Contracts and the Division of Labor

We present a tractable framework for the analysis of the relationship between contract incom-pleteness, technological complementarities and the division of labor. In the model economy, a rm decides the division of labor and contracts with its worker-suppliers on a subset of activities they have to perform. Worker-suppliers choose their investment levels in the remaining activities anticipating the ex post bargaining equilibrium. We show that greater contract incompleteness reduces both the division of labor and the equilibrium level of productivity given the division of labor. The impact of contract incompleteness is greater when the tasks performed by di¤erent workers are more complementary. We also discuss the e¤ect of imperfect credit markets on the division of labor and productivity, and study the choice between the employment relationship versus an organizational form relying on outside contracting. Finally, we derive the implications of our framework for productivity di¤erences and comparative advantage across countries. We thank Gene Grossman, Oliver Hart and Rani Spiegler, as well as participants in the Canadian Institute for Advanced Research conference and seminar participants at Harvard, MIT, Tel Aviv and Universitat Pompeu Fabra, for useful comments. We also thank Davin Chor, Alexandre Debs and Ran Melamed for excellent research assistance. Acemoglu and Helpman thank the National Science Foundation for \u85nancial support. Much of Helpmans work for this paper was done when he was Sackler Visiting Professor at Tel Aviv University.