Contracts, firm dynamics, and aggregate productivity

We construct a firm-dynamics framework to evaluate the impact of the enforcement of contracts between final goods producers and intermediate goods suppliers on firm life-cycle growth, technology accumulation, and aggregate productivity. We show that contractual incompleteness implies a wedge on profits, which disincentives technology accumulation and is potentially correlated with technology, in addition to wedges on production decisions. In our model we find that contract enforcement accounts for differences in output per worker of 22 percent when we compare India to the U.S. The impact on firm life-cycle growth, the age and size distribution of firms is quantitatively significant.

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