January 27, 2014 | Contribution by
MARIANO BOSCH, ANGEL MELGUIZO, CARMEN PAGÉS
Contributed by Mariano Bosch (Senior Specialist), Angel Melguizo (Pension Coordinator and Lead Specialist), and Carmen Pagés (Chief) in the Labor Markets and Social Security Unit, IDB
In a recent blog entry — Universal Pension, Yes, Regressive Funding, No — David Robalino posed a number of very interesting questions about the proposal that we develop in our book Better Pensions, Better jobs (a new flagship report from the Inter-American Development Bank) and elaborate in an earlier blog, It's Time for Universal Pension Coverage in Latin America.
Construction works for the Panama Canal expansion project. Panama. Photo: Gerardo Pesantez / World Bank
In a nutshell, David says that he agrees with a number of elements of our proposal, especially on universal coverage (through social, non-contributory pensions), but he disagrees with our call for establishing a system of incentives for formalization. He contends that such a system could be highly regressive, given that it would be targeted to formal workers, who have on average higher incomes.
We welcome the debate on the best way to tackle pension coverage in Latin America. In that spirit, we would like to counter that that any short-term regressivity in funding would be justified by medium- and long-term benefits, even for the poorest. Take a look at three key facts.
FACT 1: Social pensions won't be sufficient. There is a need to create more formal jobs to ensure an adequate pension level.
We strongly believe that non-contributory pensions (or social pensions) can be a good way to prevent poverty in old age — in fact, they are the only way for cohorts that would retire soon without savings. Moreover, these pensions would be affordable, even if they are universal, as long as their objective is to reduce poverty.
However, these pensions are ill-equipped to smooth consumption at a reasonable fiscal cost. Just by way of an example, the cost of providing 100 percent of the elderly in the region with a pension of say 30 percent of GDP per capita would cost around 2 points of GDP today, a hefty sum. And by 2050, the cost would reach 6 points of GDP! These estimates suggest that on top of social pensions, workers will need to draw on their contributory pensions, which currently are way too low to handle this function because of the high level of informality.
Fact 2: Subsidies are one of the key instruments available.
If we agree that we need to create more formal jobs, let's talk options. At this stage, we think that the balance of costs and benefits between formality and informality in the region is tilted toward informality, which pushes a substantial part of workers and firms in the direction of informal activities. How can this equilibrium be changed? One option — which we strongly favor trying — is reducing the “price” of formality through subsidies, benefiting workers and/or firms. Other options that might be pursued include improving taxation enforcement, providing more financial education, and establishing easier and innovative channels for pension contributions.
Which of these tools is more cost effective is something that remains to be seen. Countries need to innovate and evaluate what works best for them. But the crucial point is that there is a need to make "being formal" more attractive than it is today for firms and workers.
Fact 3: Most informal workers get formal jobs, just not for enough time. In the medium to long run, subsidies could shift more informal workers into formal jobs, which implies that subsidies will be allocated more progressively.
If subsidies (and other instruments) manage to increase the rate at which low-income workers become formal, these resources will increasingly be allocated more progressively in relative terms – that is, giving the same amount of income to everyone would decrease inequality. Furthermore, if progressivity is set as a goal of the reform, larger subsidies to workers at the minimum wage could be offered, and income taxation at the higher end could be reinforced.
In addition, one of the most striking facts — and only recently known — is that most workers in Latin America hold both formal and informal jobs throughout their lives.
||In Mexico, between 2005 and 2010, more than 40 percent of workers held at least a formal and an informal job, while only 21 percent held only informal jobs. |
||In Ecuador, between 2000 and 2010, almost 40 percent of males that lived in households that qualified for conditional cash transfers (that is, they were relatively poor) held at least one formal job between 2000 and 2010. |
This means that the formal and informal sectors aren't segmented but rather quite porous worlds — and thus even the poorest workers can get formal jobs. Of course, the more often that they can get formal jobs and the longer they can retain them, the more they'll be able to benefit from the proposed subsidies.