Social contacts and referrals in a labor market with on-the-job search

Abstract

This paper develops a matching model of the labor market with heterogeneous firms, on-the-job search and family referrals. The overall effect of referrals on wages can be decomposed into three distinct components. First, if referrals are used to help unemployed partners find jobs, then recommended workers are disproportionately concentrated in the left tail of the earnings distribution. This is a negative concentration effect of referrals, which emerges because workers accept (forward to the partner) job offers from more (less) productive employers. Second, if referrals are also used by workers to pool their less successful employed partners to more productive jobs, then the process of on-the-job search is intensified. This is a positive pooling effect of referrals. Third, better connected workers bargain higher wages for a given level of productivity. This is a positive effect of referrals on reservation wages and earnings. In the equilibrium, the overall effect of referrals can be positive (wage premiums) or negative (wage penalties). The negative effect is dominating in labor markets with strong productivity heterogeneity of firms and large bargaining power of workers. Otherwise, the positive effect is dominating. Referrals can have a negative effect on social welfare if there is a sharp drop in the search intensity after workers accept low productivity jobs.