Price Discovery in Labor Markets: Why Do Firms Say They Cannot Find Workers?

Managers often report that labor constraints – defined as the inability to find workers – are a major obstacle to firm growth. In this paper, we analyze why firms report labor constraints, instead of preempting this problem with the simple remedy prescribed by economic theory – to increase wages. Using German vacancy and establishment data, we document that constraints reflect real recruiting difficulties, are prevalent among growing firms, and reduce subsequent growth and profitability. Firms that report constraints initially underpay their workers, increase wages later, and a quasi-exogenous increase in wages alleviates their problems. Because standard search frictions alone cannot match the empirical patterns, we build a dynamic matching model that adds three mechanisms: imperfect information about market wages, wage spillovers to incumbents, and downward wage rigidity. Our evidence points to a key role for firms’ inaccurate beliefs about market wages. Hiring difficulties are prevalent for peripheral occupations and arise when firms compete in dispersed labor markets spanning industries and wage tiers, consistent with infrequent, costly learning about workers’ outside options. We find some suggestive evidence consistent with dynamic wage considerations and only weak evidence on wage spillovers.