The Costs of Political Inuence: Firm-Level Evidence from Developing Countries1

Field: Economics, Econometrics and Finance (Social Sciences)

Arrangements by which politically connected rms receive economic favors are a common feature around the world, but little is known of the form or e¤ects of inuence in businessgovernment relationships. We present a simple model in which inuence requires rms to provide goods of political value in exchange for economic privileges. We argue that political inuence improves the business environment for selected rms, but restricts their ability to re workers. Under these conditions, if political inuence primarily lowers xed costs over variable costs, then favored rms will be less likely to invest and their productivity will su¤er, even if they earn higher prots than non-inuential rms. We rely on the World Banks Enterprise Surveys of approximately 8,000 rms in 40 developing countries, and control for a number of biases present in the data. We nd that inuential rms benet from lower administrative and regulatory barriers (including bribe taxes), greater pricing power, and easier access to credit. But these rms also provide politically valuable benets to incumbents through bloated payrolls and greater tax payments. Finally, these rms are worse-performing than their non-inuential counterparts. Our results highlight a potential channel by which cronyism leads to persistent underdevelopment. Arrangements by which rms with close ties to incumbent political authorities receive favors that have economic value are a pervasive feature of business-government relationships in countries around the world. Despite the prevalence of these arrangements, however, relatively little is known about the precise form rm-level political inuence takes, or its consequences. What characterizes the bargain between inuential rms and governments? How do inuential rms compensate governments, if at all, for any benets they receive? Recent rm-level analyses have examined various determinants of political inuence, and how these connections a¤ect market valuation. Others have detailed the channels through which the benets accrue. Still other, nally, have explained how systemsof inuence come into being, and why they survive. Much less is known, however, of how these political connections a¤ect decisions within rms or of the strings that may come attached to political inuence. We investigate both the characteristics that dene political inuence among rms in developing countries as well as the e¤ects of that inuence on company behavior and performance. We argue that political inuence improves the business environment for selected rms through industrial or quasi-industrial policies, but restricts their ability to re workers. Inuential rms thus relinquish a portion of their control rights particularly over employment decisions in order to provide benets of political value to public o¢ cials. If inuence lowers xed operating costs for privileged rms, they may earn higher prots than noninuential rms but they will be less likely to invest or innovate, and their productivity will su¤er. Firm-level political inuence, therefore, can undermine the performance of politicallypowerful rms. We draw on rm-level surveys in approximately 40 developing countries, consisting of over 8,000 enterprises. We nd that politically inuential rms do indeed face a more favorable business environment than their non-inuential counterparts across several dimensions.