Contract employment as a worker discipline device

Abstract

Fixed-term labor contracting has increasingly replaced regular open-ended employment in developing countries. What justifies its emergence? What determines its intensity? What policy responses are appropriate, if any? In a two-tiered task-based model of the labor market, we demonstrate that within establishments, fixed-term contracting can indeed co-exist with open-ended efficiency wage contracts as it enables firms to enforce regular worker discipline at strictly lower cost. Furthermore, the intensity of fixed-term employment is shown to increase even in times of rising labor demand, if a fixed-term worker status does not increase the likelihood of regular job arrival. Using establishment-level data from Indian manufacturing, we find evidence consistent with such an assumption. Policy-wise, the model unveils two margins of hiring distortions associated with fixed-term employment – task assignment and total employment distortions —- against which the merits of a suite of oft-noted labor market flexibility policies can be assessed.