Building Houses on Sand: 
Social Protection Systems and Precarious Labour Markets in Middle Income Developing Countries

Since Chile’s transition to democracy, the country has dedicated important effort and resources to developing social policies that improve the lives and well-being of its population. Policies such as housing subsidies, health care that provides minimal universal guarantees to the population (known as the Plan Auge), universal minimal pensions, and the programme Chile Crece Contigo which ensures the appropriate development of children up to the age of six constitute some of the highlights. Sound macroeconomic management has done its bit: Chile has experienced more sustained growth rates than other countries in the region, while fiscal spending has been anti-cyclical, thus protecting Chileans from the worst effects of economic crises. However, the country is still plagued by significant inequalities, both in terms of access to social services, as well as in the results that they produce. Like Sisyphus, policy makers seem condemned to invest continuous effort in an elusive goal. Fiscal resources are insufficient, and more educated citizens are now more demanding in terms of their expectations while simultaneously less tolerant of the multiple inequalities that they experience on a daily basis.

A significant expert literature now exists (ranging from the IMF, the OECD, and many independent international experts) that emphasizes the negative effect of inequalities on the economic growth potential of countries, the health of its citizens, social cohesion, and development in general. Young people and women are particularly negatively affected by such policies.

The fiscal, educational and political reforms that Chile’s current government has undertaken will significantly change the underlying social and economic structures that Chilean democracy inherited from the military regime, and will make the playing field more equal. In future, more reforms that better share resources between private and public systems of social protection must be undertaken, for example in the areas of health insurance and pensions. Similarly, tax systems must become more progressive, while significant effort must focus on improving the quality of education.

The debate about how social protection systems are to be financed (universal versus individual contributions), and to what extent they should share risk must therefore take into account recent evidence on the problems generated by multiple inequalities. However, in addition, we must not forget that these contributions are generated in the labour market, which is the foundation of all social security systems. What public policy in Chile has not recognized in a sufficiently explicit manner is that as long as the bulk of employment in the labour market is still largely informal, of short duration, relatively unproductive, and low income, contributions to the country’s social security systems will never be able to generate benefits commensurate with the expectations of workers. Furthermore, the minimal social protection floors guaranteed by scant fiscal resources can never compensate for the deficiencies generated by precarious employment in the labour market. Attempting to build adequate social policy solutions in conjunction with a precarious labour market is therefore like building houses on sand.

The numbers illustrate this argument: one third of the Chilean labour force works informally, either as self-employed, freelance, or salaried workers without a formal written contract. Of the remaining two thirds (wage-earners with a contract), 35% have a short-term contract. According to 2012 administrative data from Chile’s unemployment insurance system, the duration of these jobs averaged about seven months. The remaining 65% of wage-earners have an open-ended contract. We should remember that the Chilean Labour Code is almost entirely based on the logic of long-term open-ended contracts. Today, the duration of these “long-term” contracts is also extremely short, averaging approximately 28 months, according to administrative data.

To sum up, the formal segment of the Chilean labour market has become increasingly precarious, while high levels of informality persist. This combination of informal employment and precarious formal employment has a devastating impact on social security systems: too many workers contribute nothing or very little. And even workers with formal jobs are not contributing continuously to their pension accounts, which leads to extremely low pensions.

Nobody can expect fiscal resources to compensate for these structural deficits. Instead, we have to think about solutions based on a two-pronged strategy: first, public policies that incentivize both informal workers and their employers (who tend to be informal micro enterprises) to become formal. Second, we should think about incentivizing job stability in the formal sector.

A first step in this direction was taken in Chile through legislation that prohibited employers from rotating workers between multiple tax identification numbers within a single holding company (a phenomenon known as the multi-RUT). But much more can be done: to formalize informal workers, we must think about offering them benefits in exchange for paying taxes and contributing to social security systems. For example, establishing an Earned Income Tax Credit for low-income workers as well as making child benefit payments available to the self-employed would create incentives for workers to formalize their activities. In the case of formal workers, we should think about reducing the differences between short-term and long-term contracts. Other countries such as Spain or France, which also believed that labour market flexibilisation through short-term contracts would generate more employment, have already gone down this route due to the fact that labour market segmentation of this kind made it almost impossible for less educated young people to obtain a stable employment situation.

Another way of reducing the segmentation between different types of contracts is to turn severance pay systems into social security contributions for all workers regardless of their type of contract. Similarly, unemployment insurance systems could charge employers who make more use of the insurance system higher contributions (as is done in the United States). Both measures would discourage the kind of excessive job rotation that the Chilean unemployment insurance system highlights.

In this context, we must also think about another damaging impact of job rotation that is ignored by policy makers in Chile: the hyper-flexibility of its labour market makes it impossible to ensure sufficient investment in the capabilities of workers as they rotate between one job and another, or between formality and informality. This means that the impact of excessive job rotation on productivity is as damaging as its effect on social security. 

Effective vocational training requires much more time and resources than current training systems contemplate. As a result, social protection systems, especially unemployment insurance, should be structurally and institutionally linked with lifelong learning systems to further the capacity of labour markets to invest in worker and employer training. We must not forget that the majority of employers in Chile own very small and often informal businesses, and are as much in need of training as their workers. Here, examples from other countries which have done this successfully can serve as an example. South Korea, for instance, has established permanent training (or advisory services) for both workers and employers as part of its employment insurance system.

It is critical that policy makers in Chile stop thinking about the labour market as a “market” where problems are resolved by more economic growth. In turn, this requires a paradigm shift in how we think about labour policies: we have to generate more stable jobs that generate both social security contributions as well as higher levels of productivity through appropriate regulation and institutions, instead of thinking that minimal training programmes or employment subsidies can solve the problems of our labour market. Such a paradigm shift, incidentally, would also significantly improve the multiple inequalities that prevent Chile from becoming a developed country.

Kirsten Sehnbruch
International Inequalities Institute

London School of Economics and Political Science