Vertical Integration and Institutional Constraints on Firm Behavior: The Case of the Garment Industry in Egypt

Empirical analysis of vertical integration has mostly been restricted to developed countries. But since the institutional context in developing countries is very different, so may be the factors that influence vertical integration. Estimates made using a new data set of Egyptian garment firms show that distinctive features of the business environment are indeed the most significant determinant of vertical integration. Limited access to finance restricts the possibilities for many firms to undertake the investment required to integrate, whilst volatile and uncertain market conditions make firms more likely to rely on the market for their inputs. This does not mean that transaction cost theories of vertical integration are irrelevant; for example, high monitoring costs discourage integration while disputes over quality and temporal specificities encourage it. But there are nuances related to market segment. Producers of higher quality garments rely on imported textiles. Contrary to theoretical predictions, these producers do not integrate even if search and switch costs are high, but the opposite is true of producers relying on domestic suppliers.