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Is Latvia a democracy? This is a very hard question, but let’s consider two intuitively simple,
yet very different, views of how things work in this country. Those who believe that Latvia is
clearly a democracy would begin by pointing to the fact that voters elect their
representatives into the Saeima [parliament], which appoints the government. They will also
point out that, if voters are unhappy with the government, or the Saeima, they will vote it
down in the next election. This, the argument goes, will ensure that elected representatives
(wishing to be re-elected) will, most of the time, act in the interests of voters.
In recent years, however, there has been an increasing amount of questioning of whether
the above is an accurate description of how things really work in Latvia. Some critically-
minded people argued that, although politicians are elected by the voters, they mostly cater
to the interests of small but well-organized business groups. They do so by using their
legislative and executive powers to protect the business interests of these groups, and
create profit opportunities for them. When the election time comes, business groups use
these profits to finance expensive election campaigns that help these politicians to get re-
elected. Thus, according to this more pessimistic view, Latvia may be a democracy de jure,
but de facto it looks more like some sort of oligarchy.
I have to admit from the start that I do not have the answer to the important question of
whether Latvia is a democracy de facto as well as de jure. However, I believe I can
demonstrate evidence that will shed some light on the above issues. My focus is on a rather
narrow question of whether political connections matter to the performance of firms. For
example, does making a campaign contribution make firms grow faster compared to similar
firms that made no contributions? In a well-functioning democracy, political connections
should not matter to the performance of individual firms because most voters would not be
happy with the idea that politicians use their office for the profit of some businessmen.
Political parties usually do not admit there is a quid pro quo relationship between them and
people who finance their election campaigns. What we are typically told is that contributions
are simply a token of support for a party’s program, pretty much the same as voting. In a de
facto oligarchy, however, campaign contributions are part of the implicit agreement between
politicians and business interests.
In what follows I will demonstrate convincing evidence that political connections do matter
and, specifically, campaign contributions result in benefits to the firms that make them. I will
also attempt to put these findings in a broader picture by discussing the consequences and
the causes of connections.
Before I go on, however, a likely objection has to be addressed. “So what?” – a critical
reader may ask. There is plenty of evidence of corrupt politicians and their links with
businesses, isn’t there? That is certainly true; there is no shortage of such stories in the
newspapers. This, however, is anecdotal evidence, and this kind of evidence can never be
fully convincing. We know instances when politicians are corrupt and we know instances
when they are not. The important question is whether corruption is an exception rather than
the rule? Or, is it the other way round? In other words, what we need to know is whether an
average firm benefits from being politically connected, and this is precisely the kind of
evidence I aim to deliver.
The Consequences
If one accepts that political connections matter, the question is what it means to us, the
people of this country. Some may argue that the fact that politicians actually provide
benefits to some businesses is not such a bad thing. Perhaps, but it depends on how
businesses benefit from political connections. It is a mistake to think that what’s good for
business is good for a country. The main motive of entrepreneurs is profit. They can achieve
it in a way that benefits the society – e.g. by innovating, producing goods and services and
competing to deliver the best value for money to their customers. However, they also do not
hesitate to profit from securing monopoly power, getting rid of the competition, blocking
entry of new businesses to their market – if they can get away with it. Profit seeking has its
‘dark side’. How can businesses profit with the help of politicians and what are the
consequences?
First, obviously there are plenty of opportunities to fiddle with state procurement. We can
suspect that what public sector buys is more expensive than it should have been, and
sometimes should not have been bought in the first place. Second, connections (e.g.
campaign contributions) could be a down payment to receive some services in the future.
For example, some recent events suggest that it is hard to build anything in the city of Riga
without bribing officials of the city Council. Perhaps those who help elect the winning parties
with their contributions get a discount. The above examples have been much discussed
already and their interpretation is simple. Both cases are instances of theft, and we are its
victims. For example, if it takes a large bribe to obtain a permit to construct a new
apartment complex in Riga, construction firms will treat it as an expense of doing business,
and pass it on to us, the consumers, in the form of higher prices. Clearly, what makes this
theft special is the ignorance of victims, who often do not realize their pockets have been
skillfully picked.
There is a third way of how businesses can profit from political connections and it is the
worst one. Politicians use their office to create monopoly power – by creating barriers to
entry, making life difficult for competitors, and often simply by consistently favoring
connected firms. Economists have called it the production of rents. Unfortunately, one does
not have to look far for examples. Take recent actions by municipal governments, which
would effectively create regional monopolies in garbage collection. Monopoly power means
large profits, and high prices. Moreover, in time such interaction between politicians and
businesses will result in an economy where most firms operate in well-defined niches,
protected by nuanced regulations and the power of their partners in politics. In other words,
we will see creation of a de facto oligarchy in a de jure democracy. There will be no
innovations, no prosperity. The best and the brightest will flee to other countries, leaving
mostly the new plutocrats and those they can fool and exploit. What has been happening in
Russia in the last years is a good example of this.
The Causes
If you agree that political connections are a concern, the natural question is what can be
done about it. There is no shortage of proposals as to how to put an end to corruption but
many of them are of the “forbid-and-forget” variety. For example, there are proposals to
outlaw campaign contributions from private individuals and finance election campaigns
exclusively from the state budget. I have serious reservations about the effectiveness of
such naïve solutions. In the example with campaign contributions, firms were forbidden to
make contributions but effectively continued to do so through persons connected with them,
e.g. its board members and shareholders. Or, take the recent controversy with the election
campaign of the People’s Party (Tautas partija). Where does freedom of speech end and
political campaigning begin? I am skeptical of the effectiveness of simple ‘solutions’ because
they go after symptoms one can readily observe, but do not address the underlying causes
of the problem.
What are the causes? The essence of the problem can be sketched in the following way.
Businesses seek profits. Politicians and public officials can provide profits to businesses by
conferring monopoly power in sophisticated, hard-to-observe ways – if they can get away
with it when election comes. In turn, businesses can use part of their new profits to finance
‘brain-washing’ election campaigns for the politicians that help them. As a result, the state is
captured by special interest groups, and democracy is subverted. Unfortunately, there is no
simple solution to this problem. There is no magic switch, no legal act that can forbid
something, no money that can be given to somebody to make things right. Yet a number of
issues follow from the above and I will discuss them briefly.
[1] Vyacheslav Dombrovsky, "Political Connections and Firm Performance: The Latvian Way",
Stockholm School of Economics and Baltic International Centre for Economic Policy Studies
[2] For the exception of banks, state-owned companies, and non-profits organizations.
[3] Any measure of performance based on reported profits would certainly be suspect
because of widespread perception of tax evasion.
[4] See the accompanying paper for more details on research methodology.
[5] January 1st to October 5, 2002.
[6] Average in this case (and in the next example) refers to the median and is calculated
over all years.
[7] Please see the original paper for some other interesting findings on the effects of political
connections.
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