Informal Labor and the Efficiency Cost of Social Programs: Evidence from Unemployment Insurance in Brazil
- American Economic Journal: Economic Policy (Forthcoming)
It is widely believed that the presence of a large informal sector
increases the efficiency cost of social programs in developing countries. We evaluate such claims for the case of Unemployment Insurance (UI) by combining an optimal UI framework with comprehensive data from Brazil. Using quasi-experimental variation in
potential UI duration, we find clear evidence for the usual moral
hazard problem that UI reduces incentives to return to a formal job.
Yet, the associated efficiency cost is lower than in the U.S., and is
lower in labor markets with higher informality within Brazil. This
is because formal reemployment rates are lower to begin with where
informality is higher, so that a larger share of workers would draw
UI benefits absent any moral hazard. In sum, efficiency concerns
may actually become more relevant as an economy formalizes.
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