DECIG Seminar: November 2024

Take the goods and run: Contracting frictions and market power in supply chains

Felipe Brugués (ITAM)

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Time:

Wednesday, November 13, 2024

10:00 – 11:00 AM  (ET)

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Abstract

Link to paper

Firms in developing countries often face concentrated input markets and contracting frictions. This paper studies the efficiency of self-enforced relational agreements, a common solution to contracting frictions, when sellers have significant market power and contracts cannot be enforced through courts. To this end, I develop a dynamic contracting model with limited enforcement in which buyers can default on their trade-credit debt without legal penalties. The model is shown to be identified and is estimated using a new transaction-level dataset from the Ecuadorian manufacturing supply chain. My key empirical finding is that bilateral trade is inefficiently low in early periods of the relationship, but converges toward efficiency over time, despite sellers’ market power. Counterfactual simulations imply that both market power and enforcement contribute to inefficiencies in trade, as addressing either friction alone leads to welfare losses, whereas relaxing both frictions can lead to significant efficiency gains.

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