Social safety nets in good and bad times

1. Social safety nets in good and bad times François Bourguignon Paris School of Economics

2. Definition of safety nets • Insurance mechanism: • preventing people to fall into poverty and poverty traps • cushioning economic shocks without reducing economic incentives • Generally provided by the State: • mimicking insurance systems (contributory benefits like unemployment or PYG pension systems) • as pure 'benefactor': non-contributory benefits like minimum income guarantee, universal health care, • Idiosyncratic or systemic risks

3. Key question: how to build "effective" and "efficient" safety nets? • Effectiveness: high coverage of population at risk, or the various risks and needs • Efficiency: mimize costs arising from managing safety nets, bad targeting (leakages), distorsions and disincentives • Diversity of experiences: • The welfare state in rich countries (EU) • Trucated welfare state and cash transfer programmes in emerging countries (Brazil, Mexico, Chile, Turkey) • The substitutability between informal and formal social safety nets

4. Outline of this presentation • Size and structure of safety nets in selected countries • Costs and benefits of safety nets: the social insurance vs. social assistance debate • The central issue of informality/growth in emerging countries • Conclusion: preparing safety nets to cope in times of crisis

5. Size and structure of safety nets (1) Source: OECD/Stat

6. Size and structure of safety nets (3) Source: author

7. Size, structure and effects of safety nets (4) Source: Paes de Barros, 2007

8. Size, structure and effects of safety nets (5)

9. 2. Costs and benefits of safety nets • Safety net instruments • Social insurance or "contributory" benefits: unemployment insurance, PYG pension systems, health insurance … (Bismarckian tradition, close to private insurance schemes) • Social assistance or non-contributory benefits: minimum income guarantee, housing benefits, child benefits, universal health care, conditional cash transfers ¨CCT" type (Beveridgian tradition) • Various combinations of instruments in different countries (e.g. difference between UK and continental EU), but progress of the Beveridgian tradition.

10. b. Main costs and benefit channels • Normative and positive benefits of social safety nets • Reduces poverty and inequality • Reduces uncertainty of standards of living • Increases incentives to undertake more risky but more profitable individual investment projects • Potential costs of safety nets: administrative costs, tax distorsions, work disincentives • Micro vs. Macro: safety nets as automatic stabilizers

11. Labor demand distorsion (social insurance + minimum wage) Social insurance may increase the cost of labor and unemployment in presence of minimum wage laws (or practices) No minimum wage P = worker's productivity = employer's cost = C With perfect competition and no social insurance contributions: w = P = C With social contributions, c: w+c = P = Cworkers pay for it With minimum wage (w°) No social insurance contribution: C = w° ≤ P With social insurance contribution: C= w° + c ≤ P Employers pay for it: Potential drop in labor demand Solution = finance social insurance in another way

12. Labor supply distorsion and the move towards "workfare" After tax/transfer income After tax/transfer income Inactivity trap Workfare Before tax/transfer income Before tax/transfer income Problem: this has a cost! Is it compensated by increase in labor employment?

13. Social insurance and assistance as automatic stabilizers in times of systemic crises • Basic mechanism: • Unemployment benefits increase in times of crisis, which partly compensates for the drop in final demand • Idem for means-tested social assistance programs • In main EU countries, it is estimated that automatic stabilizers may account for a fiscal stimulus as big as 1% of GDP – see IMF, March 2009. • In emerging countries with Cash Transfer programs, little doubt that the volatility of income in modest families was reduced. But how much? And is this sufficient?

14. Social insurance and assistance as reducing volatility and risk • Safety net reduces volatiliy of income, • increasing welfare • and allowing agents to take more risk and to increase expected rates of return • More difficult to find good and simple illustrations of the positive impact on risk taking and innovation (output mix of famers in poor countries)

15. 3. The central issue of informality • In emerging countries, informality is defined as workers not subject to compulsory social insurance (health and unemployment insurance and pensions) • At the same time, informality associated with lesser productivity • Informality may represent 40 to 50 % of the (urban) workforce • Interestingly, EU countries were approximately in the same situation before WWII but were then able to get rid of most informality • Why does it seem so difficult to do the same in emerging countries today?

16. Eliminating or feeding informality The case of post-war Europe • Very fast growth from 1945 to 1975 • Modernizing and expanding of administrative sector = increasing ability of controling resources • Dominant Bismarckian system • Memory of the 1930s crisis: everybody had to be insured (last ones were the farmers)

17. Eliminating or feeding informality (2) Today's emerging countries • High disparities and less need for insurance in economies with fast long-run growth • Slow growth and slowly decreasing rural sector in other countries • At what stage too generous universally provided social assistance becomes an incentive to informality? • Choice to be made between universal coverage paid on general budget or maintaining heterogeneity in services as a way of keeping incentives to formality (??) • This is the case of Mexico today with the appearance of a Progresa – or Oportunidades – "class" that benefits freely from many services initally restricted to formal workers • Cost of dual system may be substantial (Levy on Mexico)

18. Conclusion: which model to follow in emerging countries? • Bismarckian tradition countries clearly have adopted Beveridgian reforms • This does not mean that labor-determined social insurance systems must be abandoned • But too much emphasis on creating Beveridgian complements to existing systems (like CTs) may be dangerous because of the disincentives it creates ("Activation policies") • Practically: • Means-tested non-contributory benefits are fine – but can there really be temporary? • Free coverage of some risks in part of the population should be extended to the whole population, with a shift of social security contributions to the general budget. • At the same time adminsitrative capacity should be anhanced

19. Conclusion (2) • Many reasons to think that, despite their costs, safety nets – whether of the social insurance or the social assistance type – contribute positively to social welfare • The main issue is that of the way to build them and the balance between their various possible components • (Conditional) cash transfers in some emerging countries are from many points of view a good news, but they should not be over-estimated

20. Safety nets in times of crisis • What is needed in times of crisis: • Final demand stimulus (through fiscal policy) • Making sure poor people dont get into some kind of poverty trap • This could be achieved simply by means-tested benefits, if indeed means-tests are possible at all! • But if capacity to manage such programs is missing others are oftne suggested: public employment programs, wage subsidies, retraining, … • Not clear they are all effective and efficient: wage subsidies and retraining reach non-poor people. They may push final demand but not necdessarily the welfare of the poor. • Public employment programs are more attractive – e.g. self selection of poorest – but they must be in place before the crisis and involve efficienc costs anyhow. • From all points of view it seems better to have safety net instruments which are permanent and which can be scaled up in times of crisis. Cash transfers are among these instruments if they can be made actually contingent on current income.

21. Safety nets in times of crisis (end) • From all points of view it seems better to have safety net instruments which are permanent and which can be scaled up in times of crisis. • Cash transfers are among these instruments if they can be made actually contingent on current income. • In effect, the major challenge faced by emerging countries is to avoid their CCT programs to be static, so as to create a "CCT-class" insensitive to economic incentives.

22. Size and structure of safety nets (2) Source: author