Do Friends and Relatives Really Help in Getting a Good Job?

Michele PellizzariLondon School of Economics

Motivation

Extensive use of personal contacts by both firms and workers

Limited evidence for Europe (some for US)

Firms’ recruitment behaviour

How do people find their jobs?

J ob finding methods in Europe (ECHP, 1996)

15.9

10.9

16.4

27.629.3

0

5

10

15

20

25

30

35

other agency adverts directapplication

personalcontacts

How do people find their jobs? (2)

J obs found through informal channels(% of total employment - ECHP, 1996)

13.0 13.317.3 17.7

23.025.5 25.9 26.4 27.1

32.234.4

37.2 38.541.0

45.0

0

10

20

30

40

50

USA FIN NLD DEN UK ITA BEL IRL AUT GER FRA LUX PRT GRC ESP

What do we know?

Two main results from previous studies:

1. Informal search is very efficient• higher probability of finding employment• more job offers

2. Jobs found through informal methods tend to be good matches and pay higher wages

• theory (information, self selection)

• empirical evidence (US, recent working papers)

What this paper does (1)

Part 1: Empirical evidence from the ECHP

Explores the empirical evidence in European countries

Finds variation in wage premiums (+ in some labour markets, - in others)

What this paper does (2)

Part 2: Theory

Explains the variation looking at firms’ formal recruitment strategies:

• recruitment is about hiring the “right” worker

• informal is exogenous, formal is endogenous

• the effect on wage differential:

more formal lower wage premium to informal

• Determinants of recruitment effort(technology, labour market conditions)

What this paper does (3)

Part 3: Empirical test of the theory correlation between expenditure in recruitment and

wage differentials

higher expenditure in recruitment in high-productivity sectors, sectors with high training costs and in loose labour markets

Reduced form

Additional implications on the incidence of jobs found through informal contacts

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The Data

European Community Household Panel (1994-1999)• Panel dataset based on common questionnaire and sampling

procedures

• Employed workers indicate search method that led to current job

National Longitudinal Survey of Youth (1994-2000)• Different sample structure (cohort)

• Every 2 years (since 1994)

• Employees indicate search method (possibly more than one)

Eurostat Labour Costs Survey (1992, 1996)• Establishments with more 10 employees

• Recruitment cost and training cost as % of total labour costs

• Aggregate data by industry (only manufacturing and services)

The distribution of jobs found through friends and relatives

Characteristics of jobs found through friends and relatives:

• yi=found through personal contacts

• xi= gender, age (age2), hh size and composition, hh income, education, type of contract, occupation, industry, firm size.

• ECHP 1996

)'()1Pr( ii xy

Who finds job through personal contacts? (1)EDUCATION

-0.22

-0.17

-0.12

-0.07

-0.02

0.03

AUT BEL DEN FIN FRA GER GRC IRL ITA LUX NLD PRT ESP UK USA

1=tertiary edu.

1=second. edu.

Who finds job through personal contacts? (2)OCCUPATION

-0.16

-0.11

-0.06

-0.01

0.04

AUT BEL DEN FIN FRA GER GRC IRL ITA LUX NLD PRT ESP UK USA

1= higher. occup.

1= interm. occup.

Wage differentials (1)

(log) wage regression with individual controls and a dummy for jobs found through friends and relatives:

• OLS are potentially biased (heterogeneity in access to and quality of informal networks).

OLS Wage differentials

Wage differentials (2)

FIXED-EFFECTS:

• identification strategy based on comparing the same individual over time in different jobs

FIXED-EFFECT Wage differentials

Wage differentials

Mismatching or Compensating Differentials?

GER

ESPPRTNLDLUX

USAUKITAIRLGRCFIN

FRA

DEN

BEL

AUT

-0.12

-0.07

-0.02

0.03

0.08

tenure<=6 monthstenure>6 months

Summary of the evidence

Jobs found through personal contacts are concentrated into lower occupational and educational groups.

Wage differentials vary across countries and sectors

The model: motivation

Previous models have assumed some “superiority” of informal channels over formal search/recruitment methods

Relax that by endogenising firms’ formal recruitment effort

When investing heavily in (formal) recruitment, firms might have better chances of hiring the “right” worker through formal than informal

What’s driving firms’ recruitment effort?

A simplified matching model

Supply side and wage negotiation are exogenous (partial equilibrium):• fixed number of firms• firms offer a wage equal to a fraction () of expected or actual

productivity workers always accept

Firms meet workers with probability q

• either through formal () or informal (1-)

Workers are either suitable or unsuitable for the specific job offered:• suitable workers produce x=p>0• unsuitable workers produce x=0

Training costs kp, paid before production takes place

Recruitment

Recruitment costs cRf and improves the probability of finding a suitable worker, ζ(Rf):

R

1

0

nh

Probability of hiring a suitable worker through the formal channel = qζ(Rf)

Recruitment (2)

Properties of ζ(Rf):

• increasing and concave in Rf

Informal recruitment• simply replace Rf with Ri: ζ(Ri)

• Ri is exogenous

Wages:• initial wages: wf,i= ζ(Rf,i) p

• continuation wage: w= p

Optimal choice of Rf

Rf maximises the value of a vacancy:

where:

Empirical Implications

2. Relative wages:

),,,()()()()(

if RqkpfR

),()(

)(

)()(

iff

i

f

i RRgR

R

w

w

1. The determinants of recruitment effort:

Testing the empirical predictions

1. Test the determinants of recruitment effort

2. Test the correlation between wi/wf and Rf

3. Test the model in reduced form:

),,,()()()()(

if

i Rqkphw

w

More data

Rf, p, k from the Eurostat Labour Costs Survey

q=q(v/u) by sector:• unemployment by sector?

• vacancies by sector employment trend from OECD Business Trend Survey

• only manufacturing

Ri constant within countries country fixed-effects

1. The determinants of recruitment

Empirical specification:

• the model predicts:

α1>0, α2>0, α3<0

2. Wage differentials and recruitment costs

Empirical specification :

• the model predicts: <0

3. The reduced form model

Additional information from the ECHP:

• high occupation high productivity

• training

• individual fixed-effects control for Ri

Table 8: Reduced form model for wage differentials

Additional implications: the incidence of jobs found via informal

networks

Each period:• q matches are created through f,• 1-ζ(Rf) are immediately destroyed• q(1-) matches are created through i• 1-ζ(Ri) are immediately destroyed

Fraction of jobs created through i:

Incidence (2)

Implication: • there are less jobs found through personal

contacts where firms invest more in recruitment

Table 9: Incidence of jobs found through informal networks and recruitment costs

Table 10: Reduced form model for the incidence of jobs found through i

Conclusions

Do friends and relatives really help in getting a good job?• personal contacts are concentrated in low productivity jobs• variation in wage differentials

Why?• where firms invest heavily in formal recruitment there are less

jobs created through informal contacts and they tend to pay lower wages

• firms invest in recruitment especially for high productivity jobs and jobs that require training

Further research• model workers’ behaviour (self-selection?)• more work on recruitment policies (very under researched)

using firm-level data.