DP2240 Imperfect Labour Contracts and International Trade
In an economy with imperfect labour contracts, differences in the distribution of human capital are an independent source of comparative advantage. I study a world economy with two sectors, one where output is produced by teams and another where individuals can work alone. When workers' abilities are private information and workers cannot verify the value of output or the level of a firm's profits, feasible labour contracts fail to generate efficient matching of workers within teams. The mismatch of talent on teams is more severe in the country with the more heterogeneous labour force, which generates a comparative disadvantage for this country in team production. Trade exacerbates the 'polarization' of the more diverse society. National income could be raised, and the distribution of income improved, by a marginal expansion in the size of the team sector.