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Property rights and investment activity: A page from the Zimbabwe diaries

Jamus Lim's picture

In 1999, Zimbabwe initiated a series of economic reforms that were designed to greater empower the indigenous population of the country, as well as correct for inequities in the distribution of the economic resources held by the population. Whereever one may stand on the broader merits of the policy, the economic consequences are amply clear: Beginning in 2000, output and investment contracted sharply. Real GDP plunged almost continuously in the intervening years, so that by 2008, real output was at the level similar to at the time of Zimbabwe's independence in 1980, and even nominal investment stood at a fraction of levels in 1980 (see figure below). The economy of Zimbabwe, once hailed as a newly-industrializing economy of Africa, moved from middle to low-income status within a decade. To add salt to the wound, inflation started taking off not long after the turn of the century, erupting into thousands and millions of percent from 2006 onward; hyperinflation wiped out the savings of an entire generation.


Source: World Bank staff calculations, from World Bank GEM database, ZIMSTAT (2009--10), Zimbabwe Ministry of Finance (2011 estimate), and IMF staff (2012 projection).
Notes: Total gross investment includes fixed capital formation and inventory accumulation. Values for real investment and real GDP are measured in 2005 USD, while values for nominal investment are reported in current USD. Values for 2011 are estimated, and for 2012 are forecasts.

Not all is gloom and doom, however. Following dollarization,[*] the economy has stabilized dramatically. (Nominal) investment has grown by an order of magnitude since 2008, clocking in at $2.2 billion---or an investment rate of 23 percent---last year. There is a sense of cautious optimism, although more recent signs are suggestive that the initial gains to investment from economic stabilization, and the attendant credit expansion resulting from the re-injection of saving into the macroeconomy, has more or less been exhausted. The question that lies ahead, then, is the extent to which investment can remain buoyant, and serve as an engine of growth for an economy that is in such desperate need for capital formation.

Stimulating investment, of course, is easier said than done. In directed economies (think China), the state plays a major role in both the allocation of domestic credit as well as investment projects, and is able to mobilize legendary saving rates among the populace. In most other developing countries, however, investment is constrained not only by low income streams (which inhibits saving supply), but also potentially low and variable expected returns due to the wide distribution of risky projects (which discourages investment). But framing investment activity in terms of the supply of saving and demand for investment only begs the question of factors that could underlie shifts in these functions. In thinking about the future path of investment, therefore, it is valuable to think about the likely impact that structural factors can play in influencing fixed capital formation, as well as their likely paths into the future.

Two particular important factors that have consistently been found to matter in cross-country studies of nivestment activity has been the role played by financial development as well as institutional quality are crucial elements that help explain cross-country differences in investment performance (see figure below). At the bivariate level, there are clear, positive, and significant (both statistically and economically) relationships between both financial development and institutional quality vis-a-vis investment, relationships that survive even more rigorous econometric analysis that even accounts for causal effects.[] The bottom line is clear: countries that seek to boost their rates of investment will do well to improve the investment climate in terms of these structural factors. In practice, this is best realized by implementing policies that improve access to finance by firms (especially small and medium enterprises, which typically face more severe financial constraints), as well as policies that are supportive of the rule of law and property rights, especially with regard to corporate investment.

Positive relationship between investment rate and financial developmentPositive relationship between investment rate and institutional quality
Source: World Bank staff calculations, from World Bank World Development Indicators, Political Risk Services ICRG database, and ZIMSTAT (2009--10).
Notes: All variables reported in logarithms. Real fixed investment rate is defined as the ratio of gross fixed capital formation to GDP for 2010, both measured in 2000 USD. Financial development is measured as domestic credit to the private sector as a share of GDP, and institutional quality is measured as the law and order subindex for ICRG political risk. The bivariate scatterplot is constrained to the sample of developing economies represented in the regressions. The maroon line corresponds to the bivariate regression line of the real investment rate on the respective structural variable. Zimbabwe is highlighted in red.

How does this apply to Zimbabwe? It is useful to recall that, for much of its recent history, Zimbabwe had a fairly sophisticated financial sector for its per capita income. Similarly, prior to the fast-track land reform policy that began in 2000, the rule of law and property rights had been reasonably secure; indeed, its colonial history as a British settlement meant that its legal origins would have favored greater protection for investors. Taken together, these would have favored a positive trajectory for private investment in Zimbabwe, especially as it continued to develop (there is a positive relationship between both of the factors and per capita income).

Which is what makes the setbacks of the past decade so discouraging. But if Zimbabwe is able to consolidate its recent growth bounceback, and implement policies that enhance both access to finance and political stability, it has a real fighting chance at raising its level of investment in a sustainable manner. Indeed, if Zimbabwe is able to raise its level of financial development to levels comparable with, say, China in 2010 or its institutional quality to a level comparable to Peru in 2010, forecasts suggest that its investment could be as much as a fifth higher than if it simply allows these structural factors to evolve according to rates similar to that of other developing countries historically (see figure below). In practical terms, how might these policy objectives be achived, especially in the difficult post-hyperinflationary environment? That would be a subject for a future post.

*. Strictly speaking, Zimbabwe is officially a multi-currency regime, with the U.S. dollar, euro, South African rand, and Botswana pula all recognized (and circulating) as media of exchange. In practice, with the exception of a few border regions, most of the economy operates on the dollar.

. For example, analyses of a panel of up to 83 economies over the period 1985-–2009, using both fixed effects and system GMM estimators, indicate that a 10 percent increase in financial development (institutional quality) results in a 0.2–-0.6 (0.1–-0.3) percent increase in the investment rate.

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