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.

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. 2 These are also closely related to models of global value chains and global sourcing such as Costinot, Vogel and Wang (2012), Fally and Hillberry (2015), Antràs and de Gortari (2017), Antras, Fort and Tintelnot (2017). 2 the industry environment and the choices of other producers. Our paper is also closely related to the literature on misallocation in developing countries (see Hopenhayn (2014) for a survey). Several papers have extended the work of Hsieh and Klenow (2009) to settings in which distortions affect the use of intermediate inputs, e.g., Jones (2013), Bartelme and Gorodnichenko (2014), Fadinger, Ghiglino and Teteryatnikova (2016), Bigio and La'O (2016), Caprettini and Ciccone (2015), Liu (2017), Caliendo, Parro and Tsyvinski (2017), Osotimehin and Popov (2017), and Baqaee and Farhi (2017). These papers typically posit industry-level production functions and use industry-level data. Our approach of identifying wedges from factor shares (in our case, intermediate input expenditure shares) extends the work of Hsieh and Klenow (2009) along three key dimensions. First, we relate the estimated wedges to the quality of Indian statelevel institutions, which allows us draw policy conclusions from our exercise. Second, we confront the fact that firms produce in very different ways even in narrowly defined industries by explicitly modeling this heterogeneity; we allow firms to choose among several types of technologies (recipes) in the theory and identify these recipes in the data through the application of techniques from statistics/data mining. Third, we identify wedges from systematic differences in first moments, which helps to alleviate concerns about mismeasurement being interpreted as misallocation....

This paper studies the prevalence of potential anticompetitive effects of vertical mergers using a novel data set 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 for both domestic and cross-border mergers and for domestic and international relationships. It also holds when instrumenting mergers using 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. These findings are consistent with anticompetitive effects of vertical mergers, such as vertical foreclosure, rising input costs for rivals, or self-foreclosure. This paper was accepted by Joshua Gans, business strategy.

Resource based theories propose that firms grow by diversifying into products which use common capabilities. We provide evidence for common input capabilities using a policy that removed entry barriers in input markets to show that the similarity of a firm's and industry's input mix determine firm production choices. We model industry choice and economies of scope from input capabilities. Estimating the model for Indian manufacturing, input complementarities make firms 5% more likely to produce in an industry and are quantitatively as important as time-invariant drivers of co-production rates. Upstream entry barriers were equivalent to a 9.5% tariff on inputs.