Size, Trade, Technology and the Division of Labor

The division of labor is limited by the extent of the market — but the extent of the market also grows with the division of labor (Young, 1928). We formalize this feedback in a model with input-output linkages where heterogeneous firms deepen their specialization by adopting intermediate-intensive technologies. We document that intermediate intensity for U.S. manufacturing firms varies within industries and over time, and is increasing in firm size, which is the heterogeneity the model generates. Market size expansion increases specialization and (i) real income, through both firm selection and an endogenous aggregate input-output multiplier; (ii) the aggregate intermediate-to-labor cost share; and (iii) profit concentration. Calibrating to U.S. manufacturing over 1987–2007, we find that reduced trade costs expand market size and generate a quantitatively important adoption mechanism even when labor and intermediates substitute directly through CES production. The under-adoption inefficiency in this model is ameliorated by industrial subsidies, which act as substitutes to trade liberalization in increasing specialization.