Shadow Sorting

41 Pages Posted: 18 May 2006

See all articles by Tito Boeri

Tito Boeri

Bocconi University - Department of Economics; Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics

Pietro Garibaldi

Bocconi University - Department of Economics; Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics

Date Written: February 2006

Abstract

This paper investigates the border between formal employment, shadow employment, and unemployment in an equilibrium model of the labour market with market frictions. From the labour demand side, firms optimally create legal or shadow employment through a mechanism that is akin to tax evasion. From the labour supply side, heterogeneous workers sort across the two sectors, with high productivity workers entering the legal sector. Such worker sorting appears fully consistent with most empirical evidence on shadow employment. The model sheds also light on the "shadow puzzle," the increasing size of the shadow economy in OECD countries in spite of improvements in technologies detecting tax and social security evasion. Shadow employment is correlated with unemployment, and it is tolerated because the repression of shadow activity increases unemployment. The model implies that shadow wage gaps should be lower in depressed labour markets and that deregulation of labour markets is accompanied by a decline in the average skills of the workforce in both legal and shadow sectors. Based on micro data on two countries with a sizeable shadow economy, Italy and Brazil, we find empirical support to these implications of the model. The paper suggests also that policies aimed at reducing the shadow economy are likely to increase unemployment.

Keywords: Unemployment, matching, shadow activity

JEL Classification: J30

Suggested Citation

Boeri, Tito and Garibaldi, Pietro, Shadow Sorting (February 2006). CEPR Discussion Paper No. 5487, Available at SSRN: https://ssrn.com/abstract=903181

Tito Boeri (Contact Author)

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

IZA Institute of Labor Economics ( email )

P.O. Box 7240
Bonn, D-53072
Germany

Pietro Garibaldi

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy
+39 02 5836 5422 (Phone)
+39 02 5836 5343 (Fax)

HOME PAGE: http://www.frdb.org/~pietrogaribaldi/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
22
Abstract Views
3,466
PlumX Metrics