Thesis Submitted to the Kashmir Institute of Economics University of Azad Jammu & Kashmir Muzaffarabad fulfillment of the requirement of M. Phil in Economics

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ROLL NO. 16.
Session (2010-2012)




(Regd. No.2003-GHAG-1595)

A Thesis
Submitted in partial fulfillment of the requirements for the degree of

Master of Philosophy

Session 2010-2012

Department of Economics Faculty of Arts
University of Azad Jammu and Kashmir,
Muzaffarabad, Pakistan


Certified that the contents and form of thesis entitled ” Role of Conventional and Ethical F actors in the Performance OF Handicrafts Industry in Azad Jammu and Kashmir (AJ&K)” submitted by Ms. Rashida Saddique have been satisfactory for the requirement of the degree.

Co-Supervisor: Dr. MIRAJUL HAQ
External Examiner: ____________________________

Kashmir Institute of Economics

Dean Director
Faculty of Arts Advanced Studies & Research


I dedicate this piece of work to my loving brother
late Muhammad Javid Khan who passed away in 2011.
May the peace and mercy of ALLAH be on the soul of the
departed and may he be admitted to jannatul- firdaus.

Introduction and Background of the Study
Organization of study

2.1 Empirical Studies on Conventional Factors and Firm Performance
2.2 Ethics in Religious Perspective
2.3 Work Ethics and Performance in Religious Perspective
2.4 Ethics, Economics and Worker Performance
2.5 Conclusion
3.1Theoretical Framework
3.1.1 Theoretical Model
3.2 Empirical Model:
3.3 Study Area Sample Size
3.4 Sources of Data

3.4.1 The questionnaire

3.5 sample selection method
3.6 Polot testing of Questionnaire
3.7 Sample Selection Method and Estimation technique
4.1 Empirical Findings
5.1 Conclusion
5.2 Recommendations
5.3 Limitations of the Study and Future Research

List of Tables
Table No Page
Small and Medium Scale Industries Units Operating in AJ&K 6
Type of Small and Medium Scale Industries in AJ&K 7
Summary statistics 40
Empirical Findings 41


AJ&K Azad Jammu and Kashmir
CEECs Central and Eastern European countries
GDP Gross Domestic Product
HRM Human Resource Management
HRM Human Resource Management
J&k Jammu and Kashmir
OLS Ordinary Least Squire
PBUH Peace Be Upon Him
PIDE Pakistan Institute of Development Economics
SADC Southern African Development Community
SBP State Bank of Pakistan
SMEDA Small and Medium Enterprises Development Author
SMIs Small and medium Scale Industries
TFP Total Factor Productivity
UAJ&K University of Azad Jammu and Kashmir
USA United state of America
VIF Variance inflation factor

I thank the almighty God for his guidance, protection and inspiration. Without his endless mercy and care l would not have been what l am today and achieved what l have at the present moment.
I am thankful Prof. Dr. Nisar Hussain Hamdani , my supervisor, for being an excellent, tolerant and committed mentor. He provided many hours of constructive comment and discussion, and believed that I could complete the task. My heartfelt gratitude goes to my co-supervisor Prof. Dr. Miraj-ul-haq for his guidance, assistance, and encouragement helped me to be where l am today. Without his guidance and dedication this thesis could not have been completed.
I wish to thank Mr. Attique, Ashar Awan , Miss Fozia ,Madam Maryam, Madam Asma, Madam urooj, Madam amber, sir Luqman Prof. Dr. Javid Iqbal Khan and sir Kamran for their objective criticisms and thoughtful support thank you.
I thank the Librarian and staff of Kashmir Institute of Economics for their coopration. Library. I also thank abdul-Rouf (Director Small Scale industries),Naveed Hussain, Tahir bibi, Mr. Umar and Ali Abdi for their help in the research work.
I am grateful to my friends and class fellows Maria, Attiqua, Tooba, Aysha, Musarat, qurat-ul-ain and farhat for their support. A word of appreciation also goes to my family for their financial, social, moral and spiritual support during my course of study.

Rashida Saddique

This study is an attempt to test the hypothesis “whether or not ethical attributes of worker affects the performance of handicrafts industry in Azad Jammu and Kashmir”. To test the hypothesis empirically we used the extended production function i-e, along with conventional factors, ethical factors were incorporated in it. Therefore, in our empirical analysis we extended growth equation using data set of eighty three selected handicrafts firms located in Azad Jammu and Kashmir. Primary data was used that collected through a questionnaire. Ordinary Least Square (OLS) estimation technique is used for regression analysis. Our results revealed that ethical attributes of workers have positive and significant influence on firm output performance. The study also found that the conventional factors such as number of worker, capital, work hours, experience and market related factors positively and significantly affect on firm output performance. The overall findings reflected that ethical attributes of worker have strong and positive impact on the performance of handicrafts industry in Azad Jammu and Kashmir.

Chapter 1
A well-established segment of economic literature mention that a sound industrial base is desirable for socio-economic development (Ibrahim 2008, Ciemleja et al. 2011). Small and Medium Scale Industries are important parts of many economies in both highly developed and less developed countries (Graham 1999, p. 88, Razmyar et al. 2012). In developing countries, Small and Medium Scale Industries play an imperative role in the process of industrial development, which remunerate accelerate economic growth. (Akhtar, 2011). In less developed countries Small and Medium Scale Industries are involved in micro-businesses such as street vendors and small service delivery operations (Spence et al. 2010, p. 2).
Small and Medium Scale Industries products (e.g. handicrafts) play an imperative role in the export performances of developing countries. Developing countries are exporting handicrafts to the developed countries and creating a new source of revenue and employment for their economies (Szydlowski, 2008). Due to its uniqueness, variety, and standard Pakistan’s handicrafts products have a permanent place in international market.
Small and Medium Scale Industries relatively more strictly related to the economic development of AJ;K due to its geographical structure (i.e. hilly, and mountainous). Studies that have investigated the effects of Small and Medium Scale Industries in the economic development of Azad Jammu and Kashmir have found a positive and significant impact of Small and Medium scale Industries on economic development and growth (Hussain et al. 2009, Hussain et al. 2010). Handicrafts industry is an important source of income and development in AJ;K. Carpet Weaving, Namda, Gabba, Kashmir Shawls, Kashmiri Embroidery, Pherans and Wood Carving are some of the major handicraft products of Azad Jammu and Kashmir. In Pakistan Small and Medium scale Industries are facing several problems which act as a hurdle in their growth and better performance (Akhtar et al. 2011). Being an important sector of economy in both (Pakistan, and AJ;K) a plenty of research studies have analyzed the determinants and factors, which affect the performance of Small and Medium scale Industries (Handicrafts).
Both workers’ efficiency and firms’ output performance are well-debated subjects in economics. Some researchers argue that, in order to understand the determinants of firm performance, it is important to analyze employee level information. The behavior of employees and decisions related their work influence the firm output performance. The production of firms increases through employees contribution (Becker et al. 1996).The existing empirical literature explored and analyzed different determinants of workers’ efficiency and its response to firms’ output performance. Determinants related to financial performance of firm examined by Machin and Stewart (1990), McNabb and Whitfield (1998) and Munday et al. (2003). And the determinants related to workers productivity are studied by Griliches and Regev (1995), Oulton (1998) and Griffiths and Simpson (2004). However, almost these studies have defined workers productivity with workers’ human capital attributes i.e. education, training, skill, experience etc but could not identify the role of non-economic variables (divine attributes) i.e. ethics, spirituality, and religiosity. Recently various studies claims that along with conventional factors ethical attitude of labor can also play an important role in firm output performance (Spence 1999, Spence and Lozano 2000, Gibb 2005, Hamdani 2002, Hamdani and Miraj 2012) .
Ethics is a branch of philosophy that studies the meaning of values, morality and moral judgments (De George 1986, Chryssides et al. 1996, Finken 2007, Crane et al. 2010 and Freeman et al. 2010). Ahmad (2009) stated that entrepreneurial ethics has important impact on Small firms’ performance. Similarly, Berrone (2005) argued that strong ethical identities positively influence the worker performance and hence firms’ financial performance. Most of these studies have analyzed the impact of employer’s attitudes (ethics) on firm output performance while neglected employee ethical behavior.
In fact, this literature gap provides the basic motivation to undertake this study. In this study, we want to analyze the impact of both employer and employee ethical attributes on firm output performance. The border objective of the study is to investigate whether or not ethical attributes of workers affects firms’ productivity. We are limiting our analysis to the handicrafts industries, which is the one key sector of Azad Jammu and Kashmir’s economy. To meet this objective we adopted a theoretical framework of Divine Capital and empirically tested that apart from conventional factors how ethical factors affects the performance of handicrafts firms in Azad Jammu and Kashmir.
This study aims to find out the role of conventional and ethical factors in the performance of Small Scale Industries (Handicraft) in Azad Jammu and Kashmir. The main objectives of this research study are following;
1. To analyze the impact of both employer and employees ethical attitudes on handicrafts firm output performance in AJ;K.
2. To analyze the impact of conventional factors on handicrafts firm performance in AJ;K.
3. To review the theoretical and empirical development of the relationship between ethical factors and output.
Ho: Ethical factors are not affecting the performance of Handicrafts firms in Azad Jammu and Kashmir
H1: Ethical factors are affecting the performance of Handicrafts firms in Azad Jammu and Kashmir
The rest of study is organized as follow. Chapter two reviews literature on Small and Medium scale Industries, Handicrafts, ethics and their relative aspects. Chapter three describes detailed methodology and data collection procedure. Chapter four presents the results and discussion while chapter five consists on conclusion along with recommendations and limitations of the study.

Chapter 2

There is abundance of theoretical and empirical literature available related to the worker efficiency and performance of small scale industries. This chapter presents the review of existing literature relating to workers’ efficiency and economic performance of small firms. Studies related to work ethics which have any direct or indirect linkage with performance of workers are also included. Similarly work related to worker performance and ethics in economics and religious perspective is also highlighted.
Small scale industries play a significant role in the provision of employment and hence income generation. It play relatively more significant role in the economic development of technological backward countries (i.e developing countries). In developing countries Small scale industries (handicraft industry) is one of the largest source of employment. Like other developing countries, Small and Medium scale Industries in Pakistan is the one drive force of manufacturing sector; hence play a pivotal role in the process of economic growth (Khalique, 2011). The government of Pakistan has declared Small and Medium scale Industries sector as the fourth major drivers of economic growth (Batool et al. 2011). According to the Small and Medium Enterprises Development Authority (SMEDA), Pakistan, Small and Medium scale Industries represent nearly ninety percent of all the enterprises in Pakistan. It nearly employed eighty percent labor force outside of agricultural sector, and shared approximately forty percent in Gross Domestic Product (GDP) of the country (Malik et al. 2011). In this sense the better performance of these industries is essential for the development and growth of economies. There are several factors that affect the performance of small firms and hence industries performance. In AJ&K the economic development procedure started in 70’s but the industrial sector faced many constraints and hurdles in development process. Currently there are nine hundred and sixty seven Small and Medium scale Industrial units that are operating in Azad Jammu and Kashmir.
Table 2.1: Small and Medium Scale Industries units operating in AJ;K
District-wise industrial units. Private Public Total
Muzaffarabad 367 1 368
Mirpur 191 2 193
Bhimber 187 – 187
Kotli 131 – 131
Poonch 36 – 36
Bagh 37 – 37
Sudhnuti 15 – 15
Total 964 3 967

Source:Investment Opportunities in Azad Kashmir (Pakistan) (GOVT. of AJ;K 2008)
The significance of Small and Medium Scale Industries in economy cannot underestimate because Small and Medium Scale Industries are the main source to eliminate poverty, unemployment and growth in the national economy (Akhtar et al. 2011). In AJ;K and more than ninety percent of all firms outside the agricultural sector and Small and Medium scale Industries are the second largest source of employment. There are different types of small and medium scale industries according to Government of AJ;K.

Table 2.2: Types of Small and Medium Scale Industries in AJ;K
Name of Industry No
Woodwork ; Furniture House 208
Flour Mills 7
Food Industries ; Bakeries 167
Paper and Paper Products 9
Shoe Industries 13
Vespa Scoter factory 1
Arms Factories 19
Cosmetics 3
Crush Machines 91
Poultry Forms 84
Main Hotels 48
Textile Mills 11
Plastic Industries 8
Printing Press 26
Steel Furnaces and Re-rolling mills 5
Tyre ; Rubber Factory 0
Pipe Industries 14
Steel Works 154
Ice Factories 12
Miscellaneous 67
Rice Mills 20
Source: Investment Opportunities in Azad Kashmir (Pakistan) (GOVT. of AJ;K 2008)
Being a key driver of economic development especially in devolving countries, the one key assignment has been done by Hussain et al. (2009) that have analyzed the current development and performance of Small and Medium Scale Industry in Azad Jammu and Kashmir. The effectiveness of Public and Private sectors Small and Medium scale Industries development programs measured by taking sample of seventy Small and Medium scale Industries units. According to their findings, Small and Medium scale Industries play an important role in economic development of Azad Jammu and Kashmir. They have also highlighted the constraints (i.e business regulations, lack of finance, low human resource and technological competence) that effect the performance of Small industries in AJ;K. Similarly Hussain et al. (2010) examined the factors that causing the failure of Small and Medium scale Industries by analyzing data set of one hundred and ninety respondents working in Small and Medium scale Industries sector through descriptive and inferential statistics. They have found that government policies, political involvement, lack of infrastructure as well as the government’s regulations and their related costs are affect the performance of Small and Medium Scale Industries in Azad Jammu and Kashmir (Pakistan).
Batool and Salyha (2011) analyzed the performance and structure of the Small and Medium Scale Manufacturing sector of Pakistan in terms of employment and productivity. The study found that Small and Medium Scale Industries are an effective source of generating employment, productivity, export, and great potential for foreign exchange earnings. Jasra et al. (2011) also investigated the relationship between Small and Medium scale Industries success and its determinants in Pakistan. They used primary data set of five hundred and twenty small and medium enterprises of different cities (i.e, Islamabad, Rawalpindi and Lahore). They identified that financial and technological resources, marketing strategy, government support and entrepreneurial skill are contributing in the success of small and medium enterprises and argued that financial resources, decision making ability, management capability and professional attachment with the business are most important factors that affect the Small and Medium scale Industries’ performance. Kemal (1993) analyzed capital intenticty,labor capital productivity and constrants on the growth and performance of small firms in pakistan. He exmained that Small and Medium scale Industries are less capital intensive but have high productivity of capital and average labour productivity. There are constant return to scale in Small and Medium scale Industries. Lack of finance, skills demand and non-availability of raw metrail are major constrants for the expention and better performance of small business.
Small and Medium scale Industries have low growth and performance in Pakistan because these industries are home based and entrepreneurs have low educational and management background (Junejo and Chand, 2008). It is also found that micro credit and education have significant role in income enhancement of rural workers in Pakistan (Seemi, 2009). In Small and Medium Scale Industries, customer services, relative business experience and knowledge are the key success factors. While lack of a financial capital, economic, political instability and deficiency of cooperation by the government organizations are the major hurdles for the development of small firms (Hussain and Muhammad, 2010). Small and Medium scale Industries in Pakistan are facing many hurdles that affect its performance especially political volatility in the country, lack of intellectual capital infrastructure, and energy crises (Khalique et al. 2011).
Many economists investigated about the factors affecting the performance of small firms. Ibrahim (2008) identified the constraints, factors, difficulties, and challenges facing the Small and Medium Industries. He argued that favorable policies, operating environment, batter infrastructure, peace and security are essential for high performance goals for Small and Medium scale Industries. The significance and importance of Small and Medium Scale Industries in the economic performance of Pakistan and Sri Lanka is studied by Dasanayaka (2009). He used census based national level Industry data and point out that Small and Medium Scale Industries are significantly contribute in the economies of Pakistan and Sri Lanka in terms of exports, equitable income distribution, employment, innovation , tax income, social stability, domestic resources usage and regional development.
There are several factors that affect the performance of Small and Medium Scale Industries. Kazemy et al. (2011) identified the factors that affect the performance of small and medium scale industries in Iran and argued that small industrial units are complementary parts of the country’s economy. They studied human, marketing and financial factors, that effect on the performance of small and medium scale Industries in Iran. They concluded that human factors are most important factors affect the performance of small industries. Marketing factors are most effective after human factors, and marketing factors are more important than financial factors. Chittithaworn et al. (2011) identified similar factors that affect business performance and success of small and medium Industries in Thailand.
The performance of an enterprise also measured by its life cycle concept and performance measurement system influence the development of Small and Medium scale Industries. Sustainable and long run development of an economy is greatly affected by Small and Medium-sized Industries. The future opportunities, risks, uncertainty, managerial skills and efficient resource utilization to create profit have significant impact on the performance of Small Industries (Ciemleja and Natalja, 2011). The strict security requirements, extensive and difficult documentation, misconduct at banks and financial institutions and high mark-up are core hurdles for financing of Small and Medium Scale Industries (Javed and Gobind, 2011).
The basic hurdles in the growth and development of small enterprises are unawareness about government facilities, support and incentives, low literacy rate, Lack of technical knowledge and unfavorable cultural practices (Karim, 2001). Ihua (2009) comparatively examined the key factors that influence the performance of Small and Medium Scale Industrial sector in the United Kingdom (UK) and Nigeria. He identified that week management in UK and poor economic and infrastructural conditions in Nigeria are found the causes of failure of Small and Medium Scale Industries. Manzur and Abdullah (2010) found the major constraints that influenced the performance of Small and Medium Scale Industrial sector performance in Bangladesh. They identified that government regulatory constraints, high lending rate, small domestic market size and lack of technical knowledge are main constraints that affect the performance of Small and Medium Scale Industries.
A similar study was conducted in Malaysia by Moorthy et al. (2012). They used Contingency Theory of Fiedler, 1964 and the data collected from three hundred Small and Medium scale Industries in the Malaysian manufacturing sector. They argued that effective entrepreneurship, appropriate human resources management, use of marketing information, and application of information technology are significant related with the performance of the Small and Medium scale Industries. While the use of marketing information has the strongest relationship among the four variables in affecting the organization performance of Small and Medium scale Industries in the manufacturing industry in Malaysia.

The employees’ work effort plays a key role in various incentive models of worker compensation (Lazear, 2000) as well as in the efficiency wage literature (Akerlof, 1982, Akerlof and Yellen, 1990). Addison (2005) explained the impact of worker participation in works unions and councils on the firm output performance in United States and Germany. He also identified the joint impact of worker participation in unions and worker innovations on firm performance. He concluded that these both factors have significant impact on firm performance. Working hours of workers is another important factor that has significant impact on production process and firm performance. Golden (2012) found positive relationship between working hours, workers productivity and firm performance. The employee involvement also has positive and significant impact on firm performance (Jones and Takao, 2005).
Handicrafts industry also play imperative role in the economic development and growth of countries’ economy. Posthuma and Avril (2003) focused on the crafts and the visual arts in the Southern African Development Community (SADC) and argued that crafts and visual arts have essential contribution for social development and regeneration initiatives in urban centers. Information collected by interviews of stakeholders in the particular sectors, including experts, administrators, government officials, policy-makers. They maintained that region-specific factors, political and traditional issues are influence the crafts and visual arts. Szydlowski (2008) examined the growth and organization of handicraft industries in Vietnam. He concluded that new source of revenue and employment created through exporting the handicraft products to the developed world and the development of rural industrial sector, specifically handicrafts industries prevent urban scattering and extreme rural poverty. Similar results identified by Jitsuda (2010) in Northern Thailand. He found that handicrafts have considerable potential for enhancing rural industrialization and development. Through employment and income generation, handicrafts also contribute to rural poverty alleviation. Patricia et al. (2011) explored that environmental innovation has positive impact on handicraft industries. And if artisans adopted environmental standards they increase their profit through exporting the products in national and international markets.
Ethics means to see what is good and bad socially as well as morally because ethics is important for making and developing a sound and pious society . Ethical values have great importance in divine religions (i.e, Islam, Christianity and Judaism. “The Islamic society regulates the behavior of people by a certain set of values which influence economic behavior of people in a vital way like activities related to production, exchange and consumption of goods and services. The economic value of Islam can be divided into two parts, justice, honesty, cooperation, generosity and patience are positive value and greed, amassing wealth and depriving other from their due rights are negative values” (Khan, 1989).
The ethical behavior has greater importance in Jewish religion as King Solomon declared that.
“To do righteousness and justice is preferred by God above sacrifice” (Prov. 21:3)
In one of the exceptional occasions the word Tzedek is repeated twice in Torah, God commands for emphasis that
“Tzedek, tzedek tirdof” (Justice, justice shall you pursue.”) (Deut. 16:20)
“The Lord of Hosts shall be exalted in justice, The Holy God shows
Himself holy in righteousness.” (Isaiah 5:16)
Christians are called to practice the kind of unconditional, volitional, respectful love for God with one another (1 Corinthians 10:24; Ephesians 4:1-6)
“If you forgive those who sin against you, your heavenly Father will forgive you.
But if you refuse to forgive others, your Father will not forgive your sins.”
(Matthew 6:14-15).
Ethical values place the highest influence in all aspects of human life in Islam. Islam provides the moral and spiritual guidance through the Qur’an and the Prophet’s example for Muslim believers to fulfill their duties and establishing a just and peaceful society. These ethical norms and moral codes evident from the verses of the Holy Qur’an and the teachings of the Prophet ( Peace Be Upon Him) .The Holy Qur’an says:
“You are the best nation that has been raised up for mankind; you enjoin
right conduct, forbid evil and believe in Allah”. (3:110)
The Prophet (May Peace be Upon Him) also says:
“I have been sent for the purpose of perfecting good morals”. (Ibn Hambal, 8595)
“Islam is the religion of values and the privilege of human being in this world and hereafter life in this possession of divine values and attributes. Honor, justice, sacrifice, patience, generosity and responsibility are examples of these values which needs to be possessed and practice by human being in their entire life”(Naqvi 2008, p. 5).

“If we do not aspire for paradise or fear for hell or possibility of reward and punishment, even then it was necessary for us to adopt best ethics because these guide us towards success” Zadi (2009, pp 297).

Islam gives complete freedom to economic enterprise. “Islam pursues man to co-operate with others and leads him to the protection of social justice which is the mean of divine pleasure”. (Al-sadar 1993).
Justice is core value in Islamic economic system . The Holy Quran says;
“And O my people, Give full measure and weight in justice and reduce not the things that are
due to the people, and do not commit mischief in the land, causing corruption.( Surah Hud, 12:85)
Patience is another important ethical value in Islam. Allah has mentioned patience a key to achieve success in Holy Quran:
“And seek assistance through patience and prayer, and most suirly it is a thing
except for the humble ones”. (Surah Al-Baqara, 2: 45)

“O You who believe, be patient and excel in patience and remain steadfast, and be
careful of (Your duty to)ALLAH, that you may successful.”(Surah Aal-Imran, 3:200)

In civilized society of the pre-Islamic world worker was mainly provided by slaves. They worked for their masters without any reward. They were a trade able commodity and had not any right. In this background the Holly Prophet (Peace Be Upon Him) initiated the inclusive plan for the liberation and benefit of slaves. They were made to share the resource of master. The master advised to keep their slaves at the same level at which they themselves exist and the prophet (Peace Be Upon Him) made the slaves partners and share holders. This concept changed the basic economic relationship and this reform carried the seeds for the future development of the economy. Ibn-Umar said: The Holly Prophet (Peace Be Upon Him) said:
“Pay the laborer his wages before drying up of his sweat.”
(Sunn Ibn-e-Maja,BK 16,Ch. 3)
The Holly Prophet (Peace Be Upon Him) gave great importance to the economic welfare of the people and rigorous development of human resources . He allocated a high worth on industry, worker efficiency and appreciated enterprises and initiatives. Al-Miqadam reported the Hazrat Muhammad (Peace Be Upon Him) saying:
“No one has even better food then what he eats as a result of the labor of his hand. And verily, Allah’s Prophet Dawud, used to eat by the work of his hand.”
(Sahih Bukhari, BK. 34, Ch.15)

Hazrat Ali (Allah be Pleased With Him) Said:
“A person came to the Prophet of Allah (May Peace be Upon Him) and asked: ‘O Messenger of Allah: what type of earning is best?’ The Prophet (Peace Be Upon Him) said: ‘A man’s work with his hand and every business transaction which is approved, for Allah loves a believer who is a craftsman. And said a person who suffers pain to feed his dependents is like a person who fights in the cause of Allah, the Mighty and Glorious. “(Masnad Zahid b.’Ali Hadith 544).

The performance of Organization and worker ethics are closely related and interdependent to each other in Islam (A. J. Ali and Al-Owaihan, 2008, Kumar and Rose 2010). Islamic work ethics like honesty and fairness at workplace increase the organizational performance and efficiency of workers (Abbasi et al. 2012, Yousef 2000, Rahman et al. 2006, and Ahmad 1976). Hashim (2012) explained core Islamic values, beliefs and idea regarding business and trade.
The Bible and Talmud give many insights as to how employers should to manage human resources ethically and discussed the issues related to employee theft, motivation and compensation (Cohn and Hershey, 2002). They described the principles that are derived from the Bible and serve as a guide to Human Resource Management. They argued that ethics in human resource management is Bible ethics and the next world the first question an individual is asked about ethics.
“Were you honest in your business dealings?”
(Babylonian Talmud, Shabbos 31a).
They maintained that it is the responsibility of organization to take care its employees. Hillel’s version of the golden rule,
“What is hateful to you, do not do to others”
(Babylonian Talmud, Shabbos 31a),
They argued that if an organization applied these instructions then Employees and employers equitably treat each other.
Economics started as a science dependent on ethics. The theoretical connection between ethics and economics introduced by a Greek philosopher Aristotle, he linked economics as a part of practical philosophy together with politics and ethics. Later on economics developed as a scientific discipline rather than moral Philosophy. Ethical theories also have been very important in many of the famous economic theories. Bradley (1980) discussed the economic ideas of George (1980) and their ethical implications. As he writes, “Religion is seen as inseparable from life, and basic for economics. Religion has also influence the importance of universal values (ethics) as it plays various roles in virtue ethics, deontological and consequentialist moral theories. Consequentialist theories are based on the idea that right actions are the actions that lead to a result that has universal value.
The field of ethics in economics and business was emerged in 1970s (De George 1987, p. 202, Stark 1993, p. 40, Schwartz, 2007, p. 217). Adam Smith (1776) was the first economist and moral philosopher, which discussed the ethical dimensions of economic prosperity. Later on the ethical dimensions of economic growth dealt extensively by Karl Marx (1887), and Pigou (1952). In 1966 Simon Kuznets described the relation between income inequality and economic growth and stated that ethical consideration affects the income inequalities. Sen (1970, 1996) identified the ethical dimensions in social choice theory, development economics, poverty, inequality and capability development. He has stated in his book On Ethics and Economics, “that economics, as it has emerged, can be made more productive by paying greater and more explicit attention to the ethical considerations that shape human behavior and judgment” (Sen, 1987).
In recent decades economists dealt extensively with ethics and values in economic perspective. Hamdani (2002) introduced a new concept of Divine Economics. Furthermore Hamdani and Ahmad (2002) described the role of religion and ethics in economic and non-economic behavior of human being. On the basis of this divine concept Hamdani presented Divine Capital Model (2012) and assumed that Total Factor Productivity (TFP) is also affected by the divine attributes (i.e. ethics, spirituality, and religiosity) of workforce. This model further extended mathematically by Hamdani and Miraj (2012).
Various economists have argued, especially Vivian Walsh (2000, 2003) and Hilary Putnam (2003) in this journal, ethics is not separate from economics but part and parcel of it, just like fact and value are entangled in other social sciences. Fine (2004) discovered some inter-related reasons (i.e, included rigid division of economics between positive and normative economics, backward in methodology, neglect its own history as a discipline, isolation from the other social sciences, intolerant of heterodox alternatives and interdisciplinary sidelined to marginal status in method, methodology and history of economic thought) for poor ethics in economics. Chalotra (2012) examined the extent and adoption of ethical norms in Supply Chain Management of small scale manufacturing units in Jammu and Kashmir (J;K). According to State harmony with age, qualification and work experience, he shown that different age suppliers have same level of ethical perspective, and qualification doesn’t matters in relation to devotion of ethical norms and standards established. He argued that different work experience of suppliers differs insignificantly in adopting ethical code of conduct.
Ethical consideration in economics has great importance in Islam. Beekun and Jamal 2005 stated that Islam and other religions have common significant ethical values in business. They examined the Islamic business ethics in normative perspective and argued that the Islamic ethical system is unbiased, just, and caring. In Islam the responsibility of each stakeholder is based on trust (amana), benevolence and excellence (Ihsaan), equity, balance and fairness (adl and qist). Seidu (2008) discussed the importance of good employer employee relationships and states that this good relation can be achieved by adopting the Islamic principles for human resource management. He argued that in Islam the owner worker relationship is a mutual contract and Islam rich with ethical and moral qualities in which trust is a fundamental value in employer-employee relationships. He mentioned that this type of employer-employee relationship is helpful in human resource management and improvement in firm’s performance. Hussain (2010) discussed the Islamic perspective of organizational work ethics in Malaysia and argued that according to Islamic perspective, works ethics directly influence work performance and job satisfaction of workers in an organization. He stated that work performance of workers and organization is increased by practicing Islamic work ethics.
The implications of the increasing literature on ethics and economics for development debates, examines by Qizilbash (2007). He argued that ethics and economics had a considerable impact on growth. Lather (2008) measured the Ethical Quotient of Corporations in twenty five Small and Medium Enterprises in Delhi (India) and presented an overview of ethics and business related issues. He identified that in high intellectual soft services sector and low intellectual soft services have low ethical consideration. He argued that these ethical problems are disturbing for the economy and at least medium ethical considerations have needed for organizations. Ahmad and Pi-Shen (2009) explored the dominant attitudes towards ethics and social responsibility thoughts among Small and Medium scale Industries owners in Australia and Malaysia. Data was collected through interviews with twenty entrepreneurs of manufacturing and service sectors from Australia and Malaysia and was used three clusters of ethical behaviors. They identified that issues related to ethics and social responsibility have important impact on small firm in Australia and Malaysia.
Longeneckeret et al. (2005) presented a theoretical structure of ethical behavior and a comparative analysis of ethical insights of managers of small and larger companies in America from 1985, 1993 and 2001 across seventeen years. They concluded that in recent years, more ethical decisions are making by owners and managers. Ethical standards are rising over time for firms of all sizes and large and small company managers followed the same trend. Banerjee et al. (2007) compared the ethical practices of one hundred and thirty small business units of India and one hundred and twelve from Bangladesh. He identified that ethical principles are culture specific and nature of business and industry also affect the ethical practices. Furthermore the ethical practices are different in both countries.
The impact of compensation, performance evaluation, and promotion practices on the Azad Jammu and Kashmir University employee’s performance evaluated by Ahmad and Khurram (2011). Responses from one hundred and thirteen respondents were used and they analyzed that the compensation practices had significant impact on the performance of employees. And the promotion practices and performance evaluation had insignificant affect on the performance of university employees in Azad Jammu and Kashmir Pakistan. They further indicated that compensation and financial rewards had strong influence on the performance of university employees in Azad Jammu and Kashmir.
A plenty of research studies mention that ethics has significant impact on worker performance. Liao and Mei (2010) examined the relationship between ethics training and employee satisfaction. They collected data through questionnaire from senior managers of one hundred and nine companies in Taiwan. They identified that ethics training; corporate-responsibility practices and employee satisfaction have significant positive relation. Aguinis (2009) defined the performance of employee as the employee’s behavior that significantly contributes in firm performance. Yair (2010) identified the importance of motivation in the job performance of employee and presented theoretical motivational factors and practical strategies. He explained that the implementation of the strategies requires the managers, who are honest with their employees able to handle the challenge of motivation. Carr et al. (2010) examined Small and Medium Scale Industry’s owner manager willingness to share information online with the members of other organizations. Using data set of one hundred and ninety two Small and Medium scale Industries owner-managers, they identified that the social context of owner-managers such as where they trade, what growth they anticipate and size of organization influenced willingness to share knowledge online. They also explored that online knowledge sharing initiatives should enhance relationships within the business network itself as well as the technical aspects of the networking platform social capital affect the well-being and income of employee.
The employee Job performance improved by revising minimum, providing health care facilities, and developing awareness among owners and employees regarding their legal rights and responsibilities Huda (2011).The relationship between company’s spirituality and employees’ ethical behavior in religion perspective was explained by Mohamed and Azizah (2012). They used questionnaire as data collection instrument from employees and founded that low relationship between company’s spirituality with the employees’ ethical behavior due to the different employees understanding about spirituality. They concluded that company’s spirituality is exists and also affect the employees’ ethical behavior.

The above review of literature mentioned that much work have done on factors that explain the performance, growth and development of Small and Medium Scale Industries. However ethical factors (ethical attributes of worker) have less consideration in Industrial performance. Almost existing literature agreed on the fact that Small and Medium scale Industries play vital role in the economic development of both developed and developing countries. In case of Pakistan a size-able research work is available on Small and Medium scale Industries but few studies have founded on handicrafts sector. The one noteworthy importance is that no empirical study has been found that has analyzed the impact of ethical behavior of employee and employer on firm’s performance but hardly any study available in Pakistan especially in Azad Jammu and Kashmir. Most available studies focused on employer ethical behavior and neglect employees ethical behavior. Small and Medium Scale Industries especially handicrafts industry is an important source of economic development in Azad Jammu and Kashmir however almost no empirical study available on this sector.

Chapter 3
The present study is an empirical extension of the Divine Capital Model (2012) which is a part of newly emerging sub-discipline called Divine Economics. The framework of Divine Economics was elaborated in working papers and a series of papers in scientific journals or presented at international forums including Harvard University USA, Doctrine of Mahdism Conference Tehran, PIDE and a number of universities in Pakistan. The Divine Capital Model (2012) hypothesizes that Total Factor Productivity (TFP) is also affected by the divine attributes (i.e. ethics, spirituality, and religiosity) of workforce. Solow (1956) suggested that the TFP level depends on time, and hence presented aggregate production function as follows;
Y=A(t) F (K,L) (1)
Y=Aggregate output
A(t)=TFP that is time driven
K=Capital Input
L=Labor Input
In mid 1980s, i.e. Romer (1986) and Lucas (1988) argued that instead of time’t’ the level of TFP depends on the stock of human capital. Therefore, in this framework the TFP and hence the aggregate production function are presented as;
Y=A(H).F(K,L) where ‘H’ is the stock of human capital (2)
Similarly, Romer 1990; Grossman and Helpman 1991; and Aghion and Howitt (1992) argued that apart from stock of human capital ‘h’ TFP depends on domestic R;D capital stock.
Y=A(H,R) F (K,L) where ‘R’ is domestic R;D capital stock (3)
Grossman and Helpman (1995), and Coe and Helpman (1995) claimed that knowledge/technology that diffuse through imports lead to increase TFP.
Y= A(H,R,M) F (K,L) where ‘M’ is country^’ s imports (4)
We hypothesized that that TFP level also affected by the ethical attributes of workforce. Keeping in view this potential relationship, most recently a model has been developed by Hamdani (2012) known as Divine Capital Model. While a later version is its mathematical extension, presented by Hamdani and Miraj (2012), towards total factor productivity analysis. To assess the hypothesis empirically we adopt a theoretical framework of Divine capital model (Hamdani, 2012) which define that how ethical factors affects workers efficiency and hence firm’s output performance. The consequent model will enable us to examine the impact of ethical factors on firm’s output performance. Hence, along with conventional factors of production (i.e. capital, labor) we incorporate another variable in our production function that captures the impact of ethical attitudes of workers on output.
Divine Capital model claims that apart from conventional factors of production (i.e. capital, labor) divine factors also affect the firm output/performance. By incorporating divine factors our production function explained as follows.
Y=A(H,R,M,D) F (K,L) where ‘D’ is Divine capital (5)
Divine capital consists of four components, Religious capital, Spiritual characteristics, Ethical characteristics, Reinforcement physical capital (Hamdani, 2012).
The main focus of this study is to analyze the impact of ethical characteristics of labor’s on firm output performance. So we use ethics as a component or proxy to Divine Capital. Hence, apart from conventional factors of production (i.e. capital, labor) we incorporated another variable in our production function that captured the impact of ethical attributes of labor on output. Hence, in this essence the aggregate production function is presented as;
Y=A(H,R,M,E) F (K,L) where ‘E’ is ethical attributes of workers (6)
Assuming Cobb-Douglas specification, labor augmenting technology and incorporating ethical variable the model extend as follows;
Y=(EAL)^? K^(? ) (7)
‘E’ enter the equation with labor ‘L’ because ethical characteristics in human phenomena not physical capital. Hence we assume that it affects firm performance through change in worker efficiency in production function through labor. This equation postulates that along with conventional factors, growth of TFP also explained by ethical attributes of workers.
To analyze the impact of conventional and ethical factors on handicrafts industry performance in Azad Jammu and Kashmir above theoretical framework is used. With the sample size 0f 83 units following baseline model is estimating.
?HIP?_i=?_i+??EF?_i+??X?_i+µ_i (8)
?HIP?_(i )= Our dependent variable is Handicrafts Industry Output Performance, which is measured, in monetary value of sale of ith firm per annum.
?EF?_i= Worker ethical attributes index that captures the ethical characteristics of labor such as responsibility, justice, sacrifice, generosity, honesty and patience.
X_i= is the vector of all control variables. This includes total number of workers, worker-hours worked in a year, capital input (the monetary worth of all machinery, equipment, and buildings), market related factors which includes (provision of raw material, prices of raw material, availability of loan, infrastructure facilities, skilled labors, foreign products, marketing skills), government related facilities (provision of small amount of loan, provision of interest free loan, tax reduction, subsidy (on electricity, raw material, transport), Government sale and purchase center, training facilities), education (general, religious and technical) of workers of firm and total experience of workers within firm and other than firm in relevant field. Where µ_i denote error term.
Firm output performance = the dependent variable which is the monetary value of firm per annum in rupees.
Worker ethics = ethical values Index of both employee and employer of firm.
Number of worker = total number of both skilled and unskilled workers in a firm.
Working hours = total number of working hours of workers per day in a week.
Capital of firm = physical capital (the monetary worth of all machinery, equipment, and buildings) and financial capital of firm.
Market related factors = index of market related factors which includes provision of raw material, prices of raw material, availability of loan, infrastructure facilities, skilled labors, foreign products and marketing skills.
Government related facilities = index of government Facilities which included provision of small amount of loan, provision of interest free loan, tax reduction, subsidy (on electricity, raw material, transport), government sale and purchase center and training facilities.
Education = general, religious and technical education of workers of firm.
Experience =total experience of workers within firm and other than firm in relevant field.
edu*exp = interactive term of worker education with experience.
edu*exp*eth = interactive term of worker education with experience and ethics
3.3.2 Construction of variables
The dependent variable performance has defined as the annual sale of products in rupees of all firms. There are different measures of firm performance e-i firms annual output production in units and cost of production. However, firm annul sale in monetary term is mostly used to measure the financial performance of firms.
The sum of employee and employer ethical values index used to measure the firm ethics. The ethical values index consisted on six statements related to the ethical characteristics of workers such as responsibility, justice, sacrifice, generosity, honesty and patience.
Number of workers included both skilled and un-skilled workers who working in firm at full time bases. As we mentioned above we consider both employee and employer as worker.
The working hours are the average number of hours per day in a week, workers work in a firm.
Capital of firm measured as the sum of initial monetary value of firm physical capital (Initial and current monetary worth of all machinery, equipment, and buildings) and initial and current financial capital of firm.
Index of provision of raw material, prices of raw material, availability of loan, infrastructure facilities, skilled labors, foreign products and marketing skills called market related factors, which used to measure the effect of market related factors on firm performance. And Index of government facilities which included provision of small amount of loan, provision of interest free loan, tax reduction, subsidy (on electricity, raw material, transport), government sale and purchase center and training facilities is used to measure whether these facilities provided by government to Handicrafts firms or not. .For index construction, similar index made method used that mention above.
Education is the sum of general education (in year), religious education (month/year) and technical education (month/year) of firm’s workers. Experience consists on the sum of total experience of workers within firm and other than firm in relevant field. Above average calculation method used to calculate the average education level of firm and average experience of firm.
To measure the combine effect of education, experience and ethical attributes of workers, first we developed interaction term of workers ‘education with experience and then workers ‘education and experience with ethics.
This study analyzed the role of conventional and ethical factors in the performance of handicrafts industry in Azad Jammu and Kashmir. The total sample size consisted of eighty three firms. There were nine hundred and sixty seven Small Medium and Large scale industries in Azad Jammu and Kashmir. This categorized into different business sectors (Government of AJ&K, 2008). This study considered two major Handicrafts industries include wood carving and Kashmiri Embroidery (namda, gubba, kashmiri shawls).
Primary data was collected using Extended Version of Divine Economics Survey Questionnaire (2012) after adding a new section related to firm performance. The Divine Economics Survey Series started in 2000, through Quaid-e-Azam University Islamabad Pakistan. In 2006, Labor and Work life Program of Harvard University recognized the importance of this interdisciplinary survey and assisted a survey in Pakistani earthquake 2005 affected areas to explore the role of faith in post-disaster rehabilitation patterns. The 2009 survey was conducted with the assistance of University of Azad Jammu and Kashmir (UAJ&K) and Pakistan Institute of Development Economics (PIDE), Islamabad Pakistan. A revised survey is presently ongoing which incorporates cumulative experience of previous survey.
3.4.1 The Questionnaire
The questionnaire that used in this study divided in different following sections.
Section A: General information
This section includes questions about the biographical details of respondent and firm.
Section B: Firm ethics
This section consists on the index of ethical values (responsibility, justice, sacrifice, generosity, honesty and patience).The index of ethical values developed manually for this study.
Section C: Firm capital
This section consists information about capital, machinery, equipment, number of labor and building of firm.
Section D: Firm output
This section consists of three questions related to the annual turnover and output of the firm.
Section E: Market related facilities
This section consists on statements related to raw material provision and prices, loan, infrastructure facilities, skilled labors, foreign products and marketing skills.
Section F: Government related facilities
This section have questions related to the provision of government facilities related to provision of interest free loans, tax reduction, subsidy (on electricity, raw material, transport), Government sale and purchase center and training facilities.
Pilot testing of a small sample size with Muzaffarabad was conducted for pretesting of the questionnaire. The basic aim was to identify the issues related to question structure, wording, content, and layout and time requirement for a respondent to complete a questionnaire. The questionnaire was revised according to pretesting observation and hence all problems were removed. The basic draft of however for the sake convince it was also translated into Urdu.
The target population for this study was the Handicrafts Industries in Azad Jammu and Kashmir. Handicrafts sector is less established sector of Azad Jammu and Kashmir economy and the majority of Small and Medium scale Industries, are scattered widely throughout the rural area (Hussain et. al 2011). No documented information is available about location, size and number of firms. Hence, this study applied the snow ball sampling technique for data collection. Snowball sampling is non-probability sampling method used with unknown or rare population. Members of this population have not been previously identified and difficult to contact than as compare to known populations (Coleman 1958, Goodman 1961, Spreen, 1992). The dependent variable of this study is the sale of the firm per annum in rupees. This study used Ordinary least squire (OLS) for estimation because the dependent variable, sale in continuous form. Regression was run in statistical package (STATA) was used to analyze the data.

Chapter 4

In this chapter the interrelationship between firm performance and worker ethics has been analyzed by applying Ordinary least Square (OLS) statistical estimation method. The data set of 83 Handicrafts units gathered from the questionnaire and analyzed in this chapter. Summary statistics (minimum, maximum, mean, standard division) of variables under consideration are given the following table 4.1.
Table 4.1: Summary statistics

Variable Observations Mean Std. Dev Minimum Maximum
Sale of firm 83 12.3385 1.2272 10.5966 14.4573
Firm ethics 83 81.8769 7.9959 53.33 95.5
Number of worker 83 3.1325 1.2471 2 10
Total working hours of worker in firm 83 13.9373 2.2753 8 19
Total capital of firm 83 11.96306 1.403692 9.581903 14.7457
Index of market related factors 83 65.6756 10.0316 29.1 85
Government related facilities 83 45.7125 8.7038 37 86
Education 83 1.0235 1.6855 0 13
Experience 83 7.5713 5.3487 1 31
Interactive term of education and experience 83 5.2399 5. 2399 2 3.1333
Interactive term of ethics, education and experience 83 40.9718 9.6717 57. 33 114.633

The summery statistics shows that total numbers of observations are 83. The values of standard deviation show the variation/dispersion from mean. Low standard deviation indicates that the data points tend to be very close to the mean and high standard deviation indicates that the data points are spread out over a large range of values. Employee ethical index Firm ethics (both employee and employer) index have minimum value 48 and maximum 95 in handicrafts firms.The summary table shows that minimum amount of firms sale is 10.5 and maximum is 14.4 per annum.
To examine the overall fitness of the models diagnostic tests have been used. The Breusch–Pagan test is used to investigate the heteroscedasticity problem in models (see appendix B).The results given in appendix B indicates that our models are free of heteroscedasticity problem.
Variance inflation factor (vif) test was used to investigate the multicollinearity problem (see appendix C). Results given in Appendix (D) show that individual VIF values are less than 10 and tolerance values are greater than 0.1 and all of our models are free of multicolinerity problem. The Correlation coefficients of variables (see appendix D) used to see the correlation of variables included in the models. Correlation tells us about the relationship between two variables and direction and magnitude of this relationship. The Correlation coefficients of all variables, between -1 and +1 which shows the relationship exist between two variables.
In table 4.2 the empirical findings of the study are presented.
Table4. 2: Empirical Findings
Dependent Variable: Firms’ Productivity
Variables Model_2 Model_3 Model_4 Model_54
Index of firm ethics 0.022** (0.03) 0.021** (0.01) 0.023**
(0.03) —–
Number of labor in firm 0.222***
(0.00) 0.238***
(0.00) 0.218***
(0.00) 0.218***
Total working hours of labor in firm 0.101**
(0.01) 0.099**
(0.01) 0.109***
(0.00) 0.102**
Total capital of firm 0.444***
(0.00) 0.449***
(0.00) 0.4687***
(0.00) 0.474***
Index of market related factors 0.018** (0.04) 0.017***
(0.06) —– 0.021** (0.01)
Index of government related facilities —– -0.010 (0.31) —– —–
Education -0.089* (0.08) -0.069* (0.07) —– —–
Experience 0.032**
(0.05) 0.029* (0.08) —– —–
Interactive term of education and experience —– —– 0.038** (0.02) —–
Interactive term of ethics, education and experience —– —– —– 0.021**
Constant 1.757 1.388 2.324 1.231
Number of observations 83 83 83 83
R-Squared 0.671 0.689 0.620 0.645
Adj R-Squared 0.641 0.695 0.596 0.622
Root MSE 0.736 0.726 0.780 0.755
1.*** Significant at 1%, ** Significant at 5%, * Significant at 10% level
Value in parentheses is P-Values for T-test

Table 4.2 shows that our firms’ ethics variable enters in all models statistically significant and with expected positive sign. This indicates that ethical attributes of workers have a significant and positive impact on firm output performance (? =0.0319, 0.0324, 0.03213, 0.0282. p < .05see Model 1, 3, 4 and 5) which proved the hypothesis that ethical attributes of employer and employee affect the output performance of the firm. This implies that those firms which workers have high ethical values performing better. The results resemble with the findings of Jones (1995) and Jones et al. (1999) that proactive ethical initiatives have a positive impact on ?nancial performance as ethical behaviors result in the creation of slight resources, which are very important for long term business success. Similarly Ahmad and Pi-Shen (2009) also explored that in smaller firms, ethics and social responsibility issues are affect the entrepreneurial behaviors.
We claimed in earlier section that along with education and experience, ethical attributes would affect positively in worker effectiveness and, hence firm performance. This hypothesis was tested with interactive term (i.e, firm ethics, education, experience). The interactive term entered the model with expected positive sign (0.024) which is significant (p