Is it time to rethink the 30% local content for essential infrastructure tenders?

South African Government policy for major tenders requires that 30% be awarded to local contractors but Phillip Machanick believes that there is plenty evidence that this policy, rather than promoting local skills and entrepreneurship, is instead a vehicle for patronage. This has in most cases led to a negative Keynesian Multiplier i.e. an effect where government spending decreases the size of the economy. This effect occurs particularly badly when essential infrastructure project fail.

Is it time for Government to rethink its policy where it requires 30% of major tenders are awarded to a local contractor?

Rid the infrastructure spend of patronage in the post-Covid-19 reconstruction

In oft-repeated refrain is how Covid-19 mitigation measures cause more harm than good when you take into account economic damage. That argument is partly flawed because economic arguments appear not to be founded on reality of the effect of the pandemic if it runs out of control. I focus here on the argument for an economic reset for South Africa rather than a restart.

The argument that we should not have had measures with a strong economic effect misses two key points. To the extent that we are dependent on the world economy, we have to expect a slowdown anyway. And damaging our economy is not exactly harming an edifice firing on all cylinders.

Without Covid-19, we would still face major crises: meltdowns of state-owned entities — particularly Eskom and SAA, which threaten not only the fiscus but major parts of the economy — failing infrastructure projects and anaemic job growth. All of this puts us on a path to a very bitter medicine: the International Monetary Fund (IMF) conditionalities.

This does not mean I see no economic harm – many businesses are struggling and many are unlikely to reopen.

Nonetheless a crisis that forces us to rethink basics fast may be better than a slowly unfolding crisis that allows the delusion that minor improvements will save us from the inevitable if the current path is not corrected.

Failure of the developmental agenda

Let us use this opportunity to re-evaluate where the South African economy is and why the government has failed to deliver a developmental agenda. A post-pandemic developmental agenda creates the possibility to turn all this around — but not if mistakes are repeated.

Government stimulus ought to result in a Keynesian multiplier: money spent stimulates other spending beyond the direct stimulus. But what we frequently observe arising from government infrastructure spending is a negative Keynesian multiplier, an effect where government spending decreases the size of the economy. This effect occurs particularly badly when essential infrastructure projects — those that are required as enablers for other investment — fail.

Examples of failure

I illustrate how things go wrong with a few examples from my own relatively small municipality, Makana.

Makhanda (Grahamstown) has two water treatment works. One, dependent on local water, has been virtually dry since early 2018, with supply down to one small dam. The other, with supply from the national Orange River Scheme, was due for major refurbishment and upgrading by the end of 2017. This slipped to the end of 2018. And then the contractor was fired and the whole thing started over. In the meantime, a major water crisis erupted, with Gift of the Givers arriving on the scene as if intervening in a war zone.

The failed upgrade project was meant to be fast-tracked, so imagine my surprise when early in 2020 there appeared to be no progress. I tracked down the chief executive of the Amatola Water Board in February and discovered that local members of the tender award committee were obstructing the award and the project only started this year. The Amatola chief executive has since been suspended in the midst of a slew of allegations. Could her resistance to local interference have been a factor?

Why is this a systemic issue?
Government policy for major tenders requires that 30% be awarded to local contractors to promote local skills development and economic opportunity. The idea behind this is well-intentioned: Broad-Based Black Economic Empowerment (B-BBEE) must be a worthy thing to promote in such an unequal society. The focus on promoting small, medium and micro enterprises (SMMEs) also on the face of it is laudable because small business is supposed to be a major engine for job growth.

There is plenty of evidence that this policy, rather than promoting local skills and entrepreneurship, is instead a vehicle for patronage. I saw this at first hand when a major road was resurfaced. The local 30% paid for pedestrian spaces and stop-go controls. Anyone who won those local contracts would not have developed useful skills to sell to private buyers because they would have charged much more than the work was worth. And that was a successful project — the road was resurfaced to a high standard (the pedestrian spaces not so good).

Negative Keynesian multiplier

But back to the failed water treatment plant upgrade: that illustrates how government dysfunction results in a negative Keynesian multiplier. Not only was the money spent on the project wasted but, rather than a secondary additional stimulus, the water crisis made the local economy less attractive for investment. Numerous businesses closed even before the pandemic.

Worse still, there is a strong incentive to fail because the wheels of the patronage machine are greased again when a project reruns. As infrastructure failures mount up and drive away other job creation, patronage becomes even more powerful; it becomes the only game in town.

In the long run it is not sustainable because the tax base is lost.

But in the short term, failure amplifies patronage. This is what you call a feedback loop. The mild crackle in the speaker, fed through the amplifier, turns into a shriek. In economic terms, that shriek is a call for the IMF to intervene because the fiscus has run drier than Makhanda’s water supply.

Is this just a Makana issue? Clearly not. Service delivery protests around the country, loadshedding, SAA’s dive to bankruptcy even before lockdowns and numerous books with apocalyptic themes (How to Steal a City, Gangster State, The President’s Keepers, How Long Will South Africa Survive?) all point the same way.

This is where we were headed pre-pandemic. If the government is serious about a developmental agenda to extricate us from the pandemic-induced downturn, they need to rethink, otherwise stimulus expenditure will be wasted.
We can fix this

How can this be fixed?

If the government wants to spend 30% of its capital budget on promoting local small business and effective B-BBEE, make this a separate budget. Every time a major project is awarded, municipalities and SMMEs compete for 30% of the amount that the main project will cost for side projects that do not interfere with the main project. The overall cost to the government will be less since major projects, subject to less interference by patronage players, will fail less often.

Even if the 30% “local content” is misspent, as infrastructure improves, this “local content” is more likely to be constructively wasted by spending in an increasingly thriving local economy — with a positive Keynesian Multiplier effect. But that can only work if there is a local economy, which the collapse of essential infrastructure kills.

To ensure that essential infrastructure projects do not fail, the government needs another major culture change — consequence management. If an infrastructure project is deemed to be essential, anyone found corrupting the award of the contract should face the full force of the law: the Special Investigating Unit, the Assets Forfeiture Unit, lifestyle audit. If the 30% local content budget is not quite as rigorously policed and some goes astray, that is a price we can afford to pay for avoiding interference in essential infrastructure projects.

A refinement of this policy would be to award a bigger amount of this “local content” slice in areas more in need of investment. That, in the short term, would favour the patronage players as bigger amounts would flow to areas with less economic activity. Once the economy is firing on all cylinders, the patronage game will lose power and appeal. But we need to get there first.

For those who see moral outrage in any form of patronage, the feedback loop must be broken.

To use a medical analogy: think of it as containing an infection to a specific part of the body where eventually it may be surgically excised if it doesn’t go away by other means. That does not work if the infection is pervasive throughout the body.
Why we must get this right

If we do not change the way major projects are awarded and the government goes on a post-pandemic infrastructure spending spree, the usual band of tenderpreneurs and patronage players will stuff their pockets and the net effect on the overall economy will be a further slide into dysfunction.

In the short term, these groups will do well and therefore have a lot to gain from fighting any game change. Structural change is therefore essential to put in place before the recovery plan starts.

But get this wrong and we will lose our opportunity for a successful post-pandemic reset and instead of a major rebound, the negative effects of patronage-fuelled inequality will be amplified by the pandemic downturn. That puts us at risk of a rapid economic decline and the threat of the IMF conditionalities, a medication proved inefficacious many times over.

Who stands to lose the most if this is not done right?

Exactly the constituency that will be hit hardest by the negative economic effects of the pandemic: the poor. And the poor are predominantly black. Ignoring this fact and persisting with a policy that enriches elites at the expense of depriving the masses of opportunity and essential services makes a mockery of broad-based black economic empowerment.

This article was written for the Mail and Guardian by Philip Machanick  an associate professor of computer science at Rhodes University