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Unemployment Insurance in the Presence of an Informal Sector

Author

Listed:
  • David Bardey
  • Fernando Jaramillo
  • Ximena Peña

Abstract

We study the effect of UI benefits in a typical developing country where the informal sector is sizeable and persistent. In a partial equilibrium environment we characterize the stationary equilibrium of an economy where policyholders may be employed in the formal sector, short-run unemployed receiving UI benefits and long-run unemployed without UI benefits. We perform comparative static exercises to understand how UI benefits affect unemployed workers´effort to secure a formal job, their labor supply inthe informal sector and leisure time. Our model reveals that an increase in UI benefits generates two opposing effects for the short-run unemployed. First, since search efforts cannot be monitored it generates moral hazard behaviours that lower effort. Second, it generates an income effect as it reduces the marginal cost of searching for a formal job and increases effort. The overall effect is ambiguous and depends on the relative strength of these two effects. Additionally, we show that an increase in UI benefits increases the efforts of long-run unemployed workers. Using data from Brazil to calibrate the parameters of the model we provide a simple simulation exercise which suggests that the income effect pointed out is not necessarily of second-order importance in comparison with moral hazard strength: An increase in UI benefits may increase unemployed workers efforts to secure a job in the formal sector, instead of increasing informal-sector work. This result softens the widespread opinion that the presence of dual labor markets is an obstacle to providing UI in developing countries.

Suggested Citation

  • David Bardey & Fernando Jaramillo & Ximena Peña, 2013. "Unemployment Insurance in the Presence of an Informal Sector," Documentos CEDE 10496, Universidad de los Andes, Facultad de Economía, CEDE.
    • Handle: RePEc:col:000089:010496
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    File URL: https://repositorio.uniandes.edu.co/bitstream/handle/1992/8373/dcede2013-03.pdf
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    Cited by:

    1. Mantilla, Cesar & Rincón, Ferley, 2022. "Mobility and productivity in a dual labor market: an experiment," OSF Preprints 5as84, Center for Open Science.
    2. Romain Duval & Prakash Loungani, 2021. "Designing Labor Market Institutions in Emerging Market and Developing Economies: A Review of Evidence and IMF Policy Advice," Comparative Economic Studies, Palgrave Macmillan;Association for Comparative Economic Studies, vol. 63(1), pages 31-83, March.
    3. Carmen UZLAU & Mariana BALAN & Corina-Maria ENE, 2017. "Labour Market Vulnerabilities In Romania During The Post- Crisis Period," Internal Auditing and Risk Management, Athenaeum University of Bucharest, vol. 46(2), pages 12-27, June.
    4. Iain W. Long & Vito Polito, 2017. "Job Search, Unemployment Protection and Informal Work in Advanced Economies," CESifo Working Paper Series 6763, CESifo.

    More about this item

    Keywords

    Unemployment insurance; informal sector; income effect; developing countries.;
    All these keywords.

    JEL classification:

    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions
    • I38 - Health, Education, and Welfare - - Welfare, Well-Being, and Poverty - - - Government Programs; Provision and Effects of Welfare Programs
    • J65 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment Insurance; Severance Pay; Plant Closings

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