What Can Developing Countries Learn from Developed Countries?

In developed countries, social security covers workers and their dependents against old age, unemployment, health, and other risks. In developing countries, formal-sector workers have access to social insurance, and the very poor have some access to social assistance and health services, but large population groups are not covered. Extending social security coverage would require delinking social security benefits and labormarket status; creating new institutions to cover currently excluded groups; financing these new programs through general taxation; improving tax collection; reducing the costs of formal-sector benefits; and increasing the costs of informal-sector benefits. Social security is defined in the European Union as social insurance and social assistance arrangements that protect the population against various economic risks. The U.K. definition, which includes cash benefits but excludes health services, and the U.S. definition, which includes only retirement benefits, are narrower. Social insurance denotes publicly provided or mandated contributory programs that cover workers and their dependents against major life risks—essentially unemployment, health risks, and old age. Beneficiaries receive income or services in exchange for contributions to an insurance scheme. Social assistance refers to noncontributory transfer programs that are means tested and targeted in some way to the poor or those vulnerable to poverty and shocks. Other policy instruments—in particular, progressive taxation and various regulations such as minimum wage laws and other labor market policies—help support social security. These instruments and their effectiveness should ideally be evaluated together with pension and health insurance systems and social safety net programs. Social insurance is a substitute for market mechanisms when such mechanisms are not economically viable or tend to exclude part of the population. It cannot operate like standard private insurance (where each participant pays a premium equal to the expected loss plus operating costs) and cannot be financed by actuarially fair contributions. Social security is thus partly financed through taxes levied on people irrespective of their exposure to the risks that are covered. It implies substantial income redistribution across individuals. It is mainly through that redistribution that the public coverage of old age and health risks is truly social (rather than an actuarially neutral substitute for the market mechanism). Social security has major social benefits, but it also has costs. Benefits arise from gains in efficiency and from a more harmonious and cohesive society. Costs arise from distortions generated on both the tax and the benefit sides, with additional distortions generated by non-insurance instruments (for example, by reducing the incentive to supply labor).