Outsourcing, Labor Regulations and Profit-Sharing: Evidence from Mexico

This paper studies the use of domestic outsourcing to circumvent labor benefits and its consequences for firms and workers. Drawing on longitudinal establishment data and employer-employee data from Mexico, we provide evidence that many firms were outsourcing their entire workforce to avoid mandatory profit-sharing. A model shows that the incentive for this practice arises when firms face a labor supply curve that is less elastic to profit-sharing than to wages. We then leverage a reform that restricted outsourcing to assess the model predictions. The reform caused previously-outsourcing establishments to insource their workers and comply with profit-sharing, with no evidence of an effect on total employment. Treated plants partially offset the profit-sharing increase through lower wage growth, yet total worker compensation increased, consistent with our model. Self-collected survey evidence suggests that inelasticity to profit-sharing is partly explained by information frictions among workers, implying that they benefited from the reform.