Success belongs to the flexible firm: How labor flexibility can retain firm innovativeness in times of downsizing

Downsizing is known to harm innovation in developed countries. In developing countries, however, the impact of downsizing on innovation remains unclear. In addition, little is known about overcoming potentially related innovation obstacles. We close this research gap with a study across nine developing countries in Africa and South Asia. We put forward that labor flexibility (numerical, functional, and wage and reward flexibility) mitigates the negative effect of downsizing on process innovation. To test this idea, we use a firm-level data set that combines the World Bank's Enterprise Survey and Innovation Follow-up Survey for 2,912 firms. As expected, we find downsizing to be detrimental to process innovation. Labor flexibility, however, allows firms to remain innovative despite downsizing. More specifically, both numerical flexibility (temporary employment) and functional flexibility (training) buffer the negative impact downsizing has on innovation.