The Role of Referrals in Immobility, Inequality, and Inefficiency in Labor Markets

We study the consequences of job markets' heavy reliance on referrals. Referrals screen candidates and lead to better matches and increased productivity, but disadvantage job-seekers who have few or no connections to employed workers, leading to increased inequality. Coupled with homophily, referrals also lead to immobility: a demographic group's low employment rate in one period leads that group to have relatively low employment in future periods as well. We identify conditions under which distributing referrals more evenly across a population not only reduces inequality, but also improves economic mobility across generations as well as future productivity. We use the model to examine optimal policies, showing that one-time affirmative action policies involve short-run production losses, but lead to long-term improvements in equality, mobility, and productivity due to induced changes in future referrals. We also show how the possibility of firing workers changes the effects of referrals.