Is the Division of Labor Limited by the Extent of the Market? : Evidence from Chemical Industry

Stigler (1951) formalized the Smithian notion that the division of labor is limited by the extent of the market. Bresnahan and Gambardella (1998) make an analytical distinction between two dimensions of market size - the breadth and depth of markets - in terms of the effects on the division of labor. They argue that broader, but not deeper, markets promote specialization and division of labor between firms. This paper develops an empirical specification of these ideas and tests it using data from the chemical plant construction industry. We develop a simple model of the make-buy decision regarding the engineering and construction of chemical plants. In an advance over the literature, we embed this model in a market equilibrium, and estimate the resulting structural model. Our results support the theory developed by Bresnahan and Gambardella that increases in the number of potential buyers (but not the average size of the buyer) encourages firm specialization and division of labor