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.

Social Optimum, Heterogeneous Workers and Firms in the Labour Market with On-the-Job-Search

“…When increasing ∆y L and ∆y H , the (JC L ) shifts upward, and (JC H ) moves to the right. This finding is similar to that in Gautier (2002) and Stupnytska and Zaharieva (2017). Gautier (2002) finds that low-skill workers gain from the high productivity of high-skilled workers in simple jobs, while Stupnytska and Zaharieva (2017) emphasize that more vacancies are created in the regular and referral submarkets as high-ability workers search in both submarkets.…”

“…We normalize the productivity parameter y L for low productivity firms to 1.25. The productivity y H for high productivity firms is taken to be 1.45 which is close to the value of Stupnytska and Zaharieva (2017). We choose the productivity y LH equals to 1.35 which is in the middle range of y L and y H .…”

“…The flow costs of opening a vacancy c L and c H are chosen to be equal to 0.1 and 0.33, respectively, which are close by Shimer ( 2005) who assumes that the cost of a vacancy to be 0.213. For a more detailed literature review see Stupnytska and Zaharieva (2017). We assume that firms pay an entry cost for per period of time, and it is equal to 0.6, which implies the discounted present value of the cost is K = 0.6/0.012 = 50.…”

“…Our numerical results suggest that the majority of low-skilled workers are employed at high productivity firms in the equilibrium. Similar to Gautier (2002) and Stupnytska and Zaharieva (2017), low-skilled workers gain from the high productivity of high-skilled workers.…”

“…In contrast to their results we find that both types of firms emerge in the equilibrium. Blazquez and Jansen (2008), Albrecht et al (2010), and Stupnytska and Zaharieva (2017 focus on social efficiency. The model by Blazquez and Jansen ( 2008) is based on the framework of Albrecht and Vroman (2002).…”