Employment and Efficiency Effects of Social Security (SS) and Social Protection (SP) Systems in the Context of an Informal Sector and Market Imperfections: A Conceptual Review

Abstract

Most developing countries suffer serious “imperfections “in their labour, capital and product markets; a high level of informality (lack of connection with the state, e.g. non-registration, non-compliance with tax and labour regulations, etc.); and attempts to improve the welfare of specified groups through social security (SS) systems in the formal sector and (increasingly in recent years) through social protection systems (SP) designed to achieve greater overall coverage, e.g. to reach informal workers. Among the main policy issues that arise around the combined existence of these features are how to limit such negative effects as the market imperfections may have, how best to design SS and SP systems in such settings, and whether to pursue formalization be pursued as a policy and if so. The analysis of the impact of SP policies is very complicated and cannot be safely undertaken in a two sector (formal-informal) model, nor in one that assumes labour homogeneity or perfect competition in the product and capital markets. The analysis of any given case is likely to be complicated enough to pose serious barriers to the attainment of reliable conclusions, but is nonetheless worthwhile to narrow the range of uncertainty as to the impact of policy. For labour market functioning to have direct policy implications on the desirability of SP requires that labour allocation between the two (or among the three) sectors will respond to the presence of SP (as in non-queuing cases where the elasticity of formal demand for labour is not close to zero elasticity).