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Introduction

India’s formal manufacturing sector has increasingly shifted towards contractualisation, driven more by cost-cutting than genuine skill-based flexibility. This trend weakens labour rights, depresses wages, and undermines long-term productivity, particularly in small and medium enterprises, revealing deeper structural flaws in the growth model.

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Positive Impact of Contractualisation on Labour Rights & Long-Term Economic Growth

While largely seen as challenge, contractualisation can have some benefits in certain contexts:

• Operational Flexibility: Allows firms to quickly scale their workforce up or down in response to market fluctuations, helping them remain competitive.
  Eg: Contract labour acts as a buffer in economic downturns, preventing large-scale layoffs of permanent staff.
• Access to Specialised Skills: Enables firms to hire workers with niche, project-specific skills for short durations without long-term commitments.
  Eg: High-skill CLI (Contract Labour-Intensive) enterprises recorded 5% higher productivity when compared to low skill counterpart
• Cost Efficiency in Certain Segments: Particularly beneficial in large capital-intensive enterprises where cost savings from contractualisation can be channelled into R&D and capital expansion.
• Facilitates Entry into Formal Employment for Some Workers: In some cases, short-term contracts can serve as a stepping stone for informal workers into the formal economy, albeit with limited benefits.

Challenges of Contractualisation on Labour Rights & Long-Term Economic Growth

• Erosion of Labour Rights: Contract workers are excluded from core labour protections under the Industrial Disputes Act, 1947, and their weak bargaining power leaves them vulnerable to arbitrary dismissals and exploitation.
• Wage Suppression: In 2018–19, contract workers earned 14.47% less than regular employees, with the gap widening to 31% in large enterprises.
• Productivity Penalty: CLI enterprises had 31% lower labour productivity than regular labour-intensive (RLI) enterprises, with productivity gaps largest in small firms (<100 workers) at 36%  and 42% in labour‑intensive enterprises.
• High Labour Turnover & Skills Erosion: Short-term contracts discourage employers from investing in worker training and skill development, limiting innovation capacity and long-term productivity growth.
• Principal-Agent Problem: Third-party contractors may not align with employers’ long-term productivity goals, leading to moral hazard issues such as worker shirking (devoting less time).
• Rising Informalisation Within the Formal Sector: The share of contract labour in manufacturing rose from 20% in 1999–2000 to 40.7% in 2022–23, signalling deep structural weaknesses.

Policy Reforms to Promote Meaningful Formalisation

• Revive & Expand PMRPY: Reinstate the Pradhan Mantri Rojgar Protsahan Yojana, which funded employer contributions to EPS & EPF, encouraging regular employment.
• Encourage Direct Fixed-Term Contracts: Implement the 2020 Labour Code on Industrial Relations allowing fixed-term contracts directly (without third-party contractors) to reduce exploitation.
• Longer Contract Durations with Benefits: Incentivise firms to offer reasonably longer fixed-term contracts by subsidising social security contributions and linking with government skilling programmes.
• Targeted Social Security for All Workers: Extend universal access to EPS/EPF and other statutory benefits, regardless of contract type.
• Promote Skill Development & Career Progression: Link contract employment with structured training programmes to build long-term skill capacity.
• Incentivise High-Skill and Capital-Intensive Use: Encourage contractualisation only in high-skill or capital-intensive roles where productivity gains are evident, while discouraging it in low-skill labour-intensive industries.

Conclusion

The rise of contractualisation in India’s formal sector risks trapping workers in low-wage, low-skill jobs, eroding labour rights, and stunting productivity. While a small share of high-skill, capital-intensive firms benefit, most enterprises are worse off. Promoting formalisation through longer fixed-term contracts, schemes like PMRPY, social security coverage, and integrated skilling is essential to unlock manufacturing-led growth.

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