An Analysis Of Constraints To Inclusive Growth In Zambia

Presented by

Ngoza Munthali

IGC Growth Week, LSE

Provide a summary of constraints to inclusive growth in Zambia based on the report done by MCA-Zambia on “An Analysis of Constraints to Inclusive Growth in Zambia”

Purpose of the Presentation

Outline of the Presentation

• Methodology

• Findings

• Issues for discussion

Methodology

• Inclusive Growth (IG) diagnostic framework – a modification of the Hausmann, Rodrick and Velasco (HRV) growth diagnostic framework

• IG framework premised on productive employment as the main channel for achieving sustainable and inclusive growth

Methodology

Methodology

• Describing the growth process and determining the relevant growth story question/s

• Finding the binding constraints based on the employability and business environment analysis

• Identifying the root cause/s of the binding constraints

Growth Story

Growth Story

Growth Story

• Real GDP growth driven by developments in the international price of copper and its impact on the mining sector

• Further depression of real GDP growth during the period 1973 to mid 1990s due to poor response to the large TOT shock

✤ Heavy borrowing to finance consumption and investment in capital intensive import substitution industries

✤ Price controls, subsidies, etc

• Late 1990s beginning of diversification by capitalising on Zambia’s advantage in land-intensive primary goods

Growth Story

• Mining products still dominate merchandise exports (76%) making Zambia vulnerable to TOT shocks and Dutch disease effects

• The extent of the value-addition of the country’s exports also remain low despite broadening of its export products and markets

Growth Story

Aggregate poverty levels declined only slightly and remain high, especially in rural areas

Growth Story

Most rural poor are smallholder subsistence farmers...

Mean shares of household income by source, income quintile, rural areas

Growth Story

Value added per worker in Zambia

Labour productivity is much lower in agriculture than other sectors in which 70% of the Zambians earn their income

70% 23% 7%

Growth Story

Most urban poor are engaged in informal businesses and rely on multiple activities as a source of income

Mean shares of household incomes by source, by quintile, urban areas

So What Are The Growth Story Questions?

• Why has Zambia’s GDP per capita growth not reached levels attained in the first years of independence?

• What is constraining growth from being more inclusive and making a serious dent on poverty?

Binding Constraints Findings

Inclusive Growth Framework

Binding Constraints Findings

• Poor health status and low productivity are binding constraints

✤ HIV/AIDS have lowered annual real GDP growth on average by 0.3 percentage points since 1992

✤ Access to education beyond primary level a constraint to productive employment including specialized skills

Binding Constraints Findings

Binding Constraints Findings

Finance

Finance

• Access to finance and high cost of finance a challenge for MSMEs

• Poor financial intermediation attributed to this challenge

✤ Small size and coverage of the banking sector

• Low incomes among MSMEs leading to low demand for financial services

• Overall, access and high cost of finance not a binding constraint

✤ Private sector credit % of GDP increasing, interest rates spreads narrowing, domestic savings as a share of GDP increasing

Infrastructure

Infrastructure

• Infrastructure services are binding constraints in the following areas:

✤ Electricity supply – access is declining, delays in connections (93 days), quality of service is poor

✤ Water supply and sanitation – access to piped water on the decline, average consumption of water for drinking & other domestic use for rural households about 20 litres well below the average required for achieving a clean disease free environment

✤ Feeder roads

✤ Poor land transport links and high travel costs

✤ Railway transport

Natural Capital and Geography

Natural Capital and Geography

• Natural capital and geography not binding constraints

• Concerns in the following areas:

✤ Future growth risks due to climate change effects

✤ Degradation of soils in some parts of the country

✤ Unsustainable exploitation of natural capital

✤ Difficult to reach export markets and access cheap imports because of Zambia’s landlocked status

Government Failures

Government Failures

• Micro risks

✤ Not a binding constraint - investment and business climate has improved over the last five years

✤ Areas of concern – time and cost to export and import across borders, high costs of licensing, high redundancy costs, low public sector implementation capacity

Government Failures

Doing business ranking improving…

• Macro risks ✤ Not a binding constraint ✤ Areas of concern – exchange rate fluctuations and

appreciation pose a challenge to the growth of non-traditional exports (the question of the Dutch Disease effect), public finance sustainability and governance

Government Failures

Market Failures

Market Failures

• Coordination and information failures are binding constraints, especially to export sophistication

✤ Coordination failures attributed to infrastructure service related inputs, energy, transport and water which provide a link between producers and consumers and information failures such as marketing, research and product quality development

• Coordination and information failures more severe for the poor who cannot afford the fixed costs associated with finding alternative sources

Recap of the Constraints

• Low productivity and poor health status are at the root of low employability of the Zambian population

• Poor infrastructure services - electricity, road connectivity, rail transport and water supply and sanitation especially in rural and peri-urban areas

• Coordination failures – failure to provide complementary goods and services to help private investors to be profitable, innovative and competitive

Issues for Discussion

• High cost of finance not a binding constraint especially for MSMEs – heavily contested

• Railway transport – does it really offer an alternative to the current inadequate land transport?

• Exchange rate appreciation and Dutch disease effects – is it a binding constraint?

• Export diversification versus export sophistication – what has happened in the last 17 years?

Thank you for your attention!

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September, 2011

Anthony M. Simpasa Financial Markets Department

Bank of Zambia

Discussion on Presentation made at the Growth Week 2011 Conference

Zambia Session London School of Economics

CONSTRAINTS TO GROWTH IN ZAMBIA

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CONTENTS

1. Introduction 2. Overview of macroeconomic performance 3. Constraints to Growth 4. Policy Options and Potential Benefits 5. Conclusion

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1.0 Introduction

Zambia’s growth record has been dismal historically, but recent evidence

shows a strong recovery in economic performance

Real Gross Domestic Product (GDP) growth has averaged above 5% per annum over the past decade.

The unique feature of this growth momentum is that it has been broad based and less variable.

Underpinned by favourable macroeconomic policy environment coupled with strong private sector response

But accelerated growth hampered various constraints

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2.0 Overview of macroeconomic performance

Over the past decade years, Zambia’s macroeconomic performance has been

reflected in:

Positive Real GDP growth, which has averaged 5.6% per annum from 2001-2010 (see Chart 1);

Rising per capita GDP to US$1,253 in 2010 from less than US$350 in 2001

Economic growth has been broad based, signaling efforts for diversification; Inflation declined to single digit of 7.9% in 2010 from 18.7% in 2001;

Declining lending rates to an average of 14.4% in 2010 from 54.6% in 2001; and Strong real exchange rate

Easy of doing business in Zambia ranking from 84 in 2010 to 76 in 2011 (World

Bank, 2011). Ranked 4th in Africa.

2.0 Overview of Macroeconomic performance

Due to macroeconomic stability, the country is now building resilience to external shocks;

Evidenced by rapid recovery from the effects of the global economic crisis;

This raises prospect of durable economic growth; …as foreign direct investment has increased; Driven largely by the boom in the mining industry and the associated

second order effects (e.g., construction boom); Total FDI in 2009 stood at US$7.5 billion, US$4.5 billion of which

was recorded in the mining industry (GRZ, 2010); The current period of expansion is the strongest and lengthiest that

the Zambian economy has witnessed in recent memory; Zambia recently reclassified as a low middle income country; Credit rating of B+ by Fitch and, Standard and Poors.

2.1 Macroeconomic stability and investment

3.0 Constraints to Growth

Despite the favourable developments, the country still suffers from long-standing economic bottlenecks and structural impediments;

Undermined competitiveness, limited job creation and derailed poverty reduction efforts;

Sources: high indirect costs related to infrastructure deficiencies and inefficiency inadequate skills and costs associated with service-related inputs

Macroeconomic stability is essential but needs to be supported by structural and micro-level policy reforms;

This will enable the country to reach a high threshold of a competitiveness driven growth.

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Constraints

• The fundamental constraint to Zambia’s growth is the inadequacy and poor quality of infrastructure, in its broadest sense;

• Unavailability and low quality of infrastructure have reduced economic returns to private investment;

• Hard infrastructure - roads, railways, storage facilities, etc.;

• ‘Soft’ infrastructure - information communications and technology, institutions;

• Laws and other governance related structures (e.g., contract enforcement procedures;

• Key in enhancing efficient investment and competitiveness

Constraints

Electricity and energy Hydropower major source (99.4% in 2006); Excess demand, largely driven by mining activity; Long delays in providing electricity connection - 100 days to connect; Frequent disruptions – result in losses averaging more than 8% of output Low use of alternative energy (e.g., solar, wind, etc)

Transport High transportation costs; Poor state of the road network and dilapidated railway system. Paved road percentage is low and concentrated in the urban areas; Poor state of roads (feeder) limits market access and integration; This has created obstacles to increases in rural incomes and perpetuated high

poverty levels; Inadequacy of air transport facilities hinders tourism development;

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Constraints

Irrigation and large water works Most of Zambia’s agriculture production is rain fed;

Water retention facilities (dams, etc.) and harvesting techniques

are generally underdeveloped;

Inadequate irrigation infrastructure;

As a result, water productivity – GDP/water use – is only $1.6 in 2000 constant prices;

This has limited agricultural productivity and the choice of crops in the areas lacking irrigation services

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Constraints

Water and Sanitation Despite advances made in regulating and commercialisation of

the water supply system; Underinvestment in public water and sanitation supply facilities

due to budget cutback (Dagdeviren, 2008); Firms and households self-provide; Lack of regulatory enforcement of illegal connections and

dumping of waste, unplanned installations of water facilities such as sinking of boreholes;

Poor sanitation affects health of the population due to the spread of water borne diseases

Costly treatment of preventative diseases Effects on labour productivity as well.

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Constraints

Labour Productivity Zambia is a highly capital intensive economy despite excess

labour supply; Capital use per unit of labour estimated at more than three times

its East African peers; Only 23 cents per dollar of each unit of capital employed is

translated into value added, compared with Uganda’s 70 cents (World Bank, 2003);

This has resulted in severe diminishing returns to capital; Real cost of labour high to due to low levels of labour

productivity; The cost of labour is also high due to high severance and

redundancy cost of more than 140 weeks of wages.

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Constraints

Information communication and technology (ICT) Over the past few years, there has been considerable growth in the

telecommunications sector; Marked by phenomenal private investment; Three service providers, one recently privatised; In 2006, 46% of the population was within reach of a mobile signal.

This rate has increased to above 62%; However, fixed line connectivity remains poor, particularly in rural

areas where it is virtually non-existent; Information and technology sub-sector also lagging behind; Internet connectivity is characterised by poor coverage - only 1.2

secure internet servers per 1 million people Zambia’s connection is largely through satellite - limited bandwidth and

transmission delays.

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Undeveloped financial markets and cost of capital Financial liberalization has significantly improved the financial

landscape; FSDP I emphasised need to develop financial sector FSDP II focusing on competition, accessibility, inclusion, literacy, etc. More participants – banks, NBFIs, institutional investors; However, the financial sector remains shallow and illiquid; Financial sector dominated by the banking industry; Capital market still underdeveloped Lack of diverse sources of long-term finance Cost of credit still high for a majority of private firms, particularly the

SMEs (World Bank, 2008); Wide spreads and high real lending rates (>17% and 12%); Credit Reference Bureau established to address information

asymmetry related constraints to credit access FinMark Trust surveys attribute low inclusion to both demand and

supply factors;

Constraints

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Policy Options

Increasing public investment in infrastructure Exploring different financing mechanisms such as PPP; One-stop border points part of PPP framework Expansion of electricity generation capacity also taking PPP route; The government has also placed rural electrification high on the agenda to

accelerate economic development in rural areas; Tariffs revision to attract the private sector in the electricity industry; In the transport sector, the government has earmarked to spend more than

90% of the total transport resource requirements on roads under the SNDP; Upgrade airports – Kasaba bay, Mfuwe, Livingstone, etc This should help reduce freight costs and improve efficiency of

transportation services; Grading of feeder roads to improve access to agricultural markets

Policy Options

Liberalisation of international gate way to reduce connecting tariffs Improve quality of infrastructure, particularly ICTs to bridge the rural-

urban divide and enhance communication and market access; Enhancing state capacity to improve efficiency of the public service and

governance institutions; Luiz (2009) provides evidence that African states do not possess this

level of capacity but it garnered innovative partnerships. Reducing commodity dependence and diversifying the economy Need to expand the export base, focussing on value adding non-

traditional exports will raise the country’s foreign exchange earning capacity;

Continued implementation of macroeconomic and structural reforms will unlock potential of the country to register higher growth

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Potential benefits

Absence of data – affects quantification of financial losses to the economy from various infrastructure deficiencies;

Estimates suggest sizable potential benefits that would accrue from improvements in infrastructure services.

In Zambia, increasing investment in infrastructure to the tune of the required US$500 million will eliminate the inefficiencies that cause the loss of $300 million per annum;

Improving Zambia’s infrastructure endowment could boost output growth by up to 2 percentage points per annum (Foster and Dominguez, 2011);

Enterprise surveys have also shown that improving infrastructure will raise firm productivity by about 50 per cent;

Removing governance distortions, red tape and slippages will account for the remaining half;

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Potential benefits

Skills upgrade will trigger huge productivity gains and facilitate innovation and technology diffusion;

Need for government to set the agenda for investing in skills enhancing areas such as upgrading the technical and vocational training and reforming labour laws;

Improving healthcare services and accessibility, including continued efforts at combating the spread of HIV/AIDS will strengthen the human capital base;

This will ensure that the poor benefit from future growth of the non-farm economy;

Tackling market coordination failures must be approached with equal vigour in order to avoid interrupted reforms and growth spurts;

Enhancing state capacity and improving effectiveness of governance institutions, would reduce cost of delays, say in, contract enforcement, currently 39% of claim;

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5.0 Conclusions

Infrastructure deficiencies have undermined industrial productivity and reduced the potential of the economy to grow at a much faster pace;

High cost of credit stifled growth of SMEs and left economy trapped in informality

Zambia needs to create the right conditions to exploit the advantages of information-based technology to enhance productivity and competitiveness of the private sector;

Improving efficiency of the public sector and strengthening state capacity in implementing key policies is critical in improving business environment;

Explore new models of financing infrastructure investment; Emphasise need for regulatory and institutional change and

recommending avenues for more efficient planning and delivery of infrastructure services;

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Conclusions

Assess potential cost savings arising from improvements in infrastructure services to avoid creating unproductive public investments;

There is need to rethink the diversification strategy - move away from a comparative advantage driven growth to competitive advantage;

The reasons to take deeper and more meaningful policy measures is simple:- Zambia is experiencing unprecedented investment and growth expansion cycle

– where businesses need access to capital and other input services;

Failure to sustain this growth momentum would have significant consequences to the real economy and poverty reduction.

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THANK YOU

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