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Shadow Sorting

Author

Listed:
  • Tito Boeri
  • Pietro Garibaldi

Abstract

This paper investigates the border between formal employment, shadow employment, and unemployment in an equilibrium model of the labor market with market frictions. From the labor demand side, firms optimally create legal or shadow employment through a mechanism that is akin to tax evasion. From the labor supply side, heterogeneous workers sort across the two sectors, with high productivity workers entering the legal sector. Such worker sorting appears fully consistent with most empirical evidence on shadow employment. The model sheds also light on the "shadow puzzle", the increasing size of the shadow economy in OECD countries in spite of improvements in technologies detecting tax and social security evasion. Shadow employment is correlated with unemployment, and it is tolerated because the repression of shadow activity increases unemployment. The model implies that shadow wage gaps should be lower in depressed labor markets and that deregulation of labor markets is accompanied by a decline in the average skills of the workforce in both legal and shadow sectors. Based on micro data on two countries with a sizeable shadow economy, Italy and Braziil, we find empirical support to these implications of the model. The paper suggests also that policies aimed at reducing the shadow economy are likely to increase unemployment.

Suggested Citation

  • Tito Boeri & Pietro Garibaldi, 2006. "Shadow Sorting," Carlo Alberto Notebooks 10, Collegio Carlo Alberto.
  • Handle: RePEc:cca:wpaper:10
    as

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    File URL: http://www.carloalberto.org/assets/working-papers/no.10.pdf
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    Other versions of this item:

    • Tito Boeri & Pietro Garibaldi, 2005. "Shadow Sorting," NBER Chapters,in: NBER International Seminar on Macroeconomics 2005, pages 125-163 National Bureau of Economic Research, Inc.

    References listed on IDEAS

    as
    1. Steven J. Davis & Magnus Henrekson, 2004. "Tax Effects on Work Activity, Industry Mix and Shadow Economy Size: Evidence from Rich-Country Comparisons," NBER Working Papers 10509, National Bureau of Economic Research, Inc.
    2. Gustavo Gonzaga, 2003. "Labor Turnover and Labor Legislation in Brazil," ECONOMIA JOURNAL, THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION - LACEA, vol. 0(Fall 2003), pages 165-222, August.
    3. Pietro Garibaldi & Etienne Wasmer, 2005. "Equilibrium Search Unemployment, Endogenous Participation, And Labor Market Flows," Journal of the European Economic Association, MIT Press, vol. 3(4), pages 851-882, June.
    4. Kenneth Burdett & Dale T. Mortensen, 1977. "Labor Supply Under Uncertainty," Discussion Papers 297, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    5. Eran Yashiv, 2000. "The Determinants of Equilibrium Unemployment," American Economic Review, American Economic Association, vol. 90(5), pages 1297-1322, December.
    6. Fredriksson, Peter & Holmlund, Bertil, 2001. "Optimal Unemployment Insurance in Search Equilibrium," Journal of Labor Economics, University of Chicago Press, vol. 19(2), pages 370-399, April.
    7. Tito Boeri & Andrea Brandolini, 2004. "The Age of Discontent: Italian Households at the Beginning of the Decade," Giornale degli Economisti, GDE (Giornale degli Economisti e Annali di Economia), Bocconi University, vol. 63(3-4), pages 449-487, December.
    8. Gary S. Becker, 1974. "Crime and Punishment: An Economic Approach," NBER Chapters,in: Essays in the Economics of Crime and Punishment, pages 1-54 National Bureau of Economic Research, Inc.
    9. James Albrecht & Susan Vroman, 2002. "A Matching Model with Endogenous Skill Requirements," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 43(1), pages 283-305, February.
    10. Friedrich Schneider & Dominik Enste, 1999. "Shadow Economies Around the World - Size, Causes, and Consequences," CESifo Working Paper Series 196, CESifo Group Munich.
    11. Wasmer, E. & Zenou, Y., 1997. "Equilibrium Urban Unemployment," DELTA Working Papers 97-15, DELTA (Ecole normale supérieure).
    12. Tito Boeri & Pietro Garibaldi, "undated". "Shadow Activity and Unemployment in a Depressed Labor Market," Working Papers 177, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    13. repec:spo:wpecon:info:hdl:2441/8921 is not listed on IDEAS
    14. Dominik H. Enste & Friedrich Schneider, 2000. "Shadow Economies: Size, Causes, and Consequences," Journal of Economic Literature, American Economic Association, vol. 38(1), pages 77-114, March.
    15. Schneider, Friedrich, 2004. "The Size of the Shadow Economies of 145 Countries all over the World: First Results over the Period 1999 to 2003," IZA Discussion Papers 1431, Institute for the Study of Labor (IZA).
    16. Feige, Edgar L, 1994. "The Underground Economy and the Currency Enigma," Public Finance = Finances publiques, , vol. 49(Supplemen), pages 119-136.
    17. Gilles Saint-Paul, 1995. "The High Unemployment Trap," The Quarterly Journal of Economics, Oxford University Press, vol. 110(2), pages 527-550.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Unemployment; Matching; Shadow Activity.;

    JEL classification:

    • J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General

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