“Inefficient Hiring in Entry-Level Labor Markets,” A. Pallais (2012)

It’s job market season again. I’m just back from a winter trip in Central Europe (though, being an economist, I skipped the castles and cathedrals, instead going to Schumpeter’s favorite Viennese hiking trail and von Neumann’s boyhood home in Budapest) and have a lot of papers to post about, but given that Pallais’ paper is from 2011’s job market, I should clear it off the docket. Her paper was, I thought, a clever use of a field experiment (and I freely admit by bias in favor of theoretically sound field experiments rather than laboratory exercises when considering empirical quantities).

Here’s the basic theoretical problem. There are a bunch of candidates for a job, some young and some old. The old workers have had their productivity revealed to some extent by their past job experience. For young workers, employers can only see a very noisy signal of their productivity. It involves a small cost to hire workers; they must be trained, etc. In equilibrium, firms will hire young workers who have expected productivity above the firm’s cost. Is this socially efficient? No, because of a simple information externality. The social planner would hire all young workers whose productivity plus the value of information revealed during their young tenure is above the firm’s cost. That is, private firms will not take into account that their hiring of a worker creates a positive externality from information that allows for better worker-firm matches in future periods. If yound workers could pay firms to work for them, then this might fix the problem to some extent, though in general such arrangements are not legal (though on this point, see my comment in the final paragraph). Perhaps this might explain the high levels of unemployment among the young, and the fact that absence from the labor market for young workers at the start of their career is particularly damaging?

How important is this? It’s tough in a lot of real world data to separate the benefits to workers of having their underlying revealed by early job experience from workers upgrading their skills during their first job. It is also tough to see the general equilibrium effects: if the government assists some young workers in getting hired, does this lead to less unemployment among young workers in future periods or do these assisted workers simply crowd out others that would have been hired in the absence of the intervention? Pallais uses an online job market similar to mechanical turk. Basically, on the site you can hire workers to perform small tasks like data entry. They request a wage and you can hire them or not. Previous hires are public, as are optional ratings and comments by the employers. Empirical data on past interventions is somewhat ambiguous.

Pallais hires a huge number of workers to do data entry. She randomly divides the applicants into three groups: those she doesn’t hire, those she hires and gives only minimal feedback, and those she hires and provides detailed comments. The task is ten hours of simple data entry with no training, so it’s tough to imagine anyone would infer the workers’ underlying human capital has improved. Other employers can see that Pallais has made a hire as soon as the contract begins, but the comments are added later; there is no effect on workers’ job offers until after the comments appear. And the effect appears substantial. Just being hired and getting a brief comment has a small impact on worker’s future wages and employment. A longer, positive comment has what looks like an enormous impact on the worker’s future employment and wages. Though the treatment does lower wages received by other people on data entry jobs by increasing the supply of certified workers, the overall increase in welfare from more hiring of young workers trumps the lower wages.

Interesting, but two comments. First, for some reason the draft of this paper I read seems to suggest some sort of idea that this sorting is good for workers, if only between the lines. But it needn’t be so! A simple model: all firms are identical, and have cost .4 of hiring a worker. Workers have skills drawn from a uniform [0,1] distribution. No signals are received in the first period. Therefore, all workers have expected skill .5, and all are hired at wage .1 (by the no profit condition in a competitive labor demand market). After the first hiring, skill level is completely revealed. Therefore, only 60% of workers are hired in the second period, at a wage equal to their skill minus .4. A policy that ex-ante would have revealed the skill of young workers would have decreased employment among young workers by 40 percent! Note that this would be the efficient outcome, so a social planner who cares about total welfare would still want to reveal the skill, even though the social planner who cares only about employment would not do so.

Second, to the extent that skill revelation is important, young workers with private information about their skills ought self-select. Those who believe themselves to be high type should choose jobs which frequently throw off public signals about their underlying quality (i.e., firms that promote good young folks quickly, industries like sales with easily verifiable output, etc.). Those who believe themselves low type should select into jobs without such signals. If everyone is rational and knows their own type, you can see some unraveling will happen here. What has the empirical career concerns literature learned about such selection?

November 2011 working paper (No IDEAS version). I see on her CV that this paper is currently R&Red at AER.

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