Contracts and Technology Adoption By DARON ACEMOGLU,POL ANTRAS` , AND ELHANAN HELPMAN* We develop a tractable framework for the analysis of the relationship between contractual incompleteness, technological complementarities, and technology adop- tion. In our model, a firm chooses its technology and investment levels in contract- ible activities by suppliers of intermediate inputs. Suppliers then choose investments in noncontractible activities, anticipating payoffs from an ex post bargaining game. We show that greater contractual incompleteness leads to the adoption of less advanced technologies, and that the impact of contractual incompleteness is more pronounced when there is greater complementary among the intermediate inputs. We study a number of applications of the main framework and show that the mechanism proposed in the paper can generate sizable productivity differences across countries with different contracting institutions, and that differences in contracting institutions lead to endogenous comparative advantage differences. (JEL D86, O33) There is widespread agreement that differ- ductivity differences across firms, industries, ences in technology are a major source of pro- and nations.1 Despite this widespread agree- ment, we are far from an established framework for the analysis of technology choices of firms. * Acemoglu: Department of Economics, Massachusetts In- In this paper, we take a step in this direction and stitute of Technology, E52-380b, Cambridge, MA 02139, Na- develop a simple model to study the impact of tional Bureau of Economic Research, Centre for Economic Policy Research, and Canadian Institute for Advanced Re- contracting institutions, which regulate the re- search (e-mail: [email protected]); Antra`s: Department of Eco- lationship between the firm and its suppliers, on nomics, Harvard University, Littauer 319, Cambridge, MA technology choices. 02138, NBER, and CEPR (e-mail: [email protected]); Our model combines two well-established Helpman: Department of Economics, Harvard University, Lit- tauer 229, Cambridge, MA 02138, NBER, CEPR, and CIAR approaches. The first is the representation of (e-mail: [email protected]). A previous version of this technology as the range of intermediate in- paper was circulated under the title “Contracts and the Division puts used by firms; a greater range of interme- of Labor.” We thank Gene Grossman, Oliver Hart, Kalina diate inputs increases productivity by allowing Manova, Damia´n Migueles, Giacomo Ponzetto, Richard Rog- greater specialization and thus corresponds to erson, Rani Spiegler, two anonymous referees, participants in 2 the Canadian Institute for Advanced Research and Minnesota more “advanced” technology. The second is Workshop in Macroeconomic Theory conferences, and semi- Sanford J. Grossman and Oliver D. Hart’s nar participants at Harvard University, MIT, Tel Aviv Univer- sity, Universitat Pompeu Fabra, University of Houston, University of California, San Diego, Southern Methodist University, Stockholm School of Economics, Stockholm 1 Among others, see Peter J. Klenow and Andre´s Rodri- University (IIES), ECARES, University of Colorado–Boul- guez-Clare (1997), Robert E. Hall and Charles I. Jones der, the Kellogg School, New York University, University (1999), or Francesco Caselli (2005) for countries, and Tor J. of British Columbia, Georgetown University, the World Klette (1996), Zvi Griliches (1998), John Sutton (1998), or Bank, University of Montreal, Brandeis University, Univer- Klette and Samuel S. Kortum (2004) for firms. sity of Wisconsin, UC–Berkeley, Haifa University, Syra- 2 See, among others, Wilfred J. Ethier (1982), Paul M. cuse University, Universitat Auto`noma de Barcelona, Duke Romer (1990), and Gene M. Grossman and Helpman (1991) University, Columbia University, and Cornell University for previous uses of this representation. See also the text- for useful comments. We also thank Davin Chor, Alexandre book treatment in Robert J. Barro and Xavier Sala-i-Martin Debs, and Ran Melamed for excellent research assistance. (2003). There is a natural relationship between this view of Acemoglu and Helpman thank the National Science Foun- technology and the division of labor within a firm. We dation for financial support. Much of Helpman’s work for investigated this link in the earlier version of the current this paper was done when he was Sackler Visiting Professor paper, Acemoglu, Antra`s, and Helpman (2005), and do not at Tel Aviv University. elaborate on it here. 916 VOL. 97 NO. 3 ACEMOGLU ET AL.: CONTRACTS AND TECHNOLOGY ADOPTION 917 (1986) and Hart and John H. Moore’s (1990) the noncontractible activities. Since she is not approach to incomplete-contracting models of the full residual claimant of the output gains the firm. We study technology choice of firms derived from her investments, she tends to un- under incomplete contracts, and extend Hart derinvest. Greater contractual incompleteness and Moore’s framework by allowing contracts thus reduces supplier investments, making more to be partially incomplete. This combination advanced technologies less profitable. Further- enables us to investigate how the degree of more, a greater degree of technological comple- contractual incompleteness and the extent of mentarity reduces the incentive to choose more technological complementarities between inter- advanced technologies. Although greater tech- mediate inputs affect the choice of technology. nological complementarity increases equilib- In our baseline model, a firm decides on rium ex post payoffs to every supplier, it also technology (on the range of specialized inter- makes their payoffs less sensitive to their non- mediate goods), recognizing that a more ad- contractible investments, discouraging invest- vanced technology is more productive, but also ments and, via this channel, depressing the entails a variety of costs. In addition to the profitability of more advanced technologies. direct pecuniary costs of engaging more suppli- An advantage of our framework is its relative ers (corresponding to the greater range of inter- tractability. The equilibrium of our model can mediate inputs), a more advanced technology be represented by a reduced-form profit func- necessitates contracting with more suppliers. tion for firms given by All of the activities that suppliers undertake are ͑ ͒ Ϫ ͑ ͒ Ϫ relationship-specific, and a fraction of those is (1) AZF N C N w0 N, ex ante contractible, while the rest, as in the work by Grossman-Hart-Moore, are nonverifi- where N represents the technology level, C(N) able and noncontractible. The fraction of con- is the cost of technology N, A is a measure of tractible activities is our measure of the quality aggregate demand or the scale of the market, 3 of contracting institutions. Suppliers are con- and w0N corresponds to the value of the N tractually obliged to perform their duties in the suppliers’ outside options. F(N) is an increasing contractible activities, but they are free to function that captures the positive effect of choose their investments in noncontractible ac- choosing more advanced technologies on reve- tivities and to withhold their services in these nue. The effects of contractual incompleteness activities from the firm. This combination of and technological complementarity are summa- noncontractible investments and relationship- rized by the variable Z. This variable affects specificity leads to an ex post multilateral bar- productivity and is decreasing in the degree gaining problem. As in Hart and Moore (1990), of contract incompleteness and technological we use the Shapley value to determine the di- complementarity. Moreover, the elasticity of Z vision of ex post surplus between the firm with respect to the quality of contracting insti- and its suppliers. We derive an explicit solution tutions is higher when there is greater comple- for this division of surplus, which enables us mentarity between intermediate inputs. This last to develop a simple characterization of the result has important implications for equilib- equilibrium. rium industry structure and the patterns of com- A supplier’s expected payoff in the bargain- parative advantage, because it implies that ing game determines her willingness to invest in sectors (firms) with greater complementarities between inputs are more “contract dependent.” We use this framework to show that the 3 Eric S. Maskin and Jean Tirole (1999) question combination of contractual imperfections and whether the presence of nonverifiable actions and unfore- seen contingencies necessarily leads to incomplete con- technology choice (or adoption) may have im- tracts. Their argument is not central to our analysis portant implications for cross-country income because it assumes the presence of “strong” contracting differences, equilibrium organizational forms, institutions (which, for example, allow contracts to spec- and patterns of international specialization and ify sophisticated mechanisms), while in our model a fraction of activities may be noncontractible, not because trade. of “technological” reasons but because of weak contract- First, we show that our baseline model can ing institutions. generate sizable differences in productivity from 918 THE AMERICAN ECONOMIC REVIEW JUNE 2007 differences in the quality of contracting institu- Zwiebel (1996a, b) and Yannis Bakos and Erik tions. In particular, using a range of reasonable Brynjolfsson (1993) are most closely related to values for the key parameters of the model, we ours. Stole and Zwiebel consider a relationship