Regulation cost South African firms R79-billion in 2004. This is the bottom-line result of Small Business Project’s pioneering study of regulatory compliance costs to the South African private sector, from large corporations through small and medium enterprises (SMEs) to the informal sector. No comprehensive survey of this kind has previously been undertaken in this country. Indeed, to the best of our knowledge, it is the largest general regulatory cost survey ever carried out anywhere.
Organised business and the South African government agree that it is necessary to create an enabling environment that spurs economic growth and job creation.
The rewards of an improved regulatory environment are large. A 2002 study of 10 developing countries, including South Africa, by Small Business Project (SBP) and Bannock Consulting concluded that an appropriate regulatory environment was the single most important element in an economic growth strategy.
A 2004 World Bank study has found that many developing countries could improve their annual growth rates by as much as 1,4% if they created a world-class regulatory environment for business. Though South Africa has a better regulatory system than many developing countries, improving the regulatory environment could have a significant impact on economic prospects.
The report is based on a survey of the costs of regulation to the South African private sector. Between February and June 2004, a total of 1 794 businesses throughout the country were interviewed in depth. Respondents ranged from corporations on the top-200 list to enterprises in the informal sector. The survey covered all the sectors of the economy, including manufacturing, mining, construction, trade, agri-business and services.
Regulations are vital to the fair and sustainable working of market economies, but even the most socially necessary regulations create costs as well as benefits, and some of these costs may be unnecessarily high.
It is important to distinguish between a regulation and the costs created by complying with it. For example, health and safety regulations are unarguably essential. This does not mean, however, that we should accept the current level of associated regulatory costs as fixed. It may well be possible to reduce the costs of complying with regulations without reducing their benefits.
Reducing regulatory costs can be very beneficial: studies by the World Bank, covering 145 countries, have demonstrated that countries with higher regulatory costs have larger informal sectors, more unemployment and slower growth.
The SBP’s survey looked in detail at two kinds of regulatory costs faced by the private sector: efficiency costs and compliance costs.
Efficiency costs
Efficiency costs arise because regulation may distort market outcomes. If employment is discouraged by inappropriate labour market regulation, for example, then the costs of the resulting unemployment in terms of lost output and incomes is an efficiency cost. Other examples of efficiency costs of regulation would be a business’s decision to restrict output to keep sales below the value added tax (VAT) threshold, or an inability to compete in an export market because the costs of complying with regulations have made a product too expensive.
Compliance costs
Compliance costs are pure red-tape costs: that is, they are the incremental costs incurred by business in the course of complying with regulations. They include the value of time spent by business managers and staff on understanding the rules and applying them; interacting with the authorities to clarify matters arising; and the payments made for the expertise of professional advisers such as consultants, lawyers and accountants. For example, the costs of tax paperwork are compliance costs, while the tax payments themselves are not. Capital costs of compliance, such as those for effluent or smokestack equipment, were excluded.
What makes the study valuable is that it provides hard data on compliance costs. For the first time in South Africa we have quantitative information on how much red tape actually costs businesses. We also have a much clearer picture of the precise incidence of regulatory compliance costs.
It is important to note that the study has not attempted to measure the benefits of regulation.
The estimates of compliance costs are the gross of the benefits accruing to individual firms or to society in general. Clearly, the benefits of regulation are often substantial, but these are usually far better understood than their costs. It is, therefore, appropriate to focus research effort, at least in the first instance, on regulatory costs.
It is clear from the results that regulation creates significant efficiency costs in the South African economy. There is strong evidence, echoed by many other studies, to show that features of the regulatory environment discourage business growth and job creation in the formal economy.
The research has also shown that, even though regulations may not be enforced in the informal sector, the regulatory environment acts as a barrier to development by keeping a large, energetic and entrepreneurial group of black South Africans out of the formal economy. From the perspective of informal operators, the regulatory environment is a cliff. They stand at base, aware of the advantages of reaching the higher ground, but equally aware that the cliff is too steep to climb.
The survey has shown that regulatory compliance costs are substantial and it has specified, with some precision, what these costs are to South Africa.
Based on the average recurring compliance cost per firm of R105 174, and the SBP’s conservative estimate of 750 000 as the number of firms affected, the estimated aggregate recurring compliance costs for the formal sector amounted to R78,9-billion in 2004 — an amount equivalent to 6,52% of the gross domestic product.
These costs represent real resources, which have alternative uses. Businesses could employ the resources used in complying with regulation for innovation and expansion, or improving their local and international competitiveness.
The government could use some of the cost savings (and some of the income generated by the private sector in the rounds of spending and production stimulated by these savings) to improve public services or to reduce taxation. Moreover, countries that reduce their regulatory compliance costs increase their attractiveness to foreign direct investment.
The SBP project is funded by the United Kingdom Department for International Development via the Business Linkages Challenge Fund, the ComMark Trust, and the Friedrich-Naumann-Stiftung