Reforming Pension Reform: Including non wage earners

1. Reforming Pension Reform: Including non wage earners Carmen Pagés Research Department, RES Inter-American Development Bank Carmenpag@iadb.org November 27, 2006

2. DIAGNOSTICS Density of contributions for men (Berstein et al, 06) • Theoretical rate of return NOT LOW compared to OECD countries. • Problem: LOW AND UNEQUAL COVERAGE AND DENSITY OF CONTRIBUTIONS • Only 55% of LF covered • Median Density of Contributions: 48% MEN, 42% WOMEN • 10 % of Men and 20 % of women have contribution densities <10% • Very low coverage & density among self-employed

3. Proposal • Increase contributions among self-employed • Equating benefits and obligations for all workers • Increase contributions among unemployed • UI pays contributions during 6 first months • Increase contributions among new entrants • Subsidizing 24 first contributions at 50 % for low income workers. • Improve administrative procedures to expedite collection and improve enforcement.

4. Why are there workers not contributing to Social Security? • Why not voluntarily contribute? • Myopic behavior; • Insufficient earnings –not enough to satisfy certain minimum current consumption –cannot save for tomorrow; • Alternative insurance mechanisms –informal transfers; inter-generational arrangements; • Minimum wages prevent workers from “paying” for their own contributions. • And for those for whom is mandatory? • Low or unequal enforcement

5. Will mandating the self-employed to contribute work? • If full enforcement: • Myopic workers may be better off; • But those for whom contributions imply insufficient present consumption could be worse off; • Similarly, those who currently have better alternative arrangements could be worse off; • For those who prefer “not contributing” to “contributing”, participation and employment levels may decline. • How many workers in each group?

6. Will subsidizing new entrants work? • Subsidies have worked in similar contexts to increase coverage (i.e. Turkey–Betcherman, Pagés and Daysal, 2006). • But only for workers with low earnings– for higher earnings individuals, subsidies tend to be transferred to workers in the form of higher wages… • What happens to workers when subsidies run out ? • Is there substitution among workers with and without subsidies?

7. Will subsidizing new entrants work? • Not much evidence from available studies… • However, if incentives work, then substitution effects are likely… • It would be important to track the performance of workers after their 24 first months of employment to assess whether their probability of moving to U or informality increases  Panel data of all workers necessary. • Subsidies should only be available for firms that increase the NET number of registrations… but difficult to enforce.

8. To summarize: • Important to understand the reasons that cause some workers not to contribute; • Given many unknowns regarding how proposal will work in Chile, firms & workers’ behavior ought to be evaluated.

9. Thank you!