Referral Networks and Inequality

I develop a theoretical model to study the effect of using referrals on inequality and welfare in labor markets. Firms hire through the market and through referrals, workers are heterogeneous and the referral network is endogenous. The use of referrals alleviates informational frictions and also exacerbates inequality among workers. If heterogeneity is driven by productivity differences, then higher inequality improves welfare. If workers face different probability of forming a match despite having the same productivity, as in the case of discrimination, then the use of referrals is detrimental to welfare.