Using a large linked employer-employee data set, this paper studies the relationship between job reallocation, worker reallocation and the flexibility of wages in western German manufacturing. Using the plant-specific residual wage dispersion as a proxy for wage flexibility, we find that more flexible wages are associated with less job reallocation due to demand shocks being absorbed by wage rather than by quantity adjustments. As to excess worker reallocation, our results provide evidence of a significant positive relationship between excess worker flows and residual wage dispersion. Consistent with the hypothesis that more flexible wages should help employers in dissolving bad matches, this relationship is found to be most pronounced for low-quality workers. In interacting our measure of wage flexibility with the degree of plantspecific employment protection we find that less stringent firing practices may considerably reduce the need for more flexible wages in order to attain optimal worker-firm matches.
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