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> August 22, 2004
> It's Who You Know. Really.
> 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
> companies.
> 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
> decisions."
> 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
>  Copyright  2004 The New York Times Company

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