03 July 2020

Impact Evaluation of Labor Contract Law Enforcement to Firms' Hiring Cost

Does employment protection legislation really protect employees in developing countries? A recent PhD essay in Development Economics explores the issue in the case of the Chinese Labor Contract Law. The paper finds that new labor law enforcement led to a significant decline of state-owned enterprises’ hiring cost and a rise of the pre-tax wage in labor-intensive industries, but ultimately workers of both sectors don’t benefit from the law. Interview with Xiaojing Zhou on “Impact Evaluation of Labor Contract Law Enforcement to Firms’ Hiring Cost”.

Why did you decide to study the Labor Contract Law in China?

In my first year of PhD, I read an article by Hong Kong economist Ng-Sheong Cheung, which criticised this new labor law but without explaining its mechanism. So I started my research on how the Labor Contract Law works in the economy. 

Can you explain the context of the labor market in China?

The Chinese labor market is regulated by Labor Law (1995) and Labor Contract Law (2008), which is an amendment to the old one. Before 2008, many Chinese workers, especially the short-term and temporary hires, were employed with an oral contract. Their rights could not be guaranteed. To change this situation, the Labor Contract Law requires that every employment relationship has to be built upon a written contract. Even temporary hires need the written agreement with labor dispatch agencies. The new law also regulates the format of the employment contract in more details. For example, social security payments have to be specified in the contract. 

The starting point of the Labor Contract Law was excellent, but it can give rise to at least two problems. First, the written contract protects the employed, but consequently job turnover goes down and firms will be more cautious in recruitment, which decreases the job-finding rate of the unemployed. Second, social security payment accounts for about 40 percent of the total salary in China. And because of the unique household registration system, migrant workers cannot fully enjoy the social security benefit when they go back to their hometown. 

What is your research question and how is it original?

My research question is whether the Labor Contract Law caused an increase or decrease in Chinese companies’ hiring costs. Previously, empirical researches on the correlation of wage and Labor Contract Law were all microlevel, that is, based on survey data of a particular industry in one specific area, and they reached very different conclusions: some found that the Labor Contract Law significantly reduced the salary of manufacturing workers while others believed the impact to be minimal. My study is based on macrolevel data, which covers the whole country and each sector of the economy. The data is gathered from yearbooks and reports of the Bureau of Statistics; I can compare the variation of hiring costs in different sectors and different types of firms. For example, I find that the Labor Contract Law has opposite impacts on state-owned enterprises and private firms.  

What about your methodology?

My paper is a quantitative research. I first explain the possible influence channels with a theoretical model, and then use macrolevel data to prove my theory. The model tells the Labor Contract Law can raise the hiring costs by increasing the payroll tax rate and cutting the job destruction rate. However, the law also lowers the job-finding rate, with salaries of high-wage sectors going down and those of low-wage industries going up. In the empirical part of my research, there are two problems. The first is how to identify the effect of the Labor Contract Law from the effects of other regulations and economic shocks. For example, the minimum wage provision also changes the wage level. The second problem is that job destruction rate and job-finding rate are not reported in official data. Therefore, I introduce the instrument variable and use two-stage-least-squares regression to estimate the causal relationship between the Labor Contract Law and the hiring costs. The idea of the instrument variable is to kick out the interference of the unobserved factors. I find two feasible instrument variables: maternity insurance coverage and incidence of contract termination dispute. The Labor Contract Law exclusively provides the legal basis for maternity insurance participation and contract termination lawsuits in practice. And they are both not involved in wage negotiation, which makes them independent of the unobservables. And technically, these two instrument variables are valid in all kinds of econometrics tests.

Can you tell us about your major findings?

I find that the enforcement of the Labor Contract Law led to a significant decline of state-owned enterprises’ hiring costs, and also raised the pre-tax wage in labor-intensive industries.

This result is consistent with the theory and can be further explained in the specific context of the Chinese labor market. For high-wage state-owned firms, they have long been mandated to contribute to the social security funds and rarely dismiss workers. Therefore the Labor Contract Law only affects them through the decreased market job-finding rate, which cuts back high-income workers’ salary. On the other hand, the manufacturing sector in China already has a shortage of migrant workers. The Labor Contract Law did not change the job-finding and destruction rate. Still, it substantially increased the payroll tax of these low-wage workers, which further raised the hiring costs of manufacturing companies. In conclusion, for the workers of either sector, the Labor Contract Law decreased their disposable income. 

What are the concrete implications of your essay? 

My research helps to answer a controversial topic in labor economics: does employment protection legislation really protect employees in developing countries? In China’s case, the Labor Contract Law did not work well. Yes, it increases severance pay and prevents job destruction. But the turnover and job-finding rate decreases accordingly. All in all, workers did not benefit from the new law.

Finally, how will you remember your PhD life – and defense?

In a word: too short time and too much to learn. My defense took place right before the outbreak of COVID-19 in Europe. I cannot appreciate more my supervisors and my colleagues’ help. This crucial period of time makes me cherish what I already have and realise there are many more ways in which development studies could help the world.

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Xiaojing Zhou defended her PhD thesis in Development Economics in February 2020. Professor Jean-Louis Arcand presided the committee, which included Professor Martina Viarengo, thesis director, and Professor Isabelle Chort, Centre d’analyse théorique et de traitement des données économiques, Université de Pau, France.

Full citation of the PhD thesis:
Zhou, Xiaojing. “Three Essays in Developing Labour Market.” PhD thesis, Graduate Institute of International and Development Studies, Geneva, 2020.

Good to know: members of the Graduate Institute can access Dr Zhou’s PhD thesis via this page of the Institute’s repository.

Interview by Nathalie Tanner, Research Office.
Banner picture: Mechanical workers of Zhejiang Jiuli Steel Structure Engineering Co., Ltd, Huzhou City, China.