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The Labor Market Effects of Introducing Unemployment Benefits in an Economy with High Informality

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Author Info

  • Mariano Bosch

    (Inter-American Development Bank)

  • Julen Esteban-Pretel

    (National Graduate Institute for Policy Studies)

Abstract

Unemployment benefit systems are non-existent in many developing economies. Introducing such programs in these economies poses many challenges, which is partly due to the high level of informality in their labor markets. In this paper we study the consequences on the labor market of implementing an unemployment benefit system in economies with large informal sectors and high flows of workers between formality and informality. We build a search and matching model with endogenous destruction, on-the-job search and inter-sectoral flows, where agents in the economy decide optimally whether or not to formalize jobs. We calibrate the model for Mexico and show that the introduction of an unemployment subsidy system, where workers contribute during formal employment and collect benefits when they lose the job, can deliver an increase in formality in the economy while also producing small increases in unemployment. The exact impact of incorporating such benefits depends on the relative strength of two opposing effects: the generosity of the benefits and the level of the contributions that finance those benefits. We also show important policy complementarities with other interventions in the labor market. In particular, combining the unemployment benefit program with policies that reduce the cost of formality, such as lower firing costs or taxes, can produce decreases in informality and lower impacts on unemployment than when the subsidy program is applied in isolation.

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Bibliographic Info

Paper provided by National Graduate Institute for Policy Studies in its series GRIPS Discussion Papers with number 12-20.

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Length: 37 pages
Date of creation: Feb 2013
Date of revision:
Handle: RePEc:ngi:dpaper:12-20

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Cited by:
  1. Jorge Alonso-Ortiz & Julio Leal, 2013. "The elasticity of Informality to Taxes and tranfers," Working Papers, Centro de Investigacion Economica, ITAM 1308, Centro de Investigacion Economica, ITAM.
  2. Gimpelson, Vladimir & Kapeliushnikov, Rostislav, 2014. "Between Light and Shadow: Informality in the Russian Labour Market," IZA Discussion Papers 8279, Institute for the Study of Labor (IZA).

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