The basic reason this system exists is because “regular employees” are entitled to lifetime employment. They can’t be fired unless they have repeatedly broken their rules of employment, and they can’t be laid off until their employer has essentially gone bankrupt. Regular employees do get laid off from time to time, but it’s generally as part of a consensual deal—i.e., they get a big severance package to voluntarily resign.

The reason they never let contract workers stay for more than three years is that once their contract is renewed three times, they are legally entitled to lifetime employment. (It’s a fuzzier rule than that, but three times is the general understanding.) So the point of the system is to allow (ostensibly less-skilled) employees to be naturally laid off (by not renewing their contracts) without having to pay out severance packages.

Lifetime employment is not a very employer-friendly concept, but among many Japanese people it seems to have the force of religion: they see it as the fundamental difference between business in Japan and business everywhere else. Here, a business is said to be more like a family, where a member can’t be cast away except under really extenuating circumstances. It really is a strong contrast to, say, the United States, where employees are basically disposable (and are often the first expense cut when the economy goes sour).

So assuming lifetime employment remains intact and use of contracted employees declines, how are employers going to meet their labor needs? I reckon it would have the effect of downsizing firms over time: they will want to outsource more of their functions to third-party contractors, so that they have the freedom to alter or entirely cancel the scope and expense of work they need done.

One firm which already seems to be doing this is GABA, the big eikaiwa chain—it brings in teachers as “independent contractors” and essentially acts as a broker between the teacher pool and the student pool. This way, GABA isn’t saddled with unnecessary personnel expenses if demand starts to fall.