The High Cost of Political Influence

Conventional wisdom suggests that, all else being equal, a company favored by politicians should have a leg up on its competition, or at least be no worse off. Perhaps not, suggest two associate professors at Georgetown University’s Edmund A. Walsh School of Foreign Service in their January 2008 working paper, Do Politically Connected Firms Undermine Their Own Competitiveness? Evidence From Developing Countries.

“Political influence may come at the cost of lower productivity,” explains Anders Olofsgård, also a senior fellow at the Stockholm Institute of Transition Economics at the Stockholm School of Economics. “Politicians are expecting something in return from you. One way to pay back politicians is through jobs. So you may be locked into keeping higher employment than you otherwise might be.” Politically influential companies are also less likely to make the vital investments that lead to sustaining a company’s long-term growth, the paper shows.

Olofsgård and coauthor Raj M. Desai, who is also a visiting fellow at the Brookings Institution, model political influence as a quid pro quo. When companies have close ties with government officials, the authors argue, they often receive favors. Think selective enforcement of rules (or lack thereof), market restrictions that inhibit foreign or domestic competition, tax exemptions or other government actions that confer economic value. In return, however, companies are expected to give back. One method, the authors hypothesize, is by keeping their employment high, thereby appeasing the electorate and keeping the social peace that contributes to a politician’s tenure.

But bloated staffs are no bargain for any company, as Olofsgård and Desai show when they examined the World Bank’s Enterprise Surveys. Between the years 2000 and 2005, as part of those surveys, approximately 8,500 companies in about 40 developing countries were asked about their perceptions of the influence of their business, other businesses and politically connected individuals or companies on recent national legislation in their respective countries. The data indeed confirm that political influence makes companies’ lives easier in some respects. Overdue receivables, for example, were less of a problem for such corporations, suggesting that perhaps their identity as political cronies gave influential companies added respect among trading partners.

But at what cost? Politically influential companies, according to the authors’ analysis of the survey data, were more likely to maintain excess labor, as compared with noninfluential companies, even after controlling for industry and country effects, among other factors. So companies might be trading the lower direct costs that accompany political influence for lower productivity. They also tend to report more of their income to tax authorities.

What’s more, “politically influential firms are less likely to make investments and invest in the long term,” reports Olofsgård. The likelihood of a company having opened a new plant or launched a new product line in the past three years went down with greater perceived political influence. “That might be because [the companies] are giving up some control rights by becoming influential,” Olofsgård said. Less investment and innovation is unlikely to benefit the company in the long run, even if it is able to stay in political good graces. This should give any manager pause, regardless of the country within which he or she is operating, before scratching a politician’s back.

Of course, practices associated with political influence often straddle legal or ethical gray areas. Indeed, the World Bank data comprised companies operating in developing countries, where transparency, oversight and governance are considered weak in many cases. So what about developed nations? “My hunch,” says Olofsgård, “is that the trade-off between influence and employment might be stronger in developed countries.” That’s because, in developed nations, there is greater transparency regarding other means of giving back to politicians, such as political contributions — thus, he theorizes, forcing the quid pro quo exchanges toward areas like employment.

Outright corruption, notably in the form of bribery, is reported separately by respondents to the World Bank’s survey. Interestingly, “one thing we found is that influential firms engage in less direct corruption,” points out Olofsgård. So, one of the benefits of political influence is that politically connected companies pay less in bribery. Rather, the companies appear to be paying politicians back through payrolls.

There is another explanation for managers trying to gain political influence: They might be acting for personal gain, rather than for their companies’ competitive advantage. Unfortunately, the World Bank survey neither delves into personal relationships nor identifies the companies or executives who responded. This suggests that shareholders and owners, too, might want to keep a close eye on the political activities of their companies and executives.

For more information, download the paper at www.brookings.edu/papers/2008/01_cronyism_desai.aspx or contact Anders Olofsgård at afo2@georgetown.edu or Raj Desai at rdesai@brookings.edu.