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Misallocation in the market for inputs: enforcement and the organization of production

Boehm, Johannes and Oberfield, Ezra (2018) Misallocation in the market for inputs: enforcement and the organization of production. CEP Discussion Papers (CEPDP1572). Centre for Economic Performance, London School of Economics and Political Science, London, UK.

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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.

Item Type: Monograph (Discussion Paper)
Official URL: http://cep.lse.ac.uk/
Additional Information: © 2018 The Authors
Divisions: Centre for Economic Performance
Subjects: H Social Sciences > H Social Sciences (General)
H Social Sciences > HB Economic Theory
H Social Sciences > HF Commerce
JEL classification: E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Employment, and Investment > E23 - Production
F - International Economics > F1 - Trade > F12 - Models of Trade with Imperfect Competition and Scale Economies
O - Economic Development, Technological Change, and Growth > O1 - Economic Development > O11 - Macroeconomic Analyses of Economic Development
Sets: Research centres and groups > Centre for Economic Performance (CEP)
Date Deposited: 11 Jan 2019 11:53
Last Modified: 20 Feb 2019 04:09
Funders: Economic and Social Research Council
URI: http://eprints.lse.ac.uk/id/eprint/91694

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