Labor Demand and the Structure of Adjustment Costs

This study examines the nature of the costs that firms face in adjusting labor demand in response to shocks induced by changes in output demand and prices. Empirical work on monthly plant-level time-series data shows that adjustment proceeds in jumps. Employment is unchanged in response to small demand shocks, but moves instantaneously to a new long-run equilibrium if the shocks are large. Results in the large literature that assumes smooth adjustment are due to aggregation of this inherently nonlinear relation over subunits experiencing different shocks. The finding has implications for cyclical changes in productivity and for examining the effects of policies such as severance pay, layoff and plant-closing restrictions, and mandatory listing of job vacancies, all of which change the cost of adjusting employment