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

“…This result arises because in the data, more productive firms display average revenue products of capital and labor that are higher than the average in their sectors, and hence they are inferred to face lower capital and lower labor subsidies. Although this correlation is exogenous in our static model, this finding is consistent with the dynamic model by Akcigit et al (2017) 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.…”

“…Khwaja and Mian (2005) show how politically connected firms in Pakistan receive more credit from public banks, whereas Goldman et al (2013) show how politically connected firms in the United States obtain better access to public procurement contracts. Akcigit et al (2017) 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.…”

“…In a model of occupational choiceà la Lucas (1978) with two talents, we may obtain a negative correlation among entrepreneurs because of selection, even if these two talents were independently distributed in the general population. Also, as argued by Akcigit et al (2017), 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 4, we also report the correlation between each parameter and the level of cronyism.…”

Impact of Environmental Regulation Intensity on Green Technology Innovation: From the Perspective of Political and Business Connections

“…However, the resource curse theory suggests that enterprises with high political connections can exploit rent-seeking to defend their monopoly benefits, resulting in the prevention of innovation and the entry of high-quality competitors [74,75]. Akcigitet al [76] use the data of Italian firms and workers to find out that more politically connected industries face much lower firm entry, and most politician-intensive market leaders have the least intensive innovation compared with their direct competitors. When the payoff from rent-seeking is higher, enterprises will be more enthusiastic about using a rent-seeking strategy as an alternative to an innovation strategy, significantly inhibiting the entrepreneurship and willingness to innovate [77].…”

Italy: Toward a Growth-Friendly Fiscal Reform

“…Pellegrino and Zingales (2017) attribute the weak productivity growth in Italy to the lack of meritocracy in the selection and rewarding of managers, and the inability of firms to take full advantage of the information and communication technology revolution. Akcigit et al (2018) argue that political connections adversely affected firm dynamics, innovation, and creative destruction in Italy, weighing on the economic growth. Moreover, wage growth outpaced productivity growth, contributing to high structural unemployment; see Kangur (2018).…”