28
Aug

Who owns social security schemes in India? – Principles for a robust framework

By Vishnu Prasad, IFMR Finance Foundation

This post is the third in a series on Social Security for the Indian Unorganised Sector. The series will look at the challenges in the current implementation of social security schemes in India, and aim to provide a comprehensive framework for effective design, ownership, governance and delivery. This series is based on the report “Comprehensive Social Security for the Indian Unorganised Sector: Recommendations on Design and Implementation” authored by IFMR Research – Centre for Microfinance & IFMR Finance Foundation.

The first post of this series identified several key issues in the design and implementation of social security schemes in India including fragmented ownership structure of social security schemes; the lack of coordination between different agencies precluding product innovation, development, and learning; multiple window architecture for accessing benefits; and problems with targeting and identification of beneficiaries. In this post, we propose principles and design elements for building a robust ownership and governance structure for social security programs in India.

Design Principles for an Effective Ownership and Governance Structure

There are three key design elements that will be essential in a well-functioning ownership and governance structure for CSS:

i. A unified agency to own schemes so as to ensure convergence,
ii. A degree of separation between the political set up and implementation, and
iii. Active coordination between the central implementing agency and states

The Unorganised Workers’ Social Security Act, 2008 (UWSSA) appears to have tried to address the issues mentioned above when it envisaged the creation of a National Social Security Board (NSSB) to own all social security schemes in the country and State Social Security Boards (SSSBs) in each state to ensure coordination. However, the implementation of the NSSB and SSSBs have been fraught with difficulty with only a handful of states having formed SSSBs and states like Tamil Nadu declining to create such an entity. This can be partially attributed to the one aspect that the UWSSA does not address – i.e. the separation between the political set up and implementation. This is not uncommon in traditional models that have always relied on the purchaser and the provider being the same entity. For instance, the Ministry of Health in most countries is provided the funding as well as the mandate for delivering public health services. Many countries have found that this yields sub-optimal results like inefficient delivery of health services, and have therefore moved towards separating the purchaser and provider of such public services. As a consequence, countries such as Thailand and the UK have moved towards creating a ‘Trust’ structure which creates a distinction between the purchaser and the provider of public services. These countries have found that the organisational and governance efficiencies provided by this structure have resulted in improved outcomes for citizens.

For example, in Thailand the National Health Security Office (NHSO) oversees the implementation of the Universal Coverage Scheme (UCS), a universal health coverage scheme that offers both curative and preventive care. The NHSO consists of two governing national boards, the National Health Security Board (NHSB) and a standards and quality control board. The NHSB is chaired by the Minister of Public Health and consists of a wide range of members and experts from various public and private organisations. This structure enabled a degree of separation from the political set up and the involvement of a wider range of agencies and stakeholders in decision-making processes which improved the efficiency, transparency, responsiveness and accountability of the scheme. Further, by acting as the purchaser on behalf of UCS, the NHSO ensured that the Ministry of Public Health no longer wielded control over government spending on health-care services.

In a similar vein, social security schemes in India must be governed by The National Social Security Administration, a special purpose vehicle (SPV) set up as a Trust. The Board of Trustees should be chaired by the Prime Minister, and the Board itself should be comprised of the Ministers (or other senior representatives) who head the Ministries relevant to social security schemes. The NSSA should aim to bring together a wide range of stakeholders as members of the Board, like independent experts on life insurance, health insurance and public health, and pensions; representatives of insurance companies, pension fund managers, distributors; a representative from Aadhaar; and representatives of unorganised sector workers such as from labour unions and welfare boards. The NSSA will act as a controlling vehicle and not an operating vehicle governing the social security schemes. It will act as a point of convergence for the scheme, provide clarity on the roles and responsibilities of various entities, monitor and evaluate progress, and seek to bring in innovation in design and delivery through robust data collection, and research and development.

Further, each state should constitute independent State Social Security Administrations (SSSA) or its equivalent that will own and govern the implementation of the scheme at the state level. Each State should have an independent SSSA or an equivalent entity responsible establishing the target beneficiaries, awareness creation and marketing, mobilising resources for enrolment, and grievance redress and monitoring.

Open Architecture & Universal Coverage

It is desirable that social security programs are not discriminatory in nature and are available to all citizens, so that a minimum level of protection is provided for all. Currently, social security schemes like Aam Aadmi Bima Yojana (AABY) and National Pension Scheme (NPS) are targeted to the heads of households. This is fundamentally inequitable and over time could result in outcomes such as discrimination against women in the provision of social security.

As a principle, therefore, we propose that the CSS must aspire to create an open architecture that aims at universal coverage. Since CSS is meant to provide minimal levels of social security, it is only appropriate that it be made available to all citizens of India. While budgetary resources will determine the extent of subsidy available under the program – and this subsidy should be used only for vulnerable poor households or graded for the entire unorganised sector – it is essential that an unsubsidised version of the program be available to all citizens, in the spirit of universal coverage under social security.

Identification of Beneficiaries through Self-Reporting

While the legal definition provides a broad sense of an ‘unorganised worker’1, the true challenge on the ground will revolve around the identification of these unorganised sector workers. There is no clear, fool-proof mechanism available to identify and separate organised sector and unorganised sector workers today. The principle for identifying unorganised sector workers should be based on self-reporting by individuals (as recommended under the UWSSA) but not at the district administration; instead self-reporting can be done by beneficiaries. This is the strategy that has been adopted by the PFRDA for the NPS-S currently. Beneficiaries under NPS-Swavalamban directly self-report with the aggregator that they are employed in the unorganised sector and are not covered under the Employee Provident Fund (EPF) scheme.

Additionally, the design of the CSS and the extent of protection offered provide a natural disincentive for middle and high income citizens from registering for CSS. For instance, consider the Rs. 30,000 quantum of life insurance cover available under the AABY – this works out to 0.5% and 1.17% of the human capitals of a 20-year old in the fifth and fourth income quintiles respectively. It is not at all apparent that middle and high income individuals will seek to enter into these schemes and this has been borne out by the experience of the NPS-S. Translating this self-reporting mechanism to the social security program can be an effective and cost efficient strategy for identification of unorganised sector workers.


1 – As per the Unorganised Workers’ Social Security Act (UWSSA) 2008, an unorganised worker is defined as: “a home based worker, self-employed worker, or a wage worker in the unorganised sector and includes a worker in the organised sector who is not covered by any of the Acts mentioned in Schedule II of this Act”. The Acts under Schedule II are: The Workmen’s Compensation Act, The Industrial Disputes Act, The Employees State Insurance Act, The Employees Provident Fund and Miscellaneous Provisions Act, The Maternity Benefit Act and The Payment of Gratuity Act.

22
Aug

New Trustee Announcement

IFMR Trustee_Kshama

20
Aug

MBS with an impact: Mortgage backed securitisation for affordable housing finance

In the latest edition of The Euromoney Securitisation & Structured Finance Handbook 2014/15 (published by the Euromoney Handbooks, London) Sreya Ray & Vaibhav Anand of IFMR Capital have authored a chapter on the topic of Mortgage backed securitisation for affordable housing finance. In the chapter the authors provide a perspective on affordable housing finance and the challenges that it faces, along with an appraisal framework for AHFCs. In addition they detail a case study of IFMR Capital’s first ever mortgage backed securitisation for an AHFC.

Excerpt:

Affordable Housing Finance Companies (AHFCs) in India have emerged as a small but fast-growing segment committed to addressing the credit gap in the mainstream financial system for low-income households seeking mortgage finance. These AHFCs have overcome the challenges in credit appraisal of undocumented cash flows of low-income borrowers through a deep and localised understanding of the informal economy and innovative models to evaluate the financial position and creditworthiness using non-traditional data points. Given this non-traditional approach to credit appraisal, these AHFCs face challenges in accessing debt that they can then on-lend to their potential borrowers. Access to capital markets via securitisation can be a very effective tool to provide efficient, reliable and sustainable sources of funds for AHFCs on a maturity matched basis, provided the legal complexities and risks of a mortgage-backed securitisation (MBS) can be adequately managed. IFMR Capital pioneered the first ever MBS for an AHFC, Hebros AHL IFMR Capital 2014, on March 27, 2014, leading the way for AHFCs to enter capital markets.

Click here to download the chapter.

12
Aug

The Great Inequality Debate

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By Ravi Saraogi, IFMR Investments

Introduction

Simon Kuznets’ seminal 1955 study on income inequality is famous for the inverted ‘U’ hypothesis1 which posits that as an economy develops, inequality first increases and then decreases if a certain level of income is achieved. In his study, Kuznets writes that the study of income distribution “has been plagued by looseness in definitions, unusual scarcity of data, and pressures of strongly held opinions.” Half a century later, it would seem these words still hold true given the fractious debate Thomas Piketty’s work has reignited.

Piketty and his book Capital in the Twenty-First Century2 (translated in English by Arthur Goldhammer) are at the centre stage of the growing debate on wealth inequality. The book has been spectacularly successful in capturing the wealth inequality zeitgeist post the US financial crisis. The rapturous reception that Piketty’s book has received is entirely merited. Piketty has painstakingly analysed diverse set of data from no less than twenty countries dating as far back as the eighteenth century. The book combines detailed data analysis along with references to novelists Jane Austen and Balzac. It makes the claim3 that the main drive of inequality in a capitalist economy is the rate of return on capital (r) exceeding the overall economic growth rate (g), thereby leading to concentration of wealth at the hands of owners of capital. Since savings (the source of capital) is accumulated disproportionately more at the top income levels, this leads to growing inequality. Piketty calls this the “central contradiction of capitalism.” To ameliorate the rising income inequality, Piketty advocates for a global4 wealth tax regime.

What is revolutionary in Piketty’s inequality study is the combination of survey data with tax records to estimate the distribution of income. Doing this for several countries dating back several decades is no mean feat and Piketty has used various techniques and educated guesswork to tide over data limitations.

Methodology

Piketty’s conclusions are based on two “laws” which he introduces in his book – the first law of capitalism as per which capital’s share of national income has been defined as (r X k/y), where (r) is the return on capital, (k) is the capital stock and (y) is the national income. As per the second law of capitalism which Piketty introduces, in the long run, the capital-to-income ratio (k/y) will equal (s/g), where (s) is the savings rate and (g) is the growth rate (assuming the savings rate (s) to be constant). These two laws when combined, yield the result that capital’s share of income is (r X s/g). This derivation forms the bedrock of Piketty’s contention on rising inequality. With (r) expected to be higher than growth rate (g), and the growth rate assumed to be tending to zero in the long run, the derivation (r X s/g) suggests that capital’s share of national income will increase explosively.

The above characterization differs from the standard textbook version of growth models, such as Solow’s classical growth model. In the standard theory, the capital-to-income ratio (k/y) is equal to s/(g+d), where (d) stands for depreciation rate, and not (s/g) as per Piketty’s model. Thus, in the standard textbook models, when growth rate (g) approached zero, the increase in the capital-output ratio would be only marginal when compared to in Piketty’s model.

This divergence in the prediction of the capital-output ratio between the textbook growth models and Piketty’s model is reinforced by Piketty’s treatment of savings (s). In a simple Solow model (with no labour and technological growth), savings (which equals investment) is gross of depreciation. If savings (investment) exceeds depreciation, capital accumulation takes place and the economy grows. If savings (investment) falls short of depreciation, the economy shrinks. Piketty however, considers savings net of depreciation where the output in an economy is first used to replace worn out capital (i.e. to provide for deprecation) and then a constant proportion of the balance output is saved. Thus, net savings (investment) is defined as a constant proportion of net output, and for any value of growth rate (g), capital is always increasing, leading to higher and higher share of capital-output ratio.

Discussion on core ideas

banksy_canarywharfImage: Artwork by Banksy. Canary Wharf, London.

Apart from making the claim that inequality is rising back to nineteenth-century levels, the book also claims that those at the top of the income pyramid are dominated not by talented individuals but by family dynasties. Piketty calls this “patrimonial capitalism,” which is to say that today’s wealthy are dominated by inheritors rather than the newly rich, as during the “Gilded Age5” in the US. This thesis of a “rich get richer” dynamic has found widespread support, with Robert Solow writing that, “If already existing agglomerations of wealth tend to grow faster than incomes from work, it is likely that the role of inherited wealth in society will increase relative to that of recently earned and therefore more merit-based fortunes.

Piketty however makes an important distinction between the nature of inequality in Europe as compared to the US, where he finds that the thesis of the reason behind inequality (r>g) does not apply. He writes, “US inequality in 2010 is quantitatively as extreme as in old Europe in the first decade of the twentieth century, but the structure of that inequality is rather clearly different.” This has also been emphasised by Krugman who identifies the rise of “supersalaries” (and not higher return on capital as compared to growth rates) as the main cause for the “rise” in US inequality.

However, emerging research is also challenging Piketty’s hypothesis that inequality has increased due to r being greater than g, with the contention that the higher growth of capital is almost entirely due to housing6. Another important line of argument against the thesis stems from the premise that excessive focus on disparities in monetary income and wealth is misguided. This is because it ignores the improvement in the quality of life of the masses bought about by lower real cost, increased access and better quality of goods and services for consumption due to the competitive forces of capitalism (note that non-monetary factors such as ‘improvements’ and ‘access’ are not accounted for in monetary income and wealth). This point was long ago emphasized by the eminent economist, Joseph A. Schumpeter, in his book Capitalism, Socialism and Democracy, more than half a century ago. He writes7, “If we list the items that enter the modern workman’s budget and from 1899 on observe the course of their prices not in terms of money but in terms of the hours of labour that will buy them – i.e., each year’s money prices divided by each year’s hourly wage rates – we cannot fail to be struck by the rate of the advance which, considering the spectacular improvements in qualities, seems to have greater and not smaller than it ever was before.

The broad contours of the debate on inequality cannot be complete without looking at Piketty’s r>g contention in light of Schumpeter’s famous theory, the process of Creative Destruction. As per Piketty, the return of capital of 4% to 5% is stationary, consistent and exceeds the overall growth rate of 1% to 2%, thereby leading to ever increasing concentration of wealth at the hands of owners of capital. However, the process of Creative Destruction which characterizes a capitalist economy makes this interpretation difficult. As per Schumpeter8, “The essential point to grasp is that in dealing with capitalism we are dealing with an evolutionary process. It may seem strange that anyone can fail to see so obvious a fact which moreover was long ago emphasized by Karl Marx… Capitalism, then, is by nature a form or method of economic change and not only never is but never can be stationary… The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumer’s goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates.

Thus, constant churning rather than permanence is the hallmark of a capitalist system. In the U.S., 33,000 businesses filed for bankruptcy in 2013, which was a year of economic expansion. The Internal Revenue Service’s (which is the revenue body of the Unites States federal government) list of “Top 400 Individual Tax Returns” shows that from 1992 to 2009, 73% of the individuals appeared on that list for a maximum of one year and only a handful were in the list for 10 or more years9. A similar story would emerge if we analysed the Forbes list of top 100 wealthiest people or the composition of the Dow Jones Index since its inception.

Discussion on the Global Wealth Tax recommendation

Analysing Piketty’s suggestion of a global wealth tax to ameliorate “inequality” can be enlightening under a political philosophy framework, especially the framework proposed by two leading but opposite scholars of political philosophy, John Rawls and Robert Nozick. The global wealth tax may find admirers from social scientists operating under Rawls’ Difference Principle, as per which, “social and economic inequalities, for example, inequalities of wealth and authority are just only if they result in compensating benefits for everyone, and in particular for the least advantaged member of society.10” Under this principle, redistribution is justified if the condition of not so fortunate is improved. It should be noted that this does not mean that Rawls favoured absolute equality. As he writes, “But there is no injustice in greater benefits earned by a few provided that the situation of persons not so fortunate is thereby improved.11

However, the redistribution of wealth under the Rawlsian framework can be contested under Nozick’s Entitlement Theory. This theory is a criticism of redistribution that is only based on “how things are distributed (who has what)12 rather than “how (the wealth) came about.” Nozick terms redistribution agendas based on only the current distribution of wealth (without any emphasis on how such a distribution came about) as “current time-slice principles” of redistribution. As per Nozick, “Most persons do not accept current time-slice principles as constituting the whole story about distributive shares. They think it relevant in assessing the justice of a situation to consider not only the distribution it embodies, but also how that distribution came about.” Thus, under the Entitlement Theory, Piketty’s global wealth tax can be criticised on the ground that it is close to current time-slice principle of redistribution and does not take into account how the distribution of the current global wealth came about13.

A more significant issue relates to the practicality of the Global Wealth Tax itself. Piketty himself writes that the tax “would require a very high and no doubt unrealistic level of international cooperation.” Robert Schiller has proposed the idea of inequality insurance as an alternate, more workable solution. He argues that the really important concern for policymakers is to prevent disasters, specifically, outlier events – which in this context would mean a return to levels of inequality not seen for more than a century in the US. Inequality insurance would require governments to establish very long-term plans to make income-tax rates automatically higher for high-income people in the future if inequality worsens significantly (called the Rising Tide Tax System), with no change in taxes otherwise. Inequality insurance, like any insurance policy, addresses risks before they occur, therefore taking effect gradually according to a formula that is known in advance. Schiller also argues that a long-term plan legislated by one or a few countries today could help to promote an international dialogue about appropriate future policy toward inequality and enable the development of a uniform tax regime internationally.

End note

A single post cannot do justice in encapsulating the entire range of issues brought out in the open by Piketty’s revolutionary work. And while the inequality debate has strong ideological overtones and will see many more opinions, Piketty’s largest contribution perhaps is to bring inequality back at the centre stage of economic debate.


1 – Also referred to as the ‘Kuznets curve’
2 – The title of the book is a throw away to the Marxian era, whose magnum opus was titled ‘Das Capital’
3 – The following general interpretation of the main thesis of Piketty’s book has been sourced from, http://www.hup.harvard.edu/catalog.php?isbn=9780674430006
4 – Piketty advocates for a global wealth tax under which the use of tax havens to escape such taxes are rendered ineffective
5 – The Gilded Age was a period in US history spanning from 1870 to 1900 during which strong growth was accompanied by social unrest and poverty
6 – The authors have also questioned Piketty’s treatment of the housing data in his analysis
7 – Schumpeter, Joseph A., Capitalism, Socialism and Democracy, Chapter VII – The Process of Creative Destruction, p. 81
8 – Schumpeter, Joseph A., Capitalism, Socialism and Democracy, Chapter VII – The Process of Creative Destruction, p. 82-83
9 – Ibid.
10 – Rawls, John, Theory of Justice, p. 14-15
11 – Ibid.
12 – Nozick, Robert. Anarchy, State and Utopia. P. 153
13 – It can be argued that Piketty’s contention that r>g is a value judgment on the injustice of contemporary economic and political system which justifies current time-slice principles of redistribution. However, if the underlying economic and political system is “unjust”, should Piketty suggest a continuation of this system with global wealth tax or propose an alternative economic and political system?

25
Jul

Designing a Minimum Social Security Floor for the Indian Unorganised Sector

By Vishnu Prasad, IFMR Finance Foundation

This post is the second in a series on Social Security for the Indian Unorganised Sector. The series will look at the challenges in the current implementation of social security schemes in India, and aim to provide a comprehensive framework for effective design, ownership, governance and delivery. This series is based on the report “Comprehensive Social Security for the Indian Unorganised Sector: Recommendations on Design and Implementation” authored by IFMR Research – Centre for Microfinance & IFMR Finance Foundation.

Why are take-up rates for social security schemes such as Aam Aadmi Bima Yojana (AABY) life insurance and NPS-Swavalamban (NPS-S) pension doggedly low in India? What prevents a customer from investing Rs.1,000 in an NPS-S account and doubling her investment through a matching government contribution? While there are significant flaws in the delivery and implementation architecture of social security schemes in India (discussed in the first post of this series), this post argues that customers’ aversion to these products could be rational and can be partially explained by the low levels of protection offered by these schemes. We examine two products below- life insurance and public pension.

(For an overview of the schemes discussed in this post, click here).

Life Insurance

The purpose of life insurance is to help households tide over the shock of loss of income due to the unexpected death of an income earning member. The extent of life and accident cover required for an individual is closely tied to the individual’s ‘human capital’, defined as the net present value of the future real expenditure and earning streams associated with that individual. An individual’s human capital reflects the loss of net earnings to the household in event of her death. Since an individual’s human capital is closely tied to multiple idiosyncratic variables like age, education and skill level, the task of public policy is to choose the human capital associated with a particular age and income profile below which it is considered infeasible for a household to function effectively upon the death of an income earner.

In order to make this assessment, we analyse the human capital matrix across different ages and incomes . The table below provides the value of human capital for ages ranging from 20 to 55 years grouped by income quintiles. In view of the fact that social security is designed to provide a minimum cover in case of the income-earner’s death, it is pertinent to focus on the human capital of the lowest income quintile (Column 2 in the Table below).

SocialSecurity_Post2_Image1

Let us compare this with the coverage provided under current social security schemes in India. The coverage provided for natural death under the AABY is Rs. 30,000, which according to the human capital calculations does not provide adequate cover for even a 50 year old in the lowest income quintile. Considering the fact that a younger income earner’s death will have a tremendous impact on the well-being of the household, as evidenced by the human capital calculations, it is clear that the present coverage under life insurance is woefully inadequate.

While there may be financial constraints that prevent extant life cover under social security from being set at this level, it is useful to articulate this – the human capital of a 40 year old in the bottom quintile should be, at minimum, the life insurance coverage goal to work towards over a specified period of time.

Public Pension

The purpose of pension cover under social security is to secure a minimum post-retirement income for an individual. In order to arrive at such a pension floor under social security, we analyse the post-retirement corpus required by individuals across age groups- ranging from 20 years to 55 years- in the lowest income quintile. Our assumptions are based on the current structure of the NPS-S product- customers contribute Rs. 1,000 per annum into their NPS-S account and that the government fully matches the individual’s contribution for the first five years. The customer’s savings in NPS-S are invested in two assets- debt (85%) and equity (15%).

As Column 4 of the table below shows, the expected return from investment in NPS-S for a 20 year old covers only about 31% of her post-retirement expenditure. If the aim of social security pension is to secure a minimum post-retirement income, the present scheme clearly falls short of this objective.

SocialSecurity_Post2_Image2

Without a perpetual matching contribution from the government, NPS-S does not provide enough incentive for a person to join the scheme. As the report of the Committee to Review Implementation of Informal Sector Pension (CRIISP) notes, there is strong economic logic to extending the matching contribution from GoI for perpetuity . For instance, an inflation-indexed matching contribution from the government would enable a 20-year old to reduce the shortfall from her minimum corpus to 57.5%, a reduction of 11.5% from the current state. Furthermore, the large shortfall is partly a result of the conservative investment mix of the scheme. We find that moving to the life cycle investment mix used by NPS-Main, together with inflation indexed matching contributions, would allow a 20-year old to reduce her shortfall to 14.5%.

As a general principle for pensions under social security, we propose this- if the aim of pensions under social security is to guarantee a minimum post-retirement corpus, a pension product under social security for the unorganised sector should cover, at minimum, the post-retirement expenditure of individuals in the lowest income quintile.

While there are significant challenges to be overcome in the delivery mechanism, ownership structure, and governance of social security schemes in India, better scheme design that adhere to the principles articulated above could offer all citizens minimal levels of guaranteed financial protection under social security.


Endnotes:

  1. This analysis has been performed on data from a financial services firm that is operational across rural districts in three states of India for a sample of over 200,000 households.
  2. A perpetual matching contribution provides pension in the informal sector some parity with the formal sector, popularly known as the employees’ provident fund scheme. Currently, all formal sector employees covered by the EPFO are also covered by the Employees’ Pension Scheme, 1995 under which the Government of India contributes 1.16% of their wages (subject to a monthly cap of Rs.6500) towards their pension. Thus, there is every reason to accord the same treatment to the persons in the informal sector to whom NPS applies. For a detailed analysis of the economic logic behind this, refer to the CRIISP Recommendations Pages 45-46 – Available here: http://pfrda.org.in/writereaddata/linkimages/CRIISP%20Report9681894859.pdf
  3. The life-cycle investment mix varies the proportion of investment in the three classes of assets according to the age of the customer and shifts investment from riskier assets (80% of the contribution is invested in equity, and corporate bonds for a 20-year old) to safer instruments (80% is invested in government securities for a 55-year old) as the customer ages.