“The O-Ring Theory of Economic Development,” M. Kremer (1993)

A Fine Theorem

The O-Ring theory is unquestionably one of the most influential papers in applied theory of the past 20 years. The basic idea is simple: Write a Cobb-Douglas utility function where instead of labor entering as a lump of homogenous efficiency units, n units of labor for n tasks must be supplied by n individuals. This represents situations where quantity cannot be substituted for quality. A football team can only have one quarterback, and a kitchen only one head chef. With probability 1-q(i), a given agent fails at his task – all tasks are identical – and destroys 1-q(i) of the final production. This is analagous to the space shuttle Challenger, which exploded despite having only one bad part, the famous O-Ring. For now, assume no uncertainty about skill.

What happens in equilibrium? As in Becker’s marraige model, there is perfect sorting: all workers in a given firm are of the…

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