Firm Profits and Government Activity: An Empirical Investigation


Petar Jolakoski, Branimir Jovanović, Joana Madjoska, Viktor Stojkoski and Dragan Tevdovski

wiiw Working Paper No. 194, February 2021
31 pages including 13 Tables and 1 Figure

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If firm profits rise to a level far above than what would have been earned in a competitive economy, this might give the firms market power, which might in turn influence the activity of the government. In this paper, we perform a detailed empirical study on the potential effects of firm profits and markups on government size and effectiveness. Using data on 30 European countries for a period of 17 years and an instrumental variables approach, we find that there exists a robust relationship between firm gains and the activity of the state, in the sense that higher firm profits reduce government size and effectiveness. Even in a group of developed countries, such as the European countries, firm power may affect state activity.


Keywords: firm profits, government size, government effectiveness

JEL classification: C23, H11, H50

Countries covered: Austria, Belgium, Bulgaria, Croatia, Cyprus, Czechia, Denmark, Estonia, Europe, European Union, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Norway, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, Switzerland, United Kindom, EFTA, EU

Research Areas: Macroeconomic Analysis and Policy