Contract Incompleteness, Globalization and Vertical Structure: an Empirical Analysis

This paper studies the e¤ects of international openness and contracting institutions on vertical integration. It …rst derives a number of predictions regarding the interactions between trade barriers, contracting costs, technology intensity, and the extent of vertical integration from a simple model with incomplete contracts. Then it investigates these predictions using a new dataset of over 14000 …rms from 45 developing countries. Consistent with theory, the e¤ect of technology intensity of domestic producers on their likelihood to vertically integrate is decreasing in the quality of domestic contracting institutions and in international openness. Contract enforcing costs are particularly high in developing countries and their e¤ects on the vertical structure of technological intensive …rms may have signi…cant welfare costs. If improving domestic contracting institutions is not feasible an equivalent solution is to increase openness to international trade. This would discipline domestic suppliers reducing the need for vertical integration. JEL: D23, F15, L14