Heterogeneity, Selection and Labor Market Disparities

We study the incentives to improve ability in a model where heterogeneous \u85rms and workers interact in a labor market characterized by matching frictions and costly screening. When e¤ort in improving ability raises both the mean and the variance of the resulting ability distribution, multiple equilibria may arise. In the high-e¤ort equi-librium, heterogeneity in ability is su ¢ ciently large to induce \u85rms to select the best workers, thereby con\u85rming the belief that e¤ort is important for \u85nding good jobs. In the low-e¤ort equilibrium, ability is not su ¢ ciently dispersed to justify screening, thereby con\u85rming the belief that e¤ort is not so important. The model has impli-cations for wage inequality, the distribution of \u85rm characteristics, sorting patterns between rms and workers, and unemployment rates that can help explaining observed cross-country variation in socio-economic and labor market outcomes. JEL Classi\u85cation: E24, J24, J6