Joonkyu Choi, Veronika Penciakova, and Felipe Saffie
Working Paper 2021-13a
May 2021 (Revised August 2023)

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Abstract: We study the role of firms' political influence on the effectiveness of government spending. We build a unique database linking information on campaign contributions, state legislative elections, firm characteristics, and grant allocations of the 2009 Recovery Act. Using an instrumental variable approach, we document that, at the state level, a 10 percentage point increase in the share of spending given to politically connected firms lowers the job creation effect of stimulus by 30 percent. We also exploit ex-post close elections to obtain exogenous variation in political connections across firms, and we establish that connected firms are more likely to win stimulus grants, while those firms create fewer jobs after winning grants. A quantitative general equilibrium model shows that allocating more spending towards politically connected firms lowers the aggregate jobs multiplier as well and that this dampening effect is fully accounted for by connected firms charging higher markups.

JEL classification: D22, D72, E62, H57, R12

Key words: fiscal stimulus, public expenditure allocation, American Recovery and Reinvestment Act, political connections, campaign finance, regional economic activity

The authors thank Ufuk Akcigit, Salome Baslandze, Ryan Decker, Kinda Hachem, John Haltiwanger, Tarek Hassan, Thomas Hegland, Ethan Kaplan, Juan Rubio Ramirez, Frank Warnock, and Daniel Wilson, as well as seminar participants at the University of Maryland, the spring 2017 Midwest Macro Meetings, the 2017 North American Meeting of the Econometric Society, the 2017 European Meeting of the Econometric Society, the Workshop on Innovation and Entrepreneurship, Pontificia Universidad Catolica de Chile, the Federal Reserve Board, Georgetown University, the Fall 2019 I-85 Macroeconomics Workshop, the Federal Reserve Bank of Atlanta, Auburn University, the US Bureau of Labor Statistics, and the Inter-American Development Bank. They also thank Benjamin Delgado and Fiorella Pizzolon for their excellent research assistance. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to Joonkyu Choi, Federal Reserve Board of Governors; Veronika Penciakova, Federal Reserve Bank of Atlanta; or Felipe Saffie, University of Virginia, Darden School of Business.

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