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Product Market Regulation, Firm Size, Unemployment and Informality in Developing Economies

  • Charlot, Olivier

    ()

    (University of Cergy-Pontoise)

  • Malherbet, Franck

    ()

    (University of Rouen)

  • Terra, Cristina

    ()

    (University of Cergy-Pontoise)

This paper studies the impact of product and labor market regulations on informality and unemployment in a general framework where formal and informal firms are subject to the same externalities, differing only with respect to some parameter values. Both formal and informal firms have monopoly power in the goods market, they are subject to matching friction in the labor market, and wages are determined through bargaining between large firms and their workers. The informal sector is found to be endogenously more competitive than the formal one. We find that lower strictness of product or labor market regulations lead to a simultaneous reduction in informality and unemployment. The difference between these two policy options lies on their effect on wages. Lessening product market strictness increases wages in both sector but also increases the formal sector wage premium. The opposite is true for labor market regulation. Finally, we show that the so-called overhiring externality due to wage bargaining translates into a smaller relative size of the informal sector.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 5519.

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Length: 45 pages
Date of creation: Feb 2011
Date of revision:
Publication status: forthcoming as 'Informality in developing economies: regulation and fiscal policies' in: Journal of Economic Dynamics and Control, 2014
Handle: RePEc:iza:izadps:dp5519
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  1. Cahuc, Pierre & Marque, François & Wasmer, Etienne, 2004. "A Theory of Wages and Labour Demand with Intra-firm Bargaining and Matching Frictions," CEPR Discussion Papers 4605, C.E.P.R. Discussion Papers.
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