Unemployment insurance in the presence of an informal sector

David Bardey, Fernando Jaramillo, Ximena Peña

Research output: Contribution to journalArticle

Abstract

© The Author 2015.We study the effect of UI benefits in a typical developing country where the informal sector is sizeable and persistent. In a partial equilibrium environment, ruling out the macroeconomic consequences of UI benefits, we characterize the stationary equilibrium of an economy where policyholders may be employed in the formal sector, short-run unemployed receiving UI benefits or long-run unemployed without UI benefits. We perform comparative static exercises to understand how UI benefits affect unemployed workers' effort to secure a formal job and their labor supply in the informal sector. Our model reveals that an increase in UI benefits generates two opposing effects for the short-run unemployed. First, since search efforts cannot be monitored it generates moral hazard behaviors that lower effort. Second, it generates an income effect as it reduces the marginal cost of searching for a formal job and increases effort. Even though in general it is ambiguous which effect dominates, we show that for short durations UI benefits increase unemployed worker's effort to secure a formal-sector job and decreases informal-sector work.
Original languageEnglish (US)
Pages (from-to)S126-S134
JournalWorld Bank Economic Review
DOIs
StatePublished - Jan 1 2015

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unemployment insurance
informal sector
unemployment
insured person
income effect
worker
marginal costs
labor supply
macroeconomics
developing country
economy
developing world
hazard
income
insurance
effect
Informal sector
Unemployment insurance
cost

Cite this

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Unemployment insurance in the presence of an informal sector. / Bardey, David; Jaramillo, Fernando; Peña, Ximena.

In: World Bank Economic Review, 01.01.2015, p. S126-S134.

Research output: Contribution to journalArticle

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