Can Latin America Formalise Work Without Deepening Inequality?

The Inter-American Development Bank is urging Latin American and Caribbean governments to redesign labour rules, social protection and skills policies to raise productivity while improving worker welfare. Its recommendations challenge the long-standing assumption that governments must choose between protecting workers and making labour markets more competitive.

Latin America and the Caribbean face a labour-market contradiction that has persisted for decades: policies designed to protect workers can sometimes make formal employment more expensive, leaving millions outside the systems intended to support them.

The Inter-American Development Bank is calling for a broad redesign of labour regulation, social protection and workforce training across the region. Its report, Making Labor Markets Work: Improving Productivity and Workers' Welfare in Latin America and the Caribbean, argues that governments do not have to choose between higher productivity and stronger worker welfare. Better policy design, it says, can deliver both.

Informal employment remains closely tied to low productivity, unstable incomes and persistent inequality, while ageing populations, technological disruption and slow economic growth are placing additional pressure on labour markets. The debate is therefore no longer simply about creating more jobs. It is about whether economies can create formal, productive work that raises wages without excluding the people most in need of protection.

The Cost of Formality Is Keeping Too Many Workers Outside

Formal employment should provide workers with greater stability, legal protection and access to benefits. Yet when healthcare, pensions and other protections are financed mainly through payroll contributions, every formal hire carries additional costs for employers and workers.

The IDB's concern is that this structure can create a disincentive to formalisation. Businesses may avoid registering workers, remain small or rely on employment arrangements that sit outside conventional labour systems. Workers may accept informal jobs because formal opportunities are scarce or because the immediate deductions associated with registered employment outweigh benefits they may receive much later.

The result is a divided labour market. One group is covered by contracts, contributions and legal protections. Another works beyond the effective reach of those systems, often with lower earnings, weaker security and limited access to training. This divide also has implications for productivity. Informal firms may struggle to obtain finance, invest in technology or expand their operations. Informal workers may receive less workplace training and have fewer opportunities to move into more productive roles. Over time, these disadvantages can reinforce slow growth and inequality.

The policy challenge is not to remove worker protections but to prevent the financing of those protections from discouraging formal employment. Unless that distinction is maintained, reform could be misread as a demand to weaken labour rights rather than redesign how those rights are supported.

Social Protection Must Follow People, Not Contracts

The report's most far-reaching proposal is to separate basic social protection from employment status. Instead of financing healthcare and protection against poverty in old age mainly through payroll contributions, the IDB recommends using general taxation. This would reduce the additional cost attached to formal hiring while extending basic protection to people regardless of whether they hold a conventional employment contract.

Such a model would better reflect a workforce in which careers are becoming less predictable. Workers increasingly move between employers, periods of self-employment, flexible arrangements and temporary assignments. When essential benefits are tied to one type of job, people risk losing protection whenever their employment status changes.

A tax-funded system could make coverage more portable and inclusive. It could also reduce the divide between formal employees and the large number of workers who contribute to the economy without qualifying for employment-based benefits.

However, shifting social protection away from payrolls does not eliminate its cost. It transfers the financing burden to the wider tax system. Governments would need sufficient and reliable revenue to maintain healthcare and old-age support without weakening services or creating unsustainable fiscal pressure.

The transition would also be politically sensitive. Workers who have contributed to existing systems will want assurance that their entitlements remain secure. Employers may favour lower payroll costs, while unions may question whether tax-financed benefits will match the protections currently linked to formal jobs.

The reform's credibility will therefore depend on sequencing. Governments would need to secure funding, protect existing rights and expand coverage without creating gaps during the transition. A poorly managed shift could weaken confidence in the very institutions it is intended to strengthen.

Modern Work Is Outpacing Old Labour Rules

Labour regulation across the region was largely designed around a familiar model: a worker employed by one organisation under a relatively stable contract and career path. That model remains important, but it no longer captures the full range of employment relationships.

Flexible schedules, temporary work, self-employment and technology-enabled arrangements are becoming more common. Businesses want room to respond to changing demand, while workers need protection against insecurity, arbitrary treatment and unsafe conditions.

The key policy dilemma is how to allow flexibility without making instability the default condition of employment. Rules that are too rigid may discourage hiring or fail to accommodate new forms of work. Rules that are too weak may shift economic risk almost entirely onto workers. Reform must therefore focus on which protections should remain universal, which regulations need updating and how rights can be enforced across different employment arrangements.

The IDB also calls for stronger and more impartial institutions to oversee collective bargaining and ensure that labour rules are applied fairly to employers and unions. This institutional dimension is critical. Even carefully written laws have limited value when enforcement is inconsistent, politicised or inaccessible. Workers may be unable to exercise their rights, while businesses face uncertainty about how rules will be interpreted.

More credible labour institutions could give employers clearer expectations and workers greater confidence that contracts, bargaining agreements and protections will be upheld. Yet impartial enforcement requires administrative capacity, adequate resources and insulation from political pressure.

Changes to collective bargaining are also likely to attract scrutiny. Employers and unions may resist reforms they believe would reduce their influence. Governments will need to show that stronger oversight is intended to make negotiations fairer, rather than tilt the balance towards one side.

Skills Reform Is Where Better Jobs Must Become Real

Changing regulations and financing systems may make formal employment more attractive, but they will not automatically create productive jobs. Workers also need skills that match the demands of changing economies. The IDB places strong emphasis on workplace training, on-the-job learning and employment programmes that connect jobseekers with businesses. The aim is to help workers adapt to technological change while allowing employers to recruit people with relevant capabilities.

Labour markets can fail even when vacancies and workers exist at the same time. Employers may be unable to find the skills they need, while jobseekers lack reliable information about opportunities or access to useful training. On-the-job learning can help close that gap by linking skills development directly to workplace needs. Better employment services could also improve the way workers and vacancies are matched.

However, training programmes must be judged by employment outcomes, not enrolment figures. Courses that are disconnected from business demand may leave participants with certificates but no route into better work. Employers must therefore help shape programmes, provide practical learning and create opportunities for trained workers.

Skills policy also cannot substitute for economic demand. Even well-trained workers may struggle to find productive employment when investment is weak, businesses are not expanding or economic growth remains slow.

This is why the IDB's reform agenda must be understood as an integrated package. Social protection reform can lower barriers to formal employment. Modern labour rules can accommodate changing work patterns. Strong institutions can improve enforcement, while effective training can help workers move into more productive roles.

The report warns that delaying reform will make the challenge harder as populations age, technology changes rapidly and slow growth continues, but urgency should not become an excuse for rushed policy.