Working Paper: NBER ID: w24937
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 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.
Keywords: contract enforcement; input allocation; production organization; aggregate productivity; India
JEL Codes: E23; F12; O11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Weak contract enforcement (D86) | Reduction in expenditures on relationship-specific intermediate inputs (L14) |
| Congested courts (K40) | Reduction in expenditures on relationship-specific intermediate inputs (L14) |
| Slower courts (K41) | Shift towards more homogeneous inputs (D29) |
| Weak contract enforcement (D86) | Increased vertical integration (L22) |
| Congested courts (K40) | Increased vertical integration (L22) |
| Weak contract enforcement (D86) | Negative effect on aggregate productivity (O49) |