Review of Industrial Organization
13: 621–635, 1998.
1998 Kluwer Academic Publishers. Printed in the Netherlands.
Labor Flexibility, Ownership and Firm Performance
Economics Department, American University, 4400 Massachusetts Avenue NW, Washington DC
HARRY G. BROADMAN and INDERJIT SINGH
The World Bank, 1818 H. St. NW, Washington DC 20433
Abstract. Developed and developing countries alike are privatizing or corporatizing state owned
enterprises (SOEs), often citing the ﬂexibility to hire and shed labor as an advantage. However,
there is little empirical evidence on the extent to which this improves ﬁrm performance. This paper
investigates the linkage between labor ﬂexibility, ownership and ﬁrm performance using China as a
case study. We ﬁnd that SOEs are much less able to adjust quickly to demand shocks than are other
ownership forms and that the degree of worker input into hiring and ﬁring decisions slows the ability
of ﬁrms to adapt, negatively affecting ﬁrm performance.
Key words: Labor ﬂexibility, ﬁrm performance, corporatisation, privatisation.
The linkage between labor ﬂexibility, enterprise ownership and ﬁrm performance
is critical to the growth process. This is clearly reﬂected in the growing concern
in advanced industrialized countries about the effect of employment protection
legislation on job creation and employment rigidity. But it is especially true for
transition economies. In their shift toward a market system and to improve ﬁs-
cal performance, these countries are transforming their state owned enterprises
(SOEs) into commercially oriented modern corporations, with increased ﬂexibility
for wage and employment decisions, including the laying off of redundant work-
ers. In most cases – especially Eastern Europe and the Former Soviet Union – the
fulcrum for this transformation is privatization; in other cases – notably China and
Vietnam – it is “corporatization” (World Bank, 1997; Broadman, 1996; Reidel and
Comer, 1995). While labor ﬂexibility is often cited as an advantage of privatiza-
tion or corporatization, there is little empirical evidence on the extent to which
such reforms improve ﬁrm proﬁtability through enhanced wage and employment
The views contained in this paper are those of the authors alone and do not necessarily reﬂect
the views of the World Bank Group, its member countries or its Board. Support from the Research
Committee at the World Bank is gratefully acknowledged. We appreciate helpful comments from
Gary Jefferson and a referee.