Labor Market Effects of Introducing Unemployment Benefits in an Economy with High Informality

Mariano Bosch and Julen Esteban-Pretel

No 4544, IDB Publications (Working Papers) from Inter-American Development Bank

Abstract: Unemployment benefit systems are nonexistent in many developing economies. Introducing such systems poses many challenges, which are partly due to the high level of informality in the labor markets of these economies. This paper studies the consequences on the labor market of implementing an unemployment benefit system in economies with large informal sectors and high flows of workers between formality and informality. We build a search and matching model with endogenous destruction, on-the-job search, and intersectoral flows, where agents in the economy decide optimally whether or not to formalize jobs. We calibrate the model for Mexico, and show that the introduction of an unemployment benefit system, where workers contribute when employed in the formal market and collect benefits when they lose their jobs, can lead to an increase in formality in the economy, while also producing small increases in unemployment. The exact impact of incorporating such benefits depends on the relative strength of two opposing effects: the generosity of the benefits and the level of the contributions that finance those benefits. We also show important policy complementarities with other interventions in the labor market. In particular, combining the unemployment benefit program with policies that reduce the cost of formality, such as lower employment taxes and firing costs, can produce greater decreases in informality and lower impacts on unemployment than when the program is applied in isolation.

Keywords: Social Security; WP-402; Labor Policy (search for similar items in EconPapers)
JEL-codes: H26 J64 J65 O17 (search for similar items in EconPapers)
Date: 2013-04
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Citations: View citations in EconPapers (2)

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Related works:
Journal Article: The labor market effects of introducing unemployment benefits in an economy with high informality (2015)
Working Paper: The Labor Market Effects of Introducing Unemployment Benefits in an Economy with High Informality (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:idb:brikps:4544

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