Labor cost shock, export, and export compositions: evidence from China

This study investigates how a labor cost shock, the implementation of the labor contract law (LCL), impacts export propensity and composition in China. Using a firm-level panel dataset from 2004 to 2013, we find that LCL has an overall negative impact on firms’ export propensities. This negative impact is heterogeneous; it applies mainly to domestic firms, whereas the export propensity of foreign-invested enterprises (FIEs) remains unchanged because they are more productive and capable of mitigating this shock. Further analysis of a firm–customs matched dataset shows that exporters adjust their export compositions in response to labor cost shocks. Surprisingly, exporters increase their processing export ratios, while this adjustment applies mainly to indigenous exporters and FIEs. To respond to this shock, FIE exporters adjust their export composition by increasing the share of exports to advanced markets in total exports, and the number of export products and destinations in the post-LCL period. These patterns of export composition adjustments are also observed among domestic exporters, except for an increasing variety of export products.