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Friday, 27 March 2009

Five questions on diversification..

The recent collapse in commodity prices, especially the price of copper, has amplified the debate on diversification in our nation. From budget statements to independent columnists the word on every Zambian who knows a thing or two about our current economic predicament is diversification. If the explanation for the timing of this racheting-up in the diversification debate is obvious, the nature of this renewed quest remains unclear. In many respects we are still wandering in darkness on the way forward. So I thought to spark more meaningful and focused discussion, I pull together some materials scattered on this blog by way of five main questions : a)what do we mean by diversification; b)why do we need to diversify, if at all; c)what progress have we made in this area ; d) what constraints do we face in our question for further diversification; and, e)what can we now try and do differently ?

Question 1 : What do we mean by diversification ?

There are essentially four fundamental ideas that people have when they speak of diversifying the economy through the press:

  • The first revolves around the call for the country to expand the diversity of existing products that are consumed at home and exported abroad. For example the JCTR recently noted that “Zambia needs to diversify the production and consumption of its food crop away from heavy dependence on maize if it has to attain food security and we call upon the recently constituted taskforce to critically examine this issue…”. Although this is motivated by the quest to expand exports it’s also been used in agriculture as the basis for securing food security. We have heard similar calls regarding the mining industry, in particular the need for Zambia to expand the portfolio of mining products it exports abroad e.g. expanding the production of manganese in Luapula and enhancing the emeral industry.

  • The second involves the expansion in the range of markets into which existing products or services are sold. This has been less common but some have noted that there significant opportunities for existing products to be marketed abroad, this is especially the case with those products where Zambia may be able to develop a niche e.g. specialised agriculture produce, cultural products, etc.

  • The third idea involves taking advantage of opportunities to expand exports of services. This is essentially the call from moving into trade in services of which the most prominent in Zambia are: tourism; telecommunications; financial services (banking, insurance and accounting); and, transportation. The call for greater expansion in tourism has been particularly loud culminating in the Budget 2009 spending commitments as well as certain incentives. Others have also noted the possibility for Zambia to expand its air transport sector and take advantage of its geographical position.

  • Finally, the idea of moving from copper dependence to low value manufacturing products. This is the “traditional route” of diversification and is what many observers have been calling for a while. The Citizens Economic Empowerment Commission (CEEC) Commissioner last year noted: "Our country exports a number of raw materials that are processed in the developed countries and re-exported back to Zambia as finished goods at exorbitant prices. When we increase the skill levels of labour, we will be increasing value added activities and providing employment opportunities to our own people....."
The above distinction is quite important because some of the processes may be more natural than others. In other words, some form of diversification would occur naturally as the economy grows (i.e. diversification to essentially mean growth). Other forms of diversification would simply not occur even in the presence of growth (e.g. the economy might grow inspite of zero diversification within agriculture). Understanding nature of the diversification processes and their relative importance therefore becomes crucial.

Question 2 : Why bother with diversification?

There are many reasons why countries diversify generally. Achieving strong economic growth is fundamental to reducing poverty. In order to do that Zambia needs to leverage the demand and resources that are available not just within Zambia but also abroad. That means it needs to fully exploit its resources and engage in trade with the outside world. That calls for increased competitiveness in every sector in order to attract foreign direct investment and boost national productivity. Naturally debate exists here on how this can best be achieved. Its not the focus of this piece to discuss this element but simply to point out trade is crucial (for some of the on-going debate on this see Bad Samaritans, By Ha - Joon Chang (A Review)).

Economic diversification is widely seen as a positive trade objective in sustaining economic growth. Diversification makes countries less vulnerable to adverse terms of trade shocks by stabilizing export revenues, makes it easier to channel positive terms of trade shocks into growth, knowledge spillovers and increasing returns to scale, creates learning opportunities that lead to new forms of comparative advantage.

For many countries the issue is not that exports are concentrated but that they are usually concentrated on homogeneous products with individual exporting countries facing a highly inelastic demand curve such that changes in global supply translates into significant price volatility with many poor income countries such as Zambia often suffering terms of trade shocks that adversely affect investment and even consumption e.g. the recent shock to commodity prices. Violatility in income terms of trade can depress long-term growth. Indeed, though the evidence is not universal, several cross country studies have shown that greater diversification is correlated with more rapid growth of per capita income.

The issue therefore is not so much whether diversification is beneficial but rather what diversification process is worth pursuing and could be realistically achievable with deliberate policies. This is particularly important for Zambia because its quest to diversify has been somewhat mixed, with the extent of “diversification” depending largely on the metric used for measurement.

Question 3 : How much progress has Zambia made in terms of diversification?

The answer here largely depends on the definition adopted. If we focus purely on the structural composition of GDP, it is obvious that the sources of Zambia's growth are broad based, as revealed by the chart below from the latest 2008 Economic Report :

Figure 1: Sectoral Contribution to GDP (2008)
Simply put, the mining contribution to the growth in GDP is not as pronounced as many people think. As a side track, its partly why I am confident that Zambia will achieve its growth objective of 5% real GDP growth this year, despite the fall in commodity prices. For a nation supposedly dependent on copper the figures above provide food for thought. As we ponder diversification, we should ask ourselves whether we are doing enough with the copper we have.

The focus invariably has been on "export diversification" for reasons advanced above.

In terms of the diversity of products exported abroad, there are certainly signs that Zambia is broadening its export base. The diagrams below extracted from a previous blog, helps to paint the picture.
Figure 2 : Degree of Export Diversification

Figure 3: Composition of Exports

While in 1980 the largest exports accounted for 96% of exports, in 2004 they made up 80% of exports. Mining products continue to dominate exports, but while in the last 30 years the economy relied exclusively on export of ores and metals, in the last 17 years agriculture exports have become more prominent. Indeed this process of diversification appears to have spread within mining itself with some signs that Zambia has begun diversifying away from copper into other base metals and precious stones. However, in both instances the pace of diversification has been too slow.

More worryingly Zambia has not made significant progress is in the area of manufacturing which still accounts for less than 10% of exports. In addition, although tourism continues to grow off the back of limited competition from Zimbabwe, it remains far behind in terms of the level of tourists compared to regional competitors such as South Africa and Kenya. Similar picture emerges for telecommunication industry where the underperformance of ZAMTEL has restricted the growth of the industry and its ability to become a regional exporter in telecommunication services.

Figure 4 : Share of Exports across African countries

Indeed, Zambia’s performance relative to other countries remains poor in terms of export diversification (see Figure 4). Zambia has one of the highest shares of mineral exports on the African continent, making it extremely vulnerable to base metals shocks as we are current experiencing. More importantly, closer examination of data reveals that nearly all the countries with higher share of mineral and oil exports, Zambia is alone in depending on copper. Many of the high mineral dependent nations rely on oil where the windfall gains are substantially higher, lessening the need for diversification.

Question 4 : What constraints are preventing Zambia from further diversification?

Undoubtedly the historic legacy of colonialism which focused on mineral extraction and UNIP’s failed experiment in socialism are at the heart of the copper dependency. However, equally hopeless was the poor implementation of the privatisation process which led to the collapse of many non-mining sectors. The privatisation process also had another impact, the process led to significant reduction in copper output and associated revenue, eventually forcing the government to transfer these valuable resources into foreign hands.

I have previously noted that most emerging countries pursuing diversification use "resource wealth" to fund infrastructure and other industries. Chile being the most prominent. It continues to use the mineral wealth prudently, not only in terms of keeping the exchange rate in check through a stabilisation fund, but have also used windfall revenues to enhance productivity in other sectors. Indonesia in the 1970s and 80s also stands out as another example. It used its oil revenues to pursue an agriculture-led growth strategy with investment in rural infrastructure, such as irrigation and roads, as well as in input subsidies for fertilisers and pesticides. Unfortunately, Zambiah as been unable to fully utilise these national resources to its advantage and now appears to have missed the windfall gains that would have helped it secure diversification.

Beyond these general points there are specific issues related to the relevant industries. Although the tourism sector has grown significantly, its progress is being impeded by poor transport and hotelling infrastructure especially in Luapula and Northern Provinces where tourism opportunities abound. Similarly with agriculture the country suffers not only from poor physical infrastructure provision, which impedes access to markets, also from artificial constraints such as import and export restrictions as well as poor access to credit and lack of education and research - see A better vision for agriculture for more discussion.

Question 5 : How does Zambia move forward?

In order for Zambia to make rapid progress in diversification and without access to mineral wealth, it is vital that we learn how to overcome these constraints. My view is that rather than seek diversification as the goal we should recognise that growth is the goal and that diversification is the means to get there. We therefore need a holistic framework that involves a sector by sector assessment of the constraints and then finding appropriate solutions for eliminate those constraints.

A crucial aspect of diversification is “market discovery”. There are a number of areas in key sectors were the main constraints facing entrepreneurs appear to be knowledge about market opportunities. There are many good opportunities for income creation in rural and urban areas, but locals are just not aware of the opportunities or they struggle with discovering the profitable markets, this is especially the case in agriculture markets. Although private organisations are doing their bit to unlock the potential that exists, the government can play a more proactive role at the local level working with communities to identify their local assets and solving the coordination and "market discovery" failures that exist. Unlocking these opportunities would make our local areas engines of agriculture growth.

It is also critical that with reduction in mining investment, more is done to take advantage of FDI flows in other sectors especially that which is spearheaded through the MFEZs. In order to take advantage of the increase in foreign direct investment, it is critical that government puts policies in place that encourage spillovers from new FDI to domestic firms. These spillovers are critical for long-term diversification, but are not inevitable. The right conditions need to exist for them to occur. Existing empirical consensus shows that it is difficult for emerging economies, like Zambia, to extract potential benefits of spillovers when a large technological gap exists between domestic and FDI firms. It’s therefore imperative that government places FDI policy within a broader economic policy context, by taking forward necessary steps to invest in basic infrastructure, education and training, and above all encourage Zambian firmsto invest in technological development. These policies will do a great deal in increasing Zambian firms technological capability, and hence make it easier for the nation to benefit from spillovers and enhance diversification.

11 comments:

  1. Cho; This is a brilliant analysis. How crystal clear can one be? What I am beginning to suspect now is the inability of our policy makers to grasp and digest the information available. What is so difficult about making sense of what is written in this article?

    May be someone should run a workshop for Zambian administrators and policy makers with a theme of - interpretation of information and facts. When an IT student in Moscow complained about the resistance to computer introduction in the system by senior officials, we couldn't believe him. Now we do.

    By the way, that kind of workshop should be compulsory for anyone in a senior position - at least from Assistant Secretary level and above. Mayors and their deputies, leadership from political parties and Parliamentarians should also be included in that list. Some university at home should take that one up.

    I am making this point because - unless we wake up now, most of the potential development will pass us by. Moreover, I can't see how as a country we can compete with other countries if we can't make use of all available data and knowledge. The option of not doing so is giving up self control to others. That is, we would be risking letting other people from elsewhere, to come and control our destiny. For, there are plenty of people and corporations out there who would be aggressive enough to come and exploit our resources. So I am talking about our own survival. Microsoft is already ahead of us in this sphere. One day Zambians will wake up and find that they cannot have access to computers and data banks. One would have to go through Microft.

    We can't afford to sleep. I feel very strongly about these things because I lived through colonial rule myself. British and Whites in general used to treat us (blacks) as animals. I can't imagine anyone wanting to go back to those days. This time it will not be a question of color, but knowledge-based group against those with with nothing. Thus, I hope somebody is listening out there.

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  2. Cho,

    More worryingly Zambia has not made significant progress is in the area of manufacturing which still accounts for less than 10% of exports.

    Worrying but not at all surprising. Free Trade has been anti-production, by destroying the profit incentive for small producers and developing economy producers. They consistently flood developing country markets with heavily subsidized products, just to gain market share and destroy local producers. In fact, the purpose of giving huge tax subsidies to agribusiness (which doesn't need it) may just be to gain market share abroad. Even if it is not, it is still a massive market falsification that the West is not putting a stop to.

    Q 4 : what constraints are preventing Zambia from further diversification?

    Undoubtedly the historic legacy of colonialism which focused on mineral extraction and UNIP’s failed experiment in socialism are at the heart of the copper dependency.


    I strongly object to the description of UNIP's 'experiment with socialism' as having 'failed'.

    The capacity building of human resources (healthcare and education) are what created the present elite of lawyers and other professionals, who are now the mainstay of the MMD and UPND. Without 'socialist' capacity building in and through education, Zambia would not even have an educated elite.

    On the contrary, the 'free trade' beneficiaries of 'socialist' education, made sure fewer children managed to get into school, by introducing all kinds of fees, and underfunding teachers.

    Then, there is the issue of infrastructure. Much of the infrastructure that exists today was built under 'failed socialism', and frequently reminds people that it exists, when it breaks down or goes under maintenance because of the underfunding of existing infrastructure by the present crop of 'free traders'. In fact, not only has the market not stepped in, not only has nothing built by the mining companies replaced it or expanded on it, but the neglect of infrastructure which is so characteristic of the 'free trade' governments worldwide, has not expanded infrastructure at all.

    The MMD has had 18 years to construct another INDENI, and it has neglected to do so (to say 'they failed to do so' would imply that they tried but it didn't work out - in fact they didn't even try).

    I have previously noted that most emerging countries pursuing diversification use "resource wealth" to fund infrastructure and other industries. Chile is the case in point.

    In other words they use their mines (for instance) to capitalize other economic sectors.

    Somehow, this was 'not necessary' in Zambia. :-/ Because 'the market will provide'. And money will 'trickle down' from the elites when they 'create jobs'.

    Unfortunately, Zambiah as been unable to fully utilise these national resources to its advantage and now appears to have missed the windfall gains that would have helped it secure diversification.

    Not unfortunately - by design, and for the benefit of western corporations and the local politicians who have take their bribes.

    There is an article in The Post now:

    Parliament passes Mines Act
    Written by Ernest Chanda
    Friday, March 27, 2009

    Read more here...

    It can be dressed up in all kinds of fancy theories of how economies are supposed to work, but if you follow the money, things become very clear and very obvious. The money Zambia should be spending on agriculture, manufacturing, infrastructure, education, healthcare, etc. is leaving the economy as unrestricted profits for Western corporations, and some of it returns as 'Donor Aid'.


    Kaela,

    I am making this point because - unless we wake up now, most of the potential development will pass us by.

    I think there are still ways for Zambia and Africa to develop, in a way that creates wealth, knowledge, and leaves no one out of development and economic growth.

    Perhaps the concept of Producerism is something we need to look into. I would approach it from the left, and not engage in the anti-poor and xenophobic side of it. However, we need a party and policies that creates a huge middle class, because that is where all the knowledge, all the possibilities, the innovations, all the technology originates. We need to have a society where everyone is secure enough to not have to sell their labour cheaply and below a living wage. Universal education and healthcare, family or individual land ownership, home ownership, hundreds of thousands of Small and Medium Size Enterprises, including farms (100 ha or 1km2 is a good size to aim for - the average farm in the EU is 90 hectares - more than enough land to have a middle class income for the farmer, and with the development of farm businesses, several people).

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  3. Kaela,

    Thanks Doc!

    I am puzzled by our friends in Economics Association of Zambia, of which I am not a member. They don't even have a website.
    But if I was a member, I would suggest they take up the initiative and begin to educate our leaders.

    ZIPPA has been doing some workshops on certain areas. ZIPPA though is free-trade oriented....oh...I am member, not for the ideology...but because we should support such institutes...ZIPPA is the only credible institute in Zambia...which is worth the paper its written on..


    MrK,

    I can see where you are coming from.

    When I referred to UNIP's failed experiment. My view is that the UNIP model though successful in the early phase...collapsed from the late 70s, 80s...onwards..that why people voted KK out...it was not just the lack of political freedom...but also economic freedoms diminished..as people became poorer and poorer...

    Now of course MMD performed worse than UNIP...but I make it clear in the article that MMD's period was abyssmal....

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  4. Does anyone else remember back before 1992 when the world used to compare Gross National Products instead of Gross Domestic Products? There's only one basic difference, GDP measures the economic activity within the borders of the nation no matter who is doing it, while GNP measures the economic activity of the nation's citizens no matter where on the globe they are acting. The change in measurement didn't change the thing being measured (at least not by much for you Heisenberg enthusiasts), so it isn't too much of a stretch of logic I hope to suggest that the change was largely cosmetic, or political, even misleading in nature.

    In the year between the end of the 3rd quarter of 2007 and the end of the 3rd quarter of 2008, the US economy collectively paid out $2,844.7 billion to foreign direct investors, while taking in $3,389 billion from its own citizens holdings outside its borders. That is a net positive of $544.3 billion worth of income to US citizens that does not appear in their GDP number, but rather must somehow be deducted from the GDP of others. In fact, in every single quarter before and since '92, the US economy appears to be smaller when measured by GDP than by GNP. Now presumably the US is not the only country with a higher GNP than GDP, they are just the one I could find the most conveniently available data on. I strongly suspect that the entire G8, and at least a large majority of the G20 are in the same situation.

    So why would politicians in powerful countries who must face election by constituents who typically place domestic economic performance at the top of their list of criteria, then agree to a change in metric which made their economies appear to be weaker than they had before? Well lets return to the US case and flash back to the numbers for 1991. In the year between the end of the 3rd quarter of 1990 and the end of the 3rd quarter of 1991, the US economy collectively paid out $600.5 billion to foreign direct investors, while taking in $743.5 billion from its own citizens holdings outside its borders. That is still a net positive of $143 billion worth of income to US citizens, it is only about one quarter (26.27%) of what it was last year, (i.e. a 286% increase in return from FDI). Over the same period, US GDP grew from $5,849.4 billion to $14,412.8 billion (i.e. a 146% increase).

    I may be wrong, but it seems to me that this is why there is such widespread emphasis on measuring African development in terms of GDP, and why the reality on the ground never quite seems to match up with the official descriptions or predictions.

    [Data courtesy of http://www.econstats.com/gdp/gdp__q10.htm]

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  5. Oops! Somehow I always wind up glad that I checked my work a third time. It seems that the data I was using for the last post was compiled quarterly, but then averaged annually. This will not affect the % changes I am trying to highlight, but does reduce the absolute amount of money the US takes in from FDI significantly from what I reported. For the year ending in the 3rd quarter of 2008, the numbers should be $688.7 billion outward, $815.6 billion inward, for a net positive of $126.9 billion. For 1990, the numbers should be $158.1 billion outward, $185.0 billion inward, for a net positive of $26.9 billion. Well that's an even more pronounced increase than I had thought, 372% for FDI against 146% for GDP.

    My apologies for any confusion.

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  6. Yakima,

    The change in measurement didn't change the thing being measured (at least not by much for you Heisenberg enthusiasts), so it isn't too much of a stretch of logic I hope to suggest that the change was largely cosmetic, or political, even misleading in nature.

    It would certainly show that much of the gains in GDP is western mining companies doing business in Zambia, rather than coming from Zambian economic activity.

    I may be wrong, but it seems to me that this is why there is such widespread emphasis on measuring African development in terms of GDP, and why the reality on the ground never quite seems to match up with the official descriptions or predictions.

    It masks western and now eastern economic exploitation of Africa.

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  7. MrK,

    Indeed, the gap between investment income outflows and inflows is likely to be greater in the specific case of Zambia and the US. That is unless there is a large reservoir of Zambian stockholders in American corporations that I am unaware of. Unfortunately, I am unable (so far!) to find data that would enable me to convert Zambia's GDP numbers into GNP for comparison precisely, however I feel it is safe to say that opposite to the US case, the GDP number is significantly higher than the GNP is.

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  8. in deed this is a brilliant analysis and calls for seriouas consideration by those in leadership positions. i found the material also helpful in that it has enabled me understand the many issues surrounding economic diversification which the people in leadership positions have failed to clearly spell out for an ordinary, uneducated zambian to understand and make meaningful contribution to its achievement. it is difficult for people to make efforts to fight for better standards of living from their leaders when they do not know what everything is all about. i kindly request that i may interact further with the person that wrote the article for me to gain more understanding and answers to querries rerquiring clarifications. we have so much resources yet we are still poor. it hurts.

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  9. An example of diversification by Pittsburgh, once mainly reliant on the steel industry, and where the G-20 summit is taking place:

    http://www.pittsburghlive.com/x/pittsburghtrib/news/pittsburgh/s_644048.html

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  10. Kafue,

    Its a very interesting piece.

    I found the "Schumpterian" angle quite interesting. I had of course noted that nations that had diversified did so with a pot of cash! That story of course shows that a micro level, many places simply never diversify until all chips are down. For some like the old coal towns of Wales, it simply never comes. Knowing what leads others to die away, and others to live again would be useful.

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  11. Cho,

    With so many shenanigans going on, with so many politicians being in politics to further their own business ends, I think the field of Political Risk Insurance is something worth looking into.

    Why would anyone invest if some politician can come along and say - I don't like you, I don't like the party you support, I think you're encroaching on my own business activities - and then pass a law that would put your company or even industry out of business?

    Therefore, why not improve governance by making sure that if a politician does something to put you out of business, you are compensated for it?

    From Wikipedia, the free encyclopedia

    Political risk insurance is a type of insurance that can be taken out by businesses, of any size, against political risk—the risk that revolution or other political conditions will result in a loss.

    Political risk insurance is available for several different types of political risk, including (among others):

    * Political violence, such as revolution, insurrection, civil unrest, terrorism or war;
    * Governmental expropriation or confiscation of assets;
    * Governmental frustration or repudiation of contracts;
    * Wrongful calling of letters of credit or similar on-demand guarantees;
    * Business Interruption; and
    * Inconvertibility of foreign currency or the inability to repatriate funds.


    As with any insurance, the precise scope of coverage is governed by the terms of the insurance policy.

    The underwriting of political risk insurance is a dynamic, growing business. As globalisation increases, there are more corporations doing more business in more places around the world with each passing year. Some of the changes occurring in the business are high growth, new product offerings, and a greater role for private capital.[1][2]

    While political risk insurance policies are sometimes manuscripted for specific situations, the major political risk insurers have standard forms for the coverages that they issue. For "complex" or larger investments manuscripted policies are the norm and there may be several insurers providing cover in the form of a syndication, through co-insurance, or perhaps with the participation of a reinsurer on a facultative basis.

    Providers of political risk insurance include public agencies and private insurance companies. With there being a wide range of options available, the use of a specialized broker is highly recommended.
    [edit] References

    1. ^ Mishra, K.C. (May 5, 2006). "For political risk, insurance isn’t all". Rustomjee (Diligent Media Corporation). http://www.dnaindia.com/report.asp?NewsID=1027950. Retrieved 2006-07-17.

    2. ^ Kambayashi, Satoshi (April 4, 2007). "Of coups and coverage: Political turmoil is costly. Unless you are fully insured.". The Economist. http://www.economist.com/finance/displaystory.cfm?story_id=8967224. Retrieved 2007-04-08.

    ReplyDelete

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