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The Price of Political Connections

- November 12, 2010

Political connections can help firms get government contracts, friendly policies, exemptions from formal rules or other favorable treatment in the enforcement of regulations. My friends and colleagues Raj Desai and Anders Olofsgard argue that the price for these favors extends beyond the payment of bribes and campaign contributions. Politicians may also make demands on business practices. In particular, businesses may be expected to maintain bloated payrolls in order to protect politicians from the consequences of high unemployment (or to provide jobs for family members and friends). This may have a negative impact on the competitiveness of politically connected firms.

Desai and Olofsgard develop a theory of the differential behavior of politically connected firms and test the implications of this theory using cross-country business surveys conducted by the World Bank. They find that” “more influential firms indeed face fewer administrative and regulatory obstacles, and carry bloated payrolls, but they also invest and innovate less.” They conclude that these findings refute the idea that cronyism is a benevolent industrial policy that simply helps firms become more productive. The working paper is here (ungated).

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