Political Trade Protection in Developing Countries: Firm Level Evidence from Indonesia
48 Pages Posted: 8 Aug 2005
Date Written: July 9, 2005
Empirical tests of the "Protection For Sale" hypothesis typically involve regressing industry-average tariff or non-tariff trade barriers on campaign contributions or organized industry lobbies. In developing countries, politicians in power are typically interested in protecting the business interests of particular individuals "connected" to them, not industries as a whole. Political protection is therefore firm-specific and based on personal relationships between firm owners and influential politicians. Politicians rely on import licensing more than other trade barriers, since licensing requirements are easier to obfuscate from the public eye. This paper identifies "politically connected" firms from the entire population of over 20,000 manufacturing firms in Indonesia, and studies the impact of a connection to President Suharto on the probability that those firms are granted import licenses for raw-materials and for commodities for sale in local markets. We find that connected firms are between 6 and 22 percentage points more likely to receive a license than their competitors, and that these licenses often create monopolies for connected firms. We also show that licenses are valuable to those who receive them, and that there are economy-wide welfare costs of this system of corrupt protection. In particular, there is evidence that licensing increases industry concentration, and decreases the correlation between firm productivity and market share. Finally, we show that industry-level analysis of tariff rates or non-tariff barriers would miss important details of the system of corrupt trade protection prevalent in Indonesia.
Keywords: Protection for Sale, Developing Countries, Political Connections, Import Licensing, Indonesia
JEL Classification: F1, F13, O12
Suggested Citation: Suggested Citation