Privileges for Enterprises: Efficient Discrimination or Room for Abuse?

Although many enterprises in Russia have been privatized, the government still retains its influence over them; they, in turn, also try to attain state guardianship. State patronage over firms often takes the form of privileges (e.g., subsidies, tax discounts or government projects) given to firms in exchange for some “payment” (not necessarily in the monetary form). The purpose of this paper is, firstly, to reveal the incentives of both parties to set up and accept patronage and, secondly, to evaluate the economic consequences of such relations. If the government is non-benevolent, it uses privileges inefficiently. The proposed theoretical model detects the following sources of inefficiency: public goods are underprovided; the absolute level of privileges is too high; the discrimination suppressing inefficient firms may be too severe; and, finally, a self-interested government is likely to support large “old” enterprises with weak incentives to invest, which may negatively affect future economic growth.