“Proposals for labor and pension reform require major adjustments”

The national government has presented its proposals for labor and pension reforms, which need to be thoroughly examined, to the extent that the very low coverage of the current compulsory pension system (25%) is mainly due to the high level of work informality (currently in 58% of the working population), Fedesarrollo indicated.

In this sense, Luis Fernando Mejía, director of the Center for Economic Studies, the goals of increasing pension coverage and reducing work informality are actually two sides of the same coin.

“It will not be possible to improve coverage in the compulsory pension system if efforts are not made to reduce labor informality,” said Mejía.

The director of Fedesarrollo claims that while the pension reform points in the right direction, in its current version it has an excessive impact on private savings, increases the pension obligation in its contributory component and, under the current circumstances, generates insufficient savings, further deteriorating the fiscal position of the central government.

“Although the labor reform aims to protect the current formal workers, the measures will have unintended consequences for the informally employed and the unemployed: the increase in the cost of formal employment will lead to an increase in unemployment and work informality, making it coverage problem in the contributing part of the old-age protection system,” he stressed.

As for the fiscal impact of the pension reform, Fedesarrollo’s calculations in the central scenario point to a 30.2 point GDP increase in the obligations of the old-age protection system.

“This increase is split into an increase of 12.5 points of GDP due to the solidarity pillar, 8.4 points of GDP to the semi-contributory pillar and 9.3 points of GDP to the contributing pillar” said Meja.

He added that these estimates differ from what was presented by the Treasury Department, which says it would cut it by 12.3 points of GDP. “On the one hand, in the cost of the reform, the Ministry of Finance does not take into account the value of the solidarity pillar, which is the most expensive of all (12.5 points of GDP according to our calculations)”.

“This value should be included, because what is relevant to fiscal sustainability is the fiscal cost of the new old-age protection system, not just that of one of its components,” said Fedesarrollo’s director.

Recommendations on pension reforms

Fedesarrollo recommends an individual savings pillar, in which Colpensiones would compete with pension funds and other long-term savings mechanisms to offer individual savings accounts to contributors, deepening competition.

“If the idea of ​​a medium-high contribution pillar persists, lower the contribution threshold in this pillar from 3 to 1.5 minimum wage,” advised Mejía.

Another point is the introduction of a simpler savings rule, which stipulates that Colpensiones must save the entire new premium flow, updated by the growth of the wage bill (the product of the employed population and wages).

“This rule is clearer and more transparent to the markets and ensures that the reform does not allocate the new contributions flows to current expenditure, which would worsen the fiscal position of the national government,” explains Fedesarrollo.

They add that in order to reduce the fiscal impact of the reform proposal, it would be desirable to adjust the basic income before settlement (extension of the calculation period of this income) and the replacement rate, which remain unchanged in the government’s proposal compared to the parameters currently applicable.

Recommendations on labor reforms

At the moment, Fedesarrollo recommends postponing the introduction of some measures, or making them conditional on the unemployment rate remaining below a certain threshold (e.g. 8% annual average).

“The increase in the cost of formal employment in a context of economic slowdown and an unemployment rate still above 11% will exacerbate the problems of labor market deterioration that, even in the absence of reforms, will materialize this year .” he said Center for Economic Studies.

Another recommendation is to create non-contributory unemployment insurance, which can be financed with a fraction of contributions to compensation funds.

“This insurance could provide half the minimum wage for up to three months for formal workers (salaries and self-employed) who have an income of no more than 1.5 minimum wages. This is a way to protect the worker without increasing the workload when he hires the worker himself,” explains Mejía.

They add that a progressive health care contribution should be introduced, starting at 0% for those with incomes equal to or less than one minimum wage and gradually rising to 9% for those with incomes equal to or more than 25 minimum wages .

“Today, an employee must contribute 4% of his salary and a self-employed person 12.5% ​​of his income for the contributing health system. This is a powerful incentive to stay in the informal sector, as the worker in the subsidized regime can get the same benefits at no cost,” concludes Fedesarrollo.