Santiago Levy

Interview

Q/ Latin America and the Caribbean have made progress in their development, but incompletely; in particular, poverty and inequality levels are still very high, as are per capita income levels. How do you assess the progress and pending challenges in terms of growth and social inclusion in the region?

First of all, I would like to begin by thanking CAF for this invitation, congratulating the entire team on the 20th anniversary of the Report on Economic and Development (RED), which is an indispensable tool for our researchers and for all public policy makers in Latin America, and which we always read with great interest.

How to make an assessment of such a heterogeneous region? It is not easy because Latin America includes higher income countries such as Chile, and others with much lower incomes, such as Honduras and Nicaragua. So, from the outset, it is a heterogeneous region. Having said that, in general, I think we can be satisfied with the progress we have made in macroeconomic management in general -not in all countries, of course, we know there are very serious problems in Venezuela, in Argentina-, but in general, in the last 20 years, the region has shown that it knows how to manage its macroeconomic policy well and how to respond to complex external shocks such as the 2008-2009 crisis, or the Covid crisis

However, and this is a chiaroscuro, the region has not achieved what is required for development with social inclusion. We continue to be one of the slowest growing regions in the world, a region with very high levels of inequality in income and other indicators such as access to health and education. And given our per capita income, poverty remains very high. So, the glass is half full and half empty: half full in terms of learning and macroeconomic management, and half empty in terms of having built a growth strategy with social inclusion that is really capable of reducing inequality and poverty. This would be a somewhat tight assessment of what, I insist, is a very heterogeneous region.

Q/ In Latin America, informality is undoubtedly a challenge with very big implications for productivity, inclusion, environmental protection and other dimensions of development. Informality, even in this region, exceeds the levels of countries with similar per capita incomes. What elements do you consider to be key to understand or explain the excess of informality in Latin America and the Caribbean, and how do you think the problems of informality are connected to those of poverty and inequality mentioned in the previous question?

Informality is actually a manifestation of deeper problems in the social and economic structure of the region. Informality is not the cause of anything; it is really a reflection of the fact that the fundamental institutions of our societies are malfunctioning. And that explains why, despite having macroeconomic stability, despite having made progress in human capital accumulation, we continue to be a region where, in aggregate, more than half of the labor force is working informally and, although the data is not complete, most companies also work informally. Why? Because at the core, fundamental institutions for the development of our countries are malfunctioning. Informality is a complex phenomenon and one cannot point to a single cause as the reason for informality

We have problems in the regulation of the labor market, labor and social security legislation, minimum wages, but also in tax matters: special regimes for companies that are highly distorting, sometimes very incomplete taxation. And also, unfortunately, problems in other dimensions that affect the way in which workers and companies behave, for example, in terms of compliance with commercial and credit contracts. All of this affects companies’ access to credit, the way they decide to hire workers, and biases the decisions of workers and companies against salaried contracts that comply with the law, where workers have the protections of social security, minimum wages and protection against dismissal. Yes, this is a manifestation of a profound problem and has two major implications for the region. On the one hand, it prevents us from having social inclusion. We cannot talk about social inclusion when half of the workers in the region do not have access to social security. And the second major problem is that, in a context of high informality, the performance of companies and workers is affected in multiple dimensions that depress productivity. And these are two ideas that should be seen as a simultaneous result of the same phenomenon of dysfunctional institutions, high informality, lack of social protection and low productivity. One is not the cause of the other, but both are simultaneous results of dysfunctional institutions.

Q/ How do these regulations, especially those associated with employment protection, influence the levels of informality and, therefore, the region’s productivity?

There are many regulations that affect the way in which companies and workers relate to each other and what types of contracts are established, whether they are long term or short term. Sometimes we want to point to labor regulations or social security regulations, sometimes to minimum wages, and it is very difficult to identify precisely what is going on. It is like when a patient comes to the hospital and has a bullet in the lung, a bullet in the stomach and one in the liver. In reality, there are multiple causes and probably the problem of labor informality is overdetermined.

That said, if we focus on the issue of dismissal regulations, with a few exceptions, most Latin American countries do not have unemployment insurance. The privileged instrument to protect workers against the shock of dismissal is to prevent dismissal, making it very difficult and with very complex regulations that, in some countries such as Peru, make it, for example, almost impossible for companies to dismiss their workers, or in other cases make it extremely costly. The intention of these regulations is clear and welcome; they are undoubtedly well-intentioned to protect the worker. However, they are not an effective instrument to do so, because companies anticipate that if they hire a worker and there is a negative shock, they will not be able to fire him/her. And what they do then is to try to turn the legislation around through short-term contracts, or through another type of contract for fees or in different ways that prevent a long-term relationship between the company and the worker, and both lose out. So, we find ourselves in a classic example where good intentions lead to bad results. And here there is a very important field where we can improve, where there would be double gains -for workers and for companies- if we can move to more efficient and at the same time more productivity-friendly instruments of protection against unemployment.

Q/ Innovation is an essential component for sustainable growth and the human capital stock is very important in this process, let’s say, of invention. What do you think are the most promising policies within the reach of Latin American and Caribbean countries to improve education, skills development, and research and development, and how would universities and research institutions come into play here?

Undoubtedly, there is an important space for universities in the region to get closer to companies and work in a more coordinated manner, each in its own role, of course, but clearly we could improve if companies participate and dialogue with universities in the design of curricula and in clearly expressing their needs in terms of human capital formation. So, there is an important space for improving coordination between public and private universities and companies through employers’ associations. At the same time, I believe that we must go beyond the idea that all human capital formation takes place only in educational institutions. There is an immense space for human capital formation that occurs in companies. The typical person goes to high school, maybe finishes university, maybe does not always obtain a degree beyond university, but let’s say, after 25 or 27 years of age, people finish their formal education in academic institutions and from then on they have 40 years more. This is a huge space to continue accumulating human capital, and this depends on the company they work for and the relationship between the company and the worker.

There are investments in job training, where the company gives the worker a long-term contract and both internalize the benefits of what can be learned on the job. And this dimension of human capital formation, in my opinion, has been highly underestimated. It is not that we demerit the importance of education, it certainly has and all of it, but we also have to pay attention to the fact that there is a very large learning space throughout most of the life cycle of people when they are in the labor market, and for that we require better companies. And that implies that there is a dimension of human capital formation that does not have to do with university institutions, but with the regulations that affect how companies hire and establish relationships with their workers. Here we have an important space for improvement, because improvements in education, I insist, are welcome and indispensable, but it will take many years for new cohorts of workers with more years of schooling and better education to join the labor market. But in the region we already have millions of workers who are 30 years old or older and who will be in the market for the next 30 years. We cannot waste this human capital and there we have significant room for improvement.

Q/ Social protection systems have been strengthened in many countries and despite the advances in coverage and sufficiency of social protection, it is still limited, especially for the most vulnerable groups, due in part to the same labor informality we were talking about. What do you consider to be the main shortcomings or pending challenges in the region’s social protection systems?

I believe that in the area of social protection we have a great conceptual challenge that the region, to date, has not wanted to face. The problem is the following: the social insurance regulations that were adopted in the Southern Cone around the 1920s and 1930s, and in the Andean countries, Central America and Mexico around the 1940s, come from 19th century Europe, from a model where social protection is associated with the relationship between the company and the worker. That model failed in the region and that is part of the explanation why we have 50 % or more of the workforce in informal conditions. What happened is that this system was incapable of providing full coverage to the entire population, and what the countries and governments of the region did, instead of asking themselves why it could not cover the entire population, was to create an alternative and parallel system.

The main problem of social protection in Latin America is that it is segmented, fragmented. We have contributory systems for workers who are in a relationship with the companies and the companies comply with the law. And for everyone else we have another system, a patchwork of health programs, non-contributory pensions and other types of social protection programs that are an imperfect substitute, but which segment the population. Basically how this works is that if you have a job in a formal company, you have access to this type of protection, and if you have a job in other conditions, you have access to this other type of protection. I want to insist that this has nothing to do with the human capital of the individual worker. There is enough data for several countries in the region that show that the same person can sometimes be formally employed and sometimes informally employed, with the same skills and with the same human capital. But the States of the region treat the same person asymmetrically according to the labor contract he or she has, and this is not a way of structuring social protection. And yes, indeed, the governments of the region have made an immense effort to increase spending on social protection. In practically all the countries of the region, this has been the item of public spending that has grown the most in recent decades. This is welcome, but what is not welcome is that it has been done in a totally chaotic manner and without any coherence. And what we have now are basically dysfunctional systems that are part of the segmentation of the economy between a formal and an informal sector, and, therefore, if we want social inclusion in this matter, we have to rethink in depth how we structure social protection in the region. We must stop going down the same path of simply adding more and more programs and more and more spending without any logic or coherence in what is being done.

Q/ Do you think there are specific groups of the population where policy should pay particular attention to social protection?

Two problems are confused: informality and poverty, which are two different phenomena. Informality is simply being in a job where there are no contributory social security protections: health insurance, pension insurance, life insurance (sometimes, not always), unemployment insurance, minimum wage protection; that is informality. Poverty is having an income below a certain value that society considers indispensable to be considered as a person who can live in at least satisfactory living conditions. The informal population in Latin America, as I mentioned earlier, is more than 50%. But poverty in Latin America is not 50 % of the population; depending on the country, it is 10, 15 or 20 %. It also depends, of course, on how this poverty line is set. These are two different phenomena. Families in poverty, particularly those in extreme poverty, need to be helped by the State, not only by offering them protection against risks, but also with some kind of income transfers. And here the region was a pioneer in designing programs to transfer income, but this is only one part of social protection. In fact, the most important part would be to protect these families against disability and health risks that sometimes, when they overcome poverty, they fall back into poverty, because there is no social insurance. So, when we use the word social protection, we confuse two different issues: income transfer programs, which are indeed necessary for families in extreme poverty, and covering the entire population with social insurance, whether they are poor or not. Here we have a great challenge because, I insist, there is a conceptual confusion, there is a confusion of programs, there are duplications. And this works in such a way that the results are evident: increases in spending without improvements in protection.

Q/ In the next 30 years, this region is going to experience accelerated aging, as is already happening in Europe and Asia. And we also have a rapid technological advance that is profoundly transforming the labor market and the skills, this human capital we have been talking about. With these trends and the structural characteristics of the labor market, how can we rethink the design of social protection systems in Latin America and the Caribbean

I believe there are some important principles that can serve as a guide for rethinking and redesigning social protection. There are certain risks that are associated with the worker being in the company: if the company does not take safety measures at work or if it decides to fire the worker. So, insurance against labor risks, unemployment insurance, should be part of the relationship between the company and the worker, and companies should cover the corresponding insurance premiums. But there are other issues and other risks that have nothing to do with the company. Whether a worker gets sick or not is not essentially something that is associated with working with a company or working on one’s own account. Similarly, the longevity risk, whether an agent lives many or few years, is not very much associated with the type of company in which he or she worked. So, the general principle is that the risks that are directly associated with the company should be covered by the company, with premiums proportional to salaries. And most of the risks, such as sickness, longevity, disability or death, should be financed in a different way and have universal coverage, regardless of whether the worker is in a company or not, or part of his life is in a company and part is not.

This principle of separating risks according to their origin and matching a source of financing could be of great help in redesigning social protection. I have worked on some issues on this and two fundamental things would be achieved: first, a more effective and redistributive social protection, and at the same time, much more efficient companies from the point of view of being able to grow and adjust to shocks. This would help in the dimension of social inclusion and higher productivity.

Q/ What role do you imagine these multilateral organizations should play, taking into account the heterogeneity among countries and regions, and how should they be adapted to fulfill this purpose, not only from the point of view of financing, but also taking into account knowledge services or coordination among the countries themselves?

I believe that the Development Bank (BD), the Inter-American Development Bank (IDB), the CAF and the World Bank play a central role in the region and should be institutions that, hopefully, will be strengthened. You yourself pointed out, and you are right, that they play two roles. They are financial institutions that help the countries of the region, especially when there is a negative shock, to protect themselves from the international financial markets that can sometimes act erratically. The BD has clear medium-term objectives and can take risks, which international banks are sometimes unwilling to take, and help countries overcome negative shocks. This is a fundamental role, as well as providing long-term financing for projects where the risk, for example, in terms of climate change and renewable energies, is something that is difficult for the market to measure accurately. But another equally fundamental role of development banking is to help countries not only in the generation of knowledge, but also in something that is sometimes underestimated. The governments of the regions are constantly changing, every four or five years there is a change of government and, on occasions, this instability means that public policies do not have the presence or the stability necessary to be able to yield the results expected of them.

Development Banking can help countries to build medium-term development strategies that somehow overcome the short-term ups and downs associated with changes of government, providing -regardless of the hue of the government in power- suggestions and help in the vision of public policies that will enable countries to build medium-term solutions, which is something we are sorely lacking. We have too many policy changes in the very short term.

In short, I still see, and for many decades to come, a fundamental role for the Development Bank and I insist that it should continue to be strengthened, both in financial terms and in terms of the people who work in it and its institutional framework, to generate knowledge and public policy suggestions to governments, in line with the challenges we face.

Q/ What do you think is CAF’s differentiating role in the region?

Each development institution, and I am referring to the three main ones, the CAF, the IDB and the World Bank, has its strengths and weaknesses. The World Bank can bring a global vision and can bring us lessons from something that was done well in Vietnam and something that was done badly perhaps in South Africa, and learn from the good and the bad from the rest of the world. The IDB has the advantage of being in Washington and being a bridge between the institutions and financial entities that are in Washington: the Monetary Fund, the US Treasury. It is an institution that the region perceives as totally its own, where the countries of the region are the ones in charge of CAF’s governance and, therefore, it is seen as a friendly bank, not that the others are not a friendly bank, but as another bank of the region itself. This allows CAF to be able to provide aid that is not tainted by these old notions that it is reflecting the Washington consensus or perceptions of nature.

This strength for CAF implies that, if it strengthens itself financially as it has been doing, and here we must congratulate the efforts made by its president Sergio Díaz-Granados and his entire team, as well as the efforts made by its research department to improve its knowledge capabilities and its ability to generate ideas for the region, such as what we are celebrating now, the 20th anniversary of CAF’s development report.

Q/ There are two global trends that we are going to raise and discuss in this publication, which are digitalization and technological change, obviously, and the concern for sustainability that motivates the energy transition. What opportunities and challenges do you see in this context for closing development gaps in Latin America and the Caribbean?

These are two very complex challenges. We know a little more about some of them; about the others, the region and the world in general have already been working for at least two decades on the energy transition and the development of renewable energies. We understand that this requires important regulatory changes in order to promote wind and solar energy. We also understand that there can be a very important public intervention to reduce the risk in innovative programs, but we have made a lot of progress, I think we have a clear direction and we can continue to move forward with financing, with better regulations and with promotion programs. The issue of technological change and the latest developments, particularly in artificial intelligence, are a bit more complex because we know less. In fact, we still do not understand artificial intelligence, and I am not talking here only about Latin America, I think this is true worldwide, exactly in the implications for the labor market and for the development of companies.

We know that more human capital and more skills will be required, but exactly whether companies will demand more people with certain skills and fewer people with others is still an evolving issue. And what this implies is that the region must prepare itself to respond with agility and pragmatism to the situations that will develop. And here we have a challenge as well, because our labor markets are not well designed to do that. Even if we ignore social protection issues, the simple need to respond to technological change and artificial intelligence alone would require changes in our vision of firing and social segment regulations, in minimum wages, in the flexibility of schedules and work spaces so that we can respond in an agile manner to these new developments.

Q/ There is a discussion at the moment about growth and inclusion as sustainable development objectives, which do not always go hand in hand. Some argue, for example, that there could be a tension to the extent that some redistributive policies would reduce incentives for growth, and others argue for spaces in which there are synergies between these dimensions of inclusion and growth. In turn, there are also spaces of synergies and tensions between both decisions, which may be specific to each country’s situation. We know that this is a very heterogeneous region. What do you think about this discussion of growth and inclusion?

I am one of those who are on the side where there are great synergies between improving social inclusion and improving growth. Sometimes, when we economists go to school, we are taught that there is a trade-off between efficiency and equity, and sometimes we are left with that idea permanently. I believe that this idea, in the particular case of Latin America -I am not talking about France, Denmark or Korea- is generally wrong. There is great room for improving equity and efficiency in the region, because we are precisely in a context where a dysfunctional, antiquated design of social protection and tax instruments, such as special regimes for companies, are simultaneously causes of social protection that does not work well and of low productivity. Therefore, if we understand these synergies, we have an immense opportunity to redesign tax systems and improve social protection systems, advancing on the side of equity and productivity. And here I believe that if we were able to have an understanding of this, beyond ideological visions and with greater pragmatism, we would have a great opportunity to advance simultaneously. I do not believe that we can have sustained growth without more social inclusion, nor more social inclusion without sustained growth. It is not one or the other, we need both.