Case study overview: Zambia Elena Ianchovichina PRMED, World Bank Joint Vienna Institute June, 2009

Step 1: Overall dynamics

3 Higher and less volatile growth rates

Development driven by discrete events or potentially sustainable growth?

Loans to the private sector

Rural poverty reduction not responsive to growth

Step 2: The profile of the economic actors

What were the sources of income for the rural poor in Zambia? Most rural poor were smallholder subsistence farmers

What were the sources of income for the urban poor in Zambia? Most urban poor were employed in informal businesses and relied on multiple activities as a source of income

Substantial productivity differentials  Labor productivity in agriculture much lower than labor productivity in other sectors  Paths out of poverty: mainly through new employment opportunities in low- cost urban areas, or higher returns in other urban areas

Any reasons to focus on agriculture?  Even a sizable increase in employment in urban industries will result in relatively few urban jobs  Evidence that there is potential for productivity improvement in agriculture

The booming mining sector: implications for employment  The capital intensive nature implies that few new jobs are created  Adverse REER effects on the competitiveness and job opportunities of the tradable sectors

Look for constraints to inclusive growth  Consider agriculture as well as non-agriculture activities  Self as well as wage employment

Step 3: Going through the tree

Economic Growth Poverty Reduction/ Inclusion Wage-employedSelf-employed Employability Analysis (EA) Business Environment Analysis (BEA) Income increases through productive employment EA: Individual constraints viewed from the perspective of different economic actors BEA: Firm constraints viewed from the perspective of different economic actors

Is education a major constraint for the poor as individuals?  Major difference in mean years of education between the rich and poor households in urban areas, and limited access to higher education in rural areas Percentage of households with access to education facilities within five kilometers

Is health a major constraint for the poor?  HIV/AIDS costs almost 1 percent in GDP growth per year Prevalence rates are high: 17% of working age population in 2005 compared to the SSA average of 6%. High prevalence rates combined with poor health care provision and other diseases undermine  Labor stock and ability to provide labor  Productivity of the work force  Incentives for investment

Are material assets and access to land a major constraint to labor supply?  Rural households are in general asset poor  Customary land arrangements with limited transfer possibilities are dominant, with only 6-15% of land under statutory tenure  The land system is not perceived as a binding constraint to inclusive growth Land is abundant – only 40% of arable land is used Most smallholders who demand more land get land from their chiefs (only 4% of respondents mentioned lack of land as a reason for poverty) Despite small plot sizes, a typical household does not have capability to cultivate more land The system creates risks to future returns on investments Lack of serviced land with access to infrastructure is a perceived binding constraint to operations implying not land, but rural infrastructure is a bottleneck

Economic Growth Poverty Reduction/ Inclusion Wage-employedSelf-employed Employability Analysis (EA) Business Environment Analysis (BEA) Income increases through productive employment EA: Individual constraints viewed from the perspective of different economic actors BEA: Firm constraints viewed from the perspective of different economic actors

Business Environment Analysis Returns to economic activity Social Returns Private Appropriability Government failures Macro risksMicro risks Market failures Cost of finance International sources of finance Local sources of finance Domestic savings Financial sector intermediation

Is the cost of capital a binding constraint to firms’ investment and growth?

But, cost and access of capital differentials are sizable  Access and cost of capital varies with the size of the firm In 2003, nearly 50 percent of larger firms had a loan, while only 19 percent of small firms had a loan The cost of capital differential between large and small firms was more than 10 percentage points Similar differentials existed between the cost of capital of exporters and non-exporters, domestic and foreign companies Micro firms face even steeper constraints

What are the reasons for the poor access to and high cost of finance for small and micro firms?  Poor financial intermediation rather than low domestic savings or bad international finance Domestic savings as a share of GDP climbed up from 6% in 1990s to 18.1% in 2006, a share higher than the SSA average FDI and aid have been higher than the average for SSA and LICs both in 1990s and 2000s  However, there are signs of improvements the percentage of people identifying the cost of finance as the main reason for their poverty status halved in the period

Business Environment Analysis Returns to economic activity Social Returns Private Appropriability Government failures Macro risksMicro risks Market failures Cost of finance International sources of finance Local sources of finance Domestic savings Financial sector intermediation

Do low social returns constrain income growth?  Zambia is well endowed with natural resources  Landlocked geographic position: Pros: Serves as an import tax protecting domestic import- competing industries; borders 8 countries and plays an active role in regional trade Cons: reaching global markets and realizing economies of scale is a problem  Affects ability to export bulky low–value products (e.g. farm products)  Requires well-developed air transport and an emphasis on high value, low weight and volume goods

Access to air transport is low for Zambia’s level of per capita income

Are infrastructure and basic services a binding constraint to income growth?  High domestic transport costs due to poor domestic road condition and high fuel costs: affect the ability of rural residents to access markets;  The reasons for poor access is not always because of limited supply (e.g. electricity), but because of industry structure and interests  Poor quality and expensive basic services undermine the competitiveness of firms and slow down job creation

Cost-structure: firm-level averages Source: Eifert, Gelb, and Ramachandran (2005)

Connectivity services Mobile rates per minute Source: Mattoo and Payton (2007)

Business Environment Analysis Returns to economic activity Social Returns Infrastructure services Binding constraint to growth Private Appropriability Government failures Macro risksMicro risks Market failures Cost of finance International sources of finance Local sources of finance Domestic savings Financial sector intermediation

Is the macroeconomic environment a binding constraint to inclusive growth? Exchange rate developments

Changes in the second half of 2008  Kwacha significantly depreciated Strengthening of the US dollar Falling copper prices Large withdrawal of portfolio investment Domestic political uncertainty  This depreciation represents a correction of the overvaluation observed earlier  Sound macroeconomic management extremely important

Business Environment Analysis Returns to economic activity Social Returns Infrastructure services Binding constraint to growth Private Appropriability Government failures Macro risks REER appreciation Binding constraint to growth Micro risks Market failures Cost of finance International sources of finance Local sources of finance Domestic savings Financial sector intermediation

Is regulatory uncertainty and government interventions an obstacle to inclusive growth?  Regulatory uncertainty is the fourth most binding constraint to firms’ operations Most of firm owners (70 percent) think that officials’ interpretation of regulations is inconsistent and unpredictable Problem is especially acute in agriculture  Fertilizer subsidy program Last minute contracts push up the cost of the input Program not well targeted opens opportunities for rent seeking Program is expensive (accounts for 50% of the budget earmarked for agriculture, compared to only 3% for irrigation and other rural infrastructure)

Other government failures  Tax system and administration  Administrative procedures  Governance (indirect effect on capacity and delivery of binding constraints)

Business Environment Analysis Returns to economic activity Social Returns Infrastructure services Binding constraint to growth Private Appropriability Government failures Macro risks REER appreciation Binding constraint to growth Micro risks Regulatory uncertainty Binding constraint to growth Market failures Cost of finance Binding constraint for microfirms International sources of finance Local sources of finance Domestic savings Financial sector intermediation

Are market failures binding constraints for income growth?  Firms need services requiring simultaneous, large scale investments in: basic infrastructure and connectivity services which ensure access to inputs and foreign markets; marketing, state-of-the-art technology, and product quality information services  Might be a development trap: No incentives for private investor before a certain level of economic activity Especially severe in sparsely populated countries

Rural-urban differentials in connectivity service provision  Poor access and high cost of basic services are major constraints to growth  Rural areas are at a disadvantage relative to urban areas Number of households with access to facilities within 5 km Farm level productivity is negatively correlated with weak service performance Examples where there were positive coordination externalities (e.g. outgrower schemes)

Business Environment Analysis Returns to economic activity Social Returns Infrastructure services Binding constraint to growth Private Appropriability Government failures Macro risks REER appreciation Binding constraint to growth Micro risks Regulatory uncertainty Binding constraint to growth Market failures Coordination failures Binding constraint to growth Cost of finance International sources of finance Local sources of finance Domestic savings Financial sector intermediation

Bindings constraints to inclusive growth in Zambia  Regulatory uncertainty and government interventions (stop doing harm before doing good, especially severe in agriculture)  Lack of positive coordination externalities (rural-urban connectivity)  Access to post-primary education and health for the poor