Law and Economics Classics - Political Connections
At Grove City College, I teach Law and Economics--a course that explicitly examines how "people expand their options by cooperating." It therefore lies at the heart of "mere economics." In this sermon series, I'll be posting a summary of classic L&E papers over the coming weeks.
Fisman, Raymond. "Estimating the value of political connections." American Economic Review 91, no. 4 (2001): 1095-1102.
During the late 1990’s, as Indonesia’s economy spiraled downward, some were concerned that political connections, rather than fundamental issues of productivity were the true determinants of firm profitability. Testing this hypothesis is difficult. Defining political connectedness is likewise difficult. There are also endogeneity issues. Fisman uses an event study of India to investigate whether political connectedness is an important driver of profitability. He uses variations in Indonesian president Suharto’s health to compare the returns of firms with differing degrees of political exposure. Fisman finds that well-connected firms suffer more than less-connected firms in response to a severe rumor of Suharto’s health. His measure of political connectedness is the “Suharto Dependency Index” put together by a geopolitical consulting firm. One robustness check examined the relationship between other types of “bad” news and the returns of connected firms. In this case, there was connection between the bad news and the firm’s returns, suggesting that it was bad news about Suharto’s health specifically that is driving the results. These results suggest that political connections play a large role in many of the world’s largest economies, as most indices rank many other countries as being more corrupt than Indonesia.
One caution with papers like this. It's easy for contemporary economists to muddy the distinction between “theory and history.” What this paper discovers isn’t some universal law about the relationship between political connections and firm outcomes. Rather, it’s an important piece of economic history, which demonstrates the extent to which political connections mattered in this historical episode. And it inspires us to examine similar questions in other episodes, though the constraints in those other episodes may very well differ.
For more Fisman on corruption, see here.