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

31 Pages Posted: 31 May 2006

See all articles by James Albrecht

James Albrecht

Georgetown University - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute); IZA Institute of Labor Economics

Lucas Navarro

Universidad Alberto Hurtado

Susan Vroman

Georgetown University; IZA Institute of Labor Economics

Date Written: May 2006

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, matching, informal sector

JEL Classification: E26, J64, J65, O17

Suggested Citation

Albrecht, James W. and Navarro, Lucas and Vroman, Susan B., The Effects of Labor Market Policies in an Economy with an Informal Sector (May 2006). IZA Discussion Paper No. 2141. Available at SSRN: https://ssrn.com/abstract=905539

James W. Albrecht (Contact Author)

Georgetown University - Department of Economics ( email )

Washington, DC 20057
United States
202-687-6105 (Phone)
202-687-6102 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

IZA Institute of Labor Economics

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

Lucas Navarro

Universidad Alberto Hurtado ( email )

Casilla 14446
Correo 21
Chile

Susan B. Vroman

Georgetown University ( email )

Washington, DC 20057
United States
202-687-6024 (Phone)
202-687-6102 (Fax)

IZA Institute of Labor Economics

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

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