Innovation and skill upgrading: The role of external vs internal labour markets

Following technical and organisational changes, firms may react to increasing skill requirements either by training or hiring the new skills, or a combination of the two. Using matched datasets with about 1,000 French plants, we assess the relative importance of these external and internal labour market strategies. We show that skill upgrading following technological and organisational changes takes place mostly through internal labour markets adjustments. Consistently with the results in the literature, we find that new technologies and organisational changes are associated with an upward shift in the occupational structure within firms. We show that about one third of the upgrading of the occupational structure is due to hiring and firing workers on the external labour market, whereas two-thirds are due to promotions. Moreover, we find no compelling evidence of external labour market strategies based on "excess turnover". In contrast, French firms heavily rely on training in order to upgrade the skill level of their workforce. When splitting the sample across sectors, this pattern of results appears to be particularly strong for manufacturing firms whereas, in services, external labour market strategies tend to be more widespread. We then consider the determinants of the strategies chosen by firms. We argue that the relative cost of internal versus external labour market flexibility is likely to be critical and that it can be partly captured by firm size and by the density on the local labour market. We find that external labor market strategies tend to be more important when firms are located on high-density labor markets.