Events

Prof. Benjamin Friedrich
Associate Professor of Strategy
Kellogg School of Management
Northwestern University

Managers often report that labor constraints – defined as the inability to find workers – are a major obstacle to firms’ growth. This phenomenon is puzzling, because economic theory offers a simple remedy: increase wages until the worker is found or hiring is no longer profitable. We explore why firms report labor constraints instead of pre-empting them by increasing wages using administrative data from Germany. We confirm that quasi-exogenous variation in labor constraints slows down firm growth. Wages play a role consistent with basic theory: firms that report constraints initially underpay their workers, increase wages later, and a quasi-exogenous increase in wages alleviates their problems. Why then do firms not increase wages earlier to avoid the problem to begin with? Unlike financial markets, labor markets do not have an easily observable price process. Firms set wages based on their beliefs, and when they underestimate market-clearing wages, labor constraints arise. Consistent with this mechanism, labor constraints increase after quasi-exogenous wage increases in other parts of the economy and are more prevalent in settings where firms are less informed.