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.