Smithian Growth through Creative Organization∗

We model technological progress as an external effect of organizational design, focusing on how factories, based on labor division, could spawn the industrial revolution. Dividing labor, as Adam Smith argued, facilitates invention by observers of production processes. However, entrepreneurs cannot internalize this benefit and choose labor division to facilitate monitoring. Equilibrium with few entrepreneurs features low wage shares, high specialization, but a limited market for innovations. Conversely, with many entrepreneurs there is a large market for innovation, but little specialization because of high wage shares. Technological progress therefore occurs with a moderate scarcity of entrepreneurs. Institutional improvements affect growth ambiguously. JEL codes: O3, O43, L2 keywords: factory system, industrial revolution, technological change, contracts ∗We are grateful to the referees for comments and to Daron Acemoglu, Philippe Aghion, Roland Benabou, Maristella Botticini, Steve Broadberry, Micael Castanheira, Nick Crafts, Wouter Dessein, Philip Garner, Bob Margo, Frédéric Robert-Nicoud, Jim Robinson, Ken Sokoloff, Philippe Weil, and Fabrizio Zilibotti for helpful discussion. Legros benefited from the financial support of the Communauté Française de Belgique (project ARC00/05-252) and the SCIFI-GLOW Collaborative Project supported by the European Commissions Seventh Framework Programme for Research and Technological Development (Contract no. SSH7-CT2008-217436). †ECARES and CEPR ‡Boston University and CEPR §University of Warwick