Favoritism refers to the act of offering jobs, contracts and resources to members of one's own social group in preference to others who are outside the group. This paper examines the economic origins and the consequences of favoritism.

We argue that favoritism is a mechanism for surplus diversion away from the society at large and toward the group. As it usually entails inefficiencies, favoritism highlights the role of frictions in economic exchange. Favoritism is easier to sustain in a small homogenous group and when there is heterogeneity across groups. Favoritism has negative effects on incentives to undertake investments and innovation. These predictions appear to be consistent with empirical evidence.