How Mexico’s Outsourcing Ban could Benefit Central America

Biz Latin Hub CEO Craig Dempsey explains how recent legislative changes to employment law in Mexico may offer future advantages to Central America as foreign companies look to move their outsourcing operations there instead.

A recent outsourcing ban introduced by Mexico has eliminated a type of employment solution that is popular among foreign investors, with some analysts suggesting the move may come at deep cost to the country’s economy. That could prove a boon for the outsourcing industry in Central America, who’s proximity and competitive labor costs make it well-placed to hoover up some of the clients Mexico now stands to lose.

On April 23, Mexico’s populist President Andrés Manuel López Obrador, or “Amlo,” signed off on the outsourcing law days after it had made it through the Mexican Senate without contest. That vote came just a week after the bill received a sweeping majority in the lower house Chamber of Deputies.

The bill followed months of efforts by the Amlo administration to promote reform, and essentially bans the outsourcing of any jobs related to a company’s “core business activities.” While the definition of that term is not fully clear, the upshot of the legislation is that it appears to effectively eliminate a large chunk of professional employer organization (PEO) services.

What is PEO?

PEO, which can also be known as employer of record (EOR) services, is an outsourcing arrangement whereby a provider known as a PEO firm hires staff on the behalf of a client. So while the staff are officially employed by the PEO firm, the client retains full control over their workload and timetable.

Among foreign investors it is a popular way of getting a local workforce without having to go through company formation. This is particularly attractive to anyone running a limited-scale or short-term project, given the easy market entry and exit it entails.

Other draws include the fact that the PEO firm will usually have a well-established recruitment network able to find ideal staff quickly, and will guarantee compliance with local regulations as part of its service agreement — relieving the client of a due diligence burden.

Based on the client feedback Biz Latin Hub receives, that is partly why it is seen as a good option while getting to know a new market, as well as for those who want to get to work before the company formation process can be completed.

However, in many cases employees hired under PEO arrangements are performing tasks that would be deemed part of a company’s “core activities.” Think of an IT firm hiring a pair of software developers for a months-long project, or at the other end of the organizational scale, an executive engaging with regional partners and suppliers who is a company’s only employee in Latin America.

Both examples could seemingly be regarded as being involved in core activities and therefore would not be employable via a PEO arrangement in Mexico.

That begs the question: Why has Mexico banned outsourcing?

The principle behind the ban is a fair one, because the government has sought to close a loophole that many companies were exploiting to save on taxes and statutory employee contributions.

Essentially, for years companies have been lowering their tax burden and escaping mandatory employee profit sharing via outsourcing arrangements. The scheme appears to have contributed to the number of outsourced employees in the country more than quadrupling between 2003 and 2018, to hit around 4.3 million.

That has seen various efforts to bring in legislation to deal with such avoidance over the years. However, since the second half of 2020 Amlo has spoken publicly about his desire to see through legislation to end the practice.

Under the new bill, PEO firms will have to begin paying the same benefits to outsourced employees that in-house staff members would receive, including a share of profits. It also forces employers to bring anyone involved in “core activities” onto their payroll within three months.

That is where this legislation gets problematic, effectively eliminating a large portion of the PEO services market. While one option available to affected clients will be to register a business in Mexico, that will likely only be preferable to anyone who outsources a significant number of workers in the country, or who is already planning to make a deeper commitment to the market in the future.

For anyone whose needs are best met with a PEO solution, and who is not necessarily pegged to working in Mexico, looking elsewhere in the region is likely going to be their best bet.

While there are many potential destinations for those clients to go, Central America, along with the likes of Colombia and Chile, would appear to be best placed to capitalise on this.

Why would Central America benefit from Mexico’s outsourcing ban?

The fact is that investors are increasingly looking to Central America as a viable investment option, thanks in part to exponential growth that has been seen since the turn of the century.

In three of the six countries that make up the sub-region (Belize excluded), gross domestic product (GDP) more than quadrupled between 1999 and 2009. In the case of Panama, it increased more than five-fold. That was met with a corresponding rise in prosperity, as measured by gross national income (GNI).

While some of the larger economies from the region that traditionally attract investors have seen impressive growth during that same period, it has not been of the same scale. Meanwhile, although the three “Northern Triangle” countries of El Salvador, Guatemala, and Honduras still struggle with crime, each has seen a notable reduction in violence over recent years.

In the case of Guatemala — one of the three standout economic performers — the homicide rate has more than halved since 2009.

Meanwhile, Costa Rica and Panama — the other two standouts — are two of the least violent and most stable countries in the region.

Added to this is the fact that these countries are some of the most cost-effective places to hire staff in the region, as the Biz Latin Hub payroll calculator demonstrates, thanks in part to competitive rates and favourable taxation systems.

Meanwhile, employment law in the sub-region usually guarantees a longer notice period for workers than in many other parts of Latin America, so you can operate without concern for being left short-staffed on a few days of notice.

Added to this is the fact that professional services and the tech and IT sectors in Central America are growing, as well as the proximity of the sub-region to Mexico, and you begin to understand why it stands to gain so much from the recent outsourcing ban.

While it is early days yet, with the dust from Mexico’s outsourcing ban not likely to settle at least until the three month grace period for taking outsourced staff onto payrolls is over, the reality is that Mexico’s heavy-handed method of dealing with tax avoidance is likely to come at some cost to its economy.

For Central America, recent economic improvement and increasing investor interest means its outsourcing sector is well placed to benefit.

Craig Dempsey is the co-founder and chief executive officer of the Biz Latin Hub Group, an organization dedicated to assisting investors in Latin America and the Caribbean.