Building and Maintaining Productive Relationships

Productive relationships require a mutual understanding of what each party requires. We model relationship formation and termination when agents face uncertainty about which actions (if any) are productive, what we call a ``clarity problem.'' In each period of experimentation, the agent finds a productive action with some probability; this sequence of probabilities describes clarity. Our model predicts a reversal in termination rates: agents with higher clarity are less likely to end relationships in the early search phase, but more likely to end them later, since they find productive relationships easier to replace. Using transaction-level data from Ethiopia’s rose industry, we document that clarity problems are economically significant. Moreover, exporters that are more likely to form productive relationships, those with higher clarity, are also more likely to terminate them when outside options improve. This explains why domestically owned exporters, despite lower discount factors, are less responsive to positive shocks to the outside option than foreign-owned exporters. Clarity emerges as a key determinant of relationship formation and maintenance, determining whether exporters can access the higher profitability and economic growth associated with direct sales of differentiated products.