DP16888 Self-Enforcing Contracts with Persistence
We show theoretically that, in the presence of persistent productivity shocks, the reliance on selfenforcing
contracts due to limited legal enforcement may provide a possible rationale why countries
with the worse rule of law might exhibit: (i) higher aggregate TFP volatilities, (ii) larger dispersion
of firm-level productivity, and (iii) greater wage inequality. We also provide suggestive empirical
evidence consistent with the model’s aggregate implications. Finally, we relate the model’s firm-level
implications to existing empirical findings.