Expanding Social Protection and Addressing Informality in Latin America

2. Breaking the vicious circle: Better social protection for more workers

Jens Matthias Arnold

Aida Caldera

Paula Garda

Alberto González Pandiella

Abstract

This chapter 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. Reforming social protection systems to ensure some basic social protection coverage for all, regardless of whether they 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 would therefore be the capacity to raise additional tax revenues and improve spending efficiency.

2.1. Introduction

The need to build more effective, fiscally sustainable social protection mechanisms that include informal workers and entrepreneurs emerges as one of the main lessons from the COVID-19 crisis. As soon as the health crisis was over, however, many of the extraordinary, non-contributory cash transfers that were effective in reaching informal workers were gradually withdrawn or scaled back, returning to the original situation where only part of the population is covered by social protection. The pandemic was special in that it caused simultaneous job and income losses for millions of people. At the individual level, however, the same phenomenon happens every day to some households, even in the absence of a pandemic. Households will always be exposed to significant risks regarding their livelihoods, and they will need protection against severe shocks, even if not all at the same time.

Building stronger social protection for all could be achieved with a stronger focus on non-contributory social protection benefits. Labour informality is so widespread in Latin America that tying transfer benefits to formal labour market participation, which is the salient characteristic of most social protection benefits across Latin America, may risk leaving behind too many of those in need. At the same time, history has shown that countries will not simply grow their way out of informality, which can be part of a vicious circle (OECD, 2024[1]). Even those LAC countries with a strong growth trajectory such as Peru or Panama, or those with higher per-capita incomes, such as Argentina and Uruguay, have significant levels of informality.

This is not to say that past efforts to reduce informality have not borne any fruits and to the extent that they have, they should be continued. But addressing informality in Latin America requires a comprehensive strategy that reflects its deep and multidimensional roots (Jessen and Kluve, 2021[2]), (OECD, 2024[1]; OECD, 2023[3]). High regulatory and compliance burdens also deter formalisation, especially for small firms. Low productivity—driven by poor infrastructure, limited innovation, and restricted access to finance and technology—makes formal jobs unaffordable for many workers and firms. Skills gaps and limited access to quality education and training further limit worker productivity and constrain formal labour market participation. Institutional weaknesses—such as corruption, low trust in the judiciary, and limited state presence—also shape incentives to remain informal. Many firms and workers operate outside the system because they see little value in compliance or fear arbitrary enforcement. Addressing these structural bottlenecks is key but the fruits of these improvements will take time to materialise.

While better enforcement and stronger institutions are part of the solution, relying solely on enforcement does not look like a winning strategy given how endemic informality is in Latin America. Too much of a focus on enforcement before addressing other bottlenecks could also worsen unemployment and poverty, as shutting down undeclared activities is not the same as formalising them.

There is now a strong case for stepping up efforts to fight informality substantially, and this is where broader social protection reforms may come into play, given how strongly the design of social protection can affect incentives for formal job creation. Redesigning social protection in a way that takes full account of the incentives generated by social contributions has the potential for much more visible progress in formalisation, given that these contributions are a core element of the price differential between creating a formal job and an informal job. These reforms can deliver more immediate gains compared to productivity or education policies, which, though vital, take longer to yield results. When embedded in a broader strategy that tackles structural drivers, social protection reform can disrupt the vicious cycle of informality, improve living standards, and support more inclusive growth.

2.2. The link between social protection and informal employment

Informality can be related to multiple factors, such as a lack of access to quality education and training, low levels of investment, costly regulations to formalise and grow firms, but also weak enforcement and monitoring of both labour laws and tax policy (Jessen and Kluve, 2021[2]), (OECD et al., 2023[4]) (Box 2.1). Beyond these, another potentially relevant factor that has received relatively less attention in policy discussions, and the one that this chapter attempts to highlight, is the significant cost difference between creating formal and informal jobs (Box 2.1) (OECD/IDB/CIAT, 2016[5]).

Given the low levels of labour productivity in the region, one of the main impediments to formal job creation could be the relatively high mandatory social contributions and other payroll taxes that finance formal sector social protection and that reduce incentives for firms to hire workers formally, especially for self-employed and low-income workers (IMF, 2021[6]; Meléndez, Alvarado and Pantoja, 2021[7]; Levy and Cruces, 2021[8]; Loayza, 2018[9]; Jara et al., 2022[10]). As an illustration, in Latin America, on average, minimum wages plus contributions for pensions, health insurance and unemployment insurance amount to 36% of GDP per worker, compared to 22% of GDP per worker in OECD countries (Ripani et al., 2023[11]). Because regulations are imperfectly enforced, firms can effectively evade the costs of social insurance and hire salaried workers informally, and they regularly do. These costs are especially prohibitive for micro and small enterprises with low productivity—which make up the vast majority of firms in the region—pushing many to operate informally. Moreover, many self-employed workers are either not legally required to contribute or do not do so in practice, further undermining social protection coverage and financing.

Empirical evidence suggests that reducing the cost of formality through lower or subsidised social contributions can increase formal employment. In Colombia, the 2012 tax reform eliminated health contributions for workers earning up to 10 times the minimum wage. This measure led to a significant rise in formal employment, especially among small and medium-sized enterprises (Kugler et al., 2017[12]; Morales and Medina, 2017[13]; Fernández and Villar, 2017[14]; Bernal et al., 2017[15]). Targeted subsidies or progressive contribution schedules can significantly increase formal hiring among low-wage groups (Ulyssea et al., 2025[16]). In Chile, wage subsidies and reductions in social security contributions for low-income formal workers have shown positive effects on formalisation (Henoch and Troncoso, 2013[17]; Bravo and Rau, 2013[18]; Centro de Microdatos, 2012[19]; SENSE, n.d.[20]). In Turkey, the government introduced substantial social security contribution subsidies for new formal hires, which also contributed to higher formal job creation, especially among youth and women (Aşık et al., 2022[21]). This highlights how reduced social contributions can help lower informality by making formal employment more viable for firms and workers. OECD schemes often provide lower contributions for low earners.

Box 2.1. Literature on the possible causes of labour informality in Latin America

A significant amount of attention has been given in the literature to the question of why informality persists in Latin America, and in developing economies more widely (La Porta and Shleifer, 2014[22]; Perry et al., 2007[23]). There are three main theories, although given the complexity of informality, this is not meant to be an exhaustive list of potential explanations.

The first is that the cost of formalisation is too high relative to the levels of productivity of both firms and workers, leading firms and workers to choose to operate informally (Meléndez, Alvarado and Pantoja, 2021[7]). The cost of formalisation for firms includes adhering to relevant policies, such as minimum wage regulations and mandatory pension contributions. The cost of formalisation for individual workers includes mandatory contributions to social protection schemes, and for both firms and the self-employed, administrative burdens, fees and taxes, business regulations, and administrative requirements such as book-keeping.

A second theory explains informality as a survival strategy. In this view, informality is not seen as a choice over what type of work, formal or informal, but a choice between working and being unemployed (Acevedo et al., 2021[24]). The data suggests that this theory is particularly true for informal employees, who express a preference to work as formal salaried employees or to be self-employed, but do not have access to such jobs (ILO, 2018[25]). The lack of access to formal jobs may be due to a lack of employment opportunities in formal firms or a lack of the educational level necessary for a formal job. Indeed, transitions from the informal to the formal sector are most pronounced for higher-skill, higher-educated informal wage employees, only about one third of whom maintain their work status from year to year, and most of whom move into the formal sector (Ulyssea, 2020[26]). Transitions from the formal to the informal sector are more pronounced among young people, women, and low-skill workers, who make up most of the informal workforce, and who, at any one time, face a higher probability of transitioning to informal employment than other populations. This theory, however, is fully compatible with the first explanation based on the cost of formalisation. Workers who do not manage to get a foothold in the formal sector may simply have a productivity level below the cost of formal employment, for example due to their education level, or firms that use an informal workforce may not be able to achieve the productivity level necessary to bear the cost of formality.

The third theory posits that informal workers and firms may be able to formalise but choose not to because the costs outweigh the benefits of formalisation. In other words, workers and firms may be productive enough to survive in the formal sector but choose not to, to benefit from a cost advantage over formal firms or to benefit from non-contributory social protection policies which may be better than social protection received through formal work. There is some evidence to support this theory in specific circumstances. The Universal Child Allowance program in Argentina, for example, was found to strongly disincentivise the labour market formalisation of beneficiaries (Garganta and Gasparini, 2015[27]). The possibility of voluntary informality points to the importance of designing strong incentives for moving into the formal sector, for example by ensuring that the additional cost of going formal is lower than the additional benefits of doing so.

Limited regulatory capacity and weak governance encourage informality. Trade liberalisation in countries like Peru led formal firms to hire more informal workers to cut costs, offsetting reductions in the size of informal firms (Cisneros-Acevedo, 2021[28]). Women and younger workers are disproportionately affected due to barriers like caregiving responsibilities, social norms, and restricted labour market access—leading many to the informal sector. Rapid urbanisation outpaced formal job creation, exacerbating informal employment in cities (Ulyssea et al., 2025[16]).

In summary, many structural factors play a role in shaping labour informality, including people’s educational level and opportunities, tax and business regulations, and labour market regulations, including social security contributions, hiring and firing costs or minimum wage policies. Transportation and housing policies may also play a role in the cost-benefit analysis of workers and firms when deciding whether to participate in the informal or the formal sector.

The design of social protection (Box 2.2) in the region has led to an outcome that may be problematic from several perspectives. First, the lack of a formal work contract precludes many poor and vulnerable households from social protection instruments whose eligibility depends on having a formal job. As an example, even in countries with lower rates of labour informality such as Uruguay or Chile, the percentage of workers in the lowest income quintile who pay pension contributions is less than 50%. Second, the relatively high social security contributions that finance contributory social protection may actually exclude many workers from the formal labour market because of the substantial cost difference between formal and informal jobs.

Box 2.2. The design of social protection systems in Latin America

Social protection systems across the LAC region are complex, spanning multiple objectives and are generally fragmented into two parallel systems: contributory benefits, and non-contributory benefits. Many countries add to this labour market regulations such as mandatory severance payments to laid-off workers and minimum wage rules, which are typically binding only for formal-sector workers (Machinea and Uthoff, 2007[29]).

Contributory social protection systems vary from country to country but share some common features typically including contributory pension schemes such as old-age, disability, and survivor’s pensions, as well as health and unemployment insurance, and maternity or sick leave. They are financed social security contributions from employers and/or employees. Rates of employer and employee contributions vary significantly across the region, with the highest rates of employee contributions in Chile at 20.6% in 2018, and of employer contributions in Argentina, at 30% (Leyva and Urrutia, 2020[30]).

Non-contributory social protection, by contrast, is generally not financed from individual contributions, but from general tax revenues. Starting in the 1990’s, Latin American economies began investing in and expanding the coverage of non-contributory social protection, including the expansion of health coverage, non-contributory pensions and conditional cash transfers. While the benefit levels and the coverage of the target population often remain low in most countries, non-contributory social protection benefits have further reduced the incentives for seeking formal employment, by reducing the gap between the benefits available to formal and informal workers. For example, evidence from Colombia suggests that the introduction of non-contributory healthcare benefits for informal workers that are almost equal to those of the contributory healthcare scheme was followed by increases in informality (Camacho, Conover and Hoyos, 2014[31]).

Health systems in Latin America and the Caribbean (LAC) are typically organised as segmented systems, combining contributory and non-contributory schemes. Historically, access to healthcare in LAC was primarily tied to formal employment. From the 1990s, several countries expanded tax-financed schemes to achieve universal health coverage. For instance, Mexico’s and Colombia’s subsidised health regimes significantly increased coverage for informal workers. Chile restructured its public health insurance (FONASA) to subsidise healthcare for informal workers and the poor. Peru expanded its SIS (Seguro Integral de Salud) for the poor and informal sector. By the 2010s, most LAC countries had at least partially separated coverage from labour status. Contributory systems are financed by payroll taxes and serve formal workers, while non-contributory systems—tax-funded or subsidised—cover informal workers and the poor. This dual structure has increased coverage but creates horizontal inequities and perverse incentives, as informal workers may access similar services without contributing, reducing incentives for formalisation.

Reforming social protection systems may have the potential to help reducing informal employment in Latin America, as part of a comprehensive package of reforms that should include better enforcement, simpler labour regulations, and more investment in human capital. LAC countries differ substantially in their level of development and the social protection systems so the reforms to be implemented will vary from country to country. But to overcome the main weaknesses of the current setup a better social protection system could pay closer attention to two basic ideas:

1. A basic set of social protection benefits should be made available to all workers, making no distinction between formal and informal workers. The basic set would cover basic needs, such as a minimum pension and/or access to basic health services.

2. The financing of basic social protection should minimise disincentives to formal job creation, particularly in the lower income ranges predominantly affected by informality. One way to minimise such disincentives would be to reduce social security contributions in the lower income ranges, for example around the entry-level wage in the formal sector. Such a reform would, of course, only be possible if countries can rely more on general tax revenues for financing basic social protection. More comprehensive benefit packages could be available for those willing and able to pay additional contributions.

These basic ideas can be easily translated to the health system. In many LAC countries, health coverage is still tied to employment status, with contributory schemes for formal workers coexisting alongside non-contributory or subsidised programmes for informal or low-income populations. This fragmented setup has often created incentives to remain informal, especially when subsidised regimes offer access to services at no cost and with fewer conditions. To address this, reforms should focus on integrating the contributory and non-contributory systems, shifting towards more progressive and tax-based financing. First, ensuring access to a basic package of health services for all individuals—regardless of their formal or informal employment status—would align with the principle of universal protection and reduce inequality in health outcomes. Second, financing this basic coverage through general taxation, rather than employment-based contributions, would minimise disincentives to formalisation, particularly among low-income workers. For those able and willing to pay more, contributory mechanisms could provide access to more comprehensive services. Delinking health coverage from labour market status would reduce segmentation, increase access, and support a more inclusive and financially sustainable system.

2.3. A proposal for a re-design of pension systems to fight old-age poverty and reduce informality

Looking ahead, pension systems will become increasingly relevant in the context of population ageing. In 2022, the Latin American and Caribbean region was home to 88.6 million people over the age of 60, representing 13.4% of the total population. This figure will reach 16.5% in 2030 (CEPAL, 2022). Life expectancy for both sexes has also risen, from 48.6 years in 1950 to 75.1 years in 2019. The increase in the proportion of older people and the lengthening of the life cycle present opportunities but will also place demands on pension systems in the region.

Old-age pensions are meant to provide a regular income stream to those who are no longer in working age. Pension systems serve essentially two purposes: to prevent old-age poverty, and to allow some degree of consumption smoothing, allowing the elderly to maintain similar material living standards before and after they retire. Old-age pensions are a driving factor behind differences in the incidence of old-age poverty in Latin America (Gasparini et al., 2010[32]). Where pension coverage is extensive, such as Argentina, Brazil, and Chile, old-age poverty rates are often lower than poverty rates for the general population, while the opposite is true in Colombia and Mexico. Extreme poverty in old-age was around 1% in Brazil and Chile and 16% in Colombia (SIMS, 2021).

While some countries in the region have achieved almost universal pension coverage among the elderly, pension coverage remains low in many others despite several efforts to increase coverage over the last decade (Table 2.1). In Latin America, only 6 out of 10 elderly adults aged 65 and above had a contributory and/or a non-contributory pension in 2019. Focusing only on contributory pensions, the average coverage was only 38%, ranging from around 21% in Peru to 87% in Chile (ILO, 2020[33]). Coverage tends to be lower for women, rural workers, workers in small firms, and workers with low incomes and levels of education. This difference is largely driven by the high levels of informality among those groups. Despite progress in female labour force participation in recent years, the percentage of women who have access to a contributory pension (36%) is considerably lower than that of men (44%) in Latin America. While Costa Rica, Peru and Mexico are among the countries with the largest coverage gaps between women and men, with differences in the range of 15-25 percentage points, other countries such as Argentina, Uruguay and Chile have smaller gaps or even better coverage for women. In addition to the coverage gaps, there are also differences in the levels of pension benefits. Despite considerable progress in recent years, effective replacement rates of women tended to be around 20 percentage points lower over 2016-2020.

Table 2.1. Pension coverage for those aged 65+ in Latin America, 2020-22

Share of population aged 65+:	Covered by contributory pension	Covered by any pension
Argentina	79.0	79.0
Brazil	81.3	86.3
Chile	87.3	87.3
Colombia	27.7	56.8
Costa Rica	50.6	69.0
Mexico	32.2	72.3
Peru	21.4	45.0

Note: Data refer to 2022 for Argentina, Brazil, Costa Rica and Peru, 2021 for Colombia, 2020 for Chile and Mexico.

Sources: IDB SIMS database, available at https://www.iadb.org/en/sector/social-investment/sims/sims-institutions.

Recognising the generally insufficient pension coverage by contributory schemes, many countries in the region have introduced non-contributory pension schemes over the last two decades (de la Torre and Rudolph, 2018[34]). More than a dozen Latin American countries now have some form of non-contributory pension, including Mexico, Colombia, Peru, Chile, Costa Rica, Brazil, and Argentina. Many of these are limited to old-age pensions, but some countries like Brazil and Mexico also provide non-contributory disability pensions. Still, usually these non-contributory pensions are not integrated into the pension system and are part of social assistance policies. Their benefit levels range from a fraction of the extreme poverty line in Colombia to a full minimum wage in Brazil.

Countries have followed different strategies. One strategy has been to provide universal access to non-contributory pensions, regardless of whether someone also benefits from a contributory pension, as in Chile, Bolivia, Mexico and Trinidad and Tobago. A second strategy has been to expand the contributory system towards those who were not part of it, such as certain self-employed or domestic workers, by making it mandatory to contribute to the system. This choice was more common in countries that had stronger contributory pension systems and higher rates of contributory pension coverage to start with, like Argentina, Brazil, Chile, Panama, and Uruguay (Rofman, Apella and Vezza, 2015[35]). A third strategy has been to target older adults who are living in poverty with separate non-contributory programmes, with selection based on some means proxy test. This has often happened in countries with higher informality and lower rates of contributory pension coverage, including Colombia, Costa Rica, Ecuador, El Salvador, Panama, Paraguay, and Peru (Rofman, Apella and Vezza, 2015[35]).

Recent reforms across several Latin American countries – such as Chile, Colombia, Peru and Uruguay, reflect a clear shift toward more inclusive, redistributive, and financially sustainable pension systems, aiming to expand coverage while improving adequacy and long-term viability. Chile introduced a basic universal pension benefit, Pensión Garantizada Universal (PGU), to replace the previous non-contributory tier with a more generous and universal benefit. In January 2025, a major reform to its pension system increased employer contribution rates gradually, to fund a mix of individual accounts, a new social insurance pillar to improve redistribution and gender equity, and transitional solidarity benefits. Colombia adopted a new multi-tiered system in 2024, which includes a contributory public pillar for earnings up to 2.3 times the minimum wage, a complementary private savings pillar for higher earners, and a non-contributory benefit to ensure a minimum pension for low-income workers. The reform also includes credits for women related to childcare to reduce gender gaps in pension entitlements. Peru passed a pension reform in 2024 that restructures the system into four pillars—contributory, semi-contributory, non-contributory, and voluntary—seeks to expand coverage among informal workers, and increase minimum pensions. Uruguay approved a structural reform in 2023, raising the retirement age and standardizing rules across regimes to strengthen long-term sustainability while preserving broad coverage. However, in most cases, the reforms have not yet addressed the underlying incentives that sustain high informality, leaving a core challenge to coverage and financing unresolved.

2.3.1. The way forward: A multi pillar pension system

A pension system with at least two, possibly three, complementary and well-integrated pillars would be able to achieve universal coverage while delivering adequate pension benefit levels and minimising disincentives for formal job creation:

A first non-contributory basic pillar: Preventing old-age poverty could be achieved through a universal basic pension benefiting the entire elderly population, aiming at a full coverage of those aged 65+, regardless of individual work histories in the formal and informal sectors. This basic benefit could be largely financed through general taxation, so that it would not raise the cost of formal job creation during working lives. For those earning close to the formal-sector entry wage, typically the full-time minimum wage in countries with minimum wage regulations, this would be the only mandatory pension system covering them. As a result, contributions could be very low, potentially starting near zero, given that the main focus in this income range is to avoid disincentives for formal work. One way to lower fiscal costs would be to exclude very high-income individuals from receiving the non-contributory pension, as for example in Chile (OECD/IDB/The World Bank, 2014[36]).

Determining the generosity of the basic pension should consider several factors. In principle, given that the overarching aim of the basic pillar would be to fight old-age poverty, the minimum benefit could be at the level of a well-defined poverty line. In practice, a country’s fiscal space and the scope for raising additional tax revenues, rationalising, or reprioritising expenditures are key factors to take into consideration when defining the level of this minimum pension benefit.

As finding the necessary resources may be a gradual process, the basic pension could in some cases start initially at a low level, such as the extreme poverty line that some countries in the region define as the income required to buy the necessary food for survival. In some countries, such a minimum benefit would already be an important step forward. For example, Colombia’s non-contributory pension cash transfer, Colombia Mayor, currently pays out benefits that amount to only a fraction of the extreme poverty line. But there could also be good political arguments for going beyond the poverty line if it is considered that living with an income at the level of the poverty line is inappropriate for the elderly, most of which will have worked their entire lives. A basic universal non-contributory pension benefit set at the level of the poverty line could often be sufficient not only to protect these workers from old-age poverty, but also to provide a sufficient replacement rate and ensure an adequate degree of consumption smoothing, given the distance between the poverty line and the minimum wage in many countries in the region.

Such a universal basic pension would also help to close gender gaps in social protection coverage (Tuesta and Bhardwaj, 2023[37]). As women typically have a lower rate of labour force participation in Latin America, they are also less likely to access contributory pensions.

A second, contributory pillar would complement the basic pension, to achieve pension benefit levels that not only prevent old-age poverty, but are also a decent replacement for working-age incomes. The contributory and non-contributory pillars should be seamlessly integrated within the pension system to achieve the desired replacement rates for everyone in an effective way, so that the combined benefit delivers an adequate replacement rate across the income distribution. For reference, the average gross replacement rate in OECD countries is around 50–60% of pre-retirement earnings (OECD, Pensions at a Glance, 2023).

To improve both equity and incentives for formalisation, contribution rates should follow a progressive contribution schedule, similar to personal income tax systems. This would mean lower, or even zero ideally, contributions for low-income workers, particularly those earning below the minimum wage. For higher-income earners, contributions could rise gradually with wages, avoiding discontinuities that could create incentives for reporting a lower than actual income. The schedule of contributions could be guided by the following considerations: If contributions become too high too early, this may create incentives against formal job creation. If the contributions only start rising at high wage levels, the resulting replacement rates will be low and hence provide too little consumption smoothing.

The contributory pillar could be organised in different ways. First, as a pay-as-you-go system where current contributions finance the benefits of current pensioners. Second, as a funded scheme, where individual contributions are channelled to individual accounts to finance future pension benefits for the contributor. Third, as notional accounts where the system tracks contributions and applies a formula to determine the pension entitlement based on the worker's career earnings and the notional account balance. Regardless of the structure, the system should ensure that the combined pension from all pillars delivers a predictable and adequate retirement income.

The contributory pillar could in principle be administered by either private or by public entities. OECD countries have taken different avenues with success (Box 2.3), and there is no single set-up that would be inherently preferable to others.

A third pillar of voluntary individual savings could complement the basic and contributory pillar. In OECD countries, voluntary savings improve on average replacement rates by 25 percentage points for the mid-income worker (OECD, 2023[38]). In ten OECD countries, private voluntary schemes cover more than 40% of the economically active population and occupational pension plans are playing an important role providing coverage and adequacy for retirement. Automatic enrolment to these types of schemes has been effective in increasing the take-up in countries such as the United States, United Kingdom, New Zealand and Turkey.

A key aspect for the feasibility of this multi-pillar proposal is how to finance it. Most countries in the region will need to carry out tax and spending reforms to ensure its fiscal sustainability in the short and long run and should be confident that they can achieve this before considering this proposal. Reforms should only proceed as financing to the extent that adequate financing sources can be identified. Financially unsustainable pension systems have substantial negative consequences both for future pensioners, who fear for their pension, and for fiscal accounts, as countries may face higher borrowing costs to the extent that concerns about fiscal sustainability grow among investors.

The resources dedicated to the universal pension could be seen as an investment. As this spending reduces the cost of formal employment, especially for low-income workers, it could boost formality, productivity and potentially even future tax collection.

Box 2.3. Funded defined-contribution pension systems in selected OECD countries

OECD countries have different arrangements in the management of funded defined-contribution schemes with private and/or public institutions involved. There is not one single model for success in their design. Some examples taken from recent OECD Economic Surveys include the following countries:

Australia

The Australian pension system has three components: a means-tested non-contributory component (“Age Pension”) that reaches 75% of the elderly; a superannuation guarantee with a compulsory employer contribution to private superannuation savings; and a voluntary superannuation contributions and other private savings (OECD, 2020[39]). The Age Pension is designed to provide a safety net for those unable to save enough through their working life and to supplement the retirement savings of others. The Superannuation system, a defined contribution scheme, is not subject to financial sustainability issues and as the system reaches full maturity, fewer individuals will be reliant on the Age Pension safety-net.

Denmark

The Danish pension system rests on the public pension, which consists of a basic pension and a means-tested pension supplement that is paid to the financially most disadvantaged pensioners, in addition to a mandatory occupational pension scheme based on lump-sum defined contributions called ATP and quasi-mandatory occupational pension plans. ATP is as a public pension provider, investor and administrator of welfare benefits. It is one of Europe’s largest pension funds with 5.4 million members and pension assets exceeding USD 882 bn (229% of GDP). In addition, quasi-mandatory occupational pension schemes negotiated as part of collective agreements cover about 90% of the employed work force. The public pension and ATP ensure that all pensioners, regardless of labour market attachment, will have an adequate basic income. Occupational pension schemes ensure that a person’s income in retirement will not be markedly lower than the income earned during working life.

Sweden

The Swedish pension system consists mainly of public schemes and quasi-mandatory occupational plans (OECD, 2020[39]). Mandatory public earning-related pensions include both a notional defined contribution scheme and a funded defined contribution scheme. Both cover earnings up to roughly the average wage. On top of these schemes, quasi mandatory occupational pension plans negotiated by social partners in collective agreements cover around 90% of workers. A residence based basic pension (guaranteed pension) ensures a minimum level of pensions at 21% of gross earnings.

2.4. Working-age transfers

In Latin America, the larger part of income support for those in working age is distributed through so-called contributory “social insurance” schemes (Gragnolati et al., 2015[40]). Just as in the case of contributory pensions, access to this support is typically tied to contributions levied on formal workers’ wages. All 18 countries in Latin America provide sickness insurance and workplace accident benefits to formal workers and several countries in the region also provide unemployment benefits (Blofield, Giambruno and Filgueira, 2020[41]). In some cases, expecting mothers or families with children also receive income support. An overview of the main benefits provided by cash transfer programmes in seven countries in the region can be found in Table 2.2.

These contributory schemes often cover only part of the working population due to informality. Even among those who do pay contributions, gaps between legal and effective coverage have emerged and some beneficiaries who fulfil the eligibility criteria specified by law do not receive the benefits or do not take them up (Table 2.2). There could be many reasons for this, including weak programme implementation structures, difficulties in accessing benefits or low take-up, which in turn may have many reasons (ILO, 2020[33]).

Table 2.2. Legal and Effective Coverage of Social Protection Systems

Type of benefit	Unemployment		Work Injury		Maternity		Children/Family
	Legal	Effective	Legal	Effective	Legal	Effective	Legal	Effective
Argentina	28.8	10.8	41.1	47.4	34.9	31.7	102.4	79.6
Brazil	48.7	17.6	37.8	48.7	56.2	47.8	100	67.7
Chile	42.5	27	58.2	68.7	47.8	46.6	68.9	68.5
Colombia	62.1	4.6	62.1	37.7	25.6		100	36
Costa Rica	41		54.8	58.1	41	23.4	26.4	38.8
Mexico	0	6	70.3	35.4	37.2	10.4	96.8	23.4
Peru	75.1		75.1	7.4	27.3	8.8	18.8	16.1

Note: Legal coverage refers to the percentage of working age population with a right to be covered by a specific benefit. Effective coverage refers to the ratio of recipients of unemployment cash benefits to the number of unemployed persons (for unemployment benefits); the ratio of women receiving maternity cash benefits to women giving birth in the same year (for maternity benefits); the ratio of children/households receiving child/family cash benefits to the total number of children/households with children (for child benefits).

Sources: ILO, World Social Protection Database, based on SSI; ISSA/SSA, Social Security Programmes Throughout the World; ILOSTAT, ECLAC, IMF, WHO, WB, UNDP, UNICEF, completed with national data sources.

These shortcomings in the implementation of contributory income support programmes in Latin America have led many LAC countries to introduce means-tested, non-contributory cash transfer programmes in the 2000’s, often referred to as social assistance programmes. These programmes are typically financed by general tax revenues, with the explicit objective of alleviating poverty among households that are unable to generate a minimum income on their own. As with contributory benefits, the characteristics of non-contributory programmes vary significantly across countries.

In many cases, these benefits have combined means-tested income transfers with measures aimed at lifting families out of poverty over the longer run by encouraging investments into their children through conditionalities attached to benefit disbursement. These are meant to encourage school attendance and medical check-ups for children and expecting mothers, for example. These conditional cash transfers (CCTs) are perhaps the most prominent element of non-contributory social benefits in Latin America, despite their limited size. But not all of the non-contributory benefits have conditionalities attached, and means-testing is sometimes done on the basis of proxy measures, such as the place of residence.

It should be said clearly that the definitions often used in the discussion on social protection in Latin America, and that this paper follows, may at times diverge from the definition used by the OECD in the discussion of OECD member economies. In the OECD context, social assistance generally refers to unconditional transfers, beyond the means-testing, while in many Latin American economies, social assistance cash transfers often do have conditionalities attached. Even if the intention to provide transfers may have been the dominant motivation for policy makers, the general experience with conditionalities in Latin America is positive and not including them may have seemed like a lost opportunity.

Non-contributory cash transfer programmes were initially launched at the local level in Brazil, while the first systematic rollout at the national level took place in Mexico in 1997, with the Programme for Education, Health, and Nutrition (Progresa), formerly known as Prospera and Oportunidades (Cecchini and Madariaga, 2011[42]). Chile established its Chile Solidario programme in 2002. In 2003, Brazil followed suit with the nationwide rollout of the Bolsa Família programme, temporarily rebaptised to Auxílio Brasil between 2020 and 2022. These programmes have both became well-known and highly regarded programmes, whose multifaceted success has motivated the proliferation of similar programmes around the world. By 2015, every country in Latin America had a CCT programme modelled after Progresa and Bolsa Familia (Fiszbein et al., 2009[43]), and by 2019, there were more than 30 active CCT programmes in place in the region (Abramo, Cecchini and Morales, 2019[44]). Several countries have more than one such programme, and this fragmentation can easily lead to overlaps and inefficiencies.

A large body of evidence suggests that such cash transfers have contributed to significant reductions in poverty (Soares, Ribas and Osório, 2010[45]; Sewall, 2008[46]; Stampini and Tornarolli, 2012[47]; Robles, Rubio and Stampini, 2019[48]; Millán et al., 2019[49]). These cash transfers can also bring more long-term benefits for society, such as promoting credit access, better eating habits, better school attendance, better academic results, better cognitive development, reduction of domestic violence, and female economic empowerment (Banerjee, Niehaus and Suri, 2019[50]). A comparative study of CCTs has shown that they are typically more effective when paired with other measures designed to improve productive inclusion and employment, and in particular, when those other measures help integrate informal workers into the formal economy (Papadopoulos and Leyer, 2016[51]). This suggests that programme structure and context make a significant difference for programme success. At the same time, CCTs have been criticised for having negative effects in reinforcing the gendered distribution of unpaid work (and – consequently – women’s ability to participate in paid labour markets) as traditionally mothers are the ones responsible for ensuring that conditions like children’s schooling and healthcare are met (UN Women, 2019[52]).

Spending on non-contributory cash transfers and trends in spending vary significantly across countries, but are generally far lower than spending on formal-sector social insurance. The Bolsa Familia programme represented 0.5% of GDP in 2019 and covered a quarter of the total Brazilian population, although it has been expanded since (OECD, 2020[53]). Progresa represented 0.35% of Mexican GDP and covered almost a quarter of the population in 2018. Ecuador was the biggest spender on CCTs at 1% of GDP, while Chile was the lowest at 0.14% of GDP, just under half of the regional average of 0.32% of GDP (ECLAC, 2022[54]).

The evidence on the impact of cash transfers on the incentives for labour participation and formal employment is mixed (Baird, McKenzie and Özler, 2018[55]; Skoufias and Di Maro, 2008[56]). While some evidence suggests that cash transfers do not discourage - and in some cases even encourage - labour participation by beneficiaries (Banerjee et al., 2017[57]), other evidence from the region suggests that transfers can decrease incentives to participate in formal employment (Bergolo and Cruces, 2021[58]). This is often related to design weaknesses in the programmes. For example, abrupt benefit withdrawals for beneficiaries who find a job or earn more can imply high implicit tax rates for workers who lose the transfer if they earn additional income that lifts them above the eligibility threshold stipulated in the targeting mechanism. That said, it is important that cash transfers maintain strong incentives that encourage those who can generate their own income to do so. The need for strong work incentives will put limits on benefit levels for those in working age, in contrast to the elderly for whom maintaining work incentives are usually not a policy objective.

2.4.1. The way forward: A single cash transfer for the poor

Latin America’s successful experiences with non-contributory cash transfer schemes provide a unique opportunity to build on them to strengthen social protection. Where fragmented benefit systems create unnecessary complexity and scope for benefit duplication, unifying and integrating existing cash transfers into a single national programme would be a first useful step, but that may still fall short of providing universal access to such transfers.

Applying the idea of making social protection benefits available to all those who need them, as outlined at the beginning of this section, would imply getting rid of any eligibility restrictions that are not related to means-testing, i.e. extending eligibility for conditional cash transfers to the entire population. This does not mean that everyone would receive benefits, but those that qualify for them due to their low earned incomes or other qualifying conditions should be able to receive benefits without undue delays.

That is far from being the case at present. Many countries focus on specific regions within the country or within urban areas for benefit eligibility on the grounds that poverty is concentrated there. In Colombia, for example, a household has to be specifically chosen to qualify for the conditional cash transfer programme Familias en Acción (now Renta Ciudadana), and low income alone is no guarantee for eligibility. Another example is Peru, where the conditional cash transfer programme, Juntos, is targeted to rural areas. In most cases, these mechanisms are designed as some way to allocate resources that are insufficient to cover the entire population that meets the income-threshold criteria.

Universality also implies the possibility of rapid enrolment when a household loses a vital income source. Long waiting lines for programme enrolment, as have occurred in Brazil’s Bolsa Família programme in the past, for example, impede CCT programmes to fulfil their potential role of earnings replacement. If properly designed and implemented, CCTs could provide a backstop for those losing their job or income and could serve as a very rudimentary, non-contributory universal pillar of an unemployment benefit system for those who cannot access more formal unemployment insurance. In several countries, however, enrolment processes are in practice 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 cash transfer programme.

One option for designing a single cash transfer for the poor would be to extend current non-contributory benefits to all those who pass the relevant means test, effectively turning non-contributory benefits into a guaranteed-minimum-income benefit scheme for the population aged below 65. This would be a periodic cash transfer to supplement the income received by poor households to reach a certain minimum income level.

Financed from general taxation revenues, such a scheme could build on existing conditional and un-conditional cash transfers for the vulnerable and poor. The amount given to each household could consist of fixed and variable elements depending on household characteristics, as in Brazil’s Bolsa Família programme. Such a benefit is different from a Universal Basic Income, which grants an identical amount to every citizen, regardless of income (Box 2.4).

Applying some mild conditionalities to a guaranteed minimum income scheme has proven particularly valuable when children are part of the household. In that case, the cash transfer can be conditional on school enrolment of the children and necessary health check-ups for children and expecting mothers, as is current practice in many current CCT programmes around Latin America. Such conditionalities do not aim at excluding anyone but are meant to generate incentives for investing in education and health, which may facilitate the chances of a family moving out of poverty in the longer run.

To maintain the incentives for taking up work opportunities, programme design could include a graduation phase, in which the value of the transfer forgone is smaller than the additional income. This is important to avoid situations where beneficiaries might be reluctant to take up work for fear of losing their benefit, even if they become eligible again at a later moment. The design could include a phase in which for every additional income earned by the household or individual, only some parts of the additional earnings are taken into account to calculate the cash benefit, until gradually reaching a point where no subsidy is available at all. Preliminary and ex-post impact assessments should be systematically conducted to evaluate the effects on (formal) labour force participation and adjust the design if necessary.

Box 2.4. The pros and cons of a Universal Basic Income

A universal basic income (UBI) is an unconditional cash transfer granted at regular intervals to all residents, regardless of their wealth, earnings or employment status. Commonly cited advantages of such a programme are that it is simple and coverage is, by definition, universal.

The main disadvantage of an UBI is that it could be extremely costly. An unconditional payment to everyone at meaningful but fiscally realistic levels would require strong tax rises and possibly reductions in existing benefits, and would not often be an effective tool for reducing income poverty (OECD, 2017[59]). Some disadvantaged groups would lose out when existing benefits (usually all other social programmes) are replaced by a universal basic income, illustrating the downsides of social protection without any form of targeting at all (Gentilini et al., 2020[60]).

Similar to the above findings for OECD countries, a truly universal Basic Income would be fiscally unviable in most of Latin America unless benefit amounts are reduced to a level where they lose their effectiveness in providing an acceptable living to those in need. Illustrative calculations for Colombia suggest that disbursing a monetary transfer at the level of the extreme poverty line to resident would have costed 8.7% of GDP in 2020. This UBI levels still would leave many households in poverty, especially those at old-age not receiving any pensions or the unemployed or inactive. If the transfer were set to the level of the poverty line, the cost would be 20% of GDP, almost equivalent to Colombia’s entire tax revenues (OECD, 2022[61]).

Those able to work but without jobs should register with the public employment services and when they find a job, part of their wage could be temporarily exempted from the calculation of the benefit. For those adults already working but able to work more, additional hours worked and better jobs are encouraged, and for each extra income they earn the benefit is reduced by a smaller amount.

A single cash transfer for the poor would gain from strengthening state capacities to check up on self-declared information provided by the beneficiaries. This includes earnings from informal labour, which is far more difficult for the state to observe. Local networks and social assistants can play a key role checking the veracity of self-reported information. Brazil, for example, has made significant progress in building up a granular network of social workers and social centres that help in determining the fulfilment of income eligibility conditions for the Bolsa Família programme. In some cases, it has also been helpful to design incentives to encourage citizen responsibility, for example by implementing some kind of penalty for those who provide inaccurate or false information (Universidad de los Andes, 2020[62]). Maintaining large and up to date social registries of poor households are the key instruments for administering such schemes (Box 2.5).

Box 2.5. Improving social registries

Social registries of recipients identify the socioeconomic characteristics of individuals and households who are likely to receive assistance from the welfare system. Social registries help in the design, implementation and evaluation of social policies. They are typically used to identify beneficiaries or verify self-declared beneficiary information, calculate the amount of the benefit due, deliver the benefits and measuring their impact ex-post.

The coverage, accuracy, and quality of information collected and recorded in social registries has improved visibly since the late 1990s, as Latin American countries have collected more information to build the targeting instrument upon which their conditional and unconditional cash transfer programmes were founded.

In some of the less elaborate registries, individuals communicate their information each time they seek assistance. For others, social registries are based on information collected at regular intervals, for example through broad surveys that target vulnerable populations. Most countries choose to supplement these with the option for individuals to update their information via a request for a new survey. In this case, an agent or a social worker administers a new questionnaire in the applicant's home.

One recent innovation has been to use additional data sources such as administrative databases to complete and/or update the information already available in the social registries. The cross-checking of self-reported information from individuals with administrative data has been a feature of so-called "second generation" registries, which require significant efforts to identify households uniquely and unequivocally, so as to minimise duplication, inclusion, or exclusion errors in the programmes. Social registries are also increasingly combined with the massive use of information and communication technologies to inform individuals about their eligibility for a programme and/or to deliver their entitlements, for example during the COVID-19 pandemic.

With these innovations, some of which were driven by the pandemic, governments sought to improve the information available on people already receiving social benefits and expand the scope of social action to individuals not previously covered. Building on these efforts made during the crisis would further improve the targeting and the effectiveness of social benefit delivery.

One lesson that emerges from the pandemic is that large parts of the population are potentially in a situation of requiring assistance at some point, which calls for social registries to be as universal as possible, rather than being limited to poor and vulnerable populations. Connecting different data sources can be a way to achieve this, including tax records, land registry records, vehicle registrations, civil registers. Social registries should also be sufficiently flexible so that the information they hold can be regularly corrected, completed, or updated without the need for mass surveys, promoting and facilitating the process and its corresponding validation (control visits and cross-validation with other sources) (ECLAC, 2020b). This is particularly important in the case of dismissals, where people with previously sufficient incomes to make a living will need rapid support.

The level of the guaranteed minimum income benefit could be determined in various ways, but a relevant poverty line, which exists in most countries, is often a useful reference. By calculating the cash transfer as the difference from the per capita household income level and its distance from the poverty line, the programme would ensure that no household or individual is left in poverty.

Another option to provide income support would be through a negative income tax, where income support would be provided through the tax system. Workers would be required to register with the tax authority and file personal income taxes. Those who have declared their revenue is below a defined threshold would be exempt from paying the tax and would instead receive a payment from the revenue authorities. This payment decreases gradually as the individual earns more from work. Channelling the income support through the tax system has the advantage of targeting the support to low-income workers while encouraging the take-up of formal jobs. It can also foster financial inclusion and can reduce the scope for clientelism associated in some cases to some social programmes. Experience from some OECD countries, such as United States experience with the earned income tax credit, is positive (Hoynes; Patel, 2017[63]), as it has increased formal participation among groups with lower labour market attachment and reduced poverty. Such schemes have been also found to reduce informal employment in developing countries (Gunter, 2013[64]). This option presents a higher administrative burden for tax authorities, but recent and ongoing enhancements in the capabilities of several tax authorities in the region (e.g. Mexico, Colombia or Costa Rica) make it a viable option. As cash transfers, it would require continuing to enhance capacities to validate self-declared information and providing incentives for individuals to report their income truthfully. The idea of minimising formalisation disincentives calls for financing anti-poverty transfers to those in working age in a way that does not affect incentives towards informality by raising the cost of formal labour. Already, almost all CCT programmes in Latin America are financed through general tax revenues, making them particularly well-placed building blocks for enhancing social protection. To the extent that CCT programmes are enhanced and able to react more rapidly in the case of sudden income losses, they may reduce the need for contribution-based benefit programmes, particularly among low-income workers where the additional cost of a mandatory contribution may have strong effects on the prospects of finding a formal job. As in the case of pensions, a useful benchmark may be to aim for social contributions close to zero for incomes at the crossroads between formality and informality, which is typically the minimum wage.

Given that a guaranteed minimum income is designed to avoid poverty, it may not be able to achieve the full degree of income smoothing or insurance against unexpected variations in household income over time that a society may desire. For example, those with higher incomes may have a legitimate interest in insurance against the sudden and temporary income losses associated with dismissals, for example. But such insurance would need to deliver adequate replacement rates to be attractive. A person earning several multiples of the minimum wage may not be convinced by a guaranteed minimum income scheme designed to prevent people from falling below the poverty line. At the same time, such a person is much less likely to work in the informal sector.

Unemployment benefit schemes could therefore be useful to provide consumption smoothing and maintain living standards for workers above the minimum wage, and probably at some distance from the latter. This second pillar could be based on contributions and provide top-up benefits to the basic scheme. There are several possible ways to design such a complementary contributory scheme for those with higher incomes, and in those countries where such systems already exist, there may be a strong case for implementing only minor reforms.

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