Political Connections Increase a Firm's Revenues by 5.7%

Connections between firms and politicians are widespread in many countries. Although political connections might accrue private returns to connected firms, they might also create social costs for the rest of the economy. Inspired by such questions Paolo Pinotti (Department of Policy Analysis and Public Management) and Federico Cingano (Bank of Italy), in their Politicians at Work: The Private Returns and Social Costs of Political Connections (Journal of the European Economic Association, doi: 10.1111/jeea.12001), quantify the private returns and the social costs of political connections. The authors find that the revenue premium granted by political connections amounts to 5.7% on average, and such gains are particularly significant in areas characterized by high public expenditure and high levels of corruption.

The authors' identification strategy is grounded in a theoretical framework from which private returns to political connections in terms of revenues, profits and wages, and the associated social costs in terms of misallocation of public expenditure can be derived. Consequently, in order to estimate the model, they rely on a unique longitudinal dataset matching detailed information on a representative sample of Italian manufacturing firms and all their employees with administrative archives on the universe of Italian local politicians over the period 1985–1997. Given a connected firm is defined as a firm employing (at least) one individual in a local government, the findings suggest that access to political connections increases a firm's revenues by about 6%. However, such gains are viable only when a firm is connected to the local government, and not to the opposition parties.

Moreover, the authors provide evidence that supports the grabbing hand hypothesis for the mechanism at work. Namely, public demand is favorably shifted towards those firms employing local politicians. Therefore, the average effect is entirely driven by domestic sales (as opposed to exports) and by firms operating in sectors that are intensive providers of inputs to the public administration, and it is larger in regions characterized by high public expenditure (21.9%) and high corruption (8.5%). On top of that, such connection induced misallocation of public procurement lowers local administrations' public good provision by about 20%.

In sum, this study argues that political connections provide gains for connected firms at the expense of efficiency losses in the public sector. In other words, the gains made by the connected firms are not due to higher productivity, but rather due to greater sales to public procurers thanks to their connections. And these gains increase as the degree of corruption increases.