Comments on Paqueo and Orbeta’s
“Beware of the ‘End Contractualization’ Battle Cry”.

Remarks made during the Varela-Paderanga Memorial Lecture sponsored by the Foundation for Economic Freedom on 19 October 2016 in Makati City. The original paper by Paqueo and Orbeta may  be accessed here.


The call to end “contractualization” is but a continuation of the opposition led by organized labor against the practice of employing workers on a non-regular basis (i.e. as contractuals, casuals, or temporary), whether hired directly or through an employment agency. Workers hired based on these contractual arrangements generally have shorter job tenures and do not enjoy the non-wage benefits granted to regular employees. Because these labor contracts generally deviate from established notions of the employment relationship (widely interpreted as a secure, regular job), they have been perceived as circumventions of various labor regulations that increase labor cost, such as minimum wages, non-wage benefits and other labor standards, including the right of workers to unionize.

Costly regulation or not, there are real economic reasons for the variety of contractual arrangements observed in the Philippine labor market. Oliver Hart and Bengt Holmstrom, this year’s recipients of the Nobel Prize in economics for their work on contract theory, have explained the use of contracts in various settings to motivate people. As I had noted in a paper on flexible labor arrangements some years ago, the question of whether to use a non-regular labor contract or a standard employment contract (in the sense of an indefinite long-term relationship between worker and employer) involves looking at a firm’s multi-period demand for labor, and the role of specific training, screening costs, and incentives in raising work force productivity. The firm’s external environment and its internal organization have to be considered, too.

The paper by Paqueo and Orbeta is correct to point out the economic reasons for the use of temporary employment contracts (TECs), and I need not repeat the arguments here. From their discussion, it ought to be clear that the contractual arrangements described would have emerged as a result of the firms’ optimizing behaviors given their specific circumstances. The regulatory environment could only have contributed to aggravating – instead of attenuating as intended – the outcome for workers.

The call to “end all contractualization” certainly invites closer examination. The term “contractual” has a wide coverage, and generally refers to those workers whose employment is fixed for a specific project or undertaking, the completion or termination of which has been determined at the time of employment (DoLE-BLES). (By this definition, even highly-paid consultants are “contractuals”.) Although the matter has been subsequently clarified (by specifying which types of contractual arrangements in which industry/sector may be excluded, i.e. project-based), still the issue that remains unsettled is whether workers who perform functions that are seasonal or intermittent, or not part of the core activities of firms (e.g. waiters, security, janitorial, clerical, messengerial, etc.) ought to be regularized. Here the issue seems to be who takes on the responsibility for providing these contractual workers the entitlements that regular workers normally get as part of their employment contract in the absence of an employer-employee relationship.

According to DoLE figures (2014), there are about 622,000 agency-hired workers, 46% and 47% of which are in industry and services, respectively. Of those in industry, 86% are in manufacturing, while of those in services, 57% are in wholesale and retail trade, repair of vehicles and motorcycles, accommodation and food service activities, and financial and insurance activities. On the other hand, there are some 26,628 establishments engaging agency-hired workers, 70% of which are in the services sector.

Do the 622,000 agency-hired workers constitute the universe being referred to in the call to end “all contractualization”? Or are the casual hires numbering about 208,000 included, too? Or is the call specific to “endo” (the practice of terminating workers before the sixth month with or without the possibility of re-hiring them under another short-term contract)? Unfortunately, it is not clear what “all contractualization” refers to in numbers. No numbers are available either with respect to workers covered by “endo”, nor on firms resorting to such practice. Do we then assume that all workers under TECs (numbering about 9 million)[1] are the target of regularization based on the call to “end all contractualization”? This is important because the DoLE has committed to reduce “contractualization” by 50 percent this year and then completely by next year. So what numbers are we exactly talking about?

That some employers resort to “endo” in order to escape their contractual obligations to their workers cannot be discounted. However, I think that “endo” is basically a response to the “regularization rule” in the Philippines’ Labor Code, which effectively substitutes the state’s judgment for the firms’ on the question of when a worker should become a regular employee. When termination is costly, employers become more selective in hiring workers and some firms may take longer than others to discover workers’ aptitudes and determine their suitability for a regular job. As the paper argues, because firms and workers have different needs depending on their circumstances, the 6-month regularization rule limits their flexibility to work out a mutually beneficial arrangement. As a result, firms terminate workers before completing six months to keep their flexibility, while workers who are terminated may completely lose the chance to become regular workers.

In this respect, the paper’s empirical result supporting the view that TECs provide a screening device that improves the chances of workers with less impressive credentials to eventually become regular workers provides a strong argument for relaxing the regularization rule. [I have some questions on the methodology employed, particularly on the econometric technique, but this is probably a topic for another day.] To outlaw the use of TECs is not in the best interest of workers.

As a final point, I think that in the current context of globalization, rapid technological change, shorter product shelf-lives, and the ensuing process of job destruction and creation, the risk of shocks facing both firms and workers has increased. This has increased the incentive for firms to resort to alternative contractual arrangements, such as TECs, that provide greater latitude in the deployment of labor in order to remain competitive. While regulation should not curtail that flexibility, fairness and equity require that labor not be made to bear all the risk.

In light of what seems to be an irreversible trend towards flexibility in labor markets, I think that our energies are better spent thinking about mechanisms for risk sharing. The literature on publicly provided income support for the unemployed should be instructive. Such support can take various forms: unemployment insurance, unemployment assistance, severance pay, unemployment insurance savings accounts, and public works.

The determination of which income support scheme is appropriate for the Philippines, and its design, will have to consider issues of client selection, work incentives, resource mobilization, institutional viability, administrative capacity, and a large, heterogeneous informal sector. These are formidable challenges, but I would think a more productive area for policy engagement if the benefits from making labor markets more flexible are to be widely shared.


[1] Based on the Labor Force Survey (July 2014) which the Paqueo-Orbeta paper used as a reference, workers employed under temporary employment contracts (TECs) constituted around 23 percent of all employed.