Unemployment Insurance in the Presence of an Informal Sector

David Bardey, Fernando Jaramillo et Ximena Peña


We study the effect of UI bene?ts 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 behaviours 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.


Unemployment insurance; informal sector; income effects; developing countries;

Codes JEL

  • H55: Social Security and Public Pensions
  • I38: Government Policy • Provision and Effects of Welfare Programs
  • J65: Unemployment Insurance • Severance Pay • Plant Closings


David Bardey et Fernando Jaramillo, « Unemployment insurance and informality in developing countries », TSE Working Paper, n° 11-257, septembre 2011, révision novembre 2011.


David Bardey, Fernando Jaramillo et Ximena Peña, « Unemployment Insurance in the Presence of an Informal Sector », The World Bank Economic Review, vol. 29, 2015, p. 126–134.

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Publié dans

The World Bank Economic Review, vol. 29, 2015, p. 126–134