DP6671 Interest Group Politics in a Federation

Author(s): Sergei Guriev, Evgeny Yakovlev, Ekaterina Zhuravskaya
Publication Date: February 2008
Keyword(s): Federalism, Inter-jurisdictional externalities, Inter-state trade barriers, Interest groups, Multinational firms
JEL(s): D78, F15, F23, H77, P26
Programme Areas: Public Economics, Development Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=6671

The optimal degree of decentralization depends on the importance of inter-state externalities of local policies. We show that inter-state externalities are determined by spatial distribution of interest groups within the country. Interest groups who have multi-state scope internalize inter-state externalities to a larger extent than the lobbyists with interests within a single state. We use variation in the geographic boundaries of politically-powerful industrial interests to estimate the effect of inter-state externalities on firm performance. Using firm-level panel data from a peripheralized federation, Russia in 1996-2003, we show that, controlling for firm fixed effects, the performance of firms substantially improves with an increase in the number of neighbouring regions under influence of multi-regional business groups compared to the number influenced by local business groups. Our findings have implications for the literatures on federalism and on international trade as trade restrictions are a common source of inter-state externalities.