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Labor Laws and Innovation

Viral V. Acharya
London Business School - Institute of Finance and Accounting; Stern School of Business; Centre for Economic Policy Research (CEPR)

Ramin Baghai
London Business School

Krishnamurthy Subramanian
Emory University


January 26, 2009


Abstract:     
Can stringent labor laws be efficient? Possibly, if they provide firms with a commitment device to not punish employees' short-run failures and thereby spur the pursuit of value-maximizing innovative activities. In this paper, we provide empirical evidence that strong labor laws indeed appear to have an ex ante positive incentive effect by encouraging the innovative pursuits of firms and their employees. Using patents and citations as proxies for innovation and a time-varying index of labor laws, we find that innovation is fostered by stringent labor laws, especially by laws governing dismissal of employees. We provide this evidence using levels-on-levels, changes-on-changes, and finally difference-in-difference regressions that exploit staggered country-level law changes. We also find that stringent labor laws disproportionately influence innovation in the more innovation-intensive sectors of the economy. Finally, we find that while the overall effect of stringent labor laws is to dampen economic growth, laws that govern dismissal of employees are an exception: stringent laws governing dismissal promote economic growth, consistent with the evidence that they encourage firm-level innovation.

Keywords: Labor laws, R&D, Technological change, Law and finance, Entrepreneurship, Growth

JEL Classifications: F30, G31, J5, J8, K31

Working Paper Series

Date posted: January 27, 2009 ; Last revised: February 19, 2009

Suggested Citation

Acharya, Viral V., Baghai, Ramin and Subramanian, Krishnamurthy, Labor Laws and Innovation (January 26, 2009). Available at SSRN: http://ssrn.com/abstract=1333621


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Contact Information

Krishnamurthy Subramanian (Contact Author)
Emory University ( email )
Atlanta, GA 30322
United States
Viral V. Acharya
London Business School - Institute of Finance and Accounting ( email )
Sussex Place
Regent's Park
London NW1 4SA United Kingdom
+44 20 7262 5050 x3535 (Phone)
+44 20 7724 3317 (Fax)
Stern School of Business ( email )
44 West 4th Street
New York, NY 10012
United States
HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm
Centre for Economic Policy Research (CEPR)
90-98 Goswell Road
London EC1V 7RR United Kingdom
Ramin Baghai
London Business School ( email )
Sussex Place
Regent's Park
London NW1 4SA NW1 4SA
United Kingdom
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