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The endogeneity of employment adjustment costs: the tradeoff between efficiency and flexibility

  • Charles A. Fleischman

This paper models a firm's choice of employment adjustment costs as one component of its choice of production process. In making a one-time choice of production process, firms tradeoff increased flexibility--the reduced cost of changing levels of production--against the diminished efficiency of producing a given level of output. The model predicts that firms facing greater volatility in expected employment choose production processes that entail relatively low costs of adjusting employment. Using estimates of adjustment costs and employment volatility for four-digit manufacturing industries, the paper finds empirical support for the model: Among four-digit industries facing similar choices of production process, those with more volatile employment tend to have lower costs of adjusting employment. Moreover, the paper finds that interindustry heterogeneity in the amplitude of deterministic seasonal fluctuations in employment is more important than the variance of stochastic employment fluctuations in explaining the choice of adjustment costs.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 1996-48.

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Date of creation: 1996
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Handle: RePEc:fip:fedgfe:1996-48
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  1. Fuss, Melvyn & McFadden, Daniel, 1978. "Flexibility versus Efficiency in Ex Ante Plan Design," Histoy of Economic Thought Chapters, in: Fuss, Melvyn & McFadden, Daniel (ed.), Production Economics: A Dual Approach to Theory and Applications, volume 1, chapter 7 McMaster University Archive for the History of Economic Thought.
  2. George Stigler, 1939. "Production and Distribution in the Short Run," Journal of Political Economy, University of Chicago Press, vol. 47, pages 305.
  3. Stephen G. Cecchetti & Anil K Kashyap & David W. Wilcox, 1995. "Do Firms Smooth the Seasonal in Production in a Boom? Theory and Evidence," NBER Working Papers 5011, National Bureau of Economic Research, Inc.
  4. Haltiwanger, John C & Maccini, Louis J, 1988. "A Model of Inventory and Layoff Behaviour under Uncertainty," Economic Journal, Royal Economic Society, vol. 98(392), pages 731-45, September.
  5. Matthew D. Shapiro, 1986. "The Dynamic Demand for Capital and Labor," NBER Working Papers 1899, National Bureau of Economic Research, Inc.
  6. Topel, Robert H, 1982. "Inventories, Layoffs, and the Short-Run Demand for Labor," American Economic Review, American Economic Association, vol. 72(4), pages 769-87, September.
  7. Hamermesh, Daniel S, 1989. "Labor Demand and the Structure of Adjustment Costs," American Economic Review, American Economic Association, vol. 79(4), pages 674-89, September.
  8. Barsky, Robert B & Miron, Jeffrey A, 1989. "The Seasonal Cycle and the Business Cycle," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 503-34, June.
  9. Ricardo J. Caballero & Eduardo M.R.A. Engel, 1992. "Microeconomic Adjustment Hazards and Aggregate Dynamics," NBER Working Papers 4090, National Bureau of Economic Research, Inc.
  10. Timothy F. Bresnahan & Valerie A. Ramey, 1992. "Output Fluctuations at the Plant Level," NBER Working Papers 4105, National Bureau of Economic Research, Inc.
  11. Steven J. Davis & John C. Haltiwanger & Scott Schuh, 1998. "Job Creation and Destruction," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262540932, June.
  12. Bils, Mark, 1987. "The Cyclical Behavior of Marginal Cost and Price," American Economic Review, American Economic Association, vol. 77(5), pages 838-55, December.
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