Cutting Transfers to the Most Vulnerable People (Including Pensioners

New Approaches to Closing the Fiscal Gap Chapter 2 Closing the Fiscal Gap: New Approaches

Another common target for reductions, especially during inflationary times, are social transfers, mostly those related to social security and pensions (Galeano et al. 2021; Balestrini et al. 2022). This type of spending is quite rigid in industrial countries in real terms (after inflation) because it is indexed automatically to inflation. In many developing countries, however, automatic price-based formula indexation mechanisms in pensions are absent (map 2.5). This lack, combined with moderate to high inflation, makes this source of fiscal adjustment tempting for many governments given the large share of pensions in total spending.

This type of fiscal adjustment is largely regressive in LAC because most pensioners in the region have very low incomes, unlike in many industrial countries. Moreover, the negative impact on economic activity of cuts in social transfers is high in the short term because social transfer multipliers are quite large in LAC (Bracco et al. 2021). This is primarily because a large share of the population lives hand-to-mouth (see figure 2.15). Lacking savings or access to credit, these individuals and households are unable to smooth consumption by tapping savings or borrowing through financial markets. They thus consume the vast majority of the transfers. While the share of individuals living hand-to-mouth is around 23 percent in industrial countries and 48 percent in emerging economies, it reaches about 60 percent in LAC.

While pension reforms are certainly needed in many parts of the developing world—crucially, extending the retirement age, monitoring the destination and quantity of noncontributory pensions, and generally attending to their often regressive nature—inflation is a crude adjustment across the board that can potentially push many marginal households into poverty.

Map 2.5. Existence of Automatic Price-based Formula Indexation Mechanisms in the World circa 2019

Does the country have a formula-based indexation?

Yes No NA

Source: Galeano et al. 2021.