AFRICA PRIVATE SECTOR GROUP

An Assessment of the Investment Climate in Zambia

Acknowledgements We are grateful to Andrew Stone, Iain Christie, Roy Pepper, Abebe Adugna, Hart Schafer, Ahmet Soylemezoglu, Chris Walker, Rosemary Sunkutu, the PSD Sector Board, and participants at the regional review meeting, for helpful comments and suggestions. IMCS Consulting Services carried out the enumeration for this survey and we wish to thank Augustine Mkandawire, Pryd Chitah and John Kasanga for the supervision of the survey. Roy Pepper and John Nasir undertook the exploratory mission for this work and were helpful throughout this project. Melissa Himes supervised the fieldwork for several months in the field. Our colleague and friend, Gerald Tyler, provided excellent guidance and supervision in the field. Gerald had worked with RPED for over a decade, helping to build a program of research around firm survey data. Sadly, Gerald passed away a short while ago. The team would like to dedicate this Assessment to him. Project Team Constantine Chikosi (TTL), Vijaya Ramachandran, Linda Cotton, Chad Leechor (AFTPS), James Habyarimana (Consultant).

LIST OF ACRONYMS

CFR Country Framework Report

EIU Economist Intelligence Unit

FDI Foreign Direct Investment

FIAS Foreign Investment Advisory Services

FSAP Financial Sector Assessment Program

GDP Gross Domestic Product

HIV/ AIDS Human Immuno-Deficiency Syndrome/Acquired Immunity Deficiency

Syndrome

ICA Investment Climate Assessment

IMF International Monetary Fund

METR Marginal Effective Tax Rate

ZAMTEL Zambia Telecommunications Corporation

ZANACO Zambia National Commercial Bank

ZCCM Zambia Consolidated Copper Mines

ZESCO Zambia Electricity Supply Commission

ZPA Zambia Privatization Agency ZRA Zambia Revenue Authority

EXECUTIVE SUMMARY............................................................................................ I

II. HOW PRODUCTIVE ARE ZAMBIAN FIRMS? EVIDENCE FROM THE RPED SURVEY ............................................................................................................. 6

CAPACITY UTILIZATION................................................................................................ 6 CAPITAL INTENSITY AND CAPITAL PRODUCTIVITY ....................................................... 7 LABOR PRODUCTIVITY AND UNIT LABOR COSTS .......................................................... 8 FIRM PRODUCTIVITY IN ZAMBIA: A SIMPLE ECONOMETRIC TEST................................. 13

III. WHY IS PRODUCTIVITY LOW? ..................................................................... 14

EXPLANATIONS FROM ZAMBIA’S BUSINESS ENVIRONMENT ................. 14

MACROECONOMICS AND FINANCE...................................................................... 17 PUBLIC-PRIVATE INTERACTION........................................................................... 24 INFRASTRUCTURE ................................................................................................... 26 LABOR MARKET ..................................................................................................... 30 CRIME AND CORRUPTION...................................................................................... 32

IV. RECOMMENDATIONS ...................................................................................... 35

APPENDIX 1: ZAMBIA SAMPLE PROPERTIES ................................................ 45

APPENDIX 2: ADDITIONAL DATA FOR SERVICES......................................... 55

REFERENCES............................................................................................................. 56

EXECUTIVE SUMMARY In spite of broad economic reforms, Zambia today confronts the challenge of diversifying its economy and accelerating private-led growth to address the poverty of its people. Until recently, the people of Zambia were becoming ever poorer. Economic reforms in the late 1990s brought some tangible benefits, with a greater focus on fiscal discipline, better governance and promoting private-led economic growth. As the new policies were put into effect, the economy responded favorably, producing four consecutive years of solid growth, with real GDP rising 3.7 percent per annum between 1999 and 2002. However, the failure to complete the reform process left the economy vulnerable to circumstances, such as drought and a secular decline in copper prices, which together slowed the economy. Although, recently, copper prices have improved and rains have fallen, Zambia must confront the challenge of the long-term decline in the contribution of copper to the economy, by creating the macro- and microeconomic conditions for private sector-led growth in a more diversified economy. Zambia’s future does not lie in the government selecting sectors to promote, but in creating policies and institutions that encourage investors to productively and creatively employ its resources and its people. As is now well known, economic growth is critical to poverty reduction – the central objective of the Government. To increase employment and wages, productivity must increase. Both productivity and growth are achieved primarily through the development of the private sector, in the context of an enabling and competitive investment climate. The challenge is to continually improve conditions over a sustained period in a logical sequence of reforms that improves Zambia’s competitive position as a host for investment, while maximizing the benefit of this growth for its people through appropriate investments in people. This Zambia Investment Climate Assessment (ICA) forms part of World Bank Group global initiative to systematically analyze conditions for private investment and enterprise growth. Improving the investment climate is recognized as a key pillar of developing countries’ path to promote economic growth and reduce poverty. Investment Climate Assessments provide a standardized way of measuring and comparing investment climate conditions in a country, highlighting the microeconomic and institutional conditions inhibiting constraining productive investment. They help to identify priority problems whose improvement would yield the greatest and most immediate gains, looking in detail at impediments (including policy , regulatory and institutional factors) that constrain the effective functioning of product markets, financial and non-financial factor markets, and infrastructure services. The ICA compliments and amplifies a series of diagnostic work on this issue being undertaken by the World Bank Group in collaboration with the Government of Zambia. The Zambia Investment Climate Assessment (ICA) is also part of a broader, inter-regional program of investment climate studies of the World Bank Group. Throughout this report, empirical results showing the relative position of Zambia versus potential competitors will be presented. To understand the quality of investment climate in Zambia from the perspective of the private sector, the report draws on the results of a

firm survey conducted in 2003, covering a sample of more than 200 service and manufacturing firms, large and small, located in different parts of Zambia.1 This Investment Climate Assessment has three key parts: (i) Empirical analysis of productivity: For Zambia to compete internationally, it

must improve productivity. Value added per worker in Zambia is about $2700, which is higher than Uganda and Tanzania but well below Kenya, India, and China. Capital productivity is extremely low, and the capital intensity of Zambian firms is very high compared to that of comparator countries. The productivity difference cannot be accounted for solely by the quantity and quantity of inputs, highlighting the importance of understanding how Zambia’s investment climate is shaping firm-level performance.

(ii) Examination of Investment Climate Constraints: When firm owners and

managers rate seven factors as the most constraining to their operation and growth: (i) financing cost and access, (ii) macroeconomic instability, (iii) tax rates and administration, (iv) regulatory policy uncertainty, (v) crime and corruption and (vii) infrastructure (emphasizing electricity and telecom). These issue areas are detailed in national and international perspective, to better understand the sources of excess costs, delays or difficulties in doing business in Zambia.

(iii) Strategy for Improving the Investment Climate and Productivity: The

report contains ordered recommendations in five key areas: 1. Macroeconomics and finance: Urgently focus on reducing the fiscal deficit

and consequent macro-uncertainty and financial sector crowding out. 2. Public-private sector interactions:

a. Improve the tax and regulatory treatment of businesses regarding equity, transparency and predictability, with special focus on tax administration.

b. Strengthen public-private dialogue on policy and institutional reform 3. Infrastructure

a. Strengthen the regulatory framework for telecom privatization and entry. b. Strengthen the regulatory framework for other privatization of infra-

structure services to bring capital, competition and customer-orientation. 4. Labor market issues

a. Reduce the mandatory severance benefit in line with neighboring countries.

b. Carefully study policies and institutions shaping the supply of labor skills, including education, training and employer incentives.

5. Rule of law a. Strengthen the independence and financing of the judiciary through

independent budgeting and political commitment to stop interference. b. Strengthen meritocracy as basis for public sector employment,

promotion and discipline, and eliminate patronage appointments.

1 Technical details on the sample and sampling methodology are available in Appendix 1.

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How Productive are Zambian Firms? Evidence from the RPED Survey As Zambia liberalizes its economy and its firms confront greater international competition in domestic and global markets, the issue of productivity becomes key to the ability of Zambian enterprises to compete. The analysis of RPED survey results show that the labor productivity of the median Zambian firm, while higher than that in some other African nations, is low compared the median firm surveyed in India, China and Kenya. Median value added per worker in Zambia is about $2700 which is higher than Uganda and Tanzania but well below Kenya (3,475), India ($3,432),, and China ($4,397). However, when compared to lower productivity African neighbors, wages are higher too, leading to high unit labor costs. For example, while in Zambia, wages account for 41percent of value added in the median firm, the comparable figures are 27percent in India, 32 percent in China, 36 percent in Kenya, and 39 percent in Uganda and Tanzania. By international comparison, capital productivity is extremely low: firms tend to be more capital-intensive than in many African countries, yet capacity utilization averages less than 50 percent. Thus the ratio of value added to capital in the median Zambian firm surveyed is only .23, compared to .32 in Kenya, .43 in Tanzania, .50 in China, .70 in Uganda, and 1.10 in India. TFP analysis suggests the marginal productivity of labor is substantially greater than that of capital. Anecdotal evidence from firm-level interviews and experts suggest that the low labor productivity may be rooted partly in the deteriorating quality of the educational system and in the growing problem of HIV/AIDS. The World Bank’s macroeconomic model for Zambia estimates that up to 1 percent of GDP is being lost per year due to the HIV pandemic . There are also regulatory issues, such as the problems with the processing of employment permits identified by FIAS (2004). In addition, RPED’s regression analysis of productivity shows the factors significantly associated with firm productivity are related to input constraints--firms that suffer most from poor input quality and equipment damage due to power outages have much lower value added than others. This suggests the value of improvements in basic infrastructure and in quality control standards for better firm performance. However, even after accounting for these factors, a great deal of variation of productivity within Zambia and between Zambia and other countries cannot be accounted for by either the quantity or quality of capital, labor or material inputs. International experience suggests that the investment climate is, in fact, critical to economic performance, and accounts importantly for observed differences between countries and regional differences within countries.2 Therefore, the next section turns

2 For example, Hall & Jones (1999) show that productivity is far more important than the quantity of capital and labor inputs in explaining national output differences. . Kaufmann and Kraay (2002) show that per capital income growth is importantly linked to investment climate indicators, including rule of law, corruption and regulation. Earlier investment climate assessments of China, India, Bangladesh, Ethiopia and other countries demonstrate the strong association between performance outcomes and

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to the dimensions of the investment climate identified as most constraining by Zambian business managers, and how Zambia compares to other countries in these dimensions. Zambia’s Investment Climate: Constraints to Productivity and Growth In several key dimensions, Zambia’s investment climate imposes excess costs, delays or difficulties on its businesses that impede their ability to compete and grow. While business perceptions reflect only the private costs experienced by firms and must be balanced by broader public policy perspective, the major concerns expressed by Zambian businesses do have grounds, as revealed by a comparative analysis of Zambian conditions to those of other countries. Business Perceptions and Indicators of Constraints. When firm owners and managers were asked to rate different aspects of doing business, respondents indicated that some of the largest problems were (i) financing cost and access, (ii) macroeconomic instability, (iii) taxes, (iv) regulatory policy uncertainty, (v) crime, (vi) corruption and (vii) infrastructure.3 Cost of and Access to Finance. Over 80 percent of firms rate the cost of financing as a major or severe constraint. This is by far the most visible constraint across all firm types - small or large, exporter or non-exporter, foreign or domestic. The average surveyed firm having a loan paid an annual interest rate of over 28 percent, reflecting a high real rate even after inflation. Medium-sized firms with loans paid an average of 37 percent, while large firms paid just over 20 percent. Required collateral averaged three times loan value. On average, the survey finds that banks in Zambia finance 16 percent of firms’ working capital and 18 percent of investment requirements. The corresponding averages for Uganda are 7 percent and 13.4 percent, while in Kenya they are 25 percent and 27.4 percent. Small firms have the lowest access to bank loans- less than 20 percent have a loan, and of these, 93 percent must provide collateral averaging over 400 percent of the loan value. The main reason for the high cost of capital is crowding out by government spending. Government borrowing both dries up credit and provides financial institutions a low-risk alternative to investing in private businesses. Macroeconomic Instability. An overwhelming 74 percent of firms rated macroeconomic stability as a major or severe constraint on their firm’s operation, in contrast to comparator countries where it is similarly rated by about half the firms (or less. Zambia has experienced chronic and massive fiscal imbalances. In recent years, fiscal deficits (before grants) have exceeded 13 percent of GDP. These fiscal outcomes have major implications for price stability and external imbalances. Since 1991, the national and sub-national differences in productivity or growth (see http://www.worldbank.org/privatesector/ic/ic_country_report.htm. 3 These concerns echo external evaluations of the country, which focus on elevated country risk, weaknesses in trade policy, fiscal burden, macroeconomic management, regulation, and corruption. See for example, Institutional Investor (2003), the Index of Economic Freedom (2004), and Transparency International Corruption Perceptions Index (2003).

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average annual rate of inflation has been 53 percent, with the intensity of price pressure varying from year to year. In more recent years, it has moderated significantly, averaging around 20 percent and dropping to around 15 percent in 2003. This high inflation causes uncertainty for investors and banks, and raises both nominal interest rates and the risk premium on loans. The loss in purchasing power of the Kwacha through inflation is reflected in the market determined exchange rate, which has depreciated precipitously, in spite of periodic official interventions. It took 65 Kwachas to buy one US dollar in 1991; by the end of 2002, it took 4550 Kwachas. Both the decline and the volatility of the Kwacha have had a serious impact on the private sector. Zambia’s external position is very precarious. In 2001, while the trade deficit was estimated at $355 million, the current account deficit was more than twice as large. Zambia’s interest payments on external debt have far exceeded its interest income from foreign sources. The precarious external position constrains further the ability of authorities to exert monetary control. The government tends to rely on Bank of Zambia financing (bridge loans) to servicing the external debt when needed. Tax Rates and Administration. Internationally, tax rates are almost always cited by enterprises as problematic. However in the case of Zambia, business complaints have some validation in objective fact. For example, WDI figures show that the highest marginal tax rate in Zambia is 5 points higher than in its neighbors. National accounts reveal that the tax-to-GDP ratio is also higher than in neighboring countries. Perhaps just as important is the frequency with which significant penalties are arbitrarily added to the total tax bill. Onerous taxation inhibits demand, reduces sales and cuts profitability. Many firms in the private sector identify themselves as equally constrained by tax administration as by tax rates. The Foreign Investor Advisory Service (FIAS) study, conducting in coordination with the ICA study on the same sample of firms, concluded that the firm dissatisfaction derived from three sources: First, the high frequency of changes in tax policy, which are either unjustified or

unexplained to the business community. Second, the value-added tax, which has been plagued by a variety of problems in

implementation. Third, the Zambia Revenue Authority’s (ZRA) behavior toward firms, regarded as

arbitrary and punitive. Some staff lack the skills needed, are not armed with clear guidelines and are given wide discretionary power which opens the door for corrupt practices.

Regulatory Policy Uncertainty. The ICA respondents ranked the issue of regulatory policy uncertainty as the fourth most pressing constraint to growth. Some 57 percent of Zambian respondents rate regulatory policy uncertainty as an important (major or sever) problem for their firm, compared to only 28 percent of Ugandan firms. The Government’s history of frequent and unpredictable changes to key policies has had a

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damaging effect on both foreign and domestic investment. Most firms (an impressive 70 percent) judge that government officials’ interpretation of regulations affecting their businesses are inconsistent and unpredictable. Another good indicator of the cost of regulatory uncertainty is the amount of senior management spent on regulations (e.g. tax, customs, labor regulations, licensing, and registration), completing forms and dealings with officials. In Zambia, this amounts to about 13 percent, a rather high percentage compared to only 4 percent in Uganda, but lower than 14 percent in Kenya and 16 percent in Tanzania. Finally, mandatory termination benefits to employees are both high and uncertain: for example, Doing Business reports that an employee of 20 years must legally receive 40 months of severance pay upon termination, as opposed to 10 months in Kenya, 12 months in Tanzania and no legally-specified payment in Uganda. By making firing expensive and inflexible, this has a deterrent effect on firm hiring. Crime and Corruption. “Crime, theft, fraud and disorder” was identified by interviewees as the sixth most constraining attribute of the Zambian business environment. While crime does not rank as highly as it does in Kenya, for example, it is ranked as a “major” or “very severe” constraint by double the proportion of respondents as in Uganda and Tanzania, and about four times the proportion of several other comparator countries around the world. An exceptional 77 percent of firms claimed losses due to the theft, robbery or arson in the previous year. Only half of these incidents were reported to authorities (suggesting low confidence in the outcome) and of those reported, only a quarter were reportedly solved (suggesting low confidence may be justified). This suggests that public services related to law enforcement (the police and judiciary) are in need of improvement. A second indicator of confidence in the judicial system concerns whether firms are confident that the judicial system will enforce their contractual and property rights in business disputes. In Zambia some 64 percent of firms are confident of this to some extent, higher than in neighbors like Kenya where the figure is only 49 percent or Tanzania (55 percent) but lower than Uganda (70 percent) or China (93 percent). Corruption is the seventh leading constraint, but was nonetheless identified by 46 percent of firms as a major or very severe constraint. This compares to 38 percent in Uganda and 73 percent in Kenya). For firms with FDI, however, it ranks among the top five constraints, identified by 51 percent as a major or severe constraint. The respondents reported that typical firms spend an average of 1.7 percent of their total revenues on bribes in order to “get things done.” In addition, they reported that a government contract would typically require an average bribe of 3.7 percent of the value of the contract. Infrastructure Services. Firms in Zambia are also concerned about the generally poor quality and limited availability of infrastructure services. Electricity is the leading concern, cited by 40 percent of all firms and 55 percent of exporters as a major or very severe constraint. The power supply in Zambia is reportedly unreliable. Zambian firms recorded an average of 37.2 power outages last year. The percentage of production lost due to these outages is very high - overall the number is 4.5 percent

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while small firms lost 5.6 percent of their output (this is a bit better than Uganda, where firms 6 percent of production, but far worse than China, with an average 1.8 percent production loss). With regard to other infrastructural services, Zambian respondents held negative perceptions of telecommunications services when compared to most other countries in the region, except Kenya. Some 33 percent of all respondents and 51 percent of exporters found telecommunications a major or severe constraint. This compares to 5 percent of Ugandan respondents, 12 percent of Tanzanians, and 44 percent of Kenyans. The road system has been improving in recent years, but improvement has been limited to a few areas, thus respondents assign a poor rating to transportation when compared to other neighboring countries, except Kenya. Regarding water, many of the industrial districts in the major Zambian towns must incur the extra expense of buildings wells to compensate for an unreliable public supply of water.

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Recommendations The following matrix describes the set of policy issues that arise from the analysis of the investment climate in Zambia.

Area of policy concerns

Specific Policy Issues Observations/Comments Policy Suggestion

1. Macroeconomics and Finance

(a) Concerns about government borrowing, exchange rate depreciation and volatility. (b) Cost of, and access to finance is an important constraint.

• Bond market borrowing by the government by government is driving up interest rates. • Access to finance is particularly difficult for small and medium sized firms.

• Government should work with Parliament to rationalize the budget process. • Better management of the foreign exchange market to prevent short-run fluctuations in the supply and demand for foreign exchange by Bank of Zambia • Reduce the crowding out of private sector lending by ensuring that the government reduces the fiscal deficit and the level of government borrowing .

2. Public – Private Interaction

(a) Zambian firms ranked taxes as a binding constraint to private sector growth in Zambia. (b) Firms are very concerned about regulatory policy uncertainty. (c) There is a pressing need to strengthen the private-public dialogue.

• Firms’ concern is as much about the tax rates as it is about the structure of the tax regime. • Increased consultation will improve the quality of policy formulation as well as implementation while helping to reduce the deep-seated mistrust between the Government and the private sector.

• ZRA must review collection procedures and reevaluate the emphasis on tax collection versus other objectives such as increasing firm entry. • ZRA must reduce “sweetheart deals” to individual firms and focus on transparent and uniform method of levying taxes. Special attention should be paid to recommendations in the FIAS report. • Executive Office of the President should create a forum based on the best practice experience of other countries in Sub-Saharan Africa. This should include an Investor Round Table for public-private dialogue on key policies that affect the private sector.

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Area of policy concerns

Specific Policy Issues Observations/Comments Policy Suggestion

3. Infrastructure

(a) Firms report the availability of infrastructure to be a serious problem. (b) The cost of electricity is high.

• Of particular concern is the time and cost of obtaining water, telephone and electricity connections.

• Min of Telecom and other utility agencies must streamline the procedures by which utility connections are obtained. • Min of Telecom must reduce the perceived risks of investing in the private sector by reducing ad-hoc implementation of regulations by Zamtel, other utility agencies. • Utilities including electricity should be privatized within an appropriate regulatory framework in order to improve services, increase investment and promote competition. • Assessment of infrastructure services should be carried out via the preparation of a Country Framework Report (CFR).

4. Labor Market Issues

Our data show that Zambia is in great need of improving the productivity of its labor force.

• Improving the skills of the labor force is crucial. • Improving the flexibility of firms with regard to hiring locals and expatriates is important.

• Government should amend the labor law to reduce the cost of redundancy and to bring Zambia in line with neighboring countries. • Min of Labor should reduce the cost and barriers to obtaining employment permits. • Min of Health, donors, and the Business Coalition must increase prevention and treatment efforts for HIV/AIDS. • Further work needs to be done to determine how best to improve access to education and training.

5. Crime and Corruption

(a) Firms rate crime as a significant concern. (b) Considerable use of discretionary power by government, lack of transparency and heavy emphasis on enforcement of rules.

• Both economic crime (fraud) and non-economic crime raise the cost of doing business, improvement needed in criminal justice system. • Both corruption and red tape are serious problems.

• Government should submit to Parliament meritocratic reforms to civil service legislation to reduce corruption and eliminate patronage. • Judicial autonomy needs to be improved via budget allocation and greater political commitment. • Establishment of a small claims court to help reduce backlog in pending cases.

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I. Introduction Until very recently, the people of Zambia were steadily becoming poorer. The per capita GDP faltered for more than three decades, falling from $700 in 1970 to $390 in 1998. But for now that ordeal seems to have passed. Since the late 1990s, the Government has attempted to put together a new approach to economic management, with a new focus on fiscal discipline, better governance and promoting economic growth. This new way of thinking is reflected in a series of policy statements, including the Interim Poverty Reduction Strategy Paper (I-PRSP, July, 2000) and the Poverty Reduction Strategy Paper (May, 2002.) As the new policies are put into effect, the economy has responded favorably, producing four consecutive years of solid growth, with real GDP rising 3.7 percent per annum between 1999 and 2002. And this turn-around has taken place in spite of a string of bad news, including depressed and falling copper prices and the departure in 2002 of the largest foreign investor in copper production. To many Zambians long accustomed to the bad old days, the recent relief may seem like just a blip in a seemingly inexorable descent. From their point of view, reversing entrenched public-sector practices and taking away the customary largesse from interest groups would not be so easily accomplished. Observers have also noted that, while the new policy statements represent a promising break from the past, few concrete actions have been put in place. The capacity to implement them is not readily available. Furthermore, since independence, Zambia has relied almost exclusively on exporting copper to generate foreign exchange. Organized efforts to diversify production and exports only began in the 1990s. Non-traditional exports have since expanded, but their share remains less than one third of the total. Weaning Zambia from the reliance on copper and developing new sources of growth could take decades, rather than years. As is now well known, growth and poverty reduction – the central objectives of the Government -- is achieved primarily through the work of the private sector. No government can produce sustained growth and employment without increasing the investment, risk-taking and innovations of the private sector. The critical role of government is to create an enabling and competitive business environment, which includes the provision of price stability, freedom to enter and exit a business, openness to foreign trade, physical and financial services and law and order. The quality of these services constitutes the “investment climate” as seen by the private sector. The key challenge facing the Government of Zambia in reversing the long-term economic decline, and thereby advancing the goals of poverty reduction, is to keep upgrading the investment climate and ensuring an enabling and competitive environment. This report is part of the World Bank Group’s strategy to assist Zambia in fighting poverty. This survey in Zambia is part of a broader, inter-regional program of investment climate studies of the World Bank Group. It attempts to explain the reasons for large variations in GDP growth across the spectrum of developing countries. Thus, the investment climate as observed in Zambia is compared to and contrasted with those of other African countries, or with other developing countries in a different region which might turn out to be Zambia’s competitors in world export markets. Throughout this report, empirical results showing the relative position of Zambia versus potential competitors will be presented. It sets out to review the key elements of the prevailing investment climate in the country today. To understand the quality of investment climate from the perspective of the private sector, the report will draw on the results of a firm survey conducted in 2003. A total of 336 firms were

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surveyed from the manufacturing and services sectors in Lusaka, Kitwe, Ndola and Livingstone. We used a stratified random sample in the manufacturing sector to select 207 firms in Agro-industry, Metals, Chemicals and Paints, Construction Materials, Mining and Quarrying, Paper/Printing/Publishing and Textiles. The services survey was administered to 129 firms in Trading, Financial Services, Tourism and Transport. 4 This reports also compliments and amplifies a series of diagnostic work being undertaken by the World Bank Group in collaboration with the Government of Zambia. A companion report, Policies for Growth and Diversification (a country economic memorandum), will focus on country-level (macro) issues, including economic and political stability, trade and exchange-rate regimes, fiscal policies, which include the implications of public enterprises and privatization. Another related report is the on-going Administrative Barriers Study (conducted by the Foreign Investment Advisory Service or FIAS) which focuses on the procedural aspects of business regulations. Together, these reports of the World Bank Group provide a detailed description and analysis of the most important issues concerning the investment climate, and thereby serving as analytical tools for the Government to develop remedial actions. The main thrust of the report is to examine the productivity of firms and the key constraints to this productivity. These two findings – the true cost of labor and the key constraints– are related and, when viewed together, they provide an important insight about the investment climate in Zambia today. Even though wages in Zambia, while in line with those of African countries, are lower than wages in most of the Asian countries, Zambia’s productivity (measured here as value added per worker) is much lower than those of its Asian counterparts. Therefore, the resulting real cost of labor, as measured by labor cost per unit of output (or “unit labor cost”), turns out to be considerably higher in Zambia than in all the Asian countries for which data is available. In other words, from the perspective of a foreign investor, the low wages in Zambia offer no advantage, since they are more than offset by very low productivity. The various constraints -- high financing costs, taxes and the need to prevent crimes -- impose a high financial cost on private firms. In addition to these financial costs, the poor quality of physical infrastructure such as frequent power outages and inadequate roads, causes frequent disruptions and delays, further depressing output and productivity. They represent expense items that sharply reduce the net value added, hence productivity, of the businesses. Thus, a picture of business impediments emerges. In spite of the recent economic recovery, most firms are still finding it difficult to operate under the current investment climate, let alone to invest more and expand their businesses. Furthermore, the constraints appear to be more severe and widespread than in most African countries. This picture helps focus the attention of public officials on the binding constraints in the economy. Such an understanding can guide the formulation of corrective actions and in the allocation of limited public resources. Addressing the constraints will advance the Government’s strategy for poverty reduction. A better investment climate – with, for instance, lower inflation and interest rates, more

4 Technical details of the sampling methodology and sample frame are available in Appendix 1.

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transparent and customer-oriented tax administration and law enforcement – will encourage more investment. More people in Zambia will find new or better jobs. New local entrepreneurs will be able to make use of their talents. Foreign investors will find Zambia a more attractive place to do business. These are the essential building blocks for fighting poverty and achieving the goals envisaged by the Government. The discussion above is little more than a hint of what is to be discussed in the remainder of this report. Section II discusses the key empirical findings with respect to factor intensity and productivity of Zambian firms. It reviews the variations among different groups of firms within Zambia, as well as putting Zambia’s position in an international perspective. In Section III, the report discusses the factors that determine the level of productivity in Zambia, including the most important constraints to business operations as appraised by private entrepreneurs who own and/or operate the firms. International and regional comparisons are drawn in this section as well, wherever possible.

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II. HOW PRODUCTIVE ARE ZAMBIAN FIRMS? EVIDENCE FROM THE RPED SURVEY As Zambia liberalizes its economy and becomes exposed to greater international competition, a key issue that arises is the productivity of Zambian enterprises and their ability to compete internationally. We examine this issue by first looking at the characteristics of Zambia’s capital stock. We then look at factor intensity and partial factor productivities, including unit labor costs. Finally, we look at the overall determinants of productivity using an augmented production function approach. Our results show that Zambian labor productivity is low compared to India and China, but higher than some other African nations. This low productivity more than offsets wages which are presently lower than India and China, leading to high unit labor costs. Capital productivity is extremely low because of the high capital intensity of Zambian firms. Analysis of productivity via regression analysis shows that there are constant returns to scale in Zambian manufacturing. Human capital characteristics, such as education and experience, are not significant in determining firm performance; neither are other learning channels (exports, foreign ownership). The key factors determining firm productivity are related to input constraints--firms that suffer most from poor input quality and equipment damage due to power outages have much lower value added than others. Improvements in basic infrastructure and improvements in quality control standards are clearly required for better firm performance.

Capacity Utilization The utilization of capital depends on factors driven by product demand or raw material supply bottlenecks. How efficiently is the Zambian stock of capital used? The table below compares capacity utilization in Uganda with other countries. We see that Zambia is about average in terms of capacity utilization among African countries. Zambian firms are using less than 50 percent of their capacity; this is within the typical range for African countries. There is not much dispersion by size or by sector; micro and small firms utilize slightly more capacity than other firms and the wood sector has the highest share of capacity utilization across the sectors surveyed (Table 2.1).

Table 2.1: Distribution of Capacity Utilization Rates (percentage)

Cameroon Cote d’Ivoire Ghana Kenya Tanzania Zambia Uganda

Mean 46.9 70.7 54.3 63.3 51.1 48.4 58.4 Standard Deviation 28.5 25.3 27.4 28.2 27.2 30.3 22.6

By Size

Micro 40.5 66.6 52.5 56.3 58.8 50.4 50.6 Small 44.3 68.4 55.7 65.6 48.5 50.2 58.1 Medium 47.0 67.9 48.4 67.3 38.8 42.9 60.8 Large 60.6 78.5 59.6 69.3 42.3 46.4 65.0

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By Sector

Food 50.7 70.8 57.4 67.3 46.2 50.1 58.8 Textile 38.0 67.9 51.1 59.9 47.3 43.4 54.4 Wood 55..0 68.8 52.3 67.1 55.2 53.4 55.7 Metal 41.3 77.3 57.0 59.5 53.0 47.7 61.2

Note: All values are in percentages. Data for all countries are for the early 1990s, except Uganda and Zambia which are from 2003. Source: RPED, 2003

Capital Intensity and Capital Productivity In sharp contrast to India and China, the capital intensity of Zambian firms is very high ( Table 2.2). Zambian firms have over $12,000 of capital per unit of labor; this number is substantially higher than the East African comparators shown below. These data are from traditional manufacturing sectors (not mining or other inherently capital-intensive activities) and may well reflect capital buildup during the mid-1990s (a period of relatively low-cost finance) and/or optimism about future economic growth. Our data show that Zambian firms have high amounts of capital stock which yield very low returns. Table 2.2: Capital Intensity: Capital per Worker, by Firm Size, in $US

Firm Size Tanzania Uganda Kenya Zambia India China

Overall 7,757 1,464 11,186 12,161 2,380 7,654

Very Small (<10 employees) 1,040 845 16,719 n.a. 1,859 14,190

Small (10-49 employees) 7,433 1,408 6,963 15,578 2,000 5,434

Medium (50-99 employees) 7,493 2,453 17,186 18,175 2,962 6,070

Large (>100 employees) 19,279 6,667 12,735 8,178 4,158 8,525

Note: Only 3 firms in Kenya and 10 firms in China have less than 10 employees Table 2.3 shows that the productivity of Zambian capital stock is very low; the lowest in our sample of countries. Value added per dollar of capital is only 23 cents; this may reflect in part the age and poor quality of the capital stock and/or diminishing returns. The productivity of capital stock in Tanzania is almost twice as high and in Uganda it is three times higher. While firms have on average, a large amount of capital, anecdotal evidence suggests that much of this capital is old and/or underutilized. Thus, the Zambian private sector finds itself in a situation where the amount of capital available is quite high but the productivity of this capital stock is very low due to obsolescence and low quality.

7

Table 2.3: Capital Productivity: Ratio of Value-Added to Capital, by Firm Size

Firm Size Tanzania Uganda Kenya Zambia India China

Overall 0.43 0.70 0.32 0.23 1.10 0.51

Very Small (<10 employees) 1.33 0.80 1.08 n.a. 0.80 0.13

Small (10-49 employees) 0.37 0.67 0.29 0.16 1.11 0.59

Medium (50-99 employees) 0.61 0.43 0.40 0.24 1.48 0.67

Large (>100 employees) 0.26 0.89 0.30 0.35 1.16 0.47

The explanation for high capital intensity and low capital productivity may be shown by the results presented in the next table on the average age of capital stock. Age of capital stock is strongly correlated with the quality of capital and consequently with the productivity of capital. As seen in the Table 2.4 below, a majority of firms report using equipment that is more than 5 years old. In fact, 38 percent of firms are using equipment that is more than 10 years old. As expected, smaller firms use younger equipment than older firms. Medium firms have the oldest equipment--47 percent of these firms are using equipment that is more than 10 years old. This may well explain why firms simultaneously report high capital intensity as well as the underutilization of capital. It may also explain why firms report being credit-constrained; they are in fact demanding access to new and better quality capital that would enable them to compete more effectively. Table 2.4: Age of Capital Stock Overall Small

(10-49 employees) Medium

(50-99 employees) Large

(> 100 employees)

< 1 year old 1% 1% 0% 0% 1-5 years old 26% 36% 19% 20% 6-10 years old 35% 26% 34% 45% 11-20 years old 22% 20% 32% 18% >20 years old 16% 17% 15% 17%

Labor Productivity and Unit Labor Costs Firm productivity is also low in Zambia. Figure 2.1 describes median value added per worker across several countries. Zambian firms have a median value added of about $2680 per worker, which is higher than Tanzania and Uganda, but well below China and India. Ugandan firms are 68 percent less productive while Kenyan firms are on par with their Indian

8

counterparts. Zambian firms are about 22 percent less productive than their Indian counterparts. All of the countries in East Africa have a long way to go before they can catch up with China. Fig 2.1: Median Value-Added Per Worker

Interestingly, worker productivity does not vary all that much across firm size; only firms in the 50-99 size class have somewhat higher productivity than the rest (Table 2.5).

Table 2.5 Labor productivity, Median Value-Added per Worker By Firm Size, in $US.

Firm Size Tanzania Uganda Kenya Zambia India China

Overall 2,061 1,085 3,457 2,680 3,432 4,397

Very Small (<10 employees) 989 578 n.a. n.a. 3,147 1,920

Small (10-49 employees) 1,526 897 2,439 2,668 2,931 4,595

Medium (50-99 employees) 3,288 1,379 4,127 3,836 3,228 4,797

Large (>100 employees) 3,499 3,338 4,138 2,439 5,321 4,193

Notes: 1) For “very small” category, there were only 70 firms in India sample, in China sample there were only 28 firms. 2) In Zambia and Kenya, the sample design excluded very small firms.

Let us now consider the unit cost of labor in Zambia versus other countries in Sub-Saharan Africa. Unit labor cost measures the total cost per unit of output. When converted to a common currency, it enables international comparisons of competitiveness of labor. Unit labor cost in U.S. dollars is defined as:

9

ULC = (w.L/Q).(1/e) where w is the manufacturing wage L is the amount of labor employed Q is a physical measure of output e is the exchange rate defined as domestic currency per U.S. dollar

ULC can also be approximated as a ratio of nominal wage (w) to labor productivity (Q/L). For a country to have a low (competitive) ULC, it has to do one of three things (or a combination thereof): (i) keep nominal wages low, (ii) keep its exchange rate competitive, and/or (iii) increase its labor productivity. Because it is very difficult to obtain comparable physical measures of output across different countries, we use an approximate measure of ULC, which is the ratio of wages to value-added at the firm level, averaged across the sample of firms. Table 2.6 describes the ratio of wages to value-added for several countries in Asia and Sub-Saharan Africa, including Zambia in 2003. Table 2.6: Unit Labor Costs Ratio of Wages to Value-Added (median values by firm size)

Firm Size Tanzania Uganda Kenya Zambia India China

Overall 0.39 0.39 0.36 0.41 0.27 0.32 Very Small

(<10 employees) 0.45 0.33 n.a. n.a. 0.29 n.a. Small

(10-49 employees) 0.56 0.41 0.38 0.41 0.30 0.38 Medium

(50-99 employees) 0.42 0.41 0.41 0.47 0.25 0.34

Large (>100 employees) 0.25 0.35 0.34 0.39 0.24 0.29

By definition, unit labor costs are higher in countries that have either high wages or low labor productivity (or both). Unit labor costs also tend to be higher when capital intensity is lower i.e. there is usually a negative correlation between these variables. Apart from overvalued exchange rates that have hampered Africa’s competitiveness, the data on unit labor costs show that Sub-Saharan Africa, including Zambia, has higher unit labor costs relative to Asia at roughly equivalent stages of development. When present data from Africa are compared with Asian data from the 1960s and 1970s (Table 2.7), it is clear that earnings in Africa are about two-thirds higher than was the case historically in Asia, and African productivity is about one-fourth lower.

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Table 2.7: Unit Labor Costs: Past Estimates from East Asia Indonesia 1981 0.21

South Korea 1963 0.26

Malaysia 1970 0.27

Singapore 1963 0.35

Taiwan 1961 0.16

Thailand 1970 0.24 Source: Lindauer and Velenchik (1994); and RPED Surveys (1990s).

Labor costs in Zambia are high; our data show that the mean unit labor cost for the sample is 0.41 (Table 2.6). Also, we do not observe the usual negative correlation between unit labor cost and capital intensity in the Zambian case. This could be due to the fact that much of the capital stock is of low quality and is consequently underutilized, thereby raising the cost of labor in the production process. Disaggregation of the Zambian data shows that the unit cost of labor is fairly similar across size categories. When broken down by sector, unit labor costs are quite wide-ranging; sector 32 has the lowest unit labor cost while sector 33 has the highest. Exporters have significantly lower unit labor cost than non-exporters (0.24 vs. 0.55); the ratio of wage to value added is almost 50 percent lower for exporting firms. Foreign firms have lower unit labor cost than firm with no foreign equity and firms owned by non-indigenous entrepreneurs have lower unit labor costs as well. There is anecdotal evidence that suggests that with the deterioration of the educational system, technically-qualified laborers are hard to find, thereby raising the cost of labor. Enrollment ratios for primary and secondary education in Zambia are roughly typical for Sub-Saharan Africa. However, the quality of the education system is weak, as measured by low mean scores in language and mathematics in the Grade 5 National Assessment. In post-secondary institutions, there are concerns about the preparedness of their intakes from the secondary schools. Furthermore, public sector wages are relatively high and likely do not reflect the productivity of labor; this in turn may affect the wage level in the private sector. Since early 2002, the Government has been implementing a Technical Education, Vocational and Entrepreneurship Training (TEVET) Development Program (TDP), aimed at improving the quality, sustainability, demand-responsiveness, and equity of TEVET in Zambia. In November/December 2003, a Joint Review of TDP was carried out by a team appointed by donors, the Ministry of Science, Technology, and Vocational Training (MSTVT), and the TEVET Authority (TEVETA). The Joint Review found that there had been very slow progress toward the objectives of the Program, and recommended a number of steps to improve implementation. MSTVT and TEVETA are developing an Action Plan in response to the Review’s findings and recommendations. As technical skills diminish, the quality of the labor diminishes, yet the cost remains high because of a combination of low productivity and GRZ policies that create high terminal benefits for employees (Bannock Consulting, 2002). The labor law creates high terminal benefits for employees. Termination benefits currently consist of 2 to 3 months salary; this imposes a large burden on firms. This results in businesses being unable to afford to let go of

11

unproductive workers, and also suppresses salaries because the terminal benefits are tied into salaries The greatest misfortune with these labor policies lies in the fact that many employees do not earn enough take home pay to properly feed and educate their families, but, when they die, their distant relatives end up claiming a disproportionately large sum of money. Finally, it is worth noting that the high cost of labor in the public sector (including high termination costs) may well have created higher costs to the private sector as well. Rather than training managers, Zambia has traditionally received funds for advisors, weakening the capacity building potential of the liberalization effort. A large portion of foreign aid went to paying the salaries of these advisors, which resulted in resentment from local professionals. Additionally, during the Second Republic (1964-1991), Zambia suffered a significant "brain drain". The liberalization period would have been an excellent opportunity to attract competent Zambians living abroad to repatriate. Unfortunately, there was little concerted effort in finding and retaining highly qualified Zambians overseas.

There are also problems with the processing of employment permits which need to be addressed (FIAS, 2004). According to the FIAS report, an employment permit is more difficult to obtain, and the procedures, particularly for renewal, are seen by the business community as lengthy, cumbersome, and unpredictable. The FIAS report says that even foreigners who have been carrying out business for years in the country fear the moment when the self-employment permit must be renewed because of its uncertain outcome. As foreign entrepreneurs indicated in various meetings, the procedure to obtain a self-employment permit appears to them to be driven generally by suspicion and mistrust towards the private sector in general and foreign businessmen in particular. The composition of the Immigration Committee, which consists mainly of representatives from bodies in charge of national security issues and does not include representation from the economic ministries, was mentioned as an indication of this tendency. Various businessmen indicated that the Immigration Department gives the impression that it suspects them of trying to abuse the system by trying any and every way to obtain a permit to stay and work in the country or to smuggle cheap and unqualified workers or family members into the country. There is also a significant difference between the time that the process is supposed to take (2 to 3 weeks) and actual time to obtain a permit (2 to 3 months). There is also a high degree of discretion in the way employment permits and work visas are awarded. These problems are reflected in firms’ inability to hire high quality workers in a timely manner. Finally, the most recent data shows that the impact of HIV/AIDS in Zambia is enormous; about 1 million adults and 200,000 children were living with HIV/AIDS by the end of 2001 and nearly 600,000 children have lost their mother or both parents to AIDS. Life expectancy has been reduced from 57 years in 1990 to 37 years by 2001. Estimations of the impact of HIV/AIDS on the economy shows that the disease is costing the country up to 1 percent in GDP per year (World Bank, forthcoming). Although we do not have firm-level data to estimate the loss from HIV/AIDS, it is fair to say that the GDP losses directly reflect productivity losses in the private sector. The spread of HIV/AIDS has reduced worker productivity in Zambia. The high prevalence of the disease among Zambia's population is not only depleting the pool of locally available skills, it is also driving up the effective cost of doing business and in particular the cost of employment. As trained people die from AIDS, businesses are forced to train multiple people for key positions, thus increasing their training and recruitment costs.

12

Firm productivity in Zambia: a simple econometric test It is worth considering the key drivers of productivity in Zambia in order to further understand the types of policies that might be effective in raising productivity. We examine the determinants of total factor productivity in Zambia by using an augmented Cobb-Douglas production function. Results of a log-linear specification are presented in the Table 2.8. The first model presents the basic specification. The second model augments the basic one by adding additional explanatory variables. Our regression results show that that labor and capital are highly significant in determining value added. In addition to labor and capital, the key factors determining firm productivity are related to input constraints--firms that suffer the most from poor input quality and from equipment damage due to power outages have much lower value added than others. This result implies that improvements in basic infrastructure and services will lead to better firm performance; equipment damage and low input quality are the result of a weak business environment including lack of a proper supply of electricity and other infrastructure, as well as lack of access to technology and skilled labor.5 The explanatory variables in the augmented production function explain almost two thirds of the variance in productivity. We will expand on the specific issues related to the business environment in the next chapter. Table 2.8: Zambia Productivity: OLS Regression Results Model 1 Model II Intercept 4.18*

(0.78) 4.82* (0.76)

Log(capital) 0.33* (0.07)

0.31* (0.06)

Log (labor) 0.69* (0.11)

0.66* (0.10)

Capacity utilization 0.01* (0.003)

0.005 (0.003)

Food 0.09 (0.21)

0.17 (0.20)

Textiles and Garments -0.07 (0.28)

0.01 (0.26)

Wood and furniture -0.33 (0.48)

-0.17 (0.47)

Metal working 0.25 (0.31)

0.22 (0.30)

Lusaka 0.20 (0.18)

Low input quality -0.56** (0.27)

Equipment damage -1.22* (0.28)

Adj. Rsq 0.60 0.66 5 Other so-called investment climate variables do not appear to be directly significant; this is most likely due to the following reasons--they are embodied in measurements of labor and capital, there is relatively little variance across firms in cross-sectional data and their effect shows up in variables such as measure of input quality.

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III. WHY IS PRODUCTIVITY LOW?

EXPLANATIONS FROM ZAMBIA’S BUSINESS ENVIRONMENT

Since 1991, successive governments in Zambia have taken on the tremendous task of restructuring the economy in order to make the private sector the engine of growth and the principal provider of employment. Nevertheless, further changes are needed to improve the investment climate, for both domestic and foreign investors. FDI is indeed an important source of growth, the prerequisites for which must be taken into account. In considering investment in Zambia, foreign investors need to overcome many perceived and real hurdles.

Fig. 3.1: FDI Inflow

Foreign Direct Investment in Zambiain US$ million

0

50

100

150

200

250

1985-95 1998 1999 2000 2001 2002

Source: UNCTAD World Investment Report 2003

For most, Zambia’s location is a major disadvantage. Not only is it a land-locked country far away from seaports, but certain neighboring countries are also a negative influence, with war-torn DR Congo to the North and strife-laden Zimbabwe to the South. In addition, the perception of Zambia’s investment climate is largely unfavorable. The Institutional Investor, for instance, placed Zambia’s credit worthiness in the bottom quartile for Africa, below that of Nigeria and Cameroon, as well as those of nearby countries such as Mozambique and Uganda. These disadvantages are further compounded by Zambia’s relatively small economy. The Index of Economic Freedom rates Zambia poorly on trade monetary and fiscal policy, regulation and corruption (Heritage Foundation, 2004). On regulation, the report states that " . . . Business in Zambia is hampered by outdated laws that do not reflect, and therefore cannot be applied effectively to, current business practice. Acquiring a business license involves complex procedures and delays. An investment board screens domestic investment.” According to this index, Zambia is rated 118 out of 142 countries.

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Table 3.1: Institutional Investor Ranking, 2002 Regional

Rank Country Global

Rank Credit Rating

One-Year

Change 1 Botswana 39 59.0 2.3 3 South Africa 52 52.7 3.2 12 Tanzania 107 21.3 0.7 14 Uganda 111 20.0 -1.4 17 Mozambique 116 19.1 0.1 23 Zambia 128 15.8 -0.2 27 Angola 137 14.0 1.9 29 Zimbabwe 142 11.9 -1.1

Average 114 21.6 1.2 Notes: Only Sub-Saharan African countries are included. Credit rating has values within the range of 0 to 100, with 100 being the highest rating possible.

Discussions of the manufacturing sector’s perceptions of the investment climate are not meant to be a definitive priority setting tool but can be a useful contribution to the discourse. Additional quantitative data from the survey is added, where possible, to add weight to the arguments presented and round out the information on a given issue. The qualitative subjective rankings listed in Table 3.2 below give some indication of the relative importance of business environment aspects from the view of the private sector.

Table 3.2: Ranking of Constraints to Business Operations in Zambia

Zambia Small Large Non-Exporter

Exporter Foreign-Owned

Domestic

1 Cost of financing 82.1 85.7 80.3 82.2 81.8 75.4 84.9

2 Macroeconomic instability 73.9 81.8 65.2 79.0 60.0 70.5 75.3

3 Tax rates 57.5 59.7 56.1 59.2 52.7 54.1 58.9

4 Regulatory uncertainty 57.0 58.4 60.6 59.2 50.9 59.0 56.2

5 Access to finance 54.1 66.2 42.4 56.6 47.3 47.5 56.9

6 Crime, theft, fraud and disorder 48.8 49.4 53 50.66 43.64 47.54 49.3

7 Corruption 46.4 54.6 39.4 47.4 43.6 50.8 44.5

8 Electricity 39.6 32.5 50.0 34.2 54.6 41.0 39.0

9 Anti-competitive behavior 38.7 42.9 28.8 40.1 34.6 34.4 40.4

10 Skills & education of workers 35.8 36.4 37.9 36.8 32.7 31.2 37.7

11 Telecommunications 32.9 32.5 37.9 26.3 50.9 29.5 34.3

12 Customs and trade regulation 32.4 24.7 34.9 32.2 32.7 34.4 31.5

13 Transportation 30.4 28.6 30.3 27.6 38.2 29.5 30.8

14 Tax administration 27.5 32.5 27.3 27.0 29.1 34.4 24.7

15 Access to land/security of tenure 17.4 22.1 16.7 20.4 9.1 23.0 15.1

16 Labor regulations 16.9 11.7 21.2 15.1 21.8 16.4 17.117 Business licensing & permits 10.1 7.8 9.1 11.2 7.3 13.1 8.9

Respondents' Evaluation of General Constraints to Buisness Operations(% of firms evaluating constraint as "major" or "very severe")

15

When firm owners and managers were asked to rate different aspects of doing business, respondents indicated that the largest problems were the cost of financing, macroeconomic instability, tax rates, regulatory policy uncertainty, access to financing, crime, corruption and infrastructure. The analysis of service sector firms yielded very similar results in terms of the biggest constraints cited by companies, (Table A.2.1). For these firms the three leading constraints to operation are, in descending order, macroeconomic instability, cost of financing and regulatory policy uncertainty These qualitative rankings are particularly difficult to compare across countries, given the probable difference in experience and expectations of respondents. However, there is some illustrative merit in looking at the large differences regarding certain aspects of investment climate which are addressed in turn in this section, (Table 3.3).

Table 3.3: International Comparisons of Constraints

Respondents' Evaluation of General Constraints to operation (% of firms evaluating constraint as "major" or "very severe")

Zam

bia

Ken

ya

Uga

nda

Tanz

ania

Chi

na

Turk

ey

1 Cost of Financing 82.1 73.3 60.3 56.2 21.6 28.2

2 Macroeconomic Instability 73.9 51.3 45.4 42.0 26.0 53.7

3 Tax rates 57.5 68.2 48.3 72.1 34.1 38.1

4 Econ & Regulatory Policy Uncertainty 57.0 51.5 27.6 30.8 28.0 53.8

5 Access to Financing 54.1 44.1 45.0 47.1 24.1 17.3

6 Crime, theft, fraud and disorder 48.8 69.8 26.8 25.0 15.7 12.9

7 Corruption 44.6 73.8 38.2 50.0 22.4 23.7

8 Electricity 39.6 48.1 44.5 57.6 28.1 17.3

9 Anti-competitive/informal practices 38.7 65.3 31.1 23.9 17.6 22.7

10 Skills/Education Workers 35.8 27.6 30.8 24.6 26.7 12.8

11 Telecommunications 32.9 44.1 5.2 11.6 16.5 10.9

12 Customs and Trade Regulations 32.4 39.9 27.4 30.8 21.1 8.9

13 Transportation 30.4 37.4 22.9 22.5 19.4 8.4

14 Tax administration 27.5 50.9 36.1 54.7 23.7 33.1

15 Access to Land/Tenure Security 17.4 24.6 17.4 24.3 16.3 6.0

16 Labor Regulations 16.9 22.5 10.8 11.9 19.4 8.7

17 Business Licensing/Operating Permits 10.1 15.2 10.1 26.8 15.9 5.8

By and large, the perceived impediments to business are well grounded in reality. In the remainder of Part A, we’ll discuss the underlying factors that have contributed to or exacerbated the constraints. Instead of reviewing each of the items individually, we have divided the issues into five groups: (1) Macroeconomics and Finance; (2) Public-Private Sectors Interactions; (3) Infrastructure; (4) Labor Markets; (5) Crime and Corruption.

16

Macroeconomics and Finance Cost of Finance Without finance, businesses cannot develop, modernize or compete with other firms from neighboring countries where finance is accessible. As long as the GRZ continues to borrow at its current rate and Treasury Bills continue to pay attractive interest rates, commercial lenders will have no incentive to reduce their lending rates for longer term investments and working capital. The current Kwacha base rate is over 40 percent. After margins and other add-ons, the cost to the consumer for a Kwacha loan exceeds 50 percent per annum. Aside from trading firms seeking short term finance, no legitimate business can sustain this cost of finance. The current high rate of interest (and inflation) is driven by government borrowing, which is in turn driven by large public sector deficits. Figure 3.2 below shows trends in borrowing and lending rates, inflation and budget balance. Real returns on bank deposits have recovered from sub-zero levels between 1998-2000 but are currently barely positive. The uncertainty generated by budgetary problems poses a deterrent to savings mobilization via the banking system. Consequently, the key to private sector growth depends on prudent fiscal management and until the public deficit is brought under control, the private sector will be unable to access affordable external finance.

Figure 3.2: Inflation, Interest rates and Budget Balance

-3-4.289

-8.288

-3.286-5.252

-9.475

-2.423-4.566

-20

-10

0

10

20

30

40

50

60

1995 1996 1997 1998 1999 2000 2001 2002

Budget balance (% of GDP) Consumer prices (% change pa; av)

Lending interest rate (%) Deposit interest rate (%)So

urce: Economist Intelligence Unit (2003) Evidence from this survey corroborates the very high rates of interest that firms face. Table 3.2 shows that over 80 percent of firms rate the cost of financing as a major or severe constraint. The frequency of this constraint is consistent across all size, ownership and age categories.

17

Table 3.4: Use and Cost of Loans Sample Small

(10-49 Emps) Medium(50-99 Emps)

Large (>100 Emps)

Non-exporter

Exporter Domestic Foreign

% firms with loan 31.4 19.5 32.7 48.5 27.0 43.6 33.6 26.2 % loans collateral required 87.3 93.3 94.1 78.3 92.1 76.5 86.7 90.0 Value of collateral, % of loan 324.1 401.5 480.8 157.8 398.1 158.9 292.2 467.6 Cost of loan, (interest rate %) 28.1 31.1 36.8 20.1 33.0 17.6 29.7 20.8

Table 3.4 above shows the percentage of firms surveyed which have loans, the percentage of firms required to provide collateral, the value of collateral required as a percentage of the loan and the rate of interest charged on the loan. The table shows that small firms have the lowest usage rate of bank loans- less than 20 percent have a loan, 93 percent are required to have collateral on the loan the value of this collateral is over 400 percent of the value of the loan. In contrast, close to 50 percent of large firms have loans, 78 percent of these loans are backed by collateral and the value of this collateral is only 158 percent of the loan. Large firms pay only 20 percent in interest compared to the 31 percent charged to small firms.6 The lack of a robust micro-finance market structure makes it virtually impossible for small businesses to access finance. Average collateral requirements are 3 times as large as the typical loan. Collateral in the form of plant, land and buildings accounts for more than 95% of all loans. Surprisingly two-thirds of overdraft facilities in the sample are also secured by fixed assets. The banks’ low confidence in the viability/ certainty of positive cash-flows from the projects funded is reflected in the high collateral required. While the size distribution of collateral levels supports this claim, it does not satisfactorily explain collateral requirements that are on average 3 times the size of the typical loan. High opportunity costs of lending driven by public sector deficits and costly foreclosure procedures are likely factors in explaining banks stringent security requirements. In addition, it is possible that a culture of non-repayment of debt explains why banks typically require such high levels of collateral security.

Table 3.5: Use and Cost of Overdraft Sample Small

(10-49 Emps) Medium(50-99 Emps)

Large (>100 Emps)

Non-exporter

Exporter Foreign Domestic

% with overdraft 47.3 37.7 50.9 62.1 45.4 52.7 47.5 47.3 % collateral required 81.6 66.7 100.0 82.4 75.9 100.0 81.3 81.8 Cost of Overdraft 45.1 44.5 47.0 44.6 46.3 41.4 39.8 48.8

Table 3.5 above shows use and cost of overdraft facilities for the sample of firms surveyed. Again, a much lower percentage of small firms have overdrafts. 38% of small firms have overdraft facilities compared to 62% of large firms and an average of 47% for the entire sample. In real terms, firms pay staggering 25% per annum for short term credit. Exporters and foreign-owned firms face lower costs of overdraft facilities. The percentage of firms required to provide collateral is higher for large firms and for exporting and foreign-owned firms. It is possible that given the larger amounts of credit lines extended to large firms, 6 With inflation currently at about 20% (and falling owing to the recovery of commodity prices), average real borrowing rates are 10% and 0% for small and large firms respectively.

18

banks cover themselves against the possibility of firms using short term credit lines for long term investments by requiring collateral.

Comparisons with other African countries. Table 3.6 below shows the contribution of various sources for financing firms’ working capital and investment needs for Zambia, Uganda and Kenya. Caution should be exercised in interpreting these comparisons as differences in the composition of the sample could be driving differences in the contribution of particular sources. Nonetheless, a comparison is still informative of the magnitude of the problem relative to experiences in similarly developed economies.

The reliance of Zambian firms on internal funds for both working capital and new investment is not as severe as Ugandan firms but is considerably greater than Kenyan firms. The difference is driven by both access to bank finance and a more intensive use of trade credit. On average, banks in Zambia finance 16% and 18% of working capital and investment requirements. The corresponding averages for Uganda are 7% and 13.4% and 25% and 27.4% for Kenya. On average, trade credit finances 12.5% of Zambian firm’s working capital requirements compared to 5.3% in Uganda and 15.3% in Kenya. The other notable exception is the role of leasing in financing new investment. Leasing services appear much more important in Zambia than in the two East African economies.

Table 3.6: Sources of Finance7 Working Capital Investment Source Zambia Uganda Kenya Zambia Uganda Kenya Internal funds 60.7 80.0 45.8 53.3 71.1 44.6 Local commercial banks 13.9 5.7 23.5 15.4 11.6 25.4 Foreign-owned commercial banks 2.1 1.3 1.7 2.9 1.8 2.0 Leasing arrangements 1.1 0.1 0.4 5.8 2.4 0.2 Investment funds 0.7 1. 5 1.3 2.6 2.2 0.4 Trade credit 12.4 5.3 15.3 1.5 0.5 3.1 Credit cards 0.4 0.0 1.4 0.0 0.0 0.7 Equity, sale of stock 1.8 1.8 1.1 3.7 2.0 0.3 Family, friends 2.2 1.4 1.2 2.0 2.0 0.8 Informal sources 0.1 0.4 0.0 0.7 1.5 0.0 Other 5.1 2.7 2.9 6.7 4.5 6.5

7 The data used to construct these averages comes from surveys carried out in the three countries in 2002/3.

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Macroeconomic Instability It is not, in fact, surprising that the second highest ranked investment climate constraint is macro-economic instability. During interviews, the interviewees were given high inflation and exchange rate volatility as examples of macroeconomic instability resulting in 74 percent of them rating the issue as a major or severe constraint on their firm’s operation. Many firms interpreted the issue to include the predictability of macroeconomic indicators in the next year or two, and thus registered their uncertainty. Fiscal Imbalances. Zambia has experienced chronic and massive fiscal imbalances. In recent years, fiscal deficits (before grants) have exceeded 13% of GDP. In the past, the deficits were often considerably larger, as the Figure 3.3 shows. These fiscal outcomes have major implications for price stability and external imbalances.

Fig. 3.3. Budget Figures, 1995- 2001

Fiscal balance: Revenue and Expenditure

-1000000

0

1000000

2000000

3000000

1995 1996 1997 1998 1999 2000 2001

FiscalbalanceRevenue

Expenditure

Notes: Revenue excludes grants; Expenditure includes net lending; Unit: millions of local currency; Sources: IMF, International Financial Statistics

Although the Government has made attempts to reduce its employment base, both employment and spending levels have increased significantly since 1991. These increases have done little to alter the Government’s reputation for being inefficient and interventionist or for reducing the fiscal deficit. According to the Central Statistical Office, parastatal employees represent only ten percent of formal employment yet they account for over 40 percent of the national formal wage bill. The average parastatal employee has a monthly salary five times that of an average private sector employee. Among countries at the same stage of development, Zambia has been relatively successful in domestic resource mobilization. Revenue collection is about 18% of GDP in Zambia, compared to an international average of 15% for low-income countries. The revenue thus mobilized, however, has been inadequate for public expenditures which generally exceed 30% of GDP.

20

With such intense deficit spending, setting monetary

policy has been a challenging task. Pursuing a tight monetary policy would have sent interest soaring and crowded out the activities of the private sector. Instead, monetary policy for the most part has been accommodating, with the Bank of Zambia allowing money supply to grow while financing fiscal deficits.

Zambia Consumer Price Index

Inflationary Pressure. Inflation has been rampant during the last decade, as Figure 3.4 shows. Since 1991, the average annual rate of inflation has been 53%, with the intensity of price pressure varying from year to year. In the early 1990s, inflation was higher than 60% per annum. In more recent years, it has moderated significantly, averaging around 20%. Such high inflation causes uncertainty and raises interest rates.

Exchange Rate. The loss in purchasing powerthe market determined exchange rate, which hperiodic official interventions, (Figure 3.5). It1991; by the end of 2002, it took 4550 kwachaBoth the volatility and the decline of the valuethe private sector. Throughout the 1990s and thigh volatility, which creates uncertainty for inand returns to investment.

2

Fig. 3.4: Escalating CPI, 1989-2001

0

200

400

600

1989 1991 1993 1995 1997 1999 2001

of the kwacha through inflation is reflected in as depreciated precipitously, in spite of took 65 kwachas to buy one US dollar in s. of the kwacha have had a serious impact on o date, the real exchange rate has exhibited vestors in terms of the cost of imported capital

1

Fig. 3.5: Zambia - Nominal and Real Exchange Rates, 1999- 2002

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90Ju

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(Kw

acha

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)

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(Index number)

Market exchange rate (left scale)

Real Effective Exchange Rate (avg.1995=100)

Source: World Bank and International Financial Statistics

The Kwacha has been vulnerable to sharp bouts of depreciation—it lost 10 percent of its value against the dollar in two days in the last two days of 2003 owing to low demand for US dollars. Trade in the Kwacha was liberalized in July 2003, through the introduction of a broad-based dealing window. Since this date a regular monthly pattern has emerged where the kwacha depreciates for most of the month, as demand for foreign currency exceeds supply, before a relatively sharp appreciation as month-end approaches, when companies require local currency to pay their salaried employees and local suppliers. The end-month appreciation has not been enough to prevent a gradual depreciation in recent months. Thanks, however, to higher export revenue, owing to increased copper production and prices, the rate of depreciation should not be as dramatic as in previous years, (EIU, 2002 and 2003). High inflation and a lack of confidence in the currency may well ensure that the currency continues to lose value. Also, the market for the Kwacha is quite thin and is severely affected by the actions of a few players, on both the supply and demand side. Donors consist of a third of all supply of foreign exchange and a few large firms make up most of the demand. Also, many loans are denominated in foreign exchange, both in the private and public sector.

22

n

External Position. Zambia is a member of both COMESA (Common Market for Eastern and Southern Africa) and SADC (Southern Africa Development Community) and has joined their respective free trade agreements (FTAs), designed to boost intra-regional trade. Implementation of these FTAs, however, has been slow and involved trade disputes, including Zambia’s ban on Zimbabwe’s manufactured goods. When trade in services and factor income are taken into account, the external position of Zambia is even more precarious. In 2001, while the trade deficit was estimated at $355 million, the current account deficit was more than twice as large, amounting to $743 million, (Figure 3.6). A contributing factor is Zambia’s geographical location as a land-locked country more than 500 miles away from the nearest seaport. This means that the costs of transport (freight and insurance) are very substantial. In addition, Zambia’s service income, pin 2001, was not sufficient to offset tdeficit ranged from a low of $179 mfactor to the current account deficit ihave far exceeded its interest incomeHIPC initiative, however, interest paimbalance somewhat, from more thathe most recent years. The current account deficit in 2001 wfinancial accounts of close to $400 mby Zambia’s private businesses. Nofrom $255 million at the beginning tforeign exchange reserves continuedthan one month equivalent of import With HIPC debt relief, the stock of Z1998 to $5.4 billion in 2002 (or abouowed to official multilateral or bilatebillion to the IMF. Most of this debtprecarious external position constraicontrol. The government tends to relservicing the external debt when nee In conclusion, macroeconomic instathree-quarters of the sample firms, csurvey has recently been implementerated by about half the firms (or less

Fig. 3.6: External Positio

rhils yn

no is

atr nyd

bod

)

imarily from tourism which amounted to $143 million ese expenses. In recent years, the service account lion to a high of $264 million. Another contributing Zambia’s interest payments on external debt, which from foreign sources. With recent debt relief under the ment has declined, reducing the factor income account $200 million in the late 1990s to about $140 million in

Trade and Current-Account Balances

-800

-600

-400

-200

0

200

1997 1998 1999 2000 2001

Tradebalance

Current-accountbalance

as offset to some extent by a surplus in the capital and illion, which reflect donors’ contribution and borrowing etheless, the foreign exchange reserves for the year fell $183 million at the end of the year. The decline in nto the middle of 2002, falling to $124 million or less .

mbia’s external debt has fallen from $6.8 billion in 150% of GDP). Nearly all of the remaining debt is al lenders, including about $2 billion to IDA and $0.5 carries highly favorable concessionary terms. The s further the ability of authorities to exert monetary on Bank of Zambia financing (bridge loans) to ed.

ility is considered a major or severe problem by nearly ntrasted to the perceptions in other countries where this , (Table 3.3). Macroeconomic instability is similarly in all comparator countries.

23

Public-Private Interaction Taxes Zambian firms ranked tax rates as the third most binding constraint to private sector growth in Zambia. This finding concurs with that of a recent FIAS Administrative Barriers study carried out jointly with the Investment Climate analysis which treated a smaller number of issues in more detail. The FIAS study states that the issue of tax rates was identified as a problem by more than 50 percent of respondents and seemed to evoke the most negative reactions. Tax rates are almost always cited by enterprises as problematic, as seen in our international comparison, (Table 3.3).

Figure 3.7: Tax Rates, East Africa & Asia

Highest Marginal Corporate Tax Rate, 2002

30.0 30.0 30.0

35.0

30.0

35.7

25.0

30.0

35.0

40.0

Kenya Uganda Tanzania China Zambia India

Source: World Development Indicators

However in the case of Zambia, the issue figures quite prominently. The highest marginal tax rates is, in fact, higher than neighboring countries, (Figure 3.7). Perhaps more important is the frequency with which significant penalties are arbitrarily added to the total tax bill.

Many firms in the private sector are just as concerned about tax administration as they are about tax rates. This finding is all the more troubling given that the government has been making great efforts to improve tax administration since the early 1990s, with donor resources. The FIAS study concluded that the firm dissatisfaction derived mainly from the fact that: • Changes in tax policy are too frequent and either unjustified or unexplained to the

business community; • The VAT (set at 17.5 percent) has been plagued by various problems including lengthy

procedures for registration, unclear eligibility criteria and delays in refunds; and • The Zambia Revenue Authority’s (ZRA) behavior toward firms is inappropriate and

stems from the fact that the burden of proof is on the firms, particularly where penalties and appeals are concerned. Some ZRA staff lack the skills needed to perform their duties and are not armed with clear guidelines on how to interpret tax rules.

24

Tax officials are given wide discretionary power which opens the door for corrupt practices and unofficial arrangements to settle tax payments and issues. Anecdotal accounts also point out the unfair practice of negotiating and granting special “concessionary” tax terms on a project-by project-basis (especially in the mining industry) which departs from the legislated general tax regime. These “sweetheart” deals reduce the predictability of the tax regime and increase the effort required to effectively collect the taxes due. Firm owners and managers reported that the ZRA focus on tax collection seems to be at the expense of developing a modern tax policy. They feel that because the tax base is so small, the tax burden on those entities that do pay tax is disproportionately heavy. In addition, there is resentment that the large informal sector does not contribute substantially to the federal budget. Measures that improve the revenue side of the budget such as improving tax collection and expanding the tax base are particularly relevant to this issue. High tax levels and burdensome administration are undoubtedly forcing some small firms to enter or remain in the informal sector, close their businesses or relocate in other countries in the region. Any one of these outcomes will not only further reduce Zambia's tax base but hinder growth of individual firms and the economy as a whole. Regulatory Policy Uncertainty The ICA sample firms ranked the issue of regulatory policy uncertainty as the fourth most pressing constraint to growth. Although certain aspects of this broad category, such as business registration and customs administration, do not rank highly on their own as binding constraints, the overall impact of these regulations and policies is high. Firms reported that these shifts in policy exacerbate the risks that they associate with doing business in Zambia and create a disincentive to invest. The decline in FDI flows to Zambia over the past five years reflect the drop in confidence in the Zambian economy by potential foreign investors. The Economist Intelligence Unit (EIU) gave Zambia an overall Country Risk rating of "D" in their December 2002 report. In comparison to neighboring countries, Zambian constraints in this area seem generally more severe, (Table 3.3). Only 28 percent of Ugandan firms say that regulatory policy uncertainty is an important problem in their firm compared to 57 percent in Zambia. The Government has a history of frequent and unpredictable changes to key policies that has had a damaging effect on both foreign and domestic investment. Most firms (an impressive 70 percent) think that government officials’ interpretation of regulations affecting their businesses are inconsistent and unpredictable. For example, the immigration laws were recently changed requiring all non-Zambians to renew unexpired permits at high cost. No clear rationale was given when mining royalties were recently increased by 150 percent. There are also numerous relatively new agencies within the Government, some of which require licenses of one type or another such as the Competition Commission, Communications Authority, Investment Centre, and the Environmental Council, not to mention the licenses required from relevant industry regulatory bodies. One specific Zambian company with eight subsidiaries requires over 100 licenses to continue operating. Compliance with these regulatory bodies can be a struggle especially for small and medium enterprises. These agencies can be inefficient, take an inordinate length of time to process licenses while some individuals within them are reported to expect some form of bribe in order to do their jobs. One good indicator of how this bundle of issues affects firms is by looking at how much

25

time on average, the senior management spends on regulations (e.g. tax, customs, labor regulations, licensing, and registration) including dealing with officials, completing forms, etc. In Zambia this amounts to about 13 percent, a rather high percentage. There are several sources of information on one the key regulatory obligations: the challenge of business licensing and operating permits. According to the ICA results, business licensing and operating permits are not considered overall a major problem by registered firms, when considered in the context of a wide range of issues. Only 10 percent of the respondents answered that this was a “major” or “severe” constraint. This is roughly the same across ICA results in East Africa, with the exception of Tanzania where this figure is 27 percent, (Table 3) . This may be due to the fact that the sample was made up of established firms, some of which hadn’t had to deal with setting up a business in many years. The result would also most likely be quite different if considering analyses of the informal sector. Data from the Doing Business database reveals the challenges of starting a business in Zambia. While the number of steps to set up a business are not very high (6 vs. a regional average of 11), the necessary deposit is almost 138 percent of GNI per capita. In addition, it takes an average of 3.7 years to close a business in Zambia (Doing Business, 2003). Investor entry and establishing a business are also discussed in the FIAS report which looks closely at visa, self-employment and work permit processes and business licensing processes. Customs are also a focus of the FIAS report which includes a number of recommendations to the Zambian authorities, including measures to modernize customs, simplify import procedures, increase use of inland clearance facilities, improve export promotion, and reduce delays in obtaining duty drawback refunds.

Infrastructure Firms in Zambia are also concerned about the generally poor quality and limited availability of infrastructure services. Adequate infrastructure provision is one of the critical preconditions for achieving economic competitiveness and growth. The ICA identified several types of infrastructure which together act as a sizeable constraint on private sector growth, (while also directly impacting the quality of life of the country’s citizens). Infrastructure here implies several areas which are dealt with in turn: electricity, telecommunications, roads and water The power sector in Zambia is becoming increasingly unreliable. ZESCO is under strain to provide consistent and affordable power. Power cuts to industrial areas in major industrial towns result in significant production losses. For example, a five minute power cut to a plastics plant in Lusaka results in not only the loss of an hour of production but, because of the nature of the process, enough raw material loss to increase that day’s cost of production by over 10 percent. Zambian firms recorded an average of 37.2 power outages last year, (Table 3.9). Large firms experienced almost 45 power outages. The percentage of production lost due to these outages is very high - overall the number is 4.5 percent while small firms lost 5.6 percent of their output.8 Services firms report that electricity is not as much of a

8 The percent of production lost is measured as percent of production value lost and includes losses due to lost production time from the outage, time needed to reset machines or production that may be ruined due interruption of the process.

26

constraint as it is seems to be for manufacturing firms. Only 17 percent of services firms report electricity as major hindrances to doing business, (Table A.2.1). Services firms report that electricity is not as much of a constraint as it is seems to be for manufacturing firms. Only 17 percent of services firms report electricity as major hindrances to doing business (Table A.2.1).

Table 3.9 : Infrastructure Indicators

Zambia Small Large Foreign-Owned

Domestic Exporter Non-Exporte

Freq of power outages (times last yr) 37.2 29.8 44.9 35.4 38.0 41.7 35.6

% of production lost due to power outages 4.5 5.6 4.3 3.7 4.9 3.3 5.0

Have own generator (%) 38.2 27.3 60.6 42.6 36.3 63.6 29.0

Have built own well (%) 59.9 42.9 81.8 59.0 60.3 72.7 55.3

% of production lost in shipment 3.8 4.7 2.3 3.3 4.0 2.6 4.2

No. of days to obtain a telephone connection 132.5 135.0 21.7 283.3 67.9 102.5 152.5

No. of days to obtain an electricity connection 120.7 47.0 162.8 313.3 48.5 90.0 127.6

Infrastructure Indicators

More than a third of the enterprises have their own generators and over 60 percent of large firms have generators. Zambian firms must wait 120 days on average, to get access to electric power. For small firms, the situation is considerably worse. A wait of 4 months to get an electricity connection is by far the worst performance of countries recently surveyed, (Table 3.10).9

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9 Note: very few firms reported having had requested an electricity connection in the last three years.

Table 3.10: International Infrastructure Indicators

Zam

bia

Ken

ya

Uga

nda

Tanz

ania

Chi

na

Indi

a

Production lost due to power outages (%) 4.5 9.3 6.3 9.2 1.8 n.a. Frequency of power outages (times last yr) 37.2* 33.1 38.6 67.2* n.a. n.a. Have own generator (%) 38.2 70.0 35.3 55.0 17.0 68.5 Have built own well (%) 59.9 33.5 13.0 34.7 21.1** 50.1** No. of days to obtain telephone connection 132.5 123.7 33.2 23.1 12.5 n.a. No. of days to obtain electricity connection 120.7 65.6 38.3 23.1 18.2 n.a. *frequency of power outages and surges; ** percentage of firms that own a well

In a liberalized trading environment, these industries need to be competitive with industries in neighboring countries where the power supplies are more consistent and the cost of production associated with power usage is lower. Ironically, ZESCO provides excess power to Zimbabwe for US $0.03 per kilowatt-hour, one third the price of power for the average Zambian industrial customer. The business community feels uncertain about the approach to be taken to improve the quality of service delivery and access to services provided by ZESCO. It matters much less whether the required improvements in service provision come through commercialization or through privatization. What is important is that those improvements are delivered as quickly as possible to help put the Zambian economy on a more competitive footing and on a sustainable higher growth plane. The World Bank’s review of Zambia’s experience with privatization found that one of the reasons some privatized companies did not perform to the expected standard is that previously state-owned enterprises were released into a regulatory vacuum or into an inadequate or inappropriate regulatory framework. Such regulatory frameworks include the legal framework, the institutional design of the regulators and the capacity of the regulators to discharge their mandates effectively. It is at all three levels that reforms are needed, especially in the infrastructure sector, to achieve higher and sustainable economic growth. To facilitate the growth of the private sector, a sound and predictable regulatory and policy framework needs to be developed and implemented. The discussion above on regulation, privatization and commercialization applies not only to ZESCO but to ZAMTEL as well. For example, ZAMTEL controls the international communications gateway on which private operators depend heavily. At the same time, ZAMTEL is actually one of their competitors. Clearly, there are issues of leveling the playing field that need to be addressed. Telecommunications development has been compromised by the delays in commercializing ZAMTEL. The poor quality of the phone service coupled with the paucity of available modern features keeps Zambian businesses shut out from the cutting edge of communications technology. Cellular phone service in neighboring countries is much cheaper than in Zambia, where it is controlled by ZAMTEL. If there was more competition in the sector, ZAMTEL would be more motivated to try to provide better service at a more competitive price.

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Perceptions are very poor on Zambia telecommunications when compared to most other countries in the region, (Table 3.3). This is most likely due to the fact that the markets for mobile telephony are functioning more efficiently in some of these countries. Even where fixed lines are concerned, there is great room for improvement in Zambia. One indicator of this is the fact that firms reported waiting an average of over 4 months to obtain a telephone line, (Table 3.9).In the services sector, firms find telecommunications to be the most constraining factor amongst infrastructure services. About 34 percent of firms state that poor telecommunications are a hindrance to doing business, even though it takes services sector firms fewer days to obtain a new phone connection than manufacturing firms, (Table A.2.1 and A.2.2). Telecommunications obstacles are likely to constrain the competitiveness of services firms especially, such as tourist lodges which deal regularly with foreign-based tour operators and/or are located in remote parts of the country. In the services sector, firms find telecommunications to be the most constraining factor amongst infrastructure problems. About 34 percent of firms state that poor telecommunications are a hindrance to doing business, even though it takes services sector firms fewer days to obtain a new phone connection than manufacturing firms, (Table A.2.1 and A.2.2). Telecommunications obstacles are likely to constrain the competitiveness of services firms especially, such as tourist lodges which deal regularly with foreign-based tour operators and/or are located in remote parts of the country. The road system has been improving in recent years. Within Lusaka, the quality of select roads has improved dramatically, but improvement has been limited to a few areas. Most of the low and lower-middle income residents of Lusaka have to battle with very poor road infrastructure. Residents of other large towns, especially in the Copperbelt, have seen none of these road improvements. The industrial areas in these towns have such a poor road system that it affects the efficiency of transporting raw materials and finished goods into and out of their facilities. Smallholder farmers face major difficulties and costs transporting their produce to the markets in urban centers. The national road system has also been improved, but due to the over-dependence on road transport by the mines and other industries that involve the movement of heavy supplies and goods, the roads that are being built are being worn out at an unacceptably high rate, thus the poor rating of transportation when compared to other neighboring countries, except Kenya, (Table 3.3). The pressure placed on the road system by the transport of heavy goods could potentially be alleviated with better maintenance or more efficient operation of Zambia Railways following its recent concessioning to a private operator. Many of the industrial districts in the major Zambian towns do not have consistent and adequate water supplies, especially in the Copper belt. Many of these businesses have resorted to incurring the extra expense of buildings wells on their properties in order to ensure a constant flow of water. This has large capital expenditure implications and drives up the cost of doing business. In the services sector, about 37 percent of firms own wells to supply water, (Table A.2.2.). This is large proportion and reflects a poor water supply alternative. Within the service sector, firms in the tourism sub-sector are particularly vulnerable to uninterrupted supplies of electricity and water. Tourists are likely to be willing to pay a premium to lodge in facilities with better amenities, a tendency that induces a greater response on the part of firms to insure themselves against erratic water or electricity supplies.

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Labor Market Apart from the issue of labor productivity discussed in the previous chapter, the lack of labor flexibility adds to the dissatisfaction on regulatory policy. While some labor laws have been amended in recent years, the majority have not substantially changed since the period of the socialist government, (DCDM, 2002). One of the greatest complaints of employers is the requirement of terminal benefits of 2-3 months basic salary for every year of service, (see Box 3.1 for more details). This cost acts as a deterrent to increasing staff, even when needed to meet demand. The World Bank’s Doing Business database indicates that the cost of terminating workers in Zambia is far higher than in other countries in East Africa. Table 3.7 shows the data for other countries. Table 3.7: Severance Pay in Number of Months of Wages

Ken

ya

Uga

nda

Tan

zani

a

Chi

na

Indi

a

Severance pay – number of months for which full wages are payable after covered employment of 20 years.

10 0 12 20 10

Source: Doing Business Indicators, The World Bank It is also not uncommon for an employee who is dismissed and loses the right to terminal benefits to make a claim for unfair dismissal, in which case the industrial tribunal tends to find in favor of the employee.

30

Box 3.1: Labor Laws

LABOR LAWS IN ZAMBIA CONDITIONS OF EMPLOYMENT GENERAL ORDER CAP 276 SECTION 3 This order is applicable to all employees except employees: of the government of Republic of Zambia, of District Councils, engaged in domestic service, in occupations where and conditions of service are regulated through the process of collective bargaining under the Labour and Industrial Relations Act, in occupations where wages and conditions of service are otherwise regulated under the Act. Retirement Benefits – Under this order an employee who has served with a company for not less than 10years service and has attained 55 years of age shall be entitled to three months basic pay per eachcompleted year of service provided that where and employer has establish a pension scheme approved bythe Minister of Labour and Social Security, the retirement benefits shall be paid in accordance with suchpension scheme and this paragraph shall not apply. Redundancy benefits – where an employees contract of service is terminated by reason of redundancy, theemployee shall be entitled to at least one months notice and redundancy benefits of not less than twomonths basic pay for each completed year of service. Repatriation Benefits – An employee, together with his family shall be transported by the employer to the employees place of recruitment or paid repatriation allowance by employer equal to the current cost of traveling by public transport and the most direct route to the employees place of recruitment. THE EMPLOYMENT ACT CHAPTER 286 OF THE LAWS OF ZAMBIA Whenever an employer intends to terminate a contract of employment for reasons of redundancy, the employer shall : a.) provide notice of not less than thirty days to the representative of the employee b.) afford the representative of the employee an opportunity for consultation on the measures to be taken

to minimize the termination and the adverse effects on the employees and the measures to be taken tomitigate the adverse effects on the employees concerned including finding alternative employment

c.) not less than sixty days prior to effecting the termination, notify the proper officer of the impendingterminations by reason of redundancy and submit to that officer information on the reasons for thetermination, the number of categories of employees likely to be affected, the period within which theredundancies are to be effected and the nature of the redundancy package.

An employee whose contract of service has been terminated by reason of redundancy shall: a.) be entitled to such redundancy payment as agreed by the parties or as determined by the Minister,

whichever is the greater, and b.) be paid the redundancy benefits no later than the last day of duty of the employee. Provided that

where an employer is unable to pay the redundancy benefits on the last day of duty of the employee,the employer shall continue to pay the employee full wages until the redundancy benefits are paid.

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Crime and Corruption Theft, fraud and disorder This issue was identified by interviewees as the sixth most constraining aspect in doing business. While crime does not rank as highly as it does in Kenya, for example, it is ranked twice as high as in Uganda and Tanzania, and about four times as high as the other comparator countries around the world, (Table 3.3). This issue seems to affect large companies the most, (Table 3.2). In a survey on economic crime (theft by employees or management, corruption, cyber crime, money laundering, etc.) in Kenya, Tanzania and Zambia, 53 percent of Zambian companies experienced economic crime 2 to 3 times in the previous two years, (Price Waterhouse Coopers, 2002). The sample was biased toward larger companies, thus the percentage seems plausible. The majority (67 percent) of these crimes were perpetrated by individuals within the company. Non-economic crime poses considerable problems for firms as well. Compared to Kenya, (the only other country where these particular questions were asked), Zambian firms spend a similar percentage of revenues as Kenyan firms on preventing crime, (Table 3.8). Yet, twice as many firms experienced some loss in the previous year. The amount of these losses were on average similar in terms of percentage of sales. Fewer incidents were reported to the police in Zambia, however slightly more incidents were solved. Table 3.8: Indicators of Security

Zambia Kenya

Cost of security (equipment/infrastructure/personnel, % of total sales) 2.9 2.8 Percentage of firms that lost revenue due to theft/robbery/arson 76.8 33.8 For these firms:

Average sales loss ( % of total sales) 4.5 4.1 Percentage of incidents reported 52.5 79.2 Percentage of reported incidents solved 25.5 18.4

In Transparency International Zambia’s 2002 report on the country, the police were identified as most corrupt, giving an indication of how the community perceives them. The organization suggests the investigation of strategies to change that perception, (IRIN, 2002). And while a majority of firms of firms are confident to some extent that the judicial system will enforce their contractual and property rights in business disputes, it is not an overwhelming majority, 63.9 percent. Lack of adequate resources has led to a shortage of trained jurists due to the inferior salaries being offered and infrastructure constraints, leading to a backlog of cases in the criminal court system. The use of mediation and arbitration in commercial disputes has addressed some of these needs.

Corruption Corruption is the seventh leading constraining and for FDI firms it ranks among the top 5. 46 percent of the firms identify it as a major or severe problem. The interviewees reported that typically firms spend on average 1.7 percent of their revenues on bribes in order to “get things done.” In addition, they reported that a government contract usually requires a bribe of 3.7 percent of the value of the contract.

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In terms of business owners and managers perception of corruption as a major problem, Zambia seems to be rated a little better than average for the East African countries where ICAs have recently been completed, (Table 3.3). However, this is by no means a sign of an exemplary situation, which becomes evident when Zambia is compared to other parts of the world. Transparency International's 2003 corruption index ranked Zambia 99th out of 133 countries. TI’s Corruption Perception Index relates to perceptions of the degree of corruption as seen by business people, academics and risk analysts, and ranges between 10 (highly clean) and 0 (highly corrupt). In 2003, Zambia received a 2.5. The Heritage Foundation analysis of economic freedom ranked Zambia 118th out 155 countries in 2004. The publication of these types of indicators may mean that the existing corruption and inconsistency of public policy deters reputable foreign investors and attracts less desirable investors. Therefore, many of the foreign investors in Zambia are more likely to accept and promulgate a corrupt environment. Finally, it is worth noting some differences between Lusaka and other towns. Roughly half the surveyed firms, 46 percent, were located in Lusaka, and other secondary towns - including Kitwe, Ndola and Livingstone/Victoria Falls - made up the remaining 54 percent. Generally, it seems that there are not great differences among the top problems of businesses across the country. When comparing Lusaka with the secondary cities, the top five constraints are almost the same. The one exception is that for secondary towns, crime may be a bit more difficult to deal with. Crime/theft/fraud/disorder ranks as the fifth most important constraint outside Lusaka, as opposed to being the sixth most important constraint for Lusaka. There are a few areas where the investment climate differs somewhat between the capital and the outlying regions. The cost of finance and macroeconomic stability are more strongly felt in smaller towns, (Table 3.11). But the reverse is true of access to finance, which is evidently more problematic for firms in Lusaka.

Table 3.11: Regional Comparisons of Constraints Respondents' Evaluation of General Constraints to operation % of firms evaluating constraint as "major" or "very severe"

Bold = greater than 5 point difference Zambia Lusaka Other

Cost of Finance 82.1 78.9 84.7 Macroeconomic Instability 73.9 68.8 78.4 Tax Rates 57.5 58.3 56.8 Economic & Regulatory Policy Uncertainty 57.0 47.4 64.9 Access to Finance 54.1 63.2 45.5 Crime, theft, fraud, disorder 48.8 46.9 50.5 Corruption 46.4 44.8 47.3 Electricity 39.6 35.4 43.2 Anti-competitive or informal practices 38.7 36.5 40.5 Skills/Education of Workers 35.8 33.3 37.8 Telecommunications 32.9 34.4 31.5 Customs & Trade Administration 32.4 32.3 32.4 Transportation 30.4 25.0 35.1 Tax Administration 27.5 25.0 29.7 Access to Land 17.4 24.2 10.0

33

Labor Regulations 16.9 13.5 19.8 Business Licensing & Operating Permits 10.1 9.4 10.8

The estimates of electricity outages last year, seems rather constant inside and outside of the capital, (Table 3.12). Interestingly, the value of production lost is higher in towns outside Lusaka. Table 3.12 : Regional Comparisons of Infrastructure Zambia Lusaka Other

Freq of power outages (times last yr) 37.2 37.8 36.7

Production lost due to power outages/surges (%) 4.5 5.2 3.9

Have own generator (%) 38.3 33.3 42.3

Have built own well (%) 59.8 54.2 64.9

Wait to obtain telephone connection (days) 132.5 183.6 13.3

Wait to obtain electricity connection (days) 120.7 90.0 123.8 More firms in towns outside Lusaka have bought generators in the past, indicating a persistent problem with outages. They also have had to wait longer for an electrical connection. This figure is based, however, on a very small number of observations, given that so few firms are new enough to have had to obtain a new electrical connection in the last three years. The same can be said of the figure indicating the wait to obtain a telephone connection, which shows the opposite, that it takes much longer in Lusaka. A large number of firms across the country, more than half, have built their own well, indicating a need for improved public provision of water. Again, those firms outside Lusaka seem to be more dependent on private provision of water then public provision. Lusaka seems in better shape in terms of infrastructure than other towns, especially those in the Copper Belt. Access to land and land tenure in less of a problem outside of Lusaka, a typical finding given the density of capital cities. However, labor regulations are more difficult to deal with in rural areas. The other top constraints, tax rates, crime and corruption are felt relatively equally across the regions included in the sample.

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IV. RECOMMENDATIONS The results of the investment climate survey describe the story of a small private sector struggling to compete in a difficult business environment. The survey itself confirms a set of key factors that continue to bind the growth of private business and which need to be addressed on a priority basis in order to unleash the full potential of private sector-led economic growth in Zambia. The following specific recommendations in the following broad topic areas emerged from our analysis: Macroeconomics and Finance, Public Sector – Private Sector Interaction, Infrastructure, Labor Market Issues and Crime and Corruption. 1. Macroeconomics and Finance. Addressing the issue of macroeconomic instability, in particular the level of Government borrowing and money supply, will help to lower inflation and interest rates. Currently, purchases of T-bills dominate financial sector activity because of the high level of government borrowing and the consequent high rates of interest on government debt. The government currently earns about 18 to 20 percent of GDP as revenues; expenditures are about 30 to 35 percent of GDP. A part of this gap is met by donor inflows but the rest of it is financed by T-bills. The Bank of Zambia and the Ministry of Finance need to undertake the following reforms to address this situation--subsidies to inefficient state-owned enterprises must be reduced and these enterprises must continue to be privatized or rationalized.10 Public expenditure management also needs to be improved and resources need to be directed towards infrastructure (particularly roads, electricity, telecommunications and water supply). Without a commitment to fiscal discipline by the Ministry of Finance and a reduction in government borrowing, it will be difficult for firms to gain better access to credit. The Public Expenditure Management and Financial Accountability Review (PEMFAR) conducted by the World Bank in 2003 provides a detailed three-year plan of action focused on three topics—strengthening the legal framework, improving parliamentary oversight, and improving the credibility of the budget process. The PEMFAR recommends the following specific steps to be undertaken by the Ministry of Finance and where appropriate, the Cabinet and the Parliament: • Revise the Budgetary Framework

--the budget be submitted to Parliament with sufficient time (60 days) to review and enact it --Parliament approve any supplementary estimates before spending occurs --emergency expenditures be made through a voted Contingency Fund only --amount of time allowed for submitting an excess expenditure bill be reduced --the financial statements be submitted to Parliament within 6 months of the end of the fiscal year

10 The World Bank’s Privatization Review of Zambia describes several important lessons for the privatization process. The review concluded that the public as well as key stakeholders were very poorly informed about why Zambia’s privatization took place. The privatization program was driven by the need to stop the financial hemorrhage to loss-making companies from the national budget and to enable potentially profitable companies to survive. But by delaying the launch of the privatization program until the last possible moment and not communicating with the public, many options were eliminated and the net benefit to the country was significantly less than it might have been. The review recommends greater transparency in the privatization process as well as better efforts to communicate the government’s rationale to the public.

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• Strengthen Parliamentary Oversight

--improve the budget presentation --present macro framework and budget priorities as early as possible --provide adequate resources to the Budget Estimates and Public Accounts committees --submit regular reports on spending and develop a response mechanism to these reports

• Budget Preparation --reconcile differences between spending and budgeted expenditures and prepare a plan to reduce expenditures where gaps are high --develop a multi-year planning framework that is realistic --reduce the amount of supplementary appropriations so that they are used only in exceptional circumstances.

In the medium to longer term, development of micro-finance institutions will help improve access to finance, especially for the small and medium enterprise sector, which is severely constrained in terms of financing and heavily dependent on internally generated funds to meet their working capital and capital expansion requirements. In addition, firms are very concerned about the decline in and the volatility of the Kwacha. The Bank of Zambia needs to recognize these constraints and manage the foreign exchange market accordingly. Finally, the government might also think about facilitating export diversification in the medium to long term so that new export activities (such as gemstones) may be able to flourish. Better management of current exports such as copper would also help reduce foreign exchange volatility. 2. Public Sector – Private Sector Interaction. Taxes. One of the most intense interactions between the government and the private sector takes place in the domain of taxation. The Zambia Revenue Authority must be commended for the reforms undertaken thus far. In order to broaden the tax base the ZRA introduced a 3% presumptive tax on businesses with a turnover of ZK 200m or less. Previously, preparing the necessary accounts for tax purposes was a burden for small businesses (through the cost of hiring accountants, for example) and many avoided this by not sending in tax returns. Simpler tax procedures may well encourage greater compliance and estimates that this will raise ZK 7.3bn. In order to smooth the introduction of the presumptive tax, the threshold on value-added tax (VAT) registration has also been raised, to ZK 200m, although the removal of voluntary registration for VAT is expected to result in a revenue gain of ZK 26.3bn. A reduction in the number of goods that are zero-rated for VAT purposes is projected to raise an estimated ZK 95.3bn. Other tax measures include: --an increase in the portion of bank deposits exempt from withholding tax from ZK300,000 to ZK750,000 per annum (revenue loss of ZK1.5bn); --a reduction in customs duty on computers from 15% to 5% (revenue loss of ZK800m); --the introduction of excise duty on mobile-phone airtime at a rate of 10% (revenue gain of ZK15.6bn); and

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--an increase of excise duty on cars from 10% to 20% (revenue gain of ZK8.4bn). Further reforms will help strengthen the tax base further. The FIAS study is a step in that direction and concludes with a number of recommendations: • Public Relations. Relations with the business community need to be repaired which will

require changes in policy as well as in the behavior of tax authorities. Compliance provisions should be clearly stated and provided as guidelines for the use of taxpayers. The ZRA should continue its efforts to publicize relevant policies but consider other effective methods of dissemination. Increasing efforts to obtain information and feedback from the public and the business community will contribute to improved policy and relations.

• Adjustment in Approach. The ZRA should review the target-based approach to revenue collection, with a view to instituting a broader performance measurement and removing the current incentives for harassment of taxpayers. Legislation which confers wide discretionary powers on ZRA officials should be repealed. In addition, measures and procedures are required to ensure that taxpayers can report corrupt practices or other misconduct of ZRA officers without suffering retaliation

• Administrative Streamlining. There are a number of administrative recommendations to streamline and rationalize the operations of the ZRA that could be pursued. Continued efforts should be made to introduce a single taxpayer number and streamlined documentation requirements as soon as possible. ZRA should, in collaboration with MFNP, (the tax policy agency), review administration of refunds and various other tax claims. ZRA should review its audit process, in order to introduce risk-based approaches to inspection and audit. ZRA should reevaluate the penalties for late payments that are highly punitive (e.g. 0.5% per day or equivalent to about 180% per annum) and introduce a market-based interest rate for its delayed payments to businesses. ZRA should review its rules on deductibility of expenses to allow legitimate business expenses for items currently excluded and to clarify the basis on which such expenses will be accepted as deductible.

The FIAS study provides an excellent set of recommendations which should be carefully considered and implemented in order to further reinforce the tax base. Regulatory Policy Uncertainty. Regulations represent another significant area of public-private interaction. Building an enabling environment requires that sufficient attention is paid to the appropriate balance between regulation and the free market in the areas of licensing, customs, competition, and regulation of utilities. Among the recommendations for tackling investor entry and licensing requirements are the following: the GRZ should refrain from introducing investment screening procedures, review the current licensing and business entry procedures to simplify and coordinate them, reduce discretionary powers of the issuing authorities, and finally, increase the period of validity of the various licenses (FIAS, 2004). Customs are also a focus of the FIAS report which includes a number of recommendations to the Zambian authorities, including measures to modernize customs, simplify import procedures, increase use of inland clearance facilities, improve export promotion, and reduce delays in obtaining duty drawback refunds.

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The government also needs to consider introducing more competition and mitigating perceived risks to investment in infrastructure, where there is not enough public revenues to meet the required levels of investment and consumer protection. There is a need to review current regulatory arrangements to understand better how these can be improved to encourage more competition and efficiency. For example, one step that the Ministry of Telecommunications needs to take is to open up the market to non-state owned providers of telecom services. More broadly, this is an area where more diagnostic work can be done. A Public-Private Infrastructure Advisory Facility (PPIAF) review by the World Bank would be useful to help decide what the course of action should be and how the government might best receive assistance in terms of reforming the markets for utilities. Some actions can be taken immediately. In particular, the procedures for obtaining utility connections need to be streamlined and made transparent. In addition, many regulatory policies are implemented in an ad hoc manner and discretionary payments are made to get around them (FIAS, 2004). This type of situation creates a great deal of uncertainty and must be addressed. We also recommend that in parallel with appropriate interventions to modernize the regulatory framework, a Country Framework Report (CFR) be prepared for the infrastructure sector in Zambia. Such a report would review the legal frameworks, design of regulatory institutions and assess the capacity of regulators for sectors like water, telecommunications, power, road transport and airports. Public-Private Dialogue. There is a pressing need to strengthen the private-public dialogue and develop a systematic approach to get input and feedback from the private sector. It may be very useful to examine options for creating or strengthening the forum for public-private dialogue on key policies that affect the private sector. This entails strengthening the capacity of private sector representative institutions to analyze alternative policy options and make proposals to the Government. An excellent means of strengthening any dialogue that may exist and ensure on-going, structured dialogue on matters of mutual interest to the two parties is the establishment of an Investor Round Table. These investor councils are small, high-level, Presidential advisory groups comprised of approximately 20 business leaders drawn from the top echelons of international business both invested and not invested in the country, as well as local investors. The purpose of the councils, normally chaired by the President of the country, is increasing understanding between the government and companies driving private investments, to identify and accelerate government measures to address impediments to reform. Investor Round Tables held in Tanzania, Ghana, Zanzibar, Kenya and Uganda have succeeded in bringing the concerns of the private sector directly to the government and in positioning the private sector as a key player in the development agenda. Investor Round Tables can be held on a semi-annual or annual basis, thereby promoting regular discussions. Also, this mechanism can be replicated at the regional level, providing the private sector with a regular platform for dialogue. This approach of including the private sector in policy formulation can yield many benefits. For example, Zambia is currently reviewing its Investment Act and Tourism law which could use this opportunity to consult the private sector about pitfalls of the past to avoid and important provisions to consider including. Other legislation mentioned in this report will also require urgent review. These include the labor law, mining legislation, land law, tax law and business licensing procedures require simplification. These are all key policy initiatives which can significantly enhance the business environment, if undertaken in the right way. One essential requirement to ensure that the process is value-adding is to consult the private sector (and other stakeholders) on the policies to be embedded in the proposed new law. This

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helps to assure the quality of policy formulation and also implementation. It helps to reduce the deep-seated mistrust between the Government and the private sector and to minimize the abrupt policy shifts that have characterized Zambia’s business climate in the past. 3. Infrastructure One key issue for the improvement of infrastructure is determining how best to access private sector resources, given that public resources are inadequate to meet the indicated infrastructure gap. This could be done by ensuring that the private sector’s perceived risk regarding public-private partnerships is mitigated to the greatest extent possible. It is clear from our data that there is room for improvement in the provision of utilities. For those key utilities which are still under state ownership and management, there is an urgent need to implement appropriate measures to improve the quality and coverage of their service provision. Rather than privatization by asset sale, which has sometimes proved difficult to implement in Zambia, the Ministry of Telecommunications and other ministries and agencies responsible for utilities may broaden options as appropriate. As indicated earlier, what is important is to effectively restore efficiency and broad access to key services like telecommunications and electricity rather than the particular manner in which that is done. In other words, the Government has a range of options ranging from asset sale to reforming incentives, to achieve the required improvement in the investment climate. For example, under the commercialization option, the Government retains the legal title to the assets concerned but contracts out the commercial management of those assets and put in place codes of corporate governance and incentives to minimize political interference in business decisions. It is appropriate to point to gains that can be made by allowing consumers alternatives to the existing monopolistic suppliers (FIAS, 2004). It also seems desirable that private developers be allowed to contract for installation work in all utility areas, as long as they work according to the quality specifications set by the utility authorities, under their supervision, and possibly using the materials and equipment they provide. The problem of providing bulk infrastructure to previously undeveloped areas and sharing of capital costs between private users and public providers is not unique to Zambia. The FIAS report outlines some options that developed countries have used and that might be useful to Zambia. 4. Labor Market Issues Productivity of Labor. Our analysis of the data shows that Zambia is in great need of improving the productivity of its labor force. In order to fully address the issue of labor productivity, improving the skills of the labor force is crucial. Several options are feasible and are worth further study. A recent paper from the World Bank provides several suggestions (Batra and Mahmood, 2003). Direct subsidies for training are effective in terms of increasing the amount of training provided to the workforce but may not be as useful for small and medium enterprises as for large firms. Similarly, tax exemptions are also more useful for larger firms and can be used to increase training in this size category. For small and medium enterprises, a levy on wages that can be used to subsidize training carried out by firms provided might be an effective tool, given that there is administrative capacity to implement such a scheme. Matching grants schemes to increase training have also been used

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successfully to assist in building a “training culture.” Available evidence indicates that job-related skills provided in-house by firms are often an excellent way to increase the productivity of the labor force and are generally more effective than government-provided training (Mazumdar, 2002). Finally, improved access to education may also help to raise productivity. These options are worthy of further study to identify specific solutions in the Zambian context. Another way of raising labor productivity is to encourage skilled professionals to enter the labor force. In particular, Zambia can greatly improve the procedures by which self-employment permits are obtained. The investment certificate, which certifies that the investment benefits the country and will be issued with participation of the Immigration Department, should make the issuance of a self-employment permit an automatic act. There is no reason to evaluate the business plan and to estimate the effect on the Zambian economy twice, once by the Zambian Investment Centre (ZIC) and again by the Immigration Department independently. Since ZIC probably has more expertise in the evaluation of business proposals and financial statements, the evaluation process, if in fact required, would be naturally be led by ZIC (FIAS, 2004). The Government can also broaden the application of the self-employment permit to a wide range of sectors except those that are specifically identified. The grounds for refusing a permit should be clearly stated, thereby reducing the amount of discretion that is used. The procedures should be made clear and predictable. Finally, permits could be waived for very skilled professionals who would contribute valuable knowledge to the private sector.

In addition, firms have very little flexibility with regard to terminating employees (Bannock Consulting, 2002). The mandatory termination packages are a deterrent to hiring workers as they raise the cost of redundancy for private firms. The government needs to re-examine labor laws to determine how to be fair to workers as well as to firms that are struggling to compete. The Employment Act imposes a burden on firms by stipulating large payments to workers upon termination. According to this Act, an employee who has served with a firm for 10 years or more and is at least 55 years of age is entitled to three months basic pay per year of service. Exceptions to this rule must be approved by the Ministry of Labor and Social Security. If the employee is made redundant, he/she is entitled to one month’s notice and benefits of two months’ basic pay for each year of service. Several other benefits must also be made available upon termination. The cost of retrenchment is also high in the public sector, where similar termination rules apply. But in an attempt to also help the private sector, the government has attempted to interpret labor laws somewhat liberally, by allowing for a rolling one-year contract so employees cannot become eligible for terminal benefits. Unless this interpretation becomes solidified in law or in guidelines, it is yet another source of uncertainty for the investor. The high cost of exit is also a very important concern to the Zambian private sector, and the ambiguity of the government has resulted in firms being reluctant to hire workers because they do not know exactly how much money needs to be paid when laying them off. The Ministry of Labor needs to consider the full effects of the Employment Act and modify it to enable both the public sector and private firms to hire workers as necessary. A more reasonable termination package needs to be designed, such as the one proposed by the Minister of Labor in 1995 which argued for two weeks to a month’s worth of salary for each completed year of service.

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Finally, the Ministry of Health, the private sector, and the donor community need to pay more attention to the issue of HIV/AIDS. Due to a shortage of resources, Government’s response to the HIV/AIDS pandemic has been inadequate. In the face of an inadequate and poorly coordinated public sector response to the AIDS crisis, several major firms have resorted to self-help measures such as the provision of on-site clinics including in a few cases the provision of AIDS treatment. Smaller companies are unable to provide anything comparable. The government needs to invest more in prevention and treatment programs and leverage donor interest to the maximum extent possible. Also, the government can provide the private sector with tax incentives to provide on-site education and treatment. Data from other countries show that this is an effective way of addressing the problem (RPED, 2002, 2004). Recently, organizations have been established to deal with this problem in a promising first step. The Zambia Business Coalition on AIDS (ZBCA), Zambia HIV/AIDS Business Sector Project (ZHABS), Comprehensive HIV/AIDS Management Programme (CHAMP), and Zambia Health Education and Communication Trust (ZHECT) have been established to encourage and assist the private sector to implement HIV/AIDS workplace programs. With the recognition of limited capacity within each organization and that they were serving the same target populations, these organizations, together with the Zambia Health Integrated Project (ZIHP) and Capacity Building International, Germany (INWENT), have formed the umbrella organization Zambia HIV/AIDS Partnership in the Workplace. This Partnership, whose main purpose is to meet the need of HIV/AIDS workplace organizations, provides a forum for sharing experiences, coordination of efforts, and creation of synergies for joint programs. In addition, public sector response to HIV/AIDS in workplace has received support from the World Bank’s Multi-Country HIV/AIDS Program, (MAP) project as well as from other multilateral and bilateral partners. Overall national coordination of HIV/AIDS efforts is still a major issue in the light of continued weakness in capacity of the National AIDS Council. With prevalence rates reaching past 20 percent, there is clearly a need for a more effective response to the threat of HIV/AIDS. 5. Crime and Corruption. Legal reform. Improving working conditions in the judicial system and law enforcement would improve both prosecution rates and recovery of assets, so in cases where crime occurs, losses to firms are minimized. There are a number of steps that need to be taken-- the judiciary should be made wholly independent, courts should streamline judicial proceedings so as to expedite the resolution of cases in a timely fashion. Based on the low per capita income in Zambia, some effort should be made to create a low cost legal vehicle, such as small claims court. Zambia has taken a significant step in the right direction by initiating a mediation and arbitration process. This process should be made as widely available as possible to members of the private sector. The government should now shift the focus to implementing reforms. Some areas of the judiciary have been reformed on paper but these changes are yet to be implemented. The government can also increase funding for police and enable them to provide a more effective and quicker response to crime in the major metro areas.

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Anti-Corruption Measures. Reducing corruption also requires that the legal framework be revitalized in order to improve private sector confidence. If the case load in the Zambian court system can be significantly lowered and the amount of time required for legal proceedings can be dramatically reduced, confidence in the legal system would improve, and the judiciary may become a valuable tool in conflict resolution, reduction of corruption and sustenance of fair business practice. Finally, strong corporate governance on the part of firms, (accurate accounting, etc) is one of the best ways to detect and deter in-house economic crime. Given that corruption seems to thrive in systems rife with red-tape and cumbersome bureaucratic procedures, one necessary step is to improve and streamline policy formulation and implementation, in part by engaging the private sector meaningfully in the process, as discussed above. In addition, the government needs to encourage behavioral change among public sector officials, through the implementation of meritocratic systems of remuneration. The forthcoming FIAS report highlights very specific concerns regarding bureaucratic red tape and administrative barriers to doing business. Both the Government and the private sector need to commit to playing fairly; both parties must agree to conduct business in a clean and transparent manner. It would also useful to revitalize the Anti-Corruption Commission and to give it a renewed mandate. In particular, the commission should consider various incentives, including increasing salaries of the civil service, instituting meritocratic management and promotion procedures, increased financial transparency, and establishing mechanisms for public feedback that would reduce corruption in Zambia. Of particular concern is the Zambia Revenue Authority. Measures and procedures are required to ensure that taxpayers can report corrupt practices or other misconduct of ZRA officers without suffering retaliation. For example, FIAS interviews reported cases of ZRA officials exaggerating inspection assessments and then “settling” for smaller amounts, i.e. a more realistic assessment amount plus a “consideration” or under the table payment (FIAS, 2004). The recommendations made in the FIAS report should be implemented without further delay. The policy matrix that follows outlines the most important recommendations that need to be implemented in order to improve the investment climate.

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ZAMBIA: Matrix of Policy Recommendations

Area of policy concerns

Specific Policy Issues Observations/Comments Policy Suggestion

1. Macroeconomics and Finance

(a) Concerns about government borrowing, exchange rate depreciation and volatility. (b) Cost of, and access to finance is an important constraint.

• Bond market borrowing by the government by government is driving up interest rates. • Access to finance is particularly difficult for small and medium sized firms.

• Government should work with Parliament to rationalize the budget process. • Better management of the foreign exchange market to prevent short-run fluctuations in the supply and demand for foreign exchange by Bank of Zambia • Reduce the crowding out of private sector lending by ensuring that the government reduces the fiscal deficit and the level of government borrowing .

2. Public – Private Interaction

(a) Zambian firms ranked taxes as a binding constraint to private sector growth in Zambia. (b) Firms are very concerned about regulatory policy uncertainty. (c) There is a pressing need to strengthen the private-public dialogue.

• Firms’ concern is as much about the tax rates as it is about the structure of the tax regime. • Increased consultation will improve the quality of policy formulation as well as implementation while helping to reduce the deep-seated mistrust between the Government and the private sector.

• ZRA must review collection procedures and reevaluate the emphasis on tax collection versus other objectives such as increasing firm entry. • ZRA must reduce “sweetheart deals” to individual firms and focus on transparent and uniform method of levying taxes. Special attention should be paid to recommendations in the FIAS report. • Executive Office of the President should create a forum based on the best practice experience of other countries in Sub-Saharan Africa. This should include an Investor Round Table for public-private dialogue on key policies that affect the private sector.

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Area of policy concerns

Specific Policy Issues Observations/Comments Policy Suggestion

3. Infrastructure

(a) Firms report the availability of infrastructure to be a serious problem. (b) The cost of electricity is high.

• Of particular concern is the time and cost of obtaining water, telephone and electricity connections.

• Min of Telecom and other utility agencies must streamline the procedures by which utility connections are obtained. • Min of Telecom must reduce the perceived risks of investing in the private sector by reducing ad-hoc implementation of regulations by Zamtel, other utility agencies. • Utilities including electricity should be privatized within an appropriate regulatory framework in order to improve services, increase investment and promote competition. • Assessment of infrastructure services should be carried out via the preparation of a Country Framework Report (CFR).

4. Labor Market Issues

Our data show that Zambia is in great need of improving the productivity of its labor force.

• Improving the skills of the labor force is crucial. • Improving the flexibility of firms with regard to hiring locals and expatriates is important.

• Government should amend the labor law (CAP 276 Section 3) to reduce the cost of redundancy and to bring Zambia in line with neighboring countries. • Min of Labor should reduce the cost and barriers to obtaining employment permits. • Min of Health, donors, and the Business Coalition must increase prevention and treatment efforts for HIV/AIDS. • Further work needs to be done to determine how best to improve access to education and training.

5. Crime and Corruption

(a) Firms rate crime as a significant concern. (b) Considerable use of discretionary power by government, lack of transparency and heavy emphasis on enforcement of rules.

• Both economic crime (fraud) and non-economic crime raise the cost of doing business, improvement needed in criminal justice system. • Both corruption and red tape are serious problems.

• Government should submit to Parliament, civil service legislation to implement meritocratic systems of remuneration which will reduce corruption and eliminate patronage. • Judicial autonomy needs to be improved via budget allocation and greater political commitment. • Establishment of a small claims court to help reduce backlog in pending cases.

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APPENDIX 1: ZAMBIA SAMPLE PROPERTIES The mother population for the manufacturing sample was drawn from a list of all tax paying firms in 2002. The list comprised of 1229 manufacturing firms from the following sectors:

Agriculture and Agro-industry Chemicals Construction materials Garments and Leather Metals Mining and Quarrying Paper, Printing and Publishing Textiles Wood and Furniture

Table 1 below shows the sectoral composition of manufacturing in Zambia. Agriculture and Agro-industry account for more than half of all tax-paying manufacturing firms. However, this sector accounts for only 36% of total turnover. Metals, Paper, printing and publishing and Chemicals account for 11, 8.3 and 8% of the population of firms but lower shares in turnover. The Mining and Quarrying sector accounts for only 4.4% of the population of firms but accounts for 45% of total turnover. This concentration of activity in a few firms underlines Zambia’s dependence on the mining sector. Table 1: VAT paying manufacturing firms :by sector

Mother Population Number of firms Distribution of firms

by sector (Pct). Average Turn-

Over/firm

Million Kwacha

Total Turn-Over

Million Kwacha

Distribution of Turn-Over by sector

(Pct).

Agriculture and Agro-industry 669 54.4 4,054 2,712,121 36.3 Chemicals 98 8.0 3,406 333,756 4.5 Construction Materials 26 2.1 4,744 123,350 1.7 Garments and Leather 45 3.7 990 44,537 0.6 Metals 136 11.1 4,087 555,871 7.4 Mining and Quarrying 54 4.4 62,066 3,351,569 44.9 Paper, Printing and Publishing 102 8.3 953 97,220 1.3 Textile 24 2.0 8,564 205,528 2.8 Wood and Furniture 75 6.1 512 38,410 0.5

Total 1229 100.0 6,072 7,462,362 100.0

Manufacturing activity is concentrated in the urbanized provinces along the line of rail. For the purposes of drawing the sample, the country was divided into three regions:

• Kitwe and NorthWest-Western region • Lusaka and Southern-Central region • North-East Region

Kitwe and NorthWest-Western region includes all the industrial towns of Copperbelt province and urban centers in Western and North-Western provinces.11 Lusaka and Southern-Central region includes the capital city Lusaka, as well as urban centers along the line of rail between Kabwe and the two border towns of Chirundu and Livingstone in Southern province.

11 This region also includes Livingstone, a city located along the line of rail, at the border with Zimbabwe.

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The North-East region includes the urban centers of the Eastern, Northern and Luapula provinces. The line-of-rail regions account for more than 95% of the population of firms and nearly 99.5% of total turnover. The distribution of manufacturing activity is uniform across the line-of-rail regions. Kitwe and NorthWest-Western region accounts for 33% of the population of firms and 35% of total turnover. Lusaka and Southern-Central account for 63% of the population of firms and 63% of total turnover (see table A1 in the appendix). Total firm turnover in 2002 was used to define the following five categories

• Very small ($0-39,999) • Small ($40,000-100,999) • Medium ($101,000-500,999) • Large ($501,000-1,507,999) • Very large ($1,508,000-)

Very small firms account for 43% of the population of firms but only 0.4% of total turnover. Small and medium firms account for 40% of the population but only 5% of turnover. Very Large firms on the other hand account for only 7.7% of the population but 88% of turnover. This concentration is most pronounced in the mining and quarrying sector where 26% of firms in this sector are large firms but they account for 98% of the turnover. (see table A2 in the appendix for the sector-size class distribution of the mother population). In moving from the mother population of firms to the sampling frame, the North-East region was dropped owing to the negligible manufacturing activity located in this region. Similarly, the very small size class was dropped. The sampling frame included 650 firms. The stratification was done along 9 sectors, 2 regions and 4 size classes for a total of 72 potential strata. Tables A3 and A4 in the appendix show the distribution of the sample frame. The sampling frame includes 53% of the mother population and accounts for 98% of total turnover. The final sample of 282 firms in 65 populated sectors was drawn. This implies a sampling rate of 43% with respect to the sampling frame. The sampling probability was broadly proportional to turnover. The sampling rate for small and medium firms was 0.23 and 1.00 for large firms. In all, this sample includes 22.9 percent of the manufacturing firms in the VAT list but accounts for nearly 93 percent of the total turnover.

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Table A1: Mother Population Manufacturing - Sector/Location distribution.

Kitwe and Northwest-

Western Region

Lusaka and Southern-Central

Region

North-East Region

Total

Agriculture and Agroindustry

Number of firms 148 482 39 669

Total Turn-Over 397,176,344,385 2,277,232,031,473 37,712,515,024 2,712,120,890,882 Average Turn-Over/firm

2,683,623,948.5 4,724,547,783.1 966,987,564.7 4,053,992,363.1

Standard deviation Turn Over

(10,157,840,673.7) (23,377,315,759.3) (3,042,971,801.6) (20,446,068,330.1)

% of firms 22.12 72.05 5.83 % of total turnover 14.64 83.96 1.39

Chemicals Number of firms 32 65 1 98 Total Turn-Over 97,845,875,816 235,896,699,560 13,325,401 333,755,900,777 Average Turn-Over/firm

3,057,683,619.3 3,629,179,993.2 13,325,401.2 3,405,672,456.9

Standard deviation Turn Over

(5,571,294,351.4) (11,892,279,060.5) - (10,169,761,341.2)

% of firms 32.65 66.33 1.02 % of total turnover 29.32 70.68 0.00

Construction Materials Number of firms 7 19 26 Total Turn-Over 2,350,377,911 120,999,724,465 123,350,102,376 Average Turn-Over/firm

335,768,273.0 6,368,406,550.8 4,744,234,706.8

Standard deviation Turn Over

(403,659,921.8) (25,108,868,052.9) (21,480,535,393.4)

% of firms 26.92 73.08 0.00 % of total turnover 1.91 98.09 0.00

Garments and Leather Number of firms 18 27 45 Total Turn-Over 11,835,052,652 32,701,890,773 44,536,943,425 Average Turn-Over/firm

657,502,925.1 1,211,181,139.7 989,709,853.9

Standard deviation Turn Over

(1,308,127,089.9) (3,297,226,392.5) (2,675,925,636.3)

% of firms 40.00 60.00 0.00 % of total turnover 26.57 73.43 0.00

Metals Number of firms 79 56 1 136 Total Turn-Over 244,226,118,254 310,435,787,186 1,208,798,112 555,870,703,552 Average Turn-Over/firm

3,091,469,851.3 5,543,496,199.8 1,208,798,112.0 4,087,284,584.9

Standard deviation Turn Over

(15,041,651,701.0) (32,684,742,507.4) - (23,821,723,454.4)

% of firms 58.09 41.18 0.74 % of total turnover 43.94 55.85 0.22

Mining and Quarrying Number of firms 35 19 54 Total Turn-Over 1,714,071,942,533 1,637,497,189,000 3,351,569,131,534 Average Turn-Over/firm

48,973,484,072.4 86,184,062,579.0 62,066,095,028.4

Standard deviation Turn Over

(180,142,826,645.5) (368,662,752,319.1) (259,419,539,558.5)

% of firms 64.81 35.19 0.00 % of total turnover 51.14 48.86 0.00

Paper, Printing and Publishing

Number of firms 31 70 1 102

Total Turn-Over 18,801,058,103 78,361,378,296 57,787,436 97,220,223,834 Average Turn-Over/firm

606,485,745.3 1,119,448,261.4 57,787,435.6 953,139,449.4

Standard deviation Turn Over

(1,236,346,901.6) (2,799,069,131.2) - (2,422,910,395.2)

% of firms 30.39 68.63 0.98 % of total turnover 19.34 80.60 0.06

Textile Number of firms 15 9 24

47

Table A1: Mother Population Manufacturing - Sector/Location distribution.

Kitwe and Northwest-

Western Region

Lusaka and Southern-Central

Region

North-East Region

Total

Total Turn-Over 163,751,277,830 41,776,826,278 205,528,104,107 Average Turn-Over/firm

10,916,751,855.3 4,641,869,586.4 8,563,671,004.5

Standard deviation Turn Over

(26,556,367,022.0) (11,605,218,245.1) (22,039,783,313.3)

% of firms 62.50 37.50 0.00 % of total turnover 79.67 20.33 0.00

Wood and Furniture Number of firms 43 29 3 75 Total Turn-Over 33,950,884,094 4,318,904,888 140,560,876 38,410,349,858 Average Turn-Over/firm

789,555,444.0 148,927,754.8 46,853,625.3 512,137,998.1

Standard deviation Turn Over

(3,517,135,606.4) (222,083,554.2) (23,552,226.4) (2,672,979,907.4)

% of firms 57.33 38.67 4.00 % of total turnover 88.39 11.24 0.37

Number of firms 408 776 45 1,229 Distribution of firms by

sizeclass (Pct). 33.20 63.14 3.66 100.00

Total Turn-Over 2,684,008,931,577 4,739,220,431,919 39,132,986,849 7,462,362,350,345 Distribution of turn-

over by sizeclass (Pct). 35.97 63.51 0.52 100.00

Average Turn-Over/firm

6,578,453,263.7 6,107,242,824.6 869,621,930.0 6,071,897,762.7

Standard deviation Turn Over (54,701,270,462.1) (61,349,917,933.3) (2,843,560,409.0) (58,038,451,369.5)

48

Table A2: Mother Population Manufacturing - Sector/Size distribution.

Very Small Small Medium Large Very Large Total Agriculture and Agroindustry

Number of firms

242 123 197 56 51 669

Total Turn-Over

17,224,037,276 40,989,645,309 209,171,914,250 230,290,891,158 2,214,444,402,888 2,712,120,890,882

Average Turn-Over/firm

71,173,707.8 333,249,148.9 1,061,786,366.8 4,112,337,342.1 43,420,478,488.0 4,053,992,363.1

Standard deviation Turn Over

(61,885,934.1) (92,293,360.9) (499,041,020.0) (1,406,048,244.7) (62,088,810,741.0) (20,446,068,330.1)

% of firms 36.17 18.39 29.45 8.37 7.62 (54.4) % of total turnover

0.64 1.51 7.71 8.49 81.65 (36.3)

Chemicals Number of firms

37 11 22 16 12 98

Total Turn-Over

2,131,394,872 4,407,796,695 24,472,867,571 64,623,170,946 238,120,670,693 333,755,900,777

Average Turn-Over/firm

57,605,266.8 400,708,790.5 1,112,403,071.4 4,038,948,184.1 19,843,389,224.4 3,405,672,456.9

Standard deviation Turn Over

(66,459,904.5) (76,883,282.7) (515,885,341.1) (1,049,749,197.9) (23,608,965,165.9) (10,169,761,341.2)

% of firms 37.76 11.22 22.45 16.33 12.24 (8.0) % of total turnover

0.64 1.32 7.33 19.36 71.35 (4.5)

Construction Materials

Number of firms

11 6 7 1 1 26

Total Turn-Over

871,712,138 2,036,601,933 7,222,900,578 3,213,352,036 110,005,535,691 123,350,102,376

Average Turn-Over/firm

79,246,558.0 339,433,655.5 1,031,842,939.7 3,213,352,036.0 110,005,535,690.9 4,744,234,706.8

Standard deviation Turn Over

(64,467,496.7) (113,591,841.5) (335,160,648.4) - - (21,480,535,393.4)

% of firms 42.31 23.08 26.92 3.85 3.85 (2.1) % of total turnover

0.71 1.65 5.86 2.61 89.18 (1.7)

Garments and Leather

Number of firms

29 4 7 4 1 45

Total Turn-Over

1,118,835,092 1,254,924,463 8,458,979,274 17,280,934,822 16,423,269,773 44,536,943,425

Average Turn-Over/firm

38,580,520.4 313,731,115.9 1,208,425,610.6 4,320,233,705.6 16,423,269,773.0 989,709,853.9

Standard deviation Turn Over

(49,553,963.4) (75,301,526.8) (576,070,919.2) (821,945,253.4) - (2,675,925,636.3)

% of firms 64.44 8.89 15.56 8.89 2.22 (3.7) % of total turnover

2.51 2.82 18.99 38.80 36.88 (0.6)

Metals Number of firms

64 21 33 10 8 136

Total Turn-Over

3,381,198,540 7,258,220,272 40,449,718,367 37,695,373,091 467,086,193,282 555,870,703,552

Average Turn-Over/firm

52,831,227.2 345,629,536.8 1,225,749,041.4 3,769,537,309.1 58,385,774,160.3 4,087,284,584.9

Standard deviation Turn Over

(55,458,689.3) (94,506,328.6) (554,634,429.7) (1,268,199,922.7) (85,682,818,403.8) (23,821,723,454.4)

% of firms 47.06 15.44 24.26 7.35 5.88 (11.1)

49

Table A2: Mother Population Manufacturing - Sector/Size distribution. Very Small Small Medium Large Very Large Total % of total turnover

0.61 1.31 7.28 6.78 84.03 (7.4)

Mining and Quarrying

Number of firms

14 7 12 7 14 54

Total Turn-Over

909,367,573 1,960,427,749 15,509,765,715 24,681,174,420 3,308,508,396,076 3,351,569,131,534

Average Turn-Over/firm

64,954,826.6 280,061,107.1 1,292,480,476.3 3,525,882,060.0 236,322,028,291.2 62,066,095,028.4

Standard deviation Turn Over

(58,447,181.5) (35,755,059.4) (522,615,693.4) (1,197,985,992.6) (479,811,374,524.2) (259,419,539,558.5)

% of firms 25.93 12.96 22.22 12.96 25.93 (4.4) % of total turnover

0.03 0.06 0.46 0.74 98.72 (44.9)

Paper, Printing and Publishing

Number of firms

69 8 13 8 4 102

Total Turn-Over

2,561,367,921 3,030,398,348 12,957,545,087 36,237,945,831 42,432,966,647 97,220,223,834

Average Turn-Over/firm

37,121,274.2 378,799,793.5 996,734,237.4 4,529,743,228.9 10,608,241,661.8 953,139,449.4

Standard deviation Turn Over

(48,746,079.8) (79,711,194.6) (395,691,930.3) (1,315,878,077.0) (3,782,977,512.7) (2,422,910,395.2)

% of firms 67.65 7.84 12.75 7.84 3.92 (8.3) % of total turnover

2.63 3.12 13.33 37.27 43.65 (1.3)

Textile Number of firms

5 2 9 5 3 24

Total Turn-Over

398,487,475 653,805,195 12,370,824,149 20,674,651,434 171,430,335,854 205,528,104,107

Average Turn-Over/firm

79,697,495.0 326,902,597.5 1,374,536,016.6 4,134,930,286.9 57,143,445,284.5 8,563,671,004.5

Standard deviation Turn Over

(69,857,187.4) (169,695,974.8) (620,914,190.5) (1,786,854,510.9) (38,843,341,134.5) (22,039,783,313.3)

% of firms 20.83 8.33 37.50 20.83 12.50 (2.0) % of total turnover

0.19 0.32 6.02 10.06 83.41 (2.8)

Wood and Furniture

Number of firms

58 12 3 1 1 75

Total Turn-Over

2,370,131,801 3,962,864,506 2,711,368,855 7,164,256,799 22,201,727,898 38,410,349,858

Average Turn-Over/firm

40,864,341.4 330,238,708.8 903,789,618.2 7,164,256,798.5 22,201,727,898.0 512,137,998.1

Standard deviation Turn Over

(45,100,866.6) (80,640,865.6) (225,135,799.3) - - (2,672,979,907.4)

% of firms 77.33 16.00 4.00 1.33 1.33 6.10 % of total turnover

6.17 10.32 7.06 18.65 57.80 0.51

Number of firms

529 194 303 108 95 1,229

Distribution of firms by

sizeclass (Pct).

43.04 15.79 24.65 8.79 7.73 100.00

Total Turn-Over

30,966,532,688 65,554,684,471 333,325,883,846 441,861,750,537 6,590,653,498,803 7,462,362,350,345

Distribution of turn-over by sizeclass

0.41 0.88 4.47 5.92 88.32 100.00

50

Table A2: Mother Population Manufacturing - Sector/Size distribution. Very Small Small Medium Large Very Large Total

(Pct). Average Turn-Over/firm

58,537,869.0 337,910,744.7 1,100,085,425.2 4,091,312,505.0 69,375,299,987.4 6,071,897,762.7

Standard deviation Turn Over

(58,986,821.9) (91,003,406.5) (505,871,866.2) (1,334,588,999.8) (198,989,028,037.8) (58,038,451,369.5)

51

Table A3: Sample Frame Manufacturing - Sector/Location distribution. Kitwe and

Northwest-Western Region

Lusaka and Southern-Central

Region

Total

Agriculture and Agroindustry Number of firms 87 293 380 Total Turn-Over 382,255,178,634 2,251,714,030,458 2,633,969,209,092 Average Turn-Over/firm 4,393,737,685.4 7,685,030,820.7 6,931,497,918.7 Standard deviation Turn Over (12,986,301,582.2) (29,627,146,458.1) (26,766,766,245.1)

Chemicals Number of firms 20 41 61 Total Turn-Over 97,175,252,713 234,449,253,192 331,624,505,905 Average Turn-Over/firm 4,858,762,635.7 5,718,274,468.1 5,436,467,309.9 Standard deviation Turn Over (6,444,782,628.4) (14,634,332,937.9) (12,493,763,871.8)

Construction Materials Number of firms 3 12 15 Total Turn-Over 2,055,062,957 120,423,327,281 122,478,390,238 Average Turn-Over/firm 685,020,985.5 10,035,277,273.4 8,165,226,015.8 Standard deviation Turn Over (403,552,133.4) (31,493,449,919.7) (28,183,534,297.9)

Garments and Leather Number of firms 6 10 16 Total Turn-Over 11,502,737,472 31,915,370,861 43,418,108,333 Average Turn-Over/firm 1,917,122,911.9 3,191,537,086.1 2,713,631,770.8 Standard deviation Turn Over (1,720,607,793.5) (4,947,709,404.6) (4,010,082,327.9)

Metals Number of firms 44 27 71 Total Turn-Over 242,557,081,066 308,723,625,834 551,280,706,900 Average Turn-Over/firm 5,512,660,933.3 11,434,208,364.2 7,764,516,998.6 Standard deviation Turn Over (19,921,539,032.8) (46,800,217,673.3) (32,645,016,764.9)

Mining and Quarrying Number of firms 26 13 39 Total Turn-Over 1,713,452,945,025 1,636,179,702,666 3,349,632,647,691 Average Turn-Over/firm 65,902,036,347.1 125,859,977,128.1 85,888,016,607.5 Standard deviation Turn Over (207,303,917,698.5) (445,497,435,642.9) (302,930,629,241.7)

Paper, Printing and Publishing Number of firms 10 23 33 Total Turn-Over 17,881,490,164 76,777,365,750 94,658,855,913 Average Turn-Over/firm 1,788,149,016.4 3,338,146,336.9 2,868,450,179.2 Standard deviation Turn Over (1,672,581,836.4) (4,111,409,407.4) (3,596,020,065.7)

Textile Number of firms 14 5 19 Total Turn-Over 163,574,392,056 41,555,224,577 205,129,616,632 Average Turn-Over/firm 11,683,885,146.8 8,311,044,915.3 10,796,295,612.2 Standard deviation Turn Over (27,385,826,176.0) (15,214,992,405.0) (24,401,367,132.3)

Wood and Furniture Number of firms 9 7 16 Total Turn-Over 32,498,379,646 3,130,876,957 35,629,256,603 Average Turn-Over/firm 3,610,931,071.8 447,268,136.8 2,226,828,537.7 Standard deviation Turn Over (7,320,802,947.5) (289,687,784.0) (5,589,670,624.8)

Number of firms 219 431 650 Distribution of firms by

sizeclass (Pct).33.69 66.31 100.00

Total Turn-Over 2,662,952,519,732 4,704,868,777,576 7,367,821,297,308 Distribution of turn-over by

sizeclass (Pct).36.14 63.86 100.00

Average Turn-Over/firm 12,159,600,546.7 10,916,168,857.5 11,335,109,688.2 Standard deviation Turn Over (74,287,501,033.2) (82,045,434,735.4) (79,460,928,524.3)

52

Table A4: Sample Frame Manufacturing - Sector/Size distribution.

Small Medium Large Very Large Total Agriculture and Agroindustry

Number of firms 105 174 51 50 380

Total Turn-Over 35,805,102,091 191,115,045,122 211,443,779,139 2,195,605,282,740 2,633,969,209,092 Average Turn-Over/firm

341,000,972.3 1,098,362,328.3 4,145,956,453.7 43,912,105,654.8 6,931,497,918.7

Standard deviation Turn Over

(89,517,782.6) (510,199,894.6) (1,432,738,697.7) (62,618,816,517.4) (26,766,766,245.1)

Chemicals Number of firms 11 22 16 12 61 Total Turn-Over 4,407,796,695 24,472,867,571 64,623,170,946 238,120,670,693 331,624,505,905 Average Turn-Over/firm

400,708,790.5 1,112,403,071.4 4,038,948,184.1 19,843,389,224.4 5,436,467,309.9

Standard deviation Turn Over

(76,883,282.7) (515,885,341.1) (1,049,749,197.9) (23,608,965,165.9) (12,493,763,871.8)

Construction Materials

Number of firms 6 7 1 1 15

Total Turn-Over 2,036,601,933 7,222,900,578 3,213,352,036 110,005,535,691 122,478,390,238 Average Turn-Over/firm

339,433,655.5 1,031,842,939.7 3,213,352,036.0 110,005,535,690.9 8,165,226,015.8

Standard deviation Turn Over

(113,591,841.5) (335,160,648.4) - - (28,183,534,297.9)

Garments and Leather

Number of firms 4 7 4 1 16

Total Turn-Over 1,254,924,463 8,458,979,274 17,280,934,822 16,423,269,773 43,418,108,333 Average Turn-Over/firm

313,731,115.9 1,208,425,610.6 4,320,233,705.6 16,423,269,773.0 2,713,631,770.8

Standard deviation Turn Over

(75,301,526.8) (576,070,919.2) (821,945,253.4) - (4,010,082,327.9)

Metals Number of firms 21 32 10 8 71 Total Turn-Over 7,258,220,272 39,240,920,255 37,695,373,091 467,086,193,282 551,280,706,900 Average Turn-Over/firm

345,629,536.8 1,226,278,758.0 3,769,537,309.1 58,385,774,160.3 7,764,516,998.6

Standard deviation Turn Over

(94,506,328.6) (563,500,662.8) (1,268,199,922.7) (85,682,818,403.8) (32,645,016,764.9)

Mining and Quarrying

Number of firms 7 11 7 14 39

Total Turn-Over 1,960,427,749 14,482,649,445 24,681,174,420 3,308,508,396,076 3,349,632,647,691 Average Turn-Over/firm

280,061,107.1 1,316,604,495.0 3,525,882,060.0 236,322,028,291.2 85,888,016,607.5

Standard deviation Turn Over

(35,755,059.4) (541,071,065.5) (1,197,985,992.6) (479,811,374,524.2) (302,930,629,241.7)

Paper, Printing and Publishing

Number of firms 8 13 8 4 33

Total Turn-Over 3,030,398,348 12,957,545,087 36,237,945,831 42,432,966,647 94,658,855,913 Average Turn-Over/firm

378,799,793.5 996,734,237.4 4,529,743,228.9 10,608,241,661.8 2,868,450,179.2

Standard deviation Turn Over

(79,711,194.6) (395,691,930.3) (1,315,878,077.0) (3,782,977,512.7) (3,596,020,065.7)

Textile Number of firms 2 9 5 3 19 Total Turn-Over 653,805,195 12,370,824,149 20,674,651,434 171,430,335,854 205,129,616,632 Average Turn-Over/firm

326,902,597.5 1,374,536,016.6 4,134,930,286.9 57,143,445,284.5 10,796,295,612.2

Standard deviation Turn Over

(169,695,974.8) (620,914,190.5) (1,786,854,510.9) (38,843,341,134.5) (24,401,367,132.3)

Wood and Furniture

Number of firms 11 3 1 1 16

53

Table A4: Sample Frame Manufacturing - Sector/Size distribution. Small Medium Large Very Large Total Total Turn-Over 3,551,903,052 2,711,368,855 7,164,256,799 22,201,727,898 35,629,256,603 Average Turn-Over/firm

322,900,277.5 903,789,618.2 7,164,256,798.5 22,201,727,898.0 2,226,828,537.7

Standard deviation Turn Over

(80,264,501.2) (225,135,799.3) - - (5,589,670,624.8)

Number of firms 175 278 103 94 650 Distribution of firms by sizeclass

(Pct).

26.92 42.77 15.85 14.46 100.00

Total Turn-Over 59,959,179,800 313,033,100,336 423,014,638,517 6,571,814,378,655 7,367,821,297,308 Distribution of

turn-over by sizeclass (Pct).

0.81 4.25 5.74 89.20 100.00

Average Turn-Over/firm

342,623,884.6 1,126,018,346.5 4,106,938,238.0 69,912,918,921.9 11,335,109,688.2

Standard deviation Turn Over (89,109,641.8) (513,399,962.1) (1,345,240,784.3) (199,986,624,649.2) (79,460,928,524.3)

54

APPENDIX 2: ADDITIONAL DATA FOR SERVICES

Table A.2.1: Respondents' Evaluation of General Constraints to operation % Firms reporting constraint as major or severe

Sample Non -

Exporter Exporter Foreign Domestic

Macroeconomic instability 78.3 79.4 75.7 74.4 80.0 Cost of financing 72.1 71.7 73.0 61.5 76.7 Economic and regulatory policy uncertainty 65.1 59.8 78.4 66.7 64.4 Tax rates 51.9 57.6 37.8 43.6 55.6 Corruption 48.1 47.8 48.7 51.3 46.7 Access to finance 43.4 42.4 46.0 30.8 48.9 Crime, theft, fraud and disorder 39.5 40.2 37.8 41.0 38.9 Availability of equipment for leasing 36.4 32.6 46.0 35.9 36.7 Telecommunications 34.1 34.8 32.4 38.5 32.2 Customs and trade regulation 32.6 30.4 37.8 43.6 27.8 Tax administration 29.5 30.4 27.0 25.6 31.1 Legal system/contract regulation 25.6 25.0 27.0 35.9 21.1 Foreign exchange/currency regulations 24.0 27.2 16.2 25.6 23.3 Skills and education of available workers 21.7 17.4 32.4 25.6 20.0 Anti-competitive behavior 20.9 20.7 21.6 20.5 21.1 Access to land/security of tenure 19.4 17.4 24.3 15.4 21.1 Transportation 18.6 15.2 27.0 18.0 18.9 Labor regulations 18.6 16.3 24.3 30.8 13.3 Electricity 17.1 19.6 10.8 5.1 22.2 Procedures to access land and premises 17.1 17.4 16.2 18.0 16.7 Business/sectoral licensing and permits 16.3 14.1 21.6 23.1 13.3 Environmental regulations 10.9 9.8 13.5 18.0 7.8 Fire/safety and sanitary regulations 10.1 9.8 10.8 12.8 8.9 Standards and certification 8.5 6.5 13.5 15.4 5.6 Price regulations 8.5 8.7 8.1 10.3 7.8 Business inspections 8.5 12.0 0.0 5.1 10.0 Duty drawback 7.8 7.6 8.1 7.7 7.8 Registering a new company 6.2 4.4 10.8 12.8 3.3

Table A.2.2: Infrastructure Indicators – Service Sector

Sample Non-exporter Exporter Foreign Domestic

Freq of power outages (times) 20.6 20.5 20.7 21.5 18.6 Own a generator (%) 34.1 31.5 40.5 26.7 51.3 Have built own well (%) 37.0 30.0 56.0 42.0 26.0 Production lost in shipment (%) 0.5 0.4 0.7 0.4 0.6 Wait to obtain telephone connection (days) 47.6 26.8 68.4 46.8 48.4 Wait to obtain electricity connection (days) 39.6 42 36.0 25.3 61.0

55

REFERENCES Batra, Geeta and Syed Mahmood, “Direct Support to Private Firms: Evidence on Effectiveness,” WBS3170. (The World Bank, 2003). DCDM Consulting, 2002, Zambia Case Study. DCT Consultancy Services. A Strategy for Diversifying the Economy of the Copperbelt Region of Zambia (World Bank, 2003). Economist Intelligence Unit. Zambia Country Report 2004-05 (London: The Economist Intelligence Unit, 2004). Economist Intelligence Unit. Zambia Country Report 2002 (London: The Economist Intelligence Unit, 2002). Foreign Investment Advisory Services. Administrative Barriers to Investment in Zambia, (The World Bank, 2003). Hall, Robert E., and Charles Jones. 1999 “Why Do Some Countries Produce so Much More Output Per Worker than Others?” Quarterly Journal of Economics 114(1): 83-116 The Heritage Foundation. 2004 Index of Economic Freedom (Washington: The Heritage Foundation, 2004). IRIN News, 2002, Zambia: Corruption Index Highlights Perceptions, December 19. D. Kaufmann and A. Kraay (Fall 2002) “Growth Without Governance,” Economia, Volume 3, Number 1 PriceWaterhouseCoopers, 2002, Counting the Cost: An Economic Crime Survey in Zambia, Tanzania and Kenya. Transparency International, Corruption Perception Index, 2003. The World Bank, Privatization Review of Zambia: Facts Assessments and Lessons (World Bank, 2002). The World Bank. Doing Business Indicators. (World Bank, 2004). The World Bank. Public Expenditure Management and Financial Accountability Review, Report No 26162-ZA. (The World Bank, Nov 2003).

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