Chapter 2. Building better skills and creating formal jobs for all Panamanians

This chapter explores how labour markets can be a lever to help Panama increase equity and find a path towards inclusive growth. It argues that Panama’s dual labour market has been both the cause and a consequence of Panama’s large inequalities. Panama’s successful economic growth in the past decade has been based on a growth model that encompasses labour market inequality. While the productive tradeable service sector offers formal jobs for a few skilled workers; many low-skilled Panamanians are self-employed or informally employed in small, low-productive, non-tradeable service sector or agriculture firms. This chapter discusses a comprehensive policy package that would rebuild the social contract in Panama from a quality employment perspective. This chapter covers policies to strengthen education quality, endow workers with better skills, mitigate the perverse effects of labour informality and provide labour incentives to promote better quality jobs.

Quality employment is a key element in a country’s growth and development process. At the same time, it is central to a strong social contract, understood as a tacit pact between the state and citizens (OECD/CAF/ECLAC, 2018). Although Panama has a relatively small, young population, employment is a crucial element since it acts as a link between quality economic growth, poverty reduction and income equality.

Panama’s dual labour market is both a source and a reflection of Panama’s large inequalities. The scarcity of good employment opportunities has been one of Panama’s long-lasting obstacles to making the labour market more inclusive, displaying significant variations across levels of education, income and regions. Panama’s successful economic growth model of the past decade has reinforced labour market duality. The productive tradeable service sector – mainly financial intermediation and trade, logistics and communications activities surrounding the Canal and the Special Economic Zones (SEZs) – that led Panama’s strong growth offers formal jobs for a few skilled workers in Panama City and Colón. In contrast, many working-age Panamanians encounter severe labour-market difficulties. Most of them are self-employed or informally employed in small, low-productive non-tradeable service sector or agriculture firms in the outskirts of Panama City and the provinces.

Strong economic growth has provided new, quality employment for some low-skilled workers, mainly in construction and transport, making the labour market more inclusive. The expansion led by the productive and competitive tradeable services sector spiked the demand for both public and private infrastructure. To fulfil this demand, the non-residential construction sector grew for more than a decade at a rate that is equivalent to doubling its stock of structures every four years. Large infrastructure projects, such the expansion of the Canal, the renovation of Tocumen airport, office buildings, warehouses and telecom infrastructure, generated a demand for low-skilled workers. Between 2003 and 2017 the construction sector created one out of every five new jobs and more than doubled its labour force. As such, construction absorbed some of the labour released by agriculture and fishing and provided low-skilled workers with more productive and better paying jobs. This employment shift can probably explain some of the improvement observed in informality and inequality reduction within these years.

Yet, the demand for non-residential construction cannot grow indefinitely at a higher rate than the rest of the economy – and in fact it has already started to slow down –, presenting a risk of losing some of the progress achieved in employment, poverty and inequality (Hausmann, Espinoza and Santos, 2016).

Creating formal quality productive jobs for future generations is Panama’s main challenge in terms of poverty and inequality reduction. While the tradeable services sector has led Panama’s growth and employment story for some decades, its poor direct employment creation capacity and the economic deceleration of the past five years has raised concerns. Though Panama is still growing at a strong pace – average annual rate of 5.6% between 2013 and 2017 –, the number of people out of work in Panama rose for the first time since the 1990s, reaching 6.1%, as a result of weakening labour demand and the subsequent drop in the number of new, salaried jobs created. Likewise, informality has gone back to its pre-boom growth path. Going forward, if the economy does not change its ability to generate employment, Panama will need to grow at an annual average of almost 6% of gross domestic product (GDP) for the next ten years to create enough jobs for future generations and fulfil its demographic dividend.1

To continue on the path towards a more inclusive labour market and avoid the dual market trap, Panama has to work on a policy package that includes economic diversification and better education. Employability barriers in Panama are mainly related to scarce formal job opportunities and insufficient work-related capabilities, but also poor market regulation, lack of law enforcement and poor financial incentives to look for a job (such as low potential pay, low-quality jobs and no unemployment insurance).

The remainder of this chapter is structured as follows: it begins with an overview of employment and informality in Panama before going on to examine the main drivers of Panama’s labour market duality. These are: i) sectoral labour intensity and productivity differences; ii) firm size and self-employment; iii) pension coverage; iv) education and skills; and v) enforcement of labour laws. Assessing these drivers is key to making the Panamanian labour market strong, sustainable and inclusive, to reduce inequalities and to improve the lives of all Panamanians.

High labour market duality, informality and inequality

The high incidence of informality is one of the most salient features of Panama’s labour market. Informality is a key obstacle to making Panama more inclusive and labour productive. Although Panama’s economic growth has created more than half a million jobs since 2003, almost one-third of those jobs are poor-quality, informal jobs. Moreover, since 2012 two-thirds of all new jobs were informal (INEC, 2017). Informal workers are defined here as those workers (salaried and self-employed) who are not affiliated to social security systems (do not pay pension contributions) and therefore will not have the right to a pension when retired. Informality represents large losses for workers (in the form of social protection, low savings or upskilling), for firms and the wider economy (reducing productivity and tax revenues, for instance). Its interaction with contributory social-protection systems creates a vicious cycle: the majority of informal workers contribute irregularly, if at all, thereby weakening the systems which then provide insufficient support to workers when they need it. At the same time, insufficient savings accentuate old-age poverty.

Informality is high and affects the most vulnerable workers

The informal sector in Panama is smaller than in most Latin America countries, but large by Organisation for Economic Co-operation and Development (OECD) standards. Despite recent progress, labour informality remains higher than in other countries with similar levels of development such as Argentina, Turkey and Uruguay. In fact, in 2016, labour informality still affected around four out of ten non-agricultural workers and almost half of all Panamanian workers, especially affecting those in the lowest quintiles of the income distribution and thus contributing to inequality (Figure 2.1).

Box 2.1. Job quality in Panama

Overall job quality, a multi-dimensional concept capturing several job characteristics that contribute to the well-being of workers, is relatively low in Panama. The OECD Job Quality Framework is structured around three dimensions that are closely related to people’s employment situation: earnings quality (a combination of average earnings and inequality); labour market security (capturing the risk of unemployment and extreme low pay); and the quality of the working environment (measured as the incidence of job strain or very long working hours). These three dimensions jointly define job quality and should be considered simultaneously, together with job quantity, when assessing labour market performance. The OECD (2015a) has adapted the job quality framework to emerging economies by taking into account their labour market specificities, such as the weakness of social protection (inadequacy of benefits and low coverage of social insurance schemes), the relative high rates of working poverty, and the more limited data available for these countries.

Similar to other Latin American countries, Panama’s job quality is much lower than the OECD average in two out of the three dimensions. The results show special concern on the quality of earnings and risk of entering extreme low-pay status. Earnings inequality is particularly large in Panama. The levels of earnings inequality are more than three times higher than that in OECD countries as in most emerging economies (Figure 2.2) (OECD, 2015a).

The risk of workers falling into extreme low pay in Panama is high. Although workers in other emerging economies such as India, Mexico and Colombia face higher risk of workers falling into extreme low pay; Panama’s risk of falling into extreme low pay more than triple that of Argentina, Brazil and Costa Rica. Moreover, social transfers are not fully able to reduce this risk which translates into higher levels of overall labour market insecurity than in most OECD countries (2015a).

Informal jobs in Panama have poorer earnings quality and larger insecurity from the risk of low pay than formal jobs, similar to other emerging economies. Figure 2.4 uses the job quality framework to measure the quality gap between formal and informal jobs in Panama along two dimensions of the OECD Job Quality Framework. Although earnings inequality is similar among formal and informal workers; on average, formal workers earn more than informal workers. Thus the earnings quality of formal workers is substantially higher. Lower average earnings for informal workers are consistent with the perception that informal jobs are less productive. In addition, the analysis of upward and downward earnings mobility reveals that downward mobility is generally higher in informal jobs, whereas upward mobility is significantly larger in formal jobs. This means that workers holding informal jobs face a higher risk of wage loss as well as fewer opportunities for wage improvements.

Source: OECD Employment Outlook 2015.

The incidence of informality is much higher for workers from poor and vulnerable households, youth, and the less educated, perpetuating the vicious cycle of inequality and low productivity (Figure 2.5). In fact, labour informality and low skills are strongly connected, decreasing as workers attain higher levels of education. Almost 70% of the working population with only primary education are employed in unregistered jobs, compared with only 33% of those who attained a tertiary degree. Likewise, youth are more likely than their adult counterparts to end up in informal employment (INEC, 2017).

Inequalities in the labour market start early. Young workers from poor or vulnerable families are more likely to hold informal jobs than those from the middle class. Likewise, youth from these households leave school earlier than their peers in better-off households (Figure 2.6). At age 15, six out of ten young people living in poor households are in school; at age 30, however, eight out of ten are informal workers or inactive. In vulnerable households, six out of ten young people aged 30 are working informally or inactive. In contrast, remarkable differences are observed among consolidated middle-class households: nine out of ten of youth are in school at age 15, while six out of ten have a formal job at age 30.This suggests that a certain degree of labour market segmentation exists in Panama, making the transition from school to work a particularly relevant stage in young people’s careers and futures (OECD/CAF/ECLAC, 2016).

Box 2.2. The informality trap

Latin America’s labour market exhibits frequent flows between formal “good” jobs and informal “bad” jobs (Bosch, Melguizo and Pages, 2013). Flows out of informal jobs are more common than those out of formal jobs, as a considerable number of informal workers make the transition into formal jobs every year. Panel data capturing the dynamics of how workers aged 30 to 55 move in and out of informal employment in Argentina, Brazil, Chile and Mexico show that on average 34% of female workers and 29% of male workers who are currently in the informal sector will not remain there after a year (Figure 2.7). Almost 10% of female informal workers will move into formal jobs, and 22% of males will do so.

Flows out of the formal sector and into the informal sector are sizeable, stressing the need to place better incentives to stay in, or move towards formality. On average, 15% of workers who are currently in the formal sector will not be so within a year. Almost 10% will be informal workers a year later, compared with 3% who will be unemployed (Figure 2.7). This raises three labour policy issues in Latin America. First, formal jobs are scarce, and more quality jobs are needed. Second, unemployment benefits might not be generous enough to support the unemployed while they look for quality jobs, forcing them to take lower-quality jobs instead. And third, in some countries, the relatively high cost of formalisation for workers might encourage some of them to prefer informal types of employment.

This pattern of entering and leaving the formal sector is also evidence that informal jobs are more unstable owing to a higher risk of job loss. Informal jobs appear to be associated with a higher probability of making the transition into unemployment or inactivity than formal jobs, particularly among women. Transitions from informality into unemployment do not seem much higher for women than men, while transitions from informality to inactivity are quite high for women. Almost two out of three informal female workers who transition out of informality every year become inactive, compared with only 14% of informal male workers. Certainly, this can also result from personal choice. Women who are planning to leave the labour force soon for family reasons, for example, may be more likely to look for more flexible work, and thus self-select into informal work (OECD/CAF/ECLAC, 2016).

Overall, informal jobs seem to be a trap for most workers, particularly for youth, women and low-skilled workers, having long-term adverse effects on equity. While holding an informal job might be a “springboard” for some, it can have scarring effects for most workers’ employment prospects and future wages. Bosch and Maloney (2010), and Cunningham and Bustos (2011) found that informal salaried work may actually act as a preliminary step towards the formal sector. In fact, it might be a standard queue towards formal work, especially for younger workers, which can serve as training time and not necessarily harm an individual’s career path. However, Cruces, Ham and Viollaz (2012) found strong and significant scarring effects in Argentina: people exposed to higher levels of unemployment and informality in their youth fare systematically worse in the labour market as adults (OECD/CAF/ECLAC, 2016). Additionally, informal firms generally provide workers with fewer opportunities for human capital accumulation and are less productive (La Porta and Schleifer, 2014). All of this might thus pose an additional burden in earnings and career advancement to the most vulnerable (OECD/CAF/ECLAC, 2016).

Informality goes hand in hand with the Panama’s dual economy and dual labour market

Overall, strong and steady growth has led to job creation in Panama between 2001 and 2017 at an average annual employment growth of 3.4% (INEC, 2017). Panama has been one of the fastest-growing economies in the world over the previous decade, at double the regional growth rate. This growth has been led by the development of a modern tradeable service sector – financial intermediation and mainly trade, logistics and communications activities surrounding the Canal and the SEZs –, which mostly employ skilled labour. At the same time, both public and private infrastructure projects demanded by this growing logistics service sector have fuelled further growth through non-residential construction and created new – formal – jobs for non-skilled workers.

This period of expansion (2001-17) can be divided in three sub-periods: an initial growth period, the peak growth period, and slow-down period. Analysing only the extremes of the period does not provide a full picture of what happened with employment and job creation in Panama. As such it is important to differentiate these three stages. As overall economic growth strengthened from 2003-07, employment grew fast at an average of 4% as the employment to population ratio rose, unemployment halved and informality fell almost 3 percentage points. From 2007 through 2012, informality fell almost 7 percentage points as employment continued to grow, but both employment to population ratio progress and unemployment decline significantly slowed. Finally, since 2012 Panama’s employment rate has stagnated around 60% (population aged 15 and over) and informality has increased as a result of weakening labour demand and the subsequent drop in the number of new, salaried jobs created (ECLAC/ILO, 2016). This slowdown is also reflected in the rising unemployment rate (6.1% in the third quarter of 2017), which especially affects workers with only primary and secondary education (Figure 2.8) (INEC, 2017).

Formal job creation is still a challenge for Panama, even though employment grew during the three periods. It was only during the period of fastest economic growth and employment creation (2007-12) that informality significantly decreased. While the benefits of economic growth can trickle down to the informal, without formal employment-oriented policies, growth by itself cannot be relied upon to translate spontaneously into productive jobs and better working conditions. The pattern and sources of growth are equally important in reducing labour informality in the long run.

Growth resulted in some changes in the employment composition of Panama during the last decade, especially for low-skilled workers. The high demand for non-residential construction, and goods and services created changes in GDP composition that have been accompanied by changes in the structure of employment, in particular over the high-growth spell between 2003 and 2012. Job creation has been driven mainly by the construction and real estate as well as the trade sector – wholesale, transport and storage – retail and repair, which together account for almost two-thirds of all new jobs created in Panama from 2003 to 2017 (INEC, 2016). At the same time, there has some been labour reallocation from primary sectors to other sectors of the economy (Figure 2.9). The construction boom has demanded low-skilled workers and absorbed some of the labour released by agriculture and fishing. While construction created almost 100 000 jobs since 2003 (16% of all new jobs) and expanded its share of employment from 7% to 10%, agriculture created only 27 000 new jobs from 2003 to 2016 (5% of all new jobs) reducing its employment share from 21% to 15%. To a lesser extent, the transport, storage and communication sector expanded its share of employment from 7% to 9% and created 12% of all new jobs, although not all of them were for low-skilled labour. At the same time, employment in retail and repair also grew and surpassed agriculture and fishing in share of people employed (14.5% and 14% respectively). Still, agriculture and fishing continues to be the second largest employer in Panama even though the sector has registered low employment growth, low activity growth and a corresponding loss of share of GDP (INEC, 2017).

This employment shift can probably explain some of the improvement observed in inequality since the early 2000s. As low-skilled workers moved from agriculture to construction and transport jobs their salaries increased and informality fell. Yet, now that the construction boom is expected to decelerate and the modern service sector demanding high skills is expected to continue leading growth, there is a risk of losing some of the progress achieved in terms of poverty and inequality (Hausmann, Espinoza and Santos, 2016).

Creating formal high-quality productive jobs for future generations stands out as one of Panama’s main challenges in the next decade. While the dual economy has led Panama’s growth and employment story for some time now, it is time for other sectors to play a more important role in creating jobs.

Informality is closely linked to productivity

The most direct connection between productivity and labour 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). Panama is no exception; the least productive sectors such as agriculture and fishing, wholesale retail and repair, hotels and restaurants, and manufacturing are highly informal, and employ two-thirds of all informal workers (Figure 2.10).

Informality increases wage dispersion, negatively affecting equity. Formal workers earn, on average, significantly more than informal workers. Lower average earnings for informal workers are consistent with the consensus view that informal jobs are less productive.

The productivity level of a large share of informal workers leads to an output per worker that does not cover the minimum costs of formal hiring (i.e. the minimum wage). If labour income is used as a proxy for labour productivity, then the productivity of almost two-thirds of workers in Panama is below the minimum wage they would need to be paid if they were hired formally (plus the social security contribution costs). Low productivity, then, is a functional barrier to formality for these workers, as employers will not readily bear the costs of the formalisation of workers who do not produce enough to cover the costs. In fact, labour income of more than half of informal wage workers – around 65% – remains below the average minimum wage of PAB 423, while 47% of them remain below the least generous minimum wage in Panama of PAB 253 and 85% of them remain below the highest minimum wage in Panama of PAB 725. The income distribution of own account workers is very similar to that of informal wage workers with two out of three own account workers earning less than average minimum wage (Figure 2.11).

On the other hand, the productivity of formal workers appears sufficient to bear these costs. Only 8% of formal wage workers earn monthly salaries close to or below the average minimum wage of PAB 423 (and less than 2% of formal wage workers less than the lowest minimum wage of PAB 253). Although it appears that the minimum wage is too low to be binding for most formal 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 between the highest and lowest minimum wages (Figure 2.11).

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 (partly related to the complex minimum wage matrix) 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 2.12). In general, urban settings have higher labour costs, more so in Panama where the minimum wage matrix differentiates among urban and rural areas establishing a lower minimum wage for workers in rural areas. Moreover, although formalisation costs are proportional among all departments, 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 from the minimum labour cost (i.e. Coclé, Boca del Toro, Darién and the comarcas). In this regard, the presence of competitive and productive industries such as the financial sector or the Canal and the SZEs compared to low-productive agriculture and fishing, retail and repair, and hotels and restaurants are better indicators of higher levels of income and, thus, of higher labour costs and lower levels of informality (Céspedes, Lovado and Ramirez, 2016; OECD, 2015a).

Box 2.3. Estimating wage differentials for informal and female workers

Household data from 2016 make it possible to estimate the determinants of wages in Panama, accounting for a number of specific characteristics of the job, including characteristics of the worker, the employer and also regional differences. Such wage estimations also allow an approximation of the wage differentials that informal workers and women face on labour markets, conditional on other factors. These estimations are presented below.

The estimated coefficient for the indicator variable representing a formal worker, defined by contributing to the social security system, suggests a wage differential of 35% less than formal workers, all else being equal. In other words, informal workers on average are paid one-third less than formal workers with equal personal and job characteristics. Similarly, female workers earn a wage differential of 30% less than men (Table 2.1).

Individual characteristics that the estimations account for include age, approximated by three age groups. Relative to those aged between 29 and 64, youths earn less while older workers earn more. Educational attainments of the individual are accounted for in the estimations through five different categories. Predictably, wages are rising with higher educational attainments.

Table 2.1. Wage estimation results. Dependent variable: Log of monthly total labour income
	Coefficient estimate	Standard error
Informal	-0.347***	0.00149
Women	-0.308***	0.00137
Age under 25	-0.156***	0.00196
Age 50 to 60	-0.0135***	0.00148
Illiterate	-0.227***	0.00464
Some secondary education	0.179***	0.00196
Secondary education completed	0.345***	0.00198
Some post-secondary education	0.511***	0.00241
Tertiary education completed	0.903***	0.00219
More than 5 years with current employer	0.164***	0.00129
Public sector employee	0.313***	0.00287
Domestic employee	0.185***	0.00396
Hours worked	0.0230***	0.00005
Constant	4.616***	0.00461
Fixed effects for 12 major regions	included
Fixed effects for 21 industries	included
Observations	14 412
R-squared	0.547
Notes: , * and *** denote significance at 10%, 5% and 1%, respectively.
Source: OECD estimates based on microdata from Encuesta de Propsitos Multilpes of 2016 (INEC, 2017).

A productive transformation is needed to create more and better jobs

Informality is directly linked to Panama’s dual economic structure. On one hand, a small share of the working population – less than 20% – is employed in the high-productivity industries such as the financial intermediation sector and the modern tradeable service sector – logistics, communications, transport, trade services, and information – which mostly consist of formal jobs but create little employment. On the other hand, almost half of the population works in low-productivity, informal services and agriculture. This contributes to labour market segmentation: informal and formal sectors are largely separated, with a large informal sector consisting mainly of many poorly educated agricultural, retail or construction own account or microenterprise workers running firms that add little value, and a formal sector of educated workers who run bigger, more productive firms in the tradeable services sector.

The most productive sectors create little employment

Panama’s employment it is still concentrated in low-productivity, informal sectors. Although the construction boom created new formal jobs, two out of three workers in Panama are employed in a sector with below average labour productivity such as agriculture and fishing, retail and repair, and hotels and restaurants, a fact that might be at the core of the large income inequality in Panama (Figure 2.13). Moreover, half of the Panamanian construction workers are still employed informally, while the activity is expected to slow down. This demonstrates both the inverse relationship between productivity and informality and that Panama’s economy is not currently conducive to increased formal job creation.

Relative productivity across sectors shows some particularities of the Panamanian economy: a highly productive modern tradeable service sector, a fast-growing construction sector and a low-productivity non-tradeable service sector. The labour productivity of Panama’s financial sector and logistic sector activities – trade, repackaging services, and transportation, storage and communications – are between 2.5 and 3 times the total labour productivity (Figure 2.13). These are the internationally competitive activities that have driven Panama’s economic growth in the last two decades. Additionally, the construction and real-estate sectors have made significant gains in productivity, driven by expansion of the Canal and the renovation of Tocumen airport, office buildings, warehouses, telecom infrastructure, shopping malls and other infrastructure demanded by the modern service sector. At the same time, the non-tradeable service sector – mainly retail and repair, hotels and restaurants, education, health and social services – halves the total labour productivity of Panama but employs half of the working population. The analysis on the basis of sector-level data is limited by the level of detail available in labour statistics. For example, Figure 2.13 bundles private and public education and health services as well as all sectors in manufacturing, whose productivity levels are very different. More notably, it aggregates all trade and wholesale activities, while there are large productivity gaps between Panama Canal-related activities, the SEZs, and other types of wholesale. Likewise it considers the agricultural, livestock, hunting, forestry and fishing sectors as a whole as well as aggregate all restaurants and hotels whose productivity levels are very heterogeneous across the country under the same category.

There are significant productivity gains to be realised through labour reallocations from less to more productive sectors as well as through endowing workers with better skills (Figure 2.14). Three of the five sectors that employ the largest shares of the population (retail and repair, agriculture and fishing, and manufacturing) are among the sectors with the lowest productivity. Although labour productivity in retail and repair –the largest employment sector in Panama– has increased, it still very low (43%) compared to overall labour productivity. Similarly, labour productivity in agriculture, livestock, hunting, forestry and fishing – which has dropped in the past decade – is only 16% of the average productivity, while the sector employed 14% of the workforce in 2016 – the second largest employment sector. In addition, labour productivity in hotels and restaurants is less than half the average productivity and has great potential in a country that has natural resources to serve as a worldwide vacation destination.

Productivity gains in most major sectors in the past 13 years have been achieved with overall falling elasticity of job creation to economic growth. Figure 2.15 shows the growth in real gross value added, employment, and employment elasticity of growth across the sectors with the largest employment shares in the economy. The employment elasticity is a measure of the percentage change in employment associated with a 1-percentage-point change in economic growth. It represents a convenient way of summarising the employment intensity of growth or sensitivity of employment to output growth. As such, it can indicate the ability of an economy to generate employment opportunities for its population – as a percentage of its growth process – as well as used to track sectoral potential for generating employment (Islam and Nazara, 2000). A positive employment elasticity of growth indicates that increased output is associated with increased employment. An elasticity lower than 1 indicates that output is growing more quickly than employment, signifying both increases in productivity and in employment.

Elasticity varies considerably across sectors ranging from transport and storage, which experienced the most job-friendly growth, to agriculture, which has seen a reduction of its workforce. Most of the big actors in the services sector, including construction, real estate, trade and wholesale, transport, storage and communications, have generally been employment intensive during the past decade. They have also experience falling elasticity since fast employment growth was accompanied by steady productivity growth. As a result, their job creation capacity is slowing down. These sectors have created considerably fewer new jobs since 2012 compared to what happened at the beginning of the 2000s. Greater employment generation in these sectors is crucial to benefit from the demographic dividend as well as to reduce informality.

Additionally, the trend in the manufacturing, restaurant and hotel sector, and transport and storage where elasticity is above 1 and growing, is a call to attention. Manufacturing, restaurants and hotels are among the sectors with the lowest productivity in the economy – below the aggregate average – and their employment shares are growing; a further fall in productivity could be a cause for concern. Fostering labour reallocation towards more productive services is therefore an avenue to increase overall productivity in the economy.

Overall, the aggregate employment elasticity estimates for Panama have increased during the period of fastest economic growth. It varied from 0.44 during 2003-07 to 0.51 during 2007-12 and back to 0.43 from 2012-17. This implies that for every 10% change in real GDP, there is about 4.3% change in employment. Going forward, although stepping up the employment intensity of growth would be hard since elasticity is close to 0.5, it is the relative cost of capital vis-à-vis labour and the nature of investment demand that will determine to what extent growth would be job-creating. On a rough basis, about 400 000 new workers will need a job in the next 10 years. If Panama’s employment intensity of growth stays constant the economy will need to grow at almost 6% GDP annually for the next decade to meet the demographic dividend.

Promoting value-added economic activities to generate sustainable growth and employment

The noted link between employment, informality and productivity levels, along with Panama’s economic structure, indicate productive transformation as a key policy area to promote more formal jobs in the medium to long term (OECD, 2017). Policies that favour formal job creation should be combined 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.

Panama needs to spur economic activities so that they overtake construction and allow the country to continue growing at a sustainable pace. The country should promote more complex economic activities in the provinces to help decentralise growth and make it more inclusive (Hausmann, Espinoza and Santos, 2016; Agosin et al., 2014).

On one hand, Panama could further upgrade and expand the service sector to new activities. There is a need to increase value-added in exports, and in particular the export of services, which remains the most important component in the export profile. While exports on services represent close to 95% of total exports, the services’ value-added generated for these exports remains low compared to benchmark economies. Transitioning from infrastructure-driven growth (i.e. investments in the housing market in Panama City, the Canal and Tocumen airport) to more diversified and knowledge-driven growth requires better and higher investments in innovation. Panama began to promote innovation and to invest in science, technology and research in 2004. Promoting innovation in a small, service-oriented economy such as Panama’s is challenging. The country has managed to increase domestic research capabilities and to introduce incentives to invest in innovation. Panama is still far from achieving the critical stage to improve its innovation capacities and to score well in traditional innovation indicators consistent with its level of development (see OECD, 2017).

On the other hand, Panama could invest in value-added regional manufacturing such as agro-industry products. Panama’s exported goods have “low complexity” and share few connections with more sophisticated products. Panama’s current export basket of goods is mainly composed of low-complexity products, which comprise close to 76% of goods. High complexity products amounted only to 5% (Hausmann, Morales and Santos, 2016). Moreover, the proximity of Panama’s current export basket of goods to more sophisticated goods is low. The basket of goods remains rather isolated, clustered around raw materials and far from capital-intensive activities, where the largest potential to develop new high-value-added products lies (Hausmann, 2012). An export basket of goods that relies on merchandise that is labour-intensive to produce, and uses low levels of technology and processing, creates few linkages with the rest of the economy. In turn, the lack of linkages limits the possibilities for incorporating further value-added into the exports (OECD, 2017).

The development of international tourism is another opportunity for Panama to consolidate a diversification strategy. Foreign tourism flows have increased at an average annual rate of 9%. The core of international tourism in Panama comes from the United States and neighbours Colombia and Venezuela, with 307 458, 307 076 and 235 023 registered visitors in 2015 from a total of 1 946 290 visitors, which represents almost half of tourism. Still, Panama lags behind benchmark countries such as Costa Rica, the Dominican Republic and Uruguay which had between three to six million tourists in 2016. The emergence of tourism as a promising sector should be developed hand in hand with both the strengthening of the modern tradeable service sector and positioning of the country as a logistics hub, which will provide the perfect air and water connectivity to foster broader international tourism and territorial development. The decentralisation of tourism-related activities remains an essential objective for the government in coming years. To this end an ambitious capacity-building programme is being implemented with local municipalities.

Additionally future benefits of the Canal and the tradeable service sector should expand to other sectors and regions to increase competitiveness and equity in Panama. The sectoral shifts and rising wages in the Canal cluster underscore a larger concern about loss of competitiveness and concentration of economic activities. In addition to rising labour costs, the rising prices of intermediate goods and labour will make the agricultural, manufacturing and certain service sectors less competitive. While the Canal is a fundamental source of high-quality jobs and high salaries, there is a risk of increasing the concentration of production and exports around it unless the Canal’s direct benefits and spillovers are further expanded in Panama.

The Plan Estratégico de Gobierno 2015-2019 (Government Strategic Plan 2015-2019) anticipates the Canal will diversify activities towards energy including generating electricity, exploiting the trade of liquefied natural gas and liquefied petroleum gas, and bunkering (GRP, 2014). The expansion may allow the development of hub-spoke economies (i.e. moving cargo from smaller to larger vessels for the longer hauls). Construction of shipyards in the Atlantic entrance of the Canal for post-Panamax ships is also foreseen, as well as carrying out top-off operations for ships that do not satisfy the draught restrictions.

Furthermore, investment in infrastructure beyond Panama City is particularly necessary given the country’s geography, increasing competitiveness and fostering of local tourism. At the same time new infrastructure projects in the provinces could open up profitable opportunities, generate employment and promote local economic development.

Boosting formalisation in independent workers and firms

Informality can take place either by election or by exclusion. Workers and firms may make a rational choice to operate informally based on a cost-benefit analysis. However, 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 (Perry et al., 2007). 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 (OECD, 2016a).

Labour informality is largely explained by self-employment and small informal firms

A significant share of informal employment in Panama is not voluntary and rather a necessity for most workers involved. One traditional explanation in the literature is that a large share of informal employment is the result of low levels of formal job creation and as a result many workers lack occupational alternatives. The self-employed represent by far the largest group of informal workers in Panama at 54% of total informal workers, followed by 15% of informal wage workers who work for informal firms, 14% of informal wage workers who work for formal firms and 9% domestic workers (Figure 2.16).

The labour market in Panama is also dual in terms of employment by firm size. Almost half of total employment in Panama is composed by informal workers in micro, small, and medium-sized enterprises (MSMEs), especially dedicated to agriculture but also manufacturing, construction, commerce and transport, while most of the other half of the working population is employed in formal large firms: 43% of workers are employed in firms of less than 5 workers where informal rates are as high as almost 90%, while another 40% is employed in firms with more than 50 workers where most of the employment is formal (INEC, 2017) (Figure 2.17). In 2010, the first MSMEs survey done under the initiative for the Economic Inclusion of the Informal Sector in Panama (PASI for its acronym in Spanish) found that Panama has nearly 200 000 MSMEs that employ almost 430 000 workers, which means an average of 2.2 workers per MSME (CNC, 2010).

Almost half of the MSMEs have only one worker and constitute a quarter of the employment generated by the sector. Two–worker companies constitute 21% of MSMEs and generate 19% of employment; companies with 3 to 5 workers represent a quarter of the MSMEs and generate almost a third of the sector’s employment. MSMEs with 6 to 20 workers account for 6% of the total number of companies and 24% of employment (CNC, 2010).

Labour informality is extremely high among MSMEs and firms show different levels of compliance. Only 11% of all MSMEs pay the social security quota for all its workers and 9% pay for only some workers; while 59% of companies do not pay social security for any workers. Yet, 21% of the MSMEs employees have social security for other circumstances, for example, they are covered by the social security of their families or are pensioners (CNC, 2010).

Labour informality among MSMEs goes hand in hand with firm informality. PASI identified bottlenecks that MSMEs face to register and operate formally. As such, they classified companies by five main types of informality: (i) those that do not register workers at the Caja de Seguridad Social (CSS –- Social Security Agency) Social Security Agency (68%); (ii) those that do not pay for workers’ social security (79%); (iii) those that do not have a single taxpayer registry (67%); (iv) those that lack an operation permit (66%); and (v) those that lack the local government/municipality permit (60%). Only 6% of all MSMEs2 comply with all requisites (CNC, 2010).

A large number of informal MSMEs serve as subsistence employment for poor and vulnerable women. The majority of most informal business owners have had poor access to education – 27% did not complete secondary, 20% only finished primary school, and 15% had no education. Additionally, there is a strong gender bias in the sector: 57% of informal businesses are owned by women and 32% are owned by men, while only 10% are owned jointly. It is important to highlight that most business owners felt they made more money under the informal sector, which is particularly important as their enterprises represent between 75-100% of their household income. Their vulnerability is most evident through the fact that 40% of PASI-surveyed enterprises were unable to gain financing due to lack of collateral and are highly indebted to informal forms of finance. Moreover, almost 40% of informal business owners had previously owned an informal business, demonstrating a systemic and long-term trend (CNC, 2010).

Recent efforts to curb informality in MSMEs have focused on firm registration and have had limited results. Although there has been a lot of work done by Autoridad de la Micro Pequeña y Mediana Empresa (AMPYME – MSME Authority), few MSMEs are formal. In fact, Panama has put in place a number of measures to foster the formalisation of firms. These include a portal to ease the creation of a firm – Panamá Emprende –, training services, and fiscal incentives, such as access to financing and a two-year exemption from income tax for new micro firms with a turnover cap of PAB 150 000 (Law No. 33 of 2000) which covers over 100 000 firms. Firms in this scheme are included in a special registry that also grants them access to a number of other support services provided by AMPYME. Still, some firms, especially small and medium firms, have benefited from little reduction of overall formalisation costs.

The incorporation of productive units under Law No. 33 of 2000 is too broad. The main objective of this law is to establish a regulatory regime to promote the creation, development and strengthening of MSMEs, which it clearly defines. Medium-sized firms are defined as firms with turnover of between PAB 1 million and PAB 2.5 million. The inclusion of such firms under the small and medium-sized enterprises (SME) umbrella is debatable and can cause difficulties in the implementation of SME policy since firms with a turnover of around PAB 2 million have very different registration and operating constraints than firms with a turnover of PAB 150 000.

Moreover, innovative legislation passed in 2013 that would enable the incorporation of microenterprises and facilitate tax requirements has not been implemented. Law No. 132 of 2013, which regulates the creation of limited liability microenterprises, could also serve as a productivity-enhancing tool since it forces microenterprises to separate firm bookkeeping from household accounts.

A reason why MSME legislation has not been more effective in reducing labour informality among MSME workers is that the efforts to facilitate the inclusion of MSME workers in the social protection system has not been implemented. There have been no developments between the CSS and the institutions supporting MSMEs to foster labour formalisation. Although Law No. 33 states that the CSS and AMPYME should seek the massive incorporation of own account workers and MSME employees in the social security system, little has been done to create the appropriate mechanisms to promote labour formalisation that is financially sustainable for MSMEs and especially for independent workers. Neither Panamá Emprende nor the SME registry are explicitly linked to social security, nor to any of the special regulations for SMEs, including the payment of social security contributions, which are handled by the CSS. Moreover, the limited liability microenterprise law does not incorporate any stipulations to facilitate pension savings for owners and employees.

Simplify the tax burden for MSMEs and independent workers

MSME taxpayers of low fiscal significance in Panama undoubtedly constitute the most difficult sector to control and formalise. For the purposes of their identification and the design of a tax regime that recognises their taxpaying capacity and needs, they should be distinguished by i) their economic magnitude and ii) their economic activity. In terms of economic magnitude it is important to differentiate owners, independent workers and employees since the formalisation constraints they face are different and so is the proper policy response.

Panama could implement a simplified tax regime open to individuals, single-owner firms and micro units. This regime could encourage micro producers and retailers to become formal through the payment of a small monthly fee contingent on the level of annual sales being less than PAB 150 000 – which represents 96% of micro and small enterprises and accounts for 82% of the employment of the sector (CNC, 2010). At the same time the CSS should adapt its contribution quotes for independent workers both in terms of frequency and payment method and enforce the mandatory contribution of independents to the CSS in order to reduce labour informality and ensure that all workers have pension savings.

A simplified tax and pension scheme could serve as an attractive and efficient way to formalise independent workers – also called single-person microenterprises. Simplified regimes reduce the administrative burden and make it easier for low-income, informal taxpayers to comply with both the tax and social security regime by paying several taxes – such as the sales tax, pension and health insurance – in a single payment. The primary objective of its implementation is not to increase the collection of taxes but to reduce the regressive effect of compliance costs for small firms, avoiding overburdening the tax administration with a large number of small taxpayers whose revenue collection is very limited. At the same time, by including pension contributions it reduces the fragmentation derived from the contributory schemes of the formal/informal labour market, and promotes universal coverage of the population in the health and pension dimensions of social protection.

Earlier experience in Latin American countries shows that simplified regimes for small taxpayers should favour simplicity over equity of the system. As such, the fixed-fee system by category appears as the more advisable system since it does not require firms to fill out a complex and detailed income tax form. Categories should be defined by gross revenue or turnover in conjunction with a secondary parameter such as physical magnitude, number of employees or electricity used, as well as to distinguish between economy activities. Special regimes that are exclusively based on revenues or turnover encounter several operational problems since revenues and billing are difficult to control at such small scales. At the same time, relying solely on income can perpetrate the so-called “fiscal dwarfism” effect, forcing companies to stay small so as not to have to pay higher taxes. Finally, it is very important that simplified regimes be updated regularly (González, 2006).

Box 2.4. The simplified tax regime in South America: A labour formalisation tool

In the face of persistent informality among small taxpayers, Argentina and Brazil together with most South American countries developed simplified tax regimes to incorporated self-employed workers and microenterprises into their tax registries. Although these schemes are different among countries, they facilitate the payment of one or more taxes and ensure a minimum level of social protection (pensions for old age and/or health) to a large number of small taxpayers.

The Argentine Monotributo is a simplified tax regime that ensures independent workers and microenterprises comply with their tax obligations. In a single monthly payment it concentrates workers’ obligatory payments for social security contributions (health insurance and pension savings), income tax and value-added tax of the goods and services sold. Payments fees are fixed according to 11 presumptive categories defined on each individual worker or microenterprise’s turnover, number of employees, square metres of land used, electrical energy consumed and rent. Moreover, payments are differentiated among workers and firms that provide services from those that sell goods.

The eligibility requirements of the Argentine Monotributo are simple. Any independent microenterprise or co-operative worker with a maximum of 3 members can register under this scheme if their annual gross income is lower than ARP 1 050 000 (around USD 52 000) for those selling goods or ARP 700 000 (around USD 35 000) for those providing services. Additionally, independent worker, microfirm or co-operative cannot register under this scheme if they sell imported goods, or goods have a per unit price higher than ARP 2 500 (around USD 125).

Similarly, the Simples and the Sistema de Recolhimento em Valores Fixos Mensais do Tributos do Simples Nacional (SIMEI) schemes replace multiple tax obligations with a single payment in Brazil. The former is especially designed for MSMEs and the latter for independent workers up to an annual turnover cap of BRL 60 000 (around USD 16 500). Under the Brazilian corporate legislation, microenterprises are defined as those that have an annual gross income equal to or lower than BRL 120 000 (around USD 33 000) and small enterprises as those that register an annual gross income higher than BRL 120 000, but equal to or lower than BRL 1 200 000 (around USD 330 000).

Simples is a progressive tax based on firms’ monthly gross revenue, firms’ activity and tax on industrialised products (IPI) contribution, which offers lower rates compared to the payment of all them separately. This regime allows the unified collection of municipal, state and federal taxes replacing the payment of the corporate income tax, social contributions on net profits, social contributions paid by companies, contributions for social security financing, IPI, tax on the circulation of goods and interstate transportation services (ICMS), tax on services (ISS), and employer’s social security contribution. In addition, MSMEs under the Simples regime are exempt from paying several taxes including the contributions to social services such as Sesc, Sesi, Senai, Senac, Sebrae and the employer’s syndicate contribution.

Likewise, SIMEI replaces the federal income tax from Simples for a fixed monthly fee. SIMEI payments are composed by the social security contribution (5% average minimum wage), a flat fee of BRL 5 for the state tax ICMS and a flat fee of BRL 1 for the municipal tax ISS. Simples and SIMEI also provide access to benefits such as support for maternity, illness and retirement, among others.

All three schemes promote registration and financial inclusion. While Simples and SIMEI allow registration in the National Registry of Legal Entities, which makes it easier for enterprises to open bank accounts, make loan applications and issue bills; the Monotributo offers a one-month payment refund to independent workers and microenterprises that comply with all monthly payments during a calendar year using debit or credit cards.

Facilitate the operation of formal businesses

Panama should extend the use of methods to incorporate SMEs as well as contribute to reduce firms’ operating costs related to formalisation. Although the creation of Panamá Emprende encourages the registration of firms in Panama by introducing a computer system that automates, facilitates and reduces the time and costs of opening a new business, it does not simplify or reduce administrative and operational costs for SMEs. Efforts should be made to make AMPYME’s’ unique registry a useful tool for MSMEs. Registration in Panamá Emprende does not result in the automatic granting of benefits. Regularly updating the registry’s information as well as linking it to all the benefits enumerated in Law No. 33 of 2000 is essential to prevent the registry from becoming an extra administrative burden for MSMEs. Additionally, AMPYMEs could work on alternative ways to reduce the compliance costs of operating formally by analysing the costs and procedures MSMEs face while operating among different economic activities and regions, as well as working on ways to reduce barriers to MSMEs’ access to international goods and capital markets.

Panamá Emprende should serve as a tool to facilitate municipal licensing. Panamanian MSMEs need several municipal licensing levels and administrative procedures in order to operate. Some of these are costly, but mostly they are another level of bureaucracy for MSMEs. To relieve MSMEs from such burdens, the existing Panamá Emprende one-stop shops and online portal could be used for licensing procedures at both local and national levels. This would result in better co-ordination among national and local administrations in terms of business regulation, and also help to reduce red tape and recurrent costs associated with formal status.

Establish a clearer and simpler system to determine minimum wages

Panama has a complex minimum salary matrix. Every other year the government of Panama institutes a new minimum salary matrix though executive decree. The matrix is fixed by the national government following the advice of the Minimum Wage Commission and details the salary adjustment according to region, economic activity and size of the firm. The 2017 matrix lists 81 different hourly minimum wages that range from 1.53 to 3.47 PAB per hour. The agricultural sector has the lowest minimum wage and SEZs and airport workers the highest one.

Most of the minimum wages have increased at similar rates since the late nineties. This indicates that aggregate considerations dominate over sectoral or firm-level productivity considerations, generating a general increase of salaries. In practice, the evolution of minimum wages sets a floor to the evolution of sectoral minimum wages, which may erode competitiveness in certain industries. The reliance on national negotiations to set sectoral minimum wages is a symptom of the weakness of collective bargaining in the country.

Over the past decade, aggregate labour productivity growth in Panama has been coupled with the growth in salaries. Figure 2.18 compares growth in aggregate labour productivity (real value added per worker) with two measures of real labour compensation: national real median wage and the median of all minimum wages for urban regions. From 2004 to 2012, the minimum wage growth followed closely the growth in productivity. Yet, since 2012 it has fallen slightly below productivity. Conversely, median wage growth fell below productivity growth from 2004 to 2007 and corresponded closely to productivity from 2008 through 2016. This comparison suggests that increasing productivity appears to raise real wages for the typical worker in Panama. However, this is not the case for all workers in all sectors.

At the sector level, labour productivity growth in most sectors has decoupled from real median compensation growth. In the tradeable service sector, productivity and wages follow very different paths (Figure 2.19). In fact, in trade and wholesale, and transport and communication, for example, productivity fell after an initial spike, while wages continued to increase. This suggests that firms were not able to adjust wages to respond to the fall in productivity. Instead, they adjusted the quantity of employment as explained earlier in this chapter. On the contrary, in the non-tradeable service sector, where informality is more pervasive, wage growth remained significantly below productivity growth, implying that raising productivity is not sufficient to raise real wages for the typical worker in these industries. Both patterns suggest that there is a role for public policies to ensure that productivity gains are better shared in some industries, while not eroding competitiveness in other industries.

A clear and simple scheme to determine minimum wages is easier to implement and monitor. Complex minimum wage systems offer flexibility to tailor the evolution of the minimum wage to the conditions in each sector. However, more complex minimum wage matrices are more difficult to communicate, enforce and monitor, and require higher institutional capacity on the part of the state. In fact, they require that the members of a minimum wage board understand the characteristics of all the sectors, firms and regions. Thus, systems that are overly complex, like the one in Panama, tend to lose their effectiveness (ILO, 2017). While the minimum wage sets a floor informed by technical criteria, it should be distinguished from collective bargaining, which can be used to set wages above an existing floor. In the long run, strengthening collective bargaining at the firm or sector level would make the current complex matrix unnecessary. As working conditions would be negotiated between workers and firms and/or sectors, salaries would better reflect productivity changes guaranteeing both workers and firms profit from them.

Reduce the cost of formally hiring low-income workers

Labour supply and demand decisions are affected by taxation. Tax systems might deter employment by either diminishing the after-tax wage of employees, or increasing the employer’s labour costs (OECD, 2011a). From an employee’s perspective, larger net personal tax average rates (defined as the tax/benefit proportion of the gross wage an employee pays/receives after taking into account all mandatory income taxes and social security liabilities and cash transfer benefits) and net personal marginal tax rates (defined as the proportion of an additional unit of wage-earning income that is paid in respect of taxes and social security contributions net of additional benefits) provide greater incentives to reduce the worker’s labour supply and/or entry to the labour market. The latter is especially true for second earners. When the tax unit is the individual, the loss of tax allowances and credits on the basis of family income can discourage second earners’ labour market participation (OECD/CIAT/IDB, 2016).

Panama’s tax wedge, a measure of the difference between the labour costs and an employee’s take-home pay, is similar to that of other Latin American economies. The tax wedge on average wage earnings in Panama is 22.9% of total labour costs. This is 1.2 percentage points higher than the average in LAC countries (21.7%) but lower than the OECD average of 35.9% (Figure 2.20). The tax wedge includes compulsory social security contributions (SSCs), which for employees are 9.9% and for employers 13%. No personal income tax is paid on an average wage. While these figures are similar to those for the region they contrast with the significant income taxes paid by average wage workers in OECD economies (OECD/CIAT/IDB, 2016). On average, the higher the tax wedge, the more costly labour becomes.

Formalisation costs from labour taxes do not explain informality for most workers in Panama, especially those in the upper three quintiles of the income distribution. Overall, higher informality rates among wage earners do not relate to higher formalisation costs in Panama. This is a distinctive feature that differentiates Panama from the rest of the region. Theoretical formalisation costs are defined as the proportion of workers’ income that grants them access to health care and pension savings. The interaction of average income levels and the existence of a legally mandated lower earning threshold to participate in these social security programmes increase their price in most countries in Latin America. Yet, the existing earnings threshold in Panama is low relative to reported income, making the formalisation cost for individuals proportional (23% of the worker’s income) throughout the income distribution. On average, other factors might influence an individual’s or employer’s choice between formality and informality. These might include job security; labour regulations (i.e. monetary and non-monetary registration costs, firing costs, vacations); the value a person places on the programme or services; expectations of receiving future benefits; and a component of myopic behaviour by the individual or employer.

Introducing progressivity into SSCs and lowering SSCs temporarily for new low-paid workers could foster workers’ formalisation. Although there is little evidence that overall labour informality in Panama is the result of the high tax wedge, as is the case in most Latin American countries (OECD/CIAT/IDB, 2016), this applies mainly to the mid-to-higher end of the income distribution. Firms find the contributions to social security programmes are too costly relative to informal worker’s productivity at the lower end of the income distribution, since workers do not produce enough value-added to cover the costs of being hired formally. The total yearly SSCs for a single worker making an average minimum wage of PAB 423 per month adds up to more than three monthly average minimum salaries (PAB 1 334) a year. Likewise, the total yearly SSCs for a married worker with two children making an average minimum wage of PAB 423 per month adds up to more than four monthly average minimum salaries (PAB 1 775) a year. If SSCs are lowered for low-paid workers to promote formalisation, SSC ceilings should be increased to mitigate revenue losses and add progressivity to the system.

Adjust the pension system to increase the incentives of being a formal worker

Over the years Panama has reduced poverty and especially old-age poverty. An important issue for policymakers when addressing informality is to consider which dimensions of formality to target for expansion based on both workers’ preferences and policy needs. When both firms and workers are registered with the government there is a greater chance that basic health and safety regulations will be enforced, and that workers receive higher wages, better benefits (i.e. pension savings, health insurance, contracts, termination notices, paid sick leave, and paid vacations) and legal protections than informal employees. Given that Panama offers universal health coverage, having access to pension savings in the future – together with better wages, further discussed in this chapter – stands out as an important pillar in the country’s efforts to reduce poverty and decrease inequality.

Although pension coverage in Panama is better than in most Latin American countries, it is far from universal. Both in terms of the number of active workers – contributors (75%) and passive workers/pensioners (45%) – coverage lags behind OECD countries and needs to be extended to cover all the Panamanian population. Likewise, the 120 a los 65 (‘120 at 65’) non-contributory pension, which was created to protect Panamanians against old-age vulnerability and compensate for extensive informality – especially among women–, still has coverage gaps (Figure 2.21). As such, a progressive universal approach should be adopted by expanding pension coverage.

Progressive pension contribution subsidies for formal jobs, along with a social pension, diversified savings channels, and better enforcement, are promising ways to spur formality. Formality can be fostered with stronger monetary and non-monetary incentives, backed with new technologies. Although stopgap measures, such as the targeted benefits from ‘120 at 65’ non-contributory pension, serve to alleviate old-age poverty; they are not the most appropriate tool for encouraging formalisation. Instead, a combination of traditional and innovative social, tax, and labour tools should be used to improve the incentives for businesses and workers to become formal. Increasing formality through pension contribution subsidies and new savings channels would at the same time increase saving, notably among the growing Panamanian middle class, and boost growth and equity (Melguizo, 2015).

The first step towards a social security system that promotes labour formalisation is to integrate the ‘120 at 65’ non-contributory pension and the contributory system (Pillar I of the CSS) into a unique pension scheme. The central requirement to qualify for the ‘120 at 65’ non-contributory pension is not to have enough contributory pension savings to receive a contributory pension. This requirement discourages low-pay workers and those who regularly shift from formal to informal jobs from favouring formal jobs and saving. By integrating both systems, all savings would be recognised – no matter how small they are – towards a future pension benefit. As such, working in a formal job and making savings contributions would be always rewarded (Levy, 2008).

Contributory schemes need to be attractive, flexible and adapted to different forms of employment such as self-employed, domestic and temporary workers. Currently the CSS offers a special regime for domestic work, temporary agricultural work and self-employment under some circumstances. Providing alternative schemes to incorporate independent workers, domestic workers and temporary agricultural workers into the social security system is essential in order to bring a large share of the most vulnerable works into the contributory system. While contributions should be compulsory for all workers they should be accompanied by 1) possibilities for gradual incorporation to the system; 2) allowances for specific contribution patterns (e.g. less regular contributions); 3) unification of charges and services provided across all similar types of activities.

At the same time social protection programmes, subsidies and transfers can be made more efficient by creating a true social protection system, with shared tools and registries among contributory and non-contributory programmes, to mitigate the pervasive impact of informality. Panama has a large number of policies and programmes for social protection, offered by the CSS, Ministry of Education, Instituto para la Formación y Aprovechamiento de Recursos Humanos (IFARHU), Ministry of Social Development, Ministry of Labour and Ministry of Health. Integrating and co-ordinating the provision of services could significantly increase the effectiveness of social protection and the efficiency of social spending (World Bank, 2015). The creation of shared targeting instruments for multiple programmes, such as a unique social registry and one-stop processing centres for both contributory and social benefits, should make Panama’s social protection system more efficient by reducing duplication of programmes, lowering administrative costs, and simplifying bureaucracy and payments.

Finally, a greater effort must be made to communicate the benefits of formality and the risks of informality, especially in terms of old-age poverty. Evidence shows that there are linkages between pension incentives and formal-sector labour supply, especially among workers for whom the minimum qualifying conditions are binding, and among workers with higher expected pension wealth. As such pension design and reforms have the potential to create large efficiency costs (Becerra, 2017); the current and future benefits to workers should be publicised and explained to the general public to familiarise them with these benefits and with the importance of formal jobs.

Invest in better and relevant skills

High informality and low skills reinforce each other in Panama. Higher skill levels lead to higher productivity levels, which in turn lead to better access to formal jobs and even to their creation. The correlation between the use of skills in the workplace and productivity is very significant (OECD, 2016a). Usually, informal workers not only have low skills but also have poor upgrade opportunities. Informal firms generally provide workers with fewer opportunities to accumulate human capital and are less productive (La Porta and Schleifer, 2014). This makes it hard to escape the low-productivity trap and find jobs that are a good fit for their abilities. In the context of informality, certain skills tend to deteriorate or remain limited to a low value-added range, and access to unemployment insurance and intermediation services is scarce for informally employed workers. All of this might thus pose an additional burden on the earnings and career advancement of the most vulnerable (OECD/CAF/ECLAC, 2016).

Low skills is one of the main barriers to formality

The available pool of skills in Panama has improved along the last decades but is still poor. As explained in the Multi-dimensional Country Review of Panama Volume 1, the composition of the labour force in Panama has changed significantly from 2004 to 2015 towards more skilled workers. The proportion of the labour force with a low level of education (i.e. less than eight years of education) decreased from 50% in 1990 to close to 30% in 2014 (OECD, 2017). Consequently, the gap with the proportion of highly educated workers has narrowed. In 2014, more than 25% of the labour force attained more than 13 years of education, compared to nearly 15% in 1990.

Additionally, the pool of skills in Panama is disconnected from the demands of the productive sector. Although most informal workers are self-employed with low earnings, they are not necessarily unqualified workers. In fact, almost two out of three informal workers are service, sales and trade workers (22%), skilled manufacturing, construction and mining workers (17%), professionals (12%) and technicians (10%); while only 18% are non-qualified workers (Figure 2.22). Hence, either medium-skilled workers are acquiring skills that are not demanded by the productive sector of Panama, or the quality of the training they receive is poor.

A scarcity of engineers, technicians, and especially skilled-trade workers is a recurrent complaint of employers in Panama. Nearly 46% of Panamanian firms report difficulties finding the necessary skills to operate (ManPower Group, 2016). As in other countries in the region, Panama registers a wide gap between the available pool of skills and those skills that its economy and society require (OECD/CAF/ECLAC, 2014). This is due to two factors: the low coverage of secondary education and that most educated Panamanians obtain university degrees and work in industries with lower returns. Both patterns are slowly changing. While education coverage has expanded for secondary education, it is still low for a country that wants to position itself as a worldwide logistics and tradeable service hub.

Panamanian tertiary education students seem to have partially responded to the higher returns in some under-filled industries. In 2002, the six university careers with most students were business administration (21%), education (16%), humanities (12%) – which included religion and theology; language, literature and linguistics; history and archaeology; philosophy and ethics – economics (6.5%), engineering (6%) and public administration (6%). By 2015, while business administration (29%) and education (13%) are still among the top choices, engineering and IT (12%), health (8.5%), and architecture and construction (6%) – careers associated with high-return industries – gained students (INEC, 2017; Hausmann, Espinoza and Santos, 2016) as did law (7%). At the same time, both humanities and to a lesser extent education are less attractive to students, as their share of enrolment decreased 8 and 3 percentage points respectively between 2002 and 2015. Careers such as mathematics or environmental protection are still rarely chosen by students in Panama (INEC, 2017; Hausmann, Espinoza and Santos, 2016)

The size of the foreign workforce remains significant, owing to skills shortages across most economic sectors. This suggests scope for stronger investment in education to increase the number of secondary graduates, as well as a larger role of technical and vocational education and training (TVET) at all levels.

Box 2.5. Estimating education return differentials for informal and formal workers

Overall, the average returns to education have decreased during the last 15 years in Panama. In particular, Mincer earnings regression estimates show that the rate of return has decreased from around 10% in 2001 to less than 8% in 2015. A decrease of the average rate of return to schooling over time suggests that the relative scarcity of skilled labour has diminished. Yet, this decrease could be also attributed to the growth of the construction sector, which mostly hired workers with primary education (Hausmann, Espinoza and Santos, 2016).

Informal workers face lower average returns to education. When Mincer earnings regression estimates are calculated separately for formal and informal workers, they show that on average formal workers’ rate of return is more than 1% higher than that for informal workers (Table 2.2).

Table 2.2. Mincer equation for formal and informal workers (maximum likelihood estimates)
	Formal workers		Informal workers
	Coefficient estimate	Standard error	Coefficient estimate	Standard error
Years of education	0.079	(0.00018)	0.068	(0.00037)
Age	0.038	(0.00038)	0.060	(0.00080)
Age square	-0.0004	(4.91E-06)	-0.0007	(0.00001)
Women	-0.219	(0.00130)	-0.713	(0.00341)

Constant	4.561	(0.00774)	3.4373	(0.02520)
Fixed effects for 12 regions	included		included
Fixed effects for 21 industries	included		included
Observations	7 809		7 417
Notes: $\ln (w_{i}) = β_{0} + β_{1} {y e a r s o f e d u c a t i o n}_{i} + β_{2} {a g e}_{i} + β_{3} {a g e}^{2}_{i} + F E + u_{i}$ where years of education is the number of years each individual reported, age serves as proxy for the years of experience, age² its square, regional fixed effects and industry fixed effects. The return of schooling is captured by the parameter 𝛽1.
Source: OECD estimates based on microdata from Encuesta de Propsitos Multilpes of 2016 (INEC, 2016).

In addition, secondary education has lost value, whereas tertiary degrees are still high paying. Mincer earnings regression estimates to calculate the rate of return by level of education show that the return to secondary schooling has diminished from 3% in 2001 to 1% in 2015, while returns to primary school have increased between 3% and 4%. This might be the result of a supply-and-demand effect. On one hand, there has been an increase in the supply of secondary educated workers relative to workers who only completed primary school. On the other hand, the construction boom improved relative wages of workers who only completed primary education. Both effects make the time invested in pursuing a secondary degree unprofitable, except if students advance in their schooling careers to complete a tertiary degree. Indeed, though the number of workers with tertiary education increased, the return to tertiary schooling did so as well, from below 4% in 2001 to 5% in 2015 (Hausmann, Espinoza and Santos, 2016).

Upgrading skills of the population in general and improving their links to the production system can raise labour productivity levels. A secondary and a tertiary education curriculum better focused on developing technical, science, technology, engineering and mathematics and soft skills, and stronger connections between the education system and skill demands in the economy to support further productive developments, are critical to raising skill levels and productivity in Panama (OECD, 2016a). The recognition and certification of skills acquired in the informal sector is also important for policy action. Moving towards a national qualifications framework could be a relevant policy goal in the medium term to favour access to formal jobs.

Strengthening education and skills to upgrade the labour force

Shifting from infrastructure-driven growth to knowledge-driven growth will require an upgrade of the skills of the Panamanian population. Although the government has taken action in recent years by increasing expenditure and infrastructure, the educational attainment and skills of Panama’s population are low by international standards. Despite progress at all levels, and especially at the primary and lower secondary levels, only 52% of the population aged 25-64 has completed secondary education, in contrast with the OECD average of 80% (INEC, 2016; OECD, 2016b). The main challenges to building a better skilled-labour force in Panama are to expand secondary education – which provides students with the minimum skills to participate in the labour markets – to strengthen TVET education at secondary and post-secondary levels, and spread educational benefits more fairly across the country.

Inequalities in the education system begin early (only 70% of pre-primary-age children are enrolled in education), but become most evident at the high-school level through low upper-secondary enrolment rates (Figure 2.23). Only 59% of the upper-secondary education population (14 to 17 years old) is enrolled in school, with almost 15% attending a lower grade than the one corresponding to their age cohort (MEDUCA, 2015). As a result, almost 300 000 Panamanians aged 15 to 29 – 35% of youths – have not completed secondary and are not enrolled in school. By the age of 25, less than one-quarter of those who come from poor families will have completed high school (OECD/CAF/ECLAC, 2016).

As coverage increases, the low quality of education becomes apparent. Panamanian students perform poorly in reading and mathematics compared with students in Latin America and OECD countries. While secondary and tertiary education attainments remain a challenge, low qualifications are not restricted to those who left the education system. The education system is the obvious tool for improving the skills of Panama’s citizens. Performance in both OECD’s Programme for International Student Assessment (PISA) and UNESCO’s Third Regional Comparative and Explanatory Study (TERCE) is poor. TERCE scale ranks students across four proficiency levels. More than 90% of sixth-grade students performed in the lowest two levels of TERCE’s mathematics proficiency test and more than 75% did so in the reading test in 2013, ranking among the lowest countries in the region. Likewise, 15-year-old Panamanians perform poorly in PISA 2009 (the latest PISA test in which Panama has participated), where students’ proficiency in reading and mathematics are evaluated on scale of 600 points later converted into a six-level proficiency scale. In reading, one-third of Panamanian students did not achieve level 1, placing the country among the worst three countries out of the 75 participating in PISA 2009, and the worst Latin American country. In mathematics, 15-year-old students in Panama performed 136 points lower than the average OECD student and 33 points lower than the average Latin American student (OECD, 2010a). This is equivalent to more than three years and almost one year of schooling, respectively.

The large share of Panamanian students below a basic level of proficiency constitutes an obstacle to further development of more specific skills. According to the PISA test, more than 70% of young Panamanians enrolled in school do not acquire basic-level proficiency in reading, mathematics and science. These students often face significant disadvantages in their transition into higher education and the labour force. In the case of OECD economies, this occurs for a quarter of 15-year-old students (OECD, 2014b).

At the same time, the small number of top performers may hamper innovation and entrepreneurship, limiting productive transformation and upgrading. Knowledge-based and skills-based economies increasingly depend upon a broad base of technically skilled individuals, as well as a sizeable share of high performers who can produce new knowledge. Few Panamanian students perform at the top levels. Indeed, less than 1% of Panamanian students perform among the highest levels of proficiency – levels 5 or 6 – in mathematics, reading or science (OECD, 2010b). In contrast, 12% of students in OECD countries perform in the top two levels in mathematics, and 8.5% reach these levels in reading and science.

Low government investment in education is affecting both quality and coverage. Overall investment in education is low, especially compared to countries with similar per capita income. Government expenditure on education in Panama in 2016 was PAB 1 838 (equivalent to USD) per student, which represents 3.8% of GDP, below the regional average (INEC, 2017). Although overall spending has increased in absolute terms during the last decade, the annual expenditure per primary student relative to per capita GDP has remained constant, while the annual expenditure per secondary student relative to per capita GDP has increased slightly. Still, expenditures fall behind other Latin American countries and benchmark economies, especially those that rely on knowledge-driven growth, and are especially top-heavy if compared to university education spending (Figure 2.24). Spending is important in terms of education performance since PISA analysis has shown a positive relationship between spending per student and mean performance in reading, mathematics and science. As expenditure on educational institutions per student increases, so does a country’s mean performance; but the rate of increase diminishes fast (Figure 2.24). Expenditure per student accounts for 30% of the variation in mean mathematics performance between PISA-participating countries/economies – and 17% of the variation in OECD countries – while it explains 54% of the variation in mean science performance between PISA-participating countries/economies – 38% of the variation in OECD countries (OECD, 2010a; OECD, 2014; OECD, 2016b).

Ensuring that a large base of the population acquires core literacy and numeracy skills is fundamental for the diffusion of knowledge and innovation that sustains economic growth. An increase of one standard deviation in cognitive skills (measured using PISA-type exams) is associated with approximately a 2% increase in annual growth of per capita GDP (Hanushek and Woessmann, 2012). Additionally, poor early basic skills acquisition is detrimental for the later acquisition of labour specific skills. Early performance in mathematics is correlated with job-relevant numeracy skills. The results from the 2012 Survey of Adult Skills (PIAAC) show that countries performing well in PISA tend to display a relatively high performance in PIAAC and vice versa. Students’ performance in PISA will be at least partly reflected in their acquisition of job-related skills later in life. Part of the effect will depend upon the ability to pursue further education, the quality of post-secondary training in the different countries and the specialisation chosen (OECD, 2016d).

Box 2.6. Panama in PISA

The OECD has identified gaps in education participation, performance and outcomes as one of the most significant structural constraints to sustained growth in low- and middle-income countries. Progress on a range of economic indicators, including productivity, formal employment, economic diversification and reduced dependency on commodities, will be held back unless emerging economies can achieve better education outcomes, develop higher quality skills and widen their talent base.

To tackle this challenge of quality and participation in education, it is important to understand the factors that are associated with low student performance, poor attendance and dropout, especially at the secondary level. For this reason, OECD developed PISA, which aims to evaluate education systems worldwide by testing the skills and knowledge of 15-year-old students. In 2015 over half a million students, representing 28 million 15-year-olds in 72 countries and economies, took the internationally recognised two-hour test. Students were assessed in science, mathematics, reading, collaborative problem solving and financial literacy. PISA provides useful information to determine policies to improve students’ performance (Avendaño, Barrera, Nieto-Parra and Vever, 2016).

Likewise, the PISA for Development (PISA-D) project aims to increase middle- and low-income countries’ use of PISA assessments for monitoring progress towards nationally set targets, for the analysis of factors associated with student learning outcomes, particularly for poor and marginalised populations, for institutional capacity building and for monitoring international targets in the Education 2030 framework developed within the UN’s thematic consultations.

Panama is participating in PISA 2018 as well as the out-of-school component of the PISA-D project. A key aim for Panama in participating in PISA 2018 and PISA-D is to collect better, actionable assessment and contextual data on 15-year-olds who are in and out of school. As well as providing internationally comparable data on Panamanian students’ performance on tests of reading, mathematics and science, the PISA 2018 and PISA-D surveys will also provide valuable data on barriers to school attendance and factors that may impede students’ progress through education. This information will be available at the end of 2019 and will be presented in a national report.

In this context, high quality TVET is crucial for developing a highly skilled labour force, with a range of mid-level trade, technical, professional and management skills alongside those high-level skills associated with university education (OECD, 2014c). In emerging and less-developed countries, TVET is increasingly perceived as a tool to respond to changing labour market needs, while at the same time supporting social cohesion. As such, it is – and should be perceived as –a complement to those more academic programmes typically found in universities or bachillerato (upper secondary education). Given that poor skills, and hence low productivity, are sometimes seen as one reason for low levels of development and informality, investment in TVET has been argued as a means of promoting a bottom-up labour market transformation (Eichhorst et al., 2012).

Panama has a mid-size TVET sector that struggles with quality, prestige and status. At upper secondary around half of the students are enrolled in vocational programmes – though they represented only 19% of upper secondary graduates in 2015 (MEDUCA, 2016). The share of TVET secondary students is higher than that for OECD countries where 26% of the population in secondary education are enrolled in TVET programmes, but aligned with the Netherlands where 48% are enrolled in TVET programmes (UNESCO, 2016). However, only less than 10% of tertiary education graduates – only 2 000 students a year – are instructed in TVET programmes which are in high demand in the country. The nature and duration of the programmes – most of them offered by private providers – vary from institution to institution. Moreover, quality is heterogeneous: high-quality schools that are highly respected and generate positive returns for students and employers coexist with low-quality ones. Although TVET represents an important source of innovation and experimentation in the design of technical education that benefits the sector as a whole, programmes are too few and too small to drive a change in quality. As a result, TVET is often looked upon less favourably by employers and students than the academic secondary and also general tertiary education. Additionally, the qualification of teachers can differ between TVET and general education. The creation of the Instituto Técnico Superior Especializado de Panamá (ITSE) will partially address these problems by offering high-quality technical tertiary education.

Panama offers a wide variety of training programmes through the Instituto Nacional de Formación Profesional y Capacitación para el Desarrollo Humano (INADEH), the public entity in charge of technical and vocational training. INADEH has full autonomy in terms of financial resources. Its spending on training programmes is above the average (0.17% of GDP in 2014 compared to 0.12% and 0.15% of GDP for LAC and OECD, respectively). For the past 20 years, this institute has been in charge of carrying out the national training strategy by offering comprehensive training programmes that include technical, learning-at-work, languages and business courses to more than 70 000 students each year – 3.6% of Panama’s labour force. Yet, quality courses that are highly respected and generate positive returns for students and employers coexist with low-quality ones, adding to the quality and prestige struggle of the sector. Relatively few job seekers and workers with higher education participate in these programmes and INADEH struggles with quality, prestige and status among high-skilled workers. Job training and search measures need to support all jobseekers and informal workers as well as encourage the inactive by improving their employability and helping them find appropriate jobs. These programmes should help ensure that those out of work return to employment in the most appropriate job; likewise, they should help informal workers become more productive and find jobs which are a better fit for their skills.

Panama has recently strengthened its training programmes for youth, especially those from poor and vulnerable households. INADEH has developed Nuevas Oportunidades de Empleo para Jóvenes (New Employment Opportunities for Youth), a programme that offers job training and placement services to low-income youth in Panama City. Likewise, the Panama Ministry of Labour has recently developed a number of training and lifelong learning programmes for youth, particularly in less advantaged socio-economic groups and women. The Pro Joven (Pro Youth) programme, created in 2015, for example, promotes employability of youth through internships in enterprises. The beneficiaries are youth in the last year of technical and vocational programmes. Participating enterprises receive a government subsidy for hiring interns and are required to hire at least 50% of those young workers once their internship contracts ends. The programme started as a pilot with 1 000 beneficiaries and is now being scaled up. Furthermore, the Autoridad de la Micro, Pequeña y Mediana Empresa, the public entity in charge of promoting small and medium enterprise development, has also introduced a series of programmes to promote business training, with the goal of increasing formalisation among young entrepreneurs. Additionally, the Desarrollo Financiero y Empresarial (Financial and Business Development) and Fondo Emprende programmes aim to increase opportunities for entrepreneurship and promote the creation of new companies.

TVET should be better aligned with the demands of the labour market. Linkages between the TVET system and employers are relatively weak, illustrated by the low level of involvement of employers in overall TVET policy development. Although INADEH over the years has developed strong relationships with certain private sector firms, TVET must concentrate on developing the skills demanded in construction, trade, logistics, manufacturing and some retail. Courses in these sectors account for 15% of graduates, while 25% of the students graduate in low-paying trades such as agriculture, crafts, woodworking, upholstery, beauty, cosmetology and tailoring (INEC, 2017). Efforts should be made by all TVET institutions, as well as the upcoming ITSE, to develop better links with the modern tradeable service sector.

There is little co-ordination between upper secondary TVET programmes, tertiary TVET programmes, INADEH courses and the general education system. One of the main problems is that institutions operate in isolation, limiting students’ ability to pursue different options. Moreover, degrees offered by the Ministry of Education and INADEH are not harmonised, and neither connects well with the higher education system. Additionally, skills acquired from TVET often go unrecognised by the traditional education system; many students are unable to proceed to higher levels of general education studies based on TVET certificates. For this reason, is very important that the ITSE co-ordinate its programmes and curricula with the existing TVET institutions of Panama, as well as with the general education programmes.

National Qualifications Frameworks classify qualifications by level based on learning outcomes, standardise qualifications in order to facilitate the evaluation and allow comparison of skills across systems. A few countries in Latin America have started implementing National Qualifications Frameworks to align TVET education with general secondary and tertiary education. ChileValora and the Ministry of Education in Chile; Instituto Nacional de Formación Técnico Profesional (INFOTEP) and several ministries including the Ministry of Education in the Dominican Republic; and Servicio Nacional de Aprendizaje and the Ministry of Education in Colombia, for example, have implemented these frameworks. Likewise, Costa Rica, Nicaragua and Ecuador are developing co-ordination mechanisms between TVET and general education programmes (OECD/CAF/ECLAC, 2016).

TVET schemes in Panama may enhance inequality. Students enrolled in TVET are more likely to be from poor or vulnerable households than those in general education programmes (OECD/CAF/ECLAC, 2014). As noted above, those with TVET certificates have greater challenges in pursuing higher education. As a result, TVET can perpetuate inequality by amplifying the discrepancies in opportunity between those with higher and lower socio-economic status. Additionally, TVET can amplify gender disparities: many of the higher-paying, technical tracks in TVET are male dominated, while, on average, women focus in low-paying trades (UNESCO, 2010). All of this calls for improving TVET programmes to help ease the associated stigma and contribute towards a more equal education, and better-quality jobs later in life.

Panama could benefit from strengthening TVET at secondary and post-secondary, given the low coverage of upper secondary education and the shortage of skilled workers with training to work in the modern service sector (MITRADEL, 2015). In LAC in general, TVET serves an important equity function. It caters to the needs of different segments of the population: school-leavers, students looking for more practical education and older individuals seeking to deepen their professional skills, make a sideways career move or return to work after an absence (Quintini and Manfredi, 2009). High-quality vocational education pathways, particularly in upper secondary education, can help those who have become disaffected with academic education to re-engage with the education system and improve graduation rates. And vocational and technical programmes at the tertiary level can provide those with no appetite for academic education with practical skills that respond to the needs of the job market, especially in an economy with a strong service sector such as Panama. At the same time, alternative training courses such as the one provided by INADEH can provide high school and tertiary education drop-outs with job skills training to increase their employability and access formal jobs (OECD/CAF/ECLAC, 2016).

Box 2.7. Work-based learning can be a powerful tool

Workplace learning plays an essential role in high quality vocational programmes. It is a powerful tool for developing both hard and soft skills, transitioning students into employment, engaging employers and linking the mix of programmes to employer needs. At the same time, it is too often neglected. On the one hand, education and training organisations find it easier to work on their own without having to involve employers. On the other hand, employers do not recognise the potential returns from offering work placements to students.

There should be a mandatory work-based learning component in every vocational programme

Evidence from a number of countries suggests that making work-based learning a mandatory element of vocational programmes is feasible and has multiple benefits. Many institutions tend to operate in isolation, and education and training institutions are no exception. Reaching out to employers means breaking out of this isolation. It also means overcoming the resistance of classroom teachers to the idea that students can learn much in the workplace that they cannot learn so readily in the classroom. Therefore, institutions need strong incentives to establish partnerships with employers for an effective workplace learning element in programmes. But employers also need incentives. Sometimes employers believe (often wrongly) that work placements are an unnecessary cost that they can reasonably avoid; they would prefer simply to recruit graduates of vocational programmes.

Against this background, making work placements mandatory can be a game-changer. It means that programmes will only be funded when training institutions develop and maintain the active partnerships that support work placements. Under these conditions, training providers will see employer partnerships as central to their mission. For their part, employers will see that, unless they are willing to offer work placements, their source of recruits may shrink or disappear; government funding may well shift to another sector or another region. Under these conditions, many currently reluctant employers will choose to offer work placements, assuming they value the training programmes.

International examples

It is striking that poorer countries with relatively weak infrastructure (Romania) and weak labour markets (Tunisia), countries with little history of employer engagement in the vocational system (Sweden) and countries with high rates of youth unemployment (Spain) have successfully implemented mandatory arrangements for work-based learning in some of their vocational programmes (OECD, 2014c).

In Romania, all upper secondary and postsecondary vocational programmes include work placements with quality assurance mechanisms (a workplace supervisor, student portfolio and a contract between the school and employers) (Musset, 2013). In Tunisia, vocational programmes under the Ministry of Vocational Training and Employment have a mandatory work-based learning component: about 11% of students are enrolled in apprenticeship programmes where they spend one day a week in a training centre and the remaining days in the workplace. The other 89% of students are enrolled in programmes d’alternance (a combination of school-based and work-based modules), in which the length of the work placement(s) varies, but is never less than one month. Likewise, more than nine out of ten vocational students in Tunisia benefited from some type of placement with employers in 2011 (OECD, 2015b). In Spain, in both upper secondary and postsecondary programmes, workplace training normally takes place through a compulsory three-month module at the end of the programmes (Field, Kis and Kuczera, 2012).

Such arrangements cannot be implemented overnight. In the early 1990s, for example, Spanish employers had to learn how to make use of students at work, and to appreciate the benefits to their firms (Field, Kis and Kuczera, 2012). South Africa developed tax credits to foster on-the-job training, as well as a simple process for employers to take trainees from vocational programmes (OECD, 2013a).

Developing active labour market programmes to reduce skills mismatch

Labour markets can become more inclusive and resilient when active labour market policies (ALMPs) are scaled up to satisfy the needs of all workers including youth, women, indigenous populations, the vulnerable and the middle class. ALPMs such as training, public employment services and incentives for job creation and entrepreneurship, that involve people in full-time activities, increase the employability of jobseekers and contribute to keeping workers productive in a cost-effective manner (OECD, 2015b). Many vulnerable workers, such as informal workers, fall out of these categories.

Panama performs well in offering training programmes in contrast to other countries in the region. Almost 0.17% of GDP is estimated to be concentrated in training programmes (Cerutti et al., 2013). OECD countries, in comparison, spend nearly 0.15% of GDP in training (Figure 2.25). Additionally, the proportion of formal wage workers offered formal public or privately financed training (68%) is relatively high for the region (62%), and higher than around the world (53%) (World Bank, 2010). However, current training programmes lack a proper evaluation mechanism and do not have a real monitoring framework. No impact evaluations have been implemented to assess the efficiency of training expenditure, and therefore evidence of their effectiveness is lacking.

Panama should increase its offer of labour market policies other than training and spread them across the country. Apart from training, there are very few programmes to help unemployed and informal workers find jobs that are a good match for their skills. Furthermore, the few existing programmes are concentrated in the large cities.

Better supervision and enforcement of labour laws

The role of institutions in performing inspections and setting up enforcement mechanisms may also explain informality levels in Panama. Informal employment within the formal sector is particularly significant in Panama. Both informal workers working for formal firms and domestic workers account for almost a quarter of the informal worker population. These two groups are the ‘low-hanging fruit’ of formalisation policies (INEC, 2016). The authorities exercise little control over the working conditions of salaried workers. In 2017, the Ministry of Labour carried out 5 131 inspections, of which only half were labour related. Enforcement mechanisms through inspection and penalties are insufficient to encourage firms to formalise their workers.

The level of formality could increase by improving the Ministry of Labour’s supervising and law-enforcement capacity. In order to improve the supervisory capacity of the Labour Ministry, it must be given more and better qualified inspection personnel, and must improve its co-ordination with the other institutions guaranteeing labour rights, such as the CSS, and those responsible for business formalisation such as AMPYME and the Mecanismo Independiente de Consulta e Investigación (MICI). At the same time, it is necessary to increase the capacity of the labour inspectorate to address issues of safety at work for informal workers and firms by providing information and counselling about labour rights to formal workers.

Likewise, the Ministry of Labour should strive to be perceived by firms as non-tolerant of labour informality. To do so, it should work on making the conciliation and sanction process more effective, for instance by reducing the number of conciliation procedures and increasing the number and cost of fines.

Conclusions and policy recommendations

The scarcity of good quality employment opportunities, poor employability of a large share of the population and informality are persistent issues in Panama. The dual economy has resulted in a dual employment market which in turn largely explains income inequality in the country. On one hand, Panama has a strong and productive modern tradeable service sector which has steered the country’s recent economic growth. This sector is mainly composed of skill-intensive activities that create relatively little employment. On the other hand, the less-productive service sector, agriculture and in some measure the manufacturing sector, in which own-account workers and micro-productive units have proliferated, offers subsistence and informal jobs to most workers.

The spike in non-residential construction that promoted employment for low-skilled workers has started to slow down. The demand for infrastructure from the transport and financial sectors has offered a large share of low-skilled workers from the agriculture sector formal and more productive jobs, reducing informality, raising salaries and ultimately reducing poverty and inequality. The demand for infrastructure and construction is expected to decelerate significantly and employment opportunities might be reduced for this group of workers.

At the same time, labour informality remains high. Although between 2003 and 2011, high economic growth contributed to reducing the informality rate; since 2012, as the modern tradeable service sector slowed down, informality increased and two out of three new jobs created were informal jobs. As emphasised in this chapter, informality poses a triple interrelated threat representing large losses for workers, for firms and the wider economy.

To promote more formal jobs and mitigate the negative effects of informality, public policy should identify and combine 1) a short-term agenda to deal with proximate causes of informality, including poor enforcement, and encourage formalisation of firms and workers, 2) a long-term agenda to address structural causes of informality such as insufficient productive development, slow labour productivity growth in sectors that create large employment and poor skills and 3) an effort to address and mitigate the consequences of informality across a number of areas, especially in social protection coverage (OECD, 2016a). Five main policy areas for action are recommended to promote formal, better quality jobs and formal economic activities in Panama.

In order to successfully use policy as a lever to create better employment opportunities, address informality, increase productivity and reduce inequality, Box 2.6 presents the main policy recommendations of this chapter.

Box 2.8. Key recommendations for building better skills and creating formal jobs for all Panamanians

Create better conditions for productive development

Co-ordinate institutional efforts to increase economic transformation in most of the provinces with the development of the agro-industry sector and the upgrade of services linked to logistics and connectivity sector.
Set efforts for job creation and formalisation as a key item within the broader national development strategy to co-ordinate action across line ministries and agencies.

Boost the formalisation of MSMEs and independent workers

Consider a simplified tax system for independent workers and micro-productive units.
Adapt CSS contributions for independent workers (frequency and payment method) and enforce the mandatory contribution of independents to the CSS.
Disseminate and extend the use of incorporation and tax regimes for MSMEs.
Reduce red tape and administrative/recurrent costs associated with formal status, especially at the municipal level, and the compliance costs of formally operating.
Facilitate the use of the existing one-stop shops for business creation and licensing procedures.
Establish more clear and simple schemes to determine minimum wages as well as future indexations which include objective productivity criteria.
Introduce progressivity into social security contributions and lower social security contributions temporarily for new low-income workers.

Adjust the pension system to increase the incentives of being formal

Move towards universal coverage by first expanding the ‘120 at 65’ programme’s beneficiary set.
Integrate the ‘120 at 65’ non-contributory pension and the contributory system (Pillar I of the CSS) into a unique pension system.
Guarantee that the pensions of all the workers who contributed to the CSS are larger than the non-contributory pension of workers who never contributed.
Provide alternative schemes to incorporate independent workers, domestic workers and temporary agricultural workers into the social security system, which should be compulsory but accompanied by 1) possibilities for gradual incorporation to the system, 2) allowances for specific contribution patterns (e.g. less regular contributions), and 3) unification of charges and services provided across all similar types of activities.
Provide financial education and foster the creation of savings and insurance instruments for vulnerable groups (e.g. insurance against occupational hazards, crop insurance, etc.).
Communicate the benefits of formality and the risks of informality, especially in terms of old-age poverty (including in secondary school).

Invest in better and relevant skills for the labour force to accompany the productive development of Panama

Increase secondary education (including adult education) and strengthen the mechanisms to support students at risk of dropping out.
Enhance the quality of technical secondary education and incorporate current and future needs of the productive sectors into the curricula.
Increase the involvement of employers in the design of education curricula, technical programmes and workplace education.
Increase educational offerings and quality in technical careers (including non-university degrees and alternative training diplomas), especially in the provinces.
Provide reliable and free information about employment options, wage levels in different industries, and labour market status by degree and university.
Generate links between academic and technical education by implementing a national qualifications framework to align technical and vocational education with general education and allow students to easily transit across academic and technical schools as well as INADEH, ITSE and all tertiary institutions.
Include business training earlier in the educational curriculum (accounting, finance, management and supervisory, etc.).
Reinforce active labour market policies by strengthening employment services and youth training programmes to prevent young people from entering into informal jobs.
Establish a policy of lifelong learning that includes regular on-the-job training.

Supervise and enforce labour laws

Improve the links between different institutions guaranteeing labour rights (MITRADEL, CSS) and those responsible for business formalisation (MICI, AMPYME).
Increase efforts to supervise firms by endowing the MITRADEL with more and better qualified inspection personnel, and improving its co-ordination with the CSS.
Increase fines and make the sanctioning power of the MITRADEL more effective.
Make the processes of conciliation and sanctions more efficient for instance by reducing the number of procedures.
Increase the capacity of the labour inspectorate to address issues of safety at work for informal workers and firms through the provision of information and counselling about labour rights to workers.

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Notes

← 1. Assuming constant employment elasticity of growth and keeping the employment-to-population ratio at 61% and unemployment at 6%.

← 2. The Centro Nacional de Competitividad (CNCs) and the AMPYME classify MSMEs by gross income: firms that have revenues of PAB 2.5 million per year or less.