Misallocation Effects of Labor Market Frictions

We theoretically study misallocation of labor in a heterogeneous-firm model with imperfectly directed search. Some workers can direct their search, while others are uninformed about the location of wage offers ex ante and are assigned to job openings randomly. The main result is that too many workers apply to high-productivity firms, relative to the social optimum. This occurs because too many firms take advantage of their market power, attracting only random searchers. Because it is the low-productivity firms that do so, this induces all the directed searchers to concentrate at the high-productivity firms, a ''flight-to-quality'' phenomenon. Improvements in information have ambiguous effects on worker allocation, wages, and worker utility. A minimum wage can increase employment and welfare by reallocating workers across firms. With an endogenous entry choice, policy design meets with a tradeoff in balancing the misallocation inefficiency and a standard entry externality.