Optimal Policy and the Role of Social Contacts in a Search Model with Heterogeneous Workers

Abstract

This paper develops a search model with heterogeneous workers and social networks. High ability workers are more productive and have a larger number of professional contacts. Firms have a choice between a high cost vacancy in the regular labour market and a low cost job opening in the referral market. In this setting the model predicts that a larger number of social contacts is associated with a larger wage gap between high and low ability workers and a larger difference in the equilibrium unemployment rates. Next we demonstrate that the decentralized equilibrium is inefficient for any value of the bargaining power. There are two reasons for the inefficiency. First, the private gain from creating a job in the referral market is always below the social gain, so the equilibrium unemployment of high ability workers is above its optimal value. Moreover, high ability workers congest the market for low ability workers, so the equilibrium wage inequality is inefficiently large. This is in contrast to the result of Blazquez and Jansen (2008) showing that the distribution of wages is compressed in a search model with heterogeneous workers. Finally, we show that a combination of taxes and subsidies can restore the optimal allocation.

Formal Search and Referrals From a Firm's Perspective

“…Note that we do not limit referral hiring only to the employees of a given firm. This approach is a simplification that was already used in the previous literature (Cahuc and Fontaine, 2009; Stupnytska and Zaharieva, 2017). One justification for this assumption is the fact that also in our empirical data, referrals include recommendations from current employees of the firm and other social contacts who could be employees from affiliated companies, friends, and acquaintances of external consultants and long‐term customers.…”

Optimal Promotions of Competing Firms in a Frictional Labour Market with Organizational Hierarchies

“…For comparison, Albrecht and Vroman (2002) use a close value of 67%, while in the model by Stupnytska and Zaharieva (2017) the fraction of low skill workers is taken at 60%. The left panel of figure 7 shows the objective function of the firm for the default transition rates.…”

Social Networks, Promotions, and the Glass-Ceiling Effect

“…Other theoretical contributions on referral hiring in a search and matching framework include Calvó-Armengol and Zenou (2005), Ioannides and Soetevent (2006), Fontaine (2008), Galenianos (2014) and Stupnytska and Zaharieva (2017). Galenianos (2014) investigates cross-sectional frequency of referrals and shows that more intensive referral hiring is associated with more efficient matching in a given sector.…”

“…In contrast to this approach, we assume that wages in the same jobs are identical for all workers and investigate the role of social networks for the distribution of workers across different hierarchical positions. The particular mechanism of referral hiring that we use is similar to Calvó-Armengol and Zenou (2005) and Stupnytska and Zaharieva (2017).…”