Attempts to explain the limited coverage of Latin America’s social-protection schemes often blame the duality of its labour markets. Indeed, some authors equate formal employment with job-linked pension entitlements.13 More broadly, informality is often used to refer somewhat loosely to activities that are carried out outside of the legal or regulatory framework.

Such a generic term in fact spans a number of very different realities, from the outright illegal such as drug trafficking or smuggling, to very common exchanges which nonetheless take place outside formal and contractual environments, such as mutual help among neighbours. A job is informal when "the employment relationship … is not subject to national labour legislation, income taxation, social protection or entitlement to certain employment benefits" (ILO, 2003); in other words, when a labour relationship is neither observed nor protected by the government. It follows that informal employment includes not only many forms of self-employment, but also employment in informal enterprises (themselves usually excluded from labour inspection and social protection requirements), together with unregistered employment in formal enterprises or households.14 Informal employment is therefore very heterogeneous and cannot be considered merely a form of underemployment.15

A substantial and growing body of evidence calls into question the view that informal workers are shut out of the formal sector as the sole result of a segmented labour market (the "exclusion" view).16 In particular, the finding that mobility between formal and informal employment is relatively large in both directions suggests that at least part of the population in informal work chooses to be outside the regulated economy (the "exit" view).

This suggests that it is better to think of informal employment as two-tiered.17 The lower tier includes occupations traditionally associated with informality: the majority of own-account workers whose firms do not offer growth prospects, and informal employees who are queuing for formal jobs. The upper tier comprises workers that are relatively better off, including informal sector employers and entrepreneurs with accumulated productive capital18 and certain forms of false self-employment.19 There are transition costs in moving from one tier to the other.

Acknowledging these tiers – and distinguishing between exit and exclusion – should be part of the design of policies that aim to increase the coverage of social protection. The distribution of earnings between formal and informal workers is similar and therefore there are workers in the upper tier who choose to opt out of the formal economy and its social-protection networks, but who could nonetheless afford the necessary contributions. On the other hand, most workers in the lower tier cannot afford to opt into social protection as independent workers and are not offered the possibility of providing payroll-linked contributions. There is unlikely to be a "one-size-fits-all" policy that will cover both of these situations, and the same conclusion can be expected to apply to pension policies for these two (admittedly stylised) groups.

Informality and work status

For the purposes of analysis, 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 an employment relationship.20

An alternative would have been to count workers covered by social-protection schemes. This is less comparable between countries, and also suffers from potential indeterminacies as a result of the unbundling of social benefits. Cover against health problems, occupational hazards, old age, maternity or unemployment may be provided separately, and coverage for different workers may differ across these dimensions, making them formal in one but informal in others. This is particularly true of pension coverage – one of the main outcomes we seek to analyse.

Formality defined, the task is then to subdivide informal employment in a way which reveals different labour-market and social-insurance behaviours within it.

In many countries in the region, self-employed workers are not obliged to register or contribute to social-security or pension systems. The first group is therefore self-employed workers all of whom we consider as informal, or at least not formal.21 This group is subdivided according to the sector in which they work (agricultural or non-agricultural) and their level of education (in order to identify self-employed professionals). Informal employees make up the balance, and this group is similarly split into its agricultural and non-agricultural components. All in all, this leads us to define six categories: formal 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. Armed with this more nuanced – but still practical – framework, the problems posed by informality for social protection can be better analysed.

Figure 2.3 shows the composition of each of the disadvantaged, middle sectors and affluent groups in terms of these six categories, using data from the latest available national household surveys. The four panels cover Bolivia, Brazil, Chile and Mexico.22 This sample represents a good mix of country-specific and regional considerations. It covers the range of informality levels in the region (from the relatively low level in Chile, to the high in Bolivia) and the main forms of pension scheme (from the public pay-as-you-go system in Brazil to private ones based on individual capital accounts).

Our definition of middle sectors is the 50-150 one chosen in Chapter 1 – those with income between 50% and 150% of the household-adjusted median income. The disadvantaged and affluent are those below and above this range respectively.

In general – and unsurprisingly – the size of the formal workforce rises with income. Nevertheless, two important facets of informality in the middle sectors are revealed. First, the absolute number of middle-sector informal workers is high. In fact, other than in Bolivia, middle sectors are the income groups to which the greatest number of informal workers belong. Second, their proportion is high too: there are more informal than formal workers among the middle sectors in all countries but Chile.

Digging deeper, the composition of the informal workforce across income groups varies, reflecting the heterogeneity of informal work. The starkest example is Bolivia, where the majority of the working disadvantaged are in self-employed agricultural occupations at subsistence levels of returns.

The self-employed show up in all income groups across countries, reflecting a diversity not captured by our six occupational categories. Educated self-employed individuals are mostly found among the affluent, indicating their higher earning potential, except somewhat surprisingly in Brazil.

Those informal workers who are in an employment relationship are usually thought of as a particularly disadvantaged group, seen as excluded from social protection not by their own choice but by their employer (even if in practice it is often a joint decision).23 The fact that there are informal employees even in the affluent group suggests that social-security provisions in labour law may in practice have only limited enforceability.

All in all, in the four Latin American countries considered 44 million of the total 72 million middle-sector workers are informal. Labour informality is therefore very much a middle-sector issue. It remains a prime factor behind their relatively low pension coverage – and a leading indicator of potential poverty for many of today’s middle-sector households.

The middle sectors account for nearly 50% of the workforce, while the disadvantaged account for about 20% and the affluent 30%. (A notable exception to this pattern is Bolivia where the proportion is closer to one-third for each segment).

Figure 2.3. Workers by employment category and income group in Bolivia, 2002

Figure 2.3. Workers by employment category and income group in Bolivia, 2002

Figure 2.3. Brazil, 2006

Figure 2.3. Brazil, 2006

Figure 2.3. Chile, 2006

Figure 2.3. Chile, 2006

Figure 2.3. Mexico, 2006

Figure 2.3. Mexico, 2006