Covering the “missing middle” in social protection

by Juan R. de Laiglesia from the OECD Development Centre 

Providing social protection to the informal middle classes will foster social cohesion, and doesn’t cost the earth.

As citizens across the globe demand new economic models, the OECD’s newly released Perspectives on Global Development 2012 puts social cohesion on the table as a broader social development objective. Social cohesion compounds inclusiveness, equal opportunity and a sense of belonging to society, of shared destinies. Strong growth in a large part of the developing world has transformed the ways development challenges can be addressed. 

The final declaration of the 4^th High Level Forum on Aid Effectiveness held in Busan last week reminds us that poverty and inequality remain a central challenge in global development.  The OECD’s Perspectives on Global Development 2012 find that 83 countries more than doubled OECD per capita growth rates over the past decade. You would be right to think that faster than 1.8% growth is hardly impressive; but in fact 49 countries grew at more than 3.75%. In the 1990s, only 12 countries managed that.

How growth has changed the picture

First, the poor no longer live mostly in poor countries. Research by Andy Sumner,  at the Institute for Development Studies , finds that 70% of the world’s poor live in middle income countries. Two decades ago, 93% of the poor lived in Low Income Countries. This means that most of the poor live in countries where per capita incomes are above USD 2.75 a day, and more in purchasing parity terms. In other words, more countries can use redistributive instruments – from taxes to transfers to health provision – to eradicate poverty. Indeed, countries such as India or China have up-scaled social protection interventions in recent years.

Second, millions have been lifted out of poverty as average incomes have increased and emerged as a new – but vulnerable ­– middle class. As a result, half of the 2bn-strong global middle class live in emerging economies. But make no mistake, this middle class is unlike Western stereotypes of a couple with two children, a dog and one or two cars.  The emerging middle classes are vulnerable: many remain only just above the poverty line and do not have a stock of capital that would allow them to buffer major shocks such as illness nor to whether the changes in fortunes which come with old age. In Latin America, less than 10% of households have mortgage loans, and less than half of them are middle-class. Many in the emerging middle classes work informally. And yet, not being poor, they have the capacity to save and contribute to social insurance. Social protection plays a key role in buttressing their middle class status and preventing them from slipping back into poverty.

Social protection redux

Is this a job for social protection? In the past few years, the discourse around the role of social protection in development has changed dramatically. Through the work of the OECD’s Development Assistance Committee, the donor community has clearly stated the role of social protection in making growth pro-poor. Last month, the Social Protection Floor Advisory Group, chaired by Michelle Bachelet released its report entitled Social Protection Floor for a Fair and Inclusive Globalization. Social protection has moved from being viewed as merely a “safety net” built of targeted assistance to the poor to a key instrument in building fairer societies.

The past ten years have seen a true “quiet revolution” in social protection in the developing world. The rapid introduction of means-tested cash benefits has greatly increased the scale of social protection. South Africa’s Child Support Grant, introduced in 1998 covered 7.7 million children by 2008, China’s Minimum Living Subsidy Scheme (DiBao) was introduced in 1997 and reached 57 million households by 2007. The very popular conditional cash transfer (CCT) programmes in Mexico (Oportunidades) and Brazil (Bolsa Família) reach respectively 5 and 12.5 million households or about a quarter of the population in each country. The beauty of this quantum leap is that it has been made using home-grown instruments, tried and tested across developing countries. Often these new programmes coexist with contribution-based social security systems that cover formal employees.

The “missing middle”: a challenge for social cohesion

Put together, contribution-based social security and means-tested social protection for the poor leave a “missing middle” in social protection coverage. Indeed, research at the OECD Development Centre shows that the majority of middle-class workers in emerging economies such as Brazil  or Mexico are not formal employees.  Contributory pensions are open to independent workers and informal employees – those without contracts – but in practice only a minority participate in them. In the case of Brazil only 15% of the self-employed and 9% of informal employees in the middle income quintiles contribute to pensions systems.

Providing adequate instruments for the informal middle classes to insure or manage risk matters for social cohesion. First because today’s vulnerable middle class can become tomorrow’s poor. Many in the emerging middle classes lie close to the poverty line and can fall back in downturns. Second, it is a matter of horizontal equity. Social protection is a form of institutionalized solidarity: excluding certain categories from social protection deprives them of risk management instruments which are usually not available in the private market. Moreover, it runs the risk of alienating that segment of society. Finally, the middle classes have an important role to play in shaping the politics of poverty reduction. How likely are the informal middle classes to side with the poor on redistribution issues if they do not partake in the system that protects the poor?

Extending protection: more than one way forward

Social protection can be extended to cover the informal middle classes in several ways. Unbundling health, pensions and the other functions of social security helps, because they can be priced and provided separately. Contributory pensions and Unemployment Insurance Savings Accounts as implemented in Chile are examples of such unbundling. Certain instruments, like UISAs (compulsory savings accounts from which withdrawals are made during unemployment spells) can be extended to informal workers. Since they pool little risk across workers, they do not entail cross-subsidies or generate incentives to stay out of formal work. Subsidising contributions to the social security system is also possible – for example by governments’ matching deposits into retirement accounts. Matching-defined contribution pensions following that model are being implemented in Mexico, Colombia and Peru. Universal entitlements are also used today across the developing world, especially for basic healthcare and pension income.  In all cases, the key is to break the dichotomy between a social protection system for formal workers and one – or none – for informal workers. Such duality reinforces the segmentation between labour markets and contributes to deepen the fault line between formal and informal workers.

At stake is building a social protection system that not only alleviates poverty, but empowers citizens to build up and protect human capital and to participate in networks of organised solidarity. The past decade saw the emergence of a number of innovative instruments in social protection, born and bred in the South. Making inclusive systems out of these and other innovations remains work in progress.