Indeginization is incompatible with investment led growth

By Wellington Magaya
Legal Practioner,Notary Public and Conveyancer,LLBS (U.Z)

Indigenization is defined as the increasing of local participation in or

ownership of foreign owned businesses. In our jurisdiction the definition of
indigenization can be gleaned from the principal legislation which governs
the indigenization and economic empowerment process. The Act in section 2
extends the definition of foreign companies susceptible to indigenization to
those businesses owned by indigenous whites, Asians etc.This paper is
aimed at assessing whether there is compatibility between indigenization
and investment led growth especially in the new normal economy where
dependence is placed much on foreign direct investment. This will be done in
the context of Zimbabwe and a comparative analysis will be taken with a
view of showing the indigenization has not worked anywhere in Africa and
where it was implemented (fully or partially) what were the effects on the
foreign direct investment. It will at the end be shown that ultimately a
countrys growth path is determined by the aggregate decisions of investors
and businesspeople and the indigenization policies of this country is not
compatible with investment led growth.
THE NEW NORMAL ECONOMY AND ECONOMIC GROWTH
Economic growth is driven by labour and capital investment in plant,
machinery, infrastructure and human capital. In the new normal economy
the world has moved on and business leaders and policymakers need to take
note that Zimbabwe will need both foreign capital and strong export to grow
its economy. Foreign direct investment contributes to investment and growth
of the economy. Past business models no longer have a place under the new
normal economy. This means that for every economy to grow there is a need
to adopt policies and processes that attract foreign direct investment to

stimulate growth. In the Zimbabwean context, according to the United

Nations foreign owned capital stock as at 2010 was valued at $2.2 billion but
independent experts believe that the figure is much more than that and that
foreigners own roughly a third of the Zimbabwes capital stock. Since the
year 2009 the country only $800 million was invested and because of the
indigenization laws currently in place there s very little hope of attracting or
improving foreign investment to stimulate growth.

THE STATUS QUO

Currently the indigenous law of the country is as spelt out in the
indigenization and Economic Empowerment Act and the accompanying
regulations. The law compels those foreign owned or controlled companies
with net assets of $500-000-00 at least to surrender 51% of its equity to
locals within five years. This period was however reduced to forty-five days
by the regulations gazetted by the Minister of Indigenization. The Shortened
timetable in relation to mining companies resulted in the fall of the mining
index on the Zimbabwe stock exchange by 45%. Such a decline is obviously
detrimental to the countrys investment prospects and it clearly indicates the
indigenization scares away investors.
RATIONALE
In the Zimbabwean context the rationale of the indigenization regulations is
not clear. In one breadth the Minister of Indigenisation and the President
have often indicated that the law was designed to punish those foreign
owned mining companies because their governments had imposed illegal
sanction on Zimbabwe and in some instances it was said that the intention of
the legislation of to empower locals. This creates uncertainty and investors
will obviously look at this in light of the chaotic land reform program which at
some point was guided by racial and discriminatory legislation and did not

respect private property rights. The fact that it was said that the law was a
punitive meant that it could be employed to dispossess foreign investors of
their investments without any form of compensation and as was shown by
Zimbabwes poor ranking on Policy Potential Index (PPI) compiled by Canadas
Fraser

Institutes

Annual

Mining

Survey.

The PPI measures the overall

attractiveness of a country or region for mining exploration and investment

The PPI considers the effects on mining exploration and investment of government
policies including uncertainty concerning the administration, interpretation

and enforcement of existing regulations. Zimbabwes scores of 2 (2006) and

3 (2007) for the PPI are the two lowest scores recorded for any jurisdiction
since the launch of the survey in 1997.Such a poor ranking was obviously a
response to the indigenization regulations is not conducive to investment as
it reduces investor confidence and guarantees of protection to their
investments. The indigenization law remains a real threat to foreign
businesses and as long as outsiders believe that Zimbabwe is not a safe
investment destination no foreign direct investments will come our way as
investors are left with very little or no protection at all.

CAPITALISM WITHOUT CAPITAL

As stated by David Brown, CEO of Impala (one of the companies whose subsidiary
Zimplats is being targeted for indigenization) the 51% ownership structure as per
Zimbabwes indigenisation regulations, would not work because it would be
impossible to raise capital for expansion Capitalism cannot work without capital.
The greater the local ownership by employee share ownership schemes, community
trusts or state equity participation, the less capital there will be for expansion and
development because the locals have no capacity to raise funds for expansion and
such as scenario is incompatible with investment led growth .Capitalism cannot
work without markets to channel funds to preferred risk-return opportunities. Shared
ownership works only where the bulk of the shareholders are active participants, not
where ownership is segmented between consumers and those that contribute to

wealth creation by saving. The mining sector remains underutilised and

undercapitalised particularly the gold sector which is at 40 percent capacity

utilisation. The negative effects of the indigenisation law come at a time the
country is facing acute liquidity challenges after the introduction of a
multiple currency regime in 2009 and is in a desperate need for capital to
turn around its economic fortunes.
THE NEW NORMAL AGAIN- INDUSTRIALISATION
Manufacturing in this country has come face-to-face with the New Normal
again in two respects namely the de-industrialization of the economy since
1994 and the structural changes in global manufacturing. This means that
Zimbabwe has to develop a new national (macroeconomic)

strategy to enable

businesses to discover where their competitive advantage lies

and adopt new

growth engines for the economy. A countrys growth path is determined by the
aggregate decisions of foreign investors and businesspeople and not by the
government as the proponents of indigenization seem to think.

In my view the

extent, speed and durability of recovery is contingent on new investment, new

technologies and new and different production, product and marketing strategies.
Compelling companies and new investors to cede 51% ownership of the businesses
to locals who have no capacity to bring capital in the business results in investor
fright. The government has no capacity to pay or compensate foreign owned
companies for the shares in the companies because it is broke. What does this
mean for investment led growth? It means foreign direct Investment which is the
key to technology transfer will be directly affected resulting in poor or reduced
growth as foreign direct investment is essential as multinational enterprises tend to
be more efficient and act as conduits or channels of knowledge transfer through the
opening up of sectors to frontier technologies. This will not happen in an
environment like in Zimbabwe as the foreigners fear dilution of their brands,
technology and franchise by the localization of majority ownership in companies.
The indigenization policies currently in place are not attractive to the much needed
foreign investors who are the key drivers of technological change which is a key to
unlock the competitive disadvantage the country is currently facing if one to look at
developments in neighboring South Africa.

THE MALAYSIA AND NIGERIAN EXPERIENCE

Proponents and backers of the indigenization program argue that it has been done
in Nigeria, Malaysia and South Africa. Evidence on the ground suggest that these
countries realized that such localization policies are not conducive for foreign direct
investment and growth and were effectively abandoned and as things stand
Malaysia which originally targeted Chinese businesses hosts over $100 billion in
foreign capital up ten-fold from 1980. In Nigeria the strategy was abandoned in the
1990s and today Nigeria hosts 17% of the Sub Saharan Africas foreign direct
investment totalling to about $60 billion second only to South Africa. This
comparison shows that indigenisation scares away investors and once the
controversial programme is completely abandoned it foreign direct investment
which is the key driver to economic growth and will increase as investors are
guaranteed of maximum returns on their investments. Such guarantees will
increase future investment leading to faster and more equitable economic growth.
In Zimbabwe net investment turned negative in

about 2001 and by the start of

2010 the capital stock was smaller than in 1980.The countrys capital stock fell to
around 53 billion dollars in 2009 and one of the major contributing factors was
because investors both local and foreign took fright at the height of eland
expropriation, economic decline and the introduction of indigenisation laws.
EFFICIENCY AND COMPETITIVENESS
The structure of financial flows to Emerging markets generally, including Sub
Saharan African, has changed. It is now characterized by the fall in the share of aid,
rising share of private flows, increased importance of foreign direct investment and
portfolio flows and diaspora remittances. Evidence has shown that foreign direct
investment accounts for more than half of net flows into emerging markets. An
examination of the what Zimbabwe received as foreign direct investment will help
illustrate the point that that weak institutions most importantly the legal
(indigenisation laws) and political environment has contributed to a decline in
foreign direct investment and growth.Sub Saharan Africas share was 2% ($32

billion), with the largest recipients being Nigeria ($9 billion), South Africa ($6
billion), Ghana with $3 billion and Mozambique and Zambia with $2 billion
each, Zimbabwe attracted only $390 million and one of the contributing

factors to such low levels of foreign direct investment inflows is the legal,
political and institutional environment as measured broadly by using political
risk indicators. Our indigenisation laws deter foreign aid which is critical for
growth efficiency and competitiveness. The inconsistencies and the rationale
behind the policy make it incompatible with investment led growth. The
Minister responsible for indigenisation and the President have indicated that
the law is a punishment to foreign firms whose governments imposed illegal
sanction on the country and inconsistent positions on the part of the main
opposition parties makes Zimbabwe politically risky. There are genuine fears
that what happened with the land reform program where private property
was violently taken over despite the existence of international instruments
(such as BIPA) makes it difficult for Zimbabwe to compete with the other
countries for investment for foreign direct investment.

COMPETITIVENESS AND EFFICIENCY

Foreign direct investment is the catalyst that delivers technology, expertise and
market access. As has been explained above foreign investors are much more
efficient as opposed to local ones and the coming in of foreign investors enables
technology transfers as the investors bring with them new high technology
equipment and they open markets for the economy in their countries of origin and
in other economies where they have interests but which local companies have no
access to. Technological readiness, market size, education and training promote
efficiency. A loss of these investors means that a loss or reduction in efficiency and
competitiveness. The indigenization program is not investment friendly. It scares
away investors as no investor will be prepared to invest in a business in which they
have no control and their returns do not match the investment into the business. On
the ground it is clear that if locals are to take control of 51 percent of the companies
they have no means to fund the operations of the business in equal proportion to
their stake in the companies. The government is broke and no ordinary poor
Zimbabwean has the capacity to invest and fund growth in these businesses.

FUNDING EXPANSION AND FUTURE DEVELOPMENT

As indicated in the previous paragraph the state is broke and locals will not be able
to finance expansion and growth. If the state is to own fifty one percent of the
shares in all companies, then it will have to put up fifty one percent of the finance
needed to expand production. This is unlikely to happen as state is broke, meaning
that , either new projects will be postponed until the state has the money or the
minority owners will have to put up one hundred percent of the capital for only forty
nine percent of the returns. Chances that minority owners will on their own finance
the capital of the company for the government to enjoy fifty-one percent of the
profits are very minimal. No new investor would want to invest in such an
environment and it is clear that the indigenization law as it stands is deterrent and
no foreign investor will commit his resources to fund new projects under the current
regime as it simply does not make economic sense. Those companies that will be
forced to cede 51 percent of their shares to locals will not realize any expansion and
new projects will be stalled. This clearly shows that indigenization and investment
led growth are incompatible. If the government had the capacity to finance
expansion then it would make a difference but the government does not even have
the capacity to pay for the 51% shares in foreign companies resulting in it coming
up with the very unrealistic and unacceptable suggestion of paying for the shares
through minerals in the ground which minerals cannot be measured. This leaves the
threat of share grabbing just like what happened with land reform program very real
and investors will not invest in such economy hence compromising investment led
growth, efficiency and competitiveness.
CONCLUSION
In conclusion I agree that the current indigenization program is not compatible with
investment led growth. The timing is very poor. There are no realistic suggestions as
to how the cash strapped government will pay for the shares and whether it has the
capacity to fund future expansion of the existing companies. In an economy which is
on a recovery path from years of mismanagement there is need to create legal and
political institutions that attract foreign direct investment which is major contributor
to economic growth. It is my suggestion that indigenization policies need to be
revisited and the sooner the government realizes that political grandstanding will do

no good to the economy the better for everyone. An assessment of the

circumstances and sentiments by the proponents of the indigenization program in
Zimbabwe leads to one inescapable conclusion that indigenization is just being
employed as a campaign tool ahead of the forthcoming election and also given that
the land reform mantra is no longer saleable to the electorate. It must be
abandoned!

REFERENCES
1. Indigenization and Economic Empowerment Act Chapter 14:33
2. Indigenisation and Economic Empowerment (General)Regulations, 201
0
3. World Economic Forum Website