WORLD BANK GROUP AFRICA REGION, PRIVATE SECTOR UNIT 33675 SEPTEMBER 2005 Summary of Zambia Investment Climate Assessment The Zambian Investment Climate Assessment (ICA) was conducted to support the Zambian economy as it diversifies away from dependence on volatile copper extraction and enhances the competitiveness of its private sector. Current under- ■ productivity in Zambia is fed by low quality inputs rooted in and exacerbated by a difficult investment climate, as shown NOTE NUMBER 5 by Zambia’s low Institutional Investor rating (Table 1). The main investment climate constraints in Zambia are macroeconomic instability, regulatory policy uncertainty and administration, inefficient labor and infrastructure markets, and corruption. An improved investment climate based on a stable macroeconomic environment of lower interest rates and inflation and amendment of current practices would encour- age investment, create jobs, and fight poverty. This note summarizes the ICA undertaken in Zambia in 2003. It is based on a survey of over 200 service and manufacturing firms of differing locations and sizes. It aims to highlight the conditions inhibiting productive investment and discusses policy options for private sector support. Per capita gross domestic product (GDP) in Zambia de- porting copper to generate foreign exchange, and efforts to clined for more than three decades, falling from $700 in diversify production and exports began only in the 1990s. 1970 to $390 in 1998. This trend appears to have been Nontraditional exports have since expanded, but their reversed recently as a result of the new approach to eco- share remains less than one-third of the total. Private sec- nomic management put in place in the late 1990s, when tor development can support these reforms and strengthen the government began to focus on fiscal discipline, better the economy as it attempts sustainable growth. governance, and the promotion of economic growth. The economy responded favorably to the new policies, produc- Productivity Concerns for ing four consecutive years of solid growth, with real GDP the Private Sector rising 3.7 percent per year between 1999 and 2002. Since independence, Zambia has relied almost exclusively on ex- Empirical analysis of firm productivity underlines the im- portance of capital and labor inputs, which are of poor quality in Zambian firms. Two characteristics of firm pro- Table 1. Institutional Investor Ranking, 2002 ductivity, in particular, constrain firms in Zambia: Regional Global Credit One-Year Rank Country Rank Rating Change Capital productivity is low, while capital intensity is 1 Botswana 39 59.0 2.3 high. Zambian firms use over $12,000 of capital per unit 3 South Africa 52 52.7 3.2 of labor, whereas their East African comparators average 14 Uganda 111 20.0 –1.4 approximately $3,500. Likewise, value added per dollar of 23 Zambia 128 15.8 –0.2 each unit of capital is only 23 cents in Zambia, compared 29 Zimbabwe 142 11.9 –1.1 with Uganda where returns are three times that amount. Average 114 21.6 1.2 Diminishing returns are caused by low quality capital with Note: Credit rating has values within the range of 0 to 100, with 100 being an average age of 6-10 years. the highest. Nominal wages are low, but the real cost of labor is Source: Institutional Investors (2003) high. Zambia’s low wages offer no advantage to inves- tors because they are offset by low productivity. The me- Figure 1. Median Value Added Per Worker (U.S. dollars) dian value added per worker is low relative to comparator countries, as shown in Figure 1. The average ratio of labor 4500 (Median Value Added per Worker in US$) to value added is 0.41 in Zambia compared with 0.32 in 4000 Productivity of Labor by Country China. This poor performance is due in part to poor educa- 3500 tion and outdated labor laws, such as costly severance laws 3000 that impose huge burdens and suppress income, as well as 2500 inefficient hiring and firing practices. These distortions are 2000 exacerbated by cumbersome permit procedures and the 1500 HIV/AIDS epidemic, which forces firms to train multiple 1000 people for key positions, increasing recruitment costs and lowering productivity. 500 0 CHINA INDIA ZAMBIA UGANDA KENYA TANZANIA Contraints to Investment Climate Low productivity cannot be accounted for solely by the quality of inputs. It is also a product of a poor investment concerns of investors regarding firm operation and growth climate, which exacerbates poor quality inputs. To promote in Zambia. This report focuses on the top five constraints and sustain growth, governments must enable a competitive from the view of the firms surveyed and then identifies op- business environment. However, as the recent rating “D” by portunities for improvement. the Economist Intelligence Unit Country Risk assessment indicates, the Zambian private sector is perceived as difficult 1. Unstable macroeconomic conditions and inaccessible and the government’s policies are perceived as constraining. capital depress incentives for investment, especially for The firm survey outlined in Table 2 emphasizes the major smaller firms with no access to microfinance. The cost Table 2. Respondents’ Evaluation of General Constraints to Business Operations (% of firms evaluating constraint as “major” or “very severe”) Non- Foreign- Zambia Small Large Exporter Exporter Owned Domestic 1 Cost of financing 82.1 85.7 80.3 82.2 81.8 75.4 84.9 2 Macroeconomic nstability 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 17.1 17 Business licensing & permits 10.1 7.8 9.1 11.2 7.3 13.1 8.9 of capital in Zambia is too high. The average surveyed firm requires an average bribe of 3.7 percent of the contractual with a loan paid an annual interest rate of over 28 percent. value. The judicial system also suffers from poor training The collateral required for a loan averages three times the that leads to a substantial case backlog. loan size. This high cost of capital is driven by government bond market borrowing, which crowds out investment, 4. Firms are concerned about the poor quality and limit- and is spurred by high budget deficits of over 13 percent ed availability of infrastructure services. Unreliable elec- of GDP. tricity lowers productivity because of work stoppages, time Fiscal imbalances increase inflation and interest rates, needed to reset machines, ruined production, and damage which in turn increase risk to investors. Nearly 74 percent to equipment. Electricity provision in Zambia is quite inef- of firms surveyed rated macroeconomic instability as a se- fective, with an average of 37.2 power outages in 2004 alone. vere constraint, compared with half the firms in comparator Firms in China lose an average of 1.8 percent of produc- countries. Bond market borrowing by the government de- tivity due to outages but firms in Zambia lose more than presses the exchange rate and makes already high inflation double that amount (4.5 percent). volatile, raising the risk premium on loans. This situation is exacerbated by huge deficits that restrict monetary control 5. Lack of labor flexibility reduces productivity and dis- and cause the government to rely on the Bank of Zambia to suades investment. The majority of Zambian labor laws service external debt. have not been amended in 20 years. Severance pay in Zam- bia constrains firm productivity, because it is far higher 2. Despite reform, taxation and tax administration con- there than in other countries in Africa. Zambia requires tinue to inhibit profitability, and inconsistent regula- firms to pay termination benefits of 2–3 months base salary tions encumber investment. The tax burden in Zambia for every year of service, so a person employed for 20 years in is high relative to comparator countries. World Develop- Zambia would receive 20-30 months of salary. By contrast, ment Indicators show real tax burdens in Zambia, where the same person in Kenya or Tanzania would only receive the highest marginal tax rate is higher than the rate of its 10-12 months of pay. neighbors by five percentage points, as is the tax-to-GDP ratio. Policy Options The Foreign Investment Advisory Service highlights the onerous policies of tax administration by the Zambia The various business impediments outlined above impose Revenue Authority. Frequent and unpredictable changes in high financial and opportunity costs on firms in Zambia, procedures and badly trained officials with wide discretion- depressing potential investment and productivity (see fig- ary powers invite corruption and arbitrary practices. ure 2). Comparisons with other countries inside the region Regulatory policy is also cited as an important con- show that the constraints are more severe and widespread straint. Only 28 percent of Ugandan firms cite regulatory in Zambia than in most of its neighbors. To help create a policy as an important problem compared with 57 percent better investment climate and support sustainable growth, of firms in Zambia, where foreign direct investment (FDI) has declined over the last five years. Inconsistent policies— Figure 2. Inflows of Foreign Direct Investment such as the recent change in immigration laws requiring all non-Zambians to renew unexpired permits at high costs— 250 increase firms’ perceived risk in investment. Foreign Direct Investment in Zambia 200 3. Perceptions of weak law enforcement and fierce cor- in US$ million ruption hinder investment. Although 77 percent of Zam- 150 bian firms claimed losses due to theft or other crime in the previous year, only half of these cases were reported and 100 only a quarter of those were solved, which suggests that the low confidence in the police system is justified. Corruption 50 ranks among the top five constraints for firms with FDI. 0 Firms spend an average of 1.7 percent of their total revenue on bribes to facilitate operations, and a government contract 1985–95 1998 1999 2000 2001 2002 priority should be given to the following policies in five main • Labor Market Issues: areas of concern: 6. Amend the labor law to reduce the cost of redun- dancy. • Macroeconomics and finance: 7. Require ministries to take responsibility for needed 1. Manage better the budget process, stabilize the for- reforms within their areas; for example, the Min- eign exchange market, and decrease the fiscal defi- istry for Labor must investigate red tape and the cit. Ministry for Health must increase prevention and • Public-Private Interaction: treatment efforts for HIV/AIDS. 2. Review current collection procedures and create • Crime and Corruption: new uniform procedures for the Zambia Revenue 8. Improve judicial autonomy through budget alloca- Authority. tion and greater political commitment. 3. Improve public policy dialogue to increase under- 9. Establish small claims court to reduce backlog of standing between the government and the com- cases. panies driving private investments and to identify and accelerate measures to address impediments to The future of private sector–led growth does not lie in reform. selected industry promotion by the Zambian government • Infrastructure: but rather in creating policies and institutions that encour- 4. Assess current practices of infrastructure services age investors to productively and creatively employ their to identify areas for improvement. resources and people. Addressing the constraints identi- 5. Privatize utilities within an appropriate regulatory fied in the survey will advance the government’s capacity to framework to improve services and promote com- strengthen the Zambian economy and support its strategy petition. for poverty reduction. This note is part of a series of summaries of analytical work of the Africa Private Sector Unit. This note is authored by Shireen El-Wahab based on a report entitled Zambia Investment Cli- mate Assessment ( June 2005). The report was written by a team led by Constantine Chikosi, and including Vijaya Ramachan- dran, Linda Cotton, Chad Leechor, and James Habyarimana. For more information, contact Melanie S. Mbuyi via email at mmbuyi@worldbank.org or via telephone on 202 473 9574. A copy of the report is also available from www.worldbank.org/afr/ aftps