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The Effects of Labor Market Policies in an Economy with an Informal Sector

James Albrecht (), Lucas Navarro and Susan Vroman ()

No 2141, IZA Discussion Papers from Institute for the Study of Labor (IZA)

Abstract: In many economies, there is substantial economic activity in the informal sector, beyond the reach of government policy. Labor market policies, which by definition apply only to the formal sector, can have important spillover effects on the informal sector. The relative sizes of the informal and formal sectors adjust, the skill composition of the workforce in the two sectors changes, etc. In this paper, we build an equilibrium search and matching model to analyze the effects of labor market policies in an economy with an informal sector. Our model extends Mortensen and Pissarides (1994) by allowing for ex ante worker heterogeneity with respect to formal-sector productivity. We analyze the effects of labor market policy on informal- and formal-sector output, on the division of the workforce into unemployment, informal-sector employment and formal-sector employment, and on wages. Finally, our model allows us to examine the distributional implications of labor market policy; specifically, we analyze how labor market policy affects the distributions of wages and productivities across formal-sector matches.

Keywords: search; informal sector; matching (search for similar items in EconPapers)
JEL-codes: E26 J64 J65 O17 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dev, nep-dge, nep-lab, nep-ltv and nep-mac
Date: 2006-05
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Published in: Economic Journal, 2009, 119 (539), 1105 - 1129

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Journal Article: The Effects of Labour Market Policies in an Economy with an Informal Sector (2009) Downloads
Working Paper: The Effects of Labour Market Policies in an Economy with an Informal Sector (2008) Downloads
Working Paper: The Effects of Labor Market Policies in an Economy with an Informal Sector (2006) Downloads
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