Labor Market Rigidities and Macroeconomic Performance in the PRC

Abstract

It has often been assumed that there is a trade off between labor market flexibility and labor protection. Following the promulgation of the Labor Contract Law in 2008, employment protection in the People’s Republic of China (PRC) changed from less restrictive than the OECD average to more restrictive than any OECD economies with respect to indicators for severance pay and dismissals. However this change and its impact are not well recognized. Overall, labor market flexibility consists of two components. On the demand side, labor market flexibility affects employers’ decisions to hire workers. On the supply side, contrary to the common belief, improved workers’ protection could in fact also improve labor market flexibility through the labor supply. This is also rarely discussed, but could help the PRC reduce labor market rigidity. Based on a review of international experiences and the labor market situation in the PRC, this policy note provides policy recommendations on increasing macroeconomic efficiency through improving labor market flexibility without necessarily sacrificing protection for workers. In addition to strengthening job creation, supply-side government policies, such as those to help workers moderate income fluctuations (both cyclical and structural) and improve workers mobility, could help restore labor market flexibility in the PRC.