• co-auth.2441/3jrdrmhd259iqamkde1nspkq84 (1)
  • MORROW John (1)
  • SONNTAG Jan (1)
  • OBERFIELD Ezra (1)
Type de Document
  • Working paper (5)
The strength of contract enforcement determines how firms source inputs and organize production. Using microdata on Indian manufacturing plants, we show that production and sourcing decisions appear systematically distorted in states with weaker enforcement. Specifically, we document that in industries that tend to rely more heavily on relationship-specific intermediate inputs, plants in states with more congested courts shift their expenditures away from intermediate inputs and appear to be more vertically integrated. To quantify the impact of these distortions on aggregate productivity, we construct a model in which plants have several ways of producing, each with different bundles of inputs. Weak enforcement exacerbates a holdup problem that arises when using inputs that require customization, distorting both the intensive and extensive margins of input use. The equilibrium organization of production and the network structure of input-output linkages arise endogenously from the producers’ simultaneous cost minimization decisions. We identify the structural parameters that govern enforcement frictions from cross-state variation in the first moments of producers’ cost shares. A set of counterfactuals show that enforcement frictions lower aggregate productivity to an extent that is relevant on the macro scale.

This paper studies the prevalence of vertical market foreclosure using a novel dataset on U.S. and international buyer-seller relationships, and across a large range of industries. We find that relationships are more likely to break when suppliers vertically integrate with one of the buyers’ competitors than when they vertically integrate with an unrelated firm. This relationship holds also, among other things, when conditioning on mergers that follow exogenous downward pressure on the supplier’s stock prices, suggesting that reverse causality is unlikely to explain the result. In contrast, the relationship vanishes when using rumored or announced but not completed integration events. Firms experience a substantial drop in sales when one of their suppliers integrates with one of their competitors. This sales drop is mitigated if the firm has alternative suppliers in place.

Contracting frictions affect the organization of firms, but how much does this matter on the aggregate level? This paper studies how costly supplier contract enforcement shapes the patterns of intermediate input use and quantifies the impact of these distortions on aggregate productivity and welfare. Using the frequency of litigation between US firms to measure the potential for hold-up problems, I find a robust relationship between countries’ input-output structure and their quality of legal institutions: in countries with high enforcement costs, firms have lower expenditure shares on intermediate inputs in sector pairs where US firms litigate frequently for breach of contract. I adapt a Ricardian trade model to the study of intersectoral trade, and show that the variation in intermediate input shares that is explained by contracting frictions is large enough to generate sizeable welfare increases when enforcement institutions are improved.

Legal institutions affect economic outcomes, but how much? This paper documents how costly supplier contract enforcement shapes form boundaries, and quantifies the impact of this transaction cost on aggregate productivity and welfare. I embed a contracting game between a buyer and a supplier in a general-equilibrium closed-economy Eaton-Kortum-type model. Contract enforcement costs lead suppliers to underproduce. Thus, firms will perform more of the production process in-house instead of outsourcing it. On a macroeconomic scale, in countries with slow and costly courts, firms should buy relatively less inputs from sectors whose products are more specific to the buyer-seller relationship. I first present reduced-form evidence for this hypothesis using cross-country regressions. I use microdata on case law from the United States to construct a new measure of relationship-specificity by sector-pairs. This allows me to control for productivity differences across countries and sectors and to identify the effect of contracting frictions on industry structure. I then proceed to structurally estimate the key parameters of my macro-model. Using a set of counterfactual experiments, I investigate the role of contracting frictions in shaping productivity and income per capita across countries. Setting enforcement costs to US levels would increase real income by an average of 7.5 percent across all countries, and by an average of 15.3 percent across low-income countries. Hence, transaction costs and the determinants of firm boundaries are important for countries' aggregate level of development.


Multiproduct firms dominate production, and their product turnover contributes substantially to aggregate growth. Theories propose that multiproduct firms grow by diversifying into products which need the same know-how or capabilities, but are less clear on what these capabilities are. Input output tables show firms co-produce in industries that share intermediate inputs, suggesting input capabilities drive multiproduct production patterns. We provide evidence for this in Indian manufacturing: the similarity of a firm’s input mix to an industry’s input mix predicts entry into that industry. We identify the direction of causality from the removal of size-based entry barriers in input markets which made firms more likely to enter industries that were similar in input use to their initial input mix. We rationalize this finding with a model of industry choice and economies of scope to estimate the importance of input capabilities in determining comparative advantage. Complementarities driven by input capabilities make a firm on average 5% (and up to 15%) more likely to produce in an industry. Entry barriers in input markets constrained the comparative advantage of firms and were equivalent to a 10.5 percentage point tariff on inputs.