Intermediate Goods, Institutions and Output per Worker

This paper tests a specific channel through which institutions affect output per capita: the role of institutions in firm-level division of production. We argue that weaker institutions increase transaction costs, including those incurred by a firm when dealing with suppliers of intermediate goods. Firms respond to these higher costs by substituting intermediate goods produced within the firm for those externally supplied, which in turn discourages specialization and consequently decreases productivity. To test this channel, we rely on differences across sectors in their capacity to substitute internal goods for intermediate goods. We first create an index that measures the 'complexity' of a sector's intermediate structure using data from the United States. Using this index, we find that industries with a more complex intermediate goods structure suffer a relatively larger loss of productivity in countries with poorer institutions. l II) could be helpful on this task.