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

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  • Bosch, Mariano
  • Esteban-Pretel, Julen

Abstract

Unemployment benefit systems are nonexistent in many developing economies. Introducing such systems poses many challenges, which are partly due to the high level of informality in the labor markets of these economies. This paper studies 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 intersectoral 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 benefit system, where workers contribute when employed in the formal market and collect benefits when they lose their jobs, can lead to 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 employment taxes and firing costs, can produce greater decreases in informality and lower impacts on unemployment than when the program is applied in isolation.

Suggested Citation

  • Bosch, Mariano & Esteban-Pretel, Julen, 2013. "Labor Market Effects of Introducing Unemployment Benefits in an Economy with High Informality," IDB Publications (Working Papers) 4544, Inter-American Development Bank.
  • Handle: RePEc:idb:brikps:4544
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Juliana MESÉN VARGAS & Bruno VAN DER LINDEN, 2017. "Is there always a trade-off between insurance and incentives? The case of unemployment with subsistence constraints," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) 2017014, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
    2. Gimpelson, Vladimir & Kapeliushnikov, Rostislav, 2014. "Between Light and Shadow: Informality in the Russian Labour Market," IZA Discussion Papers 8279, Institute of Labor Economics (IZA).
    3. Julien Albertini & Anthony Terriau, 2018. "Informality over the life-cycle," Working Papers halshs-01957491, HAL.
    4. Afonso, Óscar, 2016. "Effects of labour-market institutions on employment, wages, R&D intensity and growth in 27 OECD countries: From theory to practice," Economic Modelling, Elsevier, vol. 53(C), pages 48-62.
    5. McKay Andy & Pirttilä Jukka & Schimanski Caroline, 2018. "The Elasticity of Formal Work in African Countries," Working Papers 1820, University of Tampere, School of Management, Economics.
    6. Traoré, Jean Abel & Ouedraogo, Idrissa Mohamed, 2015. "Public policies promoting the informal economy: effects on incomes, employment and growth in Burkina Faso," MPRA Paper 74760, University Library of Munich, Germany.
    7. repec:eee:wdevel:v:119:y:2019:i:c:p:1-22 is not listed on IDEAS
    8. Colombo, Emilio & Menna, Lorenzo & Tirelli, Patrizio, 2019. "Informality and the labor market effects of financial crises," World Development, Elsevier, vol. 119(C), pages 1-22.
    9. Alonso-Ortiz, Jorge & Leal Ordonez, Julio, 2013. "The Elasticity of Informality to Taxes and Transfers," MPRA Paper 49568, University Library of Munich, Germany.

    More about this item

    Keywords

    Social Security; WP-402; Labor Policy;

    JEL classification:

    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search
    • J65 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment Insurance; Severance Pay; Plant Closings
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements

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