Exporting firms’ factor and product-quality adjustments in response to employment protection legislation: Evidence from China

Employment-protection legislation (EPL) is known to reduce the unemployment risk of workers and employees and implicitly raises the costs of labor as a factor of production, in particular, the adjustment costs for that factor. Using firm-level accounting data and matched transaction-level trade data, the paper documents that firms responded to the inception of a new labor contract law as accepted by the National People's Congress of China in mid-2007 not only by adjusting their labor demand but also in terms of other adjustments: they raised the capital intensity of production and increased the quality of their output. The paper provides evidence that such changes and adjustments were particularly strong for firms in ex ante labor-intensive sectors and for private firms which were less shielded from adverse competitive effects than state-owned ones.