SOCIAL SECURITY REFORM and LABOR MARKETS : THE CASE OF CHILE

In 1981, Chile reformed its social security system. An inefficient and insolvent pay-asyou-go regime was replaced by system based on individual retirement accounts. Over the years Chile’s reform has been widely praised, and has been carefully studied by policy makers throughout the world. In this paper we focus on a neglected aspect of Chile’s social security reform: its impact on labor market outcomes, including unemployment and wages. We develop a model of the labor market where we assume that, as is the case in most emerging markets, a formal and an informal sectors coexist side by side. According to our model, a social security reform that reduces the implicit tax on labor in the formal sector, will result in an increase in the wage rate in the informal sector and will have an undetermined effect on aggregate unemployment. Results from simulation exercises suggest that in the case of Chile the reforms resulted in an increase in informal sector wages between 2 an 2.5%. These results also suggest that the reforms made a positive contribution to the reduction of Chile’s aggregate of unemployment. ____________________ * We are indebted to Manuelita Ureta for helpful discussions, and to Alejandro Jara and Rajesh Chakrabarti for assistance.