Trade openness, labour institutions and flexibilisation: Theory and evidence from India

There is a global trend of substituting permanent workers by workers on fixed term contracts, job outsourcing and production subcontracting. Labour institutions and globalisation are often taken to be causally related to this phenomenon, but the evidence remains inconclusive. In India, there has been an increasing use by firms in the formal manufacturing sector of temporary workers employed through contractors (contract workers) who are not represented by trade unions and do not fall under the purview of the labour laws that are applicable to directly employed workers on long-term contracts (permanent workers). We develop a model of labour demand where firms choose a mix of contract workers and permanent workers rather than permanent workers alone, essentially to counter the bargaining power of permanent workers. Our model predicts that greater import penetration will cause an increase in the employment of contract workers, while greater export orientation will have the opposite effect on contract labour usage. Our model also predicts that greater worker bargaining power will increase contract labour usage. We then test the model using state-industry-year panel data for Indian manufacturing. Consistent with our theoretical model, we find that increased import penetration leads to greater use of contract labour in Indian manufacturing, and that the effect of trade exposure on contract labour usage is stronger in states with pro-worker labour institutions.