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Diversity and social interactions

Final Activity Report Summary - DIVSOCINT (Diversity and social interactions)

Most of the decisions that people make are circumscribed by the decisions taken by their peers. The underlying reason may be instrumental, such as would be the case if there are benefits to coordination, or psychological such as social stigma, attached to social transgression. In this research project the focus is on a particular type of norm transgression, namely we investigate the role of a stigma attached to choosing to become a low-skilled worker as opposed to investing time and effort into becoming a high-skilled worker.

Our main research questions are: How does the presence of a social norm affect the composition of skill in a population? How does the degree of competition in the labor market affect skill composition in the population? In a multi-population setting can wage discrimination be optimal, even from a social perspective?

This research project provides an answer to these and related questions. In particular we show that in a model where people decide on whether to become skilled or not based on their private costs of doing so, and a social component, in any equilibrium with a positive proportion of high skilled labourers "too many" acquire skill. That is some people engage in costly skill acquisition even though it is not beneficial from a social perspective to do so. The reason is simple. When a large proportion of people in one's reference group acquire skill others are compelled to invest in skill as well in order to avoid stigma associated with being unskilled. The basic externality at work is that when deciding to become skilled the individual does not internalise that this raises the cost of remaining unskilled to others, which induces still more to invest in skill. Another feature of our model is that it exhibits multiple equilibria. Thus e.g. the same production conditions may lead to different outcomes and production in society.

Next we add a productive sector, and ask how the solution with a social norm present differs from when there is no social norm. We treat the case of the monopsonist. The monoposonist posts wage-offers and then workers take their investment decision. Generally the monoposonist contracts fewer high skilled workers than in a competitive set-up since the marginal increase in salary required to attract the marginal worker must be paid to the whole proportion of high skilled workers. But there is another effect of the norm, namely that in order to attract high skilled workers the monopsonist need not compensate workers fully, rather the drive to avoid stigma associated with low skilled positions implies that the monopsonist need not compensate workers fully for their private costs to induce investment in skill on the margin. We also examine the case of perfect competition. If equilibrium exists then the equilibrium is characterised by workers being paid their marginal product.