Research

Working Papers

Misallocation of Resources, Political Connections and External Flows (Job market Paper) (Latest version)

This paper shows that the current design of foreign aid and loans may impede growth in developing economies with weak political institutions. First, the paper provides empirical evidence that politically connected Pakistani firms pay lower effective taxes and this tax differential increases with the public external debt to GDP ratio. I then develop a political economy model in which, agents connected with the government receive lower taxes and barriers to entry in exchange for political support, causing misallocation in the economy. High external flows give the government more room to lower taxes on connected entrepreneurs, which keeps low productivity, connected firms in the market. I calibrate the model to the economy of Pakistan and show that reducing flows by 30%, reduces inequality and generates an output gain of 12%. I also show that a similar outcome could be obtained by, adding conditions to existing external flows that require a higher level of fiscal revenues or that reduce barriers to entrepreneurship.

Modelling corporate tax rates in the presence of political connections and external assistance 

This paper develops a static political economy model to show that in an environment of weak political structures that provide an economic advantage to politically connected, external assistance (aid and loans) may not encourage economic growth. In the model, endogenous tax differential arises between the agents which are connected and non connected with the Elite, due to the Elite’s dependence on the political patronage to stay in power, causing resource misallocation. I show that if the tax differential is large enough, then depending on the parameters of the economy, it is possible to get an equilibrium with misallocation: a situation where low skill entrepreneurs remain or enter in the market. I calibrate the model to Pakistan and get an equilibrium with resource misallocation. I show that decreasing  non-tax government revenue such as external debt and aid by 71%, increases tax differentials, eliminates resource misallocation, and increases output by 11%.

External Debt, Political Connections and Effective tax rates: Evidence from Pakistani firms (Working Paper)

Preferential treatment received by the politically connected firms in an economy has been identified as one of the potential causes of the misallocation of resources in developing economies restricting growth. Pakistani politics suffers with corruption and rent-seeking and in the last few years is dependent on external debt, loans and bailouts. Using data from 268 publicly listed Pakistani firms and elections data for the period of 2013-2019, this paper identifies the politically connected firms as those with key board members taking part in an election. The paper finds that politically connected firms pay 8.32 percentage points lower effective taxes. It shows that taking part in the election is enough to receive the preferential treatment and politically connected firms with winning candidates do not pay lower effective tax rates than candidates who do not win. It also finds that a 0.1 increase in the external debt to GDP ratio decreases the tax rates for politically connected firms by 6.81 percentage points. The decrease in the tax rates for the connected is higher when the public external debt to GDP ratio is used.