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The Impact of Contract Enforcement Costs on Outsourcing and Aggregate Productivity

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  • Johannes Boehm

    (Department of Economics Sciences économiques Sciences Po
    Centre for Economic Performance (CEP) London School of Economics (LSE)
    Centre for Macroeconomics (CFM))

Abstract

Legal institutions affect economic outcomes, but how much? This paper documents how costly supplier contract enforcement shapes firm boundaries, and quantifies the impact of this transaction cost on aggregate productivity and welfare. I embed a contracting game between a buyer and a supplier in a general-equilibrium closed-economy Eaton-Kortum-type model. Contract enforcement costs lead suppliers to underproduce. Thus, firms will perform more of the production process in-house instead of outsourcing it. On a macroeconomic scale, in countries with slow and costly courts, firms should buy relatively less inputs from sectors whose products are more specific to the buyer-seller relationship. I first present reduced-form evidence for this hypothesis using cross-country regressions. I use microdata on case law from the United States to construct a new measure of relationship-specificity by sector-pairs. This allows me to control for productivity differences across countries and sectors and to identify the effect of contracting frictions on industry structure. I then proceed to structurally estimate the key parameters of my macro-model. Using a set of counterfactual experiments, I investigate the role of contracting frictions in shaping productivity and income per capita across countries. Setting enforcement costs to US levels would increase real income by an average of 7.5 percent across all countries, and by an average of 15.3 percent across low-income countries. Hence, transaction costs and the determinants of firm boundaries are important for countries' aggregate level of development.

Suggested Citation

  • Johannes Boehm, 2015. "The Impact of Contract Enforcement Costs on Outsourcing and Aggregate Productivity," Discussion Papers 1528, Centre for Macroeconomics (CFM).
  • Handle: RePEc:cfm:wpaper:1528
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    Cited by:

    1. Matthew Elliott & Benjamin Golub & Matthew V. Leduc, 2020. "Supply Network Formation and Fragility," Papers 2001.03853, arXiv.org, revised Apr 2022.
    2. Christopher Hansman & Jonas Hjort & Gianmarco León-Ciliotta & Matthieu Teachout, 2020. "Vertical Integration, Supplier Behavior, and Quality Upgrading among Exporters," Journal of Political Economy, University of Chicago Press, vol. 128(9), pages 3570-3625.
    3. Lo, Chu-Ping & Yang, Chih-Hai, 2020. "Business Services,Trade,and Research Intensity," Hitotsubashi Journal of Economics, Hitotsubashi University, vol. 61(1), pages 38-59, June.
    4. Enghin Atalay & Ali Hortaçsu & Mary Jialin Li & Chad Syverson, 2019. "How Wide Is the Firm Border?," The Quarterly Journal of Economics, Oxford University Press, vol. 134(4), pages 1845-1882.
    5. Johannes Boehm & Ezra Oberfield, 2020. "Misallocation in the Market for Inputs: Enforcement and the Organization of Production," The Quarterly Journal of Economics, Oxford University Press, vol. 135(4), pages 2007-2058.
    6. Sultan Mehmood, 2021. "The impact of Presidential appointment of judges: Montesquieu or the Federalists?," AMSE Working Papers 2118, Aix-Marseille School of Economics, France.
    7. Sultan Mehmood, 2020. "Judicial Independence and Development: Evidence from Pakistan," AMSE Working Papers 2041, Aix-Marseille School of Economics, France.
    8. Lorenzo Caliendo & Fernando Parro & Aleh Tsyvinski, 2017. "Distortions and the Structure of the World Economy," NBER Working Papers 23332, National Bureau of Economic Research, Inc.
    9. Jan Grobovšek, 2020. "Managerial Delegation, Law Enforcement, and Aggregate Productivity," Review of Economic Studies, Oxford University Press, vol. 87(5), pages 2256-2289.
    10. Sultan Mehmood, 2020. "Judicial Independence and Development: Evidence from Pakistan," Working Papers halshs-03054106, HAL.
    11. MATSUURA Toshiyuki & ITO Banri & TOMIURA Eiichi, 2020. "Intra-firm Trade, Input-output Linkage, and Contractual Frictions: Evidence from Japanese Affiliate-level Data," Discussion papers 20026, Research Institute of Economy, Trade and Industry (RIETI).
    12. Harald Fadinger & Christian Ghiglino & Mariya Teteryatnikova, 2015. "Productivity, Networks and Input-Output Structure," 2015 Meeting Papers 624, Society for Economic Dynamics.
    13. David Hémous & Morten Olsen, 2018. "Long-term Relationships: Static Gains and Dynamic Inefficiencies," Journal of the European Economic Association, European Economic Association, vol. 16(2), pages 383-435.
    14. Toshihiko Mukoyama & Latchezar Popov, 2020. "Industrialization and the evolution of enforcement institutions," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 69(3), pages 745-788, April.
    15. Eppinger, Peter & Kukharskyy, Bohdan, 2021. "Contracting institutions and firm integration around the world," European Economic Review, Elsevier, vol. 137(C).
    16. Fadinger, Harald & Ghiglino, Christian & Teteryatnikova, Mariya, 2015. "Income differences and input-output structure," Working Papers 15-11, University of Mannheim, Department of Economics.
    17. Grobovšek Jan, 2018. "Development accounting with intermediate goods," The B.E. Journal of Macroeconomics, De Gruyter, vol. 18(1), pages 1-27, January.
    18. Johannes Boehm & Ezra Oberfield, 2020. "Misallocation in the Market for Inputs: Enforcement and the Organization of Production," The Quarterly Journal of Economics, Oxford University Press, vol. 135(4), pages 2007-2058.
    19. Grobovšek Jan, 2018. "Development accounting with intermediate goods," The B.E. Journal of Macroeconomics, De Gruyter, vol. 18(1), pages 1-27, January.
    20. Dominick Bartelme & Yuriy Gorodnichenko, 2015. "Linkages and Economic Development," NBER Working Papers 21251, National Bureau of Economic Research, Inc.
    21. Fadinger, Harald & Ghiglino, Christian & Teteryatnikova, Mariya, 2015. "Income differences and input-output structure," Working Papers 15-11, University of Mannheim, Department of Economics.

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    More about this item

    Keywords

    Contract Enforcement Costs; Contracting Frictions; Transaction Costs; Outsourcing; Aggregate Productivity;
    All these keywords.

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • F11 - International Economics - - Trade - - - Neoclassical Models of Trade
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
    • O43 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Institutions and Growth

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