Connecting to Power: Political Connections, Innovation, and Firm Dynamics

Abstract

How do political connections affect firm dynamics, innovation, and creative destruction? To answer this question, we build a firm dynamics model, where we allow firms to invest in innovation and/or political connection to advance their productivity and to overcome certain market frictions. Our model generates a number of theoretical testable predictions and highlights a new interaction between static gains and dynamic losses from rent-seeking in aggregate productivity. We test the predictions of our model using a brand-new dataset on Italian firms and their workers, spanning the period from 1993 to 2014, where we merge: (i) firm-level balance sheet data; (ii) social security data on the universe of workers; (iii) patent data from the European Patent Office; (iv) the national registry of local politicians; and (v) detailed data on local elections in Italy. We find that firm-level political connections are widespread, especially among large firms, and that industries with a larger share of politically connected firms feature worse firm dynamics. We identify a leadership paradox: when compared to their competitors, market leaders are much more likely to be politically connected, but much less likely to innovate. In addition, political connections relate to a higher rate of survival, as well as growth in employment and revenue, but not in productivity-a result that we also confirm using a regression discontinuity design.

Growing Like Spain: 1995–2007

“…Although this correlation is exogenous in our static model, this finding is consistent with the dynamic model by Akcigit et al. () where there is a trade‐off between investing in better technology and in better connections. Second, the elasticity of subsidies to political connections is larger for capital than for labor, a result that comes from the observed larger dispersion of capital wedges and larger (negative) correlation between capital wedges and firm productivity.…”

“…Also, as argued by Akcigit et al. (), entrepreneurs may need to choose how much to invest in improving firm productivity (e.g., investing in R&D) vs in lobbying regulators. Finally, in Panel (b) of Table , we also report the correlation between each parameter and the level of cronyism.…”

“…Akcigit et al. () show that political connected firms in Italy have higher rates of survival, higher growth in employment, and revenue, but no better behavior of productivity. However, macroeconomic estimates are almost inexistent.…”

Property Rights, Political Connections, and Corporate Investment

“…7 For instance, politically-connected firms have better access to loans (Claessens et al, 2008;Cull et al 2015;Fan et al, 2008;Li et al, 2008), favorable access to equity markets (Boubakri et al, 2012;Francis et al, 2009), more confidence in the legal system in transitional countries (Li et al, 2008), enjoy more subsidies and tax benefits (Wu et al, 2012b;Lin et al, 2015;Shi et al, 2018), and are more likely to be bailed out when facing financial stress (Faccio et al, 2006). Moreover, politically connected firms tend to be less efficient than unconnected firms (Boubakri et al, 2008;Faccio, 2010;Fan et al, 2007;Hsieh and Klenow 2009;Luez and Oberholzer-Gee, 2006), and are less innovative (Akcigit et al 2018;Shi et al 2018). Perhaps due to their advantages in access to special resources, they tend to grow faster and survive longer (Akcigit et al 2018;Shi et al 2018).…”

Does Democratization Promote Competition?: Indonesian Manufacturing Pre and Post Suharto

“…They interpret their findings as suggesting that popular mobilization can help reduce rent-seeking. Akcigit et al (2017) demonstrate that politically connected industries exhibit worse firm dynamics and stifle innovation, exploiting close municipal elections in Italy for identification. Last but not least, our paper contributes to the literature on the impact of democracy on economic performance.…”