DP9137 Professional service outsourcing, asymmetric information and wage inequality

Author(s): William Fuchs, Luis Garicano
Publication Date: September 2012
Keyword(s): Inequality, Knowledge markets, Organization
JEL(s): D82, D83
Programme Areas: Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=9137

The economy is experiencing a large shift towards professional services. Markets for these services are characterized by large information asymmetries: the difficulty in providing the necessary advice, the quality of the advice, and whether a problem is solved may all be unobservable. Our analysis considers these markets in a general equilibrium setting, which allows us to address the selection of talent into occupations and their efficiency and distributional implications. We first show that reductions in communications costs allow these markets to appear and increase wage inequality, as they favor the most skilled agents. However, under asymmetric information these markets are unable to exclude the least talented from posing as experts. If contingent contracts cannot be written, the market collapses and no services are bought or sold. If output contingent contracts are feasible, market exchanges weakly involve excessive trade. Despite the asymmetric information efficiency can be attainable when experts can solve many problems. Even when the allocation is efficient, the asymmetry of information has distributional consequences. It benefits moderately skilled agents at the expense of the least talented and most talented ones.