Unemployment insurance in the presence of an informal sector Academic Article


  • World Bank Economic Review


  • 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.

publication date

  • 2015-1-1


  • 29


  • Comparative Statics
  • Developing Countries
  • Exercise
  • Income Effect
  • Informal Sector
  • Labor Supply
  • Macroeconomics
  • Marginal Cost
  • Moral Hazard
  • Partial Equilibrium
  • Short-run
  • Stationary Equilibria
  • Unemployed Workers
  • Unemployment
  • Unemployment Insurance
  • cost
  • developing country
  • developing world
  • economy
  • effect
  • hazard
  • income
  • income effect
  • informal sector
  • insurance
  • insured person
  • labor supply
  • macroeconomics
  • marginal costs
  • moral hazard
  • ruling
  • unemployment
  • unemployment insurance
  • worker

International Standard Serial Number (ISSN)

  • 0258-6770

start page

  • S126

end page

  • S134