Misallocation in the Market for Inputs: Enforcement and the Organization of Production

Working Paper: CEPR ID: DP14482

Authors: Johannes Boehm; Ezra Oberfield

Abstract: 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 have a greater vertical span of production. 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.

Keywords: Production Networks; Intermediate Inputs; Misallocation; Productivity; Contract Enforcement; Value Chains

JEL Codes: E23; O11; F12

Causal Claims

Cause	Effect
court congestion (L91)	contract enforcement (K12)
contract enforcement (K12)	production decisions (L23)
court congestion (L91)	materials cost share of inputs (L74)
contract enforcement (K12)	use of relationship-specific inputs (L14)
court congestion (L91)	aggregate productivity (E23)
court congestion (L91)	vertical span of production (D20)