Volume 44, Number 173,
April-June 2013
Automatic Stabilization and Social Security:
Brazil, Mexico, Costa Rica and Chile
Eloy Fisher

Although there is ample literature regarding the genesis of institutional regimes that began following the Chilean reforms of 1981, there is little discussion surrounding the macroeconomic effects attributable to each of these programs in Latin America. On the theoretical level, whether or not governmental social benefits even have clear macroeconomic effects is controversial.

One prominent study on this topic was carried out by Julia Darby and Jacques Melitz (2008), elucidating the effects of automatic stabilization and cyclical sensitivity of social spending among oecd (Organization for Economic Cooperation and Development) member countries. Beyond the inclusion of taxes and unemployment insurance, they also examined government spending on health, retirement benefits, disability and illness. Their results confirmed significant cyclical movements in these areas, in turn dependent on the specific social security structure of each country. Unlike prior studies from Auerbach and Feenberg (2000), Perotti (2002) and Galí and Perotti (2003), which only validated unemployment insurance as a type of government spending that significantly contributes to automatic stabilization, Darby and Melitz are backed by growing literature studying the links between different types of social spending and the resulting impact on the economic cycle.

This text will focus exclusively on discussing the results of Darby and Melitz (2008: 732-733). Their research reveals that social spending is highly stabilizing, and the most relevant factor of this spending are pension expenditures, contributing 0.15 of a percentage point of the Gross Domestic Product (gdp). Health spending adds another 0.09 percentage points of gdp, while unemployment insurance provides a 0.06 percentage point contribution. Expenditures on illness and disability are similar to unemployment insurance; in total, these programs add up to 0.36 of a percentage point of gdp. Added to the effect of taxes, the grand total of automatic stabilization from all sources is 0.44 of a percentage point. Monetary injections and filtrations (not necessarily symmetrical) are on the order of 50 to 100 billion dollars each economic cycle for the countries included in the model. Other documents reveal similar results through a range of different estimates (Debrun and Kapoor, 2010).

However, there are a variety of hurdles in applying this methodology to determine similar effects in Latin America. The first of these issues, addressed in Darby and Melitz (2008), Autor and Duggan (2003), Black, Daniel and Sanders (2002) and Beatty, Fothergill and Macmillan (2002), lies in selecting the appropriate indicator to measure the economic cycle. Both the theory as well as the evidence demonstrate that the unemployment rate and the figures on those receiving social benefits are simultaneously determined. With the goal of sidestepping the implicit endogenous issues of using these levels, Darby and Melitz advocate for the use of primary differences and a procedure of instrumental variables together with filtered production measures, to compare realized and potential capacity and this way, detect short-term cyclical responses.

Besides this first issue, there is another predicament that the previously cited studies failed to address: they report results for social benefits systems in countries with low inflationary distortion. Although the average percentage increase in price levels for oecd member countries was around 5 percent per year between 1980 and 2010, Latin America saw an aggregate level average annual percentage increase of around 107% (Figure 1) during those same decades. In that sense, although the monetarism critique of the region over-emphasized monetary supply problems as the factors behind price distortion, it cannot be denied that inflation brought on serious set-backs for proper price determination, and as such, noise, when measuring the cyclical nature of contributions and expenditures for social security benefits in Latin America.

As shown in Figure 1, inflation in Latin America was above the average of oecd nations and sometimes, by various orders of magnitude, as was the case from the mid-1980s to the mid-1990s. This is a tricky point for automatic stabilization programs, especially because of the Oliveira-Tanzi effect (Agénor and Montiel, 2010: 100-101) during the most complicated inflationary episodes of our economic history. In times of high inflation, costs grow at a rate that damages commerce and consumer purchasing power. As such, tax contributions (whether or not strictly fiscal) fell from the levels that the government and its decentralized entities would collect if inflation were more moderate. In times of high inflation, delays in financial calculations, the collection of contributions and expenditures for benefits causes a real drop in income and spending, a vicious cycle that affects the management of these flows.

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PROBLEMAS DEL DESARROLLO. REVISTA LATINOAMERICANA DE ECONOMÍA, Volume 49, Number 194 July-September 2018 is a quarterly publication by the Universidad Nacional Autónoma de México, Ciudad Universitaria, Coyoacán, CP 04510, México, D.F. by Instituto de Investigaciones Económicas, Circuito Mario de la Cueva, Ciudad Universitaria, Coyoacán,
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