How Do Industries and Firms Respond toChanges in Local Labor Supply?

In this paper, we investigate how changes in the skill mix of local labor supply are absorbedby the economy. We distinguish between three adjustment mechanisms: through factorprices, through an expansion in the size of those production units that use the moreabundant skill group more intensively, and through more intensive use of the more abundantskill group within production units. We investigate which of these channels is dominant. Wecontribute to the existing literature by analyzing these adjustments on the level of firms,rather than industries, and by assessing the role of new firms in the absorption process oflabor supply shocks. Our analysis is based on administrative data, comprising the entirety offirms in Germany over a 10 years period. We find that, while factor price adjustments areimportant in the non-tradable sector, labor supply shocks do not induce factor price changesin the tradable sector. In this sector, most of the adjustment to changes in relative factorsupplies takes place within firms by changing relative factor intensities. Given the nonresponseof factor prices, this finding points towards changes in production technology. Ourresults further show, that firms that enter and exit the market are an important additionalchannel of adjustment. Finally, we demonstrate that an industry level analysis is likely toover-emphasize technology-based adjustments....