metadata: authors: 0: author: Camacho,Adriana
1: author: Conover, Emily
2: author: Hoyos, Alejandro
count: Colombia
docna: 0: docna: Effects of Colombia's social protection
            system on workers' choice between formal and informal employment
docty: Policy Research Working Paper
subtopic: Health Care Services Industry,Labor Markets,Health Economics & Finance,Health Insurance,Employment and Unemployment,Inequality,Rural Labor Markets
teratopic: Social Protections and Labor,Health, Nutrition and Population
abstracts: cdata!: This paper examines whether the
            Colombian government's expansion of social programs in
            the early 1990s, particularly the publicly provided health
            insurance, discouraged formal employment. Using household
            survey data and variation across municipalities in the onset
            of interviews for the SISBEN, the instrument used to
            identify beneficiaries for public health insurance, it shows
            robust and consistent estimates of an increase in informal
            employment of approximately 4 percentage points. Similar
            results are obtained using an alternative dataset,
            consisting of a panel of individuals interviewed for the
            first and second SISBEN. The findings suggest that marginal
            individuals optimized when deciding whether to participate
            in the formal sector.
geo_reg_key: 517191,119228
repnme: repnme: Effects of Colombia's social
            protection system on workers' choice between formal and
            informal employment
display_title: Effects of Colombia's social
            protection system on workers' choice between formal and
            informal employment
listing_relative_url: /research/2013/08/18092449/effects-colombias-social-protection-system-workers-choice-between-formal-informal-employment
topicv3: Labor Markets m1326488 855,Poverty m1326687 695,Health Insurance m1327759 1287,Informal Employment m1503994 2692,Health m1504661 3480
publishtoextweb_dt: 2013-08-01T00:00:00Z
historic_topic: Social Protections and Labor,Health, Nutrition and Population
no_of_pages: 37
author_keys: 0: author_key: 944141
model_extractions: WPS6564 Policy Research Working Paper 6564 Effects of Colombia’s Social Protection System on Workers’ Choice between Formal and Informal Employment _Adriana Camacho Emily Conover Alejandro Hoyos_ The World Bank Development Economics Vice Presidency Partnerships, Capacity Building Unit August 2013
Policy Research Working Paper 6564

# **Abstract**

This paper examines whether the Colombian government’s expansion of social programs in the early 1990s, particularly the publicly provided health insurance, discouraged formal employment. Using household survey data and variation across municipalities in the onset of interviews for the SISBEN, the instrument used to identify beneficiaries for public health insurance, it shows robust and consistent estimates of an increase in informal employment of approximately 4 percentage points. Similar results are obtained using an alternative dataset, consisting of a panel of individuals interviewed for the first and second SISBEN. The findings suggest that marginal individuals optimized when deciding whether to participate in the formal sector.

This paper is a product of the Partnerships, Capacity Building Unit, Development Economics Vice Presidency. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The authors may be contacted at econover@hamilton.edu.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
Effects of Colombia’s Social Protection System on Workers’ Choice between Formal and Informal Employment<sup>_∗_</sup> Adriana Camacho Emily Conover Alejandro Hoyos JEL classification codes: I11, I18, O17.

Keywords: Social Protection, Incentives, Informal Sector, Health Insurance, Social Protection, Colombia.

> _∗_ Adriana Camacho is an Associated Professor in the Economics Department and CEDE at Universidad de Los Andes, Bogot ́a, Colombia; her email address is adcamach@uniandes.edu.co. Emily Conover (corresponding author) is an Assistant Professor in the Economics Department at Hamilton College; her email address is econover@hamilton.edu. Alejandro Hoyos is a Ph.D. Student in Economics at the University of Chicago; his email address is ahoyos@uchicago.edu. The authors are very grateful to Anna Aizer, Kathryn Anderson, Donald Conover, Alain de Janvry, Amy Damon, Chang-Tai Hsieh, David Levine, Edward Miguel, Enrico Moretti, Suresh Naidu, Elisabeth Sadoulet, Dean Scrimgeour and two anonymous referees. Thanks to participants at the NEUDC conference, seminario CEDE, the Hamilton-Colgate economic seminar series, ICESI seminar participants, LACEA Conference, AEA meetings, IZA-World Bank Conference, and IEN-LACEA.

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Expansions of government-funded social programs generate controversies regarding the perverse incentives that these programs may create. Opponents claim that despite their intended benefits, people become dependent on such programs and under-report or hide their income to ensure their eligibility. Informal employment is another possible unintended consequence of social programs. In this paper, we examine the impact of Colombia’s public health insurance, the Subsidized Regime (SR), on workers’ choice of formal or informal employment.

Informal employment, which is common in many developing countries, is particularly high in Latin America. Galiani and Weinschelbaum (2012) report an average formality rate of 50% between 2002-2004 across a group of 12 Latin American countries. In addition, a World Bank report indicates that during the 1990s, informality rates increased in several Latin American countries (Perry et al. 2007). In Colombia, the average informality rate from 1990–2005 was 51%.<sup>1</sup> From a social welfare perspective, informality is often seen as undesirable since the informal sector encompasses constrained and low productivity firms, where workers have unstable jobs, are unprotected by labor laws, and are unlikely to receive benefits such as health insurance or pensions.

For some workers, informal employment is not always undesirable. Maloney (2004) indicates that informality status may be preferred by some workers because it grants them greater independence and work schedule freedom. Informality may also be favored if the cost of taxes or social security contributions exceeds workers’ valuation of the services they provide. This situation is exacerbated when the government provides informal workers with comparable free or discounted services, which is the case for the SR in Colombia (Levy 2008; Pag ́es and Madrigal 2008)<sup>2</sup> .

> The upward trend in informality rates in some Latin American countries coincides with the

> 1This rate is calculated using a benefit-based definition that refers to an employee who does not receive social security benefits through employment. In 2003, the International Conference of Labor Statisticians (ICLS) established the benefit-based definition of informality as the official one.

> 2See Loayza (1996) and De Soto (1989) for characterizations of the informal labor market and its determinants.

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expansion of social program provisions.<sup>3</sup> The cost of health insurance through employment in Colombia is often cited as anecdotal evidence of a powerful disincentive for formal employment. However, prior to this paper, no systematic empirical evidence has been presented to confirm or reject this hypothesis.<sup>4</sup> To determine whether the SR expansion generated incentives for informal employment, we use two datasets and different identification strategies. The first comes from repeated crosssections of the Colombian Household Survey. Using individual-level data and controlling for municipality and year effects, we estimate whether there was an increase in informal employment after the municipality started conducting the interviews needed to determine eligibility for the SR (known as SISBEN interviews). These interviews were implemented at different points in time across municipalities, which allows us to disentangle the effects of the expansion of the health insurance provision from other labor market reforms and macroeconomic shocks occurring at the national level during the same period of time. In section III, we show that pre-existing informality rates are uncorrelated with the timing of the SISBEN, and we find robust and consistent effects of an increase in informal employment of approximately 4 percentage points. This finding corresponds to approximately 8% of the labor force not entering the formal sector and an increase in the government’s health expenditures of approximately 11%.

Our second dataset is a panel of people interviewed in the first and second SISBEN. Using information about an individual’s eligibility status (as determined by her Poverty Index Score from the first SISBEN)<sup>5</sup> and individual fixed effects, we corroborate the increase in informal employment found with the household survey dataset. Additional estimations that account

> 3See Grosh (1994) for a review of 30 social programs in 11 Latin American countries.

> 4For example, in a news article reported by _Presidencia de la Rep ́ublica_ (Feb. 2006), the Minister of Social Protection indicated that people’s valuation of the public health insurance program (the Subsidized Regime (SR)) was high enough to create incentives to discourage formal employment. A study by Santamaria et al. (2008) reports that almost half of SR recipients (49%) indicated that they were not willing to switch to formal employment because it would mean losing their (SR) benefits.

> 5We use data from 1994–1997 for the first SISBEN and from 2003–2007 for the second SISBEN. The algorithm used to determine eligibility changed from the first to the second SISBEN.

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for SR eligibility and heterogeneous effects by household characteristics also indicate consistent results of an increase in informal employment.

The rest of the paper is organized as follows: in the next section, we provide background information on the health sector reform. In section II, we review articles that examined the effects of other reforms that occurred in Colombia during the period of our study as well as studies of informal employment in other Latin American countries. In the data section, we describe the datasets used in the analysis. In Section IV, we present the empirical results for informal employment using the two datasets and different identification strategies. We conclude in Section V.

# **I Background**

In 1990, Colombia adopted a new constitution that emphasized social program spending for the poor. Law 100 of 1993 reformed the social security system, including pensions, workplace accidents, complementary social services, and health insurance. The health sector reform aimed to achieve universal health insurance coverage through the creation of two regimes: a Contributive Regime (CR) and a Subsidized Regime (SR).

The main difference between the SR and all other changes to the social security system is that all but the SR were implemented nationally in January 1994. Unlike the SR, the other changes did not require the SISBEN. Using the variation in the implementation dates of the SISBEN across municipalities and year fixed effects as well as a discontinuous eligibility threshold for the SR, we are able to identify the effects that are due to the SR and not due to the other national changes that occurred when Law 100 came into effect.

The CR, which was implemented in the whole country after the passing of the law, made health insurance through employment mandatory regardless of occupation. The SR was de4
signed for the unemployed poor and was implemented at different points in time in different municipalities. Eligibility for the SR was determined using a Poverty Index Score calculated from answers to the SISBEN, which is a questionnaire collecting individual- and household-level demographic and dwelling information (Casta ̃neda et al. 2005).<sup>6</sup> The SISBEN was conducted at the municipal level in a similar way to the population census, with door-to-door interviews in lower-income neighborhoods. This was an unprecedented system, and nothing of this magnitude had ever been implemented in Colombia. As explained by officials, not all municipalities had the resources or infrastructure in place to conduct a census of the poor (SISBEN), so implementation dates varied across municipalities. Importantly, these dates are not correlated with the pre-reform informality rates in the municipalities. To identify the results, we use this variation in implementation dates and the eligibility indicator from when the system was introduced.

The government agency that designed the SISBEN indicates that although the instrument was designed to select beneficiaries for different social programs, during the period of our study, it was almost exclusively used for the SR, the largest program in terms of beneficiaries and costs (DNP, 2003).<sup>7</sup> This exclusive use was so extensive that initially, many people thought that being interviewed for the SISBEN was equivalent to becoming eligible for the SR. In reality, households were eligible for the SR only if they had a Poverty Index Score below a certain threshold, as determined by the answers to the SISBEN.

If a worker is formally employed, the worker and the employer are required to make contributions to the CR regardless of the worker’s occupation or the SISBEN score of his household.

Independent workers can also enroll in the CR by paying 5% of their wages.<sup>8</sup> Employers who do

> 6In the first SISBEN, the Poverty Index Score was generated using a principal components methodology that took into account demographic and dwelling characteristics at the individual and household levels. It was designed to capture long-term living conditions and was assigned at the household level.

> 7For details on how the SISBEN has been used, see Camacho and Conover (2011) and Camacho and Conover (2013).

> 8From 1995–2007, the cost to non-independent workers was 12% of a person’s wages, 25% of which were paid

5
not comply with the legislation can be sued by the workers. In exchange for these contributions, employees and their direct dependents (spouse and children, or one parent) have access to a range of health services and medications, known as the _Plan Obligatorio de Salud_ (POS).<sup>9</sup> The SR is financed with a 1% transfer from the CR and with local and central government funds. All members in a household eligible for the SR, regardless of their relationship to the household head, have free access to a package of services and medications known as the _Plan Obligatorio de Salud Subsidiado_ (POS-S).<sup>10</sup> This package is less comprehensive than the CR’s POS.

Giedion and Uribe (2009) explain that beneficiaries of both the contributive and subsidized regimes have pre-established packages of services and benefits. The CR includes all levels of care, whereas the SR package “covers most low-complexity care and catastrophic illnesses but provides only limited coverage for most hospital care and provides no short-term disability coverage” (Giedion and Uribe 2009). In particular, the SR and CR offer similar coverage for public health education and outreach, preventive care services, basic dental care, and catastrophic care. The CR provides more generous coverage for outpatient services, inpatient services and maternity care and provides sick leave (not covered by the SR).

To prevent dual enrollment, a worker cannot be covered by both the CR and SR. Participation in the CR disqualifies a worker from the SR even if he has a score below the eligibility threshold. The structure of the system raised questions about whether it generated incentives for informality because for those eligible for the SR who were willing and able to engage in informal employment, it reduced health insurance costs for both the employer and employee. In this paper, we explore whether some workers who were eligible for the SR (because of a Poverty

> by the employee and 75% by the employer. Health and pension contributions were not bundled for the period of our study.

> 9In English, POS stands for “Obligatory Health Plan.” For more information on the details of the POS and POS-S, see Tafur (1998).

> 10In English, POS-S stands for “Subsidized Obligatory Health Plan.”

6
Index Score below the threshold) and were formally employed (receiving the CR) opted out of making mandatory contributions to the CR and became informal, either by remaining employed and stopping their contributions to the CR or by switching to a non-contributory job.

# **II Related Literature**

From 1990–2005, the Colombian labor market underwent several legislative changes and economic reforms. Several studies analyze the impact of a change in labor taxes (Kugler 1999; Kugler and Kugler 2009), but these studies do not specifically address the effect of the health insurance provision on informal employment. Mondrag ́on et al. (2010) find that an increase in non-wage costs and in the minimum wage has a significant and positive effect on informal employment and a negative effect on informal wages. Gaviria and Henao (2001) report that a strategy used by households faced with a loss of employment is to participate in informal sector activities. Using data from the National Statistical Agency (DANE), these authors report an upward trend in informal employment<sup>11</sup> between 1996 and 2000 for both men and women (p.28). Unlike the studies above, we do not look at changes in labor taxes or the minimum wage, but we analyze the effects of the SR on informal employment. This analysis is important given that the cost of the SR is estimated to be 1.2% of GDP and because new reforms to the system are currently being considered in Colombia.<sup>12</sup> Other researchers have recently examined similar questions in other Latin American countries. For instance, in Argentina, Gasparini et al. (2009) find evidence of increased informality generated by a large conditional cash transfer program.

In Mexico, using the roll-out of Seguro Popular in different cities over time and controlling

> 11The definition of informality they use is as follows: workers in firms with fewer than 10 employees, nonprofessional independent workers, domestic workers, and unpaid family workers who work at least 15 hours

> 12One of the reforms that was implemented recently makes the POS and POS-S packages equal.

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for macroeconomic variables and (sometimes) state-specific trends or year dummies, CamposVazquez and Knox (2008), Bosch and Campos-Vazquez (2010), Azuara and Marinescu (2011), and Aterido et al. (2011) find conflicting results (no overall effect, a negative effect in the creation of formal jobs, a decrease in formality among small sub-groups, or a non-trivial reduction in the inflow of workers into formality) of subsidized health insurance to the poor. In Uruguay, using an extension in health benefits to dependents of private sector workers, B ́ergolo and Cruces (2010) find that the health reform had a sizable effect on the type of employment.

Most studies use an identification strategy similar to ours in measuring the effects on informality by exploiting the variation in the roll-out or implementation of a particular large-scale social program, including municipality/state and time effects to capture other fluctuations in the labor market. Unlike our paper, however, previous studies do not identify individual-level eligibility, which we use in addition to the variation across municipalities.

In a more recent paper on Colombia, Calder ́on-Mej ́ıa and Marinescu (2011) use a similar identification strategy to examine the effect of two labor reforms implemented in 2003 and 2006– 2007. The reform of 2003 imposed a requirement to use the same base income to contribute to both health insurance and pensions for self-employed workers. In contrast, the reform of 2006–2007 unified the payments to health insurance and pensions; the roll-out of this reform was performed by firm size. They also use the same identification strategy, taking advantage of the roll-out by firm size and including time, municipality, and firm size fixed effects to capture other changes in the labor market.

We consider the informality model developed by Galiani and Weischelbaum (2012) to be an adequate representation of the relation between informal-formal labor markets and the effects of having a health insurance package. Our empirical results complement their findings and are consistent with the predictions of their model.

Taken together, these studies indicate that given the high rates of informality in Latin 8
America and the desire of many governments to expand social program provisions, a better understanding of the distortions generated by them can help to inform policy decisions. Our contributions to this literature are threefold. First, to our knowledge, no other studies have considered the effect of the SR expansion on informality in Colombia using individual-level data. The health reform was a major reform; health insurance coverage in the population increased from levels below 30% prior to the reform to more than 90% today. Second, our findings are derived from two different methodologies and datasets, and the results are consistent for different robustness checks. Third, the reform took place almost two decades ago, and one of our datasets covers years before and after the reform, allowing the labor market to adjust to the reform and allowing us to test for effects in the longer term.

# **III Data**

## **Household Survey Data**

We use repeated cross-sections of the Colombian Household Survey for periods before and after the implementation of the health care reform. Specifically, the informality modules included the second trimester every two years from 1990–1996 and once every year between 1997 and 2005.<sup>13</sup> These cross-sections are representative samples of the population living in Colombia’s ten largest cities.<sup>14</sup> Informality is defined as employees between 12 and 65 years who do not contribute to health insurance through employment. This definition of informality is most appropriate for our study, which evaluates the effect of a health insurance expansion.<sup>15</sup> Table 1 shows the descriptive statistics for total, informal, and formal workers in columns

> 1, 2, and 3, respectively. There is a higher proportion of men in the labor force (56%). Men

> 13In Spanish: _Encuesta Nacional de Hogares_ (ENH) 1990–2000 and _Encuesta Continua de Hogares_ (ECH) 2001–2005.

> 14Bogot ́a, Cali, Medell ́ın, Barranquilla, Bucaramanga, Pereira, Manizales, Villavicencio, Pasto, and C ́ucuta.

> 15Alternative definitions of informality are based on the firm size, occupation, or education level of workers.

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are also more likely than women to have informal employment. The average age of workers in Colombia is approximately 36 years. The highest proportion of workers is in the 25 to 34 years of age category. Informal workers are less educated than formal workers. Furthermore, 37% of formal workers have achieved some university education, whereas the corresponding number for informal workers is only 10%. We find that 39% of formal workers are married, in contrast to only 26% of informal workers. Cohabitating is more common among informal workers. The average household size and the proportion of other relatives and non-relatives living in the household are higher for informal workers.

We create a variable for the proportion of potential beneficiaries, which we use to test for heterogeneous effects in section IV. We define potential beneficiaries as household members who are not in the nuclear family, including married children and their spouses, grandchildren, grandparents and their spouses, siblings of the household head, and other relatives. These household members would be eligible for the SR but not the CR. We also define a group of vulnerable people within the household as the proportion of children under 1 year of age and the proportion of elderly members (65 years and older). An informal worker has, on average, a higher proportion of potential beneficiaries in the household and the same proportion of vulnerable members.

# **The Onset of SISBEN Interviews**

To determine whether the SR increased informal employment, we use variation across municipalities and compare the levels of informal employment before and after the onset of SISBEN interviews. We use the SISBEN onset dates as a proxy for the introduction of the SR because the law required that to become enrolled in the SR, people needed to have been interviewed for the SISBEN. Specifically, we use the SISBEN onset date as recorded in the SISBEN database 10
when more than 1% of the total interviews were conducted in that year,<sup>16</sup> as confirmed by the Secretary of Health of each municipality, or with alternative data sources, such as newspaper articles, as specified in Appendix Table S1, which reflects the onset dates for the SISBEN by municipality.

In all of the specifications, we include year and municipality fixed effects to ensure that economy-wide changes, such as those in the minimum wage, taxes, or job security legislation, and time-invariant municipal characteristics do not influence our results. We are able to do this because there is variation in the implementation dates across municipalities. We also have specifications with controls at the individual level (including age group, schooling, marital status, sex, relation to the household head, and public sector employment); the household level (household composition characteristics specified in each table, proportion employed, average education, and average age); and labor market controls (municipal-level information for population, workingage population, economically active population, and employment; and state-level GDP). The labor market controls, which vary by state and year (and are thus unique to each municipality in our sample), should capture any differential effect of macroeconomic shocks across regions. Identification comes from assuming that the variable of interest is capturing variation due solely to the onset of the SISBEN interviews and that the characteristics likely to influence the informality rates of those municipalities that implemented the SISBEN interviews later do not differ from municipalities that implemented earlier.

We group the municipalities according to the onset in SISBEN interviews in early (1994) and late (1995) adopters. We explore the relationship between earlier and later adopters in Figure 1

> 16We do this to avoid coding an onset date that could be due to a data-entry error. For instance, in two municipalities, the onset date appears in 1994, but less than 0.01% of the total interviews for those municipalities were recorded in that year. For one of the municipalities, we confirmed the onset date with a newspaper article. For the other, we re-ran the results, changing the onset date to 1994. The results remained consistent with the results presented in Table 3. In a few cases, these dates differ from those recorded in the SISBEN database because municipalities initially conducted some interviews that were later overwritten with updated interviews. Because we are interested in the onset of interviews, we use the earliest date given by the officials.

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and Appendix Table S2. The figure shows an overall decline in informality rates over the period that we study. This decline, however, confounds general trends in health insurance enrollment, macroeconomic conditions, and the effects of the SR. Our empirical strategy will disentangle these effects to identify the effects of the SR.

Figure 1 also shows that in the years prior to the onset of the SISBEN interviews (shaded area), the informality rates of early and late adopters were almost identical. The informality rates diverge after the onset of the interviews in 1994 for the early adopters. Notably, the decline in the informality rate is lower than that observed among the late adopter group of municipalities. In 1996, after the late adopters start, their decline in informality rates also slows. Appendix Table S2 shows the summary statistics using data prior to the onset of the SISBEN interviews. We find that although the largest cities started conducting SISBEN interviews earlier, importantly, the proportion of informal workers on the eve of the first SISBEN interviews is almost the same across the groups.<sup>17</sup> To address the possibility of any labor market or demographic municipal-specific changes, in our analysis, we include labor market, demographic, and education controls.

# **Panel Using Individual-Level SISBEN Data**

As an alternative data source and to corroborate our results, we use a panel dataset at the individual level that we constructed from the first and second SISBEN. The first SISBEN was conducted between 1994 and 2003, and the second was conducted between 2003 and 2007.

Because of manipulation concerns after 1998 (Camacho and Conover 2011), we use data for

> 17We tested whether the early and late adopters had different pre-adoption informality rates by running a municipal-level regression of the informality rate in the pre-period on year and interactions between year and adoption date. An F-test of the interaction terms jointly equal to zero indicates that we failed to reject the null hypothesis of a common trend among the two groups of municipalities. This test, however, uses only 20 observations.

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the first SISBEN from 1994–1997. Eligibility for the SR was based on the Poverty Index Score obtained from the first SISBEN, and we use individual fixed effects to determine whether the informality rates observed in the second SISBEN are higher for eligible individuals.

To construct the panel, we match individual-level information from the first and second SISBEN. We restrict our sample to working-age individuals between 12 and 65 years of age. We match the datasets in two ways. (1) We use the Colombian national identity card number. This is a unique ID number initially assigned to all Colombian citizens at age 7 that changes when they turn 18. This is the more conservative match, which we call the “ID match”. (2) We expand the match using names and dates of birth to include people who may have changed ID numbers when they turned 18. In Colombia, people use two last names; the first name is generally from the father, and the second is from the mother. When we match names, we use the first and second given names and the first and second last names, allowing for spelling mistakes and for phonetic distances no greater than 3 of 10 characters using the Leveinshtein criteria.<sup>18</sup> When we use dates of birth, we allow for the possibility of recording error by using both the exact date (day, month, year), either the same date and month of birth and within four years of birth, or the same year of birth and within two months and two days of birth. We call this the “Expanded match”. We report the results using both matches.

Summary statistics for the panel dataset that we construct using both the ID and expanded matches are reported in Table 2. To find a match, the individual must be in the labor force and have been interviewed for the SISBEN in both periods. Thus, we expect some workers from the first SISBEN (such as older people) to exit the labor force, and we do not see young workers who entered the labor force in the second SISBEN. Because we are observing the same individuals, some of the demographic characteristics, such as age and education, will change (increase) over

> 18Leveinshtein distances measure the similarity between two strings or two vectors of strings. The number indicates the number of characters that need to be changed in one string to equal the other string, normalized by the length of the string.

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time. In particular, there is a slight increase in the levels of education achieved and a reduction in the proportion of single individuals. There is a 9%-10% reduction in informality rates between the first and second SISBEN. In our empirical strategy we look at the evolution of informality rates among those eligible for the SR relative to people who are not eligible.

# **IV Effect of the Subsidized Regime on Informal Employment**

## **Survey Data Results**

Assuming that the reform was effectively in place when the municipality began conducting SISBEN interviews, we estimate the impact of the reform on informal employment. We construct an indicator variable, _post_ , that aligns the starting date of SISBEN interviews for each city and is equal to one on and after the year when the municipality began conducting interviews. In this way, we are able to disentangle the effects of national-level reforms from health reforms. Specifically, we estimate probit models with the following specification: where the sub-indices correspond to _i_ for an individual, _h_ for a household, _j_ for a municipality, and _t_ for a year. Here, _inf_ corresponds to an indicator variable for being informal, defined as a worker who does not contribute to health insurance through employment; _γ_ represents municipality effects; and _σ_ represents year effects, which capture any reform and shock at the national level. _X_ is a vector of controls that vary across municipalities and over time, such as population, working-age population, economically active population, employment, and statelevel GDP. These controls serve to capture variation due to business cycles and labor market fluctuations. _Z_ corresponds to a vector of individual controls, such as age group, schooling, 14
marital status, relation to the household head, and whether the person works in the public sector. _T_ corresponds to a vector of household controls, such as proportion of children in the household, proportion of elderly, proportion of potential beneficiaries to the SR, proportion employed, average education, average age, and socio-economic strata level. _S_ captures controls for the employment sector, as described in Appendix Table S3.

We are interested in _θ_ , the parameter for the indicator variable _post_ . A positive _θ_ indicates an increase in informal employment after the onset of the SISBEN interviews. We report the estimates of equation 1 in panel A of Table 3, where we show specifications including different sets of controls in each column listed in the note of the table. The estimates show a positive and significant effect of _post_ , with an increase in informality between 4.1 and 5 percentage points.<sup>19</sup> All specifications are clustered at the municipality-year level.<sup>20</sup> Next, we construct a proxy for the Poverty Index Score to assess whether the positive increase in informal employment is concentrated among the people who are eligible for the SR.

The variables needed to construct the Poverty Index Score calculated in the SISBEN are not available in the household survey, so we use a geographical socio-economic strata (SES) indicator as a proxy. When using the SISBEN dataset, we find that this indicator is a strong predictor of eligibility (significant at the 1% level). We identify as eligible people living in SES levels 1 and 2, and, for consistency with the SISBEN implementation process, we limit the sample to people living in strata levels targeted by the SISBEN (1-3). We estimate the following regression:

> 19To explore whether the effects are driven by self-employed workers or employees, we split the sample by each of these two groups, and we find consistent results across the two groups.

> 20We thank Josh Angrist for providing direction on the appropriate clustering level. The results clustered at the municipal level are consistent with those presented here but are less significant for panel C.

15
where we follow the same definitions used in equation 1 and _elig_ is an indicator variable that takes a value of one for individuals who are eligible for the SR according to the proxy for the Poverty Index Score. The variable of interest is _δ_ . A positive _δ_ reports the relative increase in informality after the onset of the SISBEN interviews among the people who are eligible for the SR relative to those who are ineligible. The results are reported in panel B of Table 3. The table shows an additional increase in informality between 3.0 and 4.2 percentage points. These findings are consistent with the increase in informality reported in the previous results.

# **Heterogeneous Effects by Household Composition**

Features of the system, such as restricting benefits to certain family members, can generate incentives for some workers to opt out of the CR. We now explore whether these features, together with different household characteristics, affect the decision to become informal.

Family composition may affect the incentives for workers to become or remain informal because the CR benefits a more restricted group of family members: (1) if married/cohabiting for more than two years, children and a spouse/partner who is not directly enrolled in the CR; and (2) if single or without children, a parent who is a dependent. Coverage for any additional family member has an additional cost. This per capita cost is set by the government and is known as _Unidad de Pago por Capitaci ́on_ (UPC). The SR, in contrast, allows the enrollment of any member of the household, regardless of family links. The less costly and less restrictive enrollment rules for family members or dependents in the SR might encourage some people to seek this type of health care coverage. Specifically, the SR is likely to be attractive to households with large extended families rather than smaller nuclear families.

If this is the case, we expect attenuated effects on households where the proportion of potential beneficiaries for the SR (as defined in section III) is lowest and stronger effects where the 16
proportion of potential beneficiaries is relatively high. To capture this effect, we estimate the following equation: The coefficient of interest is _θ_ 3, which captures the change in informal employment after the implementation of the SISBEN in households with a higher proportion of potential beneficiaries. Panel C of Table 3 shows that the effects are large, robust to different controls, and significant, showing that as the proportion of potential beneficiaries increases in the household after the implementation of the SISBEN, the probability of being informal increases by an additional 3 to 4.4 percentage points.

Another feature of the system is the differences in packages provided to CR and SR enrollees. As mentioned in the introduction, the CR provides a more complete package of services and medicines than the SR. There may be heterogeneity in how the different packages of services offered by the CR and SR affect workers. It is possible that people who are eligible for both regimes seek different systems depending on their anticipated health needs. Households with vulnerable members, such as newborns, children, and the elderly, might prefer the more comprehensive CR. In contrast, healthy young people who do not foresee a high need for health services would prefer the SR. For them, the differential cost of the CR would be higher than the loss in terms of the quality and comprehensiveness of its health package.

We use household characteristics as a proxy for health insurance valuation. In particular, we want to see whether there are attenuated effects for households with a higher proportion of vulnerable members because, anticipating higher health care usage, these households are likely to value the CR more relative to households without vulnerable members. This is relevant for 17
policy because there was a recent discussion about whether the two regimes should provide the same package of services and medicines.

To test this hypothesis, we define a variable that calculates the proportion of children under one year of age and the proportion of elderly members. We specify a model similar to equation 3, but we substitute vulnerable members for the proportion of potential beneficiaries. We find (in results that are not shown) that as the proportion of vulnerable members increases, the probability of becoming informal decreases after the implementation of the SISBEN.

## **Household-Level Regressions**

Finally, to account for the joint decision of members within the household, we estimate whether the proportion of informal employees in the household (of the number of economically active household members) increases after the onset of SISBEN interviews among the eligible households. We find a robust and consistent effect of an increase in the proportion of informal employees in the household of 3.3 to 4.8 percentage points and of 2.2 to 2.5 percentage points among those eligible for the SR (Appendix Table S4, panels A and B, respectively).<sup>21</sup>

# **Panel Data Results**

Using a panel dataset that we construct by matching individuals observed in the first and second SISBEN, as described in section III, we estimate an individual fixed effect regression that captures the change in informality due to the SR.

We observe each individual twice. Because people would only find out if they were eligible for the SR after the implementation of the first SISBEN, we estimate for the eligible population (as determined by the first SISBEN), relative to the non-eligible, the probability of being informally

> 21Consistent with our findings, a modified version of Galiani and Weinschelbaum’s (2012) informality model suggests that the introduction of the SR could be heterogeneous depending on the household composition.

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employed in the second SISBEN, using the following specification: where _π_ is the coefficient of interest, which, if positive, implies that the probability of being informal increased among the eligible people relative to the non-eligible in different sub-samples close to the threshold. _S_ is the control for the year in which the first SISBEN was conducted, and _γi_ is the individual fixed effect.

The corresponding regression results are reported in Table 4. Using the ID matching, the table shows that informality among the eligible population increased by 4.0 to 5.5 percentage points (panel A). The results are similar but slightly lower in magnitude (2.6 to 4.0 percentage points) when using the Expanded match, as reported in panel B. The corresponding Figure 2 shows, on the left graph, the informality rates relative to the eligibility threshold as determined in the first SISBEN using data from the first (solid line) and second (dash line) SISBEN. The graphs on the right are derived from data in the left graphs. These graphs indicate the difference in informality rates for the post minus the pre period relative to the eligibility threshold. These graphs show that the decline in informality rates is lower for people to the left of the threshold (those eligible for the SR), consistent with the direction and magnitude of the results estimated when using the variation in implementation dates across municipalities.

# **V Conclusion**

In this paper, we explore whether an expansion of non-contributory health insurance for the poor discouraged workers from entering the formal sector. Although this study was conducted using data from Colombia, it explores the broader question of how linking social benefits to 19
employment could generate strategic behavior by some individuals and create distortions in the labor market. As is common in empirical work, especially work on developing countries, the ideal dataset needed to conduct this analysis does not exist. Thus, to strengthen our findings, we use two different datasets that, though not perfect, provide consistent results for the question we address.

Using the onset of the SISBEN interviews and household survey data, we estimate that informal employment was approximately 4 percentage points higher than it would have been in the absence of the reform, or roughly 8% of the labor force not entering the formal sector.

Using an alternative dataset that we constructed using matched individuals in the first and second SISBEN and individual fixed effect regressions, we estimate the effect of the SR on informality to be approximately 3 to 4 percentage points when considering people 10 points around the eligibility threshold. These results are similar in magnitude to those obtained with the survey data. The sign of the coefficient suggests that some marginal individuals were optimizing when deciding whether to participate in the formal sector. Our empirical results are consistent with an informality model developed by Galiani and Weinschelbaum (2012).

It is important to consider that our estimates could combine both the effect of the implementation of the SR and those of a change in the enforcement of laws that prohibit informal employment (see Almeida and Carneiro 2012 and Ronconi 2010 for papers that discuss enforcement for labor and social security regulations in Latin America).<sup>22</sup> If enforcement changed with the passing of the law and not with the implementation of the SISBEN, then the variation across municipalities and the year fixed effects, as well as the discontinuous change in the eligibility threshold, should allow us to disentangle the effects of the SR from those of enforcement. If enforcement changed with the implementation of the SISBEN and at the eligibility threshold, then our estimates combine both effects. Looking at newspaper article counts of labor inspections

> 22We thank a referee for bringing the issue of enforcement to our attention.

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by adoption date, we do not find any evidence that enforcement changed with the adoption of the SISBEN, but we do see an overall increase across all municipalities. This increase should be captured by the year fixed effects, and any increase in enforcement not captured by the year would downward bias our estimates.

There are documented health benefits from the creation of the SR (Camacho and Conover 2013; Miller et al. 2009). A complete welfare analysis would also account for the benefits to workers (in terms of flexibility and independence) of becoming informal. In this study, we do not attempt to measure these benefits, but we find that the implementation of the SR resulted in a non-trivial increase in informal employment. To cover the new informal workers and their families, the government’s health budget increased by approximately 11%. Overall losses in productivity that result from differences in the informal and formal sectors are quantified in studies by C ́ardenas and Rozo (2009) and Hamman and Mej ́ıa (2011), which indicate that the output per worker in the formal sector relative to the informal sector is approximately 1.85 to 1.95. In a back-of-the-envelope calculation, using their ratios and our results, the increase in informality corresponds to a reduction of 3.8% of GDP. Note that this is likely an upper bound because it does not account for workers who were previously formal but remain in the same job with an agreement with their employer to opt out of making health insurance contributions, resulting in no loss of productivity.

We emphasize, however, that expanding health insurance coverage need not translate into higher informality rates. Rather, attention should focus on incorporating changes in the system to discourage people from entering the informal sector. One such change was passed by the government in 2005<sup>23</sup> when, in recognition of people not wanting to enter the formal sector for fear of permanently losing their SR benefits, the government allowed people to save their SR

> 23See ACUERDO 304 de 2005, available at `http://www.alcaldiabogota.gov.co/sisjur/normas/Norma1.jsp? i=18274`

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slot and reactivate it if they lost their formal employment within a year of enrolling in the CR. Further changes of this type would mitigate the increase in informal employment documented here.

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