Chapter 4. Towards more formal jobs and economic activities in Peru

To promote itself to a high-income country, Peru must address the pervasive, persistent issue of informal economic activity and employment in the country. This chapter analyses informality in Peru and provides policy recommendations to mitigate the negative impacts of informality and promote more formal jobs and economic activities. Informality generally involves lower job quality and labour conditions, leaving many workers in vulnerable situations. Costs of formalisation, linked to both wages and non-wage labour costs, only partly explain informality in Peru. Low productivity levels, strongly associated with low skills levels, mean workers are not sufficiently productive to overcome the current costs of formalisation. Coupled with an economic structure concentrated in low value-added sectors, where informality is the norm, there is little opportunity or incentive for formal job creation. Peru must revise, design and implement strategic short- and longer-term policy actions to redress the underlying structural causes and consequences of informality.

Informality in Peru is high and persistent, with a pervasive impact on economic activity and on jobs. More than two-thirds of workers and almost 90% of firms are informal. Although informality has decreased, it remained high throughout the most recent period of economic expansion and progress and continues to stand among the highest in Latin America and the Caribbean. The negative impact informality has on jobs, firms and the overall economy make it one of the main barriers to inclusive development in Peru.

Informality is a complex, multi-dimensional phenomenon, both cause and consequence of the low levels of development in Peru. The broad concept refers to all economic activity that happens outside of government regulations, whether by evasion or by being beyond the scope of regulation. Weak institutional frameworks, the costs associated with formalisation, the large size of low-productivity sectors and certain cultural and socioeconomic conducts common among economic agents are some of the most relevant drivers of informality. In turn, informality has a pervasive impact on economic efficiency and productivity, tax collection, firm development and job conditions, among other consequences.

In order to promote more formal jobs and economic activity in Peru, it is crucial to better understand the complexity of this phenomenon in the country – its main causes and consequences. This chapter presents a set of strategic recommendations to increase formal jobs and economic activities while mitigating the negative impact of informality on job conditions. The first section describes informality in Peru. The second and third sections analyse its main causes. Together with an economic structure that does not generate sufficient formal job opportunities, the costs and barriers associated with formalisation, and the low levels of productivity and skills are relevant drivers of informality. The fourth section concerns the need to mitigate the impact of informality, mainly on health and pension coverage for informal workers. The chapter concludes with strategic recommendations to promote more formal job creation and economic activities and improve overall working conditions.

Informality is a long-standing, multi-faceted barrier to inclusive development in Peru

Informality is pervasive in Peru, at the centre of a cycle linking low-productivity, low-quality jobs and limited state capacity. Its causes and consequences are complex, making it particularly difficult to address with public policy. This section aims to better understand the concept, causes and consequences, and the scope of informality among both firms and workers, by disentangling this highly prevalent, multi-faceted and decades-old phenomenon that so encumbers inclusive development in Peru.

Informality is a complex phenomenon with multiple causes and consequences

In economic terms, informality refers to informal economic activity and informal employment. Informal economic activity encompasses that which happens unrecognised by the state and, therefore, does not follow the registration, recording or taxation regulations it would otherwise. Similarly, informal employment refers to that not under the protection of labour law and social security regulation. These broad descriptions encompass a range of activities and jobs, prompting much debate over the years about what constitutes informality and how to measure it. This review follows the definitions used for official statistics in Peru, which are based on those endorsed by the International Conference of Labour Statisticians (ICLS) (Box 4.1)

Box 4.1. Defining and measuring informality in Peru

The ICLS has adopted two definitions for measuring the importance of informality. The 15^th ICLS adopted a definition of “informal sector” in 1993 using production unit characteristics. The 17^th ICLS adopted a definition of “informal employment” in 2003. Together, they compose the “informal economy”, as defined by the International Labour Organization (ILO) in Recommendation 204 on the Transition from the Informal to the Formal Economy (ILO, 2013).

The informal sector constitutes all unregistered and/or small-scale enterprises that produce goods or services for sale or barter and operate with the aim of providing income to their owners and employees. Small enterprises are included in this definition, as they are often exempt from employee registration and are unlikely to be taxed or subject to the enforcement of labour laws. The definition leaves significant latitude to individual countries to define the relevant criteria (size of enterprise, incorporation status, employee registration, etc.). In practice, measurement often excludes agricultural activities due to difficulties in data collection (Hussmanns, 2004), in particular ascertaining whether agricultural household produce is for the market or for consumption (subsistence agriculture is not considered part of the informal sector).

Informal employment includes all jobs which are “not subject to national labour legislation, income taxation, social protection or entitlement to certain employment benefits (advance notice of dismissal, severance pay, paid annual or sick leave, etc.)” and includes “unregistered employees who do not have explicit, written contracts or are not subject to labour legislation, workers who do not benefit from paid annual or sick leave or social security and pension schemes, most paid domestic workers employed by households and most casual, short term and seasonal workers”. All employment within the informal sector is considered informal. Informal employment also includes all contributing family workers, employees in informal jobs in the formal sector, members of informal producers’ co-operatives and own-account workers producing for the household. Informal employment is, therefore, composed of employment in the informal sector, informal employment within the formal sector and certain types of employment in households (informal domestic work and own-account workers producing for the household).

Methods of measuring informality vary by country. Some countries measure the informal sector by non-registered enterprises, while others use employment size. Others employ a combination of both. Measuring informal employment also varies by country, some using as the main indicator lack of social protection and others using the existence of a contract, among other means.

This chapter follows the official definitions of informal sector and informal employment set out by Peru’s National Institute of Statistics (INEI). According to INEI, the informal sector refers to all unincorporated productive units not registered with the National Tax Administration (SUNAT). All unincorporated enterprises in the primary sector are considered informal. Informal employment includes all workers who present one of these conditions: 1) firm owners or self-employed workers with a unit of production that is part of the informal sector; 2) salaried workers with no social security financed by the employer (measured, in practice, by affiliation and payment of health insurance contributions); and/or 3) contributing family workers, regardless of the formal or informal nature of the productive unit that they work in (INEI, 2014a).

The impact of informality is multi-faceted and extensive, taking a toll on the economy, firms and workers alike. For the overall economy, informality results in economic inefficiencies, reduced growth and decreased productivity. Eventually, these affect government revenues through lower taxation and smaller business growth, reducing the public sector’s ability to provide public services, such as education, health care, social security and infrastructure. For firms, operating in the informal sector precludes access to capital from financial institutions and credit markets, restricting growth domestically and internationally of itself and by the diversion of earned revenue towards costs associated with informality, such as penalties or bribes. Formal firms are also affected, as they face competition from informal firms with potentially lower production costs by not complying with labour, security or quality regulations. Finally, informal workers are affected directly by the poor working conditions and lack of benefits, job security and access to training associated with informal employment. In addition, informal jobs are generally low-productivity, low-wage jobs from which the transition to formal employment is difficult, in terms of proven employment history and skill levels, thereby cementing persistence in poverty and exacerbating socioeconomic inequalities, given that informal employment mostly affects disadvantaged groups and those forced to accept any available employment to meet mere subsistence-level needs.

The complexity of informality derives mainly from its multiple drivers and the fact it is both cause and consequence of many of them. That cycle represents various pitfalls for development. The variety of causes are difficult to disentangle and make its analysis, and the mitigation of its pervasive impacts, particularly difficult. Moreover, the disparity in the definition and measurement of informality in economic literature (Kanbur, 2009) makes drawing inference from international experience and research a complicated exercise. Informality is the consequence of some specific institutional factors, such as the costs of formalisation, which can probably be dealt with by adopting specific cost-reducing policies. However, it is also the consequence of broader structural issues, such as a country’s low labour productivity or large agricultural sector or the predominance of micro and small firms. These correspond to a set of drivers of informality that needs to be dealt with over a long period of time and that demand policies with a broad scope of action.

Drawing up a policy agenda to address informality in Peru requires a consideration of the many different types of workers and firms that make up the informal economy and what drives each of them to operate informally. While broad policy statements can be made about informality, policy actions will need to be directed at specific groups, such as small firms, domestic workers, undeclared workers, independent workers, informal employees, informal mining operators, etc. The specific policy stance towards these different groups is also bound to vary, depending on country preferences and the consequences of their actions.

Informality is a widespread, long-standing phenomenon in Peru

Informal employment in Peru remains high and has persisted over time. It reached 72.8% of total employment in 2014 (INEI, 2015). At 68.8% when using the ILO definition applied to non-agricultural employment,1 it is one of the highest in Latin America and the Caribbean, well above some benchmark countries (Figure 4.1, Panel A) (OECD, 2015a). Informal employment has been persistently high in Peru, even throughout the recent period of large economic expansion, when it dropped from 79.9% in 2007 to the current 72.8% (Figure 4.1, Panel B) (INEI, 2015). Most of this reduction took place in urban areas, while in rural areas, informal employment is particularly persistent. Without further action this persistence could continue, and informal employment would be placed at 50% by 2030 according to some estimations (CEPLAN, 2016).

The incidence of informal employment is unequal across socioeconomic groups. It is higher among young workers (aged 15 to 29) and older workers (ages 65+), women, those with lower levels of education and those living in rural areas (OECD, 2015a). Among the young, informality is high for all groups and particularly high for those living in poor households. For young people aged 29, approximately eight out of ten workers are informal among those living in extreme poverty households. The rates are seven out of ten among those moderately poor and five out of ten among those living in vulnerable households (Figure 4.2).

The decline in informal employment, although limited, can be partly attributed to economic growth. Strong economic growth in Peru, particularly since 2002, led to a 44% increase in output per worker in the period 2004-12, accompanied by a modest reduction of informal employment. However, economic growth has not drastically reduced informality, likely because growth has been concentrated in sectors with high levels of productivity but little job creation. Most job creation occurred in low-productivity sectors under informal conditions (see section on productivity and economic structure). In fact, despite a net creation of formal jobs accompanied by a decreasing rate of informality in new jobs, which have been mainly formal, the trend represented a small share of total employment, and the elasticity informality-economic growth, which reflects how much impact economic growth has on the reduction of informality, has remained low in Peru (Céspedes, 2015).

Institutional changes in Peru have been another source of reduction in informal employment. These include a new obligation, as of 2007, to submit to SUNAT an electronic payroll with information on workers, pensioners or service providers, among others – information previously submitted to the Ministry of Labour. Given the greater detection capacity of the tax authority, the new obligation strongly increased the labour authority’s capacity to monitor compliance with labour regulations. Other potential explanations for the reduction in informal employment are the introduction and extension of special health insurance regimes and the Law on Small and Medium-sized Enterprises (SMEs) approved in 2003 (ILO/Formalización de la Informalidad en America Latina y el Caribe [FORLAC], 2014).

Because informality in Peru is caused by diverse and sometimes structural factors, the response must be multi-dimensional. As seen, Peru has experienced only a slight reduction in informality in the economy, even over a long period of strong growth. This persistence suggests that the drivers are complex and involve both circumstantial and structural factors. Informal employment and economic activity in Peru are very heterogeneous and manifest in different ways, requiring different policy approaches, including actions to address specific barriers to formalisation in the short term, as well as longer-term strategies to create opportunities for more formal jobs and economic activities.

Informality has many faces in Peru

Informality can take place either by choice or by exclusion. Workers and firms may make a rational choice to operate informally based on a cost-benefit analysis. They may also be pushed into informality if the conditions and costs imposed by formality preclude it as an alternative, e.g. make the job unsustainable or the firm unprofitable. Three scenarios emerge based on cost-benefit rationales: 1) informality by choice, when both firms and workers perceive the costs of formality to outweigh the benefits; 2) informality for evasion, when firms remain informal, even if the benefits of formality outweigh the costs; and 3) informality by exclusion, when workers work informally, even if the benefits of formality outweigh the costs and they would be willing to assume those costs, because there are no formal jobs available (Table 4.1).

Table 4.1. Categories of informality according to different cost-benefit scenarios in Peru, 2013
		Workers
		Cost > Benefit	Cost < Benefit
Firms	Cost > Benefit	Choice	Exclusion
	Cost < Benefit	Evasion	Optimal formality
Source: Bosch, M., A. Melguizo and C. Pagés (2013), Mejores Pensiones, Mejores Trabajos: Hacia la Cobertura Universal en América Latina y el Caribe (Better Pensions, Better Jobs: Towards Universal Coverage in Latin America and the Caribbean), Inter-American Development Bank, Washington, D.C., https://publications.iadb.org/bitstream/handle/11319/462/Mejores%20pensiones%20mejores%20trabajos.pdf.

A significant share of informal employment in Peru is not voluntary. One traditional explanation in the literature is that a large share of informal employment is the result of low levels of formal job creation so that workers do not have occupational alternatives. Some part of informal employment in Peru can be deemed involuntary or the only employment alternative available; at least 11% of workers – and up to 73.8%, if a broader definition of informal is used – can be considered informal due to lack of alternatives (Tello, 2015).

Other factors may affect the cost-benefit analysis of formalisation by firms and workers, including a certain myopia in evaluating future benefits and costs, and a lack of trust in the public sector and service provision. In fact, informality also derives from the existence of weak social contracts in Latin American countries, which in turn derive from low trust by citizens in governments and in one another, low fiscal legitimacy, and weak institutional frameworks, among other factors (Saavedra and Tommasi, 2007). The variety of approaches to categorising informality has been noted, and their delineation is beyond the scope of this report. The present analysis is limited to the two main groups: informal workers and informal firms.

Informal employment can be characterised by the employment status of informal workers. Following the INEI classification adopted in this chapter, the self-employed represent the largest group of informal workers in Peru at 41% of total informal workers; 31% are informal wage workers – either obrero (salaried labourers) or empleado (salaried employees)2 – and approximately 22% are informal family workers (Figure 4.3).

A better understanding of the socioeconomic characteristics of these informal worker demographics can guide policy actions to better support informal workers or prevent them from being informal (Box 4.2). The incidence of informality by labour status shows that 90% of all self-employed are informal, while obreros and empleados have informality rates of 74% and 38%, respectively. Salaried house workers have an informality rate of 90%. Informality is also very high among independent workers at 90%.

Box 4.2. An alternative approach to categorising informal workers by different socioeconomic characteristics

Informal workers are highly heterogeneous. Recognising that not all informal workers are poor, unproductive workers without access to more productive forms of employment is important not only to describe informal employment accurately but to determine what policies will improve welfare and reduce vulnerability.

Latent class analysis is one means of profiling groups of informal workers across different dimensions, while also accounting for their specific multiple and concurrent socioeconomic and labour market barriers to formal employment. This approach follows similar work on labour market difficulties conducted, for example, by Immervoll (2013) and Fernandez et al., (2016). The analysis focuses on characteristics of different groups (or clusters) that make up the informal sector with the aim of revealing policy-relevant information about the social and economic factors facing the groups.

The informal population (as defined by the INEI, and using the National Household Survey [ENAHO] 2014) can be classified into eight clusters. Figure 4.4 shows their distribution and features.

Overall, about half of the informal workers appear to be particularly vulnerable. Individuals in this group have a higher incidence of extreme poverty and work mostly as unpaid family workers (Clusters 1 and 2: approximately 34% of informal workers), or they are older workers with a higher prevalence of disability and chronic disease and low education (Clusters 7 and 8: approximately 16% of informal workers). The other half of informal workers consists of wealthier workers overly represented in Lima (Clusters 3 to 6: approximately 51% of informal workers), some of whom are working in the formal sector as employees with a pension system (Cluster 5, for example).

The informal sector is large in Peru and remains concentrated in micro and small productive units and in the agricultural, commerce and transport sectors. In Peru, 87% of all productive units were informal in 2012. Of these informal firms, almost all have fewer than 5 workers (98.4%), suggesting a strong association between informality and firm size. Only 1.2% of firms have between 6 and 10 workers, and 0.3% of all firms have more than 11 workers (INEI, 2014b). In addition, approximately one in three informal firms (33.8%) in the agricultural and fisheries sector are informal, while in the non-agricultural sector, most informal firms belong to the commerce sector (23.9% of total informal firms) and transport (12.2%) (INEI, 2014b).

Addressing informality in Peru will require a gradual approach that recognises that some “faces” of informality are structural and likely to persist. The large share of self-employed informal workers with low earnings are a response to the tepid employment growth the country has known. Therefore, a policy agenda to address informality needs to combine 1) a short-term agenda to deal with proximate causes of informality and encourage formalisation of firms and workers, 2) a long-term agenda to address structural causes of informality and 3) an effort to address and mitigate the consequences of informality across a number of areas, especially in social protection coverage.

Informality is largely explained by weaknesses in the institutional framework

Informality is often seen as a by-product of excessive regulations and barriers to entry into the formal sector. This is the view of the legalist tradition of informality (De Soto, 1989; Djankov et al., 2002). To what extent this logic explains informality in Peru requires an analysis of the specific regulations that apply to different groups of firms and workers, the type of incentives these create, and the costs and benefits they face for formalisation.

Business registration is the first step towards formality for firms, although not necessarily the greatest obstacle in Peru. Micro and small firms in downtown Lima report a greater disadvantage of informality, yet 75% of the firms will remain informal, even when the full cost of registration is subsidised and guidance to obtaining proper registration is offered (Jaramillo, 2013). In fact, the relative ease of attaining a business licence to operate formally in Peru compared to other Latin American countries with similar levels of informality (World Bank, 2016) suggests that there must be explanations for informal activity other than entry costs. These probably relate to the prospects of the recurrent burden attached to formalisation and/or the limited growth perspectives of these firms (Vostroknutova et al., 2015). The barriers to formality that go beyond business registration have to do mainly with tax compliance, regulation compliance and some efficiency-related considerations.

Tax regimes for SMEs can be improved to provide incentives to become formal and grow

Most SMEs are informal in Peru, and they face particular barriers to becoming formal. Costs of formalisation, like those linked to taxes and the associated book-keeping and filing procedures, can be particularly hard to overcome for SMEs, given their limited size, capacity and revenues. In an effort to bridge the barriers faced by SMEs, governments have adopted special simplified tax regimes with narrower tax bases tailored, in theory, to encourage formalisation through cost reduction and ease of compliance. Tax compliance costs average PEN 915.80 (Peruvian soles) for a business to adhere to special taxation regimes, which is a significant reduction relative to PEN 7 489.00 for firms to adhere to the general tax regime (SUNAT, 2015). These measures address the cost of tax compliance and, to some extent, special regimes have lowered efficiency hurdles for firms, but they generally do not enhance labour inspection capacities or address other regulatory hurdles.

Peru has several tax regimes targeted at a similar base, which are often redundant and bias occupational categories (Table 4.2). There is a general regime and two simplified special tax regimes for SMEs. The single simplified regime (RUS) has been in force since 2004. RUS is a presumptive tax regime open to individuals and single-owner firms aimed at encouraging small producers and retailers to become formal through the payment of a small monthly fee contingent on the level of annual sales being less than PEN 360 000 and assets being less than PEN 70 000. As a benefit, these SMEs are entitled to enrolment in and use of the Comprehensive Health Insurance (Seguro Integral de Salud [SIS]) in exchange for a single, flat tax that ranges from PEN 20 to PEN 600 per month. The second special regime for SMEs is an income tax regime (RER). It applies to small producers whose sales are less than PEN 525 000 with assets less than PEN 126 000 and fewer than 10 employees. Under this regime, firms are liable for 1.5% of net profits, compared to 28% in the general regime for corporate taxation.

Table 4.2. Tax regimes for individuals or firms with businesses in Peru, 2016
	RUS	RER	General Regime
Scheme description	A tax regime created for small retailers and producers, which replaces payment of various takes, allowing them to pay a fixed monthly fee based on their purchases and/or income. This scheme is aimed at individuals who make sales of goods or services to final consumers. Individual limited liability companies can also benefit from the RUS.	A tax regime aimed at individuals and firms with some sector restrictions.	Applies to income attained from business activities, either by a formally established firm or an individual. In general, this income is the combination of labour income and labour.
Allowances to the tax base	None	Cost of inputs to produce or maintain the source of income	Cost of inputs to produce or maintain the source of income Depreciation of equipment Research and innovation investments
Tax rates or tax liability	Tax liability varies according to the level of income: up to an income of PEN 60 000, tax liability is PEN 240; up to PEN 96 000, tax liability is PEN 600; up to PEN 156 000, tax liability is PEN 2 400; up to PEN 240 000, tax liability is PEN 4 800; up to PEN 360 000, tax liability is PEN 7 200 Includes access to the Entrepreneur SIS (healthcare system)	1.5% of net income	28% of net income
Annual thresholds	PEN 360 000 per year	PEN 525 000 per year
Other implied costs	Does not allow for tax credits due to value-added tax (VAT) and does not require bookkeeping		Requires bookkeeping consistent with international financial reporting standards
Source: OECD based on SUNAT (2016), Estadísticas y Estudios (Statistics and Studies) (database), La Superintendencia Nacional de Aduanas y de Administración Tributaria, Lima, www.sunat.gob.pe/estadisticasestudios/index.html (accessed on June 2016).

The overlap among regimes can generate perverse incentives. RER users can use invoices to deduct intermediate inputs and to recover VAT, while RUS users cannot. This turns the VAT into a de facto cost, hurting efficiency for firms under this scheme. Moreover, given the duplication and the tax benefits of these schemes, firms (single proprietor or larger) might opt for horizontal disaggregation (i.e. some firms split into two or more parts when they reach the maximum size to continue in the most advantageous tax regime), creating tax dwarfism (Inter-American Development Bank [IDB], 2013). There is plenty of anecdotal evidence supporting this claim; however, finding the supportive evidence is more elusive, given the high rate at which SMEs appear and disappear and the volatility of their incomes.

Reduction of formalisation costs to SMEs might have encouraged an increase in registered taxpayers, but the special regimes have not raised significant tax revenues. The number of registered taxpayers increased significantly during the last decade, especially users of the RUS and the RER. This was particularly the case for RER after the fiscal reform of 2007 (Decree No. 968), which raised the threshold for access and removed barriers to register in the regime. However, tax revenue collection as a percentage of GDP from these programmes remained modest, despite the increase in taxpayer numbers.

Informality remains stubbornly high for SMEs, despite these special tax regimes. A reason why SME legislation (mainly the Law on SMEs approved in 2007) has not been more effective in reducing informality among SMEs and promoting compliance is that some of its elements have not been implemented, such as the social protection regime for workers of SMEs. In addition, some of the advantages (such as the general health insurance provided through the SIS) were already accessible without having to bear the costs of formalisation.

Labour costs of formalisation represent a barrier to formality for low-income groups in Peru

In Peru, the cost of pension and healthcare programmes represent 17.5% of total labour costs for salaried workers, 10.1% of which is paid by the employee, and 7.4% by the employer. “Taxing wages in Latin America and the Caribbean” (LAC) allows a comparison of taxes paid on wages in twenty economies in Latin America and the Caribbean (Box 4.3). Relative to other countries in the region, in Peru the share of the social security burden to both employee and employer is low. Collusion between the employer and employee might arise to lessen the tax burden on both (i.e. they both agree not to contribute to pension and healthcare such that the employer reduces the total labour cost, while the employee increases the net payment in the short-run), thereby encouraging informality.

Box 4.3. Taxing wages: Estimating labour costs and tax burdens in Latin America and the Caribbean

Taxing Wages in Latin American and the Caribbean is a new high-profile report detailing taxes paid on wages in 20 LAC economies:

Personal income taxes and social security contributions paid by employees
Social security contributions and payroll taxes paid by employers
Cash benefits received by in-work families

The purpose is to illustrate how these taxes and benefits are calculated in each country and examine how they affect household incomes. The results also enable quantitative comparisons of labour costs and the overall tax and benefit position of single persons and families at different income levels.

The publication shows the amount of taxes and social security contributions levied and cash benefits received for different family types, which vary by a combination of household composition and household type. It also presents the resulting average and marginal tax rates (i.e. the tax burden).

Average tax rates show the part of gross wage earnings or total labour costs that is taken in tax and social security contributions (both before and after cash benefits). Marginal tax rates show the part of a small increase of gross earnings or total labour costs that is paid in these levies.

Informal workers earn 68% less than formal workers in Peru, thus raising the implied relative costs of formalisation for the former group. In Peru, the interaction of minimum contributions to social security programmes and the minimum wage lead to large costs of formality for informal workers at the lower end of the income distribution. The difference highlights the exclusion caused by floors mandated by regulatory schemes. This is not exclusive to Peru; it is prevalent throughout Latin American economies, with the exception of Argentina (Table 4.3).

Table 4.3. Implied formalisation costs to formal and informal salaried workers in selected countries, 2013 (employee plus employer contributions to old-age and health insurance programmes as % of wage earnings)
Country	Average cost for a formal worker (%)	Formalisation costs for an informal worker (%)
Country	Average cost for a formal worker (%)	Q1	Q2	Q3	Q4	Q5
Argentina	39.2	39.8	37.0	39.2	39.2	39.2
Bolivia	21.5	47.7	25.8	25.7	25.7	25.7
Brazil	28.0	100.7	44.7	28.6	28.0	29.5
Chile	18.5	53.7	22.4	18.5	18.5	18.5
Colombia	27.5	148.3	53.3	32.8	27.9	27.5
Costa Rica	25.3	283.7	97.6	53.6	35.1	25.7
Dominican Republic	20.1	62.9	34.5	25.9	20.5	20.1
Ecuador	15.5	51.1	24.5	18.7	15.5	15.5
El Salvador	22.5	55.8	33.0	25.0	23.5	23.5
Guatemala	9.6	46.3	29.2	20.9	14.3	11.5
Honduras	9.2	98.9	39.3	25.2	16.1	8.7
LATAM	21.2	102.7	41.9	29.0	23.6	22.5
Mexico	16.2	163.2	35.7	23.7	19.3	15.2
Nicaragua	17.7	127.1	47.2	31.9	22.3	19.3
Panama	27.7	210.5	82.7	52.0	34.7	30.0
Paraguay	22.0	80.7	38.7	26.8	22.1	22.0
Peru	20.2	118.5	36.9	23.6	20.2	20.2
Uruguay	29.4	129.8	56.8	38.0	29.9	29.4
Venezuela	11.9	29.9	14.5	12.4	11.9	11.9
Sources: OECD calculations based on IDB (2015a), Base de datos Sociómetro-BID: Sistema de Indicadores Sociales de América Latina y el Caribe, IDB, Washington, DC., available at www.iadb.org/en/research-and-data//sociometro-bid,6981.html (accessed on 7 July 2016); OECD/IDB/CIAT (2016), Taxing Wages in Latin America and the Caribbean, OECD Publishing, Paris, https://doi.org/10.1787/9789264262607-en.

In some cases, contributions to social security programmes are too costly relative to income, effectively thwarting any possibility of adhering to social security programmes by those workers. For informal salaried workers who earn an average labour income of the first decile (the lowest in the income distribution), the cost of contributing to social security programmes would be 124% of his/her labour income, rendering it unaffordable (Figure 4.5, Panel A). The cost of becoming formal diminishes as incomes rise, evidencing the positive association between higher social security contributions as a share of income and higher levels of informality within the Peruvian economy. The price of social security contributions stabilises at the level of the minimum wage (sixth decile); however, overall levels of informality remain high even after costs for social security schemes become constant. Despite lower costs, informality persists in 14% of the population, even among those in the highest income decile, again suggesting the existence of other explanatory factors for informality.

Self-employed workers with lower incomes have zero cost for formalisation, but the cost is still large for self-employed in the mid-range of the income distribution. Most informal workers are not subject to the general regime, given that a large share of them are self-employed. Independent workers in the first three deciles qualify to access the free SIS. After the fourth decile, workers have to contribute almost 90% of their income to social security programmes. This percentage declines for workers with higher income, but is still relatively high and represents a particularly large barrier to participation in social security for those in the third, fourth and fifth decile (Figure 4.5, Panel B). This creates a large gap and may create incentives to remain self-employed and not declare a share of income in order to remain with free access to SIS, which diminishes the benefit of being formal. In addition, when comparing costs of formalisation for salaried vs. independent workers (Panels A and B, respectively), the high costs of formalisation for salaried workers in low-income groups not only limits their access to social security but may also create incentives away from salaried work and towards self-employment for that group, given the free access to social security that can be enjoyed under the latter status.

There is a bias against income derived from formal employment that may encourage informality among salaried workers. This can be seen through a simulation of tax and social contributions for a taxpayer who earns PEN 60 000 annually, by tax regime (Figure 4.6). For the purposes of simplicity, let us assume that an individual abiding by formality can choose between providing a service as an independent worker or as an employee, and also that this individual can opt to provide this service as a small firm, rather than an independent individual, and so can adhere to the RUS or RER. The decision the individual faces will be influenced largely by the costs the different available tax regimes entail, namely: the fourth and fifth categories for the labour regime, and the RUS and RER for firms. The results show that the fifth category (dependent salaried workers) incurs a slightly higher cost (PEN 1 597) than the independent regime, even though they entail performing the same activity compliant with social security contributions.3 The cost difference increases to approximately PEN 10 000 relative to the RUS and RER schemes. Although the higher price of formality entitles the worker to a different set of benefits, it raises the question of how agents value these benefits. Nevertheless, under the definition of tax compliance (income tax and social security programmes), the individual is formal at very different costs, illustrating how tax schemes, in the short run, may play a role in the kind of occupational category the worker may select.

There are other regulatory costs or barriers to formalisation – such as the minimum wage or dismissal costs – that also play a role in the decision to formalise. A labour standard aimed at protecting the lowest-paid workers, it can be a cause of unemployment or informality. If set too high with respect to average wages, a great majority of the population can be excluded via the cost of social security programmes and thereby labelled informal. However, it is more relevant to analyse the impact of the minimum wage on informality by linking it to labour productivity levels (next section). Employment protection legislation (EPL) rigidity is also positively correlated with informality in Latin America and is mentioned frequently as a barrier to formal employment creation. The labour rigidities associated with regulations and non-wage costs can increase informality, especially for low-skilled workers (IDB, 2015b). EPL restrictiveness for individual dismissals is relatively low in Latin American countries and OECD economies but perceived as constraining by employers, given the lack of clarity in labour legislation regarding economic causes of fair dismissal for individual workers. However, the severance an employer is required to pay in Peru is high, compared to other Latin American countries, potentially preventing employers from entering into formal employment arrangements. In the case of dismissal, severance as a percentage of wages depends on years of employment. These range from 37.5% to 125% in the case of Peru. The corresponding range for LAC countries is 9.4% to 74.5%.

In sum, the regulatory framework creates incentives for firms to remain small and workers to be self-employed, with negative consequences to formality. In fact, the special tax regimes created to increase formality may, in some instances, have a perverse effect. Firms have incentives to remain small, given the advantages they enjoy and the significant burdens they face by growing and bearing the costs of formality. This can provide favourable conditions for small firms, that do not have the capacity to grow and create formal jobs, to remain small and continue operating informally. Conversely, firms with the potential and ambition to grow, which could be the drivers of formal job creation, may also face a disincentive to expand, given the significant extra costs they will have to bear and the unfair competition they will have to face from firms operating in the informal sector.

Informality as a result and hurdle in a low-productivity, primary-based economy

Informality is strongly linked to the structure of the economy and to low levels of productivity. Among the many drivers of informality, certain structural factors are key to explaining its prevalence and persistence. Low levels of overall productivity driven by low skills, the dynamics of job creation and atrophy, and the structure of the economy are among the critical factors. This approach to informality is concerned with supply-side and demand-side considerations. From a labour supply-side perspective, low labour productivity leads to a large share of jobs being cost-effective only in the context of informality. From a demand-side perspective, most jobs will be created in low-productivity sectors and through self-employment, mostly in subsistence and informal jobs, ultimately with little formal job creation. In this context, the large share of informality will not decrease unless productivity rises and diversification and structural change take place.

Low labour productivity is a strong barrier to formal employment

Informality is largely related to the low levels of productivity of the labour force in Peru. Although it has been growing since 2002, labour productivity in Peru has remained low in the last decades and its gap with the United States remains large; labour productivity in Peru represents 24% of the labour productivity in the United States (Chapter 2). The most direct connection between low productivity and informality is that low-productive workers do not produce enough value-added to cover the costs of being hired formally. Their production remains profitable only under informal working conditions. Evidence confirms this strong correlation between low productivity and high informality, with higher levels of informality concentrated in developing countries (La Porta and Shleifer, 2014).

Productivity levels of a large share of informal workers lead to an output per worker that does not cover minimum regulatory costs of formal hiring (i.e. the minimum wage). If labour income is used as a proxy for labour productivity, then the productivity of a significant share of workers in Peru is below the minimum wage they would need to be paid if they were hired formally. Low productivity, then, is a functional barrier to formality for this share of workers, as employers will not readily bear the costs of the formalisation of workers who do not produce enough to cover them. In fact, labour income of more than half – around 52% – of informal wage earners (dependent workers) remains below the minimum wage of PEN 750.4 The productivity of formal dependent workers appears sufficient to bear these costs. Only 7% of formal wage workers earn monthly salaries close to or below the minimum wage (Figure 4.7). Although it appears that the minimum wage is too low to be binding for most formal sector jobs, it may affect the formalisation decision of a significant share of workers. The minimum wage plays a benchmark role, which can be seen by the density of informal workers earning close to the minimum wage.

Differences in informality rates across regions are closely linked to differences in productivity levels as well as to the proportion of social security over total labour costs. There are significant differences in total labour costs and the wedges on workers’ wages (implied formalisation costs – that is, the portion of the total labour costs that goes towards paying taxes and social security contributions) between departments, urban and rural settings, and geographic areas (Figure 4.8). In general, urban settings have higher labour costs. Formalisation costs are proportional among all departments, although there is greater variance with respect to total labour costs. Informality tends to be lower in geographic locations where the total labour cost is further away from the minimum labour cost. In this regard, the presence of large, competitive, productive industries and the rich commodity resources within a department is a better indicator of higher levels of income and, thus, of higher labour costs and lower levels of informality. In these regions, social security costs represent a smaller fraction of total labour costs (Céspedes, Lovado and Ramirez, 2016; OECD, 2015a).

Upgrading skills levels is vital to break the cycle of low productivity and informality

High informality and low skills reinforce each other in Peru. Low skills levels are both cause and consequence of informality (Figure 4.9). Higher skills levels lead to higher productivity levels, which lead to better access to formal jobs and even to their creation. The correlation between the use of skills at the workplace and productivity is very significant (OECD, 2016a). By the same token, informality limits the expansion of the pool of skills as, in a context of informality, certain skills tend to deteriorate or remain limited to a low value-added range, and access to training and intermediation services in the informal sector is scarce.

In Peru, low skills and informality are strongly connected, decreasing as workers attain higher levels of education (Figure 4.10). Most workers with less than primary education are informal, and approximately 23% of workers with secondary education have a formal job. Conversely, formality is almost 70% among workers who completed higher education.

The available pool of skills in Peru is poor and disconnected from the demands of the productive sector. Results from the Programme for International Student Assessment (PISA) indicate the poor quality of education in Peru, which represents a good proxy for skills levels. An average 15-year-old student in Peru is behind the average Latin American student by the equivalent of eight months of secondary schooling and is approximately three years behind the average OECD member country student (OECD/CAF/ECLAC, 2014).

Vocational education and training (VET) is also poor in Peru; 70% of students who finish secondary education and continue with higher education choose to enter university rather than the VET system (OECD, 2015a). The disconnection between the demand and supply of skills is also large, leading to poor labour market outcomes. From the demand side, between 28% (World Bank, 2010) and 68% (ManpowerGroup, 2015) of firms face difficulties in finding a workforce with requisite skills. Despite a demand for science, technology, engineering and mathematics (STEM) skills, together with more experience and soft skills, students in tertiary education display a bias towards law, administration and business instead (OECD, 2015a). The disconnect is clear: of the nearly 2 million Peruvians with technician-level degrees, only 15% work as technicians, while only half of all technicians have completed formal training (OECD, 2016a).

Informality also limits the development of skills. First, labour market segmentation in Peru is high, and the transition from informal to formal jobs is rare. In fact, over 2007-2012 less than 4% of workers made the shift to formal employment (Vostroknutova et al., 2015). This can be harmful for skills development, as persistence at unskilled labour or low value-added tasks in the informal sector may lead to a deterioration or stultification in skills not called upon. Second, workers in the informal sector are more difficult to identify and reach with training and active labour market policies, while training at informal workplaces is almost non-existent (OECD, 2016b forthcoming).

Upgrading skills and improving their link with the productive system can raise labour productivity levels and, together with recognition of skills acquired in informal employment, favour access to formal jobs. Improving overall skills levels is critical. A curricula generally more focused on developing STEM, technical and soft skills, and a stronger connection between the education system and skills demands in the economy, are critical to raising skills levels and productivity in Peru (OECD, 2016a). Recognition and certification of skills acquired in the informal sector can be another critical area for policy action, while moving towards a national qualifications framework could be a relevant policy goal in the medium term.

The primary structure of Peru’s economy is not conducive to formal job creation

Informality is also directly linked to Peru’s economic structure, which relates to the country’s low productivity levels. An economic structure concentrated in primary and/or low-productivity sectors that employ large shares of the population in low-quality informal jobs impedes the expansion of formal employment (La Porta and Shleifer, 2014). This is the economic structure seen in Peru, coinciding with a dualist view of informality, which suggests the informal and formal sectors are largely separated, with a large informal sector consisting of many uneducated entrepreneurs running small, unproductive firms that add little value to productivity and a smaller formal sector of educated entrepreneurs who run bigger, more productive firms.

In Peru, employment is concentrated in low-productivity, informal sectors, while more productive and formalised sectors create little employment. Labour productivity varies widely across the economic sectors. Mining, finance, energy and water, and telecommunications have high labour productivity, while productivity in retail and restaurants and agriculture is particularly low. In particular, in 2013, mining was the most productive sector, with labour productivity more than 10 times the average for Peru and more than 40 times the level for agriculture. However, the few economic sectors with high labour productivity, like mining, employ a small fraction of the labour force. In contrast, retail and restaurants and agriculture employ most workers in the country and remain the lowest productivity sectors in Peru (Figure 4.11). This demonstrates both the inverse relationship between productivity and informality in Peru, and that Peru’s economy is not currently conducive to increased formal job creation.

Job creation in the recent period of economic expansion had a limited impact on formality. Between 2003 and 2013, the main structural change in employment was a movement away from the agricultural sector towards services. Most formal job creation in this period took place in the government services sector, followed by the wholesale and retail sectors, all of them sectors with productivity levels below the country average. The main source of loss of informal jobs was the agricultural sector. Overall, informal jobs accounted for approximately 60% of total job creation in the period 2002-13, with an increase in the share of formal jobs in the total economy. However, most informal job creation occurred between 2002 and 2006. After 2006, formal job creation outpaced informal job creation (Bulmer et al., 2015).

Informality also varies across sectors and geographical location, exhibiting a high correlation with agricultural activities. Departments where agricultural sectors employ the vast majority of workers exhibit higher levels of average informality and lower levels of productivity and wage earnings, reinforcing the idea that the economic structure and productivity levels are key determinants of informality rates (Figure 4.12).

A more diversified economy can support formal job creation

The noted link between informality and productivity levels, along with Peru’s economic structure, indicate productive diversification as a key policy area to promote more formal jobs in the medium to long term. Efforts to favour more formal job creation should be integrated into longer term planning, with a strong link to the broader national development strategy. Creating formal jobs requires the promotion of an economy which, from the supply side, has workers with higher levels of productivity and skills and, from the demand side, can create good-quality formal jobs to absorb those workers. This will have to be linked with the development strategy and the productive diversification strategy in a broader sense (Chapter 2).

Promoting formal job creation, boosting productivity and providing equal opportunities for all Peruvians necessitates expanded economic diversification. Several measures aimed at bolstering economic diversification should also positively affect the labour market. For instance, market regulations designed to promote entrepreneurship may result in further formal jobs and consolidate new firms and activities in Peru. In addition, improvements in the allocation of commodity-based transfers according to the level of development of Peruvian departments and investment in broad based policies to increase competitiveness should support formal jobs. In this direction, a large number of national strategic plans have been developed, some referencing the necessity to reduce informality and create formal jobs. These include the Plan Estratégico de Desarrollo Nacional Actualizado: Perú hacia el 2021; the National Plan for Productive Diversification; the National Strategy on Development and Social Inclusion: “Incluir para Crecer”; and the Agenda de Competitividad 2014-2018. In particular, a key objective of the Plan Estratégico is to increase economic diversification, boost qualified workers and lower informality. The main objective of the Agenda de Competitividad 2014-2018 is to boost competitiveness to increase formal jobs and the well-being of the population. Among its main targets for the period 2014-18, two are to increase labour productivity by 15% and to reduce informality by 5%. Recently, the Consejo Nacional de Competitividad y Formalización (CNCF) has included within its competencies a plan for formalisation.

Informality leads to lower-quality jobs and limits the reach of social protection

Informality has adverse consequences to social protection and labour conditions for informal workers and the population. As informal workers are excluded from national labour laws and social security regulations, they are less likely to have access to pensions and health insurance systems. They also face more difficult working conditions, in particular lower wages and greater difficulty in finding sufficient work.

Recent reforms have resulted in an increase in health coverage through the multiplication of avenues and subsidised programmes. The poor are targeted by programmes offering health coverage free of charge. Better-off households have greater chances of being in formal work and, therefore, enjoying social security coverage. However, a significant proportion of Peruvians in the middle of the income distribution are left outside the system.

Informality is linked to poor working conditions and underemployment

Informal jobs are generally of poorer quality than formal jobs. Not only is this the case for average earnings (see e.g. Jütting and de Laiglesia, 2009), but it is found to be the case across a range of labour quality indicators in the OECD job quality framework. This framework measures job quality in three building blocks: earnings quality, which includes the level and distribution of earnings; labour market security, which considers the likelihood of income loss; and the quality of the working environment, which, for emerging economies, is implemented on the basis of working time data (OECD, 2015b).

Informal workers earn less than formal workers

Informal workers earn significantly less than formal workers, in terms of wages, job stability and contracts. Among employed persons with a contract working more than 30 hours per week, formal workers earn hourly wages 24.3% higher than informal workers and monthly wages 22.3% higher (Jaramillo, 2013). This disparity is amplified by the fact that, of the workers considered, formal workers work fewer hours – about one day less per month (Jaramillo, 2013).

Not only are earnings lower for informal workers, they are more unequally distributed. The OECD framework’s measure of earnings quality penalises inequality, giving a much lower quality of earnings assessment for informal workers in Peru (Figure 4.13).

Informal workers face higher risks in the labour market

Unemployment risks are low in Peru but are higher for informal workers. The unemployment rate is low at 3.7% in 2014, relative to comparable countries. Moreover, duration of unemployment is also low (less than one month on average). As a result, the risk of income loss through loss of employment is very low in Peru, compared to other emerging economies, despite the lack of an unemployment insurance scheme. Despite the generally low level of labour market risk (understood as the risk of income loss due to loss of employment), informal workers are almost twice as likely as formal workers to transition to unemployment and three times as likely to abandon the labour force (OECD, 2015a).

On the other hand, informal workers are at severe risk of receiving extreme low pay. As many as 17% of informal workers earn an hourly net income below the USD 1 purchasing power parity (PPP) threshold used by the OECD (2015b) to determine extreme low pay. The corresponding figure for formal workers is much lower at 2.5%. Moreover, income support measures for able-bodied working-age people in Peru are widely insufficient to cover the risk of income loss through low earnings.

Working time patterns are also challenging for informal workers

Full-time work at a primary occupation is less likely for informal workers. While almost 40% of formal workers work between 30 and 48 hours per week at their primary occupation, only 26% of informal workers do (Figure 4.14, Panel A). Over 40% of informal workers work part-time – or between 0 and 30 hours per week – at their principal occupation, compared to just 10% of formal workers. Informal workers are also more restricted in terms of work hours. Almost 50% of informal workers work fewer than 30 hours per week at their principal occupation, compared to just over 20% for formal workers. Formal workers are also more likely to work overtime at their principal occupation; 50% of formal workers work over 48 hours per week, while only 32% of informal workers work long hours at their primary occupation. Approximately 16% of informal workers state wanting to work more hours than their usual weekly load, compared to 14% of formal workers (INEI, 2014b).

As such, informal workers are much more heavily affected by a need to work two jobs to earn sufficient income; 17% of informal workers have a secondary occupation, compared to 14% of formal workers (INEI, 2014b). To compound matters, the majority of secondary occupations are informal (93%). Even for workers whose primary occupation is formal, 81% of secondary occupations are informal (INEI, 2014a)

The pattern of working hours differs across the income distribution and between formal and informal workers. Informal workers are more likely to work short hours (Figure 4.15), but among those at higher income levels, fewer work short hours and more work long hours (over 48 hours per week). By comparison, formal workers in higher income quintiles are more likely to work full time (30 to 48 hours), and a significant proportion works over 48 hours in a normal week. These patterns suggest that the earning potential of informal workers heavily influences the quality of their jobs.

At the other end of the spectrum, a relatively large number of workers in Peru work very long hours (Figure 4.16, Panel A). About 15% of workers worked over 60 hours over the reference week.5 Long working hours are used as a proxy for poor working conditions. Domestic workers are one of the groups that systematically work long hours. The overwhelming majority of domestic workers are women (96%) and most are informal (90%). In this case, long working hours clearly signal poor working conditions. The number of hours worked by independent workers is not systematically higher than for employees in Peru, in contrast to comparable countries. In fact, formal self-employed workers are much more likely to work very long hours (36%) (Figure 4.16, Panel B). For this group, the use of long working hours as a proxy for poor job quality is questionable, as they potentially have greater agency in determining their working conditions.

Informality limits the reach of social protection

Health coverage has progressed, but coverage of informal workers remains a challenge

Health coverage remains low across Peru. As many as 31% of Peruvians do not have health insurance coverage (Figure 4.17). Health insurance in Peru is provided through contributory social security (Seguro Social de Salud [EsSalud]) as well as the subsidised Seguro Integral de Salud (SIS). Almost 40% of the population is covered by SIS, while 25% is covered by EsSalud. Other schemes insure 5% of the population. By age group, young adults have the lowest coverage, with 46% of those aged 18 to 25 having no coverage at all. The various health insurance systems that automatically cover dependents do not cover the beneficiary’s children if they are over 18, unless they are disabled or otherwise unable to work.

Informality and the prevalence of self-employment are the main causes of relatively low health insurance coverage. Of the 9.7 million Peruvians estimated to lack health insurance in 2014, only 2.6% were living in households with no active workers. Even among the poor (e.g. in the first income quintile), only 9% of citizens without health insurance are in households with no workers, a percentage that is lower the higher the income level. On the other hand, 6.3 million were living in households with no formal workers. Figure 4.18 shows coverage rates and Figure 4.19 shows the contribution of formal and informal workers to the coverage rates. The gap in coverage for formal workers is exclusively made up of independent workers;6 50% of formal independent workers do not contribute to any social security scheme.

Health protection coverage displays a U-shaped pattern, with both the poor and the better-off enjoying better coverage than the middle quintiles. This pattern is largely driven by informal workers. While 22% of workers in the first quintile are informal workers without coverage, 38% of workers in the third quintile are informal workers without coverage. At higher income levels, there are fewer informal workers. Moreover, approximately 10% of workers in the upper two quintiles are indirect EsSalud beneficiaries and work informally. Both of these conditions reinforce the U-shaped coverage pattern.

The type of health coverage differs greatly by income quintile and between income quintiles for formal and informal workers. EsSalud covers almost 70% of formal workers. The subsidised SIS, created in 2002 to cover children and older citizens without coverage and then extended to the poor and extreme poor, covers 70% of workers in the first income quintile. Other types of insurance, including private and university insurance, are more prevalent among those with higher incomes, especially formal workers, covering less than 1% of those in the first income quintile but up to 15% of those in the fifth income quintile. Over 20% of formal workers have another form of insurance, approximately half of which is through private insurance, compared to 7% of informal workers.

Smaller enterprises, which hire a larger percentage of informal workers, are less likely than larger enterprises to offer insurance. Smaller firms are more likely to be informal, as the benefits to remaining small – such as avoiding discovery by authorities and being forced to pay fines and compensation – oftentimes outweigh the benefits of expansion. Of informal workers, 92% work in firms with fewer than 20 employees, whereas 54% of formal workers work in firms with over 100 employees (INEI, 2014b). As informal firms are less likely to offer health coverage, informal workers in informal firms are less likely to have coverage; 91% of those without health coverage work in firms with fewer than 20 employees (INEI, 2014b). Additionally, health providers vary between small and large firms. EsSalud covers more workers as firm size grows, from 13% of workers with health coverage in firms with fewer than 20 employees to almost 50% of workers with health coverage in firms with 21 to 50 employees, and over 70% of workers with health coverage in firms with over 500 employees (INEI, 2014b). SIS, however, covers 45% of workers with health coverage in firms with fewer than 20 employees (INEI, 2014b).

Health coverage has progressed significantly due to universal insurance reforms undertaken in the past 15 years. Coverage progressed from 37% in 2004 to 65% in 2013 (Casalí, Cetrángolo and Goldschmit, 2015). The progressive implementation of the SIS, first aimed exclusively at poor citizens and gradually extended to other categories, played an important role in increasing coverage. More Peruvians are insured through SIS than through contributive social security since 2007. Since 2011, SIS is also accessible to a number of other categories of vulnerable workers for a small fee, subject to a means test. There are subsidised health insurance schemes for independent workers, microenterprises and entrepreneurs. The cost for independent workers is PEN 15 per month plus PEN 14 per month for every immediate family member who is covered. The cost to cover microenterprise workers is PEN 30 per month for each employee, the cost being split equally between the state and the employer. Each employee must be registered by the employer, and children and spouses can benefit as well. The success of SIS has been such that coverage rates in rural areas (where a large share of the population belongs to the target group) are higher than in urban areas.

The creation of a scheme for entrepreneurs has given new impetus to SIS. Uptake of subsidised contributive schemes has remained very low. Of all those covered by SIS – about 50% of the total population of Peru – only 2% fall under the partially-subsidised or voluntary group. Of those covered by SIS, 72% are from the original target group of poor and extreme poor, while the remainder of those covered by SIS were able to enter the programme as non-poor or through other channels. However, since 2013, operators of unincorporated enterprises who are registered tax payers in RUS are automatically granted coverage under SIS. This led to a jump in affiliation to semi-contributive regimes in 2013, from 25 000 to 224 000. However, these numbers remain small relative to the significant coverage gap.

The fragmentation of the health sector in Peru challenges coverage

The health insurance system in Peru is highly fragmented, which potentially limits its reach to certain categories of informal workers. Table 4.4 presents the main components of the health insurance system. The contributive system is the social security regime. Private providers can be contracted (at the establishment level) to provide basic care, which is financed by a partial transfer of contributions. The system also includes special regimes for agricultural workers and a voluntary regime for independents. This scheme, created under the framework of the Universal Coverage Law, was under revision at the time of writing. SIS includes as its main component a free, means-tested regime, which has been complemented by a number of specific regimes targeted at own-account workers and their families: (SIS Emprendedor), independents (SIS Independiente) and operators and workers in microenterprises (SIS Microempresas).

Table 4.4. Fragmentation in the health insurance system in Peru as of December, 2015
Regime	Beneficiaries	Contribution (monthly)	Coverage (thousands)
Contributive regime (EsSalud)			10 755
Regular regime	Formal dependent workers, pensioners, civil servants	9% of income (minimum of 9% of minimum wage	10 143
Agricultural regime	Agricultural workers: Dependent Independent	4% of income 4% of minimum wage (PEN 34)	579, of which 535 29
Voluntary regime	Independent workers, other voluntary (students, etc.)	PEN 64 (individual) and up to PEN 228 (3 or more dependents)	32
Subsidised regime (SIS)			16 773
Free regime	Poor and extreme poor	Free	16 534
SIS Emprendedor	Entrepreneur with no dependent workers enrolled in the simplified tax regime (RUS)	Free (if the entrepreneur has paid tax dues)	219
SIS Independiente	Means tested, citizens with no other insurance	PEN 39 (individual) and up to PEN 115 (3 or more dependents)	16
SIS Microempresas	Enterprises registered in the microenterprise registry: entrepreneurs and their workers	PEN 15 for workers and their family (paid by the employer)	4
Note: Coverage as of December, 2015.
Sources: EsSalud (2016), http://www.essalud.gob.pe/ Seguro Social de Salud del Perú (Peru’s Social Health Insurance), Lima, www.essalud.gob.pe/; Seguro Integral de Salud (2016).

The complex array of special regimes has failed to increase coverage significantly for microenterprises and their workers, while the free, means-tested regime has led to large increases in coverage. The uptake in independent schemes has been low, both in SIS and the social security regime. These two have significant overlap, all the more considering that the means test is not predictable for many workers as the methodology, while transparent, is complex and not easily visible to the public. Moreover, the voluntary social security regime suspended new affiliations in October 2015 (resolution 30-GCSPE-EsSalud-2015) to examine its viability, as it was being, de facto, subsidised by contributions to the regular regime. For agricultural workers, the subsidised regime is accompanied by stringent eligibility criteria (e.g. the need to present property deeds), which may go some way to explain its low uptake rate.

The articulation of the various regimes should be re-examined in light of universal coverage objectives. For example, the current system for microenterprise workers has so far not had much success in extending coverage. Although this is partly due to its late implementation, consideration should be given to whether the payment and registration requirement are consistent with the drive to extend coverage. This is particularly true considering the worker cannot directly access this system but has to be enrolled by the employer or seek coverage under the alternative system for independents, thereby fulfilling the employer’s obligation.

The progressive implementation of compulsory universal insurance needs to be accompanied by a well-articulated set of schemes that offers greater clarity on subsidy levels. The multiplicity of regimes also manifests itself in the span of coverage and even in the access to different providers. EsSalud and the SIS have different networks for health service provision. A network of service provision agreements is closing the gaps in actual service, but its effective implementation should be monitored. Current regimes offer different levels of subsidised access to health insurance, but as the example of the “regimes for independents” shows, these are not necessarily consistent.

The creation of a social regime for entrepreneurs in effect creates a single contribution for that category. Experiences in Brazil and Argentina have been positive in terms of the increased affiliation – and, to a lesser degree, contributions – attained through the SIMPLES and monotributo regimes. But in Peru this regime has appeared as if by accident through the provision of SIS, rather than by design, as a means to consolidate the fulfilment of social security and fiscal obligations. It has also not received the same degree of publicity.

The multiplicity of regimes could generate disincentives to firm growth and does create a complex overlap of eligibility conditions. Coverage for partially subsidised regimes is contingent on sales (for the microenterprise regime for new firms), number of employees (for microenterprises established before 2013) or turnover and asset value (for the entrepreneur regime), while eligibility for the subsidised independent regime depends on a relatively complex means test operated by the targeting authority, Sistema de Focalización de Hogares (SISFOH). For a microenterprise employing eight workers, going over the threshold that grants eligibility (just under PEN 50 000 in monthly sales) would imply a jump in monthly labour costs of PEN 520 in social security contributions alone.

Informality challenges pension provision and finance

Peru has one of the lowest rates of affiliation to the pension systems in Latin America. Only 40.5% of employed urban workers was affiliated to a pension system in 2013 (ILO, 2014b). While this is an improvement over the very low coverage rates of a decade ago (26.7% in 2005), the improvement has been much slower than for health coverage and has slowed down since 2010 (Casalí, Cetrángolo and Goldschmit, 2015). The low coverage of the pension system is largely driven by informality. Formal workers are much more likely to have access to pensions than informal workers. While only 16% of informal workers are affiliated to a pension system, 83% of formal workers are affiliated. Contributions are, in fact, compulsory for dependent formal workers. Since younger workers are more likely to be informal, coverage is lower for those aged 15 to 29, with 81% not covered. Coverage improves for those 30 and over, although 64% lack affiliation.

Low levels of affiliation and contribution lead to low coverage of contributory pensions. Only 34% of Peruvians aged 65 and above receive a contributory pension (AAFP, 2015). The contributory pension system in Peru is composed of two parallel systems: the defined-benefit public system (Sistema Nacional de Pensiones [SNP]) and the privately-managed defined contribution system (Sistema Privado de Pensiones [SPP]). The majority of affiliated workers are in the SPP, which was created in 1993. As a result, most pensioners who receive a contributory pension receive it from the SNP. Even for those affiliated to the pension system, contribution densities are low, with 49% of affiliated workers contributing less than half of the time spent working (Bosch, Melguizo and Pagés, 2013).

Minimum pensions exist in both systems but require long validation periods. A retiring worker has to have contributed for 20 years to receive a pension at retirement age. Given the low levels of formality and low contribution densities, this penalises workers who transit between formal and informal employment and is likely to lead to significant numbers of older people without pension benefits.

Several reforms aimed to increase coverage have not been implemented

Social pensions contribute to extending coverage. Pension 65 is a means-tested social pension for Peruvians over 65 identified as being in extreme poverty. Created in 2011, the programme covers 23% of the over-65s, making an important contribution to old-age income security. The transfer is relatively modest at PEN 125 per month, but it represents 53% of per capita rural household expenditures nevertheless (Casalí, Cetrángolo and Goldschmit, 2015).

Given the high share of self-employment in Peru, extending pension coverage to independent workers is a major challenge. The 2012 reform of the pension system (Law 29903) made pension affiliation and contributions compulsory for a subset of independent workers (in particular professional service providers). However, the policy was reversed only months after its implementation began (in September 2014). In 2014, only 14% of self-employed workers were affiliated to a pension system.

A matching contribution system is planned for Peru. The legislation to favour microenterprises established a subsidised pension regime (Sistema de Pensiones Sociales [SPS]) for microenterprise workers and operators. The SPS would receive contributions of up to 4% of the minimum wage, which the state would match with equal contributions into personal accounts. To date, this system has not been implemented. If it were to give entitlements to the same pensions as the general regime, this would imply a significant subsidy (contributions to private or public pensions regimes are 13% of wages) without a means test, as eligibility is based on not having previous affiliations to the pension system and the characteristics of the enterprise.

Avenues for extending pension coverage and preserving incentives

Incentivising pension savings while preserving incentives for formality should be a concern of pension reform and, more broadly, social protection reform that seeks to increase coverage. To this end, it is important that programmes are not systematically designed as residual – that is, requiring lack of coverage or lack of previous coverage for eligibility. It is also important to examine the effective marginal reduction in benefits from increases in income and from formalisation. Step increases in contributions can provide incentives against formalisation, in particular when there is high mobility between formal and informal work.

The coverage of non-contributory pensions could be extended. The Pension 65 social pension aims to cover the extreme poor over 65. Since the end of 2015, Pension 65 reached 500 000 beneficiaries, which is the limit set by the credits allocated. Given the coverage gap among older adults, the progressive universalisation of the social pension should be considered – that is, extending the programme to all adults above retirement age, beginning with those subsisting under the poverty line. Realising this in a financially sustainable manner would require taxing pension income and possibly progressively reducing the amount of the social pension for those receiving contributory pensions.

Avenues to incorporate independent workers into the pension system should be provided. Given the policy reversal on obligatory contributions, any policy mandating affiliation or contributions from independent workers should be matched with a greater communication effort and a design that allows for greater flexibility in payments and payment schedules so as to provide a suitable vehicle for retirement savings for independent workers. Ultimately, independent workers should be included in the system and their contributions made compulsory at a level that ensures the financial sustainability of the pension system.

The matching contribution system should be significantly revised prior to implementation. As described in law, the system would create a parallel system with significant subsidies. This alone is likely to generate adverse incentives by limiting worker mobility out of the large and largely unproductive microenterprise sector. More worryingly, the condition of no previous affiliation implies that, in order to benefit from the system, the worker would have to have been informal continuously prior to affiliation, thereby reinforcing incentives to be informal, especially for younger workers. Experience with matching contributions systems is mixed and suggests that the creation of parallel systems is generally not advisable (Bosch, Melguizo and Pagés, 2013).

Incentives for retirement savings can also be given via direct subsidies to contributions. Akin to matching contributions, subsidies to contributions can help incentivise participation in the pension system and help to decrease the cost of formality for low-earning workers. Providing public financing this way rather than by, ex-post, financing funding gaps in the pension system, contributes to providing incentives for individual workers. Subsidies could be tapered as a function of contributions or could be a fixed amount for all contributors, so that the relative weight of the subsidy is large for those with low earnings and lower (in relative terms) for higher income earners.

Conclusions and policy recommendations

Informality is a widespread and persistent issue in Peru. At 72.8%, informal employment is one of the main barriers to inclusive development in the country. Informality undermines social protection, labour conditions and the creation of better job opportunities. It affects the economy, firms and workers by reducing productivity, efficiency and competition. It also undercuts government revenues and, therefore, the quality of public services.

To promote more formal jobs and mitigate the negative effects of informality, public policy should recognise the aspects of informality that can be addressed in the short term and those more structural aspects that will require longer-term targets and plans. Four main policy areas for action are recommended to promote formal, better quality jobs and formal economic activities in Peru (Box 4.4).

Box 4.4. Main policy recommendations to promote formal economic activities and employment and mitigate the impacts of informality in Peru

1. Mitigate the pervasive impact of informality on jobs and labour conditions.

1.1 Move towards universal basic health coverage.

Implement a universal basic health package provided for free or for a fee based on existing means tests and complemented by contributory cover.
Alternatively, move towards a unique health regime, gradually unifying SIS and EsSalud coverage plans, fee structures and service provision, progressively expanding its coverage to all citizens.
Rationalise the collection of existing coverage plans and their eligibility conditions to ensure a complete set of articulated plans is available to formal workers. In particular, ensure that adequate coverage plans exist for self-employed workers.

1.2 Extend pension coverage.

Consider extending the coverage of non-contributory pensions (Pension 65); move towards universal coverage by first expanding Pension 65’s beneficiary set.

1.3 Improve working conditions.

Increase the capacity of the labour inspectorate to address issues of safety at work for informal workers and firms through provision of information; accompany their formalisation.
Provide for financial education and foster the creation of savings and insurance instruments for vulnerable groups (e.g. insurance against occupational hazards, crop insurance, etc.).

2. Promote the formalisation of jobs.

2.1 Strengthen systems of inspection and supervision.

Increase efforts to supervise informal workers in the formal sector as potential ‘low-hanging fruit’ to increase levels of formality, especially given the implementation of new tools (planilla electronica) and programmes (Programa RETO). Ensure appropriate protocols exist to exploit the various enforcement tools managed by SUNAT, the labour inspectorate (SUNAFIL) and the Ministry of Production (in particular, the REMYPE - Registro Nacional de la Micro y Pequeña Empresa).

2.2 Increase the incentives of being formal by reducing the costs of formal hiring, increasing the benefits of being formal (monetary and/or services) and making it easier (more flexible), particularly for groups where these are clearly binding.

Establish a clearly defined mechanism to determine minimum wages in order to reduce current discretion, linking its future evolution to productivity and price levels.
Explore the possibility that this mechanism incorporates the option of having a different evolution of minimum wages across regions.
Subsidise social contributions of low- and low-middle income workers.
Match contributions, combined with immediate benefits (e.g. insurance).
Provide alternatives to incorporate independent workers in the pension system, which should be compulsory again but accompanied by 1) more information and possibilities for gradual incorporation to the system and 2) allowances for specific contribution patterns (e.g. less regular contributions).

2.3 Improve communication and financial knowledge, highlighting the benefits associated to formal employment.

Associate inspection and supervision with an information campaign and counselling, along the lines of efforts for Ferias de la formalidad and Bus de la Formalidad.
Communicate the benefits of formality and the risks of informality.

3. Promote the formalisation of firms by providing incentives for and reducing the costs of formalisation.

3.1 Reduce incentives not to formalise (and to remain small, which encourages firm informality).

Simplify and reduce SME regimes; reduce current multiplicity and pervasive incentives to remain in the RUS. Align eligibility criteria for special tax, labour and social protection regimes. Reevaluate sector exclusions from special tax regimes.
Reduce the gaps in employment protection across sectors and firm sizes.
Extend the use of invoicing, including in special regimes and hitherto excluded sectors (e.g. agricultural sector); consider imposing a requirement to issue invoices.

3.2 Reduce the costs and increase the incentives of formalisation.

Reduce red tape and administrative/recurrent costs associated with formal status.
Facilitate transition to formality by a reduction (or full discount) of costs associated with the recognition of past benefits of workers that are formalised, which could be fully or partially subsidised.

4. Create the conditions for formal job creation and formal job opportunities.

4.1 Improve labour productivity through upgraded and more pertinent skills levels.

Finalise the application to the Ley de Institutos de Educación Superior to improve the quality of the technical path and its reputation.
Establish a mechanism for recognition of skills acquired in the informal sector and advance towards a National qualifications framework, following recommendations in the OECD Skills Strategy for Peru (OECD, 2016b).

4.2 Improve labour market institutions to improve matching in labour markets and increase the dynamism of the Peruvian labour market.

Reinforce the link between active labour market policies and formal jobs, mainly by strengthening programmes, such as Jóvenes Productivos, to prevent the mass entry by young people into informality, which has lasting impact on working lives.
Favour information mechanisms regarding returns to different studies; continue the expansion of Ponte en Carrera.

4.3 Link efforts to create formal jobs with broader productivity diversification strategies and skills strategies.

Co-ordinate institutional efforts to promote better-quality formal jobs with the recommendations in Chapter 2 on productive diversification and the Skills Strategy for Peru (OECD, 2016b forthcoming).
Set efforts for formalisation as a key item within the broader national development strategy to coordinate action across line ministries and agencies. Following the inclusion of a plan for formalisation within the competencies of the Consejo Nacional de Competitividad y Formalización (CNCF), the CNCF is well placed to play this coordinating role.

These recommendations were informed by the three future-state scenarios outlined in Chapter 1. This chapter concludes with an assessment of their implications to incentives, trade-offs and prioritisation of policy reforms towards increased formalisation in the case of each global trend.

In “Scenario 1: A new commodity super cycle”, there is a risk job creation linked to the commodity boom would occur in the informal sector, creating conditions that make addressing the structural causes of informality more challenging. On one hand, revenue generated from mining exports could fund policies aimed at formalisation, such as, for example, subsidising social contributions of low- and low-middle income workers or matching workers’ contributions combined with immediate benefits. However, diminished incentives for formal job creation would need to be alleviated, and policy would need to focus on the creation of formal jobs. In terms of making the most of new Chinese markets, Peru could take certain steps to ensure that jobs that are created are formal, and encourage formalisation by extending the coverage of the Law on SMEs to some sectors currently not covered, such as agriculture, and which could have a great potential for expansion and integration into global value chains.

“Scenario 2: Increasing technology and mechanisation” would entail the decline of mid-skilled jobs and the increasing division of the labour force into high-skilled and low-skilled workers. This shift, however, would also present opportunities for formal job and formal firm creation around these new technologies. In view of the dramatic impact of technology on labour, it would be important for Peru to pursue active labour market policies and skills and training, and to ensure these are specifically linked to technical education. Technology innovation centres could play a role in carrying out these functions. In this environment, policies that foster a positive environment for start-ups could lead to formal job creation.

In “Scenario 3: Rising expectations of the middle class”, improvement in public services and increased social spending puts pressure on labour costs, services and the pension system. Policy incentives to extend non-contributive social protection and pensions would be significantly diminished, while the consequences of limiting redistribution would be increased costs in the long term.

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Notes

← 1. Informal employment in non-agricultural activities is used in this case for the sake of comparability, given the international availability of this indicator.

← 2. According to the INEI, “empleado” describes a worker who usually performs non-manual work for a public or private employer for a monthly salary; “obrero” describes a worker who usually performs manual work for a public or private employer for a weekly wage.

← 3. Total labour costs are also higher for employees, since employers have to contribute to social security programmes.

← 4. Formal and informal workers’ earnings in 2014 when minimum wage was PEN 750.

← 5. The figure is not altered substantially if “normal” hours are taken instead. The former is preferred because it refers to a specific job, while normal hours for Peru are only available together for all occupations.

← 6. The definition of formal work used by INEI and this review identifies informality for dependent workers on the basis of their employers’ contribution to social security.