State of the Country Report 2021

After 30 years of independence, the Republic of Moldova still falls short of its potential as a nation, a country or state. From the perspective of each of these three concepts, the Republic of Moldova remains strongly fractured. As a nation, Moldova is not yet a community of people with a consensus on their identity and history, and also – just as important – on their future. For example, according to the 2021 Public Opinion Barometer, 50 percent of the population think that the Republic of Moldova should orient itself towards the European Union (EU), while 33 percent – look towards Russia. As a country, the Republic of Moldova is not yet able to impose its sovereignty on all its internationally recognized territory (the issue of the Transnistrian conflict remains unresolved and there is little prospect of resolution in the near future). As a state, the Republic of Moldova still remains dysfunctional in many respects, including with regard to the fundamental pillars of a state, such as democratic institutions, the rule of law and ensuring a stable economic base. The latter is evidenced by numerous crises caused by various vulnerabilities (the ‘theft of the billion’,  the banking crisis, the airport concession, the bankruptcy of many state-owned enterprises of strategic importance, and most recently, the energy crisis). 

In sum, the Republic of Moldova has failed to make a truly qualitative leap forward in its development, because fundamental problems remain (weak institutions, poor governance, a vulnerable economy, low energy security, a polluted environment, and inefficient social protection). Of course, some progress made over 30 years of independence cannot be ignored (poverty reduction, stabilization of the macroeconomic situation, institutional reforms, and the implementation of additional social protection instruments). However, these achievements can hardly be categorized as qualitative leaps towards a sustainable model of economic growth: income growth has been uneven, with huge differences between villages and towns; more than a quarter of the country's population is below the absolute poverty threshold; the environment remains highly polluted; the country remains unattractive for investors and has constantly lost competition with other countries in the region with regard to foreign investment; the justice system remains unreformed, as does the pension system; and the social protection system is poorly targeted and inefficient. The most obvious manifestation of the persistence of these problems is the high level of public distrust in the main state institutions, shown by almost all national opinion polls and international ratings.

As a result, after 30 years of independence, there is no genuine social contract between the state and non-state actors (citizens and enterprises), due to the acute lack of trust in the authorities. This is one of the most serious problems in the country today: it fuels populism and undermines government’s ability to think long-term and to implement complex and systemic reforms. Thus, each new government focuses on measures that will have an immediate impact and puts to one side the most difficult reforms. Given the electoral cycle, these reforms end up being postponed indefinitely. The most eloquent examples in this regard are reform of pensions, the energy system and the central or territorial-administrative system. 

The perpetuation – or even aggravation – of these problems has its origin in the lack of a consistent and long-term vision for the development of the country by the political elites, whose discourse has always been limited to convincing the electorate to vote for them in elections, based on populist promises (e.g. pension and salary increases) and subsequently justifying themselves before the electorate on the modest progress of reforms.

The Republic of Moldova is marked by three vulnerabilities that remain unresolved: erosion of its human capital, technological gap and structural vulnerabilities. Each are taken in turn below.

● The problem of human capital. The stock of human capital available for the social, economic and political transformation that Moldovan society requires has been steadily declining due to emigration and the ‘brain drain’. The dramatic population decline will stand out, in history textbooks, as a major feature of the early period of Moldova’s independence. According to conservative estimates, the population with regular residence shrank from 3.6 million people in 1991 to only 2.3 million in 2020 (neither figure includes the Transnistrian region) and there are no visible signs of a stabilization of this process. The negative natural growth and, in particular, the negative migration growth have both contributed to this unprecedented population collapse. Emigration has been caused by a lot of factors: in the 1990s, push factors prevailed (poverty, endemic corruption, lack of prospects for young families); currently, however, emigration decisions have been increasingly motivated by pull factors (with people seeking better education, careers, and welfare for their children). At the same time, Moldova’s formal, informal and non-formal education systems have not responded effectively to the technological, economic and cultural imperatives to develop human capital. While a certain degree of progress in the education sector reform has taken place – through the adoption of the Education Code, the reorganization of vocational schools and colleges, the development of dual education, and increases in the degree of university autonomy, etc., there remain issues regarding the relevance of the education provided in the Republic of Moldova, i.e. the way in which schools – from primary education institutions to postdoctoral cycle – respond to the current realities. 

● Technological gap. The Moldovan economy has constantly suffered from a chronic shortage of investment resources and this has led to a major technological handicap, which results in unfavourable specialization internationally, the loss of global competitiveness and a low level of labour productivity. Enhancing the investment climate for private investment, increasing the accuracy and absorption of public investment and actively attracting foreign direct investment (FDI) in the export-oriented sectors have always been recurring generic recommendations of independent analytical reports, as well as forming part of the electoral promises of most parties aspiring to power. Although some progress has been made in the private investment process, including in the agricultural sector, this is far from stable, with some exogenous shocks (the 2009 crisis, droughts, the Covid-19 pandemic) delaying the formation of new production capacity. Private investment has also been hampered by a number of institutional and structural problems, such as low confidence in the judiciary, excessive regulatory burden, anti-competitive market arrangements, and limited access to bank credit and alternative sources of financing. Small and medium-sized enterprises (SMEs) continue to rely primarily on their own resources to finance investment projects, which significantly extends their average implementation time. The government has made efforts over the last decade to improve public investment policy and mechanisms for planning: for example, there has been some improvement in the quality of national roads. However, dubious public procurements, conflicts of interest and lack of transparency in the selection of funded projects have eroded the impact of public investment. Over the last 30 years, foreign investment has played a key role in rehabilitating traditional sectors, such as telecommunications, and in the emergence of completely new sectors, such as the automotive industry. However, foreign investment remains insufficient, and in some cases foreign investment from obscure sources has made the recipient companies (banking, energy) vulnerable. As a result, after the 2009 crisis, net FDI inflows amounted to only about USD 200 million annually, on average. As a share of gross domestic product (GDP), annual net FDI inflows have declined in the last decade, fluctuating in recent years around 2 to 3 percent of GDP. With a total stock of FDI of about 40 percent of GDP, the Republic of Moldova is still near the bottom of international rankings. 

● Structural vulnerabilities. The first years of independence have been characterized by a number of systemic weaknesses in the Moldovan economy. There is an excessive dependence of the population on subsistence agriculture and this occupation, being initially a lifeline, has ultimately determined the persistence of poverty. The agricultural sector remains strongly dependent on the vagaries of weather, which, from one year to the next, is becoming more and more unpredictable and more and more challenging for farmers. Several episodes of catastrophic drought in the last three decades have complicated the agricultural sector's recovery to the production levels registered before the collapse of the Soviet Union. Another structural problem is the ageing of the population and the implications this has for the public pension system. The issue of energy dependence also remains of maximum relevance, while the problem of Moldova’s lack of its own energy resources has been aggravated by the slow implementation of the mega-projects related to connection with the Romanian system. At the same time, it is worth highlighting the progress made by the Republic of Moldova in increasing energy efficiency, determined both by investment in less energy-intensive production capital and motivational economic instruments: universal metering, raising tariffs to production cost levels, and cancelling the complicated system of cross-subsidization of tariffs. Another vulnerability that has been successfully overcome is the excessive dependence of Moldovan exports on a single market, namely that of the Russian Federation. The share of the Russian Federation in exports has decreased from 44 percent in 2000 to 26 percent in 2010, and to 9 percent in 2020. The reorientation of Moldovan exporters to other markets has been determined by both rejection factors (Russian embargoes) and pull factors (Generalized System of Preferences, Autonomous Trade Preferences, and the Association Agreement with the EU).

Against the background of the above-mentioned vulnerabilities, over these 30 years of independence, Moldova’s economy has been repeatedly impacted by a range of negative shocks, which have fundamentally undermined the dynamics of economic development and the transition to a functioning market economy, based on a sustainable model of economic growth. These shocks can be divided into five general categories: (i) shocks induced by corruption and mismanagement of the state (the ‘theft of the billion’ and the 2014–15 banking crisis, the airport concession, and the apparently intentional bankruptcy of strategic state-owned enterprises); (ii) external shocks (the Covid-19 pandemic, regional and global economic crises, the war in Ukraine); (iii) climate shocks (droughts, floods); (iv) geopolitical shocks (trade restrictions imposed by the Russian Federation since 2006); and (v) political shocks, in particular in the context of political instability in recent years.

However, the worst shocks are related to the major – even historical – failures of successive governments. Below, we note three monumental failures of Moldovan governments that have slowed or even halted the country's transformation processes. Each of these failures illustrates the serious problems with respect to the effectiveness of government faced by the Republic of Moldova since independence.

1. Bank fraud with no historical precedent. Poor governance and low transparency of the financial sector have posed major problems for the government and the National Bank of Moldova (BNM), as well as posing considerable national security risks. These vulnerabilities have materialized in the form of an unprecedented case of bank fraud, which has severely limited the country’s fiscal space, placed a huge and long-term burden on taxpayers, and made the country vulnerable to external influence. We hope that the full details of this fraud will be elucidated in a thorough and credible investigation. It is clear, however, that this event could not have happened without the tacit support – or even the active contribution – of some state institutions that are designed precisely to prevent such risks. The subordination of state institutions to group interests is the main reason why an early reaction that could have deterred this fraud, or minimized its consequences, did not occur. Following this event, Moldova’s development partners insisted on a process of cleaning up the banking sector, rehabilitating property rights and removing shareholders who do not meet the criteria of integrity and transparency. The evaluation of shareholders should be an ongoing process to prevent a recurrence of similar crises in the future. At the same time, it is clear that the magnitude and consequences of this case of bank fraud have been so severe that the sector remains exposed and vulnerable to risks.

2. Collapse of state-owned enterprises. The sector that has probably suffered the most and has failed to adapt following the transition from a planned to a market economy is that of state-owned enterprises, most of which have reached the brink of bankruptcy. In addition, these organizations have always been used to distort fair competition and/or to finance parties or achieve other political interests, to the detriment of the real interests of taxpayers and the country. In order to prevent the accumulation of quasi-fiscal debts by state-owned enterprises and their involvement in fraudulent arrangements, as well as to increase the efficiency of the use of resources throughout the economy, Expert-Grup has constantly insisted on the transparent privatization of companies, operating under free competition, the professionalization of their management, the adoption of modern standards of corporate governance, ensuring the transparency of the procurement and debt contracting processes, and the establishment of internal control and audit systems. For a long time, these recommendations have remained unheard. In fact, Moldovan governments have adopted populist and unrealistic measures, such as the arbitrary capping of the salaries of directors of state-owned enterprises. This lack of reforms has been determined not so much by incompetence but rather by conflicts of interest. The point is that many of those who are responsible for adopting policies are, at the same time, representatives of the state on the boards of directors of these state-owned enterprises, being paid directly by them. In addition, state-owned enterprises are a very convenient vehicle for the obscure financing of political parties, while the appointment of directors is a source of income for politicians. The results of these ‘policies’ are, today, unenviable: the electronics and precision equipment industries are practically defunct, state-owned enterprises, which were once respectable, are now involved in the trafficking of banned substances and products, and are forced to engage in scam procurement in order to buy raw materials from supplier companies controlled by politicians, etc. To give just one example, the currently precarious financial situation of the Moldovan Railway Company, which was once a key pivot of the economy, is the concrete result of this ‘policy’.

3. Failure to ensure the rule of law. Fair, predictable, universal and effectively enforced law is a key precondition for the functioning of a market economy. Even though there may be trust between economic agents, and even though the relations between them may be regulated by informal norms, for the long-term development of a modern economy the supremacy of formal law is indispensable. Economically speaking, the law is the main mechanism by which material, intellectual and other property rights are guaranteed, by which compliance with contractual rights and obligations is required, investments are secured and transaction costs are minimized. Two elements are of paramount importance: the content of laws, and their implementation. The content of the law should be defined based on the public interest. However, in the Republic of Moldova during recent years, the normative process, at all stages and at all levels, has remained extremely vulnerable to lobbying, conflicts of interest, and other illegal influences. Paradoxically, one of the institutions most vulnerable to such activities has always been Parliament itself, which has shown the greatest disrespect for the transparency and integrity of the decision-making process in recent decades. However, defining the legislative framework is not enough. Thus, each edition of the State of the Country Report (SCR) has showed that the Republic of Moldova repeatedly failed the test of effective implementation of legislation, especially because of the weaknesses of the judiciary. The judiciary must be clearly separated from other powers. However, its independent character also requires a high level of responsibility of judges for the decisions they take. Instead, arrogating formal independence to itself over the past three decades, the judiciary has become an opaque, self-sufficient caste that is in thrall to political influence. The country's inability to reform the judiciary is the result of the same conflicts of interest, the confluence of politics with the economy, the limited capacity of the press, NGOs and citizens to identify and expose large assets accumulated illegally, and the major weaknesses of the national system of the initial and continuous training of judges. 

Corruption has been a major government dysfunction over the past three decades. With the disintegration of the Soviet system, corruption very quickly became the oil that lubricated the rusty gears of the Moldovan economy. In 1999, Moldova scored 26 on the Corruption Perception Index calculated by Transparency International on a scale from 0 (highly corrupt) to 100 (very clean). Although the situation did not seem to have worsened in 2002, a year after the ‘reformed’ Communists took full power, the perception index fell to 21. The situation has slowly improved, reaching 36 in 2012, after which, with the bank fraud and the exposure of state institutions to vested interests, the Republic of Moldova’s position again deteriorated, sinking to 30 in 2016. In the following years, the situation partially improved, the score obtained by Moldova in 2020 being 34. At such a pace, the country would need 45–50 years to reach the level where, for example, Estonia is today.

In order to strengthen its competitiveness, the Republic of Moldova needs to needs to exploit its human capital more efficiently, become more technologically developed, and more resilient to climate change. The internal and external situation of the Republic of Moldova has constantly changed and the country has failed to keep up with technological, economic and cultural trends, adapting with difficulty to new development challenges. These are many in number; however, we believe that the country will have to address more decisively some significant challenges that lie ahead:

● Modernization of the educational system. The effective reform of education should start with reforming the initial and continuous training system for teachers, ensuring the priority financing of schools, raising professional standards and teachers' remuneration, and adapting the curriculum to new technological realities and ensuring the flexibility of its implementation, including by reducing the bureaucratic formalism that accompanies the teaching process. Online platforms need to be used more intensively to enable children to have access to the best sources of learning – the Covid-19 pandemic has shown that this is both possible and necessary. Schools should also focus equally on learning and education. Children should be protected from sources of harmful cultural influence, which lead them down the wrong paths in life, while a love for books and knowledge should be promoted as a supreme value in society.

● Closing the technological gap. Inputs in the technological convergence process must be allocated long before the results are seen. Children's creativity should be stimulated and encouraged at school, while outdated subjects such as ‘technology education’ should be replaced by robotics and computer programming. It is necessary to significantly increase the scholarships for science, technology, engineering and mathematics (STEM) specialties, to encourage young people to choose these subjects. In the research and development sector, assimilation, re-engineering and adaptation of innovations and technological solutions should be actively encouraged, as well as applied research in international partnerships on topics that directly address the society's priorities. The policy of attracting FDI should deliberately aim to integrate local suppliers into international technology and supply chains. At the same time, there is a need for more active development of the capital market, in addition to banking services, in order to increase access to finance. Here, however, it is important to understand that a number of structural factors, such as the Transnistrian conflict and vulnerabilities to external shocks, keep the country's risk level high, which is also reflected in the costs at which the Republic of Moldova borrows from abroad.

● Accelerating an increase in labour productivity. The Republic of Moldova faces major demographic challenges, caused in particular by intensive emigration and the ageing population. Thus, within a maximum of one decade, the respite offered by the increase in the retirement age will be exhausted. This will place an increasing burden on the economically active generations. In addition, the rapidly increasing technological development, automation, robotics, and the advancement of artificial intelligence will hugely reduce the value of unskilled labour. Given that the fertility rate is expected to continue to decline, while emigration, in the most optimistic scenario, will moderate but not reverse, the only chance for the Republic of Moldova to adapt to these new realities is a rapid increase in labour productivity. The development of the education system can lead to an increase in the skills of employees, who will be better able to handle new technologies effectively. However, in addition, important cultural changes are needed in the attitude towards work, in parallel with developing capacities for labour market forecasting and technological, economic and financial prospective. At the same time, the Republic of Moldova needs to embark on a smart reindustrialization process, which, realistically, should be based on FDI, should fully capitalize on the local base of raw materials and should result in expanding the range of goods with high added value. This emphasizes, once again, the importance of technological education, which can revitalize the country, in parallel with creating new, more productive jobs – not just the liquidation of unproductive ones.

● Adapting to climate change. The increasingly violent weather phenomena that have been observed in the last decades across the world, including in eastern Europe and in the Republic of Moldova, look to be permanent, being conditioned by global warming. The Republic of Moldova risks being caught unprepared to face the atypical risks that other countries have faced in recent years. In addition to being exposed and vulnerable, the country has limited reserves of resilience and recovery in the event of a major cataclysm. Does Moldova have a concrete strategy for tackling a catastrophic drought lasting not one year but two or three years? Tactically and operationally, are the specialized services able to react in the event of forest fires on the scale of those seen in southern Europe in the summer of 2021? To what extent is the urban infrastructure prepared to deal with long-lasting violent rains? These questions do not have a clear conceptual answer and, to our knowledge, there are no detailed operational response plans. As the examples of countries hit by natural cataclysms in recent years show, the costs of preparing for these events are more than justified by their possible magnitude and impact.

● Strengthening energy security. The energy crisis of 2021, manifested, on the one hand, by the sharp rise in prices for natural gas and petroleum products, and, on the other hand, by the risks undermining the supply of natural gas in necessary volumes with repercussions on the electricity sector, has highlighted multiple shortcomings in the country's energy security. Even though it was possible to extend the contract with Gazprom by 5 years, which will ensure the delivery of natural gas in necessary volumes and at a much better price compared to the spot prices, the Government should learn its lesson and start an extensive programme on strengthening the energy security: diversifying natural gas imports by procuring natural gas from international stock exchanges during the warm period of the year, when spot prices are lowest, and storing it in Ukraine and Romania; full implementation of the Energy Package 3 and development of the internal gas market; acceleration of interconnection with Romania on the dimension of electricity and strengthening of internal electricity networks and interconnection with Ukraine; subsidization of companies and population to increase energy efficiency and diversification of energy sources and, last but not least, the settlement of the historical debts accumulated by the energy complex on the right bank towards Moldovagaz.

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This publication is produced by the independent think-tank Expert-Grup, in partnership with the Friedrich-Ebert-Stiftung (FES). The views and opinions expressed in this document are those of the authors and are not necessarily shared by the FES and Expert-Grup. 

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This version of the report is a translation of the original, which was written in Romanian. Every effort has been made to ensure that the translation is a faithful reflection of the original. However, in all matters relating to the interpretation of specific terms, information, the original language version of the report shall prevail over this translation.

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