The O-Ring Sector and the Foolproof Sector: An Explanation for Cross-Country Income Differences
32 Pages Posted: 30 Nov 2009
Date Written: 2009
Differences in worker skill cause modest differences in wages within a country, but are associated with massive differences in productivity across countries (Hanushek and Kimko, 2000). I build upon Kremer’s (1993) O-ring theory of production to explain this stylized fact. I posit that there are two kinds of jobs: O-ring jobs where strategic complementarities to skill are large, and a diminishing-returns Foolproof sector, where two mediocre workers provide the same effective labor as one excellent worker. In equilibrium, an econometrician would only see small returns to skill within a country. In a world where countries vary only slightly in the average skill of workers, these assumptions are sufficient to generate massive differences in cross-country income inequality while generating only small amounts of intra-country income inequality. Implications for immigration policy, dual labor market theory, and border regions are discussed.
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