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Unemployment Compensation and the Allocation of Labor in Developing Countries

Olivier Charlot, Franck Malherbet () and Mustafa Ulus ()

No 7233, IZA Discussion Papers from Institute of Labor Economics (IZA)

Abstract: This paper studies the effects of the introduction of unemployment compensation (UC) in countries characterized by pervasive informality. We provide a simple framework to analyze the impact of UC on the allocation of workers between formal and informal activities, as well as the allocation of workers between sectors featuring different incentives to go informal. We show that a reasonable amount of UC may reduce informality, while larger amounts of UC induce large disincentives to go formal because of the level of taxation involved. We also argue that the financing of UC should be part and parcel of a well- conceived UC system. We show that UC finance based on payroll taxes is likely to entail an excess level of informality resulting from cross-subsidies between heterogenous sectors. The introduction of a simple layoff tax meant to finance the UC system is then shown to reduce informality, hence highlighting how a well-designed financing scheme may be used as a supplementary instrument to curb informality.

Keywords: labor market imperfections; unemployment compensation; informality (search for similar items in EconPapers)
JEL-codes: E24 E26 J60 L16 O1 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dev, nep-iue, nep-lab and nep-mac
Date: 2013-02
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Forthcoming in: Journal of Public Economic Theory [Online First]

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Related works:
Journal Article: Unemployment Compensation and the Allocation of Labor in Developing Countries (2016) Downloads
Working Paper: Unemployment Compensation and the Allocation of Labor in Developing Countries (2013) Downloads
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