Report No. 36583-CL Chile Towards Equality of Opportunity, 2006-2010 Policy Notes July 12, 2006 Argentina, Chile, Paraguay & Uruguay Country Management Unit Human Development Unit Latin America and the Caribbean Region Document of the World Bank I ICORE I Indicede CompetitividadRegional RD I ResearchandDevelopment (International Methodology andResearchNetworkfor Production Zonas Extremas I Acknowledgements These Policy Notes were prepared for the incoming Government o f Chile by a team coordinated by Jesko Hentschel (Human Development Sector Leader, LC7). Primary authors o fthe sector policy notes were: e Towards Equality of Opportunity: Jesko Hentschel with JosC Molinas (Senior Economist, LCSPP). Improving Access and Quality of Early Childhood Education: Emiliana Vegas (Education Economist, LCSHD). Her team included Gregory Elacqua (Associate Researcher, Universidad Adolfo Ibiiiiez) and Ilana Umansky (Education Policy Analyst, LCSHD). Policies for Better Old Age Income Support: Truman Packard (Senior Social Protection Economist, ECSHD), leading a team including David McCarthy ' (Imperial College London), Ximena Quintanilla (Institute of Fiscal Studies, UniversityCollege London) andJuanYermo (OECD). 0 Health Reform Implementation: Cristian Baeza (Lead Health Policy Specialist, LCSHH). 0 Regulation of Basic Public Services: Jose Luis Guasch (Senior Advisor, LCSFP), Juan Gaviria (Sector Leader, LCSFP) and Raffaella Mota (Consultant, LCSFP) with AndrCs Gomez-Lobo (Consultant, Universidad de Chile). Regional Development and Decentralization: Daniel Oks (Lead Economist, LCSPE), Jasmin Chakeri (Economist, LCC7A) with assistance o f Fernando Rojas (Lead Public Sector Management Specialist, LCSPS). The team would like to thank the peer reviewers for individual sector policy notes, Aurelio MenCndez (Lead Transport Specialist, EASTR), Antonio Estache (Senior Advisor, INFVP), Juan Prawda (Lead Education Specialist, LACHD), and Hermann von Gersdorff (Sector Manager, ECSHD). Further, the team received very helpful suggestions and comments from James Pdrks (Lead Economist, LCSPR) and Guillermo Perry (Chief Economist, LCRPR). This report was produced under the overall direction o fAxel van Trotsenburg (Director, LC7). Table of Contents Policy Note 1 to the New Chilean Government .,.,, Towards Equality o f Opportunity: Presentation o f World Bank Documents .,..........,.,....................,.............. 1 Policy Note 2 ImprovingAccess and Quality o f Early ChildhoodEducation ........... ......... 11 Policy Note 3 Policies for Better Old Age Income Support inChile ..... ., .... . ..... ,, . .,.,, . ... . 24 Policy Note 4 HealthReformImplementation , ,, . ............,.,.,.................................... 35 Policy Note 5 Regulation o fBasic Public Services..........,....................................... 47 Regional Development andDecentralization ......... Policy Note 6 ................,............. 59 Policy Note 1: Towards Equality of Opportunity: Presentation of World Bank Documents to the New Chilean Government' ............................................................................ 1, Introduction second section, some dimensions of inequalities of opportunity in Chile today. The third section summarizesthe main messages of the Development Policy Review and the The newly elected Chilean Government has outlined in its specificPolicy Notes in four broad areas of pro-equitypolicies: election platform an ambitious development agenda, strengthening and protecting human capacities; ensuring startingfrom,and centeredaround,improvingthe livesofthe access to infrastructure services and equitable regional Chilean population. One core element of the platform is to development opportunities; strengthening markets, improve the equality of opportunity of Chileans today, protecting people against macro-economic shocks and thereby reducing poverty, inequality and marginalization fostering innovation-led growth; and financing pro-equity while reachingmore fully Chile'sgrowth potential? development policies. Finally,we present the resultsof some quantificationsastowhat the resultsofa numberofpro-equity This package of documents aims to providethe Government policiescould be on growth, povertyand incomeinequality. with newanalyticalfindings,internationalexperiences,aswell as a number of options which might be of interest in the deliberations of policy actions that could improve equalities ............................................................................ 2. Equality o f opportunity of opportunity in Chilean society. The package includes a Development Policy Review which examines policy options Whilethe packageof policypaperspresentedhereincludesa that could help Chile to achieve the twin goals of fast and variety of technical analyses,the policy options outlined do equitablegrowth. The Development Policy Review focuses on have one common objective:to assess policies that could social protection, education, innovation, private sector helpimprovetheequalities of opportunityfor allChileans. As development, and the financing of development policies. pointedout inthe electionplatformof the newGovernment, Further, the package includesfive specific Policy Notes which if there were the needto single out one important challenge provide additional in-depth discussions on a number of for society today, it would be to improve the chances of selectedtopics,all of them importantto improvingequalities Chileans - independentof race,religion, parentalbackground, of opportunity in the country (Box 1). These specific topics gender or geographical birthplace - to get an education, had been suggested to us by a number of senior Chilean obtain good andstablework, and livehealthyand long lives, policy makers over the past months as being of potential free of poverty. This concept is also the focus of the World interestfor the incomingChileanGovernment. DevelopmentReport(2006). This presentation of World Bank documents shows, in the Policies that foster equalities of opportunity have multiple positive spin-offs for growth, poverty reduction, and the - reduction of income inequality. Equity can be defined as individuals having equal opportunities to pursue a life of their choosing and be spared from extreme depri~ation.~ A. DevelopmentPolicyReview Institutionsand policies that promote such equity - where 6. Specific Poticy Notes members of society have similar chances to becomesocially 1. Access and Quality of EarlyChildhood Education active, politically influential, and economica'lly productive - 2. Politiesfor BetterOldAge IncomeSupport - contribute to sustainable growth and development. For 3. implementationofthe ChileanHealthReform example, if people cannot reach their full potential in 4. Regulationof Basic PublicServices developingtheir capacitiesbecauseof gender discrimination 5. RegionalDevelopmentandDecentralization or socio-economic background, the overall economic development of society will be lower than its potential. ............................................................................................................................................................. 1.Thisoverview was preparedbyJeskoHentschel(Sector Leader,HumanDevelopment,World Bank.) 1 2.See www.michellebachelet.cl 3.WorldDevelopmentReport[2006),EquityandDevelopment,WashingtonD.C. 551............................................................................. Mp;: 6o ......................................................................................... .m. .....(,. 100 M.. EO .............. ...................... 60 40 20 ........................................................................ 1 20 25 30 35 40 45 50 55 60 Inequallty,GIN1clrca 1995 2 Source:World DevelopmentIndicators(2000,2005) Source:UNESCOinstitutefor Statistics Additionally, market failures in access to land, credit, or performance in school and later in life.Closelylinked to pre- humancapital marketscan impede resourcesflowing to their school education, women's labor market participation in best use, necessitating public policy interventions. Chile lags behind. The poor, hence, gain in two ways from pro-equity policies. Graph 3 includes Latin American,South-East Asian and OECD Since they tend to be the population group lacking countries with three data points: the average labor force opportunities, pro-equity policies should try to reach them participation (mid-point) with a span for each country first. In addition, unbundling such additional growth characterizing malelabor force participation (upperend) and potential would also lead, indirectly, to poverty reduction female labor force participation (lower end). As Graph 3 through higher incomes. shows, Chile had not only a low overall average labor force participation in 2003 but also wide disparities between men Lastly, pro-equity policies would lead, over time, to a more and women - with female labor force participation again equal distribution of endowments and assets (including among the lowest in the LAC region and far below levels in human capital and wealth) which would in turn reduce most OECD and especially South-East Asian countries. To income inequality - something many Chileans are becoming some degree, such striking differences will be due to sensitive to given the high inequality of incomes in the individual choice. However, they will also be due to unequal country.' Graph 1comparesincome inequalitydevelopments opportunities including inequalities with respect to in Chile to other Latin American and OECD countries from education access, gender discrimination in the workplace,or 1995 and 2000 - in both periods, Chile ranked among the the unavailability of childcare and pre-school opportunities. most unequal countries in the world. As a last example of existing inequity, Graph 4 shows access Ina number of dimensions,important unequal opportunities to improvedsanitation (2002) inselected Latin American, East exist today in Chile, especially when compared with OECD Asian and OECD countries. Access to quality and reliable countries (seeBox 2 for an example of howthe lifechances of sanitation services have numerous externalities for two Chilean childrenare markedly different today,depending households,including a significantly reduced risk of diarrhea on their family background, ethnicity, gender and their home diseases (and consequent malnutrition) for children. As location). For example, at 33 percent in 2002/2003, average Graph 4 shows, Chile ranks relatively high on overall access enrolment in pre-school education is relatively low in Chile (close to 90 percent) but the dispersion between rural and when compared to other Latin American countries but urban areas is markedly higher than in any of the countries especially when compared to many OECD countries where with higher average access rates and also several countries coverage now reaches 100percent(Graph2). Low enrolment with significantly lower average access rates (such as rates in early childhood and pre-school programs are of Indonesia,Guatemala, Venezuela, Ecuador). Such dispersion particular concernas they may adverselyaffect the children's poses a challengefor regionaldevelopment. 2 ............................................................................................................................................................. 4. Ina recentsurveyof Latinobar6metro(2001),90 percent of Chileansclassifiedthe existing incomedistribution in the country as unjustor very unjust. In Chile, markeddifferences intermsof area of residence,gendeiandraceare observedwhich influencethe lifechances of children borntoday indepen- - dentlyofanyeffortordecisionthenewbornstakeintheirlives.Two Gilegnbabies,both'-hypothetically- bornonthe15thofJanuary2006,can havemar- kedlydifferentchancestosucceedintheir lives. Letusassumethat a'was borninan indigenousfamifv,inhncoche-a ruralcommunityinfhesouthof thecountry.And 'Christian'was borninthe metropolitanareaofSa o,~p~ifically los Condes.TheaveragemonthlyincomeatChristian's household 10 is US$3,500 andthe oneat Maria'sis USS276Shrlstian'smother hasi5 years of educationandMaria's haslessthan7.The probabilityof Marianotsurviving herfirstyear of age-is4.4 times higherthanthe onefaced byChristian.Ifpresentconditionsprevailinthenextyears, the probabilityof Christian's receiving preschooleducationis43tim'eshigherthanMada's,in the fourthgtade,Christian'sscoreattheSiMCEtestwill bearound294pointswhilethat ofMarinwill be250. Duringhighschool,Maria's drop-outprobabilityis 13times higherthanChristian's.Whenthey becomeadults,Christian'sprobabilityof perceiving his healthstatusas a good one will be 58% higherthan Maria's:The probabilitythat Ma?a will have an updatedPAPis %%lowerthanforChristian'swife andherlikelihoodof dyingbecauseof vesicularcancerwill be5 times higherthanfor Christian;s wife. Maria'sriskofcommittingsuicide is 13timeshigher thanChristian's.And Maria's riskof beingassassinatedis30timeshigherwhileChristian'slifeexpectancyis atleast 14yeanmorethanMaria's. Source Staff e aboral on barea on Shqtman k y J. Berdeguk(2W);Derarro o Tentor a rura En Debares y Temar RLra er Nro I.RIMISP-CentroLatmoamerlcano para el DerarrolloRbral,Sanriqo de : Ch e 3. Elements o f Policies t h a t Foster to lead a life without poverty. They encompass a range of ............................................................................ Equalities of O p p o r t u n i t y different topics, including schooling, health,and managing risks. TheWorld Bank's Policy Notesand DevelopmentPolicy Review Access and Quality of Schooling. As pointed out above, seek to outline specific sectoral technical policy options access to pre-schooleducation is comparably low in Chile which could be useful inputs into the definition of Chile's today and, in addition,varies significantlyby socio-economic policy agenda. Such policies could be grouped into four group. Graph 5 shows that,while pre-schoolenrolmentrates broadareas: have increased since 1990 (albeit remainingbelow regional and especially OECD levels),the gap betweenchildrenfrom A. Strengthening and ProtectingHumanCapacities. differentsocio-economicgroupshaswidened. Such inequity The Development Policy Review and Policy Notes address is important given the long lasting learning impact of pre- ideas aimed at improving the opportunity for people to school education as well as its link to mother's labor force develop their capacities to the fullest and at enabling them participation which, as seen above, is significantly below ....................................................... ,oo ....................................................................................................... 90 ' 80. 70. ................................. ................................ 60, .............................................. ....................... ....................................................... 50. 40. .................... .................................................................... 30 + :fl..;t..........i;............!......................................................................... 20 II 0 Female Total OMale 3C Rural 0 Total Urban Source: World Bank Staff elaborationbasedon World Development Source:World BankStaffelaborationbasedon WorldDevelopment Indicators(2005) Indicators(2005) 3 regional and OECD averages. Also, concern over the low enrollment rates of young children in Early Childhood education(ECE) programs has risenin recentyears,especially after Chile's participation in international assessments of student performance showed great disparitiesin test scores *o { .... ............................................ ..I.I'......... ".............I... I.... g .49%.. betweenChileanstudentsand their peers in other countries. 1345% In addition, there are striking differences in scores in the national student assessments between Chilean students of differentsocioeconomic backgrounds. ..................................... ..... I.. Most countries that have succeeded in achieving universal 0 I.--. pre-primaryschool enrollment have implementedstrategies Quintile 1 Quintile2 Quintile3 Quintile4 Quintile5 that involve,bothexpandingfinancingas well as setting laws 1990 11 199881 2003 B 1 and regulations in place to ensure that parents send their Source:World BankStaff estimatesbasedon CASEN surveys young childrento ECEcenters.The PolicyNote on 'Xccessand (1990,1996,2003). Quality of Early ChildhoodEducation" presents policy options based on internationalexperience to increaseECE coverage, Managing Health Shocks. Chile's progress in improving quality and equity in Chile. Specifically, the Note provides health outcomes has been impressive but vulnerabilities to options relatedto: (i)the legaland regulatoryframework; (ii) healthshocks remainfor a significantpart of the population. service provision; (iii) quality assurance; (iv) financing; (v) As outlinedinthePolicyNoteonlmplementationoftheChilean deepening social support for ECE; and (vi) strengthening Health Reform,the recent important health reform has large researchand evaluationof ECE interventions. potential to improve equalities of opportunity as it can provide effective protection from such shocks - and the A key role for the Chilean Governmentand, in particular, for negative consequences they can have for family welfare, the Ministryof Education,could be to providethe necessary labor market participationand disinvestment in other forms coordinationbetweenthevariousexistingECEproviders.The of building human capacities of the affected families. In Government might consider strengthening the capacity 2000, 5 percent of the population in the third poorest within the Ministry of Education to regulate, monitor, and population quintile became poor because of expenditures evaluate the quality of ECE programs. Standards for ECE relatedto healthshocks,the majorityof them beneficiariesof provisioncould be developed,and financingof ECEcould be the Private Insurance Institutions (Instituciones de Salud based on meetingthese standards. In addition,the Ministry Previsional,ISAPREs). has an important role in fostering social demandfor quality ECE programs. Finally,given the needto expand ECE in Chile, Implementing the reform implies important potential the new administrationcould consider alternativefinancing improvements in the management of the public health mechanisms to develop demand for ECE, especially among sector, especially with respect to the system's incentive and low-incomefamilies. accountabilityframework. The implementationofthe system of specifically specified guarantees, however, also implies Chile has madesignificantprogressin closingthe access gap important fiscal and governance risks that will need to be between students from different socio-economic mitigated during the implementation. backgrounds in primary and secondary school enrolment, but quality differences remain.Furthermore,access to higher The Policy Note discusses several reform challenges education remains low for students from poorer considered critical for the short and medium term. First, the backgrounds. The Development Policy Review (Section E) Note examines the risk of defaulting on the explicit outlinesa numberof optionsto improveschool performance guarantees of the AUGE (Acceso Universal para prestaciones which would improve equity within the system, including integrales y Garantias fiplicitas asociadas a la atencidn de differentiating student subsidies based on their socio- prioridades- UniversalAccess for comprehensivebenefitsand economic background, stricter supervision of school ExplicitGuaranteesassociated to selected priorities)system. performance, more stringent accountability for the use of AUGE guarantees to all citizens health consultations and public resources, better dissemination and availability of treatment for 56 priority problems, with norms regulating 4 information on school quality, and a comprehensive maximum out-of pocket contribution, maximum waiting evaluationof educationpoliciesand programs. time, and quality. Second, the Note examines the framework of incentives for Protecting People in Old Age and Against Unemployment the implementationof AUGE in the overall public sector and and Poverty. Health-related shocks are not the only threats the potential response scenarios of insurers and providers to people's livelihoods. The potential impoverishingimpact and the fiscal risk relatedto such scenarios.The introduction of employment losses or old age is equally important. The of the AUGE plan poses the risk of negativelyaffecting the Development Policy Review (Section F) takes an integrated performance of non-AUGE services by public providers as look at Chile's Social Protection System and argues that well as to shift provision of services from the private to the Chile's social protection programs are generally well- public sector. Both scenarios could bring about fiscal and designed and have broad coverage, but that gaps remain service-provision risks for the National Health Fund (Fondo especially in rural areas. Furthermore, unemployment Nacional de Salud, FONASA) population of beneficiaries. At insurance does not include those working outside the this time, neither FONASA nor the Superintendence has "formal"sector, and publicemploymentprogramsdo not yet sufficiently detailed or reliable individual information reach the most vulnerable. Reforms of labor regulations, regardingthe guarantee of financial protectionor quality of changesinthefinancingof socialsecurityand improvements services for patientswho havejoined theAUGE system. inthetargetingofsocialprotectioncouldall helpto makethe system more effective. The third reformchallenge relatesto the likely low impact of the inter-ISAPREs compensation fund to reduce risk WhileChile'smulti-pillarpensionsystem iswell-designed and segmentationin the health system.The Inter-ISAPREsFund, fiscally sound, the Policy Note on "Policies for Better Old Age by itself, is insufficient to solve the problem of risk and h o m e Support": emphasizes that reforms increasing income segmentation of the Chilean health insurance coverage remains the key policy challenge for the future. system. To solve it, the new government would have the Currently,the system only covers 60 percent of workers, and option of creating a solidarityredistributionfund comprising eligibility for the minimum pension is estimated at only 50 both FONASAand the ISAPREs. percentdue to low or irregularcontributionson the part of affiliates.Graph6 shows that,among the currentcontributors The fourth challenge restswith ensuring the effectivenessof to the system, women are at a particular high risk of not the claimarrangements in the AUGE system.Regulation(and obtaining sufficient contribution times to reach even the control) symmetry of public and private insurers and minimum pension. providers would significantlycontributeto the effectiveness of the incentives to comply with the AUGE guarantees and, The PolicyNoteoutlinesoptionsfor reformof currentpension equally important, with an adequate empowerment of policies to increase coverage. It suggests that the new people in protecting their rights. The current governance administration might want to consider several options, such arrangementsfor the Health Superintendence and FONASA as:(i)removingthe rationingof social assistance pensionsto could becomean obstaclefor such regulatorysymmetry.The reduce and, eventually eliminate the risk of poverty in old new administration might consider monitoring closely the age;and (ii)restructuringthe minimumpensionguaranteeso relation between FONASA and the Health Superintendence as to providemore incentivesfor participationinthe pension to ensure equity and an effective enforcement of the system. This could be achieved by pro-ratingthe minimum regulatoryframework across public and privateinsurers. pension to award every month or year of contribution. Alternatively,savings incentives could be similarlysmoothed Finally, the implementation of a reliable and effective byreplacingthe minimumpensionguaranteewith matching monitoring system is an integral part of the AUGE reform - contribution subsidies that could be deposited directly in only such a system will verify whether the guarantees are affiliates' individualaccounts, fully exempted from AFP fees. indeedfulfilled andwhichones of the abovementionedrisks The notestresses, however,that such reformsof thefirst pillar materialize. The new government might want to define a instrumentswould need to be part of an integrated social strategy and an impact monitoring and evaluation system protection strategy that would aim to minimize the risk of based on a combination of data from AUGE's information povertyfor allChileans. system in FONASA, the ISAPREs and the Superintendence, accompanied by panel-typehousehold surveys.This would The Policy Note also outlines a number of options for the includethedesignandimplementationofa studyof baseline incomingGovernment that couldimprovetheconsumption- indicators. It might be useful for MIDEPLAN to support smoothingfunctionsof the pensionsystem. To further lower MINSAL in impactmonitoringand evaluation of the financial administrative costs, the various services of the 5 protectiondimension of the reform. Administradoras de Fondos de Pensiones (AFPs) could be unbundled and restructured, which could also contribute to telecommunications, rates of return have been high during fostering competition among AFPs. Also, to encourage the 199Os, pointing towards the need for reviewing the greater innovation and better risk-adjusted performance, institutional set-up and technical details of price regulation regulation could beshiftedawayfrom acompliance-basedto as affordability for consumersmight be improved. a risk-management approach. Such risk-based approach could allow providers the flexibility to diversify risk in both The Policy Note outlines a number of policy options that local and international markets. The new Government could could contribute to more efficient, affordable provision of also consider encouraging the innovation of better basic services as well as coverage extension. First, the investment and annuities instruments which would help Government could consider to establish Superintendencias affiliates better manage risks and the transition from work to that could have legal powers to enforce regulations and retirement.The current structure of payout options seems to imposefines on operators. SuchSuperintendenciascould also encourage individuals to retire early and to over-annuitise. In assume more political and financial independence as well as the accumulation and pay-outphase,product design, default regulatory discretion, strengthening the purely technical mechanisms and pay-out options could be better framed to base for regulatory decision-making. Also, the Government lower financial risks and more explicitly target a certain could consider fostering institutional convergence between minimum replacement rate for the average income workers. sectors by establishing only one regulatory agency per Lastly, the new administration could consider opt-in default sector, in charge of both technical and economic regulation policies to increase affiliates' incentives to participate in the as well as responsibilities for data collection and pension system. This could improve incentives to participate enforcement. Such a reform would unify the regulatory by making coverage more attractiveand easier to attain. For framework across sectors and improve coordination within example, an "opt-in" default on income tax returns could each sector. lower the transactions costs of participating for employers and the self-employed alike. Second, the Policy Note reviews tariff setting mechanisms in the basic public servicessectors.Oneoption for the incoming B. Ensuring Equitable Access to Infrastructure Services administration to avoid the problems that the efficient firm and EquitableRegionalDevelopment Opportunities approach entails in the price-setting process, including Access to Basic Public Services. Equitable access to affordable regulatory capture, would be to apply benchmarkingto the and reliablepublic basic services is a core pillar for policies to most efficient firm as has been introduced in a number of strengthen equalities of opportunity. As the Policy Note on OECD countries today. Alternatively, benchmarking could "RegulationofBasicPublicServices" points out, Chile has been also be incorporatedintothe efficientfirm model as currently one ofthe mostsuccessfulcountries inLatinAmerica interms exists. Reforms of the capital cost determination are of providing infrastructure services such'as water, sanitation, important since currently capital costs are set arbitrarily and telecommunications and electricity. However,coveragegaps differ acrosssectors. Finally,the Government might alsowant remain, especially concerning access to water and sanitation to consider replacing individual price regulation with the services as well as telecommunication in rural areas. Further, introduction of revenue caps, making the net income of in electricity distribution and fixed-telephone regulated firms independent of actual demand which is always difficult to predict. Third, the Policy Note suggests a number of sector specific policy options. In electricity, the government could consider 100 deregulation of the commercialization segment which could 80 further improve competitiveness within the whole electricity 60 sector. The node pricing system could be structured more 40 flexibly so as to encourage the formation of long-term 20 contracts. Finally, the new administration might consider 0 studying the costs and benefits of a number of alternatives Total Male Female that would improve fuel security, including new domestic t lessthan the minimum pensionguarantee productionof hydro-poweras well as developingnew import I d the minimumpension sourcesfor gas, coal, hydro and LNG. 6 IImorethantheminimumpensionguarantee Source:Bernstein.Larrainand Pino 120051. In the telecommunications sector, the Poky Note suggests options to replacethe existing asymmetric regulationmodel continues to be inequitable and biased in favor of the or to deregulate consumer rates in the local telephone ExtremeZones. In addition,the Government might consider market.Also theGovernmentcouldconsiderthe introduction evaluating the design and incentive structure of the of a newgeneration of universalaccess programs,appropriate Municipal Common Fund (FCM), which is an important to the development of new technologies. Such programs source of revenues, specially for the poorer local couldbedirectedtowards expanding broadband service,and governments. There is also the potential to improve the theycouldprioritizeschoolsandcommunities,with likelyhigh balance between the technical standards for regional and equity pay-offsfor moremarginalizedareas. local investment projects that are applied throughout the country, on the one side, and the need for region-specific To tackle the pressing problem of under-coverage in water solutions,that mayrequiregreaterflexibility. Finally,the Note and sanitation, the new administration might want to (i) suggeststhe need to continueanalyzing performance inthe clarify institutional responsibilities in the sector, (ii)target process of mainstreaming the government's current funding; (iii) promote the use of cost-effective and programsacrossregionsandconsidering possibilitiesto base appropriate technologies; and (iv) promote decentralized resource allocation on the provision of minimum levels of and integratedprogramsthat buildoncommunityinitiatives. serviceat the sub-nationallevel. Further, as price alignments within the sector have been completed, the means-tested subsidy scheme for poor Second, the Government could consider reviewing the household could be reviewed to verify whether it reaches current decision-making processes. This could lead to and protectspoor householdssufficiently. improving inter-governmental coordination mechanisms and clarifyingand rationalizingthefunctions of each levelof Regional Development. In its election program, the new government.Such evaluation might also consider granting Government has outlined an ambitious agenda in more authority to the municipalities regarding the decentralization and regional development, geared towards mobilizationof local revenues,allowingthem to establishthe reducing geographic inequality of development, increasing propertytax ratewithin a givenband. public participation in decision-making, and gradually fostering decision-making at the regional and municipal Third, to strengthen the capacity and performance of local levels. Indeed, while there has been a certain degree of governments,the national system for Management Control convergenceof per capita incomes between Chile'sdifferent and Performance Budgeting could be extended to local regions over the past 20 years, such convergence cannot be governments.This system would not only help the national observed for poverty levels. Graph 7 compares the initial and localgovernments make better decisions but would also poverty level in 1987 to reduction in the poverty level from createincentivesfor good performance. 1987 to 2003 - ideally, the regions with the highest initial povertylevelswould havealsobeentheoneswith the highest Fourth, increasingthe opportunitiesfor public participation reductionin povertybut such relationshipdid not exist. in the decision-making process and monitoring the policies of their local governments could further strengthen Chile has transferred a significant portion of its public performance incentives.Chile has experimentedwith several resources to regional and local governments, especially for public participation schemes in a project-based public investment. As a consequence, currently the regions environment, such as the InfrastructureProjectfor Territorial and municipalities represent a third of the total investment Development. Such initiatives could now be extended to expenditure. The Policy Note on "Regional Developmentand providegreater impact. Decentralization"underlinesthat to improvedecentralization and support regionaldevelopmentinChile, the Government Finally, Chile could also benefit from other countries' could consider strengthening the incentive structures and experience in strengthening information transparency and institutionalarrangementsof the current inter-governmental developingopportunitiesfor participationinthe budgetand system. The Note presents policy options in four selected monitoring processes. areas that might be relevantfor that process. C. StrengtheningMarkets, ProtectingPeopleagainstMacro- Firstly,the Governmenthassucceededinallocatingresources Economic Shocks, and Fostering innovation-led Growth more uniformlybytaking into accountthe needsfor regional Policies governing the overall economic framework, and local expenses. The latter would contribute to an including access to finance, the structure of labor markets 7 improved regionaldistribution of resources, which currently and macroeconomic policies,also have an important impact Research and Development (R&D) expenditure; private sector participation in R&D; patenting; and in the relative importance of applied, as opposed to basic, research. Like 3.4 ,................................... ~ .......................... . . ~ ~ .g P RM ........................ Spain and Italy, Chile has relied heavily on FDI and has a u 3.2 largenumberof successfulfirms that focus on innovation in both production and management.Investmentsin Science -m and Technology (S&T) and R&D are important over the 3 2.2 .......................................... ....................... medium and long term. IncreasingS&T capability includes 4c 2 0%0 10% 20% . - 2 . increasing the number of research units and well trained 30% I 40% * SO%* 60%* 70% .i workers but it also requires improving the diffusion of Poverty1987 knowledge, and that in turn implies viewing the National Source:MIDEPLAN Innovation System (NE) as a network to facilitate the transmissionof knowledge. for peopleto developtheir opportunities in terms of access - to productiveassetsandjobs aswell as intermsof protection D. Financing of Policies Geared Towards Promoting from macro-economicshocks. The DevelopmentPolicyReview Equalityof Opportunity (SectionA) argues that the newGovernmenthas a numberof Finally,the new Government's ambitious pro-equity agenda options to reduce obstacles that impede a prompt will trigger additional financing needs. The Development adjustmentto shocks.While Chile has a favorableinvestment Policy Review (Section G) offers suggestions as to how the climaterelativeto many other countriesand has donewell in efficiency and equity of the tax system could be improved establishing adequate competition policies, there remain while simultaneouslyreducingtax evasion.Manyincometax obstacles that, if reduced or removed, will lead to further credits, deductions and exemptions which benefit the increases in productivity and make the economy more relatively better-off and which unnecessarilycomplicate tax resilient to shocks. The options include: strengthening the administration could be eliminated, improving the enforcement of creditor rights; improving the efficiency of progressivityofthetax systemper se without leveragingnew bankruptcy proceedings; restructuring job security; and taxes. Closely linked to the strategic agenda on decreasing wage rigidity. The Development Policy Review `strengthening markets' outlined above, a reduction of the (SectionA) also emphasizesthe importanceof reducingone withholding tax on dividends of foreign corporationswould of the core inequalities in opportunity which impedes also reducetax evasionwhile having a positive net effect on progress in economic development: strategies to promote FDI. The reduction or elimination of VAT exemptions and access to credit bysmall and mediumenterprises. special regimes(e.g.,construction)couldboostrevenuewhile simplifying tax collection. There are also opportunities to International experience has shown that macroeconomic refine the fiscal rule so as to increase its anti-cyclical effect stabilityis a necessaryconditionfor reducingpovertyandalso and stabilize the seasonal impactof fiscal policy. improvingequalitiesofopportunity. Chilehas performedvery well onthiscount,experiencing muchlessvolatilitythanother LatinAmericancountries;however,itsdependenceon copper 4. PotentialImpactsof Improving Equalityof can make it vulnerable to changes in commodity prices.The ............................................................................ Opportunity in Chile DevelopmentPolicyReview (Section G) discusses options to improve Chile's "fiscal rule" at the margin as well as to use We conducteda number of quantitativesimulationsso as to financial instrumentsmore intensivelyso as to manage risk obtain a sense of how important improving equalities of associatedwith fluctuations inthe copper prices. opportunity could be for reducing poverty in Chile. Such simulations are illustrations and can only provide an While perhaps linked only indirectly to strengthening approximateguidance onthe overall importanceof pursuing equalitiesof opportunity of people, innovation is crucialfor pro-equitypolicies. Any quantification depends on a host of sustaining growth in a knowledge-based economy and - variables which are difficult to predict - for example, when therebyatthe heartof ensuringlastingjob creation,income analyzing the impact of universalizing secondary school generation for households, as well as to generate fiscal completion,the impact will depend cruciallyon earnings of revenues that support the overall equality of opportunity the new graduates in the labor market. Similarly, any 8 agenda. The DevelopmentPolicy Review (Section D) shows approximation of the impact of higher female labor force that, compared to the OECD, Chile lags substantially in. participationwould much depend on wages and salaries of Increased Reduced Reduced Improve Univerral female labor inter- gender Increased Reduced Reduced qualityof secondary participation regional wagegap Improve Universal femalelabor inter- gender educatlon education (by25 %) gap (by25%) (by25%) quaiityof secondary participation regional wage gap 0% education education (by 25 96) gap(by 25%) (by 25%) -1 0% .............. -20% -30% ................................... ....................................................................... ....................................................................... .................................................................................. -12%J.................................................. ............................... Source:WorldBankStaffcalculations. Source:World Bankstaff calculations. such new entrants- andwhether the newlyworking women The poverty reduction results of these quantifications are comefrom poorer or less poor households. presented in Graph 8. The potential pay-offsof improving equalities of opportunity are very significant - with the The first simulationwe conducted was to approximate the poverty rate decreasing by more than 50 percentwhen we impact on income of higher equalities of opportunity in look at improving the quality of education or close to 30 Chile.Usingthe OECDas a benchmarkfor pro-equitypolicies, percentinthe scenariowhere secondaryeducationbecomes we assessed, what key labor market characteristics (such as universal. Increases in female labor force participation and the laborforce participation,occupationand unemployment regional convergence have also an important effect with a rates, by gender)would be in Chile,given it's GDP per capita. reductionof the gender wage gap showingsomewhat lower The result is very significant:if Chile were to reach levels of impacts on poverty. As mentioned above, such simulations equalities of opportunity (in different dimensions) as are only hypotheticaland based on many assumptions- but currently prevalent in the average OECD country, this could they do show the important impactson poverty that could havean incomeeffectequivalentto seven percentof GDP. result from improving equalities of opportunity in Chile. Further, pro-equity policy reforms generally cannot be Then, to assess the impact of equity improvements on viewed in isolation so that important synergies might arise poverty and incomeinequality,we chose five specific equity (e.g., between female labor force participation and the outcomes. First,we examinedan improvementinthe quality reduction in the gender wage gap) which we have not of education which would have the impact of graduates examined here. Lastly, we have only considered the direct obtaining better paying jobs, especially those whose impact of such policies on poverty and inequality,thereby education quality is low today. Second, we assessed the not havingtaken into account the likelyconsiderablepositive potentialimpactof universalizingsecondaryeducationfor all impact on poverty through the growth effect described which would benefit especially children from poorer socio- above. economic backgroundswhose likelihood of dropping out of secondary school is relatively high today. Third, we Lastly, we also look at the impact of the above pro-equity considered the effects of increasing female labor force changes in terms of incomeinequality. Here,as presented in participation by 25 percent (which would bring the female Graph 9,we again see important ensuing reductions in the participation rate to 55 percent, close to the regional degree of incomeinequalityalthough they tend to be lower average). Fourth,we looked at the impactof reducing intra- than the impact on poverty. Inequalityin Chile is relatively regional inequalities (convergence of growth rates of less inflexible which would, if its reduction were to become an developed regions to the national averagefor a period that explicit policy goal, necessitatea number of different policy would reducethe inter-regionalgap by25 percent)as wellas, actions, of which improvement of equalities of opportunity lastly, the impact of reducing the existing gender would likely be an important - but not the sole - component. discriminationin the labor market (inwhich women are paid less althoughthey havethe same education, experience,age 9 and other characteristics)by 25 percent. ..................................................... References I...................... Bernstein, S., G. Larrain and F. Pino (2005) Chilean Pension Reform:Coverage Facts and Prospects, document presented in LACEA,Paris Mideplan (2002) Convergencia- Dirigencia Regionalen Chile: PosiblesCausasy Efectos,Santiagode Chile Shejtman A. and J. Berdegue (2004),"Desarrollo Territorial Rural:' in Debates y Temas Rurales, Nro. 1, RIMISP-Centro Latinoamericano para el Desarrollo Rural,Santiago de Chile World Bank (2000,2005).World Development Indicators World Bank (2006). World Development Report (20061, Equalityand Development,Washington D.C. 10 P o l i c y N o t e 2: I m p r o v i n g A c c e s s a n d Q u a l i t y o f Early C h i l d h o o d E d u c a t i o n i n C h i l e ' A b s t r a c t Chile has succeeded in expanding access to basic and secondary education to all children. Now the country faces the challenge of increasing access and quality of Early Childhood Education (ECE). ECE has been found to have important effects on children's performance in basic education and throughout their lives. Concern over the low enrollment rates of young children in ECE programs has risen in recent years, especially after Chile's participation in international assessments of student performance showed disparities in test scores between Chilean students and their peers in other countries as well as between students of different socioeconomic backgrounds within Chile. In addition, expansion of ECE programs could support greater incorporation of women into the labor market in Chile. Although there is strong evidence on the impact of ECE on children's performance in basic education and throughout their lives, there is scarce evidence on how to effectively design, fund and provide quality ECE programs to all children, especially those from low-income families. This Policy Note is intended to provide evidence from other countries that may help Chile improve access, equity, and quality of ECE programs. ............................................................................................................................................................. 1.This policy note was prepared for the Government of Chile by a team of World Bank staff and consultants led by Emiliana Vegas (Education Economist, Departmentof HumanDevelopmentfor LatinAmericaandthe Caribbean,WorldBank).The team consistedof GregoryElacqua(AssociateResearcher,Universidad 11 Adolfo Ibaiiez)and llana Umansky(Education PolicyAnalyst,World Bank).Thisnote summarizes a longer,moredetailedpolicy report that may be requestedfrom EmilianaVegas (evegas@worldbank.org). Chile achieved significant progress in ECE While total education investment in Chile rose substantially ............................................................................ coverage in the last decade between 1990and 2002, the share of spending going to pre- primary education has declined slightly (Figure5). Chile achieved significant progress in ECE (Early Childhood Education) coverage during the last 13 years. The gross Figure 6 presents the distribution of education spending enrollment rate for children aged 0 to 5 increased from 16% across the various chaptersof the Budget Law. With lessthan in 1990 to 30% in 2003, but the sharpest increases occurred 6 percentof total education spending going to ECE,Chile lags among children aged 3 to 5 (Figure 1). behind other countries in investmentin ECE. Indeed,the gap in per-pupil expenditurebetween Chileand OECDnations by level of education is wider in ECE than in other education levels. 60% Compared to other Latin American and OECD countries, the 40% share of total public education expenditure that is devoted to 20% ECE is low in Chile, as shown in Figure 7. 0% -. 1990 1992 1994 1996 1998 2000 2003 The potential benefits o f ECE expansion iOto2 ............................................................................ i n Chile a r e large Source:Author's calculations.CASEN. A number of factors converged to put ECE at the center of Despite this progress, Chile still has relatively policydialogue inChile.These includeevidence of significant ............................................................................ well low ECE coverage rates and inequalities persist learninggaps betweenChilean and internationalstudents as as among Chilean students of different backgrounds, Indeed, the enrollment rate of children aged 3 to 6 in ECE and research findings indicating that the brain continues to programs inChile,averaging 33% in 2003, is low compared to develop during early childhood and that ECE interventions OECD and other LatinAmerican countries (see Figure2). There are marked differences in ECE enrollment rates by age group. While over 90% of children aged 5 attend an ECE center, only half the children aged 4 attend. This share is 100. 92.6% significantly lower among childrenaged 3 or less.Only 4%for children aged 0 to 2 years old are enrolled in ECE (Figure3). 0 ~~~~ 20 Inequalitiesinaccessto preschool by student socio-economic background persist (Figure 4).There are also enrollment gaps 0-2years 2years 3 years 4years 5 years in preschool between indigenous and non-indigenous Source:Authorscalculationswith datafrom INE and Mineduc(2004). children and betweenchildren in rural and urban settings.' 1990 11998 I 2003 12 Source:UNICEF,2004. Source:Author`scalculation,CASEN 2.CASEN(2003). TotalEduc.expenditure 1expenditure Pre-school SourceAuthors'calculations,DIPRES the Third International Mathematics and Science Study (TIMSS). In addition, national assessments reveal stagnant test scoresover time (FigureB).' DIBAM Another concern is the prevailingtest score gaps between UNDERSECRETARi 61% students of diverse socioeconomicbackgrounds.As Figure 9 shows, there is a strong relationship between national test scores and socioeconomicstudent background - the greater the vulnerability,the lower the test scores.' ECE contributesto improving quality and reducing inequities in elementary and secondary school learning. Although the Source: Marcel, international and national achievement gaps have been M.Presentationinthe seminar'Models ofeducation treated mainly as a problem affecting elementary and Financingin LatinAmerica: SUBVENTION secondarylevels,researchevidencesuggeststhat the gap Santiagode Chile, 61% January26,2006 first opens during preschool years. Studies consistently show that children who do not attend high quality ECE programs have already fallen behind before they enter can create measurable differences in schooling outcomes. formal schooling. Because ECE contributes to the Furthermore,concerns over the impact of low ratesof female development of cognitive skills in children and has labor force participation in Chile on economic growth and especially strong benefits for children from poor socio- incomeinequality have led policymakersto view expanding economic backgrounds, ECE helps narrow the skills gap access to ECE as a policymechanismto raise the laborforce upon entry to school among children from diverse participationof Chileanwomen. backgrounds?For example, a recent study found that the effect of having attended pre-school on third grade test Test score disparities between Chilean students and their scores is twice as large for poor students in Argentina peers in other countries and among socioeconomic groups than for non-poor studentsa6Furthermore, research are a prominentfeature of the nationaleducationlandscape. suggests that ECE programs are more cost-effective than Figure8 illustratesthe largegap betweenaverage test scores alternative educational interventions and policies at of Chilean students and their peersfrom other countries on narrowing learning gaps in school.' ............................................................................................................................................................. 3.Mizala and Romaguera,2005. 4.The relationship betweenthe student's socioeconomicbackgroundand standardtest scoresdoes notappear lineal in Figure9,indicating that what schoolsdo also affects the outcomes.In fact, test scores across students within each socioeconomic level also present a significantvariability in Chile as well as in other countries. 13 S.See,for example, Belfield,2005. 6.Berlinski,Galianiand Gertler 2005. 7.For theoretical and empiricalreviewsof ECE programsin developing countriesand the US.,see Schady (200S),Carneiroand Heckman (2003Land Currie (2001). 1"" 350 1'.......................................................................................................................................... 550 500 .. 450 ...................... .:........ ....::..?. .................................................... IL -. . 400 5.. . . 350 KJ+.,,,..r .. 0 . 111,, I, 300 Korea Netherland Hungary Malaysia New Chile Zealand . - Source:IEA %I 2003 ECE is also linked to numerous social benefits.The positive 0 20 40 60 80 100 outcomes of ECEparticipation go beyond test scores. Recent Vulnerability index 1 Public ISubv. research in the US. indicates that benefits of ECE include Source:Authors'graphicalrepresentationusingdatafrom MINEDUC andJUNAEB,2002. lower rates of grade retention and special education, improved child health, nutrition, and emotional well-being, reduced criminal activity, and higher tax revenues (due to Massachusetts) and $1.60 (in Ohio)." Although similar lower welfare reliance).8 estimates do not exist in Chile, given the large ECE enrollment gap and the low rates of female labor force Strengthening ECE is also an economic development and participation that currently exist, it is reasonable to gender equity strategy, since it is closely related to the expect that the benefits from ECE expansion would be participationof women in the labor force. InChile, increasing even greater in Chile than in the U S preschool coverage could also contribute to reduce inequities by providing low-income mothers with the opportunity to seek employment. Chile's 35 percent female Key Characteristics o f E C E Provision i n labor force participation rate is well below other Latin ............................................................................ Chile and Other Countries American countries?Female work rates are also stratified by socio-economiclevel. Onlyone-third of women inthe lowest Legaland RegulatoryFramework incomequintile participate inthe laborforce, as compared to Most countries that have succeeded in achieving universal over 55 percent of women in the highest income quintile.'O pre-primary school enrollment have implemented strategies Figure 10 shows the number and percentage of women out that involve both expanding financing as well as setting laws of the labor force - either looking for work (unemployed) or and regulations in place to ensure that parents send their not looking for work (inactive) - by income quintile. Recent young childrento ECE centers. empirical evidence indicates that women with children in preschool are more likely to be working than mothers with In Chile, ECE policy is under the jurisdiction of the Ministryof similar characteristics whose toddlers are at home." This Education. Although the 1999 Education Law (LOCE) suggests that an expansion of preschool could potentially establishes ECE as the first education level, there is no legally havean important impact on female laborforce participation mandatory ECE in Chile. The State does, however promote in Chile. ECE through its National Plan to Overcome Poverty (Plan Nacional de Superacion de la Pobreza) and by directly Finally, cost-benefit analyses of ECE investments suggest financing various institutions that provide ECE. Recent that expanding ECE is cost-effective. Estimates of the costs evidencefrom Argentina suggeststhat the legalexpansion of and benefits of reaching universal education in various mandatory education to include children aged five, US. states indicate that for every dollar invested in accompanied by a large preschool construction program in education, the benefits are between $1.18 (in the late 1990s has led to important increases in average test ............................................................................................................................................................. 8.Belfield(2005b). 9.UNDP(2004). 9. PNUD2004. 14 10.CASEN2003. 11.Contreraset al.2005. 12.Beifield(2005b)and Belfieldand McEwan (2005). 13.Berlinski,GalianiandGertler (2005). 12OOOOO (2746) 008 I 897642 1CQOOOO i 1041 800000 I . 628091 600000 455393 ~ 400000 I - 2oo000 i 0 ' I I1 111 IV V Income quintile Unemployed iInactive Source:Authors'calculations usingCASEN,2003 voucher Source:CASEN 2003. scores in those provinces where ECE enrollment increased institution that receives funding from the national the most.') Box 1 describes the legal framework of ECE government and often outsources services to municipalities provision in OECD countries. and private voucher schools. The former First Lady presides over the Integra Foundation, which is a nonprofit Serviceprovision organization with a mission to provide ECE servicesto needy InChile, there are currently four main types of ECE providers: children. Integra is also funded directly by the national municipalities, private voucher schools, Junta Nacional de government. Jardines lnfuntiles (JUNJI)and the Integra Foundation. Many (but not all) municipal and private voucher schools offer Figure 11 shows the distribution of ECE enrollment across preschool and kindergartenwhile JUNJI and Integra provide provider types. Municipal and private voucher schools each services to 0-6 year olds. JUNJI is an autonomous public account for around 29 percent of enrollment.JUNJ1 enrolls 17 Eightof twelve OECOcountrieshavelawsguaranteeingaccesstoECEfor3to5yearolds(upperlevelECE).Thefourcountriesthatdonotofferlegalrights tothislevel- Australia,theGchRepublic,Norway,and theUS.- havebroadaccesstothislewl,and intwocountries - these - theUS.(Kindergarten) andAustralia upper level ECE programsare free.With or without legal status, many OECD countriesoffer 1-2years of free ECEto aU childrenin the yearsjust precedingtheenrollmentage for primary. However,thereare ntblueprintsfor ECEprovisionacrossOECDcountries,with yryingconsequencesfor gender equity, socio-economkequ'ky,child carequality,andla rketparticipatiin.lnFlnlandandF!ance,governments provideincegtiwsfor mothers tostay at homeraisingyoungchildrenandforfamiiiestohireprivatechildye helpthroughfinancialallwvncesfor stay-at-homemo$ers, tax credits,or other monetaryincentives.InFinland,60percentoftw@.;eafolds are'now caredfor at home,and female labor participationdroppedmarkediyafterthe incentiveswere putinplacein1986.Some&pea arguethatthIsJlueprint for ECEcanunderminigenderequityandfemalelaborparticipation,decrease childcarequality,and creategreatersocial inequity bybtld marketforlowskiliedlow-wage privatechildcareproviders[Mahon2002). 5 In the Netherlandsandthe Uk,theapproaihto expandECEfocuseson nd-sklelncentiws,such astax credits,forparentsto enrolltheirFhildrenin ECE programs. Butthe incentivesfocus on ECE for childrenaged3-6 an generally part-time.Bothof thesecharacteristicsmake female labor fofce participationfrequently of a part-timeor temporarynature.in both countries,there are large disparitiesbetweenthe number of regularwork hoursfor women and men.Privatecosts for childcareremain high, averaging 44 percentof total costsin the Netherlandsand 30 to 60 percentin the UX. Both countrieshavetargetingpolicieswhichfurther subsidizechildcare proysionstothe poor. InDenmarkandSweden, current ECEpoliciesare deigned to supportgender equity@at homeandat the,workplace,to promotehhh labor maiketparticipationfor bothgenderstoprovideuniversalECEcoveragefor chlldrenfromageonqandtoensurehighquality,education-based,ECEParentalleavepollciesaredesigned!o beattractivetomenandwomenandtohigh- ~ and lowwageearners.Parentsare subsidizedbased on ?heir salaries, andfathers have signincant rightsto leave. Cash transfersfor parentalleave are relativelyshortinduration,encouragingparentsto returntoworklnbothcountries,childrenfrom havethelegalrighttoECE,with parentscovering eitheravery low percentageofcosts(inSweden)or p!ying onaslidingscal 15 e ? , \ 1 . percent of students, while Integra accounts for 10 percent of Quality enrollment. Private non-voucher schools enroll 15 percent of Two approaches to measuring the quality of ECE programs all ECE students. focus on process and structure. Process quality emphasizes the experiences that occur in educational settings, such as Typically, there are important differences in student child-teacher interactions and the types of activities in which characteristics by provider.Those attending private voucher children are engaged.The second way to measure quality is and private non-voucher schools come from families with to review the structural and teacher characteristics of the higher incomes, on average (seeTable l), and are headed by program, such as teacher-pupil ratios, and qualifications and parents with substantially more schooling than families in experience of teachers and staff. municipal, JUNJI and Integra centers. There is also substantial variability among schools in the private voucher OECD countries tend to have established standards for ECE sector in Chile. For-profit operated schools account for provision and systems for evaluating the quality of ECE around 24% of subsidized schools and 25% of enrollments. programs, enforcing standards, and accrediting ECE Most other voucher schools are Catholic, but a growing providers." Box 3 describes the example of Australia'sQuality number are operated by Protestant churches and secular Improvement and Accreditation System for ECE programs. foundations (Elacqua, 2006). The complex nature of ECE provision is not characteristic of Chile alone, as described in The only quality-assuranceor accreditation process measure Box 2. currently used in Chile is a national registration system that . . QuintileI 41% 22% 2% 21% 15% 2896 QuintileIi 40% 29% 4% 21% 12% 24% Quintile111 29% 32% 8% 22% 9% 18% QuintileN . 22% 4b96 21% , 11% 6% 15% QuintlleV 8% 27% 59% 4% 2% 16% OECDand LatinAmericancountriesgenerallyhaveatleasttwo separate ECE programs, one for the lower(forchildren aged zerotu three)andanotherfor the upper level(forchildrenagedthreetdfive).Manycountrieshavemorethantwoprogramsand,insomecases,theseprogramsoverlapintermsofthe agesthey serve.ECEservices alsodiff6r in termsof whether they are publicor private,free or fee-based,full- or part-time,where they are located,what governmentbodyoverseesihem,andwherethelocusofdecisionmakingiscentered. UpperlevetECEtendsiobeoffe!ed byeducationdepamnentswithincountries,isapublicprovision,andisfree.LowerIevelECZontheother handislargely dealtwithoutsidethepurview oftheeducationrninistry,isfee-based,althoughitcanbestate-subsiiited,andtakesplaceincentersor homesinsteadof in schools.Withinany one countryECE can beoffered by a hostof institutions,includingdifferentlevelsof government or line ministries,charities,religious groups, non-governmentalorganizations,and for-proffi businesses.Due to its private natureand itsimportantgoal of providingcare while parents are working, lower levelECE,is morefrequently offer+ fulldaythanupperlevel ECEThewide arrayof providersandthedifferent regulatorybodiescan make coherentqualityECEprovisiondifficultandsom; coun'tries,suchas Sweden,haveplacedthe regulatoryresponsibilityfor allof ECEinone body.In the case 16 of Swedentheregulatorybodyis theMinistryof EducationandScience (Choi,2002). 14.Gombyand others (1995). certifieshealthand safetyroutinesandclassroommaterialsin ECE centers. Only 47 percent of centers in Chile have been registered. JUNJI is also in the process of implementing a more comprehensive qualitative accreditation system that will measure experiences in the center and classrooms and ratethe multiple dimensions of the preschool program,such 20 as teacher-child interactions, type of instruction, room 1s environment, materials, and relationships with parents. 10 JUNJl's accreditation system will also evaluate the center's 5 managementoffinancialand humanresourcesas well as the quality of curriculumutilizedby eachcenter. Without significant measurement in place, there is little systematic information available on the quality of ECE in Chile. Information does exist, however, on two structural Source:OECD,2005 features of Chilean ECE: teacher-pupil ratio and teacher qualifications. Preschool teacher-pupil ratios in Chile are higher than most countries (see Figure 12). However, as Recently,the Ministryof Educationestimatedthe cost of ECE Figure13 illustrates,they vary across sectors. Privatevoucher expansion in Chile] While costs will vary across regions, schools,on average,have larger ratiosthan other institutions, geographicalareas (ruralhrban) and programs,the Ministry and Integraand privatenon-voucherschools havethe lowest estimatesthat providing universalECEto all 4 and 5 year olds preschool student-teacherratios. would cost approximately US$5.7 million per year over 3 years. The estimates for targeting 0-3 year old enrollmentto Comparedto other countries,Chile has a largepercentageof the lowest income quintileswould cost approximately US$ teachers with degreesin Early Education. Almost 96 percent 22 million per year over 3 years.The Ministryalso calculated of Chilean preschool teachers have university or vocational the costs of implementing a national accreditation system degrees. However,there is limited informationon the quality (US$8 million),developing national standardized tests (US$ of EarlyEducationprograms. Only6out of the 71 institutions 800,000), and conducting a national public awareness of highereducationthatoffer undergraduatedegreesin Early campaign over 4 years (US$ 3.6 million). Educationare accredited.l5 These estimates only consider the costs of expanding Financing enrollment in existing programs. However, improving the A number of financing factors could complicate ECE quality of these programs would cost additional money. For implementation in Chile. Most notable is the fact that both example, JUNJl's annual per pupil costs for their traditional demand-and supply-sidefunding mechanismsare currently formal programs are only US$ 998 for 0-2 year olds and US$ used. Municipalitiesand privatevoucher schools are funded 679 for 3-6 year olds. In the US., Haskins and Rouse (2005) with per-pupilvouchers and JUNJI and Integrareceive their estimate that a high quality preschool program for Iow- funding directlyfrom the government budget. income families would cost about US$ 8,000. Head Start Australia's QualityImprovementandAccreditationSystem(QIAS) isapromisingmodelforaccreditingECEcentersandimprovingECEquality.TheQlAsisan evaluationprocessthatall ECEcentersmustbrtlcipatein,inordertobeaccreditedandtobeaneligiblecenterforthenationalChildCareBenefitasubsidy given to parents.Because QlAS is tied directly to accreditationand funding, over 98 percent of pfivate ECE centers go throughthe QlAS process.The accreditationprocessbegins with a self-evaluationprocessalong52 principlesrelatedto interactionsbetweenchildren,staff andparents,management, curriculum,andnutrition'andhealthpracticesamong0thers.A peer reviewerthenvisitsthecenterandover oneor twodaysindependentiyevaluatesthe centerecentershavethreechancestopassthe QlASevaluationtobecomeaccredited(OECD,2001). 17 15.Seewww.cse.cI. 40 I 3s 30. 2s 20. 15- 40 60! 10 _" 5 n 01 r i 1 I Private Integra Public JUNJl Private 1990 1992 1994 1996 1998 2000 2003 non-voucher voucher Source:Pachecoet aL(200S). Source:CASEN. spends about US$6,000 per pupil. equity,focusing on ensuring universal ECEfor children aged 3-6 may be sufficient. For quality and equity purposes, Socialand CulturalAttitudesToward ECE ensuring access to ECE among all 3-6 year olds would have Part of the explanation behind low enrollment rates in to involve targeted approaches to children from Chilean ECE may be prevailing social and cultural attitudes disadvantaged households. related to early childhood care, parenting, and education. Over 75% of Chilean parents report not sending their Service Provision children under 6 years of ago to ECE programs because they The existence of multiple ECE providers in Chile generates considerthem too young to attend. Although high,this share challenges for expanding access, quality, and equity. First, has dropped substantially since 1990, when nearly 100%of there is significant overlap insome of the services provided. these parents considered children six and under to be too Currently, JUNJI and Integra provide services for 0-6 year young to attend preschool (Figure14). olds and the municipalities and private voucher schools only enroll 4-6 year olds. Second, at present there are few Early childhood care may be seen as solely the family's systems in place to enable an effective coordination across responsibility and, in particular,the mother's responsibility. In institutions. addition, parents may believe that young children are better cared for at home than in institutional settings." A key rolefor the State and,in particular,for Chile'sMinistryof Understanding the social and cultural attitudestoward ECEin Education, is to provide the necessary coordination across Chile is necessary in order to develop effective policies for ECE institutions. To that end, it is necessaryto strengthenthe ECE expansion. Ministry of Education's capacity for the regulation, monitoring, and evaluation of ECE programs. Experience from other countries suggests that policy makers should establish a broad policy framework that specifies clearly ............................................................................ tPolicy Options to Expand Access and Raise h e Quality and Equity of ECE in Chile defined and distinct goals for the diverse early childhood programs that exist in Chile, identify specific program Legal and Regulatory Framework strategies to address those goals, and coordinate the efforts A substantial ECE expansion in Chile is unlikely to take place of ECE providers.I7 without a legal framework that supports universal ECE, at least for five- and six-year olds. For children aged zero to Quality Assurance four, policymakers in Chile need to evaluate whether public Expanding access without improving quality of ECE provision should be targeted or universally provided programs is unlikely to result in the desired effects on depending on desired effects. If the principal desired effect education quality. It is important to provide high quality is to increasefemale labor force participation, ensuring that programs, including qualified teachers that are trained to all young children aged 0-6 have access to ECE is necessary. develop the cognitive, social, and emotional skills of young ............................................................................................................................................................. , If the main desired effect is to raise education quality and children. 18 16. Rojas (2004). 17. See recommendationsin Gombyand others (1995). In the United States, estimates suggest that increased According to the estimates in the table, increased ECE enrollment in high quality programscould narrow test score coveragethrough installingclassrooms for 4 and 5 year olds gaps by as much as 36 percent (Haskins and Rouse, 2005). targeting 20% of the FDSswould allowfor a greater increase Combinations of quantity and quality ECE would likely incoverageat a total additionalcost of approximatelyUS$61 produce similar effectsin Chile. Conversely,increasingaccess million. In terms of cost-per-student, this estimated cost is to low-qualityprogramswould beinadequateto close Chile's more than 40% less than the estimated cost of increasing achievementgaps. enrollmentthrough per-studentvouchers. To ensure adequate quality of ECEservices, it is important to For the 2 and 3 year olds, an increase in coverage between developstandardsof ECE provisionthat includeteacher and 2006 and 2010 of approximately 157,380 children was personnel qualifications as well as development milestones estimated.The estimateswere basedon the assumption that (forthe lower level)and/or learningstandards (forthe upper 50% of the new enrollees would enter Integra schools and level). These standards could form the basis for a more theother 50%wouldenterJUNJlschools.Table 3showsthese comprehensiveaccreditationsystemfor ECEinChi1e.Astrong estimates.The addition of nearly 160,000 2 and 3 year old institutional and regulatorycontext may be important,also, students would cost US$361million. for boostingdemandfor ECE. For example, research indicates that demand for ECE in the US. is stronger in areas where The costof increasingECEcoveragefor childrenaged2and3 more preschoolsareaccredited.'B is much higher than that of 4 and 5 year-olds because the cost-per-student at that earlier age is almost three times Quality information deriving from an accreditation process greater than the cost-per-studentfor 4 and 5year-olds. should be made available to parents, communities, and policy-makers. Adequate public information on the quality DemandFinancing of ECEcentersis important,especiallyinthe Chileancontext ExpandingECE in Chile will requireadditional resources and where parentscan choose amonga wide variety of publicly- new interventions,bothonthe supply andthedemandsides. financed ECE institutions. Survey evidence in Chile that If ECEenrollment,at least for age4-5, is legallymandatedand demonstrates parental misinformation about ECE information campaigns to encourage families to send their underscores the need to provide information to inform the young children to ECE programs are implemented, general public view on the benefits of early childhood expandingaccess through studentvouchersin FDScould be education,especiallyfor low-incomefamilies." In order to of helpinthose areas wherethe scarcity of supplyisthe main create a greater impact on public awareness in Chile, restrictionfor ECEenrollment. resources could be used for public awareness campaigns, similar to those utilized to help families better understand Given the urgent need to expand access to ECE in Chile, the legalreformsin Chile. conditional cash transfer (CCT) programs may provide a short-termsolutionto expand ECE access, quality and equity Costsof ECE Expansion in Chile. A CCT can act as a demand-side incentiveto enroll Recently, the Ministry of Education estimated the marginal childrenin ECE. cost of increasing ECE coverage of 4 and 5 year olds (pre- kinderand kinder programs),aswell as ECEcoverageof 2and International experience with CCT programs indicates that 3 year olds. Using costs per student in 2004 as a base, two these can be very effective in getting families to send their alternative scenarios were estimated for the increased children to school; especially young children whose coverage of 4-5 year olds: (1) increasing the enrollment of opportunity costsof schoolingtend to below.The conditions children aged 4-5 through a per-student voucher in upon which the cash transfers may be granted to families municipaland privatevoucher schools, which would make it could be based solely on young children'sattendance in ECE possible to reach approximately 71,000 additional children or on a combination of children's ECE attendance and between2007 and2010;and (2)increasingthe enrollment of mother's laborforce participation. childrenaged4-5 by expandingfull-dayschools(FDS),which would make it possible to reach approximately 77,000 From a financial sustainability and equity perspective, it additionalchildrenbetween 2007 and 2010.Table 2 presents would make sense to target the CCTs to low-incomefamilies the cost estimatesof bothscenarios. ................,.......................................................,..,,.*,..................,..,....................................................... andto phasethem out over time,once mostfamilies become 19 18. Edwards,Fuller,& Liang (19%). 19.CASEN (2003). Cashtransfershavebeenshohntocorrelatepositivelywith femalelaborpartiidpation.Evidencefromthe UnitedStatessuggeststhat childcare subsidies are positivelyassociatedwith,and may be a causalfactor of,increasedfemale labor participation(Berger& Black, 1992;Blau&Tekin, 2000Gelbach, 1999, Meyers,Helntze,& Wolf, 20021,The UnitedStates,throughtheChildCare DevelopmentFund,(CCDF) givessubsidiestolow incomefamiliesinwhich parents are employed, intralning,'or inschool althoughonly a small portionof eliblefamilies participateinthe programfiesubsidycan cover any childage 13 or younger.Blau&Tekin (2000)findthat single mothersenrolled inthe CCDF programare significantly morelikely to beemployedand their childrenare significantlymorelikely to beenrolledin school.Gelbach (1999) findsthat single mothers receivinga previouschildcare subsidy in the US.alsoworked morehoursperweek, moreweeks per year,and hadhigherwages andsalariesthansingle motherswithoutthe subsidy. accustomed to sending their young children to ECE Strengthening Research and Impact Evaluation of ECE programs.Targetingpublicinvestmentin ECEwill requirethat Interventions instrumentsandresourcesbein placeto identifyand monitor A significant constraint to developing ECE policy in Chile is eligibility of the neediestfamilies. the absence of solid evaluations of preschool interventions." Giventhat current ECE levelsof enrollmentand quality need In Chile, there are already systems in place through social to be improved, policy-makersshould consider building the programs such as Chilesolidurio that provide transfers to basis for impactevaluations of ECE interventionsat the time qualified families conditioned on sending their children to of policy design. It is also important to conduct studies to ECE programs.Preliminary results of an impact evaluationof identify which ECE programs can be effectively brought to Chilesolidurio suggest that the program has had positive scale.Muchof what is knowntoday about the impactof ECE effects on preschool enrollment. Chilesolidurio is currently interventionscomes from the PerryPreschoolPrograminthe targeted only to indigentfamilies, a populationthat accounts US. This program has used random assignment to evaluate for only a small share of the families currently not served by the impact of the program on participants over more than ECE in Chile.An option would be to increaseeligiblefamilies four decades. Although such rigorousexperimentsare costly to includelowincomefamiliesinadditionto indigentfamilies. and not alwaysfeasible, alternatives to experimentaldesigns exist that mayfacilitate a sound evaluationof the impact of StrengtheningCulturalAttitudes Favorableto ECE policy interventions. Financialconstraintsare not the only, nor perhaps,the main reason why Chilean families do not send their children to preschool. 0ther interventions, including information campaigns on the benefits of ECE, are important to get young children in Chile to attend ECE. 20 20. Galasso,forthcoming. 21.Seguel,Edwards and others haveconducteda series of evaluationsof preschoolprogramsin Chile.Although it is difficult to generalize basedon a few studies, these works suggestthat the Integraprogramshavepositiveimpactson the learningoutcomes of childrenfrom low incomehouseholds. UniversalIncreaseinschoolingfor 4-5 year olds (1stand2ndTransitionLevel) Differenceow( 2006 (thousandsofdollars2004)' . - 2007 2008 2009 2010 Total 8oys/Glrls ` `17,785 -, 35,570 53355 71,139 71,139 Food 2,463 . 4,925 7588`. 9,850 ~ 24,626 . TeachingMaterial - 218 437. . 655 814 2,184 Voucher Cost 6,569 13,138 19,708` . 26,276 65,692 Total ProgramCost 9,250 . 18,501 27,751 37,001 92,502 TotalCostper Child 0.52 os2 ' os2 052 * 1.30 Expansionof Full-DaySchools(FDS)for 4.5 year olds (1stand2ndTransitionLevel). Installing20%FDSInschoolstargetedthroughMlNEDUCvoucherr Differenceover 2006(thousandsof dollars2004)* 2007 2008 2009 T 8oyslGirls4&5 year oldsFDS 9,224 38,448; .*i j 57,672 76'8% 76,896 . , Food 532 1,065 1,597 2,130 5,324 0 0 % 0 0 0 2,653 , 5,307 7,960 10,613 26,533 InfrastructureCostFM . 7,219 7219 7219 . 2 a m TotalProgramCost 13,590 16,776 19,962 60,733 Total Cost perChild 0.54 0.35 029 ' ' 026 0.79 Differenceover 2006(thousandsof dollars2004)' 2007 2008 2009 2010 Total BoydGirls2 & 3years old 39,345 78,690 118,035 157,380 157,380 . Food - 1 0 Teaching Material 0 cost 361,427 Totalhograqcon 361,427 TotalCoqperChild 230 22.InTable2:(i) the infrastructurecalculationsassumethat only 50% ofthe studentsincorporatedto FDSrequireconstructionofclassrooms;(ii) inthe construction of classrooms,their size is estimated for 35 students in Prekinderand 45 students in Kinder;(iii) basedon the assumption that studentsentering FDSare equally divided into Kinderand Prekinder;(iv) a ratio 1 classroom - 1 bathroom was estimated,which is an estimated mean between bathroom repair,construction and maintenancefor allthe infrastructureexpansionin FDS;(v) Prekinderclassrooms(40m2) require60 m2,lncluding bathroomand Kinderclassrooms(50m2) require 70 m2,includingbathroom;the costper built meter isestimated in USS459 plus 10%for project designand lO%forfurnlshing and equipment that are added to 21 the value of each classroom. 23.These estimatesinclude food and teaching material. ........................................*...*.............................................*................................................................. References Belfield. C. (2005a). "The Promise of Early Childhood Edwards.J.. Fuller.B..and Liang.X.(1996).The Mixed Preschool Education."Paper presented at the Campaignfor Educational Market: Explaining Local Variation in Family Demand and Equity. Symposium on the Social Costs of Inadequate Organized Supply. Economicsof Education Review. 15(2).149- Education.Columbia University. 161. Belfield.C. (2005b)."Economic Benefitsof Investing inYoung Elacqua. G. (2005) "Stratification versus Segmentation: How Children: New Findings." Presentation at the 2005 Annual do voucher schools respond to market incentives?Evidence Conference of Grantmakers for Children. Youth & Families. from Chile." Occasional Paper Series. National Center for Denver.Colorado. September 25-28. Study of Privatization in Education. New York: Teachers College. Columbia University. Belfield. C. and P. McEwan. (2005). "An Economic Analysis of EarlyChildhoodInterventionsin Massachusetts." (Processed.) Galasso. E. (forthcoming). "Impact Evaluation of Research paper commissioned by Strategiesfor Children.Inc. Chilesolidario."Washington. DC:TheWorld Bank. Berger.M.. & Clack. D. (1992). Child Care Subsidies. Quality of Gelbach. J. (1999). How Large an Effect do Child Care Costs Care. and the Labor Supply of Low-Income Single Mothers. Haveon SingleMothers' Labor Supply?Evidencefrom Access Reviewof Economicsand Statistics.74(4).635-642. to Free Public Schooling. Working Paper. Department of Economics.UniversityofMaryland.CollegePark. Berlinski.S..S.Galiani and P.Gertler.(2005)."PublicPre-Primary Schoolingand PrimarySchool Performance". (Processed.) Gomby. D.. Larner.M.. Stevens0n.C.. Lewit. E. and Behrman.R. (1995). "Long-Term Effects of Early Childhood Programs: Blau.D.. &Tekin.E. (2000).TheDeterminantsand Consequences Analysis and Recommendations."TheFuture of Children.33). of Child Care Subsidies for Single Mothers. Paper presented at 6-24. the Conference on incentive Effects of Tax and Transfer Policies.Washington.DC. Haskins. R. & C. Rouse. (2005)."Closing Achievement Gaps'! Futureof Children PolicyBrief.Brookings Institution.Spring. Carneiro. P. and J. Heckman. (2003). "Human Capital Policy." Mahon. R. (2002).What Kind of "Social Europe"?The Example NBER Working Paper 9495. Cambridge. MA: National Bureau of Child Care.Social Politics.9(3).343-379. of Economic Research. Mahon. R. (2002).What Kind of "Social Europe"?The Example Choi.S. (2002).lntegrating Early Childhoodinto Education:The of Child Care.Social Politics.9(3).343-379. CaseofSweden. Retrieved.from. Meyers.M.. Heintze.T..and Wolf.D.(2002).Child Care Subsidies Cleveland.G.. & Hyatt. D.(2003).Child Care Subsidies.Welfare and the Employment of Welfare Recipients. Working Paper. Reforms. and Lone Mothers. lndustrial Relations.42(2): 251 - School of SocialWork.Columbia University.NewYork. 269. Mizala.A. and Romaguera. P. (2005)"Calidad de la educacibn Contreras. Dante. Esteban Puentes and David Bravo. (2005). chilena:una asignatura pendiente."Cieplan Working Paper. "Female labour force participation in greater Santiago.Chile: OCDE.2005.Education at a Glance. 1957-1997. A synthetic cohort analysis." Journal of lnternational Development 17(2):169-186. P. Pacheco. G. Elacqua. P. Montt. and J.J. Brunner. (2005). Estrategia preescolarbicentenario. Santiago. Chile: Ministerio Currie. J. (2001). "Early Childhood Education Programs." The de Educaci6n. Journal ofkonomicPerspectives15(2)215-238. Rawlings. L.. & Rubio. G. (2003). Evaluating the Impact of Duryea. S.. 4 Morrison. A. (2004). The Effect of Conditional Conditional Cash Transfer Prorams: Lessons from Latin Transfers on School Performance and Child Labor: Evidence America.WorkingPaper. TheWorldBank. 22 from an Ex-post Evaluation in Costa Rica. WorkingPaper 505 Inter-AmericanDevelopmentBank ResearchDepartment. Rojas Lasch. C. (2004). "iC6mo afrontar desde la politica pljblica la tensidn trabajo v/s atenci6n de 10s nitios?". ExpansivaEnFoco (34).Santiago.Chile. Schady. N. (2005). "Early Childhood Development in Latin America and the Caribbean." (Processed.) Washington. DC: The World Bank. Seguel. X. and Edwards. M. (2005). "lnstalaci6n del Nuevo Curriculum en Jardines de Fundaci6n Integra. Evaluaci6n de Jardines de la Primera Cohorte." (http://www.cedep.info/indiceautor.php). Seguel. X.. Edwards. M.. M.I. Lira. A. De Amesti. E. Atalah. H. Galaz et al.. (1998)."Evaluaci6n del lmpacto de la Educacion Parvularia sobre 10s Nitios. 1994-1997." (http://www.cedep.info/indiceautor.php). Skoufias.E.. & Parker.S. (20011.ConditionalCashTransfers and Their Impacton ChildWork and Schooling:Evidence from the PROGRESA Programin Mexico.Economia.2(1).45-86. UNESCO. (2003)."Role of Childhood Care and Education in Ensuring Equal Opportunity." UNESCO Policy Brief on Early Childhood 18 (November-December). UNICEF. (2005). The State of the World's Children 2005: Childhood UnderThreat.NewYork UNICEF. World-Bank. (2005). World DevelopmentReport 2006: Equity andDevelopment.Washington:The World Bank. 23 Policy N o t e 3 : Policies for B e t t e r O l d Age I n c o m e S u p p o r t i n C h i l e ' A b s t r a c t Pension policies in Chile have provided impressive achievements in terms of reduction of fiscal liabilities and development of the financial sector and, ultimately, have contributed to significant macroeconomic outcomes. Said outcomes have also contributed to the significant poverty reduction achieved in Chile in the last two decades. However, from a household's perspective, particularly lower-income households, the outcomes of pension policy look rather less impressive. About 40 percent of workers fail to contribute to the pension system and only about 45 percent of affiliated workers are likely to receive benefits higher than the state minimum pension when they retire. This note outlines options for reforms of current pension policies to lower poverty among the elderly and improve consumption smoothing for old age, while maintaining the significant contributions of the pension system to Chile's macroeconomic performance. ............................................................................................................................................................. 1.This policy note was preparedfor the Governmentof Chile by a team of World Bank staff and consultants lead by Truman Packard (Senior Economist, Social Protection, World Bank). The team consisted of David McCarthy (Imperial College London, United Kingdom),Ximena Quintanilla (Institute of Fiscal Studies, University CollegeLondon,United Kingdom),and Juan Yermo (Organizationfor EconomicCooperationand Development, OECD, Paris). This note has benefited 24 from prioranalyticalwork done by RobertoRocha(LeadFinancialSector Economist,World Bank)andAugurto de IaTorre(SeniorRegionalFinancialSectorAdvisor, World Bank) for ajoint World Bank-IMFfinancialsector review,as well asfrom comments by MarioGuadamillas (SeniorFinancialEconomist,World Bank).This note summarizesa longer,moredetailed policy report,availableat www.bancomundial.org/cl ............................................................................without I. Introduction elderly in urban areas and 8 percent in rural areas went support, contributing to Chile's low but persistent Pension policies in Chile have provided impressive ratesof indigencepoverty. achievements in terms of reducing fiscal liabilities and developing the financial sector and, ultimately, have So with respect to pension policy, although Chile has done contributedto significantmacroeconomicoutcomesinChile. well it can do better,for these problems threaten hard-won While governments in most countriesface ballooning public progressand the country's favorable fiscal outlook.This note pensionliabilities, although it is still spendingover 5 percent poses several difficult questions for pension policy makers, of GDP on pensionsannually,Chile'sbudget is in surplusand but all seek to helpthe governmentformulatea vision of the its implicit pension debts are falling. While governments in pensionsystemChileshouldhaveinplacein 10years, andto most developing countries struggle to attract and increase identifythe actionsthat can betaken inthe nextfour yearsto privateinvestment,Chile's pension assets as a percentage of bring the current institutions for old age income support GDP rivalthose of the United Sates andthe UnitedKingdom. closer to that vision. And while the financial sectors of most Latin American countries suffer from meager development, Chile's private pension industry has helped to deepen the capital market II.The Risks t o Income from Ageing and and boost the development of banking, insurance, and a ............................................................................ Chile's Multi-Pillar Pension System sophisticatedarrayoffinancial instruments. Old age is not a bad state,perse. Inmost societies, longlife is However,from a household'sperspective,particularly, lower- considered a blessing, and even a goal of economic income households, the outcomes of pension policy look development. However, from and individual's perspective, rather less impressive. In any given month, 40 percent of ageing is accompanied by at least three distinct (although workers fail to contribute to the pension system. If this related) prospective losses to income: the loss of earnings patterncontinues, in2030 only about45 percentof affiliated ability, as the body and even the mind succumb to natural workers are likely to receive benefits higher than the state deteriorationovertime; unanticipatedlongevitythat increases minimumpension.The state guarantee itselfis only likelyto the period of life when an individual has to consume but coverabout 5 percentof affiliates,whileupto 50 percentwill cannot earn incomefrom work; and,from these,an increased be able to countonly on what they have saved on their own vulnerability to poverty in old age. Helping households to and social assistance in old age. Currently, private pensions cover these losses forms the core of broadly accepted cost households more than they should, and upon objectives of pensions policy, which are (i) to prevent a retirement do not adequately protect them from market dramatic fall in householdmeanswhen incomefrom tabor is risks when switching from savings to annuities. Further, no longeran option-the "consumptionsmoothing"objective; there are several inequities that persist. Women pay a (ii)to ensurethat these meansareat leastof a leveladequate pensions penalty when they retire. The police and military to sustain individuals'needsfor the remainder of their life - enjoy enormous pension privileges subsidized by all tax- the "income adequacy" objective; and (iii) to ensure that payers. And despite having a relatively well targeted social consumption never falls below an absolute minimum, assistance benefit, in 2003 up to 30 percent of the indigent socially-acceptablelevel - the "povertyprevention"objective. 8% ...................................................................................................................................................................................................... ........................................................................................................................................................................................ ::... 1% 0% 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 S Recognition 25 Source:DIPRES Operacional Deficitof military Minimum pension deficit pensions Bonds guaranteeand PASIS Chile's Governmentmakes an array of instrumentsavailable system are once again a topic of debate(see Bachelet,2005). to helphouseholdsmanagethe lossesthat arisefrom ageing, There is increasing concern for the system's credibility and both directly and through private provision.Since structural legitimacy. For although the system is designed to yield reforms in 1981 that introduced a shift away from a purely benefitsthat meetOECDstandards of protection,in Chile (as public pensionsystem of disparate plans, to a more uniform in other Latin American countries) the participation system in which householdsavings and the privatefinancial requirement for households to benefit from this protection sector play a dominant role,these instrumentsare generally are not beingmet. verywell matchedto cover the lossesdescribedabove. Inthe widely accepted pensions lexicon, Chile's "multi-pillar" pension system has two "first pillar" instruments, the Ill. The Challenges to Chile's Pension minimum pensionguarantee (MPG)and the targeted social ...................................,......,................................. System: Coverage, Costs and Competition assistance pension (PASIS) that pool the risk of poverty; augments consumption-smoothingthrough mandatoryAFP In the past fifteen years, the share of the labor force that accountsand annuitiesof the"secondpillar";and encourages contributes to the pension system has rarely been higher additional,voluntary"third pillar"savings through regulated than 60 percent.Most Chileanworkers have interrupted and privateinstruments("ahorroprovisionalvoluntarlo",or APV). irregular contribution histories, and upon reaching retirement age will not have the years of contributions on In meeting the consumption-smoothing, income-adequacy which the favorable comparison to OECD countries are and the poverty-prevention objectives, assuming workers based. The regulatorsof the pension system estimate that, complywith the mandateto participate,the benefitsyielded because of low and irregularcontribution histories, up to 50 by Chile'sfirst and second pillarsare generallyand favorably percent of affiliates will be ineligible for the minimum comparable to mandatory plans in the OECD. However, pension guaranteed by the government (Bernstein, Larrain whereas policy makers in most OECD countries are and Pino,2005)'. Thusneither the contributoryfirst pillar not increasingly concerned at the prospect of financially the second pillar is workingfor most affiliates. unsustainable retirement security systems, Chile's pension spending- currently still high at an averageof 5.6 percentof Explanations for low participation range from broader GDP, and composed primarily of the transition-cost of the economicfactors and labor market condition^;^ the structure 1981 reform - is quickly declining. Despite this positive of incentives householdsarefaced with giventhe parameters assessment, the pillars of Chile's old age income security of the first and second pillar as well as those of other 10% 1 (190% 5% 80% 0% 70% -5% 60% -10% 50% -15% 40% 30% -20% 20% -25% 10% -30% 1 I 0% Quintile 1 Quintile2 Quintile3 Quintile4 Quintile5 Source:Creation basedon CASEN surveys 1996and 2003 %ofchangeinthe participationof contributors 2.It is important to clarifythat this only refersto old-age pensionsand that there are other sources of income,especially in the case of women. Many women do not contribute in a sustainedmannerand therefore do not havetheir own pension;however,manyare married and liveon their husbands salaryand later on their husband'spension.Therefore,part ofthese people haveother income to finance their old age.Forexample,according to the CASENsurvey,24% of women above age 70 receivewidow's pensions. 26 3.lncluding the businesscycleand economic growth (Valdes,2002,and Packard,2001);unemployment (Bernstein,et al,2004);minimumwage legislationandjob security provisions(Valdes,2002). 4. Including the availability of non-contributory benefits and the accrual rate implied the contribution requirements for the minimum pension guarantee (Bernstein,et al,2004);and health insurancecoverage(Valdes,2002). 100% 80% 60% 40% 20% 0% Total Male Female Affiliatesexpectedto earnapensionover minimumpension Source:Bernstein, earnonlythestateguaranteeandpensioneventuallybelowminimumpension LarrainandPino (2005) 8 1!Affiliatesexpectedto earnpensionbelowthe minimumpensionandwithouta minimumpensionguarantee Affiliatesexpectedto componentsofChile's social protectionsystem;`to individual from 21 in 1994 to 6 in 2003. The fund managers have and household preferences' Estimates of the determinants enjoyedpersistentlyhighprofitswith annual returnon equity of participationfor this noteshowthat thefactors mentioned (ROE) averaging 30% in recent years, twice the ROE of abovevary inimportance dependingon the particulargroup commercial banks (IMF-World Bank, 2004). Although the of affiliates beingexamined. However, new findings point to industry`s costs have declined and are even becoming forms of employment particularly uncontracted and daily - comparable to the cost of similar financial services in OECD rate("bonorarios'qemploymentarrangementsthat lowerthe countries, there is considerable scope for further reductions likelihoodof contribution and of meeting the requirements (Valdes,2005). The fundamentalworry isthat theseproblems for MPG coverage particularlyamong younger workers and of low system coverage, lack of competition and high costs women. are notonlydetrimentaltothe systemanditseffectivenessto households,but that theythreatenthe system'scredibility.To Furthermore, low rates of participation could be linked to the extent that the system loses credibility, the important actual and perceivedhigh commissions andfees sustained gains from structuralreformsin the 1980s couldcome under by low levels of competition between the private pension attack (Gill, PackardandYermo, 2004). fund managers (Valdes, 2002, `Gill, Packard and Yermo, 2004).While there is ample evidenceof low pricesensitivity The most recentchanges to the pension system have been among those already participating in the system, high to increase investment options in the second pillar, commissions and fees could be dissuading those working measures to bring down the cost of annuities, and to outside the system from taking up coverage. This increase savings in the voluntary third pillar. Chile has argument links the three most important topics being moved towards making the mandated AFP system more debated in the discussion of reforms to Chile's pension flexible and allowing workers greater choice over their system: coverage, cost and competition.This is to say that investment portfolios. To ensure competitive pricing and to the main challenge in social security for the incoming narrow dispersion in annuity payments, a new centralized government - the lack of coverage of a majority of Chilean virtual m3rket for longevity insurance has been introduced. workers - could also be related to the efficiency of the Further,the Government'sefforts to increase the appeal of pensionsystem (Figure3). the mandatedsecond pillar, have beencomplementedwith tax incentivesfor individualsto participate inthe voluntary, Academic and political observers are increasingly critical of third pillar. Householdresponseto these changes has been the functioning of the private pension industry, wary of its positive, showing a very modest increase in participation concentrationand super-normal profits, and skeptical as to rates(Medrano,2004). whether it is keeping the promise of privatization,namely greater efficiency and lower prices for households through However,there is muchmorethat needsto be done to lower market competition.Thenumber of AFPs in the industry fell costs,ensure these savings are passedon to households,and ............................................................................................................................................................. 27 5. Includingpreferencesfor currentover futureconsumptionamong workers(TorcheandWagner, 1997,Barr and Packard,2002);aversion to financialrisk,found in Barr and Packard,(2002)amongthe self employed and among a large sampleof pooreremployees in empiricalestimationsfor this note;preferencesfor alter- native,substitutesavings and insuranceinstruments(Packard,2002);aswell as credit constraintsand liquiditypreference(Beyer andValdes,2004). increase the appeal of the system as a means to smooth Government could move towards a "rights approach" by consumption,ensure adequate retirement income, and cover removing the ration on social assistancepensions. There are at the riskof poverty inold age. Inthe remainingsectionsof this least three basic alternatives for structuring the poverty- note, we discuss specific problems with the poverty- prevention component. These are: (a) a minimum pension prevention and consumption-smoothing pillars of the guarantee,or benefittop-up to workerswho havecontributed pension systemthat lead to truncated coverage;vulnerability aspecifiednumberof years to a retirement securityregime; (b) to poverty inold age;inequitable outcomes;low competition; a benefit targeted to the elderly poor; and (c) a universal flat and high costs of private pensions. Rather than specific pension, sometimescalled a"demogrant"- paid to all men and solutions, we propose general principals to align the women over some threshold age, regardlessor their means. In Government's consideration of reforms. addition to poverty insurance, each of these structures can pool the risk of other contingencies markets are unable to manage or manage poorly, such as life-time low earnings and ............................................................................ IV. Better Poverty Prevention inflation. Many countries have at least one of the three arrangements, and most countries in LatinAmerica offer both Recent changes in the pension system are very the contributory minimum pension guarantee and a (often promising. However, an important part of the population poorly) targeted benefit to the elderly indigent. Universalflat is not affiliated to the system (Arenas de Mesa, 2000, pensions or"demogrant"are rare,and can be costly.' Beyer y Valdes, 2004). Tax incentives for voluntary retirement savings, which have been found to be Chile's MPG ensures that affiliates who have contributed for regressive in several countries, are likely to have only a 20 years retire with a minimum annuity amount, which is modest impact on savings given how few Chileans pay initially financed out of the accumulated balance in their income taxes.' Thus, the improvements to household individual account, and then by the government directly welfare from recent reforms need to be enhanced by when these savings are exhausted. In a country where all consolidating and strengthening the set of instruments workers contribute to the earnings related pension system, intended to prevent poverty in old age-the non- the current structure of the MPG is fairly good: it encourages contributory, rationed PASIS (currently set roughly equal workers to save privately and guaranteesa minimum level of to the poverty line), and the contributory minimum retirement income at a low cost to tax payers. However, in pension guarantee (which is about twice the poverty Chile where many workers will not have a sufficiently long line). Chile's pension system is failing to meet the history of contributions, a top up conditioned on poverty-prevention objective. In 2003 about 40 percent participation can not only exclude large segments of the of elderly poor and 30 percent of elderly indigent in population but also lead to perversetransfers. Chile's urban areas were not receiving pension income. In rural areas, 15 percent of the elderly poor and 9 The social assistance,"non-contributory"PAS1S is paid to the percent of the elderly indigent failed to receive benefits. elderly who pass Chile's means test. However, even for individuals who pass the means-test the PASISis not a legal Consolidation of the poverty-prevention component of Chile's right and the number of new pensions awarded in any pensionsystem could be pursuedwith three related objectives given year is strictly rationed in the budget setting process. in mind:(i)to lower and ultimately eliminate the riskof poverty The ration on PASISpensions compromises its effectiveness in old age, by shifting to a"rights"approach; (ii)to increase the as the pay-out in the "bad state" (i.e. old age poverty) is not equity impact of public subsidies to old age income, by guaranteed even to those who are eligible. Thus each of restructuring these subsidies for better incentives; and (iii) to Chile's poverty prevention instruments truncates coverage, embed old-age poverty-prevention coherently within Chile's/ albeit in different ways. Lifting the ration on the PASIS broader povertystrategy andsocial protection system. would be a straight forward and relatively inexpensive way to lower and eventually eliminate the risk of poverty in old Tolower and eventuallyeliminate therisk ofpoverty in oldage, age. Fortunately, there is a wide social consensus in support ............................................................................................................................................................. 6.Since relativelywell off individualsare those most likelyto havethe information anddiscretionaryincome to savefor longer horizons,preferential tax treatment for voluntary retirement savingscan be regressive. 7.Giil,et a1,(2004)demonstrate that these are fiscallyunviable in most Latin American countries. The universalold age benefit in New Zealand cost 4% of GDP in 28 2001 and isforecastto grow to 9% of GDP in 2050. 8.Beyer andValdes(2004)estimate that the annual costofcoveringallthe existingelderly indigents who are not receivingthe PASISwould be approximately US$ 25 million.The authors show that this additional cost could befinanced with the fiscal savingsresultingfrom the elimination of badly targeted benefits currently being paid to non-poor elderly. of this measure (see Bachelet,2005)8. important and salient criterion to individuals. A standard 20-year minimum contribution period will vary widely in Toimproveequity ofsubsidiesto old age, the minimumpension value between individuals.The contribution of a very poor guarantee could be restructured,not for povertyprevention,but worker in terms of forgone consumptionis very different in to increaseparticipation. The currentstructureofthe MPGcan relative value than the contribution of a wealthy worker. lead not only to regressivetransfers from all tax-payers to Similarly, contributions earlier in life are worth more in relatively better off affiliates, but also creates strong forgone consumption than contributions closer to disincentives to participatein the pension systemfor lower- retirement, since younger individuals are giving up use of income earners. On the one hand, the contribution their money for a longer time. A minimum contribution requirement can discourage participation. For individuals requirementdefined in months or years is a relatively poor who rotatefrequently through differentsectors of the labor proxy of savings effort. Once an unrationed,targeted PASIS market, as well as in and out of employment, the 20 year is in place to cover poverty in old age, a minimum amount contribution requirement can presenta formidable obstacle, of accumulatedindividualsavingsis a muchbetter indicator anddiscourageparticipation.Ontheother hand,itcancreate of effort for the State to encourage with subsidies. moral hazard: for workers with lower life-time earningswho are unlikelyto accumulatea balanceat retirementthat could The best poverty-prevention structure is likely to be part of a purchase an annuity for an amount higher than the MPG, broader social protection strategy. Chile has taken enormous contribution up to the eligibilitythreshold(240months)may strides in consolidatingthe segments of its social protection be a high-return investment option, but every additional system that are targeted at the poorest. The degree of contributionwill be a puretax. orchestration among social programs achieved under the Chile Solidario initiative is unprecedented in the country, To eliminate these distortions and disincentives, the MPG although there is still roomfor improvement, Chile Solidario could be pro-rated to award every year or month of includes a special protocol for the elderly indigent with contribution. Alternatively, savings incentives could be guaranteed access to the PASIS. Chile should draw from this similarly smoothed by replacing the MPG with matching experience as it considers pension reforms, for the most contribution subsidies that could be deposited directly in effectiveold-agepoverty-preventionstructure is likelyto be affiliates' individualaccounts, fully exempted from AFP fees? embedded coherently within a wider system that targets Both options have merits and weaknesses that need to be povertycomprehensivelyamong all household members. carefully analyzed. The ultimate equity impact of either of these "graduated" contributory minimum guarantee In this context, a difficult question that will have to be structures will depend on their success in attracting answered is whether any additional public expenditure that participationto theconsumptionsmoothingpillar,and would resultsfrom liftingthe PASISration,from graduatingthe MPG, have to be closely monitored. If the ration on the social or from introducingmatchingcontributionsisjustified given assistance PASIS is removed, then a public risk-pooling the needs of other vulnerable groups. Poverty is higher arrangementto coverthe riskof povertywould besecurelyin among other age groups, particularly among children. place. In many ways this makes the MPG redundant. But Current public subsidies for old age income securitycan be although even a graduated contributory MPG or matching better distributed,as discussed earlier and in the last section contributionschemetargeted a lower-incomeaffiliateswould of this note, but the measures above are likely to imply cease to be necessary as a poverty-preventiondevice, either additional spending. Better poverty prevention among the could prove highly beneficial as a means to increase old should be pursued as part of a comprehensive social incentivesto participate inthe consumptionsmoothingpillar. protection strategy that sets priorities for additional public spendingin light of sometimes competing social demands. Finally, while proposals for graduated, proportional guarantees and matching contributions are attractive for increasing interest in the pension system among lower- V. B e t t e r Consumption- S moo t hing ............................................................................ income workers, a target minimum accumulation amount rather than contributory period is a potentially much more Any market in which participation is mandatory requires ............................................................................................................................................................. 9.Among workerswho areable to evade the mandateto contribute,matchinggovernmentcontributionsare in manywaysequivalentto the earned-incometax 29 creditsthat havebeenemployed so successfullyfor povertypreventioninthe US. Conceptually,these schemesarealsoequivalenttotax-incentivesfor thirdpillar voluntarysavings,Chile'sAPV,andcould minimizeor even counterthe regressive impactofthese tax incentives. MatchingcontributionschemesexistinMexico andColombia,but havenotyet beenrigorouslyevaluated. closesurveillanceon the part of the authorities.Governments tendency for concentration in the AFP industry, allowing the haveafiduciary responsibilityto ensurethat the marketsthat largest AFPs to capture rents from fund management. By households are forced into can deliver high quality goods separating these functions each segment of the industrycan and services at low cost. While the options discussed in the achievedifferent optimal scales of operationfor overall gains previous section could lower, and even eliminate, the risk of in efficiency.1D poverty in old age, the loss of earnings ability and unanticipated longevity also need to be better covered. The unbundling of services would add complexity to the Indeed,doing so by increasing efficiency,lowering costs and system, possibly affecting the already low price elasticity of thus attracting more participation in the consumption- demand and even failure to choose between fund smoothing pillar is the best way to keep the poverty managers by affiliates. Thus, the unbundling should be prevention pillar affordable in the long run. complemented with "search assistance" offered by the regulator. This assistance could be provided by default to Furtherspecificchangesto the structure of the consumption affiliateswho fail to choose a service provider or,even more smoothing component of Chile's pension system should be proactively, to affiliates with low account balances. Indeed considered with five closely related objectives in mind: (i) to search assistance could be organized to keep lower administrative costs, mainly by unbundling the administrative costs down and meet the second objective provision of AFP services; (ii) to ensure that these cost of ensuring cost-savings are passed on to households." savings are passed onto workers in the form of lower Affiliates' interests should guide how search assistance is commissions, through structural reforms that could lead to structured. greater competition; (iii) to encourage better risk-adjusted performance,through a shift in the regulatory approach; (iv) To ensuresavings are passed on to households,the market for to help affiliates better manage the transition from fund- consumption-smoothing services could be made more accumulation to pay-out, by encouraging the creation of contestable. There are no explicit barriers to entry into the new instruments; and (v) to increase participation among a AFP industry,however, the market is far from contestable due greater number of workers, by lowering transactions costs to high start-upand sunk coststhat canput-off potential new and improving incentives. rivals. Much of these costs have to do with the operational services discussed above, rather than asset management To further lower administrative costs, AFP services could be services. However, if services were separated, banks, unbundledandrestructured.The efficient provisionofservices investmentmanagement firms and life insurancecompanies inChile'smandatoryfunded pensionsystem requirespolicies could be permitted to enter the asset management segment that will improve the price elasticity of demand.The current ofthe industry,bringingwith them expertise and competitive structure of the AFP industry is, to a large extent, a result of pressures that could help further improve efficiency and regulation and consists of three main activities which have bring down the commissions affiliates pay. very different cost structures and are subject to different competitive pressures: operational services, asset Thecurrent market segmentation bywhich foreign bankscan management, and marketing to seek out new affiliates. control AFPs but local banks cannot does not have any Operational services such as contribution collection, record obviousjustification.Specific provisionswould be required to keeping, account management and benefit payment have avoid conflicts of interest in asset management, similar to greater economies of scale given the degree of technology those appliedto the current AFPs and their foreign owners. In involved in these services. In contrast, asset management the short-term, it may be preferable to retain the AFP becomes operationally efficient at a much smaller scale. structure - a specialized financial intermediary dedicated to Further, although these two activities benefit from asset management- and allow local banks and other financial economies of scale, there is relatively greater potential for companies to set up AFP or buy existing AFPs. However, at product differentiation in asset management. However, some future point it may be preferable to turn the"AFP"int0 under the current structure, operational services drive the a licensed service that could be performed directly by any ...............................................................................................*.*..*..**....................*............................... 10.Ifthe services that are bundled together in the current AFP systemwere to be separated,a range of options existfor how they can be organized. Operational services can be reorganized to minimize costs, and asset management can be opened up to true competition. In some countries, operational services are centralizedeither under public administration (asin Sweeden) or private administration (as in Mexico). Valdes (ZOOS) proposesthat operational servicescould be offered by separate"operational service providers"(0SPs)leaving"pure"AFPsto handle only asset management. 30 11. Affiliate who do not expressly choose to join a particular operational service provider or asset manager could be assignedto one according to specific considerationsof cost and performance. In fact blocksof indecisiveaffiliatescould be auctionedto service providersfor a certain period (e.g.three to five years) through a competitive bidding process.Limitscould be placedon the number of indecisiveaffiliatesany singleserviceprovidercouldwin from auction,to prevent the largest service providersfrom leveraging their low coststo further concentratethe industry. privatefinancial institution without havingto set up a costly understandingof investmentoptionsandthe generallack of dedicated,specializedsubsidiary. publicinterestisa majorconcernina fundedpensionsystem like Chile's. A failure to invest contributions adequately To encourage greater innovation and better risk-adjusted exposes individuals to retirement income risks and, as a performance, regulation could be shifted away from a result, increases the fiscal cost of the MPG and social compliance-base to a risk-management approach. The assistance pensions. Greater attention should be paid to the regulatoryframework of AFPs and life insurance companies pay-outphase and the purchaseof annuities. needsto becomeless rules-basedandmoreorientedtowards a risk-based supervision model that allows providers the The current structureof payoutoptions seems to encourage flexibility to diversify risk in both local and international individuals to retire early and to over-annuitise. markets. A risk-based approach emphasizes efficient risk Approximately90%of earlyretireeschooseto annuitise their management capacity and internal controls inside the AFPs, fund balances. This is in striking contrast to international market discipline, and greater responsibility of some key experience. Lifeinsurancecompanyagentsandindependent players such as the external auditors. New investment brokers may be exerting influence on the payout options instrumentsare neededto allow the AFPs to better manage chosen by members. Intermediaries may also be exerting interest rate and currency risk. The development of such pressure on individuals to retire early. Early retirement instruments,however, is inhibited by current regulations that requirements have been tightened, and the new quotation rewardsinvestmentsinlow-riskand highly liquid securities. system maychangesome of these outcomes. The limits set on investment in individual securities by risk While a high annuitisation rate may be economically and liquidity couldbe replaced.Therateof returnregulations inefficient,it is consistent with ensuring that affiliatesreceive contribute to short-termism and herding in investment adequateincomein oldage. Over-annuitisationalsoimposes strategies,thus funds are managed without the objective of a positiveexternality because it lowers the potential cost of maximizingreturnfor a givenlevelof risk. These limitscould the MPG, as those who purchase annuities are unlikely to be replacedwith risk-based regulationsthat requireAFPs to claim the guarantee. However, over-annuitisation might establish a financial risk-return objective for each of the impose a negative externality cost on poorer people by pension funds that they manage. They could be held pushing up annuity rates. The widespread purchaseof long- accountable to these objectives through revised minimum term guaranteed annuities is inefficient because this is a return requirements.The global quantitativelimits on broad restrictive combination of investment and longevity asset classes and individual issuers could be retained, but protectionthatworkers might beableto achieveina cheaper their level should be set solely by the supervisory authority and moreflexibleway. rather than beingwritten inthe pension law. In the accumulation and pay-out phase, product design, These changes would accord well with the "prudent person default mechanisms and pay-out options could be better rule" financial regulation preferred in the US and the UK. framed to lower financial risks and more explicitly target a However, the scope for liberalizing the investment regime certain minimum replacement rate for the average income and the shift to a risk-management regulatory approach is worker. Achieving such a target with near absolute certainty constrained by the inherent fiduciary role of the private requiresthe purchaseof a productthat wouldfunction likea pension pillar. Unlike in countries where the benefits of deferredannuity,offering an indexed benefitat retirementin privateplans are complementedwith public defined benefit exchangefor the monthlycontributionspaidintothe system. plans, the AFP system is the core and dominant component Unfortunately, such a product can be expensive to manage of old-age incomesupport in Chile. Thusworkers are already and providers may be unwilling to underwrite longevityfor exposed to a relatively greater degree of market risk. very long periods.At the very least, however, workers should Furthermore,Chilewould haveto developthe lega1,technical have the option of buying deferred annuities with part of and regulatorycapacityto fully adopt"prudent person"ru1es. their accumulated balanceas they approach retirement.This For these reason any liberalization should be gradual as policy could also reduce adverse selection problems in suggested in IMF-WorldBank (2004). annuitymarkets. Staggeredfixedannuities- bought through a sequential purchase (via multiple premia), rather than To help affiliates better manage risks and the transition from through a single premium payment - are another product work to retirement, innovation of better investment and that would allow retiringworkersto address annuityrate risk 31 annuitiesinstrumentscouldbeencouraged.The low degree of more effectively than the current system where there is a one-off purchase decision since with staggered products VI. Looking Even Further Ahead each purchase is made at the pricing conditions of the ............................................................................ moment, helpingto diversifyinterestrate risk. Alternatively, The objectives and general principles for better poverty workers could elect to defer the annuitisationdecisionfor a prevention and consumption smoothing presented in the few years after retirement if they could invest in a portfolio two previous sections translate into a very ambitious which protected them against annuity price risk. The introductionof impairedlifeannuities- annuitieswhich paya medium-termreformagenda. But pensionpolicy should be formulatedwith closeconsiderationof longer-termproblems higherratefor workerswho are in poor health might also be - and prospects. In this final section, we pose a series of consideredas thiswould helpto makeannuitiesbetter value challenging questions that we hope could contribute to for poorer workers. lookingevenfarther ahead. To increase affiliates'Incentives to participate, opt-in default Has the timecometo eliminatethegenderpenalty?As part of policiescouldbeconsidered. The pensionsystemparameters the 1981 pension reform, the minimum retirement ages of that effectthe incentivesto participate directly are the MPG men and women were raised from 60 to 65 and from 55 to and the PASIS and how these interact on savings decisions 60, respectively. The current earlier retirement age for of lower income workers. Measures to improve incentives women was a political legacyof the old system. Indefined- were discussed earlier, however, there are additional benefit systems that pool coverage of the loss of earnings changes that could attract participation. Currently, the self ability, an earlier retirement age for women created employed and employers are free to choose whether to transfers from mento women, designed to compensatefor participate. While there are catls for the mandate to be lower-earnings in the labor market and recognize years extendedto cover self employment,based on the negative dedicated to homecare and child-rearing. However, in experience in other countries (Argentinaand Brazil) such a systems where the consumptions smoothing objective is move could actually result in increasing evasion. The pursued primarily through individual savings, this transfer alternative course is to improve incentivesto participate by from men to women does not take place. Pensions are makingcoverage more attractive and easier to attain to self determinedbythe savings and the return earnedfrom asset employed. A specific measure that could be considered investment. With a lower retirement age,women contribute would be an "opt-in" default on income tax returns that fewer total years, and have a longer period of retirement to would lower the transactions costs of participating for finance. Thus, in a defined contribution plan, the earlier employers and the self employed. This possibility of joint retirement age compoundsthe negative effect of women's payment could be defined as a default option for those longevity to lower the monthly annuity payments they taxpayers. This proposal accords well with research of receive. Berstein and Tockman (2005) estimate that earlier retirement savings behavior in OECD countries showing retirement alone imposes a loss in women's pensions of that when participation in voluntary company pension almost 30%. plans (likethe 401k in the US) is made the default option, worker enrolment doubles (Benartzi and Thaler, 2004). Just what is "Old Age" anyway? Chile's shift to defined These behavioralstudiesform the basis of proposedopt-in contributions in individual savings accounts did much to default measures in the UK where earnings-replacement protect public finances from the cost of population programsare voluntary, and for the "KiwiSaver"program in ageing. However, as development and technological New Zealand, where despite concerns for low household advances further increase life expectancy,the Bismarkian savings, voters rejected the introduction of mandatory definition of "old age" that Latin American countries, accounts in 1999. including Chile, inherited from Europe over a century ago, will continue to pose fiscal risks. Chile can expect further Furthermore,by introducingthe possibilityof a single annual population ageing, which will eventually raise contribution,rather than twelve monthly contributions,the demographic risks faced by the pension system again - transactions costs of participationfor the self employed are particularly the sustainability of public risk-pooling reducedalmostto zero. Giventhat the group of permanently benefits for poverty prevention. Many specialistssuggest self employed is relativelysmall, and most self employedfind the introduction of a "mortality-adjusted retirement age" themselves in this status temporarily (although not among (Barr 2001 and 2004, and Barr and Diamond 2006). The lower income groups), for many the opt-in default could advantage of the proposals for mortality-adjustment is 32 prevent self employment from automatically cutting that it would continuously and automatically re-caliber contributionhistory. pension plans to changes in longevity, and if done correctly, can avoid the need for periodic, politically contentious debates. HowshouldGovernmentsubsidiestotheelderlybeused?At the end of 2005, Chile will have spent 1.3% of GDP coveringthe deficits of special, separate pension plans for the police and military. In the same year, Chile will spend half this amount (0.6%) preventing poverty among the elderly. The special pension regimes were left untouched by the 1981 reform. Many of the benefit parameters of these plans are anachronisticandcostly. As Chileweighsoptionsfor changes to improve povertypreventionand consumptionsmoothing for the population as a whole, the cost of current public subsidiesto maintainthese plans should also be an item for discussion. What is the appropriate level of mandatory consumption smoothing? Once a financially sustainable structure that prevents poverty in old age is in place, how much private consumption-smoothing should the State require of households? Is mandatedsaving too low or too high?To set the parameters of the system the architects of the 1981 reform required at least an implicit benefit objective that could be targeted. Many proponents of individual accounts suggest replacement rates from 70 percent to 90 percent, which has been shown to be overly optimistic. If a more realistic objectivewere made explicit,how much would the average worker really have to contribute, and on what portion of his monthly salary to achieve this benefit objective? Is it less than or greater than the current 10 percentof a ceilingof 3.8 times average earnings? And if it is less, would lowering the contribution rate or the ceiling on earnings subject to the mandate also lower the "costs" of participationfor households and further encourage greater participation?The share of earnings subject to mandatory pensionplansinChileismuchhigherthantheOECDaverage. Lowering the contribution ceiling to 1 or 2 times average earnings would be more in line with pension systems in the OECD and might prove a more salient level of minimum consumptionsmoothingwith Chilean households(Gill,et ai, 2004). 33 ..............................................................................................................*............................................. References Arenas de Mesa, A. y Gana, P. (2003), "Proteccion Social, Stanford University Press, Palo Alto, CA Pensionesy Genero en Chilel'en ProteccidnSocial, Pensiones Holzmann, Robert, Truman Packard & Jose Cuesta, (20001, y Genero, Argentina Brasil y Chile, Bertranou, F y Arenas de "Extending Coverage in Multi Pillar Pension Systems: Mesa,A. Eds.OIT. Constraintsand Hypotheses,PreliminaryEvidenceand Future Arenas De Mesa, Alberto, (2000) "Cobertura Previsional en ResearchAgenda'lin R. Holzmann & J.Stiglitz, Eds.New Ideas Chile: Lecciones y Desafios del Sistema de Pensiones About Old Age Security,The World Bank Administrado por El Sector Privado: CEPAL Serie, InternationalMonetaryFund,"Chile:Selected Issues2005:'IMF Financiamiento del Desarrollo, No. 105, Santiago country report 05/316,Washington DC, Bachelet, M. (2005) "Estoy Contigo: Programa de Gobierno, Medrano (2004), Participaci6n en el Sistema AFP: De que 2006-2010 Depende?,Presentation at Workshop Hosted by SAFP and Barr and Diamond(2006),"The Economicsof Pensions:'Oxford CEP, "Cobertura y Competencia en el Sistema de Pensiones Review of Economic Policy, 22/1, (forthcoming) [not for AFP"November 11and 122004, Santiago. quotation and subject to change, until published in February Packard, Truman (2002), "Pooling, Saving and Prevention: 20061 Mitigating Old Age Poverty in Chile:' World Bank Policy Barr, Abigail &Truman Packard, (2002),"Revealed Preference ResearchWorking Paper,Washington,DC and Self Insurance:Can we Learn From the Self Employed in --.(2001),"lsThere a PositiveIncentive Effect from Privatizing Chile?: World Bank Policy Research Working Paper, Social Security? Evidence from Pension Reforms in Latin --. Washington, DC America:' World Bank Policy Research Working Paper, (20001, "Revealed and Concealed Preferences and Self Washington,DC Insurance: Can we Learn from the Self Employed in Chile" Rocha, Roberto,et a1,(2005),"Annuities market inChile:A Case Oxford University, Department of Economics Discussion Study:World Bank,Washington D.C. Paper Series No.53 Rofman, Rafael (2005) "Social Security Coverage in Latin Barr, A. & Packard, T. (2000), "Revealed and Concealed America" Social Protection Discussion Paper No. 0523, World Preferences and Self Insurance:Can we Learn from the Self Bank,Washington DC Employed in Chile?: Oxford University, Departamento de Torch, A. and Wagner, G. (1997)"Prevensi6n Social:Valoraci6n Ciencias Econbmicas, Documento de Discusidn Serie Series Individual de un Beneficio Mandatado:' Cuaderno de No.53. Economia34 (103) :363 - 390. Barr, Nicolas (20041, The Economics of the Welfare State, 4th Valdes, Salvador, (2005)"ParaAumentar la Competencia entre Edition,Oxford University Press las AFP: Estudios Publicos, 98, Centro de Estudios Publicos, (2001), The Welfare Stare as Piggy Bank ,Oxford University Santiago Press ---.(2002) "Social Security Coverage In Chile, 1990-2001:' Benartzi, Shlomo and Richard H. Thaler (2004) "Save More Background Paper for Regional Study on Social Security Tomorrow: Using BehavioralEconomicsToIncreaseEmployee Reform, Ofke of the Chief Economist, Latin America and Saving"Journa1 of Political Economy (US.); 112, No. 1, Part 2, Caribbean RegionalOffice,World Bank Supplement:S164-5187, February World Bank (ZOOO), "Pension Reform Primer: Annuities: Berstein, S. Y Tokman, A. (2005), "Brechas de ingreso entre RegulatingWithdrawals from Individual PensionAccounts:' gheros: LPerpetuadas o exacerbadas en la vejez?, World Bank (2004) Financial Sector Assessment Chiie, Latin Superintendencia de Administradoras de Fondos de America and Caribbean RegionVice Presidencyand Financial Pensiones, Serie de Documentos deTrabajo No8. Sector Vice Presidency, Based on Joint IMF-WorldBank FSAP Berstein, Solange, Guillermo Larrain, and Francisco Pino Report (2005) "Chilean Pension Reform: Coverage Facts and ---.(ZOOO), "Pension Reform Primer: Annuities: Regulating Prospects"paper presented at 10th LACEAConference, Paris Withdrawals from Individual PensionAccounts" Beyer, Harald and Salvador Valdes (2004) "Propuestas para aumentar la densidad de cotizaciones" mimeo, presented at the seminar"Competencia y Cobertura"hosted the by Centro de Estudios Publicos (CEP) and the Superintendency of the AFP system (SAFP),11-12 November, Santiago 34 Gill, lndermit, Truman Packard and Juan Yermo (2004) Keeping the Promise of Social Security in Latin America, PHoelai lctyh Note 4:Reform I m p l e m e n t a t i o n ' S u m m a r y In 2004 and 2005, Chile introduced a significant structural reform in the country's health system. This was a third generation of reforms, the most extensive and complex one since the creation of the National Health Service in 1952, its subsequent reform, and the creation of the National Health Fund IFONASA)and the Private Health Insurance Institutions (ISAPREs) in 1982. The reforms have the potential to improve equity, to strengthen citizen empowerment in the health system, as well as to provide better financial protection against catastrophic health shocks. In addition, the reforms substantially modify the framework of incentives geared towards improving efficiency in the health system as a whole. The new Government will face very important challenges in the implementation of the reform to ensure it fully realizes its potential - this Note outlines such challenges ahead. .......,.............~....I..............................~.,...............*.....................*..*....~~..........*....................................... 35 1. The preparation of this PolicyNote was lead by CristianBaeza (Lead Health PolicySpecialist,WorldBank). ............................................................................ Introduction towards improvingefficiency inthe health system as awhole. The new Government of President Bachelet will face challenges in ensuring that these reforms realize their full Over the last 15 years,Chile has made notable gains in health potential. indicators, including a 50% reduction of child mortality, increasing life expectancy to 78 years, and extending health We consider that the following challengescould have critical insurancecoverageto over 90% of the population. impacts on the implementation of the reform: (i) the risks of non-compliance with the explicit guarantees of the AUGE However, notwithstanding such important achievements, (Acceso Universal para prestaciones integrales y Garantias effectiveaccessto healthcareservices,insurance,and financial Explicitas asociadas a la atencidn de prioridades - Universal protection was not fully satisfactory. Chilean households Access for Comprehensive Benefits and Explicit Guarantees reported that the diseases that require costly treatments, as Associated with SelectedPriorities)system;(ii) the framework well as expenditures induced by such treatments, were the of incentives of AUGE implementation in the public sector second most important cause of "shock to the household, and the implicit fiscal risks; (iii) the Inter-ISAPREs very close to unemployment,which was reported as the first Compensation Fund and its low level of effectiveness to cause (PRIES0 2000). Additionally, recent data (Baeza and resolve risk and income segmentation; (iv) the challenges in Packard, 2006) show that health-related expenses have the regulatory schemes to ensure compliance with the significantly contributed to the impoverishment of Chilean Guarantees of the AUGE system and the potential failures in househo1ds:Morethan 1% of the country's overall population the governance design of this system; and, (v) the need to and morethan 5% of the total population inthe third quintile establishmechanismsto monitor and evaluatethe impacts of became poor in 2000 as a result of health-related out-of- the reform. pocket expenses (Figure 2). Most of these households are beneficiaries of the Private Health Insurance Institutions The context in which the reform takes place is characterized (ISAPREs-PrivateHealth Insurance). by two factors. First, the reforms are very recent and, to a certain degree (for example, the rules and regulatory In 2004 and 2005, Chile introduced a significant structural framework), are still evolving. Therefore, it is not possible to reform of the country's health system. This is a third evaluatetheir impact as of yet. Second,the reforms are highly generation of reforms, the most extensive and complex one innovative and advanced so that international experience since the creation of the National Health Service in 1952, its can be drawn on only to a limited extent in guiding reform subsequent reform, and the creation of the National Health implementation. The analyses and arguments presented in Fund (FONASA)and the Private Health Insuranceinstitutions this Note are, hence,of a more indicative nature. (ISAPREs)in 1982. The reforms have the potential to improve equity, strengthen citizen empowerment in the health This Note is structured in three sections, including the system, as well as to provide better financial protection introduction. The second section analyzes the five potential against catastrophic health shocks. In addition, the reforms short and medium term challenges.Thelast section presents substantially modify the framework of incentives geared a short summary of the challenges and possible policy ............................................................................................................................................ ............................................................... ....................... ..................................................................................... 36 Source:Ministryof Health 0 InfantMortality ....................................... Source:BaezaandPackard(2005). actions to addresssuchchallenges in the short and medium waiting time for patients, the quality of services, and term. In addition, an Annex is included with general maximumfinancialcontributionsof households.Thismarksa information regarding the framework of the reform,and its radical departure from the sector's historical tradition, objectives, includinga briefanalysisof the specific aspectsof particularlyin the public sub-sector,which used to transfer the four main laws relatedto the reform. resourcesto the factors of production (salaries,infrastructure and equipment and inputs) without a link to the actual production of services.The implementation of AUGE now ............................................................................compliance) II. Reform Implementation Challenges requires that FONASA (as the agency legally responsible for pay public health care providers for actually This section analyzes the five short and medium term provided services to FONASA beneficiaries- with quality of challengesdescribedabove.Confrontingsuchchallengeswill services assessed through compliance with the AUGE be essentialto meetthe objectivesof the reform. guarantees.This requires paymentsto providersto be based on actual billing of services, including the identification of . (i) Risks of non-compliancewith AUGE guarantees. The beneficiaries (the so-called "rufification"2, and the recording new framework of incentives generated by the of quality standards (e.g., waiting time). Under these new implementation of the explicit guarantees law (Ley AUGE) conditions,efficiencygainswill beessentialto ensurethat the could lead to significant gains in empowerment of the system adjusts the delivery of non-AUGE services on a population in the health system, improve access to services, productivity basis. and providebetterfinancialprotection.At the same time, the implementationof the healthguaranteesscheme could also Althoughthe AUGE law includesarrangementsto reducethe lead to significant efficiency improvements in the fiscal risk (forexample,indexingthe size of the AUGE planto management of the public health sector and improved the actual growth of salaries in the country and not to accountabilityof the health system to society. However, the increases in health expenses), the introduction of explicit, implementation of the system of guarantees also entails legally-enforceableguarantees- in combinationwith greater important fiscal and governance risks, which will require autonomy of public hospitals to manage their budgets - mitigation during implementation. entails financial risks. In addition, the introduction of the AUGE plan has potential effects on the behavior of public The introduction of the AUGE planimposesrequirementson providers, particularly in the production of non-AUGE all stakeholders in the health system but particularlyon the services. These risks will need to be mitigated in order to relation between FONASA and public health care providers. reduce the fiscal and service provision risks for FONASA's The level of compliance with these requirements by the beneficiarypopulation. public health sector will define the success or failure of the reformand its fiscal impact. We estimate that there is a significantriskof non-compliance The AUGE reform specifies conditions regarding maximum of the AUGE guarantees in the public sub-sector, at least ............................................................................................................................................................. 37 2. Translator'sNote:term derivedfrom the Spanishacronym"RUT:which standsforTax RegistrationNumber. during 2005,2006 and 2007.This riskstemsfrom the, to date, the admission of patientsto AUGE and compliancewith the under-developedmonitoring and control arrangements of guaranteesisfully dependenton the informationfed intothe theAUGE system aswell as from the currentlylowcapacityto system by the public or private providersthemselves. The estimate unmetdemand gaps, costsand prices in the public issue is particularly complex in the public sub-sector since, sub-sector. although proof of admission is given to the AUGE patient when he/she enters the system, it is the public providers A scenario of non-compliance of the guarantees would themselves who 'start the clock' that determine the essentiallyimplythe failureofthe coreelementofthe reform. maximum waiting time for patients. Given that providers To avoidsuchscenario,it would becrucial for FONASA- asthe haveaninherentinterestin meetingtheguaranteesspecified agency legally responsiblefor enforcingthe guarantees- and (as otherwise FONASA would have to purchase the service the Health Superintendence to command adequate from another provider), independent monitoring would be information to monitor compliance with the AUGE necessary. Currently,the waiting time guarantee might not guarantees.Monitoring these guarantees is difficult and will befulfilled as currentlyassessed- but FONASAdoes not have require highly complex information and guarantee the information that it would need to detect such non- managementsystems. At thewriting of this Note (beginning complianceand take the necessaryactions to resolvethem. 2006), we judge the existing information system not yet capableoffulfilling such complex monitoring function. Onereportingmechanismthat couldfulfill suchindependent monitoring could build on social control by FONASA and Table 1 summarizes information about individuals who ISAPREs beneficiaries. This would require that beneficiaries enteredthe AUGE system betweenJuly and November2005 entering the AUGE system would be fully informed of their under any of the 26 pathologies covered. Considering that rights and file claims if non-compliance occurs. Currently, the AUGE plan only became legally mandatory on July 1, patientsrarely make claimsfor non-compliancein the public 2005, the volumes of individuals entered in the system are sub-sector. However, information collected from recent very significant. surveys (bythe Health Superintendence)suggests that only 40%of the AUGE beneficiariesin the publicsystemare aware Although the officially reported data regarding access to of the fact that they have entered the system. An even healthservices are impressive,it appears as if FONASA or the smaller percentage knows about the specific enforceable Superintendence do not have sufficiently detailed and guaranteesand their option to file claims if such guarantees reliable information related to the compliance with the are not fulfilled. As people'sawareness increases, the sector guarantees (access, timeliness, financial protection and will potentially face more claims for non-compliance, quality of the services). Importantly,the system to monitor includingthrough the Courtsof Justice. All health issuesof the GES System Individualsawaitingflatconsultation . * * 32,219 . % Individualswithclosedcases Closedduetocompletionof treatmentandother causes 57,070 Discarded 262 duals 1,000,02 Source:SIGGES, F O N M While requiring the same degree of complexity, monitoring bemitigated.Monitoringproviders'behaviorregardingthese compliance in the ISAPRE system (by the Health three possible strategiesof response to the implementation Superintendence)will likely be easier and faster. Individual of the AUGE would be important. The system (Health Outifiedl service information systems are already in place. Ministry, Health Superintendence and FONASA) currently Further, the system to enter the AUGE guarantees in the lacks a monitoring or information system to evaluate the ISAPREs is highly regulated and requires immediate behavior of the public providers,both regardingcompliance notification of the patient that he/she is eligible for AUGE with the AUGE guarantee and the behavior of non-AUGE under the preferredhealthcare providersystem.Additionally services. The anecdotic information collected by the Bank and probably as a result of the above, 98% of the AUGE team in the field suggests that public providers are patients in ISAPREs are aware that they have entered the responding with all three alternatives simultaneously, system and know their rights and obligations. Further, the depending on the type of AUGE pathology and the type of health Superintendence has a wider array (and proven provider. application) of regulation and sanction instruments than FONASA. While the 'culture of regulation' is well probed Eachoneofthe possibleresponsesbypublic providersto the within the private sub-sector,it is rather new for the public introduction of the AUGE creates a scenario with specific sub-sector - and governance asymmetries (analyzed below) challenges: could lead such disparities to continue inthefuture. (1) Expected compliance scenario. The potential fiscal risk The needsto monitorcompliancewith guarantees,as well as attached to the expected compliance scenario derives from payment transfers to providers, highlight the importanceof the size of the AUGE plan at each stage of its expansion. In implementingan effective informationsystemfor AUGEboth turn, said size and its accurate definition depend on the in FONOSA and the Superintendence.Said system should be ability of the public sub-sector to estimate the expected based on the "rutification"of the billing of the AUGE services demand of services for the pathologies/treatmentstherein within the public sub-sector. In order to be effective, the included (including the incidence and the accumulated system should be tamper-proof, build on an automatic unmet demand gap) and on the accuracy to estimate the trigger to monitor guarantees for eligible beneficiaries, an appropriateprices to be paidfor the services (suchas not to automatic notification of rights for each patient (including generate excessive profits or losses for the providers). The proceduresto file claims).The system should also have the approved law contains an arrangement indexing the future ability to follow-up expenses linked to the health size of the AUGE planto the actual growth of salaries inChile. consultation for every household, whether through co- This is potentially a very good mechanism to mitigate the payment or other expenses. Start-up of such system is immediatefiscal risk inthisscenario,since itmakesthe size of important given that the AUGE law is effective since July 1, the plan grow at a slower rate than the historical (and 2005, andthat,theoretically,since then guaranteeshavebeen probable future) growth of health-related public legallyenforceable. The lackof reliable informationrelatedto expenditures, reducing its relative size through time. compliance with the guaranteesystem also seems to hinder However,the publicsector(FONASA)still lacksa goodcosting compliancewith the legal mandateof the Superintendence. system to support the definition of adequate prices. Such costing system is importantwhen the actualgrowth spaceof (ii)The frameworkof incentives of AUGE implementation the AUGE planis estimated (interms of quantity production), in the public sector:the implementationchallenge. From givenincreases in salaries.Overestimating such priceswould our perspective, public providers have at least three options lead to an underestimation of the AUGE growth space. An to respondto the tension introducedbythe AUGE plan:(l) in underestimation, on the other hand, could lead to an the expected compliance scenario, AUGE services are excessive growth of the AUGE plan (in terms of production produced with resources channeled through the system quantities)and to a potentialdeficit for the public providers without altering the productionof non-AUGEservices; (2) in which could lead to the scenarios discussed below or to a the non-AUGE adjustment scenario, AUGE services are situation in which the public treasury would have to step in. produced under the required conditions but this is only Such lack of a reliablecost informationin FONASA,as well as possible by diverting resources from the productionof non- the currently missing, individualized (rutified) payment AUGE services; (3) in the privatereferralscenario, compliance system of public providers' services, increase the fiscal risk. with the guarantees is achieved by FONASA through Consequently,it would bean important priorityfor the public contracting of private providers. All these three scenarios sub-sector to implement a reliable patient identification 39 entailfinancial and potentiallyfiscal risksthat would needto system for billing FONASAanda costingsystem. (2) Non-AUGE adjustment scenario. Public providers may management regulation in the public health sector. The respond to the tension that compliance with the current regulation appears to be inflexible as compared to requirements of the AUGE plan generates (particularly if the need for continuous and flexible adjustment of the there is a perceptionthat the AUGE pricesare not sufficient to purchase indicators of AUGE and non-AUGE services.This is meet their fixed-cost structure for the AUGE services). Such particularly important with regard to the introduction of responsecouldconsistof diverting resourcesfrom non-AUGE productivity incentives for individual staff and in the hiring activities to compliance with AUGE requirements.Most of the and compensation schemes. The challenges posed by interviewed managers of public health providers think that scenario (2), and by the reform as a whole, call for a this phenomenon is increasingly taking place since the reassessment of the administrative and human resources formal start-up of AUGE in July 2005. The main risk of this managementregulationinthe public health sector.While the scenario is not fiscal, at least not at the beginning, but rather establishment of hospital self-management introduced by related to the provision of health services to the population. the Health Authority Law provides a broader margin for Providers could resolve this problem spontaneously by action, it is not clear if such change is sufficient to resolve this increasing their productivity so that the resources paid challenge. through the AUGE system are sufficient to deliver health services - then, a diversion of resources from non-AUGE (3) Private referfa/ scenario. Under this scenario, the public services would not be necessary. providers cannot meet the AUGE demand, either due to lack of qualified supply or the decision of not meeting such Inthe absenceof a spontaneous increasein productivityand demand in the specified time. In this scenario, the biggest in the presence of a diversion of non-AUGE resources, it will potential challenge is fiscal. Given FONASA's legal be necessaryfor FONASA to respond rapidly by converting a responsibility,ifcompliance with the guarantee is threatened majority of non-AUGE services into valued services due to lack of supply, FONASA would have to purchase the (Prestaciones valoradas). Such valued services would have service from another public or private institution or, failing conditions similar to the AUGE services attached but without that, the Superintendence is under the legal obligation to a maximum waiting time or a maximum financial activate the third-party provider mechanism. This could lead contribution by the households. Additionally, the Health to deficits for public providers (asthey would not be paid but Under-Secretariatfor Networks would need to establish a maintain their cost structure constant) which would need to very close monitoring and evaluation of the productivity of be covered bythe public treasury. publicproviders.These two actions are recommendedbefore responding to the potential deficit of public providers with Besides the discussion in the scenario of non-compliance an increase of FONASAs public expenditure that would with the guarantees analyzed above (in which the system finance additional non-AUGE services. As mentioned above, realizes that it is failing to comply), non compliance with the the public sub-sector in general, and FONASA in particular, guarantee up to the level of activating a third provider have experienced difficulties in implementing a system of (particularly private) will require resolving at least two rutified health services in the past albeit this has been potential problems: the incentives for highly specialized required since the 1999 FONASA Law. A diversion of doctors and the actual ability of the Superintendence to resources from non-AUGE to AUGE services - with a implement a third provider system for FONASA's concomitant reduction in the production of non-AUGE beneficiaries. servicesfor the population at large -- couldwell entail afiscal risk as public pressurescould mount to increase resourcesfor The first potential problem is the incentive that highly non-AUGE services (AUGE services only accounted for 15 specialized(andscarce)doctors mayhavefor notfulfillingthe percent of FONASAs total expenditure in 2006). And such guarantees in public hospitals which would trigger the increasecould not be informed byavaluation and indexation activation of third-party providers - in which potentially the mechanism(asexistsfor AUGE services). very samedoctor would resolvethe pathology (oreven inthe same hospital but through a parallel private contract). This A particularly complex challenge in this scenario is the would not necessarilybe a problem if (i)the time periods and management of the fixed-cost structure of public providers. guarantees are met for the patient; and (ii) the doctor is not How easy, or difficult, would it be for managers of public receiving a fixed income (salary) in the hospital and, in providers to increase productivity as a response to the new addition, avariable income ifshe/he is the third provider.This 40 framework of incentives? At the core of the answer to this potential problem stresses once again the need to closely question lies the administrative and human resources monitor medical productivity in the system and the need for the administration to review the productivity incentives in risks and the lowest incomes. If the policy objective were, the compensation arrangements for public healthcare however, to achieve a better risk distribution, it would be workers. necessaryto introducechangesin the incentives and reduce the opportunities for migration between the ISAPREs and The second potential problem is related to the Health FONASA. Alternatively,the Inter-ISAPREscompensation fund Superintendence'sabilityto ensurethe availabilityof a third- could be expanded to include FONASA. In addition, the party provider for ISAPREs' beneficiaries and for FONASA's policy establishing the portable nature of public subsidies beneficiaries if guarantees are not met. Although the could be reviewed in the context of the creation of a approved legalframework providesfor the Superintendence FONASA-ISAPREs Fund. to instruct the transfer of beneficiaries to a third-party providerif non-complianceoccurs,it is not clear whetherthe Sincethe AUGE pilot was launchedin2004,the ISAPREshave Superintendencealso has the power to compel the ISAPREs lost a significant share of its members to FONASA. Two and/or FONASA to incur the expense that ensures payment possible causes for such migration of beneficiaries exist: to the third-partyprovider.Ifthis power is indeeddebatable, quality and/or price differentials. It is possible, though not the new authorities would need to find administrative very likely,for a quality differentialto appear in such a short mechanismsto ensure paymentto third-party providers if so period of time. It is more likely that the most important determinedby the Superintendence.Otherwisetherewould determiningfactor is the perceived price.There are at least be little interest on the partof potentialthird-party providers three potential effects that explain the fact that the to enter the system. This, in turn, could undermine the perceived price of FONASA is better than of the ISAPREs. capacity of the Superintendenceto enforce compliance with First, the loading effect of the ISAPREs might significantly the guarantees. affect their prices, regardlessof the technical cost of service provision.Second, the price differential could be explained (iii) The low effectiveness of the Inter-ISAPREs by the fact that FONASA has access to high-complexityand Compensation Fund to resolve the problem of risk and low price providers (public hospitals)to which ISAPREs do income segmentation in the health system. It is likelythat not have access.Third, the price differentialcould also stem the existing Inter-ISAPREsCompensation Fund would not from the existence of fiscal subsidies to FONASA "D" resolvethe riskof incomesegmentationof theChileanhealth beneficiaries.The latter two alternatives open complex insurance system. Additionally, although the reforms of the debates, which could alter the unstable balance that the regulatoryframework substantially reduce the incentives to sector has achieved regarding the population of riskselectionandrisk-dumpingfrom the ISAPREs to FONASA, beneficiaries bysub-sector. Itwould be usefulto updatethe these changes are insufficient to resolve the segmentation studies on the funding sources and the self-funding of problem.Althoughwell designed,the regulatorychangeswill FONASA's"B", "C", and " D beneficiaries. Such information is needto be accompanied byappropriatefinancialincentives. important both for an eventual reassessment of an Consequently,in order to resolvethe segmentationproblem extension of the Compensation Fundto include FONASA as comprehensively,the new governmentmight need to revisit well as for an evaluation of the reasons why beneficiaries the original ideaof creating ajoint redistributionfund,which migratefrom ISAPREs to FONASA. includesboth FONASA and the ISAPREs. (iv) The challenges of the regulatory arrangements to Apart from the incentives for market segmentation ensure compliance with the Guarantees of the AUGE (characteristic for private insurance in a competitive system and the potential flaws in the system's environment), the framework of incentives in the Chilean governance. Symmetry in the regulation' (and control) of insurance system causes high-risk and low-income insurersand public and privateproviders would significantly households to be concentrated in FONASA. This situation contribute to the effectiveness of the incentives for could or could not be problem, depending on the policy for compliancewith the AUGE guaranteesinthesystem. Further, fiscal subsidy allocation. That is, if the policy defines that such symmetry would further empower the beneficiary public subsidies are not portable and that to be granted a population to protect their rights.The current governance subsidy a family has to be affiliated with FONASA, then arrangementsfor the Health Superintendence and FONASA invariably FONASAwill concentrate the greatest share of the may becomean obstaclefor such regulatorysymmetry. ............................................................................................................................................................. 41 3. 'Symmetry' is usedhereinthe sense that the same consumer protection regulatorystandardsare applied to both public and private insurersand providers. The approved legal framework provides the Health reliableand effective monitoringsystem isa keyingredientto Superintendence with the mandate to regulate, under an ensure (i)a successful implementationof the AUGE reform;(ii) equivalent regulatoryframework, the ISAPREs and FONASA compliancewith theguarantees;and (iii)successfulmitigation as well as the public and private providers. In order to meet of politicaland fiscal risks that the reform may entail. Such a this objective,at least two conditionsare necessary.The first monitoring and evaluation system is also important to one is that the regulatoryframework has to be the same (or evaluate if the AUGE reform has Been successful with regard at least equivalent)for all actors involved.Thesecond one is to its final impact on outcomes - or whether the reform that the HealthSuperintendencehas the determinationand requiresadjustments.Currently,there is a needto definesuch authority to exercise its regulatory duty: to control a monitoring and impact evaluation strategy and design the compliance and to sanction non-compliancein accordance information and survey systems that may render such with the law. monitoringand evaluationfeasible inthe near term. Defining said strategy and a monitoringand impactevaluation system Thereare limitationsto the powersofthe Superintendenceto would be an important priorityfor the new authorities. sanction FONASA, which could limit the real ability of the Superintendence to enforce the AUGE guarantees. An As discussedin the previous sections,the reforms introduced exampleofthe aboveisthat the legislationseemsto limit the in 2004 and 2005 have the potential to achieve the possible sanctions to FONASA only to the institution of government's four formulated priorityobjectives. The reform administrative investigation proceedings (sumarios is rolled out gradually (to hedge against the institutional, administrativos) against the entity's Director in case of non- financial and fiscal risks discussed above1 and AUGE compliance.Applying this type of sanctionmay be excessive expendituregrowth limitedto the actualgrowth of salaries.In in cases of minor non-compliancebut it may be insufficient practice, this will likely imply a reduction of its relative for cases of major non-compliance. In contrast, the importanceinthe nextyears (asa shareof all expendituresfor Superintendence has a relatively broad range of sanctions health services)since overall health expenditures(fiscal and that it may impose on the ISAPREs in cases of non- private) have grown (and will probably continue to grow) compliance. Such sanctionsvary from warnings and fines to beyond the actual growth of salaries. Hence, it might be the cancellationof the licenseto providehealthservices. necessary to expand the AUGE plan beyond the growth of salaries. In this scenario, AUGEs impact evaluationcould not Additionally, the hierarchicaland intragovernmentalrelations only assume a technical role to inform policy but could also that characterizethe relationshipbetween FONASA and the provide important data for the political debate when such Superintendence could hinder applying the regulatorylegal expansionis discussed. obligation of the Superintendence and prevent regulatory equity within the system. It is not apparent whether the There are four additional core elements that would help Superintendence would use the sanction mechanism assess whether the reform is successful - beyond its established in the law as the Superintendent is part of the importancefor healthserviceusefor thecoveredpathologies: same politicaVadministrative governance framework as (i) population empowerment, expressed, for example, as FONASA's Director. In addition, the, mechanism for the compliance with the waiting time and co-payment appointment of the senior authorities of both entities can guaranteesin both sub-sectors,as well as effectivenessof the lead to a lower political status for the management of the claim resolutionprocess in the case of non-compliancewith Superintendence. The Health Superintendent is an official the guarantees; (ii)financial protection for the households appointedbythe Presidentofthe Republicbasedon a senior guaranteed byAUGE (topreventsuch householdsfromfalling management public competition, whereas FONASA's into poverty as a result of health shocks); (iii)system equity Director is a public official that enjoys the President's improvements; and (iv) system efficiency improvements, confidence, appointed without a competition. The new includingthe productionof healthservicesandthe reduction administrationmight want to closely monitor this relationin of income and risk segmentation in the insurance system. order to ensureequity and effectivenessin the applicationof These and otherelementscouldonlybeverifiedto the extent the regulatory framework and in the protection of the that the sector and the government implement an impact citizens. evaluationsystemof theAUGE reform.Itis our understanding that a detaileddesignoftheevaluationstrategiesandsystems (v)The challenge of establishingmechanisms to monitor is stillpending.Saidstrategycouldbebasedon a combination 42 and evaluatethe impactsofthe reform. Itfollowsfrom the of informationfrom theAUGE informationsystem in FONASA, challenges outlined above that that the functioning of a the ISAPREs and the Superintendence, as well as on panel- type household surveys. Regardless of the final design, it Spanish Acceso Universalcon Garantias Explicitas - AUGE)for would be important to design and implement the indicator the whole population, regardless of their health insurance baselinestudybeforethe effectsofthe AUGE implementation status. This package is mandatory and represents the render such data collectiona difficulttask. minimum level of insurance, both for the National Health Fund (FONASA) and the Private Health Insurance Giventhe incentivesandthespecificmissionofthe Ministryof Institutions (ISAPREs); (ii) Health Authority Law, which Health,with special focus on AUGEs health'impactand health introduces reforms that strengthen and make the health- service provision,it could be usefulfor MIDEPLAN(Ministryof related regulatory capacity of the State more efficient, as PlanningandCooperation)tosupportMINSAL(theMinistryof well as reforms which grant autonomy to all the public Health) in the monitoring and evaluation of the financial hospitals under the system's two highest levels of protectionimpact.MIDEPLANhas expertisein evaluating the complexity; (iii) "short"and "long"laws of the /SAPRES (Ley impact of public policies on poverty, something that could Cortaand Ley Larga),which introduce improvementsto the provevery usefulto MINSAL. regulatoryframeworkof privatehealth insurance, including the creation of a risk compensation fund among the ISAPREs. Ill. Summary of challenges and possible ............................................................................There actions t o address them are two additional elements that are useful to place the 2004-2005 reforms into context: First, the decision to The discussion of the challenges in the previous section advance with the global reform of the entire system but, shows that there are common underlying factors for the simultaneously, the decisionto implement such reform in a different risks and problems that the new administration gradualmanner.Thus,the approvedlaws includethe details might need to address in order to ensure the success of the of the final design of the system in each of the areas, but AUGE reform.Table 2 contains a summary of such risks and also define time-bound milestones to be completed over problems,as well as the possiblestrategiesto address them. periodsof 1 to 5 years.Second, the reform has to be seen in connection with the long-standing process of administrative and operational changes which were Annex implemented, either de facto or de jure, since 1990. This General Framework o f t h e Health System process included, inter alia, the implementation of several ............................................................................ Reform and its Objectives amendments to the regulatory framework of the ISAPREs and the FONASA law in 1999 (which have been (a) Reform Objectives. The policy documents that consolidatedbythe recentlyapprovedlaws). It is necessary support the reform point to four specific objectives to take these two elements into account when considering derived from the diagnosis of the health sector's priority the relatively short time-period (1 to 5 years) with which problems identified since the end of the 1980s and mid Chile is planning to complete the recently approved 1990s: (i) improving households' security by protecting reforms, which are highly complex from both a technical their health; improving their access to Chile's priority and policy point of view. health services; protecting them from the impoverishing effects that may be caused by diseases; (ii)empowering The potential contributions of the laws are the following: households and improving consumers' protection in relation to the health system through enforceable explicit (i) Explicit Guarantees Law. This law provides the core guarantees; designing instruments that allow the element of the reform; i.e., offering citizens a guaranteed population to demand compliance of such guarantees; universalprotection(ina period of 3 years) based on at least designinga regulatoryframeworkand systemthat ensures 56priority healthconditions,the timely solutionor treatment compliance by insurers and private and public providers; which is guaranteed and regulated, including financial (iii) improving the system's equity; and (iv) improving the contribution caps per household, maximum waiting times, system's efficiency. clinical guides and quality guarantee standards. The guaranteed universal protection will be implemented (b) The Reforms. The recently approved reforms are gradually over time by increasing the conditions to be containedina packageoffour lawswhich include:(i)Explicit guaranteed under the AUGE plan.An ad-hoc procedure has Guarantees Law which introduces a guaranteed insurance beencreatedto review,every3 years, the numberandtype of 43 benefit plan (Universal Access with Explicit Guarantees,in health conditions to be included in the AUGE plan as from Non-compliance lnabiliorperverseincentives Implementationofatamperw8timetyand Standarbkatkmofthesystemtomitor withguarantees I3insurersorprovldeninthe eftiaentinformationsystemtomonitorcompliance compliancewiththeguaranteesbothfor implementationofthesystem dththe-guaranteesrelatedtoaccess,tlme!iness, ~, FONASAandISAPRESusers. 'quatityandfinanadproteaion. TheSupaintendenceshouldhaweasyand promptaccess(onlie)totheinformation. Strengtheningsoda1monitoringandcontrdof The'dock'control forthe timelines-related guarantees guaranteeshwldbeautomatkorextemaltothe providdmnrrers. Massinforinationandeducationcampaign targetingthepopulationtoraiseawarenesson 'rights,claimmechanismsandneedtomakeuse ofsuchmechanisms. , I (a)Doesthereformimproveaccess and/ortechnicaldecis (b)Doesitimprovefinancial preventfromimpoverishme Ladtofregulatory Possibleasymmetryinsystem's Reviewingtherqulato~,contrdandsanction Reviewingthecontrolrelationofthe effectiverenand governanceregardingthe powersoftheHealthSuperintendenceover Superintendenceover FONASAandeventual claimmechanisms SuperintendmeFONASA FONASA increaseoftherangeof regulatoryandcontrol rebtbn. instruments EffectsoftheAUGE Productivitymonitoringa mechanismsfornon-AUG uedservicesbyFONASA Productivitymonitoring,pa istrationandmanagemen specializedmedial hu thepublichealthsector, 2006onwards.Thisprocess,lead by the Ministryof Health,will pathologies and treatments included in such package alsobe supported bythe AUGE National ConsultativeCouncil constitutethe minimum benefits that must be offered by any (CCNA), a recently created entity that performsaconsultative public or private health insurance. The initial number of role. pathologies/treatments, with which the system formally and legally started in July 2005, amounted to 26.The definition of 44 TheAUGE law requires FONASAand the ISAPREsto providea the number of pathologies/treatments that will be annually package of benefits (the AUGE Plan).The list of approved included is defined by the government at the proposal of the Ministry of Health, advised by the CCNA and based on that they did cover but without the maximumcontribution financial studies derived from the actual growth of salaries caps per household establishedbythe AUGE plan. and the cost of the servicesto be included.This reformdoes not introduce substantial modifications to the financing of (ii) Health Authority law. The Health Authority Law the healthcare insurance by workers, which amounts to a introduces very important structural and organizational minimum7% of workers' salary. transformations in the public system. It separates the health authority (regulationand stewardship role)from the role of The AUGE legal reform has the potential to contribute to management of the public service provision network, thus meetingthe four essentialobjectivesof the reform. First,the separating the role that is more inherent to the state from introduction of explicit guarantees, essentially focused on that which is more circumstantial or better explained by lowfrequency and highcost pathologies/treatments,hasthe custom and practice.The health authority is located in each potential to significantly improve households' financial region, in the Health Regional Ministerial Secretariat protection,a problemthat has been identifiedas the second (SEREMI), something which is fully consistent with the most important cause of economic shock to Chileanfamilies regionalized country structure. The Health Services have (PRIES0 2000). Additionally, the 56 pathologies initially maintainedtheir number andstructureandaregetting ready identifiedas a goalofAUGE implementation,accountfor 60% to lead the public provision of services in their respective of the burdenof diseasein Chile (althoughonlyafractionwill territories. Self-managed hospitals are created; that is, be alleviated by the health interventions themselves given hospitals that are givenadministrativepowersto manageall the current knowledge of the science in curing such the resources and budget. Hospitals that have the two pathologies). The rest will require effective disease highest levelsof complexityin the public system (typeIand preventionand healthpromotionpolicies. II)shall beunder suchself-managementsystem by2008. Second,the AUGE plan-includingall itsguarantees-is legally The reform thus separates the stewardship and regulation enforceable by the beneficiaries vis-&vis FONASA and the rolefrom the provisionroleanddeterminestheframework of ISAPREs. The legal and regulatory framework establishes incentives for the health authority (Ministry of Health) to claimand claim-resolutionmechanisms,with the potentialto exercise control over the entire sector, both public and provide effective empowerment instruments to the private.Consistent with this and regardingthe stewardship population. and regulation role, two Health Under-secretariats (vice- ministers) assume functions (one newly created):the Public Third, it contributes to further improving equity in the Health Under-secretariat (for stewardship) and the Under- Chilean healthsystem,which hassubstantiallyimproveddue secretariatof Networks(for public services provision).Also, a to the fiscal effort in health-relatedpublicexpenditureof the Health Superintendencewas createdwith two Intendancies, successive governments since 1990 (fiscal expenditure has one for healthinsurance(ISAPREs and FONASA)and another more than doubled since 1990).The explicit guarantees one for providers (public and private). This new (relatedto maximum waiting times and contribution caps) Superintendence replaced the ISAPREs Superintendence. attempt to correct for equity and consumer protection The mission of the Superintendence is to oversee FONASA problems in FONASA and the ISAPREs, respectively. and the ISAPREs, as well as to regulate public and private providers under the same regulatoryframework(with regard Finally, the introduction of the AUGE plan significantly to AUGE). changes the framework of incentives bothfor the publicand private sub-sectors.In the public sub-sector, the guarantees These reforms are additional to the reform introduced in will cause providers to be reimbursed according to their FONASA in 1999, which entrusted FONASA with health productionof actually renderedservices, likelyaccelerating a service purchasing and financing. However, both the transition from a historical supply-side financing towards implementationof the regulation of the 1999 FONASA law financing mechanisms based on "financing that meets (still pending) and the provisions that maintain part of the people's needs." This has been a particularly difficult procurement power on the health services through Decree transition to implement in the Chilean case. In the private (DFL) 36, show that the separation of the procurementand sub-sector, the guarantees will force the design and provision role has not been entirely resolved. The new implementationof a healthcare model that contains costs - framework makes FONASA legally responsible for ensuring private providers will be forced to also cover compliancewith the AUGE guaranteesto its beneficiaries. 45 pathologies/treatmentsthat were not previously covered or The healthauthority law is, together with the AUGE law, the References most important driving force of the reform. It has the ............................................................................. potential to contribute to the objectives of consumer Baeza c. and Packard T, I I B survival: Protecting ~ ~ ~ ~ ~ empowerment and protection,as well as to the objective of Households from the impoverishing Effects of Health system efficiency.Among its most important contributions, Shocks," ~ ~ Study, Latin ~~~~i~~ ~ Caribbean ~ i and the ~ ~ l are (i)the creationof the HealthSuperintendence (together ~ ~ ~Worldi Bank,~~~~~b~~2005, ~ ~ , ~ h ~ with the modificationsto the ISAPREs regulatoryframework) as a substantialmilestoneinthe improvementofthesystem's regulatorycapacity. For the first time, an externalregulatory body is created,with a surveillance roleto control FONASAs performance, something which, together with the powers granted with regard to the ISAPREs, has the potential to significantly increase consumer protection in both sub- systems and to deliver effectiveempowerment mechanisms; (ii) the separation of the stewardship and regulation management line from that of the management of public providersinsidethe Ministryof Health. Althoughthe Ministry hasbeenentrustedwith the roleof supervisingand directing Chilean health policy for many years, the organizational structure of the Ministry of Health was responsible for diverting most of its attention to the managementof public providers. The modifications in the new legal framework make it possible to separate both roles at the national and regionallevels,with significantpotentialefficiencygains. (iii)ISAPREs' Long Law. The creation of the Inter-ISAPREs Compensation Fund is aimed at introducing a risk compensation mechanism across the private insurers operating in a competitiveenvironment.The purposeof this mechanismwould beto reducethe incentivesto the ISAPREs to exercise riskselection(ofwhichthere is ample evidence in the literaturefrom the 1990sonwards),and consequently to reduce risk and income segmentation in the insurance system.However,the creationof this Fundwas establishedas al'second bestl'afterthe government abandoned,due to lack of consensus in Congress, the initiative to implement a compensation fund that would also include FONASA.The absence of risk compensation that includes FONASA is unlikely to resolve the income and risk segmentation currentlyobservedin the Chilean healthinsurancesystem. 46 PRoelgi cuyl N o t e 5 : a t i o n o f B a s i c P u b l i c Services i n C h i l e ' A b s t r a c t This Note compares the regulatory framework and practices in the different basic public services in Chile - electricity, telecommunications, water and sanitation - focusing on the institutional set-up, conflict resolution schemes, tariff regulation and determination of the cost of capital. It also includes a discussion of sector-specific issues, assessing the experience and analyzing rhe most critical regulatory bottlenecks in each specific sector. The note briefly presents a series of policy options that might conrribute, on the one hand, to making basic service provision more efficient and affordable, and on the other, to coverage expansion in rural areas. In connection wirh institurional changes, among others, the following options are presented: providing regulatory agencies wirh greater independence from the Ministries; increased regulatory discretion; and having a single regulator per sector, preferably with the rank of a Superintendency. As for tariff regulation, the Note recommends establishing some sort of comparative method ("benchmarking") and the replacement of the price caps with revenue caps. Finally, some sector- specific policy options are recommended, mosrly related to promoting deregulation and improving universal access programs. ............................................................................................................................................................. 1. This policy note was prepared by J. Luis Guasch (Project Manager, Senior Advisor, World Bank), Juan Gaviria (Sector Leader, Finance, Private Sector and 47 Infrastructure,World Bank),RaffaellaMota (Consultant,World Bank),and with the assistanceof Andres Gornez-Lobo (Consuitant,World Bank). ........................................................................... 1 Introduction providing equality of opportunity. + In many respects Chile already has a good regulatory As a result of well managed, mature and long standing framework, defined as one that obtains efficient liberalizing reforms, Chile has been at the forefront of performance of regulated firms by inducing them to (i) improving the provision of infrastructure services, provide the service at lowest cost, given a set of quality particularly through private participation. Today, Chile standards, (ii)comply with clauses addressing increased leads LAC countries in terms of performance indicators of coverage, and (iii) closely align tariffs with costs, allowing basic public services. The new Chilean administration for only normal profits. Further reforms would build on faces, nevertheless, an important task of ensuring further the remarkable results achieved so far (see Box 1) and advances in affordability and reliability of basic public adjust the overall regulatory framework in specific areas services as well coverage extensions with respect to which are outlined in this policy note. Most of the options water, sanitation and telecommunication services. Such are medium-term of naturealbeit there are severalspecific advance is an important element in a strategy of options which also apply to a shorter time horizon. 2.The magn'tudeofthis cnailenge must be put into pcrspective.Actordingt o m 2W2 census,on y 13.49aoftne popLlat,onwas rLralInChIeh adaitimone mLnstressthat nationalstat'stksmay hiae regionaland municipala ffertnces in serv'ce coveragc 48 sectors. Regulationstaff is subject to public sector wages, causing significant migration of highly qualified staff to regulated firms, increasingthe risk of"regulatory capture'! Electrification Ruralelectrifica- Second, in all sectors, the responsibility for setting tariffs rate, total tionrate,total is shared with the Ministry of Economy. Although this allows sectoral regulators to learn from tariff review ChllC 91% 86% processes in other sectors, and creates some institutional LatinAmerh .89% 61% memory and technical capacity building, it can also Developingcountries 66% 52% politicize economic regulation. Trans!tioneconomies r. ! 3 . andOECD 995% 98% . Third, the institutional setup remains diverse across sectors. Incontrast with the electricity sector,there are no split responsibilities with respect to sector regulation for telecommunications, water and sanitation. In these sectors one single institution is responsiblefor both data This note first compares the regulatory framework and collection and enforcement.There has been no consensus practice across different basic public services in Chile, on an optimal institutional structure, both in terms of the namely the institutional set-up, conflict resolution separation of responsibilities as well as the status of the mechanisms in place, price setting, and the determination regulator. of capital costs. In addition, sector-specific issues are analyzed - taking stock of the experience and discussing The consequences of those three characteristics are high the most critical regulatory bottlenecks in each specific possible capture (of rents), higher uncertainty, and thus sector. Finally, the note outlines some policy and high regulatory risk. institutional options available to policymakersin Chile. 2.2. Conflict Resolution Inparallelto the institutionalset-up, the arbitrationor conflict 2. Regulation of Basic Public Services in Chile - resolutionmechanismsvaryacrosssectors. Conflictresolution .................................**................*........................takes Background and Issues placethrough an extrajudicialarbitrationscheme (Box 3) but such schemes differ across sectors (Table 3). If the 2.1. Institutional Set-up: Not enough autonomy and regulatorand regulatedfirm cannot reachconsensus intariff heterogeneity across sectors setting matters, arbitration panels are constituted in the The current institutional set-up has three main water and sanitation, and telecommunicationssectors while characteristics. First, regulators are government bodies, an automatic price-setting mechanisms is triggered in the part of a ministry,and not autonomous agencies (see Box electricity sector. Rules governing the arbitration panel 2). The level of independence, however, varies across deliberations in the water and sanitation, and . . Inthe elechickysectortherearetwo main regulatorybodies,the NationalEnergyCommission(CNE),whichpropfses secto,ralpolicyandshares responsibility on regulatedtarff setting with the Ministryof Economy, and the Superintenden4of ElectricityandFueir [SEQ, which collects data for the purposes of enforcementandregulation,monitor,s sew iomercomplaints, SECisamulti-sectoralagency,inchargeofregulatinge&ricity,gas and otherfuels. I I The main regulatory body in the telecoms semi is the Under-Secretariat for Teiecommunicatlons (SUBTELI within the Ministry ,of Transportationand Telecommunications,Amongitsmaindutiesareto pesentproposalsfor nationalpoliciesforthesector,adylnisterandcontroltheuseoftheradio-magnetic spectrum,processconcessionapplications,andrunthe proceduresfor ratesetting. Inthe wore! ondsunitationsertw the Superintendency of SewerageServices (SISS) is responsiblefor conductingtechnkaldudes in preparationfor tarifl setting,technicalandeconomicmonitoring,protectingtheconsumer,andimplementingtheconcessionsregime, 49 telecommunications sectors themselves differ. Given the work. Such models are based on numerous assumptions rules of the price setting mechanisms, incentives exist for and parameters. both the regulating bodies as well as the regulated companies to under- or overestimate cost developments. The efficient company approach forces the regulator to Separately, conflicts involving market power matters are micromanage the regulated firm, with the burden of proof also the responsibility of antitrust authorities, which have placed on the regulator to show that the company can be been recently reformed. Chile has chosen a balanced mix more efficient. With asymmetric information, the company between sector-specific regulators and relevant antitrust has ample space to game the system. or to convince authorities.' Chile's main competition regulator is the members of the expert panel of its position by providing National Economic Prosecutor,a government agency. In very detailed information regarding its operating general, the judiciary acts as the final arbiter in Chile. In environment, expenditures and other information only the past, the judicial arbitration system operated availableto the company.' relatively slowly given the lack of judges' familiarity with economic and technical matters. The March2005 creation An analysis of the regulated companies' rates of return of the Competition DefenseTribunal (Tribunalde la Libre during the 1990s shows that the application of the efficient Competencia) is likely to have a positive impact on judicial firm model has not been very successful in setting efficient expediency. tariffs. In electricity distribution, the rates of return of regulated companieswere systematicallyabove20%,with The consequence of those (imperfect) conflict resolution rates of return above 30% in some years? Moreover,the rules is (incentive-driven) inaccurate reporting, leading to regulated companies in this sector earned higher rates of distortions in the alignment of costs and tariffs. return than the electricity generating companies that operated in a competitive, and thus more risky, 2.3. Regulation ofTariffs Based onthe"Efficient" Firm environment. In telecommunications, rates of return in Tariff setting in Chile is based on the efficient firm model. fixed telephones were also quite high during the nineties, Tariff setting i s thereby based on the design of a model with rates above 20% common and in some years above how a representative, regulated firm could (and should) 30% or even 40%: More recently, though, rates of return Inthe worer ondsanitationsector,when regulatorandregulatedfirm cannotagreeoncostsestimates,derivedfromtariff studies,anArbitrationPanelis putin piace.'The expertpanel mustdeliberate on thoseparametersfor which there is disagreement and the number of parametersindisagreement can reach - hundreds.Thepanel,ty choosingsomeparametersproposedbytheregulatorandsome,others proposedbytheoperator,oftenendsupaveraging thetariff proposalsofeachside. tftheieisdisagreementwithinthepanel,tariff decisionsarereachedbyoneexpert(mutuallychosenbythetwo parties). Thispanelist isgiwn30 daystoreacha decisionwhich mightbe difficultgiventhat ($)hemightnothavebeeninvolvedin thetariffstudies. Inthetelecommuni@nssector,the aibitrationpaneldoesnothavetochoosebetweenthetwoestimates(formallyInthissectorthereisonly oneestimate, sinceonfythe regulatedcbmpanyco l a st@) andthepanel's opinionsare notbinding.The telecommunicationsregulator(SUETEL) hasdiscretion todeterminetowhatextenttoado I's judgment and,iherefore,to decide on final Inelectricitydistributionthedisputeresolutionmechanismisdistinafromtheothers. Ifthereis eementbetweenthestudiescommissionedbytheregulator and by the regulatedcompany, a weightedavenge of both estimatesis ca1cuiated.A 2i3 weight on the regulator'sconsultantreportand a 1/3 weight on the regulatedcompany's consultantreportare usedto fk pricesfor distributbn.Thisdisputeresolutionmechanismcreatesperverseincentivesfor bothpartlerThe partiesimbedwilltendtooverorunderstitecostestimatessincefinaltariffswillautomaticallybeanaverageofthesevalues.ln contrast,inthetelecommunications sectorthe regulator has morediscretion,but(slhecannotignorethe commissionedrep&taltogether;therefore,some perverse incentivesstillpersist. 50 4. Kerf et al, 2005 5.Dyck and DiTella,2002,find that electricity distribution companieshavebehavedstrategicallyunderthe efficient company regulationinChile,suggesting that the modelfirm approach is vulnerableto gaming. 6.Serra, 2002, pp.11-43. Electricitydistribution Weightedaverageofcohestimatesof n.a. Article 107,OFL No1 bothparties(U3authorities, 1/3 com- pan!es) . ' . have been lower as regulators have learned to use the rate of a savings account at the publicly owned Banco instruments at their disposalto set tariffs. Estado. During the last decade, this rate has been at least three to four points below the true risk-free rate for 2.4. The Determination of the Cost of Capital investors,distorting the cost of capital calculations. The determination of the cost of capital for regulated industries, an important input in tariff setting, is arbitrary The consequences are higher tariffs than appropriate and (Table 4). In electricity distribution, the industry's cost of misalignmentsamong costs and tariffs. capital is fixed by law at a rate of 10% in real terms. In periods of low interest rates, the 10% cost of capital is 2.5. Sector-Specific Regulatory Features probably excessive for this industry, whereas it may be Electricity insufficient in other periods. On average, 10%is likely too Priceshavefallen, quality hasimprovedandcompanieshave high for this industry. In the water sector the cost of kept high rates of investment and a strong financial capital is equal to the risk-free rate (determined by the performance. Electricity prices significantly fell from the rate of return of Central Bank notes) plus a risk premium beginning of the 1990s until 2002, reflecting declines in varying from 3% to 3.5%. Again, nothing precludes the the regulatedvalue addedof distribution (VAD)and in the real risk premium to be above or below this range. In the regulated node price (see Figurel).Generation costswere case of telecom, the law states that the cost of capital substantially reduced with the introduction of combined should beestimatedusingthe Capital Asset PricingModel cycle gas turbines (CCGT), and there was also an (CAPM) and the risk-free rate to be used is the interest improvement in capacity utilization. In 2004 electricity 51 7.Fisher and Serra, 2002. prices in Chile were relatively low by international standards (Table 5). The combination of the real price decline and high rates of return reflects substantial efficiency improvements and generous regulatory reviews of the VAD (Pollitt, 2005). Perhaps as result of for households industry better investment decisions, quality has also improved - technical and non-technical losses, as well as power outages due to transmission failures have fallen sharply since privatization. More recently, especially after the withdrawal of Argentinean gas in 2004, node prices have shown an upward trend. The central task regarding electricity pricing is to liberalize the node pricing system while offering consumers the choice of tariff stability. There are two types of electricity customers - regulated and free. Free customers are large consumers (with maximum demand above 500 kWB)that can contract directly with generators without the intervention of the regulator.On the other hand,the tariff for small customers is highly reguiated and consistsof the sum of the node price at which distribution companies buy energy from generators, and the remuneration of distributors.The current node pricing system is based on a four year forward looking average of electricity prices, comprises a number of unique characteristic^.^ First, a and is thus illsuited to respond to short term information model of asymmetric regulation exists, whereby only the (as recently happened in the 1998-99 supply crisis). incumbent has its tariffs regulated. Second, there is Hence, the task is to introduce reforms that liberalize the freedom of entry as concessionsare not exclusive. Third, node pricing system while, in parallel, providing tariff incumbents must grant interconnection for new entrants security to consumers. Rather than introducing a at terms and rates fixed beforehand (compulsory competitive market for electricity supply as in the United connection). Fourth, rate freedom exists unless the Kingdom and California,the Chilean reform could entail a competition authority states that for specific services system in which consumers can choose between different there is not enough competition to warrant a free rate combinations of tariff stability versus lower (but variable) system and when such exception is invoked, rates are prices, thus allowing the market to ration supply computed according to the costs of an "efficient" firm. efficiently to droughts or other conditions that may Fifth, reduction or elimination of cross subsidies and the occasionallylimit supply availability. existence of an universalaccess fund aimed at stimulating private sector investment inrural areas, using a minimum In the electricity sector, the lack of independence of Chilean subsidy mechanism. regulators may be the most striking feature of its institutional arrangements. Both regulatory bodies are In spite ofpositive resultsin the sector, thereare some issues subject to the operational control of the Ministry of of concern in the regulation of the telecommunications Economy, whose oversight is not limited to tariff issues. sector.The combination of deregulation, privatization and There is an inefficient division of responsibilities between universal service has produced remarkable results in the two main regulatory bodies,CNE and SEC. terms of expansion of lines, mobile phones and quality improvement. Outstanding concerns include (i) TelecommunicationsSector asymmetric regulation might have lead, in practice, to The telecommunications sector regulatory framework some "cream skimming" with effects on efficiency'O; (ii) ............................................................................................................................................................. &The Ley Corta (LawNo. 19,940/2004) loweredthe thresholdfrom 2 MWto 500 kW. 52 9.See Paredes,2005. 1O.ColomaandTrazijan,2004. 11.VolP (voiceover internet protocol) refersto atechnicalstandardthat enablesthe transmissionof the voice traffic inwholeor inpart,over oneor more networks, which use the Internet Protocol(IP) (Cohenet al,2005). ."v,,,rr* ..".'.'.".."..."',... October 1982 October 1984 A1f87 ril October 1989 A1892 ril October 1994 A ril 1897 October 1999 Index A SEP-dl October 2002 A ril 2804 October 2005 Source:CNE. rate regulation has becomeincreasinglycomplex over the PSTN services. However, if services are provided over the years, and asymmetric regulation has prevented internet, they are not subject to the same conditions, but regulated operators from adequately competing and the regulator is suggesting a broadband voice license. investing; (iii) when compared to the OECD countries Considering the increasing convergence, the proposed during the past few years, Chile does not seem to be solution appears to be problematic. A more flexible closing the digital divide. In terms of education, the licensing regime, taking into accountthe influence ofVolP challengefor Chile is how to effectively expand Enlacesto technology in the telecommunications industry is rural isolated areas. required to unleashthe full potential of the technology. Implications of New Technologies on Telecommunications Water and Sanitation Sector Regulation. The development of VolP (voiceover internet In the water & sanitation sector, a central feature of the protocol)" technology has changed the way that regulatory framework is that it allowed for full cost recovery. telecommunications can take place - mostlyby increasing The new rate system was first used in 1990 and water the rate of transport, the number of applications and the tariffs have been raised to the true economic cost of the number of possible platforms (Meiseland Needles, 2005). service over the years. Recent tariff reviews have VolP technology has also brought challenges for the translated into significant price increases in real terms regulatory framework as there is an increasing which have raised concerns about the effectiveness of convergenceof telecommunications,broadcasting, media tariff regulation in the water and sanitation sector. and information technology service sectors. If it was possible under the vertical model to regulate according Sector regulation includes a subsidy system to protect the to the type of network (Le., wireline telephony, wireless poor which is currently under review. To protect the poor, telephony and broadcast radio/ TV, and cable TV), as the the government introduced an innovative direct, means- technology has evolved the lines between the different tested subsidy scheme which can cover between 25-85% network types have become blurred. Regulationneeds for of an eligible household'swater and sewerage bill up to a converged services therefore differ from the old network certain limit of total consumption after which the client regulatory schemes. While the old regulatory methods pays the full cost of the service. The drawbacks of the tried to stimulate the reduction of costs and the subsidy approach are its high administrative costs and the development of an "efficient" company, new regulation difficulties of designing eligibility criteria. A reassessment should concentrate on promoting investment to reach of the affordability of water and sewerage charges, as well more subscribers with broadband services. Chile is no as the targeting properties of the current subsidyscheme, exception. To respond to the challenges of VolP is required before changes in the subsidy scheme can be technology, in July 2004, the Chilean regulator SUBTEL considered. launched a public consultation on VolP, according to which if voice services are offered through the existing In contrast with the urban areas, the rural water and Public Switched Telephone Network (PSTN), the operator sanitation sector has not benefited as much from the major 53 is required to comply with the regulations that apply to reforms. Despite coverage gains over the past decade, especially in the provision of community-managed (iii) Political and financial independence.Ideally,regulatory drinking water services to inhabitants living in agencies should also become more independent from concentrated rural communities, a third of the total rural Ministries as a clearer separation between technical and population still lacks a potable drinking water supply. In political activities should reduce the risk of regulatory terms of sanitation, only sixty percent of the rural capture. Overall policy making for the sector would, population has access to a sewer or septic system. naturally, remain within the Ministries. 'Upgrading' However, the water subsidy is also provided for rural regulatory bodies to Superintendencies could give them householdsand communities. more political and financial independence. Granting powers to the President to nominate and remove regulators from office following transparent and pre- ............................................................................ 3. Policy Options and Recommendations established procedures would increase credibility of leadership within the sector. Nominations could be for fixed periods and removals could be limited to a violation 3.1. Institutional Set-up of duties. Regarding the heterogeneous regulatory framework, a move towards more independence from Ministerial (iv) Regulatory discretion. If more political independence control, moretransparency,regulatory discretion (andless were to be given to regulators, Chile could consider excessively detailed legislation) and increased efficiency increasing the level of regulatory discretion. Technical through improved coordination should be considered. details and numbers,such as market thresholds,regulated Someof the options availableto the new government are: rates of return, number of personnel in the regulatory agency, etc., could be decided by the regulator in (i)lnstitutional responsibilities and design. One option to conjunction with the relevant industry governance foster institutional convergence is to establish only one bodies,and not specified in the legislation. Inthis scheme, regulatory agency per sector, in charge of both technical the decisions of the arbitration panel might not be and economic regulation, as well as with responsibility for binding anymore (as in the water sector), but be rather data collection and enforcement. Substantial more similar to an experts' report (as in the coordination benefits could materialize." Such a reform telecommunicatians sector), with the regulator having would unify the regulatory framework across sectors and the discretion to deliberate in the end.This would render improve coordination within each sector, especially if the regulatory framework more flexible. Superintendencies were to be established that have legal powers to enforce regulations and impose fines on 3.2. Regulation of Tariffs operators. Regardingthe regulation of tariffs, Chile has a number of policy options to consider, whose adoption will depend (ii) Giventhe scarcity of highly skilled professionalsin the on the extent to which it is prepared to distance itself public sector, a more radical option could be to establish from the "efficient"firm approach: a "super regulator of basic services: which would be entrusted with exercising control over companies that (i)A more radical policy option would be to avoid the have activities in more than one regulated sector. The problems of the efficient firm approach by replacing the "super regulator" would be a high-profile, visible model in its entirety. Higher level approaches (including regulator, preferably structured as a commission in order models such as DEA, SFA and C0LS)l3 have been to reduce the risk of regulatory capture. Such super successfullyapplied by regulators elsewhere - e.g. United regulator would not be concerned with the technical Kingdom, the Netherlands,Norway, Australia/ New South regulation of any specific sector, but would ensure Wales. These techniques are more transparent, less regulators' independence and the balance between the vulnerable to strategic behavior, and can make use of different sector regulators. A less radical option would be international data for comparison. to formalize the coordinating role of the Divisidn Desarrollo deMercados of the Ministry of Economy, which (ii) A less radical option would be to incorporate some in practice is the current coordinating body. ............................................................................................................................................................. form of benchmarking in the efficient firm approach and 54 12.Pollitt,2005 13.DEA(DataEnvelopmentAnalysis),SFA (Stochastic FrontierAnalysis)andCOLS(CorrectedLeastSquares)arefrontier benchmarkingtechniques,i.e.they measure the relativeperformance of all firms against an efficientfrontier.While DEA is basedon linear programming,both SFAand COLSare statistical techniques. 14.Gomez-Lobo andVargas,2002. to address the main weaknesses of the model." incremental improvements. Benchmarkingcould enrich the efficient firm exercise,and could also stimulate the development of a system of (i)Deregulation of commercialization. Reform legislation information collection and compilation in order to have only recognized three segments - generation, comparableand reliabledata. Further, insteadof trying to transmission and distribution. The Ley Corta has already set micro-parameters,the regulator could instead focus moved in the direction of reducing the barriersto entry to on the "big picture': leaving the company to decide in the commercialization market by imposing non- which specific departments efficient improvements discriminatory access rules. However, unless should take place.The regulator should concentrate on commercialization is deregulated, the full competition establishing standard, transparent and simplified potential of this segment will not be unleashed.Similarly procedures,which can be replicated by third parties, and to the best practices in developed countries (e.g. the whose outcomes can be made, as much as possible, United Kingdom), regulation should be confined to the readily available for consultation. Similarly, it would be core network (transmission and distribution), and the important for the regulators to develop regulatory potentially competitive segments (generation and accounting frameworks in all sectors,with periodical data commercialization) should be left as much as possible collection in a unified and auditable format. deregulated.In addition, Chileshould considerwhether to impose any integration restriction in order to prevent the (iii) Reforms of the capital cost determination would be distribution company from discriminating in favor of its important. In the case of telecoms, the definition of the commercialization subsidiary. risk-free rate could be changed so that the real market risk-free rate can be used in the tariff calculations.In the (ii) Node pricing flexibilization. Chile could consider electricity sector, replacing the legally determined cost of whether to keep the node pricing system or to liberalize capital by the system used in the telecommunications it. Some argue that the node pricing system is sector might be a good option - which also holds for the unnecessary and inhibits long term contracts (Pollitt, capital cost calculation in the water and sanitation sector. 2005). Others argue that the node pricing system is excessively rigid when facing shocks, such as the energy (iv) Some additional changes with respect to the tariff crisis of 1998-99 (Diaz et al, 2001). If the node pricing setting methodology could be useful.Current regulations system is to be retained, it needsto be more responsiveto set a price ceiling per unit of product sold (kWh, 17-13of all information available, and the information processing water, minutes of calls, etc.).This implies that all demand should be independent of the regulator. Consumer risk is borne by the operator. Therefore, demand safeguardsshould be preserved. estimation during a tariff setting process becomes a strategic variable and a source of conflict between (iii) Fuelsecurity.Fuel security is the most pressing energy operators and the regulator. In order to reduce this sector issue, especially after the recent shortage of conflict and given that operators for the most part do not Argentinean gas. The heightened concern with security control demand levels, introducing a system of revenue has already been reflected in the investment planning for caps, as in the United Kingdom,instead of price caps may the sector. RecentlyCNE published a revised schedule of be an interesting option. In this case, if in a particular year recommended investments in new generation and the actual demand is different from the projected capacity for 2005-15. The new schedule increased the demand, tariffs are adjusted automatically so that share of coal as a source of generation by 20%, whereas revenuesare equal to their cost recovery levels. reliance on imported natural gas from Argentina was halved. Importing natural gas from Bolivia would be the 3.3. Sector-SpecificPolicyOptions best option in economic terms. However, if this is Electricity currently not available for Chile, the second best policy Chile has implemented the most advancedand successful options could be increasingthe shares of coal or hydro,or power sector reform in Latin America. Therefore, the bringing LNG imports. LNG import facilities are now in an policy recommendations for this sector aim at relatively advanced stage of planning and will probably be built ..................................................................................... ........................................................................ 15.LNGdevelopmentinChilefaces somedifficult factors,inc1uding:therelativelysmallsizeofthe market and itsdistancetothe supplycenters,which could reduce investor's interest in the project; and the possibility of facing in the future the competition of piped gas from the neighboring countries if pipelinesare built betweenthe countryand Peruor Bo1ivia.haddition,the SouthAmericaRingProject mightleadtothe constructionof newinterconnectiongas pipelinesbetween 55 Argentina,Chile, Peruand Brazil. 16.Endesa(Spain)has shown interestin investinginfour large hydroelectricplants (2,430 MWof capacity) inthe Aysen region. 56 during the course of the next few years." In addition, efficiency from increased competition, and regulation Chile might want to assess the costsand benefits of other would be, as much as possible, ex-post. alternative fuel supplies, including building or financing gas pipelines,storagefacilities and converting facilities to (iii) Universalaccess. The Governmentcould also consider fuel oil. the introduction of a new generation of universal access programs, appropriate to the development of new (iv) Alternative sources. Clearly, Chile still has untapped technologies.These programs could be directed towards sources of clean and cheap energy in the form of expanding broadband service, and they could prioritize hydroelectric power. However, these projects, such as the schools and communities. Moreover, Government might ones currently being considered in the Aysen region in consider how to ensure the sustainability of these the south of the country, run into strong opposition from programs, and how to lower internet connectivity costs to environmental groups.I6 How to reach a social consensus rural areas. and strike the right balance between hydroelectric development and the conservation of pristine and (iv) New technology. With the development of VolP untouched natural environments is perhaps one of the technology, new legislation should take into account the most pressing challenges for the electricity sector in the increasing convergence between network types, coming decade. ensuring that the framework is consistent and provides non-discriminatory access to the natural monopoly Telecommunications segments. Moreover, in this context tariff rebalancing is The dynamicsof the telecommunications sector demands inevitable and will have to take into account the impact a continuous reappraisalof policies and regulations.Chile ofVolP. faces a few policy options; however, most importantly, it should consider replacing - or at least refining -the 1982 Water and Sanitation General Telecommunications Law for a more modern With the exception of a possible overhaul of the efficient legislation, in particular, a law which incorporates company regulatory model, the regulatory needs in the guidelines for access charges regulation. Key policy water and sanitation sector are more "fine tuning" rather options are: than overhauling pillars of the regulatory framework. However,one specific issue goes beyond"fine tuning'; but (i) Asymmetric regulation. Chile could consider whether should neverthelessbe stressed:rural access to water and the asymmetric regulation approach should still be sanitation services.Although in urban areas affordability favored in the current context. Restricting competition of consumption - not of connection - is the main issue, with an incumbent is now widely regarded as an and there has been remarkable progress during the last inefficient policy. Abandoning asymmetric regulation decade, especially in providing drinking water services to would be a radical turn that would probably have a concentrated rural communities throughout the country, positive impact on efficiency. At the same time, there a third of the total rural population (which is rather small would be the need to address the possible abuse of in Chile) still lacks a potable drinking water supply and monopoly power bythe incumbent.To prevent this abuse, only sixty percent of the rural population has access to a competition authorities would have to be vigilant and sewer or septic system. Therefore, there are still active. challenges with respect to the expansion of water and sanitation service coverage. (ii)Deregulation of consumer rates. A less radical policy option would beto deregulate consumer rates in the local (i)Coverage extension. Some policy options to increase telephone market while retaining the right for the coverage would include clarifying institutional regulator to set the rates for the incumbent. This would responsibilities, targeting fundingla, application of more allow the incumbent to be flexible enough to respond to cost-effective and appropriate technologies, and competition, but there would be safeguards to the fostering of decentralized and integrated programs consumer as regulated rates would be kept as an building upon existing community initiatives (World alternative?' There would be an improvement in terms of Bank,2004). .....................................................................................................................*....................................... 57 17. Saavedra,2005. 18.Perhaps more emphasis should be placed on targeting benefitsto the rural population in order to usethis as an instrument for expandingcoverage in rural areas.Anotheralternativewould be to introduce asystemof supplyside subsidiessimilarto the ruralelectrificationand ruralpublic telephoneprograms. (ii) Means-tested subsidy scheme. Policy makers might Diaz, C. A., A. Galetovic,and R. Soto (2001).'Anatomia de una want to review how to adapt the means-tested subsidy Crisis Electrica'.Revistade Anllisis Econ6mic0,V. 16, No. 1, pp. scheme now that most of the necessary price alignments 3-57, June. in the sector have taken place. Also, policy makers might want to address if and how the system would need to be Dyck, I. J. A. and R. Di Tella (2002). 'Cost Reductions, Cost changed so as to effectively reach the most vulnerable Padding and Stock Market Prices: The Chilean Experience households. with Price Cap Regulation',Harvard NOM ResearchPaper No. 03-22,October 8. (iii) Tariffregulation. Given that there are more than three hundred water and sanitation systems in Chile, the sector Fischer, R. and P. Serra (2002).'Evaluaci6n de la Regulacibnde could benefit from using some form of benchmarking - las Telecomunicaciones in Chiles', Revista Perspectivas, which could be done even in the context of the efficient Departamento de lngenieria Industrial, Universidad de Chile, firm approach. Vol.6,No. 1, pp.45-77. Regulation Gbmez-Lobo, A. and M.Vargas (2002).'La Regulacidnde Las Chile should study how to improve the regulation of Empresas Sanitarias en Chile: Una Revision Critical, Revista vertically- or horizontally-related markets; in particular, Perspectivas, Departamento de lnginieria Industrial, the policy maker could define what the regulated firm can Unlversidadde Chile,V. 6. No. 1,pp.89-109. do in related markets. For instance, can water companies have businesses in the treatment of industrial liquid Kerf, M., I.Net0 and D. Gerardin (2005). 'Controlling Market discharge, or river control? How will the participation of Power - Balancing Antitrust and Sector Regulation in regulated companies in more competitive sectors affect Telecoms', Public Policy for the Private Sector, Note No. 294, competition? June 2005. Komives, K., V. Foster, J. Halpern and Q.Wodon (20051, Water, Electricity and the Poor: Who Benefits from Utility Subsidies?, The World Bank,Washington, D.C. Meisel, J. B. and M. Needles (2005). 'Voice over Internet Protocol (VolP) Development and Public Policy Implications', V. 7 (3),pp.3-15. Paredes, R. D. (2005). Lessons from The Deregulation Transition in Chile's Local Telephony Market', ..........................................................*.................TelecommunicationsPolicy,29, References pp. 333-350. Pollitt, M. G. (2005).'Electricity Reform in Chile: Lessons from Bitran, E., A. Estache, J. L. Guasch, P. Serra (1999). 'Privatizing Developing Countries', Cambridge Working Papers in and RegulatingChile's Utilities, 1974-2000:Successes,Failues, EconomicsCWPE0448, University of Cambridge,Cambridge. and Outstanding Challenges' in Perry, G. and D. M. Leipzig (eds.) 'Chile:Recent PolicyLessons and EmergingChallenges', Saavedra, E. (2005). 'Marco Regulatorio de Los Servicios World Bank Institute. Blsicos en Chile', ILADES, UniversidadAlberto Hurtado,Julio. Cohen, T., 0. Mattila and R. Southwood (2005). 'Global Serra, P. (2002). 'Regulaci6n del Sector Electrico Chileno', Symposium for Regulators', Work in Progress, Medina Perspectivas,Vol.6,No.1, pp.11-43. Conference Centre,Yasmine Hammamet,Tunisia World Bank (2004). Chile - Rural lnffastructure in Chile - Coloma, F. and J. Tarzijln (2004). 'Regulation, Objectives, Enhancing Efficiency and Sustainability, Report No. 29037, Problems and Options in Local Telephony', Working Paper, P. Finance, Private Sector and Infrastructure Unit, Latin America 58 UniversidadCat6licade Chile, lnstituto de Economia. and the Caribbean, May. RP e g i o n a l D e v e l o p m e n t a n d D e c e n t r a l i z a t i o n ' o l i c y N o t e 6: A b s t r a c t Over the past 15 years, Chile has gradually moved towards an increasingly decentralized system of government. With subnational governments now accounting for a third of all public investment expenditure, the Government's initiative to strengthen equity of opportunity will thus require a strong focus at regional and local levels. Currently, regional disparities are large in almost all dimensions, and the distribution of public investment remains skewed towards the Extreme Zones. In order to make the next phase of decentralization reforms more effective, the Government could consider improving the regional distribution of public resources, strengthening local and regional institutions, aligning resource allocations with decision-making authority, and increasing local accountability through greater transparency and participation. This policy note is meant to serve as a basis for discussions with the new Government on a range of issues related to regional development and decentralization. In line with the Government's policy agenda, it could be followed by a deeper engagement on selected topics. ............................................................................................................................................................. 59 1. This policy note was prepared by Daniel Oks (Lead Economistfor Chile,World Bank) and Jasmin Chakeri (Economist,World Bank) and with the assistance of Fernando Rojas (LeadPublicSector Management Specialist,WorldBank). ............................................................................ 1. Introduction policies are only part of the solution and thus have to be firmly integrated into broader strategiesto stimulate regional Inits election program, the new Government hasoutlined an development. Some of the key elements for such a strategy ambitious agenda in decentralization and regional are also addressed. development, geared towards reducing geographic inequityof development, increasing public participation in decision- After a brief review of regional economic and social making, and gradually fostering decision-making at the development, this note outlines selected issues and policy regional and municipal levels. The Government's program options infour areas:(i) Improving the regional distribution of focuses on four priority areas: (i) strengthening the voice of public resources; (ii) Aligning these resourceallocations with citizens,and empowering localgovernments to formulate and decision-making authority; (iii) Strengthening subnational implement policies that respond to their preferences; (ii) capacity;and (iv) Increasingcitizen participation and voice. enhancing the capacity of local government and creating incentives for good performance; (iii) transferring more responsibilitiesto regionaland municipal governmentsfor key 2. The Current State of Re ional public services;and (iv)decreasing inequities among regions. ............................................................................ Development and Regiona Disparities 4 Decentralization in Chile has been gradual and cautious, with RegionalDevelopment.Chile'snationaleconomic successis a strong focus on the 13 regions, headed by the centrally mirrored by a steady improvement of economic and social appointed intendentes, as the main units of subnational indicators in all regions over the last 15 years. Between 1990 administration. At the same time, municipalities, which are and 2001, average regional GDP growth rates were all run by popularly elected alcaldes and consejosmunicipales, positive and ranged between 2 percent p.a. in region XI1 play an important part in delivering key social services, (Magallanes)and 8.3 percent in region 111 (Atacama). During including basic health and primary education. Taken the same period, poverty rates decreased significantly in all together, regions and municipalitiesnow account for a third regions - between 10and 24 percentage points. of public investment spending (Graph 1) a share that is - higher than in most other Latin American countries. Given Regional Convergence. The pattern of this regional that municipalities and regions play such an important part economic progress has led to some, albeit limited, in the delivery of public services,they will be a crucial link in convergence in regional incomes. As analytical work carried the Government's drive towards achieving equality of out by "MIDEPLAN" has shown, regions with lower initial opportunity for all Chileansno matter where they live. levels of income grew modestlyfaster than those with higher levels between 1960 and 1998,leading to a slowly narrowing The decentralization of resources has not been accompanied gap in per capita income (MIDEPLAN,2002). While the trend byan equaltransferof decision-making authority. As aresult, in other Latin American countries is less clear, Chile's local governments do not have much influence on key experience is similar to that of other OECD countries - the policies that affect development in their areas. As this policy narrowingof intra-country incomegaps tends to beslow and note shows, the strengthening of incentive structures and periods of overall convergence often include shorter periods institutionalprocessescouldfacilitate the movementto more inwhich convergence slows or even reverses(Box 1). decentralized decision-making. However, decentralization Even if gradual convergence of per capita GDP can be observed, other measuresof regional inequity do not display the same trend. In Chile, for instance, a narrowing of the gap Local (11%) in poverty rates between regions has not occurred. Graph 2 comparesthe initial poverty level in 1987 to the reduction in Regional FND - the poverty level between 1987 and 2003 - ideally, the (14%) regionswith the highest initial poverty levelswould havealso been the oneswith the highestreduction inpoverty,but such Regional relationship does not appear to exist. Further, growth in other (6% Central(68%) Chile's poorer regions has slowed in recent years. If this recent trend continues,a significant reduction in the poverty 60 5ource:MiDEPLAN(2005) gap - and continued inter-regional convergence -will be difficult to achieve in the near future (Covarrubias,2005). Competitiveness. According to the Regional Second,a numberof poorerregionsshow important levelsof Competitiveness Index (Indice de CompetitividadRegional, competitiveness: Biobio (VIII) and Atacama (Ill),both regions ICORE),which evaluatesa number of economic,institutional with high poverty rates, rank well above the average; in fact, and social indicators relevant for sustainable regional they fare better than two of the extreme zones (Zonas development, the regions with the highest share of national Extremas).Similarly, a number of regions with relatively low GDP are also the most competitive. By the same token, the per capita income (suchas Los Lagos and Coquimbo, X and region with the lowest per capita product and highest IV) have an above-averagecompetitivenessscore of around povertyrate (Araucania,IX) scores lowest on the ICORE. 0.4 (Graph3). The ICORE' results offer some further interesting insights. Virtually all regions increased their competitiveness index First, there does not appear to be a clear relationship between 2000 and 2005 - the exceptions being Region betweena region'seconomic growth andits competitiveness Metropolitana and Araucania - but poorer-low income score. For instance, two of the regions that grew fastest regions in general experienced the strongest increases.Of between 1990and 1999,OHiggins (VI)and Aisen (XI), scored the six regionswith povertylevelsabove 20 percentin 2003, relativelylowonthe ICOREin2000,in partdueto thefact that only one (Araucania)did not improve its ICORE; the others these are resource-rich regions. Instead, regions with low averageda 31 percentincrease. growth such as Valparaiso (V) and Magellanes (XII) scored relatively high. The only two regionswhere healthy growth DisparitiesRemain Large. Giventhe slow pace of regional and a high ICOREscore coincide are Antofagasta (11) and the income convergence and the lack of progress in poverty MetropolitanRegion(Covarrubias,2005). convergence, it is perhaps not surprising that regional .................................. ,,....................... 1 3.4 ..................... ~~ 3.21................................. WRM ...................................................................... .................................. ...................... ....... ...... ................... ............................. ..................................... ',111....................IX ..... 0.05 ..................................................... 2 2.0 0% 10% 20% 30% 40% SO% 60% 70% 0 0 0.2 0.4 0.6 0.8 1 Poverty,1987 lcore2005 Source:MiDEPLAN,2004 Source:informe CIEN, Universidadde Desarollo; MIDEPLAN;INE, 2005 61 2. The ICOREawards scores in seven areas,which are then aggregatedto a global scorewhich determinesa region'srank.The seven areas are: Human develop- ment; management;scienceandtechnology;infrastructureand capita1;financialsystem; governmentand public institutions;integration and Internationalization. disparities in Chile are significant in almost all dimensions. of the country (World Bank, 200Sa). Graph 4 compares per Poverty rates range from 11 percent in Antofagasta to 30 capita public investment in 2004 across regions; the Zonas percent in Araucania, while two regions alone (Biobio and Extrernas (regions XI and XII) recorded by far the highest per Metropolitan) are'home to half of all the poor people in capita investment levels. Chile. Per capita GDP in Chile'srichest region, Antofagasta, is more than S times as high as that in the poorest one Matching the regional investment data to poverty levels (Araucania). The existence of such large disparities presents (Graph 5) shows that higher regional poverty rates are not aformidable challenge and underscoresthe need for region- associated with higher public investment levels. However, it specific solutions to development. is clear that such assessment is strongly dependent on investment levels in the Zonas btrernas - excluding those Policy Implications. In summary, Chile's regions have areas from the assessment results in a more pro-poor experienced a slow economic convergence and a general distribution offunds. Of course,poverty alone may not bethe increase in their competitiveness, while disparities remain most appropriate indicator of whether a region's needs are significant. The linkages between the competitiveness being met. Other economic, social and geographic indicators indicators and convergence, on the one hand, and the - such as population density, relative prices, data on current Government's regional development policies, on the other, infrastructure access and underlying economic growth need to be explored in greater detail to determine whether potential - can be used as additional proxies to measure a these have been effective. The improvement in the region's expenditure needs. competitiveness of Los Lagos, for instance, may be linked to government-supported public-private partnerships that stimulated the formation of clusters and chains of production. It should be noted here that is not clear how effectively development policies can influence regional convergence. .................................................... Shah and Shankar (2001) contend that in most developed and developing countries, regional development policies have failed to bring about greater regional convergence. Policies aimed at boosting economic .growth and reducing v Xlll VI VI1 I Vlll x IV II IX 111 XI1 XI regional economic disparities thus need to be carefully Region evaluated in terms of their costs and benefits and Source:MiDEPLAN,2005 *I municipal !I regional li! national convergenceeffects. Chile's generous incentives towardsthe Zonas xtrernas,forinstance, are likely to have contributed to growth inthe targetedareas,reducing the gap ina number of The distribution of regional investment funds - including socialand economic indicators between RegionsIand XI1and primarily the fondo Nacional de Desarro//oRegional ffNDR), Metropolitan Santiago. But they have not been a very cost- Convenios de Prograrnacion, and lnversidn Sectorial de effective or efficient tool (World Bank, 200Sa). Asignacion Regional - shows a positive relationship with poverty rates (Graph 6). This is likely due to the fact that the distribution of the FNDR, which represents close to 70 ............................................................................ 3. Regional Distribution of Public Resources percent of all regional investment, takes into account regional socio-economic indicators such as population, As part of the Government's decentralization reforms, the unemployment and per capita GDP. The revised Regional share of funds under the control of regions has increased Government Law* places even greater importance on significantly. But the regional distribution of public poverty incidence inthe allocationof the FNDR, making it the investment is unbalanced. Taking all investments single most important criterion. (independent of their source offunding)' intoaccount,public investment today is heavily biased towards the Zonas At the local level, the main mechanism designed to achieve Extrernas - regions with specific geographical and historic a more equitable distribution of resources is the fondo significanceinChile inthe far northern and southern reaches Cornlin Municipal (FCM), an inter-municipal compensation 62 ............................................................................................................................................................. 4. Only including direct public investment, not programs designed to mobilizeprivateinvestmentin the regions. 5. Law 19.175,revised in 2005. 450 ............................................................... 400 ....................P ........................................ (2004,excludingextremezones) .............................................................. 0% 10% 20% 30% 40% 0 0% 10% 20% 30% 40% Poverty rate Source:MIDEPLAN,INE,200S Poverty rate Source:MIDEPLAN,INE,2005 fund, through which richer municipalitiesshare part of their the high technical standards set by the Government. But own revenueswith other municipalities. The FCM is rather thesestandardscannotbe met inall projectsinall regions:In unique in Latin America; its design resembles closely the thecase of infrastructureprojectsinsparselypopulatedrural equalization tools used in Germany and Australia, both areas, for instance, the regional proposals may not always federal states. In Chile's case, municipalities contribute a conform to the technical requirementsset by the national fixed share of the revenue collected from the property tax, agencies (World Bank, 2004b). This may lead to low or motor vehicle taxes, fees from commercial licenses@atente) inadequate infrastructure investment in those areas for and traffic fines to the fund. The national Government's technical reasons and not necessarilyfor a lackof potentially contribution to the fund is fixed annually in the national available funding. budget, and while currently only accountingfor 10 percent ofthe FCM,is set to grow over time. The distributionformula Finally,the nationalgovernment has for a long time favored takes into account relativepoverty, populationsize, property the ExtremeZonesof the countrywith a privilegedincentive tax exemptions,andthe ratioof per capitamunicipalincome package.Thispackageis primarilyfounded on a geopolitical to nationalincome. The fund can be usedfor both recurrent rationale rather than efficiency or equalization objectives. and capitalexpenditures,representingon average a third of The incentivesincluded in the Extreme Zones package are all municipal revenues. Inthe case of poorer municipalities, currently beingreviewed interms of effectiveness,efficiency however,revenuesfrom the FCMrepresent morethan halfof and control, and a revised policy could be based more on total revenues.' equity considerations than predominantly on geopolitical factors. There are a number of additional challenges that unless - addressed in a timely manner - could foster increased Policy Options for a Better Regional Distribution of inequality between regions and among municipalities. For Resources. While more analytical work needs to be instance, poorer regions benefit from the way regional and conductedto assess the overall effectivenessof the current local investmentfunds are distributed,but they may not be transfer system, the Government could take measures to able to make effective or efficient use of these resources. improvesome of theexistingmechanisms.The performance There areat leasttwo reasonsfor this:First,inorder to qualify of the FCM, which is already a well-designed transfer for projects financed by regional investment funds, mechanism, could be further improved by incorporating municipalitiesprepareprojectproposalsandsubmitthemto additional sources of municipal revenues into the sharable the regional level. While this may help ensure that project pool and by reviewingthe criteria used for the distribution. proposals reflect local priorities,municipalitieswith weaker Whilethere is evidencethat the FCMhasanequalizingeffect capacity in project preparation may not be able to produce on per capitafiscal resources, other indicatorsfor municipal proposals of high quality, which decreases their chances of expenditureneeds(suchas numberof school-agedchildren, winning approval. Second, once submitted to the national incidence of malnutrition etc) could be added. Carefully level for evaluation, the Governmentreviews and evaluates reviewingthe incentivestructure of the FCM, particularlyits regional proposals against high technical standards. This effect on local revenue mobilization (see below)and on the processfavors those regionswith conditionsthat allowfor a collectionof the nationallyadministeredpropertytax,would cost-effectiveimplementation of projects that conform to also be important. ............................................................................................................................................................. 63 6. Easedon datafrom SINIM. The Governmentcould also review the tradeoffs between would receive less transfers in the future. Fourth, the ensuring technical standards of regional or municipal analysis could include an assessment of local and regional investment projects on the one hand, and flexibility to institutional capacities - including, for example, local choose a project design that corresponds better to local capacity to deliver quality education. Fifth, the analysis needs on the other hand. Chile's methodology for project embodied in the previous four steps could be integrated evaluation is sound and sophisticated. An option to with subnational economic planning exercises and the consider as an alternative-- at leastfor smaller projects-- to forthcoming regional investment plans (anteproyectos the current approach of applying the rigorous evaluation regionales de inversion, ARI) to ensure that compensation criteria to every project no matter its size would be the ex- transfers are reflected in current expendituredecisions. ante setting of general and technical criteria for the use of sectoral funds, accompanied by an ex-post monitoring and evaluation system that ensures that the funds are used as 4. Aligning Resource Allocations w i t h plannedand that the projects are of satisfactoryquality. ............................................................................ Decision Making Authority Further analytical work could provide important leads for As mentionedabove,Chile's modelof decentralizationplaces policy options for using transfer and equalization a large share of resources in the hands of regional, and to a mechanisms to support a broader regional development lesser extent local, governments without an equivalent strategy and reduce regional inequities in Chile. A mix of transfer of decision-makingauthority. This approach helps both economic growth strategiesand social considerations the national government ensure that regional services and is needed to shape regional development plans. As investments correspond to uniform standards across the mentioned above, Chile has successfully used economic nation. By the same token, it does not allow for much planning in several cases to achieve regional and local flexibility to respond to regional and local preferences and growth conditions. Regional strategies for growth and needs, which is one of the key principlesof decentralization. competitivenesscan be pursued in parallel with plans to Chile has already experimented with increasedparticipation provide minimum service levelsthroughout the country. of local governments in specific programs. Over time, these initiatives could be improved and scaled up, and An explicit territorial policy could build uponthe analysisof accompaniedbyadditional revenueassignments. Doingthis current equalizationimpactof government programsinthe successfully hinges on improved intergovernmental territories. Following, for example, the recent Canadian coordination, clarification of functional assignments, and a federal social pact,which is designedto enable all provinces gradual increase in subnational revenue raisingauthority. to providecomparable levelsof servicestaking into account revenue raising capacity, such analytical work could focus Intergovernmental Coordination. With the multitude of on five areas. First,the analysis could decompose the per actorsin a decentralized context-the Ministryof the Interior, capita inter- and intra-regionalincidenceof different forms sectoral agenciesand their deconcentratedoffices, regional of public expenditures and investments by source of and local governments - there is a strong need for a well- funding and over time. Given the fact that Chile does have functioning coordination mechanism for planning, a number of budget programs that are allocated on a implementation and management of public investments regionalbasis,it is notjust the fiscal transfersthrough FNDR and services. .InChile,the lack of such a mechanism has led or the Zonas Extremas (ZE) policies that need to be in some cases to the unresponsiveness of investments to measured. Second, the analysis could include a review of local needs, duplication of investments by competing the incentives and capacity to raise revenue at the local programs, and over-design of infrastructure for local level. Third, it could attempt to determine the approximate conditions (World Bank, 2004b).The recent revision of the per-capitacost of providing minimum subnational services Regional Government Law attempts to improve that are to be guaranteedto any Chilean citizen regardless coordination somewhat by requiring the intendentes, ofwherethey live. This would helpdesigna transfer system together with the SEREMls (the regional representatives of that ensures minimum per capita resources sufficient to the national ministries),regional service directors and the guarantee minimum service standards. Territories that do regional consejos, to prepare ARI, which -include all direct not have sufficient revenues to meet minimum service public investmentas well as other programs such as CORFO standards would be compensatedaccordingly. In order to aimed at promoting regionaldevelopment.TheARI have to 64 maintainfiscal neutrality,territories that already have more betaken intoconsiderationinthe budget formulationofthe revenues than needed for standard subnational services sectoral agencies. It is not clear how the ARI, once implemented,will affectregional investment, but given that could be valuable in improving cross-sectoral and they are not binding at the national level, their impact may intergovernmentalcoordination. be small. There is also room for increased horizontalcoordination,i.e. among units of the same level of government. In many A potentially effective option for improving coordination countries, subnational governments enter partnerships with would be a territorial approach which shifts the focus from each other (or with private organizations)to provide certain sector-specific to geographic strategies, thereby ensuring a services. InSpain,there is a longtraditionofmuncomunidudes more integratedsolutionto regionaldevelopment.Territoria1 through which local governments agree to jointly perform development strategies can also be useful to take into one or more services; a successful example is the Greater account the linkages between neighboring provinces and Bilbao Water Partnership which manages water supply and municipalitiesin differentregions.Theterritorialapproachto seweragetreatmentfor 24 municipalities(Font et al., 1999). development provides an opportunity not only to improve regional coordination between levels of government, but In Chile, cooperation between municipalities has been also between government, community associations, private somewhat limited,partly because of restrictionsimposedby firms and individuals with the objective of promoting Law 18.695, which prevents such associative bodies from regional development in a specific territory. It aims to registeringas legal entities,and because of limited available facilitate integration by maximizing synergies at the local financing (SUBDERE,1999). level through networking across all agents or agencies involved. The territory provides the base to identify The national government could provide more support for capacities,businessopportunities,competitivenesspotential, such arrangements to take advantage of externalities, bottlenecks and constraintsto development. economies of scale or insufficient capacity of individual municipalities through co-financing associative Territorial planning is widely used in OECD countries: The arrangements.For example, matchinggrantsfrom the central European Union, for instance, launched the LEADER initiative government couldencouragemunicipalitiesto collaborateon as part of an integrated rural development strategy in 1991 solid waste, urban planning, or tourism. A simulation of the (OECD,2003). Chilehasgained experiencewith the territorial potentialbenefits of municipalassociationsin education and approach through SUBDERE's Infrastructure for Territorial healthservices suggests that in these sectors, there may not DevelopmentProject(WorldBank,2005d), and is now starting besignificantgainsinefficiency or qualityof services; but ina to apply the concept of territorial planning in rural areas number of well-defined areas such as bulk purchases of through a projectcovering roads,water, sanitation, electricity supplies, cooperation couldbebeneficial (WorldBank,2005~). and information & communication technology in selected regions (Box 2). Another experience is the Chile Emprende Clarification of Functional Assignments. In order for program (Box3). The experience gained from these projects intergovernmental coordination to work, the functions of The lnfranructureforTerritorialDevelopmentprojectwas Initiatedin 2005 I$ the ChileanGovernmentwiththefinancingandtechnicalassistancefrom the WorldBankJheobjectiveis to ImprovethroughselectedInvstmentsin ruralinfrastructure(roads,el&ricity, waterhanitationand telecommunications)the livingconditionsof the rural populationin25territorieslocatedinthe regionsofCoqulmbo,Maule, BioBio,AmucaniaandLosLagosAttheendofthe project In2009, itis expectedthat 90 qrcentof the populationwifl haveacceapwater, sanitationand rurai~dqrificationsepices and thatthe useof transport servkeswillhaveincreasedby20percent, A key element of the projectstrategyis the preparationof multi-sect?territorialdeveJapmentplans(p orcodederarrollorerrifwial,PWDT).Theseplans prioritize among selected interventionsin rural infrastructurethat will help implement a territorialdevelopment strategy defined by local stakehoklers themselves, based on the economic potentialof the territories.Benefitsarisefrom an enhancedeffectivenessof rural infrastructureinvestmentswithgreater complementaritieracrosssectorsanda betteralignmentwithlocalnheds.ln addition,thepartialdevolutionof investmentdecislonsatthelocallevelisafirst movetowards a greaterempowermentof localstakeholdersandtherethinkingof theexistingcentralizeddecisiin-makingframework By early 2006,the processto prepareterritorialdevelopment plans had been initiatedin 1Iterritories (regionsof Bio-Bio andCoquimbo).This processhad createda real momentumfor local stakeholdersto voice uptheir needsand thinkstrategicallyaboutthedevelopmentof their territories, 65 each level of government must be clearly defined. In Streamlining. The basket of services that has evolved in general, Chile has an economically efficient allocation of Chile over past decades is complex, and in some cases, out- responsibilities across different government levels. While dated. For example, there are 75 development programs there are opportunities to take better advantage of that contribute to the goal of rural growth, while in parallel economies of scale and deal with externalities, the main there are another 44 social service programs targeting the issueis the management of existing assignments, especially rural poor. These 119 programs involve over 25 different in service provision. It is not clear, for instance, to what national agencies. With such multiplicity of programs, extent rain-water drainage is a municipal responsibility, or coordination and efficient service delivery at any level - what is the role of the region with regardsto urban and rural whether national, regional or local - is clearly difficult. As roads. services are increasingly decentralized,and as local priorities increasingly determine local expenditure patterns, regional There is also scope to develop mechanisms through which and local governments will be challenged to juggle and set local, regional and central levels of government can discuss priorities acrossthis large number of national programs.The their respective competencies and responsibilities for very process of decentralization, therefore, provides an investment decisions. For example, a regional road, while ekcellent opportunity for the government at all levels to clearly a regional responsibility, may benefit from consolidate and rationalize these service programs, and consultation with, and participation of, those municipalities thereby achieve higher levels of efficiency and cost savings. affected by the project. This could help improve the design, Chile Solidario and Chile Emprende have already started this ensure appropriate service provision and ensure process of streamlining intheir respective sectors. complementarity with local investments such as access roads. LocalRevenue.Clearer functional assignmentsand stronger intergovernmental coordination could be important in Ifmore decision-making power and responsibilityfor service ensuring a more effective role for local governments. delivery is to be decentralized to the subnational level, the However, this would not address the disconnect between role of the national ministries could be adjusted. The expenditure responsibilities and revenue assignments. SEREMls (the regional representatives of the national Currently, Chile has a highly centralized system of public ministries) currently retain a dominant role in designing, revenues, with transfers financing the bulk of regional and implementing and monitoring services in the regions. Over local expenditures.Thisblurs the link betweenbenefits,which time, as the capacity of regional and local governments are provided at the local level, and costs, which are borne by grows,sectoral agenciescould havea more important role to the central government via transfers to the local level.This play in the setting of regulations and standards, the approach can lead to weaker local accountability, but also to provision of technical expertise, and in monitoring inefficiencies due to the existence of the so-called"flypaper performance. effect": intergovernmentaltransfers stimulate local spending 66 by more than an equivalent increase in private income Decentralization as an Opportunity for Government (Gramlich, 1987). Thereare veryfew countries inwhich localgovernmentscan The national government can also influence subnational finance themselves entirely through locally-raised revenue. capacity by setting incentives tied to performance. While Chilean municipalities currently collect on average about overall accounting, reporting and communicationstandards half of their total revenuesat the locallevel. However,there across levels of government generally function well, is great variation:shares range from less than 10 percent to subnational governments still lag far behind the national 80 percent. The bulk of own source revenuesare accounted level in terms of systematic monitoring and evaluationwith for by property and vehicle taxes and commercial licenses. a focus on results management. The national system for However, high and often discretionaryexemptions and lags management strengthening and results-basedcontrols-- in in property valuation limit reliance on local revenues and particular the DIPRES-managed system that has been thereby constrain the efficient allocation of resources. expanding consistently since 1997 - has not yet been extended to subnational governments (except when Policy Options. The Government could consider granting subnationalgovernments participateina nationalprogram). more control to municipalities over property taxes. An Adjustment and extension of the more advanced systems important option - interms of revenue impact would be to - developed by the national government is a key element in reducethe levelof exemptions (exemptionstotaled around strengthening institutional capacity and in creating 60 percent in the early 1990s) and to keep property incentivesfor good performance. valuations updated. Another option would be to grant local governments greater discretion over tax rates within a There is now a system in place (SINIM,Sistema Nacionalde certain band (between 1 and 2 percent of property lndicadoresMunicipales)that provides over 150standardized valuation,for instance).The advantage of such a band is that indicators for each of the 341 municipalities. This it would, on the one hand, allow municipalities to be information is not only transmitted to the national responsive to local demands for public goods (and exert government, but is easily accessible to the general public pressure on them to increase efficiency) and, on the other through the SUBDEREwebsite. This informationcan provide hand, limit tax competition between municipalities. To an initial set of performance-based indicatorsfor extension preventmunicipalitiesfromsettingtax rates deliberatelylow of the management-focused DIPRES system, thereby in order to minimize their contributions to the FCM, such offeringa moreextensiveview of localperformance. contributions could be calculated based on a uniform tax ratefor all municipalities- regardlessof the actual tax rate in Criticalto institutional strengthening is the option of giving each location-which would not penalize local governments municipalities greater flexibility to modify their that choose a higher actual rate (World Bank, 1993). organizational structure, especially in personnel management. The recent changes in the municipal government law and the Chilean constitution have given 5 , Strengthening Institutions and municipalities more responsibility for human resource .................................................,............,.............effectively Enhancing Subnational Capacity management, but these provisions have not yet been implemented. Human resources management A keychallengefor Chile'sdecentralizationduringthe coming has been found to be one of the most important obstacles administration is to continue enhancing subnationalcapacity preventing improved performance in education and health in order to ensure a highqualityof service delivery. care,despiteincreasedspending(WorldBank, 2005~). Programs to strengthen local institutions have intensifiedin the past years through the PROFIM projects (Programa de More flexibility could entail greater discretion in hiring and FortalecimientoMunicipal), which have focused on municipal firing of personnel, and the introduction of performance planning, financial and human resource management, and incentives as part of remuneration. Experience from the management of health and education services. Regional PROFIM shows that greater flexibility has led to the capacity is being strengthened through a program aimed at preparation of plans for human resources management, raisingtheefficiencyand managementofregionalinvestment. organizational restructuring, and streamlining of International experience shows that in addition to direct administrativeprocesses. capacity building programs, there are a number of indirect mechanisms that could help improve local government PolicyOptionsfor Institutional Strengthening. A phased- performance. For instance, nationwide local government in adjustmentand extensionto the subnationallevels of the associations can be a useful forum for sharing information, DIPRES-based system for Management Control and Budget 67 disseminatingbestpractices,and identifyingtraining needs. by Results could be an important element of a broader program to enable local governments to formulate and of 12 indicatorsper government institution.Introductionof implement policies that respond to local preferences, a rigorous and sustainable program of performance enhancing the capacity of local governments and creating indicators at subnational levels would require technical incentives for good performance. The system has proven to assistance from the center.Pilot introduction would again beone ofthe mosteffectiveworldwide;it hasthe potentialto be a logical approach. evaluate not just programs but government performance and policies as well, including the increasingly important (v) The integrated management balance includes regionaldevelopmentand innovationplans. management reports with an assessment of the overall performance of each regional or local government, its SE, The system currently consistsof six main programs of which main results achieved during the previous fiscal year, five could, in an adjusted manner, be phased in at sub- investmentprojectsand expectedtransfers. nationalgovernmentlevels. (i)The evaluation program(EP) could be readily extended to 6. Increasing Public Participation and selected priority programs at subnational levels. .............................................*.............................. Voice Implementationof the PE might start with desk evaluations, then extend to impact evaluations. What appearsto be most The public can also play an important role in improving the importantis to linkthe EP to regionaland local budgetcycles performanceof subnational governments by holding them so that like at the national level evaluations enrich budget - - accountable for their actions. There are at least two decisi0ns.Apilotapproach,beginningwith the largestregions important preconditionsfor increasedlocalaccountability:1) and municipalities,could be implementedin the earlyphases transparency and accessibility of information on public of the extensionof the EP to subnationallevels.Disclosureof services and local government performance; and 2) evaluation reports -- including its recommendations- and mechanisms through which citizens can voice their government commitments for enhancing the quality of the preferencesand concernsto localdecisionmakers. program would facilitate civil society participation in the monitoringof the evaluation's impact. In order to achieve the objectivesof Chile's decentralization reform - better responsiveness, and a more efficient (ii) The strategic definitions (SD) could provide the allocation of resources the Government could consider - strategic framework of subnational government. SD would building on existing initiatives aimed at transparency and enhance the quality of local and regional planning,tie the public participation. EP to the budget cycle and link the logical framework of subnational programs with government priorities at all Public participation in the planning process offers the levels - thereby contributing to intergovernmental opportunity both to disseminate information and to receive expenditurecoordination. feedback on what is needed.The municipal government law requiresthat the preparationofthe communitydevelopment (iii) The management enhancement program could plans (Plande Desarrollo Comunal, PLADECO)include public contribute to the development of standardized, common participation. Under PROFIM, the process encompasses procedures in subnational administrations. The program severalmechanismsfor the public to provideinputs:surveys, would needto be adjustedto the particularitiesof local and suggestion boxes, personal interviews with stakeholders, regionaladministrations(particularlyin the areas of Human communitymeetingsandfocus groups. Ingeneral, it is upto Resourcesand IntegratedTerritorialManagement)in order to the municipalities to decide on the extent and form of the properly reflect those management features of participationprocess. intergovernmentalcoordinationthat dominatethe profileof managementcapacity,particularlyat the regionallevel.Pilot, Territorial planning, if well designed, also offers an phased-inintroduction could include a bonusfor employees opportunity for more public participation.Thereare already of subnationalgovernmentswith good performance. some initiatives underwaythat are aimed at strengthening the voice of local stakeholdersand regional governments: (iv) Performance indicators. DIPRES has already as part of the Infrastructure for Territorial Development accumulated an enormous experience in identifying and Project, territorial development framework plans for 68 increasinglyrefining performance indicators institution by infrastructure investment are prepared through a institution.At this point, the nationalsystem has anaverage participatory process. Every municipalityalso has to have an economic and social beextendedto a larger share of the budget. council made up of community representatives.The council is chaired by the alcalde and is required to comment on the (iii)ParticipatoryPerformanceMonitoring:One of the most cuenta publica, and the efficiency of municipal services. This effective tools to monitor local government performance arrangementthusin principle,ensuresa certainlevelofex-post are citizen report cards. In Bangalore,India,a localNGOfirst accountabilityofthe municipalgovernmenttothecommunity. used citizen report cards to assess the quality of local Equally important is the ability of the general public to services. Report cards are now a common tool in other monitor the performance of their local governments. countries as well; for instance,in the Philippines, where the Expanding the national performancemonitoring system to results of the local government performance survey are subnational governmentswouldfacilitatethis,as itwould not linked to budget allocations. Other tools include public only provideinformationfor the executiveand congress,but surveys and instrumentsthat assess citizens'willingness to engage citizens in the assessment of programas and enable payfor certainservices. them to betterformulateand monitor their own priorities. Policy Options to Strengthen the Voice of Citizens. International experience with participation and voice mechanismscould helpChile improveand expandits system to strengthen local accountability. The OECD approach generally emphasizes availability of information on local government performanceandformal feedback mechanisms. A number of middle-income countries, on the other hand, have had success with more direct models of public involvement. Both approaches are relevant for Chile, given the initiatives that are currently under way. Three areas in particularare of interest: (i)Strengthening transparency: When local governments makeinformationon localservicestandardsreadilyavailable, citizens are able to assess whether local governments performadequately.InAustralia,Citizen'sChartershave been adopted at the statekerritory level, guaranteeing specific standards for service delivery. In the UK,local governments produce annual Best Value performance plans with public consultation, and the plansare made available to the public. The performance indicators are then published at the national level, enabling citizens to compare their local government's performance againstotherjurisdictions. (ii) Participatory budgeting: Participatory budgeting can increase efficiencyin budget allocations by reducingagency costs and breakingdown information barriers between the state and society. It also ensures that there is a high level of transparency in the budget formulation process.One of the most successful examples of participatory budgets can be found in the municipality of Porto Alegre in Brazil, where citizens take part in determining spending priorities for infrastructureand social services through a system of grass- rootsassemblies. 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