The economic theory in this research is based on price theory, however, the phenomena relating to labor market interventions can be understood and studied using other theoretical explanations. According to Ronald Harry Coase (1960), the prerequisite for a market transaction is a clear delineation of private property rights. Thus, a labor law
that protects the freedom of contract, instead of purposively favoring the labor side, provides the necessary institution for a market economy, which in turn promotes growth. Interventions, such as the LCL create a disputed area of wealth between labor and capital, which leads to a tragedy of the commons and dissipation of rent.
Furthermore, although interventionist policies are often based on externalities and information asymmetry, it should be noted that apart from market failure, there is also the cost of using government. From the perspective of a firm’s margin, Ronald Harry Coase (1937, p. 394) argues that ‘a point must be reached where costs of organizing an extra transaction within the firm are equal to the costs involved in carrying out the transaction in the open market.’ If we view the government as a firm that provides a public service, similar assertions can then be made that the optimal government boundary is determined by the services it offers. Regarding efficiency, it is not sufficient to support interventions based on so-called defects in the market but to show that the transaction cost of using government is smaller than the market cost. The LCL was enacted to reduce social conflicts in China, however labor disputes increased dramatically after 2008, hence Remington and Cui (2015) raised questions about the relative costliness of the intervention, not to mention other negative impacts.
These negative impacts have been well-described by the theorem of rent-seeking developed by Krueger (1974), which improves the share of existing wealth for certain groups without creating anything new. According to Wade and Dabla-Norris (2001), rent-seeking activities would decrease efficiency through poor resource allocation, reduction in wealth-generation, lost government revenue, increased income inequality, and (potentially) national decline10.
The analysis indicating an increase in informal workers in this research is the
10 Note that the rent-seeking theory provides similar predictions to the price control theory mentioned later. The difference between these two approaches is their perspectives, one from interest groups, and the other from the property rights of goods. It is clear that any interest group gaining certain exclusive rights from an employer would be positive in terms of the intervention.
mathematical proof of the insider/outsider theorem (Lindbeck & Snower, 1988; Lindbeck & Snower, 1984; Lindbeck & Snower, 2001). This theorem described dominant insider workers who enjoy more favorable employment opportunities than outsider workers. Lindbeck and Snower also use institutions that affect turnover costs, such as employment protection legislation (Elmeskov, Martin, & Scarpetta, 1998) and trade unions, to explain this different employment status.
3.7 Conclusion
One of the weaknesses in the study of economics is the inability to produce repeated experiments involving the variables of interest while controlling other factors. To overcome such drawbacks in social science, this study provides an alternative approach. It includes three multiples: multiple hypotheses, multiple testing, and multiple theories.
The models developed in this paper, based on suggestions from Cheung (2008), provide multi-hypotheses relating to the LCL in China. This explains the increase in labor disputes and strikes, the rises in informal workers and the capital/labor ratio, the criticisms from businesspersons, and support from some interest groups, such as trade unionists, lawyers, and judges. Also, it provides an evaluation of these labor market interventions based on efficiency and equality.
This multi-hypotheses approach provides two advantages. First, Milton Friedman (1962) illustrates why an illogical argument can be corrected for a specific case. He shows that the alleged syllogism, ‘Socrates is a man, Socrates is X, therefore all men are X,’ happens to be correct, when X represents ‘mortal,’ but not when X represents ‘Greek.’ More importantly, the ‘correct’ prediction when X stands for ‘mortal’ does not make the syllogism valid. Thus, he points out, the logical analysis is more applicable to many cases in addition to the particular one it studies. This comprehensive application of the theoretical analysis indicates that the assumptions in this study are realistic, reliable, and logical.
Second, the evidence presented in this paper provides an opportunity to evaluate the validity of competing hypotheses. As mentioned repeatedly, certain interest groups deliberately want to mislead the public. One popular argument is presented in the Lewis Turning Point (LPT) theory, which interprets the rising cost of labor as a result of demographic changes. However, the co-existence of an increase in unemployment11 and the high cost of labor not only refutes the demographic argument but also indicates that the cost of labor is raised by institutional factors.
Furthermore, to improve the reliability of a causal relationship, repeated experiments are essential. Therefore, empirical results from different datasets, nations, and time periods presented in this paper functioned as a natural experiment. It demonstrates that with other variables in various circumstances, we can always find correlation between labor market interventions and related phenomena. This approach is particularly crucial in our case, as labor departments around the world were avoiding testing the effectiveness of their policies.
Similarly, labor market interventions are an application of the broader range of theories. They involve price control theory, Coase theorem, the tragedy of the commons, rent- seeking and the insider/outsider model. These theoretical works, along with consistent empirical studies, reinforce the validity of the results of this paper.
Moreover, this paper also incorporated different legislation, such as the Social Average Wage Level, the Labor Contract Law, and social security into one model as Addison and Hirsch (1998) suggested, which demonstrates the interrelationships between different government interventions in the labor market. It also answers an unasked question of why both mandated benefits and employment protection legislation have a similar effect on the labor market, such as an increase in informal workers (Almeida &
11 The official Chinese unemployment figure is highly unreliable. However, it is reported that a large number of workers returned to their hometown and the government urged them to start their own businesses.
Carneiro, 2009; Lazear, 1990), and an increase in the capital: labor ratio (Cette, Lopez, & Mairesse, 2016; Mitchell, 1990).
Finally, this study has limited its focus to homogeneous assumptions. Thus, the modification cases should be examined in the future. Further explorations could include the impact of deregulation in the EPL (without changes in mandated benefits) and labor unions on informal workers,12 and the decline in capital investment after costs of labor reach certain levels.13 This analysis also sheds light on other branches of economics, such as the ‘sticky wage’ in macroeconomics and the sources of TFP in development economics.
12 An empirical paper (Morikawa, 2010) about Japanese union studies found union reduction in informal workers, and studies regarding the EPL increase in Europe have found contradictory results (Fialová, 2010; Hazans, 2016). 13 As the hanging capital/labor ratio is a temporary solution to avoid rising labor costs, the only choice for these surviving firms facing the perpetually rising pressure of the EPL is to reduce investment as indicated by the law of diminishing returns. The scope of the paper restricts me from exploring this situation. However, this hypothesis not only follows common sense, but is also supported by evidence. Like the old adage goes, it is important to compare like with like. A comparison between Germany and France, two countries with similar industrial structures, can demonstrate some seeming contradictions in empirical findings. Brenke (2013) closely examines the manufacturing sectors in Germany and France from 2001 to 2011. Contradicting common belief, modernization runs from the agricultural industry through the manufacturing industry and only later to the service industry. He finds that Germany has maintained a strong position in the manufacturing industry, with good economic performance. Its service industry has not evolved into an engine of growth. On the other hand, there has been deindustrialization in almost all branches of industry in France, which has also experienced depressed economic growth. Brenke (2013) further argues that differences in wage policy affect wage growth, which in turn influences the competitiveness between the two nations. The wage growth rate has been much faster than productivity growth in France. Conversely, the German wage rate has lagged behind production increases.