Flexibility of firms' labor demand: Substitutability or complementarity

Based on merged data from the IAB-establishment panel survey and the historic files of the employment statistics register, a translog cost system was estimated for six qualification groups (blue and white collar workers stratified into unskilled, skilled and highly-skilled employees) for West German production industries for the year 1995. Substitution possibilities between differently qualified employees are investigated at the establishment level. The derived substitutional relationships within the blue collar workers were very similar to those within the white collar workers. Skilled employees and, to a lesser extent, highly skilled employees are substitutes for the unskilled. This could at least partly explain the rise in unemployment amongst the unskilled. In contrast, the demand for skilled workers does not depend on the wage of the highly skilled employees and vice versa. The frequently cited results that the own-wage demand elasticity decreases with skill, can be confirmed between skilled and highly skilled employees, but not between skilled and unskilled employees. The elasticities of substitution between blue collar and white collar workers are relatively low; unskilled, skilled and highly skilled blue collar workers are found to be complements to the analogue group of white collar workers. Finally, the evidence does not favor the capital-skill complementarity hypothesis.