Will financial penalties save the day?

BY CHENAYI MUTAMBASERE

Adam Smith is known to have said: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own self-interest. We address ourselves not to their humanity but to their self-love, and never talk to them of our own necessities, but of their advantages.”

The recent government announcement left any right thinking individual boggled as to how the SI 127 intends to benefit the greater good. Will the enforcement of penalties rescue the economy?

The imposition of penalties to drive out bad behaviours has been used in other countries such as the UK and United States to target, especially bankers. Economists however have argued that these have not worked as often simply because agents will always choose profits.

William K Black, professor of Law and Economics at the University of Missouri-Kansas City and former executive director of the Institute for Fraud Prevention in Morgantown, West Virginia noted that it is in the financial interest of agents to violate the law.

Penalties appear inadequate to stomp out “bad behaviour” as it were, because as long as the deal is sweet enough, agents are willing to take the risk. Penalties have a very small role to play in influencing the behaviour changes of rent seekers.

If we recall that the origins of all this cocktail of policy were the currency shortages which reached an unprecedented peak in 2016. Not long after, the governor then introduced the bond notes which were pegged at 1:1 with the US dollar in spite of a public outcry as to how unfair this was.

This policy failed to improve the currency shortages and also to sustain the 1:1 currency regime. Again, at that time, the state threatened to punish anyone refusing to accept 1:1, but here we are four years later with a 1:120/135 rate which is being forced to 1:84.

The heavy handedness of the penalties as applied to individuals clearly implies that the perception is that it is rent seekers who are single-handedly fuelling the parallel market into existence. This fails to consider the system that agents operate in and the behaviours it encourages. The economy will always be subject to the basic laws of demand and supply. Regulatory enforcement may attempt to change this, but eventually it is demand and supply that rules the day.

Zimbabwe has a high demand for access to foreign currency, hugely because we are an import economy, both the formal and informal trade relies heavily on imports.

Our industrial production is yet to take off to the point where there is adequate value-addition to raw materials or, indeed, where production efficiencies result in local goods being affordable. This status quo means that we have a high demand for external currencies.

High demand for foreign currency on its own is not necessarily a bad thing where there is adequate supply to meet the demand. Zimbabwe, however, has been in a capital deficit position since 2016. There is hardly any capital injection into the economy.

Due to corruption and human rights abuses, Zimbabwe was blacklisted by credit rating agencies meaning the government is not able to borrow. Further, the continued infringement on property rights (which includes sporadic statutory instruments) is off putting for foreign investors therefore there have been limited flows of capital investments.

The gold mining sector has been subject to corruption and expropriation to the extent where the last budget statements reported declining income from the gold mining sector for the last financial year. A high demand for foreign currency with restricted supply invariably will have a greater influence on the exchange rate than any penalties ever could.

I alluded earlier to the fact that it cannot be rent seekers alone driving the exchange rate disparity, but rather the system. Zimbabwe has a buoyant informal sector and high unemployment, with nearly 90% of adults active in this sector. The informal sector is excluded from formal banking routes such as participation in the formal currency auction.

Their transactions therefore are undertaken in the parallel market. The central bank has little influence over this market. By and large, the majority of these transactions are unbanked with a reported unbanked adult population of over 50%. Therefore, traceability becomes difficult and penalties become very difficult to enforce.

One could argue that the presence of these new penalties is likely to increase informal transactions. The policymakers are suggesting that rent-seeking individuals were purchasing foreign currency at a lower rate during the formal auction and then selling at a higher rate in the parallel market.

Some will fear being monitored through this vehicle. This is likely to force transactions outside the formal routes. This exit of the formal market by traders will result in reduced cash transactions through banks and access to the same cash by banks and we are back to ground minus.

For the Zimbabwean economy to thrive, two key things must happen in tandem; investors must inject more capital and the domestic market must be strengthened.

For the former to happen investor confidence relies on economic policy. There must be confidence that the economic policies are geared towards a stable and strong domestic market  without interfering in investors’ property rights.

Consider that as most companies commenced their trading year in January,  they would have planned their cash flows and stock valuations at the start of the year.

Some four months later the government made unplanned announcements on foreign currency exchange  rates. What this means is businesses have to revalue their stocks and cash flow strategy. This manifests in immediate price increases. Not only do the price increases reflect the immediate  policy changes but also in anticipation of further sporadic government announcements.

Increased prices reduce disposable income in the market thus weakening domestic aggregate demand. As prices increase, domestic demand reduces and it becomes more beneficial to cross the border to seek better prices. In anticipation of this, businesses may focus more on immediate gains as long term gains are unlikely. In the end, this results in a self-fulfilling prophecy of hyper-inflation and poor domestic demand.

History dictates that in Zimbabwe, investors first exit the formal market before exiting the country altogether. I remember in 2008 after visiting a supermarket, a young man following me to the car whispering something.

As his posture did not appear threatening, I asked him to repeat what he was saying in a low voice. He whispered “sister murikuda mastrawberries here?” I whispered back, “ehe ndomada”, and, behold, he re-emerged with a very well-packaged and sealed pack of strawberries which I exchanged for a green back or two. They appeared to have been off a supermarket shelf. This period was plagued with shortages.

Rent-seeking investors will find ways to sustain margins. When it becomes too difficult to operate in the formal market they will simply exit it. The impact of this will be felt through cash  and commodity shortages.

To cut a long story short, it would have been prudent to negotiate with the market rate and peg the regime rate at 120. This would have immediately halted rent-seeking behaviours. Reducing the rate is a temporary solution to a permanent problem.

Eventually the rate will climb back up again, but in the interim, SI 127 undermines business confidence, which culminates in  hyperinflation and investors exiting the market. The adverse effects of this all seem too high a price to pay.

The interesting thing with economics is that, in the end, the impact of poor, policy does not discriminate. Cash shortages, hyperinflation and a weakened currency impact everyone whether rich or poor. It affects our participation even in the international payments clearing system.

Banks abroad will decline payments from Zimbabwean banks as was happening in the past. Essential services such as healthcare will struggle to access affordable materials from foreign markets. The list is endless, thus we appeal to the butcher’s self-love to reconsider policies that are likely to further cripple the economy.

Mutambasere is a Zimbabwe development economist and technology architect based in the UK. These weekly New Horizon articles are coordinated by Lovemore Kadenge, an independent consultant, past president of the Zimbabwe Economics Society  and past president of the Institute of Chartered Secretaries and Administrators in Zimbabwe. Email: kadenge.zes@gmail.com/ cell: +263 772 382 852