Growing apart: The division of labor and the breakdown of informal institutions

In this paper, we model the co-evolution of the division of labor and informal institutions based on three assumptions. First, informal institutions lower coordination costs among specialists, which increases the equilibrium division of labor. Second, advances in the division of labor increase the size of interpersonal trading groups and thereby undermine the game theoretic basis of informal institutions. Finally, the collective nature of informal institutions implies that they are undervalued in private decision making. Together these assumptions imply that the equilibrium division of labor is too high from a social perspective. Consequently, the economy has greater than optimal complexity and grows at a higher than optimal rate of growth. Journal of Comparative Economics 34 (1) (2006) 75–91. Pierce Hall 107, Smith College, Northampton, MA 01063, USA.  2005 Association for Comparative Economic Studies. Published by Elsevier Inc. All rights reserved.