The Anatomy of Behavioral Responses to Social Assistance When Informal Employment Is High

Abstract

The disincentive effects of social assistance programs on registered (or formal) employment
are a first-order policy concern in developing and middle-income countries.
We study the impact of a conditional cash transfer (CCT) program in Uruguay on the
employment of adult members in beneficiary households in a context of high informality.
Our research design relies on the sharp discontinuity introduced by program eligibility
rules around a poverty score threshold combined with longitudinal administrative data.
We find reductions of about 6 percentage points (a 13% drop) in formal labor force participation
among all beneficiaries and of 8.7 percentage points (a 19% drop) for single
mothers. The implied elasticity of participation in the formal sector with respect to the
net-of-tax rate is about 0.78 for the full sample and about 1.3 for single mothers. The
reduction in labor supply is stronger among individuals who have a medium propensity
to be formally employed, with a smaller reduction in the case of infra-marginal individuals.
We also present suggestive evidence that the reduction in formal employment
increases inactivity and informal work in equal proportions. Finally, despite pervasive
informality in the context of the Family Allowance assistance program (AFAM), the
program’s marginal value of public funds of 0.61 implies an efficiency cost within the
range of cash transfer programs targeted to families in the United States.

Keywords: welfare policy, labor supply, registered employment, labor informality

JEL Classification: H31, I38, J22, O17