Pitfalls of fixed-term hiring

Much of the burden for India’s dismal job creation performance has been attributed to its rigid employment protection legislations, which make dismissal of permanent workers very onerous. Over the past 15 years, India has seen a sharp increase in contract workers, as firms have increasingly hired them to circumvent labour market rigidities. However, this has resulted in significant informalisation of the workforce, as contract workers can be fired easily, do not enjoy benefits such as health, safety, welfare and social security, and receive significantly lower wages than permanent workers.

In this backdrop, the proposal to introduce fixed-term employment

(FTE) in all sectors is indeed a welcome step. It attempts to create additional jobs by imparting flexibility to enterprises to adjust their workforce and at the same time enhances workers’ job security. According to the draft FTE notification put out by the Ministry of Labour and Employment, contractual workers are entitled to all statutory benefits available to their permanent counterparts in the same factory. These workers are ensured same work hours, wages, allowances, and other benefits as that of permanent workers, along with all statutory benefits available according to period of service. Further, employers can directly hire fixed-term workers from the market, without mediation by a middleman i.e. contractor, and start disbursing wages and enforce social security themselves. However, employers are not mandated to give notice to a fixed-term worker on non-renewal or expiry of his or her contract. Nor are employers required to provide retrenchment benefits to workers hired on fixed-term contracts. Thus, by making it easier for firms to lay-off workers, this move is expected to trigger job creation.

Over recent decades, many countries, particularly in Europe, facing sluggish job creation due to high level of employment protection for permanent employees, have taken recourse to FTE. Besides reducing firing costs and providing firms with a buffer during seasonal and cyclical fluctuations, the underlying idea behind FTE contracts is to serve as stepping stone to a permanent job. Firstly, by facilitating transition from unemployment to a temporary job (FTE), and secondly, by increasing the chances of a movement from FTE to a permanent job. The latter progression is enabled by the fact that the initial temporary employment period provides an opportunity to screen employees and retain only those who are good matches. This is particularly pertinent in economies with strong employment protection, as firms want to minimise the risk of a mismatch with workers.

FTE has tremendous potential to transform labour markets but empirical research has shown that its impact can be ambiguous. Liberalisation of FTE contracts in countries with strong employment protection for permanent employees can create a deep segmentation of labour markets, with FTE representing the majority of the employment contracts used in new hires and a significant share in total employment. This happens as employers remain reluctant to convert FTE jobs into permanent ones, and consequently, the share of FTE rises rapidly, while fewer workers are hired as permanent employees. The case of the Spanish labour market, which has one of the highest rates of FTE in the EU, is striking. Around 90 per cent of all entries into employment start as FTE, and these workers either end up getting stuck in FTE or, more frequently, become either unemployed or selfemployed rather than employed on a permanent basis.

Such a segmentation of the labour market can have adverse effects on permanent workers too. The availability of a separate competing pool of workers (i.e. fixed-term workers) may result in firms’ management using them to their strategic advantage to suppress the bargaining power of their permanent workers. In a recent study, my co-author P P Krishnapriya and I find that the rising use of contract workers in India has enabled firms to curb the bargaining power and consequently wages of their existing regular workforce. That the real wages of directly hired workers in the organised manufacturing sector has remained virtually stagnant over the last 15 years is suggestive of this behaviour.

Therefore, it is important to have an appropriate framework to regulate FTE. Key safeguards include defining the maximum duration of successive fixed term contracts, defining the number of renewals of these contracts and requiring objective reasons to justify their renewal. A comparative analysis by the Hoda and Rai (2015) across OECD and emerging countries found significant variation in regulatory rigor on FTE contracts. Amongst the OECD countries, France has one of the strictest norms. It bars the use of FTE for permanent tasks. FTE contracts can be entered only for a limited period for temporary assignment, renewal is permissible only once and the maximum duration allowed is 18 months. Brazil regulates FTE reasonably, permitting one extension with the cumulative duration of the contract not exceeding two years. In China, there is no restriction on the type of work for which FTE may be used, but after two fixed term contracts or after working in succession for 10 years, the worker gets the right to enter into an open-ended contract. India, too, needs to put in place appropriate safeguards vis-a-vis limitations on cumulative duration and number of successive FTE contracts to prevent their misuse. This is necessary to ensure that FTE does not simply foster employment growth in the short run, but also serve as a pathway to productive and permanent employment in the long run.

1. Draft rules for Industrial Employment (Standing Orders) Central (Amendment) Rules, 2018, https://labour.gov.in, last accessed February 20, 2018

2. Eichhorst, W (2014) “Fixed-term contracts”, IZA World of Labor, 2014, 45

3. Hoda, A and D K Rai, “Labour Regulations and Growth of Manufacturing and Employment in India: Balancing Protection and Flexibility”, ICRIER Working Paper

No. 298, 2015

The writer is senior fellow, Indian Council for Research on International Economic Relations