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Zimbabwe economy like an athlete on steroids

ZIMBABWE’S economy has been growing faster than Hong Kong’s, the traditional bas¬tion of free-market capitalism.

ZIMBABWE’S economy has been growing faster than Hong Kong’s, the traditional bas¬tion of free-market capitalism. The rapid Gross Domestic Product growth and poor business environment appear to be a paradox.

Between 2009 and 2011 GDP growth averaged more than 7%. By comparison, Hong Kong’s economy grew 5%.

The country has been on a growth trajectory following the adoption of the multi-currencies in January 2009. Critics, however, contend that Zimbabwe is coming from a low base and hence the high growth rates.

Below is an edited version of a report by the Cato Institute titled: Zimbabwe: Why Is One of the World’s Least-Free Economies Growing So Fast? It gives an insight into how the economy is likely to play out going forward.

Given its stature as one of the world’s worst business environments, Zimbabwe’s rapid growth might seem a puzzling reversal after nearly a decade of economic contraction. To be fair, the country is better off than it was four years ago.

This began with its adoption of the United States dollar and South African rand as Zimbabwe’s official currencies (known as dollarisation) in early 2009. The change replaced Zimbabwe’s largely worthless currency and swiftly quelled the rampant hyperinflation of previous years.

Nearly 9% of its gross domestic product comes from off-budget grants from the outside world and those grants have rapidly increased over the past several years.

Another factor is the mysterious 2010 sale of more than half a billion dollars’ worth of unused government-issued stamps (to buyers unknown).

There has also been a rapid escalation of sales of raw minerals that have had the good fortune to benefit from higher commodity prices.

Yet the country’s increasing reliance on exporting raw commodities, rather than investing in manufacturing, puts it in a vulnerable position subject to volatile world prices beyond its control. Dollarisation has played an important role in stabilising the economy, and has yielded improvements in local markets and the tourism sector.

But the artificial financial injections from the outside world have propped up the economy and enabled the government to move to lower governance and economic freedom ratings while damaging its long-term growth prospects.

Yet there is some cause for optimism. Economic development is not far beyond Zimbabwe’s grasp as it has the shell of a constitutional framework, a government originally organised along democratic structures and a previous record of respecting property rights and rule of law.

For the most part, the rules were followed until 2000, the first year of the commercial farmland expropriations. From that time forward, President Robert Mugabe ignored judges and referendums when it suited him. But presidential elections in 2013 may provide an opportunity to put the country’s guiding rules into better practice.

If Zimbabwe seizes that opportunity and puts secure rule of law, good governance, and property rights at the forefront, it will have far more upside potential in the long run, and far more of its population will benefit.

The previous decade Throughout the first decade of the 21st century, Zimbabwe became “Exhibit A” on how to wreck a national economy.

The Mugabe government seized thousands of large-scale commercial farms without compensating the landholders who held the property titles. As a result, there was a cascading set of economic failures despite the agricultural sector commanding only 15% of the economy.

Property titles for the farms became worthless and hundreds of banks holding the deeds went out of business because mortgage payments were no longer being made.

Hundreds of retail and commercial businesses that dependent upon the farming sector also failed, and government tax revenue rapidly shrank as a result, creating enormous budget deficits.

The government filled the gap by printing money, resulting in hyper-inflation. Johns Hopkins University economist Steve Hanke calculated that, by November 2008, Zimbabwe’s annual inflation was the second highest in history, at 79,6 sextillion percent.

To put that in perspective, Hanke calculated that prices were doubling every 24,7 hours. After dollarisation in early January 2009, inflation immediately fell to −2,3% by the end of the month and stabilised thereafter.

The land seizures symbolised an overall breakdown in rule of law. Foreign investors fled and spooked tourists changed travel plans, creating even more of a downward economic spiral.

The country formerly known as the breadbasket of Africa (which had exported its agricultural surplus) was now dependent upon food aid from the outside world, as the new farmers often had little knowledge of farming.

By 2005, the loss of the country’s wealth from the land seizures alone — at $5,3 billion — was calculated to be more than all the foreign aid Zimbabwe had received since its independence in 1980. Today, high GDP growth rates are welcome news for Zimbabwe.

But the recent growth should be put into context.

Zim vs. “The Lion Kings” Zimbabwe’s rapid growth does put it in the recent company of some other sub-Saharan African countries. An analysis by The Economist finds that between 2001 and 2010, six of the world’s 10 fastest-growing economies were in sub-Saharan Africa.

Dubbed the “Lion Kings,” these countries include Angola, Chad, Ethiopia, Mozambique, Nigeria, and Rwanda. Over that decade, their annual GDP growth averaged between 7,9 and 11,1% and by 2011 Zimbabwe was out-performing all of them.

In looking for parallels between Zimbabwe and its six African brethren, something does not quite make sense.

Unlike Zimbabwe’s plunge to the bottom third percentile in World Bank governance quality, the average quality of the six Lion Kings’ governance is generally on the upswing, rising from the Artificial economic growth.

Like an athlete who relies on steroids to build muscle mass versus another who comes by his strength through disciplined training, all growth is not the same.

As we have seen, Zimbabwe’s economic growth now largely relies on a rapidly growing public sector that is fed by enormous injections of funds from the IMF and new loans from the Chinese government.

Another development involving international aid flows has also provided a temporary boost to Zimbabwe’s economy.

Beginning in 2009, the international aid community bypassed the Zimbabwean government and sent aid directly into the economy through non-governmental organisations. As a result, these aid expenditures are now counted in the government accounting ledgers as “off-budget expenditures.”

On the face of it, this money does lots of good. For example, USAID distributes tens of millions of dollars for food, training of conservation farming, use of drought-resistant crops, improvement of livestock health, and establishment of goat production, for example. Yet it is important to remember that in the era of relatively secure property rights prior to 2000, Zimbabwe rarely had a need for food aid; in fact, its commercial farms generated food surpluses that were exported to neighbouring countries.

Those secure property rights also gave incentives for farmers possessing titles to invest in irrigation equipment and manmade dams, conservation practices and drought-resistant crops, all without the help of the international community.

Today, the aid does “good” in the short run, but it does damage in the long run by orienting the communal farmer to dependency on outside support.

How foreign aid finances deficits Since dollarisation stabilised the economy, Zimbabwe can now collect taxes far more efficiently than it could with hyper-inflation which had made accounting nearly impossible for anyone in business or government.

Hyperinflation ended by the end of 2008 and a paltry $133 million in taxes was collected that year, but by 2011, tax revenue had jumped to $2,6 billion, according to the International Monetary Fund (IMF).

There were pressing needs for infrastructure improvements in roads, bridges, schools, and hospitals, and government wages needed adjustment because of the previous decade’s hyper-inflation. But despite the more than

1 800% rise in tax collections over those three years, government expenditures have risen faster. As a result, deficits climbed from $124 million in 2008 to $583 million in 2011. In relative terms, deficits now have more than doubled as a percentage of nominal GDP, from 2,9% in 2008 to 6,5% in 2011.

This raises a question: Where does the money come from to finance this profligate deficit spending? Dollarisation should have forced the government toward fiscal discipline, as it took away the government’s ability to cover its deficits by printing money.

In addition, there is certainly no market appetite for Zimbabwean government bonds to finance government deficits. As a result, the government should have moved in the direction of raising the confidence of foreign investors through improving World Bank governance and “Doing Business” indicators.

But dollarisation failed to discipline the government’s deficit spending.

One reason for this failure is that the IMF and the Chinese government have given Zimbabwe hundreds of millions of dollars in grants and loans in recent years. As a result of the worldwide financial crisis, the IMF gave the Zimbabwean government a one-time $500 million hardship grant in 2008, issued in special drawing rights (SDRs).

This available cash has given the government more leeway for overspending. Perhaps shrewdly, Zimbabwe used $140 million of that money to repay outstanding obligations to the IMF.

Aside from clearing its own books, the IMF is not keen on releasing the SDRs to pay off other creditors such as the World Bank (where Zimbabwe owes more than $1 billion), rather it has encouraged Zimbabwe to spend the money internally on projects such as power stations, railways, and agricultural inputs.

Consequences of a cruder economy

Although vastly smaller now than before the farmland seizures, Zimbabwe’s agricultural sector still supports a broad and complex set of industries within the country. Dozens of different crops create demands for domestic manufacturing and distribution companies. The farms often purchase inputs locally and then sell their crops to Zimbabwe manufacturing companies.

Historically, the agricultural and manufacturing sectors have been economically intertwined, so it is no surprise that the value-added products from manufacturing have been on the decline since the past decade of farm seizures.

In 2001, about 60% of Zimbabwe’s manufacturing firms either depended upon the country’s agricultural outputs or supplied inputs for the farming sector, according to an OECD report. As a result of the destruction of the commercial farming sector, hundreds of related businesses have since closed.

According to data obtained from the Massachusetts Institute of Technology’s Atlas of Economic Complexity, Zimbabwe now exports far fewer types of goods than it did in1995, when there were 759 products shipped out of the country.

In 2010 (the latest year for which data are available), the number of products had declined to 604. Along with the steady decline in manufacturing there is now a more top-heavy export distribution.

For example, in 1995, the top 10 exports accounted for 55% of all the foreign exchange. In 2010, the top 10 exports accounted for 81%. Decline in economic complexity

Zimbabwe’s mining output is exported in its raw state, and thus does not support related manufacturing industries to nearly the same extent as agriculture once did.

For example, two South African mining companies — Anglo American Platinum and Impala Platinum — currently send raw platinum from their Zimbabwean mines to South African refineries.

The lack of domestic refining and associated manufacturing is not necessarily the mining companies’ fault, given the Zimbabwean government’s heavy-handed efforts to promote expansion of the mining sector’s refining capabilities.

But investing in an expensive smelter in a country with one of the world’s worst business environments is a daunting proposition.

This policy of export bans hurts small-scale chrome miners the most, since they are forced to sell their raw minerals to the sole Zimbabwe refinery, ZIMASCO, which typically offers them prices well below the market rate and only accepts certain varieties of minerals.

So, ironically, a policy meant to help the country ends up hurting local producers the most, since foreign refineries can source their raw minerals from other countries. A recent report estimated the lost opportunities from the export bans on chrome included forgone revenue at $4 million and more than 2 000 jobs.

Even so, Zimbabwe produced 154 336 tonnes of high-carbon ferrochrome worth $135 million in 2010, more than double the 72 223 tonnes in 2009.

Platinum production rose 26% during the same time, while gold production jumped by 96%. Since 2009, world prices for these three minerals have risen between 70 and 85%, also boosting industry revenues.

The industry now accounts for 50% of all of Zimbabwe’s foreign-exchange revenue.

The South Africans and Chinese have shown particular interest in securing flows of these minerals to serve as inputs for their manufacturing sectors.

The dollar value of Zimbabwe’s mining exports more than tripled between 2009 and 2011. Although the economy wide ripple effects in the manufacturing sector are far fewer than in agriculture, there is no doubt that a strong mining sector helps the economy because some of the income translates to community development, including new infrastructure, roads, housing, schools, and health clinics.

But a serious downside of moving to a basket of exports that is based on raw commodities is that it yields an income flow that is destined to be both volatile and unsustainable — essentially moving toward an all-eggs-in-one-basket strategy.

In contrast, in a complex manufacturing-based economy, each element in the supply chain adds value through a combination of labour, capital, and materials.

As a result, the final good’s price is more able to absorb shocks from changes in external world commodity prices because it is also composed of dozens, if not hundreds, of different domestic input prices that rarely act in concert.

GDP growth unsustainable Zimbabwe’s rapid GDP growth and poor business environment appear to be a paradox.

In fact, the growth is the result of unsustainable economic factors that have created an artificially high growth rate, including a 12-fold increase in government expenditures since 2008, with government deficits fed by enormous inflows of foreign grants and loans from the IMF, China, and Western countries (both on-and-off-budget).

Thus, until Zimbabwe’s government begins fixing its internal problems of extraordinarily poor governance, insecure property rights, and dependence upon foreign aid and raw exports, its current high GDP growth rates are not a reliable indicator of its long-term prospects.

  • The Cato Institute is a public policy research organisation in the United States — a think tank – dedicated to the principles of individual liberty, limited government, free markets and peace.