Jens Matthias Arnold
Aida Caldera
Elizabeth Friesen
Expanding Social Protection and Addressing Informality in Latin America
Abstract
Informality remains a defining feature of Latin America’s labour markets, with around half of workers employed outside formal arrangements. While rates have slowly declined in some countries, progress is uneven and fragile. The many faces of informality — from self-employed vendors to domestic workers and employees in small firms — highlight the diverse realities of those without contracts, secure incomes, or access to social protection. The COVID-19 pandemic was a wake-up call: it exposed the vulnerability of informal workers, who were among the hardest hit by job and income losses, and underscored the urgent need for more inclusive and resilient social protection systems.
Latin America has long been characterised by high rates of poverty and inequality, coupled with weak economic performance and widespread and persistent informality. Significant social progress was made during the decade of the 2000’s in the context of strong economic growth supported by high commodity prices, with inequality and poverty declining in many countries across the region1 (Figure 1.1) (Lustig, Lopez-Calva, and Ortiz-Juarez 2016; Meléndez 2021). Reaping the benefits of significant improvements in access to education, several countries in the region saw the emergence of a new middle class, and upward social mobility improved, albeit from low levels. Many of those unable to benefit from improvements in the labour market benefited from the establishment or expansion of non-contributory cash transfer programmes.
Note: LAC refers to a simple average of 18 Latin American countries. Data for Argentina refer to urban areas only. Data may differ from the data published by the statistical institutes in each country.
Source: Economic Commission for Latin America and the Caribbean (ECLAC), Based on data from Household Surveys Database (BADEHOG).
Labour informality, a long-standing feature of Latin American economies, showed similar improvements in most countries, while remaining at high levels in all of them (Figure 1.2 and Figure 1.3). Official definitions of informality vary across institutions, but the informal sector can generally be understood as workers and firms that operate on the margins of relevant laws and regulations. One salient feature is that informal firms and workers generally do not pay contributions to standard social security schemes such as old-age pensions, health or unemployment benefits, where those exist. Between 2003 and 2014, informality declined visibly, reflecting the results of the commodity boom, including better access to education, as well as some policies to promote the formalisation of salaried workers, own-account workers, and informal production units, including a single tax regime in Argentina and the Individual Microentrepreneur Law in Brazil (Castelao Caruana 2016; Corseuil, Neri, and Ulyssea 2014; Abramo 2022). Several countries, including Chile, Colombia, Mexico and Uruguay, also introduced subsidies or reductions in employers’ social security contributions to encourage the formal hiring of targeted groups such as young workers, women, and low-income earners. Evidence suggests that formalisation during this period was in large part responsible for a simultaneous reduction in income inequality (Amarante and Arim 2015).
% of total employment, 2002-2023
Note: Informal workers are defined as all persons who, during a given reference period, were employed in at least one informal sector enterprise, irrespective of their status in employment and whether it was their main or a secondary job. Given the different definitions of and measurement methodologies for informality there may be differences between the ILO data presented here and data published by national statistical institutes. Data for Argentina refer to urban areas only.
Source: ILO statistics.
These positive trends stagnated in the latter half of the 2010’s, and some even reversed, as the commodity prices boom vanished and so did economic growth (Gasparini and Cruces 2021). Between 2010 and 2019, average GDP growth in largest seven Latin American economies (Argentina, Brazil, Chile, Colombia, Costa Rica, Mexico and Peru) dropped from 6.7% to 1.0%. Since 2014, poverty rates in many countries in the region have been on the rise again, while the declining trend of income inequality came to a standstill. Informality also started to rise again marginally. Between 2015 and 2019, based on data for 16 countries, the regional informality rate rose from 49.9% to 51% (ILO, 2020[1]). This rise in informality has been attributed to short-lived formalisation efforts by governments, in addition to fading economic momentum (Salazar-Xirinachs and Chacaltana 2018).
This renewed deterioration in social outcomes was the backdrop for the COVID-19 pandemic, which hit Latin America much harder than other regions of the world, and which starkly revealed structural weaknesses in the region’s social policy frameworks. Around 15% of cases and 28% of Covid-related deaths occurred in Latin America, which accounts for just 8% of the world population (Schwalb et al. 2022). Economic damages were similarly severe, as the region experienced the worst economic contraction in its history. The pandemic exacerbated many pre-existing problems and inequalities, as incomes at the bottom of the distribution took a much larger hit than those further up. In the first year of the pandemic, poverty and extreme poverty rates jumped by two percentage points each, and regional inequality, measured by the Gini coefficient, increased for the first time since 2013 (CEPALSTAT, 2022). This is particularly concerning, given that even after the decline of the 2010’s, inequality in the LAC region was still the highest in the world (Amarante, Galván, and Mancero 2016).
The pandemic triggered an unprecedented labour market crisis, characterised by sharp falls in employment and labour market participation, largely driven by structural weaknesses in the labour market, such as high informality. While in previous downturns, the informal sector was able to absorb those dismissed from formal jobs, this time informal employment contracted more than formal employment. Mobility restrictions imposed to contain the spread of the pandemic put particular strains on contact-intensive informal activities in commerce, hospitality, and other service sectors (Bárcena et al. 2021). While the duration and enforcement of lockdowns differed across Latin America, the region saw some of the longest-lasting mobility restrictions in the world. Argentina, as an extreme example, implemented 119 days of strict nation-wide lock-down and 304 days of less restrictive lock-downs, making it the country with the longest-lasting mobility restrictions in the world (Sagripanti and Aquilano 2022). Extended school closures, lasting more than an entire academic year from March 2020 to September 2021 in most LAC countries, led to lower educational achievement and higher dropout rates (Gómez and Uzín P. 2022). In 2020, Costa Rica saw an estimated loss of half of an academic year of mathematics, corresponding to a 12-point drop in student Programme for International Student Assessment (PISA) scores (Vargas Cullell and Román Vega 2021) while Mexico reported increased dropout rates, losses in numeracy and reading, and increased gaps in fundamental learning by gender and socioeconomic status (“Encuesta para la Medición del Impacto COVID-19 en la Educación” 2021; Hevia et al. 2022). School closures also put severe strains on parents, especially women, and reinforced inequalities as disadvantaged households had lower access to digital learning possibilities.
Widespread informality also made it harder to protect workers’ livelihoods during the pandemic because informal workers typically lack access to social protection and employment benefits. When the pandemic hit, over 50% of income earners in the region were in the informal sector, with country-specific informality rates ranging from 25% in Uruguay to almost 80% in Honduras (“Women and Men in the Informal Economy: A Statistical Picture” 2018; Acevedo et al. 2021).
% of total employment, 2023 or latest year
Note: Data for Argentina refer to urban areas only.
Source: ILO statistics.
1.1.1. The faces of informality
Informal workers include people engaged in a variety of different types of economic activities. Most are own-account workers, meaning they are self-employed or work in microenterprises such as family businesses (Figure 1.4). Informality does not necessarily implicate illegality, and vice versa. Depending on the legal regulations of a country, for example, a firm may be legal but informal if the country does not require small firms to contribute to social insurance programs for their workers (Levy and Cruces 2021).
% of employment, 2023
Note: Data on own account workers for Chile and Costa Rica include contributing family workers in subsistence farming. Data for Argentina refer to urban areas only.
Source: ILO statistics.
Informality impacts certain groups more than others (Figure 1.5). Rates of informal employment are higher among women than among men, although men make up the bulk of informal workers due to their higher overall representation in the labour market (Salazar-Xirinachs and Chacaltana 2018). Age is also a relevant factor, with the very young and the elderly experiencing the highest rates of informality. Education also plays a key role, the low educated tend to work more in the informal sector than the highly educated. Informality is also more prevalent in rural areas than in urban ones and in the agriculture sector, compared to the services and industry sectors.
Note: Data for Argentina refer to urban areas only. In Panels A and C, informality follows the ILO definition. In Panels B, D, and E, a worker is considered informal if he/she does not have the right to a pension when retired.
Source: SEDLAC (CEDLAS and the World Bank) and ILO statistics.
Informality is generally correlated with negative socioeconomic and economic outcomes. While not all informal workers are poor, and poverty exists in the formal sector, a significant body of research shows that workers in the informal economy face a significantly higher risk of poverty than workers in the formal economy (Figure 1.6). Informal work is usually associated with lower wages, lower productivity, lower educational levels, and less social protection, as well as higher rates of inequality and mortality (Abramo 2022; Silva-Peñaherrera et al. 2021; Perry et al. 2007).
% of workers living with less than the international poverty line by worker formality, 2021 or latest year
Note: Data for Argentina refer to urban areas only. Data for Chile is 2017.
Source: OECD Key indicators of informality.
As COVID-19 distancing measures led to unprecedented declines in economic activity in 2020, millions of households living on informal labour incomes suddenly lost their livelihoods. Most contributory social protection regimes in Latin America, which constitute the bulk of overall social spending, are tied to formal employment, thus excluding informal workers (Levy and Cruces, 2021[2]). Short-time work schemes or other social security elements of the policy response to Covid-19 were therefore inaccessible to informal workers. In response, many governments relied on existing non-contributory cash transfer programs and social registries to deliver aid, but these ad-hoc measures took time to scale up, update registries, and reach newly vulnerable groups. Policy support for both formal workers and the poor was made available quite swiftly when the pandemic hit in 2020. By the end of March 2020, just one month after the first case was detected in the region, seven of ten Latin American countries pledged additional cash assistance to vulnerable households as identified through existing cash transfer programs (Blofield, Giambruno, and Filgueira 2020). However, delivery faced delays and coverage gaps due to limited registry coverage and institutional constraints.
Weak social protection mechanisms in the region failed to prevent the deep social crisis caused by the pandemic. As countries imposed lockdowns, millions of families working in the informal economy experienced a dramatic drop in income, with no social protection to cushion the shock (OECD, 2020[3]) (OECD, 2021[4]). Vulnerable households with informal labour incomes, in particular, had no social protection mechanism to fall on (Robles, Rubio, and Stampini 2015; Busso et al. 2020). Before the pandemic, many informal workers had moved above poverty thresholds and were no longer eligible for cash transfers, but without gaining access to the kind of social protection in place for formal employees. Beyond the grasp of income tax systems, and with no access to social benefits, many informal workers remain outside the radar of the state.
Reaching informal workers during the pandemic became a priority among Latin American governments, with many pledging additional cash assistance to the broad sector of informal households by the end of April 2020 (Blofield, Giambruno, and Filgueira 2020). Reaching informal workers, however, was a challenge requiring innovative ideas. Several governments established more inclusive “demand-driven” mechanisms for identifying those in need, which allowed people to self-identify and apply for assistance (Blofield, Giambruno, and Filgueira 2020). In Brazil, more than 50 million Brazilians used a smartphone application to apply for an emergency benefit established after the outbreak. In Chile, the program Ingreso Familiar de Emergencia (IFE) was expanded to include a government-created website, through which individuals could apply to receive a cash transfer. In the case of the Ingreso Solidario programme in Colombia, applications were not even necessary. Recipients for the cash transfer were identified through existing registry databases, cross-referenced with existing beneficiary registries from the largest cash transfers programs and administrative records from other public entities, making it possible, for the first time, to identify and target low-income and vulnerable households not currently receiving benefits (Gallego et al. 2021).
In addition, beneficiaries often lacked access to banking services, so governments had to respond creatively and ensure that beneficiaries could access their benefits by creating basic bank accounts. Like Brazil, Colombia was successful with digital payment channels, paying out benefits to 1.5 million households not previously covered by social benefits, and including free digital banking products. Chile supported more than two million vulnerable and informal households through different cash transfers, handing out debit cards to those without a bank account. Such programmes significantly mitigated income loss in low-income households (Busso et al. 2020; Lustig et al. 2020).
Despite lacking the effective targeting mechanisms of conditional cash transfers, the emergency assistance to households not previously covered appeared to be reasonably well-targeted in some countries, especially when considering their rapid rollout, as they provided proportionally more support to those who suffered most. In Brazil, for example, lockdowns lead to a higher projected increase in poverty for afrodescent and indigenous populations than for other populations, but because expanded social assistance was larger for households whose head was afro descendant or indigenous, those populations experienced no differential impact from the pandemic (Lustig et al. 2020).
At the same time, the policy response placed a significant burden on the fiscal accounts of many countries in the region, which were already lacking fiscal space or in some cases even experiencing mounting stress prior to the pandemic. Several Latin American countries enacted emergency spending more than 4% of GDP (Figure 1.7). This support significantly reduced the fiscal space that many of these countries have.
Cumulative discretionary fiscal response, % of GDP
Note: Estimates as of September 27, 2021. Em. Econ. = simple average of emerging economies shown in chart. Adv. Econ. = simple average of AUS, BEL, CAN, CHE, CZE, DEU, DNK, ESP, FIN, FRA, GBR, ITA, JPN, KOR, NLD, NOR, NZL, SGP, SWE, USA.
Source: IMF Database of Country Fiscal Measures in Response to the COVID-19 Pandemic, available at https://www.imf.org/en/Topics/imf-and-covid19/Fiscal-Policies-Database-in-Response-to-COVID-19.
The COVID pandemic underscored the need to build more effective social protection mechanisms that include informal workers and entrepreneurs. Labour informality is so widespread in Latin America that tying social benefits to formal labour market participation, which is the current guiding principle of social protection across Latin America, will inevitably leave behind too many of those in need. Non-contributory benefits as currently designed cannot fill this void, as the pandemic demonstrated vividly. In several countries, eligibility for conditional cash transfers is in principle universal, but in practice, enrolment processes are either too much top-down, leaving little scope for needy households to apply for help, or too slow to support people in the face of sudden income losses. An important first step would therefore be to make cash transfer programmes more agile, so that they can disburse quickly when people lose their livelihoods, following the examples of the UK’s Universal Credit or Malaysia’s BSH programme.
Beyond this, a strong case can be made for putting an end to the dichotomy between contributory and non-contributory basic benefits. This dualism is hard to justify from a moral or practical point of view. Basic health and pensions and protection against poverty and unsatisfied basic needs should be available to all and more universal social safety nets based on means-tested cash transfers could also help to reduce the widespread fragmentation of social programmes, and strengthen their effectiveness. In addition, the following chapter will argue that this dualism of social protection often creates incentives for firms and workers to remain informal, given that the substantial cost difference between formal and informal job creation is directly linked to social protection financing.
Besides its social consequences, widespread informal employment also implies that many firms remain entirely in the informal sector, which in turn has implications for productivity. Productivity levels of informal economic units, especially of small size, are a major concern in the region (OECD et al., 2023[5]). Firms employing informal workers often stay small (Figure 1.8) as they try to fly below the radar of tax authorities to avoid not only taxes and the higher cost of formal labour, but also burdensome regulations that discourage formalisation (Ulyssea, 2020[6]). These regulatory and cost pressures create strong incentives to operate informally and limit firm growth. The lack of access to credit for informal activities further diminishes their growth prospects. Informal firms typically underinvest into the skills of their workers, given that they are often on less stable contracts and suffer high job turnover, adding to the productivity penalty. Among low-skill informal wage employees, only between 44% and 53% remained in their employment status the following year, with most moving into informal self-employment, and less than 10% moving into formal salaried jobs (Maurizio and Monsalvo, 2021[7]).
Distribution of informal workers by firm size, %
Note: Data for Argentina refer to urban areas only.
Source: OECD Key indicators of informality.
Informality also weighs on the productivity of the formal sector through unfair competition. Informal firms, which have lower operational costs due to non-compliance with costly regulations, can lower prices further than informal firms, “stealing” market shares from formal firms (Amin and Okou 2020). These lower prices dampen the profitability of formal firms, reducing their incentive to scale and restricting access to funds for investment and innovation. In Latin America, an average of 55% of formal firms across seven countries compete.
Finally, informality also leads to lower tax collection, not just because many informal workers do not pay income taxes, but also because the prevalence of the informal sector hampers governments’ ability to increase tax rates for formal workers, as doing so may incentivise workers to drop out of the formal sector to join the informal sector (Besley and Persson 2014). Informal activities use and congest public infrastructure without contributing the necessary tax revenues to fund it (Johnson, Kaufmann, and Schleifer 1997; Loayza 1996) and lower tax revenues weaken the government’s fiscal capacity for well-targeted social protection programmes.
In synthesis, the current combination of insufficient social protection and high labour informality is not a satisfactory outcome. The pandemic has only demonstrated once again how much the current dual set-up stands in the way of better social and growth outcomes. In the remainder of this book, we discuss the interplay between poverty, social protection, labour informality and productivity and point to possible policy reforms that are both fiscally sustainable and capable of improving outcomes across all these three fronts.
Chapter 2 “Breaking the vicious circle: Better social protection for more workers” argues that among the many roots of labour informality, including low access to high-quality education and training and a weak institutional framework and enforcement, the design of the social protection system is a key factor, and one that may deserve more attention than it has received. Labour informality and social protection coverage may be interlinked, and high social contributions can be a key barrier to formal job creation in the region. It argues that reforming social protection systems to ensure some basic social protection coverage for all, regardless of whether people work in the formal or informal sector, while simultaneously reducing the cost of formal employment, has significant potential to reduce labour informality, raise productivity, and decrease poverty and inequality, all of which are long-standing challenges in the region. To do so, basic social protection would need to be financed by general tax revenues, rather than social security contributions. One necessary condition for successful implementation will be the capacity to raise additional tax revenues, improve the efficiency of public spending and reallocate expenditures from other areas, ongoing challenges in the region.
Chapter 3 “Policy options and implementation challenges” notes that the reforms advocated in this book would imply a significant re-design of social protection systems and finding the necessary political consensus will face challenges and opposition. The chapter elaborates on the possible challenges and identifies groups that might oppose the reforms, while discussing options to overcome the challenges.
The country-specific chapters covering Argentina, Brazil, Chile, Colombia, Costa Rica, Mexico and Peru discuss how reforming social protection systems to ensure some basic social protection coverage for all would work in each of these countries.
Three principal messages can be gleaned from the book:
First, the need to reform social protection systems across Latin America to make them more effective and fiscally sustainable has become more salient after the COVID pandemic.
Second, a basic set of social protection benefits available to all workers, whether they work in the formal or the informal sector, should and can be put in place, although it would require the ability to raise additional tax revenues and improve spending efficiency. Moreover, the incentives for formal job creation would be strengthened if its principal source of financing for such basic social protection were shifted towards general tax revenues, as opposed to social security contributions, which tend to increase the cost of formal job creation.
Third, reforming social protection systems will not be easy, but these reforms can provide the basis for both stronger and more inclusive growth in Latin America.
References
[1] ILO (2020), Panorama Laboral En Tiempos de La COVID-19: Impactos En El Mercado de Trabajo y Los Ingresos En América Latina y El Caribe.
[2] Levy, S. and G. Cruces (2021), “Time for a New Course: An Essay on Social Protection and Growth in Latin America”, UNDP Latin America and the Caribbean Working Paper Series, No. 24, United Nations Development Programme, https://www.latinamerica.undp.org/content/rblac/en/home/library/human_development/time-for-a-new-course--an-essay-on-social-protection-and-growth-.html (accessed on 21 September 2021).
[7] Maurizio, R. and A. Monsalvo (2021), “Informality, labour transitions, and the livelihoods of workers in Latin America”, Vol. 2021, https://doi.org/10.35188/UNU-WIDER/2021/953-2.
[4] OECD (2021), OECD Employment Outlook 2021: Navigating the COVID-19 Crisis and Recovery, OECD Publishing, Paris, https://doi.org/10.1787/5a700c4b-en.
[3] OECD (2020), Supporting livelihoods during the COVID-19crisis: closing the gaps in safety nets, https://read.oecd-ilibrary.org/view/?ref=132_132985-hrr3dbjimj&title=Supporting-livelihoods-during-the-COVID-19_crisis.
[5] OECD et al. (2023), Latin American Economic Outlook: Investing in Sustainable Development, OECD Publishing, Paris.
[6] Ulyssea, G. (2020), “Informality: Causes and Consequences for Development”, https://doi.org/10.1146/annurev-economics-082119-121914, Vol. 12, pp. 525-546, https://doi.org/10.1146/ANNUREV-ECONOMICS-082119-121914.
← 1. The notable exception is Costa Rica, which saw no change in the Gini coefficient according to ECLAC statistics and an increase of the Gini coefficient according to official national statistics. This trend was driven in large part by public sector wages (González Pandiella and Gabriel 2017) and an increase in the education premium due to increasing skill mismatches. Colombia also experienced a lesser decline in the Gini coefficient than that of other Latin American countries (Aristizábal-Ramírez, Canavire Bacarreza, and Jetter 2015).