- On average, employers in Latin America pay 50% more in non-wage labor costs than in wages, driven by social security contributions and labor regulations.
- High costs of formal labor, combined with low productivity, are a key driver of informality and leave many workers without access to basic protections.
- Rethinking how social protection is financed — beyond payroll contributions — could help expand coverage and build more inclusive labor markets.
Imagine this scenario: a small business wants to grow. To do so, it needs to hire one more person. The salary seems manageable. But once social security contributions, mandatory benefits, and other charges are added, the total figure makes the business hesitate. Suddenly, hiring formally costs much more than it first appeared.
This is not just an isolated anecdote. A recent IDB report, Salaried Labor Costs in Latin America and the Caribbean: A Ten-Year Update, estimates that employers in Latin America pay, on average, an additional 50% on top of wages in non-wage labor costs, such as social security and employment protection mechanisms. This figure rises to 70% in countries such as Argentina, Brazil, and Peru, and falls to just under 40% in Trinidad and Tobago, Jamaica, and Chile.
The new data and analysis from this study raise a key question: why is formal employment so costly? The answer largely lies in the design of labor laws and social protection systems.
In economics, these are referred to as “non-wage labor costs.” But these costs are not simply market variables — they are largely legal obligations. These include contributions to pension systems, health insurance financing, paid leave, and severance payments, among others.
These rules aim to protect workers and balance the relationship with employers. Over the 20th century, Latin America incorporated them into its legal frameworks, making the employment contract the gateway to basic social rights.
But here lies the paradox: this model works well only in contexts with high levels of formal employment. In economies characterized by high productivity heterogeneity across firms, legal costs can be too high for small businesses or certain sectors.
Informality can be explained, at least in part, as the result of high labor costs combined with low productivity. While it also reflects multiple other factors — such as how regulatory frameworks shape labor market incentives, limitations in governments’ enforcement capacity, and gaps in workforce human capital — the high cost of formal employment is a central component of the explanation.
From a legal perspective, this means that informal workers remain outside a fundamental set of institutions. They lack access to social security, guaranteed minimum wages, protection against dismissal, and the ability to bring disputes before labor courts.
Perhaps the most relevant institutional dimension of the problem lies in how social protection systems are designed. In most Latin American countries, pensions, health care, and other social benefits depend primarily on payroll contributions tied to formal employment.
In contexts of high informality, this can create a vicious cycle: contributions increase the cost of formal employment, that higher cost incentivizes informality, and, in turn, informality reduces revenues for the social protection system.
This design can deepen segmentation between protected workers and those who remain excluded.
Across different contexts, there is a growing need to revisit how formal employment and social protection are linked. Possible alternatives include strengthening mechanisms financed through general taxation, moving toward more universal social protection systems, or reducing reliance on payroll contributions. These options aim to address coverage challenges in labor markets with high informality, although their implementation must consider each country’s specific context.
Explore the evidence behind these challenges in Salaried Labor Costs in Latin America and the Caribbean: A Ten Year Update.