How Responsive Are Wages to Firm-Specific Changes in Labour Demand? Evidence from Idiosyncratic Export Demand Shocks

Abstract Do firms adjust wages in response to changes in their own demand level or to changes in competitive pressure from rival employers? We study how exporters adjust wages in response to unexpected product demand shocks during the 2008–9 Great Recession. Using rich data on Portuguese firms’ pre-recession export shipments, we measure firm-level shocks to export demand during the Recession. We show that shocks constructed at the firm level are not necessarily firm-specific and can be decomposed into a common component affecting all producers in a product market and an idiosyncratic component affecting individual firms within markets based on the locations of their pre-recession customers. We demonstrate that while both components impact firms’ output and their workers’ wages, the common component spills over from firms to their labour market rivals, whereas the idiosyncratic component does not. We find that 10–15% of firms’ idiosyncratic demand passes through to their employees’ wage growth with no effect on retention rates, implying significant dependence of wages on noncompetitive quasi-rents. Moreover, we find that wages respond primarily to shifts in internal labour demand when labour markets are thin, but they respond more to competition from other employers when labour markets are fluid. These results indicate that employers’ ability to set wages hinges on the underlying competitiveness of the labour market.