Horizontally Differentiated Labor Markets: An Exploration, Part 1

A worker’s productivity is only imperfectly revealed when employed to perform a particular task: the match could be imperfect, and her productivity dependent on that of other workers in the team she is working in. We embed both elements of informational imperfection in combination, within a parsimonious parametric model that involves horizontally differentiated skills, as well as firms varying in size and structure of tasks from specialized to diversified. The typical worker’s productivity is revealed only via that of her team, the firm. The team’s productivity can be improved upon by frictionless re-matching within the internal labor market. Any misalignment between the distribution of skills and tasks can be removed only by external labor market actions constrained by informational frictions. There are two parts. In part 1, we analyze internal market equilibrium, but assume for the external market that firms can realize their desired demand. In part 2, we realistically consider labor supply in the external market as furnished by separations, and structured by signals involving the typical worker’s employment history. We demonstrate generic opposite effects involving internal and external market activities. In the internal market, constrained efficient re-matching yields the average productivity of firms to increase in size and diversity of structure. Beyond that, the cumulative distributions of firms by productivity are stochastically dominant across firms by increasing degree of diversification. While with the satisfaction of desired demand in the external market the firms improve in expected productivity, the strength of improvement decreases in firm size and diversity of structure. Productivity gains via re-matching in the internal market may be overturned by the losses due to imprecise matches of hires from the external market: The more internal rematching leads to leftward skewness in the distribution of firms towards higher productivity, the less informative is the specification of desired demand (and, as we show in part 2: in the supply) in the external market.