Explaining Zambian Poverty: A History of (non-agriculture) Economic Policy since Independence

Alan Whitworth
The paper attempts to explain why, despite abundant natural resources, fifty years after Independence Zambia has some of the worst poverty in Africa. High copper prices meant the UNIP government enjoyed substantial fiscal resources in the decade after Independence, facilitating a rapid expansion in social infrastructure. However, investment undertaken in response to Rhodesias UDI (oil pipeline / refinery, TAZARA) led to a permanent increase in costs. Much was also wasted on an extraordinary expansion of the states role in the economy and a vain attempt at industrialisation through import substitution. Nationalisation of the copper mines in particular proved disastrous. Increased public service wages and subsidies were no longer affordable once mineral prices and taxation collapsed in the mid1970s. Anticipating a rebound in prices, government chose to borrow rather than cut expenditure. As prices continued falling, fiscal deficits and debt became unsustainable. Lack of foreign exchange, compounded by political interference, led to financial losses by parastatals adding to fiscal pressures. By the 1980s public expenditure was largely confined to debt service, wages and subsidies crowding out expenditure on basic social services of most benefit to the poor. The reforms of the MMD government from 1991 eventually succeeded in reversing the downward spiral. Trade liberalisation, elimination of most subsidies and a major privatisation programme stemmed the fiscal haemorrhage. Though controversial, privatisation of the mines was a turning point. Substantial investment in mining triggered a sustained period of rapid growth, boosted by rebounding copper prices from 2004. With debt relief and increasing mineral taxation, this helped establish fiscal and macroeconomic stability creating real fiscal space. While this facilitated increased expenditure on basic services, much of the proceeds of the second copper boom were wasted on uneconomic road projects and poorly targeted agriculture subsidies. Poverty reduction was limited to the urban population. The PF government since 2011 has revived a number of populist UNIP policies, suggesting that the lessons of that era are poorly understood.

I. Introduction At Independence in October 1964 Zambia had the fourth highest GDP per capita in Africa (www.NationMaster.com). As the fiftieth anniversary of Independence approaches it has some of the worst social and poverty indicators on the continent, despite sustained GDP growth since the turn of the century. This paper attempts to explain why, despite a rich natural resource endowment and relative peace and political stability, poverty has increased in Zambia. The history of Zambian economic policy is of more than just academic interest. It will be argued that, while external factors - notably Southern Rhodesias UDI and the collapse in copper prices from 1974 contributed significantly, Zambias poor economic performance is largely explained by misguided macro and micro economic policies adopted during the Kaunda era. The damage caused by these policies, some of which persist to this day, is poorly understood by the Zambian public and politicians. As a result, rather than learning from past mistakes, the Patriotic Front government elected in 2011 appears to be repeating some of them. The paper has one conspicuous omission. The majority of Zambians are dependent on agriculture, and the unambiguous failure of successive governments agriculture policy is arguably the single most important reason for increased poverty. However, this is such a large subject that it merits a separate standalone paper.

II.

The Zambian Economy at Independence

Zambias colonial inheritance was unusual. Instead of being a separate colony, Northern Rhodesia was part of the Central African Federation (of Northern and Southern Rhodesia and Nyasaland now Zambia, Zimbabwe and Malawi respectively) between 1953 and 1963. The Federal capital was Salisbury (now Harare). From the outset the benefits of Federation were very unevenly distributed, with industry and infrastructure concentrated in Southern Rhodesia. Most of the tax from the Northern Rhodesia copper industry was diverted to the south1. Under the Federation Northern Rhodesia lacked many of the governmental functions fiscal, industrial and commercial policy, transport and power, overall control of educational policy, defence and foreign affairs that any independent country (and even any fully fledged colony) would regard as indispensable. Many of the ministries with which Zambia began life had only been in existence for a few months (Martin 1972:47). As a result, Zambia inherited much less at independence in terms of infrastructure, industry and public administration than most normal former colonies. Essentially, the inheritance comprised a thriving copper mining industry, the infrastructure needed to support it (particularly the railway through Southern Rhodesia to Mozambican ports and hydroelectricity from Kariba) - and little else. Manufacturing was limited to plants supporting the mines and a handful of industries where proximity to the final market was important (eg breweries, maize milling, cement). Most damagingly, Zambia found itself at independence with a smaller number of educated Africans in relation to the population than virtually any other of Britains African colonies. In 1963 there were fewer than 100 Zambian university graduates and fewer than 1,000 secondary school graduates ..[The] lack of skilled manpower at all levels was probably the biggest single constraint on Zambias development in its early years (Martin 1972:49). Zambias economic prospects were also constrained by geography. Being a large, sparsely populated country meant that providing social infrastructure (health, education, roads) would inevitably be relatively expensive per person. Its small population and domestic market meant there was limited scope for manufacturing unless export markets could be accessed. However, trade prospects were limited by being landlocked and poor transport links with all neighbours apart from Southern Rhodesia. On the other hand, Zambia also had some substantial advantages relative to other former African colonies. Foreign reserves in 1965 were equivalent to nine and a half months import coverage (IBRD 1966:14). Most obviously, Zambia had some of the richest mineral deposits in the continent and was the
1

The Federal Treasury estimated that during the nine years from 1 July 1954 to 30 June 1963, Northern Rhodesia contributed 201.3 million to the Federal current revenues, while only 126.3 million was spent in Northern Rhodesia, giving a surplus of 75.1 million (IBRD 1966:7).

fourth largest copper producer in the world. On the eve of Independence Zambia bought back the mineral rights (and royalties) of its own sub-soil riches, which the British South Africa Company had owned since 1891. Now that taxation of the copper industry was no longer siphoned off by the Federation, the new government could look forward to a substantial stream of fiscal revenue. Copper contributed 93% of exports and 71% of government revenue (equivalent to 18.5% of GDP) in 1965 and more than half of government revenue every year until 1971 (Table 1). Minerals were by no means Zambias only natural resource. One of the largest countries in Africa by area, it had substantial land resources; 39 million hectares, 58% of which was classified as having medium to high potential for agricultural production. It also had an excellent climate for agriculture and was well endowed with water resources valuable both for agriculture and for generating hydro-electricity. Finally, with Victoria Falls and some of the best game reserves in southern Africa, there was considerable potential for tourism. The political context also appeared relatively favourable. The transfer of power had been entirely peaceful. No ethnic group was dominant. With a much smaller settler population than Southern Rhodesia, the new government did not have to cater to settler interests and could focus entirely on the needs of the African majority. Inheriting little meant starting with a clean slate. With its rich natural resources and good fiscal prospects, therefore, Zambia started life with great potential (an over-used term in the Zambian context). This paper attempts to explain why, fifty years later, so little of this potential has been realised. The paper divides the history of Zambian economic policy into four periods: 1. Independence to the mid-1970s 2. Mid-1970s to 1991 3. 1992 to 2011 4. 2011 to 2013 Given the prominent role that copper has played throughout, it starts with an account of the key developments in the Zambian copper industry from the opening of the first mine in 1929 through to the modern day. III. Copper Production and Revenue

The fortunes of Zambias copper industry have been closely correlated with those of the formal economy since well before Independence. The main links are: (i) the industrys demand for Zambian goods and services; (ii) employment; (iii) foreign exchange; and (iv) government revenue. Although copper represented between 38% and 48% of GDP in the five years after Independence (Table 1), links with the rest of the economy have always been weak. Mining is an enclave industry everywhere, with few backward and forward linkages; most inputs are imported, while processing beyond smelting / refining into cathode is rarely economic. It is also a capital-intensive industry, creating relatively few jobs. Direct employment in Zambias copper mines has rarely exceeded 50,000, or 10% of the formal labour force, though many other 3

jobs are created indirectly. Mining is also much the most important source of foreign exchange. Except for the period 1998 2003 (when it averaged 64%), copper has always represented at least 75% of Zambian exports. With few linkages, jobs only for a relatively privileged minority, and with profits accruing to foreign owners, minings greatest value to the economy is its contribution to government revenue. If productively invested, revenue from mining can benefit the entire population. This section focuses on minings contribution to public revenue. Later we examine how effectively it has been invested. As in any business, gross revenue from copper is determined by two variables price and production volume. Figure 1 presents trends in both world copper prices (US Dollars per ton, right axis) and Zambian copper production (metric tons, left axis) for the period 1930 to 2010. To allow comparability over such a long period price data is shown in constant 1998 US Dollars. We start with prices. Northern Rhodesia started producing copper in 1931, during the Great Depression. From a low of $1,520 per ton in 1932 world prices rose progressively, if unevenly, for the next four decades. At Zambian Independence in 1964 the price was $3,750. Prices continued rising with fluctuations - for the next decade and reached a peak of US$5,630 per ton in 1974. In late 1974 prices started a long period of decline, falling to $4,290 per ton in 1975 (all 1998 constant prices). While the immediate trigger was the global recession following the 1973 oil crisis, the price collapse also reflected fundamental shifts in patterns of base metal use, technological innovation in communications, and rapid growth of world copper supply (McPherson 2004:305 and 40-41). Prices continued falling in real terms again with fluctuations - until 2002, when they hit an all-time low of $1,510. They then rebounded dramatically, recovering in five years all the losses of the previous 27, driven largely by growing demand from China. A new peak of $5,690 was reached in 2007. Prices dipped in 2008 and 2009 as a result of the global financial crisis, before recovering in 2010. Turning to production, Figure 1 shows a strikingly similar pattern in Zambian copper output to the price trend. There was a progressive increase up to 1969, before a fatal cave-in and flooding at the Mufulira mine (25% of output) in 1970 led to a temporary fall in output. Production recovered to 713,000 tons in 1976 (Table 1) before the onset of a long period of decline between 1977 and 1998, when output was just 256,000 tons. Following privatisation of the mines and substantial foreign investment (including two major new mines, Kansanshi and Lumwana), production rapidly rebounded from 1999, boosted by the increase in copper prices from 2004. The collapse in copper production was due to a number of factors. Continuous maintenance and investment is needed in mining to maintain, let alone increase, output because ore grades decline and mineral deposits become less accessible (more costly) at greater depths. Maintenance and investment in Zambias mines tailed off during the 1970s for a number of reasons. Firstly, in 1969 the Government acquired 51% of the equity in the 4

two major mining groups, to be paid out of future profits - backed by government guaranteed bonds. Agreements were signed with both groups to ensure continuity in management. However, in 1973 the Government cancelled the agreements and paid off the bonds in full. This is discussed below.
Figure 1 Zambian Copper Production and World Prices, 1930 - 2011

Sources: Based on Fraser and Larmer (2010: Figure 1) 1) Production data 1930 1963, United States Geological Survey Minerals Yearbook (various years), available online at http://minerals.usgs.gov/minerals/pubs/commodity/copper/index.html 2) Production data 1964 2011, Bank of Zambia 3) Price data from U.S. Geological Survey (2011), copper statistics, in Kelly, T.D. and Matos, G.R., comps., Historical statistics for mineral and material commodities in the United States: U.S. Geological Survey Data Series 140, available online at http://pub s.usgs.gov/ds/2005/140

These abrupt changes discouraged further investment by the former owners. Henceforth, investment would have to come from government. However, as shown below, the collapse in copper prices from 1974 triggered both a fiscal crisis, which drastically reduced public resources available for investment, and a foreign exchange crisis which made it difficult to import essential inputs. Falling prices also hit corporate earnings, which were sometimes insufficient to cover spare parts and maintenance, let alone new investment. Meanwhile, the sealing of the Rhodesian border between 1973 and 1978 and the liberation wars in Angola and Mozambique significantly increased transport costs. These problems were compounded by pressure for rapid Zambianisation of management positions, increased political interference and spending on unprofitable non-mining activities.2 By the early 1990s, ZCCM [Zambia
2

Sardanis (2003:297-299) claims ZCCM became a state within a state and that management yielded to the whims of the Government and transformed ZCCM from a respectable mining group into a mindless conglomerate encompassing all sorts of irrelevant

Consolidated Copper Mines, the state mining conglomerate] had been drawn so far into the indirect financing of state and party activities that rents in the mining sector had been all but eliminated..Between 1997 and 1998, ZCCMs reported pretax losses totalled approximately US$650 million almost $1 million per day (Adam and Simpasa 2010:63 -65). As prices continued falling, the mines entered a downward spiral of falling earnings, maintenance and production which was only halted by privatisation. The decline in copper production is frequently attributed to falling prices. However, a comparison with Chile is revealing. The level of copper production was similar in Chile and Zambia in the 1960s. However, despite facing the same prices as Zambia, copper production in Chile increased by an average of 4.1% pa in the 1980s and 11.0% pa in the 1990s (Meller and Simpasa 2011:15). Like Zambia, much of Chiles copper industry was nationalised in the early 1970s. The key difference was that, whereas the Chilean government treated its mines as a business and invested heavily in them, GRZ raided them for political purposes. 3 Figure 1 shows how the decade between Independence and 1974 was a boom period for Zambian copper revenues, with both prices and production at historic highs. Following privatisation of the mines and the rebound in prices since 2004, copper revenues are booming again.
Table 1 Coppers contribution to GDP and GRZ Revenue, 1964-1978 Production MT 000 632 696 623 663 665 4 748 683 633 698 681 700 619 713 660 656 Contribution to GDP % Kw million 290 379 379 411 637 457 268 317 506 607 204 330 223 272 40 44 39 38 48 36 23 23 32 32 13 18 11 12 Contribution to Revenue Kw million % of revenue % of GDP 57 53 134 71 18 163 64 19 146 53 15 183 60 17 237 59 18 218 52 17 114 36 10 56 19 4 108 29 7 341 53 18 59 13 4 12 3 1 -1 -

Year 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978

Source: Production data from Bank of Zambia; revenue data from Meyns (1984:8) based on Zambia Mining Year Book, 1969 - 1978

businesses such as maize milling, dry cleaning, commuter trains, farming, tractor assembly and tourist resorts. 3 Total mineral rent between 1970 and 2010 was US$ 15 billion [in constant 2000 prices]. Assuming that production had remained constant around 700,000 tons each year up to 2010, and applying average annual copper prices for each year, Zambia total mineral rent would have been around US$ 60 billion. Under these assumptions, Zambias policy cost it US$ 45 billion of lost rent (Eunomix 2013). 4 Production was extraordinarily high in 1969 because of additional processing (25-30,000 MT) of concentrate stockpiled from earlier years due to transport problems.

What has been the impact of the two booms in copper revenue on public revenue? Since no dividends were paid during the period of majority state ownership of the mines, public revenue from mining essentially comprises taxation. Mineral taxation is a function of profits and the mineral tax regime. Table 1 illustrates minings extraordinary contribution to government finances during the first boom. High copper prices meant the mines earned substantial profits. The mineral tax regime was highly effective in capturing a large proportion of these profits some 70% - for government. Mineral tax receipts were highest between 1965 and 1970, contributing between 52% and 71% of government revenue and equivalent to 15% - 19% of GDP. These are exceptionally high figures for a non-oil exporting country.5 In addition, while data is not available, much personal income tax and indirect tax revenue was also derived from the mining sector. As a result, the Zambian Government had access to substantial financial resources in the first decade of Independence. The extraordinary expansion in public services and in the role of the state described below was largely financed by mining. Apart from 1974, when the copper price reached its highest real level in half a century, mining tax receipts dropped sharply after 1970 - and had completely evaporated by 1977 (Table 1). This reflected mainly the fall in gross revenues (and profits) as a result of falling prices. However, it was aggravated by a change in the tax regime in 1970. Until 1970 mines paid standard company income tax at 45% of profits, royalties of 13.5% of the copper price per ton less K16 and a special export (windfall) tax of 40% of the London Metal Exchange price per ton above K600. In 1970 royalties and export tax - taxes on production, payable regardless of profitability - were abolished. They were replaced by a mineral tax on profits at 51%, with standard income tax (now 35%) payable on the balance of profits. While the effective tax rate of 68% differed little from before the change, tax was now solely dependent on profits (World Bank 1972: Annex, p.7-9). As profits slumped, so did taxes. GRZ received negligible mineral revenue between 1977 and 1983, when it introduced a Mineral Export Tax of 4% (increasing to 13% in 1985) of the gross value of copper exports. Mineral revenues averaged just 2.4% of GDP between 1985 and 1991 (World Bank 1992:6). However, by the mid-1990s ZCCMs finances had deteriorated so much that, instead of receiving tax revenue from ZCCM, government was increasingly forced to bail it out. A decade after privatisation, with both production and prices at similar real levels to those of the late 1960s, many Zambians expected similar levels of mineral tax revenue to the previous boom. However, this has not materialised. Whereas mining tax was equivalent to a cumulative 104% of GDP between 1965 and 1970 (Table 1), the cumulative figure for 2006 to 2011 was just 12.6% of GDP (Whitworth 2013: Table 1).6 This is a complex, contentious

Total GRZ revenue in 2012 was equivalent to 23.2% of GDP, of which Mining represented 3.8%. 6 These figures are not strictly comparable because of the deterioration in the accuracy of national accounts in recent years and the under-estimation of GDP.

subject and a detailed explanation is beyond the scope of this paper. Following is a brief summary of the main factors. Firstly, the mines were privatised in the late 1990s when they were incurring heavy financial losses and copper prices were at historic lows (Figure 1). Selling at the bottom of the market, GRZ was in a weak negotiating position and was forced to offer generous tax concessions in the Development Agreements negotiated with the buyers. Secondly, the huge maintenance backlog at the privatised mines meant the new owners had to invest substantial amounts just to clear the backlog - in addition to new investment. Most tax regimes allow accelerated depreciation of investment to be deducted from taxable profits and allow tax losses to be carried forward to future years. Zambias regime was unusual only in allowing investment to be fully depreciated in the year of investment, instead of being spread over a number of years. In these circumstances one would not expect mines to have positive taxable income until several years after financial profits are first declared. In addition to the above legitimate reasons for delayed / reduced mining tax, there have been allegations of corruption in negotiating the Development Agreements and of transfer pricing by some mines. While these are not considered here, it would be very difficult for the Zambia Revenue Authority to effectively police transfer pricing if it were going on. Frustrated at the low levels of mining tax despite the copper boom, in 2008 GRZ revoked the Development Agreements and introduced a number of new tax measures. The mining tax regime was revised again in 2009, 2011 and 2012 (Manley 2013). The most significant single measure was the increase in the mineral royalty rate from 0.6% of gross sales value in the Development Agreements to 3% in 2008 and to 6% in 2012. Mining tax revenue increased from 0.5% of GDP in 2005 to 3.8% in 2012 a result of both tax reform and continued growth in copper revenues (Whitworth 2013: Table 1). While well short of the 1960s levels, significant mining revenue was again available to fund expanded public expenditure. IV. Economic policy from Independence to the mid-1970s

The broad economic objectives of the new government were to diversify production to make the economy less dependent on a single commodity, involving both the encouragement of new industry and a radical improvement in agriculture, and to step up as fast as possible the rate of social investment in education, health services, roads, etc (Martin 1972:54). While, as discussed below, successive governments industrialisation (and agriculture) policies have largely failed, significant investment in social infrastructure was made in the early years. Most of the countrys education and health facilities were constructed during the decade after Independence7. A major road construction and upgrading programme was also undertaken, with most of the
7

Between 1965 and 1975 Zambia education expenditure averaged 14.4% of total government spending and 5.1% of GNP, well above typical levels elsewhere. There was a dramatic increase in enrolment at all levels. The results have been a truly impressive expansion of formal and vocational training facilities (World Bank 1977:117).

trunk network paved and an extensive network of unpaved secondary and feeder roads connecting remote areas. The government was determined to build an industrial sector, which was seen as the key to diversification and economic independence. It was assumed initially that this would be driven by the private sector. Industrialisation was to be achieved through import substitution, reflecting the prevailing thinking in the development literature at the time. The idea was that, by offering protection from foreign competition through tariffs8 and non-tariff measures, firms would be induced to manufacture domestically goods which had previously been imported. While costs and prices would be higher in the short term, the implicit assumption was that growth and economies of scale would eventually reduce costs. The Role of the State Zambia was a mixed economy at Independence. While it inherited a number of public enterprises - eg electricity, rail and air transport, agricultural marketing and development and rural sector financing - most commercial activity, dominated by mining, was privately owned. Initially, the government appeared content with this arrangement. A decade after Independence the landscape had been completely transformed. As shown below, the industrial sector had expanded enormously but driven by the state, not the private sector. The World Bank summarised the situation in the mid-1970s as follows: State-controlled enterprises dominate Zambia's economy. They play a key role in almost all major economic sectors, including Zambia's mining industry, manufacturing, wholesale and retail trade, energy, transport, finance, hotels and restaurants, and agricultural services and marketing. In 1975 the Zambia Industrial and Mining Corporation (ZIMCO), the giant state-owned parent holding company embracing some 73 state controlled subsidiaries, reported a turnover of K 1.2 billion [US$1.8 billion], total net assets of K 1.5 billion [US$2.3 billion, of which the mines accounted for about 80%], total employment of over 100,000 persons or close to 25% of total national wage employment. Including an additional 14 major statutory bodies and corporations, it is estimated that well over half of Gross Domestic Product per year originates in the parastatal sector and that parastatals together employ at least a third of total national wage employment (World Bank 1977:i). Reading the previous paragraph today the extent of state domination of the economy appears extraordinary. It was one of the most remarkable economic developments in post-colonial Africa, with profound consequences for future generations. In just a decade Zambia had gone from a predominantly private economy with very weak public institutions and fewer than 100 university graduates to a country where the state dominated not just the commanding
8

During much of the 1970s the nominal rate of protection for all goods was estimated at 34%, and the effective rate at 160%. As a result, domestic sales were much more profitable than exports (World Bank 1993:17).

heights of the economy but virtually all medium and large scale business.9 It is hard to think of a successful modern economy with anything like this degree of state control. It is now widely recognised that governments are ill equipped to undertake such commercial activities as manufacturing and agricultural marketing, let alone wholesale and retail trade, hotels and restaurants. How did this come about? The growth of the state took three distinct forms: 1. Investment to reduce dependence on Southern Rhodesia following its Unilateral Declaration of Independence (UDI) in November 1965; 2. Direct investment in large scale manufacturing where the private sector was unwilling to invest; and 3. Nationalisation of private enterprises. 1) UDI UDI in 1965 had a profound impact on the Zambian economy, the effects of which are still felt today. Its colonial history had tied Zambias economy firmly to that of its southern neighbour. Virtually all its international trade was transported through Rhodesia by rail or road the only paved roads out of the country went south. Fuel was imported via the pipeline from Beira to the Rhodesian refinery at Umtali. Though it was jointly owned, the power station on which the copper mines depended was situated on the south bank at Kariba. Zambia suddenly found itself in the forefront of the economic war that broke out between Rhodesia and the rest of the world. Many of the sanctions invoked against Rhodesia worked much more quickly and devastatingly against itself. For example, the oil embargo cut off Zambias supplies, too, and it had to depend on a ridiculously elaborate and expensive airlift over distances of upwards of a thousand miles (Martin 1972:52-53). While sanctions caused considerable short term disruption, the fiscal damage was limited by booming revenue from mining. However, the infrastructure investments GRZ was forced to undertake to reduce dependence on Rhodesia and the impact of sanctions had far greater long term significance for the economy. They were undertaken for urgent strategic reasons, rather than any great desire for an increased role for the state in the economy. Following the oil embargo, Zambia had to make urgent alternative arrangements to import fuel. A contract was signed (by Indeco see below) in 1966 for an Italian financed and constructed 1,700 km pipeline from the refinery at Dar es Salaam to Ndola. The TAZAMA pipeline was jointly owned by the Zambian (65%) and Tanzanian (35%) governments; oil products started flowing in 1968. Subsequently, the Indeni refinery was commissioned at Ndola in 1973. A blend of crude and finished products is imported and then refined and separated at Indeni to meet the Zambia market mix. The pipeline played a critical role during the Rhodesia crisis. However, following Zimbabwes independence in 1980, much of TAZAMA / Indenis rationale
9

Total parastatal assets increased from K 234 million in 1964 to an estimated K 2 billion in 1976 (World Bank 1977:i).

10

evaporated and it soon became a liability. Indenis small aging plant could not compete with modern refineries, while distributing fuel throughout a territory as large as Zambia from a single point (Indeni) was more costly than direct import of finished products due to high internal transport costs. Unable to bring itself to close TAZAMA / Indeni (with the loss of 600 jobs), instead of liberalising fuel imports, the Government has protected its monopoly with a 25% import duty on finished products. As a result, Zambia today has among the highest fuel costs in the world with obvious implications for competitiveness and poverty (Whitworth 2014). Other major energy sector investments undertaken to reduce dependence on Rhodesian imports include the Kafue Gorge and Kariba North Bank hydroelectric schemes (commissioned in 1972 and 1977 respectively) and Maamba Collieries. While Kafue was clearly economic, the collapse in copper production from 1977 meant the extra 600 MW generation capacity at Kariba North Bank was effectively unutilised for two decades - at huge economic cost (Whitworth 2014). The coal deposits at Maamba were developed in 1968 mainly to meet the needs of the copper mines. However, once Indeni was commissioned in 1973 the mines switched from coal to heavy fuel oil. In the short term, Zambia responded to the need to re-route its international trade by establishing a large-scale road haulage operation (400 trucks) on the 1,600 km Great North Road between Dar es Salaam and the line of rail at Kapiri Mposhi. Zambia Tanzania Road Services, a public private partnership between the Zambian and Tanzanian governments and Italian financiers and operators, also negotiated by Indeco, became Zambias principal freight carrier for a decade from 1966 (Sardanis 2003:180). The long term solution was thought to be a new rail route to Dar es Salaam. The idea had been rejected as uneconomic by the World Bank in 1964, but UDI changed everything. In 1970 the Chinese government offered to construct a line from Dar es Salaam to the Copperbelt and provided a US$400 million interest free loan to the Tanzanian and Zambian governments to finance construction of the line and procurement of rolling stock. The Tanzania Zambia Railway (TAZARA) commenced operations in 1976 and in 1977 transported 81% of Zambias exports and 85% of its imports (World Bank 1981: Tables 4.05 and 4.06). However, the following year rail services to the south were resumed because of reliability problems with the line and congestion at Dar es Salaam harbour. Zimbabwes independence in 1980 removed TAZARAs raison detre completely. It has never made a profit and soon became a white elephant. With a design capacity of 5 million tonnes a year, freight traffic has never exceeded 1.2 million tonnes (in 1986). It is questionable whether there was enough freight for one railway line to operate profitably once copper production started its long decline in 1977, let alone two lines. By the time copper production rebounded in the 2000s the mines had little need for railways because the road network had greatly improved and, following the end of apartheid, a completely new trucking industry was offering highly competitive freight rates between Zambia and South Africa. So instead of securing Zambias routes to the ocean, TAZARAs construction 11

meant that neither railway was profitable, leading to higher unit costs and the deterioration of both systems (Raballand and Whitworth 2014). All the above investment decisions were entirely reasonable in the context of UDI, but they were enormously expensive and caused lasting damage to the economy. 2) Direct investment While its initial policy was to leave industrialisation largely to the private sector, the Government was prepared to invest itself (sometimes in joint ventures) in projects that were deemed strategic and/or where the private sector was reluctant to invest. The success of the road haulage operation and the TAZAMA pipeline increased GRZ confidence in its own ability to undertake major commercial projects. The Governments own programme was spearheaded by the Industrial Development Corporation (Indeco), a small development finance company engaged primarily in long-term lending to the private sector inherited from the Federation. Headed from 1965 by Andrew Sardanis, a Cypriot / Zambian businessman, Indecos initial role was to participate in, or set up if necessary, industrial enterprises and to provide incentives for prospective foreign and Zambian private investors. It became the main channel for applying government funds to industry by means of loans, share capital and the provision of factory buildings (Martin 1972:57). In addition to Tanzania Zambia Road Services and TAZAMA, between 1965 and 1967 Indeco signed contracts for several major projects, most of which were in production by 1970. The largest (K18 million) was for Nitrogen Chemicals of Zambia (NCZ), a colossal fertiliser plant which also produced explosives for the mines. Other major contracts included a fully integrated textile mill, Kafue Textiles (K7 million), Zambia Metal Fabricators (a copper cable plant), a second cement plant, tyres, grain bags and fishing, plus two Intercontinental Hotels and several smaller enterprises (Martin 1972:63). The following observation by Martin is crucial in understanding the reasons for the problems experienced by Zambias industrial parastatals from the mid 1970s. Indeco tended to take the view that if a local industry could be established which did not raise the cost of the product by more than about 30%, the best thing to do was set it up as quickly as possible (Martin 1972:67). In other words, economic viability was not a primary concern; industry was wanted for its own sake, almost regardless of cost10. Many Indeco investments were simply not economically viable.11 While financial viability could be secured through tariff and other protection12 from imports, this was at considerable cost to consumers and to competitiveness; and once protection was removed many Indeco projects were doomed.
10

NCZs costs would have been significantly lower had it used a petro -chemical base instead of expensive local coal (Martin 1972:66). 11 Examples include NCZ, Livingstone Motor Assemblers, Kapiri Glass and Mansa Batteries. 12 Sanctions against Rhodesia (and apartheid South Africa) unintentionally provided substantial protection to domestic businesses until 1979.

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3) Nationalisation By 1968 the government became convinced that most foreign-controlled and local expatriate companies, which still made up most of the private sector, were more preoccupied with fast and high returns and with transferring capital abroad than with local reinvestment, diversification of Zambia's economy and Zambianization of personnel (World Bank 1977:i). In April 1968 President Kaunda announced the Mulungushi Reforms, the first in a series of economic reforms which, among other things, considerably expanded the role of the state primarily by taking majority shareholdings in established larger scale private enterprises. In one of the most significant measures 25 leading non-mining companies (mainly department stores, suppliers of building materials, quarries, transport companies and breweries) were invited to offer the Government at leas t 51% of their shares while continuing to manage them. Indeco was to negotiate the purchase of the shares, with compensation limited to book value, and hold them on Governments behalf. The President also announced that retail trading outside the main city centres, and certain other businesses (eg smallscale government building contracts, rural transport contracting and small quarrying), were henceforth to be confined to Zambian citizens. Restrictions were also imposed on local borrowing by non-Zambian businesses and remitting dividends overseas. In essence, the reforms spelled out a policy whereby large scale enterprise would henceforth be the reserve of the State while the small enterprise sector would be opened to Zambian citizens by barring the resident expatriates (mainly ethnic Indian traders) who dominated the sector.13 Following the December 1968 elections a major review of mining legislation, taxation and policy was undertaken. The outcome was announced in the Presidents Matero speech in August 1969: i. Mineral rights would henceforth revert to the state and a new system of licences would be introduced ii. The State would have the right to a 51% share in any new mine iii. Royalties and export tax would be replaced by a single mineral tax on profits iv. Existing mines were asked to give 51% of their shares to the State (Martin 1972:155-156). Negotiations over the transfer of shares would again be conducted by Indeco, which would pay a fair value represented by book value to be paid out of future dividends. Negotiations with the two groups of mining companies, Anglo American and Roan Selection Trust (RST), were concluded within two months with agreement in principle on all the main issues. Anglo Americans assets were valued at just over K240 million and RSTs at K165 million; 51%
13

Macmillan notes that, instead of attracting Zambian entrepreneurs into the commercial vacuum created, the banning of Indian retailers simply led to the closure of many rural shops and trading networks. As a result, the Mulungushi Reforms had disastrous results for most Zambians especially those in rural areas (Macmillan 2008:212).

13

of these came to K125 million and K84 million (US$292 million in total). The old shareholders would receive (ZIMCO see below) bonds in exchange, unconditionally guaranteed by the Government, to be repaid in twelve years from 1970 for Anglo and eight years for RST with an interest rate of 6% (Martin 1972:176). There were exclusive management, sales and service agreements with both groups to ensure continuity in management for at least ten years. In November 1970 President Kaunda announced a further round of measures to increase state participation, this time in the financial sector. The measures included: i. 51% state participation in the foreign banks14, and the merger of five local commercial banks into two new banks ii. The establishment of a State Insurance Corporation which would take over the business of the existing insurance companies iii. Complete take-over of the building societies As the President said, this basically completes our economic reforms.Now Zambia is ours and more and more wealth is ours too (Martin 1972:240). The financial sector takeovers differed from the earlier rounds in that the Government no longer proposed signing management agreements with the former owners to ensure continuity of management; self-management was to be the new policy (Martin 1972:247-8). In addition to acquiring majority stakes in the mines, between 1965 and 1975 the Government established nearly 80 parastatals either through own investment or acquisitions. Of these, 45% were in manufacturing, 30% in retail / wholesale, finance, and other services, and the remaining 25% in transport, agriculture and energy. In 1973 the Government decided to redeem the ZIMCO bonds in full, despite a penalty of US$55 million, and to terminate the management agreements. It paid $231 million after borrowing $150 million from the Eurodollar market.15 Now it could participate more actively in decision making. In 1974 the first Zambian Managing Directors were appointed at Anglo American and RST. Alarmed at the change of policy, foreign shareholders were unwilling to invest further resources in the mines. This forced the state to inject additional funds; its equity in both mining groups had risen to 61% by 1981. The Government encouraged both groups to rationalise their mining operations and in 1982 they were merged to form one giant conglomerate, Zambia Consolidated Copper Mines (Burdette 1984:47).

14

Government, however, failed to reach agreement with Barclays, Standard and Grindlays banks regarding their take-over and instead expanded the operations of the National Commercial Bank. 15 Sardanis suggests that the decision was instigated by Tiny Rowland of Lonhro, who had personal ties with Kaunda, and that Zambia unnecessarily overpaid by over $100 million because the bonds were trading at a substantial discount on international markets (Sardanis 2003:266-278).

14

Following the acquisition of the mines, there was a reorganisation of the parastatal sector. Indeco continued to be responsible for industrial parastatals, but as part of the Zambia Industrial and Mining Corporation (ZIMCO) which was set up as the master holding company for all parastatals. While, with the benefit of hindsight, attempts to control so much of the formal economy were surely doomed to failure, it is important to consider how Zambia got into this position16. Firstly, as noted above, because of UDI the Government was forced to get involved in certain sectors (fuel, transport, coal). Secondly, public ownership was viewed very differently in the 1960s. Large parts of the UK economy, the former colonial power, had been nationalised - including coal mining. State ownership was widely seen as a legitimate way for newly independent countries to establish economic independence; many African countries sought an increased role for the state in the economy, through both ownership and planning. The influential Seers Report had proposed a major increase in government involvement in the Zambian economy, so as to expand infrastructure, promote agriculture and direct more resources into regional development (UN/ECA/FAO 1964). Thirdly, and critically, Zambia had the resources to pursue a policy of extensive economic nationalism. The combination of high copper prices and an effective mineral tax regime meant Zambia could afford a level of public expenditure in the 1960s that other newly independent countries could only dream of without accumulating excessive debt. Finally, the process of extending state ownership was initially well managed by Indeco on behalf of Government. Paying for shares through future dividends rather than up front minimised the fiscal impact. The former owners received fair prices and, since they retained 49% of the equity and were encouraged to stay on, still had an incentive to manage effectively. Indeco was acutely conscious of the need for strong management. Until the move to self-management in 1970, the policy of negotiating management contracts with former owners or (for new projects) international firms meant the change of ownership had relatively little impact on operations. The extension of state ownership began relatively smoothly. Apart from the banks, few of the firms invited to sell their shares refused. Agreement with the mines in 1969 was quick and amicable. With the help of tariff protection, most of Indecos manufacturing projects were financially (if not economically) viable. The manufacturing subsidiaries achieved an after-tax rate of return on net assets of about 7-8% until 1974. From 1970 to 1974 there was an estimated annual net inflow of funds from Indeco to the [Government] budget on current account17. The greatest part of revenues was from income taxes, followed by interest payments (World Bank 1977:35). However, the extension of the state into areas well beyond the core functions of government carried great risks for the economy and public finances.
16 17

The political motivation for nationalisation is discussed in Larmer (2010:36). There was a net outflow on the capital account to finance GRZ investment in Indeco projects (World Bank 1977:36).

15

Investing in infrastructure and industrial projects which were not economically viable - and protecting their monopoly with import controls - meant increasing the cost structure of the economy at the expense of consumers and competitiveness. And if parastatals incurred losses, for whatever reason, GRZ would be under pressure to bail them out in order to continue operations and save jobs. Arguably, the greatest risk derived from the nature of Zambias industrialisation. Industrialisation was seen as a route to economic independence and reduced dependence on imports. However, a strong exchange rate made imports of capital and intermediate goods relatively cheap. Along with an import substitution strategy which provided protection from imported finished goods, this encouraged the development of a highly capital and import intensive industrial sector while discouraging non-traditional exports. Dependence on imports had increased; instead of finished products, Zambia was now dependent on imports of intermediate goods. Any disruption to foreign exchange supplies would not only affect the supply of finished goods but would also jeopardise operations of the new industrial sector. Fiscal performance to the mid-1970s With mining revenues averaging 17% of GDP between 1965 and 1970, GRZ was able to dramatically increase public expenditure while seemingly following conservative macroeconomic policies. Despite the effects of UDI and despite funding most of the investment programme from domestic resources, the budget was usually in surplus. Gross national savings averaged 37% of GNP over the period while gross domestic investment averaged 28%; about one-third of national savings was provided by government recurrent budget surpluses while the remainder was contributed by the private and parastatal sectors (World Bank 1977:18). Expansion of the money supply was consistent with the growth of real income and the progressive deepening of the financial system, inflation was low and external debt was minimal (McPherson 2004:30). However, expenditure policies adopted during this period were building up severe fiscal problems for the future. The substantial social infrastructure programme inevitably gave rise to increased recurrent expenditure commitments; expanded education and health facilities required more teachers and health workers, new roads needed to be maintained, and so on. In addition, the government pursued a policy of very rapid Zambianization and an extraordinary expansion of the entire government personnel establishment. The latter increased at a rate of 18% per annum during 196469. Also, by 1969 most senior posts were staffed by Zambians. During 196474, the civil service increased six-fold and became almost fully Zambianized (Gulhati 1989: 29). The fiscal implications were compounded by a rapid increase in public service wages over the period.18

18

The index of average real earnings of African workers in the formal sector rose by 33% in 1967 and by a further 15% in the period up to 1973 (Gulhati 1989:10).

16

Finally, in an attempt to insulate urban consumers from rises in local production and distribution costs and in import prices, GRZ introduced subsidies for such items as maize, fertiliser and fuel during this period which subsequently proved difficult to withdraw. Despite increased expenditure, the Government budget was in surplus for three of the five years between 1965/66 and 1970 and was in approximate balance for the period as a whole. However, once mineral tax revenue started tailing off from 1971, the fiscal picture changed dramatically; except for 1974, the budget (excluding grants) was in deficit each year for the rest of the century. Government savings fell from the equivalent of 13% of GNP (cumulative) between 1965 and 1970 to virtually nil between 1971 and 1975. Public investment bore the brunt of the decline with government savings financing just 15% of government net capital expenditure compared with 95% during 1965/66 -1970 (World Bank 1977:70-72). While the fiscal deterioration coincided with falling mineral revenues, they were not the direct cause. Government revenue actually rose slightly from 26.6% of GDP between 1965-70 to 27.6% between 1971-75. Non-mineral revenue increased from K181 million in 1970 to K431 million in 1976 as a result of increased tax rates and coverage and improved administration more than offsetting the fall in mineral revenue over the period19 (World Bank 1981:82). The main cause of the fiscal deficits was not revenue, but recurrent expenditure, which increased from 18.8% of GDP during 1965/66-1970 to 26.5% during 1971-75 - reaching 35% in 1975 (World Bank 1977:78 and 1981:12). There were several causes. Firstly, subsidies increased dramatically. With relatively stable world food prices, subsidy bills remained in the range K20-35 million up to 1972. Following the onset of world inflation and the jump in world food prices, subsidies increased to K82.8 million [US$128 million] 15% of net recurrent expenditure - in 1975. Secondly, defence expenditure increased in response to heightened tensions with Rhodesia. Thirdly, the recommendations of the Mwanakatwe Commission in 1975 led to a 25% increase in the public service wage bill. Finally, as discussed below, borrowing costs were becoming increasingly significant (World Bank 1981:81). Summary: Independence to mid 1970s Zambias first years of independence coincided with a period of high copper prices. With a tax regime which taxed mining profits heavily, this represented a huge windfall for the new government. Much of this windfall was invested in physical and social infrastructure and in new manufacturing industries, while some was used to acquire equity in private firms. GRZ appeared to be making good progress towards its industrialisation objective: manufacturings share of
19

Zambia's tax ratio from 1965-75 was 83% greater than the 1969-71 average for 47 less developed countries (15.1% of GNP) covered in an IMF study, and was the highest of any of the countries examined (Chelliah et al 1975).

17

GDP increased rapidly from 6% in 1965 to 17% in 1975 (World Bank 1993:14). However, appearances were deceptive. A number of major projects had been undertaken with little regard to economic viability, either in response to UDI or because industrialisation was desired for its own sake. Many were simply uneconomic. The fundamental problem was that at Independence Zambia was a landlocked country of less than four million (mostly very poor) people. This was a tiny market, yet poor transport links with its neighbours (apart from Rhodesia) meant there was little prospect of reaching the market levels needed to bring costs down and make industrial investments viable. While protection from imports meant industries could be financially viable at the expense of consumers - despite high unit costs, with a strong currency and little incentive to seek export markets they could never become competitive. Moreover, much of the industrial sector was capital-intensive (creating few jobs) and import-dependent. Progress in building social infrastructure was also less impressive than expenditure figures suggest. Schools and hospitals tended to be overdesigned, leading to high unit costs (Gulhati 1989:14). This applied also to the substantial investment in roads20. As a result, substantial public investment21 failed to deliver the anticipated growth. While real GDP growth averaged 3.9% p.a. between 1965 and 1974, per capita growth was only 0.6% p.a (Table 2). This was due to the low productivity of much of the investment, as reflected in the increase in the overall (70% public, 30% private sector) incremental capital: output ratio from (an already high) 7:1 in 1967-73 to 24:1 in 1973-79 (Gulhati 1989:14).
Table 2 Period 1965 - 1974 1975 - 1991 1992 - 1998 1999 - 2011 1965 - 2011 Zambian GDP Growth since Independence Average real GDP growth, % 3.92 0.67 0.29 5.26 2.56 Average real GDP per capita growth, % 0.62 -2.62 -2.29 2.62 -0.38

Source: World Bank: World Development Indicators 2012

In short, much of the public investment funded from the first copper boom was wasted. Once foreign exchange supplies and mineral revenue dried up Zambia was left with a high cost and fundamentally uncompetitive industrial sector and one largely owned by the state. Meanwhile, the rapid expansion in the public service and in subsidies meant the budget was increasingly exposed in the event of a fall in revenue.

20

Zambia had the highest proportion of over-engineered roads (paved roads with less than the 300 vehicles per day threshold needed to make paving economically viable) in a survey of 21 African countries (Gwilliam et al 2008:37). 21 See World Bank (1981:87).

18

V.

1975 to 1991

As noted above, with buoyant copper revenues in the 1960s GRZ was able to finance most public expenditure capital and recurrent from the budget. At end 1969 external public debt amounted to US$ 277 million, mostly financing hydroelectric schemes and roads. Service payments on this debt amounted to $ 25.8 million in 1969, just 2.9% of export earnings (World Bank 1981:103). Debt increased sharply in 1970 as a result of the government guaranteed ZIMCO bonds (US$ 292 million) to compensate the copper companies for the state's 51% equity stake and a US$ 200 million loan from China for the TAZARA railway. While the fiscal position started deteriorating from 1971, there was no great cause for alarm until 1975 when the economy experienced a number of external shocks. Within the space of several months, Zambia shifted from having budget and balance of payments surpluses to massive deficits on both accounts. The 1974 budget surplus of 3.4% of GDP became a deficit of 21.5% in 1975, while the balance of payments surplus of 0.5% of GDP turned into a deficit of 29.4% (McPherson 2004:30). The external shocks comprised: (i) a sharp decline in the copper price (a 51% real drop) which caused a 43% decline in export revenues between 1974 and 1975; (ii) a major increase in world oil prices in 1974; and (iii) rising transport costs following the oil price shock and the sealing of the Rhodesian border in 1973. The current account deficit was K439 million, or 85% of exports. This was compounded by an internal shock as GRZ total expenditure increased from 30.8% of GDP in 1974 to 50.1% in 1975 (World Bank 1981:12). The Government response to the shocks of 1975 was to have a profound, lasting impact on the economy. Faced with such large deficits, the essential judgement GRZ had to make was whether the shocks were likely to be permanent in which case drastic fiscal adjustments would be required or temporary. If temporary, GRZ could borrow funds to tide it over until, say, copper prices rebounded when it would be able to repay the debts. With the benefit of hindsight, the fateful GRZ judgement (gamble?) that the shocks would prove temporary proved a disastrous misjudgement. However, this was by no means obvious at the time. The copper price had collapsed in 1970, only to rebound in 1974. Why should the 1975 price collapse be more permanent? Nobody anticipated that it would take thirty years for world copper prices to recover. World Bank forecasts anticipated prices recovering by 1980. 22 As it turned out, copper prices continued falling until 2002 (Figure 1). Mineral revenue, which had financed most public expenditure between Independence and 1974, dried up by 1977. While state mismanagement compounded the mines problems, with falling prices, tax revenues would probably have been little different even if they were still privately owned. The loss of mineral the price of copper relative to the prices of Zambia's imports is expected to rise from 78.2 in 1976 to 102.0 in 1980 (a 30% increase) (World Bank 1977:134).
22

19

revenue created a large hole in public finances. While non-mineral revenue had increased, so had expenditure. Substantial real cuts were made in both capital and recurrent expenditure between 1975 and 1978. While this succeeded in reducing the deficits, with revenue continuing to decline, it was not sufficient to eliminate them (Gulhati 1989:17). Once introduced, increases in the wage bill and subsidies proved difficult to reverse, while increased debt meant higher interest payments. As a result, the fiscal deficit averaged 14.5% of GDP between 1975 and 1979, 13.8% in the 1980s, 6.0% in the 1990s and was not brought under control until 2004 (McPherson 2004: Table 2-1). The economic policies (fiscal, monetary, debt, exchange rate, subsidies, price control, etc) GRZ adopted in response to the 1975 shocks failed. As shown below, Zambia experienced one of the steepest declines in income ever seen in peace-time and by the 1980s was effectively bankrupt. How did this come about? As noted, the collapse in copper prices from 1974 led to two key deficits. Firstly, the drop in export revenue produced a balance of payments deficit and a reduction in the supply of foreign exchange. Secondly, the mines profits fell sharply and mineral tax revenue (based on profits) dried up, resulting in a fiscal deficit. We look first at the balance of payments deficit. During the 1960s and 1970s Zambia, like most countries, had a fixed exchange rate - with the Kwacha pegged initially to Sterling and from 1971 to the U.S. Dollar. For as long as copper exports were booming this was not an issue. The appropriate policy response to a persistent balance of payments deficit in economic theory (and modern practice) is to allow the currency to devalue so as to increase import prices - discouraging imports - and encourage exports. However, as noted above, the import substitution strategy and the strong exchange rate during the boom years had resulted in an industrial sector which was highly import-dependent. Devaluation would increase the costs of manufactures and imported food and was resisted by both industry and the urban populace. Rather than devalue, therefore, GRZ decided to borrow to cover the deficit. Initially, this presented little difficulty. International financial institutions, flush with bank deposits from oil exporters, were keen to lend. The Zambian economy was seen as basically sound and it was anticipated that low copper prices and deficits would be temporary. While interest on the loans added to the fiscal deficit, this appeared the lesser evil. However, as low copper prices and deficits persisted, foreign borrowing became increasingly difficult and availability of foreign exchange became the key constraint to production. The official exchange rate was devalued on a number of occasions, but every adjustment was too little and much too late (McPherson 2004:158). Increasingly, GRZ relied on non-market measures to address the foreign exchange shortage: import bans, quantitative restrictions and administrative allocation of foreign exchange by the Bank of Zambia.23 By fixing the official exchange rate and rationing foreign exchange, the policy inevitably led to a
23

World Bank (1993: Annex A) identifies six different regimes for managing the exchange rate between Independence and 1992, including an auction between 1985 and 1987.

20

black market and gave a premium to those fortunate enough to be allocated foreign exchange (mainly parastatals). These arrangements were time consuming and contributed to the misallocation of resources. Real imports in 1978 were 57% of 1969 levels, leading to serious shortages of inputs and spare parts and to pervasive under-utilization of capacity. By 1978 capacity utilization averaged about 60%, but some enterprises - unable to obtain foreign exchange for spare parts - were operating at 15% to 25% of capacity (World Bank 1981:16, 28). Turning to the fiscal deficit resulting from the simultaneous collapse in copper tax revenue and greatly increased expenditure in 1975, GRZ clearly needed to reduce expenditure substantially. Significant cuts were made, but they were never sufficient. Rather than cutting politically sensitive areas such as public service wages and subsidies, cuts were focused disproportionately on lower profile areas of the recurrent budget and on capital outlays (Gulhati 1989:16). As a result, much of GRZs substantial investment in social infrastructure in the period after Independence had severely deteriorated by the 1990s. For example, a survey of 8,800 km of trunk, main and district roads in 1995 found that, as a result of the collapse in maintenance funding, only 20% were in good condition and 29% in fair condition while 51% were in poor condition. 90% of feeder roads were in poor condition (World Bank 1997: 12). Although primary education expenditure increased by 5% in real terms between 1975 and 1985, this was entirely due to salary increases. The proportion spent on teaching materials and classroom supplies fell from 9.8% in 1975 to 1.7% in 1985. Meanwhile, there was a 40% increase in enrolment over the period (Kelley 1991:40). Anticipating that copper prices would rebound before long, GRZ financed the fiscal deficit through borrowing, both domestic and foreign. Government borrowing from the domestic banking system contributed to a 258% increase in domestic credit expansion between 1974 and 1978, leading to an increase in the money supply. Along with rising fuel and transport costs, this resulted in a jump in inflation, which reached 20% in 1978 before restrictions on credit expansion were imposed under an IMF Standby Agreement in 1978. GRZ responded by increasing subsidies which peaked at an extraordinary 6.7% of GDP in 1980 (World Bank 1996:5) and by attempting to control prices. The latter was done both directly, through the Prices and Incomes Commission established in 1981, and indirectly via the pricing policies of government controlled parastatals. Few prices accurately reflected demand or costs of production. Although parastatals sometimes received subsidies to offset the financial losses resulting from price controls, this aggravated the fiscal deficit. With no improvement in copper prices and persistent deficits, foreign debt accumulated at an astonishing rate. The external debt stock doubled from about US$800 million in 1970 to $1.6 billion in 1975 and doubled again to $3.3 billion in 1980, by which time it exceeded 100% of GDP and was already unsustainable. It continued growing, reaching $7.2 billion in 1990 over 200% of GDP (Fernholz 2004:266). 21

The longer deficits persisted and the more debt accumulated the harder deficit control became. The share of interest in total expenditures rose from 5% in 1975 to 15% in 1984 and 31% in 1985. The estimated budget figure for 1986 was 41% (Gulhati 1989:37). As foreign exchange became increasingly scarce, many parastatals got into financial difficulty (see below); government guarantees on their loans were invoked further adding to the debt stock or they had to be bailed out from the budget. In addition, unpaid or unsettled balances guaranteed by creditor and debtor governments or export credit agencies were rescheduled and became public external debt. Inevitably, GRZ fell into arrears on debt service. By 1990, arrears alone exceeded US$3 billion, about the size of GDP (Fernholz 2004:265-6). Parastatals As noted above, in 1975 parastatals accounted for over 50% of GDP and nearly all industrial production. Indecos manufacturing subsidiaries were financially profitable initially and made a significant net contribution to the budget. Yet by the 1990s most parastatals were in such severe financial difficulty that the new MMD government embarked on a major privatisation programme. In trying to understand what went wrong it is important to distinguish between problems attributable to government ownership and policy and those due to external factors such as copper prices. The first point to emphasise is that, as noted above, many of Indecos investments were never economically viable. While they could earn financial profits - despite high costs - by exploiting their monopoly, this was dependent on protection from imported competition. While Indecos operations were profitable initially, this was in a context of expatriate management, little political interference and plentiful foreign exchange. In his Mulungushi speech President Kaunda called for Indeco to be run at a profit and in a proper commercial and businesslike way, but also to keep the national interest in mind at all times (Tangri 1984:120). The latter became increasingly significant over time. Indeco has only possessed limited autonomy and has been subject to a series of ad hoc political directives on specific operational issues.including type and location of investments and pricing decisions (Tangri 1984:121). Management and staffing was a key factor. Conscious of the extreme lack of skilled manpower at Independence, Indeco initially attached great importance to management contracts with expatriate firms or former owners. However, political impatience with the pace of Zambianisation led to a change of policy. Some management contracts were cancelled (including the copper mines) and pressure was put on parastatals to accelerate appointment of Zambians to managerial and professional positions, with little regard to qualifications and experience. To compound matters, managers and professionals were not allowed to stick to their posts for a reasonable time; instead they were shunted around from position to position. Consequently, learning on the job was undermined and the attitude of milking the company" was widespread. Finally, overstaffing became a conspicuous feature of parastatals; between 22

1975-80 jobs increased twice as fast as production in the public sector while private firms shed workers more rapidly than their output fell (Gulhati 1989:23). Establishing a viable manufacturing sector in such conditions would have been difficult whatever the external environment. However, falling copper prices provided the killer blow. As noted, the combination of a strong currency and import substitution had resulted in an industrial sector which was highly import-dependent. Once the balance of payments turned into deficit, even though they received preferential treatment, parastatals had increasing difficulty accessing foreign exchange. This disrupted operations and lead inevitably to lower capacity utilisation and higher unit costs. To compound matters, parastatals were increasingly subject to price controls on their outputs as government sought to suppress inflation. Although they received subsidies to compensate, these rarely covered the full loss. Not surprisingly, therefore, Indecos return (before depreciation) on net assets declined from 12% in 1969/70-1971/72 to sizeable losses by the end of the 1970s (Gulhati 1989:23). Indecos auditors qualified their annual accounts each year between 1980 and 1986, noting that their preparation on a going concern basis was dependent upon continued support from ZIMCO ie subsidies from the mines or GRZ. The 1987 Annual Report noted that the profit margins earned still remain inadequate to meet the group's debt servicing obligations, asset replacement expenditure and working capital requirements (Craig 1999:78). The poor performance of the parastatal sector was widely recognised - from the President down. As early as 1977 the Report of a Special Parliamentary Select Committee noted that: Government annually makes a large allocation of capital funds to support projects undertaken by parastatal organisations. This has arisen largely because these bodies are not able to generate their own capital for plant renewal and new investment.... Poor management, absence of inventory control, overstaffing, inadequate pricing of products and political interference have been named as some of the reasons for the poor performance of the parastatal sector (Craig 1999:79). Increasingly GRZ was forced to bail out parastatal losses, estimated at US$455 million between 1985 and 1989 (World Bank 2002:5), crowding out expenditure on basic public services. As losses accumulated the very survival of parastatals even the viable ones was in jeopardy. Reforms24 With debt continuing to mount despite significant reductions in expenditure, and no sign of a recovery in copper prices, it became increasingly clear to the government that its economic strategy was not working. However, an IMF programme agreed in 1981 was suspended after a year because of disagreement over reforms proposed for 1982. GRZ attempted to put off reform by borrowing. When private sources of credit dried up in 1982, it could
24

This section draws heavily on Bonnick (1997: 49-53).

23

postpone reform no longer. In return for IMF and World Bank support in 1983 GRZ made its first attempt at reform: it devalued the Kwacha by 20%, raised interest rates, relaxed price controls, gave exporters preferential access to half their foreign exchange earnings, increased the price of maize meal by 30% and fertiliser by 70%, and introduced a 4% Mineral Export Tax. Soon after, in an effort to force a rescheduling of its debt, GRZ unilaterally suspended payment of its foreign debt - causing the World Bank to suspend disbursements. Following elections in October 1983, in which President Kaunda was re-elected, negotiations reopened with the IMF, World Bank and other donors with a view to reviving the reform programme. This resulted in further price liberalisation, subsidy reduction, and interest and exchange rate reform. Fiscal policy was also tightened and the fiscal deficit cut from 16% in 1982 to 10% in 1984. However, in the face of industrial unrest, in 1985 GRZ relaxed some of the financial policies aggravating the fiscal and external deficits. Another IMF / World Bank backed reform programme, launched in late 1985, scrapped the import licensing and foreign exchange allocation arrangements and introduced a foreign exchange auction system. This produced a devaluation of the Kwacha from K2.2 to K5.15 to the US Dollar at the first auction. Following a period of relative stability, things deteriorated sharply in late 1986. Falling copper exports and a failure to contain an increase in the money supply led to a sharp devaluation in the exchange rate. Concerned that this was fuelling inflation, GRZ tried to intervene in the auction to limit the devaluation. However, this only succeeded in undermining confidence in the auction and the Kwacha fell to K19 to the Dollar by the end of the year. While the programme helped non-traditional exports expand rapidly, growth was negligible, inflation shot up and when food subsidies were reduced there were food riots in December 1986. In May 1987, with the Kwacha at K21 to the Dollar and rising social unrest, President Kaunda announced that the government was abandoning the auction and the IMF / World Bank reform programme and would pursue its own adjustment programme, the New Economic Recovery Plan. The new programme fixed the Kwacha at K8 to the Dollar, introduced extensive price controls and import restrictions, and limited debt service payments. The main priority was increasing output, even if this meant increasing the money supply and inflation. While GDP growth improved in 1987 and 1988, this was largely due to good rains (and maize harvests) and a short lived rise in copper prices. Inflation was exacerbated by the growing fiscal deficit and lax monetary controls and the underlying problems continued25. In 1988 the auction was reintroduced to allocate foreign exchange, but not to fix the rate. Then the Kwacha was devalued by 25%, some import restrictions were removed again, and monetary reserve requirements and interest rates were raised. In June 1989
25

Inflation increased from 44% between 1985 and 1987 to 128% in 1989, and averaged over 90% between 1990 and 1991 (World Bank 1996:13).

24

GRZ decontrolled all consumer goods prices apart from maize. With other measures, this paved the way for a new agreement with the IMF and World Bank. However, (unsuccessful) attempts to engineer a pre-election boom in the period leading up to the October 1991 elections through increased public service wages, expansionary fiscal measures and increased maize and other subsidies resulted in the programme being abandoned yet again. Summary: 1975 to 1991 The Kaunda / UNIP administration presided over one of the steepest ever economic declines in peace time. With GDP contracting by an average of 2.6% per capita per annum between 1975 and 1991 (Table 2), Zambia went from middle income to least developed country status. With the highest level of public debt per capita in the world, it was effectively bankrupt. The manufacturing capacity built up at great expense during the postIndependence boom was heavily dependent on imports and foreign exchange. While no one predicted how long copper prices would take to recover the fundamental problem was that, by becoming deeply involved in economic production, the state had bitten off more than it could chew. Once mining revenue and foreign exchange dried up, GRZ was unable to adjust expenditure sufficiently. Huge expenditure on debt service, bailing out parastatals and subsidies for urban consumers meant large fiscal deficits and the collapse of funding for basic social services and investment. Although data is not available, the failure of UNIPs economic (and agriculture) policies resulted in a sharp increase in poverty - directly through falling incomes and indirectly through the collapse of public services. VI. 1991 to 2011: MMD

The 1991 elections ended the UNIP era and brought to power the Movement for Multiparty Democracy (MMD) with a strong mandate for reform. With inflation exceeding 100% and GDP declining, in February 1992 President Chilubas government agreed a comprehensive reform programme with the IMF and World Bank aimed at stabilising and restructuring the economy and at stimulating growth (World Bank 2004:7). The main reforms are summarised below. Fiscal policy. Progress towards stabilisation was undermined initially by a prolonged drought in 1992, continued falls in copper revenues and high preelection wage settlements, which exacerbated both the fiscal deficit and inflation. In 1993 the government introduced a cash budget system to strengthen budgetary control expenditure. In 1994 the Zambia Revenue Authority was established to strengthen revenue collection and in 1995 Value Added Tax replaced the cumbersome sales tax. With the abolition of most consumer and producer subsidies and with increasing aid, the fiscal deficit after grants started to come down from 1995 averaging 4.9% of GDP between 1995 and 2000 (McPherson 2004: Table 2-1).

25

Monetary policy. In 1993 the Bank of Zambia removed all restrictions on bank lending and deposit rates and allowed official interest rates to be determined by the market at the weekly Treasury Bill auction. Exchange Rate. In 1992 the Government allowed the exchange rate and the allocation of foreign exchange to be determined by the market through bureaux de change. By 1993 most foreign exchange controls had been removed and by 1994, when the Kwacha became fully convertible, the foreign exchange market was completely decontrolled. Agricultural liberalisation. Subsidies of mealie meal and fertilisers were eliminated in 1992. In 1993 GRZ decontrolled maize producer prices and withdrew from marketing agricultural inputs. Trade liberalisation. GRZ embarked on a radical programme of trade and industrial policy reform in 1992, eliminating all licensing and quantitative restrictions on imports and exports over a five year period. Tariffs were reduced and the tariff structure simplified. The effect of these reforms was to transform Zambias trade regime from one of the most protectionist in Africa to apart from fuel and maize - one of the most liberal. This has been consolidated over time with further tariffs reductions under regional trade agreements. It meant the abandonment of the import substitution policy that had been in place since Independence. Following mounting problems with foreign exchange access, price controls and political interference during the 1980s, this was a disaster for many of Indecos industrial parastatals. Some had never been economically viable and depended on protection from imports for survival. Dismantling tariff protection and the removal of producer subsidies was the final nail in the coffin. Privatisation. The MMD election manifesto contained a strong commitment to privatisation, recognising the need both to stem the fiscal haemorrhage from loss making parastatals and to attract investment to enable potentially profitable companies to survive. A privatisation act was passed in 1992, and the Zambian Privatisation Agency (ZPA) was created to convert parastatals to private ownership. In many respects ZPA was highly successful. By March 2000, 113 enterprises out of the original portfolio of 144 had been privatised (Table 3). Although 38 parastatals had been forced into liquidation before the privatisation programme began (World Bank 2002: Annex 1), the vast majority survived one of the primary objectives of the programme. While employment in nonmining parastatals fell from about 28,000 before privatisation to an estimated 20,000 four years later, this was inevitable; most parastatals had bloated staffing levels and significant reductions were necessary for competitiveness and to stay in business (World Bank 2002:19). Meanwhile, the need to be able to trade shares led to the establishment of the Lusaka Stock Exchange as part of the programme.

26

Despite resistance to the dismantling of its portfolio by ZIMCO (which GRZ resolved by liquidating ZIMCO in 1995), a World Bank study concluded that Zambias privatisation programme up to 1996 (before privatisation of the mines) was the most successful in Africa - with many examples of best practice that should be followed by other countries. In particular, ZPA was exemplary for the attention it has paid to ensuring public accountability and transparency (Campbell White and Bhatia 1998:64). Privatisation of ZCCM was a different story. The conglomerate was to be broken up and sold in separate packages, with the state retaining responsibility for pension and environmental obligations. Contrary to legislation, the process was led not by ZPA but by former managers of ZCCM opposed to privatisation overseen by a committee of ministers. Political interference (particularly over Luanshya mine) contributed to delays and increased financial losses. Pressure from the IMF, World Bank and others resulted in the eventual sale of packages one by one through often opaque bilateral negotiations with preselected preferred bidders (Adam and Simpasa 2010:66).26 However, with copper prices approaching their lowest real level in a century (Figure 1), GRZ was in a weak negotiating position and was forced to offer generous tax and other concessions to close deals.
Table 3 Extent of Privatisation, 1992 to March 2000 Number in original Portfolio 9 27 27 81 144 Number Privatised 1 19 24 69 113 Number Remaining in State Ownership 8 8 3 12 31

Size of State Enterprise Size unclassified Large Medium Small TOTAL

Source: Craig (2000:358)

While no systematic ex post evaluation has been carried out of the privatisation programme, it was a landmark in the transformation of the Zambian economy. This is most clearly seen in mining where, despite a murky privatisation process, substantial foreign investment inflows triggered a rebound in copper production (and GDP growth) - well before copper prices started to recover (Figure 1). This was repeated across much of the former ZIMCO empire, with new investment leading to rapid growth in such diverse areas as sugar, cotton, cement, dairy, livestock, maize milling, breweries, electricity transmission, trucking, construction and hotels. 27 Along with enabling the survival of most former parastatals, the main impact of privatisation was to relieve GRZ of responsibility for bailing out parastatal losses - facilitating both the restoration of fiscal discipline (see below) and increased expenditure on public services.
26 27

See Adam and Simpasa (2010:65-68) for details of the mining privatisation process. It is revealing to examine the performance of those parastatals that were not privatised, such as ZESCO, Zamtel, Zambia Railways, TAZARA, TAZAMA and Indeni. Each faced serious operational (eg load shedding, unplanned closures) and / or financial problems during the 2000s.

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Despite the above evidence, many Zambians remain ambivalent about privatisation. Craig (2000:361) noted as early as 2000 the striking contrast between the positive view of the international community and that held by Zambian civil society that the privatisation process was deeply flawed - with allegations of looting by ministers. While few specific allegations have been made - none have come to court - privatisation was still a sensitive topic during the 2011 election campaign. This is partly explained by the secrecy over the mining Development Agreements and low mining tax despite booming copper prices. There is also resentment that few of the privatised assets were acquired by Zambians (World Bank 2002:26). Also while the losers from privatisation those who lost their jobs - were highly visible, the winners were dispersed and largely unaware that they were benefiting. There is little public awareness of the extent to which parastatal losses were to blame for the collapse in public services from the 1980s - or that in many cases the only alternative to privatisation was liquidation. Economic Recovery and Return to Growth It took some time for the above reforms to have an impact and GDP per capita continued falling until 1998 (Table 2). However, following privatisation of the mines - a turning point in Zambian history and new investment, the rebound in copper production (Figure 1) produced a return to growth. This was reinforced from 2003 by the rapid rebound in copper prices, which encouraged further investment. As a result, both the mining industry and the economy generally have seen a virtuous cycle of growth (mirroring the previous vicious cycle of decline). Zambia has experienced an unprecedented period of sustained real GDP growth, which has continued to the present - averaging 5.2% p.a., or 2.6% in per capita terms, between 1999 and 2011 (Table 2). Booming copper exports quickly eliminated the balance of payments deficit (from -13% of GDP in 2003 to a surplus of 8.3% in 2006) and facilitated the replenishment of foreign exchange reserves. They also contributed, together with a number of other factors, to a dramatic turnaround in public finances from 2004. One important contributor was the Heavily Indebted Poor Country (HIPC) debt relief scheme. When Zambia joined the HIPC scheme in 2000 (termed Decision Point) it started receiving interim relief on its foreign debt. As a result, foreign interest due fell from 5% of GDP in 1998 (Hill 2004:85) to 1.3% in 2002. This gave GRZ a strong motive to finally bring the fiscal deficit down to sustainable levels in order to reach HIPC Completion Point. As a result of the combined effect of lower foreign interest, expenditure cuts and GDP growth (which increased the denominator), in 2004 the fiscal deficit (NB after grants) was halved to 2.9% of GDP much the lowest level in 30 years. It was sustained at a similar level through 2012. The establishment of fiscal discipline helped Zambia reach HIPC Completion Point in 2005. Interim debt relief became irrevocable and total external debt 28

was cut from US$ 6.2 billion in 2005 (86% of GDP) to a modest US$ 962 million (9%) by 2006. In per capita terms, Zambia received more debt relief than any other HIPC country, transforming the countrys balance sheet overnight. Foreign interest fell to an insignificant 0.1% of GDP by 2007 (Whitworth 2013). The drop in the fiscal deficit greatly reduced GRZs need for domestic finance, leading to a drop in interest rates and inflation. The combination of lower domestic borrowing and interest rates meant a fall in the domestic interest bill from 2.9% of GDP in 2004 to 1.8% in 2006 (and 1.1% in 2011), reducing expenditure (and the deficit) still further. It also encouraged private investment by reducing government crowding out of the private sector from domestic financial markets; in 2007 credit to the private sector exceeded public borrowing for the first time in decades (Whitworth 2013). With both the balance of payments and the fiscal balance under control, negligible foreign debt, healthy foreign exchange reserves and (from 2009) inflation in single figures, by the late 2000s macroeconomic stability had finally been established - after three decades. The improvement in the macro economy was underlined by the issue of Zambias first ever sovereign credit ratings in 2011 by Fitch and Standard & Poors (both B+). At last, with a booming mining sector and macro stability, Zambia had a solid platform for investment and growth and the prospect of rebuilding public infrastructure and services. The pace of rebuilding was dependent on the level of resources at GRZs disposal. Whereas the first copper boom financed much of Zambias public infrastructure, the level of fiscal resources generated by the second boom was much smaller at least initially. Mineral tax revenues resumed in 2005, but were still only equivalent to 1.9% of GDP in 2010. Moreover, the increase was offset by a drop in non-mineral revenue over the same period. Despite flat tax revenue, fiscal space increased significantly due to lower expenditure mainly on interest. As a result of debt relief and fiscal discipline the combined domestic and foreign interest bill fell from 4.1% of GDP in 2002 to 1.2% in 2011, releasing resources for more productive use. Given that GDP grew by some 75% over the period, and with mineral tax revenue reaching 3.8% of GDP in 201228, from about 2007 GRZ had increasingly significant discretionary resources at its disposal (Whitworth 2013). Another effect of economic recovery was a substantial reduction in Zambias aid dependence. Having been financially autonomous during the first decade after Independence, GRZ signed numerous financing agreements with international financial institutions and bilateral donors from the late 1970s in order to plug growing fiscal and balance of payments gaps. However, most aid was suspended when the government abandoned its IMF programme in 1987. Following the change of government and the MMDs commitment to a new IMF programme, donor support rose to unprecedented levels, averaging
28

Mining revenue was 5.5% of GDP in 2011 due to the one off payment of arrears of windfall tax, which was introduced in 2008 but dropped the following year.

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about US$ 950 million pa between 1990 and 1994. Zambia became one of the most highly aid dependent countries in Africa. However, the same factors in the previous paragraph that explain the growth in discretionary resources also led to a steady reduction in Zambias aid dependence. In 2002 total net aid to Zambia was equivalent to 21.9% of GDP and 97.6% of total domestic public expenditure. Although aid was fairly flat in nominal US Dollar terms, these ratios had fallen to just 5.4% and 23.3% respectively by 2011 (Whitworth 2013). Before examining how GRZ chose to spend its new resources, the novelty of this situation should be emphasised. GRZ was emerging from a three decade long fiscal crisis during which virtually all resources were devoted to wages, debt service, subsidies (until the 1990s) and bailing out parastatals. There were simply no discretionary resources left over for public investment or anything else. What little investment had taken place was funded by donors. So when, after a gap of 30 years, GRZ found itself with resources of its own to spend there was no system or technical capacity left in the Finance Ministry to allocate resources between competing uses and investments. In their absence, expenditure decisions were largely politically driven. Analysis of fiscal performance during the final years of the MMD government shows that discretionary resources were largely allocated to three uses: 1. The Farmer Input Support Programme (FISP, mainly fertiliser subsidies), expenditure on which increased by 0.5% of GDP (to 1.0%) between 2005 and 2011; 2. Food Reserve Agency (FRA) purchases of maize at above market prices, which increased by 1.6% of GDP (to 1.8%) over the period; and 3. Paving roads, which increased by 1.5% of GDP (to 1.6%). Between them they accounted for 3.6% out of an estimated 4.4% of GDP increase in discretionary resources between 2005 and 2011 (Whitworth 2013). The principal rationale for the HIPC initiative was that debt relief would release resources being used unproductively for debt service in poor countries (ie create fiscal space) and allow them to be used instead for poverty reducing public expenditure. However, the three main uses to which the MMD government allocated increased resources appear to have been of little benefit to the poor. FISP, which has faced numerous operating problems, has been largely captured by a minority of larger, wealthier farmers while crowding private traders out of the market (Sitko et al 2012). Meanwhile, the benefits of the FRA maize support prices are disproportionately enjoyed by the relatively large farmers over 5 hectares, even though they constitute only 3.8% of the smallholder farm population, while most Zambians who are net maize purchasers lose through paying higher prices (Jayne et al 2011). Despite Zambias large backlog of road maintenance, most additional GRZ road funding since 2009 has been used to upgrade a small proportion of roads to fully engineered paved standard. As discussed below, few of these projects have sufficient traffic potential to be economically viable.

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Overview of MMD Economic Management, 1991 - 2011 The MMD government can be considered one of the most radical and successful economic reformers Africa has seen. The major reforms of the Chiluba period privatisation, trade and financial sector liberalisation, abolition of most subsidies and price controls caused considerable pain initially. However, boosted by the copper boom from 2003, they laid the groundwork for the establishment of fiscal discipline and macro-economic stability from the mid-2000s and the longest unbroken period of growth in Zambias history. By the 2011 elections the macro economy had never been in better shape. Some qualifications to this glowing assessment are in order. Firstly, most of the reforms consisted essentially of just reversing misguided policies from the UNIP era which had clearly failed. Secondly, there was little alternative. The country was effectively bankrupt and dependent on support from donors and the IMF - who insisted on reform; the delay in privatising the mines suggests support for reform was less than whole hearted. Thirdly, economic performance was greatly boosted by external factors such as the copper price recovery and debt relief. Fourthly, while macro-economic performance was transformed, the micro / sector record was much less impressive - with increased fiscal space being largely dissipated on political projects and no progress in agriculture. Finally, the MMD era is associated with increased levels of corruption particularly under Presidents Chiluba and Banda. Improved economic performance was accompanied initially by a significant reduction in poverty. Systematic poverty measurement began in 1996 with the first Living Conditions Monitoring Survey (LCMS). The Poverty Trends Report 2010 shows that the poverty headcount ratio fell from 68.1% in 1996 to 59.3% in 2006 while extreme poverty declined from 44.5% to 36.5% over the same period. Most of the reduction took place between 1998 and 2004 and in urban areas; whereas urban poverty fell from 40.5% in 1996 to 26.7% in 2006, rural poverty only fell from 84.2% to 76.8% (Republic of Zambia 2010: iii). Despite continuing growth, there was negligible further reduction in poverty between the 2006 and 2010 LCMS. Since 2006, changes in the rural, urban and national poverty rates have all been statistically insignificant (World Bank 2012:1). Despite falling poverty until 2004 Zambias highly unequal income distribution deteriorated further, with the Gini coefficient increasing from 47.4% in 1996 to 52.6% in 2006 (Republic of Zambia 2010:iv). The slowdown in poverty reduction, increasing inequality, lack of employment opportunities and the public perception that corruption was increasing all contributed to the MMD being voted out of office in 2011.

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VII.

2011 to 2013: Patriotic Front

The essential economic challenge facing the Patriotic Front (PF) administration was to ensure that macro-economic stability and rapid growth benefited the entire not just the urban population, through employment creation and improved service delivery. The combination of macro stability and healthy investment in mining meant that robust GDP growth was likely to continue. While experience showed that growth per se has little direct impact on jobs and poverty, mineral tax revenues were becoming increasingly significant29 and fiscal space was growing rapidly representing a real opportunity for the new government to increase services to the poor. Moreover, the fiscal transformation meant public expenditure was no longer limited by tax revenue. Following debt relief GRZ had an unusually healthy balance sheet and, with a good long term outlook for copper, was in a strong position to resume commercial borrowing. With conventional aid flows flat, the MMD government had started borrowing from new semi-concessional sources such as China and the Development Bank of Southern Africa. Following the issue of Zambias first sovereign credit ratings, and with the completion of its IMF programme (which restricted commercial borrowing) in 2011, a completely new opportunity presented itself issuing sovereign bonds. With bond yields in developed economies at historic lows, Zambia was able to take advantage of increased interest in emerging markets to issue its first Eurobond for US$ 750 million - in September 2012. Despite a low yield of 5.625%, the issue was fourteen times oversubscribed a striking indication both of the transformation in Zambias reputation in financial markets and the scale of its borrowing capacity. How effectively has the new government used the resources resulting from macro stability and the second copper boom in pursuit of poverty reduction and jobs creation? Has it learnt from the mistakes of previous administrations? While it is too early to assess results, there are disturbing signs that history is repeating itself. We look first at economic policy measures and then at public expenditure. An inescapable conclusion from the above examination of Zambian history is that government ownership and management of the means of production has impoverished the country. Early actions of the PF government suggest this is not well understood. Its first major policy reform was to cancel the 2010 privatisation of Zamtel on the grounds of alleged corruption. While the initial valuation lacked transparency, sale proceeds of US$ 257 million exceeded those of all the other privatisations combined - and further foreign investment had contributed to a marked turnaround in performance. Zambia became the first country to renationalise a telecoms utility30. This was followed by the unilateral cancellation in 2012 of a 20 year concession (signed with a South African firm in 2003) to operate Zambia Railways. In 2013 GRZ announced that it was considering establishing a publicly owned airline, despite the
29

Mineral tax revenues were equivalent to 3.8% of GDP in 2012, following the doubling of royalties on copper and cobalt to 6% of gross sales value. 30 The case is being contested in court.

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financial collapse of all three previous (one public, two private) Zambian national flag carriers and growing competition from foreign airlines. There have been signs of a return to Kaunda era interventionism under the PF government, particularly through the Bank of Zambia. In 2012 the Bank both increased minimum capital requirements for commercial banks - to encourage them to increase domestic lending - and prohibited the use of foreign currencies in domestic transactions. In 2013 it imposed interest rate caps on bank and other loans - intended to help small enterprises borrow more cheaply -and introduced tighter controls on foreign exchange transactions. Many of the new governments economic policy measures can be characterised as populist, aimed particularly at the urban population. Despite their failure in the 1970s and 1980s, there was a revival of subsidies and price controls. The two large agriculture subsidy programmes inherited from MMD, FISP and FRA maize purchase, were both retained despite unambiguous evidence of their ineffectiveness. The dismissal of the Energy Regulation Board after the election and the failure to appoint a new Board until 2013 meant that energy tariffs were effectively frozen since Board approval was required for increases. Electricity tariffs already among the lowest in Africa and well below cost recovery level - fell further in real terms (Whitworth 2014). Meanwhile, with rising world oil prices, unbudgeted fuel subsidies jumped to US$145 million (0.7% of GDP) in 2012 and US$ 220 million (1%) in 2013 before fiscal pressure forced their abandonment in May 2013. Both energy subsidies benefit primarily the relatively wealthy, urban population. PF wages policies also appear eerily familiar. Firstly, in 2012 the minimum wage was increased, doubling in the case of domestic workers. While this benefits those poorer workers who retain their jobs, international experience suggests it is likely to be at the expense of fewer jobs in total. GRZ then agreed a wage deal which increased the public service wage bill by an extraordinary 45% (37% in real terms) from September 2013. Having been close to 8% of GDP throughout the previous decade, the wage bill was projected at over 11% of GDP (60% of revenue) in 2014. Again, the beneficiaries are largely urban. Expenditure on transport infrastructure was also to increase. US$ 120 million of the Eurobond proceeds was earmarked for Zambia Railways31. However, this figure was dwarfed when President Sata launched the Accelerated National Roads Construction (Link 8000) Programme to upgrade 37 roads (8,200 km) to bitumen standard at an estimated cost of ZKw28 trillion (US$5.3 billion) over five years (http://www.postzambia.com/postread_article.php?articleId=28959). Following the increase in expenditure on paving roads from 0.1% of GDP to 1.6% between 2005 and 2011, PF road plans imply further increases to 3-4% of GDP annually. Yet few of the road projects have been subject to economic appraisal. If they were most would almost certainly be non-viable. As shown elsewhere,
31

As noted above, there are serious doubts whether Zambia needs two railway systems.

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Zambia already has more paved roads than are justified by traffic volumes. Except for some urban roads, the cost of upgrading remaining unpaved roads to paved standard instead of maintaining them properly exceeds the economic benefits, given low traffic potential. Paving roads is of little benefit to the poor and crowds out rehabilitation and maintenance of the unpaved network activities with much better economics and benefits for the poor (Raballand and Whitworth 2014). VIII. Conclusions

Zambias post-Independence copper boom was a mixed blessing. While the revenue windfall financed substantial investment in social infrastructure, it also encouraged GRZ to take on a much larger role in economic production than it could handle and to incur expenditure that could not be afforded once the boom ended. Failure to adjust expenditure to falling mining revenue set off a downward spiral of fiscal deficits, inflation and borrowing - effectively bankrupting the state. Meanwhile, attempts to industrialise through import substitution only succeeded in turning Zambia into a high cost, import dependent economy. Once foreign exchange dried up parastatal losses accumulated compounding fiscal problems and threatening firms survival. The inevitable outcome, aggravated by the failure of agriculture policy, was a collapse in production and in funding for basic public services and increased poverty. The reversal of many UNIP policies by MMD succeeded in steadying the ship. Privatisation of the mines was a landmark, leading to the longest period of growth in Zambian history greatly assisted by the second copper boom. Together with trade liberalisation, the end of parastatal bailouts, the abolition of most subsidies and debt relief this helped restore fiscal and macroeconomic stability. With growing mineral revenue, this led to the creation of meaningful fiscal space for the first time in 30 years - and the opportunity to make real inroads into poverty. However, while expenditure on basic services increased significantly from the early-2000s, much of the fiscal space was wasted on political projects and poverty reduction was largely confined to urban areas. With no administration capable of implementing effective agriculture policies, the gap between urban and rural areas continued to widen. While it is too soon to draw definite conclusions, there are worrying signs that the PF administration has failed to learn from history and is repeating mistakes from the first copper boom. Re-nationalisations and increased interventionism indicate greater faith in the capacity of the state to manage the economy than the track record supports. Meanwhile, commitments in 2013 on wages and roads alone could easily add 5% of GDP to public expenditure more than total revenue from mining. When other measures such as the creation of 29 new districts, moving the headquarters of Southern Province and rebasing the Kwacha are taken into account, expenditure looks set to increase substantially for little economic return. With little prospect of mining revenue increasing much above its 2012 level of 3.8% of GDP,

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Zambia appears in danger of a return to unsustainable fiscal deficits and heavy borrowing with the poor losing out once again.

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