CORRUPT PROTECTION FOR SALE TO FIRMS: EVIDENCE FROM INDONESIA *

Abstract

Empirical tests of the “Protection For Sale” hypothesis typically involve regressing industryaverage tariff or non-tariff trade barriers on lobbying by industries. In developing countries, politicians in power are more interested in protecting the business interests of particular individuals “connected” to them, not industries as a whole. Tariffs are not firm-specific (and are subject to WTO penalties), which is why politicians assign import licenses on the basis of corrupt or nepotistic personal relationships with individual firm owners. 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. By conservative estimates, being connected triples the likelihood of receiving a license relative to the firm’s competitors, and having a member of the Suharto family on the firm’s board of management quadruples this likelihood. Moreover, licenses often create monopolies for connected firms, as their competitors are less likely to receive the same import license. There are indications of welfare losses from this system of corrupt protection. In particular, licensing increases prices for downstream producers and consumers, increases industry concentration, and decreases the correlation between firm productivity and market share. Finally, we show that it would be difficult to uncover details of the system of corrupt trade protection prevalent in Indonesia by conducting industry-level analysis of the determinants of tariff rates or non-tariff barriers.