Inequality, Selection, and Efficiency in Labor Markets

Everyday events such as hirings, layoffs, poachings, and promotions generate outcomes depending on the productivity of workers. While search frictions may attenuate the impact of pre-market worker productivity dispersion into wage inequality, the selectivity or screening of employer decisions tend to work in the opposite direction. Hence, labor market transitions may magnify the pre-market inequality effect into employment and wages. Moreover, we present some evidence showing a suggestive link between labor market flows and wage inequality. To rationalize these facts, we construct and solve an equilibrium nonsequential search model with on-the-job search, in which selection plays a potentially large role to explain how labor markets act as a catalyst for wage and employment inequality. We also show that costly screening and search frictions generate a welfare-maximizing level of inequality and unemployment.