Labor Market Informality, Risk, and Insurance

In labor markets with substantial informality, distinct working arrangements offer different prospects for workers. Formal employment provides insurance programs requiring social security contributions and taxes. Informal and self-employment lack public insurance to mitigate risk but offer valuable routes out of unemployment. Workers face complex tradeoffs involving present and future risks, the ability to insure them, liquidity, and earnings. To investigate this question, I develop a life-cycle model of employment type and savings in a frictional search environment. I estimate the model using linked longitudinal survey and administrative Chilean data, exploiting policy reforms. The estimates suggest that formal sector insurance is valued; informal workers would be willing to forgo earnings to be formal employees. Informal opportunities also provide substantial insurance against unemployment risk. Exploring counterfactual policies, I show how the insurance values can be interpreted as summary measures of the attractiveness of these sectors given the policy and labor market environment.