Equilibrium Unemployment as a Worker Screening Device

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We present a model of the labor market with asymmetric information in which the equilibrium of the' market generates unemployment and job queues so that wages may serve as an effective screening device. This happens because more productive workers -- within any group of individuals with a given set of observable characteristics -- are more willing to accept the risk of being unemployed than less productive workers. The model is consistent with cyclical movements in average real wages as well as with differences in unemployment rates across different groups in the population. We also show that the market equilibrium is not, in general. constrained Pareto efficient Moreover. we identify a new category of nonexistence problems, different in several essential ways from those earlier discussed by Rothschild-Stiglitz [1976J and Wilson [1977]. We also extend the analysis to incorporate the possibility of renegotiation, showing that a separating-renegotiation-proof-equilibrium exists for certain parameters and that a renegotiation-proof equilibrium is always constrained Pareto efficient Finally, we present a version of the model in which firms enter sequentially, as in Guash and Weiss [1980]. But contrary to the main result in that paper, we show that there is no advantage of being late, provided workers have rational expectations.

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