Labor Market Policies in a Dual Economy

Julen Esteban-Pretel and Sagiri Kitao

Labour Economics, 2021, vol. 68, issue C

Abstract: A structural model of heterogeneous agents is built to account for the labor market dynamics of an economy with a large informal sector and to quantify effects of labor market policies on employment, worker flows, savings and welfare in a dual economy. The introduction of unemployment insurance has only a small impact on unemployment but induces a sectoral reallocation of formal labor into informality. Generous severance payments lower the wage of formal jobs and reduce flows from unemployment to formality. In financing expenditures, shifting a tax burden from labor income to consumption increases the size of a formal sector, enhancing productivity and welfare. Economic and welfare consequences of policy reform can significantly differ from those in a single-sector economy due to workers’ incentives to avoid taxes and maximize transfers by moving across sectors.

Keywords: Informal sector; dual economy; unemployment insurance; severance payment (search for similar items in EconPapers)
JEL-codes: E6 J2 J6 O17 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:labeco:v:68:y:2021:i:c:s0927537120301603

DOI: 10.1016/j.labeco.2020.101956

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