Selective Hiring and Welfare Analysis in Labor Market Models
Firms select not only how many, but also which workers to hire. Yet, in most labor market models all workers have the same probability of being hired. We argue that selective hiring crucially affects welfare analysis. We set up a model that is isomorphic to a search model under random hiring but allows for selective hiring. With selective hiring, the positive predictions of the model change very little, but the welfare costs of unemployment are much larger because unemployment risk is distributed unequally across workers. As a result, optimal unemployment insurance is higher and welfare lower if hiring is selective.