FOLLOWING on from my previous article which explores the potential impact of informal institutions on Foreign Direct Investment, this article seeks to discuss another key issue called governance/institutional distance (gap). Businesses and investors need strong formal institutions in order for them to thrive. Formal Institutions ensure fairness and minimises arbitrary decisions in business disputes
As the quality of Zimbabwe’s institutions deteriorated, the government announced a ‘Look East’ policy. The policy is meant to have been announced in an effort to shore up a struggling economy and manage sanctions that had been imposed by the ‘west’. The ‘look east’ policy was a change in national trade and investment policy from emphasis on the west to the east.
When the policy change was announced, the general consensus was that this shift was caused by the fact that the west was critical of the Zimbabwean government and had imposed sanctions against the country whereas the east was happy to keep a blind eye on what was happening in Zimbabwe.
Given the deterioration in the formal institutions in Zimbabwe at the time, I wondered whether the government announced this shift in policy having noticed that investors from countries with strong formal institutions were less likely to risk investing in the country anyway.
Institutional distance is the similarities or differences between quality of institutions in two different regimes, the host and the home country of the potential investor. The idea behind the theory of institutional distance is that investors are reluctant to invest in a country where the quality of institutions is far too different (mostly inferior to the home country); by implication this means that investors are more comfortable investing in countries with institutions that are comparable to the home country.
This may mainly be because accurate forecasts and predictions are easier to achieve in familiar environments. For example, British investors are likely to balk at the idea of being asked to partner with the Zimbabwean Armed Forces (and cede 51%) in a business venture whereas a Chinese investor may not hesitate at that opportunity because that might be normal practice in China. This implies that the bigger the institutional differences, the less likely it is for the investor to invest in the host country.Advertisement
According to World Governance Indicators, Zimbabwe’s governance/institutions have deteriorated very significantly in the last two decades (see chart 1 below). The indicators are based on responses to surveys on people’s perception of the rule of law, control of corruption, government effectiveness, voice and accountability, political stability and regulatory quality.
Responses are gathered from a number of survey institutes, think tanks, non-governmental organizations, international organizations and private sector firms and score allocates. The estimate of governance ranges from approximately -2.5 (weak) to 2.5 (strong). Chart 1 below looks at the average scores since 1996. I have added the scores of other countries around Zimbabwe for comparison.
Odd one out: Quality of Zimbabwe’s institutions compared to neighbouring countries