Setting the framework
The World Bank’s 1994 report Averting the Old Age Crisis: Policies to Protect the Old and to Promote Growth set the agenda for structural pension reform in the world. Given rapid demographic transition, the weakening of informal protection networks, and both present and future financial burdens, they recommended a multi-pillar pension system. A key element was the introduction of mandatory individual capital accounts, managed by the private sector. Latin America became – by far – the most ambitious adopter of this reform agenda: Chile had already led the way in 1981 and was followed by Peru in 1993, Colombia in 1994, Argentina in 1994 (though reformed again in 2008), Uruguay in 1996, Mexico and Bolivia in 1997, El Salvador in 1998, Costa Rica and Nicaragua in 2000 and Dominican Republic in 2003.2
As well as improvements to their fiscal position, these "structural pension reformers" sought to secure macroeconomic benefits including higher productivity, higher domestic savings and investment, and a boost to the development of their domestic capital and financial markets.3 They were also expected to enjoy positive labour-market effects. Individual pension systems – because of the clearer link in members’ minds between the contributions they make and the benefits secured – should provide better incentives than traditional defined-benefit pay-as-you-go schemes (such as operate in OECD countries). In turn this should lead to a higher structural employment rate, higher labour supply, and lower levels of informality.4
In practice evidence on these labour impacts remains controversial. The taxes needed to support the unreformed pension schemes may not have had as great an impact on employment as was supposed.5 And, even allowing for the relatively short period of time since the reforms were adopted (around15 years on average, with lengthy transitional rules), the incentives to join the formal sector and pay contributions to the new system have proved weaker than expected. In fact, only Chile among the reformers – and to a lesser extent Brazil, a non-reformer – seem to be bucking the regional trend. Some studies have been able to conclude that in Chile the pension reform has led to a significant increase in formal employment, and reduction in unemployment.6 In Brazil, informal employment remains above 40% but has decreased steadily since 2003 with accelerating net annual generation of formal employment.7
Short-sightedness or lack of information on the part of workers, the interaction with labour and social legislation, rational decisions based on volatile returns or high start-up fees, and social preferences for anti-poverty (rather than savings) programmes all contribute to explain low overall coverage rates in the region.8 This leads us to conclude that social-protection policies need to be designed in conjunction with a framework of appropriate social, labour and macroeconomic institutions. Pension systems – and social protection in general – should adopt a pragmatic "political economy of the possible" approach.9 This means responding to three key social and institutional features in Latin American: high labour informality, a relatively young (although rapidly ageing) population, and limited fiscal resources.
The 2009 edition of the Latin American Economic Outlook (OECD, 2008) looked at the difficulties in measuring or defining informality in the region.10 Informal employment is believed to account for more than 50% of total non-agricultural employment in Latin America, with the proportion ranging from around three-quarters in Ecuador and Peru, to a little over one-third in Colombia and Chile. The extent of informality in a country is in part inversely linked with per capita income, but – as Figure 2.1 shows – this measure does not explain everything. Informality in Argentina and Ecuador, for instance, is nearly
20 percentage points higher than per capita income in those countries would imply.
Figure 2.1. Informal employment and real GDP per capita (percentage of informal employment in total non-agricultural employment in emerging countries, mid-2000s)
Not all informal workers are poor and unproductive (nor do they all work outside the formal economy). Nor should they all be seen as victims of exclusion from the formal sector since some of the informality observed reflects a voluntary exit rather than exclusion.11 Even so, many informal workers lack adequate employment protection and access to social safety nets.
The second key influence on pension policy is the "demographic bonus". According to the latest projections by the United Nations, Latin America is in the second stage of its demographic transition. During this the ratio of dependants (defined as people under 15 or 60 and over) to working-age population is relatively low – particularly compared with the OECD average.12 As a whole the region will enjoy this demographic bonus for the next two decades; slightly less in Chile, but 50 years and more in Guatemala and Bolivia (see Figure 2.2 for the old-age component of dependency).
The bulge in potential workers implied by this one-off demographic shift presents a unique opportunity to extend social-protection schemes, as long as these new workers can be led to join the schemes as affiliates and – more importantly – as contributors. Moreover, the simultaneous relative ageing of the population should proportionately reduce demand for early-life expenditure, such as primary education, freeing public resources for other areas.
The third – and unsurprising – factor is the availability of funds. Public resources are scarce in Latin America. As will be discussed in Chapter 4 (and extensively analysed in OECD, 2008), this shortage can principally be laid at the door of low tax-collection rates, particularly in the case of personal income taxes – rates are low by international standards even controlling for differences in per capita income. The resulting lack of resources restricts the public sector’s ability to take effective (and in many cases efficient) measures such as extending universal health care, or permitting wider access to minimum pensions.
The bulge in potential workers implied by this one-off demographic shift presents a unique opportunity to extend social protection schemes, as long as these new workers can be led to join the schemes as affiliates and – more importantly – as contributors. Moreover, the simultaneous relative aging of the population should proportionately reduce demand for early-life expenditure, such as primary education, freeing public resources for other areas.
The third – and unsurprising – factor is the availability of funds. Public resources are scarce in Latin America. As will be discussed in Chapter 4 (and extensively analysed in OECD, 2009), this shortage can principally be laid at the door of low tax-collection rates, particularly in the case of personal income taxes – rates are low by international standards even controlling for differences in per capita income. The resulting lack of resources restricts the public sector’s ability to take effective (and in many cases efficient) measures such as extending universal health care, or permitting wider access to minimum pensions.
