What drives firms to prefer contract workers over permanent employees, and who bears the cost?

Indian manufacturing firms employ two broad categories of workers: permanent employees, who have ongoing contracts and full legal protections, and contract workers, who are hired through third-party labour contractors for fixed-term or specific-task assignments. The share of contract workers in India’s organised manufacturing sector has risen steadily, from around 16% in the early 1990s to over 40% by the 2020s in many industries, and higher still in sectors like chemicals, metals, and textiles. Understanding why requires looking at what permanent employment actually costs a firm under Indian law.

One reason for the high cost of permanent employees is the Industrial Relations Code, 2020, which went into effect on the 25th of November 2025. Under it, firms employing 300 or more workers cannot retrench employees, close a plant, or declare workers redundant without prior permission from the state government. That permission is slow to obtain and uncertain in outcome. A permanent worker who turns out to be unproductive or whose role becomes obsolete cannot easily be reassigned to different tasks without government permission. This provision effectively makes workforce flexibility illegal for large, organised firms.

Government data show that between 2012 and 2021, firms retrenched around 8,000 workers. This is an average of 800 workers being retrenched every year. This figure is improbable in a country where crores of workers exist in manufacturing jobs. Whether that figure reflects the process being inaccessible, firms routing around it through contract labour, retrenchments occurring informally and going unrecorded, or simply poor data collection is difficult to establish with certainty. What is clear is that formal retrenchment has ceased to function as a routine mechanism of workforce adjustment.

Contract workers fall outside most of these provisions. The firm’s legal relationship is with the labour contractor, not with the worker, which insulates the firm from retrenchment requirements and the Industrial Disputes Act’s restrictions on reassignment and closure. The cost of permanent employment pushes firms toward contractualisation or informality. The protections available to permanent workers raise the price of permanent employment high enough that firms systematically substitute away from it, so the workers the regulation was meant to protect end up outside its reach