Explainer: The Role of Small Business in Fighting Corruption

October 30, 2023

Disclaimer / Author’s Note: This article will be the first in a series of economics and reform focused articles that we’ll be running over the next 2 months. In this series we’re going to take a look at various aspects of the Moldovan economy to better understand why things are as they are and what important reforms are needed. I’m writing these articles based on experience from my day job as a small business owner in Moldova and from my work as President of the Moldova Small Enterprise Alliance AIM. These articles are meant to help readers better understand the problems and opportunities within the Moldovan economy. As such, they are a blend of analysis and opinion. Please feel free to leave comments and let me know what you think.

Understanding the Impact of Corruption on the Economy

In my 7 years on the board of the Moldova Small Enterprises Alliance, and my 9 years as a small business owner in Moldova, few things have been as consistent as the “top 3 problems” small business owners say they face. They are:

1. Corruption

2. Access to Finance

3. Access to Information

Over the years the order has changed from time to time but the problems have not. At least that was true until around a year ago when most businesspeople suddenly began coping with a new challenge that pushed all the others down the priority list. This new worry is “workforce,” or the ability to find and retain qualified workers. We’ll return to this topic in a future article, but for now suffice to say that one of the most disruptive impacts of COVID-19 and the war has been an acceleration in outward migration and a major labor shortage in many sectors.

But sticking to the 3 “classic” challenges we can immediately see that 2 are related. “Access to information” refers to the challenges that business owners have in navigating the state bureaucracy. How to I apply for a permit? What are the required documents to certify my products? What government office manages this process? This information is often opaque to the point of total obscurity. This is by design. By creating an asymmetrical information environment officials can much more easily extort bribes or demand “facilitation payments” in exchange for their “assistance.”

So we immediately see that 2 of the top 3 challenges that businesses say they face are corruption related. Over the last 9 years I can also say that “corruption” is the #1 reason cited by Moldovan businesspeople or aspiring entrepreneurs who decided to leave the country and find their fortune in the west.

Before going any further, if you want a primer on “what is corruption?” please refer back to this previous Moldova Matters article. The article explains the types of corruption faced by small businesses (and many individuals) as well as their impacts.

How Corruption Systematically Poisons the Economy

Corruption is a crime, but it is a very specific type of crime. By its very nature, this crime involves a state and a non-state party where the state party is always a criminal, and the non-state party may be either criminal or victim (e.g. extortion). If corruption becomes widespread enough in a system it can undermine the very existence of the rule of law. In Moldova Matters we often write about justice reform efforts and highlight the current government’s fight to try and cleanse the judiciary and law enforcement of corrupt actors. In this light, the above statement is intuitive - if judges are corrupt then the rule of law is clearly threatened. But the effects of pervasive corruption go much deeper than this and impact the economy in a host of corrosive ways.

If it is possible, or even preferable, to run a company outside of the law then the rule of law itself is damaged and the impetus to affect reform is diminished.

A corrupt system makes it “possible” to take various actions as a business outside the law by means of bribery. Examples abound from getting a building permit approved without following the necessary codes to bribing inspectors to look the other way on unofficial salaries. Things get worse however when it becomes “preferable” rather than simply possible to run your company in this way.

Running a non-compliant company can become preferable in multiple ways. As we mentioned above, problems of access to information are designed to create intentional asymmetries that empower state officials. These officials prefer corrupt businesses because their personal incentive is to gather as much illicit wealth in the form of bribes as possible. These corrupt officials do not care about a company paying taxes or operating according to health codes because if they did then company would have less incentive to pay the bribes. In a healthy system this set of incentives would be stacked against the threat of prosecution or jail time. In Moldova, most corrupt officials have higher administrative cover or, due to problems in the court system, at best experience a “catch and release” style prosecution. In these cases the authorities performatively arrest an official only to quietly release them later. This can be done because a deal was cut or because a judge ordered it. Any regular Moldova Matters reader will know that this happens with the big fish as well as the small ones. With this set of incentives the “algebra of deterrence” results in a highly unbalanced equation.

This interplay of incentives between corrupt officials and companies creates broader problems for the rule of law even outside of specific cases. Specifically, without set rules there is little path or mechanism to create reforms. In any country laws must be periodically updated to take account of changing times. That is especially true in a young nation such as Moldova where a very high percentage of the laws currently on the books were inherited from the Soviet period. For example, Moldova’s laws governing restaurants were largely written in the mid 1970s and retain Soviet jurisprudence - aka a legal approach which sought not only to define what is prohibited but to also exhaustively specify what is allowed and how it should be done. For example:

• In Moldova all waiters in restaurants are legally required to wear white gloves.

• Bartenders must be fluent in 3 languages and be “adept at using a telephone.”

• Workers in the coat check are required to repair customer’s clothing if asked at no cost.

• Dishes may not be served unless the recipe has been approved by the required state agency and it is registered in the “national book of recipes.”

I could go on and on. These laws are what business owners colloquially call “dead laws,” which are largely unenforced now. As a new business owner figuring out which laws are “dead” and which are very much alive is a highly difficult task - which is the point. At any time these laws could be enforced and a company found not to be compliant threatened with a fine or extorted for a bribe. With a maze of unknowns like this it is not only bewildering trying to operate a company but it is also very difficult for people to stand up and talk about making reforms. Simply speaking up might highlight non-compliance and since the laws are rarely enforced (or the bribes are affordable) people just keep quiet.

If you are wondering how strong this “keep your head down” instinct is, re-read our past article about the Blue Medical Passport. The requirement for tens of thousands of restaurant and sanitary workers to submit to anal-probing and STD tests yearly would cause riots or revolutions in many countries. In Moldova it doesn’t, most likely because *any* amount of a bribe is preferable to that treatment. This is just one more example of how corruption prevents things from getting fixed.

Note: The Ministry of Economy successfully advanced legislation this summer to remove the requirement for the Blue Medical Passport and push the Ministry of Health to propose a new system. This is a great start… but since no new system has been put in place the old one is still simply running on “inertia” for now even without a legal basis.

Understanding “Unloyal Competition”

Another topic that must be understood when looking at the economic impacts of corruption is “unloyal competition.” This phrase is a sort of “catch-all” used in Moldova to refer to the competitive advantages gained by companies operating in a non-compliant way. Various mechanisms exist to create the imbalance between honest and dishonest companies, but in most cases it is about tax-evasion and the authorities looking the other way in exchange for bribes. Here are some examples of unloyal competition in Moldova:

• VAT “fiscalization” - Companies wanting to evade taxes often chose to “fiscalize” (aka report) only a percentage of transactions and pocket those that aren’t reported as cash. This evades the standard 20% VAT tax rate on retail sales. It is especially common in the restaurant industry where the “standard” evasion used to be around 50-60% of checks (though things are somewhat better now because of the large scale adoption of electronic payments by bank card in the last 4 years). Factoring in profit taxes that are not paid in this scheme a restaurant operating under these terms can be more than 100% more profitable than one following the law.

• Salaries in Envelopes - Moldova has a “flat” tax rate of around 40% on payroll. Many companies pay unofficial salaries for all or part of a worker’s compensation. With payroll as one of the largest expenses for small business this creates a massive imbalance between compliant and non-compliant companies.

• Evasion of Customs fees / Smuggling - Taxes on imports in Moldova are quite high and corruption amongst border police officers is notorious. Companies that pay bribes to pass their shipments through at discounted or zero rates operate under a major competitive advantage. In many cases, compliant companies are competing against non-compliant ones. These often include the vendors at the bazaar which has long had a reputation for selling smuggled goods.

• Unofficial Authorizations - Bribes to officials so that they “look the other way” have also long been an issue. This was especially challenging during COVID as social distancing and other restrictions were in place. For my restaurant, we carefully managed our capacity, organized barriers, maintained 1.2 meters between people and closed by 8 or 10 pm depending on the restrictions in place. For our troubles we were forensically inspected on multiple occasions by corrupt officials seeking to extract bribes. At the same time, 3 night clubs, operating less than 2 blocks from us, ran illegal all-night parties with no social distancing on a daily basis.

These are only some few examples of the types of unloyal competition caused by corruption. This situation can be crushing for honest and compliant companies. In one case, a company I know engaged in light manufacturing has calculated that they pay more taxes than their next 20 competitors combined. The company in question controls around 30% market share in their field with the 20 making up almost all of the other 70%.

The fact of unloyal competition, and the inability and lack of interest by many state agencies in countering it, creates a deeply unbalanced economic situation for honest and compliance companies in Moldova.

Clarifying the Sources of Corruption

Up until now we’ve highlighted various aspects of the problem of corruption in the economy and we’ve seen how it can hurt small business as well as be driven by small companies who don’t play by the rules. It’s worth taking a quick moment to focus on the underlying cause of corruption… and what isn’t that cause.

Some years ago I met with a former Minister of Economy (who shall remain unnamed). In that meeting he began by explaining how he intended to fight corruption. He said the following (paraphrased):

“I have a plan to fight corruption and end it tomorrow. You people [referring to the small business owners across the table] should stop paying bribes. Done. If you do that we won’t have any more corruption. I think I’ll organize a campaign and we’ll put that message up on billboards around the country - ‘stop paying bribes.”

Putting aside the dizzying intellect that this man displayed in what was a *very* short meeting, it is worth looking at the underlying argument. “Businesses (and individuals) are responsible for corruption because they pay bribes.”

This argument is, to put it simply, completely false. I expanded on this a lot in our past article about bribery, but at the end of the day the counterargument is simple. The state has a monopoly of force and the state is one of the 2 parties in the crime of corruption. In that crime, the most culpable party is the one who wields the most power. A business owner may offer a bribe but cannot ruin the livelihood of an official who rejects it. The official who extorts a bribe explicitly promises just such ruination. This is not to excuse the payment of bribes, but to center the culpability with state agencies for corruption.

At the same time it is incorrect to see a corrupt official as the source of the problem. Individuals and companies all respond to economic incentives and algebras of deterrence. The system itself cultivates this poisonous moral and economic relationship. This is not a question of “bad apples” it is a question of “bad laws.”

The Role of Small Business in Reform

So now we come to a discussion of solutions. In future articles we’ll talk in much more detail about specific problems, policies and ideas to fix them. Today we’re going to focus on why small businesses need to be heavily involved in the solutions and why their ideas should be listened to by those in power.

Firstly let’s address the “small” vs “big” question. I am not arguing that small businesses have more of a moral responsibility to advocate for change than big companies. Every business operating in Moldova has an interest in supporting economic reforms that reduce corruption and put the country on a path towards higher economic growth. At the same time, small businesses have a much bigger interest in the systemic reform that is needed to fix this problem than most big companies. The reason for this is that big companies (whether local or international) have a few advantages small businesses don’t:

• Boutique Solutions - Big investors often ask for special treatment. This is not unique to Moldova, in the US we all saw how Amazon tried to force cities to bid against one another to offer tax breaks in order to attract a company headquarters. Moldova is a small market and companies don’t need to be Amazon sized to look for special treatment. Some years ago a foreign company entering the market told the government that they didn’t want to issue a certain type of tax document - they got an amendment in the law which exempted companies with a certain number of parking spaces from having to comply. IT companies in Moldova pay a 7% flat tax on revenue (payroll + rent. This is a topic we’ll get into later) in place of the myriad taxes other companies pay. None of this is illegal and every company and industry must look after their bottom line. But companies that can access “boutique” solutions have zero incentive to solve broad problems in the economy when they could just solve problems for themselves.

• Legal Departments - If your company can afford a legal department you can solve the “access to information” problem. That does not mean it is *easy* to get things done for large companies - a Byzantine bureaucracy is equal opportunity. It does mean that company owners don’t visit the same office 10 times in a week to be told to go away and come back over and over with new varieties of paperwork, signatures and stamps. Lawyers meanwhile live for paperwork and stamps and this work justifies their salaries. By making bureaucracy a simple “cost” senior leadership often doesn’t know what the major problems are and has little incentive to advocate for changes.

• Scaleable Administrative Overhead - Similarly, while small business owners might say “why do I have to spend all my time filing these senseless reports?” A large company will simply hire more accountants. The local construction store in Chisinau has 9 accountants on shift at all times to issue Moldova’s complicated B2B invoices called “factura fiscals.” Small companies can’t afford any accountants on shift at all times and so miss out on much of the B2B market. The ability to scale up administrative departments not only insulates company owners from the challenges of complying with complex bureaucracy, it also entrenches a competitive advantage against smaller companies which can’t afford that scale.

Put simply, large companies can often look after themselves. Small companies are in no position to do the same and must therefore operate under the premise “a rising tide floats all boats.” With the only path to reform being one that looks at everyone’s collective problems small businesses are ideally positioned to advocate for the most impactful changes in the economy.

Besides this, most companies in Moldova are small and medium businesses (98.4%) and these companies employ most of the country’s workers (59.1%). It only makes sense to turn to them for ideas about what needs to be fixed and what the priorities should be.

How AIM’s Companies are Pushing Back Against Corruption

The Moldova Small Enterprise Alliance, AIM, has been advocating for systemic reforms to combat corruption since I co-founded the association 7 years ago. We will dive deeply into specific ideas about systemically removing the underpinnings of corruption and the sources of corruption in future articles. But before we look at that we need to start with first principles. This article has explained much about how things “are.” We need to first talk about how things “ought to be.” Not in a technical sense, but in a big picture sense.

AIM is first and foremost a community of optimists. Almost by definition you need to be a bit crazy and highly optimistic to start a small business. That is only more true in Moldova. As optimistic entrepreneurs AIM’s members support systemic change that results in a level playing field. To explain what this would look like we’ve created 2 guiding documents which serve as a statement of goals and expression of how things ought to work.

Branding from AIM’s campaign - a community of “Optimistic Entrepreneur’s in Moldova”

The Small Business Bill of Rights

Back in 2019 AIM worked to reformulate the many challenges and complaints of companies into a solutions-oriented document. We created what we called the “Small Business Bill of Rights” for Moldova. The document outlines the rights that small companies expect the government to observe in 17 articles and 8 title groupings. In it we outline rights of access to information, to appeal decisions to competent 3rd parties, to pay taxes under a fair and equal tax code and to interact with professional, competent and (frankly) polite public servants.

The Small Business Bill of Rights was meant to be a starting point on the big questions of reform. Many parts of the bill are already codified in Moldovan law, some are not. The fact that these ideas were included in the bill underlined that whether or not they are in law - the system as it is does not function. As we discussed above, corruption makes people and companies less likely to stick their heads up and talk about problems. AIM’s goal was to not only get this conversation moving about the key issues, but to also provide a framework for solving them.

The Small Business Code of Ethics

Following the Small Business Bill of Rights AIM launched its Small Business Code of Ethics in September of this year. While the Bill of Rights was meant to outline the expectations of companies with regards to their regulation and treatment by the government, the Code of Ethics is a commitment by companies to follow the rules and play fairly. This does not simply mean small businesses agree to follow the law, that should be table-stakes even if it is often hard to do. It means a commitment to following the “spirit of the law” when laws are unclear or so broken as to necessitate work-arounds. It also extends fair-play to engagements with other companies in the competitive environment. Competition is the core of capitalism and business. But fair competition is a necessary requirement for a healthy and growing economy.

Having spent years engaging with public officials from many governments and countless state agencies I understand very well how “businessmen” are perceived in Moldova. Ministers say business owners are responsible for corruption and should “just stop paying bribes.” University rectors have an unnerving tendency to call us “dirty capitalists” when we question the employability of their graduates. MPs are far more likely to accuse businesspeople they just met of wrong-doing than to ask “how can we help you grow your business?”

The relationship between the public and private sector in Moldova has been broken for many years. It is still seen through a Soviet lens of distrust, a feeling which is mutual. Advancing a Code of Ethics and outlining the set of rights that businesspeople expect to be respected are both mechanisms for resetting this conversation. Moldova’s economy is not in good shape. It’s never been strong, but now it is facing a sort of permacrisis driven by COVID, war, inflation and ever increasing rates of migration. In order to fix things and to build a better future all stakeholders need to start pulling in the same direction.

AIM will be releasing its plan for reform in the next weeks and it will dive into lots of specific issues and technical solutions. We’ll run some articles here looking at these problems and ideas and examining in greater detail how Moldova has succeeded in reforms, and how much more work there is to do. But at the core, AIM’s agenda asks that all stakeholders declare a common goal - Moldova should be among the best places in Europe to do business. We are very far from that goal right now, but with the right approach and a little bit of mutual trust we can get there.