The Political Economy of Labor Cost Behavior: Evidence from China

Abstract

In China’s transitional economy, one of the major objectives of the government is to maintain social stability. We hypothesize that, through state ownership and appointment of executives, Chinese government officials can influence firms’ employment decisions and reduce labor cut when firms’ sales decline, thus affecting the labor cost stickiness. Consistent with this hypothesis, we find that state owned enterprises (SOEs) have a higher degree of labor cost stickiness than non-SOEs, and SOEs with politically connected managers have stickier labor costs than those without. Such effects are stronger in regions with weak market institutions and during time periods when government officials are to be promoted. We also show that the government reciprocates SOEs’ sticky labor policies with subsequent subsidies. In contrast, political forces have little impact on the stickiness of other costs, indicating that the impact of the government is the strongest on labor employment. Collectively, our results support the argument that political incentives shape firms’ labor employment decisions and thus labor cost behavior.