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Finance and Economics Discussion Series
Finance and Economics Discussion Series logo links to FEDS home page Limited Network Connections and the Distribution of Wages
Kenneth J. Arrow and Ron Borzekowski

Abstract: It is well-known that 50% or more of all jobs are obtained through informal channels i.e. connections to family or friends. As well, statistical studies show that observable individual factors account for only about 50% of the very wide variation in earnings. We seek to explain these two facts by assuming that the linking of workers and firms is mediated by limited network connections. The model implies that essentially similar workers can have markedly different wages and further that the inequality of wages is partly explained by variations in the sizes of workers' networks. Our results indicate that differences in the number of ties can induce substantial inequality and can explain roughly 15% of the unexplained variation in wages. We also show that reasonable differences in the average number of links between blacks and whites can explain the disparity in black and white income distributions.

Keywords: Wages, labor markets, social networks, inequality

Full paper (189 KB PDF)

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Last update: August 18, 2004