With Friends Like These: Endogenous Labor Market Segregation with Homogeneous, Nonprejudiced Agents

I Introduction IT HAS LONG BEEN KNOWN that wage inequality between workers from different demographic groups such as race and gender shows up in large part through occupational segregation (Bergmann 1986; Blau and Kahn 2000). A more recent literature in economics, heavily influenced by the sociological literature on social networks, has examined the question of how occupational segregation, and more generally inequality between groups of workers, arises through segregation of social networks (Montgomery 1991; Durlauf 2006; Tassier 2005; Ioannides and Datcher Loury 2004; the latter has a wide-ranging review). There are really two avenues by which segregated social networks have been seen to create wage inequality when different networks are not identical. First, social contacts affect the accumulation of human capital and social capital, which in turn affects wage opportunities (Durlauf 2006). Second, the majority of jobs are found through personal referral (Stevenson 2008); when firms hire through referral, differences in whom their current workers know will create differences in whom firms hire for a particular job. Even without segregation, the randomness with which workers receive job offers when firms hire through referral may cause large inequalities based on dumb luck (Arrow and Borzekowski 2004); if workers in different social networks have differential access to job offers, then systematic inequalities may also arise (Tassier and Menczer 2005). Given the importance of such inequalities, it is a natural question how segregation should arise. There has been an extensive empirical literature, largely studying the effects of segregated neighborhoods, suggesting that segregation, once engendered, perpetuates itself (see Durlauf 2006 for an overview). The general mechanism in this literature is that people with poor opportunities choose (or can only afford) to live in poor neighborhoods, which in turn lowers the economic opportunities available to their children. As to what creates segregation in the first place, the economics literature has given two answers. First, segregation may be based on taste: following Schelling (1971), if people have "mild" preferences to associate with people like themselves, then over time, individuals' myopic behavior will lead to a segregated society even though everyone may prefer to not be in such a society. Akerlof (1997) has shown how a desire to conform can lead to social differentiation with perverse outcomes when groups of people find themselves initially clustered together according to observable characteristics. Second, segregation may be based on individual attributes, most commonly human capital (Montgomery 1991; Benabou 1993). Within the labor market, firms may pay their workers to refer friends with similar productivity characteristics; at the neighborhood level, human capital may create positive spillovers to one's neighbors, and those with a lot of it may be in high demand and seek each other out, cutting themselves off in the process from those with low human capital. The current article attempts to illustrate an altogether different basis for segregation. In contrast to most of the literature, I suppose that workers are entirely homogeneous both in their productive attributes and in their tastes. Segregation is based instead on the desire for a closed social network, in which people's lists of friends overlap heavily. While the effects of closed networks have received detailed attention in the sociology literature (Coleman 1988; Portes and Sensenbrenner 1993), they have been given less study by economists. The paper that comes closest to this concept of segregation in the economics literature is probably Berman (2000), who considers a model where members of a community try to isolate their peers from activities outside the community in order to steer them toward activities within the community because the latter create positive externalities but are difficult to observe. …