The coverage of contributory social protection schemes in Latin America is low. As highlighted by the World Bank, in the case of old-age pensions, coverage remains under 50% of the economically active population for all but three countries – Chile, Costa Rica and Uruguay – despite the reforms introduced since the 1990s (Rofman et al. 2008). Following the Chilean example, many countries in the region introduced private mandatory individual pension accounts, which aimed to reach financial sustainability and to strengthen incentives to participate. However, the share of workers contributing actively remains similar to that of traditional systems.
Labour informality is pervasive and heterogeneous in Latin America
The dual structure of labour markets in Latin America and the Caribbean plays a part in explaining this limited coverage. In recent research (da Costa et al. 2011) we analyse the relative roles of informality and incomes in explaining coverage, using data from nationally representative household surveys from Bolivia, Brazil, Chile, and Mexico from the mid-1990s to 2006.1
We define formal employment as that which is subject to a written contract or a document that certifies social protection entitlement through employee status (such as the Brazilian carteira de trabalho). Using the existence of a labour contract to determine formality facilitates comparability since it echoes a form of regulation that is common to the countries of Latin America – the obligation to formalise and register a subordinate employment relationship. Our results highlight that informality remains high, ranging from 85.6% in Bolivia (2002), to 64.4% in Mexico (2006), 56.8% in Brazil (2006), and 42.4% in Chile (2006).
To highlight the heterogeneity of labour (in)formality, we further classify workers not into formal and informal but in six categories:
- formal salaried workers,
- self-employed with completed tertiary education,
- non-agricultural informal employees,
- non-agricultural self-employed,
- agricultural informal employees,
- and agricultural self-employed.
Motivations, incomes and applicable labour legislation differ across all these categories (in a similar vein, see Jütting and de Laiglesia 2009). Armed with this more nuanced – but still manageable – framework, the problems posed by informality for social protection can be better analysed.
Middle-income workers tend to be informal…
The informal workforce is not composed only of poor workers; labour informality is also a middle-class issue. We categorise households in three groups depending on the level of adult-equivalent household income2: disadvantaged, middle income, and affluent. Households are classified as middle income if they have incomes between 50% and 150% of the household-adjusted median income per head for the country. The other two groups, affluent and disadvantaged, are those above 150% and below 50% of the median, respectively.
Focusing on four countries alone – Bolivia, Brazil, Chile and Mexico – 44 million middle-income workers are informal out of a total 72 million middle-income workers in those countries. In fact, there are more informal than formal workers among the middle class in all of these countries except Chile. Not surprisingly, social protection systems fail to reach even half of middle-income workers, leaving them without adequate employment protection and access to social safety nets.
Figure 1. Middle-income workers by employment category in Latin America
Note: Percentage of total middle-income workers (0.5 – 1.5 median household adjusted income)
… and contribute rarely to their pension schemes
The interaction of informality with contributory social-protection systems creates a vicious cycle. The majority of informal workers contribute irregularly, if at all, weakening those systems and providing insufficient support to those same workers when they need it. Most formal workers (i.e. salaried employees with a contract) contribute adequately to the pension system; from around 75% in Mexico in 2006, to 95% in Chile and 99% in Brazil (well above 40% in Bolivia in 2002).3 By contrast, in the case of informal workers, contributions are extremely limited, below 15% in Brazil, Chile and Mexico, and almost negligible in Bolivia. Moreover, coverage is more clearly linked to income levels than in the case of formal workers. Without reforms, then, poverty in old age is likely to exacerbate inequalities observed among the working-age population.
There are also marked differences in contribution rates among informal workers. In Brazil, where contributions are compulsory for the self-employed, 21.4% of the self-employed outside agriculture contribute for only 12.3% of non-agricultural informal employees. The difference is smaller in Chile, where such obligation was not in force in 2006 (the year of the data we use).
Figure 2. Middle-income workers pension coverage rate in Latin America
Note: Percentage of affiliates (Bolivia and Mexico) or contributors (Brazil and Chile), over middle-income workers (14-64 years). Formal workers are those subject to a written contract or a carteira de trabalho in Brazil
Pension policies to cover the uncovered
This situation represents a pressing challenge for public policy. Low levels of affiliation and irregular contribution histories put people at risk of downward social mobility when they get sick, lose their job, or retire. Three key features of Latin America’s socio-economic situation must be taken into account when designing a pragmatic reform: high levels and heterogeneity of labour informality, a young (although rapidly ageing) population, and limited fiscal resources. Social insurance for many people will have to be provided by means other than via formal employment. In fact, such policies must encourage participation in contributory systems by the informal middle class – people who are more likely to be able to save and to desire social-protection coverage. They may help to mobilise the savings for social insurance and build a fairer and more efficient social risk-management system.
Ex post policies (targeted at people after they retire) include spreading social pensions not linked to individuals’ history of contributions to the system, as implemented in Bolivia and Chile; such schemes are expensive (from 1% of GDP each year) but effective against poverty (see ECLAC 2006; Levy 2008; Pages 2010; Ribe et al. 2010). Within the scope of mandatory contributory pensions systems, policymakers should also evaluate reducing the number of years of necessary contributions to qualify for a minimum pension, in order to keep the promise of covering informal middle-income workers with spotty contribution records.
Ex ante policies (targeted at people during their working life) seem likely to have the most promising results for the middle-income workers: from compulsory affiliation for the self-employed (especially for the more educated segments), to a range of hybrid approaches for workers in the lower reaches of the middle class who may not be able to afford to contribute, such as “semi-compulsory” affiliation, in which workers are automatically enrolled, but are able to opt out. Greater flexibility regarding contributions, with respect to both amounts and timing (even permitting withdrawals in limited circumstances such as long-term unemployment or health problems) are other policy tools that can benefit workers in the lower middle class. Reforms to address the concerns of upper middle-class workers should focus on the so-called “matching defined contributions” (Holzmann et al., 2009), i.e. transfers made by the state to individuals’ defined contribution pension plans, conditional on their own voluntary contributions, as introduced in various forms in Colombia, Mexico and Peru.
da Costa, R, JR de Laiglesia, E Martinez and A Melguizo (2011), “The Economy of the Possible: Pensions and Informality in Latin America”, Working Paper 295, OECD Development Centre, Paris.
ECLAC (2006), Shaping the future of social protection: Access, financing and solidarity, UN Economic Commission for Latin America and the Caribbean (CEPAL), Santiago de Chile.
Jütting, JP and JR de Laiglesia (eds.) (2009), Is Informal Normal? Towards More and Better Jobs in Developing Countries, OECD Development Centre, Paris.
Holzmann, R, DA Robalino, and N Takayama (2009), “Closing the coverage gap. The role of social pensions and other retirement income transfers”, World Bank.
Levy, S (2008), “Good intentions, bad outcomes. Social policy, informality and economic growth in Mexico”, Brookings Institution Press.
OECD (2009),Pensions at a glance: Retirement-income systems in OECD countries, OECD, Paris.
OECD (2010), Latin American Economic Outlook 2011: How Middle-class is Latin America? OECD Development Centre, Paris.
Pages, C (ed.) (2010), The age of productivity. Transforming economies from the bottom up, Inter-American Development Bank and Palgrave Macmillan, New York, NY.
Ribe, H, DA Robalino and I Walker (2010), “From right to reality: Achieving effective social protection for all in Latin America and the Caribbean”, World Bank.
Rofman, R, L Lucchetti and G Ourens (2008), “Pension systems in Latin America: Concepts and measurements of coverage”, Social Protection and Labour Discussion Paper 0616, World Bank, Washington, DC.
1 The data come from the Encuesta Continua de Hogares de Condiciones de Vida (ECH) 2001-2002 for Bolivia; Pesquisa Nacional por Amostra de Domicilios (PNAD), 1996, 1998, 1999 and 2001-2006 for Brazil; Encuesta de Caracterización Socioeconómica Nacional (CASEN) years 1994, 1996, 1998, 2000, 2003 and 2006 for Chile, and Encuesta Nacional de Ingresos y Gastos de los Hogares (ENIGH) years 1998, 2000, 2002, 2004-2006 for Mexico.
2 This classification is proposed in the OECD Latin American Economic Outlook 2011 (OECD, 2010 and www.latameconomy.org). Indeed, 50% of the median adult-equivalent per capita income is used to define the poverty line in a number of countries, especially within the OECD. In Latin America this threshold, although significantly above the $1.25 PPP a day measure, may classify as middle income people considered poor by official statistics. Income includes both labour and non-labour income in adult-equivalent terms.
3 In Chile data cover contributors to both the private pension funds (Administradoras de Fondos de Pensiones, AFP), and to the previous public pay-as-you-go system (Instituto de Normalización Previsional, INP). In Mexico, data reflect enrolment in the private pension system (Sistema de Ahorro para el Retiro, SAR), to the public institutions (Instituto Mexicano de Seguridad Social, IMSS; Instituto de Seguridad y Servicios Sociales de los Trabajadores del Estado, ISSTE), to the state company Pemex scheme, and to university insurance programmes. In Bolivia, coverage is proxied by enrolment in the private pension system (AFP). Finally, in Brazil, data cover contributors to the Instituto de Previdência at all its levels: national (Instituto Nacional Seguro Social, INSS), federal and local.