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How Does Informal Employment Affect the Design of Unemployment Insurance and Employment Protection?

Author

Listed:
  • Emilio Espino
  • Juan M. Sanchez

Abstract

The authors use a simple model to study the optimal design of unemployment insurance and employment protection. Workers are risk averse and face the possibility of unemployment. Firms are risk neutral and face random shocks to productivity. Workers can participate in a shadow economy, or informal sector. The model yields several lessons. First, countries should encourage formal employment to address the issue of informal employment. In extreme cases, such encouragement translates into high severance payments and negative payroll taxes. Along these same lines, unemployment payments cannot be too large. In fact, when the risk of informality is extreme, the authors find that unemployment benefits should be negative, which is (in effect) a positive tax on the lack of formal employment.

Suggested Citation

  • Emilio Espino & Juan M. Sanchez, 2015. "How Does Informal Employment Affect the Design of Unemployment Insurance and Employment Protection?," Review, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlrv:00041
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    File URL: https://files.stlouisfed.org/files/htdocs/publications/review/2015/q2/EspinoSanchez.pdf
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    References listed on IDEAS

    as
    1. Yuzhe Zhang & David L. Fuller & B. Ravikumar, 2013. "Who is concealing earnings and still collecting unemployment benefits?," The Regional Economist, Federal Reserve Bank of St. Louis, issue apr.
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    Cited by:

    1. Mesén Vargas, Juliana & Van der Linden, Bruno, 2017. "Is There Always a Trade-off between Insurance and Incentives? The Case of Unemployment with Subsistence Constraints," IZA Discussion Papers 11034, Institute of Labor Economics (IZA).
    2. Iain W. Long & Vito Polito, 2017. "Job Search, Unemployment Protection and Informal Work in Advanced Economies," CESifo Working Paper Series 6763, CESifo Group Munich.

    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • 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

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