When labour market flexibility hinders innovation: a cross-country panel quantile analysis for manufacturing firms

This paper examines the impact of labour market flexibility on private sector R&D expenditure. Using firm-level data spanning 2005–2019 on over 2900 firms in 13 countries, we explore the implications of labour market freedom on R&D spending. Instead of relying on traditional estimators that focus on the ‘average’ effects alone, we evaluate these effects using a method-of-moments quantile regression framework, bringing out the heterogeneity across the firms’ innovation distribution. We show that the impact of labour flexibility on innovation greatly hinges upon the dominant innovation regime prevalent within the sector. Our results show that R&D effort responds favourably to labour flexibility in sectors based on ‘garage’ type radical innovation (Schumpeter I) industries. Contrastingly, more labour flexibility dampens learning and knowledge management in sectors characterised by the ‘routinized’ innovation model, which relies on incremental accumulation of historical knowledge (Schumpeter II industries). From a policy perspective, these results have important implications for economies considering structured labour market reforms. Finally, we show that property rights are quite crucial for firms in sectors characterised as ‘high cumulative’ in the Peneder’s (Res Policy 39(3):323–334, 2010) taxonomy. We also show substantial effects of trade openness, governance and high-technology exports on firm-level R&D spending.