South Africa’s dilemma: Extract minerals or mine ideas?

by Adrian Saville: CIO of Cannon Asset Managers and visiting professor in Economics and Finance at the Gordon Institute of Business Science.
Should South Africa give up on an entrepreneurship-driven economy and just hand over the reins entirely to big business, big miners, and big banks?

There is a bad joke that goes: The way to make money in South Africa is start a small business, sell it to a big business, and start again.

Hardly the sort of sustained impact and entrepreneurial ecosystem the South African government had in mind when it released the National Development Plan in 2012, and pinned its hope for economic growth and job creation on boosting entrepreneurship. However, the reality is that the 200 business incubators and accelerators, dedicated small business ministry, and countless column inches written about the power of entrepreneurship have failed to meaningfully shift the dial towards an economy buzzing with formal and informal small- and medium-sized (SME) businesses. This is not to suggest that these efforts have failed – rather, that the social and economic stresses that plague South Africa run deeper than any progress brought by these collective efforts.

Despite a predisposition towards entrepreneurship, and healthy early-stage activity in this space, according to the Global Entrepreneurship Monitor, SMEs and start-ups just keep falling out of contention. As the GEM SA 2021-22 report notes, “A high business discontinuance rate is problematic for an economy. South Africa ranked the third-worst in this category in 2021 (13.9%).” This was attributed to excessive red tape, business unprofitability, and challenges in accessing finance.

This takeaway is certainly not the full story. Nor is the clear disconnect between entrepreneurial will and success sufficient reason to assume that South Africans just don’t have what it takes. After all, South Africans are well known for thriving in other markets.

Crunching the numbers

Given the complexity of this issue, it is not sufficient to come armed only with acres of research and empirical evidence. It is also important to look at this question from an anecdotal and experiential perspective – this is particularly true because of the paucity of ongoing and robust data available in South Africa on this crucial topic.

As the Centre for Development and Enterprise (CDE) noted in a 2021 report, “Before we can develop an effective policy framework, we need much better data and a serious debate about what is possible. We know too little about what makes some small firms succeed while others fail, which sectors have the strongest businesses, and where the best opportunities to establish and grow small firms are concentrated. Most policies in this field are based on very little empirical evidence.”

The CDE underlined this point by noting discrepancies related to the actual size of the SME sector, highlighting estimates of between 670 000 businesses and six million businesses, despite the sector “employing only a sixth of South Africa’s workers and contributing a mere 6% to GDP”.

Until we clearly understand the nature and shape of the sector – including formal and informal township businesses – it is always going to be challenging to understand the potential impact a vibrant entrepreneurial sector could have on South Africa’s economy and in reversing a spiralling unemployment rate – which stood at 32.9% in the first quarter of 2023 and 60.7% for youths aged 15 to 24, according to Statistics SA.

What we do know from global and domestic evidence is that, once they are big, businesses generally do not create jobs. So, from that perspective alone, South Africa cannot afford to give up on SMEs.

This is by no means an insult to big firms, it is just the reality. Larger businesses have achieved a state of capability and an infrastructural footprint that means they don’t need more people, they need better systems, more efficient processes, and often greater capital intensity. Whether a big business grows through acquisition or organically to the point that it doubles in size, this would certainly not lead to a doubling of headcount.

In 2016, together with Andrew Dittberner (who these days plies his trade as chief investment officer at Old Mutual Private Client Securities), I did some work to gauge the impact of the largest companies listed on the JSE compared to smaller listed companies. We determined that over the 25 years from 1987 to 2012, the largest companies on the JSE actually reduced headcount by around 30% while smaller companies increased headcount by a factor of 15 times.

This stands to reason: while climbing off low bases small businesses need to increase headcount if they are to grow. It is hardly surprising, therefore, that SMEs created 70% of jobs and GDP worldwide in 2021, making them the “backbone of economies”, according to research from the World Economic Forum and the National University of Singapore Business School.

Furthermore, research tells us that the higher the number of small businesses, the greater the incidence of employment. Here, South Africa fails again. Evidence from our study in 2015 shows that South Africa has about 1 200 small firms per one million population, which is half the number of Mexico and a third of the number of Chile, where the unemployment rate sat at around 5%. Unemployment and the absence of small businesses correspond; in fact, they map quite closely together.

What we do with the jobs created by small business is another question entirely.

South Africa’s jobless growth

There is a widely held view that economic growth will solve South Africa’s unemployment problem. Yet, if we look at the employment elasticity of growth – or what happens to jobs when we get a 1% change in economic growth – South Africa produces a positively harrowing number.

In the 1970s, when the South African economy grew by 1% you got 0.99% more jobs, so almost one to one. That’s pretty inefficient growth, because it shows that headcount grows in line with the economy. So, while this type of growth is absorptive of people into the economy, which is good for labour, it is not necessarily good for capital and investment.

Fast forward to the 2000s and we see South Africa’s employment elasticity falling to 0.08 or 0.14, depending on the measurement period. This scenario means that if you doubled the size of the economy – 100% growth – employment would only grow by between 8% and 14%. In other words, almost all of the engagement goes to capital, not people.

This also tells us that economic growth isn’t the missing ingredient, and economic growth does not automatically equal jobs. If anything, over the past 20 years South Africa has essentially had exclusive – jobless – growth rather than inclusive, transformative growth.

So, what levers are left?

This brings us back to entrepreneurship, startups and encouraging people to start SME businesses. Great in theory, but in practice South Africa has been woeful in creating the sort of enabling ecosystem needed to do this effectively. In short, we have a structural problem and again we can see this clearly by interrogating the data.

This brings us back to the earlier point about South Africa’s 1 200 small firms per one million population. When we consider that economic success story South Korea had 4 400 small firms per one million population in 2015, it is clear that South Africa’s number is insufficient to create the sort of vibrant ecosystem needed to birth unicorns and tech start-ups.

Make no mistake, South Korea is also battling to get to grips with the challenge of entrepreneurship, despite the success story of that economy since the 1960s. In much the same way that South Africa’s public sector historically built enterprises in both public and private sector, so is the South Korean story underpinned by that government’s support of the large family-owned business conglomerates, or chaebols, such as Samsung, Hyundai and LG.

Over the years these chaebols have become so powerful in the South Korean economy that they now dominate the South Korean economic landscape – in 2019 alone the Bank of Korea noted that the five largest chaebols were responsible for 44% of the country’s GDP. What is also noteworthy is how much employment comes from the five major chaebols. In 1991-1995 the average number of employees working for the "big five" was 480 000, by 2006-2010 this was down to 460 000 – which reiterates the point that the growth of big business does not correspond with job creation.

In the case of South Korea, the impact of this dominance is now trickling down into the labour market and the preferences of in-demand human talent. Young university graduates would rather land a job in a big firm than opt to start their own business – a corporate job is first prize.

However, unlike South Korea, which leveraged its chaebols, South Africa has eroded the value and impact of its state-owned enterprises and industrial conglomerates over the years, and confused the role of a substantial and supportive state with, as former Eskom CEO André de Ruyter put it, "a feeding trough".

As a result of this missed opportunity, South Africa doesn’t have the luxury of using its strong institutions as a springboard. This means the nature of growth needs to change and with that, we need small, rather than large, firms.

What makes this challenging is the industrial and geographic structure of our economy. Our industries are overwhelmingly stuck in the 1970s – with the exception of the automotive cluster, which has been built under substantial sponsorship and protection (which raises its own questions about global competitiveness). Geographically, we are also stuck with the apartheid legacy of the urban and rural divide.

These challenges are far more widespread and punitive than access to finance.

It’s all about access

One of the projects we’ve been conducting at the GIBS Centre for African Management and Markets is the Aspen GIBS Route-to-Market Challenge. The challenge is focused on identifying SMEs in the healthcare arena and then catalysing their growth and success by helping establish routes to market. Aspen Pharmacare and Raizcorp are our partners in this endeavour, and the results of our first year’s work together are extremely promising. But we need this effort multiplied 10 000-fold to change the face of the country.

This isn’t just another Dragon’s Den, it draws on the work done in Nigeria by David McKenzie, a World Bank economist. I first came to learn of McKenzie’s work by reading economist Andrew Leigh’s book Randomistas: How Radical Researchers are Changing Our World, which delves into the use of randomised controlled trials and experimental research to unearth solutions to complex problems by approaching them with scientific rigour.

In Randomistas, Leigh discusses a Nigerian programme, the Youth Enterprise With Innovation in Nigeria (YouWin!), which McKenzie discussed in a 2017 article published in the American Economic Review. The competition organisers invited applicants – of which there were more than 24 000 – to attend a business plan training session and produce a detailed plan. The organisers randomly selected the entries and while top-scoring applicants won national or regional merit awards, the nearly 1 200 graduates of the programme all received an average of US$50 000. Three years on, and business survivorship was materially higher than the control group, revenue had grown faster, the firms displayed higher levels of innovation, and they had grown headcount faster.

This tells us that route to market is critical. In fact, when you combine access to market with hands-on experience and training, plus a "can-do" attitude, that’s when entrepreneurs flourish.

In short, South Africa doesn’t need another incubator. It doesn’t need more red tape bogging down the creation of business, and it doesn’t necessarily even need more financial resources. It needs an evidenced-based approach to SME curation where the central role of big business is to give small business a break. Entrepreneurship has a vital role to play in South Africa’s development. We just need to put the right structures in place to move from mining resources to mining and marketing our ideas, enthusiasm, and latent capability.

Think out of the box, not under the ground

South Africa has many natural resources it could be leveraging, including its location in roughly the same time zone as Europe, and the widespread use of English – the unofficial language of global business. This should make South Africa an attractive destination for start-ups and entrepreneurs from around the world.

The South American nation of Chile certainly recognises the appeal of attracting entrepreneurs to its shores. This is why, in 2010, it launched Start-Up Chile as a way of attracting international talent. Entrepreneurs from anywhere in the world can pitch their business idea to Start-Up Chile and, if successful, they could secure up to US$100 000 in start-up capital, get mentorship and an entrepreneurship visa to live and work in the country, along with their families.

Similarly in Estonia, Garage48 is a start-up hackathon that turns ideas into working prototypes in just 48 hours. You could be licenced, have a board of directors, be taken through a shark tank, and have a social media presence, in just 48 hours. Plus, they back this up by offering mentorship, training, and networking opportunities with investors.

South Africa should also be taking advantage of the growing nomad work-from-home economy and attracting – and looking after – top global talent. This would require more streamlined visas, less red tape, and a radical mindset shift beyond the ways of the past and the idea that every company built and developed here must be owned by a South African. Instead, great ideas from around the world, be it a biotech innovation or a small manufacturing concept from South Korea, Mexico or Bolivia, should be welcomed.\

High-level wrap

  • We hear time and again that small business and entrepreneurs create jobs and boost economies.
  • Studies tell us that many businesses fail – with South Africa having a particularly high incidence of this. Often unprofitability and issues accessing funds are cited.
  • Surely, by now, we’d have found the right balance to create a conducive environment for small businesses?
  • Given that entrepreneurship is not gaining traction, should we rather focus on supporting big miners and the big businesses and big infrastructure that support them?
  • Yet the data tells us that big business does not create jobs.
  • We also know that South Africa’s structural issues remain an impediment for entrepreneurs.
  • Is there anywhere else to look?

Useful resources:
Gordon Institute of Business Science
Making an impact to significantly improve the competitive performance of individuals and organisation through business education to build our national competitiveness. GIBS is a leading business school in the heart of Sandton’s business hub, offering a wide range of executive and academic programmes.
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