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> August 22, 2004
> ECONOMIC VIEW
> It's Who You Know. Really.
> By DANIEL GROSS
> In many economics faculty lounges, the mere suggestion that markets
> are something less than efficient is likely to elicit cool stares.
> But Kenneth J. Arrow, a 1972 Nobel laureate and professor emeritus at
> Stanford, recently turned a skeptical eye on the efficiency of one
> vast market - the labor market - and reached some intriguing
> conclusions about what distinguishes better-paid workers from their
> lower-paid peers. It's not what you know, Professor Arrow, a prolific
> theorist, suggests; it's who you know.
> If labor markets were truly efficient, pay among workers with
> similar credentials would not vary much. But within groups of
> similarly situated workers, income inequality has risen in recent
> decades. What's more, Professor Arrow said, "Observable
> characteristics like intelligence, education, experience and age
> explain only half of the difference."
> To get at the other 50 percent, he and a Stanford colleague, Ron
> Borzekowski, now at the Federal Reserve in Washington, reimagined
> the place of workers in the equation. Instead of regarding employees'
> wages as responses to the laws of supply and demand, they constructed
> a model that views wages as functions of competitive bidding among
> A computer connected to 100 computers is economically more powerful
> than a PC linked to only 10 - that's the network effect. It turns out
> that the same holds for workers and their personal connections to
> companies. While the Internet's breadth may offer individuals the
> chance to post their qualifications for millions of employers to see,
> about half of all jobs are still found through personal contacts of
> some sort.
> And the more connections you have, the more you end up being paid.
> Why? Companies that make judgments based solely on a résumé are
> flying blind, to a degree. By contrast, if a job applicant once
> worked with a current company employee, or attends the same church as
> a company worker, the company can glean hints about how that
> applicant will perform. Such personal information - about reliability,
> or a sense of humor - can lead companies to bid more aggressively for
> someone's services. But such data is conveyed almost exclusively
> through personal network connections. And if the information is
> available to 10 potential employers instead of 2, wages are more
> likely to be bid higher.
> The network effect is weaker, though, for people seeking the most
> highly skilled positions.
> "For jobs that require higher education and technical skills,
> network connections don't matter as much," said Harry J. Holzer,
> professor of public policy at Georgetown University. Honors graduates
> of Harvard Law School will probably receive a host of job interviews,
> regardless of how many partners they know at how many law firms. But,
> Professor Holzer said, when it comes to relatively unskilled jobs,
> such links are crucial. When hiring a baby-sitter, the fact that an
> applicant may have worked for a neighbor or relative carries far more
> weight than a résumé.
> In fact, in a recent working paper, Professor Arrow and Mr.
> Borzekowski conclude that a worker's net worth can have a lot to do
> with the worker's network. In their model - and it is just a model,
> not based on empirical data - a person with one corporate connection
> would be expected to earn $19,570. By contrast, a person with links
> to five companies would be expected to earn $30,410. Ultimately, they
> conclude, "the difference in the number of ties can induce substantial
> inequality and can explain 15-20 percent of the unexplained variation
> in wages."
> The economists also suggest that network effects may help account for
> income inequality among races. In 1998, for men 24 to 40 years of age
> who had finished high school but had no further education, the
> average income for African-Americans was $26,223 and for whites was
> $33,123. If one hypothesized that the average African-American worker
> had links to 3.2 companies and the average white worker had links to
> 5.7, that would go a long way toward explaining the large wage gap,
> Professor Arrow said.
> THE hypothesis makes sense, said Jeffrey A. Robinson, assistant
> professor of management and entrepreneurship at New York
> University's Stern School of Business. "Minorities are often
> disconnected from the web of social relationships that lead to hiring
> Professor Arrow has not pursued the policy implications of his
> findings, but others have. To improve the lot and prospects of
> middle-income workers and the working poor, it may not be enough
> merely to focus on the traditional twin pillars of job training and
> education. Policy makers may also need to focus on upgrading the
> number and quality of workers' links to companies.
> "The challenge is to expand the role of social brokers - individuals,
> nonprofit and government agencies - that can facilitate connections to
> companies once people have the skills," Professor Robinson said.
> Daniel Gross writes the "Moneybox" column for Slate.com.
> Copyright 2004 The New York Times Company
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