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

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.

Economic Resilience: Spillovers, Courts, and Vertical Integration

“…The same firms are also more likely to acquire firms from the same industry as the affected supplier (Column II). This result is consistent with Boehm and Oberfield (2020), who show that supply chains located in areas with more congested courts are vertically more integrated in India. Overall, the results are consistent with difficulties in establishing new relationships due to court-induced contracting frictions and potential future hold-up problems.…”

“…Courts are essential for firm-to-firm relationships, since they have the ultimate authority to enforce a contract between contracting parties. While courts are an important determinant in choosing business partners (Johnson et al, 2002;Boehm and Oberfield, 2020), the overall effect of court quality on the transmission of shocks is ambiguous. Imagine a downstream firm facing disruptions due to a sudden loss of a supplier that provides inputs and trade credit.…”

“…Our paper is closest to Boehm and Oberfield (2020). While they analyze how court quality affects industry structure, we document how quality of local courts affects propagation of shocks.…”

Mapping the Landscape of Transactions: The Governance of Business Relations in Latin America

“…Boehm (2018) calculates, under a set of conservative assumptions, that on average countries would grow by 18% if enforcement costs were zero. Boehm and Oberfeld (2018) find that a feasible reduction in court congestion alone in India would increase productivity by 5%. In a small survey of Romanian firms, Murrell and Paun (2010) asked about the willingness-to-pay for first-best institutions and found that the transaction costs of exchange are as high as 23% of value added.…”

The Impact of Institutional Quality on Manufacturing Sectors in Russia: Panel Data Analysis

“…All of these papers focus on estimating the coefficients of the interaction terms between a sector's institutional dependence and the jurisdiction's 5 Levchenko (2007) develops a formal macroeconomic model of this phenomenon based on the approach pioneered by Caballero and Hammour (1998). Boehm and Oberfield (2018) present a related microeconomic model. 6 A detailed discussion of some of the advantages of sub-national data can be found in Snyder (2001).…”