Red tape is strangling small businesses

The fundamental impact of governance failure, overregulation, and burdensome taxation in South Africa is that productive entrepreneurship as well as innovation have been crowded out. 

For example, early-stage entrepreneurial activity declined from 7.8 percent in 2008 to five percent in 2009, significantly lower than countries with a similar GDP per capita — but interestingly, similar to the entrepreneurship rate in Russia, an economy resource-rich and struggling with rent-seeking and corruption and where innovation has, as in South Africa, declined during the commodity boom.

In 2019, according to the UK based Global Entrepreneurship Monitor (GEM), South Africa ranked 49th out of 54 economies on GEM’s National Entrepreneurship Context Index, ahead of only Croatia, Guatemala, Paraguay, Puerto Rico and Iran.

In comparison, people in countries such as Brazil, India and China are two to three times more likely to be entrepreneurs than South Africans. 

The result is stagnation in the structural transformation of the economy, keeping it ironically dependent on sectors such as agriculture and mining where looting, instability, violence and rent-seeking are most endemic. The country is locked in a downward-spiral poverty trap and upward-spiral inequality trap.

SA entrepreneurship decline 

What is clear from the evidence is that South African entrepreneurship has been on a seesaw journey, but largely declining for a long time. This is especially troubling because entrepreneurship is an engine of economic growth. It promotes the innovation needed to exploit new opportunities, promote productivity and create employment, while also addressing societal challenges, which now include the economic shock wave created by the Covid-19 pandemic. 

The promotion of entrepreneurship and small business formation will be central to restoring the economy after the blows inflicted to it by Covid-19.

Prior to Covid-19 micro, small and medium enterprises constituted by far the majority of businesses in South Africa. Over 98% of all employing firms in the country employed fewer than 250 people, including medium-sized businesses, and the majority of firms (66%) were micro businesses with 10 or fewer employees.

Yet instead of seeing SME’s as the engine room of our economy despite all the lip service paid by government and big business to them, they are forever treated as an economic midget. Policy and regulations are made for big businesses with large compliance departments and years of much-documented hostility by the government directed at big business, sweeping all “business” together in unhelpful generalisations.

What can be done?

Encouraging the creation and promotion of an enabling environment for small businesses in South Africa is fundamental to developing a competitive and vibrant economy. 

Simplifying administrative processes around registering and running a new business should be high on both South Africa’s political and policy agendas. The administrative simplification strategy should try to address the burden introduced by new regulations and existing burdensome regulations.

According to the Small Business Project, based on studies tracking a cohort of 500 SME’s (including micro-businesses) over a period of six years, on average, small businesses spend between four and six percent of turnover on compliance with regulatory demands. This is highly regressive and leads to inefficient allocation of capital within small businesses, which hurts overall investment and job creation.

Many of the common barriers to business growth and sustainability, especially small businesses, talk to the quality — and quantity — of regulatory change over the past two decades, particularly the period from 2008 onwards. 

More and more red tape 

New legislation, and subsequent rafts of regulation, are added to existing rules without government policymakers systematically analysing either the lack of enforcement of existing regulations and/or the impact of new regulations on policy coordination or coherence. 

This not only increases the regulatory burden but adds significantly to policy uncertainty. Cumulatively, it results in a proliferation of red tape, sabotaging the survival of small businesses especially and their ability to grow productively and employ more people.

The Africa Continental Free Trade Area presents an opportunity for the government to formulate trade facilitation measures which harmonise and simplify the current burdensome customs documentation and procedures and address the costs and complexities small businesses face at South Africa’s ports of entry. In short, the government should slash the costs and time needed to export and import goods.

Reforming protective labour laws is also essential. The process of employing and terminating an employment relationship should not be costly. The costs here are measured by considering the time, effort and expenses associated with both initiating and terminating employment relationships — which often include the need to employ labour law specialists to guide employers through the legally compliant procurement or termination of employment process(es).

Given the significant costs associated with initiating and terminating employment, the risks associated with taking on a relatively young, fresh out of school and/or otherwise inexperienced employee — with the hope of training that person and providing them with employment, remuneration, opportunities for further skills development, promotion and positive future prospects — are extremely high.

In short, restrictive labour laws in South Africa have a suffocating effect on job creation — especially when it comes to employing young people — and are incredibly burdensome to small businesses.

The views expressed are those of the author and do not necessarily reflect the official policy or position of the Mail & Guardian or the Free Market Foundation.

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Sindile Vabaza
Sindile Vabaza is an aspiring economist who writes for the Free Market Foundation

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