Economic and Political Networks and Firm Openness: Evidence from Indonesia

Abstract

Using a firm-level dataset from the manufacturing sector in Indonesia, we examine how firms’ ties with the government in receiving rents and with other firms and their managers' trust toward foreigners and views of globalization are correlated with each other. We find that firms’ strong political ties are associated positively with the level of managers’ trust toward domestic citizens and the number of domestic buyers and suppliers and negatively with their level of trust toward foreign citizens. In turn, managers’ trust toward foreign citizens and firms’ transactions with foreign firms are positively correlated with each other, and trust and business networks within the country also show a positive correlation. Then, when managers trust domestic citizens more or when firms transact with more domestic firms, managers are more likely to have a negative view of globalization, incorporating such factors as the foreign ownership of firms and free trade. The results suggest a vicious cycle between the political ties of local firms and protectionist views and policies against globalization, which lead to economic stagnation due to a lack of diffusion of knowledge from abroad. This mechanism may explain why middle-income countries experience economic stagnation and cannot escape the “middle-income trap.”