Banning contract work: Implications for input choices and firm performance

Abstract

What are the effects of an outright ban on fixed-term contract workers in an establishment? By strengthening job security, it could affect total employment, and severely impact firms’ investment choices and the resultant productivity and profitability. We test the impact of a unique natural experiment by the Indian state of Andhra Pradesh which prohibited contract workers from engaging in core activities in manufacturing industries. Using plant-level panel data from the Annual Survey of Industries, we find robust evidence of a large decline in contract labor usage in core activities, and a modest but statistically significant increase in regular labor engaging in core activities. Capital usage increased with a small increase in total factor productivity, but revenue and profits significantly declined, potentially due to higher input costs. Placebo tests results indicate no change in contract and regular labor engaged in the firm’s non-core activities that were not a part of the law change, and no effect on the treatment firms prior to the law change. Firm closures and spillovers to neighboring states were absent.