How do political connections affect firm dynamics, innovation, and creative destruction? This is a recurrent topic on this blog, and here is an interesting working paper⁽¹⁾ published by the Bank of Italy this summer, delving into the question.

Ufuk Akcigit, Salomé Baslandze and Francesca Lotti study the political connections that help firms ease their bureaucratic and regulatory burden:

The model highlights how political connections influence an economy’s business dynamism and innovation, and generate a number of implications guiding our empirical analysis.

They document a “leadership paradox” that clearly illustrates the political economy problem of creative destruction. A summary of their findings:

• Fact 1 Market leaders are the most politically connected but the least innovative, relative to their direct competitors.
• Fact 2 At the firm level, political connections are associated with higher employment and revenue growth but not with productivity growth.
• Fact 3 Politically connected firms are more likely to survive, and their survival probability increases along with the political power of the politicians they employ.
• Fact 4 Politician-employees earn significant wage premiums relative to their co-workers. This premium implies an average 20%-80% rent sharing between the politicians and the firm, respectively.
• Fact 5 New firms enter more-connected industries at a slower rate, but conditional on entry, entrants are more likely to be connected than in other industries.
• Fact 6 More-connected industries have a lower share of young firms and exhibit lower growth and productivity.

In short:

Market leaders are much more likely to be politically connected, but much less likely to innovate. Political connections relate to a higher rate of survival, as well as growth in employment and revenues, but not in productivity. At the aggregate level, gains from political connections do not offset losses stemming from lower reallocation and growth.

The business of “market leaders” is not innovation.

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(1) Akcigit, Ufuk, Salomé Baslandze, and Francesca Lotti. ‘Connecting to Power: Political Connections, Innovation, and Firm Dynamics’. Temi di discussione (Economic working papers). Bank of Italy, Economic Research and International Relations Area, July 2022. https://econpapers.repec.org/paper/bdiwptemi/td_5f1376_5f22.htm.