Why politics and business should not mix

In a new column at VoxEU.org Jiangtao Fu, Daichi Shimamoto and Yasuyuki Todo discuss Politically connected lending and economic development.

A long held view of many economists is that firms with good political connections obtain loans with more relaxed terms than those who are not politically connected. The Fu, Shimamoto and Todo column presents evidence from Indonesia that firms whose owners or directors have a personal relationship with a politician are more likely to have their loans approved by state-owned banks, and are more likely to receive the full amount applied for. However, the labour productivity of such firms is on average lower. This suggests that in some cases, politically connected lending may distort the efficiency of resource allocation and be detrimental to economic development.

Fu, Shimamoto and Todo write,

The Indonesian government implements policies to facilitate credits to SMEs with growth potential. However, our results suggest that such public credits are most likely to be given to unproductive but politically connected firms. The distorted allocation of resources may harm the economic growth of Indonesia and lead the economy into a middle-income trap. Possible solutions to this problem include reducing the political influence in state-owned banks (e.g. their privatisation), building SMEs’ credit information sharing system, and strengthening the ability of financial institutions to evaluate loan applications.

These results highlight, if such highlighting is really needed, why politics and business should never mix. Some countries are better at separating business from politics but all countries need to be aware of the dangers of the mixing of the two. Those dangers include reducing much needed economic growth. The column also points to one advantage of privatisation, in this case of state-owned banks, it helps depoliticise business decisions.