0.12 0.09 0% 2% 2% 625% China 0.00 0.01 0.01 0.02 0.05 0.09 0% 1% 2% 3403% Australia 0.01 0.01 0.01 0.03 0.05 0.06 0% 1% 1% 597% Source: UN Comtrade (2002-2016b) The role of JVs in Sri Lanka’s Apparel Industry Just as in Vietnam, FDI played a central role in Sri Lanka’s upgrading in the apparel industry. There are, however, points of differentiation between the two countries. Specifically, Sri Lanka’s gains are primarily the result of JVs between global buyers and large local firms—not direct investment, as in Vietnam. Most partnerships involved buyers that provided access to important markets as well as technology and knowledge transfers. Two of the larger Sri Lankan firms include MAS Holding and Brandix Lanka. Both are engaged in a variety of JVs. Brandix started in 1972 with the production of casual wear, largely woven bottoms. As part of its development, the company purchased several local firms and engaged in JVs with foreign and local firms. The company entered into at least eight JVs between 1990-2009, pursuing partnerships in the US, Hong Kong and the United Kingdom to expand supply chain linkages. Brandix has been the key domestic investor in the opening of apparel sundries plants in Sri Lanka for thread, buttons, hangers, elastic, and dyeing. The company has also spent money on knit and woven fabric facilities to meet part of its own demand as well as for external customers.43 43 In 2018, Brandix’s website said it was a US$750 million business that employs 48,000 people and has 42 production facilities in Sri Lanka, India and Bangladesh. 60 MAS Holdings started in 1987 and is Sri Lanka’s largest intimate apparel manufacturer. JVs have provided the company with critical advantages, including the following: 1) access to major brands and retailers such as Limited and M&S, Bhs, and Next; and 2) world-class apparel manufacturing technology (Barrie 2004). MAS Holdings also has JVs in other countries: India (Intimate Fashions), Maldives (Linea Clothing), Madagascar (Cottonline) and Vietnam (Fashionline). The intimate division produces for buyers such as Victoria’s Secret, Gap, Marks & Spencer and Nike (the largest four buyers). The active division produces for buyers such as Nike, Speedo, Adidas, Reebok, Ann Taylor and Columbia and involves mostly swimwear.44 The JVs have also indirectly led to other companies building facilities in Sri Lanka. MAS Holdings’ expertise in intimate apparel products can be traced to the JV with MAST Industries, which is the US- based sourcing arm for Limited Brands (IFC, 2007). That specialization allowed the company to enter Victoria’s Secret supply chain, which is also owned by The Limited. Over time, Victoria’s Secret has asked some of their raw material providers to relocate to Sri Lanka, including suppliers of various components that go into making bras and underwear, like lace and pads and also warp knit fabric (just-style.com, 2006). Advanced Forms of Upgrading in Sri Lanka’s Apparel GVC MAS and Brandix have both helped Sri Lanka’s apparel sector move into to higher value products. Lingerie is one example, with the product upgrading driven by the JV arrangements described above. A JV between MAST, MAS and Triumph was instrumental in starting the lingerie business in Sri Lanka in the end of the 1980s/beginning of the 1990s. Unit value analysis shows that Sri Lanka’s apparel exports have traditionally had higher unit values than other Asian apparel exporter countries, highlighting some of the country’s product upgrades (Tewari, 2008). While technology levels vary across the sector, the large manufacturers have invested in new technology and workforce development (JAAF, 2002). The Joint Apparel Association Forum launched the Productivity Improvement Program (PIP) in 2004 in the context of the Five-Year Strategy to reduce waste, provide leaner organizations and increase productivity in factories. The large manufacturers in Sri Lanka have been engaged in implementing lean manufacturing methods in their production processes to reduce wastage and lead times and lower production costs. The largest manufacturers have also invested in supply chain enabling technologies such as enterprise resource planning (ERP) systems as the efficient management of supply chains has become increasingly important in the apparel sector (Wijayasiri & Dissanayake, 2008). More recently, the three largest manufacturers have started to invest into environmentally compliant facilities due to growing concerns regarding the environmental impact of industries and pressure from buyers to adhere to environment-friendly standards. MAS, Brandix and Hirdaramani invested in “green factories” which ensures that environmental impacts are minimized, especially through the reduction of energy and water consumption.45 There have also been clear steps toward functional upgrading. An important part of the apparel sector in Sri Lanka today provides full manufacturing services offering input sourcing and at least an understanding of ODM activities. These efforts were driven by large manufactures such as Brandix 44 In 2018, MAS was a US$1.8 billion business, employs 44,000 people and has over 42 production facilities. 45 UNIDO recommended Brandix’s ‘green apparel factory’ as a model of sustainable production to manufacturers around the world. The 130,000 square-foot Brandix Eco Centre is the Group's lead manufacturing plant for Marks & Spencer and has been rated Platinum under the Leadership in Energy and Environmental Design (LEED) Green Building Rating System of the US Green Building Council (USGBC) (just-style.com, 2010). 61 and MAS that started in the early 1990s to increase their capabilities and develop broader services. They established their own design centers with in-house staff that worked closely with the design teams of brand owners. MAS has since established design studios in the UK, the US and Hong Kong to offer design solutions to its main customers Victoria Secret, Gap and Speedo. Brandix has not opened design centers abroad but marketing offices in New York and London to improve links with buyers (Wijayasiri & Dissanayake, 2008). Some large manufacturers have also established their own brands to move into the OBM segment. MAS developed a range of intimate wear under the brand Amante in 2007, which was a significant innovation as Sri Lanka’s apparel industry did not have any brands until that point. Amante was first introduced in Bangalore, Chennai and Hyderabad, but it hopes to expand across India and to the rest of South Asia with further potential in the Middle East. The brand caters to the middle and upper income class and competes with international brands such as Triumph, Etam and La Senza (Wijayasiri & Dissanayake, 2008). Holistic Government Policies to Attract JVs and FDI The prevalence of JVs in Sri Lanka’s apparel industry can be partially attributed to holistic efforts by the Sri Lankan government and Board of Investment to make the country attractive to outside investors. Beginning with the 200 Garment Factory Programme, which was initiated in 1992 and has been hailed as being a “turning point” for Sri Lanka’s apparel industry (Kelegama & Wijayasiri, 2004),46 the government has attempted to nurture the sector through a comprehensive set of policies designed to make Sri Lanka appealing.47 Some of the more notable strategies that have been employed include the following: • Tax concessions among other fiscal incentives. Sri Lanka offers a range of fiscal incentives to exporters, including concessions with income taxes, National Building taxes, the Ports and Airports Development Levy and VAT exemptions (WTO, 2016). While many of those benefits are available to all firms, the apparel has lower threshold for some incentives (WTO, 2016). Depending on the size of investments, large enterprises can receive tax holidays and incentives for between 6-12 years. • One-stop customs shops helps reduce wait times. The number of hours it takes Sri Lankan customs to process imports are among the lowest in the region (see Table 15 above). As part of its strategy to encourage investment, Sri Lanka’s EPZs offer customs facilities to simplify customs processes. There are 13 EPZs in the country, including two dedicated entirely to apparel manufacturing (WTO, 2016). • Duty-free imports of inputs and capital goods. All imports of textile materials, yarn, and related intermediate and capital goods required for the garment export industry are free of import duty (US Commercial Service, 2017). Table 21 below presents the import tariffs for Sri Lanka, Pakistan and other countries in the region. 46 The 200 Garment Factory Program set the goal of establishing 200 apparel factories in rural areas to help stimulate Sri Lanka’s economic development. It has been credited for increasing female participation in the sector (social upgrading). It also showed that female workers benefit from working in factories located close to their villages (Kumar et al., 2016). 47 It should be noted that not all have succeeded. The WTO noted that the incentive regime was complex and somewhat overlapping, and seems to have fallen short of the goals of expanding the industrial base, both product- and region-wise” (WTO, 2010). 62 Table 21: Import Tariffs for Inputs in Asian Apparel Industries Product Sri Lanka Pakistan India Bangladesh Cambodia China Vietnam Category Yarn Cotton 0% 5-25% 10% 5-10% 0% 5-6% 5% MMF 0% 0-10% 10% 5-25% 0% 5% 0-5% Woven Fabric Cotton 0% 15-25% 10% 25% 7% 10-14% 12% MMF 0-15% 15% 10-12.5% 25% 7% 10-18% 12% Knit Fabric 0% 20-25% 10% 25% 7% 10-12% 12% MFN Avg. Duties 3.5% 16.6% 12.2% 19.4% 5.5% 9.6% 9.6% (Textiles) Source: Kumar et al. (2016). There are other ways the government has boosted the sector, including infrastructure. Sri Lanka’s railroad, port and road infrastructure all rank between 55th and 61st in the world (WEF, 2017). In recent years, the government has made improvements to ports in Colombo and Hambanthota, which is on the southern tip of the island. The Hambanthota is a US$1.12 billion project that is part of China’s One Belt, One Road Initiative (Sri Lanka EDB, 2018). 4.2. Key Lessons for Pakistan Vietnam and Sri Lanka both offer lessons for Pakistan as it looks to increase growth in the apparel GVC. While both countries have pursued foreign investment to drive product and process upgrading in the sector, there are nuances that are worth accentuating. These include the following: • Vietnam’s growth in the apparel sector over the last 15 years has been dramatic. With annual growth of 15.4% in the period from 2006 to 2016, it has solidified its position as the world’s fourth-leading apparel exporter. Significantly, Vietnam’s expansion has been broad- based across product categories. Strong backward linkages have provided access to key inputs that support diverse manufacturing activities. Foreign companies generally locate in designated industrial or export zones. These are active components of the government’s strategies for attracting investors. • Sri Lanka’s participation in the apparel GVC exceeds expectations based on population and GDP figures. Growth in the sector centers on a narrow range of products, including intimate apparel (pajamas, bras and swimwear). JVs between the some of the country’s largest manufacturers and global buyers have been common. Foreign companies are willing to locate in Sri Lanka because of a comprehensive suite of strategies enacted by the government, including infrastructure investments, tax concessions, duty-free imports and one-stop customs shop. The supportive environment has helped Sri Lanka initiate more complicated upgrading activities, including functional, environmental and social. 5. Proposed Upgrading Trajectories for Pakistan Apparel GVC Pakistan has had some moderate success pursuing upgrading in the apparel GVC. The advances that can be quantified the most easily include product upgrading within the trouser category—denim manufacturers have moved into the supply chains of leading global brands such as Levi’s, and the unit value associated with Pakistan trouser exports increased 48% in the period from 2005 to 2016— process upgrading within the entire sector—interviews conducted for this report indicated that 63 many firms have reduced lead times from 4-6 months to as little as 35 days—and social upgrading with the increase of female workers—the average annual growth rate for women’s employment from 2010 to 2015 was 10% (Huynh, 2017). However, all these advances come with caveats; since women’s participation in the apparel sector is still among the lowest in the world, there are hesitations to even label the gains as social upgrading. There are plausible paths to generate increasing returns in the form of higher exports and employment opportunities. With its strengths—an integrated industry with high domestic ownership located in a country with a long history of producing cotton and relatively competitive labor prices— there are multiple options. The following section outlines the potential upgrading trajectories. It is loosely ordered by time horizon and complexity. In terms of greatest likelihood of success, Duke GVCC believes that Pakistan solidifying its position in existing products (the first upgrading trajectory) is the most straight-forward. The Sri Lanka case study highlighted countries in similar positions in the chain who have excelled by concentrating on a narrow sub-set of outputs. If, however, it is a priority for Pakistani stakeholders to increase exports across the board (like Vietnam), then it can pursue steps that will lead to product diversification. Both the long-range trajectories would require sustained vision and implementation strategies. In terms of probability, Pakistan could likely expect results in pursuing increased social upgrading, especially since it is starting at a low base. 1. Short- to medium-term product and process upgrading to solidify position in existing product categories. Pakistan’s largest category of apparel exports are trousers. Led by a strong cluster of denim manufacturers that have integrated into the supply chains of companies such as Levi’s and others, Pakistan is the sixth largest individual trouser exporter in the world, seventh if one considers the EU-15 as one bloc. While Pakistan’s annual growth rate in export value in trousers was 11.6% from 2006 to 2016, its global market share (4% by value, 3% by volume) indicates there is still room to grow. To sell more jeans and trousers and other product categories where Pakistan has a presence, stakeholders can concentrate on steps that increase direct connections with buyers. Human capital should also be a focus to increase awareness of fashion trends and brand awareness. Foreign investment would likely be a critical enabling factor. The case study on Sri Lanka offer examples on how it created investment environments that were attractive to global apparel companies and build its presence in intimate apparel. 2. Short- to medium-term product upgrading (diversification) by increasing backward linkages in supply chain. A defining feature of Pakistan’s apparel industry is the limited expanse of export products by type and material. The result is 71% of the country’s exports are concentrated in three product categories: trousers, sweaters/sweatshirts and knit shirts. Gaps in the supply chain with respect to MMF materials is a major reason for this specialization. Pakistan imported US$1.55 billion of MMF fabric, yarn and fibers in 2016. The “Backward Linkages” section of this report detailed other prominent import categories, including cotton, labels, trim and accessories. There is certainly reason to emphasize diversification. As detailed in the Global section, buyers are consolidating their supply base and looking for capable Tier I suppliers that can produce a broad range of products to reduce complexity and costs. Pursuit of this upgrading strategy would involve some of the same steps as solidifying positions in individual products; however, 64 the country’s complicated tariff regime should be a focus more so than stabilizing cotton production. FDI attraction can also target specific supply chain gaps, with trim and accessories manufacturers necessary to expand product diversity. 3. Medium- to long-term functional upgrading by moving into OBM & ODM activities such as design and branding. Because Pakistani firms are domestically owned and vertically integrated, the potential of moving into design and brand development is much higher than Southeast Asian competitors. In countries such as Vietnam where there are high rates of foreign ownership, the subsidiaries tend to cater to the needs of headquarters. That, in turn, limits the potential for functional upgrading in the country where manufacturing is located since higher-value activities often remain with the overseas headquarters. Strategic JVs in Sri Lanka have allowed major companies in that country—MAS and Brandix—to master skills that have supported moves into branding and design activities. With FDI dynamics less of a factor in the local industry, Pakistan could potentially engage in downstream activities such as design and branding, especially for regional countries where there has been less market penetration by leading global brands. 4. Medium- to long-term social upgrading by increasing share of women workers in the sector. As highlighted, the share of women workers in Pakistan’s T&A industry (36%) is lower than most peer countries, save for India. There is a myriad of reasons for the low female participation, including cultural norms, poor public transportation and inadequate child care options. While the situation is evolving, with programs sponsored by international aid organizations playing a prominent role, Pakistan’s low numbers of female workers is an opportunity to attract additional donor support. That could provide benefits for the sector, including increased productivity, and for the country as a whole, including poverty reduction and health and education outcomes.48 In countries such as Bangladesh and Cambodia where women already account for 80% or more of the apparel workforce, firms are (1) less likely to let workers miss work to advance skills, (2) families are unable to let women stop working for 3-6 months to attend training courses because they are dependent on female wages, and (3) international organizations are not as abundant in countries that already have high female participation rates. Donors are often keen on increasing female participation and are willing to provide funding for training programs to support such efforts. Pakistan’s domestic ownership could also prove advantageous since local management, if lobbied, would have the power to attempt to increase female labor force participation. 48 For an in-depth look at the benefits associated with women’s participation in the T&A workforce, see chapter 4 of (Lopez-Acevedo and Robertson (2016). 65 6. Appendix Table A-1: Worldwide Cotton Production and Exports, 2014-17 Volume (480-pound bales, 1000s) Share Country 2014/15 2015/16 2016/17 2014/15 2015/16 2016/17 Top Five Producers (Ranked by 2016/17) India 29,500 25,900 27,000 25% 27% 25% China 30,000 22,000 22,750 25% 23% 21% United States 16,319 12,888 17,170 14% 13% 16% Pakistan 10,600 7,000 7,700 9% 7% 7% Brazil 7,180 5,920 7,020 6% 6% 7% Top Five Exporters (Ranked by 2016/17) United States 11,246 9,153 14,917 32% 26% 40% India 4,199 5,764 4,550 12% 17% 12% Australia 2,404 2,828 3,727 7% 8% 10% Brazil 3,910 4,314 2,789 11% 12% 7% Uzbekistan 2,600 2,200 1,750 7% 6% 5% Source: USDA FAS (2018). Note: Each year of production data is from growing seasons that begin each August. Table A-2: Top 10 Apparel Importers by Year and Value, 2008-16 Value (US$, billions) World Share Partner 2008 2010 2012 2014 2016 2008 2010 2012 2014 2016 EU-15 153 143 144 165 152 45% 43% 39% 41% 40% United States 76 73 81 86 84 22% 22% 22% 21% 22% Japan 24 25 32 29 26 7% 8% 9% 7% 7% Hong Kong 18 16 15 15 12 5% 5% 4% 4% 3% Canada 7 8 9 9 9 2% 2% 2% 2% 2% Rep. of Korea 4 4 5 8 8 1% 1% 2% 2% 2% China 2 2 4 5 6 1% 1% 1% 1% 2% Australia 3 3 4 5 6 1% 1% 1% 2% 2% Switzerland 5 4 5 5 6 1% 2% 1% 1% 1% Poland — — — — 6 — — — — 1% Russia 4 5 8 7 — 1% 2% 2% 2% — Top 5 278 264 280 304 284 81% 80% 77% 76% 75% Source: UN Comtrade. Note: HS02, 61+62 codes. (—) indicates a country was not in Top 10 in given year. 66 Table A-3: Apparel Lead Firm Types and Examples Examples Lead Firm Types and Sub-Types Description US EU Like department stores, but Asda Hypermarkets, sell a wider variety of Walmart, (Walmart), Discount products; rather than Target, Tesco, stores private-label, the term Kmart Carrefour, Mixed “store brand” may be used Metro Retailers/ Marks & Mass Carry private label, Sears, Macy’s, Spencer, Merchants Department exclusive, or licensed JC Penney, Karstadt, El stores brands only available in the Dillard’s, Corte Ingles, retailers’ stores Kohl’s Harrod's, Retailers Debenhams Specialty stores that carry a REI, Dick's Specialty mix of brand types, Sporting stores including private, exclusive Goods and others Specialty Gap, Retailers H&M, Mango, Specialty Retailer develops & owns American New Look, Apparel Stores private label brands only Eagle, NEXT, C&A, (Private Label) available in stores Abercrombie TopShop & Fitch Firm owns brand name, but PVH, Ralph not manufacturing; Espirit, Brand Lauren, products are sold at mass Adidas, Hugo marketer Carter's, merchant stores and often Boss Non- Nike, Levi’s Brand owner through specialty store. Retailers Firm owns brand name and Brand manufacturing; more likely VF, Inditex (Zara) manufacturer to coordinate supply of Hanesbrands intermediate inputs Source: Frederick, 2015. 67 Table A-4: Selected Apparel-Related Private Labor Standards and Organizations Name Members Funding Model Scope Est. Certified Factories Global Fair Labor Yes: Buyers, Membership Fees Multi-industry, 1999/ 44 companies; Association Suppliers, Colleges, (Annual) majority apparel 2001 21 suppliers (2013) Workplace Civil Societies Worldwide 1,826 (2013); Responsible Application Fees; Multi-industry; China (33%), Accredited No 2000 Auditor Fees majority apparel India, BNG, Vietnam Production (~10% each) (WRAP) 3,388/892 (Total/T&A; Yes: Corporate Certification Multi-industry; SAI 8000 1997 2014, June); India (55%); Members Fees; Donations ~25% apparel China (21%) of T&A Regional/National Government, Fair Wear 1999/ Yes: EU Buyers (80) Membership Apparel 15 production countries Foundation 2001 Fees, NGOs Membership Fees Buyer Partners (28) (Annual) + Cost per Factory/Year GMAC, Cambodia: 500 factories 39 (2014) Cambodia Gov., 2001 (government mandatory) US DOL US DOL; Jordan Jordan: 60 factories 28 (2013) 2008 MOL (government mandatory) Haiti: 29 (all government — US DOL 2009 ILO/IFC Better mandatory) Apparel Work Programs SECO, Irish Aid, 43 (2014) NL MOFA, 2009 Vietnam: 200 factories Service Canada 7 (2014) US DOL 2010 Lesotho: 23 factories 9 (2013) US DOL 2011 Nicaragua: 23 factories 18 (2014) NL MOFA, SECO 2011 Indonesia: 100 factories US DOL, SECO, NL MOFA, — 2014 Bangladesh: n/a Service Canada, DFID, Travail Advocacy Groups/Initiatives Clean Clothes Yes: EU: trade Government & Campaign Apparel 1989 unions, NGOs Private (CCC) Source: Frederick (2015). 68 Figure A-1: Pakistan’s Raw Cotton Production, Imports and Exports, 2008-16 3,500 12,000 3,000 10,000 2,500 8,000 Production 2,000 Trade 6,000 1,500 4,000 1,000 2,000 500 0 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 Production Imports Exports Source: USDA Annual Reports. 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Exporters reject government's bond float plan for tax refunds. Retrieved January 1, 2019, https://tribune.com.pk/story/1878462/2-exporters-reject-govts-bond-float-plan- tax-refunds Theuws, Martje and Pauline Overeem. (2014). The abuse of girls and women workers in the South Indian textile industry. Netherlands: Centre for Research on Multinational Corporations (SOMO) and The India Committee of the Netherlands (ICN). http://www.indianet.nl/pdf/FlawedFabrics.pdf. 73 UN Comtrade. (2002-2016a). Textile and Textile Product Imports, HS02 (6-digits). Retrieved 8/21/15 (2002-14); 5/7/17 (2015); 12/13/17 (2016); 6/13/18 (2016; 11 new reporters), from United Nations Statistics Division (UNSD)from http://comtrade.un.org. ---. (2002-2016b). World Apparel & Textile Imports, HS02 (2-digits). Retrieved 8/22/15 (2002-2010); 5/4/17 (2015); 8/9/16 (2014); 8/11/16 (2011-13; replaced previous data); 11/23/17 (2016); Added 64 and 65 for 2002-16 (11/23/17); 6/13/18 (added 11 new 2016 reporters), from United Nations Statistics Division (UNSD)from http://comtrade.un.org. ---. (2002-2016c). World Apparel Imports, HS02 (6-digits). Retrieved 2002-2010 (8/22/15); updated 2014 (8/9/16); updated 2011-13 (8/11/16); added 2015 (5/4/17); added 2016 (12/14/17); added 11 reporters for 2016 that had not reported (6/13/18), from United Nations Statistics Division (UNSD)from http://comtrade.un.org. UNIDO. (1963-2014). Industrial Statistics Database: INDSTAT2-ISIC Rev3 (2016 edition). Vienna, Austria: UNIDO. ---. (2017). Implementation Handbook for Eco-Industrial Parks. Vienna, Austria: United Nations Industrial Development Organization (UNIDO). www.unido.org/sites/default/files/files/2018- 05/UNIDO%20Eco-Industrial%20Park%20Handbook_English.pdf. US Commercial Service (2017). Sri Lanka - Import Tariffs. US Commercial Service. Retrieved October 15, 2018, www.export.gov/article?id=Sri-Lanka-Import-Tariffs USDA FAS (2018). Cotton: World Markets and Trade. United States Department of Agriculture (USDA) Foreign Agricultural Service (FAS), 30. Retrieved October 26, 2018, https://apps.fas.usda.gov/psdonline/circulars/cotton.pdf van Klaveren, Maarten (2016). Wages in Context in the Garment Industry in Asia. WageIndicator Foundation, 126, www.wageindicator.org/main/Wageindicatorfoundation/publications/2016/wages-in-context-in- the-garment-industry-in-asia-full-report-and-handouts van Klaveren, Maarten and Kea Tijdens (2018). Mapping the Global Garment Supply Chain. WageIndicator Foundation, 74, https://wageindicator.org/documents/publicationslist/publications-2018/2018- garment-wageindicator.pdf VIR (2016). Binh Duong welcomes $760 million garment and textile project. Vietnam Investment Review (VIR), 1. Retrieved October 15, 2018, www.vir.com.vn/binh-duong-welcomes-760-million- garment-and-textile-project-42860.html Wage Indicator. (2018). Minimum Wage in Pakistan. Retrieved October 15, 2018, https://wageindicator.org/salary/minimum-wage/pakistan. WEF. (2017). The Global Competitiveness Report 2017–2018. Geneva: World Economic Forum (WEF). http://www3.weforum.org/docs/GCR2017- 2018/05FullReport/TheGlobalCompetitivenessReport2017%E2%80%932018.pdf. Wijayasiri, Janaka and Jagath Dissanayake. (2008). Case study 3: The ending of the multi-fiber agreement and innovation in Sri Lankan textile and clothing industry: Working Paper 75. Paris, France: OECD. www.oecd.org/dataoecd/18/55/41091122.pdf. WITS. (2018). Pakistan Trade Summary 2016. Retrieved October 15, 2018, WTO. (2010). Trade Policy Review: Sri Lanka. Geneva: World Trade Organization (WTO). https://www.wto.org/english/tratop_e/tpr_e/tp337_e.htm. ---. (2015). Trade Policy Review: Pakistan. Geneva: World Trade Organization (WTO). February 17. www.wto.org/english/tratop_e/tpr_e/s311_e.pdf. ---. (2016). Trade Policy Review: Sri Lanka: World Trade Organization (WTO). September 27, 2016. https://www.wto.org/english/tratop_e/tpr_e/s347_e.pdf. 74 Pakistan in the Offshore Services Global Value Chain January 2019 Prepared by Vivian Couto and Karina Fernandez-Stark Duke Global Value Chains Center, Duke University This research was prepared by the Duke University Global Value Chains Center on behalf and under the guidance of the World Bank. The report is based on both primary and secondary information sources. In addition to interviews with firms operating in the sector and supporting institutions, the report draws on secondary research and information sources. The project report is available at www.gvcc.duke.edu. Acknowledgements The Duke University Global Value Chains Center would like to thank all of the interviewees, who gave generously of their time and expertise, as well as the Sustainable Development Policy Institute (SDPI) for its extensive support during our field research in Pakistan. The Duke University Global Value Chains Center undertakes client-sponsored research that addresses economic and social development issues for governments, foundations and international organizations. We do this principally by utilizing the global value chain (GVC) framework, created by Founding Director Gary Gereffi, and supplemented by other analytical tools. As a university- based research center, we address clients’ real-world questions with transparency and rigor. www.gvcc.duke.edu Duke Global Value Chains Center, Duke University © January 2019 2 Pakistan in the Offshore Services GVC 1 Introduction............................................................................................................................................................. 6 2 The Offshore Services Global Value Chain ..................................................................................................... 7 2.1 The Global Offshore Services Industry ................................................................................................... 8 2.2 Offshore Services Global Value Chain .................................................................................................. 11 2.3 Distribution of Supply and Demand in the Offshore Services Global Value Chain.................... 15 2.4 Lead Firms and Governance .................................................................................................................... 17 2.5 Human Capital in the Offshore Services Value Chain: Skills and Gender .................................... 18 2.6 Standards and Certifications .................................................................................................................... 20 3 Pakistan in the Offshore Services Global Value Chain ................................................................................ 23 3.1 Pakistan’s Current Participation in the Offshore Services Global Value Chain .......................... 25 3.2 Industry Organization ................................................................................................................................ 27 3.3 Industry Evolution in Pakistan’s Offshore Services Global Value Chain........................................ 30 3.4 Human Capital and Gender of Pakistan’s Offshore Services Industry........................................... 32 3.4.1 Availability and Employability .............................................................................................................. 33 3.5 Advantages and Constraints .................................................................................................................... 37 3.5.1 Advantages............................................................................................................................................... 38 3.5.2 Constraints .............................................................................................................................................. 39 4 Lessons for Pakistan’s Upgrading in the Offshore Services Industry from Global Experiences ....... 42 4.1 Case Studies: India and Uruguay ............................................................................................................. 43 4.1.1 India ........................................................................................................................................................... 44 4.1.2 Uruguay .................................................................................................................................................... 47 4.2 Lessons Learned for Pakistan .................................................................................................................. 50 5 Recommended Upgrading Trajectories for Pakistan ................................................................................... 52 Annex I. Tables............................................................................................................................................................... 60 3 List of Tables Table 1. The Offshore Services GVC Horizontal Subsegments: Definitions and Total Contract Value in Q4 2017 (US$ million) ........................................................................................................................................ 14 Table 2. Job Profiles in the Offshore Services Global Value Chain ................................................................... 19 Table 3. Mandatory Quality Standards of the Offshore Services GVC ............................................................ 22 Table 4. Distribution of IT-BPO Exports, by Share in Exports (2018) ............................................................. 28 Table 5. Key Industry Stakeholders in the Offshore Services GVC .................................................................. 28 Table 6. Women in the IT Segment, Pakistan vs. Selected Countries .............................................................. 36 Table 7. SWOT of Pakistan’s Offshore Services Industry ................................................................................... 38 Table 8. Selected Upgrading Trajectories in the Offshore Services GVC ....................................................... 42 Table 9. Performance in the Offshore Services GVC; Pakistan, India and Uruguay ...................................... 43 Table A 1. A.T. Kearney Offshore Services Location Index, Selected Countries (2017) ............................ 60 Table A 2. Networked Readiness Index, Selected Countries............................................................................. 61 List of Boxes Box 1. Upgrading Trajectories of the Medical Transcription and Billing Company ...........................................................32 Box 2. English Skills in Pakistan: Issues and Challenges .............................................................................................................34 Box 3. Demographics of Pakistani Americans .............................................................................................................................35 List of Figures Figure 1. Market Size of the Global IT-BPO Industry, 2009 – 2017 ........................................................................................ 9 Figure 2. Global Outsourcing Deals (2010 – 2017) ...................................................................................................................10 Figure 3. Offshore Services Value Chain .......................................................................................................................................12 Figure 4. Geographical Distribution of Service Delivery Centers, 2011 – 2018 (%).........................................................15 Figure 5. Dynamics of Supply and Demand in the Offshore Services GVC (2018) ...........................................................16 Figure 6. Pakistan in the Global Services Location Index by A.T. Kearney (2016) ............................................................25 Figure 7. Pakistan’s Participation in the Offshore Services GVC, 2017 ................................................................................26 Figure 8. Pakistan’s ITO and BPO Exports, 2006 – 2017 .........................................................................................................30 Figure 9. MTBC Upgrading Trajectory in the Offshore Services GVC for the Healthcare Industry ............................32 Figure 10. Summary of Pakistan’s Offshore Services Industry Talent Pool (2017) ............................................................33 Figure 11. Educational Attainment of Pakistani American (2015) ..........................................................................................35 Figure 12. Share of Women Employed in the Low-end BPO Segment, Pakistan vs. World Leaders ...........................36 Figure 13. Pakistan and Competitors in the WEF Networked Readiness Index (2017) ..................................................37 Figure 14. Offshore Services Exports by Segment, 2000 – 2017............................................................................................44 Figure 15. Upgrading Trajectories of Indian Offshore Services Industry (left); Ratio of Median Value Added to Sales (left) ...................................................................................................................................................................................45 Figure 16. India’s Offshore Services Industry: Evolution and Policies ...................................................................................46 Figure 17. Uruguay’s Offshore Services Exports and Employment, by Segm ent ................................................................47 Figure 18. IT Services Exports from Uruguay: Product Development vs. Software Services ................................................48 Figure 19. Upgrading Trajectories of Uruguay’s Offshore Services Industry (left); Exports per Employee (right) ...49 4 Acronyms BOI Board of Investment BPM Balance of Payment and International Investment Position Manual BPO Business Process Outsourcing CMMI Capability Maturity Model Integration CRM Customer Resource Management ERM Enterprise Resource Management F&A Finance and Accounting FAST Foundation of Advancement of Science and Technology FDI Foreign Direct Investment FTE Full Time Employees GDP Gross Domestic Product GSLI Global Services Location Index GSP Global Services Program (Uruguay) GVC Global Value Chains HEC Higher Education Commission HIPPA Health Insurance Portability and Accountability Act HRM Human Resource Management ILO International Labor Organization ITC International Trade Center ITeS Information Technology Enabled Services ITO Information Technology Outsourcing KPO Knowledge Process Outsourcing LUMS Lahore University of Management Sciences MNC Multinational Company NSDC National Skills Development Center (India) NUST National University of Sciences and Technology P@SHA Pakistan Association of Software Houses PITB Punjab Information Technology Board PSEB Pakistan Software Export Board R&D Research and Development SEZ Special Economic Zone SLA Service Legal Agreement STEM Science, Technology, Engineering and Mathematics STP Software Technology Park WEF World Economic Forum 5 1 Introduction Pakistan entered the offshore services1 GVC in the mid-2000s, gaining recognition as an alternative offshoring location in 2009. By this time, India and the Philippines had already achieved maturity in the global market, as other countries in Eastern Europe and Latin America were emerging (e.g. Poland, Mexico, Czech Republic). Coupled with perception issues, the late engagement of Pakistan in the GVC places the nation in the initial stages of development. To date, leading global third- party providers have no presence in the country, with the majority of exports deriving from domestically-owned companies. In 2017, Pakistan exported US$655 million in offshore services, while India and the Philippines surpassed US$117 billion and U$25 billion in export revenues, respectively (ASEAN Briefing, 2017; NASSCOM, 2017a; PSEB, 2018). While underdevelopment is apparent vis-à-vis global market leaders, Pakistan’s offshore services exports have shown steady growth—15% CAGR in the 2008-2017 period (PSEB, 2018). Pakistan’s offshore services industry is centered on rudimentary Information Technology Outsourcing (ITO) sectors (e.g. software maintenance, troubleshooting management, website development). Driven by the growth of one single large company (6,000 FTE in Pakistan and 14,000 worldwide) funded by Pakistani-American in the early 2000s, the country is slowly expanding its participation in Business Process Outsourcing. Like in ITO, most BPO services are reckoned as transactional tasks (e.g. virtual assistance and voice-based customer support). Pakistan’s engagement in sophisticated sectors is embryonic but successful; by 2018, about half a dozen large companies provide high-end solutions to large verticals in the US, including Financial and Insurance, Healthcare and Energy.2 The entire IT-BPO industry is built on strong business ties with clients in the United States. Accordingly, the destination of about one half of IT-BPO exports is the United States (PSEB, 2018).3 Pakistan has been ranked amongst the top fifty economies to relocate IT-BPO processes since 2009 and is the most cost-effective location in the world in 2017 (A.T. Kearney, 2011, 2014, 2016, 2017). One highlight of the nation is its positioning in the freelance market; Pakistan is ranked as the fourth most popular country for freelancing in the world, according to the 2017 Online Labor Index by Oxford Internet Institute (OII)—after India, Bangladesh and US. 4 Main advantages of Pakistan’s offshore services industry revolve around its sizable talent pool and low labor costs. Quality of service and talent adaptability to foreign markets is evolving favorably. As awareness grows amongst foreign clients, the industry is projected to boom in the following five to ten years (Field Research, 2018). 1 Offshore services refer to services conducted in one country and consumed in a different country. It includes Information Technology Outsourcing, Business Process Outsourcing (BPO) and Knowledge Process Outsourcing (KPO). Information Technology Services (ITO) is the basic building block for the offshore services value chain and is centered around the production and use of software and IT services. Business Process Services (BPO) is a highly diverse category that contains activities related to the management of business functions. Knowledge Process Services (KPO) refers to specialized activities that often require professional licensing, such as in the legal, and financial fields. 2 Examples include IT security platforms for financial institutions (NETSOL Technologies), artificial intelligence platforms for the healthcare industry (e.g. ‘Afiniti’ by The Resource Group), and geoscience management solutions for the exploration and extraction of petroleum (LKMR). 3 For the pursposes of this report, offshore services is also under the name IT-BPO exports. 4 The Online Labor Index of the University of Oxford is the first economic indicator providing an online gig economy equivalent of conventional labor market statistics. It measures the supply and demand of online freelance labor across countries and occupations by tracking the number of projects and tasks across platforms in real time (Kässi & Lehdonvirta, 2016). 6 Looking forward, government stakeholders must reckon that the offshoring services GVC is generally largely dependent on foreign investment from developed countries such as the US and UK, and leading economies from the demand side, like India. Constrained by the country’s poor security perception, Pakistan will need to intensify its efforts to address challenges deriving from an ambiguous fiscal framework, inadequate specialized infrastructure, weak quality of tertiary level education, and limited budget for international marketing and investment attraction strategies. This report uses the Global Value Chain (GVC) methodology to understand how Pakistan participates in the global offshore services industry. GVC analysis has proven to be an effective tool for advising country governments on economic development and specific policies for industry upgrading. The study incorporates global and local analyses using both qualitative and quantitative data. Secondary information was used, including industry reports, journal articles and company data. Finally, a number of interviews were conducted during a field trip to Pakistan. More than 25 interviews with industry stakeholders were conducted, including private companies, educational institutions and Pakistani government officials. This report is structured as follows: first, it provides an overview of the offshore services GVC to present a clear understanding of the scope of the industry, how markets are structured and how changing distribution of demand and supply destinations alter structural dynamics in the chain. It then analyzes the industry within Pakistan, detailing the country’s position in the global market as well as the internal organization of the industry and the human capital status. After assessing the advantages and constraints observed in Pakistan, it looks to India and Uruguay for comparative case studies, detailing the lessons learned for Pakistan. The report concludes by outlining potential upgrading strategies to enhance the country’s competitiveness in the global market. Across the entire report, focus is placed on the opportunities than Pakistan can leverage in the export market, excluding the domestic market space. 2 The Offshore Services Global Value Chain Key Points • The industry has grown exponentially in the last decades. Companies from developed countries looking to improve their efficiency, decided to unbundle and offshore several of their non-core business operations. • Two of the leading suppliers of these services are India and the Philippines. Countries export services in three major forms: captive centers; global third-party providers; and domestically-owned third-party providers. • The offshore services industry refers to services produce in one country and consumed in a different nation. The broad categorization of services is as follows: Information Technology Outsourcing (ITO); Business Process Outsourcing (BPO); Knowledge Process Outsourcing (KPO); and services specialized by sector. The offshore services industry describes the trade of services performed in one country and consumed in another. This includes direct exports, as well as the international relocation of services activities that companies previously performed in their home country, ranging from software maintenance to research and development. To illustrate, in 1998 Microsoft established a 7 fully-owned division in Hyderabad (India) to become the largest R&D center outside the US. Ten years later, over 45% of the top 500 global R&D spenders such as Amazon, Boeing and Microsoft had established a captive center in India (Thakur & Ghosh, 2018). The relocation of activities can also be attained through international outsourcing, e.g. subcontracting a third-party provider based abroad. India is also the home of some of the top global outsourcing players in the world (Everest Group, 2018c). In 2017, India’s largest IT exporter (TCS) signed a US$2.25 billion outsourcing deal with Nielsen (a US television rating measurement firm) to provide a wide range of professional services like application development, management sciences, and financial planning (Business Today, 2017). The offshore services GVC consists of general business services that can be provided across all industries as well as services that are industry specific. The first category includes three main segments: • Information Technology Outsourcing (ITO) is the basic building block for the offshore services value chain and is centered around the production and use of software. • Business Process Outsourcing (BPO) is a highly diverse category that contains activities related to the management of business functions, including finance and accounting, procurement, supply chain management, and human resources management.5 • Knowledge Process Outsourcing (KPO) refers to specialized activities that often require professional licensing, such as in the legal, and financial fields. Examples of tasks within this category include: legal, business intelligence and data analytics services.6 2.1 The Global Offshore Services Industry Offshore services emerged as a dynamic global sector over the past two decades. The information and communication technology (ICT) revolution that began in the early 1990s transformed the way companies do business by allowing for the separation of the production and consumption of services. In the search for efficiencies and economies of scale, firms began offshoring and outsourcing a variety of corporate functions. Driven by the need to lower costs and access talent, firms looked beyond the boundaries of the developed world. This has provided important opportunities for growth and employment in developing regions. Firms are attracted to less developed countries as offshore destinations because of their competitive advantages in areas such as low human resources costs, technological skills, language proficiency, time zones, and geographic and cultural proximity to major markets. As more sophisticated work such as new product development, research and development (R&D), and other knowledge-intensive activities are performed abroad, the supply of scientific, engineering and analytical talent offered by developing countries has also become key in attracting firms. Measuring offshore services industry is not a simple task because official statistics do not provide accurate quantitative assessment.7 While the market figures for this industry may vary because of 5 List is indicative and non-exhaustive. 6 List is indicative and non-exhaustive. 7 Generally, countries do not collect detailed data on services exports within the global offshoring market frame. There are a relatively small number of trade classification codes to accurately identify services activities and companies have little incentive to disclose this information, while globally consensus has yet to be reached on how to collect data that correspond to appropriate definitions of services. In addition to this dearth of available 8 the different terminologies and methodologies adopted, private associations and consulting firms managing global outsourcing deals provide fair estimates. By 2017, estimations of the market size ranges from US$262 billion to US$1.3 trillion in revenues (Figure I), and around 6 million employees globally (Everest Group, 2018b; KPMG, 2017a; NASSCOM, 2018). Estimates from KPMG indicate that the offshore services industry grew at an average annual rate of 22.7% between 2012 and 2017, which is far greater than global GDP growth rates, which ranged from 2.5% to of 2.8% in this period (Figure 1). Figure 1. Market Size of the Global IT-BPO Industry, 2009 – 2017 1,400 1,299 10% 1,225 1,218 1,245 1,165 1,197 Market Size (US$ Billion) 1,200 1,067 8% 1,026 Growth Rate (%) 1,000 6% 800 4% 600 2% 400 0% 200 -2% 0 -4% 2010 2011 2012 2013 2014 2015 2016 2017 Estimation Annual Growth Rate GDP Annual Growth Rate Source: Authors based on Fernandez-Stark et al. (2011); IBI (2005); NASSCOM (2011, 2012, 2014, 2018); The World Bank (2018). Several trends have shaped the offshore services industry in recent years. The following are the most likely to create both threats and opportunities for Pakistan: 1. Global expansion and sophistication of Indian services providers. Between 2011 and 2018, the top ITO Indian providers (TCS, Wipro, Infosys and HCL) expanded their global footprint significantly, investing at least US$6,274 million in more than 132 new delivery centers (or expansions) around the world. The largest share of investment has been in Western Europe and North America (33% and 30%, respectively) while, the United States accounts for the largest portion of jobs (44%).8 The spread of Indian providers was accompanied by a strategic shift oriented towards engaging in projects focused more in business value and outcomes and less in the firms’ traditional cost arbitrage-based inputs (HfS, 2018). This, along with the following trends, suggests labor demand is increasingly leaning towards even more qualified talent and specific knowledge. and reliable data, the different methodologies adopted to quantify the size of the offshore services industry have resulted in widely varying estimates from disparate sources (Fernandez-Stark et al., 2011). 8 To illustrate, since May 2017 to August 2018, Infosys (India’s second largest ITO firm) hired over 4,700 in the US, including nearly 500 people for its technology hub in North Carolina. In addition, the company announced the creation of 10,000 new jobs in multiple innovation hubs across the US with a focus on artificial intelligence, machine learning and other emerging digital technologies. 9 2. Rise of intelligent process automation and digital technologies. Intelligent process automation in this report encompass latest productivity-enhancing ICT, including sophisticated business software packages and other technologies developed to better understand customer tastes and better tailor goods and services to identified needs. The combination of intelligent process automation with manufacturing, known as Industry 4.0, is expected to drive the offshore services market towards digitalization and automation. This adjustment is progressively diminishing the importance of traditional offshore services; hence, third-party providers have been moving their value proposition from labor arbitrage to automation arbitrage, developing hyper digital platforms such as ‘Infosys Nia’ and ‘Holmes’ by Wipro. 9 As the intelligence processes market develops, the labor demand will shift from computer science engineers to technology and data specialists with computational, design, systems, and management skills (CBI, 2017; EESC, 2017). 3. Increased complexity is pushing average contract value up. In line with increasing sophistication and digital transformation of the offshore services industry, between 2010 and 2017 the average value of global outsourcing contracts doubled, whilst the number of outsourcing deals, experienced a 38% fall. 10 In spite of this, in 2017, as much as 79% and 86% of ITO and BPO deals (respectively) were valued at less than US$100 Million (KPMG, 2017a). Thus, while companies will need to remain active in terms of upskilling and incorporating most up-to-date technologies, the services offshoring space is likely to continue to give room to small and medium-sized companies. Figure 2. Global Outsourcing Deals (2010 – 2017) 2,000 235 250 1,805 Outsourcing Deals (number) 1,800 Average Contract Value 1,590 1,600 1,464 1,473 1,444 200 (US$ Million) 1,400 1,200 1,077 1,114 150 115 891 1,000 99 800 100 600 400 50 200 0 0 2010 2011 2012 2013 2014 2015 2016 2017 Source: Authors based on KPMG (2014, 2017a). Note: Deals analyzed are offshore services contracts of size US$5 million and above only. The count and value of the deals may vary notably in reality and is only indicative of market movements and trends in the offshore services space. 9 ‘Infosys Nia’ is an AI platform that forecasts revenues and products need to be built, as it analyzes customer behavior, content of contracts, compliance and fraud (Infosys, 2017). HOLMES helps enterprises hyper-automate processes, redefine operations and reimagine their customer experiences (WIPRO, 2018). 10 This trend has also been recorded by other leading consulting firms, such as Everest Group, which evidenced a 20% increase in the average annual contract value of outsourcing deals in the 2014 – 2017 period (Everest Group, 2018g). 10 4. Automation is emerging as a threat to developing countries, but contact-center services delivery continues to grow. The threat of automation replacing humans, especially, contact-center representatives, has been intensively debated in the past decade. Yet, the contact-center industry is expected to continue growing, outpacing the US$91-93 Billion by 2020 (Everest Group, 2018a). Indeed, automation will reshape the processes within these operations, but technologies will most likely work alongside contact-center agents, not replacing them (Naumov, 2018). For instance, it can be expected that automation enables agents to pass on monotonous tasks such as tagging and categorizing emails or responding to basic queries and rerouting calls. This would enable more agents to focus on higher-level service interactions that contribute to customer satisfaction and retention (Clinton, 2018; Naumov, 2018). To illustrate, the largest provider of customer support services in the world, the Philippines, has increased its revenues from US$8.9 Billion in 2010 to an estimated US$22.9 Billion in 2016; within this period, employment grew from 0.5 to 1.2 million (Site Selection Group, n.d.; TESDA, 2017). In brief, customer experience will continue to be heavily dependent on high-empathy and creativity skills, thus on human talent (Clinton, 2018; Fersht & Snowdon, 2018). In addition to the behavior resistance to automation, evidence shows technological and organizational barriers to adopt automation in the short and medium term. The proliferation of ecommerce is also a source for additional contact-center demand (Franca et al., 2018). 2.2 Offshore Services Global Value Chain The offshore services GVC is composed by different functions which can be organized according to employee education and experience level. As seen in Figure 3, these functions can be subdivided in horizontal services provided across all industries (presented on the left of the diagram) and vertical services specific to particular sectors of the economy (presented on the right). The activities included in horizontal services support generic business functions and rely on process expertise. These services range from manual, repetitive, and transactional processes to judgment- based operations that depend on analytical skills. Overall, there are three horizontal main segments, described in the text below. Table 1 describes its subsegments thoroughly, providing examples and total contract value by 2017. Information Technology Outsourcing (ITO). This segment dominates the global outsourcing space with a contribution of 52% of the total deal value in 2017 (KPMG, 2017a). Most ITO contracts (85%) combine services belonging to two or more subsegments. The bundling of several ITO services into one contract grew from US$7.2 in Q4 2015 to US$21.2 in Q42017 (KPMG, 2017a). In brief, large organizations are hiring less service providers able to provide a wide range of solutions rather than multiple specialized vendors. On the meantime, high value-added activities, such as Product Development and Intelligent Process Automation, still capture a very small share of the market, contributing to 3% of ITO contract value in Q42017 (KPMG, 2017a). 11 Figure 3. Offshore Services Value Chain Source: Authors. Notes: This diagram captures the industries with the highest demand for offshore services. (a) Each industry has its own value chain; within each of these chains, there are associated services that can be offshored; (b) This graphical depiction of vertical activities does not imply value levels; each vertical industry may include ITO, BPO and advanced activities. Business Process Outsourcing (BPO). The segment accounts for 18% of worldwide outsourcing contract value (KPMG, 2017a). BPO can be subdivided into two categories: low-end BPO and high-end BPO. Low-end BPO consists of customer support services primarily, and accounts for 0.4% of the entire BPO contract value in Q4 2017 (KPMG, 2017a). High-end BPO comprises repetitive yet judgment-based activities such as finance and accounting, human resources management and supply chain management. These accounted for 7%, 27% and 30% of BPO revenues in Q4 2017, respectively (KPMG, 2017a). Opposite to ITO, BPO contracts combining several BPO services accounted for 4% of total contract value in Q4 2017 (KPMG, 2017a). This suggests that specialization is far more important in the BPO segment as compared to the ITO segment, which is more likely to favor large organizations able to provide a wide range of solutions within one single contract. Knowledge Process Outsourcing (KPO). This segment captures the highest value-added of horizontal services in the chain, such as market intelligence, business analytics and legal services. While KPO and BPO require different levels of qualifications and expertise, they frequently involve similar functions. As a result, statistics are difficult to separate; thus, several consulting firms would include KPO data within the BPO segment. These indicate that 10% of BPO deals in Q4 2017 entailed KPO solutions, adding to US$41 million (KPMG, 2017a).11 11 Unfortunately, more concrete and reliable estimations of this segment are currently not available. 12 Vertical services require specific industry knowledge. These may be so highly specialized to their sector that they have limited applicability in other industries; for example, information security software for the finance industry, loyalty program management in the travel and hospitality sector, and transcription services in the medical sector are vertical services (Fernandez Stark & Gereffi, 2016). In the GVC literature, value is generally determined by examining the transformation of inputs to outputs at each stage. Inputs in the services sector, however, are intangible, including factors such as critical thinking, analytical and communication skills. This creates difficulties in accurately depicting “value-add”. However, industry analysis shows that participation in different stages of the GVC depends primarily on two key factors: labor costs and expertise (Fernandez Stark et al., 2011). Value in the classification scheme presented in Figure 3 is thus determined by using human capital requirements as a proxy, that is, the approximate employee education and experience level required to perform different service functions for each stage (Fernandez Stark et al., 2010). Employees located in the lower part of the value chain diagram have less education and experience, while the employees in the upper section of the value chain are more educated and have more years of experience. By indicating the human capital required at different levels of the offshore services value chain, this classification scheme provides decision-makers with an instrument for determining where they may be best suited to play a role in the industry (Fernandez Stark & Gereffi, 2016).12 12 Section 2.5 provides more detail on Human Capital in the Offshore Services GVC. 13 Table 1. The Offshore Services GVC Horizontal Subsegments: Definitions and Total Contract Value in Q4 2017 (US$ million) Subsegment Description Value (Share) (a-b) Information Technology Outsourcing: US$ 24,950 Million (Q4 2017) Infrastructure Management of software applications, network resources, and services 200 required for the existence, operation and management of an enterprise (1%) IT environment. Examples: data center outsourcing, network management, hardware deployment and support, hosting services. Software Services Pre-defined support and maintenance solutions adapted to software 2,600 products owned by foreign clients. Examples: remote troubleshooting, (10%) installation assistance, basic usability assistance IT Consulting Advisory services that help clients assess different technology and 250 methodology strategies and, in doing so, align their network strategies (1%) with their business or process strategies. Examples: Assessment of network requirements and formulation system-implementation plans (advisory services): development of logical design of network environment and supporting infrastructure (architecture planning); advising on the rollout and testing of new network deployments (implementation planning). Product Development and trade of own software packages, applications or digital 0 Development platforms, owning the IP of all new software. Examples: packed, mass- (0%) market software. Intelligent Process Solutions where technology used is smart (e.g. robotics, chat bots, image 700 Automation (IPA) recognition, machine learning) and can be utilized to automate processes. (3%) Examples: Specification of detailed instructions for robot to perform (process development); assignment of jobs to bots and monitoring activities (robot control). (a-b) Business Process Outsourcing: US$ 7,156Million (Q4 2017) Finance and Services belonging to the Finance and Accounting function of 1,517 Accounting organizations. Examples: accounts payable, accounts receivable, general (22%) ledger, financial reporting, treasury and cash management. Human Resources Service belonging to the management of organizations’ personnel. 3,981 Management Examples: recruiting, training, payroll, administration of health benefits (56%) plans, retirements plans, and workers’ compensation insurance. Procurement and Solutions pertaining to Procurement, Logistics and Supply Chain 384 Supply Chain Management functions of organizations. Examples: management of logistic, (6%) Management purchase orders process, support of internal category managers. Content/Document Document and content management solutions to support the business 28 Management functions of organizations. Examples: document shredding, storage and (0.1%) imaging. Contact/Call Center Customer Relationship Management (CRM) solutions and services. 28 Examples: outbound calls, inbound calls, voice-based technical support, (0.4%) support through social media. Marketing and Sales Management of sales and marketing functions of an organization. n.d. Examples: design of marketing strategy, lead generation, management of sales pipeline to social media. Source: Authors based on Gartner (2018); Golecha (2018); KPMG (2017a); Arvato Bertelsmann (2017). Notes: This table captures the segments with the highest demand for offshore services, thus KPO is excluded. (a) Total value of service offshoring deals of size US$5 million and above only. (b) Total includes other ITO or BPO services, as well as bundled services, which describes any combination of two or more ITO or BPO subsegments. Value and shares are retrieved from KPMG member firms’ research and analysis based on IDC contract database. 14 2.3 Distribution of Supply and Demand in the Offshore Services Global Value Chain The supply of offshore services is principally located in developing countries, mainly concentrated in two countries: India and the Philippines. Driven by low-cost yet educated labor forces, combined, these economies account for about 70% and 63% of global Full Time Employees (FTE) and revenues, respectively (Everest Group, 2017). Nearshore Europe (e.g. Poland, Ireland, Scotland and Ukraine) is the second largest offshore services workforce, accounting for 14% of total FTE. Third in place is Latin America and the Caribbean (LAC), followed by Africa (10% and 6%, respectively) (Everest Group, 2017). While still leading supply, Asia Pacific’s portion in the offshore services industry has been gradually declining since 2011 (Figure 4).13 Currently, seven countries from the region rank in the first ten positions on one of the most reliable offshore locations rankings, the Global Services Locations Index (GSLI).14 These economies are: India, China, Malaysia, Indonesia, Vietnam and Philippines. Almost two thirds of Asia Pacific’s share of the global market is composed by India and Philippines (42% and 20%, respectively) followed by Singapore (13%) and Malaysia (10%). The remaining 15% is scattered amongst other countries within the South Asia and East Asia and the Pacific regions (Everest Group, 2017). Within the ITO segment, India remains the leader for large-scale projects, as measured by revenue and scale of IT-ready resources. The second most attractive location within the GSLI, China, continues to make extensive investment in an effort to leverage ITO scale and compete for coveted market share (Longwood et al., 2017). Figure 4. Geographical Distribution of Service Delivery Centers, 2011 – 2018 (%) 100% 8% 18% 16% 16% 19% 20% 26% 29% 80% 34% 23% 31% 60% 26% 40% 38% 41% 23% 40% 58% 59% 53% 20% 48% 44% 43% 48% 39% 0% 2011 2012 2013 2014 2015 2016 Q4 2017 Q1 2018 Asia Pacific Nearshore Europe, Middle East and Africa Latin America and the Caribbean Source: Authors based on Everest Group (2018b, 2018e); Srivastava and Raychaudhuri (2017). Note: Asia Pacific includes both ‘South Asia’ and ‘East Asia and the Pacific’ categories from the World Bank. Demand is concentrated in developed countries. The largest buyer of the offshore services industry is North America (namely the US), accounting for 36% of the international outsourcing 13 ‘Asia Pacific’ includes both ‘South Asia’ and ‘East Asia and the Pacific’ categories from the World Bank. 14 The Global Services Location Index (GSLI) is elaborated by one of the few most respectable consulting firms in the offshore services industry: A.T. Kearney. It evaluates 55 countries against 38 measurements across three major categories: financial attractiveness, people skills and availability, and business environment. Financial factors constitute 40% of the total weight in the published Index. The two remaining categories – people skills and availability and business environment – constitute 60% of the total weight (A.T.Kearney, 2017). 15 deals announced in 2017. The European Union follows with 28% of total share, while the UK accounts for 12% of the demand side, a slowdown from 2015 due to Brexit (Everest Group, 2017). The map in Figure 5 illustrates the geographical distribution of supply and demand in this industry by country. To create this map Everest Group surveys national trade promotion and investment attraction agencies, or private associations from each colored country. While Pakistan would classify as an “nascent location”, the country did not provide any formal information to Everest Group as to be placed on the map. This information already suggests limitations in marketing efforts. At the firm-level, demand for offshore services is led by large firms and MNCs with global operations. The scope and size of their activities and the complexity of their infrastructure and systems led to significant operational costs, which, in turn, impacted their competitiveness. High overhead pushed MNCs to look for strategies to reduce costs, including establishing delivery centers in low-cost countries or alliances with outsourcing providers. In 2017, three quarters of deals were made by companies with annual revenues exceeding US$ 1.5 Billion (Everest Group, 2018d).15 Figure 5. Dynamics of Supply and Demand in the Offshore Services GVC (2018) Source: Everest Group (2018b). Notes: Analysis based on headcount for offshore services exports in 2015, i.e. FTEs employed locally in offshore services exports across IT and BPO activities. References: Nascent locations (<20,000 FTEs); Emerging locations (20,000 – 100,000 FTEs); Established locations (100,000-500,000); Mature locations >500,000 FTEs). Information is based on country or city-level investment promotion agencies, Offshore Services organizations, and Everest Group. Source geographies represent most relevant demand markets. 15 Demand levels differ by industry: the largest share of buyers from ITO and BPO deals is controlled by the Government sector (24%), followed by the Banking, Financial Services and Insurance (BFSI) sector with 16% of share, and the Technology and Communication industry, with a portion of 12% (Everest Group, 2018d). 16 2.4 Lead Firms and Governance The industry is composed of three groups of key players that govern the industry: (i) captive centers; (ii) global third-party providers; and (iii) domestically-owned third-party providers (Gereffi & Fernandez-Stark, 2010). Each group represents a distinct delivery model. These are examined below: Captive centers are divisions or subsidiaries of multinational companies that provide services to the home company from a nondomestic location. This business model allows the organization to keep control of their internal operations while reducing costs by establishing in less costly locations. In 2018, enterprises such as Alibaba, Analog Devices, BMW, Cisco Systems, Dropbox, Samsung and Volkswagen opened captive centers performing digital functions in countries different to their headquarter (Everest Group, 2018f). Global third-party providers are large specialized companies providing a wide range of IT and BPO services to different clients. The latter select these providers based on competitiveness factors; in 2018, Centers for Medicare and Medicaid Services (US) selected Intelenet (earlier Serco) for analytics services, while KMD selected IBM for cloud services (Everest Group, 2018f). Among the top 20 ITO services providers, 12 are based in the United States and other developed countries (e.g. Accenture, Cognizant, IBM, Capgemini) while 8 are new multinationals from India like Infosys, HCL, Wipro and Tech Mahindra. During the 2000s, third-party providers acquired sufficient maturity and financial capability to assume operations not only in their own country but others as well. Establishing delivery centers in new emerging locations enabled third-party providers to mitigate concentration risk and take advantage of skills and time zones, as well as to tap into new markets. By 2018, TCS had over 147 delivery centers in 21 countries (TCS, 2018a). More recently, third-party providers partnered with specialized firms to accelerate their entry into higher value- added segments. To illustrate, in 2018 IBM partnered with a Russian oil producer (Gazprom Netf) to develop new technologies in the areas of Artificial Intelligence, predictive analysis, big data, and industrial IoT for improved efficiency of geological exploration and production of onshore oil reserves (Everest Group, 2018f). The third group is comprised by domestic firms based in developing countries which provide IT and BPO solutions for clients abroad, such as NETSOL Technologies and Systems Limited (Pakistan). Different to global third-party providers, these organizations are well less internationalized, with most exporting to regional markets rather than to the US or Europe. SMEs and freelancers with more than 50% of revenues in exports are included in this category. The governance structure of the industry varies depending on the segment of the GVC. In the lower stages of the chain, interaction between buyer and supplier is limited; the latter is confined by detailed customer’s specifications and obligations comprehensively described in a Service Legal Agreement (SLA). In these stages, third-party providers are selected based on cost primarily. As value-added increases, the interaction between client and supplier is greater and the relevance of cost diminishes. Due to higher transactional costs, the relocation high-value added functions, such as business analytics or legal services is predominantly done through captive centers (Fernandez- Stark et al., 2011). 17 2.5 Human Capital in the Offshore Services Value Chain: Skills and Gender The educational level and skills in local workforces have been key drivers of location decisions in the offshore services industry. Providing services in any level of the value chain, be it through entry in the value chain or upgrading, thus depends on the availability of required labor qualifications, technical, and soft skills (Fernandez Stark et al., 2011). Table 2 outlines the different educational profiles and training requirements for each segment of the GVC. Formal education is used as a preliminary screen for potential recruits; in fact, the worldwide offshore services industry employs predominantly tertiary level students. Soft skills are required and are consistent across countries; these include communication skills (e.g. active listening and voice clarity, basic computer skills, and language ability) critical thinking, creativity, and complex problem solving thinking (Gereffi et al., 2011; KPMG, 2017b). Experience in developing countries has shown that although these may not be adequately covered by official education systems, strategic investments in workforce development by the public and private sectors have been critical in improving competitiveness and positioning in the global market. These include selective competency-based hiring, minimum formal education, induction sessions, specialized and on-the job training, skill certification, mentoring, and leadership development programs (Fernandez Stark et al., 2011). 18 Table 2. Job Profiles in the Offshore Services Global Value Chain Formal Education Skill Position Job Description Training/Experience Requirements Level ITO Maintains equipment and network Specific technical courses, Technical diploma / IT Technician devices, provides software support for on-the-job training, and Degree updates experience IT Software Programs software applications for Technical diploma / Software programming Programmer general or customized use degree courses and certifications Provides advice to help firms align IT Master’s degree in Consulting/management IT Consultant strategy with their business goals Engineering experience Bachelor’s / Master’s / Designs, develops, and programs Software R&D Doctoral degree in Software programming innovative software packages and Engineer engineering/computer courses and certifications functions science BPO Answers in-bound calls regarding High school / Two-three-week of Call Center specific products and provides general Bachelor’s training and on the- Operator customer services. degree job training Provides accounts receivable and Finance and accounts payable processing, High school / Technical training and on- Accounting reconciliations, ledger keeping, and Technical institute the-job training Analyst income and cash statement diploma in accounting monitoring. Marketing and Supports inbound and outbound sales, Technical / Short training and on-the- Sales sales order processes, and customer Bachelor’s degree job training Representative monitoring. BPO Quality Ensure BPO agents meet specified Technical and Assurance and Technical training and on- client service standards and university-level Team the-job training monitoring agent performance professionals Managers KPO Provide guidance to businesses and individuals making investment Bachelor’s degree in Charted Financial Finance decisions; assess the performance of business Analyst (CFA) Analyst stocks, bonds, commodities, and other administration Certification types of investments. Provides business services, such as Bachelor’s / Business market research, business opportunity Master’s degree Experience Analyst assessment, strategy development, in business and business optimization. administration Reviews and manages contracts, Experience and training in leases/ licenses. May provide litigation Legal Analyst Law degree specific country legal support or intellectual property systems services Undertakes projects to increase the Master’s/Doctoral Experience/industry Researcher stock of knowledge; develops new degree specialization products based on research findings. Skill Level: Medium-High: Technical Low-Medium: Literacy and Medium: Technical High: University degree and Education/Undergraduate numeracy skills; experience education/certification higher Degree Source: Fernandez Stark et al. (2011). 19 Gender dynamics vary significantly across the different segments of the offshore services GVC. In the lowest stages of the GVC, female employees are predominant. In the global call center workforce, 71% of agents are women (Hultgreen, 2018). Despite this figure suggest significant gender integration, the share of BPO female workers decreases in developing countries, falling to 52.5% in the Philippines and 31% in India (David, 2015). Within this service segment, female employment in call centers is mostly at the agent level, while management is typically male dominated (Ahmed, 2013; Messenger & Ghosheh, 2011; Schwarzer, 2015). To illustrate, in 2016, one quarter of the Indian IT-BPO management were females (Economic Times, 2016). The reasons behind this relate to the strong gender bias in role assignation: women struggle to attain promotion due to disruption in family life and difficulty to balance between the dual burden of work and home. Worldwide, the ITO segment presents significantly different gender dynamics. Females are vastly underrepresented in Silicon Valley tech jobs, as well as in South and East Asia economies becoming technology hubs; to illustrate, 70% of India and Singapore’s tech workforce are male (Agarwal & Malhotra, 2016; Spenser, 2017). Barriers faced by girls and women in South and East Asia include: lower access to ICT tools and connectivity; limited time to pursue skill adoption due to domestic and care work; limited mobility; online harassment; limited gender-sensitive content in ICT training; weaker networks to leverage in job search and greater discrimination as compared to men (SPF & Dalberg, 2017). In addition, female IT workforce is still highly stratified, with the largest numbers of female workers concentrated in entry-level positions and lower-tier segments: by 2011, only 3% of female employees in IT occupied senior roles, 16% were middle management, and 81% were junior (Powell & Chang, 2016). In addition, the Indian IT workforce is largely urban and middle and high class and hail from educated families (Agarwal & Malhotra, 2016). Even when women do enter the IT workforce, most are bound by lifecycle factors such as marriage, childbirth and domestic work (Agarwal & Malhotra, 2016).16 These create severe barriers for females’ career development women in an industry that requires continuous training, application and long-work hours. 2.6 Standards and Certifications In order to regulate the quality of services, as well as to enable transparency and comparability, the industry has developed a number of standards and certifications. These provide a common language and help to define service requirements, customer expectations and recognized terms and definitions. They also reduce the risks that might affect customers, such as data security vulnerabilities. Relevant certifications and standards for companies are summarized in Table 3.17 At the firm level, data security and intellectual property protection continue to be increasingly critical, especially in the BPO segment.18 To address these concerns, global buyers and customers 16 In India, one third of women that ultimately drop out of the IT industry attribute it to the lack of suitable employment opportunities. Assigned social roles, such as taking care of children and/or family reasons compile 49% of reasons why women fail to continue in the Indian IT industry (Powell & Chang, 2016). 17 ISO has already published more than 700 standards that apply to specific services, and has also developed ISO/IEC Guide 76 addressing consumer issues (ISO, 2016). 18 The major concerns include: operational disruption due to cyber-security breaches; liability risks through data loss; unauthorized data extraction/modification within company-internal data flow; damage to company reputation 20 would only admit service providers certified in Payment Card Industry Data Security Standard (PCI-DDS). The ITO segment relies on a range of voluntary, market-led, standards setting organizations with global reach. Some verticals within the offshore services GVC (e.g. Healthcare) have also been widely regulated by Acts developed by national bodies, such as the Health Insurance Portability and Accountability Act (HIPAA) introduced by the United States government. HIPAA enforces hospitals, clinics, insurance providers, and all third-party entities that obtain personal information on their behalf, to comply with standards for how Personal Health Information (PHI) can be recorded, accessed, shared and stored. To obtain the HIPAA certification, companies must train their personnel in courses designed to teach agents and technicians how to comply with the privacy and security rules. Different to other certifications, there is no implementation specification that requires a covered entity to “certify” its compliance; rather, covered entities are obliged to perform a periodic technical and non-technical evaluation that establishes the extent to which an entity’s security policies and procedures meet the security requirements.19 While the exact cost of implementation is very difficult to estimate – and available data is significantly outdated – HIPAA compliance has been compared with Y2K preparations in terms of their impact and costs (Arora & Pimentel, 2005).20 Whilst compliance with PCI-DDS and HIPAA is an essential-to-critical consideration for every company providing customer support to US healthcare organizations, certain certifications remain voluntary, with very limited reach amongst third-party providers that are far below in global rankings. To illustrate, by 2018, the official body of COPC had certified only 7 organizations in India and 25 organizations in APAC (excluding India). Further, each segment of the offshore services GVC has globally recognized professional certifications or global skills standards. These can include working knowledge of global software platforms (e.g. Microsoft, Cisco, and Oracle certifications) or financial analysis skills (e.g. CFA certification from the Global FCA Institutes). and loss of trust due to data loss; misuse of data during exchange of information with partners; loss of intellectual property; violation of regulations and laws on data security or data privacy; and endangerment of operators or users (CBI, 2017). 19 The evaluation can be performed internally by the covered entity or by an external organization that provides evaluations or “certification” services . 20 In 2005, the average costs varied from US$10,000 for a small private practice to US$14 million for a larger organization (Arora & Pimentel, 2005). 21 Table 3. Mandatory Quality Standards of the Offshore Services GVC Standards Description Relevance and Certifications PCI-DSS The Payment Card Industry Data Security Standard (PCI-DDS) increases Critical controls on financial services to protect consumer information against fraud. For example, call centers cannot record consumers’ confidential information, such as security codes. HIPAA The Health Insurance Portability and Accountability (HIPAA) is a US law that Essential ensures confidentiality, integrity and availability of protected health information (PHI). It applies the Privacy Rule to business associates’ contractors, where any vendor which receives or utilizes protected health information from, or for, the covered entity needs to ensure the integrity and security of healthcare information. COPC Customer service provider global standard that focuses on implementing best Voluntary practices to improve performance metrics in customer satisfaction and service, inbound and outbound sales, dispatch, collections, retention, remittance processing, fulfillment, and other related operations. ISO 270001 The ISO 27000 series of standards covers security. Best practices for privacy Voluntary and 27002 data protection include limiting access to personally identifiable information to verifiable need to know, such as payroll personnel, and privacy protection training for individuals with access to that data. CMMI ® The Capability Maturity Model Integration (CMMI) is a globally-recognized set Voluntary of best practices that enable organizations to improve performance, key capabilities, and critical business processes. ISO/IEC ISO/IEC 30105 specifies the lifecycle process requirements performed by the Voluntary 30105-1:2016 IT-enabled business process outsourcing service provider for the outsourced business processes. It defines the processes to plan, establish, implement, operate, monitor, review, maintain and improve its services. Source: Authors based on Avasant (2012); ISO (2016); CCMI Institute (2018). 22 3 Pakistan in the Offshore Services Global Value Chain Key Points • By 2017, the country accounted for 0.1% of IT-BPO exports in the world.1 This positions Pakistan well below the top 50 exporters of offshore services globally (ITC, 2018). • The country’s participation in the offshore services GVC is due to a booming IT industry. In 2017 Pakistan exported US$572 million in IT services (PSEB, 2018). This figure is about 5 times higher than in 2007. The destination of about one half of total IT exports is United States, followed by the United Arab Emirates and European Union, with 9% and 8% of total exports, respectively (PSEB, 2018). Pakistani- Americans have led the expansion of the industry building on their strong business ties with the US. • Pakistan has yet not been able to attract prominent foreign operations, • Country exports are highly concentrated in low value-added services within the ITO and BPO segments: in 2017, almost one third of Pakistan’s offshore services exports derived from basic/transactional services like software maintenance and voice-based customer support (PSEB, 2018). • Freelance is a growing activity; however is restricted to rudimentary virtual assistance tasks, including data entry, website technical help and troubleshooting, and social media management (Field Research, 2018). In 2017, offshore services exports from Pakistan totaled US$655 million. The majority of revenues (87%) derives from the ITO segment, while the BPO segment accounts for 13% of exports (PSEB, 2018). The industry accounts for 0.2% of the country’s GDP, and 2.4% of total country exports (services and goods). These indicators are 0.07 and 1.3 percentage points higher than in 2013 (PSEB, 2018). Employment is estimated at 15,000 specialists (Rahman et al., 2017). This figure is unofficial and departs from unknown methodologies. Accurate statistics on employment is a challenge for all developing countries competing in this market, i.e. Pakistan is no anomaly. Finally, in Pakistan, services exports deriving from freelance activity is relevant; while total number of freelancers is presumably not reliable, with estimations ranging from 50,000 to 150,000 (Field Research, 2018). While both quantitative and qualitative data suggest that Pakistan’s offshore services industry is thriving, industry experts remark that growth has been driven by firm-level efforts and strong business linkages with Pakistani American in the US. Special treatment from the government side has been reckoned as limited—at least until 2017, when several incentives were announced. Whilst large companies with over 10 years of market experience frequently appraise the lack of intervention, the newest generation of firms and freelancers indicate the need for certain interventions, including improving the quality of tertiary level education and ameliorating the business environment, particularly, the visas regime (Field Research, 2018). In the light of a sizeable labor pool and low labor costs, potential growth is apparent. Yet, compared to its regional competitors, Pakistan is at the initial stages of progress. Reasons behind this sentence are as follows: 23 • By 2017, the country accounted for 0.1% of IT-BPO exports in the world.21 This positions Pakistan well below the top 50 exporters of offshore services globally (ITC, 2018). Regional competitors such as India, the Philippines and Sri Lanka accounted for 34%, 3% and 0.5% of the total IT-BPO market, respectively (ITC, 2018). • Different to regional and global competitors, which base its value proposition in the presence of leading third-party providers and MNC, Pakistan has yet not been able to attract prominent foreign operations, recording no presence of the principal IT-BPO providers in the world (e.g. Accenture, Cognizant, TCS). Also, captive centers from multinational corporations are very few, accounting for less than 20% of offshore services exports in 2017 (Field Research, 2018). The dearth of foreign operations continues to hurt Pakistan’ perception as a reliable offshore services location.22 • Pakistani IT firms remain very small in size compared to Indian firms; to illustrate, the largest IT-BPO firm in Pakistan employs about 20,000 workers worldwide, whilst India’s largest IT-BPO provider employs up to 395,000 workers (Field Research, 2018; TCS, 2018b).23 The small size of Pakistani companies limits the possibilities of meeting the needs of large global corporations and deters its credibility as an experienced services provider. • Country exports are highly concentrated in low value-added services within the ITO and BPO segments: in 2017, almost one third of Pakistan’s offshore services exports derived from basic/transactional services like software maintenance and voice-based customer support (PSEB, 2018). Freelance activity is restricted to rudimentary virtual assistance tasks, including data entry, website technical help and troubleshooting, and social media management (Field Research, 2018). • According to A.T. Kearney (2017) Pakistan is the least attractive location for offshoring services in Asia, excluding high-income economies. As shown in Figure 6, Pakistan is ranked 30th in one of the most relevant offshore services indexes in the world: The Global Services Location Index (GSLI), elaborated by A.T. Kearney, one prominent IT-BPO management consulting company. Pakistan’s poor positioning is due to its deficient business environment. In this metric, the country ranks lowest amongst all 55 considered economies.24 21 We use statistics collected by the International Trade Center (ITC) for comparability reasons. Categories considered include computer services and other business services from Balance of Payment Methodology Revision Sixth (BPM6). Computer services consist of hardware and software-related services and data-processing services; they exclude non-customized packaged software (systems and applications) and video and audio recordings on physical media; computer-training courses not designed for a specific user; and leasing of computers without an operator. Other business services cover research and development, professional, and management consulting, as well as technical, trade-related and other business services. 22 The presence of captive centers and third-party providers helps countries to build a reputation as a reliable destination to offshore services activities. 23 The companies are The Resource Group (Pakistan) and Tata Consulting Services (India). 24 See Section 3.5.2 for more details on Pakistan’s business environment. 24 Figure 6. Pakistan in the Global Services Location Index by A.T. Kearney (2016) 0 1 2 3 4 5 6 7 India (1) 3.3 2.63 1.14 China (2) 2.37 2.69 1.26 Malaysia (3) 2.92 1.47 1.72 Indonesia (4) 3.25 1.53 1.2 Vietnam (6) 3.31 1.39 1.22 Philippines (7) 3.13 1.57 1.17 Thailand (8) 3.06 1.38 1.43 Sri Lanka (11) 3.42 1.07 1.22 Bangladesh (21) 3.34 1.23 0.8 Pakistan (30) 3.35 1.3 0.63 Singapore (51) 0.77 1.54 2.31 Labor and Operational Costs (a) People skills and availability (b) Business Environment (c) Source: Authors based on A.T.Kearney (2017). Notes: Numbers next to country’s names correspond to the position in the GSLI Index, which ranks up to 55 countries; (a) A higher mark corresponds to lower costs of establishing an offshore services operation25; (b) A higher mark means a larger and more qualified talent pool26; (c) A higher mark equals to a better business environment27. 3.1 Pakistan’s Current Participation in the Offshore Services Global Value Chain28 Pakistan participation in the offshore services GVC is depicted in Figure 7. The country is active in the ITO and BPO segments, primarily. These account for 87% and 13% of total exports, respectively (Field Research, 2018). The vertical segment is composed of a small number of companies (about a dozen) that have developed specific knowledge in at least three sectors, including: Banking, Financial and Insurance Services (BFSI), Healthcare industry, and Energy. This segmentation is based on a wide analysis of the entire offshore services industry, including both large companies and SMEs. While a closer look to top 10 exporters provides a more nuanced scenario, segments of participation of these companies are quite illustrative; also, these account for 20% of total Pakistan’s offshore services exports. By 2018, 3 out of 10 top exporters provided IT services for a wide array of industries, with 2 of them having opened BPO operations as well. Two other companies exported BPO services exclusively, namely data entry and customer support for different clients around the globe. Firms specialized in vertical sectors totaled 3 out of 10 (PSEB, 2018). 25 Metrics used for this category include: average annual wages, average compensation costs for relevant positions (BPO analyst, IT programmer, contact center representative), average cost of infrastructure (occupancy, electricity, telecommunications), blended travel cost to major customer destinations (New York, London, and Tokyo), relative tax burden, costs of corruption, and exchange rate movements. 26 Metrics used for this category include: estimated IT/BPO sector size, quality/skill ratings for relevant positions (quality of management school, college education quality and relevant industry certifications for IT, BPO, and contact centers). 27 Metrics used for this category include: political risk (political stability, terrorism risk, regulatory burden), foreign investment, ease of doing business, A.T. Kearney Global Cities Index “personal contact” index, blended metric of country infrastructure quality (telecom, electricity), overall local infrastructure quality, ratings of intellectual property protection, ISO information security certifications, software piracy rates. 28 Except for specific citations, the source of this section is Field Research (2018). 25 Figure 7. Pakistan’s Participation in the Offshore Services GVC, 2017 Source: Authors based on Field Research (2018) and PSEB (2018). References: Colored subsegments indicate active participation; Weight of subsegments’ outline indicates the estimated participation in the global market, with thicker outlines representing larger relative participation in total exports; Gray-colored subsegments indicate no current participation Within the ITO segment, Pakistan participates in the software services and product development category. The former is much larger than the latter: by 2017, about 90% of offshore services exports derived from software services firms (Field Research, 2018). Pakistan is not active in other horizontal ITO activities. Within the BPO segment, Pakistan is positioned in the low-end BPO category, with 90% of revenues deriving from the contact/call-center sector (Field Research, 2018). The country is not active in high-end BPO nor KPO activities. The highest value-added services exported from Pakistan derive from about a dozen large companies with over 10 years of experience in the market and substantial business ties with the US. These firms provide complex IT-BPO and KPO solutions to knowledge-intensive sectors in developed economies, ranging from asset finance and leasing software for the Banking, Financial Services and Insurance (BFSI) in the region (e.g. NETSOL Technologies), to medical transcription and artificial intelligence platforms for the US Healthcare industry (e.g. Medical Transcription and Billing Company), and geoscience management solutions for the exploration and extraction of petroleum in various countries (e.g. LKMR). One highlight of Pakistan’s participation in the offshore services GVC is the freelance activity. While there are no official estimates of the size of exports, the nation is ranked as the fourth most popular country for freelancing in the world, according to the Online Labor Index published in 26 2017 by Oxford Internet Institute (OII)—after India, Bangladesh and US. 29 Pakistani freelancers export a wide variety of low value-added IT-BPO services, such as virtual assistance for schedule management, web design, software development, online marketing, content writing, graphic design, online search, translation and transcription services, and data entry, among many others (Field Research, 2018). 3.2 Industry Organization There are about 3,500 companies registered in the Pakistan Software Export Board (PSEB). About 50% of these (1,762) would have been active in the global market during 2017 (PSEB, 2018). This section highlights the organization of the industry, with a focus on the key stakeholders involved in its development. Different to most offshore services locations, in Pakistan, domestically-owned companies are predominant along the entire value chain; within the Top 10 IT-BPO exporters, only 1 is foreign (Field Research, 2018).30 Leading global third-party providers such as Accenture, Wipro or TCS have no presence in Pakistan. Captive centers from MNC companies are also absent. The dearth of foreign operations severely underscores the nation’s positioning in the list of preferred platforms for offshore services operations. Within the ITO segment, the industry can be organized based on two criteria, namely market share and functions. • Market share: 25% of exports derive from the top 20 exporters (Table 4). The remaining three quarters of exports are captured by micro-freelancing organizations founded by returning expats or successful former freelancers (Field Research, 2018). Companies within this group employ over 1,000 FTE each and many have affiliates in the US or neighboring countries (e.g. NETSOL Technologies, Systems Limited, Teradata). Naturally, these firms can provide quality solutions while maintaining extensive payrolls. • Functions: the great majority of exports (90%) derive from the software services sector. Solutions pertaining to the product development account for 10% of total ITO exports (Field Research, 2018). Different to software services firms, product development companies depend more on quality, skills, certifications and business linkages in the US than on scale. To illustrate, most firms within this group would employ 50 to 70 professionals (Field Research, 2018). While most ITO firms have been founded by Pakistani-Americans; some product development firms were started by local graduates from incubators in Tier-I Universities such as Lahore University of Management Sciences (LUMS), National University of Sciences and Technology (NUST), and Foundation of Advancement of Science and Technology (FAST) (Field Research, 2018). 29 The Online Labor Index of the University of Oxford is the first economic indicator providing an online gig economy equivalent of conventional labor market statistics. It measures the supply and demand of online freelance labor across countries and occupations by tracking the number of projects and tasks across platforms in real time (Kässi & Lehdonvirta, 2016). 30 S&P Global Market Intelligence Company. 27 Table 4. Distribution of IT-BPO Exports, by Share in Exports (2018) Firm Group Exports Share in exports (%) Share in total number (US$ million) of exporting firms (%) Top 10 exporters (a) 166 20% 0,6% Top 20 exporters 208 25% 1.1% Top 115 exporters 416 50% 6.7% Top 747 exporters 623.5 75% 42.7% All (1,750 firms) 831 100% 100% Source: Authors based on PSEB (2018); Field Research (2018). Note: (a) In order of share in revenues: NETSOL Technologies, S&P Global Market Intelligence Company, Systems Limited, Ibex Global Solutions, Teradata Global Consulting, i2c Pakistan, Afiniti Software Solutions, SBT Pakistan, Ahsan Enterprises, Medical Transcription and Billing Company. Pakistan’s BPO segment is controlled by a few large companies capturing more than 2/3 of BPO revenues, including: Ibex Global Solutions (The Resource Group), SBT Pakistan and Ahsan Enterprises. Remaining exports derive from BPO units within large ITO companies (e.g. Systems Limited) (Field Research, 2018). Another important group in the Pakistani offshore services industry is composed of freelancers performing virtual assistance through online platforms such as Upwork. Like large companies, freelancers often have some personal or business connection with a relative or acquaintance in the US, which facilitated their establishment as stable IT-BPO services exporters. Beyond firms, the industry consists of supporting public and private institutions, most based in Lahore and Islamabad (Table 5). In the private sector, Pakistan Software Houses Association (P@SHA) is widely recognized as the most prominent industry supporting institution (Field Research, 2018). P@SHA has led significant lobbying and advocacy initiatives to drive policy development. Public sector efforts for the IT and BPO industry are coordinated by the Pakistan Software Export Board (PSEB), a Government body under the Ministry of IT and Telecom (1995). Table 5. Key Industry Stakeholders in the Offshore Services GVC Level of Name Role in the Offshore Services Industry Engagement • Lobby and advocacy to ensure government support. Pakistan Software • Help formulate policies to strengthen the industry. Houses Association (P@SHA) • Address queries from potential clients and foreign agencies interested in outsourcing to Pakistan. Ministry of IT and • Principal counterpart of the private sector and P@SHA Telecom • Provides IT services and infrastructure to the local government and Punjab Information private businesses. Technology Board • Develop policy alternatives and plan initiatives for building an (PITB) internationally competitive IT industry in the province. Higher Education • Works with private stakeholders to update the IT tertiary courses Commission (HEC) curricula and develop basic technical courses for freelancers. Pakistan Software • Registers IT and BPO companies. Export Board (PSEB) • Collects IT and BPO exports. Source: Authors based on Field Research (2018). 28 PSEB is mandated to promote the offshore services industry in local and international markets; however, the body has not been able to develop sufficient marketing strategies and support mechanisms (Field Research, 2018). To illustrate, in five years, PSEB has only organized six outbound trade delegations to target markets, supporting an average of eight companies per year. (less than 3% of its members) (Field Research, 2018). Reasons behind this are threefold, including: limited resource allocation, visa restrictions for Pakistani engineers and technicians, and lack of engagement from the private sector (Field Research, 2018; Jamal, 2017). More specifically, larger firms rely on its own business network to obtain outsourcing deals, and smaller firms are reluctant to participate in international forums under a Pakistan pavilion due to poor perception in target markets (Field Research, 2018). PSEB is also responsible for the registration of IT and BPO firms; registry requires the payment of an annual fee, which is compulsory for firms to benefit from current and future fiscal and non-fiscal incentives, as well as to transfer US dollars from and to foreign clients. While PSEB has been mandated with a wide array of other functions—ranging from undertaking research on the state of the industry to assist companies in acquiring quality, security and other certification—it is well documented that PSEB is considered an administrative agency solely. When asked by the most supportive government agency, firms indicate the relevance of topmost authorities from the Ministry of Information Technology and Telecom (Field Research, 2018). In fact, it is largely reckoned that PSEB (along with The Universal Service Fund and the National ICT Research and Development Fund) have little to do with policy-making, and are only focused on narrow mandates (Khilji & Zahid, 2017). During the past decade, stakeholders described in Table 5 have worked to consolidate key demands of the industry. The most relevant advances and remaining challenges are as follows: • Software Technology Parks. Pakistan has developed 14 Software Technology Parks. This totaled nearly 1 million square feet. Yet, buildings do not address offshore services companies’ requirements such as uninterrupted year around operations, quality bandwidth, reliable power and security, accessibility, expandability and parking space. In addition, most space has been occupied by government agencies. For micro-freelancing companies, these buildings are not affordable (Field Research, 2018) • Incubators. According to the HEC of Pakistan, currently 8 university incubation centers are established with the objective to support the development of spinoffs and entrepreneurs’ access to financial and technical resources along with value added services such as intellectual property rights. Yet, incubators are too away to achieve the maximum output in terms of economic development, job creation, innovation and R&D commercialization (Jamil et al., 2016). More recently (2017), the Prime Minister announced five incentive packages and tax holidays for the IT industry. These include: (i) extension of the tax holiday on IT exports from 2019 to 2025; (ii) 5% cash reward on IT exports; (iii) reduction of sales tax to 5% on IT within the Federal Areas; and (iv) reduction of the minimum acres of land required to create a Special Economic Zone to 5 acres of land (Field Research, 2018). 29 The incentives above will pave a way towards the execution of Pakistan Digital Policy, published in 2018 by the Ministry of Information Technology and Telecommunications.31 While this policy goes a long way in terms of signaling its importance as an engine for economic growth, it should be underscored that goals are too general and poorly detailed. In brief, Pakistan’s Digital Policy acts could be appreciated as an affirmation of the importance of the IT sector in the country; however, strategies and sequence of actions required to meet objectives are unspecified. This deters Pakistan’s opportunities to build a valid roadmap for the formulation and implementation of the policy. Finally, the document does not provide with any evaluation or monitoring mechanisms. It could be expected that these failures hinder execution and compliance. 3.3 Industry Evolution in Pakistan’s Offshore Services Global Value Chain Pakistan entered the offshore services GVC in the mid-2000s through IT exports. However, it was not until 2009 that the country gained some recognition as an alternative offshoring location, when it attained its first admission into the GSLI ranking (A.T.Kearney, 2011). By this time, both India and the Philippines had already achieved maturity in the global market, while others in Europe and Latin America were already emerging (e.g. Poland, Mexico, Czech Republic). Nonetheless, over the past ten years, IT-BPO exports increased by a factor of four, going from US$113 in 2007 to US$655 in 2017 (Figure 8). Within this period, the Compound Annual Growth Rate (CAGR) stands at 15% (PSEB, 2018). This indicates that Pakistan’s sector, while still relatively small, has embarked on what should be a prosperous upgrading trajectory within the offshore services GVC. Text below Figure 8 describes each segment evolution separately. Figure 8. Pakistan’s ITO and BPO Exports, 2006 – 2017 700 Exports (US$ million) 600 83 73 500 61 400 40 300 37 572 27 487 459 200 293 330 214 246 100 181 186 151 71 103 - 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 ITO BPO Source: Authors based on PSEB (2018). 31 Section 3.5.2 expands upon the Pakistan’s Digital Policy. 30 Information Technology Outsourcing. As evidenced in Figure 8, the country’s participation in the offshore services GVC is due to a booming IT industry. In 2017 Pakistan exported US$572 million in IT services (PSEB, 2018). This figure is about 5 times higher than in 2007. The destination of about one half of total IT exports is United States, followed by the United Arab Emirates and European Union, with 9% and 8% of total exports, respectively (PSEB, 2018). Pakistani-Americans have led the expansion of the industry building on their strong business ties with the US. The great majority of IT companies serve a wide range of industries, with less of half a dozen companies providing solutions for vertical industries (see segment ‘Verticals’). Business Process Outsourcing. In 2017, Pakistan exported US$83 million in BPO services (PSEB, 2018). This figure is 7 times higher than in 2007. The emergence of the BPO segment traces back to 2002 when a group of Pakistani American investors based in the US relocated some of these firms’ customer support to Lahore. As founders owned several American start-ups, the group grew rapidly through acquisitions and private equity (Field Research, 2018). Currently, the company has 20,000 employees globally, from which around one third is based in Pakistan.32 Segment expansion and global recognition as a reliable BPO location has been constrained by Pakistan’s high-risk perception and rigid visa regime. In the contact/call-center industry, customers typically visit the offshore operations as a quality assurance strategy. However, Americans are reluctant to travel to Pakistan for security reasons. This constraint is hard to overcome for new companies, placing much needed efforts in supporting the upgrading of existing operations. Verticals. Companies providing services for vertical industries are by far the most sophisticated players of Pakistan’s offshore services GVC. Based on interviews with experts, firms included in this category include; (i) NETSOL Technologies, which provide IT and KPO services for the Financial and Insurance sector; (ii) Medical Transcription and Billing Company (MTBC), which specializes in high-end IT-BPO solutions for the Healthcare industry; (iii) and LKMR, a formerly captive operation responsible for software development and data analysis for companies in the Energy Sector, specifically in oil and gas exploration. Box 1 expands on the MTBC example to provide the reader with a good example of how Pakistani companies can upgrade their offerings and expand its global footprint. 32 Other locations include Philippines (8,000 FTE), Jamaica and Nicaragua (Field Research, 2018). 31 Box 1. Upgrading Trajectories of the Medical Transcription and Billing Company MTCB, Medical Transcription Billing Corp. is a publicly traded company that provides a wide range of ITO and BPO solutions for healthcare clients in the US, from data entry to electronic health record, and voice recognition software (Figure 9 displays the company’s upgrading trajectory). The company serves an expanding array of healthcare entities from single physicians, to medium sized health institutions as well as independent physician associations spread across over 40 US states. In 2017, global FTE reached 2,450, 80% of whom work in Pakistan’s center (remaining 20% seats are split between the US headquarters, and a development center in Sri Lanka). MTBC was founded in the US in 1999 by a Pakistani American. The firm began operations as a billing company, providing electronic claim services for healthcare providers located in New Jersey. Thanks to growing demand, the company grew quickly. In 2002, it established its first subsidiary in Islamabad to support the headquarters in the US. Location choice was based on the founder’s business ties with Pakistani entrepreneurs, as well as on personal knowledge of the country’s economics, talent, and culture. Figure 9. MTBC Upgrading Trajectory in the Offshore Services GVC for the Healthcare Industry In the early 2000s, the Pakistan operation provided data entry, transcription and billing services for MTBC US headquarters. During this time, services were provided through a third-party software which connected MTBC to clients. By 2005, the operation had developed its own software; at first, the software enabled physicians to schedule their medical appointments and manage their agenda. Later, they included a tool for physicians to evaluate the patient eligibility for insurance. Over the course of the next five years, MTBC upgraded to provide online electronic medical records, allowing clients to access their patients’ medical record away of the office. By 2018, MTBC’s comprehensive product portfolio included fully integrated artificial intelligence, revenue cycle and practice management solutions, as well as other lower value-added services, such as transcription and data entry. Company management cite the quality of Pakistani professionals as key to their success. MTBC is currently exploring new vertical markets and IT products, including software development for health insurance companies. Source: Authors based on Field Research (2018); MTBC (2018). 3.4 Human Capital and Gender of Pakistan’s Offshore Services Industry A sustainable offshore services industry is entirely dependent on the availability of human capital equipped with the necessary skills and proficiencies to deliver outsourced processes. A large population represents greater possibilities to host a variety of GVC processes with high potential to scale operations. Nevertheless, the human capital structure of the offshore services GVC generally begins at 12 years of education (Gereffi et al., 2011). While Pakistan is the sixth largest population in the world, high-school graduates account for just 3.85% of total population and only about 2% of individuals between 20 to 29 years old have completed a tertiary level degree (PBS, 2014; UNDP, 2017). 32 3.4.1 Availability and Employability In Pakistan, the labor demand of the offshore services industry spans from high school graduates to tertiary level graduates, depending on the segment in which companies participate (Figure 10). Low-end BPO employ high-school graduates with good English communication levels. While the labor pool of Pakistan would seem large enough to enable expansion in the BPO segment, English- language skills, combined with neutral accents and cultural understanding of the customer host environment, exist only among the highest-educated strata of the Pakistani society. Figure 10. Summary of Pakistan’s Offshore Services Industry Talent Pool (2017) Source: Authors based on Field Research (2018) and PBS (2014). Notes: (*) 2014/15; (**) 2016/17. Labor demand in the ITO segment differs significantly depending on the level of sophistication of the services: while software services companies that provides basic services employ IT graduates from Tier-II and Tier-III universities, product development firms that offer more complex tasks engage exclusively with IT graduates from Tier-I universities such as LUMS, NUST and FAST (Field Research, 2018). While no precise figures of graduates are available, the private sector estimates that around 10,000 individuals graduate from all universities annually.33 Equally important for success in the offshore services GVC is the employability of the talent pool. That is, talent should be equipped with basic technical skills (i.e. computer literacy, English language comprehension, etc.) and relevant domain proficiencies (i.e. coding, graphics design proficiencies, etc.) that can ensure quality delivery of specific outsourced services. In Pakistan, the employability rate is very low; product development firms consider that graduates from Tier-II and Tier-III universities lack the most critical programming skills and English language fluency necessary. Only 10% of the graduates from the Tier-II and Tier-III universities are considered employable by product development firm, so they mainly hire from Tier I universities. (Field Research, 2018). For software services and BPO companies, which hire graduates from any university (namely, Tier-II and Tier-III) and high school institutions, the employability rate increases to 50%, and 30% respectively since they require less skilled workers (Field Research, 2018). 33 Estimates range from 10,000 to 20,000 (Field Research, 2018). These disparities highlight that the lack of reliable and disaggregated statistics on human capital is a major challenge that needs to be addressed. 33 As a result, product development companies only hire talent graduated from ‘progressive’ universities such as LAMS, FAST and NUST. These Tier-I universities are highly linked to Pakistan’s IT industry. However, these institutions graduate fewer than1,000 students annually (Field Research, 2018). Furthermore, as graduates from these universities usually come from wealthy families, they usually seek job opportunities in higher paying sectors or abroad; as a result, firms must pay a considerable wage premium for IT graduates of these Tier I universities over their peers at Tier-II and Tier-III programs. Major skill gaps in computer science engineers include: (i) inability to code in contemporary technology platforms; (ii) weak English skills (Box 2); (iii) poor comprehension readiness to address foreign clients’ concerns; (iii) inadequate soft skills, namely communication and teamwork; (iv) poor knowledge of corporate culture, e.g. reporting, compliance, escalations, e-mail etiquettes and protocols. Firms also highlight that Pakistani graduates generally lack critical thinking, creativity and problem-solving skills (Field Research, 2018). Box 2. English Skills in Pakistan: Issues and Challenges Literacy in English is considered a prerequisite for participating in the offshore services GVC. While Pakistan is the world’s third largest English-speaking country after India (2nd) and United States (1st), with almost one half of its population speaking English as a second language, proficient English speakers are more likely the highest strata of Pakistani population. The English constraint is rooted in the two distinct systems of education based on the medium of instruction: English and Urdu. The English medium schools are privately owned and cater to the upper class as well as some sections of the middle class. In contrast, the Urdu medium schools are mainly public sector schools catering to the lower income groups and they offer free education in addition to other incentives such as free textbooks (at least at the primary level). Private schools offer ‘quality’ education to elite children in highly resourced classrooms through the medium of English. The outcomes for these children, who also have acquisition-rich home environments, are higher levels of proficiency in English compared to those children studying in poorly resourced classrooms who have little or no exposure to English outside the 30–35-minute English class every day in school. At the tertiary level, most teachers do not have formal qualifications or training in English language teaching. Source: Authors based on Capstick (2011); Kroulek (2017) While some firms (especially software services firms) are less pessimistic about the talent shortage (profile of employee does not require advanced coding skills and can be trained on-the-job) all firms interviewed indicate that English language remains a severe constraint. This is particularly true for graduates of Tier-II and Tier-III universities, where most teachers lack formal qualifications or training in English language (Capstick, 2011). Lack of technical and technological skills are rooted in weak fundamentals in Science, Technology, Engineering and Mathematics (STEM), low quality of tertiary level professors, and inadequate teaching methodologies. Pakistan biggest constraint is the lack of educational materials and qualified teachers to encourage cognitive development or analytical and critical thinking skills from the primary and secondary levels (Field Research, 2018). In the tertiary level, even if the IT curricula are updated, professors lack the basic knowledge to efficiently instruct students in critical IT skills. 34 Finally, education models are based on theoretical instruction, which firms consider to be archaic and inadequate to prepare individuals in IT skill (Field Research, 2018). While brain drain lowers the availability of appropriate human capital, expats in the US have become a strategic asset for Pakistan’s offshore services industry; the great majority of IT firms participating in the GVC were funded by Pakistani Americans or returning expats, and currently, most management personnel are expats or US citizens. In the United States, Pakistanis are considered a well-educated segment of the population (Box 3); a far greater share of first and second generation Pakistani-Americans earned undergraduate degrees than the US population overall, and individuals in this population are more than twice as likely to hold advanced degrees (PWC, 2017). Box 3. Demographics of Pakistani Americans Pakistani Americans play a critical role in Pakistan’s offshore services industry. Several returnees have founded successful IT companies, while those still living and working in the US collaborate with Pakistani-based companies. These groups have developed strong ties with each other in the past 20 years. In 2015, around half a million Pakistani immigrants and their children (the first and second generation) lived in the US. More importantly, their educational attainment levels are, on average, higher in the Pakistani diaspora than in the general US population, as is household income. Seven out of ten US born Pakistani Americans have at least a bachelor’s degree (Figure 11). Figure 11. Educational Attainment of Pakistani American (2015) Pakistani American US Born 30% 38% 19% 13% All Pakistani American 24% 29% 18% 29% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Postgrad Bachelor's Degree Some College High School or less As a result, nearly 32% of the Pakistani diaspora is employed in a professional or managerial occupation (1% higher than the general US population). These occupations include specialized fields (e.g. engineering, science, law, or education) as well as administrative and managerial jobs (e.g. finance, or human resources). Furthermore, they are entrepreneurial; the Pakistani diaspora in the US has established numerous, well-funded, and professionally managed organizations. As a result, households headed by a member of the Pakistani diaspora had a substantially higher median annual income than US households overall. The median annual income of Pakistani diaspora households was about US$66,000 versus US$56,516 for all US households. Source: MPI (2015); PWC (2017) Female Participation in the Sector While Pakistan holds the last spot in the Economic Participation and Opportunity sub index of the Global Gender Gap Index 2016, the IT segment features a slightly lower share of female workers compared to developed economies such as the US or UK (Table 6). Considering female participation in the overall labor force (22%) and the global bias towards male professionals in technology fields, the finding on Pakistan’s female participation is somewhat remarkable (The 35 World Bank, 2018). This can partially be explained by the human capital structure of the Pakistan sector; in general, women who work in IT companies had access to higher-education degrees in Tier-I to Tier-II universities. Table 6. Women in the IT Segment, Pakistan vs. Selected Countries Country Enrolled in IT College Studies Working in the IT industry Year Pakistan 14% 15% 2016 India 45% 30% 2014 United States 22% 25% 2017 United Kingdom 18% 16% 2014 Brazil 15% 38% 2014 Source: Authors based on Field Research (2018); NASSCOM (2017b); Khalil et al. (2015). Low participation of females in IT studies and IT employment is rooted in concerns for safety, mobility restrictions and traditional family roles (Field Research, 2018). Due to the 24/7 requirements of offshore services, many employers mentioned that not being able to work after 6 PM restrains job opportunities for women. One key challenge for women is simply the commute to work; first, traveling without the company of father or husband remains an issue. Second, the inadequate transportation system is of such significance that females may ignore better job opportunities and go for lesser value jobs just to avail transport facility provided by the organization (Faiza, 2013). The share of women enrolled in IT education is extremely low when compared to the ITO leader (India) where female participation in higher education IT studies accrues to 45% (Table 6). The female share of Pakistan’s low-end BPO segment is higher at 25%. This figure is well below India and Philippines’ BPO industries, in which women account for 40% and 50-60% of total employment, respectively (Figure 12). Female employment is constrained by time zone issues; the US working hours are evening hours in Pakistan and females are reluctant to work late. While some companies have attempted to provide transportation services to women leaving work after 7 PM, most females are not allowed by parents or husbands to commute unaccompanied. Figure 12. Share of Women Employed in the Low-end BPO Segment, Pakistan vs. World Leaders 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Philippines India Pakistan Female Male Source: Author based on Begum (2013); David (2015); Field Research (2018). 36 3.5 Advantages and Constraints34 Pakistan has been ranked amongst the top fifty economies to relocate IT-BPO processes since 2011 and is the most cost-effective location in the world in 2017 (A.T.Kearney, 2011, 2014, 2016, 2017). Despite low labor costs and decent service quality as per compared to India and Philippines, its attractiveness as an offshore location is severely restricted by investor perceptions that the country’s security risk is too high. Infrastructure failures, administrative burdens, and low quality of education further constrain the country’s ability to expand and improve competitiveness in high value-added segments (Figure 13). Figure 13. Pakistan and Competitors in the WEF Networked Readiness Index (2017) Political and regulatory environment 7 6 Business and 5 Government usage innovation 4 environment 3 Pakistan 2 India 1 Philippines 0 Business usage Infrastructure Individual usage Skills Source: Authors based on WEF (2017). Notes: A detailed list of each country position in the world ranking is displayed in Table A-II, Annex II. 34 Except where otherwise indicated, data from this section is based on information gathered during Field Research in August 2018. 37 Table 7. SWOT of Pakistan’s Offshore Services Industry Strengths Weaknesses • Sizeable talent pool. • Low attractiveness to foreign investors and clients • Satisfactory price-quality relationship. due to negative image and rigid visa regime. • Decent telecommunication infrastructure. • Lack of clarity in the national offshore services • Favorable positioning in the freelance global strategy; inadequate public-private coordination market. • Regulatory barriers and poor business environment. • Inadequate specialized infrastructure (office space) • Severe mismatch between skillsets provided by the tertiary level and private sector needs. • Inadequate international marketing; lack of branding. • Lack of reliable relevant data to position the industry in the global market. Opportunities Threats • Leverage Pakistani expats and Pakistani • Increased negative perception of the country. Americans involvement in the US IT industry. • Reputation risk derived from Pakistani low-skilled • Close political ties and existing trade freelancers providing poor quality work. agreements favor Pakistan in pursuance of • Digital transformation is requiring highly skilled tapping the growing Chinese market. workforces to accompany the automation and robotization processes. Source: Authors based on Field Research (2018). 3.5.1 Advantages Pakistan’s advantages in the offshore industry revolve around its large young-English-speaking talent pool and low labor costs. These strengths align to main location drivers within the offshore services GVC. The following sub-section expounds upon the strengths indicated in Table 7. 1. Sizeable labor pool. Pakistan is the world’s third largest English-speaking country after India (2nd) and US (1st). In Pakistan, around 49% of the population speak English as a second language, i.e. 94.3 million people (Kroulek, 2017). In addition, for customer support services, English pronunciation is relatively more neutral than in Sri-Lanka and India. The English advantage can facilitate Pakistan’s growth in the BPO segment. However, the quality of English language needs to be improved. 2. Satisfactory price-quality relationship. According to A.T. Kearney’s GSLI, Pakistan is the most financially attractive in the world for offshoring IT-BPO services (A.T.Kearney, 2017). Also, IT companies with presence in India and Pakistan point out that in very low- end solutions, the quality of Pakistan’s talent pool surpasses that of India. In the low-end BPO segment, operational costs are 60% lower than in the Philippines, the world’s customer support powerhouse. This edge is favored by the low competition for labor in Pakistan, due to the relative immaturity of the sector. 3. Decent telecommunication infrastructure. IT-BPO firms consider the telecommunication infrastructure adequate, with most stakeholders recognizing large advances in recent years. A few experts mentioned concerns on the speed of the internet broadband; it would not be as poor as to be regarded as a constraint. 38 4. Favorable positioning in the freelance global market. Pakistan is ranked as the 4th most popular country for freelancing in the 2017 Online Labor Index elaborated by OII after India, Bangladesh and United States. Within the somewhat unique context of Pakistan’s competitiveness due to its image perception, the positioning in freelancers’ platforms provides Pakistan a platform to showcase the availability and quality of IT-BPO talent. 3.5.2 Constraints While Pakistan’s potential is apparent, upgrading trajectories are severely constrained by its weak security situation and policy uncertainty. By discouraging FDI and business visits to and from Pakistan, this poor perception impacts the nation’s competitiveness and contributes to the underdevelopment of the IT and BPO sectors. In addition, to low employability rates discussed earlier, growth is further hindered by inconsistencies in the regulatory framework, business environment and inadequate physical infrastructure. Finally, international marketing activities, including reliable quantitative information, are absent. The following sub-section expands upon these challenges. 1. Low attractiveness to foreign investors and clients due to the country’s negative image and high-risk perception. This is the most widely-stated constraint facing the sector. Pakistan is generally perceived as a high-risk investment proposition, particularly by US firms, which are the largest IT services importers. In 2018, the US Department of State rated Pakistan with the Advisory Level 3, i.e. ‘reconsider traveling’, pinpointing terrorism as the main reason. Similarly, the ‘political stability and absence of violence/terrorism’ index from the World Bank ranks Pakistan in the 125th position in a total of 126 countries. According to industry stakeholders, potential buyers or investors in the US frequently decline to travel to Pakistan, impeding potential business and partnerships with local companies, as well as foreign investment. 2. Lack of clarity in the national offshore services strategy and inadequate public- private coordination. While Pakistan’s first Digital Policy was launched in 2018, this lacks the defined goals and strategies required to meet national objectives. This is compounded by a lack of leadership from the institutions empowered to promote IT services exports and attract FDI. In response, many government departments, at the federal and provincial level, have created their own IT-BPO strategies. This has resulted in redundant and overlapping initiatives spread among different public agencies with limited and short-term impact. Furthermore, while P@SHA and the Ministry of IT have made progress over certain issues, (e.g. income tax exception until 2025) there is considerable debate between the private and public sectors on how to best develop the industry and its enabling conditions. Underlying this is the low level of awareness about the offshore services GVC is, and its dynamics and benefits. 3. Ambiguous regulatory framework and poor business environment. Excessive bureaucracy, high levels of corruption, and frequent and unpredictable regulatory changes creates uncertainty for investors (domestic and foreign alike). For IT firms, additional regulatory barriers and administrative burdens can be identified. The lack of a clear definition for IT products and services by the tax revenue office deters foreign investment, which requires transparent tax regimes, while locally, it opens up smaller, local companies 39 to harassment from tax enforcement authorities. Interviewees cite that this frequently leads to random charges and/or bribery, i.e. large sunk costs. Bureaucratic requirements discourage registration of local companies, leading to high informality amongst small software companies and technology startups. Many of these companies can only receive international payments through private banks or Western Union; no globally recognized online payment platforms (e.g. PayPal) are licensed to operate in the country. This impacts freelancer credibility as quality services providers, adds administrative burdens of having to open a bank account, while at the same time reinforcing the high-risk perception held by potential foreign clients. Finally, the visa regime, in addition to the security situation, further hinders foreign clients from visiting Pakistan; this is particularly troublesome for expanding the country’s penetration into the US market. 4. Inadequate specialized infrastructure (office space). Both in Lahore and Islamabad, local and foreign companies struggle to find office space aligned to international standards and requirements of the offshore services industry, e.g. 24/7 availability, IT-ready infrastructure, among others. The existing buildings do not address offshore services companies’ requirements such as uninterrupted year around operations, quality bandwidth, reliable power and security, accessibility, expandability and parking space. Moreover, since the Special Economic Zones (SEZ) regime was not developed from an offshore services’ industry perspective, the minimum size of an SEZ (20 hectares) is vastly larger than current demand from the IT industry. This constraint is even more important for small IT product- based companies and freelancers, who lack affordable IT plug-and-play spaces (e.g. co- work) to expand their business and/or provide more complex and sophisticated services. Finally, the number and size of technology business incubators is also very limited for Pakistan’s potential. 5. Severe mismatch between skillsets provided by the tertiary level and private sector needs. Except for Tier-I universities, tertiary education is failing to provide the students with the knowledge and technical skillsets needed by the IT industry. Producing globally employable graduates has been a challenge to Tier-II and Tier-III universities. As a result, the employability rate is very low: only 10% of IT graduates are considered employable by high-value added IT firms. Most relevant reasons behind this constraint include: (i) faculty members from Tier-II/III universities are not fully competent in coding skills nor in English-language; (ii) pedagogical know-how is inadequate to the industry needs (e.g. excessive theoretical instruction and low exposure to IT); (iii) quality assurance systems are absent.35 6. Inadequate international marketing and lack of branding. Pakistan has not developed a satisfactory international marketing strategy as to effectively position the country as an outsourcing/offshoring destination. While PSEB was formed the goal to promote the industry worldwide, the organization has failed to articulate and execute adequate initiatives towards FDI attraction and/or export promotion. PSEB has yet not engaged with renowned location advisory services’ companies, such as Deloitte, KPMG, or 35 Other aspects behind low quality of education include: poor socio-demographic conditions of the students 40 EY. Moreover, local companies avoid associating themselves with the Pakistan brand at international fairs organized by PSEB. Other institutions, such as Pakistan’s Board of Investment (BOI) have no role on promoting the offshore services industry abroad. 7. Lack of reliable data to position the industry in the global market, e.g. number of IT graduates. Pakistan’s international positioning is also severely limited by the lack of accurate and official information regarding the number of foreign operations established, exports, employment, human capital qualifications, and number of IT graduates. Currently, national statistics of the pool of IT enrollees and graduates by field of specialty and level of educational attainment are not available. 41 4 Lessons for Pakistan’s Upgrading in the Offshore Services Industry from Global Experiences Economic upgrading is defined as actors moving to higher value activities in GVCs in order to increase the benefits from participating in global industries (Gereffi et al., 2005). In the offshore services GVC, four principal upgrading trajectories can be identified (Table 8).36 Table 8. Selected Upgrading Trajectories in the Offshore Services GVC Type Diagram and Description This encompasses the shift from basic customer support services to the provision high-end BPO services; it is a common Upgrading within the BPO trend for countries entering the GVC through the low-end BPO segment. High-end BPO activities rely on similar repetitive functions as with call centers, although as a whole, they draw on segment a slightly more educated labor force. Limited direct interaction facilitates growth of these functions as they do not heavily depend on language fluency. Training in high-end BPO functions is predominantly carried out by the private sector and on-the-job. Examples: South Africa is an important destination for BPO services currently employing 47,300 people and growing at 20% per year, which is twice the global growth rate of the industry, and three times faster than India and the Philippines. Currently, South Africa is actively working in expanding their BPO activities from low-end BPO to high-end BPO. This trajectory describes functional upgrading to offer all services in the ITO, BPO and KPO segments. Maintaining the Broad Spectrum services Functional Upgrading to provision of low value services while at the same time providing high valued services requires a large but versatile low-cost labor supply. In small countries, inflationary pressure on wages due to limited but skilled workforce encourages countries to upgrade into higher value services or lose their competitiveness in the industry to other lower cost countries. Examples: Costa Rica is the most illustrative case of upgrading towards Broad Spectrum services. While transactional services are still being present, higher value-added functions were added over time, and today these operations carry out not only low value-added functions, but also high value activities. Companies offering some ITO, BPO and KPO services for a through Vertical wide range of industries specialize and focus on key industries. Specialization Functional Upgrading This trajectory is closely correlated with leading productive industries in the host country. Examples: The Czech Republic, which entered into the offshore services industry through the establishment of BPO shared services activities, has quickly upgraded into R&D segments of vertical industries, particularly in the automotive, aerospace and IT areas. Source: Authors based on Fernandez Stark and Gereffi (2016) . 36 For more information about upgrading trajectories in the Offshore Services industry, please see Fernandez- Stark, K., P. Bamber and G. Gereffi (2011). 42 4.1 Case Studies: India and Uruguay In analyzing different prospective paths for upgrading for Pakistan in the offshore services GVC, it is useful to look more in depth at specific examples from countries facing similar questions of how to develop the enabling conditions for the industry and add value to services exports. Two cases were selected for further examination: • India offers a compelling display of growth via specialized infrastructure and tax incentives within the Software Technology Parks (STPs), coupled with investments in talent development to leverage its cost-competitive but qualified labor. These initiatives drove investments by domestic firms and MNCs, allowing India to become the leading supply market of both traditional offshore services and digital services to the Industry 4.0. • Uruguay provides an example of entry into the offshore services GVC by capitalizing on a qualified IT market which needed to tap into foreign growth markets. Uruguay expanded from software services to product development and from ITO to high-end BPO. Initiatives aimed at upgrading were supported by a highly coordinated approach with public and private institutions supporting the IT industry and a national strategy focused on the entire offshore services industry. Table 9. Performance in the Offshore Services GVC; Pakistan, India and Uruguay Indicator Pakistan India Uruguay IT-BPO exports 655 52,278 177 (US$ millions, 2017) Entry Year Mid 2000 Early 1990 Late 1990 Entry Point Mid ITO (Software Mid ITO (Software Mid ITO (Software Services) Services) Services) Participation in Segments Mid ITO (Software All Mid ITO (Software Services) Services); High-end BPO (e.g. F&A, Supply Chain Management) Highest Value Activity Intelligent process Intelligent process Intelligent process (widespread only) automation automation automation Industry Composition Domestic Domestically-owned GIC and shared services companies, SMEs third-party providers, centers predominantly, predominantly foreign third-party except in ITO where providers, and GIC domestic SMEs prevail MNC Drivers Cost and benefits of Maturity, cost and Quality/skills, scale availability of IT-skills, political/legal/economic benefits of scale stability; similar time zone (East Coast) Business Associations P@SHA: efficient NASSCOM: strong body; ICT Chamber (500 body, focus on independent funding; members): forerunners in lobbying and focus on the selling of the economy; focus on advocacy services lobbying and advocacy Source: Author based on ILO (2017); Uruguay XXI (2017b); World Bank (2017). 43 4.1.1 India India is the leading global economic actor in the offshore services industry with a 55% share of the global IT services market. Low costs, strong technical and language skills, presence of premier educational and research institutions, historical concentration of high-tech firms, connections between locally born entrepreneurs and MNCs, as well as strong private association culminated in India becoming the largest exporter of IT in the world (Rao & Balasubrahmanya, 2017). In 2017, offshore services totaled US$116.8 billion, equivalent to 20% of foreign exchange reserves and 1.6 times more than in 2012 (NASSCOM, 2017a). IT services exports have been the major contributor; these were estimated to have been US$66 billion during FY2017 (Figure 14); exports rose at a Compound Annual Growth Rate (CAGR) of almost 13% during 2009-2017. BPO follows, accounting for 22.2% of exports. The US has traditionally been the largest importer of Indian IT services exports, with 62% of exports in 2017. These service are concentrated in just a few end- markets; approximately 80% of offshore services exports from India is across four sectors: Banking, Finance Services and Insurance (BFSI), telecom, manufacturing and retail (IBEF, 2018). Figure 14. Offshore Services Exports by Segment, 2000 – 2017 70 1,100 1200 1,025 1,050 Global In-House Centers (#) 60 Exports (US$ billion) 1000 790 825 50 760 710 710 800 40 460 600 30 400 20 180 10 200 0 0 2000 2005 2010 2011* 2012 2013 2014 2015 2016 2017 IT services IT products BPO Number of GIC's Source: Authors based on IBEF (2018). The Indian IT-BPO industry comprises over 15,000 firms. The industry exhibits a pyramidal structure with a handful of firms at the top. There were only 11 firms with an annual turnover greater than US$1 billion in 2013 (less than 0.1%), but they accounted for over 40% of total export earnings, and provide employment opportunities to roughly 35-38% of the workforce (IBEF, 2018). While larger firms generally offer bundled end-to-end solutions that encompass the entire offshore services GVC, small and emerging players excel in niche services/verticals (Bhattacharjee & Chakrabartib, 2015). Industry Evolution The Indian offshore services industry has developed from small beginnings at the bottom of the value chain to a major player in all segments of the global industry (Rao & Balasubrahmanya, 2017). Behind the rapid evolution of the IT and BPO sectors is its first mover advantage gained through the early development of an export platform for software services. Figure 15 outlines the upgrading trajectories of the Indian industry from its initial stages in 2000 when its strengths lay only in the low-end ITO sector to its emergence as one of the leading global players across all 44 segments in late-2000s, and the most sophisticated technologies pertaining to the Industry 4.0 in recent years.37 Figure 15. Upgrading Trajectories of Indian Offshore Services Industry (left); Ratio of Median Value Added to Sales (left) 0.8 0.76 0.69 0.7 0.57 0.6 0.5 0.4 0.3 0.2 0.1 0 2004 2009 2015 Source: Authors (left); Rao and Balasubrahmanya (2017) (right). With an abundant supply of technically skilled professionals (second only to the US), India could capitalize on the severe global manpower shortage of the IT boom in late 1990s; estimated to be over 1 million in the US alone This, coupled with high spending to resolve the Y2K problem was a boon for Indian IT professionals (Bhattacharjee & Chakrabartib, 2015). By 2000, India’s IT sector was already highly developed, while some activities within the BPO segment were just beginning to emerge (particularly call centers and financial activities). By 2006, a broadening and deepening of IT activities was combined with greater emphasis on higher value-added services in the financial and health care industries, amongst others. Driven by the availability of high-quality talent, synergies with existing traditional sourcing operations in the area and low operating costs, by 2017 India was now at the cutting edge of IT technology; it is host to some of the largest Internet of Things (IIoT) labs outside of home countries for several MNC. Firms such as ABB, Alibaba Group, and Western Union opened GIC performing digital functions, while GE, Bosch and SAP are ranked as five of the top ten industrial IoT employers in India (Everest Group, 2018b; Gupta, 2017). Bosch alone has 14,000 R&D associates in India, making it the company’s largest R&D campus outside of Germany with 27% of its R&D employee count; the campus is focused on developing data mining and software solutions (Bosch, 2016). Policies and Programs The government has played a key role as a facilitator in the evolution of the offshore services industry in India. While the liberalization of the economy in 1980s was not intended to support the offshore services sector, it created the enabling conditions for services exports, e.g. improvement of the telecommunications infrastructure. 37 TCS provides data processing and engineering support for Rolls Royce since the 2000s. More recently, Wipro supplied mining and construction equipment manufacturer, JCB, with an IoT solution to connect their global fleet, i.e. from the sensors to the cloud (Telematics Wire, 2016). 45 Figure 16. India’s Offshore Services Industry: Evolution and Policies Source: Authors based on Bhattacharjee and Chakrabartib (2015); Heeks (2010); IBEF (2018); Konrad Adenauer Stiftung (2015); NASSCOM (2011, 2012, 2017a); Rao and Balasubrahmanya (2017); Sahoo and Dash (2014). Notes: (*) Indian software professionals were taken abroad to the clients’ sites to execute short -term projects and lower-end jobs like coding and data conversion. The most significant institutional intervention was the establishment of Software Technology Parks (STP) in 1988. Established in 39 locations, they provided ready-to-plug IT and telecommunication infrastructure, in addition to tax benefits, and satellite uplinks. Moreover, STPs provided support for related items such as import certifications and market analysis. The overall improved conditions for foreign direct investment encouraged many foreign firms to establish their businesses in India. The influx of multinational subsidiaries, in turn, resulted in rapid knowledge transfer, improving the availability of qualified human capital in the country. Radical reforms continued through 1990s after a severe balance of payments (BOP) crisis which led to the abolition of industrial licensing, removal of entry barriers, exemption of corporate tax, opening up communication facilities, trade liberalization, devaluation of the rupee, and reduction in import duty on computers. These initiatives attracted multinationals which set up their captive centers in India. The growing presence of foreign firms benefited local companies, which acquired quality certifications and captured a wide range of skills beyond programming, such as quality assurance, project scheduling, among others. By the end of the 21st century, the Indian IT industry had firmly established its credibility in the world market. The leading Indian firms were quick to realize that demand for low-end value-added services had limited learning opportunities and value-added. As a result, supported incentives for skill development (Finishing Schools), public-private collaboration, and efforts by industry association NASSCOM, they diversified into various domains such as insurance, finance, customer support, among others. Finally, while the STP regime was terminated in 2011, a new Special Economic Zones scheme has taken its place, which offers similar incentives. 46 A key underlying element of India’s leadership is the tremendous depth of India’s educated labor pool. The number of IT-BPO professionals employed in all sectors in India grew more than four times during 2000 – 2007, with aggregate employment reaching 1.25 million in 2007 (Fernandez- Stark et al., 2011). By 2017 this number doubled, reaching 3.86 million FTE (NASSCOM, 2017a). One critical component of the human capital advantage was India’s brain gain, reverted form India’s brain drain. During the 2000s, professional and technical expats living in the US and the UK have been returning to India, driven by the rise in salaries, but particularly, enabled to do so by the cease of restrictions related to visas, investment and the purchase of property by Indian nationals who were citizens of other countries. 4.1.2 Uruguay Uruguay’s began to export IT services in the early-1990s and gradually expanded its participation in the offshore services GVC. Led by local firms, ITO represents a key economic sector for the country. In 2017, exports from this segment alone totaled close to US$380 million, making it the higher IT exporter per capita of Latin America and the Caribbean (Uruguay XXI, 2017b). Today, Uruguay has presence in most segments of the GVC, although with different degrees of participation (Figure 17). Figure 17. Uruguay’s Offshore Services Exports and Employment, by Segment Source: Authors based on (Uruguay XXI, 2017b). Notes: The size of the bubble indicates the share of each segment in the offshore services industry. While the country has a small population (3.4 million), and only graduates about 100 computer science engineers per year, the overall population’s education level is very high. Moreover, Uruguay stands out as a privileged location in terms of political and economic stability, strong institutions (e.g. IP protection, Personal Data Protection) and safety. 47 Industry Evolution Uruguay’s software industry began to develop in the 1980s, although computer science majors had been offered since 1968. Further development was enabled by four components: (i) qualified human resources; (ii) strong network of business leaders developing state-of-the-art technologies and competitive methodologies both at the regional and global level; (iii) construction of alliances and cooperation networks with large international companies headquartered in the US; (iv) strong ITC infrastructure (González, 2009). Today, the industry includes more than 350 IT companies providing horizontal and vertical product development, intelligent process automation, and IT services (Uruguay XXI, 2017b). The arrival of Indian lead firm TCS in 2002 introduced new competition, forcing domestic firms to become more competitive and reinforcing its ability to provide high-end services, as well as product development. This investment was followed by many others, particularly from US-based tech firms establishing software development centers in Montevideo. Examples include NetSuite, Verifone, Bull, IBM, and Microsoft, among others (González, 2009). Supported by specific policies, Uruguay was able to economically upgrade both within the ITO segment and the entire offshore services GVC. As showed in Figure 18, Uruguay’s product development exports gradually surpassed the software services category, going from 22% to 60% of IT total exports in the 2010 - 2015 period. Figure 18. IT Services Exports from Uruguay: Product Development vs. Software Services 300 Exports (US$ million) 250 200 106 204 241 118 150 169 100 166 50 105 50 62 57 - 2010 2011 2013 2014 2015 Product development Software Source: Authors based on Couto (Forthcoming). In addition to the growth of product development exports, the inflow of FDI prompted Uruguay’s upgrading in the value chain to position itself as a preferred location for a wide range of services in the industry. By the early 2000s, Uruguay began to expand its presence as a regional F&A shared services provider, logistics hub and financial services center for MNC such as BASF, Roche, and Ricoh. The country has also developed specialized industry-specific software for the BFSI, maritime and livestock (traceability system) verticals. FDI and local development led to significant growth in exports per employee, which tripled between 2007 and 2014, evidencing economic upgrading throughout all segments of the offshore services industry (Figure 19). 48 Figure 19. Upgrading Trajectories of Uruguay’s Offshore Services Industry (left); Exports per Employee (right) 2007 2014 Change Segment (US$ (US$ 2007 – million) million) 2014 (%) BFSI (V) 0.12 0.42 252% High-end 0.03 0.24 721% BPO ITO 0.06 0.09 53% Offshore 0.06 0.24 284% Services Source: Authors based on Couto (Forthcoming); Uruguay XXI (2017b) Policies and Programs Uruguay has maintained favorable, stable and reliable regulatory frameworks for FDI and offshore services exports since late-1980s. While the most significant growth of the industry was experienced before the government became actively involved with the industry (1999), the state provided the enabling conditions for its early development decades before. These include the Free Trade Zones (FTZ) regime, created in 1987 to promote both goods and services exports. Any firm under the FTZ is exempt from all corporative taxes—except social security—and any other tax to be created in the future (Uruguay XXI, 2017b). 38 FTZs have had a significant impact on the development of the industry, accounting for 50% of offshore services exports by 2014 (Uruguay XXI, 2017b). Private operators of these zones were the first stakeholders to promote Uruguay as an offshore services location in the early-2000s, successfully attracting captive centers centers and centers of excellence of international third-party services providers. While the IT services industry benefited from FTZ largely, the state had a specific agenda to promote software exports. The active intervention of the government commenced in 1999, when the software industry was declared one of national interest, and a plan with long-term objectives to make Uruguay a technological hub was established. During the 2000s, the state supported the IT services industry through the development of efficient public telecommunication infrastructure and specific tax treatment (VAT and income tax exemption for exports). These policies were largely a consequence of the lobbing capacity of the Uruguayan Chamber of IT companies (CUTI). In the second half of the 2000s, in dialogue with CUTI, Uruguay’s government recognized the IT services industry as one of five key economic growth engines. This resulted in the creation of new supporting legislation and institutions, including the Intellectual Property (IP) Protection Law and the Agency for Research and Innovation (ANII). The IP protection law was approved in 2003, providing owners of computer software the exclusive right to authorize its reproduction, distribution, transformation and communication to the public. ANII was created in 2006 as an 38 Benefits: income tax exemption; dividends paid to shareholders domiciled abroad are also exempt from paying taxes in the country; foreign staff may opt between making social security contributions in Uruguay or in their country of origin; foreign sales and purchases of goods and services are not taxed by VAT, neither are sales and services provided within the free zone; IRAE does not apply either when sales destined for the national territory do not exceed 5% of the total sales in goods in transit or deposited in the free trade zone (Uruguay XXI, 2017b). 49 entity to promote research and implementation of knowledge to the country’s economy; it provides funds for research projects, postgrad scholarships, and innovative projects. In March 2012, the country developed a national strategy entirely focused on the offshore services industry: The Global Services Program (GSP).39 The GSP was financed by the Inter-American Development Bank (IADB) and the Uruguayan Government for a total of US$13 billion (Uruguay XXI, 2017b). The GSP is an ongoing project, aimed at increasing FDI, exports and employment in the offshore services industry. The program is run by the parastatal National Trade and Investment Promotion Agency (Uruguay XXI) through an Implementation Unit attached to the Executive Directorate of this organization. Engagement with the private sector (e.g. CUTI and the Shared Services Association), as well as facilitation services to articulate new business associations in higher end segments (e.g. architecture and engineering) are critical features of the GSP. Through public-private cooperation, the GSP was able to complete the following achievements: • Collection and publication of quantitative and qualitative reliable data on the industry; • Participation in more than 50 international offshore services fairs and events; • Organization and financing of guided visits for more than 100 potential foreign investors; • Facilitation of the residencies and visa procedures for foreign investors and Computer Science Engineers; • Investment of US$2 million in more than 120 training programs (over 3,500 individuals) developed by offshore services companies to expand their business or upgrade in the value chain. This support—named ‘Specific Demand Finishing Schools’—provides firms the possibility of implementing tailored training programs with subsidies of up to 70% of the direct costs. According to GIC established in Uruguay the ‘Specific Demand Finishing Schools’ program is one key component of the country’s value proposition for FDI attraction and after-care. The instrument is well-known for its flexibility, agility, and compliance. Within the GSP, special funding was assigned for the IT services industry (PROTIC). The initiative allows to co-finance up to 70% of the total cost of export business plans, with a maximum support of US$20,000 per company per year. Covered activities include commercial visits to foreign clients, participation in events abroad, reverse missions (bringing clients or potential clients to the companies’ premises in Uruguay), consultancies and acquisition of databases. In the 2012 – 2016 period, PROTIC enabled more than a dozen companies to implement their business plans in the US, which in turn enabled them to reach new clients and open subsidiaries in San Francisco and New York (Uruguay XXI, 2017a). 4.2 Lessons Learned for Pakistan India and Uruguay present different value propositions in terms of size of talent pool and cost- arbitrage. These countries are also significantly different when comparing its business environment. Nonetheless, both countries have managed to position themselves in an increasingly competitive GVC by supporting the private sector and facilitating the enabling conditions to enhance the economic benefits of chain participation. In both cases, valuable lessons exist for Pakistan if it is going to prioritize its expansion in the IT industry and entry into the BPO segment to a more significant degree. 39 The GSP was the first national strategy for the offshore services industry in Latin America and the Caribbean. 50 1. Establishment of specialized infrastructure and tax treatment. Third-party providers and MNC in the offshore services industry, in general, have come to expect Technology Parks or Special Economic Zones (SEZ) benefits as a necessary condition for potential consideration. Both India and Uruguay have established strong SEZ with world-class infrastructure and competitive fiscal terms to support both foreign and local firms alike. Benefits in both countries include tax holidays, capital investment promotion policies, and 100% foreign equity ownership. In addition, these provide consulting and training services, implementation of internet infrastructure, data centers, incubation services, PMC services, systems integration and installation, and operations and maintenance of application networks, among many others. Overall, India’s STP and Uruguay’s FTZ have helped to support investor confidence in operating in unfamiliar business environments, and overcome constraints associated with operating in developing countries. 2. Skill development is a critical element in driving economic upgrading and growth and private sector should lead. While at different scale, both India and Uruguay have developed programs to develop human capital for the industry, illustrating the importance of skilled and employable professionals for the industry. The offshore services industry is highly dynamic and education systems often cannot respond in a timely manner to the changing requirements of the companies. Hence, policies towards skill development and economic upgrading should be driven by the needs of the private sector, which should be highly involved in skill development. In addition, instruments to facilitate training within companies should avoid excessive bureaucracy and be as agile as possible. 3. Strong industry coordination and public-private dialogue facilitated articulation of industry growth strategy and skill development strategies. India’s offshore services sector is well organized through NASSCOM, while Uruguay’s IT sector builds upon the efforts of the Uruguayan IT Chamber (CUTI). Continuous dialogue with the government—namely, Ministries of IT and Finance—have had tremendous impact on the development of effective and sustainable skill development strategies, e.g. Finishing Schools in India, and Demand Specific Finishing Schools in Uruguay. These have also been critical for national branding initiatives and consistent messaging; this is very relevant for offshore services, as per the value proposition of the country should be consistent across all stakeholders. 4. FDI is critical to demonstrate credibility as well as to upgrade, especially in economies with little or negative visibility in the offshore services industry. Solid and prosperous entry in the offshore services GVC usually happens after an international third- party establishes in one country, indicating the importance of the demonstration effect for other investors. As services (and human skills) are intangible, and production and consumption happen simultaneously, location choices of MNC largely depend on the experience of other global companies. 5. After care is a key factor for economic upgrading. Both India and Uruguay have demonstrated that companies are more prone to establish value-added operations in countries that focus on improving the overall business climate for an MNC, such as reducing bureaucratic hurdles, easing migration restrictions and guaranteeing property rights. 51 5 Recommended Upgrading Trajectories for Pakistan Pakistan recently entered the offshore services GVC. Compared to other developing countries, its entry as a reliable offshore services location has been slow. Under these circumstances, the most pressing issue for Pakistan is to solidify its position in traditional offshore services segments such as IT and BPO. After consolidating both industries and gaining global recognition as a qualified and trustworthy competitor in these segments, Pakistan can pursue upgrading into more sophisticated processes. Successful experiences in Pakistan are built on its sizeable talent pool, cost arbitrage and strong business linkages with Pakistani-Americans living in the US. These elements are the most relevant components of Pakistan’s value proposition relative to competing nations across the globe. As such, they suggest a promising positioning of the country in the offshore services GVC. Three upgrading trajectories in the short- to long-term are recommended for Pakistan’s advancement in the offshore services GVC: (1) Process upgrading to increase participation in the BPO segment; (2) Product upgrading to develop worldwide recognition as a qualified IT provider; and (3) Functional upgrading into specific verticals to leverage existent competitive advantages. Short-term: Process upgrading to increase participation in the BPO segment. By the early 2000s, connectivity deficiencies and security concerns battered Pakistan’s competitiveness as a BPO provider. Major improvements in internet infrastructure in the last decade have led to a conducive business environment for BPO operations. Recovery is evidenced by the upgrading experience of TRG and recent expansion of customer support operations in large ITO firms (e.g. Systems Limited). With a large youth cohort (nearly a third of the country’s total population) Pakistan is ranked as the third largest English-speaking population in the world. Its attractiveness as a platform for unbundling BPO tasks is supported by low labor costs, estimated at 60% of those in the Philippines (Field Research, 2018). Accordingly, Pakistan offers the most basic conditions to compete in the BPO segment. While continuous growth in leading BPO locations suggest that job destruction is unlikely in the next three to four decades, automation will most definitely change skill and educational requirements for this segment.40 With an adequate set of policies in place— ranging from skill development strategies to FDI attraction and business environment improvements—Pakistan can attain process upgrading and increase its participation in the BPO segment in the short-term. Medium-term: Product upgrading to develop worldwide recognition as a qualified IT provider. Despite sustained growth, Pakistan IT exports and freelance activity remain concentrated in rudimentary services, with 90% of revenues deriving from low value-added sectors of the global market. Despite this, development of highly sophisticated solutions is on the rise, with some companies offering artificial intelligence platforms and geoscience management for vertical industries in the US. Qualified diaspora in developed economies provide Pakistan with a major opportunity to make foreign markets aware of its talent quality and cost arbitrage. By revisiting tertiary education shortfalls, collecting accurate data on the industry and ensuring adequate and affordable 24/7 office space is available, Pakistan can leverage its organic development and expect to become a cost-effective and qualified hub for higher value-added IT processes. Long-term: Functional upgrading into specific verticals. Once Pakistan attains a solid position in the ITO and BPO segments, it will be easier to transition from horizontal to specialized 40 See Section 2.1. for further information on this topic. 52 solutions, i.e. supplying IT and BPO services to vertical/sophisticated industries. This opportunity finds its roots in the process of knowledge accumulation driven by the spillover effect of the segment employees. To illustrate: companies such as NETSOL Technologies, S&P Global and MTBC provide adequate training to their employees as a means of correcting skill deficiencies; this training is associated with the introduction and dissemination of knowledge and new technologies to the country. In addition, it can be expected that IT-BPO companies specialized in certain verticals increase the demand for specific skilled workers and send signals about the need and opportunities for specific skills to educational institutions. 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Wipro HOLMES™ Retrieved October, 16, 2018, from https://www.wipro.com/holmes/what/. World Bank. (2017). World Bank Open Data. Retrieved 2017 December, 17, from World Bankfrom https://data.worldbank.org/. 59 Annex I. Tables Table A 1. A.T. Kearney Offshore Services Location Index, Selected Countries (2017) Country 2017 2016 2014 2011 Index Ranking 2017 Rank Rank Rank Rank Financial People Skills and Business Attractiveness Availability Environment India 1 1 1 1 1,14 3,3 2,63 China 2 2 2 2 1,26 2,37 2,69 Malaysia 3 3 3 3 1,72 2,92 1,47 Indonesia 4 5 5 5 1,2 3,25 1,53 Brazil 5 4 8 12 1,27 2,65 2,02 Vietnam 6 11 12 8 1,22 3,31 1,39 Philippines 7 7 7 9 1,17 3,13 1,57 Thailand 8 6 6 7 1,43 3,06 1,38 Sri Lanka 11 14 16 21 1,22 3,42 1,07 Egypt 14 16 10 4 0,99 3,37 1,26 Bangladesh 21 22 26 NA 0,8 3,34 1,23 Morocco 27 34 34 37 1,29 2,9 1,1 Pakistan 30 28 25 28 0,63 3,35 1,3 Source: Authors based on A.T.Kearney (2011, 2014, 2016, 2017). Notes: (a) The Global Services Location Index (GSLI) evaluates 55 countries against 38 measurements across three major categories: financial attractiveness, people skills and availability, and business environment. Financial factors constitute 40% of the total weight in the published Index. The two remaining categories – people skills and availability and business environment–constitute 60% of the total weight (A.T.Kearney, 2017). 60 Table A 2. Networked Readiness Index, Selected Countries Indicator Pakistan India Philippines Political and regulatory environment Effectiveness of law-making bodies 95 50 83 Laws relating to ICT 117 23 81 Judicial Independence 82 64 76 Efficiency of legal system in settling disputes 107 42 87 Efficiency of legal systems in challenging regulations 101 39 80 Intellectual property protection 112 50 17 Software piracy rate, % software installed 96 53 67 No. Procedures to enforce a contract 128 128 69 No. Days to enforce a contract 125 137 116 Business and innovation environment Availability of latest technologies 79 108 78 Venture capital availability 78 13 39 Total tax rate, % profits 49 123 92 No. Days to start a business 97 114 114 No. Procedures to start a business 114 133 138 Intensity of local competition 98 101 56 Tertiary education gross enrolment rate, % 115 89 73 Quality of management schools 70 55 40 Government procurement of advanced technologies 52 26 59 Infrastructure Electricity production, kwh/capita 111 98 103 Mobile network coverage, % population 125 111 67 Internet bandwidth, kb/s per user 115 116 79 Secure Internet servers/million pop. 123 105 96 Skills Quality of education system 75 43 31 Quality of math & science education 89 63 67 Secondary education gross enrolment rate, % 124 103 78 Adult literacy rate, % 106 95 41 Source: Authors based on WEF (2017). 61 Pakistan in the Medical Device Global Value Chain January 2019 Prepared by Danny Hamrick and Penny Bamber Duke Global Value Chains Center, Duke University This research was prepared by the Duke University Global Value Chains Center on behalf and under the guidance of the World Bank The report is based on both primary and secondary information sources. In addition to interviews with firms operating in the sector and supporting institutions, the report draws on secondary research and information sources. The project report is available at www.gvcc.duke.edu. Acknowledgements The Duke University Global Value Chains Center would like to thank all of the interviewees, who gave generously of their time and expertise, as well as Mahrukh Kayani for her invaluable assistance in our field research. We would also like to thank the Sustainable Development Policy Institute (SDPI) for its extensive support organizing our field research in Pakistan. The Duke University Global Value Chains Center undertakes client-sponsored research that addresses economic and social development issues for governments, foundations and international organizations. We do this principally by utilizing the global value chain (GVC) framework, created by Founding Director Gary Gereffi, and supplemented by other analytical tools. As a university- based research center, we address clients’ real-world questions with transparency and rigor. www.gvcc.duke.edu. Duke Global Value Chains Center, Duke University © January 2019 2 Pakistan in the Medical Device Global Value Chain 1 Introduction...................................................................................................................................................... 6 2 The Medical Device Global Value Chain ................................................................................................... 7 2.1 The Global Medical Device Industry ................................................................................................. 7 2.2 The Medical Devices Global Value Chain......................................................................................... 9 2.3 Global Trade in the Medical Devices Global Value Chain.......................................................... 15 2.3.1 Global Demand ........................................................................................................................................ 15 2.3.2 Global Supply ............................................................................................................................................ 17 2.4 Lead Firms and Governance .............................................................................................................. 20 2.4.1 Regulation and Public and Private Standards..................................................................................... 23 2.5 Human Capital, Workforce Development and Gender ............................................................. 26 3 Pakistan in the Medical Device Global Value Chain .............................................................................. 30 3.1 Pakistan’s Current Participation in the Medical Device Global Value Chain ......................... 30 3.1.1 Pakistan’s Medical Device Exports....................................................................................................... 33 3.2 Industry Organization ......................................................................................................................... 35 3.3 Upgrading and Industry Evolution in Pakistan’s Medical Device Global Value Chain .......... 37 3.4 Human Capital ...................................................................................................................................... 38 3.5 Advantages and Constraints .............................................................................................................. 39 3.5.1 Advantages................................................................................................................................................. 40 3.5.2 Constraints ................................................................................................................................................ 41 4 Lessons for Pakistan’s Upgrading in Medical Device from Global Experiences ............................. 42 4.1 Case Studies .......................................................................................................................................... 44 4.1.1 Dominican Republic ................................................................................................................................ 44 4.1.2 Malaysia: Leveraging Experiences in Related Industries.................................................................. 49 4.2 Key Lessons for Pakistan .................................................................................................................... 54 5 Recommended Upgrading Trajectories for Pakistan ............................................................................ 55 6 Appendix ......................................................................................................................................................... 57 7 References ...................................................................................................................................................... 60 3 List of Tables Table 1. Medical Devices Categories based on Use, Characteristics and Production Expertise ........ 13 Table 2. Global Medical Devices Imports, by Income Level Group 2002-2016 ...................................... 16 Table 3. Top Five Global Exporters by Product Category, 2016 ............................................................... 18 Table 4. Growth of Selected Offshore Production Locations ..................................................................... 20 Table 5. Top Ten Global Firms in the Medical Devices Industry, by Revenue 2017 .............................. 21 Table 6. Employment in Medical Devices Sector, Select Leading Countries 2008-2015 ....................... 27 Table 7. Select Job Profiles in the Production Segment of the Medical Devices GVC .......................... 29 Table 8. Firm Characteristics, 2016-2017 ........................................................................................................ 35 Table 9. Key Industry Stakeholders in the Medical Device GVC................................................................ 37 Table 10. SWOT of Pakistani Medical Device Industry ................................................................................ 40 Table 11. Upgrading Trajectories in the Medical Devices Global Value Chain ....................................... 43 Table 12. Malaysian Medical Device Firms by Type ....................................................................................... 51 Table A- 1.Medical Devices Product Categories, Based on Trade Data Classifications 57 Table A- 2.Top Five Global Importers by Product Category by Value ($US Mil), 2016 ....................... 58 Table A- 3.Leading Importers in East Asia & Pacific ....................................................................................... 58 Table A- 4. ISO 13845 Certification by Region, 2004-2016......................................................................... 59 Table A- 5.Medical Device Regulation in Major Asia-Pacific Markets ........................................................ 59 List of Figures Figure 1. Medical Devices Global Value Chain ......................................................................................................... 10 Figure 2. Production Stages for Precision Metals..................................................................................................... 11 Figure 3. Imports of Medical Devices by Geographic Region (US$, Billion), 2006-2016 ............................... 16 Figure 4. Top Ten Global Surgical/Medical Instruments Importers (US$, Million), 2006-2016 .................... 17 Figure 5. Top Ten Exporters Surgical/Medical Instruments, by Year 2006-2016 ............................................ 19 Figure 6. ISO 13485 Certification, by Region 2004-2016 ...................................................................................... 26 Figure 7. Pakistan Export by Medical Device Sector, 2004-2016......................................................................... 31 Figure 8. Pakistan in the Medical Devices Global Value Chain ............................................................................. 32 Figure 9. Pakistan's Medical Device Exports (US$) by Exporters per Destination, 2016/2017 .................... 33 Figure 10. Pakistan’s Medical Devices Export Destinations (% of total exports), 2006-2016 ...................... 34 Figure 11. Dominican Republic Exports in the Medical Devices GVC, 2006-2016 ......................................... 45 Figure 12. Dominican Republic Medical Device Exports, Select Regions 2006-2016 ..................................... 46 Figure 13. Malaysia’s Medical Device Exports (US$) by segment, 2006-2016 .................................................. 50 Figure 14. Medical Device Export Share by Segment, 2006-2016 ....................................................................... 52 List of Boxes Box 1. Production of Precision Metal Medical and Surgical Instruments .................................................. 11 Box 2. The Shifting Nature of Surgical and Medical Instruments ................................................................ 14 Box 3. New Medical Devices Regulation in Europe ....................................................................................... 25 Box 4. Community Manufacturing Centers ..................................................................................................... 38 4 Acronyms ADOZONA Asociación Dominicana de Zonas Francas (Dominican Association for Free Trade Zones) AMMI Association of Malaysian Medical Industries ATC Apprentice Training Center, Pakistan CAFTA-DR Central American Free Trade Agreement CARIFORUM Forum of the Caribbean Group of African, Caribbean and Pacific States CMC Community Manufacturing Center CNC Computer Numeric Control CNZFE Consejo Nacional de Zonas Francas de Exportación (National Council of Export Processing Zones) EAP East-Asia Pacific EGFSN Expert Group on Future Skills Needs E-O Ethylene-Oxide EPZs Export Processing Zones EU-15 European Union FDA Food and Drug Administration, United States GVC Global Value Chains HAI Hospital Acquired Infections ILO International Labor Organization IMDRF International Medical Device Regulators Forum M&As Mergers and Acquisitions MDA Medical Device Act (Malaysia) MFN Most Favored Nation MIDA Malaysia Industrial Development Authority MIDC Metal Industries Development Center, Pakistan MMDA Malaysia Medical Device Association MNCs Multinational Corporations MRI Magnetic Resonance Imaging NB Notifying Bodies PSQCA Pakistan Standards and Quality Control Authority R&D Research and Product Development SCCI Sialkot Chamber of Commerce and Industry SIMAP Surgical Instruments Manufacturers Association of Pakistan SIMTEL Sialkot Material Testing Laboratory SMEs Small and Medium Sized Enterprises T&A Textiles and Apparel TDAP Trade Development Authority of Pakistan TEVTA Technical Education and Vocational Training Authority, Pakistan UID Unique Identification UK United Kingdom US United States of America WHO World Health Organization 5 1 Introduction Pakistan is a long-established actor in the medical devices global value chain (GVC), a multi-billion global dollar industry covering a wide spectrum of products from inexpensive, single use items such as bandages and dressings, to high-cost, state of the art capital equipment, such as magnetic resonance imaging (MRI) machines. For years, Sialkot, Pakistan has been a traditional global cluster for export-oriented contract manufacturing of precision metal instruments used in general surgery. Success to date has been based on decades of production experience passed down generation to generation, combined with low-cost labor supply. However, changing dynamics in the global medical device industry mean that past drivers of competitive advantage are becoming less relevant. Pakistan has seen its medical devices exports plateau in recent years as new products and competitors have entered the market. In order to sustain its participation in the industry, Pakistan needs to adopt a specific growth strategy based on improved efficiencies, entry into new markets and diversification of production. Since the turn of the century, the global medical devices industry has experienced considerable growth, reaching US$360B in 2017, as populations have expanded and aged, diseases spread and health care coverage increased. This growth has created new opportunities but it has also been accompanied by significant changes in the industry that have important implications for Pakistan’s sustained participation. First, technological advancements in surgical techniques and production capabilities have become to shift the demand away from traditional surgical instruments to new, smaller and smarter tools that reduce patient risk and recovery time. Second, high health care costs and regulatory requirements have led to the restructuring of the value chain around fewer, larger and more diversified firms; this has created considerable barriers for entry in established markets. Third, in response to these pressures, lead firms are consolidating production in select locations with strong capabilities in a diverse range of products, from surgical instruments to highly regulated implantable devices. Opportunities for growth still exist in emerging markets, where healthcare expenditure is increasing, however, this window will be limited as lead firms seek to gain market share in these growth regions. As a result, as has occurred in multiple globalizing industries, small, less innovative firms struggle to maintain their positions in key markets and are often pushed down the chain into low-margin contract manufacturing activities. While Pakistan’s exports have grown steadily along with global industry trade in the past decade to reach US$355M in 2016, Pakistan remains a small-scale exporter globally of surgical instruments and recent years show a notable slowdown as new products and competitors have entered the market and internal human capital deficiencies and inefficient production practices have stifled the industry. In order to sustain its position in the industry, Pakistan needs to adopt a specific growth strategy that engages both public and private sector actors towards common goals. Specifically, Pakistan should upgrade production processes to increase productivity, diversify its product portfolio and strengthen ties with emerging markets. The country’s past success in textiles and apparel also offer an opportunity for the country to become a more significant player in the medical textiles industry. Policies supporting these upgrading trajectories will need to capitalize on strengths of the industry, including its reputation as a low-cost supplier and existing geographical concentration of firms while also addressing human capital, institutionalization, and production challenges. Numerous reports have documented Pakistan’s production of precision metal surgical instruments over the past two decades. However, these reports fail to consider the broader forces that are changing the medical devices industry as a whole, which will have important implications for Pakistan’s continued participation in the industry. This report therefore seeks to situate Pakistan’s 6 production of surgical instruments into the broader medical devices GVC. This GVC framework will allow policymakers to better understand how the global medical device industry is evolving, assess Pakistan’s current position in the chain and identify opportunities for economic upgrading. Research on Pakistan is aided by field research conducted in September 2018. In total, 15 interviews with key stakeholders across three cities (Sialkot, Lahore, and Karachi) were completed. Private sector actors of varying sizes accounted for the majority of interviews (73%) and 85% of all participants were located in Sialkot. Interviews were further aided by firm level data based on Pakistan Custom’s Authority data provided by the World Bank. The report is structured as follows: It first provides an overview of the medical devices GVC to present a clear understanding of the scope of the industry, how markets are structured and how changing distribution of demand and supply destinations and lead firm organization alter structural dynamics in the chain. It then analyzes the domestic industry within Pakistan, first detailing the country’s position in the chain as well as recent trends and the internal organization of the industry. After assessing the advantages and constraints observed in Pakistan, it looks to the Dominican Republic and Malaysia for comparative case studies, detailing the lessons learned for Pakistan. The report concludes by outlining potential upgrading strategies to enhance the country’s competitiveness. 2 The Medical Device Global Value Chain Key Takeaways • The global medical device industry is a US$360B industry and covers a wide spectrum of products from inexpensive bandages, to technology-intensive hearing aids and high-cost items such as magnetic resonance imaging (MRI) machines. Surgical/Medical instruments, the largest segment, represents 28% of exports. • A few select locations have been prioritized by device companies, particularly for lower cost products in disposables and surgical instruments; these sites are now shifting into higher value orthopedics and implantables products. • The use of hand-held precision instruments for general surgery has dominated the healthcare market for decades, in recent years the emergence of new, less invasive surgical techniques has begun to drive demand for a new set of tools. 2.1 The Global Medical Device Industry Surgical/Medical instruments are part of a broader global medical devices industry. Covering a wide spectrum of products from inexpensive bandages, to technology-intensive hearing aids and high-cost items such as magnetic resonance imaging (MRI) machines, the medical devices sector is a strong, global growth industry.1 The global market reached an estimated US$360B in 2017 (BMI Research, 1 These include “all instruments, appliances and materials that are designed for diagnostic and/or therapeutic purposes to monitor, treat, prevent or alleviate disease, injuries or handicap and that do not strictly achieve their action by pharmacological, immunological or metabolic means” (WHO, 2017). 7 2018a), while trade in 2016 at US$203B (UN Comtrade, 2018).2 Surgical instruments represent an important share of global medical device industry trade, accounting for approximately 27-30% over the past two decades and US$56B in 2016 (UN Comtrade, 2018). Advances in science and technology, surgical techniques, an aging global population and increased access to more advanced medical care around the world, continue to drive demand in the industry and foster the development of new products. Developed country markets are mature, with low but steady growth rates, but they still remain the most valuable accounting for over three-quarters of the global market share (Frost & Sullivan, 2017). Recently, however, developing countries have emerged as key growth opportunities thanks to rising incomes, aging demographics, and government increases in per capita healthcare expenditure, particularly an expansion of healthcare beyond major cities (BMI Research, 2018a; CFRA, 2018). The production of these devices is concentrated in a relatively small number of companies. Lead firms with a global presence account for more than half of the world’s market share. At the same time, nonetheless, faced with rising health care costs, governments and health care organizations have begun to apply coordinated procurement and reimbursement3 models to gain leverage with suppliers (BD, 2018; Boston Scientific, 2018; Medtronic, 2018). As a result, the medical devices sector has begun to focus on global production networks to improve economic efficiencies, and harness qualified human capital abroad. This offshoring of production provides important opportunities for developing countries with available skilled labor to leverage cost arbitrage and a favorable location to participate in this lucrative sector. Numerous countries from Latin America (Brazil, Costa Rica, Dominican Republic, Mexico) and Asia (China, India, Malaysia, Singapore, Taiwan) have developed industrial policies to attract this global expansion, targeting both foreign direct investment and domestic firms alike (Bamber & Frederick, 2018; BMI Research, 2018a; Field Research, 2018b; World Bank, 2011). The following sections present the medical devices GVC, discuss the global geographic distribution of demand and supply, examine the leading firms in the sector and the manner in which the chain is governed through public and private standards as well as provide an overview of differing human capital needs in different parts of the chain. By analyzing these global dynamics, these sections provide a “blue print” for Pakistan policy makers as the country develops its strategic plan for future growth. Three major trends have shaped the global medical devices industry in general, and the instruments sector specifically in recent years: (1) demand has been growing for minimally invasive surgical instruments; (2) shifting regulatory environment; and (3) rise of select offshore locations. Each is discussed below. 2 The products included in this measure are detailed in Table A- 1of the Appendix. Trade data was analyzed for the period 2006-2016. 2016 was the latest available comprehensive data at the time of publication. 2017 trade data was incomplete and therefore misleading. 3 Reimbursement procedures, whereby health insurance organizations agree to finance particular procedures, can act as a barrier to entry for new products. Due to their high prices, many medical devices are beyond the reach of individual patients if they are not covered by their health insurance. Insurers can require additional proof of the effectiveness of a device beyond that required by the regulating agency before they agree to finance it. 8 Growth in demand for minimally invasive surgical instruments. While the use of hand-held precision instruments for general surgery has dominated the healthcare market for decades, in recent years the emergence of new, less invasive surgical techniques has begun to drive demand for a new set of tools. Minimally invasive or ‘keyhole’ surgery has grown in popularity in advanced healthcare markets thanks to the reduction in recovery time and hospital stays, and overall reduced risk. Large surgical instrument manufacturers have invested considerably in bringing new laparoscopic and endoscopic devices to market, training surgeons and encouraging a shift to these new tools. This tendency has combined with the demand for single-use instruments as health care providers seek to manage per-patient costs and reduce potential liability from hospital-acquired infections. Increasingly strict regulatory environment. The regulatory environment is changing globally due to changes in the European Union (EU-15), the withdrawal of the United Kingdom (UK) from the EU-15, the adoption of new frameworks by emerging markets, as well as a revision of the requirements of the Food and Drug Administration (FDA) in the United States. Regulators maintain that these changes are designed to improve the safety and efficacy of products on the market, as well as to stimulate innovation. However, these changes – such as the new European Union requirements for re-registration of all products – raise costs and uncertainty for manufacturers of medical devices around the world. These changes will be particularly challenging for small and medium sized enterprises (SMEs) to withstand and supportive policies must be considered. Consolidation of select offshore production locations. Albeit slower than other manufacturing industries (Brocca et al., 2017), medical devices producers have launched offshore production strategies to help reduce their costs and access new markets. Overall, a few select locations have been prioritized by device companies, particularly for lower cost products in disposables and surgical instruments; these include Ireland, Mexico, Singapore, Costa Rica, Dominican Republic and Malaysia. ‘Medtech’ has become a prioritized sector in these countries and clusters of foreign and local firms have emerged. These countries are steadily consolidating their share of, and ranking in, global exports (see Table 3) favored for their combination of capable workforce, geographic location for access to market, supportive export policies, and oversight in intellectual property protection (Bamber & Frederick, 2018; Bamber & Gereffi, 2013; BMI Research, 2018a; Giblin & Ryan, 2012). While these sites began in lower cost product segments, the fastest growth segment over the past decade are in higher value orthopedics and implantables (i.e. therapeutics; see Table 4). 2.2 The Medical Devices Global Value Chain First, an overview of the broader medical devices GVC is provided followed by more specific stages involved in the development of medical and surgical instruments in particular, such as precision metal works. Each stage of the chain is discussed, in addition to detailing the key product and market segments included in this industry. Breaking down the value chain to this level of detail allows policy makers to more accurately map Pakistan’s current and potential opportunities in this global industry as a whole, rather than taking a monoscopic approach focused solely on surgical instruments. Due to the growing overlap in ownership, production, distribution and buyer behavior across the range of products in the medical devices sector, understanding trends and changes in the surgical and medical instruments sector is best understood by analyzing them in their broader context. 9 This report utilizes the medical devices GVC defined by Bamber and Gereffi (2013) to provide the broader context of the industry (see Figure 1). Figure 1. Medical Devices Global Value Chain Research & Product Components Post-Sales Assembly Distribution Marketing & Sales Development Manufacturing Services Final Products Market Segments Prototype Software Assembly Capital Development Cardiovascular Equipment Training Process Electronics/Electrical Development Packaging Therapeutic Components Orthopedics Devices Consulting Regulatory Precision Metal Approval Sterilization Surgical & Medical Works General Surgery Instruments Complaints Process Plastics Extrusion Management Development Infusion & Molding Disposables Systems Maintenance/ Sustaining Weaving/ Repair Engineering Knitting Textiles Consumables Others Input Suppliers Buyers Wholesale Resin Metals Doctors & Nurses distributors Hospitals Individual Chemicals Textiles (Public/Private) Patients Source: Authors based on Bamber and Gereffi (2013) Note: For simplicity and relevance for Pakistan categories such as respiratory devices are not displayed. The highest value segment of the chain is research and product development (R&D). During this stage, new products are conceptualized, prototypes are produced and tested and potential manufacturing capabilities are assessed. Following initial concept tests, the product is then registered for regulatory approval in the desired market(s). This can be a lengthy process, depending on the market’s regulatory approach, the risk category of the device and clinical trials required. Generally, inputs and production processes must be validated to obtain regulatory approval. At this stage, both a firm’s internal production capacity and the availability of potential vendors can influence production decisions. The initial product price is determined and potential for reimbursement is assessed. Once the device enters production, a team of engineers continues to improve upon the production process (sustaining engineering). These engineers work in close contact with the product development teams. Lead firms often acquire new products through mergers and acquisitions (M&As) rather than undertaking the product development process internally (Simoens, 2009). This provides an opportunity for smaller firms to enter the market. In recent years, R&D in the medical and surgical instruments category has focused on the development of minimally invasive devices. The production segments, components manufacturing and assembly, are typically the lowest value-added segments of the chain and are comprised of several different functions 10 depending on the final product. Box 1 details the production stages of precision metal instruments. Finally, once final assembly is complete, the product must be labeled, packaged and sterilized before distribution. Labeling and inserts are important parts of the production process, since incorrect information regarding use attached to a medical device can have fatal consequences. Sterilization takes place using one of several methods: E-beam (electrons are accelerated through the product); ethylene-oxide (E-O) (product is sterilized by gas); and gamma ray sterilization are amongst the most commonly used. While gamma ray sterilization is required for dense products, such as those containing liquids, most other products can either undergo e-beam or E-O sterilization. However, due to high costs of validation, usually one method is selected for regulatory approval per product. Sterilization in production locations allows for direct sales shipments. Box 1. Production of Precision Metal Medical and Surgical Instruments Precision metal medical and surgical instruments are used in a variety of procedures. While several instruments exist, the production process is similar for all of these products (see Figure 2). Figure 2. Production Stages for Precision Metals Manufacturing Refining Finishing Inputs • Forging • Filling • Polishing • Metals • Trimming • Grinding • Final Assembly • Die Making • Machining • Heating • Testing • Cleaning • Sterilization • Packaging Source: Authors. Raw materials: Consist primarily of metal inputs; the specific metal used varies by buyers’ needs. The most common metal used is stainless steel but other materials such as titanium and tungsten carbide may also be used. Within stainless steel, magnetic and non-magnetic steel categories are used depending on the specific instrument being produced. Quality of inputs is an important consideration and buyers may specify the precise origin of metal inputs and the grade of the metal to be used. Manufacturing: This is labor intensive and involves a series of complex steps, several of which can be geographically separated: First, a die is made for the instrument, followed by forging when hot metal is placed into the die-casting and struck to forge the shape needed. This can be done mechanically or manually depending on the firm’s level of sophistication; mechanical processes allow for higher volumes and reduced waste. The instrument is then trimmed and machined to achieve the desired shape. Maintaining a constant temperature of the forge ensures better quality by reducing stress and softening the product for further processing. Refining then occurs where joints and grooves are fashioned and the desired edges produced. The instrument is then re-heated to harden the metal. Throughout production, a constant temperature must be maintained (annealing) to avoid brittleness and guarantee quality. Finishing: Polishing, cleaning and packaging of the instrument. Tests are performed to insure against environmental and chemical corrosion and devices are cleaned using an ultrasonic cleaner to remove dust particles. Sources: Field Research (2018a); Liaqat (2013) Distribution, Marketing and Sales: Medical devices producers may distribute through wholesale distributors, such as Cardinal Health, or directly to their end clients via internal distribution centers 11 or catalogues. End clients may be hospital or clinic administrators, those responsible for direct patient care such as doctors, nurses and specialists, and through retail directly to the patient themselves. Distribution channels depend on the type and value of particular products. Lower-value products tend to be distributed through wholesale distributors, while high-value products are likely to be sold directly to hospital administrators. Products might also be sold as integrated solutions, which combine medical devices, training, consulting and other post purchase services. Sales channels for medical and surgical instruments vary by type; disposables are often sold in surgical kits packaged with items such as surgical drapes while reusable instruments such as forceps and retractors are sold through direct orders (Field Research, 2017). In the face of rising health care costs, buyers are improving their negotiating positions by establishing purchasing groups, moving individual doctors’ practices under the umbrella of hospital administrations to benefit from economies of scale, introducing tendering processes and reducing their overall number of suppliers (Medtronic, 2018; Seligman, 2012). Increased competition to become selected suppliers means that medical devices manufacturers spend significantly on direct marketing and building relationships with clients. As early as 2010, it was estimated that in Europe, 56% of the cost base for a product is spent on marketing and sales (Frost & Sullivan, 2010). Finished products: Surgical and medical instruments are one of a number of product categories in the medical devices sector. For this report, the following categories are used: (1) Consumables;4 (2) Disposables; (3) Surgical and Medical instruments; (4) Therapeutic Devices; (5) Capital Equipment; and (6) Other Devices (Bamber & Gereffi, 2013; Sturgeon et al., 2015). These are detailed in Table 1. 5 4 Consumables can also be considered a medical supply rather than device; nonetheless, they are becoming increasingly sophisticated and potential substitutes for medical devices including sutures and thus are included in the analysis. 5 Detailed definitions of each of these product categories by trade codes are available in Table A-1. For the purposes of this study, “medical devices” are limited to those products that are designated strictly for use in dental, medical, surgical or veterinary practices. Medical and surgical furniture, such as hospital beds, were not included in this study. 12 Table 1. Medical Devices Categories based on Use, Characteristics and Production Expertise Product Examples Characteristics Production Capabilities/Medical Category Expertise Consumables Bandages and dressings Highly cost driven Compliance with cleanroom standards; generally, not subject to regulatory controls/standards Disposables Plastic syringes, catheters and Single-use products; Compliance with specific medical needles, sutures highly cost driven devices standards Surgical and Forceps, medical scissors and Multi-use products Compliance with specific medical medical dental drills, as well as sterilized between uses; devices standards instruments specialized minimally invasive single-use versions of the surgical instruments same instruments; cost- driven Therapeutic Hearing aids, pacemakers and Implantable and non- their prolonged use inside the body, devices prosthetics implantable devices to the production of implantable devices help people manage requires considerable expertise, physical illness or particularly with respect to bio- disability; quality and skill compatibility driven Capital Ranges from infusion pumps Single-purchase Medical and electronics expertise equipment and blood pressure monitors to equipment used considerably large investments repeatedly over a such as MRI equipment or number of years; large, computed tomography long-term investments Other Devices Breathing devices, oxygen Multi-use products for Compliance with specific medical therapy devices, gas masks, single users; single-use devices standards massage equipment products; Source: Authors. Each of these product categories represents a wide range of products. The surgical and medical instruments category, for example, represents thousands of distinct devices (Box 2). Variation among products is common depending on specific use and material used in production. Instruments are further classified by their use, which is often determined by the quality of inputs and the quality of production; these classifications include: • Surgical Operation Room Quality - this is the highest quality of instruments using the best grade steel input for forging and with high expectations for quality shaping and grinding. • General medical use - these instruments are reusable instruments but have a slightly lower quality than operation room grade • Single use instruments6- these use lower quality steel inputs and are designed for single use. This category is growing in popularity in developed markets because they eliminate the need for sterilization and remove risk of contamination across patients (Field Research, 2018a). 6 Defined by the FDA as “intended for use on one patient during a single procedure . . . and is not intended to be reprocessed (cleaned, disinfected/sterilized) and used on another patient (FDA, 2015).” 13 Box 2. The Shifting Nature of Surgical and Medical Instruments Traditionally, this product segment has been considered mature with little product differentiation beyond branding and cost. Well-established products include forceps, retractors, surgical scissors, needle holders and scalpels, measuring instruments amongst others. Over the past two decades, however, two major trends have begun to shift the dynamics of this segment. First, notable technological and medical advances have made surgeries easier and faster to perform, improved outcomes and reduced both surgical and post-op complications. These include advances in powered devices, minimally invasive instruments and surgical robotics. This has been driven by significant R&D activity; globally, close to 60,000 patents have been filed in the past ten years for endoscopic devices alone Although adoption has been uneven, applications of these tools cover most major fields, including neurosurgery, cardiovascular, orthopedic, plastic and reconstructive surgery. Second, demand has grown for single-use surgical instruments to manage hospital acquired infections (HAI) resulting from improper or inadequate sterilization of multi-use devices, and to increase responsiveness to pricing requirements from healthcare insurers (Freedonia, 2016). Some growth estimates suggest that demand for single-use products is expanding at twice the rate of reusable products. These trends vary by market. The shift to minimally invasive instruments has been particularly important in high-income countries (which account for the bulk of medical devices spending), while middle- and low-income countries have been slower to shift. Between 2010 and 2015, there was a notable increase of minimally invasive instruments for surgical procedures in the EU for the most common surgeries, including laparoscopic appendectomies and hysterectomies. Although lower-income countries face challenges in sterilization of reusable instruments, the demand for these instruments continues to be stronger than for single-use versions as healthcare providers seek to contain costs in the face of small budgets. North America leads demand for single-use instruments with an estimated 33% of the market in 2018, followed by Europe with 26%. Sources: (BCC Research, 2014; Eurostat, 2017; WIPO, 2018). Note: Search parameters for WIPO database were A61B, endoscope & endoscopic, AD: 2007-2018. End market segments are generally divided according to the body system they are used to treat. These segments include cardiovascular health, orthopedics, respiratory issues, anesthesia, neurology and spinal health, renal health, urology and reproductive health, hematology, dentistry, ophthalmology, biomaterials and tissue generation, as well as specific treatment types, such as oncology, diabetes management and advanced wound treatment. Cardiovascular and orthopedics have been the two leading market segments for most of the past decade (Frost & Sullivan, 2017; Markets and Markets, 2011). While large firms today have become highly diversified in the end markets they serve, due to the level of expertise and innovation required in the production of each device, smaller and medium size manufacturers tend to specialize in one or more specific end market (Field Research, 2017; Simoens, 2009). Each of these end markets may require all, or a subset of, the product categories described above. For example, in the treatment of cardiovascular conditions, gloves and catheters may be used for a transfusion (disposable), a pacemaker for cardiac rhythm management (therapeutic), surgical instruments such as clamps and forceps during heart surgery (surgical instruments) and a patient monitor during recovery (capital equipment). 14 Finally, post sales services or post-market services include training on equipment and consulting, account management for the supply of accessories, maintenance and repairs as well as regulatory requirements such as adverse events or complaints handling (Ghemawat, 2007; WHO, 2017). As embedded software and sensors grow in their importance in the industry, post sales analytics and corresponding services are becoming increasingly important differentiators amongst firms (Frost & Sullivan, 2017). 2.3 Global Trade in the Medical Devices Global Value Chain7 Global trade in medical devices has expanded considerably since 2000 in response to growing populations, increased access to healthcare and efforts to increase production efficiencies. Between 2002-2016, trade more than doubled, and growth remained robust – albeit, slowing – following the global economic crisis in 2008. Trade is generally in final products as many companies operate vertically integrated production sites.8 Demand is highest amongst high-income groups but it is growing fastest amongst upper middle and lower middle-income group countries. The EU-15, led by Germany, remains the strongest source of both demand and supply, yet, its shares of the global markets have declined since 2006. China has steadily gained market share; indeed, Chinese growth rates in demand and supply have outstripped all other countries since 2002. On the supply side, in absolute terms, export value has grown in almost all locations. Fewer than 5 of the leading 50 exporters in 2016 have experienced a decline in exports since 2006 (e.g. UK, Indonesia, and Sweden). Growth rates, however, vary across countries as several production locations have consolidated their position within the value chain (e.g. Mexico, Singapore, Ireland), and new sources of demand have emerged in respond to increased spending on healthcare (e.g. East Asia & Pacific, South Asia and Latin America and the Caribbean). This section analyses these major global trends to provide a broader context for Pakistan’s potential growth trajectories, in addition to analyzing the evolution of the surgical/medical instrument segment. 2.3.1 Global Demand Global demand is driven by high-income countries, which accounted for 81% of all medical devices imports in 2016. Middle-income countries, however, are emerging as new markets. In 2002, these absorbed just 12% of imports; by 2016, these had reached a combined 19% (Table 2), representing approximately US$39B in healthcare imports. 7 Global trade analysis is based on the following six product categories: Disposables, Instruments, Therapeutics, Capital Equipment, Consumables and Respiratory Devices. The details for each of these categories can be found in Table A-1 in the Appendix. 8 The capital equipment segment is a notable exception as many of the components are sourced from specialized suppliers within the electronics GVC. Although there is considerable flow in raw materials across borders, due to their application in multiple sectors basic trade statistics cannot isolate these. 15 Table 2. Global Medical Devices Imports, by Income Level Group 2002-2016 Income Group Share of Imports (%) Growth Rates 2002- 2006- 2002 2004 2006 2008 2010 2012 2014 2016 2016 2016 High Income 87 87 85 83 82 80 80 81 203 66 Upper Middle Income 10 10 11 13 14 16 15 15 382 133 Lower Middle 2 3 3 3 4 4 4 4 454 130 Low Income 0 0 0 0 0 0 0 0 262 81 World 100 100 100 100 100 100 100 100 227 75 Source: UN Comtrade (2018) Based on HS-2002 product categories defined in Table A-1; all exporters; downloaded 27/08/2018. Note: Income group level based on World Bank classifications (See World Bank, 2017). With a large population, and high healthcare expenditure, the EU-15 leads the demand for global imports of medical devices (Figure 3). EU-15 demand is dominated by the top five importers (Germany, Netherlands, Belgium, France, and the UK). North America and East-Asia Pacific (EAP) follow, with similar market shares (23% and 20% respectively in 2016). North American demand is led by the US, while EAP demand is more diversified amongst several countries (e.g. China (30%), Japan (25%), Australia (10%) Rep. of Korea (7%), Singapore (7%). Nonetheless, the fastest growing markets globally are Asian; EAP and South Asia grew at 114% and 153% over the past decade (compared to global 75%). Low health care spending, however, in several countries in South Asia (BMI Research, 2018a), including Pakistan and Bangladesh, underscores the uneven demand across the region. Figure 3. Imports of Medical Devices by Geographic Region (US$, Billion), 2006-2016 90 Imports (US$, Billion) 80 70 60 50 40 30 20 10 0 2006 2008 2010 2012 2014 2016 EU-15 North America East Asia & Pacific Europe & Central Asia Latin America & Caribbean Middle East & North Africa South Asia Sub-Saharan Africa Not Assigned Source: UN Comtrade (2018). Based on HS-2002 product categories defined in Table A-1; all exporters; downloaded 27/08/2018. 16 In 2016, surgical/medical instruments category accounted for the largest share of trade by value (28%), followed by therapeutics (25%) and capital equipment (21%) (see Table 3). The category has grown at a slightly higher than the average rate of 81% (2006-2016). The mature, low value and low weight and general use characteristics of these products makes them highly tradable. While the EU-15, led by Germany, accounts for the strongest share of demand for instruments (35%), this has declined by approximately 6% over the past decade. The UK represents just 10% of EU-15 demand and 3.6% of global demand, valued at just under US$2B in 2016. Of the leading importers, China is by far the highest growth market, growing at 365% (2006-2016), followed by Mexico at 117% (Figure 4). All leading markets experienced considerable growth in absolute terms; the slow redistribution of market share is thus indicative of the rising demand for healthcare products in emerging markets rather than a decline in demand in traditional markets. Figure 4. Top Ten Global Surgical/Medical Instruments Importers (US$, Million), 2006- 2016 25,000 Imports (US$, Million) 20,000 15,000 10,000 5,000 0 2006 2008 2010 2012 2014 2016 EU-15 USA China Japan Mexico Canada Australia Switzerland Singapore Rep. of Korea Russian Federation Source: UN Comtrade (2018). Based on HS2002: 90184, 90185, 90189, Retrieved 7/27/18 2.3.2 Global Supply The industry is dominated by mature manufacturing locations in the US and EU-15; these two origins accounted for close to two-thirds of all exports in four of the six product categories analyzed, and over half in the two remaining product segments (Table 3). Once a strong third contributor, Japan’s share of global supply has declined; a leading exporter in 2002 in all categories, by 2016, it was only a top five exporter in the more specialized capital equipment product segment. Within the EU-15, Germany is the most important exporter, growing at 204% between 2006-2016, almost three times the rate of the global average. 17 Table 3. Top Five Global Exporters by Product Category, 2016 Capital Disposables Therapeutics Instruments Consumables Other Equipment Exporter Shar Share Share Share Share Share Value Value Value Value Value Value e (%) (%) (%) (%) (%) (%) World 34,944 17.2 41,704 20.5 51,375 25.2 56,074 27.5 7,275 3.6 12,240 6.0 EU-15 15,734 45.0 17,807 42.7 27,969 54.4 22,176 39.5 3,608 50% 3,533 28.9 USA 7,359 21.1 9,372 22.5 9,308 18.1 13,951 24.9 709 10% 2,733 22.3 China 1,989 5.7 3,129 7.5 1,387 2.7 1,879 -- 1,295 18% 2,733 22 Switzerland -- -- -- -- 6,110 11.9 2,555 4.6 -- -- -- -- Mexico 2,889 8.3 -- -- -- -- 3,443 6.1 -- -- -- -- Japan -- -- 3,624 8.7 -- -- -- -- -- -- -- -- Singapore -- -- -- -- 1,633 3.2 -- -- -- -- 838 6.8 Rep. of Korea -- -- 1,190 -- -- -- -- Costa Rica 1,142 -- -- -- -- -- -- -- -- -- -- -- Australia -- -- -- -- -- -- -- -- -- -- 672 5.5 Czechia -- -- -- -- -- -- -- -- 306 4% -- -- Top Five 29,112 80.0 35,122 81.4 46,407 90.3 44,004 75.1 5,918 81 10,509 86 EU-15+US 23,092 66.1 27,179 65.2 37,277 72.6 36,126 64.4 4,317 59 6,266 51 90181*, 90182*, 90184*, 90185*, HS02 Codes 90183* 9021* 300590, 300510 9019, 9020 9022, 841920 90189* Source: UN Comtrade (2018). Based on HS-2002 product categories defined in Table A-1; all exporters; downloaded 27/08/2018. Surgical and medical instruments, regionally, is led by the EU-15 and the North America, although two key countries, the US (US$13.9B) and Germany (US$7.7B) dominate supply, accounting for 53.2% of exports in 2016 (Figure 5). While a large share of this output is manufactured in these countries, firms do also undertake final branding, labeling, repackaging and sterilizing of products produced in other locations. The EU-15, however, has steadily lost close to 10% of the market share since 2006; France, Sweden, Spain and the UK have all seen their exports of these instruments decline in absolute terms during this period. 18 Figure 5. Top Ten Exporters Surgical/Medical Instruments, by Year 2006-2016 30,000 Exports (US$, Million) 25,000 20,000 15,000 10,000 5,000 0 2006 2008 2010 2012 2014 2016 EU-15 USA Mexico Switzerland China Japan Singapore Israel Dominican Rep. Costa Rica Source: UN Comtrade (2018). Based on HS2002: 90184, 90185, 90189, Retrieved 7/27/18 Several emerging sites have joined mature manufacturing locations and steadily consolidated their positions within the medical devices value chain. These include China, Mexico, Singapore, Republic of Korea, Costa Rica and Malaysia. Newcomers China, Malaysia and Costa Rica, in particular, have grown very fast - three to four times (227%, 300%, 296% respectively) the global average over the last decade. These locations generally entered global trade through one product category and have either gained export share in that category, diversified into multiple categories or both (see Table 4). The fastest growing product category for the majority of these countries today is the therapeutics segment. Surgical/Medical instruments, nonetheless, is a key product category for these locations; Mexico, China, Singapore, Dominican Republic and Costa Rica have all joined the top ten global exporters in this category since 2002. With the exception of China, with few local lead firms of their own, exports of these countries are dominated by multinational corporations (MNCs) and the strengthening of these exporters is illustrative of the industry’s general strategy to protect its intellectual property and quality by offshoring to a select number of strategic locations. 19 Table 4. Growth of Selected Offshore Production Locations Fastest Growth Total Exports, 2016 Leading Product Category, 2016 Product Category, 2016 Growth Growth Growth Country Value Rate Rate Rate Share (US$ 2006- Category 2006- Category 2006- (%) millions) 2016 2016 2016 (%) (%) (%) Capital China 12,411,200,713 227% Equipment 25% 245 Therapeutics 361 Ireland 11,254,566,441 123% Therapeutics 48% 92 Consumables 625 Surgical/ Medical Mexico 8,822,991,749 120% Instruments 39% 170 Therapeutics 228 Singapore 5,773,677,403 164% Therapeutics 28% 168 Other 1,124 Rep. of Capital Korea 2,603,829,215 180% Equipment 48% 162 Therapeutics 664 Capital Costa Rica 2,507,955,659 296% Disposables 46% 151 Equipment 9,744 Surgical/Medical Israel 2,069,763,000 77% Instruments 50% 179 Therapeutics 1,460 Surgical/Medical Malaysia 1,843,212,496 301% Instruments 36% 262 Therapeutics 852 Dominican Surgical/Medical Republic 1,060,869,130 85% Instruments 85% 72 Therapeutics 9,251 Source: UN Comtrade (2018). Based on HS-2002 product categories defined in Table A-1; all exporters; downloaded 27/08/2018. 2.4 Lead Firms and Governance The global medical devices industry is highly consolidated and dominated by a small number of MNCs. Traditionally, these firms focused on leadership in niche markets, but this has changed over the past decade in response to increased buyer power. Increasingly larger buyers -- including public health programs,9 consolidated hospital networks and insurers’ and group purchasing organizations -- seek lower prices, and fewer, but larger, vendors to cope with rising healthcare costs.10 As a result, lead firms have developed capabilities to serve a broad range of market segments, from cardiovascular and orthopedics to diabetes management, and product categories, such as minimally invasive instruments and diagnostics and imaging equipment as well as provide global coverage. Over the past decade, there were 300 M&A completed valued at over US$100M in the industry.11 With large R&D and acquisition budgets and regulatory offices, these lead firms play a major role in 9 For example, in China, regulations require public hospitals to utilize centralized provincial procurement systems (BMI Research, 2018b). 10 Many of these programs limit the number of vendors which can participate in their procurement systems. Vendors with the greatest breadth of products therefore benefit (Medtronic, 2018). 11 Medtronic, Stryker and Boston Scientific have been amongst the most active acquirers during this period, collectively acquiring some 80 firms. Medtronic has also been the highest spender with close to US$50B in acquisitions (Zephyr, 2018). 20 shaping the evolution of the global industry. Table 5 highlights the top 10 global firms in the sector by revenue. Table 5. Top Ten Global Firms in the Medical Devices Industry, by Revenue 2017 Firm Primary Specialties Revenue Employment (HQ) (US$ Billion, (2017) 2017) Medtronic Cardiovascular, Neuromodulation, 29.71 102,688 (Ireland/USA) Diabetes, and Surgical Technologies. Johnson & Johnson Surgery, Orthopedics, Cardiovascular 26.6 134,000 (USA) Abbott Laboratories Branded Generic Drugs; Medical 20.85 99,000 (USA) Devices; Diagnostic Assays; Nutritional Products GE Healthcare Medical Imaging; diagnostics 19.1 52,000 (USA) Danaher Corporation Environmental & Applied Solutions, Life 16.88 67,000 (USA) Sciences, Diagnostics, and Dental Siemens Healthineers Medical Imaging; diagnostics 13.8 45,000 (2016) (Germany) Cardinal Health Medical, Surgical, Cardiovascular 13.5 49,800 (USA) Becton, Dickinson and Medical Devices, Instrument Systems, 12.48 41,900 Company and Reagents (USA) Phillips Healthcare Personal Health; Diagnostics and 12.3 71,000 (Netherlands) Treatment; Connected Care & Health Informatics; HealthTech; Legacy Items Stryker Corporation Ortho, Medical & Surgical, Neuro 11.33 33,000 (USA) Source: Company Websites, One Source, Hoovers. The surgical instruments segment is more fragmented than other product segments, with a number of smaller, independent producers participating in the industry (BCC Research, 2014). Nonetheless, four of the top ten lead firms are important players in this segment, with their instruments divisions generating multi-billion dollar revenue in 2017: Medtronic (US$5.5B), Stryker (US$5.5B), BD (US$3.5B) and Boston Scientific (US$3.4B).12 These firms are pushing a strategy to shift surgeons towards the minimally invasive procedures, for which they have been developing new tools over the past decade and which now account for a considerable share of revenue. Medtronic 12 Based on annual reports. Medtronic is a leading player in surgical instruments; its Minimally Invasive Therapies division earned US$5.5B in 2017 (Medtronic, 2018). Stryker’s Medical and Surgical instruments net US$5.58B in 2017; around US$1.6B in endoscopic tools (Stryker, 2018). 21 refer to this as their ‘open-to-minimally invasive strategy’ (Medtronic, 2018), that is, gaining a reputation in open surgery tools as a means to shift surgeons towards less invasive ones. This includes training surgeons to use their instruments; surgeons tend to favor products they were trained on. The growth strategies of these lead firms include a keen focus on emerging markets in general, and Asia-Pacific in specific (BD, 2018; Boston Scientific, 2018; Medtronic, 2018). This marks a potentially important threat to independent, traditional tools manufacturers in the region. The medical devices GVC is typically highly vertically integrated to protect important investments in intellectual property creation, contract manufacturing is growing (Brocca et al., 2017), particularly in the production of mature precision metal surgical and medical instruments, as well as in precision metal implantable devices. Contract manufacturing in these product segments occurs across the globe with major clusters found in Germany, Hungry, Malaysia, Pakistan and Poland. Quality assurance is typically the most important concern in this outsourcing, followed by cost. Regulations generally place the burden of quality and supplier compliance for any part of the manufacturing process on the branded firm (Bos, 2018; McHugh et al., 2012; Sethuraman, 2018).13 Rigid and sophisticated qualifications thus generally apply to ensure quality and suppliers comply with regulatory demands (Weber et al., 2010). However, unlike other medical device products where suppliers are locked in for long time periods by these regulations (Fennelly & Cormican, 2006), switching costs for mature products like traditional surgical instruments, are relatively low as equivalence is easily illustrated and regulatory oversight is lower (Brocca et al., 2017). In addition to quality concerns and liability, the large scale of the lead firms means that vendor and contractor decisions are primarily made within the corporate headquarters. Raw material contracts are negotiated for global supply due to leverage for large orders, quality assurance and guarantees for on-time delivery; although supplying less demanding emerging markets opens up avenues for contract manufacturers to source locally. Although global production facilities or contract manufacturers may be required or allowed to provide supplier recommendations regarding major inputs, they typically only have autonomy over non-essential inputs, such as maintenance and repairs supplies. Furthermore, all decisions regarding the global distribution of the firm supply chain, such as the location of the production of different product lines and activities, are made at the corporate level. Lead firms have generally limited production to a handful of locations over which they have significant oversight. Further, due to their dominance in the market, the investment decisions of large lead firms have resulted in notable trends in the emergence of new offshore locations – including in Galway (Ireland), Baja California (Mexico), Singapore, Santo Domingo (Dominican Republic) and Penang (Malaysia). These locations are generally prized for progressive skills development capabilities, geographic and regulatory proximity to key markets, intellectual property protection, and increasingly cost. Global production facilities must compete based on cost, quality and proven capabilities to drive growth and upgrading (Brocca et al., 2017; Fennelly & Cormican, 2006). Most firms begin their new locations with a few, existing products in low risk categories, ramping up as sites improve their capabilities (Bamber & Gereffi, 2013). 13 As private label production increases in this sector, regulators are acknowledging that the final brand may not be engaged in the design, development or manufacture of the product and are thus adapting regulations focused on the final company placing the product on the market (MHRA, 2017). 22 2.4.1 Regulation and Public and Private Standards The medical devices sector is governed by a combination of public and private standards that are closely related and are designed principally to ensure a safe, quality product for the health of the patient using the device. Failure of a medical device can have severe and fatal consequences. Regulatory controls vary by the type of device, but may include technical documentation, clinical trials and testing of the biocompatibility of materials, among others. In addition to regulatory controls, criteria laid out by public and private healthcare insurers regarding which devices are eligible for reimbursement can also affect which products survive from the prototype stage to market (BMI Research, 2018b; Medtronic, 2018). These insurers can often require more rigorous clinical evidence of effectiveness than required by regulatory controls (Lin et al., 2010). Generally, medical devices are categorized by perceived risk to the patient and whether the new device is subject to general controls (basic), special controls (more specific), or requires clinical trials. Globally, the majority of surgical instruments fall under either general controls or special controls. Traditional instruments dedicated to open medical and surgical procedures have typically been classified as low risk products (i.e. Class I); classification approaches for minimally invasive instruments diverge, with some regulatory agencies applying additional scrutiny (BMI Research, 2018b; Sethuraman, 2018). Due to their significant market shares, the standards set by the US, the EU-15 and to a lesser extent, Japan, have to date controlled the development and commercialization of new products in this sector (see Table 9). While varying in design and application, the regulatory requirements of these have generally been considered the global gold standard, and many other countries will fast- track devices with FDA, CE or Japanese approval. Of the three, with slightly less rigorous requirements and faster approval times,14 devices have often been first launched in Europe and the European CE Mark has thus been considered the basic requirement for entry into many emerging markets without their own regulatory frameworks (Medtronic, 2018; Puri et al., 2011). Recent developments, however, may shift this status quo. These include: 1. More emerging markets are adopting medical device regulatory frameworks of their own (BMI Research, 2018b; Boston Scientific, 2018; WHO, 2017; Wong & Tong, 2018). The guidelines developed by the World Health Organization’s (WHO) Global Harmonization Task Force (GHTF) between 1993 and 2012 have provided the foundations for many of these new regulatory systems. By 2016, over half of WHO member states (113/194) had established some regulatory system. There has been considerable activity in the Asia-Pacific region, Singapore (2007/2010),15 India (2017/2018), and Malaysia (2012/2018), have all rolled out new programs, while the ASEAN group have all agreed to the ASEAN Medical Device Directives (2015) largely aligned with GHTF (Sethuraman, 2018). While these countries have followed the approach taken by the GHTF founding members, they are increasingly beginning to develop their own regulation from the ground up. Africa and the Middle East are the least regulated regions (WHO, 2017). 14 In the EU, Notifying Bodies or (NB) are used to approve new medical devices for sale in their member states. Each medical device manufacturer may choose the NB to evaluate their device, leading to competition between NBs for evaluations. 15 Singapore’s regulatory agency has even found itself in the forefront in having to roll out regu lations for products not yet regulated by the FDA/ EU-15 (Sethuraman, 2018). 23 2. The new Medical Device Regulation entered into force in the EU-15 in 2017 replacing the existing Medical Devices Directives. This creates standardized, and higher requirements on all EU member states in allocating the European CE mark (see Box 3 for further information). Traceability through Unique Identification (UID) numbers and centralized registration is a central change, and all devices must be listed in EUDAMED, a new centralized database. Industry response is that this will significantly increase the burden for compliance in Europe and drive innovation towards the US (Boston Scientific, 2018; Lowe, 2017; Medtronic, 2018). This is further complicated by the pending withdrawal of the UK from the EU-15 in 2019 and whether or not a deal is reached. A “no deal” exit will result in all devices with CE marks provided by UK Notifying Bodies having to reapply or contract with a EU-15 member state NB (European Commission, 2018). 3. In 2018, the FDA announced that it will also reform the requirements for the approval of medical devices in the US. The goals include streamlining processes, to encourage manufacturers to develop safer products to replace existing devices, and to require cyber security measures for vulnerable devices ("Inside FDA's new plan to bolster medical device safety," 2018). The US will also be requiring UID. Despite these changes, both regional and international initiatives continue to work towards standardizing national and industry medical device regulations and requirements, removing barriers to entry and ensuring new innovative, life enhancing and saving technologies can reach patients in need. These include the International Medical Device Regulators Forum (IMDRF), which is made up of the EU, the US, Australia, Brazil, Canada, China, Japan, Russia, Singapore, South Korea, and the WHO. The Asian Harmonization Working Party has been working towards harmonizing requirements for the growing Asian market, specifically and emerging markets in general16. Initiatives are primarily focused on information sharing and the development of regulatory capabilities. 16 As Asia-Pacific emerges an alternative market, its regulatory frameworks are now more important for firms. The general tendency in the region has been to lower the regulatory requirements for low risk devices helping to increase access and lower costs, increase those for high risk devices and, at the same time, establish fast track channels for innovative devices with high potential market demand (Field Research, 2018b). Table A- 5 in the Appendix presents the key changes in medical devices regulation in the region. 24 Box 3. New Medical Devices Regulation in Europe In May 2017, the new Medical Devices Regulation entered into force in the EU-15 replacing the existing Medical Devices Directives with a three-year phase in period. The goal of the regulation is to strengthen the safety of medical devices in the regional market and update existing legislation from the 1990s allowing it to be more responsive to forthcoming challenges in the sector. All devices, even existing ones on the market, will be required to comply with the new legislation by 2020, requiring all products to be re-registered affecting every company operating in the medical devices sector in Europe. Changes include increasing safety and efficacy requirements; the creation of a EU-wide database EUDAMED containing all medical devices approved by the region’s notifying bodies intended to increase transparency; new traceability mechanisms; financial mechanisms for protecting the consumer from defective devices. An important part of this is presenting a standardized set of requirements for all EU-member countries. The legislation also introduces new equivalence requirements for avoiding lengthy medical trials; in this case, a second device manufacture must have significant supporting documentation of equivalence – essentially a contract with a competitor on access to their data. This is anticipated that it will slow down the release of new products on the market, and potentially make the launching of new products in Europe more onerous than that in the US. The ultimate result is that the EU-15 may be replaced as the launch point for many products. To remain in the market, firms will need to allocate both financial and human resources to achieving European compliance. Allowances have been made for SMEs to help reduce the additional costs of compliance. Source: Lowe (2017); Monitor (2017). 2.4.1.1 Private Standards The primary private standard is the ISO standard for medical device manufacturing, ISO 13485 Medical Devices, Quality Management Systems.17 Launched in 2003, certifications in this standard grew globally at a CAGR of 26% to 29,585 by 2016. The evolution of certification by region over the past decade further illustrates the growing importance of the Asia Pacific region in global manufacturing, as the region’s capabilities have grown and awareness has spread regarding the need for certification. East Asia & Pacific and Central and South Asia have outpaced established sites during this period; accounting for just over 5% of certifications in 2004, the region held an equal share of certifications as the US by 2016 (Figure 6). 17 There are several additional standards regarding supporting activities such as cleanrooms, sterilization (ISO 11135-1 Ethylene-Oxide Sterilization and ISO 11137-1-2- Radiation Sterilization). 25 Figure 6. ISO 13485 Certification, by Region 2004-2016 100% 5% 90% 15% 13% 15% 16% 21% 21% 80% 35% 23% 21% 70% 21% 30% 21% 21% 60% 50% 40% 30% 20% 10% 54% 45% 56% 59% 55% 49% 50% 0% 2004 2006 2008 2010 2012 2014 2016 Europe Middle East Africa Central and South America North America East Asia and Pacific Central and South Asia Source: ISO, 2018 These private quality standards have begun to overlap with public standards as harmonization efforts continue. In particular, ISO 13485 is increasingly being used by regulatory agencies as a proxy for quality audits (BMI Research, 2018b; Sethuraman, 2018). This is due to its proximity to regulatory requirements of multiple countries; in addition to US and EU, its supports firms for compliance with Australia, Canada and Taiwan, and is comparatively similar to Japanese requirements (Bos, 2018). The 2016 revision of the standard further increases alignment with both FDA and pending EU MDR regulations for good manufacturing practices (Bos, 2018; FDA, 2012). ISO 13485:2016, raises the requirements for suppliers and contract manufacturers, increasing the likelihood of unscheduled audits from regulatory agencies (Bos, 2018). 2.5 Human Capital, Workforce Development and Gender Globally, the workforce is small, estimated at 1.5-2M in total (UNIDO, 2016). Leading exporters such as the US, Germany and China employ 308,000 (BLS, 2018), 178,000 (Eurostat, 2015) and 409,500 workers respectively; Mexico is one of the world’s leading offshore production locations by workforce size with 116,000 (INEGI, 2018), with others such as Malaysia and Singapore are much smaller by comparison with approximately 31,000 and 14,800 workers respectively (AMMI, 2016). Table 6 provides a comparative perspective illustrating employment growth between 2008-2015. 26 Table 6. Employment in Medical Devices Sector, Select Leading Countries 2008-2015 Share of Global Growth Employment Country Employment Rate 2012 2015 2012 2015 2012-2015 World 1,667,468 1,776,018 7% EU-15* 428,238 437,240 26% 25% 2% Germany 184,354 197,974 11% 11% 7% China* 365,465 409,457 22% 23% 12% USA 358,713 325,067 22% 18% -9% Mexico 98,661 111,796 6% 6% 13% Japan* 90,363 90,363 5% 5% 0% Brazil 50,626 58,221 3% 3% 15% India* 46,559 50,835 3% 3% 9% Korea* 5,707 37,601 0% 2% -- Switzerland 22,528 23,860 1% 1% 6% Turkey 18,425 22,242 1% 1% 21% Malaysia 14,372 19,594 1% 1% 36% Vietnam 14,190 17,721 1% 1% 25% Poland 14,455 17,096 1% 1% 18% Costa Rica 11,882 16,290 1% 1% 37% Hungary 11,593 13,616 1% 1% 17% Czechia 12,770 12,962 1% 1% 2% Singapore 9,844 11,422 1% 1% 16% Other Countries 93,077 100,635 6% 6% 8% Note: a based on 90/97 countries with reported employment in ISIC 2660 Irradiation/ electromedical equipment.and 3250 Medical and dental instruments and supplies /total. b EU-28 total sourced from EUROSTAT, 2018. Individual European countries listed from UNIDO INDSTAT ISIC Rev 4. 4 digits. Source: UNIDO (2016); Eurostat (2018) While small, the global workforce is growing as demand for medical devices continues to rise around the world, increasing some 58% between 2008-2015. Growth has been modest (<10%) in more mature production locations during this period,18 with the exception of Germany, where employment grew by 20%. Non-traditional manufacturing hubs such as Singapore, Brazil, and Malaysia grew the fastest, with their sector workforces each growing by over 50% in the same period,19 as medical devices firms have expanded into new destinations to lower costs, tapped into contract manufacturing operations and access new markets (Brocca et al., 2017). Even Mexico’s large medical devices workforce grew an additional 24% between 2010-2015. This growth offers developing countries a small, yet important opportunity for job creation. Keeping up with this growing demand is challenging, however, as the workforce typically consists of skilled and semi-skilled labor. Consequently, support by an adequate set of education and training institutions is needed. Due to the fatal consequences of human error and the potential for liability suits, the quality of the human capital involved in production of medical devices is essential to business success. Indeed, human capital has been identified in certain cases as the single most important factor driving site selection in the medical devices manufacturing sector (Field Research, 2012; Kimelberg & Nicoll, 2012). Thus, remaining competitive and upgrading in the medical devices 18 The US workforce contracted by 1% during this period. 19 Malaysia growth rate measured for 2009-2015, as 2008 data not available. This was approximately 70%. 27 industry requires the availability of an appropriately qualified workforce for each stage (Bamber & Gereffi, 2013; Gereffi et al., 2011). The experience and skill level of the workforce differs depending on the stage of the value chain (Table 7) (Gereffi et al., 2011). Understanding the human capital needs for these different segments of the value chain is important for assessing feasible growth trajectories for Pakistan’s medical instruments sector and the human capital development policies that must be put in place to support that upgrading. Lower-value segments of the chain such as components manufacturing and assembly require a large number of semi-skilled labor and technicians performing labor-intensive operations, while higher-value segments of the chain such as R&D require a more specialized workforce, including researchers and product designers with industry experience, venture capitalists and a large number of engineers. The majority of the roles in the industry are in production together with a handful of bottleneck positions. Using the US medtech labor force as an example, the leading occupations are production (52%), office & administrative (13%) and engineering (8%). Healthcare practitioners and life sciences professionals (e.g. chemical and biology technicians) account for just 2.2% of roles in the industry. Approximately one third of manufacturing roles require either a two-year degree, technical or vocational training plus experience in addition to up to two years of on the job training, while the remaining two-thirds require a minimum of high school and a few months to a year of on the job training (BLS, 2018; O*Net OnLine, 2018). Germany has similar requirements for its workforce, with the industry association also citing current high demand for regulatory professionals in response to the major shifts in global regulation in the sector (BVMed, 2018). Overall, the dependence on primarily high school and technical education makes the industry well suited for growth in developing countries. 28 Table 7. Select Job Profiles in the Production Segment of the Medical Devices GVC Formal Skill Training/ Position Job Description Education Level Experience Requirements Components Production & Assembly Grinding, Min: On the job Grind, sand, polish using hand-held electrical tools or High school Polishing, Buffing training machines following basic instructions to provide final diploma/ technical Equipment Max: 1 years product according to set specifications. education Operators Experience Molding, Set up, operate, or tend metal or plastic molding, casting, High school On the job Coremaking, and or coremaking machines to mold or cast metal or diploma/ technical training for up to Casting Machine thermoplastic parts or products. education 1-2 years Operators Operate machine tools to produce precision parts and Technical On the job Machinists instruments education training High school Experience: Need Assemble components of medical devices into final Assemblers diploma/ technical of speed and products education accuracy skills Experience: Need of speed and Packaging Operate or tend machines to prepare industrial or High school accuracy skills; Equipment consumer products for storage or shipment. diploma/ technical understanding of Operators education traceability systems Transportation Physically move materials or operate industrial trucks or High school and Material tractors equipped to move materials around a Experience; on diploma/ technical Moving warehouse, storage yard, factory, construction site, or the job training education Occupations similar location. Supervisory roles; oversee the pace of the work and Technical Line Leaders & ensure stoppages are minimized, monitor production education/ Management Production Flow levels, train new workers, and manage constant problem Bachelor’s skills Supervisors solving. degree Maintain final quality prior to distribution of product, Technical Knowledge of Quality Control monitored by buyers. education quality systems Design, develop, test, and evaluate integrated systems for managing industrial production processes, including Industrial human work factors, quality control, inventory control, Bachelor’s Management Engineers/ logistics and material flow, cost analysis, and production Degree skills Engineers coordination. Other engineering roles can include mechanical, chemical, biochemical and electrical/electronic depending on the product mix. Investigate the growth, structure, development, and Specialized Bachelor’s Microbiologists other characteristics of microscopic organisms, such as knowledge in degree bacteria, algae, or fungi.. microbiology Specialized Regulatory Undertakes audits of products to ensure they meet Bachelor’s knowledge in Compliance regulatory compliance of target markets. Degree regulations of Officer specific markets Source: Authors based on BLS (2018); O*Net OnLine (2018) and extensive firm interviews. Furthermore, unlike other sectors such as textiles and apparel and electronics which are highly feminized (Bamber & Staritz, 2016), the medical devices GVC is characterized by greater gender equity in overall employment numbers and lower variation as product composition changes. Many of the leading exporters of these products have similar shares of male and female employment. In 29 2015, 47% of the US workforce was female (BLS, 2018); in China, 50% (UNIDO, 2016), while in Mexico, the share was slightly higher with 59% (INEGI, 2018). The female share of the workforce tends to be higher in production as compared to the overall manufacturing sectors (US: 27%; China: 40%; Mexico: 35% (INEGI, 2018), although with a lower share of senior management and ownership roles. 3 Pakistan in the Medical Device Global Value Chain Key Takeaways • Pakistan’s historic position as a surgucal instrument producer is insufficent to maintain participation in a changing global medical device industry. • Pakistan is a small player in the medical device GVC with exports totalling US$355M in 2016; 98% of exports are in surgical/medical instruments. • The industry is comprised mainly of micro-small firms that rely on historic production methods. Only 85 firms reported exports above US$1M in 2016. These firms account for over 60% of exports. • Pakistan has several organizations and institutions to support the industry but there is overlap in activites and all focus almost exclusively on surgical instruments. • The industry is struggling to retain a skilled workforce and invest in needed technological advancements to remain competetive. As a result, industry growth is stagnent. Pakistan is a small, niche actor in the medical devices GVC with US$355M exports in 2016 (0.1% of industry exports) (UN Comtrade, 2018). The country’s participation in the medical device GVC is centered on precision metal instruments and is concentrated primarily in one city, Sialkot. The nation has a long history in the production of these devices, dating back to the 1940s. Following local demand by missionary hospitals in the 1920s, Pakistan began exporting during World War II and currently exports to 110 nations globally (PCA, 2018).20 The combination of a historical supplier of precision metals and its low-cost labor supply have contributed to its current participation in the chain. However, the changing dynamics of the global industry – including in the mature surgical instruments niche - mean that these past drivers of competitive advantage are becoming less relevant. Pakistan has seen its medical devices exports plateau in recent years as new competitors and products have entered the market. In order to sustain its position in the industry, Pakistan needs to upgrade its processes to increase productivity, diversify its products portfolio and strengthen the industry’s ties with emerging markets. The country’s past success in textiles and apparel also offer an opportunity for the country to become a more significant player in the medical textiles industry. This section discusses Pakistan’s participation in the medical device value chain and current trade dynamics as well as the internal industrial organization of the industry. The country’s strengths and weaknesses as a participant in the medical devices GVC are also examined to determine the viability of growth. 3.1 Pakistan’s Current Participation in the Medical Device Global Value Chain Pakistan’s exports in the medical device GVC are primarily concentrated in precision metal instruments (Figure 7). Metal Instruments account for close to 98% of Pakistan’s medical device 20 Firm level data is based on Pakistan Custom’s Authority data provided by the World Bank. 30 exports in 2016 while consumables (e.g. bandages) account for just 2% (UN Comtrade, 2018). Exports of medical devices have consistently grown over the last decade, increasing 97% since 2006, outpacing the global average of 75% (UN Comtrade, 2018). Figure 7. Pakistan Export by Medical Device Sector, 2004-2016 2016 2014 2012 2010 2008 2006 2004 0.00 50.00 100.00 150.00 200.00 250.00 300.00 350.00 400.00 Exports (US$, million) Consumables Disposables Instruments Therapeutics Capital Equipment Other Source: UN Comtrade (2018). Based on HS-2002 product categories defined in Table A-1; Pakistan exports; downloaded 27/08/2018. Analysis of exporter firm data indicates that exports have plateaued between US$350-380M between 2014 and 2017 (PCA, 2018). Following steady growth, the industry began stalling in 2014 as more nations entered the precision metal instrument product category and Pakistan found its niche threatened. Further, as buyers in established markets shifted more towards single use instruments, buyers exerted downward pressure on prices, further squeezing producers and stalling industry growth. 31 Figure 8. Pakistan in the Medical Devices Global Value Chain Research & Product Components Post-Sales Assembly Distribution Marketing & Sales Development Manufacturing Services Final Products Market Segments Software Prototype Assembly Development Capital Cardiovascular Equipment Training Process Electronics/Electrical Development Components Packaging Therapeutic Orthopedics Devices Consulting Regulatory Precision Metal Approval Works Sterilization Surgical & Medical General Surgery (1853 firms) Instruments Complaints Process (US$346M) Management Development Plastics Extrusion Infusion & Molding Disposables Systems Maintenance/ Sustaining Repair Engineering Consumables Weaving Others (US$7M) Knitting Textiles Input Suppliers Buyers Wholesale Resin Metals Doctors & Nurses distributors Hospitals Individual Chemicals Textiles (Public/Private) Patients Source: Authors using PCA, 2018 data Pakistan’s involvement in the medical device is concentrated in the Components Manufacturing and the Assembly segments; most products are sent on to other destinations for final packaging and branding (Figure 8). Using both domestic and imported steel (PSDF, 2016), production occurs primarily in Sialkot (PCA, 2018). This is an almost exclusively export-oriented sector, with over 95% of production exported, to over100 markets. In the 2016/2017 fiscal year, 1,853 firms reported exports. Despite the size of the population, domestic demand is low as a result of very low healthcare expenditure (BMI Research, 2018a).21 As a result, even micro-firms in the industry focus on export-oriented activities. Virtually all activity is focused on the production of precision metal instruments with little activity occurring in other product segments; instruments account for 98% of all sector exports. The top 20 medical device exporters (by value) participate exclusively in instruments (PCA, 2018). These devices are primarily mature surgical instruments classified as Class 1 (FDA), however, a small number of firms are also producing more advanced endoscopic instruments and accessories (FDA, 2018b). Finally, in addition to the medical sector, these products are destined to dental, veterinary and manicure/pedicure industries which have similar needs for metal products (SIMAP, 2018), although with varying regulatory requirements. Components manufacturing. All manufacturing processes, from die casting to final components is undertaken in Pakistan, although due to the complexity of the process (Box 1; see section 2.2) only the largest firms perform all activities, with smaller firms sub-contracting different stages to 21 Pakistan has the lowest per capita healthcare expenditure of the Asia-Pacific region and its large rural population further complicates the profitability of the domestic market. Pakistan’s medical device sales per capita are US$4.1 compared to a global average of US$50 and an average of US$39.9 in the Asia-Pacific region (BMI, 2018). 32 more specialized vendors in the country (Chaudhry, 2010, 2011; Field Research, 2018a). For example, most firms subcontract heat treatment and hardening process locally, with one firm undertaking approximately 90% of national orders (Field Research, 2018a). Assembly. Assembly, packaging and sterilization activities are undertaken, although to varying degrees. Assembly and final packaging for export is limited primarily to larger firms, which provide final products for their buyers. Local sterilization is very limited, with most only using ultrasonic cleaning. Products are sterilized when they reach their final destination, before use by the end consumer. Single use or disposable instruments are an exception to this rule; these products undergo a more extensive cleaning and sterilization process prior to packaging. However, even these devices are often exported to other markets for final sterilization and packaging before being sent to the end consumer (Field Research, 2018a). 3.1.1 Pakistan’s Medical Device Exports Pakistan exports medical instruments across the globe, reaching 107 nations in 2017 (PCA, 2018). Despite this wide scope in export destinations, total exports are concentrated among a small group of nations, including the US, the UK, and Germany. Further, firm size is closely related to export destinations with larger firms being most active in established markets. Market penetration into lower value export destinations is low; approximately half of these destinations is served by five or fewer Pakistani firms (FY2016/2017), while 19 nations imported medical devices from just one Pakistani firm (Figure 9). Firms exporting to new markets are often smaller in size, reflecting a limited focus on market diversification in the country (PCA, 2018). Figure 9. Pakistan's Medical Device Exports (US$) by Exporters per Destination, 2016/2017 Number of exporting firms 1 436 Source: PCA, 2018 33 While select markets remain the most important export destinations for Pakistan, recent shifts to regional and developing markets suggest this strong dependence on select markets may be changing (Figure 10). Traditional export markets remain key export destinations. However, new actors are rising in prominence. The US, Germany and the UK are the largest export markets for Pakistan; In 2016, the US accounted for 29% of exports while Germany and the UK accounted for 14% and 9% respectively. The share of total exports among these nations remained relatively stable over the past decade, with export value increasing to US$101.5M in 2016 for the US, a 164% increase between 2004-2016. Germany grew 148% during the same period while the UK rose 242% (UN Comtrade, 2018). Figure 10. Pakistan’s Medical Devices Export Destinations (% of total exports), 2006- 2016 2016 2014 2012 2010 2008 2006 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% USA Germany United Kingdom France India China Japan Australia Italy Brazil Rest of World Source: UN Comtrade (2018). Based on HS2002: 90184, 90185, 90189, Retrieved 7/27/18 While the traditional export destinations remain stable buyers for Pakistan, the emergence of trade partners in regional markets and developing economies suggest future growth markets. For example, exports to India have grown significantly in the last decade. Prior to 2012, no surgical instrument exports were reported to India from Pakistan but by 2016, it accounted 4% of total exports, US$14.5M. Similarly, China, with no Pakistani imports prior to 2014, accounted for 3% of total surgical instrument exports from Pakistan in 2016 (UN Comtrade, 2018). These new markets are growing faster than the country’s traditional partners; from 2014-2017, the growth rate of exports to China was 69% and India 19% compared to 4% in the US and an overall export growth rate of 3% (PCA, 2018). Pronounced differences exist in market orientation based on firm size. Exports from larger firms are overwhelmingly represented in US-destined exports, while smaller firms are seen serving the 34 EU market. Of the leading export firms22 from 2014-2017, 96% exported to the US while 81% exported to Germany and 70% to the UK. Nearly half of the exports of the largest exporters (>US$5M) were destined to the US in 2016 (PCA, 2018). Smaller firms focused more on EU and smaller regional markets where regulations have been less stringent and lower economies of scale are required. Export destinations for smaller firms are also less concentrated, with the top three markets comprising 31% of all exports for firms under US$500K (Table 8). 3.2 Industry Organization The medical instruments cluster in Pakistan consists of a few medium sized firms and several micro and small, family owned firms. The majority of firms are small with minimal participation in the GVC. In the 2016/2017 fiscal year, only 11 firms reported exports greater than US$5M while 74 reported exports above US$1M. These firms account for nearly 60% of exports (Table 8). Two thirds of firms had exports above US$10,000 but less than US$100,000 for the same year (PCA, 2018). Medium firms are able to meet stringent regulations of international buyers and meet larger volume demand. They also have invested in new technologies and have machinery onsite. These firms tend to be structured and employ outside workers, using modern machinery, compared to smaller firms which are frequently family operations with multigenerational histories in the industry. Some of the largest firms, such as QSA Surgical have sophisticated operations due to their historic partnership with global firms in the 1990s (Field Research, 2018a; Nadvi, 1999). Nonetheless, even smaller firms are well established with annual exports. 61% of firms exporting in 2016/2017 also registered exports in the previous two years and these firms account for 94% of all exports. The average exports for firms in FY2016-2017 was US$251K; however, the median exports that same year was just US$50,250, illustrating the prevalence of small exporters (PCA, 2018). Table 8. Firm Characteristics, 2016-2017 Firm Size by export Number of Firms (% of Share of Key Markets (% of exports) value (US$) firms) Exports 11 (<1%) 22% United States (48%) Exports Over US$5M United Kingdom (12%) Germany (10%) 74 (3%) 37% United States (30%) Firms Between Germany (17%) US$1M150 employees and >US$6M in revenue • Often partner with MNCs to enter the GVC • Fully compliant with local and international standards Multinational firms ~26 firms • Primarily focuses on export • Account for highest percentage of export revenue • Fully compliant with local and international standards Source: World Bank 2011; AMMI 2016 The medical devices industry in Malaysia is coordinated by several actors. Two industry associations, the Association of Malaysian Medical Industries (AMMI) and the Malaysia Medical Device Association (MMDA) both represent medical device firms in the nation. AMMI, consists of 67 firms who account for half of all medical device exports in Malaysia. Members include several local and international firms, such as 3M, Becton, Dickinson and Company, Boston Scientific, B. Braun, Johnson & Johnson, Terumo, among others (AMMI, 2016). MMDA, in contrast to the outwardly focus AMMI works to promote local operators and manufacturers who primarily serve the domestic market. Beyond industry associations, the government has aided the growth of the industry most recently by naming medical devices as a key sector in the Eleventh Malaysia Plan (RMK-11), established in 2016 and providing a strategic growth plan through 2020 (MITI, n.d.) Malaysia’s growth can be divided into two key trajectories: (1) Inter-sectoral Upgrading from medical supplies, primarily latex gloves, to medical devices; and (2) Product Upgrading through diversification into new medical devices segments such as therapeutics and capital equipment. Each of these upgrading paths is examined in further detail below: 1. Inter-sectoral upgrading from surgical gloves to medical devices. Malaysia’s participation in the natural rubber industry helped to spur its participation in surgical gloves (Daly et al., 2017). After solidifying its position as a natural rubber exporter in the 1980s, Malaysia began to engage in manufacturing activities, producing latex gloves (RJA, 2011). Over time this industry grew with 105 firms participating in export-oriented latex glove production in 2014 (MIDA, 2014). Capitalizing on success in the surgical gloves industry, and the knowledge and capacities learned from surgical gloves, Malaysia shifted into the medical device industry. Initially, firms leveraged experience in latex rubber to move into other medical plastics, producing disposable kits and blood transfusion tubing, gradually moving from domestic use to export (World Bank, 2011). Leveraging capacities and knowledge of international certification requirements and regulatory requirements abroad, Malaysia moved further into surgical and medical instruments production. This transition was aided by both the entry of MNCs into the country and also the emergence of larger local firms who began as contract manufacturers for simple products and grew in capabilities to produce complex products, such as finished orthopedic devices (World Bank, 2011). While exports were minimal, they grew at a steady 51 pace across multiple categories. By 2014, Malaysia’s medical device exports surpassed surgical glove exports for the first time, indicating a successful chain upgrading. 2. Product upgrading by diversifying into surgical/medical instruments and capital equipment is notable. Beyond moving from surgical gloves to medical devices, Malaysia is also upgrading into more advanced product categories. For several decades, Malaysia has been a small, but consistent supplier of surgical and medical instruments. However, since 2006, Malaysia has consistently increased exports of therapeutics and capital equipment (Figure 14). In 2006, 5% of medical device exports were therapeutics, however, by 2016 it increased to 13% of total medical device exports, an 852% increase. Capital equipment export share also grew, albeit at a slower pace, increasing from 18% to 22% of total exports, growing 383% (UN Comtrade, 2018). This growth reflects strategic positioning and investments that allowed the country to learn from other industry activities to enter higher value product segments and improve its competitive position. The established activities in electrical components, such as semiconductors facilitated entry into medical capital equipment (Frederick & Gereffi, 2016). Figure 14. Medical Device Export Share by Segment, 2006-2016 2016 2014 2012 2010 2008 2006 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Surgical/Medical Instruments Consumables Capital Equipment Therapeutics Other Disposables Source: UN Comtrade (2018). Based on HS-2002 product categories defined in Table A-1; Malaysia exports; downloaded 27/08/2018. Product upgrading benefited from increased institutionalization via the establishment of a regulatory council and by the concentration of firms in select areas, which spurred cluster formation. Under the regulatory council, firms improve production processes and move towards international compliance, helping them better connect with global firms and integrate into the medical devices GVC. Programs and Policies Growth has been driven by specific programs and policies that increased both the scope and depth of participation in the medical device GVC. These policies were led both from the top-down and the bottom up. State-led programs from Medical Device Act (MDA) and the Malaysia Industrial Development Authority (MIDA) combined with the promotion of the industry by government agencies as a high growth sector further spurred growth. At the same time, AMMI and key private sector stakeholders provided strong support for growth. The major programs and policies implemented that facilitated this growth are detailed below. 52 3. Inter-sectoral upgrading into Medical Devices. Malaysia’s established position in the surgical gloves industry provided a base for entry into the medical device GVC. By capitalizing on established abilities in latex rubber, and the subsequent move to surgical gloves, Malaysia was able to attract new investments in medical supplies. Further, attractive investment packages and the creation of EPZs helped bring demanding foreign firms into the nation, facilitating movement into medical devices. Specific program/policy the country used to help spur this movement include: • To attract investments, Malaysia enacted the Promotion of Investment Act in1986. Under the current iteration of the policy, foreigners are allowed to hold 100% equity in operations and are given additional tax incentives and investment tax allowances (Koty, 2017). • In the mid-2000s Malaysia created investment programs specifically for medical devices. First, the creation of EPZs for major manufacturers, attracted surgical glove producers, and allowed local firms to expand operations. Most notably the Malaysian firm, Top Glove, expanded to 40 factories in country and abroad. It is now regarded as the largest producer of surgical gloves, which now produces additional medical supplies (Top Glove, 2018). • The country also offered additional tax incentives for medical device and other high-tech manufacturers. These included tax allowances and exemptions of 100% for up to five year plus additional incentives after the five-year period for capital equipment investments and other reinvestments in the industry (MIDA, 2008). • The AMMI works towards promoting Malaysia via participation in regional and global showcases and by forging links with foreign firms. Having one actor dedicated to this activity helps to streamline messaging and spur the development of a national brand (AMMI, 2016). • Workforce development programs undertaken by public and private educational institutions cultivate a skilled workforce. These programs developed curriculum based on input from industry participants with a focus on developing firms capable of producing devices suitable for export (Hui-Nee, 2013). • The certification and knowledge for these advanced medical supplies provided a base for firms to expand into other devices, such as catheters and simple medical instruments (World Bank, 2011). • Investments in infrastructure and logistics helped improve efficiencies within the country and allowed for better integration into global supply chains. This includes investments in seaports, airports and telecommunications in major medical device producing regions (MIDA, 2008, 2014). 4. Product Upgrading by diversifying into multiple medical device product categories. Malaysia is growing into more sophisticated product lines, buildings its domestic capabilities as a medical device hub. This has allowed for advancement of domestic firms to supply MNCs and helped make Malaysia a more attractive location for global firms. Actions to help spur this growth included: • The Eleventh Malaysia Plan (RMK-11), the strategic plan for economic growth in the country, prioritized the medical device sector as a high potential driver of economic growth. Under the program, public and private sector actors are investing US$4.1B over four years to further growth and create 86,000 new jobs by 2020 (AMMI, 2016). Investments focus on R&D as well as improvements in education and new business ventures (MIDA, 2018). 53 • A tax incentive program established in the mid-2000s promoted investments in new equipment for all firms operating in the medical device sector to foster the adoption of more complex technologies, citing growing demand domestically and in key ASEAN nations, such as Singapore (Hui-Nee, 2013). Manufacturing companies receive special incentives to invest in new equipment and technologies. Firms, operating in the country can receive tax incentives totaling up to 60% of capital equipment investments (MIDA, 2008). • The MDA strengthened patent and intellectual property right protection in the medical device field. By closely monitoring all production in the nation, it can better protect firm specific knowledge, an important consideration for many global firms. This was critical to upgrade into more advanced and innovative product categories. • The establishment of a national regulatory council under the Medical Device Act helped to promote adoption of GMPs among local producers, creating opportunities for deeper GVC participation. Aligning with regional and global market regulations helped to strengthen linkages with foreign firms. Specific programs that helped achieve this upgrading include: o Stipulation that all medical device establishments register with the government and receive permission to participate in the industry. This safeguards manufacturing and quality standards (Gross, 2012). o Participation in the Asian Harmonization Working Party helped to align Malaysia with other regional markets in several industries, including medical devices. The voluntary working group aims to align members with best practices and facilitate sharing of knowledge towards a more standardized regulatory approach to industries. Malaysia, along with Singapore, are seen as having the most advanced regulatory environment of the ten nations in the ASEAN Medical Device working group (Field Research, 2018b). 4.2 Key Lessons for Pakistan The Dominican Republic and Malaysia have both managed to drive their growth in an increasingly competitive GVC by using both diversification and intersectoral upgrading to enhance the economic benefits of chain participation. In both cases, valuable lessons exist for Pakistan if it is going to integrate into the medical devices GVC to a more significant degree. 1. Establishment/use of EPZs to increase competitiveness and strengthen linkages with key global firms. Global investors in the medical devices industry, in general, have come to expect EPZ benefits as a necessary condition for potential consideration (tax holiday, duty free imports and exports, no land /local taxes). Both the Dominican Republic and Malaysia have established strong EPZs with competitive terms to support both foreign and local firms alike. Benefits in both countries include tax holidays, capital investment promotion policies, national treatment and 100% foreign equity ownership. These EPZs have helped to support investor confidence in operating in unfamiliar business environments, and overcome constraints associated with operating in developing countries. This geographic clustering of firms has also helped to contribute to knowledge spillovers in Malaysia. 2. Leveraging of related industries to enhance participation in the medical devices GVC. While neither country entered the GVC based on a homegrown industry, their participation in the medical devices sector has notably drawn on capabilities developed in near-by industries. Malaysia was able to use regulatory and quality compliance and technical 54 experience in both rubber glove and electronics components manufacturing to launch into medical supplies and then capital equipment devices. The Dominican Republic leveraged its capabilities in the T&A sector combined with its regulatory knowledge of supplying low cost devices such as certain catheters to move into specialized medical textile products, tapping into a strong labor pool and deepening the product range offered. 3. Strong industry coordination and institutionalization facilitated articulation of industry growth strategy in Malaysia. Malaysia’s medical devices sector is well institutionalized through AMMI. The AMMI serves as a marketer of the industry, promoting industry growth and potential abroad and working to attract FDI. The agency works closely with the MDA to assure all actors meet minimum quality standards and helps better gauge industry activities and coordinate activities. The coordinated approach facilitates national branding initiatives and consistent messaging has led to the development of the nation’s reputation as a global medical device supplier. 4. Workforce development has been identified as a critical element in driving product upgrading and growth. Both countries have developed a range of programs to develop human capital for the industry, illustrating the importance of skilled personnel for the industry. These have been focused on the specific segments in which the countries are operating. The Dominican Republic has focused on operator programs combined with training a smaller number of professionals in select roles through study abroad programs and engineering electives. 5 Recommended Upgrading Trajectories for Pakistan Opportunities for Pakistan to make strong headway into the medical device industry are limited in the short term by productivity challenges, technological and labor constraints. and limited existing capabilities beyond precision metal. These should be addressed before longer-term growth strategies are pursued. Pakistan’s participation in the medical device GVC has benefited from inertia, yet changing dynamics such as shifting global demands and a declining workforce necessitate change in order for the industry to survive. Despite historical competitive advantages in surgical instruments, Pakistan is facing new challenges, with exports plateauing in 2016 and 2017 (UN Comtrade, 2018). In addition, important security concerns along with a difficult business climate make investments by MNCs an unlikely proposition in the short term. However, several upgrading trajectories in the short to medium term will help position the industry for growth in the long term. Recommended upgrading trajectories include: Short term: Process upgrading to increase production efficiencies. The most pressing upgrading trajectory is to make investments in new technologies and training programs to increase the productivity of the industry. The surgical instrument industry is facing growing pressure to reduce cost and increase productivity while also facing labor shortages. Several stakeholders cited these issues as significant challenges to future growth in the industry. Currently, the industry is plagued by low levels of technology with manual production and slow production times. Investments in new technology can help increase production efficiencies in the industry. These investments should be determined based on a review of capabilities and where current bottlenecks exist in production. A shift towards more technologically advanced production also signals a greater demand for semi-skilled labor in order to use new machines and production tools. Training challenges are especially notable given the nature of production and the need for several years as an 55 apprentice before reaching full productivity in the production of precision metal instruments. By investing in training programs and curriculum to attract new workers and by continued investment in new technologies to increase productivity, Pakistan can increase the competitiveness of the industry. Medium term: Market diversification into emerging markets with growing demand for medical devices. Despite exports to over 100 nations, Pakistan’s exports remain concentrated with 52% of total exports going to the US, Germany, and the UK (UN Comtrade, 2018). Moving forward, Pakistan should seek to grow exports in emerging markets. Diversifying export market will help mitigate risk to increased regulatory changes and downward pressure on price from lead firms. Taking advantage of increasing economic partnerships and cooperation, China offers a growing market opportunity, especially considering the potential for increased economic cooperation under the Belt and Road Initiative. Other Asian markets like India, Singapore, and China Hong Kong also offer promising alternatives for Pakistan. These nations are raising healthcare expenditures, insurance coverage is expanding and demand is growing along with population. These markets also tend to have lower regulatory hurdles for entry, allowing smaller firms the chance to increase exports. Long Term: Product diversification into new medical device segments, specifically disposables and therapeutics. The medical device GVC covers many products. Currently, Pakistan only participates on a large scale in one notable product category, surgical instruments. Successful medical device clusters around the world have consolidated their position by developing capabilities in a diverse base of products. In particular diversification into disposables, a labor- intensive segment that capitalizes on Pakistan’s low-cost labor supply. A second segment, therapeutics, such as implantables, the fastest growing product segment globally. Initial upgrading into implantable devices is occurring in Pakistan among select firms but policies that help promote this trend on a larger scale will better position the nation in the medical device GVC. Pakistan should also pursue policies that encourage producers to cater to trends on the global market within the precision metal product category such as single use and minimally invasive instruments. Intersectoral upgrading into related industries. Within Pakistan, several related industries, such as T&A and offshore services exist. Strategic partnerships can create new opportunities for deeper medical device GVC participation. Pakistan can encourage partnerships among textile and medical device firms to spur movement into medical textiles and with services exporters to provide medical IT services, such as transcription. Furthermore, given rising competition and high entry barriers for medical devices, one strategy for growth is to use the experience and knowledge from current participation in the industry to build strengths in other sectors, such as barber tools, manicure/pedicure supplies, and cutlery. This is advisable especially for firms struggling to comply with new regulatory standards and buyer demands in the medical device GVC. Further, unlike Pakistan, countries such as Malaysia, which are highly active in the medical device GVC have a strong domestic market that can support many smaller firms. Pakistan can leverage its capabilities from several generations in surgical instruments and its current activities in related fields to increase competitiveness in related metal instrument industries including potentially launching their own brands due to lower barriers to entry for new actors. 56 6 Appendix Table A- 1.Medical Devices Product Categories, Based on Trade Data Classifications Product Product HS Code HS96 Codes 6-Digit (HS02-07 changes) Category Examples Aggregation 901831: Syringes, with or without needles Needles, 901832: Tubular metal needles and needles for sutures syringes, 901839: Needles, catheters, cannulae etc. (medical) (changes to Catheters, catheters, Disposables 90183 cannulae & the like in HS02) tubing, IV sets, 9018391010-90: Infusion equipment bandages, 9018399010-20: Infusion and transfusion of serum surgical gloves 9018399090: Other needles and catheters, cannulae and the like 901841: Dental drill engines (expands to dental drill engines, whether/not Dental combined on a single base with other dental equipment in HS02) Instruments, 901842: Instruments and appliances, used in dentistry Forceps, Medical & 90184 901850: Ophthalmic instruments and appliances (expands to “” nes 90.18 in Medical Surgical 90185 HS02) Scissors, Instruments 90189 901890: Instruments, appliances for medical, etc. science, nes (expands to Dialysis Instruments & appliances used in medical/ surgical/veterinary sciences, incl. Devices, other electro-medical apparatus & sight-testing instrument, nes in 90.18 in Defibrillators HS02) 902111: Artificial joints (changes to 902131: Artificial joints HS02) 902119: Orthopedic/fracture appliances, nes (changes to 902110: Orthopedic/fracture appliances in HS02) Artificial body 902121: Artificial teeth parts, hearing 902129: Dental fittings, nes aids, Therapeutic 902130: Artificial body parts, aids, and appliances, etc. (changes to 902139: pacemakers, 9021 Devices Artificial parts of the body other than teeth, dental fittings & joints in HS02) crutches, 902140: Hearing aids, except parts and accessories implants, 902150: Pacemakers prosthetics 902190: Orthopedic Appliances, nes (expands to appliances which are worn/carried/implanted in the body, to compensate for a defect/disability (excl. of 9021.10-9021.50) in HS02) 841920: Medical, Surgical Or Laboratory Sterilizers 901811: Electro-cardiographs 901812: Ultrasonic scanning apparatus 901813: Magnetic resonance imaging apparatus MRI, 901814: Scintigraphic apparatus Ultrasound 901819: Electro-diagnostic apparatus, nes (expands to “” used in medical/ machine, X- surgical/dental/ veterinary sciences (incl. apparatus for functional exploratory rays, Patient 90181 examination/for checking physiological parameters), nes in 90.18) in HS02) Capital Monitoring 90182 901820: Ultra-violet or infra-red ray apparatus (expands to “” used in Equipment Systems, 9022 medical/surgical/dental/veterinary sciences in HS02) Blood Pressure 90221: Apparatus based on the use of X-rays, whether or not for medical, Monitor surgical, dental or veterinary uses, including radiography or radiotherapy 90222: Apparatus based on the use of alpha, beta or gamma radiations, whether or not for medical, surgical, dental or veterinary uses, including radiography or radiotherapy apparatus 902230: X-ray tubes 902290: Other, including parts and accessories 300510: Dressings, adhesive; and other articles having an adhesive layer, packed Consumables Bandages and for retail sale for medical surgical, dental and veterinary use. /Medical 3005 dressings 300590: Wadding, gauze, bandages ad similar (excluding adhesive dressings) Supplies impregnated or coated with pharmaceutical substances, packaged for retail. Breathing 9019: Mechano-therapy appliances; massage apparatus; psychological aptitude- devices and testing apparatus; ozone therapy, oxygen therapy, aerosol therapy, artificial Other other 9019 respiration or other therapeutic respiration apparatus; Appliances mechano- 9020 9020: Other breathing appliances and gas masks (excluding protective masks therapy having neither mechanical parts nor replaceable filters) devices 57 Source: Bamber & Frederick (2018) ; see also Bamber & Gereffi (2013) for another application. Table A- 2.Top Five Global Importers by Product Category by Value ($US Mil), 2016 Capital Disposables Therapeutics Instruments Consumables Other Equipment Importer Shar Share Share Share Share Share Value Value Value Value e Value Value (%) (%) (%) (%) (%) (%) World 34,944 17 41,704 20 51,375 25 56,074 28 7,275 4 12,240 6 EU- 22,506 64.4 20,100 48.2 33,282 64.8 31,435 56.1 4,568 63 7,025 57 15+US EU-15 14,833 42 11,478 28 24,028 47 19,781 35 3,347 46 4,035 33 USA 7,673 22 8,622 21 9,254 18 11,653 21 1221 17 2,990 24 China 1,603 5 4,671 11 2,382 5 3,018 5 -- -- 449 4 Japan 1,832 5 2,566 6 2,312 5 2,546 5 197 3 645 5 Mexico 940 3 -- -- -- -- 1,726 3 209 3 -- -- Switzerland -- -- -- -- 1,753 3 -- -- 159 2.2 -- -- India -- -- 943 2.26 -- -- -- -- -- -- -- -- China, HK -- -- -- -- -- -- -- -- -- -- 413 3 Top Five 26,881 77 28,280 68 39,729 77 38,725 69 5,134 71 8,532 70 Pakistan 96 0.3 97 1.6 45 0.1 111 0.2 7.99 0.11 21.43 0.18 90184*, 90181*, 90182*, HS2002 90183* 9021* 90185*, 300590, 300510 9019, 9020 9022, 841920 90189* Source: UN Comtrade (2018). Based on HS-2002 product categories defined in Table A-1; all exporters; downloaded 27/08/2018. Table A- 3.Leading Importers in East Asia & Pacific 2002 2004 2006 2008 2010 2012 2014 2016 East Asia & Pacific (US$, Million) 10,850 15,899 19,195 24,089 29,866 37,788 39,901 41,008 Share of Regional Imports (%) China 14 16 15 19 21 25 28 30 Japan 43 39 36 34 33 31 27 25 Australia 10 11 11 12 11 10 10 10 Rep. of Korea 8 7 9 8 7 7 7 7 Singapore 5 7 7 6 6 6 7 7 Source: UN Comtrade (2018). Based on HS-2002 product categories defined in Table A-1; all exporters; downloaded 27/08/2018. 58 Table A- 4. ISO 13845 Certification by Region, 2004-2016 Growt Certifications Global Share h Rate 200 200 200 200 201 201 201 201 2004- 2004 2006 2008 2010 2012 2014 2016 4 6 7 8 0 2 4 6 2016 Europe 1307 3574 7463 11034 12232 12884 14705 54% 45% 54% 56% 59% 55% 49% 50% 1025% Middle East 54 267 286 456 723 760 834 2% 3% 2% 2% 2% 3% 3% 3% 1444% Africa 29 37 63 104 186 164 168 1% 0% 0% 0% 1% 1% 1% 1% 479% Central and South America 23 106 164 219 320 316 423 1% 1% 1% 1% 1% 1% 1% 1% 1739% North America 850 2444 3033 4040 4719 5631 6185 35% 30% 21% 23% 21% 21% 21% 21% 628% East Asia and Pacific 123 1257 1966 2480 3328 5628 6329 5% 16% 18% 15% 13% 15% 21% 21% 5046% Central and South Asia 16 341 259 501 809 897 941 1% 4% 3% 2% 3% 4% 3% 3% 5781% World 2402 8026 13234 18834 22317 26280 29585 1132% Source: ISO Survey, 2017 Table A- 5.Medical Device Regulation in Major Asia-Pacific Markets Country Authority Most Recent Relevant Regulation 2014: Regulations for the Supervision and Management of Medical Devices' (Decree China Food and Drug Administration China No 650); Announcements No. 25 and No. (Ministerial level since 2013) 74 containing 186 new standards for medical devices Central Drugs Standard Control Organisation & State Licensing India Authorities 2017: Medical Device Rules Pharmaceuticals and Medical Devices 2014: Pharmaceuticals and Medical Japan Agency Devices Law Medical Devices Authority, Ministry of Malaysia 2012: Medical Devices Act Health New Zealand Medicines and Medical New Zealand Devices Safety Authority 1981: Medicines Act Medical Devices Branch, Health Sciences 2010: Medical Device Regulation; 2013/14: Singapore Authority Remote Health/Telemedicine Guidelines Ministry of Food and Drug Safety (High Risk Devices) and Medical Device 2003: Medical Device Act (Law 6909) & South Korea Information & Technology Assistance 2011: Amendment (Law 10564) Centre (low risk devices) Source: Authors based on (BMI Research, 2018b). 59 7 References AMMI. 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