Social insurance

Aggregate labor productivity is a central indicator of an economy’s economic development and a wellspring of living standards. Somewhat controversially, many macroeconomists see productivity as a primary driver of fluctuations in economic activity along the business cycle. In some countries, the cyclical behavior of labor productivity seems to have changed. In the past 20–30 years, the US has become markedly less procyclical, while the rest of the OECD has not changed or productivity has become even more procyclical. Finding a cogent and coherent explanation of these developments is challenging.

Social security programs generally seek to provide insurance and to reduce poverty and inequality. Providing insurance requires little redistribution. But reducing inequality and alleviating poverty do require redistribution. To reduce inequality, programs must redistribute income, but redistributing income is not the same as reducing inequality. While some programs redistribute large amounts of income without noticeably reducing inequality, others reduce inequality with less redistribution and fewer labor market distortions. A non-contributory tier, which provides benefits without requiring contributions, is a key component for reducing inequality.

Cash transfers are a popular and successful means of tackling household vulnerability and promoting human capital investment. They can also reduce child labor, especially when it is a response to household vulnerability, but their efficacy is very variable. If not properly designed, cash transfers that promote children's education can increase their economic activities in order to pay the additional costs of schooling. The efficacy of cash transfers may also be reduced if the transfers enable investment in productive assets that boost the returns to child labor. The impact of cash transfers must thus be assessed as part of the whole incentive system faced by the household.

Job displacement is a serious earnings risk to long-tenured workers, both through spells of unemployment and through reduced wages on subsequent jobs. Less developed countries often rely exclusively on government mandated employer-provided severance pay to protect displaced workers. Higher income countries usually rely on public unemployment insurance and mandated severance pay. Beyond these options, more administratively demanding plans have been proposed, including UI savings accounts and “actual loss” wage insurance, though real-world experience on either model is lacking.

In reforming unemployment benefit systems, the policy debate should be on the appropriate level of benefits, the subsidies needed for people who cannot contribute enough, and how to finance the subsidies, rather than on whether unemployment insurance or individual unemployment savings accounts are better. Unemployment insurance finances subsidies through implicit taxes on savings, while individual savings accounts with solidarity funds finance subsidies through payroll taxes. Taxes on certain consumption goods and real estate could be considered as well and could be less distortionary.

Informal employment accounts for more than half of total employment in Latin America and the Caribbean, and an even higher percentage in Africa and South Asia. It is associated with lack of social insurance, low tax collection, and low productivity jobs. Lowering payroll taxes is a potential lever to increase formal employment and extend social insurance coverage among the labor force. However, the effects of tax cuts vary across countries, often resulting in large wage shifts but relatively small employment effects. Cutting payroll taxes requires levying other taxes to compensate for lost revenue, which may be difficult in developing economies.

Unemployment insurance can be an efficient tool to provide protection for workers against unemployment and foster formal job creation in developing countries. How much workers value this protection and to what extent it allows a more efficient job search are two key parameters that determine its effectiveness. However, evidence shows that important challenges remain in the introduction and expansion of unemployment insurance in developing countries. These challenges range from achieving coverage in countries with high informality, financing the scheme without further distorting the labor market, and ensuring progressive redistribution.

Job displacement represents a serious earnings risk to long-tenured workers through lower re-employment wages, and these losses may persist for many years. Moreover, this risk is often poorly insured, although not for a lack of policy interest. To reduce this risk, most countries mandate scheduled wage insurance (severance pay), although it is provided only voluntarily in others, including the US. Actual-loss wage insurance is uncommon, although perceived difficulties may be overplayed. Both approaches offer the hope of greater consumption smoothing, with actual-loss plans carrying greater promise, but more uncertainty, of success.