Downsizing, Firm Performance, and Income Distribution: Evaluating the Labor Restructuring Program in Chinese Firms

Abstract

This paper uses a new data set of Chinese state-owned enterprises (SOEs) and private firms to evaluate the effects of labor downsizing on firms' technical efficiency, financial performance, and employee wages. Since downsizers and non-downsizers differ greatly in firm characteristics, we use propensity score matching to deal with firm heterogeneity. We find that downsizing has serious short-term costs in terms of allocation efficiency and financial performance. For mild downsizing, SOEs suffer more in profitability, and private firms more in allocative efficiency. The distribution of surplus after downsizing is more favorable to owners in private firms, and labor in SOEs. For severe downsizing, SOEs and private firms exhibit lower TFP growth with similar magnitudes. Thus, the public sector downsizing has failed to achieve its objective of reversing the trends of declining productivity and profitability of state enterprises in the short run. Our findings imply that SOEs face slightly more severe labor constraints than private firms, and that private firms emphasize profit goals while SOEs place a greater weight on labor protection. Finally, controlling for differences in firm characteristics through matching makes important differences in the estimates of downsizing effects.