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Social programs in Mexico are inadvertently causing a major distortion in the labor market, said Santiago Levy Algazi, vice president of sectors and knowledge for Inter-American Development Bank and former general manager and chief economist for the IDB Research Department. “They are inadvertently introducing a tax on salaried work and a subsidy to unsalaried work,” Levy said during a Myron Scholes Global Market Forum, co-sponsored by The Initiative on Global Marketsand Chicago Council on Global Affairs, at Gleacher Center on April 17.
“This distortion is causing a wedge between the cost of labor to firms and the value to workers,” he said. “It implies a 30 to 35 percent wedge for a worker between being hired as salaried or non-salaried. That’s a big tax, and it’s higher for unskilled workers than for skilled workers.”
Under Mexican labor and social security laws, formal companies are required to help pay the costs of all benefits for salaried workers “from birth to death,” Levy said. Workers must automatically pay a percentage of their salary for all of the offered services, he said.
“For many reasons, workers may value those benefits at less than their actual costs,” Levy said.
Meanwhile, the Mexican government has introduced and funded many social programs to protect non-salaried, informal workers who are self-employed, Levy said. “The thinking of the government is that as Mexico grows and becomes developed, more and more workers will have salaried jobs and social security,” he said. “But in the meantime, we can’t leave these workers without any benefits, so we’ll create social programs for them, including health, housing, pension, and day care.”
Social programs for non-salaried employees represented 1.7 percent of national GDP in 2007 – a number that rose to nearly 2 percent in the 2008 budget, Levy said. Funding for these “social protection” programs has doubled compared to social security funding in the last 10 years, he said.
Of 44 million workers in Mexico, 57 percent are salaried but 58 percent are informally employed, Levy said. “If the law was fully respected, all salaried workers would be formal,” he said. “But contrasting these numbers tells you there is a lot of illegality. That’s endogenous to what is going on.”
Workers will alternate between formality and informality until the utility of being formal equals the utility of being informal, Levy said. For firms, the cost of employing formal workers receiving social security is 1.5 times higher than employing informal workers, he said.
If salaried employees value their benefits less than firms actually pay for them, social security acts as a tax on salaried labor, Levy said. “This will shrink the size of the salaried sector in the economy,” he said. “Firms will react by cutting employment. The social programs for non-salaried employees will widen the problem. It will actually be more attractive to be informal because now you get something for nothing.”
Of three million businesses in Mexico, 763,000 are formally registered, Levy said. Many firms are very small, although not all small firms are informal, he said. “There is a lot of illegal activity in Mexico,” Levy said. “If you are a big firm, it’s kind of hard to be illegal, because the government will soon find you and fine you. So if you have more than 50 workers, it’s kind of difficult to be illegal. Firms will choose to be illegal or legal, depending on the probability of being fined.”
A similar situation exists in many other Latin American countries, he said. “The political pressure faced by Latin American governments to deliver social benefits to their citizens is so huge that they are caught in a vicious circle,” Levy said. “The formal sector is small and the government delivers benefits to all these urban informal workers. The government is shooting itself in the foot because it is generating incentives to make the informal sector even bigger.”
--Phil Rockrohr