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

102 Pages Posted: 25 Mar 2020

Date Written: March 2020

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.

JEL Classification: E32, F12, O11

Suggested Citation

Boehm, Johannes and Oberfield, Ezra, Misallocation in the Market for Inputs: Enforcement and the Organization of Production (March 2020). CEPR Discussion Paper No. DP14482, Available at SSRN: https://ssrn.com/abstract=3560289

Johannes Boehm (Contact Author)

Sciences Po ( email )

28 Rue des Saint-Peres
Paris, 75006
France

Ezra Oberfield

Princeton University ( email )

22 Chambers Street
Princeton, NJ 08544-0708
United States

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