Political Connections and the Effectiveness of US State Government Resource Allocation

We find that US state governments allocate economic incentive awards disproportionally to firms that are politically connected to state politicians and that these political connections distort the effectiveness of resource allocation. A connected firm is more than three times more likely than an unconnected firm to receive an incentive award, and the award amount is 51 percent larger. This relation is robust to unexpected gubernatorial departures and close gubernatorial elections for which endogeneity is less of a concern. Importantly, unconnected firms that receive awards generate 1.5-2.0 times greater future job growth, and only awards to unconnected firms are associated with job spillover to other industries and long-run aggregate local economic growth. Connected awards are more likely and larger when politicians' motives appear self-serving. Collectively these findings suggest that awarding economic incentives to politically connected firms is not an effective use of state taxpayers' funds. The state-the machinery and power of the state-is a potential resource or threat to every industry in the society. With its power to prohibit or compel, to take or give money, the state can and does selectively help or hurt a vast number of industries. (Stigler 1971, p. 3)