The Political Economy of Entry: Lobbying and Financial Development

Abstract

We present a model of endogenous lobby formation in which wealth inequality and political accountability undermine both entry and financial development. The elite will seek a lower level of effective minority protection than the middle class to prevent potential entrants from raising financing. The elite wins because its lobby can promise larger political contributions due to the higher rents earned by restricting entry. Entry and investor protection improve when wealth distribution becomes less unequal, and the political system becomes more accountable. Evidence across 48 countries indicates that greater accountability and lower income inequality are associated with stronger legal enforcement, even after controlling for legal origin and per-capita income. Moreover, greater political accountability increases entry in external capital-dependent industries; its inclusion makes financial development insignificant. These results suggest that lobbying protects established interests by creating entry barriers and undermining legal enforcement.