Across the world and, especially in India, politics and business often intertwine. Firms use political connections for favourable regulations, to cut red tape, or to access resources. These connections can help firms, but how do they impact competition and innovation in an economy?

According to a new National Bureau of Economic Research working paper by Ufuk Akcigit of the University of Chicago, Salomé Baslandze of the Einaudi Institute for Economics and Finance, and Francesca Lotti of the Bank of Italy, political connections in business can stifle innovation and quash competition.

The authors analyse data from Italy, a country with a reputation for political-business nexuses, and where firms are allowed to hire politicians. Combining data from Italian companies, workers, politicians and elections between 1993 and 2014, they find that firm-level political connections, defined as politicians working in firms, are widespread, especially in larger and older companies.

As companies get larger, they hire more politicians and this helps performance by overcoming market frictions (such as regulatory requirements). The authors show that politically connected firms are more likely to have higher employment, growth and survival rates. And this survival rate increases with the seniority of the politician hired. However, more politically connected firms file fewer patents, implying they are less innovative.

Extending this to industries, the authors argue that political connections tend to be associated with worse industry dynamics such as lower market entry, growth and productivity. According to the authors, all this could have significant social costs and political connections can be an impediment to productivity growth.

While Italy may be an extreme case of business and political linkages, the authors point to the US and Europe, where productivity growth has been weak and business dynamism has declined as market concentration has increased amid rising spending on lobbying. Indian policymakers and voters should take note.

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