Labor Market Effects of Unemployment Insurance and UBI in Developing Economies

Alexandre Cunha, Guilherme Gallego, Marcelo Santos and Bernardus Doornik

No 646, Working Papers Series from Central Bank of Brazil, Research Department

Abstract: This paper studies the labor market impacts of implementing a Universal Basic Income (UBI) in developing economies with large informal sectors. We study an unexpected reform in the unemployment insurance policy in Brazil that tightened the eligi bility criteria for most (but not all) formal workers. We provide evidence that unemployment insurance (UI) benefits reduce formal employment, and this effect is amplified by informality. We then study the consequences of replacing the existing trans fer and UI policies with a universal basic income using a search-and-matching model where workers and firms jointly sort between formal and informal jobs. We calibrate the general equilibrium model to match key moments concerning unemployment, wage, and wealth distributions, as well as the distribution of transfers. Our model captures important trade-offs of UBI in developing countries. While UBI improves incentives to work formally relative to traditional welfare, its implementation raises concerns about financial sustainability due to limited tax revenue. We show that a universal basic in come of nearly $80 for each household per month, which replaces the existing transfer programs and UI benefits, can lead to welfare gains, particularly for less skilled individuals. We show that the increase in formal sector activity helps offset the higher tax burden and is a key channel through which outcomes for low-education groups improve with the reform.

Date: 2026-05
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