Coexistence of public and private job agencies: Screening with heterogeneous institutions

In response to the analysis of bureaucracies and the finding of inherent inefficiencies, public choice theory argues for an increase in competition by contracting out government services and deregulation. The paper explores the effect of coexisting public and private employment services in a model with private information of the worker about her ability and unobservable effort choice. The employer's use of an efficient unemployment exchange and an efficient private agency may lead to optimal screening with first best contracts. This is due to the assumption that good types of workers lose more human capital than bad types in periods of unemployment or mismatch. In contrast to standard screening contracts, a bad type of worker earns an information rent if the employment exchange is inefficient, but the employer chooses not to use the private agency for good types.