How the Government shoots BEE in the foot

Tusker is a BEE private-equity fund and our articles inevitably illicit quite a lot of reaction – much of it’s against BEE, and especially the perceived link between BEE and corruption (the extent of which understandably draws angry responses from fed up South Africans, especially in the business community).

To be clear, Tusker believes in the need for transformation and has built its business around making BEE ownership financially sensible and strategically advantageous for our clients.  However, this does not mean that Tusker is blind to the challenges that BEE presents.  Some challenges are ideological.  Other challenges relate to practicalities such as bad implementation or regulatory uncertainty.  But, the biggest single problem is that Government has given BEE a bad name as we explore further below.

On many levels, BEE has been a real success:

Credit must be given where credit is due:  Government brought us BEE and it has not all been bad. Despite the common perception, it is just not true that only a handful have benefitted from BEE. There is no doubt that the South African economy’s racial composition has changed significantly in the decade and a half that we have had BEE: many BEE schemes have generated wealth for black people in shares; many black managers and youth were trained and recruited for BEE purposes; and multiple suppliers and communities have benefitted from BEE.

In the BEE Act’s lifespan the spending power of black people and the size of the middle class of black people has also ballooned, changing forever the racial makeup of the economy.  Whether this could have been achieved more efficiently is a rearward-looking policy question, but economic statistics show that Black people now have the majority of jobs in the economy, own the most houses, make up up most of the membership of pension funds.

However, black people also remain the majority of the unemployed, homeless and poor.

To say that too few have seen the benefit of BEE is impossible to argue with. To say that the corrupt have used BEE as a vector is also impossible to argue with (but it’s not true that BEE causes corruption either).

Where’s the blame?

The limited success of BEE cannot however be blamed entirely on Government, especially since Government has not made BEE compulsory.  The fact that many businesses have effectively ignored BEE is a choice they have been allowed to make.

What then has Government done wrong?

Government isn’t leading by example: 

We analysed the B-BBEE Commissions’ report here and compared it to the analysis of our own database. Probably the most telling fact is this:

“…even that is not as surprising of the state’s coverage – remembering that the state is the champion of champions for BEE.  The report states that only 4 out of 299 State-Owned Entities and Organs of State Entities submitted their annual Compliance Reports.

Yes, you read that correctly. The government doesn’t care enough about BEE to get verified.”

Simply put, Government is not in compliance with its reporting obligations in terms of the BEE Act.  They have not been leading by example, making it more difficult for the B-BBEE Commission to take other serial offenders to task.

Maybe this could be overlooked if Government championed BEE in other ways, but have they?

In theory, the BEE Act aims to encourage procurement from black providers of an equivalent service at an equivalent price, but in practice it appears that the government pays a heavy premium to procure from black companies even though the price and quality would be worse than otherwise. This is obviously wasteful expenditure and an inefficient use of taxpayer money, but does it circumvent the purposes of the BEE Act? Since the Act’s purpose is to transform, the answer is no.

Government is not good at juggling all of South Africa’s needs: 

Government has an unenviable task. The theory behind the BEE Act was that Government would use its enormous purchasing power and annual expenditure budget of nearly R1 trillion on promoting black businesses and participation in the economy by black people.  This would be hard enough if this were Government’s only objective, but Government has to also consider the existing economy (read tax collections), international investor sentiment (read investor capital flows) and consumer and business confidence (read economic activity) to promote economic growth.

Such imperatives promote economic growth (which would also be radical, given the state of the economy at the moment), but might not change the racial composition of the economy.  Even though it’s unclear what the target or ideal racial composition of the economy is, more should definitely benefit from being active participants in the South African economy.

Luckily, Government is also tasked with growing the economy and this, of necessity, means it cannot be solely obsessed with BEE.  So, the second Government BEE problem is that it has been bad at its impossible task of juggling BEE and other competing objectives.

No definition of success:

Some policies are easy to understand. E.g. reduce unemployment to an acceptable level of say 5%.

The BEE-Act not so much. When has enough transformation happened? When has enough BEE been done? Should BEE be stopped when black people are the majority of the economy?  If this were Government’s sole objective it could achieve it by chasing away citizens (like Zimbabwe) or by discouraging foreign investors (like Venezuela).

The lack of sunset clauses is probably deliberate. The argument is probably that “we’ll know when when we know” that sufficient transformation has occurred, and in the meantime it’s a useful political tool.

Government removes the incentive to do BEE:

The most common criticism of BEE (read the comments on our facebook page) is that it has fostered cadre deployment, bribery and corruption and resultant poor service delivery.

These are completely separate problems that are global phenomenon and have existed long before and independently from BEE, but one should critically consider whether the way Government has transacted has advanced B-BBEE or if it has in some way frustrated the objectives of the BEE Act.

There are many good corporate citizens that have organized their BEE affairs (which involve giving up money, control or both) by doing the right things, only to lose a tender to someone who won it in because they are better at stuffing cash in Louis Vuitton handbags, offering real estate in Dubai or by bribing a verification agent to falsify a certificate.

Inevitably the question is asked: why bother with BEE? Every corrupt deal removes the incentive to do BEE.

BEE trumps all other commercial considerations for Government:

BEE as we know it is not the first time in history that one group has tried to dominate a market place by giving itself preferable terms.

Stereotypical examples abound of how Jewish businessmen, freemasons and local business chapters have promoted their members’ business interests.  The Broederbond and the Proudly South African campaigns are local examples, which are similar to BEE in that they want to encourage business with one group (to the exclusion of others).

Obviously, they are different in that these are not legislated, but as BEE is voluntary (for everyone in the private sector), they also seek to give preference to one group.  So, the theory is that when all else is equal (cost, quality, ability to deliver) then preference should be given to black businesses. This is how BEE is supposed to work and this form of BEE is really hard to argue against.

In reality though BEE trumps all other commercial considerations and contracts are awarded to black businesses sometimes at the expense of quality or cost.  Awarding a contract to construct a road to a black business may look cheap until someone pays with his or her life, which could be the result of shoddy workmanship not being considered in awarding the contract.  Quality should always be considered.  So should price.  Why pay more than the market price?  The Jewish, Broederbond and masonic business deals were always done at a special price “for my friends” but Government’s special price is sometimes above the market cost, because a middle man takes a cut or simply because a black person is offering the service.

In a free market one would not pay more than one should for anything – unless there is corruption, bribery or some other form of rent seeking or because it is somebody else’s money and there is no regard to that. When BEE trumps commercial considerations of quality and price then taxpayer money is wasted and frustrations build, making it harder to encourage others to comply.

Government is not always a great client to have: 

No matter how much business one wins from any contract, it is worth nothing until actually banked.  Despite ongoing assurances, Government is a notorious late payer. Every time Government is late in paying, it affects the working capital of the black business.  Only businesses with much more other business or with sufficient cash reserves can survive.  Unfortunately, many businesses are not in such a position and either go out of business (waiting for the cheque from Government) or decide to do business with everyone except Government, not bothering to tender for its business.  This cuts Government efficiencies and fails to promote BEE.

So what should Government do?  They should support B-BBEE fully – by doing good clean business on the best terms it can, and rewarding those that have legitimately transformed with contracts that pay them as promised.