Informalization of the formal sector: Evidence from India's manufacturing industries

The employment structure of India's formal manufacturing sector has undergone substantial changes since the early 2000s with a steep rise in the use of contract workers in place of directly hired workers. Much of the existing literature has attributed the widespread use of contract labour to India's rigid employment protection legislation. The resulting informalisation of the workforce in the organised sector raises concerns about the sustainability of employment growth. Using a 14-year plant-level panel data from the Annual Survey of Industries, we find that in addition to labour market rigidities and the existence of a wage differential between contract and directly hired workers, plants in the organised manufacturing sector have another important incentive to hire contract workers. Plants appear to be using contract workers to their strategic advantage against the directly hired workers to keep their bargaining power and wage demand in check. Importantly, the strength of this bargaining channel varies across plants depending on their capital intensity of production, size and existing contract worker intensity.