Labor Demand on a Tight Leash

TL;DR

This paper introduces a labor demand model accounting for pre-match hiring costs in tight labor markets, analyzing their impact on firms' employment and wages using German firm data.

Contribution

It provides a novel empirical analysis of how labor market tightness affects firm labor demand and quantifies pre-match hiring costs as a significant portion of wages.

Findings

Doubling labor market tightness reduces firm employment by 5%.

Wage elasticity of demand decreases from -0.7 to -0.5 after accounting for externalities.

Pre-match hiring costs constitute 40% of annual wages.

Abstract

We develop a labor demand model that encompasses pre-match hiring cost arising from tight labor markets. Through the lens of the model, we study the effect of labor market tightness on firms' labor demand by applying novel shift-share instruments to the universe of German firms. In line with theory, we find that a doubling in tightness reduces firms' employment by 5 percent. Taking into account the resulting search externalities, the wage elasticity of firms' labor demand reduces from -0.7 to -0.5 through reallocation effects. In light of our results, pre-match hiring cost amount to 40 percent of annual wage payments.