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The Aggregate Costs of Political Connections

Author

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  • Jonas Gathen

    (CEMFI, Centro de Estudios Monetarios y Financieros)

Abstract

This paper quantifies the aggregate costs of political connections using a general equilibrium model in which politically connected firms benefit from output subsidies and endogenously spend resources on rent-seeking activities. The model is structurally estimated using rich firm-level data for the Indonesian manufacturing sector and a firm-level measure of political connectedness based on a natural experiment from the authoritarian rule of Suharto at the end of the 1990s. A major innovation is to flexibly identify the distribution of output subsidies from relative total factor productivity (TFPQ) distributions across connected and non-connected firms. While only 1.3% of firms are connected, I find that connections impose large costs, with permanent consumption losses of 7.4% and output losses of 2.7%. 2/3 of costs are driven by too much dispersion in subsidies across connected firms, while 1/3 are driven by an excessive level of subsidies.

Suggested Citation

  • Jonas Gathen, 2025. "The Aggregate Costs of Political Connections," Working Papers wp2025_2505, CEMFI.
    • Handle: RePEc:cmf:wpaper:wp2025_2505
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    More about this item

    Keywords

    Misallocation; firm dynamics; political connections; corruption; rent-seeking; development.;
    All these keywords.

    JEL classification:

    • O11 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development
    • O25 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Industrial Policy
    • O43 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Institutions and Growth
    • D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Political Processes: Rent-seeking, Lobbying, Elections, Legislatures, and Voting Behavior

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