Job Market Signaling and Job Search

The high cost of searching for employers borne by prospective employees increases friction in the labor market and inhibits formation of e¢ cient employer-employee relationships. It is conventionally agreed that mechanisms that reduce the search costs (e.g., internet portals for job search) lower unemployment and improve overall welfare. We demonstrate that a reduction of the search costs may have the converse e¤ect. We show that in a signaling job market with random matching lower search costs lead to fewer employees willing to exert e¤ort and, in a separating equilibrium, to more individuals opting to stay completely out of the job market and remain unemployed. Furthermore, we show that lower search costs not only deteriorate the market composition, but also impair e¢ ciency by leading to more expensive signaling in a separating equilibrium. Keywords: signaling; job market; job search; separating equilibrium; unemployment; moral hazard JEL classi…cation: D82; C72; C73; J64 This paper was conceived during the activities of the Game Theory and Evolution group in 2006-2007, organized by Sergiu Hart and Avi Shmida and hosted by the Institute for Advanced Studies and the Center for Rationality, the Hebrew University. We are thankful to the group members, in particular to its organizers and the host institutions. We also thank Tymo…y Mylovanov and Eyal Winter for valuable comments. y University of Bonn and KSE-KEI. Email: [email protected] z Hebrew University of Jerusalem. Email: [email protected]