Firm Political Influence, Industrial Policies, and Intra-Firm Linkages

Linkages between foreign firms and domestic suppliers can generate positive impacts for these suppliers, such as productivity gains and skills and technology transfers. However, the materialization of these foreign direct investment (FDI) linkages is not automatic. Many factors can affect the materialization and the extent of these linkages, such as foreign and domestic firm characteristics and host economy conditions, which have been amply studied in existing literature. One aspect which has received relatively little attention is the role of political economy factors. This paper seeks to examine the impact of firm political influence on linkages between foreign firms and domestic suppliers. The firm-level empirical analysis, based on the World Bank Enterprise Survey (WBES) and the Political Influence Index (PII) for 41 economies, finds that a foreign firm’s political influence is negatively associated with the degree of linkages it creates. The mechanisms of this negative relationship are that elite firms may use their political influence to evade obligations, commitments, or expectations to create linkages; to influence industrial policies leading to barriers to the entry of non-elite firms or to ineffective linkages policies; or to monopolize supply contracts. The findings also identify important heterogeneity, as the negative relationship between political influence and linkages is only significant for manufacturing firms, not for services firms, and most prominent in countries characterized by intermediate governance levels. Qualitative analysis can provide additional insights into the mechanisms underlying associations between firm political influence and linkages outcomes, elucidating the role of country- and sector-level political and economic attributes. The results have important implications for designing effective linkages policies in developing countries.