Better Pensions and Jobs in Latin America

The publication by the Inter-American Development Bank of a timely book Better Pensions and Better Jobs: Towards Universal Coverage represents a significant contribution to the literature on the subjects of pension provision and the economics of the labor market in Latin America and the Caribbean Region. This research study presents a diagnosis of the pension coverage situation in the region, describes a conceptual framework for understanding and systematizing the lessons that emerge from the diagnosis, analyzes various recent reforms aimed at expanding coverage, and offers guidance for implementing future possible reforms. Extending pension systems’ coverage is the most important challenge in building social protection systems in the region; this objective is critical to achieving the goal of providing adequate income for millions of individuals who will retire in the coming decades. In 2010 the percentage of adults who were age 65 or older represented only about 6.8% of the population; projections to 2050 indicate that this age group will increase to about 19.8% over a period of 40 years, or about 140 million persons compared to about 38 million today. Over this period significant demographic shifts in the age distribution of the population will result in the ratio of working age individuals to persons age 65 and over reducing from 9.6 currently to about only 3.2 in 2050.

Contributory pension systems are not currently expected to generate enough savings for old age since most jobs in the region are in the informal sector where workers are not contributing to social security. Also, economic growth, even if it continues at the rate of the last decade, will not be sufficient to resolve this problem of providing adequate old age income. In the absence of reforms, it is estimated that as many as 60% of the 140 million elderly persons in 2050 will not have an adequate pension in their old age. The coverage deficit will be higher among women and will be heavily concentrated among workers who have low or middle-income jobs, work for small businesses or are non-wage earners, such as the self-employed. This low coverage will have significant social, political, fiscal and economic consequences. Families will need to devote greater effort and resources to the care of the elderly. Persons aged 65 and older will represent between 20% and 30% of the potential electorate; their needs will be a powerful influence in the election process. Lack of coverage is a latent fiscal cost, because countries will have to allocate more resources in the future to compensate for this inadequate coverage. How the coverage gaps are addressed will likely affect the functioning of the labor market, investment decisions, and long-term productivity growth. Consequently, pensions will become one of the cornerstones of economic and social policy in Latin America and the Caribbean in the coming decades.

Because of the constraints of existing pension systems that are based on the principle of coverage related to employment in the formal sector, reforms are necessary in order to move towards universal coverage. Significant changes will be required to overcome these constraints. Two potential solutions to accomplish this objective are: (i) granting pensions to those reaching retirement age who do not have social insurance coverage; (ii) making workers currently in the labor market save for their future. Experience in the region, among countries with different income and formal labor market situations, such as Bolivia and Chile, indicates that non-contributory pensions are an effective means for increasing the number of people with regular income in old age. Introducing non-contributory pension arrangements would, however, be a disincentive for workers to participate in the formal labor market and its contributory systems. Reducing the charges associated with formal employment would positively affect participation in the formal labor market. The design of non-contributory social protection systems should consider financial sustainability and the potential economic effect on the labor market. Establishing a universal pension system and providing subsidies to expand formal employment are key components for expanding coverage. Together with innovations in savings channels and better supervision of pensions and the labor market, they are the fundamental driving forces that will enable the region to move in the direction of achieving universal coverage.

The Latin America and Caribbean region is experiencing favorable demographic, economic, and fiscal conditions at present. This provides good opportunities for bold reforms to achieve universal pension coverage and greater participation in the formal economy. The emerging middle class could constitute the socioeconomic and political base of the pension reforms. The financing of pension reform will require an increase in the resources allocated to these policies, representing a significant challenge in the region in both technical and political terms. Initiatives to allocate part of the collection of value-added taxes or natural resource taxes are seen as potential means of overcoming these challenges.