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Public administration and Black Economic Empowerment

Index

• BEE and economic performance in SA
• Is BEE a South African growth catalyst June 2017
• Procurement Issues Sum 01 June 2017

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BEE and economic performance in SA

1 Introduction

The paper lays out a conceptual framework for evaluating the impact of Black Economic Empowerment (BEE) on economic growth both directly via its influence on the behaviour of business, and indirectly by its effect on political stability. The authors give a preliminary analysis of the impact of BEE on business conduct and performance, and economic growth.

BEE (also Broad-Based BEE) was defined in 2001 by the BEE Commission as “an integrated and coherent socio-economic process” … “aimed at redressing imbalances of the past by seeking to substantially and equitably transfer and confer ownership, management and control of South Africa’s financial and economic resources to the majority of the citizens.” The goal is to “ensure broader and meaningful participation in the economy by black people to achieve sustainable development and prosperity.”

The authors recap that “BEE is about attempting to create a degree of economic equality which would not itself be a natural market outcome of the changed political environment” after 1994.

2 Phases of BEE

2.1 Phase 1: Uncoordinated policy: 1993-1999

Initially BEE involved the transfer of equity from a white company to a (usually) pre-identified black person or black-run business. Beneficiaries usually had prominent political profiles, but limited business experience. Transactions were often financed by loans granted by the seller which were secured by future earnings flows of the company – thus loan repayments assumed rising dividends and share prices. These initiatives were largely market-driven by the private sector, with little government intervention, and were uncoordinated. Many of these BEE deals unraveled when the stock market declined in 1998.

The authors argue that this narrow-based form of BEE in essence secured property rights – white firms enabled the new political elite to have a vested interest in secure property rights.

2.2 Phase 2: Big Push to overcome Apartheid legacy: 2000-2014

In 2001 the government’s BEE Commission recommended a more active and interventionist role for the state to promote BEE. Specific criteria were proposed to measure the degree of ownership of BEE companies – a black company is more than 50.1% owned and managed by black people; a black empowered company has at least 25.1% black ownership and management, and a black influenced company has 5 to 25% black ownership and management.

A series of industry charters followed, with the mining charter causing some stir – share prices on the JSE plunged and capital outflow reached R11 billion. Government outlined a generic scorecard with relative weights attached to different dimensions of BEE in a strategy document for B-BBEE. The scorecard described what BEE compliance meant for business, and government committed to using its purchasing and licensing powers to compel companies to comply. The passing of the Broad-Based Black Economic Empowerment Act in 2004 also created a firmer and more systematic basis for economic transformation.

The authors describe B-BBEE as a “Big Push” which stemmed from the recognition that government intervention is needed to address market and political failures.

2.3 Phase 3: Self-sustaining empowerment?

While the authors argue that BEE interventions can be viewed as transitory – a “Big Push” to break up the inherited social and economic inequalities and to drive SA towards higher levels of productivity, equality and social welfare, the future of B-BBEE appears very unclear. Specifically, it is not known what will happen in the future once targets (in industry charters) have been met.

In essence, when affirmative targets are achieved in the Big Push view of the world, black ownership and black representation at management level would be unalterable. Thus, there would be no need for future action plans to guarantee that black people hold assets or management positions in proportion to their relative weight in the population.

In the authors’ view, there is no long-term need for B-BBEE to generate self-sustaining empowerment. Once the country has rid itself from the economic legacy of Apartheid, black people will empower themselves. However, the authors caution – although the need for B-BBEE may be transitory, “the policy can easily become permanent because it can become captured by special interest or generate opportunities for rent seeking”.

3 What problems is BEE intended to solve?

Human and physical resources were grossly misallocated under Apartheid, causing major economic inefficiencies and inequalities. Market failures may continue to replicate adverse conditions even after discriminatory laws and structures are removed – i.e. market forces will not change the misallocation of resources on their own.

The extent of inequality in South Africa has the potential to destabilise democracy because populist policies may become attractive to the masses. So government has to intervene to advance efficient resource allocation, political stability and enduring democracy.

Potential policy responses from government include income redistribution via the fiscal system in the form of taxes, or alternatively, asset redistribution. However, the latter may violate constitutionally-protected property rights and lead to large losses due to reduced investment. A final policy option to remove inequalities and improve social mobility is affirmative action. It has much in common with asset redistribution by admitting that a purely market-based approach will not improve social mobility, or may take too long and risk political stability.

Although BEE policies may be seen as socially efficient, the authors ask how the form of BEE applied will measure up when evaluated against the criteria of improving resource allocation and political stability. The authors argue that social welfare and economic growth should also be considered when evaluating BEE.

The authors distinguish between Broad-Based BEE (B-BBEE) and Narrow-Based BEE (N-BBEE). B-BBEE increases the opportunities, skills and welfare of black workers so that the political majority in society may become better off, thereby reducing inequality and the threat of populism. On the other hand, N-BBEE may aim to satisfy a political elite – by giving the elite access to government contracts to gain competitive advantage. But this may create a higher probability of populism.

The authors argue that N-BBEE has dominated in South Africa and has become the norm, despite rhetoric about B-BBEE. While N-BBEE had no noticeable impact on inequality, it does create resentment, and the authors warn that it makes populism more likely.

Although government has the correct incentives for BEE (relieving poverty and driving socially desirable policies), policy outcomes are impacted by societal influences. Given that politically connected people have benefited from BEE deals, it is likely that government may be challenged in adopting the optimal BEE policy. Furthermore, while BEE policies are seen as transitory (to change the equilibrium of allocation of resources), given the interests that benefit from such policies, government may be reluctant to commit to a transitory approach.

4 The impact of BEE on economic growth

The authors use a costs/ benefits analysis to consider the impact of BEE on businesses (firms).

When benefits are viewed in terms of firm value, BEE measures to hire black managers may enable firms to increase their productivity (and so discard incorrect racial stereotypes that Africans are less productive). However, the authors argue that it is unlikely to see positive productivity effects from BEE in the short term. Another benefit is that BEE may help businesses to preserve their property rights, esp. if they fear expropriation. Because BEE-compliant firms have greater access to state contracts, BEE will boost profitability and may even drive investment if investors have a preference for BEE (e.g. when the PIC is a major shareholder).

On the other hand, the costs of BEE are less clear, but do exist. Share transfers at discounted prices (often used in BEE deals) constitute direct costs to current shareholders. If BEE deals commit businesses to higher levels of dividend payments (to enable BEE beneficiaries to repay loans advanced to purchase shares), this will impact retained profits available for re-investment. BEE policies that force businesses to hire less qualified workers and to up-skill their workforce, affect productivity levels and the costs of doing business. Accordingly, the authors argue that BEE may reduce productivity, investment, profits and share price.

While a key social benefit of BEE is the avoidance of populism, there are also social costs. The prevalence of N-BBEE forges links between business and politically connected people, and this may lead to rent-seeking and measures aimed to advance existing incumbents. In turn, this can reduce market competition and innovation, and distort government policy. As such it is a cost to society and is likely to curb economic growth.

BEE also reduces competition in procurement (only BEE-compliant bidders will be considered) and increases costs for government (to weigh BEE credentials and price). Firms seeking BEE certification need to incur costs to comply and undergo evaluation. This adds to the costs of doing business. Although smaller firms are exempt from BEE, the prospects of having to implement BEE may deter smaller firms from expanding and innovating, thus impacting economic growth.

5 A summing-up

The authors argue that there are two potential linkages between BEE and economic growth. First, BEE influences property rights which has a first-order effect on incentives to invest and innovate, and thus influences the rate of economic growth. The impact of BEE on property rights may be positive if it leads to the avoidance of populist economic policies, or negative, if there is uncertainty about the future evolution of BEE policy.

Second, BEE may influence business productivity (but there are also potential negative impacts). Lack of data prevents an assessment on the impact of BEE on productivity.

In Phase 1, N-BBEE secured property rights and thus stimulated economic growth. In Phase 2, (despite the introduction of B-BBEE) there is still an emphasis on ownership. The authors argue that a full move to B-BBEE and a refocused BEE policy will be necessary to enhance property rights because N-BBEE will not secure such rights in the long-run. The lives of the majority of black South Africans must be transformed to give them a vested interest in the security of property rights.

6 The impact of BEE on economic growth in Phase 2: an empirical strategy

BEE consists of a “vector of policies” that include the transfer of assets, appointment of black executives and management, affirmative action, skills development and aspects of human capital. Since these components are used simultaneously, it is difficult to independently estimate their effect on the behaviour of businesses.

Partaking in BEE will vary across businesses, depending on the costs and benefits faced. The authors consider a series of potential instruments for predicting the impact of BEE:

1. The extent to which firms depend on state contracts will determine their incentives to engage in BEE and the extent of government’s leverage over them.
2. The extent to which institutions such as the PIC hold equity in the business – the greater the PIC shareholding, the more a firm should engage in BEE.
3. The initial ownership of the business will matter – where an individual, family or firm owns 50% or more of the shares, it is less likely that the business will engage in BEE.
4. Firms operating in industries with a charter will face different incentives to engage in BEE than firms in industries without a charter.

The authors remarked on the lack of data, and that problems with data also made inferences either difficult or impossible.

Although BEE proponents claim that BEE is complementary to sustained growth, the authors found no empirical analysis of the possible connections between any aspect of BEE and the behaviour and growth of businesses. Many factors influence both BEE and profits, and even if these are correlated, it would not provide insight into the causal effect of BEE on profits.

The authors used data available of JSE listed companies to complete BEE scorecards, considered the proportion of shares held by black people and proportion of black management, as well as firm spending on skills development as a percentage of turnover. Other data analysed included information in published company accounts including turnover, profits, share price, dividends, fixed assets and employment.

7 Conclusions

The authors discussed several ways in which BEE can influence growth – both positively and negatively. They concluded that it is difficult to know which effects will dominate.

The authors stated that for an economy to grow, businesses must make profits, invest and increase their productivity. The authors were unable to identify significant effects of BEE on profitability, labour productivity or investment of businesses. From the data analysis, the authors concluded that BEE seemed to have had very little impact on business behaviour. If anything, they found weak evidence that BEE has a negative effect on investment and labour productivity.

The authors offered several possible interpretations of their findings:

1. Data problems hampered interpretation and inference.
2. It was too early for empirical tests on BEE’s implications for the economy.
3. The economic costs and benefits of BEE cancel each other out – zero aggregate sum.
4. The major issue may be the aggregate effects (avoidance of populism) but this cannot be estimated at firm level.
5. BEE does not have large effects on the business behaviour, of, but BEE does influence distribution.

While the authors cannot say which of the views are correct, they do offer policy recommendations on BEE. The paper highlighted some unsatisfactory aspects of BEE and revealed areas where policy needs to be clarified and amended:

First, transfer of ownership in BEE is unlikely to have large positive effects on business productivity or economic growth. Also, enduring property rights security requires a broader base than a BEE policy can provide. Thus, the BEE policy should change to de-emphasize ownership, and rather increase focus on aspects that can increase productivity and broader transformation of the economy. In particular, aspects such as enterprise development and skills development should be given more prominence in BEE codes.

Second, BEE policy is open-ended and there is no mechanism to evaluate its impact on any of the outcomes it is supposed to influence. Although industry charters set targets, they do not state what happens once the targets are achieved. This creates uncertainty for business and investors. The authors recommended a second BEE commission to evaluate the policy against the targets set.

Third, good data must be collected to evaluate BEE policy. The authors recommend that BEE verification be linked with financial auditing as a mechanism to begin credible data collection.

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Is BEE a South African growth catalyst June 2017

1 Introduction

Black Economic Empowerment (and Broad-Based BEE) is a policy intervention driven by government aimed at addressing the skewed economic profile of the South African economy. BEE requires the private sector to restructure and to provide opportunities for previously disadvantaged individuals (PDIs).

The focal aspects of BEE require change to intra and inter-firm relational patterns of capital and control, staff selection, promotion and development, supply chain, enterprise development and social engagement.

2 Theorizing about economic relationships

When analysing whether BEE is a growth catalyst, Andrews refers to the theoretical literature on economic and organizational structures. The literature argues that entities (e.g. firms) are in relationships with others. Entities display both internal and external relationships which form intra and inter-firm networks that connect different economic players in different ways. These networks (or structures) reflect social values and shape behaviour patterns, empowerment efforts and opportunities for economic growth. While these structures can facilitate or inhibit opportunities for individuals and firms, they have a bearing on national growth and development.

The relational structures (seen as a factor of production) are impacted by different systems of organizing logics (i.e. cultural practices and collective understandings). These logics resist change and favour distinct development trajectories, e.g. Korea and Taiwan. If organisational structures support entrenched patterns of access to economic opportunities (and remain unchanged), they will not permit the inclusion of PDIs.

Andrews suggests that the same structural variables determining who participates in and benefits from an economy also shape what new ideas enter, what products are made and what growth opportunities exist. For BEE to be a growth catalyst, it has to change the relational structures in industries, open up the economy to PDIs, to new ideas, entrepreneurs, and production activities (which must absorb labour and enhance exports).

Andrews says that structural change is at worst extremely slow and at best open to obstruction and manipulation, esp. by elites.

3 Observations about the South African economy

Andrews notes links between the organizing structures in the economy and economic weaknesses. South Africa’s formal economy is characterized by high levels of capital concentration and vertical integration in key industries. Vertical consolidation has aggravated the already-low levels of industrial competition and has resulted in closed markets and “old boy networks” that keep out new (and perhaps more efficient and competitive market entrants). Andrews remarks that capital, control, commercial and interpersonal relationships in large firms are tight-knit. The formal economy is closed to those who lack experience in big organisations, the desired professional qualifications, and the right social and racial profile.

In South Africa SMMEs face significant barriers to entry. These structural problems may explain why SMMEs contribute less to GDP and employment than in many other countries. These structural factors limit new entrants and ideas, exclude outsiders (esp. entrepreneurs and low skilled workers), and keep levels of innovation low, all of which constrain growth. The closed and concentrated structures also impede firms in establishing a strong export presence.

For South Africa to achieve economic growth, it will have to move from concentrated and closed relational structures to de-concentrated and open ones. Further, the country will have to create a competitive climate to enable emerging business to grow and prosper.

Micro, small and survivalist enterprises which are often viewed as forming the second economy, are largely separated from the first economy. Such businesses have little access to capital and markets, and lack linkages to economic, professional and social factors required for building effective commercial relationships. Entities in the second economy are separated by significant barriers from the dominant economic action and players in bigger business.

An even more isolated group is found at the bottom of the economic structure – the unemployed and under-employed. Andrews states that they are true outsiders in the economy mainly because the networked organizing structures determine who is empowered and who is not. This group continues to confound policymakers, esp. the sub-group comprising educated young people who struggle to find employment before their late 20’s.

A major challenge in South Africa is that the outsiders significantly outnumber the insiders who are benefitting from the new economic paradigm.

4 Why BEE could be a South African growth catalyst

Andrews states that catalyzing growth will require structural change that “shakes the primary commodity-based organizing logics that deem big, closed firms most appropriate”. Likewise, racial patterns in the economy will only adjust when structural changes challenge the race-based organizing logics which enable some groups of whites to be empowered insiders and other group’s disempowered outsiders. Andrews argues that the big business organizing logics that frustrate growth are similar to those distorting racial empowerment. These structural constraints that resign many people, ideas and emerging firms to outsiders, likewise harm growth, esp. in the context of dynamic global markets. Andrews suggest that a solution to the structural constraints should address racial inequity as well.

4.1 BEE and structural change

Andrews views BEE policy as a tool to both correct structural issues impacting economic growth and racial access. BEE is fundamentally about empowering PDIs, but is also about economic empowerment.

Andrews also considers the elements of BEE policy. The initial narrow focus of BEE to transform capital and control structures in big business has produced only a few beneficiaries. More recently B-BBEE requires firms to change capital and control structures, management structures, procurement relationships, activities involving enterprise development and the way firms engage with society. These requirements are contained in the Codes of Good Conduct and a scorecard for assessing a firm’s BEE status when it requires services from or offers goods/services to government. Table 1 shows the generic BEE scorecard.

Table 1: The generic BEE scorecard

Element	Weighting (%)
Ownership	20
Management control	10
Employment equity	10
Skills development	20
Preferential procurement	20
Enterprise development	10
Residual contributions (i.e. social development involvement)	10

BEE focuses on large and medium sized business. Firms with revenues ranging from between R5 million and R35 million are subject to a scaled down Qualifying Small Enterprises version, while firms with revenue below R5million are deemed compliant. A fully compliant business ranks itself as a “level 4 contributor” which means that goods/services it supplies to other firms are valued at 100% when the other firms work out their preferential procurement scores. Firms with a score below level 4 are a BEE cost to the businesses they supply, and firms that score higher than a level 4 contributor (above 75 points on the scorecard) offer a BEE gain to the business they supply.

Thus, Andrews argues, BEE policy is configured to address inter-firm relational structures. If a firm wants to do business with government, it has to make changes to ownership and control structures. Similar changes are needed if a firm aims to do business with a firm that contracts with government. Effectively firms can gain or lose private sector business due to BEE status.

4.2 BEE and ASGISA overlap – catalyzing racial transformation and growth

Andrews says that BEE targets relational structures for change (ownership, supply chain etc.) and the problems that define the country’s economic structure. Generally, BEE aims to enhance access and openness. ASGISA (government’s shared growth strategy) has a similar aim – to move from close-knit, closed relational structures with few insiders to more open, loose structured with many insiders. While BEE is about racial transformation and economic empowerment, ASGISA aims to surmount macroeconomic constraints with infrastructure plans, sector investment strategies, skills formation, second economy interventions and public administration improvement.

Andrews argues that BEE and ASGISA policies overlap in four key areas of structural change:

1. Both seek to open the formal economy to new entrants and new ideas. This requires de-concentration of capital, control and management structures that will accept more insiders (mostly PDIs) at the top of the economy.
2. Both require changes to inter and intra-firm structures that define human resources management. Both policies expect firms to enable stronger skills formation and to appoint more managers from the ranks of PDIs.
3. Both aim to stimulate new business, esp. opening opportunities for smaller business and to forge more connections between the first and second economies.
4. Both embrace elements aimed at uplifting the bottom of the economy through community engagement and job creation.

Stemming from the above four areas, Andrews submits:
Proposition 1: BEE will catalyze growth if it facilitates the changes in the four areas, and if it allows these structural impacts:

1. Open big business – optimal concentration, but significant de-concentration; greater competition with new entrants and new ideas.
2. Introduce new people connected to broader networks, bringing new ideas, knowledge experience, and opportunities; accelerate training and build high quality, creative workforce that advances on career ladder.
3. More constructive vertical connections; more small business insiders and opportunities, SMEs and micro enterprises thrive and many gain more influence.
4. Stronger communities with links to formal economy – creating opportunities, breaking structural constraints and fostering viable micro businesses and employment.

Andrews concedes that some observers prefer BEE policy to focus on structural change at the top of the economy only, and not deal with broad empowerment. But, Andrews argues that BEE’s potential is to induce real change in the ways firms relate and in the cultural concepts shaping relationships. The BEE Charters embody the kind of change envisaged – the substantive changes to the way a sector views itself and its corporate and social engagements are rarely achieved through government programs. The key is for firms to be receptive and open to new opportunities, networks and members.

5 Why BEE may not be a South African growth catalyst

This paragraph explores a counter-proposition to the previous discussion.

5.1 Negative perspectives on BEE

Early BEE initiatives focused on transfer of ownership, but unraveled as stock markets declined in 1998. According to some observers, entry of black PDIs into business control and management structures has been slow, with little real change in procurement patterns.

Andrews refers to studies on the early stages of BEE (before 2002) which found that structural transformation was both slow and problematic. Actual experience showed that improved access for new black directors, professionals and managers was not always matched with improved treatment and empowerment. Black professionals identified limited experience and limited nature of work assigned to them as barriers, as well as racial bias of supervisors, lack of black mentors and client prejudice.

Actual gains were narrow and the income gap between insiders and elites, and outsiders has grown since BEE was introduced. BEE’s slow start may be attributed to entrenched structural impediments in the economy (i.e. high levels of concentration and centralisation of capital) as well as a limited skills pool of PDI contenders for middle and senior management positions.

5.2 A counter proposition: BEE may not catalyze growth (or transformation)

Some theorists question the potential of organisations to change, and argue that the structural constraints targeted for change are exactly the constraints to change themselves. The argument goes further – dominant, elite business networks resist change because they tend to reproduce and preserve, or gain more control. In essence, “when elites are forced to change they will do so at the margin”. Any new entrants will be limited in number and look similar to current members of the network. To conserve the network as much as possible, elites will uphold control, access and benefit patterns.

These concerns are relevant for BEE. Since South Africa is dominated by elites, BEE can have “elitist consequences” – rather than achieving its purpose, BEE may only enrich the few. In view of this context, a counter proposition to the first may be:

Proposition 2: BEE will not catalyze growth because it will not lead to effective structural change in the South African economy. Institutional macrostructures that underlie the economic patterns limiting racial transformation and growth are rigid and do not change easily; they are especially protected by elites with an interest to maintain them.

6 So, is BEE a South African growth catalyst? Analysis and evidence

At the time of writing, statistics available on BEE deals could not indicate whether the first or second proposition best described the South African situation. Researchers are challenged to gather data on BEE – because firms are sensitive to assessment and fatigued by ongoing measurement for regulatory purposes. There is also no central repository for BEE data. Available data do not show how firms achieved BEE scores – only aggregate scores achieved against the seven elements in the BEE scorecard are reported.

6.1 A research methodology

Andrews adopted a qualitative research approach to examine the two propositions in a study of 25 JSE listed companies. The study gathered information on details behind responses to BEE requirements. Companies’ annual reports were probed and more information was gathered in interviews and from media documents.

Although the approach has limits, Andrews gleaned useful reflections to raise with policymakers and for further research.

6.2 Evidence from firm responses to BEE

The research focused on whether the companies’ BEE responses enhanced growth, and to assess the degree to which responses were:

1. Opening the formal economy to new entrants (esp. PDIs) and new ideas through de-concentrating capital, control and management structures;
2. Introducing new people (esp. PDIs) to broader networks, bringing in new ideas, experience, knowledge and opportunities; enabling training and building a high-quality skilled workforce;
3. Forging more constructive vertical connections to include more PDIs and SMEs, creating business opportunities at the lower end of the economy and linking SMEs and micro entities to the first economy;
4. Fostering stronger communities with links to the formal economy by stimulating micro businesses and work opportunities for the unemployed.

Andrews uses the research findings to consider what measures or approaches can be taken to improve BEE policy so that it may generate growth.

6.2.1 Is BEE opening big business?

Twenty out of 25 firms had transferred equity to BEE owners, with more transactions in the pipeline. Andrews found that although big business has enabled capital transformation, BEE has not materially changed the concentration aspect of big business ownership. BEE beneficiary groups were narrow and elitist. Big business introduced only a few new, different players – established figures or groups with strong ties to government, business or both, and who formed part of the social elite. After the BEE transactions old and new elites continued to look and behave similarly.

The research showed that when looking for BEE partners, companies were looking for established persons with contacts and abilities to add instant value to the business. Andrews says that this approach both constrained the number of BEE partners and limited the degree to which big business opened itself up. Firms preferred “safe bets” as BEE partners rather than new entrants (who were hard to find and almost impossible to screen, and who ran the risk of not procuring the financial support needed for the deal). Andrews says that business looked to minimize risk when concluding BEE deals.

Andrews argues that that the BEE scorecard does compensate big business for the perceived risk of engaging newcomers – the same points are allocated to big business irrespective of whether the BEE partner is established or a newcomer. Thus, the construct of the BEE scorecard limits the degree to which BEE deals open the economy to new entrants.

The research showed that companies found black directors from three sources: they entered with the BEE partner or an established BEE player; or, through industry associations or other big organisations; or, via professional associations (e.g. for accountants, engineers, lawyers) where they meet existing white directors. So companies look in “tried and trusted networks” for directors – much the same approach as for seeking new co-owners.

Andrews found that although firms are gradually changing the racial profile of their boards, they continue to depend on connected and qualified individuals from elite professions (who looked like they did). Given the dependence of big business on established, connected and qualified individuals, Andrews questions what this means for the potential of BEE to open up the economy to newcomers?

6.2.2 Is BEE introducing and building South Africa’s talent?

Andrews considers the degree to which BEE policy is affecting intra-firm human resource decisions and relationships. Evidence gathered show that beyond racial considerations, firms prefer to appoint people with profession-based qualifications and prior experience in large organisations. Professional qualification is regarded as a vital screen for PDI talent, esp. at board and senior management level. Accordingly, Andrews observes that directors and managers reflect pre-existing values and control structures. This reflects how business perceives talent and staff quality.

Andrews argues that these practices lead to several problems:

• Firms are not fostering meaningful change in the type of person appointed – instead managers are drawn from a known, stable network that was always well represented. This could undercut new ideas.
• There is a rigid PDI talent barrier at the top of the economy, and the talent pool of PDI professionals is small; If BEE appointments are only drawn from this group, BEE will fail to open big business up to a large group.
• Given these skills constraints, the pressure on firms to meet BEE codes creates negative incentives. It kindles artificially high demand for an already high demand group – leading to very high salary demands and job-hopping. Pressure to push PDIs through the education system without sufficient training undermines confidence in qualifications. Firms also tend to stop hiring white professionals already in the system which impacts negatively on the supply of high-level skills to the economy.

Andrews argues that the BEE codes are too rigid, esp. when recognising the qualification-bias of formal sector employers who seek talent from the same narrow skills pool. He says that quotas will not solve problems, rather but exacerbate them. Policy must focus on growing skills at the top of the economy. Since low-skilled jobs are a “complement of high skilled jobs”—it is necessary to grow the top in order to accommodate more people at the bottom.

Although firms develop talent for internal promotion, firms face fierce competition for skills and find it difficult to hold onto PDIs groomed for management. This may be a disincentive to employers for developing general business skills in staff.

6.2.3 Is BEE creating vertical connections in the economy?

Andrews considered how businesses create vertical connections (via supply chains and enterprise development) to open up economic opportunities.

Firms are adopting BEE preferential procurement requirements in different ways, including with insourcing/outsourcing approaches. Insourcing occurs if a firm takes an in-house service function (maintenance, catering) and sets up the staff in separate SMEs to provide the firm with those services. Outsourcing takes place if in-house services are replaced by an outside BEE firm. Another way is for a firm to put pressure on its suppliers to change their BEE status so that the procuring firm becomes BEE compliant. Another option is to replace a non-BEE supplier with a BEE supplier.

Although changes to procurement may create opportunities for emerging SMEs or micro entities, new supplier relationships hold risks (e.g. lack of financial and/or management skills, unproven track record and reliability questions). It may also be costly to set up new preferred suppliers. BEE points are awarded on amounts spent, and it is immaterial whether firms engage with repeat suppliers or newcomers. Andrews argues that BEE scorecards should recognize the risks companies face when dealing with new entrants – i.e. award points for dealing with new entrants in order to open the economy to newcomers.

Successful initiatives by firms in the formal economy to establish links with emerging enterprises (via JVs or business development) often depended on the involvement of key persons to create bridges between the entities. Research also found that the greater degree of decentralisation of authority at local level (in poorer, rural areas), the greater the likelihood of creating local business linkages.

6.2.4 Is BEE opening the economy at the bottom?

Job creation is a major issue at the bottom of the economy. Andrews says that BEE has not given enough attention to this. If done well, vertical business connections have great benefits for those at the bottom of the economy. However, most are not done well. BEE codes do not specify what the interventions should look like.

The study found that although all 25 firms had active corporate social responsibility (CSR) programs, most were poorly coordinated charity engagements. Andrews argues that while CSR should have an element of charity, there should be greater emphasis on coordinated community development, including job creation. Particularly, CSR should involve initiatives that bridge the first and second economies (e.g. firms “adopt” local communities; JVs and subsidised supplier arrangements; training; firms engage in an accountable, sustained and coordinated manner with poor communities). SCR programs should uplift communities.

7 Ideas to ensure BEE could be a South African growth catalyst

Andrews avers that BEE as currently practiced may be a constraint on growth. He argues that BEE exacerbates the skills crisis in South Africa because firms continue to base employment decisions on established hiring practices – using professional bodies and professional qualifications to search and screen candidates.

He highlights the BEE effects on economic structures:

• Big business is only opening at the margin; most structural barriers still exist; only marginal adjustments occur at the edges of networks;
• The slow addition of black talent into formal firms using pre-existing search and screen structures aggravates skills constraints and limits the openness of the BEE impact;
• Vertical connections are developed on basis of pre-existing relationships;
• BEE does not explicitly foster job creation or skills formation of people not already in formal sector; such initiatives have impact on local communities; traditional ‘charity engagements neither empower, nor uplift communities.

Andrews suggests that these findings should concern government. It is necessary to ask questions about the implementation and design approaches for BEE.

7.1 Would an emerging values emphasis yield more effective change?

Andrews argues that BEE should be driven by the emerging shared values underpinning the context of development (i.e. to be inclusive, to empower, to create more opportunity, to grow, to see communities and children thrive, etc.). If BEE can focus on the value change itself, rather than on the behaviours quantified in the BEE codes, it is likely to be more successful. So, Andrews argues that BEE will be more successful if driven by shared values to improve society, rather than mere compliance with codes. This leads to the next propositions:

Proposition 3: BEE will catalyze structural change more effectively when driven from an emerging value orientation supporting the change; the impact will be less effective when an instrumental, technical approach is taken.

Proposition 3a: Firms with broad internal and external engagements will exhibit a stronger emerging values orientation in their BEE approach, which will enhance likelihood of effective structural change.

7.2 Does “space for change” yield more effective change?

Andrews refers to the impact of Malaysia’s affirmative action- and national development policies which were growth-directed. Initial policies encountered many problems and a struggling economy impeded the coveted change. So a new approach was adopted – policies aimed at creating wealth ahead of redistributing it. Some ethnic requirements were relaxed and authorities took a more overt stance to advance entrepreneurship, managerial expertise and skills development. These policies “buoyed the economy and provided economic room” for transformation and growth, as shown in the emergence of SMEs. Andrews argues that the economic space created more to share and allowed room for more sharing. Also, affirmative action policies were less prescriptive on firms – with less emphasis on ownership quotas. Firms had more “decision space” to work out how they would pursue transformation.

Andrews observes that the local BEE charters in financial services- and minerals and energy sector seem to have emerged from a “creative policy space” where parties looked at relevant structural measures to bring about transformation. He argues that these charters were also driven by emerging value sets which helped define the decision space. According to Andrews, initiatives springing from value-based changes are more directly empowering than numbers-based measures in BEE codes. In this context the following propositions are outlined:

Proposition 4a: BEE will catalyze structural change more effectively when there is economic space – facilitated by growth and opportunity.

Proposition 4b: BEE will catalyze structural change more effectively when there is decision space for organisations and sectors to dialogue and self-discover the appropriate change for their setting, and how to implement it.

Andrews found evidence that BEE activity in SA was stronger when the economy was growing.

7.3 Do self-set targets yield more effective change than quotas?

Andrews refers to literature studies indicating that quotas and targets are distinct. Quotas are rigid and set a destination, while targets are more aligned to a value-lead approach – they work even when not met.

Andrews reasons that targets (also BEE targets) enable firms to focus on their goals, thereby guiding them to produce value. Setting targets for social transformation processes will move organisations to work with transformation in the same way as with other business matters.

Andrews argues that self-set targets have value, especially if they are monitored and reported upon – thus allowing for accountability and ongoing relevance, while avoiding counter-productive results. A good approach would be for industries to provide monitoring of targets (e.g. reputable industry-based entities), while firms could also provide transparent reporting. From this, two further propositions are posed:

Proposition 5a: BEE will catalyze structural change more effectively when targets of change (firms) set their own Bee targets; quotas will likely result in less change.

Proposition 5b: BEE will catalyze structural change more effectively when targets are monitored and reported on by a credible, consistent and capacitated entity.

Andrews says that some firms who do set their own BEE targets tie those into their internal performance goals which are then measured in performance assessment processes. A number of South African companies also outsourced the assessment to verification agencies.

7.4 Do elements focused away from elites yield more effective change?

Andrews refers to the Malaysian experience where policies focused on opening the economy from the middle and bottom-up, to new firms, new people and new ideas. Entrepreneurial development lead to growth and job creation. There was less focus on change of ownership at the top of the economy.

Andrews argues that Malaysia’s approach steered away from changing the rigid, elite-protected structures at the top of the economy. Instead, the focus was to bring change to the less protected and more flexible structures at other points of the economy. He also argues that change is fostered by emerging values which are better shared in more open organisational settings. Often firms at the top of the economy are more “closed” than those below, and are thus less amenable to change. Malaysia achieved success when its affirmative action policies focused on growth-enhancing change in the middle of the economy, rather than the growth-constraining measures at the top. In this context Andrews suggests a proposition for the design of BEE policies:

Proposition 6: BEE will catalyze structural change more effectively through the elements that focus on initiatives below the top of the economy. Elements at the top of the economy are likely to be addressed in a more limited, instrumental fashion (because of greater resistance to their change, a lower emerging value basis to the change, and the fact that such change is less of an economic stimulant).

Andrews says that the study of 25 listed companies supports this proposition. He argues that elite access points – ownership, control and management structures are particularly resistant to change. Andrews says that firms will try to minimize the degree of change – and thus not move away from their trusted networks. This approach will result in narrowly defined beneficiaries and added costs for companies (paying premiums for black professionals).

7.5 Does certainty matter to BEE change?

Andrews considers whether BEE policy requires clarity in terms of time and timing, particularly the length of time that the policy needs to be in place. This is important because BEE may constrain social and economic behaviour, esp. if applied over a long period.

At the time of writing there was no sunset clause for BEE. There was also uncertainty about the consequences for a firm that fully satisfies BEE criteria at a certain point, but did not at some later stage due to situational changes beyond its control. Andrews argues that firms will respond more effectively if there is greater certainty that real change will be acknowledged.

Andrews outlines an emerging proposition:

Proposition 7: BEE will catalyze structural change more effectively when firms believe the policy has a defined end-point; specifically, where firms believe that real BEE change will result in the end of BEE regulation.

Andrews found that firms become fatigued and frustrated if they are continually expected to make BEE deals because earlier ones either fell apart or a BEE partner cashed in.

8 Conclusions and recommendations for future research and policy adjustment

Andrews argues that economic and organisational structures reflect values and influence patterns of behaviour, empowerment and opportunities for economic growth.

South Africa’s economic structures impacted negatively on access, equity and economic opportunities for PDIs, as also responsiveness and creativity. Andrews argues that transformation and growth require change in economic structures, and the same changes could address both these goals.

The central research proposition is that BEE will catalyze growth if it opens the economy to new PDI entrants and new ideas. However, Andrews observes that BEE has the opposite effect. For instance, BEE beneficiaries are from a small closed group. Further, because economic structures are protected by elites, they do not merely change in the timeframe and manner that BEE policy suggests. This raises the counter proposition that BEE will not generate growth.

A study of BEE responses by 25 JSE listed companies found that while firms actively responded to BEE requirements, they did so in a rather static macro-structural context. Ownership, control and management interventions revealed a minimum change approach as PDI partners were added at the margin. Race aside, PDIs also resembled the old white owners, directors and managers. This limits the number of BEE beneficiaries, and intensifies the demand for limited skills.

The study showed that some firms were not developing vertical connections in the economy that could foster entrepreneurial opportunities for esp. SMMEs. Firms that are growing vertical linkages are having to create capacities to bridge the network divides. The payoff seems high, esp. at the bottom of the economy where gains are seen in “found”, trained and screened talent, new jobs and new enterprises.

Andrews considered approaches to BEE to ensure that the policy stimulates growth. He argued that:

1. BEE should be led from an emerging values basis (rather than rigid requirements);
2. BEE actions should be allowed to evolve from economic and decision space;
3. Firms be permitted to set their own targets (and not be subject to rigid quotas) and targets should be measured by industry-based credible entities;
4. BEE should focus at the middle and bottom of the economy whereby large firms reach down and invest in training and job creation
5. BEE should have a sunset clause that states clearly when it will be considered successful enough to end (for the policy as a whole and for firms).

Specific suggestions for policymakers include:

• Government should increase the number of BEE points allocated to firms for doing BEE deals with new entrants (create an incentive to acknowledge the greater risks to engage with new ideas, products and people than with established partners);
• Instead of redressing employment equity at top management level, government should focus on building pools of high level skills (elites) and on job-creation at the bottom end, with candidates being groomed/trained to become upwardly mobile;
• BEE policy should focus on the middle and bottom of the economy and reward firms for employing and training unemployed persons – this reward should be equal to the ownership component which appears to have more symbolic value than it deserves;
• BEE should have an open architecture approach to emphasize the emerging values that underpin it; including a Code of good Conduct with options adding up to 140-150 (including training and job creation elements). Firms should be able to choose in which elements they wish to score points (assessed out of 100);
• BEE beneficiaries claiming to be broad-based, (esp. if entrusted with funds) must report against key performance indicators;
• Government should lead the way in demonstration projects aimed at creating vertical connections in key sectors;
• Government should define what the outcomes of BEE policy are – set out what success is, set terms when success will be declared and the policy reach its conclusion (for business as a whole and individual entities).

Finally, Andrews pleads for in-depth research for the important social transformation policy and reiterates that BEE could be a growth catalyst.

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Procurement Issues Summary 01 June 2017

1 Introduction

This paper examines four issues:

1. Contracting for municipal infrastructure delivery
2. Public-private partnerships (PPPs)
3. Large capex procurement in Transnet and Eskom
4. The “Competitive Supplier Development Program” of the Department of Public Enterprises (DPE).

2 Municipal Government Contracting for Local Infrastructure Projects

Municipal authorities are responsible for delivering water, wastewater and sewerage treatment, electricity reticulation, local road and housing projects that are key to improving the quality of life of disadvantaged people.

ASGISA identifies municipal capacity as a constraint to growth. Interviews by the author revealed that many municipalities face major problems to deliver infrastructure projects.

The essential problem is the inability in low-capacity municipalities to set requirements for what is being built, and to award and administer contracts. Because municipalities lack skills in quality control, consultants and contractors are getting away with shoddy work.

Kelman recommends a new approach – a concession that low-capacity municipalities are incapable of organising procurement and contract management for infrastructure projects. Kelman proposes that:

2.1 Municipalities remain responsible for local infrastructure strategy -- infrastructure grants, equitable share grants and other funds from national government are still made available but some municipalities would for-go the task of organising infrastructure delivery.

2.2 Municipalities rated by National Treasury as “poor” in terms of capacity cannot contract for the delivery of infrastructure projects. Instead, they will use a sector-specific national organisation (e.g. National Roads Agency for roads, Water Boards or Department of Water and Forestry (DWAF) for water reticulation/sewerage treatment, ESKOM for electricity reticulation and possibly the DPW for housing) or another national organisation (e.g. the IDT) willing and capable of providing the particular services. Municipalities will pay these national entities to set the specifications (development requirements), run procurement and manage contracts, including repair/maintenance. Other municipalities (not rated with low-capacity status) may opt (but are not compelled) to use national entities to organise infrastructure delivery.

2.3 The national entities would provide the procurement/contract management or even direct delivery of the projects themselves at pre-established rates.

2.4 The national organisations would be public entities (SOEs) and able to hire staff (e.g. engineers) at market salaries instead of being subject to civil service salary limitations.

Kelman interviewed senior officials at the abovementioned entities who showed support for the proposed approach. Kelman’s rationale is as follows:

1. Effective procurement and contract management is essential when municipalities buy services for infrastructure delivery from third parties. The absence thereof adds to transaction costs and paves the way for theft.
2. The approach will provide an incentive for poor-capacity municipalities to improve as they will prefer to regain full control over the infrastructure delivery process.
3. The national entities will procure local construction firms and carry out maintenance of the new facilities using in-house staff and local labour (similar to Eskom’s arrangements for electricity reticulation to about 200 municipalities).
4. Different rural infrastructure projects could be grouped or bundled, e.g. road projects may be grouped with water/sewerage projects and one national entity then takes responsibility for the procurement package (as ESKOM, the National Road Agency, DWAF and IDT already do).
5. The entities would train local people to do repairs/maintenance, and some already have experience in using high-labour, low-machinery production processes.

Kelman remarks that no solution to local infrastructure problems will be perfect or a quick fix. He raises the critical shortage of civil engineers in South Africa. Another caveat is the reluctance shown by low-capacity municipalities to take in engineering or other professional staff made available for free by the Development Bank of Southern Africa as part of capacity-building initiatives.

3 Public-Private Partnerships (PPPs)

In South Africa national and provincial government have implemented PPPs in areas such as prisons, hospitals and roads.

Kelman highlights a number of reasons for using PPPs:

3.1 PPPs are often included in off-budget spending, thus allowing government to avoid uneven (“lumpy”) capital investments and on-budget spending increases. However, keeping PPPs off-budget may make them appear artificially attractive. Thus, efforts to avoid on-budget spending are a bad reason for using PPPs.

3.2 One advantage of PPPs involves the performance improvements made possible by cost-savings incentives and opportunities for shifting risks to the private sector. PPP payments are usually linked to getting the project operational, and so government can save money by not advancing funds on a similar basis as it would for a conventional construction project.

3.3 PPPs create incentives for proper design and functionality of the asset – thus saving on future repair/maintenance costs.

3.4 Quality standards in PPP hospitals and prisons are higher than for government-run units, and the PPPs adhere to the specified contractual standards which are often above government’s minimum standards.

3.5 By providing for pre-commitment on maintenance spending that is already priced into PPP payments, government can avoid crises, risks and additional costs associated with maintenance delays.

3.6 PPPs encourage public entities to improve their performance, or run the risk of having more of their work handed over to PPPs.

3.7 PPPs can be structured to discourage corruption by providing for termination of contract and loss of a partner’s equity interest in the project if corruption is found.

Kelman also advises on how to set up the PPP arrangements:

1. Risk should be assigned to the party in the best position to bear it – if a vendor is able to control certain risks, the vendor (and not government) assumes the risk, while government assumes the risks over which the vendor has little or no control.
2. Revenue streams to the vendor should only start once the PPP project is operational (up-and-running). This will serve as an incentive to complete the project.
3. Government should consider alternatives to the “build-own-operate-transfer” model for PPPs if revenue for the vendor is generated by user charges (e.g. road tolls) where the vendor has no control over the usage risk. One alternative is the “design-build-finance-operate model where the vendor acts as a concessionaire and receives usage payments from government. Another option is not to make PPPs responsible for any direct service delivery, e.g. the PPP builds and maintains the hospital, but does not provide the healthcare.
4. The risk from long PPP contracts is that demand for the asset will lessen over time due to demographic or technological changes. Thus, the length of PPPs may be shortened, while still providing for appropriate maintenance/repair incentives.
5. The choice of discount rate used for future payments to PPP vendors can have a huge impact on whether PPP projects are economically advantageous for government. It may be appropriate to use a discount rate equivalent to the yield on SA government bonds with a maturity corresponding to the length of the PPP project.
6. The attractiveness of PPPs is affected by whether and how they are placed on-budget. Budget accounting should not influence the choice of PPPs versus other infrastructure methods, but a broader economic perspective should be considered.
7. Contracts for PPPs should incorporate service level agreements or other performance measures, as well as appropriate design requirements for construction projects. Otherwise, vendors can deliver quickly and cheaply, resulting in a shoddy or poor performing project. Implementation issues involved in monitoring maintenance and upkeep on projects must be taken seriously. PPPs providing that a concessionaire should train local people to do maintenance/repair also create local jobs, and save costs of dispatching roving maintenance staff.
8. To ensure that government gets a good deal from a PPP, competition is needed before a PPP is awarded.
9. PPPs are complex contracts to negotiate, and government needs high-quality banking and financial expertise on its side. Bidders are often represented by bankers who are experts in negotiating and structuring deals. The SA government may seek advice from British banks with significant PPP experience, and use international aid funds to pay for such consulting services.
10. PPP contracts carry high transaction costs and do not make sense for smaller projects – a good rule of thumb is an initial vendor investment of R100 million. A PPP approach is only feasible for smaller individual projects if they are grouped at provincial level, or through cooperation across several municipalities.
11. PPP contracts must include governance mechanisms to deal with contractual changes required for unforeseen situations or environmental changes, esp. because PPPs run long-term. Off-ramps from the project should be available to either party as well as details of termination liabilities if the project is abandoned.
12. The regulatory (i.e. scrutiny) and promotional (encouragement and procurement capacity) roles of National Treasury with regard to PPPs should be split.

4 Large Capex procurements

A contracting process has three basic stages:

1. Development of requirements (what customer asks for) and of a contracting strategy (fixed-price, or cost-based, incentives)
2. Competing a contract and selecting a vendor (bid adjudication)
3. Managing the contract once awarded (monitoring costs, quality, and performance and change orders).

Based on interviews with Transnet procurement officials and a review of bid documents, Kelman made the following preliminary remarks:

4.1 The basic strategy for creating capacity to structure, compete and do post-award management of large contracts appears sound. At the time, Transnet lacked organisational capacity to manage the contracting process described above. Transnet brought back apartheid-era contract managers to create in-house capacity and also an international contract/project management firm/consortium (Hatch) to provide expertise and bodies to manage the process. Kelman approved of the approach.

4.2 While bid documents and competition procedures appeared sound, those did not guarantee against cost overruns or problems in contract administration.

4.3 Attention was paid to post-award contract management, and contracts were not simply allowed to “manage themselves”.

4.4 Requirements and vendor selection may be improved by:

4.4.1 Setting contracting requirements in terms of performance, rather than design (e.g. in respect of concrete, rather state the requirements for the strength, durability, performance features than to specify the use of a certain kind of concrete);

4.4.2 Including value engineering clauses in the contracts (i.e. providing that a contractor may submit ways to save money, or improve performance, and that the contractor receives part of the savings attained if its ideas are accepted by the customer);

4.4.3 Evaluating proposals for “unbalanced bidding” where a bidder quotes artificially low on one chunk of work, and too high on another, only to pave the way for cost growth later because too few units were allowed for in the artificially low chunk of work.

4.5 Possible collusion on large capex projects was a concern – e.g. the “winning” contractor brings in “losing” contractors or competitors agree to divide up work across projects (possible cartel pacts). Government should not provide bid price information to losing bidders as this may encourage cartel arrangements.

4.6 Measures to deal with bid-rigging may include:

4.6.1 Creating a “bounty system” as in the USA – where private parties who bring evidence of rigging, may receive a share of the fines or penalties levied for a conviction;

4.6.2 Procurement staff comparing relevant aspects of tender bids by the same companies on different capex projects to look for suspicious differences with regard to pricing or technical quality that may indicate bid rigging;

4.6.3 For commodities, government using online auctions as a tool to increase competition and lower prices;

4.6.4 Government limiting the extent to which work may be divided up and sub-contracted to unsuccessful bidders (to prevent collusion). But there are counter-arguments:

• Such limits restrict normal practice of holding a prime contractor responsible for performance while it is free to subcontract at its own risk;
• Using losing bidders as subcontractors relieve capacity constraints on large projects;
• Contractors may find other ways to collude in any event.

5 Competitive Supplier Development Programme (CSDP)

This policy is mostly developed by the DPE to nurture the competitive advantage of existing domestic firms. Instead of requiring foreign bidders to use a percentage of local content in large projects, foreign suppliers are required to either invest directly or buy from existing domestic firms.

Officials driving the CSDP hope to encourage multinationals to source certain kinds of production for their worldwide supply chain, and not only for a specific project. Thereby the DPE hopes to develop a capacity for exports from industries with a competitive advantage – i.e. industries with both a strong labour - and engineering content. More specifically, it is hoped that foreign multinationals will invest in improving local manufacturing capabilities either via foreign direct investment or through building up local suppliers.

A list of industries where South Africa has a good chance of becoming internationally competitive could be drawn up, upon which local-content efforts can be centred.

Procurement professionals believe the main goal of procurement is to provide an entity with best-value goods and services (“value for money”), and that other goals (including industrial policy goals) may impose price and/or quality penalties in government purchases.

By 2007 the DPE modified its strategy by warning against paying long-term or short-term price premiums for local supply as it would not increase the global competitiveness of the local supply base.

Kelman recommends an approach to implementing CSDP into the procurement system of SOEs:

1. Local supply considerations should not be a binding minimum requirement, but be one evaluation factor. If it remains a strict requirement, a bidder will not win a contract without some commitment to local content, no matter how much is added to the price. But, if supplier development is an evaluation factor, the tender proposals can be ranked against each other, together with other elements in proposals.
2. Bidders should have as much freedom as possible to choose the areas where they want to offer supplier development, so that they may choose areas that are most cost-effective for them.
3. Outside consultants or experts in industrial structure and economists should be used to select promising areas for supplier development.
4. Price premiums should be avoided – otherwise the CSDP may evolve into an expensive subsidy system for local suppliers.
5. Some basic guidance documents on CSDP from the DPE will be helpful (so that procurement officers do not need to reinvent the wheel for each major capex project).