Imperfect Contract Enforcement and the (In)Efficiency of International Firm Location

This paper explores the location decisions of final-good producers under imperfect contract enforcement. The legal systems' quality is measured by the contracting environment in each country. The final producers' location decisions create different outcomes in terms of efficiency. We find one inefficient outcome, where final producers locate in the country with the weaker enforcement in pursuit of higher profits, which leads to losses in production and trade. But opening up for international trade and contracting acts as a substitute for a poor legal system, by making final producers prefer the country with the stricter enforcement, leading to an efficient equilibrium.