Heterogeneity, selection and labor market disparities

We propose a model in which differences in socioeconomic and labor market outcomes between ex-ante identical countries can be generated as multiple equilibria sustained by different beliefs on the value of effort for finding jobs. To do so, we study the incentive to improve ability in a model where heterogeneous firms and workers interact in a labor market characterized by matching frictions and costly screening. When effort in improving ability raises both the mean and the variance of the resulting ability distribution, a complementarity between workers’ choices and firms’ hiring strategies can give rise to multiple equilibria. In the high-effort equilibrium, heterogeneity in ability is larger and induces firms to screen more intensively workers, thereby confirming the belief that effort is important for finding good jobs. In the low-effort equilibrium, ability is less dispersed and firms screen less intensively, which confirms the belief that effort is not so important. The model has novel implications for wage inequality, the distribution of firm characteristics, productivity, sorting patterns between firms and workers, and unemployment rates that can help explain observed differences across countries.