Ordinarily labor market equilibrium implies that the marginal worker is indifferent to employment, and that the employer is indifferent between equally productive employees. When the marginal worker is indifferent to employment, employer preferences do not matter. If, however, the marginal worker strictly prefers to be employed, the employer can give favors, and may wish to do so even at some cost to efficient production. Not only may inefficient workers be employed, but the employer may also choose to employ too many workers. We refer to this as the brother-in law effect. When the brother-in-law effect is due to unionization, employment of brothers-inlaw leads to increased employment – under some circumstances leading even to over employment relative to the workforce that would be employed without unionization. If the employment effect is strong – because brothers-in-law are relatively good workers – nepotism improves efficiency. If the employment effect is weak – including in principalagent models where there are informational rents – nepotism is inefficient.
