variables. Results displayed in Table 11 reject the possibility that connected firms in Egypt entered slower-growing sectors. Treatment group sectors in Jordan exhibited greater investment, and no significant differences with the control group sectors with respect to value added, wages, or profits.

# **Evidence on mechanisms: Political connections and the distribution of employment**

The entry of politically connected firms can slow the growth of unconnected firms for three reasons. First, politically connected entry can affect the behavior of unconnected firms that remain in the sector. These firms might shrink due to fewer profitable investment opportunities. They might also stop growing in order to stay small enough to operate _under the radar_ of their politically influential larger competitors. Second, politically connected entry might force faster-growing unconnected firms to exit these sectors. Third, the presence of connected firms might discourage new (potential) entrepreneurs from entering these sectors. We present evidence here that is consistent with the first of these mechanisms.

In more competitive economies, the policy advantages of connected firms should force unconnected firms to exit, the second mechanism. In Egypt, however, firm exit is low by international standards (Hussain and Schiffbauer, 2014). Instead, consistent with the first mechanism, employment is concentrated in (old) micro and small firms: establishment census data show that firms with fewer than ten employees account for 72 percent of aggregate employment (Hussain and Schiffbauer, 2014; World Bank, 2014).<sup>45</sup> To see if this skewed distribution of firms is due to the presence of political connected firms, we test whether the entry of politically connected firms skews the employment distribution of the sectors they enter towards smaller, less productive firms.

This distributional shift is consistent with the argument in Aghion, et al. (2001). They predict that in sectors dominated by firms with large and exclusive cost advantages, such as those granted to politically connected firms in Egypt, the firm size distribution should exhibit a large politically connected market leader and a potentially large number of small or (informal) micro firms using vintage technologies to serve local market niches. Thus, over time, a few large firms and many small firms should emerge in politically connected sectors. While the large connected firms create some jobs, the bulk of employment in these sectors will be concentrated in less productive, but more numerous micro or small firms, operating under the radar of their politically influential large competitors. In fact, in Egypt these firms _are_ less productive (Hussain and Schiffbauer, 2014; World Bank, 2014).

Given our findings that political connections in Egypt translate into large policy privileges and the fact that the distribution of employment across firms in Egypt is skewed towards less productive micro and small firms, the size distribution of firms should become more skewed when politically connected firms enter previously unconnected sectors. The evidence presented below is consistent with this mechanism in Egypt.

Figure 3 compares the distribution of employment of initially unconnected sectors (see Table A4 in the Appendix) before (1996) and after (2006) the entry of politically connected firms. It shows that the distribution of employment became more skewed towards micro and small firms after the entry of connected firms; the difference in the distribution is significant at the one percent level

> 45 Consistent with these findings, our data suggest that the 469 politically connected firms only account for about seven percent of aggregate employment in Egypt.

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