The Division of Labor, Investment, and Capital

Abstract

This paper uses a dynamic general equilibrium model based on corner solutions to formalize the classical theory of investment and capital which considers investment to be a vehicle for developing a high level of division of labor in roundabout productive activities. If it takes time for a specialist producer of tractors to learn the right method in producing commercially viable tractors, specialization in producing tractors is infeasible in the absence of investment in terms of consumption goods which are consumed by the specialist producer of tractor before he can sell tractors. If specialized learning by doing can speed up accumulation of professional knowledge so that roundabout productive machines becomes cheap, such investment for increasing the level of division of labor in roundabout productive activities will speed up economic growth. Due to the tradeoff between economies of specialized learning by doing and transaction costs, the model can be used to investigate the effects of a change in the transaction cost coefficient, which can be affected by policy, the legal system, and urbanization, on the evolution of division of labor, on real interest rates, and on saving rate.