Why do we care?• Myopia:Lack or biased informationLimited cognitive skillsPsychological problems• Imperfections in labor markets• Imperfections in capital markets• Imperfection in insurance markets (adverse selection)
What are the problems?• Low coverage• Design problems that distort labor markets:Lower participation ratesLower employment levelsHigher informality
Why ?• Many are self-employed• Unemployment• Labor mobility• Low income individuals cant afford contributions• Low productivity firms cant afford pay-roll taxes• Evasion ?
Unemployment is an issueVENURUPERPARPANNICHONGUASLVECUDOMCRCCOLCHIBRABOLARG02468101214160 1 2 3 4 5 6 7Inflow rates (% employed)Unemploymentduration(months)Combinationsconsistent with a5% unemploymentrate.
Unemployment risks arehigher in the informal sector...01234567Apr-02Aug-02Dec-02Apr-03Aug-03Dec-03Apr-04Aug-04Dec-04Apr-05Aug-05Dec-05Apr-06Aug-06Dec-06Apr-07ProbabilityofUnemployment(%).Informal W (3.8%)Informal SE (2.85%)Informal E (1.05%)Formal W (1.11%)Brazil
There is also considerablemobility between jobsAnnualTransition RatesSelf-employed Informal FormalSelf-employed -- 0.53 0.35Informal 0.29 -- 0.47Formal 0.25 0.43 --Mexico
Value added per workerFirms rankingMinimum cost of laborExcludedMOROCCOTax-wedge reduces formal employment(0.1-0.5 elasticity).... low productivity firms self-select in theinformal sector
How the SI systemaffects outcomesTAXESSUBSIDIESExplicitImplicitExplicitPay-rollNon-contributoryinsuranceContributions notlinked to benefitsBehaviorsof employers andworkersHow do SI programs affect labor markets ?Workers do not valuebenefits "in full"
Example of implicitredistribution in UB programsBalanceintheindividualaccount(%ofwage)-150-112.5-75-37.5037.575Months1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 164% contribution rate50% replacementrate during 3months
What is the evidence?Employmentlevel90100110120Tax wedge0.1 0.2 0.3
Tax-wedgeThe difference between the total cost of labor and take-home payTax Wedge = W . (1+taxE) - W. (1-taxW) - Value SS benefitsW: wagetaxE: taxes paid by employer (social security contributions)taxW: taxes paid by workers
What is the evidence?Non-contributory programs provideincentives for informal work (Mexico andColombia)8-20% of netformalemploymentcreationWorkers valuation of mandatorybenefits (health care) affects the choicebetween formal and informal jobs(Uruguay)Transfers (social pensions) canreduce formal employment andparticipation (Chile)- 4.1% formal participationof workers older than 40Higher propensity of womenwith children to drop out oflabor market-5 % amongplan memberswith nochildren
Mandatory savings rates and default portfolios do not account fordifferent “preferences” and observable characteristics that matter(e.g., labor income).ChileDefaultAverage
Unemployment insurance can affect unemployment rates and theshare of formal, informal and self-employment (Brazil)DesempleoEmpleo FomalEmpleo InformalCuenta Propia-0.05 -0.038 -0.025 -0.013 0 0.013
Recommendations atfive levels• Integration of SI programs• Bundle and level of SI benefits• Redistribution• Financing and tax-wedges• Incentives for enrollment
Integrate programs• Have one SI system open to all workers• This can be done by "shutting-down" schemesand re-enrolling workers ...• ... or closing schemes to new entrants, whowould enroll in a national scheme
Review the bundle of SIbenefits• Focus on pensions (old-age, disability,survivorship) health insurance, andunemployment insurance• Give more choice to individuals in defining thelevel of benefits:Define a basic bundle of benefits as a default"Nudge" individuals to update their defaults and provideinformation/guidance
Make redistributionexplicit and well targeted• Link contributions (including from employers) to benefits• Identify the share of the cost of the bundle of SI benefitsthat will be subsidized at each level of income (could beuniversal):Subsidies can match the contributions or top-up thebenefits of plan members...... there has to be a "smooth" decline in the subsidybased on incomeIncome can be inferred through proxy means tests (PMT)
Income LevelBenefitSubsidiesVoluntary contributions
Income LevelBenefitSubsidiesContributionsVoluntary contributions
Income LevelBenefitSubsidiesVoluntary contributions
Reduce tax-wedges• Having more individual choice in defining the bundleof SI benefits can help...• Also linking contributions to benefits and financingredistribution through general revenues:Reallocate expenditures (e.g., subsidy reform)And/or increase other taxes (e.g., consumption, property, wealth)• Consider exemptions for firms below a given level ofproductivity
Incentives to enroll• With large informal sectors it is not possible to enforce enrollment... ithas to be voluntary• Administrative processes must be simple• Rely on "aggregators" that operate in small villages and markets, aswell as through cooperatives• Rely on mobile technology• Run information campaigns• Provide financial incentives:Those who enroll are eligible for a minimum level of benefits and/or matchingcontributions
Final remarks• There are important problemswith coverage, labor markets,and equity• Part of the solution is tointegrate programs, have morechoice, and rethinkredistributive arrangements• The political economy of reformis not easy• But making redistributivearrangements explicit can help