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Unemployment Compensation and the Allocation of Labor in Developing Countries

  • Charlot, Olivier

    (THEMA, University of Cergy-Pontoise)

  • Malherbet, Franck

    (CREST, Ecole Polytechnique, IZA and fRDB)

  • Ulus, Mustafa


    (Galatasaray University Economic Research Center)

This paper studies the effects of the introduction of unemployment compensation (UC) in countries characterized by pervasive informality. We provide a simple framework to analyze the impact of UC on the allocation of workers between formal and informal activities, as well as the allocation of workers between sectors featuring different incentives to go informal. We show that a reasonable amount of UC may reduce informality, while larger amounts of UC induce large disincentives to go formal because of the level of taxation involved. We also argue that the financing of UC should be part and parcel of a well- conceived UC system. We show that UC finance based on payroll taxes is likely to entail an excess level of informality resulting from cross-subsidies between heterogenous sectors. The introduction of a simple layoff tax meant to finance the UC system is then shown to reduce informality, hence highlighting how a well-designed financing scheme may be used as a supplementary instrument to curb informality.

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Paper provided by Galatasaray University Economic Research Center in its series GIAM Working Papers with number 13-3.

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Length: 50 pages
Date of creation: 22 Feb 2013
Date of revision:
Handle: RePEc:ris:giamwp:2013_003
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