The Impact of Contract Enforcement Costs on Outsourcing and Aggregate Productivity
Johannes Boehm
Sciences Po
This draft: October 28, 2015
Abstract
Legal institutions affect economic outcomes, but how much? This paper documents how costly supplier contract enforcement shapes rm 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, rms will perform more of the production process in-house instead of outsourcing it. On a macroeconomic scale, in countries with slow and costly courts, rms should buy relatively less inputs from sectors whose products are more specic to the buyer-seller relationship. I rst 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-specicity by sector-pairs. This allows me to control for productivity dierences across countries and sectors and to identify the eect 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 rm boundaries are important for countries' aggregate level of development.
JEL codes: D23; F11; O43; L22\
Keywords: Contract enforcement costs; Contracting frictions; Transaction costs; Outsourcing;Aggregate Productivity