Doing Business in Mozambique

Sent: Sunday, March 18, 2007 9:37 AM

Hello one final time from Africa (for now)--

The reality of ending this brief stint as freelance photojournalist and returning to my “real world” of finishing grad school and studying for the bar exam is reluctantly sinking in.

But before that happens, I want to share some wonderful experiences and news from our recent trip to Maputo, Mozambique (pictured left). The purpose of this trip was to complete a project for the International Finance Corporation (the IFC is the private investing arm of the World Bank). The project asked my 4-person MBA team to research the history of venture capital and early-stage business investing in the United States, then learn as much as possible about what U.S. “best practices” might be transportable to Mozambique. We were then asked to recommend an investing model that would both stimulate economic activity and provide a positive rate of return.

Our team spent months conducting interviews and research back in Washington before beginning this trip. We conducted more interviews of investment professionals and other participants in this industry when we got to South Africa. In Mozambique we had the chance to meet with entrepreneurs and tour their businesses, interview development experts from USAID, and explore Mozambique’s only major city (Maputo).

We visited Maputo’s university (Universidade Eduardo Mondlane, or UEM for short) yesterday afternoon and met with the Dean of their newly-forming MBA program. I got invited to come back and lecture as a visiting professor, so it looks like I might be returning to this remarkable region of the world in the not-too-distant future before starting at my law firm in the fall.



MOZAMBIQUE IN CONTEXT
Flying from Johannesburg to Maputo is a bit like what I imagine it would be like to travel in a time machine. Johannesburg is a large, complex, cosmopolitan city. The airport bustles with tourists, business travelers, and government officials from every corner of the globe. The airport in Maputo (the largest city in Mozambique) doesn’t have walkway gates. Planes simply park in front of the terminal, a set of stairs rolls up, and passengers get off and walk through sliding glass door before proceeding to an awaiting customs official. The planes are still filled with businesspeople and tourists, but not nearly as many of them. Why the difference?

Like South Africa, Mozambique has been inhabited by Europeans for about 500 years. But unlike South Africa, Mozambique’s European colonizers were more focused on trade with India and the colonization of Brazil than on the economic development of their possessions in sub-saharan Africa. Europeans showed much greater interest in the development of South Africa because of the strategic importance of the Cape sea route (the fastest way to get to India and Asia from Europe before the Suez canal was to go around the Cape of Good Hope), and because of South Africa’s vast mineral wealth. The discovery of diamonds in 1867 and gold in 1886 may have brought war and other forms of conflict to South Africa in late 1800’s and afterward, but these discoveries also brought a wave of immigration that would serve as the bedrock for the RSA’s economic development.

More importantly, South Africa has held regular elections for almost a century. Mozambique first held democratic elections in 1994. South Africa has enjoyed self-rule for about 100 years, while Mozambique did not gain its independence from Portugal until 1975. South Africa is one of the only countries in Africa that has never experienced a military coup or other forceful transition of power from within the government. By contrast, Mozambique was flattened by a civil war that erupted shortly after independence when the communist FRELIMO party took power. According to one source, FRELIMO “eliminated political pluralism, religious educational institutions, and the role of traditional authorities.” FRELIMO was resisted by an armed rebel movement sponsored at times by neighboring Rhodesia and South Africa. The rebels were organized into a party called the Mozambican National Resistance (REMANO). The ensuing civil war killed roughly 1 million Mozambicans, while 1.7 million others took refuge in other nations (Mozambique’s current population is less than 20 million). FRELIMO and REMANO persist as the two dominant political parties to this day.

FRELIMO did emerge from the civil war as the ruling party, however the constitution that it ultimately agreed to provides for a multi-party political system, a free market economy, and free elections. FRELIMO still maintains a strong grip on the government of Mozambique. In the 2004 elections, FRELIMO party member Armando Guebuza won 64% of the popular vote, and the FRELIMO party won 160 of 250 seats in Parliament.

It is hard to overstate the negative impact Mozambique’s civil war had on its economic development. In 1996, Mozambique was one of the world’s poorest countries. According to the International Food Policy Research Institute, “it was so poor that mean per capita consumption was below the absolute poverty line.” Brighter days lay ahead, however. The return of war refugees in the mid-1990’s facilitated an economic rebound, culminating in a 10% growth rate from 1997-1999 until floods in early 2000 slowed growth to 2.1%. Growth has rebounded once again. Today, Mozambique is one of the fastest-growing economies in the world, posting an 8% GDP growth rate in 2006 on a population growth of only 1.3%. However, it is much easier to greatly increase national wealth on a percentage basis year after year when you don’t have much to start with. Mozambique’s per capita GDP is only $320 a year, and about half the population still lives in poverty. Put simply, Mozambique has come a long way since the end of its civil war, but it still has a very long way to go.

WHAT HOLDS MOZAMBIQUE BACK?

As is the case in so many other countries in Africa, Mozambicans live in poverty largely as a result of a government that has not created the conditions necessary for sustainable economic growth and entrepreneurship. The World Bank ranks Mozambique 140th in terms of “ease of doing business.” To provide a basis of comparison, the World Bank identifies 5 procedures (needing, on average, 5 days each to complete) required to register a business in the United States. 13 procedures were identified in Mozambique (requiring, on average, 113 days each to complete). 13 procedures at 113 days each is 1,469 days, or just over 4 years (assuming one works 7 days a week for 4 years continuously just to have the right to open his or her doors). Commercial contracts are effectively unenforceable through the legal system. If one is somehow lucky enough to obtain a judgment from a Mozambican judge, the procedure will take on average 1,010 days, compared to a 351.2 day average for nations that are members of the Organization for Economic Cooperation and Development (OECD).

Would-be entrepreneurs are held back not just by the remnants of socialist thought paradigms, but also by a legal structure that does not adequately recognize or protect property rights. In his book, The Shackled Continent, author Robert Guest cites the value of unexploited urban shacks and informally owned fields in Africa at over $1 trillion dollars. For economic purposes, this $1 trillion of land and property is dead capital, because the Africans living on it do not have the ability to borrow against its value and use the proceeds to start a business that could feed their families. In Mozambique, freehold land ownership is not allowed. While citing Peruvian Economist Hernando de Soto, Guest made a great point when he wrote “Third World leaders wander rich-country capitals begging for aid and investment. All the while, they fail to notice a much larger source of potential wealth at home.‘ In the midst of their own poorest neighborhoods and shanty towns,’ writes de Soto, ‘there are trillions of dollars, all ready to be put to use if only the mystery of how assets are transformed into live capital can be unraveled.’”

So why doesn’t Mozambique simply pass laws guaranteeing property rights for all citizens? The answer lies in the socialist philosophy still believed by many that land is for “the people,” therefore ownership of it by an individual constitutes theft. More importantly, however, the issue of land rights brings back bad memories of Portuguese colonizers in the minds of many Mozambicans in power today. For this reason, land rights are more of a political than an economic issue.

However, the simple passage of a law protecting property rights for Mozambicans, by itself, probably would not create favorable economic conditions as quickly as one would hope. In The Shackled Continent, Guest acknowledges the work of Tony Hawkins (a business professor at the University of Zimbabwe). Hawkins points out that most of the peasants who would be given title to their land under an African property-rights regime are unfamiliar with written contracts, much less with the business transactions that would allow them to collateralize their property. America was also a nation of “squatters” for a very long time. It took hundreds of years for America and other rich nations to form uniform property codes. In 1642, Virginia passed a law that gave squatters a right to be compensated for improvements to the land they occupied. If the owner of the land was unwilling to pay, the squatters were given the right to buy out their landlord at a price set by a jury. According to Guest, “this helped many squatters to become legal.” As pioneers moved west, states enacted laws similar to the 1642 Virginia law. “The Homestead Act of 1862 and the mining law of 1866 essentially formalized the arrangements that extra-legal farmers and prospectors had already worked out for themselves hundreds of miles from Washington,” writes Guest.

No matter how sound the economic and political policies of a nation may be, a country cannot reach its full economic potential until it has reached its educational potential. Our tour of UEM was encouraging because we saw so many Mozambicans who were clearly happy to be in school and eager to learn. The new MBA program we visited was designed to enable students to earn their MBA’s at night while working during the day. However, UEM needs resources, just as Mozambique needs more and better schools with enlightened teachers in order to help these students reach their potential and begin to lift their nation out of poverty.

Finally, Mozambique needs better and more transparent government if private investors are to gain enough confidence to invest their money there and reduce poverty in the process. I had dinner with Marianne Camerer, co-founder of the government watchdog NGO Global Integrity (http://www.globalintegrity.org/) while I was in Cape Town. When the conversation turned to the importance of open, honest, competent government in preserving the well-being of the people those governments are supposed to serve, her passion for her work and her organization shined through. Global Integrity has a unique index used to rate governments along six axes. Below is a comparison of how Mozambique fared on each axis in comparison to South Africa and the United States:

The executive summary to Global Integrity’s report is helpful to understanding why Mozambique fares so poorly relative to other countries whose citizens enjoy a much higher standard of living:

Corruption in Mozambique is made possible by the very nature of the Mozambican
state, where the power of the ruling party overlaps with the state
machinery. Despite massive fraud, especially in the privatization process, no
senior government representative has ever been convicted, so corruption
continues with impunity. In this small African country, pledges to strengthen
transparency and integrity are easier said than done.

The history of how Mozambique’s political elites have enriched themselves has been amply documented. It essentially resulted from the country’s calamitous privatization projects and the squandering of bank resources. More than 10.4 trillion meticais (US$400 million) disappeared from the banking system in the 1990’s. The state was forced to repay the money.

….Allegations of corruption also come from foreign companies trying to invest in the country. For example, following the approval in December 2005 of a new procurement law, a French scanner-production company complained that a contract had been manipulated. Although customs authorities denied any corruption, the damage was done: Mozambique gained a reputation of a country manipulated by political elites. And the reputation is not undeserved. External investors are often forced to give shares and partnerships to ministers in exchange for license approvals. This deters internal, as well as external investment and limits commercial development….

Corruption does not only flourish at the highest political levels in Mozambique, it also grows through bribes paid to traffic police, hospital workers and the sexual extortion that takes place in schools.

It would be a mistake for Mozambique to simply try to copy the laws of the United States and expect a similar economic result. Just as the United States needed property laws that reflected the reality of what was already happening when it passed the Homestead Act, Mozambique needs property laws that preserve the relationships Mozambicans already understand while allowing them to turn their assets into live capital. I hope I get the chance to return one day and identify / discuss some ways to make that happen with people who could help to implement those ideas.


INVESTING IN MOZAMBIQUE: THE IFC AND USAID

We began our visit to Maputo with a meeting with USAID representatives. One of the USAID representatives had been involved with investing in Mozambique since 1989 and has since turned his attention to working to reforming the policies of the government. The concern I had with our assignment and project generally was that we had been asked to design a venture capital fund for a country that has only one company listed on its stock exchange and no debt or other liquid capital markets. If a new Mozambican company was able to attract the necessary seed financing, there are extremely few technical and management consultants around to help it get over the stumbling blocks that present themselves as the business tries to grow.

Venture capitalists plan on seeing about 8 or 9 of 10 investments fail or go sideways when they put their money into a new company. This is why United States VC’s generally invest only in companies situated in high-growth industries, such as software and biotech companies. If just one of these investments becomes the next Google or Microsoft, the VC can earn a huge cash return (called “getting liquid”) by selling shares either through an initial public offering on a public exchange or to the owners of another company. A VC will have a very hard time doing that in Mozambique, because there aren’t many other companies and there is no real public stock exchange to sell to.

A USAID report that described a long string of failures the IFC has had with venture capital investing. The report stated:

The IFC has also provided resources for venture capital companies. A recent
evaluation of eight such enterprises in which the IFC invested $40 million from
1976 through 1986 concluded that this indirect support had serious problems. The
venture capital companies had difficulty persuading owners of promising
businesses to sell part of their equity; managers of venture capital companies
were usually inexperienced and had to learn by doing; and developing a
management that created proper incentives was difficult.

Overall, the IFC’s venture capital portfolio performed poorly. Estimated real rate of
return on its projects in venture capital companies was minus 5%, compared with +6% on its overall portfolio. In other words, the IFC’s investment in venture capital companies lost 5% of its value for each year it was invested.

Since previous IFC investment attempts in Mozambique have failed, there is a concern that if another fund is created and that fund also fails, the private investors whose money stands the best chance of improving economic conditions could be scared off.

SGL PRINTING

After arriving in Maputo we met with Nadya, the owner of SGL printing. SGL focuses on high-end printing services for the local business community. SGL was started by Nadya and her partner in Canada; the company moved to Nadya’s home in Mozambique when Canada went into recession in 1982. Tracy recently arranged a capital infusion of hundreds of thousands of dollars into SGL; that money was used to buy a machine that tripled the company’s production output. Nadya confided that she hopes to use her business to retire, but at the moment her profits are pushed downward by competition from another business that allegedly functions as a money laundering operation. According to Nadya, there are three major printers in Maputo. One prints for 97 cents per copy. She sells her product for 84 cents. The alleged money launderer somehow manages to sell for 30 cents.

The exciting thing about IFC’s recent investment in SGL is that the new machine improved production enough to require Nadya to increase the size of her labor force from 50 to 60 employees. Nadya pays her most junior employees at least three times the minimum wage (the minimum wage is about $60 per month), even though she claims could pay them less if she chose. The more skilled employees of course earn a better wage. Junior workers in the pre-production room earn $500 per month; senior workers make $1000 per month. So because of the IFC’s partnership with SGL, 10 more people in Maputo have jobs that can enable them to maintain a standard of living well above what they would have had otherwise.

Because Nadya came from Canada, her business is considered “foreign owned” and is subject only to the 16% foreign tax rate. However, this benefit will expire in a few years, and SGL will be subject to a 32% domestic corporate tax rate. I asked her why there wasn’t more chaos and how there could be much business at all if the legal system was so useless. She explained that in Maputo everyone knows everyone, so having a good reputation is very important to a firm’s future economic viability. People essentially have to work disagreements out amongst themselves, because the legal system is too broken to utilize.

When we asked Nadya what her concerns for the future are, she mentioned a trade agreement into which Mozambique has entered with South Africa and other countries. The agreement is called the “South African Development Compact” (SADC). If BEE (Black Economic Empowerment) is the affirmative action of Southern Africa, SADC is its NAFTA. Nadya is worried about competition coming over the border from the RSA.

Because SGL is a local business, Tracy wasn’t as concerned about the impact of SADC as she would have been had Nadya been running a business more susceptible to competition from abroad. Nadya told us that it was hard to work with the IFC because the due diligence process was so extensive. However, Nadya added that “we wouldn’t be where we are today without the IFC.”

DÉJÀ VU CHOCOLATE

We also had the chance to meet with Milton, the co-owner of a chocolate business in Maputo called “Deja Vu.” Milton was educated in South Africa, but identifies himself as Mozambican. Tracy used IFC money to provide Milton with some management consulting and market research support, and had a meeting on Friday to approve an equity investment that would double his production. Milton was very excited about his partnership with Tracy and the IFC. He claimed that up until now he was unable to grow his business because loans are overcollateralized by Mozambican banks.

A chocolate factory just before Easter in a Catholic country is an intense place. Other than some soft jazz playing in the background, there was total silence in the room as we toured the production floor. The employees were nearing the end of a 12-hour shift that had begun at 7 am. In spite of competition from South Africa, Déjà vu seems to have carved out a niche for itself in Maputo’s chocolate market. Mozambicans like their sweets; it is expected that the market could easily absorb all of Milton’s product even if he were to triple production.


PRESENTATION TO IFC MOZAMBIQUE

We used all this information to present the best case we could for how an investment model could be structured that would both stimulate economic development and make money. During the meeting, the conversation turned to the need for a paradigm shift both among Mozambicans and among the donors who give money to them. The IFC made the point that donors must realize that money alone will not solve this problem; only a change in the way people think and govern themselves will produce the kind of results everyone is hoping for in the long term.

One of the IFC representatives attending the meeting was a young Mozambican named Sabino. Sabino is not as privileged as we are; he cannot afford to come to Georgetown to get an MBA. But he is an absolute sponge for information…a self-taught venture capitalist. He even (accurately) corrected me at one point regarding the history of venture capital in the United States (thankfully no one asked me to research the economic history of Mozambique). Toward the end of the meeting, I looked at Sabino and told him I hope to return to Maputo in 20 years and reminisce about the meeting we were having. I hope that when we have that conversation, the system of laws, government, and capital markets currently operating in Mozambique will be a distant memory. He looked admiringly at the “Big Red Book” I obtained for Professor Martin Ginsburg’s class on Structuring Private Equity and Venture Capital Transactions. I promised to get a copy in his hands before I graduate. My other teammates told Sabino that they envision him as the head of the Mozambican version of the Carlyle group in 20 years. He didn’t laugh at that. He actually looked at it as a real possibility.

Sabino is not naïve. In his recent, excellent book, The Emerging Markets Century, Antoine van Agtmael points out that we currently live in a world where 15% of the population controls about 80% of the wealth. Agtamael estimates that by 2035, 50% of the wealth will be controlled by underdeveloped nations like Mozambique. If Agtmael is right, this state of affairs will be created not by a pure transfer of wealth from developed economies to underdeveloped ones, but by growth from within. There is a good chance that Sabino's of this world (and those who align themselves with people like him) stand to make an awful lot of money in the next 30 years. [postscript: much thanks to Jack Levin, the author of "Structuring Private Equity and Venture Capital Transactions," who did generously-and quickly-ship a copy of his book to Sabino].

If I had to sum up my time here in Africa, I would say the two biggest themes of this trip are "hope" and "possibility." The evening we returned to Johannesburg from Maputo we enjoyed a farewell dinner at our hotel. At that dinner, we were treated to an a cappella duo of these students from the Community and Individual Development Association City Campus (or CIDA City Campus). CIDA is the first private higher education institution in South Africa to offer a virtually free business degree to students from disadvantaged backgrounds. Listening to their voices, it is hard not to be hopeful for the future of this region of the world: http://www.youtube.com/watch?v=VdqEWWfnlEE

Very Best,
Jim