A friend of mine has been trying to start an artisanal liquor business in a small Latin American country. He learned to ferment fruit, crafted a logo, scrounged for and sanitized several hundred glass bottles, registered his corporation with all the various agencies, and paid all of his initial taxes. After producing his first batch and selling it to a number of small shops, he decided it was time to expand. Unfortunately, when he began to negotiate sales to larger restaurants and grocery stores he ran into a major complication: liquor taxes. The high level of liquor taxation made his business model completely unprofitable. Trying to understand how any other liquor business stayed afloat, he discovered that one liquor manufacturer and importer dominated the market, and didn’t pay any taxes. How? Corruption. In order to stay in business, my friend had a choice: (A) he could stay small, fly under the radar, and avoid paying taxes, or (B) he could navigate the perilous and uncertain process of bribing his way out of paying taxes. He ended up choosing a third option: he closed up shop and went back to his day job.
Ultimately, the fate of one small liquor business is not that important. But my friend’s experience illustrates a much more general phenomenon, one that is likely familiar to readers with experience in countries where corruption is widespread: corruption protects incumbent firms, undermines entrepreneurship, and constrains growth and job creation—particularly by small and medium-sized enterprises (SMEs), which are often the primary drivers of economic growth, employment, and innovation. Corruption can be a critical roadblock to entrepreneurs and small business owners who can’t bribe their way out of regulation. In fact, pervasive corruption can shift business incentives to such a significant extent that it can impact the shape of an economy dramatically.
Beginning with Hernando DeSoto’s groundbreaking work on informal economies in The Other Path, researchers have mapped out the various ways in which the uneven application of government rules and regulations (linked to pervasive corruption) prevents entrepreneurs from expanding and formalizing their businesses. Part of this has to do with scale: larger firms can more easily absorb the costs of payments to rent-seeking regulators or corruptible tax collectors. Another has to do with the political benefits of incumbency: researchers have found that corruption hampers the growth of smaller, more profitable private sector firms much more than for larger, state-owned firms (see here for an example from Vietnam). Smaller firms are more acutely impacted by corruption, but smaller firms also tend to resort to bribery more often while larger, more established firms are able to lobby for favorable regulatory changes. Corruption can also create barriers to accessing finance where capital markets are concentrated and access comes at a price—a common problem in developing countries. This further retards the growth prospects for emerging businesses.
In spite of all of the evidence, there has not been sufficient attention in the anticorruption community on the unique disadvantages faced by SMEs. Moreover, the acute burden of corruption felt by SMEs trying to grow in a complex regulatory environment provides them with a strong incentive to mobilize in favor of anticorruption reforms. This heightened incentive, in combination with the broad-based cross-section of the population SMEs benefit and their robust economic potential, makes them a formidable ally in the fight against corruption. Indeed, there is evidence that SMEs can serve as a powerful and effective interest group in favor of anticorruption policies even in authoritarian countries.
But the anticorruption community hasn’t really figured out how to mobilize and encourage this latent constituency for reform (although the OECD’s recent Global Anti-Corruption and Integrity Forum included a panel on the issue). To the extent that the anticorruption community focuses on SMEs at all, it’s in the context of calling on them (and other businesses) to commit to stronger compliance: a subcomponent of the UN Global Compact’s 10th Principle encouraging businesses to work against corruption, and “Collective Action” efforts have sought to include SMEs but have done so primarily from the perspective of increasing their compliance with anticorruption norms, rather than leveraging their unique systemic disadvantages. For example, a business-led Integrity Network in Egypt “specifically engaged” SMEs by asking them to sign an integrity pledge and encouraging MNEs to provide tangible business incentives to SME’s to implement their pledge.
Rather than focusing solely on improving SMEs’ anti-bribery compliance programs, anticorruption advocates should also leverage the unique position and self-interest of SMEs to mobilize them to demand credible anticorruption policy reforms. Simply by acknowledging SMEs as distinct from MNEs when designing programs that partner with “Business” to fight corruption (such as “Collective Action” efforts), would help consolidate SMEs interests and result in more effective interventions. Providing technical assistance and a forum for local networks of small businesses, entrepreneurs, and informal market participants can encourage the development of a strong interest group with a broad base and provide the necessary international and institutional backing to mitigate fears of reprisal. Focusing on particular areas of reform, which might have a disparate impact on SMEs, is another way to empower SMEs in a corrupt system. For example, enacting whistle-blower protection laws for businesses that denounce corruption would likely be used by and benefit SMEs disproportionately. By leveraging the untapped power of SMEs, international organizations and civil society groups could help fight corruption while simultaneously empowering the key drivers of economic growth and development.