Institutions and the Organization of Production

Several studies show that countries' institutional frameworks affect which goods are produced most efficiently in the country. Industries in countries with strong legal institutions tend to specialize in the production of "complex" goods where the production process depends on well-functioning contracts between companies. Similarly, countries with well-developed financial markets have a comparative advantage in manufacturing that requires large investments. Companies in countries with substandard institutions can, however, adapt their structure in many ways to succeed in the production of complex or investment-intensive goods. For example, companies in countries where contracts with subcontractors work worse, can choose to buy up their subcontractors instead (so-called "upstream vertical integration"). Financial development can lead to an increased amount of small companies whose production chains are integrated to a lesser extent. At the same time, access to credit can be important for financing vertical integration. The purpose of this project was to investigate how much the design of production chains depends on the institutional characteristics of countries. With the help of export data, we tested whether vertically integrated industries are less sensitive to legal problems. We also investigated the relation between financial development and vertical integration.