The Real Economic Impact of Political Uncertainty

This project based in Brazil aims to uncover novel facts about the nexus between politics and economics.

The uncertainty of the political system is a key feature affecting the local investment climate, which firms and entrepreneurs must consider when deciding to start, expand, or contract their businesses. This uncertainty is quite salient in cases in which firms and politicians are directly connected and political favours might be at play. This is particularly true for developing countries, where the political elites have strong ties with the private sector, access to information about firms is limited, and contract enforcement is subject to severe frictions. This aims to disentangle the mechanisms of uncertainty and political connections in determining firms’ dynamics and their strategic decisions during electoral cycles.

The researchers will first assemble a novel and rich dataset that covers the past 15 to 20 years via the combination of confidential and publicly available datasets, as well as newly collected data. The datasets will be linked using individual and firm tax identifiers, which allow for an almost perfect match of the millions of observations available. The newly combined dataset will be used to illustrate a set of facts that relate political uncertainty to outcomes such as firms’ investment and productivity dynamics, entrepreneurs’ location decisions and agglomeration spillovers, and intra-firm specific decisions to reallocate resources across plants and to insure workers. Finally, political uncertainty will be investigated to see whether it is the only channel through which real economic outcomes can be affected by political cycle. The concluding part of the analysis will attempt to estimate the level of misallocation that can be attributed to political uncertainty and political connections.

Understanding the consequences that high uncertainty can have for local economies in developing countries is key for policymakers, especially during elections. Likewise, understanding the role of political finance is now crucial as part of the democratization process of poorer countries.