Unemployment Insurance in the Presence of an Informal Sector
AbstractWe study the effect of UI benefits in a typical developing country where the informal sector is sizeable and persistent. In a partial equilibrium environment we characterize the stationary equilibrium of an economy where policyholders may be employed in the formal sector, short-run unemployed receiving UI benefits and long-run unemployed without UI benefits. We perform comparative static exercises to understand how UI benefits affect unemployed workers´effort to secure a formal job, their labor supply inthe informal sector and leisure time. Our model reveals that an increase in UI benefits generates two opposing effects for the short-run unemployed. First, since search efforts cannot be monitored it generates moral hazard behaviours that lower effort. Second, it generates an income effect as it reduces the marginal cost of searching for a formal job and increases effort. The overall effect is ambiguous and depends on the relative strength of these two effects. Additionally, we show that an increase in UI benefits increases the efforts of long-run unemployed workers. Using data from Brazil to calibrate the parameters of the model we provide a simple simulation exercise which suggests that the income effect pointed out is not necessarily of second-order importance in comparison with moral hazard strength: An increase in UI benefits may increase unemployed workers efforts to secure a job in the formal sector, instead of increasing informal-sector work. This result softens the widespread opinion that the presence of dual labor markets is an obstacle to providing UI in developing countries.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by UNIVERSIDAD DE LOS ANDES-CEDE in its series DOCUMENTOS CEDE with number 010496.
Date of creation: 22 Jan 2013
Date of revision:
Contact details of provider:
Unemployment insurance; informal sector; income effect; developing countries.;
Find related papers by JEL classification:
- H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions
- I38 - Health, Education, and Welfare - - Welfare, Well-Being, and Poverty - - - Government Programs; Provision and Effects of Welfare Programs
- J65 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment Insurance; Severance Pay; Plant Closings
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-03-09 (All new papers)
- NEP-IAS-2013-03-09 (Insurance Economics)
- NEP-IUE-2013-03-09 (Informal & Underground Economics)
- NEP-LAB-2013-03-09 (Labour Economics)
You can help add them by filling out this form.
reading list or among the top items on IDEAS.Access and download statisticsgeneral information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Universidad De Los Andes-Cede).
If references are entirely missing, you can add them using this form.