This paper proposes a production function describing processes subject
to mistakes in any of several tasks. It shows that high-skill workers
-those who make few mistakes-will be matched together in equilibrium,
and that wages and output will rise steeply in skill. The model is con
sistent with large income differences between countries, the predomina
nce of small firms in poor countries, and the positive correlation bet
ween the wages of workers in different occupations within enterprises.
Imperfect observability of skill leads to imperfect matching and thus
to spillovers, strategic complementarity, and multiple equilibria in
education.