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Policy Brief : Work after COVID: A New Regime for Independent Workers

Eduardo Levy Yeyati and Luca Sartorio

April 2020

A specter is haunting the world: the specter of COVID-19. The ability of national states to deal with the impact of this pandemic is perhaps the most important public policy challenge in decades. In addition to the ineludible health emergency, in a context in which productive lockdowns are reproduced on a global scale, governments face the double challenge of sustaining workers’ incomes and mitigating demand shortages that deepen the economic depression.

To avoid a social debacle and stabilize workers’ labor income during the lockdown, two broad policy tools have been tested, sometimes simultaneously: job protection through soft credits and direct subsidies to firms conditioned on avoiding layoffs and, if the crisis is such that not all jobs can be preserved, income protection through the broadening and strengthening of unemployment insurance to workers.

Is this the right policy choice? In the developed world, yes. As a recent theoretical paper analyzing the economic impact of COVIC-19 suggests, in the event of a lockdown of contact-intensive sectors, “full insurance payments to affected workers can achieve the first-best allocation”.[1] However, although job protection (as opposed to income protection) may generally hinder the efficient allocation of resources (for example, by inhibiting labor turnover to accommodate changes in technology), in times of exceptional crisis a policy based solely on income protection can lead to an excessive volume of layoffs, generating permanent collateral damages from a transitory shock. Hence, the benefits of combining both employment and unemployment subsidies in the emergency.

Is this the right policy choice in the developing world? Probably, but it is not nearly enough. There is a critical shortcoming to these income-protection policies: by definition, they only cover formal salaried workers. And, in the developing world, this accounts for half of the labor force, at best. There is an important distinction, however, within this group of exclude outsiders. Whereas informal salaried workers are an anomaly that can, in principle, be contained with better monitoring, and lower labor taxes and administrative costs, the so-called “self-employed” or independent workers, is excluded legally, by design. And there are a lot of them.

Let’s put things in perspective: whereas in OECD countries only 15% of the employed is self-employed, in Latin America this number more than doubles: independents amount to 25% of total employment in Argentina, 28% in Chile and Uruguay 28%, 30% in Brazil and Mexico, and more than 50% in Peru and Colombia.

Unlike formal salaried workers, the self-employed are fully exposed to drops in their monthly earnings –in tranquil times and, much more so, during dramatic crises.

For starters, in most countries, labor benefits are tied to jobs. This makes historical sense: those benefits are the product of decades-old struggles between activity-specific unions and business chambers and, as a result, were instrumented for union insiders and, by extension, non-unionized salaried workers in the same activity. These benefits include working hours, licenses, on-the-job training and severance payments –and social security, which still is fundamentally contributory in nature in most countries and thus restricted to formal salaried employees who contribute through payroll taxes, thus deepening the inequality in access to the pension system.[2][3]

Moreover, the income instability of the independent worker is highly procyclical: in a context of a drastic activity collapse, not only do they see their hours worked –and the associated labor income– reduced; as noted, none of the income-stabilizing measures listed above protects them, pushing the independent worker to the welfare line.

Protect people, Austrian style

In 2003, Austria implemented a reform that abolished severance payments by replacing them with occupational pension accounts to which the employer generates monthly contributions (equal to 1.53 percent of the worker’s salary) to a segregated pension account that accrues to the worker only after a layoff or a quit, thus providing some limited income protection.

More precisely, upon termination of an employment relationship, the worker owns the accumulated “portable” pension wealth, which is transferred to the new employer if the worker is re-employed. Otherwise, access to the funds is regulated to avoid depleting the pension account in good times: they are available only after three years of tenure, and could be drawn in case of a layoff, when firm and worker agree to terminate the relationship, or after the end of a temporary contract. By contrast, when the worker quits her firm (or is dismissed for misconduct), he keeps the claim but cannot withdraw the money, to avoid misuse or fraud.

This scheme can be easily extended to independent workers, in a way that allow them to save for the rainy days much in the same way as the Austrian worker does while on the job. Indeed, the Corporate Staff and Self-Employment Provision Act of January 2008 broaden the coverage of the Austrian scheme to include self-employed and freelancers. Since January 1, 2008, Austrian employers are required to pay 1.53% contributions to a self-employment provision fund for freelance employees.

More in general, one could imagine a new Regime for Independent Workers under which registered workers set a benefits account to which, for each payment that the worker receives, a proportional sum is transferred directly by the payer. How much will depend on the scope of the coverage. For example, it would be natural to allocate some money for sick and maternity leaves and holidays, in addition to unemployment insurance. It should not be difficult to establish categories by, say, a 12-month moving average of labor earnings, and to estimate declining contribution factors based for each of those brackets to account for the fact that the pension account is meant to secure an income floor. Similarly, while a time tenure may not apply in all cases, withdrawing rules can emulate the Austrian model: money from this account would be withdrawn only if the worker´s registered income in a predetermined period of time falls below a threshold level.

A “grey zone” regime: The case of faux independents

A frequent problem in countries with a high proportion of independent work is the “false” or “bogus” self-employment which refers to cases in which firms misclassify what should otherwise be an employment relationship as a relationship between a firm and an independent contractor to avoid taxes and regulations. Many workers lie in this “grey zone” between employment and self-employment: presumably, they choose when and where to work but, in reality, they are economically dependent from a unique “client” in a liaison virtually indistinguishable from formal salaried employment. These situations are often the result of deliberate illegal practices to avoid employment-related charges and hiring bans, both in the private and the public sectors –it is also close, albeit not identical, to the particular case of the drivers working for raid-hailing companies.

Addressing this loophole, many countries have extended social protection to individuals in this situation (OECD, 2019). In 2012, Portugal broaden unemployment protection to “dependent” self-employed workers. The criteria established to determine a “dependent self-employed person” was that at least 80% of the worker’s annual income has come from a single client (and in 2018, the criterion was reduced to 50%, further expanding coverage). On the other hand, Spain has a labor category called “economically dependent self-employed worker” (TRADE, for its acronym in Spanish) that allows access to social protection like health and accident insurance, pensions and unemployment benefits to workers whose income depends on a single client in more than 75%.

The strengthening of these intermediate figures is the natural way to extend benefits to faux independents and, coupled with the new regime proposed here, should fill in gaps of a labor benefits net for the whole span of independent workers.

A badly needed second best

Remedies to include no salaried workers are not without their disadvantages. For example, the Austrian model can generate financial inefficiencies: if a worker maintains a long-term relationship with an employer, funds accumulate in an occupational pension account that could otherwise be used for consumption or investment decisions. However, if the regime addresses this caveat by allowing employees to withdraw funds after a certain contribution period while still employed, excessive withdrawals may weaken the income coverage upon termination of employment –something not unusual in the Austrian experience (Hofer, Schuh & Walch, 2012). Withdrawal conditions should carefully balance these two risks.

Similarly, a “grey zone” regime can be used perversely by firms to mask salaried relationships. Eligibility criteria must be clearly defined and easily identifiable since vague definitions of “dependent self-employment” come at the risk of creating two rather than just one gray zone: one between “employees” and this “third category” of workers; and one between this “third category” and the self-employed (OECD, 2019).

That said, nothing can be more damaging to the independent worker´s wellbeing than inaction. Indeed, the COVID-19 pandemic only highlighted the huge inequalities in the safety nets between developed and developing countries, in particular, those arising from the prevalence of independent workers in the latter group. This crisis will surely widen the schism between countries and, within countries, between insiders and outsiders of the labor force. This duality should not addressed as part of the policy response to the crisis. If not, regardless of the size of the income-protection policies that developing countries can afford, disparities in labor markets will deepen the toll of the corona crisis on poverty and inequality.

 

[1] Guerrieri et al. (2020), “Macroeconomic Implications of COVID-19: Can Negative Supply Shocks Cause Demand Shortages?”, NBER Working Paper No. 26918.

[2] In those cases, the employee can choose between receiving the severance payment all at once or applying it toward a future pension. See Kettemann, Kramarz & Zweimüller (2017).

[3] More recently, as countries try to mitigate this inequality by introducing a pillar of universal benefits, the divide between contributing salaried workers and non-contributing independent ones deepens the structural imbalances between contributions and benefits within the system, increasing the contingent social security debt.

 

References

Guerrieri, V., Lorenzoni, G., Straub, L., & Werning, I. (2020), Macroeconomic Implications of COVID-19: Can Negative Supply Shocks Cause Demand Shortages? NBER Working Paper No. 26918. National Bureau of Economic Research.

Hofer, H., Schuh, U., & Walch, D. (2011). Effects of the Austrian Severance Pay Reform. Reforming Severance Pay, 177. In Holzmann, R., & Vodopivec, M. (Eds.) Reforming severance pay: an international perspective (pp. 177-194). The World Bank.

Kettemann, A., Kramarz, F., & Zweimüller, J. (2017). Job Mobility and Creative Destruction: Flexicurity in the Land of Schumpeter. University of Zurich, Department of Economics, Working Paper, (256).

OECD (2019), Policy Responses to New Forms of Work, OECD Publishing, Paris.

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