Working Paper: CEPR ID: DP7171
Authors: Viral V. Acharya; Ramin Baghaiwadji; Krishnamurthy Subramanian
Abstract: Can stringent labor laws be efficient? Possibly, if they provide firms with a commitment device to not punish short-run failures and thereby incentivize the pursuit of value-maximizing innovative activities. In this paper, we provide empirical evidence that strong labor laws indeed appear to have an ex ante positive incentive effect by encouraging the innovative pursuits of firms and their employees. Using patents and citations as proxies for innovation and a time-varying index of labor laws, we find that innovation is fostered by stringent labor laws, especially by laws governing dismissal of employees. We provide this evidence using levels-on-levels, changes-on-changes, and finally difference-in-difference regressions that exploit staggered country-level law changes. We also find that stringent labor laws disproportionately influence innovation in those sectors of the economy that are more innovation intensive. Finally, we find that while the overall effect of stringent labor laws is to dampen economic growth, laws that govern dismissal of employees are an exception: dismissal laws promote economic growth, consistent with the evidence that they encourage firm-level innovation.
Keywords: Entrepreneurship; Growth; Labor Laws; Law and Finance; R&D; Technological Change
JEL Codes: F30; G31; J5; J8; K31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Dismissal laws (J63) | Economic growth through enhanced firm-level innovation (O39) |
| Stronger labor laws (J89) | Greater innovation (O35) |
| Increase in labor law index by one unit (J89) | Increase in patents and citations (O34) |
| Tougher dismissal regulations (J63) | Greater innovation (O35) |
| Stricter dismissal laws (J63) | Higher innovation rates (O39) |