Essays on Firms and Political Connections in Indonesia

Akhmad Rizal Shidiq

Advisor: Garett Jones, PhD, Department of Economics

Committee Members: Alex T. Tabarrok, Carlos D. Ramirez

Buchanan Hall, #D180
September 07, 2016, 11:00 AM to 08:00 AM


In the first chapter, I show evidence of credit-market imperfection in Indonesia: investment spending is sensitive to firm cash flow. These imperfections are stronger for firms that are not politically connected to former president Suharto. This result generally holds for a variety of controls. This result also underscores the importance of political connections in providing firms with preferential access to the external financing commonly found in developing economies. The removal of Suharto from power in 1998 did not substantially reduce the value of a Suharto connection, and may have strengthened the value of such a connection. This highlights the possible durability of political connections in the credit market.


In the second chapter, I estimate the impact of political connections on creative destruction in the Indonesian manufacturing industry between 1991 and 2005. I find that a higher industrial concentration of firms connected to the former president Suharto reduces unconnected firms' ability to efficiently respond to productivity shocks. The presence of politically connected firms pushed unconnected firms against a higher production selection threshold and forced them to forego production activities that would have been feasible to initiate or maintain in a competitive industry.  As a result of political-connections-induced congestion, for each ten-percentage point increase in the share of assets in a three-digit-level industry held by connected firms, the productivity wedge between unconnected and connected firms, as measured by the firms' total factor productivity (TFP) rose by 4 percent. Moreover, the fall of the Suharto regime in 1998 reduced the productivity gap for firms the closer they had been to Suharto, suggesting productivity congestion declined and highlighting the role of political connections in jamming up creative destruction. 


In the third essay, I estimate the impact of business-group membership a firm's performance in the Indonesian manufacturing industry in 1996 and 2006. I find that being a member of a business group positively affected firms' performance. It appears, however, that the business-group membership premium came from providing better access to the market, rather than by having a differential effect on production activities. The result generally holds across estimation strategies. In the main specification using the propensity-score matching, being a member of a business group increased the firms' earnings by 21 percent and labor productivity by 11 percent. Business-group memberships evidently brought firms better access to the markets for imported inputs and highly educated labor, and, to some extent, the export-product market. The effects of business-group membership on firms' production activities were more ambiguous: relative to the standalone firms, the affiliated firms spent more on wages, less on materials, and generally the same amount of investment. This finding provides more evidence for the benefit of business-group membership for firms in developing economies.