Lobby for benefits: Information-driven policy uncertainty and sectoral misallocation

Firm's political activity (rent seeking behavior) introduces an endogenous component in policy legislation. For instance, Bombardini (2008) studies the effects of corporate lobby in shaping trade policies and Kang (2012) studies the effects of lobbying activities by the energy sector. However, there has been relatively little attention devoted to the relationship between corporate rent seeking and fiscal uncertainty, and how it affects the economy at an aggregate level. This issue has gained attention in the recent years in conjunction with the rise in political/policy uncertainty during the great recession (Baker, Bloom, and Davis, 2013).

In this paper, we study the aggregate effects of the interplay between corporate rent seeking and fiscal uncertainty. To do so, we build a two sector model with dispersed information and an endogenous rent seeking decision. In our economy, firms lobby to get a preferential treatment such as tax benefits. Yet the realized benefits also depend on lobby decisions of other firms. At the industry level, the sector that lobbies more intensively gets higher average benefits while, at the firm level, the firm that spends more than the realized sectoral average lobby expenditure has benefits above the mean (we provide firm level evidence for the US to justify this modelling choice). As a result, policy uncertainty is endogenous and it is driven by a firm's rent seeking behavior, and its beliefs about the aggregate lobby in each sector. In sum, our mechanism is distinct in two important channels. First, in our model political uncertainty distorts the marginal return of investment affecting aggregate productivity through the misallocation of private investment. Second, political uncertainty is endogenous through the political economic friction presented under a dispersed information environment.

We bring our model to the U.S. slow recovery from the recession of 2007. During the recovery periods, there has been a surge in fiscal policy uncertainty and lobby expenditures. Both have been predominantly driven by tax issues as suggested by Baker, Bloom, and Davis (2013) and the volume of tax lobbying. Employing our model where the firm's rent seeking behavior is viewed as corporate lobby for the preferential tax treatment, a slow recovery of aggregate total factor productivity can arise endogenously when firms making investment and rent seeking decisions in response to unexpected substantial negative productivity shocks.