Applied governance and growth diagnostics:

Basic framework and some illustrations from Zambia

DRAFT for discussion

Verena Fritz1

This version: January 09, 2009

Introduction Growth and poverty reduction are the twin goals of development. Countries have fared differently with regard to these goals, and face a range of obstacles to achieving them. Governance has increasingly become recognized as a third important dimension of development – both as an end in itself, and as an important means to achieve growth and poverty reduction (WB 2007a and b). A lively debate about how governance is linked to growth at the aggregate level has emerged (see e.g. North et al. 2008). To date, however, little work and guidance is available on how the two themes can be joined in country and sector diagnostic work. Part 1 of this note outlines a basic framework for exploring governance and growth in country diagnostic work. Part 2 provides some illustrations, utilizing recent analytic work on Zambia. On the growth side, this note builds on the diagnostics framework developed by Hausmann, Rodrik and Velasco (2005), which focuses on binding constraints to growth.2 It also includes some reflection about constraints to shared or inclusive growth, i.e. a pattern of growth in which the poor participate in the economic gains, and in which the benefits of growth are shared broadly.3

1 Governance Specialist, PRMPS. Guidance was provided by Brian Levy (Adviser PRMPS) and Kenneth Simler (Senior Economist PRMPR). Helpful comments were received from Elena Ianchovichina and Susanna Lundstrom (Senior Economists PRMED), Kai Kaiser (Senior Economist PRMPS) and Kapil Kapoor (Country Manager, Zambia). The views and ideas reflected are solely those of the author and not those of the World Bank as an institution. Any remaining errors are the author’s responsibility.

On the governance side, the note is informed by current efforts at developing problem-driven governance and political economy diagnostics more widely to inform World Bank strategies and operations (see WB 2008a) as well as by a stream of contributions to introducing governance dimensions more prominently into the WBG’s analytic and operational work in recent years (see WB 2007a and b, Levy 2007, WB 2006).

2 Further information on World Bank growth diagnostics work, inclusive/shared growth, and the HRV framework can be found at http://go.worldbank.org/99C1XPRDC0. 3 There is no unequivocal definition of shared or inclusive growth. Benefits from growth may be widespread, while at the same time inequality increases (as in China over the past two decades). This note refers to the general idea of growth that creates economic opportunities for many; it is not the place to discuss the concept in depth.

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The intended audience of this note is country teams who are planning or undertaking growth diagnostic work and who are searching for ways for bringing governance into the picture.4 Teams interested in undertaking growth diagnostics that include governance and political economy aspects may want to explore some of the materials cited here for further information and background.5

PART 1 – A basic framework for analyzing governance and growth in country diagnostic work This part sets out a brief basic framework that can be used to think about governance and growth in country diagnostic work. The focus of the framework is on how to diagnose governance and political economy factors affect particular constraints to growth or shared growth that have been identified through a growth diagnostic, and on the implications for identifying policy solutions that are feasible given the country context.

1. Background – the ‘big picture’ debate on governance and growth and their interdependencies Recent years have witnessed an evolving and growing literature on governance and growth. Some key issues have emerged: the starting point is the empirical observation that richer countries tend to have better governance across a range of dimensions than poorer ones. This observation has given rise to the hypothesis that improving governance will translate into higher growth. At the same time, there is a long-standing strand of literature in the social sciences posing that growth and rising incomes lead to changes in societies which in turn foster better governance (Huntington 1968; Lipset 1994; Levy and Fukuyama 2008). A number of cross-country studies have tested various specifications of the hypothesis that better governance contributes to higher growth. The results from this literature, however, are somewhat inconclusive. This is not least due to the fact that governance indicators have only emerged relatively recently and that methodologies for generating valid indicators are still evolving. Still, a majority of relevant studies find that governance – or certain aspects thereof – matters for growth (e.g. Kaufmann and Kraay 2002, Seldadyo, Nugroho, de Haan 2007). Some of the recent literature on governance and its relationship with growth has emphasized that selected aspects of governance may be more important than others (Khan (2006) and by Meisel and Ould Aoudia (2008)), and have consequently pointed to

4 Furthermore, there is an increasing interest within the wider donor community in the linkages between governance/politics and growth to which the notes seek to contribute. See the 2007 DfID/SOAS workshop on ‘Governance for Growth’: http://www.gsdrc.org/go/dfid-conference-papers/governance-for-growth-seminar; and a recent paper by Williams et al. (2008). 5 The Problem driven governance and political economy framework is expected to be posted as a web-based version in early 2009. For draft versions, please contact Verena Fritz (vfritz@worldbank.org) or Kai Kaiser (kkaiser@worldbank.org).

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a need for prioritization within the governance agenda. Based on regression analysis, Meisel and Ould Aoudia (2008: 24) point to government capacity, leadership commitment to and vision of development, and the ability for ‘concertation’ of societal interests as potentially particularly important aspects of governance.6

At the same time, there also appears to be considerable variation across how different countries have progressed towards sustained growth and better governance – and different elements of governance may matter more or less for countries at different stages of their economic development.

The Report by the Growth Commission (2008) generally endorses the notion that governance matters for growth and concludes that “credible, inclusive and pragmatic governments” were a key ingredient across the 13 high-growth success cases analyzed by the Commission.7

A summary of the ‘big picture’ debate about governance and growth and of implications for the World Bank is provided by North et al. (2008). This collection of papers also addresses some important gaps in our current knowledge; in particular the fact that there appear to be multiple institutional solutions to achieving governance that can promote growth (Rodrik 2007).

An important aspect of the two-directional relationship between governance and growth is that the sources of growth are also likely to have an impact on how governance evolves. For example, growth based on extractive activities is widely believed to be more problematic for governance than growth based on manufacturing and services. Extractive activities can weaken the taxation-accountability link between the state and citizens (if most revenue is derived from extraction). Moreover, the competition for appropriating rents from natural resources can aggravate corruption problems and can reduce incentives for politicians to act in the public interest.

1.1 Constraints to growth and ‘good enough governance’: the search for priorities A key rationale for the ‘constraints to growth’ diagnostics is to distil priorities out of the multitude of issues which may require addressing in a developing country. As noted above, within the field of governance, there is a corresponding increasing awareness that ‘not everything matters (or can be addressed) right now’. As with regard to growth, it is often easy to observe a multitude of governance problems – a poorly functioning judicial system, pervasive corruption, poor incentives and structures in the civil service, no functioning system of property rights, costly regulation, and so forth. However, especially in low income countries, there is an urgent need to prioritize what governance improvements are most crucial, because the political, financial and capacity resources for improving governance are scarce (Khan 2006). Grindle has conceptualized this as striving for ‘good enough governance’ (Grindle 2007) rather than sweeping governance reforms. Thus, both within the growth and the governance communities there is an

6 These features are frequently associated with a ‘developmental state’ (Fritz and Rocha Menocal (2007)). 7 http://www.growthcommission.org.

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increasing recognition about the need for defining priorities – while disagreements remain within and across these communities what the key priorities are.8

2. A basic framework for applied country and sector diagnostic work around growth and governance The basic framework developed here is linked to these wider debates. However, its primary aim is to provide some ideas of how to look at governance as related to growth – and constraints to growth – as part of country and sector diagnostic work, rather than to explore the overall relationship between governance and growth. The diagnosis of constraints to (inclusive) growth is taken as the starting point. Such a diagnosis then leaves teams with the challenge of defining which of these constraints to tackle and how to choose entry points for doing so. As this note argues, governance and political economy factors often play a very important role for why constraints to growth have emerged, and why countries face difficulties in addressing them. Consequently, it can be important for teams to link growth diagnostics to governance and political economy analysis in order to arrive at feasible reform options and strategies.

2.1 The three layers of ‘problem driven’ governance and political economy analysis Problem-driven governance and political economy (GPE) analysis provides a useful framework for approaching the governance and political economy dimensions which are related to identified constraints to growth and to move from the identification of constraints to growth to strategies and policy implications. Problem driven GPE analysis has three layers. The first layer is that of defining the problem – which in this case is the identification of the binding constraints to growth. The second layer consists of identifying the governance arrangements related to a certain constraint to growth. For example, if the high cost of transport is a constraint to growth, the relevant governance arrangements are those for financing maintenance of transport infrastructure, the arrangements for public and private investment planning and execution (including procurement) related to transportation, as well as licensing of transport companies, potentially the issue of bribery along transport corridors, and so on.

8 In this regard it is crucial to emphasize that ‘good enough’ is from the perspective of governance as a means rather than governance as an end.

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The third and crucial layer focuses on analyzing the underlying political economy factors. This layer of inquiry asks why governance arrangements have not been changed so as to promote better outcomes. For example, why does a government not take consistent action to reduce mal-governance around infrastructure procurement? Or why is the monopoly of a state-owned enterprise in utilities preserved, and/or why does commercialization get stalled? Drilling down to this layer is essential for understanding what has been holding back progress, and it is essential for defining strategies for approaching sector reform. A wide range of political economy factors can be at play – including rent-seeking interests, problems of political capacity (e.g. weak governments that are not willing/able to push for difficult reforms), clientelist structures, including state capture, as well as more ‘micro-political’ factors such as the relationship between particular stakeholders. Frequently, the underlying reasons for not improving governance arrangements are related to wider socio-political drivers. For example, the kick-backs generated from public procurement may be ‘needed’ to finance election campaigns; or regulation of the banking sector may be weak because members of the governing coalition enjoy informal privileged access to credit, which in turn is part of the elite arrangements which help to maintain political stability.

2.2 A governance and political economy diagnostic tree for constraints to (shared) growth This section looks more specifically at a diagnostic strategy that can be used to move from the general idea of looking at governance arrangements and underlying political economy drivers to identifying at what points they affect constraints to growth (or shared growth) and potential policies for addressing them. Graph 1 develops a ‘governance and political economy diagnostic tree’. The tree looks at different potential pathways of how a constraint to growth might be addressed – starting from whether it could in principle be solved through private sector action, or whether it

Box 1: Three diagnostic layers and instruments

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requires government intervention.9

Apart from a left and right hand stream, the diagnostic tree is also broadly divided into an upper part that concerns the policy decision stage, and a bottom part that looks at governance and political economy constraints at the implementation stage. This tree is indicative of how a diagnostic can think through the different steps in the process that would have to occur in order to arrive at a successful solution. In actual cases, the tree may be more complex or have somewhat different branches, etc.

Political economy constraints at the policy decision stage are frequently related to (a) the fact that the status quo generates rents which key stakeholders are unwilling to give up, (b) weak ‘political and social capital’: i.e. the fact that governments frequently have insufficient support to implement unpopular reforms; and citizens and businesses may have insufficient trust in the government’s ability to use additional resources well, and (c) nationalist sentiment: resentment to foreign involvement and/or advice can be an important political economy driver against certain types of policy solutions.10

Political economy and public sector constraints at the implementation stage are also important. Lower level bureaucratic corruption and weak fiscal and administrative capacity can affect and undermine policies even after agreement among national decision-makers has been reached. Furthermore, stakeholders at the implementation level may have their own political economy incentives to resist change. Importantly, political economy and public sector constraints are frequently linked and interacting: i.e. there may be a lack of public sector capacity, but also a lack of political incentives to foster capacity. Looking at the left-hand side of the tree, even where private sector solutions would in principle be feasible, this may be blocked by government – e.g. because private provision is perceived as not accepted by voters (e.g. due to tariff increases), or because there are attractive rent-seeking opportunities linked to public sector provision, etc. [GPE constraint type 1 in the graph]. In other cases, private solutions to a constraint to growth are possible and accepted at the decision-making level – but can only be successful if a good enough regulatory framework is in place (e.g. good enough regulation assuring potential private investors in utilities and infrastructure that they will be able to reap a profit). Therefore, there are risks of governance and political economy failures also at the implementation and regulation stage [type 2 constraint in the graph]. Looking at the right hand side, in many cases government action will be needed to address constraints to growth, or at least an active involvement of government together with the private sector (e.g. through PPP arrangements, or the government integrating private and public provision of education, and providing parts of it directly). In such a case, a first question is whether the government actually has the fiscal, institutional, and

9 E.g. because the constraint has a strong characteristics of a ‘public good’ that the private sector has insufficient incentives to provide. 10 Nationalist sentiment can serve as a public justification for rejecting certain reform options, even if the ‘real’ political economy motivations are rather rent-seeking interests. However, nationalist sentiment can nonetheless be a potent factor if it strongly resonates with the public.

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human capacity to take action (which are, however, also linked to political decisions about trade-offs for allocating public resources, enabling the emergence of public sector capabilities, etc.).11

Even if the public sector in principle is equipped with sufficient resources to take action (or could leverage external resources), there may be a number of reasons why nonetheless addressing the constraint fails, or is achieved only partially. Politicians may fail to compromise over the policy option to adopt for a solution, may resist the changes in governance arrangements that are necessary and/or demanded by external donors in exchange for providing resources, or corruption and rent-seeking at the implementation stage undermines the policy that is being pursued [either lack of resources or ‘lack of political will’ or some combination results in a type 3 constraint as depicted in the graph]. Finally, for constraints to growth that require active government engagement to be addressed, there can again be governance and political economy failures at the implementation stage [see type 4 constraint]. Only if potential governance and political economy challenges can be solved both at the decision-making and at the implementation stage, can an identified constraint to growth be successfully addressed. It is worth noting that in ‘real world’ cases, there may often be a back and forth. For example, there may first be an attempt to pursue a private sector based solution, but this may be reversed, but then a public sector solution is attempted (see e.g. the illustration from the Zambia electricity sector) – or vice versa. Also, if addressing a constraint to growth fails at the implementation stage, there may be repeated attempts at eventually managing implementation. Furthermore, the diagnostic path is in principle similar, whether the concern is about governance and political economy obstacles to relieving binding constraints to growth as such, or about constraints to shared growth. The difference is that in many situations there are likely to be more constraints to shared growth than just to growth as such (e.g. constraints related to employment creation, regional spread of growth, etc.); as well as the fact that the policy options for addressing constraints to shared growth and consequently the governance and political economy feasibility of these options may differ from policy options that are exclusively focused on growth as such. The next section of this basic framework discusses some issues of how to identify reform options that are feasible given frequently arising governance and political economy challenges, with a view to increasing the likelihood that the proposed policy solutions to constraints can be successful given the context in which they are pursued.

11 Politically committed governments can in principle ‘leverage’ capacity, e.g. by attracting donor funds, to address constraints to growth. However, low fiscal resources certainly limit options for a government to act on constraints to growth.

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Graph 1: Governance and political economy diagnostics tree for identified constraints to growth

Identified constraint to

growth

Can (in principle/ primarily) be solved by

private action

Requires government action

Private action is accepted as potential

solution by key stakeholders

Private action is NOT accepted as

potential solution by key stakeholders (PE PROBLEM)

Private sector willing/able to go it alone: Private sector

provision (e.g. mobile telephony)

Private and public sector jointly (PPP)

Government lacks resources (fiscal &

administrative) (Classic PS PROBLEM)

Government has resources (fiscal &

administrative)

Interests in government and

among key stakeholders favorable

(= ‘pol will’)

Interests in government and

among key stakeholders opposed

(= no ‘pol will’) PE PROBLM

Government provides no solution; constraint

remains

[GPE constraint type 3]

Government provides policy

and resources for solution

Governance is good enough for

successful implementation

Governance is too bad for

implementation (PE + PS

PROBLEM)

Constraint to growth is

successfully addressed

Regulation by government is too weak and/or affected by rent-seeking (combined PS +

PE PROBLEM)

Regulation by government is

good enough to enable private

solution to work

Constraint to shared growth

remains

[GPE constraint type 2]

Constraint to shared growth

remains

[GPE constraint type

Solution does not work, constraint to growth

remains

[GPE constraint type 4]

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2.3 Identifying feasible reform options through complementary diagnostics In many cases, analyzing the governance arrangements and the underlying political economy dynamics will lead to the conclusion that tackling binding constraints to growth ‘head on’ is unlikely to succeed, as it will run into the one of the governance and political economy failures outlined above. This is also clearly reflected in operational experience: in many countries, ‘head on’ first best reform options have been pursued, but have ultimately been stalled or reversed. However, when reforms fail, a constraint to growth remains unaddressed – often leading to a renewed search for alternative solutions. This raises the issue of feasible or ‘good enough’ policy options. Such policy options deviate – possibly substantially – from the (technical) first best reform path, but are aimed at being feasible in the governance and political economy context and help to relax the constraint to growth at least to some degree. For example, decision-makers may be unwilling or unable to tackle corruption and inefficiencies in infrastructure provision across the board, but they may be able to do so for certain strategic projects or locations (such as export processing zones) enabling somewhat higher growth and job generation. In turn, this may enable further improvements of governance later on. Feasible options are generally highly situational. The framework set out here may be useful in defining suitable options. Moreover, the overall set of complementary diagnostics which can lead from an initial identification of a constraint to growth to a ‘smart’ policy approach should include technical as well as governance and political economy diagnostics. Graph 2 depicts this ‘diagnostic triangle’. Bringing those types of diagnostic work together provides the best opportunity to define strategies for World Bank policy dialogue that are well prioritized, technically sound, as well as adapted to the governance and political economy environment. Feasible as well as promising policy options emerge out of a dialogue between the different diagnostic components, as reflected at the center of the graph. An implication for country teams is wherever possible to use those three types of diagnostic work in a strategic and complementary way that can help to hone in on key policy issues.

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Graph 2: Diagnostics triangle: Growth constraints, technical diagnostics & ‘problem driven’ GPE analysis

Binding constraints to growth:

what are priorities and what are not? (based on growth diagnostics tree)

Governance and political economy diagnostics tree:

1) Identification of public sector and political economy obstacles and underlying drivers of why constraints have not been successfully addressed to date.

2) Assessment of feasibility of policy options

Technical diagnostic: what can be done to alleviate the binding

constraints? (setting out options)

WB policy advice to government/ engagement with local

stakeholders

dialogue

Raises questions Selects priorities for

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3. Summary of the basic framework and looking ahead Understanding drivers and constraints to growth at country level is a key concern for World Bank country teams. Growth diagnostics focused on the binding constraints to growth have been developed to respond to this. At the same time, a growing number of teams are keen to understand governance and political economy issues better, as they have experienced how crucially such factors can impact on policy reform processes. Consequently, as this brief note sets out, and as the illustrations from Zambia (see part 2 below) show, there is considerable merit in joining up growth and governance issues in country-level analysis, because this can help teams both to identify growth issues and to develop feasible strategies for addressing them.12

There are two issues to consider in pursuing such joined up country diagnostic work further – which also concerns how the country diagnostic work links back to the ‘big picture’ debate briefly summarized in section 2:

• One, distilling sets of shared priorities. Both the constraints to growth and the ‘good enough’ governance agenda aim at identifying priorities in each respective area. The challenge is to move towards identifying priorities for growth which are consistent with the identified governance and political economy constraints and of governance priorities which are informed by ‘needs for growth’.

• A second challenge for joining up analytical work on growth and on governance

is to gain more conceptual clarity around determining the thresholds below which overall governance is a major constraint (and how this might be measured reliably). In operational terms, it raises the question of how to prioritize working on governance and political economy constraints affecting particular sectors/constraints to growth versus pursuing changes in overall governance – on the assumption that these would (eventually) have systemic impact.

Generally, the worse overall governance is (e.g. as reflected in aggregate governance indicators), the more governance and political economy factors are likely to stand in the way of a successful solution of constraints to (inclusive) growth. A key contribution that the specific diagnostic work can make is to define where to intervene and how, in order to start or re-start a virtuous cycle of more or more inclusive growth and better governance. Further applications very likely will raise more questions of this nature, and hopefully will also point to clearer answers. Certainly, it will be an interesting and challenging endeavor to move the debate about growth and governance from the aggregate level to concrete country-level diagnostics and discussions. If they are of value, such approaches should contribute to more informed choices of entry points and policy advice.

12 While this note has suggested one way in which this may be done, there may be a number of other options that emerge as such work is being carried out in more countries.

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PART 2. Application – some illustrations from Zambia This part discusses some application of the framework to Zambia, and specifically to two infrastructure-related constraints to growth identified for that country (the power and telecommunications sector) in particular. These illustrations draw on two diagnostics that were carried out for Zambia: a diagnostic on constraints to growth (Ianchovichina and Lundstrom 2008) and a GAC for CAS diagnostic looking at governance and political economy issues that would affect the upcoming CAS period and Bank work on the various CAS pillars (Levy and Palale 2008).13

1. Summary of identified constraints to growth Zambia has experienced relatively stable growth since 1999. This stands in sharp contrast to preceding decades, during which growth was volatile and in many years negative, resulting in a substantial decline of per capita incomes between 1966 and 1995. Inflation sharply decreased since the mid-1990s, and exports have started to become somewhat more diversified. Nonetheless, poverty levels have remained high, with only a slight reduction since the early 1990s. A key interest of the diagnostic on constraints to growth is therefore in those constraints responsible for why growth has not been more inclusive. The paper identifies poor infrastructure – energy, transport, telecoms, water – and in addition the lack of insurance, marketing, professional services, as well as poor overall governance (as reflected in aggregate governance indicators) and a relatively weak regulatory environment as key constraints. In their combination, these constraints result in poor access to domestic and international markets, as well as to inputs, extension services, and information. Ultimately, this results in low returns to self employment (especially in agriculture), and in limited expansion of wage employment, limiting the inclusiveness of growth. The analysis also points to the limited access to and quality of secondary and tertiary education for the poor as a factor that may be further depressing returns to self-employment. Further constraints it points to are currency appreciation. Thus, the overall concern of the growth diagnostic is about why growth has not been more inclusive (and may not be sustainable), rather than a failure to achieve higher growth rates per se. Growth has been driven by a natural resource boom based around Zambia’s Copperbelt.

2. Key features of overall governance in Zambia The governance and political economy diagnostic undertaken as background work for the new Country Assistance Strategy had several components, including a summary of

13 It should be noted that the illustration primarily draws work covering two sides of the diagnostic triangle set out in the framework. However, technical sector analysis did inform the sector-focused governance and political economy assessment.

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overall country-level governance and political economy issues, and a discussion of selected sector specific issues (Taylor and Simutanyi 2007). The country-level analysis argues that overall governance in Zambia is marked by an extreme tilt towards the status quo. A political culture that is neither fully rule-based nor characterized by unbridled rent-seeking and corruption has emerged, which favors indecision and conservatism, rather than radical departures politically or economically that could alienate fragile constituencies and provoke a wider reaction by civil society. This makes it difficult to pursue more ambitious reforms. Furthermore, the analysis emphasizes that elite economic nationalism is becoming a re-nascent part of Zambia’s development discourse. This nationalism surfaced vividly in the country’s 2006 elections, and it is also evident in some of the sector reform dialogue, as will be discussed below.14

Thus, the country-level diagnostic highlights some of the overarching elements of governance which pose a challenge in terms of adopting policies that could help to overcome constraints to growth.

The following sections first look at key national policy documents (the PRSP). In these, poor infrastructure has indeed been recognized as a priority. The illustration then turns to two specific sectors – power and telecommunications – to understand more deeply why nonetheless the identified priorities/constraints to growth have not been successfully addressed to date.

3. Policy context: Are the diagnosed binding constraints to growth the focus of development strategies and official policy commitment in Zambia? The current overarching development strategy for Zambia is the 5th National Development Plan (PRSP) – covering the period 2006-2010.15

The overall theme of the plan is “Broad based wealth and job creation through citizenry participation and technological advancement”.

The FNDP is linked to a National Vision 2030 which identifies a number of development goals, including: (a) reaching middle-income status; (b) significantly reducing hunger and poverty; and (c) fostering a competitive and outward-oriented economy. The strategic focus of the FNDP is “Economic infrastructure and human resources development”. The plan emphasizes: Infrastructure, especially roads, bridges, dams and various means of communications. The emphasis will be on maintaining the existing infrastructure. It should be noted that rural and agricultural development alone cannot achieve the objectives identified in this Plan. Structural transformation and urban growth are also important for the long-term development process, not least for providing markets for agricultural products.

14 The term ‘elite economic nationalism’ is taken from the prior analysis by Levy and Palale. It is meant here in a neutral sense. As commentators have pointed out, a sense of shared nationhood can be an important positive driver for development. At the same time, elite nationalism can to some degree be serving elite rather than national public interests. In either case, it is likely to preclude certain policy options that involve and (are perceived to) benefit external stakeholders. 15 FNDP (2006), i. The choice of title is noteworthy: the 4th national development plan was implemented from 1989 to 1991 – when it was abandoned in favor of structural adjustment reforms.

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However, such growth largely depends on the private sector and, therefore, requires a supportive environment. Consequently, one of the key targets of the FNDP is to create the enabling environment supportive of private sector growth and ensure that the country has good infrastructure, a supportive macroeconomic environment and skilled human resource. The development of human resources will entail the implementation of a range of actions and reforms to develop and make available to the economy appropriate skills. Thus, apart from economic infrastructure, this Plan focuses on social investments in health and education.” Zambia’s existing official development strategies therefore seem to reflect a focus on the diagnosed constraints, even though they are still weak with regard to clearly setting out priorities (and trade-offs in addressing these in the context of scarce resources). So if the constraints are recognized, and are set out as priorities in fundamental policy statements, two questions arise:

1) Why have Zambian governments let these constraints emerge (or have failed to solve them to date)?

2) Looking forward, what are the political economy challenges to addressing these constraints?

The following section looks at two crucial sectors: electricity and telecommunications to understand these dynamics in greater detail for two key constraints.

4. The power sector From the perspective of inclusive growth, there are two concerns about the power sector: first, the growing economy and especially the mining sector as a key driver of growth have an increasing demand for electricity, and without new investments, this demand cannot be met (see also WB 2008b: v). Second, poorer and more remote regions of Zambia have little access to power networks. As the IL paper proposes, this holds back more regionally balanced growth and hence is especially relevant for making growth more inclusive. As described in the growth diagnostics, a key obstacle to power sector expansion has been very low tariffs. The political economy analysis provides a background to the legacies of the sector and efforts at sector reform. Following independence, the power sector in Zambia was based on full integration (across generation, transmission, and distribution) and public ownership through ZESCO (Zambia Electricity Supply Corporation).16

In the 1970s, hydropower stations were built using multilateral funding. As the economy began to decline since the early 1980s, supply of electricity did not face a capacity constraint for many years.

This situation promoted the setting of very low electricity tariffs. Moreover, however, prices were set low without any provisioning for the cost of an eventual replacement of investments, and also only insufficiently covered ongoing operations and maintenance

16 ZESCO had been created in 1969 as the state-owned electricity company, during the nationalization period following independence in 1964. See http://www.zesco.co.zm/ZESCO_history.pdf.

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expenditures. As a consequence of this supply and demand situation and the decision not to cover maintenance and replacement costs adequately, Zambian electricity consumers enjoyed one of the lowest tariffs in the world, below 3c (US) per kilowatt hour. About half of all generated electricity is consumed by residents and small businesses, while the other half is consumed by the mining sector (for a brief summary see also IMF 2008).17

The low tariffs resulted in extreme under-investment in maintenance and a deterioration of power generation and distribution infrastructure. This problem has become more acute in recent years, as the expansion of the mining sector and overall economic growth is driving up demand for electricity, while actual generating capacity continue to decline due to the lack of maintenance and investments. Zambia’s electricity supply-demand balance is expected to turn negative some time between 2008 and 2011. Low tariffs have also provided little incentive or resources to expand the electricity network regionally. The World Bank has been involved in sector reform dialogue since the 1990s, aimed at changing the governance arrangement in the sector. The ‘first best’ reform strategy pursued was the (standard) package of privatization and unbundling of generation, transmission, and distribution, which would in turn require (significant) tariff increases and a re-balancing of prices across the ‘bundles’ in order to attract private investors to each of them. Despite initial government commitment to this agenda, all these options were explicitly or implicitly rejected by the government in 2002/2003. The governance and political economy assessment sets out four key reasons – or political economy drivers – for the choice made by the Zambian government to maintain the existing governance arrangement in the sector, rather than reforming it in line with World Bank supported proposals:

1) Unbundling and privatizing ZESCO would contravene the interests of political elites. Major infrastructure companies provide important discretionary resources (e.g. to contribute to election campaigns of political parties).18

2) Access to jobs. While the number of jobs at ZESCO is not very high (around 5,000), the jobs are well-paid by Zambian standards. Such jobs are an important tool for patronage; i.e. to be able to allocate jobs based on political loyalties.

Procurement contracts of such a company are highly lucrative and ‘useful’ in terms of dispensing patronage and, possibly, for collecting kick-backs.

3) Increasing tariffs would be (highly) unpopular among urban middle classes and elites – and could upset important groups supporting political power holders. Consumers would in general be reluctant to pay more. This stance is re-enforced by a lack of trust that higher tariffs would really be used well and result in better services.

17 According to IMF (2008: 55) (citing a Cost of Service Study) average electricity tariffs would need to be increased by 48 per cent to provide full cost recovery for ZESCO. 18 ZESCO’s annual turnover is equivalent to 7% of the national budget – and is managed through its corporate treasuries, not the control apparatus of the national budget. A further reflection of the political importance of ZESCO is the fact that it was led by one person throughout the 10-year Chiluba government, with a level of influence comparable to that of senior ministers (Zambia infrastructure background note: 10).

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4) Economic nationalism.19

In the early 2000s, North American and Nordic consortia expressed an interest to invest in new hydropower generation, responding to efforts by the Office for Promoting Private Power Investment (OPPPI) which had been created in support of the reform agenda then on the horizon to win international private sector investments. However, in October 2003, the government suddenly instructed the OPPPI to drop the proposals and handed over responsibility for developing power sector investment to ZESCO.

Overall, the political economy analysis suggests that for the electricity sector the tilt towards the status quo is very strong. Consequently, fundamental reforms of sector governance arrangements and policies along the lines that had been discussed until 2003 are highly unlikely to win the necessary political backing. Since rejecting World Bank supported reform proposals in 2003, the government has still been seeking to expand generation capacity – responding to considerable structural incentives and pressures – but to do so without fundamentally changing the governance arrangement in the sector (i.e. public ownership and an integrated structure). The government authorized state-owned ZESCO to attract investors, and the latter has been able to attract some response from the Indian Tata conglomerate, and from Chinese companies (linked to Chinese investments in the mining sector).20 21 Furthermore, mining companies – which consume roughly half of all electricity, and have been affected by power shortages since 2007 – accepted a 35 per cent increase in electricity tariffs in early 2008.22

This situation raises several issues. Firstly, turning investment promises into reality is likely to require some minimum of adjustments in the sector. Secondly, efforts at rehabilitation and future better maintenance of old as well as new capacity require ‘good enough’ governance, as well as some financial basis – which most likely would have to come from increased tariffs. Thirdly, the issue of how to enable an expansion of electricity to poor and remote areas – important for strengthening the link between growth and poverty reduction – has so far remained unaddressed. For the World Bank, the situation raises the question whether it can and should engage in incremental and feasible reform as long as there is no political commitment to follow a ‘first best’ route. The 2008 CAS signals that the World Bank remains committed to engage in the power sector (through investment lending and TA). A new national energy policy to be adopted by Cabinet is expected to provide a (‘good enough’) policy basis, while the dialogue would continue to focus on developing ‘a cost-recovery tariff

19 See fn 14 above. 20 Tata has a long-term history of doing business in Zambia. See e.g. http://www.tata.com/0_tata_worldwide/africa_calling/articles/20050421_zambia.htm. 21 See: http://www.tataafrica.com/news/media_reports/20070124_power_stn_zambia.htm. 22 Also, the AfDB recently signed an agreement with ZESCO to provide a US$1.2 million grant for advisory services to prepare the financial and other strategies for the electricity generation projects at Zambia's Itezhitezhi and Kariba dams. See: http://allafrica.com/stories/200806160710.html.

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framework’ and on monitoring ZESCO performance benchmarks (WB CAS 2008: 26-27). Given this set of challenges – but also incentives emanating from a growing economy and mining sector – the political economy analysis proposes several elements of a feasible route to approach sector reforms in an incremental fashion. Firstly, it proposes that ZESCO has to be taken into account as a full partner in any reforms (rather than as an entity to be dismantled). Secondly, it proposes that mining companies may be willing to pay for new investments – with the dual goal of securing continued electricity supply, and to foster a favorable relationship with host communities – through different (i.e. higher) pricing arrangements for any additional generation capacity that is being created. Thirdly, it proposes that the World Bank could seek to support a series of interlocking commitment among local stakeholders with the goal of breaking out of the current low level equilibrium. These interlocking commitments would entail the utility (ZESCO) committing to efficiency improvements, consumers and regulators committing to sustainable prices, and donors and other financiers committing to make incremental resources available for investments.

5. Telecommunications Telecommunications is a second infrastructure sector which is identified by Ianchovichina and Lundstrom as a key binding constraint to more inclusive growth. There are two aspects to the constraint: the cost of mobile calls and of international calls is high (relative to other countries), access to the fixed-line network remains scarce in areas outside Lusaka and the Copperbelt. In addition, the telecommunications infrastructure has not expanded to meet the emerging demand for broad-band connections.23

The first aspect of high prices is most strongly emphasized as a key binding constraint to growth and job creation.

Access to fixed lines is still very limited – numbering only about 90,000 lines (for a population of around 11.5 million). However, the number of mobile phone subscribers has increased rapidly in recent years to 2 million. In the mobile telephony market, there is one dominant private provider, Celltel, controlling about 80 per cent of the market, a second private provider (MTM), and state-owned ZAMTEL which holds the third license for mobile calls.24

Pricing in telecommunications is bifurcated: the rates for local fixed line calls are low. However, the cost of international calls as well as those of mobile phone calls is high. Mobile rates in Zambia are $0.44, compared to $0.14 in Mozambique and $0.04 in Mauritius (Ianchovichina and Lundstrom 2008: 42). International calls cost upward of $1 per minute. This situation clearly holds back innovation, development dynamism, and employment creation. 23 The scarcity of broad-band connections is a linked to wider regional problems of a lack of fiberoptic (as opposed to satellite) connections to the global broad-band infrastructure. See: www.worldbank.org/rcip. 24 For a technical analysis of these issues see Arnold et al. 2007.

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Reforms to the telecommunications sector have been pursued in Zambia since the mid-1990s, when a Communications Authority of Zambia (CAZ) was created. However, while the CAZ succeeded in licensing cellular operators, three key problems remained unaddressed: poor regulation of mobile cross-connections; the removal of ZAMTEL’s monopoly on international calls; and lack of expansion of fixed line and broad-band services regionally beyond Lusaka and the Copperbelt. In recent years, the World Bank Group and other donors have invested in promoting further change in the sector, but so far, none has been achieved. The governance and political economy assessment explores the underlying governance arrangements which account for this pricing situation and the failure to achieve a greater degree of reform. Fixed phone line services, as well as the international gateway (IGW) to date are controlled by the state-owned provider, ZAMTEL, which holds a de facto monopoly on international connections.25 For ZAMTEL, the IGW is its major source of income.26

For mobile telephony, regulation of inter-connections between different networks has not been improved to promote greater competition and consequently lower prices; and the regulator CAZ appears to have remained weak.

Interestingly, there are both important similarities and important differences compared to the electricity sector. Similarities concern the somewhat similar political economy considerations around ZAMTEL and the IGW (compared to ZESCO). Similar to ZESCO, ZAMTEL provides valuable formal sector jobs (with a current staff of 3,000) and as long as these jobs remain under public sector control, they are available for maintaining patronage networks. Furthermore, preserving ZAMTEL and its IGW monopoly provide a strong revenue stream, and associated opportunities for deriving rents and dispensing patronage – as well as keeping ZAMTEL financially afloat. As part of this rationale, the Zambian government has strongly resisted propositions by donors and international investors to liberalize the IGW.27

A major difference compared to electricity is that global and technological changes have been powerful structural drivers of change for the telecommunications sector in Zambia as elsewhere. In particular, as noted above, mobile phone users are now more than 20 times the number of fixed line users. Thus, technological change has already brought about a significant shrinkage of ZAMTEL’s role. At the same time, it has created a large and growing number of stakeholders in mobile telephony. The governance and political economy analysis therefore suggests two things: one, that – in clear contrast to the electricity sector – there is potentially quite a broad ‘demand side’ for reform in telecommunications because reforms have the potential to bring lower prices for consumers (rather than higher costs as in the case of electricity). Furthermore, a 25 Formally, the IGW was liberalized in line with international recommendations. However, the fee for potential investors was set so high as to make any such investments unattractive. 26 To defend this monopoly situation, Zambian authorities have gone so far as to declare alternative options – Voice Over IP (VOIP) illegal. 27 Political economy or other drivers for the poor regulation of mobile call interconnection are less clear. Notably, donor/WB attention has focused with greater intensity on IGW liberalization than on improving regulation of the mobile telephony market.

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feasible approach to reforms would focus on promoting a reduction in mobile telecom charges first; while putting less focus for the time being on IGW liberalization – given that the latter is likely to be more threatening to key decision-makers and related patronage networks. Such a shift in reform emphasis could be palatable to Zambian elites as well as attractive to consumers – and it could provide some boost to inclusive growth which may in turn enable additional changes later on. The 2008 CAS indicates the World Bank’s commitment to continue to engage in the sector, pursuing an agenda of ‘incremental progress … consistent with local political economy realities’ and focused on building a coalition of stakeholders around building an agenda for incremental improvements (WB CAS 2008: 27).28 In late 2008, the government announced its intention to partially privatize Zamtel.29

Dora Siliya

The general idea appears to be to find a strategic equity partner. The main motivation stated by Minister of Communications and Transport is to stop the need for continued subsidies from the state budget of the loss-making enterprise. However, as commentators pointed out, it is unclear how this would be done (e.g. whether a Zambian or regional equity partner would be preferred), and how a deal would be made attractive for potential investors, given Zamtels existing role of providing patronage resources.

6. Summary of the illustrations from Zambia As these illustrations from Zambia indicate, in some areas, finding a sound as well as feasible set of reforms may be easier than in others. Against the background of a strong overall ‘tilt towards the status quo’, achieving at least some progressive change in the telecommunications sector appears somewhat less of a challenges than reforms to the electricity sector. However, even for the latter, some feasible entry points can be identified, as outlined above. In part 1, this note briefly touched on the issue that there is also a causal direction from the sources of growth to governance; and in particular, that growth driven by extractive activities carries risks of affecting governance negatively. This issue is clearly relevant for Zambia, which has been undergoing a mining boom in recent years. Addressing this concern in depth is beyond the scope of this note. Nonetheless, a brief comment is in order here. A natural resource boom generally increases fiscal revenues available to a government – so that in principle, it could start addressing constraints to (inclusive) growth which

28 The CAS also flags the potential for Zambia to participate in the Regional Communications Infrastructure Program (RCIP) – an initiative to connect Eastern and Southern Africa to the global broadband infrastructure – as an additional incentive for the government to engage on further sector reforms, and to pursue policies that would reduce the constraints to growth related to the sector. For a description of RCIP, see: www.worldbank.org/rcip. NANDTECHNOLOGIES/0,,contentMDK:21280033~menuPK:3625563~pagePK:210058~piPK:210062~theSitePK:282823,00.html. 29 See: ‘Privatization of Zamtel begins’ http://www.zambianwatchdog.com/?p=630 (December 4, 2008), ‘More back Zamtel privatization’ – Lusaka Times, December 7, 2008, http://www.lusakatimes.com/?p=6193.

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previously it could not afford to (or at least could not finance from domestic resources).30

30 In Zambia, up until 2007, the mining boom contributed to growth, but led only to modest increases in government revenue due to low tax rates. In early 2008, the government raised ad valorem royalties for mining companies from 0.6 to 3 per cent and corporate taxes from 25 to 30 per cent. Since then, government revenue has risen sharply.

However, often, the public sector is at least initially poorly equipped to use such extra funds well, not least because structures for public investment planning are often weak. Moreover, if overall governance worsens, this also has a negative effect on the prospects of effectively addressing constraints to growth in the longer term. Specific diagnostics for the governance risks related to natural resource management are currently being developed (see e.g. Dunning 2008), which for resource rich countries will be an important complement to the type of diagnostic work outlined in this note.

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Meisel, Nicolas and Jacques Ould Aoudia (2008), Is ‘Good Governance’ a Good Development Strategy? Working Paper no 58. Paris: Agence Francaise de Developpement. North, D., D. Acemoglu, F. Fukuyama, D. Rodrik (2008) Governance, Growth and Development Decision Making Washington D.C.: World Bank. http://siteresources.worldbank.org/EXTPUBLICSECTORANDGOVERNANCE/Resources/governanceandgrowth.pdf Rodrik, D. (2007) One Economics, Many Recipes: Globalization, Institutions, and Economic Growth. Princeton: Princeton University Press.

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