The 13th Month Syndrome and Other ‘Rigid’ Worker Protections

We all know that labor market regulations are an important part of the decision to outsource to a foreign country. They standardize the rules for employer and employee, …

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We all know that labor market regulations are an important part of the decision to outsource to a foreign country. They standardize the rules for employer and employee, and make factors like labor costs much more predictable. At the same time, consensus is that excessively strict regulations do not allow the labor market to function efficiently.

The question for US companies eyeing the LATAM outsourcing industry is, when do these regulations become too rigid?

The current situation in many Latin American countries could be ‘too rigid’. Enterprise Surveys, a firm that specializes in company-level data collection in emerging markets,  conducted a series of surveys done last year across 14 countries in the region to test for the effects of strict labor regulations on the workforce. The subsequent report by David Kaplan, from Enterprise Surveys, states that laws such as high legally mandated severance payments, mandatory retraining of redundant workers, and restrictions on hours worked not only prevent the labor market from operating efficiently, but also cause lower levels of workforce participation, and higher levels of unemployment. He concludes that making regulations more flexible would lead to an average net increase of 2.1% of total employment.

The irony is these laws are often union-driven requirements to protect workers, but they sometimes end up doing the opposite. “We had many employees who legitimately wanted to work two or three 12-hour shifts during the week rather than five 8-hour shifts, but because of the overtime rule we couldn’t allow that” — Maggi Williams, VP Corporate Development, KM2

 

The Situation for Companies

 

So how do US companies already invested in the area feel about LATAM labor laws? Maggi Williams, VP of Corporate Development at KM2 Solutions, says that inflexibility in the labor system is definitely a problem. “There are always issues around the hiring and firing of employees”, she says. “Labor laws are often employee friendly, and there haven’t been any substantive changes in recent times to make companies’ lives easier”.

Termination of an employee is a formal process, often accompanied by large severance payments and mountains of paperwork.  Even under ‘just cause’ conditions, it can be difficult to remove workers, and in the smaller Caribbean countries the labor department tends to get involved in most termination decisions. Firms react to all this by being very careful about hiring employees.

There seems to be a severe policy disconnect between the goals of LATAM countries to attract foreign companies, and their enforcing stringent labor regulations that make it difficult for those same companies to operate freely. While the situation can be better or worse depending on the country in question, there are a few terms and conditions common to the region that you should be aware of:

The 13th Month Syndrome

Employees in most LATAM countries are entitled to a ‘13th month’ salary, payable by the employer in December of each year. In Brazil this corresponds to the highest compensation paid to the employee during the year, while in other countries like Colombia, Argentina and Nicaragua, it is calculated as the basic salary paid in the last month of service. Each country has its own take on the 13th month salary – Mexican law requires minimum two weeks salary instead of a month, and Chile’s 13th month pay is split between September and December.

It’s necessary to understand that the 13th month salary is different from a Christmas bonus. It is a requirement that is government mandated. The firm is obliged to pay up if an employee has a year of service, and if he does not, the salary is calculated accordingly. “In total this represents a significant cost for companies, especially the smaller ones”, says Williams. “It’s so important to include it in your budget calculation”.

Termination and Severance

Brazil has by far the most onerous penalties for termination without cause. Through a mandatory welfare mechanism known as an Unemployment Guarantee Fund (FGTS), the employer deposits 8% of the employee’s monthly salary into an account that earns interest and is monetarily corrected.  In the case of unjust termination, the worker can withdraw the entire FGTS fund plus another 40% on the total amount.  Terminations are very formal in Brazil and have to be filed with the labor authority to be legal.

Other LATAM countries are also strict about severances, although less so. In Chile, Argentina and Colombia the payment is equal to one month’s salary per year of service (Chile has a maximum of 11 months), while in Mexico it is 12 days of salary per year in the company. Severance in the Dominican Republic is paid on an increasing scale from 19-23 days salary per year of service, and in Nicaragua it is a month’s pay per year worked upto the third year, and 20 days pay per year upto the sixth year.

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Due to the legal approval and paperwork needed it can be quite difficult to remove employees even with cause, although most countries do not require compensation in this case. The exception is Costa Rica which still requires an indemnity of one month’s salary and vacation pay for termination under ‘just cause’ conditions.

Restrictions on Working Hours

Common to nearly all Latin American countries, and very strictly enforced, these regulations are often problematic for companies in the region. The workweek is usually 40-45 hours, divided into 8 hour shifts. When firms talk about rigid labor regulations, this is what they mean – the limit absolutely cannot be exceeded.

Overtime pay is very expensive, even upto 1.5 times the normal hourly rate. “Since the time schedules are so rigid, it’s difficult to provide services to US clients efficiently”, says an Associate VP Human Resources in Guatemala who preferred to remain unnamed. “The number of hours work you can perform for them is reduced, especially if you’re not in the same time zone as they are”.

The irony is these laws are often union-driven requirements to protect workers, but they sometimes end up doing the opposite. “We had many employees who legitimately wanted to work two or three 12-hour shifts during the week rather than five 8-hour shifts, but because of the overtime rule we couldn’t allow that”, says Maggi Williams.

The Way Forward: More flexibility?

 

Labor market reform is a touchy subject in Latin America. There are emerging outsourcing powers like Chile and Colombia with aggressive foreign investment campaigns, as well as established call center giants like Brazil and Mexico, all trying to balance making things easier for companies versus making things easier for their workers. The strong presence of labor unions always throws a wrench in the works, especially in countries like Argentina and Mexico where any new legislation is deeply influenced by them.

Labor laws are very necessary to preserve stability for both employer and employee, by laying down specific rules and guidelines that govern that relationship. Williams talks about choosing to open a call center for a client in either Colombia or Argentina a few years ago. “Both countries have more or less the same laws”, she says. “But Colombia doesn’t appear to  enforce every minute detail of the labor regulations as Argentina does, and that was a big part of my decision.”  She recommended Colombia.

While there is no question that more flexibility in the LATAM labor market would benefit companies and investors, it is just as clear that that won’t be happening anytime soon. But as David Kaplan writes, reform will hurt the most where it’s needed the most. If countries in the region would consider tweaking their labor laws to ensure that they are fair to the worker while being reasonable to the employer, they may see a lot more investment in the future.

 

The workweek is usually 40-45 hours, divided into 8 hour shifts. When firms talk about rigid labor regulations, this is what they mean – the limit absolutely cannot be exceeded
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