There is a growing interest among economists in studying the implications of political connections, particularly in the business world of developing and transition countries. It has been found that political connections help firms secure favorable regulatory or tax conditions (Faccio forthcoming) and obtain access to resources such as bank loans (Mian and Khwaja forthcoming), which ultimately increase the value of firms (Shleifer and Vishny 1994; Fisman 2001). Despite a vast accumulation of evidence on the relationship between political connections and economic benefits, most works in this literature assume that entrepreneurs have political connections, and researchers have largely overlooked another important question: Why do entrepreneurs enter politics? Our purpose in this article is to answer this question.
There has also been a voluminous literature that examines the underdevelopment of markets and market-supporting institutions in developing and transition economies. Governments in these countries normally possess considerable control over the allocation of resources either through their power of planning or through their control of state-owned enterprises, including banks (Nee 1992; McMillan 1997). Because of the high degree of control exercised by these governments and the imperfections in the product and credit markets, private businesses cannot fully rely on the markets to secure resources. The same governments may also intervene in private business by frequently imposing unnecessary regulations (red tape) and/or very high tax rates (Johnson et al. 2000; Hellman et al. 2003; Guriev 2004). According to De Soto (1989) and Brunetti et al. (1997), these regulations and taxes have come to impose considerable costs on private firms in transition economies. Apart from the weaknesses in state and market institutions, the legal systems in these countries are also very weak (Hay and Shleifer 1998). Because laws are either nonexistent or are not enforceable, entrepreneurs cannot rely on the legal system to secure property rights and enforce contracts (McMillan and Woodruff 1999a; Frye and Zhuravskaia 2000).
Because of the lack of market-supporting institutions, private entrepreneurs in these countries either are passive victims or have to rely on other institutions to do business. Entrepreneurs in Eastern Europe and Russia have been observed to go underground to escape overregulation and high taxes (Johnson et al. 1997, 1998; Friedman et al. 2000). In Vietnam, the courts are incompetent, and entrepreneurs there depend heavily on relational contracting to lower their contract enforcement costs (McMillan and Woodruff 1999a, 1999b). In China, to overcome these institutional difficulties, local governments themselves became involved in business operations, and in the 1980s this led to the creation of an exceptionally innovative government ownership form known as the township-village enterprises (TVEs). (1) A recent study by Djankov et al. (2005) finds that entrepreneurs are less likely to expand their businesses if local institutions are weak.
Another response to state and market failures, one that has been much overlooked in the literature, occurs where entrepreneurs actively participate in politics to overcome the lack of well-functioning markets and market-supporting institutions. Or, to put it the other way, entrepreneurs' motivation to participate in politics is shaped by the institutional environment in which they operate (Bartels and Brady 2003). Many entrepreneurs in Russia, to defend themselves against "legislation that could raise their taxes, tie them to red tape, or threaten their property rights," are vying to secure a seat in the Duma, the popularly elected lower house of Russia's legislature. Dmitry Orlov, a political scientist at the Independent Center for Political Technologies in Moscow, estimates that one-fifth of the Duma's 450 seats are going to be directly occupied by businesspeople and twice as many as that (about 180 positions) could go to business lobbyists representing their clients' interests (Business Week, December 8, 2003). …