Firm-specific exchange rate shocks and employment adjustment: Evidence from China

This paper examines how exchange rate shocks affect intra-industry labor reallocation across firms. Using comprehensive Chinese firm-level data, we examine the employment response to exchange rates of firms that are heterogeneous along two dimensions: external orientation and trading partner distribution. Firm-specific effective exchange rates are constructed to accurately measure exchange rate shocks pertinent to individual firms. We find that exchange rate movements induce significant labor reallocation across firms with different degrees of external orientation and with different trading partners. Trading partner distribution is as important as external orientation in explaining firms' heterogeneous employment response to exchange rates. Compared with effective exchange rate measures at more aggregate levels, using firm-specific effective exchange rates generates estimation results more consistent with theory and substantially increases the estimated impact of exchange rates on intra-industry job reallocation.