Editor's Note: This is the second post in a series that will focus on the impact of corruption and poor governance on enterprise and development in the "bottom of the pyramid." Read the first part here.
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Let's visit one of my favorite cafés in Jinja, Uganda. Just off the town's main street with its red dust and buzzing motorcycle taxis, this café is a tiny storefront barely the size of the typical American garage. Crammed with about six tables covered in red-checkered plastic tablecloths, overlooked by a languid ceiling fan, the place does steady business at lunchtime, when locals sit elbow to elbow to eat heaping plates of matooke, greens, and groundnut sauce.
At first glance, this cafe seems like the model small enterprise success story. The owner (let's call him "Robert") grew up in one of the impoverished villages surrounding Jinja, where even a ride into town can represent a day's wages. A few years ago, he decided to take his carefully-saved earnings from years of farming and open his own business.
Since then, a steady stream of hungry customers would have seemed to make Robert one of the fortunate few who has climbed his way out of poverty into at least the lower-middle class.
But Robert's success has not gone unnoticed. One day,a local official stopped by the café, and after consuming a meal "on the house," asked to see a business license that Robert had never heard of. Securing the license would cost money, of course-and Robert had no idea if it was a legitimate fee, a shady markup on a real fee, or a wholesale fiction.
Refusing to pay was not an option-Robert knew too well the stories of other small business owners whose intransigence had resulted in "faulty paperwork" or "health code violations" that eventually shuttered their stores.
But paying the fee turned out to be just the beginning. Robert would be troubled for months afterward with suspect demands from tax officials, health inspectors, and the same enterprising license provider.On one of my last visits, he had not only abandoned his previous dream of expanding into the next storefront but despaired of finding the money to send his youngest child to school.
Robert's story represents one of the countless examples of the type of corruption that is choking enterprise in the developing world, squeezing most the ones who can least afford it. Thirty-five percent of African businesses reported that they were expected to make informal payments to public officials to "get things done," roughly similar to other parts of the developing world. (In OECD countries, this number was about 13%.)
Would-be entrepreneurs also face a more subtle, but no less destructive, form of corruption. The process to even open a business in many developing countries is arduous, time-consuming-and fraught with opportunities for officials to solicit "facilitating payments." It takes two months to register a business in Latin America; in OECD countries, it takes two weeks. The official fees for opening a new business in sub-Saharan Africa constitute an astounding 100% of the average per capita income; in OECD countries, that figure is 5%. Who wouldn't consider paying a bribe in order to speed up the incorporation process, or pay a much lower official fee in exchange for a little more unofficial cash?
Moreover, the regulations and tax codes in many poorly-governed countries are so complex that bribing officials is often easier than navigating the legitimate system. And it can be cheaper, too-particularly in sub-Saharan Africa, where the average enterprise tax rate is 66.8% of profits (p. 93).
Faced with such a daunting start-up process-and then high tax rates and larcenous officials if their business is successful-many entrepreneurs simply retreat to the shadow economy. Roughly 10%-25% of firms are formally unregistered when they start operations in developing countries, although the percentage of workers employed in the (non-agricultural) informal sector ranges from about 57% in Latin America to up to 85% in parts of Asia.
This constitutes an enormous segment of the economy that goes unregulated, unmonitored, and (officially, anyway) untaxed. So the vicious cycle continues: high tax rates for the official companies, more businesses responding by going off the books, and less revenue for the national government, which becomes more dependent on foreign aid.
And in a sad logic, entrepreneurs may prefer to be plagued by low-level corruption than help fund higher levels of corruption in the national government. Paying small bribes may thwart their dreams of expansion and even threaten their children's education-but if it protects their livelihoods, at least they are getting something for their money.
I never asked Robert about the official status of his business, but when I asked him once about taxes, he laughed. He gestured out the window of his café, at the trash heap across the street, the broken street lamps, and the potholes wafting dust across the crooked road.
"Do you see our return on investment?"
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Upcoming in this series: How businesses are fighting back against corruption; internal corporate governance; the promising work of development organizations.