Connecting to Power: Political Connections, Innovation, and Firm Dynamics

We study the Italian firms and their workers to answer this question. Our analysis uses a brand-new data spanning the period from 1993 to 2014 where we merge: (i) firm-level balance sheet data, (ii) the social security data on the universe of workers, (iii) patent data from the European Patent Office, (iv) registry of local politicians, and (v) detailed data on local elections in Italy. We find that firm-level political connections are widespread, especially among large firms, and that industries with a larger share of politically connected firms feature worse firm dynamics. Market leaders are much more likely to be politically connected and less likely to innovate, compared to their competitors. In addition, connections relate to higher survival and growth in employment and revenue but not in productivity – the result that we also confirm using regression discontinuity design. We build a firm dynamics model where we allow firms to invest in innovation and/or political connection to advance their productivity and to overcome certain market frictions. The model highlights the new interaction between static gains and dynamic losses from rent-seeking for aggregate productivity.