Economic policy uncertainty and firms' labor investment decision

Abstract

Purpose

The purpose of this paper is to empirically investigate the impact of economic policy uncertainty on firms' labor investment decision, which includes labor investment level and efficiency, especially human capital allocation.

Design/methodology/approach

This paper uses Economic Policy Uncertainty Index for China and Chinese A-share listed firms in the period 2002–2016 to constructs a sample of 20,779 firm-year observations and applies the methods of pooled OLS regressions to do an empirical study.

Findings

This paper finds that firms' labor investment is negatively correlated with economic policy uncertainty. And firms' labor investment efficiency (and overinvestment in labor) is positively (negatively) correlated with economic policy uncertainty, which is more significant for non-SOEs and firms with less government intervention. Further, the positive relation between economic policy uncertainty and labor investment efficiency is more significant for labor-intensive firms, firms in competitive industry, firms in developed labor market and firms under strong labor law protection. In addition, economic policy uncertainty induces firms to make adjustment on human capital structure and allocate more employees with high human capital, which eventually helps firms achieve higher total factor productivity.

Social implications

The study of this paper indicates that the government needs to consider economic policies' impact on firms when introducing and changing policies and guide firms to improve human capital allocation under different internal and external conditions to finally realize the optimal allocation of social resources.

Originality/value

This paper studies the influence of external economic policy environment on firms' labor investment decision, which lacks adequate attention in the literature and indicates that under economic policy uncertainty, firms actively decrease labor demand and increase labor investment efficiency by optimizing human capital allocation.

Citation

Chu, J. and Fang, J. (2021), "Economic policy uncertainty and firms' labor investment decision", China Finance Review International, Vol. 11 No. 1, pp. 73-91. https://doi.org/10.1108/CFRI-02-2020-0013