Informality, the State and the Social Contract in Latin America: A Preliminary Exploration

Article excerpt

Abstract:

This article sees informality in Latin America as a reflection of dysfunctional interactions between individuals and the State and of the latter's inability to perform adequately in regard to redistribution and the provision of public goods and services. This translates into low rates of social security contribution and coverage; pervasive evasion of tax, labour and business regulations; and low levels of tax collection, law enforcement and trust in the State. The challenge for these countries, the authors argue, is to build more inclusive social contracts underpinned by realistic domestic consensus, taking account of country-specific institutional backgrounds and prevailing social norms.

This article contributes to a research agenda covering different aspects of the complex problem of informality in Latin America. One can look at informality as a labour market phenomenon and focus on the changes that would be required in the productive structure or in tax and labour legislation to reduce the share of informal employment. One can also look at it from the point of view of the firm, and focus on the effect of business regulations on the cost of registration and the likelihood that a firm will become "formal". The aim of this article is to look at these issues from a different, complementary and (in a sense) broader perspective. This perspective sees informality not as a problem in itself, but as a reflection of deeper fractures and systemic malfunctions in Latin American societies, with multiple manifestations in the economic and social spheres. We believe that many countries' very high levels of informality and their increase in recent years cannot be understood by looking at parameter changes in the "traditional" margins that economists tend to focus on when studying labour market informality, product market informality, or social security contributions.

Many of the features that can be observed in Latin American countries today - and which relate to different notions, dimensions and measures of informality - are indeed a reflection of broader systemic failures. Such features include:

* low levels of participation in the social security system;

* low coverage of many social insurance schemes, especially among poor people;

* a large number of small firms (and larger ones) partially or completely evading tax, labour and business regulations;

* low and uneven enforcement of laws;

* exclusion from access to property rights, judiciary services and other public services;

* low quality of many state-provided social services (such as health care or education);

* opting out of publicly provided social services by the rich;

* low levels of trust in the State and in the fairness of dominant anangements;

* low levels of tax collection, due to low compliance and small tax bases.

Each of these features is in itself a reflection of a dysfunctional interaction of individuals and groups with the State that is, in turn, intimately linked with the latter's inability to perform effectively and equitably its main roles, i.e. provision of public goods, protection and redistribution. Seen from a less state-centred perspective, these features also reflect dysfunctional social equilibrium among citizens. In other words, several aspects of informality are ultimately a reflection of the way individuals interact with the State and with each other - that is, of the degree of "formalization" and inclusiveness of each country's social contract.

This article follows a common (and loose) usage of the expression social contract to refer to some degree of societal consensus over some basic aspects of the operation and role of the State vis-à-vis the private sector, for instance with regard to its fiscal and social protection systems. In the words of Lledo, Schneider and Moore (2004, p. 47): "Much of Latin America lacks an (implicit) social contract between governments and the general population of the kind that is embedded in taxation and fiscal principles and practices in politically more stable parts of the world. …