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In developing and emerging economies public finance could play a greater role in redistribution. In many developing countries, low levels of revenue from direct income taxes and limited targeting of public spending reduce countries’ capacity to use the tax-benefit system as a powerful redistribute tool, as in mature economies. In Latin America, for example, the average tax-to-GDP ratio is 14 percentage points below the OECD average of 34.6% despite an 8-point rise since 1990. Brazil and Argentina stand out as countries where tax revenues relative to GDP are already close to OECD levels (OECD 2014g). Because of the existence of large informal sectors it is difficult to raise revenue from personal income tax, and governments tend to rely on revenue from taxes and goods and services (including customs and excise duties) more than in OECD countries. By contrast, income tax revenues in China have risen rapidly from a very low level and could reach 5% of GDP by 2015, mainly reflecting fast growth and under-indexation of the tax schedules, so that a broader array of households are now taxed (Piketty, T and N. Quian., 2009). The example of China, and of OECD countries at earlier stages of their development, underlines the importance of socio-economic policies that foster both economic growth and social advances, notably in education and health care, and favour the rise of a large middle class in the formal sector that accepts the need to share part of the burden of financing transfers to the disadvantaged.

Box 3.3. Boosting social programmes in Latin America

Relative to their GDP, tax revenues are considerably lower for Latin American (LAC) countries than the OECD average: 20% as against 34% in 2010 (OECD 2014g). Tax bases tend to be narrow and biased towards nonprogressive taxes in LAC, where tax evasion is also high. (Gomez Sabaíni, et al, 2012) As a result, tax-benefit systems are much less redistributive in LAC than in the OECD area: while the fall in the Gini coefficient before and after taxes and transfers in countries like Poland, Portugal or Spain is nearly 20 points, the reduction in most LAC is below 2 points. Overall, both LAC and OECD countries face the challenge of selecting the tax instruments that are least distortive so as to minimise their adverse growth and employment effects. Consequently, despite significant increases in the past two decades, LAC countries still spend much less in relation to GDP on social programmes, such as education and health care, than OECD countries.

Much has nevertheless been done in several LAC countries to strengthen social protection programmes, including old-age pensions and income transfers to vulnerable households. These programmes have contributed, in different degrees, to alleviating poverty among the targeted population. In particular, unlike old-age pensions, conditional cash transfers have been particularly cost-effective, achieving considerable reductions in inequality at a relatively low cost to the government budget (IPEA, 2012). However, the growth effect of social protection programmes depends on the extent to which they are financed through higher, distortive taxes which create incentives to informality.

The issue of how these schemes are financed, e.g. contributions or general tax revenue is crucial in this respect Pension reforms have been central to the social protection agenda in Latin America. Recently, non-contributory pension systems (Bono Solidario, Bolivia) and schemes providing retirement income for informal workers (Beneficios Económicos Periódicos, Colombia) have been introduced. Private pension systems have brought some of the advantages of fully-funded schemes, but limited coverage and low replacement rates persist, which intensifies the incidence of old-age poverty risk.

3.2 - Revisiting structural policies Structural policies are at the heart of Inclusive Growth. Structural policies hold the promise to unlock the productive potential of individuals and enterprises in ways that can create more and better rewarded jobs, and generate resources that can be used to help poorer households. Malfunctioning labour markets make it difficult for some socio-economic groups to find and keep good jobs, and this is too often exacerbated by inadequate education and training facilities from early childhood and throughout adult life.

Promoting inclusive labour markets and ensuring that workers have the skills necessary to profit from them are thus key elements of the agenda which seeks to combine strong economic growth with greater inclusiveness. Economic growth can also be boosted when firms operate in a competitive environment. But there can be losers as well as winners from structural reforms, which need to be identified when designing policies to cushion vulnerable groups from the adverse effects of reforms.

Promoting inclusive labour markets

Making labour market policies more growth-friendly and pro-inclusiveness requires addressing three main challenges: i) tackling large differences in employment rates across socio-economic groups, with particularly low rates amongst youth, women, older people and low-skilled individuals; ii) reducing persistent in-work poverty, particularly in developing countries and emerging market economies, because of the prevalence of informality, and especially among lone parents and single-earner households with children in OECD countries; and iii) addressing low job quality in terms of insecurity and strain.

To do so, policy makers need to confront a number of important trade-offs. The first is to provide effective social protection systems while at the same time promoting access to productive and rewarding work. A second is to strike a balance between providing the flexibility required by employers and the need to protect workers. A third is to provide levels of wage flexibility that are conducive to strong economic performance and low unemployment, while limiting in-work poverty and the rise in earnings inequality.

Unemployment benefits help to smooth household consumption through periods of unemployment, but can also create disincentives to work. Unemployment benefits help individuals to overcome liquidity constraints while searching for a better job, and therefore play an essential part in any well-functioning labour market (OECD, 2011a). Japan, Korea, Italy and Turkey have sought to expand and extend coverage to all workers as an incentive to higher participation (OECD, 2013o). Chile is set to improve its unemployment benefits system by increasing the average replacement rate as well as the maximum and minimum benefits. However, beyond a certain threshold, generous benefits extended over a long duration and with few conditions, can unduly reduce incentives to work. This why, in some countries, including Belgium, Finland, France, the Netherlands and Portugal, there is a need to reduce duration and replacement rates, and otherwise strengthen job-search incentives, while Spain should strengthen the link between unemployment benefits and active job-search assistance.

Striking an appropriate balance between the need to provide flexibility to employers and the need to protect employees represents a major challenge to policy makers. In countries where employment protection is much stronger for regular jobs than for temporary ones, employers have an incentive to offer temporary contracts, which tend to affect certain groups of workers more adversely.

Young workers especially may get trapped into a sequence of temporary jobs and unemployment spells, and have difficulties in fully integrating into the labour market. This tends to increase wage inequality and might not have a durable impact on employment. A reduction in the level of protection of permanent jobs helps to reduce labour market duality, making it easier for vulnerable and less experienced workers to find jobs. Several countries are already working to this end, and reforms have been implemented in the Southern euro-area countries covering different aspects of employment protection legislation, such as a clarification of dismissal criteria in Spain, a decrease in severance pay in Portugal, and the adoption of measures to reduce the cases of forced reinstatement of dismissed workers in Italy. A combination of high flexibility in hiring and firing, as well as high replacement rates together with effective activation policies for the unemployed can help keep unemployment rates low, as in Denmark.

Reducing the legal extension of collective wage agreements might lower labour costs and promote employment, especially for the low-skilled, which is good for growth, but it might also contribute to widening wage distribution. As noted in Chapter 2, a reduction in the coverage of collective-bargaining arrangements has contributed to rising earnings inequality in many countries.

Collective bargaining has been amended in Spain to give priority to firm-level wage agreements over sectoral ones. France introduced new legislation “accords de maintien dans l’emploi” (“job safeguarding agreement”) in May 2013, which enables employers to negotiate individually with the unions concerning the adjustment of working hours and wages for up to 2 years, in exchange for job security and to reduce potential lay-offs.

Flexible wages allow employers to adjust to temporary and deeper-seated changes in demand, but there are social costs. The challenge is to provide wage flexibility which is consistent not only with good economic performance and low unemployment, but also low in-work poverty and earnings inequality. The example of Germany shows that it is possible to reduce unemployment significantly in a short period of time, but with rising earnings inequality, and calls for the introduction of a minimum wage (Box 3.4). A relatively high standard minimum wage narrows the distribution of labour income, but if it is set too high, youth and low-skilled workers may be priced out of the labour market. In developing countries, even though minimum wages may encourage informal work, they are often a useful tool against in-work poverty in the formal sector. Moreover, working-time flexibility matters. The experience of the global financial crisis has shown that working-time adjustments significantly contributed to high labour market resilience in countries such as Germany and Japan. This helps to mitigate workers’ income losses, while allowing them to maintain their attachment to the labour force and skills, and the firms they work for are better able to survive downturns.

Box 3.4 Boosting employment through labour market reforms: the German example

In order to address the challenges presented by stagnating economic growth, high structural unemployment and demographic ageing, Germany embarked on a series of wide-ranging labour market reforms during the period 2002the Hartz reforms”). The reforms aimed at strengthening job-search activities for the unemployed, providing jobacceptance incentives, and encouraging labour force participation, particularly among women and older workers. In addition, measures were taken to: reduce the maximum duration of unemployment insurance benefits; close options for early retirement; lower employer social security contributions; and increase the scope for the use of temporary contracts.

The impact of the Hartz reforms on unemployment and labour force participation, along with other factors, has been impressive. After 2005, the harmonised unemployment rate has fell by six percentage points from over 11.3% to 5.5% in 2012, while the labour force participation rate increased by over three percentage points. Consequently, over that seven year period, the employment rate increased by over seven percentage points. These positive trends largely continued during the global financial crisis except for a slight reversal in the first half of 2009. The turnaround in the labour market since 2005 and its high level of resilience during the crisis reflect improved labour market matching and are sometimes dubbed the “German jobs miracle”.

However, the German miracle has not been costless: in-work poverty and earnings inequality have both increased. The increase in employment has been to a large extent driven by an increase in marginal employment or work in fixed-term or temporary contracts. The Hartz reforms promoted the use of low-wage low-hours employment contracts by, respectively, increasing the scope of Mini jobs and introducing Midi jobs. Such jobs are either exempt from employer social security contributions or subject to reduced rates. The rise in in-work poverty and earnings inequality led to an intense debate on the appropriateness of a national minimum wage. The current coalition partners have agreed to introduce one as of 2017.

Policies that facilitate access to quality jobs promote growth and reduce inequality simultaneously. Labour market reforms have a bearing on outcomes of several non-income dimensions that matter for Inclusive Growth. For instance, an increase in non-standard employment, such as involuntary part-time or temporary jobs, can lower job quality, in particular for low-skilled workers. It can also increase job strain, adversely impact mental health, and reduce worker capacity to connect to social and professional networks. As a part of a policy programme for increasing job quality, measures to improve employment prospects for youth include effective counselling, job-search assistance and temporary hiring subsidies for low-skilled youth. For instance, Estonia, Ireland and the Slovak Republic have stepped up their job-search assistance by not only increasing resources but also by streamlining existing measures to increase effectiveness. However, such active labour market policies impose a burden on government budgets, and their effectiveness varies widely across programmes, suggesting that programme design is all-important and that countries can learn a great deal from the experience of others (Martin and Grubb, 2001).

Making work pay and fighting in-work poverty requires implementing targeted policies. Fulltime work can be an effective and sustainable way out of poverty, but it does not entirely eliminate the risk of poverty, particularly in developing countries and emerging market economies, or for lone parents and single-earner households with children in OECD countries. Social transfers play a key role, precisely because they can be targeted to the most vulnerable households. In-work benefit schemes, such as the US Earned Income Tax Credit can be particularly effective (Box 3.5). In emerging market economies, conditional cash transfer programmes can provide the most vulnerable with a basic income floor, while ensuring that future generations are better equipped to participate actively in the labour market and find sustainable ways out of poverty by conditioning benefit receipt on children’s enrolment in school.

Box 3.5. Balancing strict eligibility requirements with in-work support: Welfare reform in the United States The well-studied 1996 US welfare reform provides substantial evidence on both the employment as well as poverty effects of welfare-to-work packages targeted at recipients of social assistance and similar benefits. It also highlights the trade-offs that characterise the different options faced by policy makers.

The main element of the US reform was to replace the Assistance for Families with Dependent Children (AFDC) with the Temporary Assistance for Needy Families (TANF), which is time-limited and subject to more stringent behavioural requirements. Bringing down the number of benefit recipients was a major objective associated with reforming welfare benefits in a considerable number of US states.

The evidence shows that the earnings and employment of low-income lone parents (the principal target group of the US reform) increased as a result of stepping up welfare-to-work measures, and that some of the positive employment effects can be attributed to a virtuous cycle of declining beneficiary numbers, lower spending on out-ofwork benefits, and a resulting increase in funds available for work-related support (Earned Income Tax Credit (EITC) as well as the extended availability of public support for childcare and health insurance). However, because of the more rigorous eligibility requirements for TANF, and the resulting narrowing of the group entitled to benefits, average household incomes rose by less or not at all.

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